1. Introduction to macroeconomics Flashcards
What is macroeconomics?
The study of the economy as a whole
Concerned with the aggregated economy
Macroeconomics gives us the tools to understand how changes in the macro variables occur and how they impact the fabric of society
Macroeconomic issues
Output
Economic growth
Inflation
Unemployment
These are areas of interest of the economist but also of the policymaker
Output
Sum of all production
Economic growth
The change in production
Unemployment rate
Percentage of the workforce without work
Inflation rate
Measures the change in the cost of living
Difficult to measure - we cannot keep track of the changes in all prices all the time
International trade
The exchange of products to and from aboard
Aggregated variable
Average value
Time series data
Time series data is a collection of observations obtained through repeated measurements over time
Can be useful for tracking changes in GDP over time
Preliminary data analysis
An analysis that comes from the observation of a basic presentation of economic data
Can be in the form of summary statistics or from the profiles and directions of the times series data itself
Economic modelling
A simplification of the economy that we use to explain economic linkages
Helps predict reaction of economy to shocks and economic policy
Include certain assumptions we must make
Models assume that all other factors outside of our analysis remain constant (ceteris paribus)
Models are considered static - they do not account for changes in time
Come in the forms of words, mathematical equations, or diagrams
Schedule
A line or curve in an economic module Reflects the behaviour of an agent inside the model
Equilibrium
A specific state where the agents of a model share the same behaviour in terms of the variable of interest
Exogenous changes
Changes that happen outside of the model
GDP
Output method: Sum of all production in economy - final goods or added value
Income method: Sum of income including wages for workers and dividends for shareholders
Expenditure method: Sum of all money spent in the economy - can be split into different components
Nominal GDP
Sum of production using current quantities and current prices
Can change if quantities or prices change
Real GDP
Sum of production holding prices constant at some base year
Changes only if quantities change
GDP deflator
Measure of inflation
Measure of the level of prices of all new, domestically produced final goods and services in an economy in a year
Takes into account ALL goods (food, clothes, military weapons…)
Calculated by dividing Nominal GDP by Real GDP
Weights can change in the GDP deflator - the composition of the basket of goods can change over time
Issue is it does not account for imported goods purchased by consumers
Consumer Price Index (CPI)
Weighted average of prices faced by consumers (does not include housing costs)
Uses a fixed basket of goods - we look at the change in prices of the goods over a period of time
ONLY includes goods that a consumer would purchase
Weights are fixed for prices of different goods
Retail Price Index (RPI)
Measures the change in the cost of a representative sample of goods and services
Uses a basket of goods like CPI but more directed towards families
Includes housing costs - reason it is often higher than CPI
Money
Any item or verifiable record that is generally accepted as a means of payment for goods and services
Money can be an asset and a liability at the same time
Economic Policy
An economic policy is a course of action that is intended to influence or control the behaviour of the economy.
Implemented and administered by the government
Balance of Payment
Records international flows of money and goods (like a balance sheet)
Current accounts and Financial accounts should balance out - be equal
-inflows (+ve)
-outflows (-ve)
- goods exported out (+ve)
-goods in (-ve)
What does macroeconomics try to answer?
Why some countries grow faster than others?
Why some countries experience high inflation while others keep prices
stable?
Why all countries experience recessions - periods of falling incomes and
rising unemployment?
Mathematical models
Help measure the success of models
Make quantifiable predictions
Schools of thought
Classical Macroeconomics: completely against intervention by policymakers - belief in flexible prices
Keynesian Economics: Sticky prices, argues the effectiveness of fiscal and monetary policies
Elements of mathematical models
1) One type of error term: the connection between our model and reality (distance between our models results and the data)
2) Two types of variables: the exogenous (predetermined) and the endogenous (determined).
3) Three types of equations: behavioural equations, equilibrium conditions and identities
Fiscal policy
Refers to the use of government spending and tax policies to influence economic conditions
Monetary policy
Control of the quantity of money available in the economy and the channels by which money is supplied
Controlled by the Central bank NOT government
Aims:
Maximum employment
Stable prices
Moderate long-term interest rates
Quantitative easing
Monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money
Aim is to expand economic activity
Problems with aggregation
Information loss
Only includes ‘average’ of all agents - does not take into account differences between all these agents
What is the purpose of the error term in an economic equation?
Exactly measures the difference between what is predicted (the fitted value) and the reality (the observed value) in a model
Error term completes the model
Crowding out effect
Theory that rising public sector spending leads to a decrease or possible elimination of private sector spending
Example: Large governments increasing borrowing is the most common form of crowding out as it leads to an increase in interest rate
Economic stimulus
Action by the government to encourage private sector economic activity by engaging in targeted monetary or fiscal policy
Commonly employed during times of recession
Tools used to implement economic stimulus:
Lowering interest rate
Increasing government spending
Quantitative easing
Monetary transmission mechanism
Process by which asset prices and general economic conditions are affected as a result of monetary policy decisions
Closed economy
A closed economy is one that has no trading activity with outside economies
Entirely self-sufficient
No imports or exports
Open economy
An economy that interacts freely with other economies
A percentage of its goods and services are traded internationally
growth rate
quarterly change in GDP
models
Can be written in words or represented mathematically
Has simplifying assumptions - e.g. number of representative agents
Used to predict the reaction of the economy to shocks and policy
