Macroeconomics

COURSE 2024-2025.
DEGREE IN
Lesson 1. Key economic INTERNATIONAL

variables BUSINESS
Outline
1.1. Aggregate Output
1.2. The Unemployment Rate
1.3. The Inflation Rate
1.4. The Short Run, the Medium Run and the Long Run

Reference: Chapter 2 in Macroeconomics, a European Perspective. 4th Edition

(Blanchard et al., 2021)

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1.1. Aggregate output
• The measure of aggregate output is called gross domestic
product (GDP).
• How would you define aggregate output in the economy?
Three definitions and ways to construct GDP:

1. GDP is the value of final goods and services produced

in the economy during a given period.
– We want to count only final goods, not intermediate goods.

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1.1. Aggregate output
2. GDP is the sum of value added in the economy during a
given period.
– The value added by a firm is the value of its production minus
the value of the intermediate goods used in production.
– The two definitions imply that the value of final goods and
services can be thought of as the sum of the value added by all
the firms in the economy.
So far, we have looked at GDP from the production side. The
other way of looking at GDP is from the income side.

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1.1. Aggregate output
3. GDP is the sum of incomes in the economy during a
given period.
– Aggregate production and aggregate income are always equal.
– GDP is the measure of aggregate output, which we can look at from the
production side or the income side.

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1.1. Aggregate output
• Consider an economy with two firms, Firm 1 and Firm 2.

• Compute aggregate output using the three definitions.

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1.1. Aggregate output
• Nominal GDP is the sum of the quantities of final goods
produced times their current price.
• Nominal GDP increases over time for two reasons:
– The production of most goods increases.
– The price of most goods increases.
• Our goal is to measure production and its change over time 
we need to eliminate the effect of increasing prices on our
measure of GDP.
• Real GDP is the sum of the quantities of final goods times
constant (not current) prices.

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1.1. Aggregate output
• Example:
Real GDP
Year Quantity of Cars Price of Cars Nominal GDP (in 2015 dollars)
2014 10 $20,000 $200,000 $240,000
2015 12 $24,000 $288,000 $288,000
2016 13 $26,000 $338,000 $312,000

• Real GDP in 2014 (in 2015 dollars) = 10 cars x $24,000 per car = $240,000.
• Real GDP in 2015 (in 2015 dollars) = 12 cars x $24,000 per car = $288,000.
• Real GDP in 2016 (in 2015 dollars) = 13 cars x $24,000 per car = $312,000.

• The year used to construct prices is called the base year.

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1.1. Aggregate output
• Nominal GDP is also called GDP in current dollars.
• Real GDP is also called GDP in constant dollars, GDP
adjusted for inflation, or GDP in 2015 dollars.
• GDP will refer to real GDP.
• Yt will denote real GDP in year t.
• Nominal GDP and variables in current dollars will be denoted
by a dollar sign in front of them, e.g., $Yt.

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1.1. Aggregate output
Figure 1.1. Nominal and Real GDP (million euros). Spain, 1955–2011
1.200.000
1.200.000

1.000.000 1.000.000

800.000 800.000

600.000 600.000

400.000 400.000

200.000 200.000

0 0
1955
1959
1963
1967
1971
1975
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011

1955
1959
1963
1967
1971
1975
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
PIB nominal PIB real € de 2000 PIB nominal PIB real € de 2005

Source: INE, Ivie

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1.1. Aggregate output

•Do you know how big your country is from the economic
point of view? Look at GDP
•What is its standard of living? Look at GDP per capita
INEbase / Economy /Economics accounts /Annual Spanish National
Accounts: main aggregates / Results

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1.1. Aggregate output
Figure 1.2. Real GDP growth (%). Spain, 1995-2022 To assess the performance of an
economy, economists focus on the
8
rate of growth of real GDP.
6 5,8
4
2
GDP growth in year t is:
0 (Yt − Yt-1)/Yt-1.
-2
-4 -3,8 • Expansionary periods are periods of
-6 positive GDP growth.
-8
-10 • Contractionary periods or recessions
-11,2
-12 are periods of negative economic
-14 growth (two or more quarters with
negative growth rates).
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Source: INE

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1.2. Unemployment rate
• Employment is the number of people who have a job.
• Unemployment is the number of people who do not have a
job but are looking for one.
• The labour force is the sum of employment and
unemployment.

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1.2. Unemployment rate
• The unemployment rate is the ratio of the number of people
who are unemployed to the number of people in the labour
force.

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1.2. Unemployment rate
• A person is unemployed if he or she does not have a job and has
been looking for a job in the last four weeks.
• Those who do not have a job and are not looking for one are
counted as not in the labor force.
• Most rich countries rely on large surveys of households to
compute the unemployment rate.
• In Europe, this survey is called the Labour Force Survey (LFS).
• In Spain, the INE (Instituto Nacional de Estadística) elaborates
the Economically Active Population Survey (in Spanish, EPA). It
relies on interviews of 65,000 households per quarter.

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1.2. Unemployment rate
• Discouraged workers are those who give up looking for a
job and so are no longer counted as unemployed.
• The participation rate is the ratio of the labour force to the
total population of working age.
• Because of discouraged workers, a higher unemployment rate
is typically associated with a lower participation rate.

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1.2. Unemployment rate
Figure 1.3. Unemployment rate in the EU15 and United States since 1981

The difference in the average

level of the unemployment rate
suggests a different functioning
of the labour market between
the two continents.

Source: OECD.Stat
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1.2. Unemployment rate

• Why Do Economists Care about Unemployment?

1. Direct effect on the welfare of the unemployed, especially
those remaining unemployed for long periods of time.
2. A signal that the economy is not using its human resources
efficiently.

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1.3. Inflation rate
• The inflation rate is the rate at which the price level
increases.
• Inflation is a sustained rise in the general level of prices - the
price level.
• Deflation is a sustained decline in the price level (negative
inflation rate).
• The practical issue is how to define the price level so the
inflation rate can be measured. Two price indexes:
• GDP deflator
• CPI

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1.3. Inflation rate
• The GDP deflator in year t (Pt) is the ratio of nominal GDP to real
GDP in year t:

• It is called an index number (100 in the base year), which has no

economic interpretation.
• The rate of change has a clear interpretation: the rate of inflation.
πt = (Pt − Pt-1)/Pt-1

Nominal GDP is equal to the GDP deflator times real GDP: $Yt = PtYt

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1.3. Inflation rate
• The set of goods produced in the economy is not the same as the set of
goods purchased by consumers because:
– Some of the goods in GDP are sold not to consumers but to firms, to the
government, or to foreigners.
– Some of the goods bought by consumers are not produced domestically but are
imported from abroad.
• The Consumer Price Index (CPI) is a measure of the cost of living.
• The CPI is published monthly by the INE, which collects price data for 479
items in 177 cities.
• The CPI gives the cost in euros of a specific list of goods and services over
time.
• Consumer Price Index (CPI).INE-Spain - YouTube

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1.3. Inflation rate
• Why Do Economists Care about Inflation?
– Inflation affects income distribution when not all prices and wages rise
proportionally.
– Inflation leads to distortions due to uncertainty, some prices that are
fixed by law or by regulation.
• Most economists believe the “best” rate of inflation to be a low
and stable rate of inflation between 1 and 4%.
• The ECB has defined price stability as a year-on-year increase in the
Harmonised Index of Consumer Prices (HICP) for the euro area of below
2%.

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1.4. The Short Run, the Medium Run, and
the Long Run
• What determines the level of aggregate output?
• In the short run (e.g., a few years), year-to-year movements in
output are primarily driven by movements in demand.
• In the medium run (e.g., a decade), the economy tends to return
to the level of output determined by supply factors, such as the
capital stock, the level of technology, and the size of the labor force.
• In the long run (e.g., a few decades or more), the economy
depends on its ability to innovate and introduce new technologies,
and how much people save, the quality of the country’s education
system, the quality of the government, and so on.

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