Advanced Macroeconomics

Marco Delogu
Macroeconomic Data and Economic Models: Intro
Introduction 2

1. Definition of Macroeconomics variables along with their

construction and properties
2. GDP: Gross Domestic Product
3. Real vs Nominal
4. Consumer Price index
5. What is an Economic Model
6. References:
I Garin, Lester and Sims , Intermediate Macroeconomics,
version 3.01 chapter 1 and 2, see link
GDP: Definition 3

GDP: Gross Domestic Product: is the current money

(dollars/euro) value of all Final goods and services that are
produced within a country within a given period of time.
1. Goods: are physical things that we consume (like a shirt)
while Services are things that we consume but which are not
necessarily tangible (like education).
2. Final: intermediate goods are excluded from the calculations.
Ex: (1) values of tires are subsumed in the value of newly
produced cars (2) replacement tires sold at an auto shop for an
already-owned car are included.
3. Current: means that the goods are valued at their current
period market prices
Important: Measure of the standard of living in an economy..
many issues, if we have time we will cover the Human
Development Index
GDP: Definition (2) 4

n
X
GDPt = p1,t y1,t + p2,t y2,t + ... + pn,t yn,t = pi,t yi,t
i=1

where i indexes the goods, t denotes time and p and y denote

price and quantities. As defined, GDP is a measure of total
production in a given period (say a year). It must also be
equal to the total income in a given period. Example: sale
price of goods is distributed as income: wages to labor, profits,
and interests to capital.
Expenditure Approach: measures GDP as the sum of
consumption C, Investment I, government expenditure G and
net exports N X = |{z} X − |{z}
IM
Exports Imports

GDPt = Ct + It + Gt + (Xt − IMt )

GDP: Definition (3) 5

I Agents: (1) Households (2) Firms, (3) Government, (4)

Rest of the World
I Aggregate expenditure is simply the sum of spending on
final goods of these actors.
I Total value of production must be equal to the total value
of expenditure
I Remark: Transfer payments not included in government
expenditure as they do not constitute expenditure in new
goods and services
I We subtract imports because the notion of GDP is the
value of goods produced within a country.. example: ↑ C
goes up but ↓ IM goes down for the same value.
I Caveats: (1) Investment in new housing (2) Inventory
investment
Fig (1): Log of Nominal GDP 6
Fig (2) GDP 7
Summary Figures 8

I US data.. benchmark of developed countries. Fig (1),

seasonnally adjusted and quarterly data from 1947-2015,
Fig (2) Components
I Figures in logs: interpret differences in logs as percentage
differences
I No correction for inflation, makes series smoother, growth
looks faster in the 1970 due to high inflation
I Consumption, 60 − 70%, Investment 15%, more volatile,
Government Expenditure 20%, spikes coincide with wars
Real vs Nominal 9

GDP varies because prices or quantities change. Welfare

standpoint: we would like to disregard the price changes.

What matters for well-being are quantities consumed!.

In principle real prices are denominated in units of goods, whereas

nominal prices are denominated in units of money. Money is
anything that serves as a unit of account.
Example: Assume that one good y, traded using money M which
serves as numeraire, unit of account. p the price tells us how many
units of M are needed for one unit of good. If y = 10, p = 1.5 then
nominal output is (1.5 ∗ 10) = 15, which is the nominal value. To get
the real value j divide for p and you get back 10. We are concerned
with real not nominal variables. We get utility on how much we
consume!

From nominal to real gets difficult with many goods.

Real vs Nominal: two goods 10

Suppose two goods and two prices. The nominal quantity is:

N ominal = p1 y1 + p2 y2

Relative Price: tells how many units of good 2 we obtain

leaving one unit of good 1... More than one definition
$
p1 good1 good2
= $
=
p2 good2
good1

p2 p1
Real1 = y1 + y2 or Real2 = y2 + y1
p1 p2

Important: if prices double and quantities remain the same: (1)

nominal GDP doubles but (2) our welfare doesn’t change!
Constant Dollar GDP 11

I Let’s try to include more than one good. Take one year as
a baseline
I In subsequent years multiply quantities using base year
prices

Yt = p1,t y1,t + p2,t y2,t + ... + pn,t yn,t

Yt+1 = p1,t y1,t+1 + p2,t y1,t+1 + ... + pn,t+1 yn,t+1
Yt+2 = p1,t y1,t+2 + p1,t y1,t+2 + ... + pn,t y1,t+2

From the one above we can define a Price Index as the ratio of
nominal to real GDP in a given year with Pt = 1
Pn
i=1 pi,t+h yi,t+h
Pt+h = P n for h = 0, 1, 2..
i=1 pi,t yi,t+h
Real vs Nominal: Remarks 12

I Normalized real and nominal GDP coincide in the base

year. Price level equals one in the base year.
I Choice of base year is arbitrary: percentage variation
affected by the choice of variation.
I Solution chain-weighting: calculate GDP in two
consecutive years using both prices as a base year and then
make a geometric average. This is important in practice.
I Notice that most of models that we will consider will be
about economies producing only one good.
Real Variables (1) 13
Inflation, GDP deflator 14
Real Variables (2) 15

I Trend Growth: approximate pretty well with a trend line.. log

scale, implies constant growth. Recessions looks like small blips..
I Average growth rate between 1947-2016 is 1.6 percent (quarterly)
which translates in an annualized rate of 6% for nominal GDP.
For Real GDP growth is eqaul to 3.2% at an annualized rate.
I Growth in nominal GDP should approximately equal growth in
prices (inflation) plus growth in real GDP
I Average inflation 3% per year.. note that the sum works...
substantial heterogeneity in the evolution of inflation (very high
in the 1970)
I At least part of the increase in real GDP over time is due to
population growth. With more people working, it is natural that
we will produce more products and services.
I From a welfare perspective what is important is whether there
are more goods and services per person.
GDP per capita 16

When we study model of economic growth we’ll see that what is

important is GDP per capita, the average consumptions per
person.
Population growth in US pretty smooth over time, growing at
1.2 percent per year. We have that annualized data are

3.2%
| {z } + 1.2%
| {z } + 2%
|{z} = 6.4
|{z} ≈ 6
|{z}
P rices P opulation GDP percapita N ominalGDP N ominalGDP

Notice that the amount of stuff produced per person has

grown by about 2 percent per year since 1947 in the US
Consumer Price index 17

Consumer Price Index, CPI. This is the variable that captures

the concept of inflation usually discussed in the news. To define
the CPI we neeed to define a basket of goods that the average
household consumes. Let N the number of goods and xi the
amount of each good consumed. Total price of the basket is:

Costt = p1,t x1 + p2,t x2 ... + pN,t xN

Keeping quantities fixed we can define the relative price of the

cost of basket
PN
cpi Costt i=1 pi,t xi
Pt = = PN
Costb i=1 pi,b xi

Choice of the base year is arbitrary

Consumer Price Index 18

I Basket is kept fixed (both goods and quantities). Issue of new goods!
I If prices are rising CPI will be greater than 1
I On average CPI gives a higher measure of inflation than the
deflator..Why: CPI fixes base year prices and uses updated
quantities. The fixing of quantities explains why CPI gives a higher
value. When prices change, individuals tend to buy relatively less of
the more expensive goods and more of the cheaper
ones..substitution effect...keeping the basket fixed CPI fails to
capture those changes.
I Deflator is based on what the country produces
I Hence For getting a sense of the overall price inflation on what is
produced the deflator is better. To get a sense of nominal changes in
the cost of living the CPI is a better measure.
I Chain weighting can be used to limit the influence of the choice of
the base year
Labor Market Statistics 19

1. Extensive Margin: the number of person working

2. Intensive Margin: how many hours a person works
Let L the working population, E the number of people working,
E ≤ L and h the number of hours each people work. Then the total
hours worked are N = h ∗ E. Hours per capita capture movements
both margins:
h∗E
n=
L
The most used statistic in the press is the unemployment rate. First,
we need to define the Labor Force, LF : (1) working population E
plusindividuals looking for a job S. U the unemployed is the people
not working and not looking for a job. Note that E ≤ LF ≤ L
Unemployment Rate 20

The labor force participation rate is:

LF
lf p =
L
The unemployment rate is:
U
u=
U +E+S
Issue of the unemployment rate:
I changes if the number of unemployed change... but this number
can change if some who were officially unemployed quit looking
for a job: Discouraged Workers
I Unemployment rate does not provide information about the
intensity: part time jobs
I Looking to the number of hours per capita probably gives a
better picture
Labor Market Variables (1) 21
Labor Market Variables (2) 22

I Hours per capita fluctuates around a mean, no obvious

trend
I Labor force rate trended up since 1950... women entered in
the labor market
I Average hours per worker have declined over time...
I lack of tend in total hours because the extra bodies in the
labor forces covered the loss due to the fact that people on
average work less
I Hours worked tend to decline during recessions, while the
unemployment rate tends to increase
I Labor force participation rate tend to decline during
recessions
Economic Models 23

Economist like to develop and use simple models to understand reality

and derive meaningful policy implications

In that Empire, the Art of Cartography attained such perfection that

the map of a single province occupied the entirety of a city, and the
map of the Empire, the entirety of a province. In time, those
unconscionable maps no longer satisfied, and the cartographers guilds
struck a map of the Empire whose size was that of the Empire, and
which coincided point for point with it. The following generations, who
were not so fond of the study of cartography as their forebears had been,
saw that that vast map was useless, and not without some pitilessness
was it, that they delivered it up to the inclemencies of sun and winters.
In the Deserts of the West, still today, there are tattered ruins of that
map, inhabited by animals and beggars; in all the land there is no other
relic of the disciplines of geography.

Jorge Luis Borges

Economic Models 24

I To an economist, a model is a simplified representation of

the economy; it is essentially a representation of the
economy in which only the main ingredients are being
accounted for.
I a model is composed of a set of mathematical relationships
I Through these mathematical relationships, the economist
determines how variables (like an interest rate) react to
each other (e.g. investment).
I Models are not the only way to study human behavior.
I In the natural sciences, scientists typically follow a different
approach... And also in Economics Credibility revolution
I Economic Models may be related, for some specific
questions, to the role that have models in Astronomy
All models are wrong, but some are useful 25

I All models are not created equal and some models are better to
answer one particular question but not another one.
I Possible answer: a model should be able to capture features of
the data that it was not artificially constructed to capture.
I In the same way, a simplified version of the economy will not be
able to account for all the data that an economy generates.
I In addition to providing us with a laboratory in which experiments
can be performed, models allow us to disentangle specific
relationships. Reality is too complex
I While some assumptions may seem odd, the reality is that
abstraction is part of every model in any scientific discipline. All
science, rely on parsimonious representations of the real world to
analyze real problems
I New York is significantly larger than the screen of your
smartphone. However, for the purpose of navigating Manhattan or
finding your way to Buffalo, it is essential that the map does not
provide the level of detail you see while driving or walking around.
Recap 26

I GDP we saw its definition ... revenue from production

equals income
I Real vs Nominal...GDP may change over time because
either price or quantities change.. change in quantities are
the ones important from a welfare standpoint
I Consumer price index... we saw that this index may
overstate inflation on average..
I Key Labor Market indicators
I Tried to give the intuition on what is an Economic Model..
In the next lectures we will develop economi models and
use them to guide ourself in understanding the very
important topic of Economic Growth