Macroeconomics & The global Economy
Ace Institute of Management
Session 1
Instructor
Sandeep Basnyat
Sandeep_basnyat@yahoo.com
9841 892281
Objectives
• To acquaint students with basic knowledge of
macroeconomic theories
• Define, explain and analyze macroeconomic
terms, theories and indicators in general
• Apply learning in decision making processes
and solve real world issues
• Use and explain the macroeconomic and
developmental problems in a country
Evaluation Criteria
•
•
•
•
•
•
•
Class Participation
Group Presentation
Midterm exams
Term exam
Class Tests
Assignments
Group Term Paper
5%
10% (5 Groups)
15%
40% (End Term)
10% (2 Tests)
10% (1 Assignment)
10% (Submit at end)
Case study presentations
• Case study oriented classes
• Possibility of external evaluator
• Evaluation Criteria: (10 x 3 = 30 marks)
– Did the presentation reflect a team work among its
members?
– Were the students prepared for the presentation?
– Did the students look confident while deliberating?
(including eye contact & voice clarity)
Case study presentations
• Case Study Presentation Schedule
– Group1
– Group2
– Group 3
– Group 4
– Group 5
Session 3
Session 5
Session 6
Session 9
Session 10
Class tests, Assignment & Term paper
• Class Test 1:
• Class Test 2:
• Assignment:
Session 4
Session 11
Session 9
• Term Paper:
– Preliminary Selection of Topic for term paper
Session 3
– Development of Research idea on term paper
Session 5
– Submission and Approval of the Topic with plan
Session 7
– Submission of term paper
Session 12
What you studied in Microeconomics..
• Basic demand and supply functions of
individuals and markets
• Profit maximizations of individual firms in
different markets
• Consumers and Producers welfare theories
• Cost and benefits of firms in different markets.
• And so on…
• But NOW ….
Introduction to Macroeconomics
Macroeconomics, the study of the economy as a
whole, addresses many topical issues:
• Why does the cost of living keep rising?
• Why are millions of people unemployed,
even when the economy is booming?
• What causes recessions?
Can the government do anything to combat
recessions? Should it?
Introduction to Macroeconomics
Macroeconomics, the study of the economy as a
whole, addresses many topical issues:
• What is the government budget deficit?
How does it affect the economy?
• Why does Nepal have such a huge trade deficit?
• Why are so many countries poor?
What policies might help them grow out of poverty?
And our analysis look...
U.S. Real GDP per capita
(2000 dollars)
40,000
9/11/2001
First oil price
shock
30,000
long-run upward trend…
20,000
Great
Depression
Second oil
price shock
10,000
World War II
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
U.S. inflation rate
(% per year)
25
20
15
10
5
0
-5
-10
-15
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
U.S. unemployment rate
(% of labor force)
30
25
20
15
10
5
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Why learn macroeconomics?
1. The macroeconomy affects society’s well-being.
Each one-point increase in the unemployment rate
is associated with:
 920 more suicides
 650 more homicides
 4000 more people admitted to state mental institutions
 3300 more people sent to state prisons
 37,000 more deaths
 increases in domestic violence and homelessness
Why learn macroeconomics?
2. The macroeconomy affects your well-being.
In most years, wage growth falls
when unemployment is rising.
change from 12 mos earlier
4
5
3
3
1
2
1
-1
0
-3
-1
-5
-2
-3
1965
-7
1970
1975
unemployment rate
1980
1985
1990
1995
2000
2005
inflation-adjusted mean wage (right scale)
percent change from 12 mos earlier
5
Introduction to Macroeconomics
Macroeconomics:
• Deals with the economy as a whole.
Study of the economy as a whole.
Its goal is to explain the economic changes that affect
many households, firms, and markets at once.
HOW DO MACROECONOMISTS THINK?
1. Theory as a Model:
Used to describe the real world eliminating unnecessary
details
Don’t forget to
floss!
A road map
A model of human
anatomy
The model teeth
HOW DO MACROECONOMISTS THINK?
Macroeconomic models : Symbols and Equations
Two important variables in a models:
Exogenous variables; and
Endogenous variables.
• Exogenous (Independent) variables : that a model
takes as given.
• Endogenous (dependent) variables : which the model
tries to explain. (What happens to..??)
THE MODEL OF SUPPLY AND DEMAND
• Assume the following two relationships for CD market:
Qd = D(P,Y) …………………(i)
Qs = S(P,Pm) …………………(ii)
Equation (i): shows that Quantity of the CD demanded is the
function of the Price of the CD and Income level of the
consumer or the aggregate income of the economy.
Equation (ii): shows that Quantity of the CD supplied is the
function of the Price of the CD and Input price of the materials.
• The equilibrium in the CD market is given by:
Qd = Qs
THE MODEL OF SUPPLY AND DEMAND
Supply, Qs
Price
P
*
Demand, Qd
Q
*
Quantity
THE MODEL OF SUPPLY AND DEMAND
Exogenous Variables:
Aggregate Income, and
Price of the materials
(taken as given)
Endogenous Variables:
Price of the CD, and
Equilibrium quantity of CD
Price
Supply
P*
Demand
Q
*
Quantity
The model explains what happens to Endogenous variables
(Price and Equilibrium Quantity of CD sold) when one of the
Exogenous variables (Aggregate Income and Price of the
materials ) changes.
EXAMPLE: CHANGES IN EXOGENOUS VARIABLES
P
S
SHIFTS IN DEMAND
D
Q
SHIFTS IN SUPPLY
D'
P
S
D
Q
S'
PRICES: FLEXIBLE VS. STICKY
• General Assumption: Market equilibrium of supply and
demand, (market clearing process).
• Markets clearing continuously, is unrealistic.
• Need prices to adjust instantly to changes in supply and
demand. But, prices and wages often adjust slowly.
• Although market clearing models assume that wages
and prices are flexible, in actuality, some wages and
prices are sticky. But they do depict the equilibrium
toward which the economy gravitates.
• Short term analysis vs Long term analysis for Price Sticky
vs Price Flexibility
GDP, CPI AND UNEMPLOYMENT
Three statistics that economists and
policymakers use:
Gross Domestic Product (GDP) is the dollar
value of all final goods and services
produced within an economy in a given
period of time.
The consumer price index (CPI) measures
the level of prices.
The unemployment rate tells us the
fraction of workers who are unemployed.
Gross Domestic Product (GDP)
Two ways
of viewing GDP
Total income of everyone in the economy
Total expenditure on the economy’s
output of goods and services
Income $
Labor
Households
Firms
Goods/ Services
Expenditure $
For the economy as a whole, income must equal expenditure.
GDP measures the flow of dollars in the economy.
In general, to compute the total value of different goods
and services, the national income accounts use market
prices. Thus, if
$0.50
$1.00
GDP = (Price of apples  Quantity of apples)
+ (Price of oranges  Quantity of oranges)
= ($0.50  4) + ($1.00  3)
GDP = $5.00
Y = C + I + G + NX
Total demand
for domestic
output (GDP)
Consumption
spending by
households
Investment
spending by
businesses and
households
Net exports
or net foreign
demand
Government
purchases of goods
and services
This is the called the national income accounts identity.
Calculating GDP
Components of U.S. GDP, 2004: The Expenditure Approach
BILLIONS OF
DOLLARS
Personal consumption expenditures (C)
Durable goods
Nondurable goods
Services
Gross private domestic investment (l)
Nonresidential
Residential
Change in business inventories
Government consumption and gross
investment (G)
Federal
State and local
Net exports (EX – IM)
Exports (EX)
Imports (IM)
Gross domestic product (GDP)
Note: Numbers may not add exactly because of rounding.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
8,214.3
PERCENTAGE
OF GDP
70.0
987.8
2,368.3
4,858.2
1,928.1
8.4
20.2
41.4
16.4
1,198.8
673.8
55.4
2,215.9
-624.0
10.2
5.7
0.5
18.9
827.6
1,388.3
- 5.3
1,173.8
1,797.8
11,734.3
7.1
11.8
10.0
15.3
100.0
World Top 10 GDP in Millions of US Dollars in Market Price
(Source: IMF2008/2009)
12. India - 1,235,975
162. Bhutan - 1,269
109. Nepal - 12,615
181. Kiribati - 130
160. Maldives- 1,357
1) Used goods are not included in the calculation of GDP.
2) The treatment of inventories depends on if the goods
are stored or if they spoil.
• If the goods are stored, their value is included in GDP.
• If they spoil, GDP remains unchanged.
• When the goods are finally sold out of inventory, they are
considered used goods (and are not counted).
3) Some goods are not sold in the marketplace and therefore
don’t have market prices. We must use their imputed value as
an estimate of their value. For example, home ownership and
government services.
4) Intermediate goods are not counted in GDP– only the value
of final goods.
Reason: the value of intermediate goods is already included in
the market price.
Value added of a firm equals the value of the firm’s output less
the value of the intermediate goods the firm purchases.
Measuring GDP by the Value Added Method
FIRM
Cotton Farmer
Textile Mill
Shirt Company
L.L. Bean
VALUE OF PRODUCT
VALUE ADDED
Value of raw cotton = $1.00
Value added by cotton farmer
= $1.00
Value of raw cotton woven
into cotton fabric = $3.00
Value added by cotton textile
mill = ($3.00 – $1.00)
= $2.00
Value of cotton fabric made Value added by shirt manufacturer = $12.00
= ($15.00 –$3.00)
into a shirt = $15.00
Value of shirt for sale on L.L.
Bean’s Web site = $35.00
Value added by L.L. Bean =
($35.00 – $15.00)
Total Value Added
= $20.00
= $35.00
Exercise:
(Problem 2, p. 40)
– A farmer grows a bushel of wheat
and sells it to a miller for $1.00.
– The miller turns the wheat into flour
and sells it to a baker for $3.00.
– The baker uses the flour to make a loaf of
bread and sells it to an engineer for $6.00.
– The engineer eats the bread.
Compute & compare
value added at each stage of production
and GDP
Other Exclusions from Expenditures
• Expenditure on purchase of goods and services during
specified time period.
– Previous expenditure reflects the change in ownership only.
• Avoid “neither good nor a service”
– Does not reflect production such as bonds/ stocks
• Avoid expenditure by governments for which it does
not receive a good or service in return
– Eg.: Transfer payments such as Social security,,
unemployment compensation etc.
Measuring GDP from Income side
• Sum of income of all factors of production gives the
GDP from income side
• GDP = Rent + Wages + Interest + Profits
Calculating GDP
U.S. National Income, 1980 (Shapiro: Table 2-1, Pg.27; Adjusted)
BILLIONS OF
DOLLARS
Gross Domestic Products (GDP)
Compensation of employees
Proprietors’ income
Corporate profits
Net interest
Rental income
Transfer payments to households if any.
2341.3
1804.4
130.6
183.8
190.6
31.9
Calculating GDP
Compensation
of employees includes wages, salaries, and
various supplements—employer contributions to social
insurance and pension funds, for example—paid to
households by firms and by the government.
Proprietors’ income The income of non-corporate
businesses such as small farms, shops.
Rental
income The income received by property owners in
the form of rent.
Corporate profits The income of corporate businesses.
Net
interest The interest received by the businesses minus
interest they pay plus interests earned from the foreigners.
Remember: Gross Domestic Product (GDP)
• Gross domestic product (GDP) is a measure of the
income and expenditures of an economy which
includes all items produced in the economy and
sold legally in markets.
But:
– It excludes items produced and sold illicitly, such as illegal drugs.
Other Measures of income
•
•
•
•
•
Gross National Product (GNP)
Net National Product (NNP)
National Income (NI)
Personal Income (PI)
Personal Disposable Income (DI)
National Income Accounting contd..
• GDP + NFI from Abroad = GNP
GNP is the monetary value of final goods and services
produced by the nationals (income earned by the nationals
on foreign countries minus income earned by foreigners at
home)
• GNP – Depreciation (Capital Consumption) = NNP
Depreciation is the net capital consumption during the
accounting year
• NNP – Indirect Business Tax = NI (National Income)
National Income Accounting contd..
• NI – Social contributions – net interests paid by
individuals – corporate profit tax –undistributed
corporate profit + Dividends + Govt. & business
transfers to individuals + Net interest paid to individual
= PI (Personal Income)
• PI – Personal tax and non-tax payments (such as parking
tickets) = DI (Disposable Income)
Disposable income is the final income that a consumer
spends on the purchase of goods and services
• DI – Saving – Personal Interest Payment – Household
Transfer Payment = Personal Consumption Expenditure
Calculating other measures of Income
GDP, GNP, NNP and National Income, 1980 (adjusted from Income
Method)
GDP at factor cost
Plus: Receipts of factor income from the rest of the world
Less: Payments of factor income to the rest of the world
Equals: GNP at factor cost
Less: Depreciation or capital consumption
Equals: Net national product (NNP)
Less: Statistical discrepancy
Equals: National income (NI) at factor cost
DOLLARS
(BILLIONS)
2341.3
+ 415.4
- 127.9
2628.8
- 287.5
2341.3
- 219.9
2121.4
Calculating other measures of Income
National Income, Personal Income, Disposable Personal Income,
and Personal Saving, 1980 (adjusted)
National income
Less corporate taxes Plus transfer payments
Equals: Personal income
Less: Personal income taxes
Equals: Disposable personal income
Less: Personal saving
Less: Personal interest payments
Less: Transfer payments made by households
Equals: Personal Consumption Expenditure
DOLLARS
(BILLIONS)
10,275.9
39.6
2161.0
338.7
1822.2
103.6
46.5
1.1
1671.1
Real vs. nominal GDP
• GDP is the value of all final goods and services
produced.
• Nominal GDP measures these values using
current prices.
• Real GDP measure these values using the
prices of a base year.
Practice problem, part 1
2006
2007
2008
P
Q
P
Q
P
Q
good A
$30
900
$31
1,000
$36
1,050
good B
$100
192
$102
200
$100
205
• Compute nominal GDP in each year.
• Compute real GDP in each year using 2006 as the
base year.
Answers to practice problem, part 1
nominal GDP
multiply Ps & Qs from same year
2006: $46,200 = $30  900 + $100  192
2007: $51,400
2008: $58,300
real GDP
multiply each year’s Qs by 2006 Ps
2006: $46,200
2007: $50,000
2008: $52,000 = $30  1050 + $100  205
Real GDP controls for inflation
Changes in nominal GDP can be due to:
– changes in prices.
– changes in quantities of output produced.
Changes in real GDP can only be due to
changes in quantities,
because real GDP is constructed using
constant base-year prices.
U.S. Nominal and Real GDP,
1950–2006
14,000
12,000
(billions)
10,000
8,000
6,000
Real GDP
(in 2000 dollars)
4,000
Nominal GDP
2,000
0
1950
1960
1970
1980
1990
2000
GDP Deflator
• The inflation rate is the percentage increase in
the overall level of prices.
• One measure of the price level is
the GDP deflator, defined as
Nominal GDP
GDP deflator = 100 
Real GDP
Practice problem, part 2
Nom. GDP
Real GDP
2006
$46,200
$46,200
2007
51,400
50,000
2008
58,300
52,000
GDP
deflator
Inflation
rate
n.a.
• Use your previous answers to compute
the GDP deflator in each year.
• Use GDP deflator to compute the inflation rate from
2006 to 2007, and from 2007 to 2008.
Answers to practice problem, part 2
Nominal
GDP
Real GDP
GDP
deflator
Inflation
rate
2006
$46,200
$46,200
100.0
n.a.
2007
51,400
50,000
102.8
2.8%
2008
58,300
52,000
112.1
9.3%
Chain-Weighted Real GDP
• Over time, relative prices change, so the base
year should be updated periodically.
• In essence, chain-weighted real GDP
updates the base year every year,
so it is more accurate than constant-price GDP.
• But we usually use constant-price real GDP,
because:
– the two measures are highly correlated.
– constant-price real GDP is easier to compute.
Exercise 1: For your understanding
• Make a note of:
– Real and Nominal GDPs of some of the important
countries and compare
– Prepare a list of top 10 countries with their Real
GDP growth rate and PPP growth rate.
Consumer Price Index (CPI)
• A measure of the overall level of prices
• Uses:
– tracks changes in the typical household’s
cost of living
– Adjusts for inflation
– allows comparisons of dollar amounts over time
How to compute CPI
1.
Survey consumers to determine composition of
the typical consumer’s “basket” of goods.
2.
Every month, collect data on prices of all items
in the basket; compute cost of basket
3.
CPI in any month equals
Cost of basket in that month
100 
Cost of basket in base period
Exercise: Compute the CPI
Basket contains 20 pizzas and 10 compact discs.
prices:
2002
2003
2004
2005
pizza
$10
$11
$12
$13
CDs
$15
$15
$16
$15
For each year, compute
 the cost of the basket in
each year
 the CPI (use 2002 as the
base year)
 the inflation rate from the
preceding year
Answers:
2002
2003
2004
2005
Cost of
basket
$350
370
400
410
CPI
100.0
105.7
114.3
117.1
Inflation
rate
n.a.
5.7%
8.6%
2.8%
The composition of the CPI’s “basket”
Food and bev.
17.4%
Housing
Apparel
6.2%
5.6%
3.0%
3.1%
3.8%
3.5%
Transportation
Medical care
Recreation
15.1%
Education
Communication
Other goods
and services
42.4%
Reasons why
the CPI may overstate inflation
• Substitution bias: The CPI uses fixed weights,
so it cannot reflect consumers’ ability to substitute toward
goods whose relative prices have fallen.
• Introduction of new goods: The introduction of new
goods makes consumers better off and, in effect, increases
the real value of the dollar. But it does not reduce the CPI,
because the CPI uses fixed weights.
• Unmeasured changes in quality:
Quality improvements increase the value of the dollar, but
are often not fully measured.
CPI vs. GDP Deflator
prices of capital goods
– included in GDP deflator (if produced domestically)
– excluded from CPI
prices of imported consumer goods
– included in CPI
– excluded from GDP deflator
the basket of goods
– CPI: fixed
– GDP deflator: changes every year
Categories of the population
• employed
working at a paid job
• unemployed
not employed but looking for a job
• labor force
the amount of labor available for producing
goods and services; all employed plus
unemployed persons
• not in the labor force
not employed, not looking for work
Two important labor force concepts
• unemployment rate
percentage of the labor force that is
unemployed
• labor force participation rate
the fraction of the adult population
that “participates” in the labor force
Exercise 1: For your understanding
• Make a note of:
– Real and Nominal GDPs of some of the important
countries and compare
– Prepare a list of top 10 countries with their Real
GDP growth rate and PPP growth rate.
– Find CPI Index of various some important countries
and check the inflation rates.
Numerical Example 1
Calculate GDP, GNP, NI and DI
Employee compensation (EC)
Rental income (RI)
Net interest (NETI)
Capital consumption (CC)
Corporate taxes (CT)
3,244
16
467
567
145
Social Security taxes (SST)
Personal taxes (PT)
Undistributed corporate profits (UCP)
Corporate profits (CP)
Proprietor's income (PROI)
Indirect business taxes (IBT)
Transfer payments (TP)
Population (POP)
440
700
37
297
402
470
660
250 (billions of
people)
Solution to Numerical Example 1
GDP
= Employee compensation + Rental income + Net interest + Corporate
profits + Proprietor's income = Billion $4426
GNP
= GDP + NIF = 4426 + 0 = Billion $4426
NI
= NNP – Indirect Business Taxes
= GNP – Capital Consumption - Indirect Business Taxes
= Billion $3389
DI
= PI – Personal tax and non-tax payments
= NI – Social contributions– corporate profit tax –undistributed
corporate profit + Govt. & business transfers to individuals –
Personal tax and non-tax payments
= Billion $ 2727
For Further practice:
Macroeconomics by N. G. Mankiw, 6th edition. Q.N. 2, 5, 6 and 7.
Numerical Questions and Solutions for Practice
1) Abby consumes only apples. In year 1, red apples
cost 1$ each, green apples cost 2$ each, and Abby buys
10 red apples. In year 2, red apples cost 2$ each, green
a.
apples
cost 1$ each, and Abby buys 10 green apples.
Compute a consumer Price index (CPI) for apples for
each year. Assume that year 1 is the base year in which
the consumer basket is
fixed. (Mankiw. Pg. 41. Q. 7)
Solution for Q. 1
Price in Current Year
CPI in Year 1 = ------------------------------Price in Base Year
------(PRed1 x QRed1) + (PGreen1 x QGreen1)
--------------------------------------------------------- = 1
(PRed1
------------x QRed1) + (PGreen1 x QGreen1)
Price in Current Year
CPI in Year 2 = ------------------------------Price in Base Year
------(PRed2 x QRed1) + (PGreen2 x QGreen1)
--------------------------------------------------------- = 2
(PRed1
------------x QRed1) + (PGreen1 x QGreen1)
Numerical Questions and Solutions for Practice
2) Suppose that the Nominal and Real GDP for country Z
in 1998 were $8,798.1 (in billion) and $8,536,
respectively. While for 1999, the figures were $9,295.4
and $8,897.7.
a) Calculate the implicit GDP deflator for 1998 and 1999
b) Calculate the Inflation rate (Calculated as the ratio of
differences in GDP Deflator with the GDP in base Year).
(Related to Mankiw. Pg. 41. Q. 6)
Solutions for Q.2: hint
NGDP 1998
8798.1
Deflator in Year 1998 = ------------------------ = ---------------- = 1.0307
---8536.0
----RGDP 1998
NGDP 1999
9295.4
Deflator in Year 1999 = ------------------------ = ---------------- = 1.0447
---8897.7
----RGDP 1999
Now Calculate Inflations rate yourself
Thank You