We propose a methodology for measuring the size and properties of the shadow economy. We use a two-sector dynamic deterministic general equilibrium model with four different trends: hours worked, investment-specific productivity, formal productivity, and shadow productivity. We find that the shadow productivity trend is endogenous, in the sense that it is an exact function of model parameters and the other three trends. We also document that, in order to be consistent with observed (real-world) trend growths, the shadow sector needs to exhibit increasing returns to scale, which is contrary to the standard procedure of imposing decreasing returns to this sector. We apply our methodology to a set of seven Latin American and Asian countries and document several empirical regularities that emerge from our analysis, the most important one being that the volatility of shadow sector output is considerably larger than the one in formal sector output.JEL codes: E26, E32, O17.

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Dynamic stochastic general equilibrium (DSGE) models have become the workhorse of modern macroeconomics and the standard way to communicate ideas among applied macroeconomists. Undergraduate students, however, often remain unaware of their existence. The lack of specialized knowledge can hurt them if they decide to attend graduate school. Indeed, many first-year PhD students discover that the material they are currently learning differs significantly from what they mastered in college. But this can change. In this essay, I describe how to teach a full-fledged macroeconomics course where DSGE models take center stage. I discuss how to arrange such a course within a one-semester time frame, detail the main components of instruction, and finish with some thoughts based on my teaching experience at Macalester College.

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