Introduction to Macroeconomics

• Macroeconomics studies the entire economy, not just individuals.
• Macroeconomics addresses economic growth, business cycles, unemployment, inflation, inequality, and government intervention during crises.
• Saltwater economists favor government intervention, while freshwater economists do not.
• Long-run economic growth relies on increased productivity, physical and human capital, economic policies, and institutions.
• Small annual growth rate differences can lead to large differences in living standards.
• Increased money supply is a primary cause of inflation.
• Too little money can lead to decreased demand, supply, and prices.
• There is a short-run trade-off between inflation and unemployment.
  • Increased inflation leads to decreased unemployment, and vice versa.
• Stabilization policies are not always effective as solutions.
• A well-performing economy is characterized by high income.

Measuring Economic Activity and Well-being

• Income equals expenses and total products.
• Gross Domestic Product (GDP) measures a nation's income and expenditure.
• GDP measures the cost of living, calculated by the total value of all goods and services produced within a country in a specific time.
• GDP only considers the value of the final product.
• GDP measures goods and services produced by both Swiss and foreign companies within Switzerland.
• Gross National Product (GNP) measures goods and services produced by Swiss corporations in Switzerland and abroad.
• Net Factor Income from Abroad (NFIA) calculates goods and services produced by Swiss corporations abroad, minus goods and services produced by foreign corporations in Switzerland.
• GNP is calculated as GDP + NFIA.
• Net Domestic Product (NDP) is GDP minus capital depreciation.
• Net National Product (NNP) adjusts for capital depreciation and net factor income abroad.
• NNP is calculated as GDP + NFIA – Capital Depreciation.
• Total output (Y) is the sum of consumption (C), investment (I), government spending (G), and net exports (X-M).
• Aggregate supply (Y+M) equals aggregate demand (C + I + G + X).
• Nominal GDP measures the value of products/services at their current prices.
• Real GDP measures the value of products/services at constant prices.
  • Real GDP is used to determine actual increases in production.
• Real GDP is calculated as (Nominal GDP / GDP Deflator) * 100.
• GDP reflects the number of products/services multiplied by their prices.
• The GDP deflator measures the increase in prices of products/services, to find real GDP.
• GDP per person is a measure of economic well-being, indicating average income and expenditure.
  • It is not a perfect measure of economic well-being
• The Human Development Index (HDI) measures well-being.
  • HDI comprises 1/3 life expectancy, 1/3 education, and 1/3 GDP per capita.
  • Shortcomings include neglect of unpaid work, illegal activities, and environmental costs while negative impacts such as pollution are counted as a plus, and it ignores quality of life.
• Alternative well-being measures include environmental degradation, national rather than domestic factors, income inequality, and value of leisure.
• Measuring the cost of living tracks price changes over time using the Consumer Price Index (CPI).
  • CPI reflects the cost of living and allows for inflation comparisons across periods.
  • When CPI rises, consumers must spend more to maintain their standard of living.
• CPI is used to adjust wages, utility prices, monetary policy, investment decisions, and government policies.
• Indexing wages adjusts salaries to maintain purchasing power with a 3% inflation rate raising salaries by 3%.

Constructing and Interpreting CPI

• CPI construction involves creating a representative consumption basket.
• Track the prices of goods and services within the basket over time.
• Calculate the basket's total cost each year.
• Select a base year and set its basket cost to 100.
• For other year, calculate an index number by comparing the cost to the base year and multiply by 100.
• CPI problems include substitution bias that can arise when people respond to changing relative prices.
• The intro of new goods where CPI cannot adapt to consumption changes quickly causing life look more expensive than it is.
• The unmeasured quality changes that may arise when the quality increases of new iPhone, but CPI don't adjust for this and it reflects on the real value.
• CPI assumes consumer homogeneity so the same measure does not match with reality very well.

CPI vs GDP Deflator Differences

• GDP deflators measure prices of domestic goods, while CPI measures prices of goods bought by consumers.
• GDP deflators use a basket that adapts, unlike CPI, and it is a Paasche Index.
• CPI uses a fixed consumption basket and is a Laspeyres Index.
• A Producer Price Index measures the cost of goods sold by firms integrating goods bought by firms like evolution of the CPI.

Inflation and Investment Decisions

• Investment decisions should be based on real returns, not nominal returns.
• Interest represents a future payment for a money transfer.
• Nominal interest rate is the reported rate without inflation adjustment.
• Real interest rate accounts for the effects of inflation.
• Real interest rate = Nominal interest rate – Inflation.
• Example: Borrowing CHF 1,000 at a 15% nominal interest rate with 10% inflation results in a 5% real interest rate.

Production, Economic Growth, and Productivity

• Living standards are dependent on the good and service production.
• Before 1900, GDP depended on population size, post-1900 it depends on production efficiency.
• A 1% GDP change can make a big difference: GDP per capita in 2000:
  • Argentina = 1915x(1.0186)100 = 12,093
  • Japan = 1256x(1.0281)100 = 26,477
• Purchasing Power Parity (PPP) is used to compare GDPs.
  • The World Bank (WB) and International Monetary Fund (IMF) use PPP in developing countries.
  • The Organisation for Economic Co-operation and Development (OECD) uses PPP in developed countries.
• The Big Mac Index can be used to compare prices.
• PPP amount = GDP / PPP rate.
  • Example: Luxembourg $112,875 / 1.03 = $109,587
  • Burundi $783 / 0.37 = $2,116
• Differences in growth are determined through productivity and a standard of living.
• Labor productivity is the quantity of goods and services a worker can produce in an hour. (productivity = output/hours worked)
• Output (Y) is dependent on labor (L), human capital (H), physical capital (K), and natural resources (N).
• LHKN use technology (A) to transform them into output.
• A is a measure of Total Factor Productivity (TFP).
• More inputs (LHKN) lead to more outputs (Y).
• Production function example: Y = A F(L, K, H, N).
  • If multiply -> α*Y = A F(α *L, α *K, α *H, α *N)
  • If divide -> Y/ L = A F(1, K/ L, H/ L, N/ L)
• Labor productivity relies on resources available.
• Higher physical or human capital and natural resources result in higher productivity.
• Example: Y = AF(KL) where (L&H = labor and K&N).
• Cobb-Douglas formula: Y = AKα Lβ, where α+ β= 1
• α = DGP that goes to capitalist
  • (Elasticity of output with respect to capital (% increase in output resulting from a 1% increase in capital)
• β = GDP that goes to the workers
  • (Elasticity of output with respect to labor (% increase in output resulting from a 1% increase in labor)
• α+ β= 1 so if a is 1/3 β will be 2/3 so Y = AK1/3 L2/3
• More labor (work) results in less time for human capital (study).

Government Policies for Productivity and Living Standards

• Encourage saving and investment.
• Encourage foreign direct investment (FDI) and portfolio investment.
• Encourage education and training (human capital).
• Establish and maintain property rights and political stability.
• Promote free trade for specialization.
• Promote research and development.
• Increasing physical capital raises productivity and output.
• Increase in human capital boosts productivity.
• Developing countries should focus on basic rather than high-skills education.
• Positive externalities from education can lead to new ideas.
• Brain drain happens when educated workers emigrate to richer countries.
• Natural resource administration is crucial for sustainable growth
  • “Curse of natural resources” describes how some mineral rich countries suffer from lower economic growth.
  • They often face weak institutions which make it hard for them to manage well

Diminishing Returns, Convergence, and Productivity

• Growth has limits. More inputs result in more outputs but effects diminish as inputs increase.
• Adding a computer to someone who has none makes more of an impact than adding one to someone who has 1,000.
• Output depends on Total Factor Productivity (TFP). Growth is higher in poor countries because it is less expensive with less risk.
• Without political and economic stability growth will diverge causing wealth to concentrate.
• Economic convergence can still happen if poor countries achieve sustained growth.
• Examples of growth include: China improved from worse than Burkina Faso in 1980 to a 10% annual growth rate.
  • They moved from agriculture into new sectors that initially had lower quality but increased productivity over time.

Understanding and Measuring Unemployment

• Unemployment influences living standards through lost earnings and loss of self-esteem.
• Okun’s Law describes the relationship of unemployment's impact on the GDP.
  • Real income growth% = 3% - 2*Change in unemployment rate
  • Change in unemployment rate = (3% - Real growth) / 2
• Switzerland requires 1.5% GDP growth to maintain an efficient labor market, while the US requires 3%.
• The natural rate of unemployment does not just go away on its own and requires long-run policies which result in structural and frictional unemployment.
• Frictional unemployment is short-term while people are transitioning to jobs.
• Structural unemployment happens when there is an imbalance in the supply and demand skillset.
• Cyclical unemployment is year-to-year fluctuation that requires short-term policies to solve.

Measuring Unemployment

• Data can come from surveys of households.

• Data can come from claimant counts.

• People between 15 and 65 are considered.

• Enployed + Unemployed = Labour Force

• Unemployment rate = (Number of Unemployed / Labor force) * 100

• Labor force participation rate = (Number of Unemployed+Employed / Adult population)

• Requirements to be unemployed:

  • Not working
  • Actively looking in the last 4 weeks
  • Available to work in the next 2 weeks

• People are categorized as employed, unemployed and non-participant

• Discouraged workers need to want to work but have stopped so they are not included

• Free riders may fraudulently attempt to claim to be uneployed

• Under-employed workers are considered employed and are not differentiated in labour statistics.

• L = workers in labor force, E = employed workers, U = unemployed, U/L = unemployment rate

• S = rate of job separation, F = rate of jobs finding

• Steady-state condition: people who lose/leave jobs = people who find a job U s

L s+ f

• When the rate of finding a job is 19% a month and the rate of seperation is .1% a month the natural rate will be 5%

Government and Unemployment: Creating Solutions

• Gov Policy - Agencies finding info for jobs and workers matching
• Gov Policy - training programs
• Gov Policy - benefits cover for workers that are unemployed at state level
• Benefits provide better matches between workers leading to higher prod and inc.
• Increase in cost of being unemployed

Categories for rigidity:

• Minimum Wage
  • Higher than optimal wage
• Labor Unions
  • Insiders hold into positions making it difficult for lower workers
  • Outsiders are non-paid workers for cheap labour to save money
• Efficiency
  • Company will pay for higher work rates

Trends affecting work

• Industrial revolution
• Sectoral Shifts

Causes and Effects of Unemployment

• In an ideal world, labor supply would equal labor demand.
• In reality, job searches take time and structural unemployment.

Economic Factors:

• The government can lower unemployment through agencies, training, and insurance.
• Benefits of insurance lead to greater productivity.
• Costs of insurance reduce the urgency of finding a job.
• Causes for wage rigidity include minimum wage laws, labor unions, and efficiency wages
• Long term trends and industrial revolutions

Understanding Consumption, its Factors and Theories

• Y = C + I + G + NX = Aggregate Demand
• Y (output) = C (consumption)+ I (Investment) + G (government expenditure) + NX (export - import)
• With consumption making up (70%) of AD and savings are Dispoable Income less Consumption, the Consumption becomes an important indication of Wealth.

Keynes's Conjectures

• ->* Marginal Propensity to Consume (MPC) = How consumption changes due to inc in income or consumption by income
• ->* MPC + MPS =1
• ->* If icnome inc -> Savings inc = Average Propensity to Consume (APC)
• ->* C = consumption / Income
• In old times, Housesholds with higher incomes consume more, so Households with higher incomes save more = (APC) decreases as income increases
• keynesian -> C grows slowly as overtime = not true now - ppl borrow so Consumption grows

Fisher Model -> time and lifetime Consumption

• Ppl decide and chose Consumption to have maximum lifetime satisfaction
• Budget
• P1 is present
• Pt+1 is future
• Income 1,2 is money/present or tomo Income
• Comsumption 1,2 present future use
• Savings is money - C present = used later with S

Present Value

• All Consumptions have value to not lose more than what You have

Consumption for better Unit

• Optimze = Optimal = where budget is optimal = can trade
• Keynes - Consumption is income based
• Fisher - Time isnt an issue

Save

• saving - r inc = Savings up = Consumption down
• Debt - Loan = less saving = Consumes less
• Credit - r Increase = inc saving = Consumer More

Budget

• If cant borrow = have less comsumption = make less Consumption happy

C Life-cycle

• Old ppl = use savings
• Yong ppl = Save more

Cycle to use savings

• APC is Comsumption = a = (Wealth1+wealth 2) + Income
• Higher savings causes = lower APC and Consumption
• With high savings more wealth

###Permanent Income

• Ppl smooth consume more income change - job change = they consume more
• if Income = bonuses ppl do not change Comsumption
• Change if rich then power

Model for

• Fisher > PPL act well with wealth and lifetime
• LifeTime> Systematic wealth in cycle over time
• Income > Random issues fluctuate
• Everything unexpected needs new plan