Lecture 1 - Introduction to Macroeconomics

UCLA - Econ 102 - Fall 2018

François Geerolf

Contents
GDP: The Product Approach 1
Personal Consumption Expenditures - Consumption (C) . . . . . . . . . . . . . . . . . . . . . . . . 1
Gross private domestic investment - Investment (I) . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Government Purchases (G) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Net Exports (NX) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

GDP: The Income Approach 5

Cobb Douglas Production function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Income Side in the Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

GDP: The Product Approach

We first Let us start with what is perhaps the most important accounting identity in macroeconomics:

Y = C + I + G + X ≠ M.

Note that very often we denote net exports N X as N X = X ≠ M so that GDP is simply:

Y = C + I + G + N X.

In some textbooks, imports are also denoted by IM instead of M .

We look at each component of GDP in turn:
- Consumption (C)
- Investment (I)
- Government Purchases (G)
- Net Exports (NX)

Personal Consumption Expenditures - Consumption (C)

Figure 1 plots GDP from the BEA, as well as PCE, in millions of dollars. US GDP being in the vicinity
of USD 20 trillion dollars (or USD 20,000 billions, or USD 20,000,000 millions), this looks about right. On
this figure, data for GDP is taken from the Bureau of Economic Analysis’s National Income and Product
Accounts (NIPA) here and data for Personal Consumption Expenditures is taken from there.
To get a better of sense of how big consumption is as a fraction to GDP (although you may eyeball it on
this picture), we might plot consumption as a function of GDP, which is what I do below. You can see that
Personal Consumption Expenditures are approximately 60 to 70 % of GDP. You can also see that it’s
been rising since the end of the sixties. We will discuss that.
Personal Consumption Expenditures are divided up into:
- Durable Goods (more than 3 years of durability): e.g. cars.
- Non-durable Goods (less than 3 years of durability).
- Services.

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UCLA - Econ 102 - Fall 2018 Introduction to Macroeconomics

2.0e+07
Gross domestic product (line 1) − Quarterly
Personal consumption expenditures (line 2) − Quarterly
1.5e+07

1.0e+07

5.0e+06

0.0e+00
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 1: US GDP from NIPA (BEA)

69
68
Consumption (% of GDP)

67
66
65
64
63
62
61
60
59

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 2: Consumption as a share of GDP from NIPA (BEA)

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UCLA - Econ 102 - Fall 2018 Introduction to Macroeconomics

45
Goods, Services (% of GDP) Goods
Services
40

35

30

25

20
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 3: Goods and Services Consumption as a share of GDP from NIPA (BEA)

21

20
Investment (% of GDP)

19

18

17

16

15

14

13

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 4: Investment as a share of GDP from NIPA (BEA)

Services have become more important than Goods in total consumption since the 1970s.

Gross private domestic investment - Investment (I)

Investment has two components: - non residential investment is the purchase of new capital goods by firms:
structures, new plants.
- residential investment is the purchase of new houses.
Gross private domestic investment is approximately 15 to 20 % of GDP, as you can see on Figure 4. It is
also very volatile over the cycle.

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UCLA - Econ 102 - Fall 2018 Introduction to Macroeconomics

Government Purchases (% of GDP)

25
24
23
22
21
20
19
18
17
16
15
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 5: Government Purchases as a share of GDP from NIPA (BEA)

5
4
Net Exports (% of GDP)

3
2
1
0
−1
−2
−3
−4
−5
−6
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 6: Net Exports as a share of GDP from NIPA (BEA)

Government Purchases (G)

Government purchases are composed of purchases of goods by the government plus the compensation of
government employees. Overall, they comprise about approximately 20% of GDP, as can be seen on Figure 5.
Note however that they do not include transfers from the government of interest payments on government
debt.

Net Exports (NX)

Net exports of goods and services are approximately -2 to -6 % of GDP, at least in the modern period
(and in the United States), as you can see on Figure 6.

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UCLA - Econ 102 - Fall 2018 Introduction to Macroeconomics

GDP: The Income Approach

Cobb Douglas Production function

In order to organize our thinking, let’s write out a Cobb-Douglas production function, defined as:
Yt = At Kt– L1≠–
t ,
where – is a number between 0 and 1. Let us think of a firm who chooses the amount of labor it uses Lt as
well as the amount of capital it uses Kt in order to maximize its profits:
max At Kt– L1≠–
t ≠ rKt ≠ wLt .
Kt ,Lt

From Econ 101, it should be clear that a way to solve this problem is simply to set the derivatives of the
profit function equal to 0 with respect to Kt and Lt which gives:
–At Kt–≠1 L1≠–
t ≠r =0
when differentiating with respect to Kt and
(1 ≠ –)At Kt– L≠–
t ≠w =0
when differentiating with respect to Lt .
The total wage bill wLt is then given by:
wLt = (1 ≠ –)At Kt– L≠–
t ú Lt = (1 ≠ –)Yt .

The total income going to capital rKt is given by:

rKt = –At Kt–≠1 L1≠–
t ú Kt = –Yt .

Thus, the share of capital in value added is:

rKt
=–,
Yt

while the share of labor in value added is

wLt
= 1 ≠ –.
Yt

The Income Side in the Data

So in practice, how much goes to the compensation of employees, and how much goes to the returns to
capital? The answer is that it goes approximately for 1/3 to capital and for 2/3 to labor. The calculations for
these are less straightforward than for computing the share of consumption, investment, as we did above. The
reason is that in practice, the division between labor and capital is not as clear cut in the national accounts
as one might hope: for example, someone who owns her/his own business reports most of her/his income in
the form of capital income, even when a large part of it is actually labor income, so that compensation of
employees is (vastly) understated. Figure 7 shows which results are obtained using this understated measure.
It needs to be adjusted upwards by about 10% of GDP, for the reasons mentioned above.
For our purposes, we only need to remember that the share of compensation of employees is approximately
2/3 of value added. Therefore, we will very often work with a Cobb-Douglas production function such that:
1/3 2/3
Yt = At Kt Lt .
Lecture 2 will walk you through the Solow growth model, where we shall make heavy use of that Cobb-Douglas
production function.

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UCLA - Econ 102 - Fall 2018 Introduction to Macroeconomics

59
Compens. of Employees (% of GDI)

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1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Figure 7: Compensation of Employees as a share of GDP from NIPA (BEA)