Introduction

1. Introduction The macroeconomic approach National accounting

2. Organisation of the semester • Same organisation as last term: • Same marking system for the seminars • Same split on conference mark / final exam • The exam will have the same format: • Multiple choice • Questions on lecture material • 2 Exercises

3. Organisation of the semester • Seminar marks will be the same • 2 class tests counting for 50% • Exercise mark counting for 30% • Attendance and participation for 20% • As for last term, you are free to hand in your work when you wish. • The exercise mark is the average of the best 6 marks

4. Organisation of the semester • Part 1 : Equilibrium in the goods and money market • Weeks 2-6 • Part 2 : Relaxing the fixed price hypothesis • Weeks 7-10 • Part 3 : Extending the model : international trade and growth • Weeks 11-12

5. Macroeconomic questions • Why are incomes higher today than in 1950 ? • Why do certain countries have high rates of inflation? • Is money neutral or can it influence economic activity? • What causes recessions ? • How can public intervention reduce the size and duration of unemployment ? • How can public intervention increase the well-being of the population?

6. Introduction The Macroeconomic approach Gross domestic product The rate of inflation

7. The macroeconomic approach • The Macro approach is different than the micro approach • It’s not just a question of scale: macro can look at individual markets, micro can involve “general equilibrium” analysis • It’s more a question of the methodology used: • Micro looks to understand the decision process of individual agents • Macro looks to understand the flows of goods and services in the economic circuit

8. The macroeconomic approach • So macro still uses models and maths, but not in the same way as micro: • In particular, Keynesian macroeconomics has no optimisation behaviour. • This is actually a criticism that was made in the 70’s, (Lucas critique): macroeconomic knowledge is not supported by individual decision making. • As a result, more modern approaches (like “rational expectations”) are micro founded, so they do have optimising behaviour as well.

9. The macroeconomic approach • The aim is to understand the behaviour of certain aggregate variables : income, prices, unemployment, etc. • The main approach is to solve a system of equations : • An equation needs to be provided for each variable to be explained. • Each “equation” is provided by a market equilibrium condition. • You need as many markets as variables to solve for the equilibrium

10. The macroeconomic approach • Modelling strategy Money market equilibrium Keynesian Equilibrium IS Curve LM Curve Labour market Equilibrium IS-LM model Aggregate supply curve Aggregate demand curve Model of macroeconomic fluctuations

11. Introduction The Macroeconomic approach Gross domestic product The rate of inflation

12. Gross Domestic Product • GDP allows us to evaluate, with a single number the market value of economic activity • This is possible because of the existence of accounting identities, which underpin national accounting • Each transaction has a seller and a buyer so we have ⇒ Income = Expenditure • GDP is equal to the sum of all the incomes paid to members of an economy • GDP is also equal to the sum of all the expenditures on the goods and services produced by this economy

13. Gross Domestic Product Expenditure can be broken down into: C Consumption : Durable goods, non durables, services I Investment : Fixed capital formation, non residential & residential, G Public expenditure : Goods and services purchased by the administrations (X-M ): Net value of exchange with the rest of the world

14. Gross Domestic Product

15. Gross Domestic Product A few national accounting identities: GNP: Gross National Product = GDP + factor incomes from the rest of the world - factor incomes paid to rest of the world NNP: Net National Product = GNP - depreciation NI: National Income = NNP – Indirect taxes on productions (VAT)

16. Gross Domestic Product • GDP also measures the value produced • This is because the value of a good is conserved in a transaction • Therefore GDP = sum of incomes = sum of expenditures = sum of value added produced. • Two equivalent methods exist • GDP is the value of the final outputs (difficult to calculate) • GDP is the sum of value added at each stage of production (the one used in practice) • GDP only measures the value produced in a given period (1 year), not in earlier periods

17. Gross Domestic Product • Example: an economy has produced 4 apples and 3 oranges during the year • These products are added, weighted by their respective market prices in order to obtain the market values • Imagine that apples are sold at 0.5€ and oranges are sold at 1€ • GDP = (0,5€ × 4) + (1€ × 3) • GDP = 5 €

18. Gross Domestic Product • The general formula for year t is:

19. Gross Domestic Product

20. Gross Domestic Product • GDP is used to measure the overall level of economic activity in a country • If GDP increases from year to year, then the economy is said to be experiencing growth • If GDP is falling from year to year, then the economy is said to be experiencing a recession (or a depression, for extended periods of time)

21. Gross Domestic Product • However, nominal GDP can change for two reasons • A change in the level of economic activity • A change in the level of prices • Therefore, before we are able to use GDP to measure changes in economic activity, we must make sure we use a single set of prices. • That way GDP is measured in constant €s • Application of “Ceteris Paribus”

22. Gross Domestic Product Real GDP is always expressed with respect to an arbitrarily chosen base year

23. Gross Domestic Product

24. Gross Domestic Product

25. Gross Domestic Product Real GDP is usually calculated by using a deflator on Nominal GDP

26. Gross Domestic Product By construction, the GDP deflator is always equal to one for the base year.

27. Introduction The Macroeconomic approach Gross domestic product The rate of inflation

28. The rate of inflation • The most well known measure of prices is the Consumer Price Index (CPI) • Inflation is a general increase in the level of prices (measured by the index) • To calculate the index, the prices of thousands of goods and services are collected • The CPI then aggregates these into a single measure of the level of prices • The prices are weighted by the shares of the various goods in the “representative basket”

29. The rate of inflation • CPI in 2008 based on a basket of 3 apples and 2 oranges in 2000 (base year)

30. First Oil Shock Second Oil shock Disinflation policy Creation of the Euro The rate of inflation CPI Inflation in France

31. The rate of inflation • Is the CPI the same as the GDP deflator ? • These indices are similar... • Both measure the level of prices • Both are based on a “basket” of goods • ... but not identical • The weights don’t change in the CPI, they do in the deflator • The baskets are different : the deflator includes all goods, the CPI consumer goods • The CPI includes imported goods, not the deflator • The methodology is not the same.

32. The rate of inflation

33. The rate of inflation CPI and GDP deflator for France