WEEK 1
Terminology
 Macroeconomics is the study of the economy as a whole. It deals with broad
aggregates. Its goal is to explain the economic changes that affect many households,
firms, and markets at once.
 Macroeconomic Problems
o High inflation rate
o High unemployment rate
o High interest rates
o Low economic growth or stagnation
o High public debt
Global Financial Crisis
 From 2000 to 2007, the world economy had a sustained expansion. In 2007, U.S.
housing prices started declining, leading to the subprime mortgage crisis and to a
major financial crisis. The financial crisis turned into a major economic crisis with
falling stock prices. In the third quarter of 2008, U.S. output growth turned negative
and remained so in 2009. Through the trade and financial channels, the U.S. crisis
quickly became a world crisis.
o Subprime mortgage = a type of home loan extended to individuals with poor,
incomplete, or non-existent credit histories.
 Graphically, World impact
 Figure 1.1 Output Growth Rates for the World Economy, for Advanced Economies,
and for Emerging and Developing
Economies, 2000 2018
 Notice poorer countries saw a
smaller impact than more advanced
economies
 Countries that were developed
and traded with USA saw big impact
– markets were more intertwined
 Poor nations, less trade = less
impact
 SA – lots of trade with western
world therefore ended up with big
impact from the recession.
 Due to emerging economy as
well, SA suffered even more as more
volatile economy
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THE EURO AREA
The European Union (EU) is currently a group of 27 European countries with a
common market.
 The United Kingdom withdrew from the European Union on January 31, 2020.
 In 1999, the EU formed a common currency area called the Euro area, which
replaced national currencies in 2002 with the euro.
 The Euro area faces two main issues today:
o How to reduce unemployment?
o How to function efficiently as a common currency area?
 While the United States recovered from the 2008 2009 crisis, output growth in the
Euro area was negative between in both 2012 and 2013.
 In 2018, output growth was below the pre-crisis average and the unemployment rate
was 8.3%.
 While the average unemployment
rate for the Euro area was 8.3% in
2018, countries like Spain had an
unemployment rate of 15%.
 Much of the high unemployment
rate was the result of the crisis.
 Even when Spain had its lowest unemployment rate of 8%, it was nearly three times
that of the Germany today.
 Some economists believe labour market rigidities with too much protection for
workers are the main problem.
 Supporters of the euro argue:
o economic advantages due to no more changes in exchange rates to worry
about its contribution to the creation of a large economic power
 Those against it argue:
o The drawback of a common monetary policy across euro countries
o The loss of the exchange rate as an adjustment instrument within the euro
area
THE USA
 The United States is big: with an output of $20.5 trillion in 2018, it accounted for
24% of world output.
 The U.S. standard of living is high
o Output per capita is $62,500, close to the highest in the world.
 Economists also look at:
o Output growth
o Unemployment rate
o Inflation rate

The U.S. economy in
2018 was in good shape,
leaving the effects of the
2008 2009 crisis behind
with one of the longest
economic expansions on
record.

The federal funds rate the interest rate the
Fed controls went from 2.5% in July 2007 to
nearly 0% in December 2008.
Why did the Federal Funds rate stop at zero?
o This constraint is known as the zero
lower bound
o If it were negative, then everyone
would hold cash rather than bonds.
Why are low interest rates a potential issue?
o Low interest rates limit the Fed’s ability to respond to further negative
shocks.
o Low interest rates may lead to excessive risk taking by investors to increase
their returns.
Productivity growth is important for a
sustained increase in income per
person, but since 2010, it has been only
about half as it was in the 1990s.
The slowdown in productivity growth is
worrisome because the standard of
living especially for the poor may not
increase.
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CHINA
 Its population is more than four times that of the United States
o But its output at $13.5 trillion is only about 60% of the United States.
 Output per person is roughly 15% of that of the United States.
 China has been growing very rapidly for more than three decades.
 China’s rapid output growth has been driven by high accumulation of capital and
technological progress.
 The slowdown after the
crisis is considered to be
desirable as more of output
would go to consumption
instead of investment.
SA

SA hit harder due to
more exposed to
trade and relations
with developed
countries

SA = High unemployment rate, expanded rate
= even higher
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Inflation, Similar patter, but some exceptions
CPI is a measurement of basket g+s prices and the change in these prices
CPI included price of imported goods
The GDP deflator is a measure of the money price of all new, domestically
produced, final goods and services in an economy in a year relative to the real
value of them.

Govt debt as a % of GDP
o Govt debt as a % of GDP on the rise in SA, means a big issue for SA
o Lots of loaning and expansionary monetary and fiscal policy
o High Debt ratio means can default
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Reop rate: Repo rate used to help
maintain a low and stable rate of
inflation
Recent: continuous rise
KEY MACROECONOMIC INDICATORS/VARIABLES
 Price Index = A measure of the price level.
 Consumer Price Index (CPI) = A widely cited index number for the price level; the
weighted average of prices of a specific set of goods and services purchased by a
typical household.
 Inflation refers to a situation in which the economy’s overall price level is rising
 The inflation rate is the percentage change in the price level from the previous
period.
o CPI (consumer price index) & GDP deflator are the proxies for inflation.
 The consumer price index (CPI) = a measure of the overall cost of the goods and
services bought by a typical consumer.
o It is used to monitor changes in the cost of living over time.
o When the CPI rises, spend more rands to maintain the same standard of
living.
 The CPI is calculated as follows:
o (1) define a market basket,
o (2) determine how much it
would cost to purchase the
market basket in the current
year and in the base year
o (3) divide the Rand cost of
purchasing the market basket
in the current year by the
Rand cost of purchasing the
market basket in the base
year, and
o (4) multiply the result by 100.
 The Inflation Rate The inflation rate is calculated as follows:

o Sub in GDP Deflator, same result
NB: The CPI is an accurate measure of the selected goods that make up the typical
bundle, but it is not a perfect measure of the cost of living.
o (ie. the substitution bias or the introduction of new goods may cause the CPI
to overstate the true cost of living).
GDP Deflator v CPI
 The GDP deflator reflects the prices of all goods and services produced domestically
 CPI reflects the prices of all goods and services bought by consumers (these goods
can include imported goods)
 Another price index is the producer price index , which measures the cost of a basket
of goods and services bought by firms rather than consumers.
GDP/GNP
 Gross domestic product (GDP) measures the output produced by factors of
production located in the domestic economy
 Gross national product (GNP) measures the output produced by domestic citizens
(domestically or abroad)
 GNP = GDP + net income from abroad – net income earned by non-SA’ns in SA
NOMINAL/REAL GDP
 Nominal GDP is the sum of the quantities of final goods produced times their current
price.
o Aka GDP in current prices
 Nominal GDP increases for two reasons:
o The production of most goods increases over time
o The price of most goods increases over time Our goal is to measure
production and its change over time.
 Real GDP is the sum of quantities of final goods times constant (not current) prices
o Aka GDP in terms of goods, GDP @ constant prices
 Formula for relationship between the 2:
Nominal GDP ( ) is equal to the GDP deflator ( ) times real GDP ( )

Economic Growth is measured by increases in Real GDP
WHATS NOT INCLUDED IN GDP
 Certain non-market goods and services performed at home by family members.
 Sales of used goods
 Financial transactions such as trading of stocks and bonds
 Government transfer payments such as social security
 Value of Leisure time, clean environment
 Underground activities
GDP AND ECONOMIC WELL BEING
 GDP is the best single measure of the economic well-being of a society.
 GDP per person tells us the income and expenditure of the average person in the
economy.
 Higher GDP per person usually indicates a higher standard of living (BUT what about
income distribution?).
 GDP is not a perfect measure of the happiness or quality of life, however.
WAYS TO COMPUTE GDP
1) Production approach
 Production approach = Output intermediate consumption* + taxes on products
subsidies on products
o *Goods that are inputs for the production of final goods.
 major drawback of this method is the difficulty to differentiate between
intermediate and final goods.
2) Income/Value-added approach
 Income Approach = add the sum of all incomes earned (wages, interest, rents, and
profits) in producing goods and services
 Value added Approach = add the value added at each stage of production of all
goods and services
3) Expenditure method
 Household Sector - Consumption (C)
 Business Sector - Investment (I)
 Government Sector - Government Purchases (G)
 Foreign Sector - Net Exports C (X – M)
GDP =
UNEMPLOYMENT RATE
 Employment is the number of people who have a job.
 Unemployment is the number of people who do not have a job but are looking for
one.
 The labour force is the sum of employment and unemployment.
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The unemployment rate is the ratio of the number of people
who are unemployed to the number of people in the labour
force.
Discouraged workers are those persons who give up looking for a job and so no
longer count as unemployed.
The participation rate is the ratio of the labour force to the total population of
working age.
Because of discouraged workers, a higher unemployment rate is typically associated
with a lower participation rate.
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Why Do Economists Care about Unemployment?
o 1. Because of its direct effect on the welfare of the unemployed, especially
those remaining unemployed for long periods of time.
o 2. It is a signal that the economy is not using its human resources efficiently.
OKUNS LAW
 Okun’s law: The relation between output growth and the change in unemployment:
High output growth  decrease in unemployment rate
 In the Figure below, the line that best fits the points is downward sloping.
 Output growth that is higher than usual is associated with a reduction in the
unemployment rate.
 Output growth that is lower than usual is associated with an increase in the
unemployment rate.
THE PHILLIPS CURVE: UNEMPLOYMENT AND THE INFLATION RATE
 The line is downward sloping,
meaning that higher unemployment
leads, on average, to a decrease in
inflation, and vice versa.
 When unemployment has been
above 5%, inflation has typically been
above 2%.
THE SHORT RUN, THE MEDIUM RUN, AND THE LONG RUN
 In the short run (e.g., a few years), year to year movements in output are primarily
driven by movements in demand.
 In the medium run (e.g., a decade), the economy tends to return to the level of
output determined by supply factors, such as the capital stock, the level of
technology, and the size of the labour force.
 In the long run (e.g., a few decades or more), the economy depends on its ability to
innovate and introduce new technologies, and how much people save, the quality of
the country’s education system, the quality of the government, and so on.
GOODS MARKET
 When economists think about year-to-year movements in economic activity, they focus
on the interactions among demand, production, and income
o Changes in the demand for goods lead to changes in production
o Changes in production lead to changes in income
o Changes in income lead to changes in the demand for goods
 Consumption (C): goods and services purchased by consumers
 Investment (I) or fixed investment: the sum of nonresidential investment and residential
investment
 Government spending (G): purchases of goods and services by the government;
excluding government transfers
 Exports (X): purchases of South African goods and services by foreigners
 Imports (M): purchases of foreign goods and services by South African consumers, firms
and the government
 Net exports or trade balance: X – M
 Exports > Imports  Trade surplus
 Imports > Exports  Trade deficit
THE DEMAND FOR GOODS
 Z ≡ C + I + G + (X – M)
o The above identity defines the total demand for goods ( Z or AD ) as
consumption, plus investment, plus government spending, plus exports, minus
imports.
o In a closed economy (X = M = 0)
 Therefore, in a closed economy:
Z≡C+I+G
 We assume:
o Fixed prices
o Closed economy
o No monetary sector
o I, G, T and
are exogenously determined
 Remember that in the SR, demand determines the output level
 (Exogenous = outside the model, the variables are not Dependant on other variables)
CONSUMPTION FUNCTION
 Consumption (C) is a function of disposable income ( )

= is the income that remains once consumers have received government transfers
and paid their taxes.

= consumption function
o This is a behavioural equation that captures the behaviour of consumers.
 Assume that the consumption function is a linear relation with two parameters, and
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is the marginal propensity to consume (MPC =
)
are what people would consume if their disposable income equalled zero (also
called ‘autonomous’ consumption).
Changes in
reflect optimistic or pessimistic attitude about the future (or simply
consumers’ confidence)
SAVINGS AND MPS
 Saving = Disposable Income less Consumption:
S=
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Marginal propensity to save (MPS) is the ratio of the change in saving to the change in
disposable income:
MPS =
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Disposable income is:
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where Y is income and T is taxes:
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Replacing
in the consumption function GIVES:
THE DEMAND FOR GOODS
 Endogenous variables: variables depend on other variables in the model
 Exogenous variables: variables not explained within the model but are instead taken as
given.
 Investment is given as:
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A bar on investment means investment is taken as given
Autonomous consumption is exogenous
T and G describe fiscal policy: the choice of taxes and spending by the government.
T and G are exogenous because: Governments do not behave with the same regularity
as consumer or firms.
THE DETERMINATION OF EQUILIBRIUM OUTPUT
 Replacing C and I from equations (3.3) and (3.4):
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Equilibrium in the goods markets requires:
o This is an equilibrium condition:
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Replacing Z above by its components gives 𝑌�
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In equilibrium, production (Y) is equal to demand, which in turn depends on income
(Y), which is itself equal to production, output.
Macroeconomists always use three tools:
o 1. Algebra to make sure that the logic is correct
o 2. Graphs to build the intuition
o 3. Words to explain the results
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Rewrite equation above:
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Reorganize the equation:
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Divide both sides by (1 – c1)
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which characterizes equilibrium output in algebra.
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Autonomous spending:
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Recall that c1 = MPC
Autonomous spending is positive because if T = G (balanced budget) and c1 is
between 0 and 1, then
is positive, and so is autonomous spending.
The term
is the multiplier, which is larger when c 1 is closer to 1.
EXAMPLE:
o If c1 equals 0.6, the multiplier equals 1/(1 0.6) = 2.5, meaning that an increase
of consumption by $1 billion will increase output by 2.5 x $1 billion = $2.5
billion.
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MULTIPLIER
 The number that is multiplied by the change in autonomous spending to obtain the
overall change in total spending.
 The multiplier (m) is equal to 1 / (1 - MPC).
 If the economy is operating below Natural Real GDP, then the multiplier = the number
that is multiplied by the change in autonomous spending to obtain change in Real GDP
 Change in total spending = Multiplier x Change in autonomous spending or
o m=Change in Y/change in autonomous spending
o = ∆Y/∆
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Other multipliers:
o Expenditure multiplier =1/1 - MPC
o Lump sum tax multiplier = - MPC/1 - MPC
o Proportional tax multiplier = 1 / [1 – MPC*(1 - t)]
THE DETERMINATION OF EQUILIBRIUM OUTPUT
 TP curve = 45-degree line.
o It is called a 45-degree line because it bisects the 90-degree angle at the origin.
 At any point on the TP curve, total production is equal to Real GDP (TP= Real GDP).
 This is because TP and Real GDP are different names for the same thing.
TE =
EFFECT OF MULTIPLIER ON GRAPH
 Suppose c0 increases by $1 billion.
 An increase in autonomous spending has
a more than one for one effect on
equilibrium output.
o AB: first round increase in production
o BC: first round increase in income
o CD: second round increase in demand
o DE: second round increase in production
and income
 The total increase in production after
n+1 rounds:
1 + 𝑐1 + � 𝑐12 + � 𝑐13 + ⋯ + � 𝑐1𝑛 �
o which is a geometric series with
a limit of 1 / (1 – c1

Using the TE TP framework, the economy
is currently in equilibrium at point A,
producing QE.
 Natural Real GDP, however, is greater
than QE, so the economy is in a
recessionary gap as well as being in
equilibrium.
NB: If fears of future recession, can cause
disposable income to drop despite no other
factor influencing it!
IN SUMMARY (OF DETERMINING EQUILIBRIUM)
 Production depends on demand, which depends on income, which is itself equal to
production.
o An increase in demand leads to an increase in production and income, which
in turn leads to a future increase in demand.
o The increase in output is larger than the initial shift in demand, by a factor
equal to the multiplier.
o The multiplier depends on the MPC
 The adjustment of output over time is called the dynamics of adjustment.
 How long the adjustment takes depends on how and when firms revise their
production schedule.
IS MODEL
Total Savings= Private Saving + Public Saving
Private Saving (S)
S=Yd - C
S=Y - T - C
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Public Savings (T G)
If T > G: Budget surplus
If T < G: Budget Deficit
Production=Demand Y=C+I+G
Subtract (T) from both sides & move (C) to the left:
Y-T–C=I+G+T
S=I+G+T
I = S + (T - G)
Investment = Private Saving + Public Saving
This is called the IS Relation
In equilibrium:
o IS RELATION I=S + (T - G)
What firms want to invest must be equal to what people and the government want
to save.