ECO102: Principles of Macroeconomics
Winter 2023
Lecture 1
Nathanael Vellekoop, PhD
Department of Economics
University of Toronto
Lecture 1 – Sizing Up the Economy (Chapter 9)
A. What is Macroeconomics?
B. GDP, Measurement and Limitations
Next week: Real and Nominal GDP
Self-study: Millions, Billions and Trillions
Required Readings
- “GDP is the wrong tool for measuring what matters”
- “Why GDP statistics are failing us”
9.1-9.3
9.4
9.5
A. Introduction
• Last lecture:
• This lecture:
• Answer:
What is macroeconomics about?
Study of the economy in the aggregate: income,
prices, unemployment and interest rates
• Larger context:How is it different from microeconomics?
• Core concepts: Gross Domestic Product (GDP)
• Key tool:
Three approaches to measuring GDP
• Recap:
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A. Micro versus Macro
• Microeconomics
─ Study of the behavior of individual economic units
o Households
o Firms
o Financial institutions
─ Outcomes affected by market structures and government policies
• Macroeconomics
─ Study of aggregate economic outcomes
o Level and growth of national output (GDP)
o Interest rates and inflation
o unemployment
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A. Micro versus Macro (2)
• Macroeconomics: The economy is a collection of many
households and firms interacting in many markets
• Why is Macro not just the sum of all firms, households and
markets?
• Answer 1: the whole (=aggregate behavior) is more than the
sum of individual parts
=> example: traffic jam
• Answer 2: income is given in micro (=exogenous, outside the
model), but explained in macro (=endogenous, in the model)
=> example: micro household gets a budget 5
A. Motivation for Macroeconomics
• Two key empirical observations:
1. Between countries: wide differences in levels of economic
development.
2. Within countries: sizable fluctuations in economic activity
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A. Fluctuations
Have a closer look at the United Kingdom (1875-2020)
1. National income (percentage growth)
2. Unemployment rate (percent)
3. Inflation (percent)
Source: https://core-econ.org/theeconomy/book/text/13.html#131-growth-and-fluctuations
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A. Fluctuations in GDP: England 1875-2022
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A. Fluctuations in GDP: United States 1948-2022
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A. Fluctuations in GDP: United States 1948-2022
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A. Growth versus Fluctuations
The main concern of government economic policy is to:
1. Smooth fluctuations in the short run
2. Promote growth in the long run
Why?
• Prevent the negative effects of high unemployment and high
inflation
How?
=> Fiscal and monetary policy
• Fiscal: government spending and taxation
• Monetary: money supply and interest rates
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A. Also Macro: Inequality
• Political and social implications of widening inequality
• Economic implications?
• Bad for growth
• Bad of other economic outcomes
• Should Inequality become a major objective of macro policy?
“Creating an inclusive recovery was fundamental to the
central bank's role in helping to manage the economy.”
Tiff Macklem, November 2021
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A. Why Macroeconomics?
• The aggregate is more than the sum of the parts
• Why do CEOs look at the macroeconomy?
=> it is the economic environment in which consumers,
workers and investors make decisions.
• Large role for policy: growth, poverty, “good jobs”, green, etc.
• Next step: how do we measure “national income”?
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Lecture 1 – Sizing Up the Economy (Chapter 9)
A. What is Macroeconomics?
B. GDP, Measurement and Limitations
B. Gross Domestic Product (9.1)
• Gross Domestic Product (GDP) is the market value of all final
goods and services produced within a country in a year.
-
Market value: market price times quantity
Final goods and services: not intermediate goods
Produced: resales not included (=change of ownership)
Within a country: including made by foreign-owned firms
In a year: need a timeframe
=> GDP is a key measure of economic activity
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B. Three Equivalent Approaches to GDP (9.2)
1. Production approach (Value added)
• Sum of value-added by all firms
• Value added = revenue minus costs of intermediate goods
2. Expenditure approach
• Add up the amount of spending by purchasers of domestically
produced final goods and services
3. Income approach
• Add up income earned by factors of production or inputs (e.g.
wages, interest payments, dividends to shareholders, rents)
• Returns to factors of production – labor, capital, land
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B. GDP: Value Added Approach
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B. GDP: Expenditure Approach
GDP is the sum of the following:
1. Consumption (C)
2. Investment (I)
3. Government purchases (G)
4. Net exports (NX) – Exports minus Imports
Y = C + I + G + NX
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B. GDP: Expenditure Approach (2)
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B. GDP: Expenditure Approach (3)
Consumption (GDP = C + I + G + NX):
Household expenditures on all goods and services, excluding
newly constructed housing.
1. Durable consumption
2. Nondurable consumption
3. Services
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B. GDP: Expenditure Approach (4)
Consumption (GDP = C + I + G + NX):
Firm expenditure on goods used for production of goods and
services in the future; expenditures on capital goods;
residential housing.
1. Inventory Investment: at market value
2. Business Fixed Investment: capital stock (manufacturing
equipment)
3. Residential Investment: building of new houses
Note: excludes buying of stocks, bonds; includes depreciation
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of assets
B. GDP: Expenditure Approach (5)
Consumption (GDP = C + I + G + NX):
Government expenditure on goods and services.
Includes:
1. Consumption
2. Investment
Excludes:
• Transfer payments
• Interest payments
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B. GDP: Expenditure Approach (6)
Consumption (GDP = C + I + G + NX):
Foreign Expenditure on domestic-produced goods and
services minus Domestic Expenditure on foreign-produced
goods and services.
• Net Exports (NX) = Exports - Imports
• Exports (X): produced domestically; consumed elsewhere.
• Imports (M): produced elsewhere; consumed domestically.
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B. GDP: Income Approach
Total income generated from the production of goods and services
domestically
• Factor incomes (to factors of production)
Net Domestic Income =
i. Wages and salaries (labor) +
ii. Interest (on capital loans and bank deposits) +
iii. Business profits (dividends and retained earnings)
• Non-factor payments
─ Income earned by government as a result of production of goods
and services = Net Indirect taxes (HST less subsidies)
─ Depreciation (part of gross profit)
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B. GDP: Income Approach (2)
Y = Factor Payments + Non-factor Payments
= wages + business
profits + interest
= net indirect taxes +
depreciation
• Depreciation: the loss in value of physical assets due to use
• Indirect Taxes (or subsidies): included in market prices and
goes to government
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B. GDP: Income Approach (3)
• Labor share describes the
share of total income
going to workers.
• Capital share describes the
share of total income
going to owners of capital.
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B. Measuring GDP – Example
• Bennett Lumber Company is a family-owned company in
British Columbia that chops trees into lumber.
• Some of this lumber is used by a furniture company in
Ontario, McCreary Modern, to make couches. They pay $400
for the lumber.
• The couches are sold to Canadian Tire for $1,100, which
markets them to customers for $1,500.
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B. Measuring GDP – Example (2)
Spending Approach
• Bennett Lumber sells wood for $400
• McCreary Modern sells couch for $1,100
• Canadian Tire sells couch for $1,500
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B. Measuring GDP – Example (3)
Value Added Approach
• Bennett Lumber sells wood for $400
• McCreary Modern sells couch for $1,100
• Canadian Tire sells couch for $1,500
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B. Measuring GDP – Example (3)
Income Approach
• Bennett Lumber sells wood for $400
• Bennet paid $300 in wages
• McCreary Modern sells couch for $1,100
• McCreary paid $500 in wages
• Canadian Tire sells couch for $1,500
• Canadian Tire paid $200 in wages
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B. Problems with GDP (9.3)
1.
2.
3.
4.
5.
6.
Prices are not values.
Nonmarket activities are excluded.
The shadow economy is missing.
Environmental degradation is not counted.
Leisure does not count.
GDP ignores income distribution.
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Lecture 1: Recap
• Gross Domestic Product is used to measure national income
and production of a country in a year
• Can compare over time (growth) and between countries
• Three approaches: production, spending and income
• Not a perfect measure of economic value…
… but does correlate with many outcomes we care about.
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• This week: tutorials and assignment 1
• Next lecture: chapters 11 and 12 – Unemployment and
inflation
• Question How do we measure unemployment and inflation?