INTRODUCTION TO

MACROECONOMICS
LEARNING OBJECTIVES
• In this chapter, you will learn about:
• Measuring the Size of the Economy: Gross Domestic Product
• Adjusting Nominal Values to Real Values
• Tracking Real GDP over Time
• Comparing GDP among Countries
• How Well GDP Measures the Well-Being of Society
 We will study macroeconomics from
three different perspectives:
• 1. What are the macroeconomic goals? (Macroeconomics as a
discipline does not have goals, but we do have goals for the
macro economy.)
• 2. What are the frameworks economists can use to analyze the
macroeconomy?
• 3. Finally, what are the policy tools governments can use to
manage the macroeconomy?
Primary Goals
• Economic growth ultimately determines the prevailing standard
of living in a country. Economic growth is measured by the
percentage change in real(inflation-adjusted)gross domestic
product. A growth rate of more than 3% is considered good.
• Unemployment, as measured by the unemployment rate, is the
percentage of people in the labor force who do not have a job.
When people lack jobs, the economy is wasting a precious
resource-labor, and the result is lower goods and services
produced. Unemployment, however, is more than a statistic—it
represents people’s livelihoods.While measured unemployment is
unlikely to ever be zero, a measured unemployment rate of 5% or
less is considered low (good).
Goals…
• Inflation is a sustained increase in the overall level of prices, and
is measured by the consumer price index. If many people face a
situation where the prices that they pay for food, shelter, and
healthcare are rising much faster than the wages they receive for
their labor, there will be widespread unhappiness as their
standard of living declines. For that reason, low inflation—an
inflation rate of 1–2%—is a major goal.
Policy Tools
• National governments have two tools for influencing the
macroeconomy:
The first is monetary policy, which involves managing the money
supply and interest rates.
The second is fiscal policy, which involves changes in government
spending/purchases and taxes.
Measuring the Size of the Economy:
Gross Domestic Product
• By the end of this section, you will be able to:

•Identify the components of GDP on the demand side and on the

supply side

• Evaluate how gross domestic product (GDP) is measured

• Contrast and calculate GDP, net exports, and net national product
gross domestic product (GDP)
• the value of all final goods and services produced within a
country in a given year. The measurement of GDP involves
counting up the production of millions of different goods and
services—smartphones, cars, music downloads, computers,
steel, bananas, college educations, and all other new goods and
services produced in the current year—and summing them into a
total dollar value.
• This task is straightforward: take the quantity of everything
produced, multiply it by the price at which each product sold, and
add up the total.
GDP Measured by Components of
Demand
• This demand can be divided into four main parts:
• Consumer spending(consumption), business spending
(investment), government spending on goods and services, and
spending on net exports.
• Based on these four components of demand, GDP can be
measured as:
GDP = Consumption + Investment + Government + Trade balance
GDP = C + I + G + (X – M)
What is meant by the word
“investment”?
• What do economists mean by investment, or business spending?
In calculating GDP, investment does not refer to the purchase of
stocks and bonds or the trading of financial assets. It refers to the
purchase of new capital goods, that is, new commercial real
estate (such as buildings, factories, and stores) and equipment,
residential housing construction, and inventories.
• Inventories that are produced this year are included in this year’s
GDP—even if they have not yet sold. From the accountant’s
perspective, it is as if the firm invested in its own inventories.
GDP Measured by What is Produced
• Five categories: durable goods, nondurable goods, services,
structures, and the change in inventories.
The Problem of Double Counting
• Statisticians who calculate GDP must avoid the mistake of double
counting, in which output is counted more than once as it travels
through the stages of production.
• Intermediate goods, which are goods that go into the production
of other goods, are excluded from GDP calculations.
Other Ways to Measure the Economy
• Gross national product(GNP)

• Net national product (NNP) is calculated by taking GNP and then

subtracting the value of how much physical capital is worn out, or
reduced in value because of aging, over the course of a year. The
process by which capital ages and loses value is called
depreciation.

• The NNP can be further subdivided into national income, which

includes all income to businesses and individuals, and personal
income, which includes only income to people.
Adjusting Nominal Values to Real Values
• By the end of this section, you will be able to:

• Contrast nominal GDP and real GDP

• Explain GDP deflator
• Calculate real GDP based on nominal GDP values
• The nominal value of any economic statistic means the statistic is
measured in terms of actual prices that exist at the time.

• The real value refers to the same statistic after it has been
adjusted for inflation.

• Value = Price × Quantity or Nominal GDP = GDP Deflator × Real

GDP
• Real GDP = Nominal GDP Price Index
• Real GDP = Nominal GDP Price Index / 100
• Real GDP = Price × Quantity

• % change in real GDP = % change in price + % change in quantity

OR

• % change in quantity = % change in real GDP – % change in price

Tracking Real GDP over Time
By the end of this section, you will be able to:

• Explain recessions, depressions, peaks, and troughs

• Evaluate the importance of tracking real GDP over time
• Analyze the impact of economic fluctuations on a country’s
output and price level
• The generally upward long-term path of GDP has been regularly
interrupted by short-term declines. A significant decline in real
GDP is called a recession. An especially lengthy and deep
recession is called a depression.

• Real GDP is important because it is highly correlated with other

measures of economic activity, like employment and
unemployment. When real GDP rises, so does employment.
Business Cycle
• The movement of the economy from peak to trough and trough
to peak

• The highest point of the economy, before the recession begins, is

called the peak; conversely, the lowest point of a recession,
before a recovery begins, is called the trough. Thus, a recession
lasts from peak to trough, and an economic upswing runs from
trough to peak.
Comparing GDP among Countries
By the end of this section, you will be able to:

• Explain how GDP can be used to compare the economic welfare

of different nations
• Calculate the conversion of GDP to a common currency by using
exchange rates
• Calculate GDP per capita using population data
Converting Currencies with Exchange
Rates
• To compare the GDP of countries with different currencies, it is
necessary to convert to a “common denominator” using an
exchange rate, which is the value of one currency in terms of
another currency. Exchange rates are expressed either as the
units of country A’s currency that need to be traded for a single
unit of country B’s currency.
Converting GDP to a Common Currency:
Example
• Using the exchange rate to convert GDP from one currency to
another is straight forward. Say that the task is to compare
Brazil’s GDP in 2013 of 4.8 trillion reals with the U.S. GDP of $16.6
trillion for the same year.
• Step 1. Determine the exchange rate for the specified year. In
2013, the exchange rate was 2.230 reals = $1. (These numbers
are realistic, but rounded off to simplify the calculations.)
• Step 2. Convert Brazil’s GDP into U.S. dollars:

Brazil's GDP in $ U.S. = Brazil's GDP in reals Exchange rate (reals/$

U.S.)
= 4.8 trillion reals /2.230 reals per $ U.S.
= $2.2 trillion
GDP Per Capita
• The U.S. economy has the largest GDP in the world, by a
considerable amount. The United States is also a populous
country; in fact, it is the third largest country by population in the
world, although well behind China and India. So is the U.S.
economy larger than other countries just because the United
States has more people than most other countries, or because
the U.S. economy is actually larger on a per-person basis?

• GDP per capita = GDP/population

How Well GDP Measures the Well-Being
of Society
By the end of this section, you will be able to:

• Discuss how productivity influences the standard of living

• Explain the limitations of GDP as a measure of the standard of
living
• Analyze the relationship between GDP data and fluctuations in
the standard of living
• The level of GDP per capita clearly captures some of what we
mean by the phrase “standard of living.” Most of the migration in
the world, for example, involves people who are moving from
countries with relatively low GDP per capita to countries with
relatively high GDP per capita.
• “Standardofliving”isabroadertermthanGDP.WhileGDPfocusesonpr
oductionthatisboughtandsoldinmarkets, standard of living
includes all elements that affect people’s well-being, whether
they are bought and sold in the market or not.
 Limitations of GDP as a Measure of the
Standard of Living
• While GDP includes spending on recreation and travel, it does not
cover leisure time. Clearly, however, there is a substantial difference
between an economy that is large because people work long hours,
and an economy that is just as large because people are more
productive with their time so they do not have to work as many
hours.
• GDP includes production that is exchanged in the market, but it
does not cover production that is not exchanged in the market.
• While GDP includes what is spent on environmental protection,
healthcare, and education, it does not include actual levels of
environmental cleanliness, health, and learning. GDP includes the
cost of buying pollution-control equipment, but it does not address
whether the air and water are actually cleaner or dirtier. GDP
includes spending on medical care, but does not address whether
life expectancy or infant mortality have risen or fallen. Similarly, it
counts spending on education, but does not address directly how
much of the population can read, write, or do basic mathematics.
 Does a Rise in GDP Overstate or Understate
the Rise in the Standard of Living?
• The fact that GDP per capita does not fully capture the broader
idea of standard of living has led to a concern that the increases in
GDP over time are illusory. It is theoretically possible that while
GDP is rising, the standard of living could be falling if human health,
environmental cleanliness, and other factors that are not included
in GDP are worsening. Fortunately, this fear appears to be
overstated.
• On the other side, rates of crime, levels of traffic congestion, and
for example, inequality of incomes are higher in the United States
now than they were in the 1960s. Moreover, a substantial
number of services that used to be provided, primarily by
women, in the non-market economy are now part of the market
economy that is counted by GDP. By ignoring these factors, GDP
would tend to overstate the true rise in the standard of living.