Basic macroeconomic variables
EC 235 | Fall 2023
Materials
Required readings:
Blanchard, ch. 2.
- Up to Section 2—4.
The basic measures
The basic measures
The study of macroeconomics revolves around a few basic variables (measures):
Gross Domestic Product (GDP);
Unemployment rate;
Inflation rate.
In addition to their own effects in the overall performance of an economy, these 3 variables also share relevant relationships, namely:
Okun’s law;
Phillips curve.
Gross Domestic Product
Gross Domestic Product
An economy’s Gross Domestic Product (GDP) is defined as the sum (in money value) of all final goods and services produced in an economy in a given period.
- The most important word in this entire definition is final.
This implies that intermediate goods are excluded from the final calculation of GDP.
With the basic definition in mind, the next important distinction is between nominal and real GDP.
Gross Domestic Product
| Year | Quantity Produced | Price/unit ($) | GDP |
|---|---|---|---|
| 2019 | 100 | 10,000 | |
| 2020 | 120 | 12,000 | |
| 2021 | 110 | 12,500 | |
| 2022 | 125 | 14,000 |
Gross Domestic Product
The key difference between real and nominal measures (GDP is only one of them) regards taking prices into account.
Given that the real economy has more than one good/service, calculating real GDP requires averaging the total output a country produces in a given period.
The price of goods and services are the natural choice for weighting this average output.
Gross Domestic Product
Board time.
Gross Domestic Product
Understanding GDP in full is not possible without looking at growth rates.
How to tell whether an economy has grown or not over time?
- The growth rate (%) of a variable between two periods is calculated by:
\[ \text{Growth rate} = \dfrac{\text{Value in the last period} - \text{Value in the initial period}}{\text{Value in the initial period}} \times 100 \]
Gross Domestic Product
The unemployment rate
The unemployment rate
While GDP is the most important variable measuring an economy’s size and performance, it must not be evaluated in isolation.
An individual is considered unemployed if they are:
- not currently employed;
- actively looking for a job in the previous four weeks.
The unemployment rate
Furthermore, the labor force is the sum of employed and unemployed individuals:
\[ \text{Labor force} = \text{Employed} + \text{Unemployed} \]
Thus, the unemployment rate (u) is the ratio between the number of unemployed individuals (U) and the total labor force (L):
\[ u = \dfrac{U}{L} \]
The unemployment rate
Those who are not currently employed and not actively looking for a job are considered not in the labor force.
Lastly, the labor force participation rate is the ratio between the labor force and the total population of working age.
The unemployment rate
Why should we care about unemployment?
The inflation rate
The inflation rate
Inflation denotes a sustained increase in the general price level of an economy.
The inflation rate is the growth rate of the price level over time.
Conversely, if the price level decreases over time, the economy experiences a deflationary process.
Three measures of inflation are worth investigating:
- The GDP deflator;
- The Consumer Price Index (CPI);
- The Core CPI.
The inflation rate
The GDP deflator is a price index measuring the average prices of all final goods and services included in the economy.
It is the ratio of Nominal GDP to Real GDP in a given year.
The inflation rate
As the GDP deflator includes all goods and services produced in a given year, it includes several goods and services that us, final consumers, actually do not care about.
Thus, the Consumer Price Index (CPI) attempts to represent the consumption basket of a typical urban consumer.
The US Bureau of Labor Statistics (BLS) calculates the CPI, through the Consumer Expenditure Survey (CES).
- Consumer expenditures are divided into 8 groups, including food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services (including tobacco, personal services, etc.)
The inflation rate
The CPI’s Core Index excludes food and energy prices, which tend to be the most volatile components of the CPI measure.
The inflation rate
Why should we care about inflation?
Relationships
Relationships
Aggregate output, unemployment, and inflation cannot be completely understood without their interdependence.
Although we will explore some of their relationships in more detail later, it is worth spending a few minutes introducing them right now.
First, output and unemployment can be analyzed together through Okun’s law.
- It states that, if output growth is high, unemployment will decrease.
Second, unemployment and inflation are related through the Phillips curve.
- When unemployment becomes very low, the economy is likely to overheat, and that this will lead to upward pressure on inflation.
Relationships
Relationships
EC 235 - Prof. Santetti