Core Macroeconomic Principles: Business Cycles to Saving
Chapter 1: Economic Fundamentals
Chapter 1
Business cycle: expansion & contractions of economy.
Aggregation: adding individual markets into economy-wide totals.
Positive $\rightarrow$ descriptive/factual (“is”).
Normative $\rightarrow$ value judgment (“should”).
Key Activities:
- Forecasting $\rightarrow$ predict future values.
- Analysis $\rightarrow$ interpret current events.
- Data development $\rightarrow$ improve measurement systems.
- Research $\rightarrow$ theory + empirical testing.
Comparative statics $\rightarrow$ Start in equilibrium $\rightarrow$ apply a shock $\rightarrow$ compare old vs new equilibrium.
Chapter 2: Measuring Economic Output (GDP)
Chapter 2
The Expenditure Identity:
$$Y = C + I + G + NX$$
- $Y$ = GDP/output/income
- $C$ = consumption
- $I$ = Investment (incl. inventory)
- $G$ = government purchases (no transfers)
- $NX$ = exports – imports
Counted in GDP:
- Final goods
- New goods
- Inventory increases
- Government services
- Exports
Not in GDP:
- Used goods
- Household production
- Transfers
- Financial transactions
- Imports
Value Added = Value of output – Value of intermediate inputs.
Gross National Product (GNP) = GDP + NFP (Net Factor Payments).
NFP $\rightarrow$ income earned abroad by residents – income paid to foreigners.
Nominal GDP $\rightarrow$ current prices $\times$ current quantities.
Real GDP $\rightarrow$ base prices $\times$ current quantities.
GDP Deflator = Nominal GDP / Real GDP
- Measures price level of domestically produced goods.
- Variable-weight index.
Fixed Basket Inflation (CPI)
Inflation $\pi = (\text{Cost}_{\text{new}} – \text{Cost}_{\text{base}})/\text{Cost}_{\text{base}}$
Chapter 3: Production and Labor Markets
Chapter 3
Production Function
$$Y = AF(K,N)$$
- A $\uparrow \rightarrow$ productivity $\uparrow \rightarrow Y \uparrow$.
- If Y $\uparrow$ with $K, N$ fixed $\rightarrow A \uparrow$.
Marginal Product of Labor (MPN) $\rightarrow$ extra output from 1 more worker.
Marginal Product of Capital (MPK) $\rightarrow$ extra output from 1 more unit of capital.
Labor Demand
Real Wage ($w$) = MPN.
- Labor demand = MPN curve.
- Depends on: Productivity ($A$), Capital ($K$), technology.
Labor Supply
- Depends on: Population, Preferences, Wealth, Expected future wages.
Labor Market Equilibrium
$N^D = N^S$
Determines:
- Equilibrium real wage $w^*$.
- Equilibrium employment $N^*$.
Labor Market Shocks Analysis
| Shock | $N^D$ | $N^S$ | $w$ | $N$ |
|---|---|---|---|---|
| $\\uparrow$ Productivity ($A$) | $\rightarrow$ | $-$ | $\uparrow$ | $\uparrow$ |
| $\\uparrow$ Capital per worker | $\rightarrow$ | $-$ | $\uparrow$ | $\uparrow$ |
| $\downarrow$ Capital per worker | $\leftarrow$ | $-$ | $\downarrow$ | $\downarrow$ |
| $\\uparrow$ Population | $-$ | $\rightarrow$ | $\downarrow$ | $\uparrow$ |
| $\\uparrow$ Wealth / stock prices | $-$ | $\leftarrow$ | $\uparrow$ | $\downarrow$ |
| Negative supply shock | $\leftarrow$ | $-$ | $\downarrow$ | $\downarrow$ |
| Both $N^D$ & $N^S \leftarrow$ | $\leftarrow$ | $\leftarrow$ | ? | $\downarrow$ |
Hiring Rule (Firm)
Marginal Revenue Product of Labor (MRPN) = $P \times MPN$.
Hire until $\rightarrow$ MRPN $\ge w$. Stop when $\rightarrow$ MRPN $< w$.
Unemployment Types
- Frictional $\rightarrow$ job search.
- Structural $\rightarrow$ skills mismatch/tech change.
- Cyclical $\rightarrow$ recession.
- Seasonal $\rightarrow$ time of year.
At full employment:
- Cyclical unemployment = 0.
- Frictional + structural still exist.
Labor Market Rates
- Unemployment rate $\rightarrow u = \text{Unemployed} / \text{Labour Force}$.
- Participation rate $\rightarrow \text{LFRP} = \text{Labour Force} / \text{Working Age Population}$.
- Employment ratio $\rightarrow \text{Employed} / \text{Working Age Population}$.
Chapter 4: Saving, Investment, and Interest Rates
Chapter 4
Private Saving ($S^{pvt}$) $\rightarrow (Y + NFP – T + TR + INT) – C$.
Government Saving ($S^{gov}$) $\rightarrow (T – TR – INT) – G$.
- $S^{gov} > 0 \rightarrow$ surplus.
- $S^{gov} < 0 \rightarrow$ deficit.
National Saving ($S$) $\rightarrow Y + NFP – C – G$ or $S = S^{pvt} + S^{gov}$.
Open Economy
$S = I + CA$ (Current Account)
- $CA > 0 \rightarrow$ net lender.
- $CA < 0 \rightarrow$ net borrower.
Uses of Private Saving
$S^{pvt} = I + (-S^{gov}) + CA$.
Private saving finances:
- Investment.
- Government deficit.
- Lending abroad.
Interest Rates
- Nominal interest rate: $i$.
- Inflation rate: $\pi$.
Real Interest Rate $r = i – \pi$.
Expected Real Interest Rate $r^e = i – \pi^e$.
After-tax Expected Real rate $r_{a-t} = (1 – t)i – \pi^e$.
Saving and Investment Shocks
| Shock | $S$ | $I$ | $r$ |
|---|---|---|---|
| $\\uparrow$ Gov deficit | $\leftarrow$ | $-$ | $\uparrow$ |
| $\\uparrow$ Productivity | $-$ | $\rightarrow$ | $\uparrow$ |
| $\\uparrow$ Expected future income | $\leftarrow$ | $-$ | $\uparrow$ |
| $\\uparrow$ Taxes | $\rightarrow$ | $-$ | $\downarrow$ |
Consumption Intuition
- Temporary income $\uparrow \rightarrow$ mostly saved.
- Permanent income $\uparrow \rightarrow$ mostly consumed.
- Interest rate $\uparrow$ (saver):
- Substitution effect $\rightarrow$ consume less now.
- Income effect $\rightarrow$ consume more.
- Net effect depends (often substitution dominates).
Key Concept Reminders
| If question mentions… | Think about… |
|---|---|
| “inventory change” | Investment ($I$) |
| “used goods” | NOT GDP |
| “foreign-owned factory in Canada” | GDP yes, GNP maybe no |
| “technology / AI” | Productivity $\uparrow \rightarrow N^D \rightarrow$ |
| “population growth” | $N^S \rightarrow$ |
| “minimum wage above equilibrium” | binding $\rightarrow$ unemployment |
| “expected future income $\uparrow$” | saving $\downarrow$ |
| “government deficit $\uparrow$” | saving $\downarrow \rightarrow r \uparrow$ |