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Second Part Macroeconomics Lecture 7 Macroeconomic Aggregates.

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1 Second Part Macroeconomics Lecture 7 Macroeconomic Aggregates

2 Macroeconomics Macroeconomics is the field of economics that studies the behaviour of the economy as a whole. It is the study of aggregate measures of the economy and this aggregation is done by understanding how individual economic units function. So it deals with the issues like growth, inflation, unemployment etc. Macroeconomics can be best understood by comparing it with microeconomics which considers the decisions made at an individual or firm level. Macroeconomics considers the larger picture, or how all of these decisions sum together. An understanding of microeconomics is crucial to understand macroeconomics. To understand why a change in interest rates leads to changes in real GDP, we need to understand how lower interest rates influence decisions, such as the decision of how much to save, at the firm or household level. Once we understand how an individual, on average, will change their behaviour we will then understand the large scale relationships in an economy. Examples of macroeconomic aggregate are GDP, GNP, CPI, inflation etc.

3 Economic Agent In economics, an agent is a decision maker in a model. Every agent takes part in transaction with another agent. In microeconomics there are two agents: a)Consumer / Buyer/Household b) Producer / Seller/Firm In macroeconomics there are four agents: a)Consumers/Households b) Producers/Firms c) Government d) Foreign Country

4 Factor MARKET BUSINESS FIRMS PRODUCT MARKET HOUSEHOLDS Circular flow model (A Simple Model of Economic Interaction)

5 GDP Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a country in a given period of time. Breaking down the definition: GDP is the Market Value... - Output is valued at market prices.... Of All Final... -Records only the value of final goods, not intermediate goods (as value is counted only once).... Goods and Services Goods and Services... - Includes both tangible goods (food, clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

6 ... Produced... – Includes goods and services currently produced, not transactions involving goods produced in past (Used goods)... Within a Country... – Measures the value of production within the geographic confines of a country.... In a Given Period of Time. – Measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

7 Calculating GDP Suppose there are two goods in the economy. For example: Rice and Wheat Formula is GDP= ( Price of Rice X Quantity of Rice) + ( Price of Wheat X Quantity of Wheat) Here we can use either current price or base price.

8 REAL VERSUS NOMINAL GDP Depending on which price we are using in GDP calculation we can make two classification of GDP. Nominal GDP and Real GDP 1) Nominal GDP values the production of goods and services at current prices. 2) Real GDP values the production of goods and services at constant prices.

9 Dr. Aminul I AkandaSource: books and web materials Table: Real and Nominal GDP

10 Gross national product (GNP): If we add receipts of factor income (wages, profit, rent and interest) and grant/aid from the rest of the world and subtract payments of factor income and grant/aid to the rest of the world from GDP then we get GNP. GNP = GDP + Factor Payments from Abroad + aid received from Abroad - Factor Payments to Abroad - aid given to Abroad GDP VERSUS GNP Whereas GDP measures the total income domestically, GNP measures the total income earned by nationals. Question: What are the other differences between GDP and GNP? Gross national product (GNP):

11 Price Index: GDP Deflator and CPI Price Index is a measure of the economy's price level or a cost of living. Most popular price index: 1) GDP Deflator 2) Consumer Price Index (CPI)

12 GDP Deflator It shows the state of overall level of prices in the economy. It is also known as implicit price deflator. The GDP deflator is calculated from the ratio of nominal GDP to real GDP for same year times 100. GDP Deflator= (Nominal GDP)/(Real GDP) X 100

13 CPI ( Consumer Price Index) A consumer price index (CPI) is price index that measures changes in the price level of consumer goods and services purchased by households. It is used to monitor changes in the cost of living over time by a typical household When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living.

14 Fix the Basket: Determine what goods and services are most important to the typical consumer. – So first identify a basket of goods and services that a typical consumer buys. – Then through a survey identify the amount of these goods and services consumed by the typical consumer every month. How the Consumer Price Index Is Calculated

15 Example of a CPIs Basket? 16% Food and beverages 17% Transportation Medical care 6% Recreation 6% Apparel 4% Other goods and services 4% 41% Housing 6% Education and communication

16 How the Consumer Price Index Is Calculated Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. Compute the Baskets Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.

17 How the Consumer Price Index Is Calculated Choose a Base Year and Compute the Index: Choose a Base Year and Compute the Index: – Designate one year as the base year, making it the benchmark against which other years are compared. – Compute the index by dividing the cost of the basket in one year by the cost of that basket in the base year and multiplying by 100.

18 Calculating CPI Formula: CPI = (Total cost of a bundle of goods or service at current price)/ ( Total cost of a bundle of goods or service at base price)X 100 Example: Suppose a typical household consumes 30kg rice and 20 kg flour in a month. So the basket of goods is consisted of rice and flour. The quantity of rice and flour will be held constant across years. In this case CPI =

19 Table 1 Calculating the Consumer Price Index and the Inflation Rate: An Example


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