Basic Macroeconomic Concepts

Summary

Covers core macro measures and definitions: GDP (final goods / value added / income), nominal vs. real GDP, labor-market stats, and inflation (GDP deflator, CPI).

Builds on 14.02 - Course Introduction.

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Gross Domestic Product

We need to start with definitions. The main measure of aggregate output is the Gross Domestic Product (GDP) of a country. This is much harder to answer compared to the value of a company, say Apple. What does a $25 Trillion GDP even mean? How do we aggregate everything?

Another challenge is that some goods are used to produce other goods. How do we sum them up? We call these intermediate goods, goods that are used in the production of another good. Products which are not used to make anything else are called final goods.

Example

Steel is an intermediate good when used to build cars.

	Firm 1: Steel Co.	Firm 2: Car Co.
Revenue from Sales	$100	$200
Expenses
- Wages	$80	$70
- Steel Purchases	—	$100
Profit	$20	$30

In this example, the steel company sells 100 of steel to the car company (an intermediate good). The car company uses it to produce cars worth 200 (a final good). If we simply added revenues (200 = 300), we would *double count* the steel. The correct measure of aggregate output is the value of *final goods only*: 200. Alternatively, we can sum the value added by each firm: 100 (steel) + 100 (cars minus steel) = $200.

Definition - GDP

1. GDP is the value of the final goods (and services) produced in the economy during a given period.
2. GDP is the sum of value added in the economy during a given period.
3. GDP is the sum of incomes in the economy during a given period (wages + profits).

The idea of value added is quite intuitive when you think about it as selling materials for more than you bought them thanks to your process (i.e. building a car). If we merge two firms, the GDP doesn’t change thanks to these careful calculations.

At the aggregate level, output ≡ income, meaning every dollar of value produced becomes someone’s income (either wages or profits). This is an accounting identity, not causal. At the firm level, this doesn’t hold: a single firm can produce a lot but earn little profit, or vice versa.

Nominal GDP is the sum of quantities of final goods produced times their current price. This is interesting because both the production and price of most goods increases over time. This is imperfect, though, as we want to decouple the two variables. Thus, Real GDP (or just GDP as we know it) is the sum of quantities of final goods times constant prices. We denote nominal GDP by \Y_tand real GDP byY_t$. We will mostly focus on real GDP, mostly for simplicity.

Example

Suppose an economy only produces cars:

Year	Quantity	Price	Nominal GDP	Real GDP (2011 prices)
2011	10	$20,000	$200,000	$200,000
2012	12	$22,000	$264,000	$240,000
2013	14	$24,000	$336,000	$280,000

Nominal GDP grew 68% (336k), but real GDP only grew 40% (280k). The difference is inflation.

Notice that nominal GDP equals real GDP where the price line is set.

Note

You can pick any year you want as the base. Real GDP growth shouldn’t be affected by base year.

Note

For >1 good, you weight the importance of the good by price, but since relative prices change, GDP growth depends on which year is used. To reduce the impact, we use GDP chained.

The Labor Market

Employment (N) is how many people who have a job, whereas unemployment (U) is how many people do not have a job but are looking for one. The labor force (L) is the sum of the employed and unemployed:

The unemployment rate (u) is the ratio of the unemployed to the labor force:

How do countries calculate unemployment? Most use large surveys.

Example

The US uses the Current Population Survey (CPS) to interview 60,000 households a month.

A person is unemployed if he/she lacks a job and has been looking in the last 4 weeks. Those not looking for one are not in the labor force. Discouraged workers are those who give up looking, and the participation rate is the ratio of the labor force to all working age people.

Example

The participation rate in the United States surged in the 70s and 80s as women joined the labor force.

Source: FRED - St. Louis Fed

Inflation

Definition

Inflation is a rise in the general price level . The inflation rate is how fast the price level increases:

Deflation is thus a sustained decline in the price level. The GDP deflator is one measure of :

Another way to measure inflation is the Consumer Price Index (CPI), which measures cost of living. It is published monthly by the BLS and uses price data for 211 items from 38 cities. It inherently captures just a subset of the economy’s inflation.