Module 1

Macroeconomic Measurement & Core Concepts

Three key macroeconomic concepts form the foundation: aggregate output, inflation, and unemployment. Understanding how they are measured is essential before building models.

Aggregate Output: GDP

Gross Domestic Product (GDP) is the primary measure of aggregate economic activity. National income accounts provide an accounting system used to measure it. GDP = GDI by construction — these are flow variables, measured per period.

Three Ways to Measure GDP

Total value of final goods and services produced — excludes intermediate goods to avoid double-counting.
Total value-added — sum of (sales revenue − cost of intermediate inputs) across all firms.
Total income — sum of all incomes earned (wages + profits).

Definitions 1–2 are the production side (GDP). Definition 3 is the income side (GDI).

Example: Steel and Car Production

	Steel Company (Firm #1)	Car Company (Firm #2)
Sales Revenue	RMB 1,000	RMB 2,100
Wages	RMB 800	RMB 700
Steel (intermediate)	—	RMB 1,000
Profit	RMB 200	RMB 400

Final goods: Only cars = RMB 2,100
Value-added: RMB 1,000 (steel) + RMB 1,100 (cars) = RMB 2,100
Total income: Wages 1,500 + Profits 600 = RMB 2,100

All three methods produce the same result. The accounting identity GDP = GDI holds by construction.

Nominal vs Real GDP

Definitions

Nominal GDP ($Y_t$): Sum of quantities times current prices.
Real GDP ($Y_t$): Sum of quantities times constant (base-year) prices. Controls for changes in purchasing power.

In the base year, nominal and real GDP are equal by construction.

GDP Deflator: $P_t \equiv \frac{\$Y_t}{Y_t} \times 100$ — an implicit price index measuring the average price of aggregate output. Equals 100 in the base year.

Inflation

Inflation is a sustained increase in the general level of prices. Deflation is a sustained decrease.

Two Key Price Measures

GDP Deflator

$P_t = \frac{\text{Nominal GDP}_t}{\text{Real GDP}_t} \times 100$

Measures the average price of all domestically produced final goods and services.

Consumer Price Index (CPI)

Measures the average price of a consumption basket purchased by typical households.

Includes imported goods; uses fixed weights.

Inflation Rate: $\quad \pi_t \equiv \frac{P_t - P_{t-1}}{P_{t-1}}$

CPI and GDP deflator typically move together over time.

Unemployment

The labor force is partitioned into employed ($N$), unemployed ($U$), and not in the labor force ($NL$). Only those actively looking for work count as unemployed.

Unemployment Rate: $\quad u \equiv \frac{U}{L} = \frac{U}{N+U}$
Participation Rate: $\quad \frac{L}{\text{Working-age population}}$

Important Nuances

Those not working and not looking are not in the labor force.
Unemployment rate changes due to: size of pool of unemployed ($U$) or size of labor force ($L$).
Discouraged workers may leave the labor force, causing the unemployment rate to understate slack.

National Income Identities

GDP Components (Closed Economy)

Total demand for goods:

$Z \equiv C + I + G$

In equilibrium, output equals demand: $Y = Z$.

Investment = Savings

Private saving: $S \equiv Y_D - C = Y - T - C$

From goods market equilibrium $Y = C + I + G$:

IS Identity: $\quad I = S + (T - G)$
Investment = Private Savings + Public Savings

$T > G$: government runs surplus, public saving positive.
$T < G$: government runs deficit, public saving negative.

Open Economy Extension

Net exports: $NX \equiv X - IM$

$Y = C + I + G + NX$

From this, $NX = (S - I) + (T - G)$ — a trade surplus corresponds to excess of total saving over investment.