MACROECONOMICS I
Anna Donina
Lecture 1
February 18, 2022
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MACROECONOMICS I
Lecturer: Anna Donina, Junior Researcher at CERGE-EI,
Prague (anna.donina@cerge-ei.cz)
Text-book: Mankiw, Principles of
Economics/Macroeconomics (latest edition available)
Lectures/Seminars: Friday 09:00 – 10:50 / 11:00 – 12:50
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GRADING
• Midterm exam (40%)
• Project presentation (20%)
• Final exam (40%)
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ECONOMICS
Microeconomics
Study of how households and firms
 Make decisions
 Interact in markets
Macroeconomics
Study of economy-wide phenomena
 Including inflation, unemployment, and economic growth
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PRINCIPLES OF ECONOMICS
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© 2018 CENGAGE LEARNING®. MAY NOT BE SCANNED, COPIED OR DUPLICATED, OR POSTED TO A PUBLICLY
ACCESSIBLE WEBSITE, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A
CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE OR SCHOOL-APPROVED
PRINCIPLES OF ECONOMICS
Principles of decision making
• People face tradeoffs
• The cost of any action is measured in terms of
foregone opportunities
• People respond to incentives
• Rational people think at the margin
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PRINCIPLES OF ECONOMICS
Principles of interactions among people
• Trade can make everyone better off
• Markets are usually a good way to organize
economic activity
• Government can potentially improve market
outcomes if there is a market failure or if the
market outcome is inequitable
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PRINCIPLES OF ECONOMICS
Principles of the economy as a whole
• Productivity is the ultimate source of living
standards
• Money growth is the ultimate source of inflation
• Society faces a short-run tradeoff between
inflation and unemployment
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QUESTION
• How would you measure/assess my economic health?
• What information do you need to understand whether
I am in good or bad economic situation?
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LOOK FOR THE ANSWERS TO QUESTIONS
• What is Gross Domestic Product (GDP)?
• How is GDP related to a nation’s total income
and spending?
• What are the components of GDP?
• How is GDP corrected for inflation?
• Does GDP measure society’s well-being?
INCOME AND EXPENDITURE
Gross Domestic Product (GDP)
 Measures total income of everyone in the economy
 Also measures total expenditure on the economy’s output of
goods and services
Income equals expenditure
 For the economy as a whole
 Because every dollar a buyer spends is a dollar of income
for the seller
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THE CIRCULAR-FLOW DIAGRAM
The Circular-Flow Diagram
 Simple depiction of the macroeconomy
 Illustrates GDP as spending, revenue, factor payments, and
income
Preliminaries
 Factors of production are inputs like labor, land, capital, and
natural resources.
 Factor payments are payments to the factors of production
(e.g., wages, rent).
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THE CIRCULAR-FLOW DIAGRAM
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Households:
▪ own the factors of production,
sell/rent them to firms for income
▪ buy and consume goods & services
HouseholdsFirms
Firms:
▪ buy/hire factors of production,
use them to produce goods
and services
▪ sell goods & services
THE CIRCULAR-FLOW DIAGRAM
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Markets for
Factors of
Production
HouseholdsFirms
Income (=GDP)Wages, rent,
profit (=GDP)
Factors of
production
Labor, land,
capital
Spending (=GDP)
G & S
bought
G & S
sold
Revenue (=GDP)
Markets for
Goods &
Services
THIS DIAGRAM OMITS
The government
 Collects taxes, buys goods and services
The financial system
 Matches savers’ supply of funds with borrowers’ demand
for loans
The foreign sector
 Trades goods and services, financial assets, and
currencies with the country’s residents
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GROSS DOMESTIC PRODUCT (GDP) the
market value of all final goods &
services produced within a country in a given
period of time.
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GROSS DOMESTIC PRODUCT (GDP) IS…
…the market value of all final goods & services produced
within a country in a given period of time.
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Goods are valued at their market prices, so:
 All goods measured in the same units ($ in the U.S.; CZK in CR)
 Things that don’t have a market value are excluded, e.g.,
housework you do for yourself.
GROSS DOMESTIC PRODUCT (GDP) IS…
…the market value of all final goods & services produced
within a country in a given period of time.
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 GDP includes all items produced in the economy and
sold legally in markets
 GDP excludes most items produced and sold illicitly.
It also excludes most items that are produced and
consumed at home.
GROSS DOMESTIC PRODUCT (GDP) IS…
…the market value of all final goods & services produced
within a country in a given period of time.
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 Final goods: intended for the end user
 Intermediate goods: used as components
or ingredients in the production of other goods
 GDP only includes final goods—they already
embody the value of the intermediate goods
used in their production.
GROSS DOMESTIC PRODUCT (GDP) IS…
…the market value of all final goods & services produced
within a country in a given period of time.
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 GDP includes tangible goods (like cars, mountain
bikes, beer)
 and intangible services (cleaning, concerts, cell phone
service).
 GDP includes currently produced goods, not goods
produced in the past.
GROSS DOMESTIC PRODUCT (GDP) IS…
…the market value of all final goods & services produced
within a country in a given period of time.
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 GDP measures the value of production that occurs
within a country’s borders, whether done by its own
citizens or by foreigners located there.
 Usually a year or a quarter (3 months)
GDP COMPONENTS
Recall: GDP is total spending.
Four components:
 Consumption (C)
 Investment (I)
 Government Purchases (G)
 Net Exports (NX)
These components add up to GDP (denoted Y):
Y = C + I + G + NX
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CONSUMPTION (C)
Consumption, C
Total spending by households on goods and services
Note on housing costs:
 For renters, C includes rent payments.
 For homeowners, C includes the imputed rental
value of the house, but not the purchase price or
mortgage payments
 Not included in C: purchases of new housing
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INVESTMENT (I)
Investment, I
Total spending on goods that will be used in the future
to produce more goods
 Business capital: business structures, equipment,
and intellectual property products
 Residential capital: landlord’s apartment building;
a homeowner’s personal residence
 Inventory accumulations: goods produced but not
yet sold
“Investment” does not mean the purchase of financial
assets like stocks and bonds. 27
GOVERNMENT PURCHASES (G)
Government purchases (G)
All spending on the goods and services purchased by
the government
 At the federal, state, and local levels.
Excludes transfer payments
 Such as Social Security or unemployment
insurance benefits.
 They are not purchases of goods and services
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NET EXPORTS (NX)
Net exports, NX = exports – imports
 Exports: foreign spending on the economy’s goods
and services
 Imports: are the portions of C, I, and G
that are spent on goods and services produced
abroad
Adding up all the components of GDP gives:
Y = C + I + G + NX
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U.S. GDP AND ITS COMPONENTS, 2021
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Billions % of GDP Per capita
Y $22,993 100.0 $69,278
C 15,750 68.5 47,454
I 4,107 17.9 12,374
G 4,051 17.6 12,205
NX -915 -4.0 -2,757
https://fred.stlouisfed.org/series/PCECA: Table 1.1.5
https://research.stlouisfed.org/fred2/series/POPTHM?cid=104
EXERCISE 1 GDP AND ITS COMPONENTS
In each of the following cases, determine how much GDP
and each of its components is affected (if at all).
A. Marek spends czk 3000 to buy his girlfriend dinner at
the finest restaurant in Brno.
B. Roman spends czk 20000 on a new laptop to use in her
publishing business. The laptop was built in China.
C. Paulina spends czk 15000 on a computer to use in her
editing business. She got last year’s model on sale for a
great price from a local manufacturer.
D. Škoda builds czk 50 billion worth of cars, but consumers
only buy czk 47 billion worth of them.
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EXERCISE 1 SOLUTIONS
A. Marek spends czk 3000 to buy his girlfriend dinner
at the finest restaurant in Brno.
Consumption and GDP rise by czk 3000.
B. Roman spends czk 20000 on a new laptop to use in
her publishing business. The laptop was built in
China.
Investment rises by czk 20000, net exports fall by czk
20000, GDP is unchanged.
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EXERCISE 1 SOLUTIONS
C. Paulina spends czk 15000 on a computer to use in
her editing business. She got last year’s model on
sale for a great price from a local manufacturer.
Current GDP and investment do not change,
because the computer was built last year.
D. Škoda builds czk 50 billion worth of cars, but
consumers only buy czk 47 billion of them.
Consumption rises by czk 47 billion, inventory investment
rises by czk 3 billion, and GDP rises by czk 50 billion.
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REAL VS NOMINAL GDP
Total spending rises from one year to the next
 Economy — producing a larger output of goods
and services
 And/or goods and services are being sold at
higher prices
Nominal GDP
 Production of goods and services
 Valued at current prices
REAL VS NOMINAL GDP
Nominal GDP
 Values output using current prices
 Not corrected for inflation
Real GDP
 Values output using the prices of a base year
 Is corrected for inflation
For the base year
Nominal GDP = Real GDP
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EXAMPLE
Compute nominal GDP in each year:
2014: $10 x 400 + $2 x 1000 = $6,000
2015: $11 x 500 + $2.50 x 1100 = $8,250
2016: $12 x 600 + $3 x 1200 = $10,800
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Pizza Latte
year P Q P Q
2014 $10 400 $2.00 1000
2015 $11 500 $2.50 1100
2016 $12 600 $3.00 1200
37.5%
Increase:
30.9%
EXAMPLE
Compute real GDP in each year, using 2014 as the base
year:
2014: $10 x 400 + $2 x 1000 = $6,000
2015: $10 x 500 + $2 x 1100 = $7,200
2016: $10 x 600 + $2 x 1200 = $8,400
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Pizza Latte
year P Q P Q
2014 $10 400 $2.00 1000
2015 $11 500 $2.50 1100
2016 $12 600 $3.00 1200
20.0%
Increase:
16.7%
$10 $2.00
EXAMPLE
In each year,
• nominal GDP is measured using the (then) current prices.
• real GDP is measured using constant prices from the
base year (2014 in this example).
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year
Nominal
GDP
Real
GDP
2014 $6000 $6000
2015 $8250 $7200
2016 $10,800 $8400
EXAMPLE
The change in nominal GDP reflects both prices and
quantities.
The change in real GDP is the amount that GDP would
change if prices were constant (i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
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year
Nominal
GDP
Real
GDP
2014 $6000 $6000
2015 $8250 $7200
2016 $10,800 $8400
20.0%
16.7%
37.5%
30.9%
NOMINAL AND REAL GDP IN THE U.S., 1980–2020
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Real GDP
(base year
2012)
Nominal
GDP
THE GDP DEFLATOR
GDP deflator
 A measure of the overall level of prices.
= 100 ×
𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
𝑟𝑒𝑎𝑙 𝐺𝐷𝑃
 Measures the current level of prices relative to the
level of prices in the base year
Economy’s inflation rate
 Compute the percentage increase in the GDP
deflator from one year to the next
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EXAMPLE
Compute the GDP deflator in each year:
2014: 100 x (6000/6000) = 100
2015: 100 x (8250/7200) = 114.6
2016: 100 x (10,800/8400) = 128.6
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year
Nominal
GDP
Real
GDP
GDP
Deflator
2014 $6000 $6000
2015 $8250 $7200
2016 $10,800 $8400
100.0
114.6
128.6
14.6%
12.2%
ACTIVE LEARNING 2
Use the above data to solve these problems:
A. Compute nominal GDP in 2014.
B. Compute real GDP in 2015.
C. Compute the GDP deflator in 2016.
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2014 (base year) 2015 2016
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
ACTIVE LEARNING 2
A. Compute nominal GDP in 2014.
$30 x 900 + $100 x 192 = $46,200
B. Compute real GDP in 2015.
$30 x 1000 + $100 x 200 = $50,000
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2014 (base year) 2015 2016
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
ACTIVE LEARNING 2
C. Compute the GDP deflator in 2016.
Nom GDP = $36 x 1050 + $100 x 205 = $58,300
Real GDP = $30 x 1050 + $100 x 205 = $52,000
GDP deflator = 100 x (Nom GDP)/(Real GDP)
= 100 x ($58,300)/($52,000) = 112.1
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2014 (base year) 2015 2016
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205
GDP AND ECONOMIC WELL-BEING
Real GDP per capita
 Main indicator of the average person’s standard of
living
But GDP is not a perfect measure of well-being.
Why?
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GDP DOES NOT VALUE:
 The quality of the environment/culture/education
 Health of children
 Leisure time
 Non-market activity, such as the childcare
a parent provides at home
 An equitable distribution of income
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THEN WHY DO WE CARE ABOUT GDP?
Having a large GDP enables a country to afford
 Better schools, a cleaner environment, health care, etc.
Many indicators of the quality of life are positively
correlated with GDP. For example…
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GDP AND LIFE EXPECTANCY IN 12 COUNTRIES
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GDP AND AVERAGE SCHOOLING IN 12 COUNTRIES
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GDP AND OVERALL LIFE SATISFACTION (0 TO 10 SCALE) IN 12 COUNTRIES
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SUMMARY
• GDP measures a country’s total income and expenditure.
• The four spending components of GDP include:
Consumption, Investment, Government Purchases, and Net
Exports.
• Nominal GDP is measured using current prices. Real GDP
is measured using the prices of a constant base year and
is corrected for inflation.
• GDP is the main indicator of a country’s economic wellbeing,
even though it is not perfect.
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