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Introduction to
Macroeconomics
Team

Lectures:
- Michał Brzoza-Brzezina
Office hours: Mondays, 15.10 - 16.10, room 412 b „G”,
Lecture materials: http://akson.sgh.waw.pl/~mbrzez

-
Repetitions:
Tomasz Chmielewski
http://www.politykapieniezna.pl
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
2
Textbook(s)
Main textbook
Burda & Wyplosz: Macroeconomics. A European Text. 4th ed. or
later, Oxford University Press
Availability:
- SGH library
- NBP library
Companion website: http://www.oup.com/uk/orc/

As long as it helps, you can use the Polish edition, but remember:
- lectures, exams, homework etc. are in English
- we advice to use the Polish version only to learn how to
translate terms
 Further reading will be given during the lectures
Note: if not stated otherwise source of figures, tables etc is OUP.
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
3
Exams and grades

Grade for repetitions depends on homework
and activity,
 Final exam will be taken after the last lecture,
 Grade for lectures depends on this final exam
(75%) and points from repetitions (25%),
 Those who receive >90% of points from
repetitions are exempt from the final exam
with grade 5.
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
4
Outline


-
1. What is macroeconomics?
Questions raised by macroeconomics
The role of models
Modern approach to macro modelling
Our approach to macro modelling
Syllabus
2. Macroeconomic accounts
Gross domestic product
Flows of incomes and expenditures
Real and nominal variables
Macroeconomic identities
This lecture follows chapters 1 and 2 of the textbook
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
5
1. What is macroeconomics?
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
6
Questions raised by macroeconomics

Macroeconomics concentrates on the
behaviour of aggregated variables: GDP,
consumption, investment, unemployment,
inflation, wages, exchange rates, balance of
payments etc.
 Tries to answer several important questions
and provide policy advice.
 Note: macro performance affects micro
happiness (welfare)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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What determines long-run growth?
Real Gross Domestic Product, 1870 - 2010
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Why do some economies grow faster than other?
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
9
What causes cyclical fluctuations? Should we reduce
them? How can we do it?
Quarterly Rate of Change in GDP (in %),
UK, 1962:1-2010:4
(% change of GDP in one quarter relative to previous quarter)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
10
What causes unemployment? How can we
reduce it?
Unemployment rates: EU, US, Switzerland
(percent)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
11
What causes inflation? How can we fight it?
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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How do financial markets interact
with the macroeconomy?
Example: financial crisis 2007-08
caused a deep recession
 Did wrong macro policy (e.g. to
expansionary monetary policy) cause
the crisis?
 How does the credit crunch affect
economic growth? How can we fight it?

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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How to deal with poverty and
inequality?
Poverty and inequality are a serious
problem both in national and
international dimentions
 Which policies help, which do not?
 Often an empirical question
 Serious problem: endogeneity!

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
14
The role of models



Reality is extremely complicated
To understand it we need models
Simplified versions of real world (selected aspects)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Models are only models …
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Fig. 1.10
Endogenous and Exogenous Variables
Endogenous variables are the object of analysis in an economic
model.
Exogenous variables are determined outside the economic model.
© Oxford University
Press, 2012. All rights
Modern approach to macro modelling





Until 1970s macro models based on ad-hoc
relationships of aggregated variables
e.g. Phillips curve: permanent trade-off between
inflation and unemployment
This resulted in misleading policy advice (Phelps,
Friedman, Lucas critique) – stagflation in 1970’s
Everything in macroeconomics comes from individual
behaviour
Mainstream approach since 1980’s: We should base
every macro model on individual behaviour
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Microfoundations

Households maximize lifetime utility
They choose consumption, labour supply, real money holdings to
maximize:

Mt
max U  t 0  u ct , lt ,
Pt


t



subject to budget constraint
 Firms maximize profits
They choose prices and production method subject to production
function, market structure (competition), price stickiness etc.
 In equilibrium (after aggregation) all markets clear:
Labour demand equals labour supply
Production equals consumption
Money demand equals money supply
 This is called general equilibrium
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Example – contemporaneous macro model
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Our approach to macro modelling




-



In line with modern macroeconomics
microfounded
important role for expectations
analyzed in general equilibrium
But much simpler
one or two periods instead of infinity, less formal
We will
Analyze separately major markets:
goods (consumption, investment)
labour
money
Put them together to form general equilibrium
Add monetary policy to close the model
Use the model to analyze reaction to shocks, business cycles,
monetary policy reaction, fiscal policy etc.
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
21
Syllabus
1.
2.
3.
4.
5.
6.
7.
8.
9.
Introduction to macroeconomics
Private and public sector behaviour
Labour market
Money and credit
General equilibrium and monetary policy
Business cycle
Economic growth
Open economy issues
Fiscal policy
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
Microfoundations
and GE
22
2. Macroeconomic accounts
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
23
What are national accounts?
Set of statistical definitions
 Plays central role in studying
macroeconomics
 Discretionary with many drawbacks
 But still the best way to measure
economic activity and development we
have

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Gross domestic product
GDP is a measure of productive activity
 It is a flow variable
 Measured for a geographic area
(usually country)
 Defined over a time interval (usually
year or quarter)
 Can be measured in three ways

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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GDP: definition 1
GDP=sum of all net final sales
 Only final sales – e.g. for consumption
purposes.
 Intermediate sales are not accounted
for – GDP does not depend on the
length of the production chain

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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GDP: definition 2
GDP=sum of value added
 Value added is the difference between
sales and cost of raw materials,
unfinished goods and imports
 Value added is not counted twice
 Hence, sum of value added must equal
value of final sale (corrected for tax).

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
27
GDP: definition 3
GDP=sum of factor incomes
 One persons expenditure (def. 1) is
someone else’s income
 Usual production factors: labour and
capital

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Drawbacks of GDP accounting
Measures directly only legal economy –
underground activities are estimated roughly
 Does not account for many important
activities – e.g. housekeeping
 GDP is a bad measure of welfare – does not
account for social conditions (e.g. good
sidewalks or playgrounds), environmental
conditions, equality of incomes etc.
 Alternative measures exist, e.g. UN human
development index.

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Satisfaction with life index
GDP per Capita and Life Satisfaction in 2006
GDP per capita 2006
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Components of HDI
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Source: HDR 2013
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Circular flow
As mentioned, every expenditure is
someone’s income
 Examples:
- taxes are private sector’s expenditure
but the government’s income
- imports are the domestic economy’s
expenditure but the foreign economy’s
income

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
33
Figure 2.02
Circular flow (manual)
Government
(T-G)
Rest of
World
Private
Sector
(X-Z)
(S-I)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Now sit and enjoy
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
35
Figure 2.02
Circular flow (automatic)
Government
(T-G)
Rest of
World
Private
Sector
(X-Z)
(S-I)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
36
Figure 2.02
Circular flow (automatic)
Government
(T-G)
Rest of
World
Private
Sector
(X-Z)
(S-I)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
37
Figure 2.02
Circular flow (automatic)
Government
(T-G)
Rest of
World
Private
Sector
(X-Z)
(S-I)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
38
Figure 2.02
Circular flow (automatic)
Government
(T-G)
Rest of
World
Private
Sector
(X-Z)
(S-I)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
39
Table 2.3
Components of GDP
Consumption (C)
Investment (I)
Government
purchases (G)
Australia
Germany
France
UK
56.4
58.5
56.8
65.0
22.4
18.2
20.1
17.0
17.4
18.9
23.6
21.0
Italy
Japan
Canada
Switzerland
59.3
57.4
56.4
59.1
20.7
24.0
21.4
21.4
19.9
18.1
19.7
11.3
USA
Euro Area
69.8
57.2
18.8
20.8
15.8
20.5
Source: IMF
Table 2.4
GDP and Household Disposable Income, 2009
GDP
Households disposable income
(billions of € )
(billions of € )
% of GDP
Germany
2,395.0
1,554.2
64.9
France
1,907.7
1,293.9
67.8
Sweden
290.9
154.4
53.1
Switzerland
354.5
211.4
59.6
10,122.6
7,911.5
78.2
1,565.7
1,057.6
67.5
United States
United Kingdom
© Oxford University
Press, 2012. All rights
Sources: OECD Economic Outlook, ECB
Real and nominal variables

Most economic variables including the
national accounts can be measured in
nominal or real terms
 Nominal variables are measured in units of
money
Examples: nominal GDP, nominal consumption,
nominal wages
 Real variables are measured in units of
goods
Examples: real GDP, real consumption, real
wages
 Real variables tell us how much purchasing
power has our income, wage etc.
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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How to construct real variables?
Nominal variables are usualy easily
available: e.g. the lecturers wage
 Real variables are constructed by
dividing the nominal variable by the
respective deflator (price of the
underlying good)
 Real GDP=Nominal GDP/GDP deflator
 Real wage=Nominal wage/CPI

M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Deflators
Inflation in Italy, 1985-2010
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Source: IMF
Table 2.01
Euro Area: Growth Rates (% per annum)
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
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Source: Eurostat
Key accounting identities

From definition 1 (final sales go for
consumption, investment etc.):
Y=C+I+G+X-M
 From definition 3 (incomes are spent on
consumption, savings and (net) taxes):
Y=C+S+T
 Resulting balance of sectors:
(S-I)+(T-G)=(X-M)
 Savings of the private and public sector equal
(approx.) the trade balance
 Consequence: twin deficits
 Important: these are all definitions, do not
speak about causality!!!
M.Brzoza-Brzezina:
46
Macroeconomics II - Introduction
Table 2.5
The Accounting Identity in 2010 (% of GDP)
S-I
T-G
CA
USA
Japan
Belgium
-5.6
10.3
3.9
-8.8
-6.7
-2.6
-3.2
3.6
1.3
Denmark
France
Germany
4.7
2.6
8.1
0.8
-4.8
-2.5
5.5
-2.2
5.6
-1.3
11.5
0.7
-2.2
-3.8
-5.2
-3.5
7.7
-4.5
4.7
5.8
4.1
1.6
-8.3
-3.9
6.3
-2.5
0.2
Italy
Netherlands
Spain
Sweden
UK
Euro area
© Oxford University
Press, 2012. All rights
Source: OECD
Twin deficits
Source: Wikipedia
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
48
The Effect of Fiscal Consolidation on the Current Account
John Bluedorn and Daniel Leigh
M.Brzoza-Brzezina:
Macroeconomics II - Introduction
49