1. Introduction to macroeconomics

Question 1

What is macroeconomics?

Answer 1

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

Question 2

Macroeconomic issues

Answer 2

Output
Economic growth
Inflation
Unemployment

These are areas of interest of the economist but also of the policymaker

Question 3

Output

Answer 3

Sum of all production

Question 4

Economic growth

Answer 4

The change in production

Question 5

Unemployment rate

Answer 5

Percentage of the workforce without work

Question 6

Inflation rate

Answer 6

Measures the change in the cost of living

Difficult to measure - we cannot keep track of the changes in all prices all the time

Question 7

International trade

Answer 7

The exchange of products to and from aboard

Question 8

Aggregated variable

Answer 8

Average value

Question 9

Time series data

Answer 9

Time series data is a collection of observations obtained through repeated measurements over time
Can be useful for tracking changes in GDP over time

Question 10

Preliminary data analysis

Answer 10

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

Question 11

Economic modelling

Answer 11

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

Question 12

Schedule

Answer 12

A line or curve in an economic module
Reflects the behaviour of an agent inside the model

Question 13

Equilibrium

Answer 13

A specific state where the agents of a model share the same behaviour in terms of the variable of interest

Question 14

Exogenous changes

Answer 14

Changes that happen outside of the model

Question 15

GDP

Answer 15

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

Question 16

Nominal GDP

Answer 16

Sum of production using current quantities and current prices
Can change if quantities or prices change

Question 17

Real GDP

Answer 17

Sum of production holding prices constant at some base year

Changes only if quantities change

Question 18

GDP deflator

Answer 18

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

Question 19

Consumer Price Index (CPI)

Answer 19

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

Question 20

Retail Price Index (RPI)

Answer 20

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

Question 21

Money

Answer 21

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

Question 22

Economic Policy

Answer 22

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

Question 23

Balance of Payment

Answer 23

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)

Question 24

What does macroeconomics try to answer?

Answer 24

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?

Question 25

Mathematical models

Answer 25

Help measure the success of models

Make quantifiable predictions

Question 26

Schools of thought

Answer 26

Classical Macroeconomics: completely against intervention by policymakers - belief in flexible prices
Keynesian Economics: Sticky prices, argues the effectiveness of fiscal and monetary policies

Question 27

Elements of mathematical models

Answer 27

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

Question 28

Fiscal policy

Answer 28

Refers to the use of government spending and tax policies to influence economic conditions

Question 29

Monetary policy

Answer 29

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

Question 30

Quantitative easing

Answer 30

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

Question 31

Problems with aggregation

Answer 31

Information loss

Only includes ‘average’ of all agents - does not take into account differences between all these agents

Question 32

What is the purpose of the error term in an economic equation?

Answer 32

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

Question 33

Crowding out effect

Answer 33

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

Question 34

Economic stimulus

Answer 34

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

Question 35

Monetary transmission mechanism

Answer 35

Process by which asset prices and general economic conditions are affected as a result of monetary policy decisions

Question 36

Closed economy

Answer 36

A closed economy is one that has no trading activity with outside economies
Entirely self-sufficient
No imports or exports

Question 37

Open economy

Answer 37

An economy that interacts freely with other economies

A percentage of its goods and services are traded internationally

Question 38

growth rate

Answer 38

quarterly change in GDP

Question 39

models

Answer 39

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