Macroeconomics

Until now Microeconomics Examine the functioning of individual industries and the behavior of individual decision-making units, firms and households.

Macroeconomics deals with the economy as a whole. It deals with aggregate behavior not individual decisions as in microeconomics.

Important Macroeconomics Variables

Three of the major concerns of macroeconomics are

Output growth

Unemployment Inflation and deflation

Output Growth

aggregate output The total quantity of goods and services produced in an economy in a given period. business cycle The cycle of short-term ups and downs in the economy. recession A period during which aggregate output declines. depression A prolonged and deep recession. expansion or boom The period in the business cycle from a trough up to a peak during which output and employment grow.

A Typical Business Cycle

Unemployment

unemployment rate The percentage of the labor force that is unemployed. Labor Force = Number of employed + Number of unemployed Unemployment Rate = (Number of unemployed/Labor Force)*100

Inflation and Deflation

inflation An increase in the overall price level. hyperinflation A period of very rapid increases in the overall price level. deflation A decrease in the overall price level.

The Three Markets Goods-and-Services Market Firms supply to the goods-and-services market. Households, the government, and firms demand from this market. Labor Market In this market, households supply labor and firms and the government demand labor. Money Market The money supply and demand determines the general price level and the inflation.

National Income Accounting

Basic concept of national income accounting is the Gross Domestic Product (GDP) (Gayri Safi Yurtici Hasila (GSYIH))

GDP is the total market value of all final goods and services produced domestically within an economy in a given period of time.

Final goods and services refers to the goods and services that are sold to the purchasers for final use.

Intermediate goods are the goods that are produced by one firm for use in further processing by another firm.

In order to avoid double counting, we do not count intermediate goods The value of the final goods already reflect the price of the intermediate goods contained in it. Electricity
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Domestically refers to the production located within the country.

In a given year means that the sale of goods produced in prior years, for example, used cars, are not included in this years GDP.

Total market value refers to the quantity of goods multiplied by their respective prices. Using prices allows us to express the value of everything in a common unit of measurement.
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Discussion Question:

Would the following transactions be counted as part of GDP? a) A seafood restaurant buys 1000 TL worth of fish b) You pay 175 TL to have your car repaired c) A supermarket pays 2000 TL for computer maintenance to its computer provider d) You buy your roommate's monitor for 120 TL e) You make 20 TL shoveling snow for your neighbor

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Quantity
2 cars 3 computers

Price
15,000 3,000

Value
30,000 9,000 39,000

Gross domestic product

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Definitions and Derivations of GDP

GDP1: value of all final goods and services produced in an economy during a given period (monthly, quarterly or monthly) GDP2: sum of value added in an economy during a period. Value added by a firm: Sales- Payments for the intermediate goods (Value of production for firm- value of intermediate goods) GDP3: sum of incomes in an economy during a period

Example : 2 Firms producing milk & smoothie Firm A: Milk Production in 2010 Revenue from Sales Expenses Wages Profit

120,000 TL 75,000TL 75,000 TL 45,000TL

Firm B: Smoothie Production in 2010 Revenue from Sales 200,000TL Expenses 155,000 TL Wages 35,000 TL Milk Purchases 120,000 TL Profits 45,000TL

Value Added (Katma Deger)

Value Added is the total income generated in the production of a good V= TR p q - Total Intermediate Input Costs

Total wages + Total gross profit

Income of workers Income of the capitalist

Total gross profit= Profit Interest I + Rent R V Total wages W Profit Interest I + Rent R
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 GDP in terms of value added GDP = Total value of all final goods and services = Total value added by all sectors = W++I +R

Example Suppose that there are 3 goods produced in the economy. x, y and z Suppose that the current (market) prices of x, y and z are as follows: Px=1, Py=4 and Pz=2

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 Input requirements of these goods are as follows: 1 unit of x = 1 unit of Labor 1 unit of y = 2 units of Labor + 0.5 units of x+ 1 unit of z 1 unit of z = 1 unit of Labor + 1 unit of x

Suppose that, in the economy, the total productions are x=13, y=6 and z=10 units

Net output is the amount of a good that is available for final use. It is the amount of the good that is not used as an intermediate good.
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 What are the net outputs of x, y, and z?

Net output of x = 0 13 units of x are produced, 13 units of x are used up in the production of y and z. Hence, 13 units of x is used up as intermediate goods.

Net output of y = 6 units 6 units of y are produced.

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 Net output of z = 4 units 10 units of z are produced. 6 units is used in the production of y, that is, 6 units of z are used as intermediate good.

What is the total value of final goods (GDP)? GDP =Total value of final goods = [Py x 6 ] + [Pz x 4] = 32

What is the value added for these three industries? Vi= TR - Total Intermediate Input Costs, where i indicates the industry
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Vx p X 13 0 1 13 13 Vy p y 6 p X 3 pz 6 4 6 1 3 2 6 9 Vz pz 10 p X 10 2 10 110 10
Vx V y Vz 32 GDP

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Expenditure Approach of GDP

Now, we will discuss the expenditure approach in calculating GDP. The amount spent on all final goods and services during a given period should be equal to the GDP

Total Income (GDP) = Total Expenditure

There are four main categories of expenditure:

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1) Consumption Expenditures

i)

Private (Personal) Consumption (C): Expenditures on all goods and services by resident households in an economy. All expenditures on
Food, drink, clothing, cinema tickets, restaurant meals, electricity, water, telephone bills, and etc

The largest part of GDP consists of C

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ii) Government Consumption (Cg): Expenditures by the government for final goods and services

Expenditures on office supplies, road maintenance, salaries of all government employees,.

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2) Investment Expenditures (I)

i) Net Investment: All expenditures on newly produced capital goods by profit-making organizations and the government Second-hand machine is not net investment Sometimes it is difficult to make the distinction between what is considered investment and what is considered consumption Expenditures by firms for items that last more than a year are counted as investment. Expenditures for items that last less than a year are seen as purchases of intermediate goods.
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ii) Depreciation Expenditure: All expenditures to maintain the capital stock of the economy Repairs of the machines, replacing some parts, .. Indicates no additions to the capital stock but represents expenditures on the capital stock

iii) Gross investment: Total expenditures in capital by profit-making organizations and the government. Gross Investment=Net Investment+ Depreciation

I Gross Investment of profit-making organizations Ig Gross Investment of the government

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3) Exports Expenditure (X)

Total expenditures of nonresidents on domestically produced goods and services

Hence, Total use of goods and services= C + I + G(Cg + Ig) + X Total Sources: GDP+M (Import) Total Use= Total Sources C + I + G + X= GDP + M GDP = C + I + G + (X-M)
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GDP

C I G (X - M ) all expenditures by residents net exports (trade balance)

Aggregate expenditure (AE)

GDP AE

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 Trade Balance

( X - M ) GDP C I G
measures the amount by which the domestic source of goods and services exceeds total uses of resources by domestic sectors.

If C+I+G>GDP, X<M trade deficit

If C+I+G<GDP, X>M trade surplus

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Basic Concepts Related with GDP

So far, we considered nominal GDP, GDP in current prices.

GDP will increase when prices increase, even if the physical quantities of the goods produced remain the same.

A measure of total output that does not increase just because prices increase is called real GDP.

Real GDP takes into account price changes by using the same prices for both years.
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Quantity Produced Year 2004 2005 Cars 4 5 Computers 1 3 Cars 10,000 12,000

Price Computers 5,000 5,000

Nominal GDP 45,000 75,000

Quantity Produced Year 2004 2005 Cars 4 5 Computers 1 3 Cars 10,000 10,000

Price Computers 5,000 5,000

Real GDP 45,000 65,000

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Calculating the Growth of Real GDP

Quantity Produced Year 2004 2005 Cars 4 5 Computers 1 3 Cars 10,000 10,000

Price Computers 5,000 5,000

Real GDP 45,000 65,000

We can calculate the growth of real GDP for this economy: (65,000 - 45,000)/45,000 = .444, or 44.4%

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Price Level Changes

Two different indexes to measure price level changes GDP Deflator GDP Deflator = (Nominal GDP/ Real GDP)*100 Nominal GDP in 2005 = P2005*Q2005 Real GDP in 2005 = P2004*Q2005 GDP Deflator =P2005/P2004 CPI A price index computed each month by the State Institute of Statistics in Turkey using a bundle that is meant to represent the market basket purchased monthly by the typical urban consumer.

Calculation of CPI in 2004, Assume that the consumption basket includes 5 basket of apples & 2 oranges a month where 2002 is the base year.

GDP Deflator and CPI are ratios of price levels. What is the difference? GDP deflator reflects the prices of all goods and services produced domestically, while CPI concerns all products.

Gross National Product (GNP)(Gayri Safi Milli HASILA)

GDP is the sum of all incomes of residents of an economy as a result of domestic activities. In an open economy, there will be residents earning income as a result of providing services to nonresidents. Consider a Turkish construction firm undertake construction in Russia owners earn profits and their workers receive wages these profits and wages are called as factor income not included in GDP
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 We define Net Factor Incomes from Abroad (NFI)

NFI = Factor income from abroad by residents - Factor Income paid to nonresidents

The major positive item of NFI in Turkey is the income of workers especially in Germany.

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 Given the NFI, the total income earned by citizens of a country is GNP,

GNP= GDP+NFI

Sum of domestically earned income and net factor incomes from abroad

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 Example:

Consider Honda factory that is operated in United States.

Honda corporation is a Japanese firm The wage of US workers will be counted in US GDP The profit of the company will be counted in Japanese GNP, not in Japanese GDP Because the profit is not earned in Japan.

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Disposable Income and Saving

Disposable Income is the income that is available to the whole economy for spending on final goods and services.

Disposable Income (Y) = GNP + Net Transfers

Net Transfers:

Net Transfers = Transfers Received Transfer Payments (Aid received by Turkey) (Aid sent by Turkey)
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 Disposable income (Y) can either be consumed or saved, Y = Consumption + Saving

Distinguishing savings and consumptions between government (Sg and Cg) and private (S and C), we have: Y = C +Cg +S + Sg

We can also divide the Total Disposable Income (Y) as Public Disposable Income (T) and Private Disposable Income (Yd): Y = Yd + T

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Aggregate Expenditure and Equilibrium Output

A Basic Model

Closed economy no transactions between residents and non-residents

No government no taxes or public expenditures

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 Due to the closed form GDP=GNP=Y Net Factor Income = 0 Net Transfers = 0

Due to the absence of the government AE = C + I G= 0, X-M=0 T=0, Y=Yd Y= Yd = C + S So, income not spent on consumption is spent on saving.
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Consumption Function

C=C(Y)=C0+cY Consumption depends on the level of income (Y) C0 is called as autonomous consumption, which shows the minimum amount of consumption c, the slope term of the consumption function, is called as marginal propensity to consume (MPC), c=MPC=C/ Y Obviously, c is always positive and less than 1.

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 Example The aggregate consumption function is C = 100 + 0.75Y

At a national income of zero, consumption is $100. For every $100 increase in income (Y), consumption rises by $75.
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Saving Function

As we know, S =Y C, so S(Y)=Y - C(Y) S(Y)=Y (C0+cY) S(Y)= C0 +(1-c)Y = C0 +sY , s=1-c

C0 = autonomous saving If your income is too low to meet basic needs, then you need to use your previous savings. s is called as marginal propensity to save(MPS), s=MPS=S/ Y
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 Since s=1-c, MPC+MPS=1 For example, if MPC = 0.6, then 60 cents of each additional dollar are consumed and 40 cents (MPS = .4) are saved.

Derivation of the aggregate saving function

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 C = 100 + 0.75Y, S=Y-C

AGGREGATE INCOME, Y AGGREGATE CONSUMPTION, C AGGREGATE SAVING, S

0 80 100 200 400 400 800 1,000

100 160 175 250 400 550 700 850

-100 -80 -75 -50 0 50 100 150

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 Given these, we can define desired aggregate expenditure, AE(Y) is

AE (Y ) C (Y )

I0
planned Investment

C0 I 0 cY

I0 is the desired or planned investment refers to the additions to capital stock that are planned by firms.

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 Throughout this chapter, we will assume that planned investment is fixed. It does not change when income changes.

When a variable, such as planned investment, is assumed not to depend on the state of the economy, it is said to be an autonomous variable.

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 Graphical analysis for the desired (planned) AE

Planned AE is found by adding consumption spending (C) to planned investment spending (I) at every level of income.
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Determination of Equilibrium

The economy is in equilibrium when Aggregate Income (output) (Y)= Planned AE

Given that AE = C + I0 , the equilibrium condition Y =AE Y= C + I0 So, the economy is out of equilibrium Y > AE Y < AE

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 Y > C + I0 Aggregate output > planned aggregate expenditure Unsold output will go to the stocks of the firms Actual investment is greater than planned investment.

Y < C + I0 Aggregate output < planned aggregate expenditure Some part of the stocks of firms will be sold There occurs unplanned disinvestment Actual investment is less than planned investment.

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 Lets see these concepts on a schedule. C=100+0.75Y, I0 =25

(1)
AGGREGATE OUTPUT (INCOME) (Y) (Y

(2)
AGGREGATE CONSUMPTION (C) (C

(3)
PLANNED INVESTMENT

(4)
PLANNED AGGREGATE EXPENDITURE (AE) (AE) C+I

(5)
UNPLANNED INVENTORY CHANGE Y (C + I)

(6)
EQUILIBRIUM? (Y = AE?) AE?)

100 200 400 500 600 800 1,000

175 250 400 475 550 700 850

25 25 25 25 25 25 25

200 275 425 500 575 725 875

100 75 25 0 + 25 + 75 + 125

No No No Yes No No No
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Saving/ Investment Approach to Equilibrium

Given that AE = C + I0 and Y = C +S At the equilibrium S(Y)= C0 +sY = I0

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The Multiplier

The multiplier of autonomous investment describes the impact of an increase in planned investment on equilibrium income.

An increase in planned investment causes output (income) to go up.

People earn more income, consume some of it, and save the rest.

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 How do we find the multiplier?

We know that the marginal propensity to save is

MPS

S Y

For equilibrium, S= I

MPS

I Y 1 MPS
Y 1 1 I MPS 1 MPC
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Y I

The multiplier is equal to

 Example: C=10+0.8Y I0=30 Given these information AE= 10+0.8Y+30=40+0.8Y For the equilibrium AE=Y 40+0.8Y=YY*=200 Or, S=I0 S=-10+0.2Y=I0 -10+0.2Y=30 Y*=200 MPS=0.2, Multiplier= 1/MPS=5

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 Suppose that I1=40 I=40-30=10

Y*= Multiplier. I =5.10=50

So, the new equilibrium income is 200+50=250

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