Chapter 2: The Data of Macroeconomics

1. Measuring Economic Activity – Gross Domestic Product (GDP):

o Definition: GDP is the total market value of all final goods and services produced
within a country in a given period.

o Income, Expenditure, and the Circular Flow:

 In the economy, income must equal expenditure because every transaction

has a buyer and a seller.

 Circular flow model: In this model, households provide factors of production

(labor, capital, etc.) to firms, and in return, firms provide income to
households. Households then spend this income on goods and services
produced by firms, creating a circular flow of income and expenditure.

2. Real GDP vs. Nominal GDP:

o Nominal GDP measures the value of output at current prices, while Real GDP adjusts
for inflation and measures the value of output using the prices of a base year.

o Real GDP gives a more accurate picture of an economy’s growth over time by
isolating changes in output from changes in prices.

o GDP Deflator: GDP Deflator=Nominal GDPReal GDP×100\text{GDP Deflator} = \frac{\

text{Nominal GDP}}{\text{Real GDP}} \times 100GDP Deflator=Real GDPNominal GDP
×100 It measures the price level and helps to distinguish between inflation and real
growth.

3. Components of GDP:

o Consumption (C): Spending by households on goods and services.

o Investment (I): Spending on capital goods that will be used to produce goods and
services in the future (factories, machines, etc.).

o Government Spending (G): Spending by the government on goods and services.

o Net Exports (NX): Exports minus imports. It measures the value of goods produced
domestically and sold abroad, minus the value of goods produced abroad and sold
domestically.

4. Other Measures of Income:

o Gross National Product (GNP): Total income earned by a nation’s residents (includes
income from abroad).

o Net National Product (NNP): GNP minus depreciation.

o National Income: Total income earned by residents (adjusted for taxes and
subsidies).

o Disposable Personal Income: Income remaining after taxes, available for households
to spend or save.
 5. Consumer Price Index (CPI):

o The CPI measures the overall level of prices in the economy by tracking the cost of a
fixed basket of goods over time. It's used to calculate the inflation rate, which is the
percentage change in the price level from one period to the next.

6. Measuring Joblessness – The Unemployment Rate:

o The unemployment rate is the percentage of the labor force that is unemployed and
actively seeking work. It’s an important indicator of the overall health of the
economy.

Chapter 11: Aggregate Demand I – Building the IS-LM Model

1. The Goods Market and the IS Curve:

o The IS curve represents equilibrium in the goods market (where total demand for
goods equals total supply).

o Keynesian Cross: This model shows how changes in spending can have a multiplied
effect on income. It’s based on the idea that in the short run, output is determined
by aggregate demand.

o Multiplier Effect: An increase in government spending, for instance, can raise

aggregate demand and result in a larger increase in income due to repeated rounds
of spending.

2. Deriving the IS Curve:

o The IS curve shows combinations of interest rates and output where the goods
market is in equilibrium.

o A higher interest rate reduces investment, leading to lower aggregate demand and
thus lower output. This creates the downward slope of the IS curve.

3. The Money Market and the LM Curve:

o The LM curve represents equilibrium in the money market, where the supply and
demand for money are equal.

o Theory of Liquidity Preference: Keynes proposed that the interest rate adjusts to
balance the supply and demand for money. People hold money for transactions and
as a store of value. The demand for money decreases as the interest rate rises
because people prefer to hold bonds that offer higher returns.

4. Deriving the LM Curve:

o The LM curve shows combinations of interest rates and output where the money
market is in equilibrium.

o A higher level of income increases the demand for money, which raises interest
rates. This gives the LM curve an upward slope.

5. The IS-LM Model:

 o By combining the IS and LM curves, we get the IS-LM model, which determines both
the equilibrium level of income and the interest rate in the short run.

o Shifts in the IS Curve: Changes in fiscal policy (e.g., government spending, taxation)
shift the IS curve. For example, an increase in government spending shifts the IS
curve to the right, increasing output and raising the interest rate.

o Shifts in the LM Curve: Changes in monetary policy (e.g., changes in the money
supply) shift the LM curve. An increase in the money supply shifts the LM curve to
the right, lowering interest rates and increasing output.

6. Policy Implications of the IS-LM Model:

o Fiscal Policy: Expansionary fiscal policy (increased government spending or tax cuts)
shifts the IS curve to the right, raising income and interest rates.

o Monetary Policy: Expansionary monetary policy (increased money supply) shifts the
LM curve to the right, lowering interest rates and increasing income.

o The model illustrates the interaction between fiscal and monetary policy. For
example, if fiscal policy increases demand (shifting the IS curve right), monetary
policy can either accommodate this by shifting the LM curve to the right (keeping
interest rates stable) or tighten the money supply (shifting LM left) to prevent
inflation.

These two chapters are fundamental for understanding how macroeconomic data are measured and
how fiscal and monetary policies influence the economy in both the short and long run. Make sure to
grasp the key concepts of GDP, CPI, unemployment, and the IS-LM model, as they are likely to feature
heavily in your exam. Let me know if you need more clarification on any topic!