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Introduction
The macroeconomic approach
National accounting
Organisation of the semester

Same organisation as last term:
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Same marking system for the seminars
Same split on conference mark / final exam
The exam will have the same format:
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Multiple choice
Questions on lecture material
2 Exercises
Organisation of the semester
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Seminar marks will be the same
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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
Organisation of the semester

Part 1 : Equilibrium in the goods and money
market
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Part 2 : Relaxing the fixed price hypothesis
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Weeks 2-6
Weeks 7-10
Part 3 : Extending the model : international
trade and growth
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Weeks 11-12
Macroeconomic questions
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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?
Introduction
The Macroeconomic approach
Gross domestic product
The rate of inflation
The macroeconomic approach

The Macro approach is different than the
micro approach

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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:
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Micro looks to understand the decision process
of individual agents
Macro looks to understand the flows of goods
and services in the economic circuit
The macroeconomic approach

So macro still uses models and maths, but
not in the same way as micro:
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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.
The macroeconomic approach
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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 :

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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
The macroeconomic approach

Modelling
strategy
Keynesian
Equilibrium
Money market
equilibrium
IS Curve
LM Curve
Labour market
Equilibrium
IS-LM model
Aggregate supply
curve
Aggregate
demand curve
Model of
macroeconomic
fluctuations
Introduction
The Macroeconomic approach
Gross domestic product
The rate of inflation
Gross Domestic Product
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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
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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
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
GDP  C  I  G   X  M 
Gross Domestic Product
109×€
Per Cap. €
1 950.1
25 210.2
1 565.7
22 696.7
1 086.8
17 499,1
427.2
6 878,6
345.5
5 563,1
5.3
85,3
514.0
8 276,2
-48.2
-776,1
Exports
515,6
8 302,0
Imports
563,8
9 078,0
Gross Domestic Product (2008)
Consumption
Final consumption expenditure of households
Investment
Gross formation of fixed capital (households and firms)
Changes in Inventory
Public expenditure
Final consumption expenditure of public admin.
Net Exports
Sources: Comptes nationaux INSEE 2008
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)
Gross Domestic Product
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GDP also measures the value produced
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Two equivalent methods exist
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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.
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
Gross Domestic Product

Example: an economy has produced 4
apples and 3 oranges during the year
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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€
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GDP = (0,5€ × 4) + (1€ × 3)
GDP = 5 €
Gross Domestic Product

The general formula for year t is:

 


 

nominal
Apples
Apples
Oranges
Oranges
GDP2007
 P2007
 Q2007
 P2007
 Q2007
nominal
Apples
Apples
Oranges
Oranges
GDP2008
 P2008
 Q2008
 P2008
 Q2008
GDPt
nominal

  Pt  Q
i
i
i
t

Gross Domestic Product
Gross Domestic Product

GDP is used to measure the overall level of
economic activity in a country
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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)
Gross Domestic Product

However, nominal GDP can change for two
reasons
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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.
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That way GDP is measured in constant €s
Application of “Ceteris Paribus”
Gross Domestic Product
Real GDP is always expressed with respect to an
arbitrarily chosen base year

 


 

real,base 2000
Apples
Apples
Oranges
Oranges
GDP2007
 P2000
 Q2007
 P2000
 Q2007
real,base 2000
Apples
Apples
Oranges
Oranges
GDP2008
 P2000
 Q2008
 P2000
 Q2008

i
GDPt real   Pbase
 Qti
i

Gross Domestic Product
real,base 2000
GDP2000
?

 
real,base 2000
Apples
Apples
Oranges
Oranges
GDP2000
 P2000
 Q2000
 P2000
 Q2000
real,base 2000
nominal
GDP2000
 GDP2000

Gross Domestic Product
Gross Domestic Product
Real GDP is usually calculated by using a deflator on
Nominal GDP
GDP Deflator
GDP Deflator
base
t
Nominal GDPt

Real GDPtbase
base 2000
2008

P

P
Apples
2008
Apples
2000
 P  Q 

 P  Q 
i
t
GDP Deflator tbase
 
 
Apples
Oranges
Oranges
 Q2008
 P2008
 Q2008
Apples
Oranges
Oranges
 Q2008
 P2000
 Q2008
i
t
i
i
base
i
i
t


Gross Domestic Product
By construction, the GDP
deflator is always equal
to one for the base year.
Introduction
The Macroeconomic approach
Gross domestic product
The rate of inflation
The rate of inflation

The most well known measure of prices is
the Consumer Price Index (CPI)
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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”
The rate of inflation
o CPI in 2008 based on a basket of 3 apples
and 2 oranges in 2000 (base year)
CPI
base 2000
2008
CPI
base 2000
2008

P

P
Apples
Oranges
Oranges
 Q2002
 P2008
 Q2002
Apples
Oranges
Oranges
 Q2002
 P2002
 Q2002
P

P
Oranges
 3  P2008
2
Oranges
 3  P2002
2
Apples
2008
Apples
2002
Apples
2008
Apples
2002
 
 
 P  Q 

 P  Q 
i
t
CPItbase
 
 
i
base
i
i
base
i
i
base

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
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Creation of the Euro
Disinflation policy
Second Oil shock
First Oil Shock
The rate of inflation
CPI Inflation in France
The rate of inflation
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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
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... 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.
The rate of inflation
 P  Q 
Laspeyres index CPI 
 P  Q 
 P  Q 
Paasche index GDP Deflator

 P  Q 
i
i
base
t
base
t
i
i
base
i
base
i
i
t
base
t
i
t
i
i
base
i
i
t
The rate of inflation
CPI and GDP deflator for France