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ECON1102 Notes
Macroeconomics 1 -2

Chapter 1: Aggregate Production and Prices
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Key aggregate variables include: total production of goods and services, the general level of
prices, the level of employment and the unemployment rate

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g
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services) is to use the cost of providing the good or service
in place of its unknown market value
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3 Intermediate Goods and Value added
 GDP refers to final G/S, doesn’t include intermediate goods
 Intermediate goods: good that is used in the production of another good or service
 In calculating GDP, it is important to count the value of each good only once, avoid double
counting intermediate goods = value added concept
 Value added: the market value of a firms production less the cost of inputs purchased from
other firms
 Two ways to calculate the contribution of the production of a good to GDP
o One method is to measure the market price of the good when it
o The second method is to add-up the value added of each producer who contributes to
the final product
 Production approach: to calculating GDP is the summation of value added for all businesses
operating in an economy
 The definition of GDP refers to the production within a country
 The final element of the definition of GDP refers to it being measured over some period of
time, typically 3 months/1 quarter – excludes G/S produced in an earlier period, but re sold
in the current period

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4 Expenditure Approach to GDP
 Expenditure approach: to calculating GDP entails the summation of expenditures on
domestically produced final goods and services by households, businesses, governments and
by the rest of the world
 Expenditure on goods and services by final uses = value of their production
o Household expenditure = consumption spending C
o Business expenditure = private investment spending I
o Government spending G
o Domestically produced gods and services that are purchased by the rest of the world
= exports X
o Foreign produced that are purchased from the world = imports M
o Net exports NX= X-M
 Decomposition of GDP Y = (triple equal sign) C + I + G + X – M
 Supply of G & S = Demand for G & S
o The triple equal sign indicates this is an accounting identity
o The value of production of final goods and services must be equal to the value of
expenditure on final goods and services
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5 Statistical Discrepancy
 The three approaches to measuring GDP can result in errors and differences in result
 The ABS averages these three measures
 Private Investment – Inventories
o Inventories are currently unsold stocks of goods held by businesses, calculated by
inventory level (end of period) – inventory level (beginning period)
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6 Second Hand Goods
 A fraction of expenditure will involve the purchase of second-hand or used goods
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include the purchase of a used car or a second-hand
prices across all sectors
CPI: is a measure of the change, over time, in the cost of purchasing a fixed basket of goods
and services
o Measure of change in the cost of living and in the level of prices faced by an average
consumer
o Is based on the use of a fixed basket of goods and services – basket reflects the
average consumption pattern for various households in a period
o CPI provides how this changes compared to the previous years
𝒄𝒐𝒔𝒕 𝒊𝒏 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓
𝑪𝑷𝑰 =
𝒄𝒐𝒔𝒕 𝒊𝒏 𝒃𝒂𝒔𝒆 𝒚𝒆𝒂𝒓
we can use the CPI to calculate a measure of the rate of inflation for this simple economy,
using the symbol π

𝝅=
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𝑪𝑷𝑰 − 𝑪𝑷𝑰 (𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒑𝒆𝒓𝒊𝒐𝒅)
𝑪𝑷𝑰 (𝒐𝒇 𝒑𝒓𝒆𝒗𝒊𝒐𝒖𝒔 𝒑𝒆𝒓𝒊𝒐𝒅)

inflation is a situation in which the general price level in an economy is rising, while deflation
(or negative inflation) represents a situation in where the general price level is falling
inflation is measured by the percentage change in the CPI over a given period
o inflation rate = 0 implies prices are constant
o inflation rate > 0 implies prices are rising
o inflation rate <0 implies prices are falling
Biases in the CPI
One source of bias arises due to quality improvements, when improvements in quality are
widespread and not taken into account the CPI suffers from quality adjustment bias and will
tend to over-estimate the increase in prices (or the cost of living)
Second type of bias in the CPI arises because the consumption basket is held fixed at its abse
year level, it doesn’t take into account substitute goods, which will tend to overstate what the
consumer actually spends on buying their combination of goods
The CPI will thus tend to overstate the consumers true cost of living

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3 Costs of Inflation
 Important to distinguish between relative price change and a change in the general price
level
 When inflation is unanticipated, it can produce undesirable redistributions of income or
resources among different groups in the economy
 Unexpected inflation tends to transfer resources away from people with fixed incomes or
with incomes that are not fully indexed to the actual inflation rate
o Redistributions of wealth, transfer from lenders to borrowers
o Increase will decrease saving
o Distorts tax systems if not indexed to inflation

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Typically, a change in relative prices provides a signal to businesses to change their
production, while a change in the inflation rate does not
One policy for minimizing the costs of inflation is to index all prices and wages in
the economy to the actual inflation rate
Two postivie costs associated with (positive) inflation
o Menu costs: refer to any real (resource) costs associated with changing prices due to
inflation
o Shoe-leather cost refers to the idea that people will need to make more frequent
trips to the bank and in doing so will wear out their shoes more quickly

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4 Optimal Rate of Inflation
 1-3% of inflation

Chapter 2: Employment, Unemployment and the Labour market
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