Introductory Macroeconomics: Lecture Notes (Weeks 1-12)
Week 1: Lecture 1
• GDP
o Market value of the goods and services produced in a certain region over a period of time (measure of market activity).
§ Helps to identify: a) changes in the pace of economic activity, b) international comparison, c) composition of production, expenditure and income, d) changes in employment, hours worked and
productivity
o Summarises transactions over a quarter so that state of economy can be easily observed
o Market value (what goods are valued at)
§ Value output at market value (ie. phone at market value)
§ Allows us to aggregate across a range of goods and services
§ Avoids some forms of production: household production (cleaning, childcaring) since no market value and activities of underground economy (illegal, not captured)
§ Government production has no market price (defence, education, health) so it is valued at cost of production (rather than market) o Final goods and services
§ GDP only considers final goods and services to avoid double counting of intermediate goods (ie. count wheat, flour and bread)
§ By this logic also don’t count goods produced in the past that are resold today (would’ve been recognised at production)
§ Financial assets are not a good/service
§ Goods produced by Australians overseas not in GDP Week 1: Lecture 2
• Measurement methods for GDP
o Production: Look at market value of the output produced (adding up contributions of firms, value of output sold) value added
o Expenditure: Looking at transactions of final goods and services, attributirng them to different components (classify them in different ways- consumption, capital, labour income)
o Income approach: Look at what firms are earnings and how they distribute between workers in economy and owners of firms.
§ Should equal but might differ by small amounts since these are all measured by surveys
§ Also, timing of production and expenditure might differ (resolve this issue by treating unsold inventory as an investment and goes into expenditure
• Circular Flow of Income o Factor market
§ Households supply labour and capital to firms in exchange for money
§ Labour and capital (machinery) transactions o Goods market
§ Firms produce output which is supplied to households in exchange for money
§ The revenue firms earn through the goods market is distributed through the factor market to owners or capital holders.
o GDP measurement (Income)
§ Labour income is earned by households in the form of wages and capital income is earned through profit
§ There is the labour share of income and capital share of income (total output is divided between worked and owners of capital stock)
§ Comparing the above 2 shares is meant to be an indication of inequality
o GDP measurement (Expenditure)
§ Different final transactions in the economy and distribute them to different participants in economy
§ Household sector- consumption C
§ Business sector- investment I
§ Government sector- government spending G
§ Overseas sector- exports minus exports since looking at goods produced in Australia (X-M) (minus imports since would be in C) o GDP measurement (Production)
§ Sum up the amount of valued added by all producers in economy
§ Attribute value add to different sectors o Real GDP
§ Make comparisons over time since the value of money changes over time
Week 2: Lecture 1
• Inflation
o Informs us about economy performance and had implications on monetary/fiscal policy
o Macroeconomic models try to explain output, inflation and interest rates jointly
• Measuring inflation
o Price indices are a good measure for inflation
§ Consumer Price Index
• Measures the cost of purchasing a particular bundle of goods and services relative to a base year
• Requires data on prices over time, household expenditure to select a reasonable bundle of goods/services
• Calculation of CPI
o Expenditure in base year (P0,1,2…)= price of given good
* quantity consumed of given good
o Consider how much expenditure required to consume base year consumption bundle in P (t): sum of pit, qi0 (ie. same quantity but consider new prices).
o CPI (period t) = P (t) / P (0)
§ Value of CPI in period 0=1
§ Inflation calculation
• Rate of change of aggregate prices over time
• (Current CPI- last quarter or year CPI)/last quarter or year CPI
• Annual rate is less volatile than quarterly since might be noise in quarterly. However, quarterly is better in the sense that it is more up to date.
• Other method is weighted average (Textbook) o Use of inflation
§ Indexing some welfare payments (payments should increase at the same rate as inflation)
§ Deflating- comparing monetary values across time (ue CPI to see how many baskets of goods and services you can buy with money,
compare nominal values of money by deflating using price level) o Bias in measurement
§ Changes in composition of goods change over time- moving from expensive to cheaper goods with price movements (they update the bundle of goods and services over time to reflect consumption trends and fix this problem)
• Similar problem with GDP
§ Difficult in measuring product quality (ie. computer 2000 vs now even though price might not have changed, implying no inflation)- leads us to overstate inflation since we should be paying more for a computer today than 2000
o Costs of (high) inflation (look at textbook)
§ Noise in price systems
• Price system is how market allocates resources for consumers and producers. High levels of inflation makes it harder for people to identify price signals due to rise in prices as a result of inflation.
§ Redistribution of wealth
• When inflation is higher than expected, hurts people who have lent money but helps who borrow. Ie. repaying 10 000 in the future, real value is less, so they receive less and you retain more as borrower.
§ Planning difficulties
• If value of money is changing rapidly and inflation is volatile, it becomes harder to think of investments and plan money.
§ Shoe leather costs
• Raises the cost of holding money, since erodes purchasing power of any given amount of cash, so want to hold in bank account but need to frequently visit to withdraw cash (inconvenient)
• Interest rates
o Nominal interest rate is your return on an asset (ie. invest $1, 1 + i return) o Since price level is consistently changing , it is more relevant to consider
purchasing power o Real interest rate
§ Captures your return on investment not in monetary terms, but the G
& S you can buy
§ Quantity you can buy= $/price level at given point in time
§ The above equation informs whether you should save or consume
§ Real interest rate= (quantity goods and services consume by saving)/(q. of G & S if consume immediately) also = (1+i)/(1+pi)
• Good approximation for real interest rate = i-pi (as long as I and pi are small)
o Expected real interest rate
§ Re=i-pie
§ Decisions are made based on expected real interest rates
§ Expected real interest rate determines economic decisions Week 2: Lecture 2
• Look to understand consumption, saving and investment since related to Y (output)
• Consumption and Saving
o After-tax income can be saved (fund future consumption) or consumed (connected)
o Wealth is defined as an individual’s assets (financial and real) less liabilities o More inclined to consume if high wealth
o Wealth is stock, whereas saving is a flow since it is the change in wealth over time (ie. saving per unit of time)
o Housing prices increase, consumption decreases and this reduces output so wealth has impact on economic decisions
o Since output is a flow concept so are all of its components
• Incentives for saving
o Lifecycle saving- borrow money when income is low and save money when income is high (income graph is upside down parabola but consumption is constant)
§ As a result, debt when young, middle age have savings and when retiring, spending assets over lifetime
o Precautionary saving- unexpected events in future (insurance) o Bequest saving- savings for the next generation
• Determinants of savings
o Real interest rates since this is opportunity cost of consumption (higher interest rate, more incentive to save)
o Demographics- age structure is important (ie. ageing population would have less savings since more old people retiring)
o Beliefs about future events
• Other sectors
o Firms save through retained profits for projects in future
o Government saving is taxation revenue less expenditure (budget surplus)
• National Saving in Closed Economy
o Closed economy (no trade with rest of world- Exports-Imports=0) o Y= C + I + G (consider C and G consumption expenditure, gvoernemnt
expenditure we assume is all expenditure)
o National saving = national Income (Y) – Private and public consumption expenditure (C+G)
o This means that in closed economy S=I (since Y=C + I + G) o Another to conceptualise this is:
§ S=(Y-C-T) private saving + (T-G) public saving
§ T is taxes less transfer and interest payments by government to private sector (net tax, how much gov. has after payments)
§ T-G is budget surplus and private saving is by households and firms
• Investment and Capital Stock
o Investment is defined as expenditure on durable goods that add to capital stock whereas savings is just the decision to not consume
o Capital stock: stock of durable goods (not intermediate) that exist at a point in time that can be used as part of the production process
§ K (in future)= (1- depreciation rate) * capital stock now + It (addition of new capital stock)
§ Capital is a stock concept (measured just in $) whereas investment is a flow concept (measure per unit of time)
o Determinants of investment
§ Firms make decisions to maximise profit
§ When you rent capital goods, you pay rental fee ( r ) + depreciation cost (delta)
§ Benefit is that capital stock increases output (F(k)) and assume output is sold at price p
o Profit
§ Profit= p * F(k) – (r+ delta) k, note: r + delta is rental price
§ Let derivative = 0 to find profit maximising amount
§ P * F’(k) is marginal revenue of additional capital stock (since F’(k) simply reflects how much additional output is produced by additional unit of capital stock)
§ (r+depreciation) is marginal cost of additional capital stock
§ Marginal product= F’(k)
§ Look at lecture slide for graphical representation
• P*F’(k) is downwards sloping, even though F’(k)>0, F’’(k)<0 since diminishing marginal product
• If real interest rate increases, horizontal line increases, firm would want to decrease capital stock it uses
o Market for Loanable funds (saving v investment)
§ As real interest rate increases, people want to save more
§ Investment as a result decreases
§ Supply and demand where I=S at r*
• Increase in savings due to more uncertainty about future, savings shifts right
