Macroeconomics Summary of Unit 1

Unit 1 Open-economy macroeconomics: Basic concepts

1. There are three different approaches to measuring an economy’s output: the income approach, the expenditure approach and the product approach.

2. GDP is the value of all final goods and services produced within an economy in a given year. GNP is the value of all final goods and services produced in the economy by its citizens and permanent residents in a given year (excluding the income earned by foreigners).

3. The expenditure approach is the most important one in measuring GDP: Y = C+I+G+NX. There is another item that is added to GDP, that is, changes in inventories or stocks.

4. To compare the economic well-being of two persons in two countries, GDP per capita is used, which is GDP divided by the population.

5. Nominal GDP is GDP measured at current prices. Real GDP is GDP obtained after taking into account a constant price, which is referred to as the base year price.

6. The GDP deflator is the ratio of nominal GDP to real GDP.

7. Not all items are included in computing GDP. Non-market and underground activities, leisure activities, costs of pollution, transfer payments and sales of used goods are omitted.

8. Consumer price indices are used to measure the cost of living.

9. A consumer price index indicates the cost of living of an average consumer surveyed in the national household surveys to determine the weights to be used.

10. The weights of the various items in a market basket of goods and services represent the share of expenditure of each item in the total expenditure. The sum of the weights of all goods and services

equals 1.

11. The inflation rate is calculated by using different price indices. If the CPI is used, the inflation rate equals the CPI in the current year minus the CPI in the previous year divided by the CPI in the previous year multiplied by 100, which yields result as a percentage.

12. Another important price index is the producer price index (PPI), which measures prices that producers receive for the production of their goods and services.

13. There are three problems associated with using the CPI as a measure of cost of living: substitution bias, introduction of new products and changes in quality.

14. Real variables are nominal variables that can be adjusted by some other variables.

15. Indexation is used to solve problems pertaining to inflation.

16. Real interest rate differs from nominal interest rate by subtracting the expected inflation rate.