WEEK 1
COURSE OVERVIEW
Yingnan Zhao
Department of Economic
University of Toronto Mississauga
Fall 2022
Macroeconomics
■ The study of the structure and performance of national economies and of
the policies that governments use to try to affect economic performance
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 2
Macroeconomics
■ The study of the structure and performance of national economies and of
the policies that governments use to try to affect economic performance
■ Variables that reflect economic performance?
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 3
Macroeconomics
■ The study of the structure and performance of national economies and of
the policies that governments use to try to affect economic performance
■ Variables that reflect economic performance?
– GDP, GDP growth: Production of goods and services (G&S)
– Consumption, investments, imports and exports: Demand for G&S
– Unemployment: Supply and demand of labour
– Inflation: Determination of price levels in the G&S market
■ Key markets: Goods, financial, and labour markets
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 4
Two Perspectives in Macroeconomics
1. Economic growth in the long run (e.g., in 20+ years)
– Determined by technology, human capital (e.g., education), labour force,
physical capital, resources, etc.  Economic fundamentals
2. Economic fluctuation in the short (e.g., 0-5 years) to medium (e.g., 6-20 years) run
– Due to shocks from supply and demand sides
– Monetary and fiscal policy affect the demand side of an economy
Short run
0-5 years
Medium run
6-20 years
Long run
20+ years
Fall 2022 University of Toronto Mississauga, Department of Economics, Yingnan Zhao 5
Real GDP per capita
Data Source: Penn World Table
Fall 2022 University of Toronto Mississauga, Department of Economics, Yingnan Zhao 6
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Real GDP per capita
■ The upward sloping curves reflect economic
growth (i.e., a steady increase in aggregate
output over time) – Focus on long run
– Average growth rate in CA: ~2%
■ Key questions in long-run growth:
1. What determines economic growth?
2. Are there variations in levels and growth
rates of GDP across countries?
3. How do the patterns evolve over time?
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 7
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Data Source: Penn World Table
Real GDP per capita
■ The upward sloping curves reflect economic
growth (i.e., a steady increase in aggregate
output over time) – Focus on long run
– Average growth rate in CA: ~2%
1. What determines economic growth?
– Technology, human capital (e.g., education),
labour force, physical capital, resources,
etc.  Economic fundamentals
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 8
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Data Source: Penn World Table
Real GDP per capita
■ The upward sloping curves reflect economic
growth (i.e., a steady increase in aggregate
output over time) – Focus on long run
– Average growth rate in CA: ~2%
1. What determines economic growth?
– Technology, human capital (e.g., education),
labour force, physical capital, resources,
etc.  Economic fundamentals
2. Are there variations in levels and growth rates
of GDP across countries?
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 9
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Data Source: Penn World Table
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 10
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 11
Real GDP per capita
■ The upward sloping curves reflect economic
growth (i.e., a steady increase in aggregate
output over time) – Focus on long run
– Average growth rate in CA: ~2%
1. What determines economic growth?
– Technology, human capital (e.g., education),
labour force, physical capital, resources,
etc.  Economic fundamentals
2. Are there variations in levels and growth rates
of GDP across countries?
3. How do the patterns evolve over time?
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 12
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Data Source: Penn World Table
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 13
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 14
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 15
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 16
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 17
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 18
Economic Growth Theory
■ Economic growth in the long run (e.g., in 20+ years) is determined by
economic fundamentals
– Technological progress
– Accumulation of human and physical capital
– Changes in labour-force structure
■ Heterogeneity in both level and growth rate of GDP
■ Developing countries grow at a faster rate than developed countries 
Convergence of economic growth
■ Solow growth model (Week 9-13, Winter 2023)
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 19
Real GDP per capita
Data Source: Penn World Table
Fall 2022 University of Toronto Mississauga, Department of Economics, Yingnan Zhao 20
10000
20000
30000
40000
50000
60000
70000
rgdpe_pc_CA rgdpe_pc_USA
Unit: USD
Growth Rate of Real GDP per capita
Data Source: Penn World Table
Fall 2022 University of Toronto Mississauga, Department of Economics, Yingnan Zhao 21
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
CA US
Business Cycles
■ Business cycles: Repeated expansions and
recessions in aggregate economic activities
■ The entire sequence of decline followed by
recovery, measured from peak to peak or
trough to trough
Fall 2022 22University of Toronto Mississauga, Department of Economics, Yingnan Zhao
Business Cycles in Canada
Fall 2022 23University of Toronto Mississauga, Department of Economics, Yingnan Zhao
Source: Macroeconomics, A. Abel, B. Bernanke, D. Croushore, R. Kneebone, 9th Canadian edition, Pearson
Fundamental Questions about Business Cycles
■ What causes business cycles?
– Shocks from supply and demand sides
■ How does the shocks affect the economy?
– The behavior of macroeconomic variables (e.g., consumption, investment,
employment, interest rate, price level, and output etc.) over business cycles
■ Are business cycles harmful to the economy?
– Inefficient allocation of economic resources over business cycles due to
economic frictions (e.g., sticky prices, financial frictions)
■ How should policymakers respond to cyclical fluctuations?
– Macroeconomic policy (monetary and fiscal) to overcome or mitigate the
effects of recessions/overheating on an economy
Fall 2022 24University of Toronto Mississauga, Department of Economics, Yingnan Zhao
Fundamental Questions about Business Cycles
■ What causes business cycles?
– Shocks from supply and demand sides
■ How does the shocks affect the economy?
– The response of macroeconomic variables (e.g., consumption, investment,
employment, interest rate, price level, and output etc.) to exogenous shocks
■ Are business cycles harmful to the economy?
– Inefficient allocation of economic resources over business cycles due to
economic frictions (e.g., sticky prices, financial frictions)
■ How should policymakers respond to cyclical fluctuations?
– Macroeconomic policy (monetary and fiscal) to overcome or mitigate the
effects of recessions/overheating on an economy
Fall 2022 25University of Toronto Mississauga, Department of Economics, Yingnan Zhao
Fundamental Questions about Business Cycles
■ What causes business cycles?
– Shocks from supply and demand sides
■ How does the shocks affect the economy?
– The response of macroeconomic variables (e.g., consumption, investment,
employment, interest rate, price level, and output etc.) to exogenous shocks
■ Are business cycles harmful to the economy?
– Inefficient allocation of economic resources over business cycles due to
economic frictions (e.g., sticky prices, financial frictions)
■ How should policymakers respond to cyclical fluctuations?
– Macroeconomic policy (monetary and fiscal) to overcome or mitigate the
effects of recessions/overheating on an economy
Fall 2022 26University of Toronto Mississauga, Department of Economics, Yingnan Zhao
Short and Medium Run
■ Model frameworks: in a closed and an open economy
1. IS-LM: Short-run, Fall 2022
2. AS-AD: Medium-run, Week 1-6, Winter 2023
■ Key markets: Goods, financial, and labour markets
■ Goal:
– Interactions of the markets and determination of key variables: Output,
employment, interest rates, inflation
– Analysis of the effects of exogenous shocks on macroeconomy (e.g., changes in
consumer and firm confidence, minimum wage, supply-chain disruptions etc.)
– The role of macroeconomic policy in affecting macroeconomy: Monetary, fiscal,
and foreign exchange policy
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 27
Two Perspectives in Macroeconomics
1. Economic growth in the long run (e.g., in 20+ years)
– Determined by technology, human capital (e.g., education), labour force,
physical capital, resources, etc.  Economic fundamentals
2. Economic fluctuation in the short (e.g., 0-5 years) to medium (e.g., 6-20 years) run
– Due to shocks from supply and demand sides
– Monetary and fiscal policy affect the demand side of an economy
Short run
0-5 years
Medium run
6-20 years
Long run
20+ years
Fall 2022 University of Toronto Mississauga, Department of Economics, Yingnan Zhao 28
Roadmap
■ GDP and its calculation
■ Nominal vs. real GDP
■ Inflation rate: GDP deflator and consumer price index (CPI)
■ Reading: Blanchard and Johnson, Chapter 2 (US edition: Chapter 2.1, 2.3, 2.5 & 2.6)
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 29
GDP AND ITS CALCULATION
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 30
Gross Domestic Product (GDP)
■ Which of the following correctly defines GDP?
A. GDP is the value of the final goods and services produced in the economy
during a given period
B. GDP is the sum of value added in the economy during a given period
C. GDP is the sum of incomes in the economy during a given period
D. All of above
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 31
Gross Domestic Product (GDP)
■ Which of the following correctly defines GDP?
A. GDP is the value of the final goods and services produced in the economy
during a given period
B. GDP is the sum of value added in the economy during a given period
C. GDP is the sum of incomes in the economy during a given period
D. All of above
■ Answer: D
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 32
Gross Domestic Product (GDP)
■ Which of the following correctly defines GDP?
A. GDP is the value of the final goods and services produced in the economy
during a given period
“Expenditure approach”
B. GDP is the sum of value added in the economy during a given period
“Product approach”
B. GDP is the sum of incomes in the economy during a given period  Income
“Income approach”
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 33
Final goods vs. intermediate goods (a good
used in the production of the final goods)
Production – the value of the intermediate goods
Labour income (60%), capital income (30%),
tax revenues (income of governments, 10%)
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 34
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
1. What is the value of final goods and services?
2. What is the value added of the steel company and of the car company?
3. What is the total income in the economy?
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 35
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
1. What is the value of final goods and services?
– Final goods: Cars, $210
– Intermediate goods: Steel, $100
– GDP = $210 (revenues from car sales)
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 36
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
2. What is the value added of the steel company and of the car company?
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 37
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
2. What is the value added of the steel company and of the car company?
– Value added of steel company: $100
– Value added of car company: $210 -$100 = $110
– The sum of the value added = $100+110 = $210 = GDP
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 38
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
3. What is the total income in the economy? $150 + $60 = $210 = GDP
Calculation of GDP: An Example
Steel Company
Revenues from sales $100
Expenses (wages) $80
Profit $20
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 39
Car Company
Revenues from sales $210
Expenses $170
Wages $70
Steel purchases $100
Profit $40
3. What is the total income in the economy? $150 + $60 = $210 = GDP
– No tax
– Labour income (i.e., wages): $80 + 70 = $150
– Capital income (i.e., profits): $20 + $40 = $60
NOMINAL AND REAL GDP
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 40
Nominal GDP vs. Real GDP
■ Nominal GDP: the sum of the quantities of final goods produced times their
current price Also called GDP in current dollars
■ Example:
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 41
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Nominal GDP in Year 0: Nominal GDP in Year 1:
Nominal GDP vs. Real GDP
■ Nominal GDP: the sum of the quantities of final goods produced times their
current price Also called GDP in current dollars
■ Example:
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 42
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Nominal GDP in Year 0: 200,000 Nominal GDP in Year 1: 230,000
Nominal GDP vs. Real GDP
■ Nominal GDP: the sum of the quantities of final goods produced times their
current price Also called GDP in current dollars
■ Example:
1. The level of output has increased
2. The price level has increased
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 43
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Nominal GDP in Year 0: 200,000 Nominal GDP in Year 1: 230,000
Price Level in Canada
Source: Bank of Canada
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 44
Nominal and Real GDP in Canada
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 45
Nominal GDP vs. Real GDP
■ Real GDP: the sum of the quantities of final goods produced times constant price
 Also called GDP in constant (or a specific year) dollars
■ Example:
■ Using Year 0 as the base year: Real GDP in Year 1 = _______. Growth rate = _____.
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 46
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Total: 200,000 Total: 230,000
Nominal GDP vs. Real GDP
■ Real GDP: the sum of the quantities of final goods produced times constant price
 Also called GDP in constant (or a specific year) dollars
■ Example:
■ Using Year 0 as the base year: Real GDP in Year 1 = 210,000  5% increase
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 47
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Total: 200,000 Total: 230,000
Technical Details When Calculating Real GDP
■ The relative price of goods change over time
– When using the price levels in a constant year to calculate real GDP, the weight
of goods and services is the relative price
– When relative prices change, the weight changes  Choice of year matters
– Using Year 1 as the base year: Real GDP in Year 0 = 220,000  4.5% increase
■ The quality of goods change over time: Hedonic pricing
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 48
Year 0 Year 1
Quantity Price Sum Quantity Price Sum
Potatoes (kg) 100,000 1 100,000 100,000 1.2 120,000
Cars (units) 10 10,000 100,000 11 10,000 110,000
Total: 200,000 Total: 230,000
INFLATION RATE
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 49
Inflation Rate
■ Inflation rate: The growth rate of price levels
■ Price level measured by price indexes:
– GDP deflator: Nominal GDP/Real GDP, reflects the average price of final
goods and services produced in the economy
– Consumer price index (CPI): reflects the average price of the expenditure
basket of a typical urban consumer
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 50
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 51
CPI Inflation vs. Cost of Living
■ CPI inflation overstates true increases in the cost of living by up to 0.6% due to
1. Quality adjustment bias
2. Substitution bias
■ Overstated CPI inflation  Understated real family income
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 52
Summary
■ Time horizon in macroeconomics:
– Short run: Fluctuations in aggregate demand
– Medium run: Return to level of output determined by supply factors
– Long run: Evolution of technology, labour force, capital stock, etc.
■ GDP: The production of final goods and services, the sum of value added, total income
■ Nominal GDP: Quantities of output multiplied by current prices
■ Real GDP: Quantities of output multiplied by constant prices in a certain year
■ Inflation rate:
– GDP deflator: Average price of goods and services produced
– Consumer price index (CPI): Average price of a consumption basket
Department of Economics, University of Toronto Mississauga, Yingnan Zhao 53