EC 2113 

What is macroeconomics?

Principals of Macroeconomics with Dr. Lozano

Exam Two Study Guide

10/27/15

Ch. 7 ­ The Basics of Macroeconomics 

● Macroeconomics ­ the part of economics concerned with large­scale or general economic factors, such as interest rates and national productivity. 

○ Main Factors ­ The main three factors of Macroeconomic study are GDP (Gross­Domestic Product), Inflation, and Unemployment. 

■ GDP 

● The GDP is a measure of total expenditure in an economy. Essentially it is how 

much money people have spent on every product that an economy produces. 

The GDP at its most basic is a multiplication problem: the amount of final goods 

sold multiplied by their price. Their price is referred to as market value. GDP is 

measured regularly, be it yearly or quarterly (3­months) as it projects economic 

growth and decline in a nation. 

What is inflation rate?

○ Final Goods ­ The goods which are intended for the last user. Example: 

A tire sold to a car manufacturer is a component of those cars, as such 

it is not a final good, instead it is called an intermediate good. A tire 

used to replace a busted one is a final good because the car owner is 

the one actually using it. 

○ Restrictions 

■ Things without market value, such as doing your own 

housekeeping, are excluded from measurement. 

■ Illegal commodities are also excluded. 

● Determining the Final Price of a Final Good

What is unemployment?

● The New Circular Flow of the GDP 

○ When looking at the GDP, there is a new Circular Flow model that must If you want to learn more check out What are the major differences between how white and red wines are made?

be discussed. This model adds the Government, the Financial Market, 

and all other Economies. 

○ Using this model there is a way to calculate the GDP of an economy 

using this equation: GDP = C + I + G + NX.​Wherein: 

■ C = the total spending by households on goods and services. 

For renters this includes rent payments, for homeowners this 

includes rent payments paid to the homeowner but not the 

purchase price or the mortgage. 

■ I = Machinery, Structures, Inventories. The total spending on 

goods that make other goods. 

■ G = Government Purchases and Sales excluding transfer 

payments (such as Social Security). 

■ NX = Exports 

● 

Two Approaches To GDP

Expenditure/Output Approach 

Income/Allocations Approach

Consumption by Households 

+

Investment By Businesses 

+ Don't forget about the age old question of Who is the Belgian chemist and alchemist that weighed a growing plant to determine where the growth was coming from?

Government Purchases 

+

Expenditures by Foreigners

Wages 

+

Rent 

+

Interest 

+

Profit 

+

Statistical Adjustments

● Nominal vs. Real GDP and the GDP Deflator 

○ GDP is a dollar measurement, which presents some problems. 

○ Nominal ­ A GDP measurement based on the prices that prevailed 

when output was produced

○ Real ­ A GDP measurement based on a base year price and reflects We also discuss several other topics like What is carrying capacity and how is it related to popula2on growth?

changes in price level. 

○ Example: 

■ 

Pizza 

Lattes 

Nominal 

GDP

Real 

GDP

GDP 

Deflator

Inflation

Year 

Price 

Quantit 

y

Price 

Quantity

2011 

$10 

400 

$2 

1000 

$6000 

$6000 

100.0% 

0.00%

2012 

$11 

500 

$2.50 

1100 

$8250 

$7200 

114.6% 

14.6%

2013 

$12 

600 

$3 

1200 

$10,800 

$8400 

128.6% 

12.0%

■ Nominal GDP is Price of that year times the Quantity of that 

year​. 

■ Real GDP is Price of the base year (2011) times the 

Quantity of that year. 

■ GDP Deflator ­ ( Nominal GDP / Real GDP ) * 100. The GDP 

Deflator show the average increase in price between two 

times. The difference between two Deflator values is the value 

of inflation. 

○ Shortcomings of GDP 

■ Nonmarket Activities and the Underground Economy are not 

counted. 

■ Improved Product Quality ­ the increase in price may not be 

due to inflation but product quality increased. 

■ Composition and Distribution of the Output/Income 

Distribution­ GDP does not reflect who gets most of the wealth 

because it assumes equal distribution, which is impossible. 

■ Noneconomic Sources of Well­Being ­ Other things that don't If you want to learn more check out How does Baraka contrasts classic blues from country blues?

have to be paid for that offer payment in happiness. 

○ Institutional Structures of GDP 

■ Needed for a High GDP ­ Strong property rights, Patents and 

Copyrights, Efficient Financial Institutions, Free Trade, 

Competitive Market System. 

■ General Trends of High GDP ­ Literacy and Widespread 

Education, Life Expectancy. 

○ Factors Affecting Productivity and GDP Growth ­ with the percentage of times an increase has been because of them. 

■ Technological Advancement (40%) 

■ Quantity of Capital (30%) 

■ Education and Training (15%) 

■ Economies of Scale and Resource Allocation (15%) 

○ Positive and Negative Views of Economic (GDP) Growth 

■ Positive 

● Greater Material Abundance, Increased Standards of 

Living. Leisure Time, Expansion and Application of 

Human Knowledge. 

■ Negative

● Larger economies use up more resources and 

damage the environment more. This is due to the rule 

that growth in Economies increases competition for 

resources. 

■ Inflation Rate ­ The rate of Inflation is the average percentage price increase between two years. It has an equation in the form of [(CPI Year 2 ­ CPI Year 1)/CPI Year 1] X 100 ● CPI ­ Consumer Price Index

○ Measures the typical consumer’s cost of living. It is the basis of Cost of Living Adjustments (COLAs) in many contracts and Social Security We also discuss several other topics like What is Biological (physical) anthropology ?

benefits.

○ Calculation

■ Fix the “basket” ­ The Bureau of Labor and Statistics uses

surveys to determine what the typical consumer buys and sets

up a “basket” of items and services that are bought.

■ Find the prices of the items in the “basket.”

■ Multiply the prices to the amounts to find the total cost of the

basket.

■ Choose base year and compute the index: (Cost in Current

Year/Cost in Base Year) X 100

■ This value, which is the CPI, can be used to find the Inflation

rate in a given year.

○ Example:

■ Assume the Typical Basket is 4 Pizzas and 10 Lattes.

Year 

Price 

of 

Pizza

Price 

of 

Latte

Basket 

Cost

CPI 

Inflation Rate

2010

10

2

60

100 x (60/60) We also discuss several other topics like In what ways did the 1920s represent both a loosening of social mores and a rise of social conservatism?

= 100

(100­100) / 100 = 0

2011

11

2.50

69

100 x (69/60)

= 115

(115­100) / 100 = 15

2012

12

3

78

100 x (78/60)

= 130

(130­115) / 115 = 13

○ Problems with CPI ­ It is not a perfect measurement.

■ Over time some prices increase faster than others.

■ Consumers substitute higher priced goods for ones that

become relatively cheaper, which mitigates the price increase

effect. CPI calculation misses this because the basket is fixed

for a number of years because it is difficult for the BLS to do its

data collection.

■ Increases in the CPI tend to overstate increases in the cost of

living.

○ Contrasts Between CPI and the GDP Deflator

■ Imported Goods ­ CPI does use​, GDP Deflator does not use​.

■ Capital Goods ­ CPI does not use​, GDP Deflator does use.

■ The Basket ­ CPI has a fixed basket​, GDP Deflator uses

current production.

○ Correcting Variables for Inflation ­ Comparing Money Figures for

Different Times

■ Ex: Minimum Wage ­ Did the minimum wage have more

purchasing power then or now?

● 1964 ­ $1.15, 2010 ­ $7.25

● To compare, use CPI to convert ‘64 $ to ‘10 $

○ $ in Today = $ in Year T x (CPI Today/CPI

Year T)

○ $8.09 = $1.15 x (220.3/31.3) Where the CPI

in 2010 is 220.3 and the CPI in 1964 is 31.3

■ Purpose: Indexation ­ a $ amount is indexed for inflation and is

auto corrected for inflation either by law or in a contract.

■ Inflation is a general increase in prices and fall in the 

purchasing value of money. 

● Income Distribution 

● Administrative Inefficiencies 

● Effects on Creditors and Debtors 

○ Real vs. Nominal Interest Rates 

■ Real Interest Rate: Nominal Rate ­ 

Inflation Rate 

■ Ex: A $1000 loan with a 9% Interest 

Rate and 3.5% Inflation Rate 

■ Real Interest rate is 5.5%. The 

higher the Rate of Inflation in 

comparison to the Interest Rate, the 

more the situation favors the debtor 

instead of the creditor. If the 

Interest Rate was 3.5% and the 

Inflation Rate was 9% then the Real 

Interest Rate would be ­5.5%, 

which means that in effect the 

debtor will pay less than the loan 

back. 

■ Unemployment 

● Labor Force: The adult population excluding Elderly, Severely Disabled, Hospitalized, Jailed, Military, and Full­Time Students. It includes both the Employed and Unemployed. 

○ Labor Force Participation Rate: 100 x (labor force/adult population) ● Unemployed: The portion of the population that is searching for work but does not have it. 

○ Unemployment Rate: 100 x (# of unemployed/labor force) 

● Duration of Unemployment: 

○ Typically ⅓ for under 5 weeks, the other ⅔ for under 14 weeks. 

○ Usually only 20% of unemployed are so for over 6 months. 

○ Most observed unemployment is long­term. The small group that is long­term has fairly little turnover. 

● Natural Rate of Unemployment: The normal rate around which the actual fluctuates. Frictional + Structural. ​Cyclical Unemployment is the deviation from the Normal Rate and is parallel with business cycle. 

○ Frictional ­ Occurs when workers spend time searching for the job best suited to their skills. 

○ Structural ­ Occurs when there are fewer jobs than workers.

● Sectoral Shifts ­ Changes in the composition of Labor Demand (what types of workers are more desirable/needed than others). This contributes to Frictional and is normal. 

● Labor Force Statistics 

○ Produced by the BLS, based on a regular survey of 60,000 households and an “adult population” that begins with age 16. 

● Issues with Unemployment Rate 

○ Doesn’t show the Discouraged Worker Stat or the Downgrading Stat (employees with higher education forced into lower level jobs by 

circumstance). 

● Government Assistance 

○ Government Employment Agencies that provide information about jobs. ○ Public Training Programs to train workers for specific tradeskill jobs. ○ Unemployment Insurance that protects workers income for a set time period. 

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