Lecture 2: Basic Macroeconomic Concepts

I expect that there will be many fun lectures in the sense that we're going to have you know we're going to be discussing a little more exactly at the right time in which that issue is an is an important issue at least as D in the newspapers and you know we live in we are going through a very interesting time for microeconomist inflation is unusually high something needs to be done about that er um we still have problems on the supply side of the economy as a result of CO as a result of the slow

reopening of China um we have a war going on which is affecting also the price of energy and it's particularly impacting Europe and all these things are the situation is very fluid all of them can change at at any moment and uh and policy makers are s therefore paying very close attention to all these things it's not a normal time if you're a policy maker macroeconomist microeconomist policy maker uh you you are not sleeping a lot on these days and so so I expect that we will have plenty of time to discuss interesting things and

analyze them um at a slightly higher level than you can do at this moment now I also told you in the previous in the introduction that that this particular lecture is not going to be of that kind you know it's going to be very boring in the sense that you know we need to start with definitions and and and I don't know who likes definitions I don't it's very boring now there is an interesting or a curious side of the definitions we're going to discuss which which is that if you were taking 1401 microeconomics many

of the concepts we're going to describe require no definition they're obvious I mean if you I ask you for output of a factory that produces cars it's pretty obvious that it's a number of cars if I ask you for the prices of those cars is pretty obvious what the price of a car is not so for macro because if I ask you what is the output of the US economy well there's millions of goods and services are produced at the same time so so what do we mean by output a single measure of output or

if I ask you about the price level or the inflation the rate at which that price level is changing well what are we talking about it's very easy to see where the price of a car is going up but if we're mixing sort of millions of different goods and services then it's a little harder and that's the reason we need this lecture because it's it's a little harder than 1401 and we need to Define basic things but they have a trick because you're suming apples and oranges not only apples and oranges apples oranges health services

financial services all of them in in one piece and so so it's a little trickier and that's the reason we need this boring lecture we need to go through that slightly trickier definition of output prices and so on ER okay so let me let me start with the most basic thing aggregate output at the end of the day when where the econom is in a recession or not and so we don't like it or we do like it depends on what is happening to Output is output growing at the pace it used to grow is

it growing less or it's declining well that's very important for macro and to understand the health of an economy the microeconomic health of an economy but we need to start by defining what we mean by output and because it's a tricky thing to do when you're adding so many apples oranges Financial Services ER entertainment and lots of things that are very different H it wasn't there we didn't have a good way of doing that in fact the national accounts as we know them in the US is something that we have since the post-war period in

in the late 40s that we develop the technique the approach to come up with a measure of our output before that we had measures proxies you know industrial production is very high I meaning we're producing lots of cars stuff like that and somebody but something systematic like we have today is a pretty recent uh thing okay we call that NEPA the national income and product account income and product that's going to be very important for macro as you'll see in a minute um so the main measure of aggregate output is what we call gross domestic

product or simply GDP you hear GDP that means output of an economy why is gross and not net you're not going to worry about that in this course okay but that's you hear GDP most microeconomist wouldn't say output they would say GDP it's very short it's efficient and so on well that's what it means it's the output of an economy but how do we Define it as I said before it's much harder than when you have an individual good by the way I will be most of the time I will say Goods but really is

goods and services but it's very long to say goods and services no so whenever I say Goods I'm not trying to play any trick on you I really mean goods and services I just mean lazy okay and most people are lazy that way okay now what is the difference between goods and services you you're not going to worry a lot about that in this no you're not going to worry at all about that in this course but just to get a sense goods are things that you know that are tangible services are things that are

not that tangible there are benefits that you receive from the task that someone else operates on you so you go to the to you know the medical center you don't come up with a piece of a machine to well they may lend you something but but you don't come out with an objective you come out with the service provided by a doctor to you okay and the same happens if you go to a bank you don't come with a ATM with you what you come up with is the service of having done a transaction or

deposit or go on a mortgage or something like that it's a service if you go to a restaurant again you don't what you can what you have is an experience it's a people provided an experience to you things are a little tricky because if you do a take out well is that an experience or is really the goods so so if you get into those details which you're not going to get it gets to be tricky but but but just to get a sense on average a consumer in the US two third of the consumption

is in services not in Goods it's not sort of the banana and so on that you buy it's a lot of the financial services health services and entertainment and things like that traveling that's what you spend most of your time having clarified that you can of forget that from now on I'm going to say Goods occasionally may say goods and services but I always mean the same okay good so um so how do we measure these things so well there there are different ways ER of of of doing this something happened to my slide there

okay there we are um so suppose that you have a an economy that is very simple I don't need to tell you how simple this economy is it has just two firms okay suppose we have an economy that's very simple has two firms one firm produces a steel and the other one produces cars and the company that produces cars buys all the steel from the company no body you as a consumer don't buy you don't buy steel directly the car company buys a steel uses to produce a car and you buy the car okay so

that's our simple economy and that's those are the the accounts of the of the simple economy so there you have company one has a revenue from sales it sells $100 okay so price of steel times steel is $100 the second company H uses B is Ste uses workers and sells $200 no so the question I ask you the first question I ask you here is well what is the GDP of this economy here you have an economy that has two goods needless to say a real economy is a lot more complicated than this but you

have two companies and I ask you what is GDP so the obvious things that you could come up with is well I Su all the revenues okay so that's the obvious one the total GDP of these economies is 300 that's a sensible answer okay at least at this moment I would accept that as a sensible answer in the quiz I wouldn't but here it's a sensible answer I mean well you ask me for what is the total output of that economy I sum up all the revenues on sales and that's 300 okay so so um

is it 300 well or is it 200 I mean that's another you says well look only the final goods perhaps should count because you know this is the only thing that you as a consumer will ever see this part not that those are two sensible answers and what I'll show you in three different ways is that the right answer is 200 for that economy okay not 300 the right answer is 200 so method one H and all these methods are used and they use to check each other H to compute H GDP uh so method

one is what I said here is final goods you said GDP is the value of the final goods and services producing the economy during a given period of time notice that GDP is a concept of a flow it's something you produce in a year okay that's the reason you say GDP of the US in 2022 was you know 23 23 trillion dollar is in a year okay it's a it's a period of time okay so so that's one definition and one way of of of er of making sense of this definition is imagine that I

give you the same economy with the same two factories and now all of a sudden I tell you you know what I'm going to merge the two companies so company the car company will buy the steel meal or whatever well if I now put together those two accounts now I never see the steel because it that's all happening inside the the factory and it's still the case that the economy would be producing 200 Cars and all that you would see is 200 no because I would put this thing together there was a steel that this

company had purchased from that but now it's all inside okay so so if I put them together then that steel there doesn't appear because it's all produced inhouse and now GDP would be 200 well it makes no sense that just because I change the ownership structure of the companies that your GDP changes collapses from 300 to 200 if I only measuring final goods though I don't have that problem it's still 200 doesn't matter that I have the merge slice and LIC in 20 or whatever so that's that tells you that that's we're going the right

way here because you know it's it's a very robust answer that is you don't count intermediate output you only count the final goods which are the things that the consumer will buy buy the firms will buy for investment and things of that kind that foreigners will buy alternative method is GDP is the sum of value added in the economy during a given period of time what is value added the difference between final the final goods produced by a company and the intermediate inputs it purchased to produce those goods okay so what is the value added

of the steel company here it's the answer is there but you know but what is the value added it's 100 how do I know it's 100 well because it's not buying any intermediate input and the revenue is 100 okay so that's the reason I get 100 there okay 100 there's no intermediate input what is the value added of the car company well the revenue on sales is 200 but it purchase 100 in intermediate inputs so the value is 200 minus 100 the value out of this company is 100 100 plus 100 I get my 200

again yep consider wages to be in really good no that's those are not Goods those are factors of production okay so this and the same there are machines in that factory that are helping you produce things that's a service of the machine it's Capital that's not an intermediate input an intermediate input is another good or service that you buy for the the purpose of producing that that good okay so workers is not workers are working inside your company and so on if the work was if the work was produced was outsourced and you had another

company that produces something that you use from those workers that would be an intermediate input but you would have to count the value out of the other of the companies you have outsourced too you see so that's method two two and you see we get exactly at 200 those two method methods are called production methods there are different ways of measuring the production of the economy the third method and the last one is an income method which means look all that is produced has to be earned by someone the workers the owners of capital somebody

has to own that if the firms sell collectively $200 those $200 have to be allocated to someone someone means workers the owners of capital of the first Ms or in realistic economies the government you pay taxes and things of that kind okay we're not going to worry about the government for a while so that's an alternative method it's method three you just sum the incomes so who are the factors of productions here related to your question in this there is no government here no taxes so we have only workers and profits you the capital the

owners of the Company wages is 80 + 70 is 150 profits is 20 + 30 50 150 in wages plus 50 in profit gives you back your 200 okay so those are the three ways we have of measuring these things and you see they give you exactly the same result now there is something as I as I from the construction of national account there is something interesting in what I just said which is look I can that production is the same as income that's going to be very important for macro very important for macro and

it's totally unimportant for micro when you're looking at a company for example in micro and you're looking at a car company by itself it is true that you know the output of that company becomes income part for the owners of the company and part for the workers but that income needs not be spent in cars can spend in food entertainment and whatever not so in macro because what else you going to spend it to than in the same good that you're producing in the aggregate good so it's very interesting that's a very distinctive feature of

micro that is not present in micro is that that income has to be spent in the same Goods if the econom is closed later on we're going to open the economy to the rest of the world and then you get you buy some Chinese goods and blah blah blah but if you keep it close hey you are not going to buy cars that's what you work on but you're going to have to buy it in the single good of the economy which is the sum of all the goods that we we consume an average that's

going to be very important anyways this time is this stuff move in the right direction okay so that's that's that's that now you know what GDP is and the different ways of measuring you're going to have to remember that for for p set one and for quiz one and you might as well forget it for the future it's good that you understand the concept but it's different ways of constructing is not very important second thing we need to worry about is that whenever you're thinking about the output of an economy you're really trying to think

about the real output meaning number of cars and number of machines and so on but you have inflation for example then prices of these things are growing and so the total revenue on sales is growing but they don't mean the same and we want to certainly separate these two things and for that reason we have a concept which is called nominal GDP and another one which is called real GDP nominal GDP is the simplest thing on Earth is essentially you know we had only one final goods company there which was cars but mind you have

cars refrigerators many many things nominal GDP simply you sum all the final goods and you multiply them by the the current price and that gives you the dollar GDP that you have I don't know what it is in the US today you could check it but it's $24 trillion a so that's it P * Q you know prices times quantity and you sum across all the final goods that's we have to that's one way of calculating thing that's nominal GDP but again what we really care about is we're going to get a lot about later

on is how that econom is doing over time is it growing is it not growing nominal GDP can grow for two different reasons can grow because the economy is really becoming more productive is producing more Goods or because prices are going up now at this moment real nominal GDP is growing very fast in the US despite the fact that we may have recession this year we don't know but nobody has any doubt that nominal GDP will grow because we have lots of inflation and so you want to separate these two things and the thing that

removes the inflation component is what we call real GDP and real GDP if you hear the word only GDP and and that was produced by somebody understand what he's talking about GDP really means real GDP okay if you just hear GDP people are try is trying to say the output of the economy well that's real GDP and the real GDP is computed many tricks but but essentially what you do is you consume you you you you also sum across all the goods you also Su across the goods but you use constant prices not the prices

of that point in time necessarily okay so I'm going to give you a very concrete example but before doing that for this course we're going to call nominal GDP and all nominal variables are going to have that's what the textbook does they're going to have a dollar sign in front so that's our measure that's nominal GDP GDP is going to be Y without the dollar that's real GDP okay for the first part of the course up to quiz one we're we're going very we're going to worry very little about nominal things because we want to

have prices completely fixed but but you still need to know the concept and that's real GDP so now let me give you an example so suppose you have this this this the simple economy we had before we're just going to look at final goods because that's what we need to look at to con to construct GDP and so this economy produces cars and supposedly produces 10 cars in 2011 12 cars in 2012 and 13 cars in in 2013 but suppos the price of a car is what you see there 20,000 24,000 and 26,000 nominal GDP

is simply the product you know of this times that that gives you $200,000 12 cars times $25,000 gives you 288 and so on that's nominal GDP real GDP you have to pick which price you want to use but only use one and don't vary it over time okay so in this particular case we pick 2012 okay so that means when you say GD real GDP at 20 2012 2012 base 2012 or at 2012 prices means that you're using the prices of 2012 you don't bury that you let quantities change over time but the prices remain

fixed so in this case real GDP at $22 is you know is 10 cars times 25,000 that give you 240,000 12 cars time 24,000 28 this is interesting for this year nominal GDP is the same as real GDP why is that it's an accident exactly we're using that's a base year so that's nominal GDP will always be equal to real GDP at the base year that's the Year we're picking as the base know because those are the prices we're using I what about 2013 well is is not 26,000 * 13 is 24, 1013 so we

get 312 and it's obvious here that real GDP is growing less than nominal GDP why is that well because this economy has inflation prices are rising over time and we want to remove that when we want to look at the real concept the real concept removes the price effect there are times in which you don't want to remove all that price effect and it happens a lot for example in computers because sometimes the increase in the price of the computer is simply because the computer is better and and you want to correct for quality and

so on but again that's not something you need to worry about in this course okay maybe some of you deciding the pace which you want me to move I'm really puzzled by this stuff here this is this is from the book and you see what happened in in the US with nominal and real GDP with base year 2012 so as I said before these two curves one is nominal GDP the red line the blue line is real GDP we're using Bas year 2012 so at that point they have to be the same and what you

see very very clearly there is that a the Blue Line real GDP is flatter than the red line why is that why is it yeah is inflation see yeah by the way I do have a reference for you so ask me after the okay good um anyway so yeah in the US between 1916 and 2018 real nominal GDP increased by a factor of 38 while real GDP by a factor of 5.7 big difference so so you better be careful when when you look at GDP that you are removing inflation especially in I mean if you

were to look in Argentina these guys have had a recession a chronic recession for a long time big recessions but nominal GDP is explo clothing because they have 10,000% inflation so so so it makes a big difference especially over time this is just so you get the picture the complete picture for the US this is a GDP growth in the US since we have national accounts okay and some noticeable things well again recessions this was a big recession remember we call this the Great Recession big recession and well this is covid and then this is

2020 and then they bounce back in 2021 when we reopen the economy big growth but that's very anomalous I mean that's a very weird shock okay but that's a you see these are all the shaded areas are recessions recessions are defined in a slightly more complicated way than that but one sort of er popular way of describing ression is as episode where you have two consecutive quarters of negative inflation that's not the formal definition of res but it's pretty close okay and so so that's that's what you have there another concept is an employment rate

the unemployment rate so that's GDP and we're going to the in the first part of the course we want to worry a lot about that we're going to build a model on how to find equilibrium H GDP okay and we're going to see what happens with fiscal policy with monetary policy how how does equilibrium GDP macroeconomic EIC output changes with different forms of policies or when consumers get scared or stuff like that okay what about the unemployment rate the unemployment rate is not something we want to worry a lot about until the second part of

the course after quiz one but I still I want to get over with these definitions so what is employment is a number of people who have a job that's easy unemployment is slightly less easy because it's first of all obviously to be an employee you don't have to have a you cannot have a job so but it's not enough that you don't have a job is an unemployed person is somebody that doesn't have a job and is looking for one okay not all unemployed people look for your job not all non-employed people are looking for

jobs okay so un to be unemployed you need to not have a job and be looking for one the labor force what we call the labor force is the sum of those two groups the employed and the unemployed that would like to get a job okay the unemployment rate which is something I showed you in the previous lecture is just a ratio of these two concepts the unemployed over the labor force notice over the labor force not population the labor force which is a sum of the employed and those that are unemployed that do not

have a job and are looking for a job okay how how is an employment measure in the US is mostly a survey and I have the the the info there it's called the CPS the current population survey that consults lots of households and they ask them about the employment status whether they have been looking for a job over the last two weeks or not and so on and that's the way we come up with with the number as as I said before H those that do not have a job but are not looking for a

job they haven't been looking for a job in the last two weeks are called not in the labor force that's that's what we say now these concepts are between an employed and not in the labor force is it's not not that clear we we we look at the employment rate but we also tend to look at those people as well because many people are simply discouraged they would like to get a job but they have been looking for a while and they haven't found it and it it happens that there is a lot more discouraged

workers during recessions and when you're having a big recession it's very difficult to find a job so it's very easy to get discourage and so that's the reason we look at broader measures of non-employment than the typical unemployment rate because a lot of those not in the labor force people that do not have a job and are not looking for a job are really discouraged they just give up after a while okay the participation rate and that's a very important concept something you would have ignored most of the time is very critical at this moment

the participation rate is the ratio of the labor force to the total population of working age and you exclude people you know in prison and stuff like that but but a so it's label force is which is the sum of the employed and the unemployed divided by those that could work in principle okay and that we call that's what we call the participation rate how do these numbers look I showed you this picture in the previous uh lecture and that's the unemployment rate it skyrocketed during covid but it has declined enormously and as I said

in the previous lecture a big issue is that the unemployment rate today is extremely low we haven't seen levels like this since the early 60s okay the unemployment rate today is at record low levels and that's a problem some wonderful but it's also as a problem because we have an inflation problem and those two things are connected as you will learn later on in the course okay but that's what we have right now that's the unemployment rate now the reason the unemployment rate is so low there are two reasons really one is that there was

lots of stimulus policy fiscal policy monetary policy so aggregate demand and consumers that were fed up of being locked out of restaurants and trips and so on for two years you know decided to travel and so on so so and they had lots of savings the the US consumer accumulated excess saving of $2.7 trillion and now they're spending this time China a big reason why people expect a big bounce back is because they also had a lot of savings because they were locked up for for quite some time so so as a result of that

there's lots of demand for goods and as you're going to learn in the next lecture that means lots of output as well H but the second H reason is the following is the participation rate okay people haven't come back to work in the magnitudes that we expected so that's a participation rate in the US remember participation rate is labor force over all those that could work in principle okay ER what do you think is this look at the participation rate used to be in the 6 below 60s and then there was a big rise in

the participation rate in the US what do you think is this due to women joining work women yeah joining the workforce that's what it did okay that's that since then since just women did all that they had to do sort of we have been declining and that that's that's an issue but ER but look at what happened here lots of people exit the labor force during covid I mean you know they had to take care of the kids and and and or or the elderly and so people withdrew from the labor force they didn't want

a job it was also discouraging it was very difficult to get a job for iag you work in a restaurant it was impossible to get a job in a restaurant so but everyone expected this to recover to the previous level and it hasn't okay so you be you see that the participation rate has not come back to the levels preo is substantially below and that's one of the reasons you know that restaurants complain that they don't have workers and so on so forth is that many people haven't come back to a labor force we thought

this was going to be temporary now there's a concern that a lot of that is really permanent people decided that you know life at home wasn't that bad after all less income but but they spend more time with the kids or whatever and so H ER and that's an issue and that that's a big reason behind the low unemployment rate and the fact that we have all this inflation has to do with everyone in particular the fed miscalculated the bounce back of of the participation rate good so as I said before we're not going to

look at labor market issues until sort of the second part of the course after quiz one and the same is for inflation we're not going to look at inflation issues until the second part of of the course because to connect them I mean I they are connected and we're not going to look at Labor markets until sort of a lecture from now or so okay but let's look at but this is an important variable and certainly something you're facing every single day in the newspapers and so on the inflation rate so by inflation when you

hear inflation that typically means the sustained rise in the general level of prices so it's not that the price of cars went up relative to the price of hotels or now down price hotel is that on average prices are rising that's what we call an inflation inflation um so we're going to call the price level PT and there are many different price levels all you see so the inflation rate when you hear the inflation rate is the rate of change of that price level an episode of deflation the opposite of what we're experiencing now where

we're exper inflation is when that inflation rate is negative Japan most prominently has experienced something like that not now but experienced it for on and off for the last three decades or so um so what is the price level there are many ways of defining it and then there many different price levels a very popular one is what is called the GDP deflator and it's the one you see Le you is never mentioned in the newspapers okay but we economists tend to look at the deflator the deflator is nothing else than the ratio of nominal

GDP to real GDP another one is far more popular and more relevant for you as consumers is what we call the Consumer Price Index that's the CPI you hear CPI that's what it is so it's it's it's it's you calculate the rate of inflation from the CPI you calculate the same way but you use a CPI there instead of the GDP deflator now it turns out H that obviously confused with it it turns out that these two measures are sort of pretty well aligned okay there are differences that may be interesting at some specific point

in time but they tell you more or less the same picture in particular there is absolutely no doubt that we have an inflation problem these days you can be as selective as you want with the price index you want to use and people are getting very selective now we have CPI excluding ER well one thing that that makes a lot of sense is to exclude the most volatile Goods so typically the CPI we we use what called core CPI which removes energy and food which are very volatile prices you don't want the thing to be

moving all over the place but now we're also beginning to remove shelter because shelter inflation is very high and sticky and so on so so people can get to be very selective but no matter how you look at the thing we have a problem okay that there's no way around that so that's the the way again we're not going to look we're going to talk a lot about this problem of course but we need to build tools and and we're going to get there in about nine lectures from now okay nine lectures from now we're

going to be able to talk about what what is going on in with Ms I mean you can talk whenever you want but with Ms okay so that those are the concepts I wanted to discuss today those are the definitions and relief that we got over this stuff let me just show you we have five minutes or so er equivalent numbers for other places around the world that's China okay that's China That's GDP growth for China and there are several things you can see from for this GDP series the first is that it was very

high this these numbers look a lot on average it's a lot higher than the US when I show you the US you know the rate of growth was moving around 2% one and a half perc blah blah blah occasionally recessions and so on this is China look you had you know numbers like 10% or so that's interesting we want to know why is that you can have so much difference in different countries okay and and that's what we're going to do in the third part of the course when we look at growth we're going to

look at these kind of factors what can give you sustained rate of growth sustain I mean for a long period of time higher than in another country the the main factor just to preview what will happen is is H is simply that China was a lot poorer than the us at the beginning and when you're poorer and you put your act together you can grow a lot faster than the rest now China is slowing down aside from covid it's very clear for quite some time that they have been worried because clearly GDP growth is declining

okay and and and they're terrified about that and and and many of the things that are happening with China have to do with the fear Associated to uh slow down in the rate of growth when they are still quite poor in per terms okay so that's a lot of what happens in China has to do with that if you look at Japan look at Japan Japan also grew very fast in the 60s okay you see this very fast rate of growth then it began to slow down and pom here collapse they have a massive crash

in the in in in financial markets equities and land the price of land was enormous in Japan at this time it had a big Financial bubble you know for those of you that know Japan or if you don't know it doesn't matter there's a the Imperial Park in Tokyo which is a park that is much smaller than Central Park or whatever the value of that land at some point in time was the same as the value of the entire State of California okay that's the order of magnitude it was not for sale but you know

in terms of location times price but that's that bubble crash and since then Japan has never been able to recover its modu okay it has been sort of growing at a very low rate for a very long period of time and one of the things that scares China is that this may happen to them because this happened to Japan when they were already quite Rich Japan was pretty poor after the war naturally and they grew very fast in the 60s but then they had this issue Financial bubble and so on they crashing had never been

able to recover and China is worried that you know that this slowdown happens to them ER before they have acquire reached sort of the level of income per capita that Japan reach when that happened they common factors behind the two of them as well demographic factors demographics are very negative for both of them and which naturally will slow down the rate of growth we're going to look at that later this is inflation in Japan H you see sort of the most countries had high inflation around there because the the were the price of oil they

with massive oil shocks and so on so inflation was pretty high but the problem of Japan has been the opposite since the bubble crash in the late 80s early 990s they have had very low inflation H even deflation and that's been a big problem part of the reason why they have had so low growth is because they have been in this deflationary trap and then you something you will will look at later on in the course when when you have deflation it's pretty it's very difficult to use monetary policy to get out of a recession

and that's the reason they keep getting a stack there so that's all I wanted to say for today and I'm relief again that this lecture is behind us in the next lecture we're going to introduce the first model what we're going to look at is is H is how to determine equilibrium GDP and how that depends on on the a variety of things including fiscal policy not monetary policy that will happen later um but uh how scared you are consumers preferences and fears and so on so that's the plan so unless there are any questions

about this no so see you next Monday