Ece 202 Notes Study Economics Yr1 Prt2

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Table of Contents Table of Contents....................................................................................................................1 :TO MAKE :SHORTENED NOTES OF TO STUDY LATER AFTER EXAM FOR FUTURE:& magazines/journals for economics-& questions for lecturers still to ask................................5 Questions & answers:.......................................................................................................5 Shortened notes to make:................................................................................................5 All Multipliers and index ratios:and Marginal propensty's to Consume................................6 Chapter 1:.........................................................................................................................6 Chapter 6..........................................................................................................................6 Chapter 7..........................................................................................................................6 All Formulas:........................................................................................................................6 Chapter 1:.........................................................................................................................6 Chapter 18:.......................................................................................................................6 Chapter 19:.......................................................................................................................6 IMPORTANT NOTES from LAST SEMESTER..........................................................................9 CHAPTER 1 ...........................................................................................................................10 : INTERDEPENDANCE OF MAJOR SECTORS, MARKETS AND FLOWS IN THE ECONOMY..........10 Important Boxes/concepts/graphs/pages:.........................................................................10 box 3.1 p48t Stocks and Flows.........................................................................................11 3.1 p46 THE 3 MAJOR FLOWS IN THE ECONOMY: Production ,Income and Spending........11 3.2 p47 The Interdependance between Households and Firms.........................................12 TYPES OF FIRMS:P50 BOX...............................................................................................13 Market Types;.................................................................................................................14 The Circular flow of Goods and Services Diagram.(NOT SPENDING+INCOME)...............14 The Circular flow of Income and Spending.(NOT GOODS & SERVICES).........................15 Abbreviations of major Terms:.......................................................................................15 3.3 pg 52 Introducing the Government:............................................................................16 3.4 Introducing the Foreign Sector....................................................................................17 Financial Institutions in the circular flow of income andspending.3.5t..............................18 Total Production,Income,Spending-Revisited....................................................................19 Abbreviations of major Terms:.......................................................................................19 CHAPTER 2 ...........................................................................................................................20 : MEASURING THE PERFORMANCE OF THE ECONOMY..........................................................20 Important Boxes/concepts/graphs/pages:.........................................................................20 1 . Macroeconomic Objectives-2.1p9s,p61t.......................................................................21 5 Macroeconomic Objectives used to Judge the Performance of the EcoEnomy............21 #1 Macroeconomic Objective :Econ.Growth : GDP-Gross Domestic Product-Measuring the Level of Economic Activity.4.2t,p63...................................................................................22 Aspects on the definition of GDP....................................................................................22 About GDP:.....................................................................................................................22 The 3 Methods of Calculating GDP:...............................................................................23 Difference between the 3 Methods of calculating GDP..................................................23 Measurement at Market Prices,Basic Prices and Factor Cost(or Income).......................24 GDP at Current prices & GDP at Constant Prices:...........................................................25 Other Measures of Production ,Income and Expenditure...............................................25 GNI (or GNP)- Gross National Income ............................................................................25 Expenditure on GDP.......................................................................................................26 ECS102-8 economics Part2 Yr1

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GDE: Gross Domestic Expenditure.................................................................................26 SUMMARY of national accounting totals.........................................................................26 #2 MACROECONOMIC OBJECTIVE : Full Employment :Measuring Employment and Unemployment..................................................................................................................27 #3MACROECONOMIC OBJECTIVE:STABLE PRICES:Measuring Prices,the Consumer Price Index..................................................................................................................................27 The Consumer Price Index. ............................................................................................27 #4 MACROECONOMIC OBJECTIVE: Balance of Payments...................................................28 #4 MACROECONOMIC OBJECTIVE:Equality in Distribution of Income: 3 Methods of Measuring Inequality. .......................................................................................................29 Method #1 of 3 : Lorenz Curve.......................................................................................29 #2Gini Coefficient:(or RATIO).........................................................................................29 #3Quantile Ratio............................................................................................................30 Extra Notes:....................................................................................................................30 CHAPTER 3 ...........................................................................................................................31 : THE MONETARY SECTOR.(MACROECONOMICS)ch ch15t,pg353.........................................31 Important Boxes/concepts/graphs/pages:.......................................................................31 INTRODUCTION:.................................................................................................................32 The Functions of Money:....................................................................................................32 1-Money as a meduium of exchange:.............................................................................32 2- Money as a unit of account:......................................................................................32 3-Money as a Store of Value:..........................................................................................32 4-What Money is Not:.....................................................................................................32 Different Kinds of Money...................................................................................................33 Money in RSA.....................................................................................................................33 TERM 1-Coventional measure:M1...................................................................................33 TERM 2-M2......................................................................................................................33 TERM 3-M3......................................................................................................................33 Financial Intermediaries....................................................................................................34 THE SOUTH AFRICAN RESERVE BANK................................................................................34 Issuing banknotes and coins...........................................................................................35 Acting as banker for other banks....................................................................................35 Acting as banker for the government.............................................................................35 Acting as custodian of countries gold and other foreign reserves..................................35 formulating and implementing monetary policy............................................................35 The Supply of Money.........................................................................................................35 Banks: in the money creation process.(role in supply)..................................................35 2-Reserve Asset position and Credit Multiplier:..............................................................36 3-Other Factors in Supply of Money...............................................................................36 EXTRA BOX:Bonds,the Bond market and Capital...............................................................36 The Demand for Money....................................................................................................37 Interest Rates:................................................................................................................38 Equilibrium in the Money Market.......................................................................................38 Simulaneous control over the supply of money andthe Interest Rate-Authority Controlling Supply .........................................................................................................39 The Instruments of Monetary Policy..................................................................................39 1-Accomodation policy...................................................................................................39 Open market policy........................................................................................................40 Public Debt management...............................................................................................40 Intervention in foreign exchange markets......................................................................40 CHAPTER 4 ...........................................................................................................................41 ECS102-8 economics Part2 Yr1

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: THE PUBLIC SECTOR.(MACROECONOMICS)........................................................................41 Important Boxes/concepts/graphs/pages:........................................................................42 1-Role of Government in the Economy : An Overview: 16.1p384......................................43 -2-Fiscal Policy and the Budget..........................................................................................43 -3-Government Spending-16.8p401..................................................................................44 -4-Financing of Government Spending 16.9,p403.............................................................44 -5-Taxation 16.10..............................................................................................................45 -1-Criteria for a good tax:...............................................................................................45 -2-Different Types of Tax:...............................................................................................45 -6-Taxation in RSA.............................................................................................................45 -7-Tax Incidence-ie: Who really Pays the Taxes?...............................................................46 The Impact of a Specific Excise Tax:..............................................................................46 CHAPTER 5 ...........................................................................................................................47 : THE FOREIGN SECTOR.(MACROECONOMICS)......................................................................47 Important Boxes/concepts/graphs/pages:........................................................................48 -1-WHY Countries Trade:...................................................................................................49 Intra industry trade:.......................................................................................................50 -2-Trade Policy...................................................................................................................50 TYPES OF GOVERNMENT CONTROLS FOR Int .Trade.....................................................50 -2-Arguments for the use of Trade Barriers:...................................................................52 Arguments against Trade barriers..................................................................................53 Trade Policy in RSA.........................................................................................................53 Gold in the Internationqal monetary system;.................................................................53 The GATT,The Uruguay round and WTO-world trade organisation.................................53 The Balance of Payments..................................................................................................53 The Balance of Payments and Economic activity and Policy in RSA. .............................54 Gold and other Foreign Reserves:..................................................................................54 The Int.M.Fund.+World Bank..........................................................................................54 Exchange Rates: ...............................................................................................................54 The foreign exchange market:.......................................................................................55 REASONS FOR THE DEMAND FOR DOLLARS:..................................................................55 REASONS FOR THE SUPPLY FOR DOLLARS:...................................................................55 THE EQUILIBRIUM EXCHANGE RATE:..............................................................................55 Intervention in the Foreign Exchange Market:................................................................56 Exchange Rate Policy.....................................................................................................57 The Terms of Trade:..........................................................................................................57 CHAPTER 6 ...........................................................................................................................59 : INCOME DETERMINATION IN A SIMPLE KEYNESIAN MACROECONOMIC MODEL(MACROECONOMICS).................................................................................................59 Important Boxes/concepts/graphs/pages:........................................................................60 -1- Production Income and Spending:................................................................................60 The Basic Assumptions of the Model:................................................................................61 Consumption Spending:-----------------------------------.............................................................61 The Consumption Function.............................................................................................61 The position of the consumption function ....................................................................63 The Equation for Consumption Function.........................................................................63 SAVING;..........................................................................................................................63 Investment Spending:........................................................................................................63 The Investment Decision:...............................................................................................64 Equation for Investment Function:.................................................................................65 ECS102-8 economics Part2 Yr1

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The Simple Keynesian Model of a Closed Economy without Gov.......................................65 Total Spending or (Aggregate Demand.)........................................................................65 The 45 0 Line..................................................................................................................66 The Equilibrium level of Income:....................................................................................67 The Algebraic Version of the simple Keynesian Model:..................................................68 -7-Impact of a Change in Investment Spending:The Multiplier..........................................69 -1-What the multiplier means:........................................................................................69 -2-How it can be calculated from the formula................................................................70 -3-Why it's size depends on the marginal propensity to consume.................................70 -4-How it can be represented graphically.......................................................................70 CHAPTER 7 ...........................................................................................................................72 :KEYNESIAN MACROECONOMIC MODELS INCLUDING THE GOVERNMENT and THE FOREIGN SECTOR.................................................................................................................................72 1-Introduction:...................................................................................................................73 2-Introducing The Government into our Model:.................................................................73 1-Government Spending:(G)...........................................................................................74 2-Taxes(T)......................................................................................................................76 Fiscal Policy:...................................................................................................................78 2 -Introducing The foreign Sector into the Model:The Open Economy..............................78 Introduction:...................................................................................................................78 Fiscal Policy inthe Open Economy:.................................................................................80 CHAPTER 8 ...........................................................................................................................81 : MORE ON MACROECONOMIC THEORY AND POLICY............................................................81 The Aggregate Demand Aggregate Supply Model 8.1sp511t............................................82 The Aggregate Demand Curve.......................................................................................83 Changes in Aggregate Demand:.....................................................................................84 The Aggregate Supply Curve..........................................................................................85 The Slope of the Aggregate Supply Curve:.....................................................................85 Changes in Aggregate Supply........................................................................................86 The Monetary Transmission Mechanism............................................................................87 Links between Interest Rates , Investment Spending and Rest of Economy .................87 ..........................................................................................................................................88 Monetary and Fiscal Policy in the AdAs Framework...........................................................88 Expansionary and Contractionary Monetary and Fiscal policy.......................................88 Monetary and Fiscal Policy lags......................................................................................88 The relative effectiveness of monetary and fiscal policies:............................................89 CHAPTER 9 ...........................................................................................................................90 : INFLATION:..........................................................................................................................90 Introduction.......................................................................................................................90 Definition of Inflation:........................................................................................................91 The Measurement of Inflation:...........................................................................................91 The Consumer Price Index. ............................................................................................91 The Effects of Inflation:......................................................................................................92 Hyperinflation-the Greatest Cost of Inflation..................................................................93 The Causes of Inflation:.....................................................................................................93 Demand- Pull and Cost-Push inflation.............................................................................93 CHAPTER 10 .........................................................................................................................97 : UNEMPLOYMENT:................................................................................................................97 Unemployment:....................................................................................................................98 ECS102-8 economics 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The Employment Pool:.......................................................................................................98 Measuring Unemployment.................................................................................................98 The Costs of Unemployment:.............................................................................................98 Types of Unemployment:...................................................................................................99 Policies to Reduce Unemployment....................................................................................99 Unemployment in the Keynesian & AD-AS Models..........................................................100 CHAPTER 11 .......................................................................................................................102 : Economic Growth:.............................................................................................................102 Introduction:.......................................................................................................................102 Definition and Measurement of Economic Growth..............................................................103 Some problems associated with GDP as measure of economic growth:......................103 Calculating Economic Growth:......................................................................................103 The Business cycle:......................................................................................................104 Sources of Economic Growth:.............................................................................................104 Supply Factors:.............................................................................................................104 Demand Factors:..........................................................................................................105 -----------------------------------------------------------------------------------------------------------------------------

:TO MAKE :SHORTENED NOTES OF TO STUDY LATER AFTER EXAM FOR FUTURE:& magazines/journals for economics-& questions for lecturers still to ask. Questions & answers: 1. Answer to which journals/magazines-Journals+ magazines: 'SEE'-"studies in economics and econometrics"(international journal),+ also "Journal of economics –for RSA”,financial mail + business day+ gauteng business etc. 2. still to ask-":whwere do you get the actual elasticity indexes, the investment multiplier from marginal propensity to consume in keynes theory,also the graphics for demand& supply curves with real info-also all other graphs with real info etc? 3. why do they call income from natural resources rent- where it should be profit from mines, forrests,fisheries etc., and how to calculate gdp using 'interest 'and 'rent' – profit & wages one can understand- arnet there going to be other income fro FOP here somewhere( alot of it missed somewhere maybe?)

Shortened notes to make: 1. 2. 3. 4.

ECONOMIES OF SCALE & SCOPE PAGE 56 OF NOTES-CH 6 SEE under consumption spending points 2&3 non-income determinants of consumption pg 466 t marginal production/maximum profit curves:of the production curves-profit ratios etc: semester 1

5.

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All Multipliers and index ratios:and Marginal propensty's to Consume Chapter 1: Chapter 6 1) #@#=1/1-c Government

: Multiplier for Keynesian macroeconomic model without foreign sector or

Chapter 7 1) The old marginal propensity to consume is c with taxes included.The slope of this curve is c(1-t) which is allways smaller than c. 2) The new marginal propensity to consume is c(1-t) with taxes included.The slope of this curve is c(1-t) which is allways smaller than c. 3) The Multiplier without Taxes= #@#= 1/1-c 4) Multiplier with Taxes = #@#=1/1-c(1-t)

All Formulas: Chapter 1: Chapter 18: 1)

Chapter 19: GOVERNMENT SPENDING 1) Equilibrium position of Tot.Income-Production/Tot.Spending-Demand : Y0=Abar :Income equilibrium =Tot. Autonomous Spending 2) Consumption Function: c=C/Y : 3) Equilibrium Income=Y0 4) To calc: EQUILIBRIUM level we start with 5) Equilibrium condition : Y=A(where eqilibrium is) 6) so :Y=C+I+G because (A=C+Ibar+Gbar) 7) and C=Cbar +cY) 8) So: Y=(Cbar+cY)+I+G 9) Thus:to solve above equation: 10) Y-cY=Cbar+Ibar+Gbar 11) so: Y(1-c)=Cbar+Ibar+Gbar 12) THUS: Y0=1/1-c(Cbar+Ibar +Gbar) : (19.4) 13) General formula can still be written: Y0=#@# (Abar) :(19.5) 14) Y=A(the equilibrium 45 deg line)******** 15) so :Y=C+I+G because (A=C+Ibar+Gbar)********* ECS102-8 economics Part2 Yr1

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16) and :C=Cbar +cY (consumption curve equation)******* 17) So: Y=(Cbar+cY)+I+G 18) Where Y0 is equilibrium of A and Y 19) .Where:#@#=multiplier , Abar = total autonomous spending

TAX 1) Tax Rate: T=tY 2) Specific exercise:If the Gov. wishes to close the gap between full employment (=Yf as an example) and lower levels by incresing spending –they must work pout how much with above formula.=^Y=@^G :so:^G=^Y/@. where multiplier will increase %income morethan %spending

Exports&Imports 1) 2) 1) 2) 3) 4) 5)

The Formula for Imports/Exports is: A = C+I+G+(X –Z). term Net Exports usually referred to as =(X-Z) from A = C + I to A = C + I + G.+(X-Z) Y=A (equil. condition) A=C+ Ibar+Gbar +(Xbar-Zbar) (aggregate spending where I,G,X,Z, are autonomous) C=Cbar +c(1-t)Y (consumption function) SUBSTITUTING: a) Y=A b) Y=C+Ibar +Gbar+(Xbar-Zbar) c) Y=(Cbar +cYd)+Ibar+Gbar+(Xbar-Zbar) d) Y=(Cbar +c(1-t)Y))+Ibar+Gbar+(Xbar-Zbar) e) Y-c(1-t)Y=(Cbar +Ibar+Gbar+(Xbar-Zbar)) f) Y=(1-c(1-t)) *(Cbar +Ibar +Gbar+(Xbar-Zbar)) g) Y0=1 /1-c(1-t) *****(Cbar+Ibar+Gbar+(Xbar-Zbar))

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IMPORTANT NOTES from LAST SEMESTER ( +extra notes from class this semester=) • Bull market-buying bonds • bear market-selling bonds at lesser price with hope of buying them back at an lesser price. • demand deposit =sight deposit • repo rate replaced the financial rand • Passive way of money supply=you deposit +withdrawing • Active way of-bank relends –see multiplier. • 1. -The 4 Factors of Production +sometimes 5th identified =technology and their respective INCOMES 1.1. Natural resources or land=RENT 1.2. Entrepeneurship =Profit 1.3. Capital =Interest 1.4. Labour =wages/salaries 2. Law of demand +Supply=higher price/more supplied/less demanded cet par. 3.

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ECONOMICS part 2 Yr1 ECS102-8 CHAPTER 1 : INTERDEPENDANCE OF MAJOR SECTORS, MARKETS AND FLOWS IN THE ECONOMY. Important Boxes/concepts/graphs/pages: 1. 2. 3. 4. 5.

Pg47-Produc/income/spending flows diagram Pg52-circular flow of-1-goods/services diagram/-2-income /spending pg 57/58-circu;lar flow of goods +services with Government+Foreign+Financial sector. BOX3.1 pg48-Stocks&Flows BOX3.2 pg50-Different types of firms

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box 3.1 p48t Stocks and Flows 1. Whether economic variables either a STOCK or FLOW variable-important to allways consider when considering any economic variable-some variables not either of though. 2. a. A STOCK:Has no Time dimension: at a moment. can only be measured at a moment,no time period,-still picture of economy:eg water in a dam –"the level of"-. b. A FLOW: Has a time dimension,over a period of time –the period concerned must allways be specified. eg:water flowing out of a dam-"flowing in/out"3. RELATIONSHIP? between stocks and flows.:Stocks can only change as a result of flows. eg : Investment flow change capital stock. Population stock changes from birth/death flow. 4. There are other variables other than stocks and flows. 5. Prices are ratios between different flows(not stocks). 6. RATIO between two stocks or two flows have no time dimension. 7. RATIO between a stock and a flow or vis.versa do HAVE a time dimension 8. Failureto distinguish between stocks and flows can have faulty reasoning and analysis consequenses. 9. STOCKS 1-wealth 2-assets 3-liabilities 4-capital 5-population 6-balance in savings account 7-unemployment 8-gold reserves held by RSA reserve bank 10-stock inventory

'increasing wealth' 'paying for assets' (??not direct??) direct direct direct direct direct direct

FLOWS over period:income over period:profit over period:loss over period:investment over period:no.of births /deaths over period:Saving(differencespend/earn) over period:demand for labour over period:gold sales /gold production production

3.1 p46 THE 3 MAJOR FLOWS IN THE ECONOMY: Production ,Income and Spending. -IN ECONOMICS EVERYTHING IS RELATED TO EVERYTHING ELSE ,OFTEN IN MORE THAN ONE WAY. –( the basis of this chapter)quote:anonymous. – IN MIXED ECONOMY: FOR THE DIAGRAM: "The 3 Major Flows in the Economy" -Production –generates- Income(from various FOP only) –generates (used to(partly) spend on)- Spending-Buys/pays for Production

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Spendi ng

gg gg

Producti on

Income

1. 2. 3. 4. 5.

In the mixed economy. Production ,income and spending are flows. Productions aim is to use/consume raw or other products to satisfy human wants. the sole aim and purpose of production is consumption-adam smith.Production creates income earned in production process by the various factors of production.ie:distribution of income. 6. Total spending in economy is the total spending of 4 major(or 5) major participants in economy. 7. VARIOUS sectors of economy: 4+1=5 major types : 7.1. Households,Firms,Government,Foreign sector, + is 5th (if include to 5)Financial sector: all participate in the sequence of production /income /spending and all also contribute to each of the major flows of economy:(incl.towards production) 8. The other important economic activity that links the various sectors of economy is : Exchange (apart from—not incl. production/income/ spending ,exchange is another link between –ie relations in economic/between the economic sectors. 8.1. usually occours in markets 8.2. The fundamental markets in the economy are: 8.2.1. Goods and services market 8.2.2. Factors of production market.(fop market)labour/raw materials/entrepeneurial/capital. 9. The ultimate aim of production is to satisfy human wants and needs.(byusing/cosume raw materials or other products) 10. Income is actually the remuneration/reward for application of the factors of production.

3.2 p47 The Interdependance between Households and Firms. 1. 2 Major sectors of economy are :Households and Firms, of: 2. 5 Major Sectors of economy2.1. households 2.2. firms 2.3. government 2.4. foreign sector 2.5. financial sector HOUSEHOLDS 1. Households:all the individuals who live together and make joint economic decisions,or others make for them./individuals,consumers/interchangably used terms. 1.1. joint income+1.2. primitive times no Gov,foreign sector,firms etc 1.3. members are consumers-consumption 1.4. Are the basic units in an economic system

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1.5. Own the FOP and sell these factors to Firms,receive income and buy consumer goods +services,consumed to satisfy human wants/needs. 2. In mixed economy-Households own most FOP/own labour/own capital goods/eg;anglo american-owned by shareholders. CONSUMERS: 3. Total consumption Expenditure(or aggregate C.E)=total consumption /spending in economy(on consumer goods and services by households). 3.1. Symbol="C" 4. In market economy consumers determine what should be produced. 5. In economic analysis we assume consumers are rational-Max satisfaction for means at their disposal. 6. FOP cannot satisfy human wants directly-thus sell to firms to convert.-Income from fop flows from. FIRMS 1. Definition of firms:The unit that employs FOP to produce goods and services that are sold in the goods market. 2. Characteristics of firms: 2.1. basic productive unit in the economy 2.2. are actually artificial units 2.3. ultimately owned /operated by individuals/households-eg shareholders 2.4. Assumption is that rational-aim to max profit. 2.5. Profit=total revenue-explicit cost 2.6. "I"=capital formation or investment. (in capital goods) 2.7. purchase fop on the 'factor markets' 2.8. Decide what+/how+/+to whom distribute from 3-central questions in economics.

TYPES OF FIRMS:P50 BOX Individual /Sole proprietorship 1.1. 1.2. 1.3. 1.4.

All decisions +ownership vested in single person Main weakness unlimited liability-owner responsible all debts+liabitities of firm. Relatively easy to form /dissolve Suited activities require personal supervision,where: scale of operations,and financing requirements not large. 1.5. Has no separate existence from owner-assets of firm are assets of owner. 1.6. Limited liability to raise funds for expansion 1.7. eg : shops,hairdressers,farms,plumbing services.

Partnerships:

1.8. Suited to all activities needing specialised abilities-benefit from specialisation. 1.9. Differs little from sole proprietorship. 1.10.Action of partners binding on other partners including unlimited liability. 1.11.Partners are joint owners of firm. 1.12.Exept for a bit better financing possibilities ,same liability +other of sole proprietorship. 1.13.eg:attorneys ,accountants,doctors,etc.

Companies 1.14.Identity in eyes of law separate from owner. 1.15.Least risky form because liability usually limited to value of shares owned. 1.16.Attract better financing through eg: shares ,bonds,bank credit. 1.17.Separation of owner /mangement can create problems. 1.18.Specialists can be employed to manage firm. ECS102-8 economics Part2 Yr1

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1.19.Can be sometimes abused by unscrupulous people. 1.20.Significant red tape to establish. 1.20.1. TWO TYPES: PRIVATE company: a. Max 50 members b. Right to transfer shares restricted c. Only must have 1 member d. (Pty)Ltd in RSA:Proprietry limited. e. eg:Alusaf (Pty Ltd),Clicks stores(Pty Ltd),Johnson tiles(Pty Ltd) 1.20.2. PUBLIC company. a. Not fewer than 50 shareholders b. Any max shareholders c. Company that wishes to raise finance through the issuing of shares thus shares easily transferable. d. Shares easily transferable e. Many listed on JSE f. eg:Anglo american,Remgro,Old Mutual,Sappi 1.21.many foreign owned or multinational companies operate in RSA eg:siemens,microsoft,shell,ibm.

Close Corporations. 1.22.Since 1985 RSA new type. 1.23.Display cc after name ,must by law. 1.24.Easier to establish than private or public companies. 1.25.max 10 min 1 members. 1.26.Each member "% Specified interest in close corporation." 1.27.Can only dispose of interest with permission of other members. 1.28.Created to afford advantages of companies without having to register as a fully fledged company under the companies act. 1.29.By 1990 more CC's than companies in RSA

Other forms of Business enterprise :

1.30.Co-operatives(eg agriculture) 1.31.Trusts 1.32.Public enterprise (Gov.eg eskom,sabc) 1.33.Informal sector:spaza,hawker,shebeen,subsistence farmers.

Market Types; Goods Market. 1.1. market for goods and services-consumers mostly buy.

Factors market

1.2. all factors of production markets 1.3. production /producers/firms mostly buy. 1.4. include labour market+capital goods market. •

Aggregation:lump all different markets into one heading,ie:in macro economics.

The Circular flow of Goods and Services Diagram.(NOT SPENDING+INCOME) 1. Diagram which illustrates the interaction between markets and firms. 2. Households offer FOP for sale on factor market 3. Firms buy FOP on factor market and combine FOP and offer for sale on Goods market. ECS102-8 economics Part2 Yr1

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4. Consumers /Households purchase Goods on Goods market.

SE LL U BO HT G

S Pr ER G od VI O uc CE OD O N e/ S S : c : A o N m D bi ne FO . P

FO : P

to

FIRMS

GOODS MARKET

FACTOR MARKET SA LE

O

FO P FF : ER FO

HOUSEHOLDS

R

G O SE A OD R N S (S VI D O C TO LD ES )

The Circular flow of Income and Spending.(NOT GOODS & SERVICES) 1. It's direction is OPPOSITE to Goods and Service flow. 2. Usually a MONETARY flow. 3. INCOME types from FACTORS OF PRODUCTION: 3.1. Labour =Wages and Salaries 3.2. Natural resources=Rent 3.3. Capital =Interest 3.4. Entrepeneur =Profit 3.5. Profit from fop also to households income,also rent,+interest+wages. H G

E

HOUSEHOLD S

Sp en di ng

GOODS MARKET

EN SP

IN D

FACTOR MARKET IN W CO A PR G M O ES E FI / T

I N CO M

FIRMS

Abbreviations of major Terms: I=Investment in capital goods(machines,bridges,robots etc). C=Households spending on consumer goods and services. G=Government spending on goods and services. E=foreign spending on RSA goods and services. ECS102-8 economics Part2 Yr1

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Z=RSA spending on foreign goods and services. S = Saving S= Total Expediture= Total Expenditure on SA Goods&Services=(less imports) ANSWERS FROM LECTURER: 1. "G" represends both spending by the government and income received by those who are selling the goods. 2. Likewise, "C" represends both like you put it.(.spending flow or goods flow or income origin flow for sellers) 3. For Investment (I) It is the same as above.(spending flow or goods flow or income origin flow for sellers of capilal goods) 4. It is once again the same,(for both,"T" for People Spending tax or Government receiving tax or both ) 5. They are for both."E" and "Z" are for 'spending' and 'goods flowing"

3.3 pg 52 Introducing the Government:

Central gov. all gov. depts also CSIR,SABS, universties

general government: incl.provincial gov.=9 provinces admin+local gov=muncipalities+district councils

Public sector= pubic corporations-eskom,transnet,sabc,rand water,post office,armscor, (can be regarded as firms for purposes of our flow diagrams) +all of other government parts=ALL OF

1. Government :includes local,regional or provincial,+national gov.////Incl:polititians ,civil servants,muncipal,mayors,etc, also public corporations eg:Escom/Transnet/SA Reserve Bank. 2. Gov. employees are only Gov. in official capacities,privately they are households. 3. Public Sector :in economics refer to public sector- means government +everything owned by, as representative of the people. 4. Government is not assumed to ,DOES NOT ACT RATIONALY,like firms,1-political party strategies vary and -2- individual politicians can be biased by personal factors(eg reelection-short term benefit bias) 5. Primary function of government in economy-establish framework within which economy operates. 6. Secondary functions of Gov.:INVOLVES 3 important FLOWS: a. "G" =government spending on Goods and services &Factors of production(mostly labour). ECS102-8 economics Part2 Yr1

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b. "T' =Taxes levied on households+firms,-used to finance services eg roads,defense. c. Transfer payments :from wealthy to poor eg:pensions.(DOES NOT AFFECT OVERALL SIZE OF INCOME/EXPENDITURE/PRODUCTION FLOWS-like taxes and "G" do so no "abbreviation" given for 'economic workings outs'. 7. Gov. provides services eg:defense,roads,dams,health services in return for Goods+ services &FOP purchased ,financed mainly by taxes. 8. Transfer payments :Do not affect overall size of income/expenditure/production flowslike "T"taxes and "G" do so no "abbreviation" given for 'economic workings outs'. 9. Government Spending on FOP and Goods +Services = injection into the flow of spending +income 10. Taxes are a leakage/withdrawal from circular flow of income between households + firms.

NOTE : BELOW-INCOME & SPENDING and GOODS & SERVICES(HERE CALLED PRODUCTION) Figure 1 Government in the circular flow of production,income +spending

(goods and services)

(goods and services)

3.4 Introducing the Foreign Sector. THE FORIEIGN SECTOR IN THE CIRCULAR FLOW OF iNCOME AND SPENDING-NOT goods & services! Payment for imports

(leakage)

Foreign sector

Firms spending and income

spending and income

Households

payments for exports injection

1. 2.

4th major sector-foreign sector-consists of rest of world +international fin.istitutions governing flow of funds and goods & services between countries. 2 broad categories:developing countries+industrial countries A. industrial countries: europe mostly-germany,italy,france,USA,Australia

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B.

3. 4. 5. 6.

7. 8. 9. 10. 11. 12. 13. 14.

developing countries:africa/asia etc-most south american +RSA=middle income,most poorestafrica-worst-sierra leone,burundi,ethiopia World bank classifies its members into 4 groups(levels of income):low income,lower middleincome,upper middle income,high income. Industrial=all high income,Developing=all re 'Open Economy'-strong links with rest of world-exp/imp/multinationals. 'globalisation'-recent yearst middle/lows economic links between countries grown stronger. i. economic/or political development can result in massive flows of funds between countries. ii. many firms tend to look at whole world as market for their goods iii. become very easy to shift funds between countries iv. global village where firms from different parts of world must compete with each other. A countries economic links with rest of world are often crucial determinants of level and pace of economic activity in the domestic economy. "Z" = Imports –rsa mainly capital &intermediate goods "E"= Exports-rsa mainly gold & minerals For exports the 'Spending ' originates in rest of world.-thus constitute an 'injection' into circular flow of income =spending in domestic economy. For imports 'spending' originates local, constitutes leakage from circ. flow inc.+spend. Flow of income +spending is also in opposite direction to FOP and Goods +Services. Most important international economic orgaisations:International Monetary Fund,World Bank,World Trade Organisation. Rsa most important trade partners =industrial countries=60%exports,66% imports---Africa to rsa=3% imports,18% exports

Financial Institutions in the circular flow of income andspending.3.5t Diagram: FINANCIAL INSTITUTIONS IN THE CIRCULAR FLOW OF INCOME AND SPENDING. (NOT goods & services /production---NOTE NB !!!!) FIRMS jjjjjjjjjjjjjjjjjjj j

. Spending and Income

saving

Investment

FINANCIAL SECTOR

Spending and Income

Saving

HOUSEHOLDS 1.

Financial Institutions:include Banks,insurance companies,pension funds(Iscor/Mine employees pe..)JSE securites exchange. 2. Financial Institutions act as links between households +firms with surplus funds and households and firms which require funds. 3. Main function of financial sector:channel /act as funnel for savings to flow to investment spending. 4. Units(firms/or households) can be classified as; i. Surplus Units-those in a position to save because spending less than income ECS102-8 economics Part2 Yr1

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5. 6. 7. 8. 9. 10.

ii. Deficit Units -those require funds spending more than income "S" = Saving "S" =To Save:means decision not to consume for households (defined as the act of not consuming)firms can also save by not spending all their income. Saving means a leakage/withdrawal from the circular flow of inc.+spend. Savings channeled to financial instituions-households do save some of income-, (savings deposits)become available to deficit units to expand production capacity. (capital goods) called : :Investment : which is a addition or injection into circular flow of inc.+spend. Linkage in economics between expansion of the production capacity(investment) and the decision to refrain from spending on consumer goods(saving)

Total Production,Income,Spending-Revisited 1. 2. 3.

4. 5.

Aggregate /Total producton=all prod in economy Aggregate /Total Income = Rent-nat.resources + Interest-Capital + wages-labour + profit-entrepeneur Aggregate/Total Spending= by 4 major sectors in economy=1-households-2-firms-3government-4-foreigners where(if one is trying to work out spending on (SA GOODS AND SERVICES) = spending on {SA GOODS AND SERVICES Only}= E-Z = (spending by foreigners on rsa (E)Exports MINUS spending by rsa consumers on (Z)Imports Total Expenditure = C+I+G+ (X-Z) (T)Taxes and (S)Savings and (Z)Imports represent = Leakages or Withdrawals.

Abbreviations of major Terms: I=Investment in capital goods(machines,bridges,robots etc). C=Households spending on consumer goods and services. G=Government spending on goods and services. E=foreign spending on RSA goods and services. Z=RSA spending on foreign goods and services. S = Saving S= Total Expediture= Total Expenditure on SA Goods&Services=(less imports)

THE MAJOR ELEMENTS OF THE CIRCULAR FLOW OF INCOME AND SPENDING (Note Well NOT goods & services/production here-ONLY income&spending!!) C,S,T,Z=LEAKAGES Z

I,G,X=INJECTIONS

FIRMS S

Foreign Sector

and

C & Y

X ECS102-8 economics Part2 Yr1

G

I

FINANCIAL SECTOR S HOUSEHOLDS

Governmen t

C & Y T

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ECONOMICS part 2 Yr1 ECS102-8 CHAPTER 2 : MEASURING THE PERFORMANCE OF THE ECONOMY. Important Boxes/concepts/graphs/pages: pg 80 lorenz curve graph BOXES: changes in purchasing power:pg78 price index construction:pg76/75

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1 . Macroeconomic Objectives-2.1p9s,p61t 1. Economist must judge objectively-not own well being-1-which criteria to use? 2measure criteria? 2. For firms we use profit as crieria,? use for macroeconomy?

5 Macroeconomic Objectives used to Judge the Performance of the EcoEnomy i. Economic Growth>most important one,to grow empl.&liveStandards,econ. must grow,eg:pop.incr ii. Full Employment >need econ.growth to fill up, iii. Price Stability >inflation-not prices-see normalo supply&demand iv. Balance of Payments Stability (or External Stability)>&foreign exchange rate v. Equitable Distribution of Income. more normative less positive,social +political threat security 3. i. Economic Growth : a. First and arguably most important of criterion b. If population grows –economy must also grow or 1. unemployment 2. living standards cannot increase c. requires yardstick-use GDP-therefore GDP also central concept in national accounts. ii.Full Employment a. Problems from unemployment: 1. personal levelA. psycological suffering B. material suffering 2. macroeconomic levelA. serious threat to Social and Political Stability b. Must have economic growth to get more employment,but you can get economic growth without extra employment: eg technological advances cause less labour ,and more production. iii. Price Stability a. Since WW2 and 1973 prices only rise ECS102-8 economics Part2 Yr1

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b. Price stability Refers to keeping inflation as low as possible,not no change(refer to demand/supply problem in a market based economy). c. Yardstick used to measure inflation =CPI-consumer price index. iv. Balance of Payments(or External stability) a. 2 aspects : in technical terms we say: 1. balance of payments itself 2. Exchange rates b. South Africa must export goods/services to earn foreign currency to pay for imports. v.Equitable Distribution of Income(or Socially Acceptable Dist.....) a. Partly a Normative/subjective/value judgement issue-NOT positive. b. Assigning priority to the different objectives.-esp. this one ,some say unequal distribution of the above is way of causing savings +investmnet which will in turn benefit poor. c. Highly unequal generates social + political conflict. d. Can also have important efects on the structure and development of economy.

#1 Macroeconomic Objective :Econ.Growth : GDP-Gross Domestic Product-Measuring the Level of Economic Activity.4.2t,p63 1. Definition: GDP (or GVA-value added)(gross domestic product) is :The total value of all final goods and services produced within the borders of a specific country in a particular period.

Aspects on the definition of GDP 1. 3 /4 further aspects on definitition of GDP: a. GDP means :Within boundry of country=geographic term, MEANS: 'within border' if ever referred to as "in economy" for GDP b. "over a period(year) :GDP is a FLOW(measured over period)+ concerns only new goods and services produced in relevant period:also called "Current Production"Goods produced in a former period and sold in current period are not included in calculation. Goods eg:Houses/cars resold again are not included either. c. Gross-("G"DP) : GROSS in 'gross domestic product' means :without subtracting DEPRECIATION from GDP total ,if we subtract GDP then =NET total.

About GDP: 2. GDP is a FLOW 3. We refer to gross domestic INCOME as : "GDP" and NOT GDI if referring to it.(even though same) 4. TERM "NDP" : Net Domestic Production :is GDP – minus Depreciation of machinary etc,it is more correct measure of economic performance,since it adjusts gross production for the decrease in value of capital goods. But GDP not NDP is mostly used because depreciation is difficult to calculate. 5. TERM "Consumption of fixed capital" is Depreciation of eg machinary.this is very important/significant shows what proportion of total output must be saved to maintain economys capacity(ie. :re-invested in capital goods)in 2002 was 13% of SA GDP! 6. TERM GDP is also called GVA-Gross Value Added. 7. Stats RSA and reserve bank calculate this.-GDP is a central concept in their national accounts. ECS102-8 economics Part2 Yr1

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8. GDP one most important barometers of performance of economy,(Macro. Growth obj. most impotant 9. Prices ,not quantity ,(5 chickens +4 apples??)used to determine GDP ,and only value added used or double counting results. 10. Term :"Current Production" means only thatyeargoodsand services produced use tocalculateGDP.

The 3 Methods of Calculating GDP:

Spendi ng

gg gg

Producti on

Income

BY:The Production or Income or Spending method. i. THE PRODUCTION METHOD:(or VALUE ADDED METHOD) Value method - Add value added part of all prices -not quantities sold- of all goods&services. VALUE OF SALES VALUE ADDED VALUE intermediate goods Farmer 10000 10000 -(assuming) Miller 12500 2500 10 000 Baker 18000 5500 12 500 Shopkeeper 21000 3000 18 000 TOTA 61500 21000 40 500` L ii. EXPENDITURE METHOD(FINAL GOODS and SERVICES method) a. Only Final goods added,not Intermediatry goods or you get double counting ie:ultimate use–eg:flour for consumer is final good ,but flour for baker is'nt. b. If flour of baker not sold in period it gets counted as "inventories",in national accounts iii. INCOME METHOD(incomes of the factors of production) a. Income earned =Gross income,not net income.Rent,salaries not subtracted. b. Income is earned by –producing- that is adding value to goods and services,thus income for whole economy can only be increased if 'production' increases. c. Refers to income from 4 Factors of Production:-ONLY1. RENT 2. INTEREST 3. SALARIES 4. PROFIT

Difference between the 3 Methods of calculating GDP 1. National Accounts use all 3 methods to calculate GDP and these must balance like normal accounts. 2. The 3 methods essentially measure the same thing but at different points in the circular flow of Production/Income /Spending. 3. Reward from FOP-Income /=Spending (used to purchase) /= Production ECS102-8 economics Part2 Yr1

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4. Income from FOP = Rent(Land NR) , Interest(Capital) , Profit(Entrepeneurship) , Salaries(labour) Income from FOP = Total Value of Production in Economy. 5. remember that Primaryinputs are= FOP and secondary inputs are eg flour for baker etc. 6. SEE TABLE ABOVE IN :Income type : for next workings out as well.: 7. If :Baker uses : PRIMARY INPUTS: SECONDARY INPUTS from farmer Wages and Salaries 2500 Intermediate goods& 12 500 services Rentals 1000 Interest 500 Profit 1500 He sells for 18 000 He buys flour for 12500 FINAL GOODS TOTAL 18000 :cost=18000 If the same is applied for all those before him:miller/farmer (the 12500 he spent on flour also gets . subdivided like this),then we see that total income from FOP=value final goods were sold for. 8. Thus :Value of TOTAL SALES = Total Primary income + Value of intermediate goods and services. or :Total sales – intermediate goods etc. =total primary income(FOP) 9. Since value of total sales in this sequence= value of "Final goods and services" (all "Intermediate g&s" automaticly included). :THEN value of final goods and services =Total income 10. Therefore OUTPUT expressed in monetary terms should = total primary income derived from it. 11. Income=Spending(expenditure 'final goods only')=Production METHODS.

Measurement at Market Prices,Basic Prices and Factor Cost(or Income) 1. The 3 methods of measuring GDP will only yield equal results if used with same set of prices.

2. 3 SETS of PRICES that can be used to calculate GDP = PRICES TYPE USED USED FOR CALCULATING : CALC. FROM SUBTRACT a. Market Prices Expenditure method(Final Final goods Subsidies & LESS this = goods ) Indirect Basic Prices Tax&Subs./Unit good or service.(TxTaxes on Vat,imp+ exp.) (Subsidyproducts exports/Domestic for bread ) b. Basic Prices Production Val. added OTHER taxes LESS this = method(val.add) & subsidies Factor Prices Other Tax&Subs NOT /Unit on products goods/service eg:Tax-payroll,land tx,buldings,licence firm. :Subsidies-on employment or payroll

c.

Factor Cost Income method(factor cost)

Factor cost fop

+"Other"=ba s

3. Therefore different valuations of GDP yield different results ,so one should always check prices used. ECS102-8 economics Part2 Yr1

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4. Different prices are only from different types of taxes and subsidies on goods and services. 5. TERM: 'Indirect' taxes = taxes on products eg VAT 6. Taxes And Subsidies fall into 2 categories at national accountants a. TERM Taxes and Subsidies on Products i. Taxes on products =tax payable /unit :VAT & Duties on Imports & Taxes on Exports ii. Subsidies on products=subsidies linked to goods/service=per unit to encourage export & domestic product subsidy eg:bread below cost b. TERM OTHER Taxes and Subsidies (NOT per unit goods or service) i. OTHER taxes =NOT /unit goods&service eg:payroll,land,buildings,business licence. ii. OTHER subsidies=NOT /unit goods&service eg:employment or payroll. 7. GDP @market prices – Taxes& subsidies on products=GDP@ basic prices 8. GDP @basic prices – OTHER Taxes& subsidies on products=GDP@ factor cost/FOP /Factor Income 9. GDP @factor cost(FOP)(income) + OTHER Taxes& subsidies on products=GDP@ basic prices

GDP at Current prices & GDP at Constant Prices: 1. TERM GDP at Current prices = Nominal GDP:expressed at current years price levels/not converted 2. TERM GDP at Constant prices = Real GDP :use a BASE years prices,convert others to that years : inflation eg1995 3. TERM Nominal GDP-gdp at current prices 4. TERM Real GDP-GDP at constant prices 5. TERM Nominal value-also called :'Monetary value' means in "terms of the name" ie at face value , 5000 = 5000 or less/more 6. TERM Real value-means actual or essential,refers to purchasing power ,what? money can buy. 7. Inflation :causes monetary values of goods/pricesto change per year-thus cannot compare different years GDP's 8. In world of inflation,All values,not just GDP,must be expressed in nominal and real terms tocompare 9. TERM Purchasing power-what a certain amount of money can buy.To calculate:The % of the first/base years price over the % of currrent years price .(how much this years go in last years=?70%)EG: 2000=100%=base year,this year 2003 = 115% of that:answer =100%/divided by 115%= 0.87: so to work out a answer you say 0.87 * 5 baskets in 2000 will give purchasing power of 4.35 baskets at current years prices. 10.TERM Base year:year used as guideline for coverting other years prices to, to find Real value/Constant Prices

Other Measures of Production ,Income and Expenditure. GNI (or GNP)- Gross National Income 1. TERM GNI=Gross National Income= :(IS NOT GDI,but GNI) derived by: a. SUBTRACT from GDP: all FOP-income earned in borders of SA by FOREIGN NATIONALS. b. ADD to GDP :all FOP-income earned outside borders of SA by RSA NATIONALS. i. include in FOP-Interest from money lenders,dividends(profit) etc. 2. TERM GNP=Gross National Product=same as GNI ECS102-8 economics Part2 Yr1

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3. TERM:Primary Income Payments&Receipts:Payments=to foreigners ; Receipts=from foreigners. –The FOP add/subtract in calculation can also be called this instead. 4. TERM :NET primary income pay.OR rec.=to rsa- to rest of world : the result is the answer. 5. GDP: best to measure level+rate change of Economic Activity+job creation in SA. 6. GNP :best to measure level+ rate change of Income and Standard of living 0f RSA citizens. 7. In RSA GNI has allways been a bit smaller than GDP.

Expenditure on GDP 1. Expenditure-spending method (final/intermediate consumption) approach to calc.GDP by C,G,I,XZ consumption method-and is allways at Market prices,not basic or factor cost. 2. GDP=C+I+G+X-Z a. C-largest amount,in Nat.Accounts subdivided into Non-durable,semi durable,durable. b. I-Most volatile.Called Gross capital formation in national accounts,includes Government capital goods investment in nat.acc.,Subdivided into : i. TERM:Gross Fixed capital formation :(purchases of capital in current year) ii. TERM:Changes in Inventories :Goods made past years purchased in current year,and goods made this year unsold.-can be positive or negative number.(ii)Added to (i)=gross capital formation. c. G-final consumption exp. by Gov.-does not include Investment /capital. d. X-exports added to GDP e. Z-imports subtracted from GDP 3. TERM Residual value in national Accounts for aqbove calculayin means-where 3 different methods of calculating GDP conflict-ie Production method,Expenditure method,Income method. 4. TERM Gross Capital Formation:In national accounts Investment spending called capital formation,Note includes Gov. spend on Investment.,and Gross means not less depreciation.

GDE: Gross Domestic Expenditure. 1. TERM GDE =gross domestic expenditure-only money spent in the borders :incl.imp./excl.exp 2. Measured at Market prices,not basic prices or factor cost. 3. GDE=C+I+G -NOT include (x) exports BUT DOES include imports 4. GDP=C+I+G+X-Z 5. TERM Net Exports=(used for common GDP calculation) =X-Z 6. If GDP>GDE then exports must be more than imports (net exports must be positive)and Visa Ver

SUMMARY of national accounting totals 1. GDE=C+I+G a. C-largest amount,in Nat.Accounts subdivided into Non-durable,semi durable,durable. b. I-Most volatile.Called Gross capital formation incl. Gov. capital goods invest. i. consists of:Gross Fixed capital formation-'I' buy+Changes in Inventories-last years+,not sold c. G-final consumption exp. by Gov.-does not include Investment /capital. ECS102-8 economics Part2 Yr1

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(TERM Residual value difference 3 methods calc GDP) = GDE -------------------------------a. X-exports added b. Z-imports subtracted =GDP at market prices --------------------------------- primary income payments +primary income receipts =GNI (GNIncome) at market prices (TERM:NET primary income pay.OR rec.=larger minus smaller (name =larger))

#2 MACROECONOMIC OBJECTIVE : Full Employment :Measuring Employment and Unemployment. 1. TERM Unemployment:of those willing and able to work ,the rate/index/% etc of those not employed. 2. Employment&Unemployment :In principle easy to measure:1-No. of able workers-2No. of employees;BUT Quite difficult to measure in practice:;parttime,seasonal;criminal prostitutes,drugseller,Hawkers/informal,+Those not seeking work etc.

#3MACROECONOMIC OBJECTIVE:STABLE PRICES:Measuring Prices,the Consumer Price Index. The Consumer Price Index. 1. 2.

3.

4.

Economists are interested in :1-what is happening to prices of goods&services in general-2-inflation-3-info on price movements for nominal&real(ratio to other prices)3-purchasing power TERM INDEX NUMBER:expresses value of some series over given period as % of it's value in a base period.eg the CPI-consumer price index is an INDEX NUMBER. a. Specific Indices :for relative changes:-for only one good-not weighted average of lots -Convert all of different years prices to percentages of one of the years prices ,to compare these %'s to each other ie:price/base price*100/1=% of base price.,thus the answer is egYear B is 127 % of base year A price,BUT an increase of 27% and the new price is 127% of the old price-but increase is only 27%!!!!!!!!NOTE!!!! b. General or Composite Indices :for combine different series:CPI is a composite index where a lot of different indexes are compiled(eg % change in bread price is one in series,% for meat another) and this series of prices are combined AGAIN BY according to a weighted average(how much bread eaten to meat)to get final composite or general index. TERM Purchasing power- first year/last year = eg 0.87= the 'Real' value of or what a certain amount of money can buy.To calculate:The % of the first/base years price over the % of currrent years price .(how much this years go in last years=?70%)EG: 2000=100%=base year,this year 2003 = 115% of that:answer =100%/divided by 115%= 0.87: so to work out a answer you say 0.87 * 5 baskets in 2000 will give purchasing power of 4.35 baskets at current years prices. Price increases ie Inflation erodes the real value or purchasing power of a fixed nominal amount.

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5.

TERM CPI Consumer Price Index:=115 % or 120% is an index of the prices of a representative "basket " of consumer goods and services: it thus represents the cost of the shopping basket of goods & services of a typical RSA household.CPI is normally =115% or 132% or so (not 6.2% like inflation:ie the change from one years to the next .)

6.

term Inflation RATE: If you subtract Last years CPI from this years cpi ,AND divide the quotient by last years cpi * 100 (the percentage %)you get the inflation rate ie:127%-105% / 105

7. 8.

% *100 TO construct the CPI ,Stats SA must : a. Select the "goods and services" to be included in the "Shopping Basket." : ..To select-Stats SA does survey of household every 5 years. b. TERM Determine Weight of each good/sevice: ..Stats SA does a survey 5 yrly to determine relative importance in Av. Consumers Basket. c. TERM Decide on a BASE YEAR for calculating CPI : ..Base year is year in which the Survey(5 yearly) is done d. Decide on FORMULA for calculating CPI ..Standard price index formula used,Weight of item decides it's effect on CPI, e. Collect prices each month to calculate CPI. A_....RSA 1500 different goods&services,in -1- 40 groups/subgroups,for which a CPI is calculated for each one -2- 5 expenditure groups,pensioners,9 provinces+14 major urban areas.+metro+other urban areas+rural B_Prices are collected by questionaire sent to 2200 retailers110 000 quotations per month and info. double checked.,Prices used are first 7 days of month. CPI available 2nd half of following month. Used to calculate inflation. large base 1500goods means cpi is fairly accurate.

9. 10. 11.

#4 MACROECONOMIC OBJECTIVE: Balance of Payments 1. 2.

3. 4. 5. 6. 7. 8.

Balance of payments :summarises between local& foreign-usually yearly. TERM: Balance of payments consists of 2 major accounts: a. Current account:Part of "balance of payments" account,Account of a country of all:Sales:Exports,Purchases:Imports+Primary Income Pay&Rec. b. Financial account:Account of country of all flows of financial products only into and out of country like sales +purchases of -bonds,shares also loans etc . TERM :Surplus on Current account:Exports exceeded Imports TERM :Deficit on Current account:Imports exceeded Exports. TERM :Surplus on Financial account:(also –NET INFLOW of Capital):Inflows of money exceeded Outflows of Money. TERM :Deficit on Financial account:(also –NET OUTFLOW of Capital): Outflows of money exceeded Inflows of Money. TERM :Change in the Countries Gold and Foreign Exchange Reserves:Add current &financial accounts.-the result serves as the balancing item on the balance of payments. Compiled by SA reserve bank in SA,from SARS info. mostly.

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9. 10.

Purchasing Power =year 1% / year 2 % .Also ,or nominal % /price level %=real value. eg:between 1920-1930 purchsing power increased by 40 % in SA ie :there was negativeinflation.

#4 MACROECONOMIC OBJECTIVE:Equality in Distribution of Income: 3 Methods of Measuring Inequality. 1. a-measuring performance of economy in general no easy task ,-b- but measuring this one type is most difficult of all.-data from tax returns/census etc.-then applying measures to estimate degree 2. TERM Personal distribution of Income:to people/races/levels,all fop included. 3. TERM Functional distribution of Income:Between FOP only.

Method #1 of 3 : Lorenz Curve 1. Term A Lorenz Curve is a simple graphic device which illustrates the degree of inequality in dist. of income.(or any other variable)-named after american statistician developed it 1905. 2. To construct: a. Make Chart with -1-Population % poorest to richest -2- Income -3- Cumulative Population -4- Cumulative Income % Number of Each Population Income Poorest 20% 3 % Next 20% 7% Next 20% 15 % Next 20% 25 % Richest 20% 50 %

Cumulative Population Income 20 % 3% 40 % 10 % 60 % 25 % 80 % 50 % 100 % 100 %

b. Plot Graph –

i. see graph pg80 in textbook ii. iii. iv. v.

vi. vii. viii. ix.

(-1-)Horizontal axis =Cumulative %'s of Population. (-2-)Vertical axis =Cumulative %'s of Income. Axes are joined to form a square Diagonal drawn from Origin A to point B corner:Diagonal indicates a perfectly equal distribution of income-Serves as a reference point. ie: perfectly equal distribution occours along line :first 20% population would earn 20% of income and so on etc. A Lorenz curve ALLWAYS starts at Origin and ends at B(opposite corner = 100%). Greater distance between diagonal and Lorenz Curve – the greater the inequality. Area (shaded) between diagonal and Lorenz curve = called- "Area of inequality" Greatest possible inequality: where 1 person earns all money=curve O-AB(triangle)

#2Gini Coefficient:(or RATIO) 1. TERM Gini coefficient or ratio =area of inequality /divided by/ area of triangle [axes-diagonal]. 2. Divide (AREA of INEQUALITY) :by: (AREA of DIAGONAL and AXES(right corner=A)0 3. Varies between 0-1. If perfectly equal then =0 (lorenz curve=diagonal) or If utterly unequal = 1. ECS102-8 economics Part2 Yr1

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4. In practice between 0.3(highly equal) and 0.7(highly unequal). 5. TERM Gini Index = Gini coefficient multiply*100 (ie between 0-100 then,not 0-1) 6. By Italian demographer Corrodo Gini 1912

#3Quantile Ratio 1. TERM Quantile Ratio is [the % income of Highest 20%] divided by [% income of Lowest 20%] 2. The Higher the ratio ,the Higher the inequality. 3. We use each groups % percentage of Countrys Total Income to work it out ,not actual income Rands. 4. Economists also often compare : top 20% to bottom 40% and top 20% to bottom 20%.

Extra Notes: RSA: best known for ;precious metals,fruit,wine Services sector largest. muanufacturing sector 15% of GDP maize most important crop,mined=mang,gold,chrome,platinum ,coal,diamonds. export production nurtured in eg:ostridge meat,high value fruit,wine Gauteng 33% of GDP,western cape15% unemployment 29.4%=4.7million=SA ranked as on of most unequal disb.of Income in word,where accurately measurable.

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ECONOMICS part 2 Yr1 ECS102-8 CHAPTER 3 : THE MONETARY SECTOR.(MACROECONOMICS)ch ch15t,pg353

Explain what money is and explain its functions Define M1, M2 and M3 Discuss the functions of the SARB Explain and illustrate with the aid of a diagram the interaction between the interest rate and the demand for money Discuss the instruments of monetary policy Study unit outcomes and activities

Important Boxes/concepts/graphs/pages:

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M

INTRODUCTION: • • • • •

Money important -double coincidence of wants,etc Years 'neutrality of money '(print 2*more money ,cause 2*higher prices )y , was economic cornerstone,today different thinking slightly. a bank is a place that will lend you money if you can prove you dont need it.-bob hope money is a good servant but a bad master-proverb english money like muck,not good exept it be spread around-francis bacon.

The Functions of Money: 1-Money as a meduium of exchange: 1. TERM Barter economy :is characterised by numerous unneccessary exchange transactions. causes problem of double coincidence of wants.2. TERM Double coincidence of wants=is if both parties DO want opposite persons goods-not where one must first exchange for something else at another person,ie:you want others shoes,you got shirts,but shoe guy wants pants.so you go look for pants to change for your shirts first.,then go get the shoes with that. 3. TERM Monetary Economy:money used as a intermediatry or lubricant. 4. TERM medium of exchange –ONLY function of money unique to money&most basic function of 5. TERM:Definition of Money:Money is any thing that is generally accepted for payment for goods and services or in settlement of debt.

2- Money as a unit of account: 1. An agreed/common unit of comparison of the cost of goods,anything can be a unit of account. 2. 2nd in importance to no1 -exchange med- above. 3. Inflation can cause it to loose usefulness as unit of comparison a bit in terms of 'Real' values.

3-Money as a Store of Value: 1. The most Liquid form in which wealth can be kept (derived from can be medium of exchange) 2. Money can be disadvantagous as a store with Inflation,other maybe better eg:land,works of art,shares,post stamps. 3. Many people with great wealth do not own much money,they use assets for in times of inflation. 4. Standard of deferred payment(and interest),and means whereby credit is granted.

4-What Money is Not: 1. Money is NOT : 1-Wealth(=assets,+ money) or 2-Income ECS102-8 economics Part2 Yr1

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2. Is not a Flow,money is a Stock which can finance a much larger flow of income during a period.

Different Kinds of Money. 2. eg:cocoa beans,cigarettes,tea,seashells,cattle,silver:earliest forms were commodities value intrinsic. 3. Uniformity,durability,divisability,ability to be carried. i. Coins,too heavy, ii. Paper money.1st paper money was certificates of deposit at goldsmith. iii. TERM Fiduciary/credit money(gov. issued partly covered by gold in reserve) iv. Today-no gold deposits ,based on confidence in Gov.to control supply of notes. v. Cheque accounts-next development-Constitutes largest part of money stock indeveloped lands 4. debit +credit cards&electronic payment make difficult pinpoint exactly what money is esp.infin Markt 5. A cheque ,debit or credit cards or electronic transfers ARE Transfer methods NOT MONEY-the deposit is,and a credit card is in addition1 a means of getting short term loan AND 2method transfer. 6. Credit card means of deferring/postponing payment. 7. Credit card :Also people 'economise' on holding money,hold less on avg,buy on credit pay end mnth.

Money in RSA. 1) Not easy to measure money,ie:assets/differnt means of payment/ 2) Economists interested in store of value function of money:3 measures of money by SARB:M1,2,3

TERM 1-Coventional measure:M1 1) M=C+D (Money quantity =Cash(all coins ,notes)+demand deposits with monetary sector.) 2) TERM THE Money Supply =C ,not D of M=C+D only cash in circulation outside banking sector can be regarded as the money supply. 3) monetary sector incl. in SA :land bank,public finance corporation,private banks,post bank, SARB 4) Solely on basis as medium of exchange (Incl. M1A=cash notes+coins only) 5) TERM :Demand deposits =91% of money in SA,refer to deposits can be withdrawn immediately.

TERM 2-M2 1) M2 =M1+all other short term and medium term deposits of the domestic private sector with monetary institutions(more than 1.5 times m1 in SA) 2) Short term=less than 30 days ,Medium term=less than 6 months.can only withdraw sooner at a cost 3) Quasi money =nearly money : short and medium term deposits,since maturity not very long.

TERM 3-M3 1) M3 =M2 + all long term deposits of the domestic private sector with monetary institutions. 2) Long term deposits-maturity value longer than 6 months. 3) Most comprehensive measure of money.,also regarded as most reliable indicator. ECS102-8 economics Part2 Yr1

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4) Emphasis is more on store of value function as we move from m1-m2-m3,m3 most store function.

Financial Intermediaries. 1) Financial intermediaries main function is : to act as an intermediary between surplus units and deficit units in the monetary economy. 2) TERMIndirect/Direct Financing:Indirect-through financial intermediatry/Direct –person to person 3) TERM Financial Transactions :Distinguished from real transactions by fact no goods/other services involved.(distinction between 2 divides economy into real and financial sector) 4) TERM Real transactions :All transactions where goods and services are involved. (divides fin/real) 5) The institutions in the financial sector have one main function, namely to act as an intermediary between surplus units and the deficit units in the monetary economy.

6) 7) When the government borrows money, it uses treasury bills and government stock or bonds as security. 8) TERM Security or Credit instrument issued. In exchange for funds, a piece of paper issued,this document stipulates the interest rate at which funds are loaned as well as when and how the loan is to be repaid. Examples of credit instruments are bills of exchange, promissory notes, and bankers' acceptances. Government uses treasury bills and gov.stocks and bonds. 9) Financial intermediatries includes:Insurers,pension funds,banks,unit trusts,finance companies,SARB. 10) TERM Interest is amount borrower must pay lender for use of funds concerned. 11) Banks can create money by granting overdrafts which is M1 money class.=D (of C=D=M1),and banks can do this because need only keep % of deposits in reserve bank ,so can lend rest out. 12) TERM monetary baseAlso known as high-powered money. It usually refers to the stock of cash (notes and coins) and includes the cash in the hands of the non-banking public, vault cash of banks and cash deposits with the Reserve Bank

THE SOUTH AFRICAN RESERVE BANK. 1) SARB established 1920 by act,primary goal in the South African economic system as "The achievement and maintenance of financial stability". ECS102-8 economics Part2 Yr1

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2) Cannot be dictated to by parliment how use instruments of monetary policy-guaranteed operational independance.by Constitution 3) TERM Monetary Policy-Definition:the measures taken by the monetary authorities to influence the 1--1-Quantity of money or -2- Rate of interest to : ..To achieve:-1- Stable prices -2- Full employment -3- Economic growth.(mis 1diff.earnings/2For.ex. 4) 5 main functions of SARB a) Issuing banknotes and coins b) Acting as banker for other banks c) Acting as banker for the government. d) Acting as custodian of countries gold and other foreign reserves. e) formulating and implementing monetary policy.

Issuing banknotes and coins •

Sole right in SA to issue banknotes+coins.Bank purchases assets to get cash in general circulation

Acting as banker for other banks 1) SARB holds minimum cash reserves for banks that they are required to hold. 2) TERM clearing bank :Acts as for banks by meeting the claims and obligations of banks by using their reserves. 3) TERM lender of last resort :to banks.(if banks need funds over and above that from surplas depositors to finance deficit lenders/ or other things. 4) financing of fin.inst. changed alot since 1990's-first redisdounting of assets+overnight loans,then: 5) TERM :(REPO)Repurchase tender system-Interest rate of SARB to Banks,(also how much is lent per time can be controlled) 6)

Acting as banker for the government. •

grants credit,advise gov.,issue treasury bills ,administer exchange control.

Acting as custodian of countries gold and other foreign reserves. •

holds gold and foreign exchange reserves-level is one of main indicators of state of economy.

formulating and implementing monetary policy. eg currently price stability main one in SA

The Supply of Money. • For this we assume:M1=m=c+d,only banks hold demand deposits& a central bank controls banks.

Banks: in the money creation process.(role in supply) 1- Money is created by banks and not printing presses because accept surplas,lend to deficit 2- Difference lend /deposit rates is income banks receive. 3- Only institutions allowed accept deposit from public, Banks activities regulated by Act,Monitored by SARBank.

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4- The most notable feature of banks is able write a cheque to draw against account,or transfer on demand,therefore it they be treated as money.-very convenient so little interest paid. 5- Demand deposits can be created in tho ways: a. Deposit=(^='change in') ^M=^C+^D so = -C1000+D1000=M0 b. Overdraft facilities. ^M=^C+^D so = C0 +D1000=M1000 -bank created credit

2-Reserve Asset position and Credit Multiplier: 1. TERM :Cash reserves : IN SA 2.5% of Total Liabilities WITH RESERVE BANK at 0 interest ;amount banks know have to pay for withdrawals/transfers to other banks-eg confidence run on bank- eg saambou 2002 run on bank. 2. TERM CREDIT multiplier:=formula is 1/b^(change)R=D(deposit M=C+D) (In RSA 1/b is 40) : If someone deposits money in a bank,by multiplying that ammount by the Cred. Multipl. you get the eventual amount of bank deposits,including the original one ,that can be created by that deposit eventually.This works like that because only a certain percentage of each deposit can be lent out to someone ,the rest must be banked by law in the reserve bank.Now if a bank lends a % out of every deposit they receive ,those who lent this money pay others who re-deposit that amount with other banks,which continues the cycle until no more bank deposits can be created from one original deposit. 3. TERM:Classical cash reserve system :where gov. does control economy by changing the rate to be held in reserve bank.Today it is not an essential part of monetary control system in SA,we use cost of additional reserves 4. BUT Under the present system the money supply process in SA is a function of demand for credit ,and this is determined by the level of the interest rate of banks lending out money,and not by the amount of credit banks are able and willing to extend. This reduces gov.control over size of money supply(reserve rate wont affect)

3-Other Factors in Supply of Money 1. Foreign trade exports/ BRINGs money into/increases supply of money in country,and imports reduce it a. A countries money supply increase when gold & foreign reserves increase and decrease visa versa. 2. Gov. spending increases supply of money by reducing amount of taxes,which take money out of suppy,being kept in the SARB(today gov. keeps some of tax in normal banks to incr. supply of moneyin circulation 3. TERM inflationary financing:Gov. lending from reserve bank can cause inflation to rise.

EXTRA BOX:Bonds,the Bond market and Capital. 1. TERM A BOND is a Financial Instrument that promises the issuer (the borrower)will regularly pay the holder(lender) Interest and will repay the capital amount on a certain date.eg:Gov. issues bonds to finance its expenditure.The features in a bond are. a. The Principle:The amount the issuer will repay the bondholder when bond expires. b. The Maturity Date:the expiry date-must pay all date. c. The Coupon rate:Interest at annual rate.-usually fixed rate,and dates the interest must be paid are also specified. 2. Bonds can be traded/sold : eg. on Bond exchange of JSE called Bond Exchange of SA. Bond market forms part of capital market which is a market for long term financial instruments. ECS102-8 economics Part2 Yr1

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3. On capital Market 4 main types of long term financial instruments are traded. a. Fixed-Interest-Bearing Securities (or bonds). b. Variable Interest Securities c. Shares d. Negotiable Documents. 4. Interest rates determined in capital market (eg on gov. bonds with different maturities) are long term rates and determined by market forces of supply and demand. 5. TERM Perpetuity:a special kind of bond where no maturity date is set-only a fixed amount of money is set to be paid each year as interest and buyer makes no promise to buy it back. 6. The most important relationship in the market for interest bearing securities is the inverse relationship between the price of bonds and the interest rates on them.bond prices high when interst rates low and visa versa-is inverse reationship.

The Demand for Money. 1. Holders of wealth must decide in which form to keep:eg financial assets,land ,art,antiques 2. TERM demand for money is: the amount holders of wealth decide to hold as money balances. 3. TERM Financial assets: there are 2 types a. Bonds(interest bearing assets) b. money 4. TERM Fixed property:Means real estate. 5. :The Opportunity Cost of holding any money balance is the actual interest that could have been earned had the money been used to purchase bonds instead. 6. TERM Liquidity Preference :The Reasons for holding money instead of bonds are :ByKeynes in30's a. TERM Transactions motive:for paying for goods,wages weekly so hold money between,the more money you earn,more need to pay for –so transactions need for money is function of national income. b. TERM Precautionary Motive:for emergencies,also function of national income. c. TERM Speculative Motive:-keynes most important add to monetary economics.If Interest rates high then opportunity cost is high for money so people invest in bonds.Also there is a negative /inverse relationship between qty money Demanded for speculation and interest rates. 7. TERM Active Balance: for 1-transactions or 2-precautionary motive.-main determinant-Income 8. TERM Passive(or idle) Balance : for speculative motive. –main determinant-Interest rate 9. Equation for demand for money: L=f(Yi) L-Liquidity preference/Y-National Income/iInterest Rate 10. Graph of DEMAND FOR MONEY: a. Active balance Curve:=f(Y) Income controlling factor:Vertical line,shift right income increase/visaversa. b. Passive balance Curve:=f(i) negative slope reflects inverse relationship between interest rate and Qty demanded of money. ie:cash held with purpose of investing if rates are high enough will=0.At certain interest (i1)rate no funds will be demanded for spec.purposes.(i1)(this should be on diagram where curve meets vertical line and interest is highest . c. The Joint or total money demand curve or Total Liquidity Preference graph(same as passive graph but label curve "L= L1+L2" ( is merely the horizontal addition of the two other graphs/is made up of the other two graphs) ECS102-8 economics Part2 Yr1

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i. The negative slope reflects inverse relationship between interest rate and Qty Demanded- for speculation purposes ie:cash held with purpose of investing if rates are high enough will=0 ii. The position of curve:affected mainly by demand for active balances.-from income level.Increase in Income levels will shift LL curve to right,decrease LL to left. iii. See pg 370 textbook for diagrams.

For the Horizontal axis:label is "Qty. of money demanded"/For vertical:Interest rate.

Interest Rates: • •

When referring to interest rate means:all interest reates tend to move in harmony with each other up or down.(another typeof simplification is income also could be GNI or GDP.) different types eg:mortgage rates,rate on government stock,interbank lending rate,prime rate of banks,repo rates,various rates on deposits etc.

Equilibrium in the Money Market 1. TERM:Demand-Determined money supply.: That there is no independant money supply curve,but the money supply(or Qty. of money) is determined by the demand for money(due to 'transaction' and 'precaution' reasons) and the interest rate(cost of credit). 2. This approach differs from traditional explanantion of equilibrium in money market,which was based on assumption that authorities can control the supply of money-ie that there is an independant money supply curve. 3. According to this approach, the money supply is determined by the interaction of the demand for money and the interest rate,because it is not possible to determine a suooly curve for money due to the miney creation process being too complex. 4. The interest rate in return is determined mainly by the monetary authorities,by means of the Repo rate . 5. LL represents the demand for money curve which indicates the quantity of money demanded at various interest rate levels. If the monetary authorities set the interest rate (for instance through accommodation policies) at i2 the quantity of money demand is L1. Since the supply of money is determined by the demand for it, the money supply is M1 which is equal to L1. At a lower interest rate of i1, both the quantity of money demanded and supplied increases to L2 and M2. There is no independent money supply curve since the money supply depends on the demand for money and the cost of credit THE MONEY MARKET:

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The supply of money is determined by the interaction of interest rate and demand for money.see up(5)

Simulaneous control over the supply of money andthe Interest RateAuthority Controlling Supply 1. The above/todays approach differs from traditional explanantion of equilibrium in money market,which was based on assumption that authorities can control the supply of money-ie that there is an independant money supply curve. 2. But-if authority sets interest rate at certain level by adjusting REPO rate,then they loose control of the money supply because it will now be determined by the Interest rate only. 3. The traditional approach was:see diagram page 372 text if money supply curve mm(vertical line) is increased it shifts right ,then interest rates will fall(see new intercept).and visa versa.

The Instruments of Monetary Policy. • •

• •

In Rsa a high priority is currently given to market orientated policy instruments. The MARKET ORIENTATED Key Instruments of Monetary Policy are: 1. Accomodation policy. 2. Open market policy. 3. Public Debt management 4. Intervention in foreign exchange markets. Other NON-MARKET RELATED Instruments of Monetary policy are: 1. Credit ceilings 2. Deposit rate control(DISCONTINUED IN rsa) Other types unclassified; 1. Changes in terms of HP agreements. 2. Changes in exchange control regulations. 3. Also Moral suasion is used;SARB can influence banks by consulting with them.

1-Accomodation policy. 1. TERM:Accomodation policy of SARB :mainly comprises changes in repo rate and other conditions on which cash is made available to banks.Changes in repo rate cause changes in cost of credit to banking public,thus can control the supply of money in economy. 2. If banks short cash-they can a. Change other fin.assets to cash b. borrow on interbank market. c. If none above possible-can obtain funds from SARB as "lender of last resort" by Repo agrmnts. 3. TERM:Repo Agreement or repurchase agreements:the sale of an existing security (financial asset) at an agreed price,coupled with an agreement by the seller ECS102-8 economics Part2 Yr1

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to purchase back the same security at the same price,and including an agreed amount of interest as cost of obtaining funds also specified on agreement,on a specified date(usually in 7 days time). .The underlying securities which may be used for this purpose are :Gov.bonds,Land bank/treasury bills,reserve bank debentures.(first leg is flow 1 way,second leg is flow other way) 4. Introduced 1998,repurchse agreement between SARB and it's banking clients, . 5. Repos are at present the main source of funds for banks as a measure of last resortthus control.

Open market policy. 1. TERM Open Market Policy is where the SARB sells or buys domestic financial assets(mainly Gov. Bonds or Treasury bills) in order to exert a specific influence on interest rates and the Quantity. of money. a. SARB- buy from banks at low prices (to force 'buy') and debit /increase their cash reserve in payment ,thus allowing banks to create more money by lending out or ,visa versa SARB sells domestic financial assets to banks to in turn decrease the amount of money they can use to create a supply of money by lending out ... b. There is an inverse relationship been prices of such securities and the Yield/Interest that can be earned on them,so ,if high prices of purchase,then yield is lower and visa versa etc,thus banks must sell low to be able to get buyers or visa versa to get sellers. ...Thus if banks buy at high prices,they will send interest rates up,and if sell at low prices they will send interest rates down,sothis can also be used to support the accomodation policy of the SARB, c. ...in RSA this is used to :Sell cheap bonds ,to cause banks to use Repo system,to make accomodation policy of SA more effective. 2. TERM domestic financial assets: treasury bills and government bonds ,or land bank bills or municipal stock etc. 3.

Public Debt management •

Market-orientated

Intervention in foreign exchange markets. •

Market-orientated

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ECONOMICS part 2 Yr1 ECS102-8 CHAPTER 4 : THE PUBLIC SECTOR.(MACROECONOMICS) The public sector Description of public sector Spending and income flows with government Pure public goods versus private goods Pure public goods and the market Burden (impact) of an excise tax Glossary ability-to-pay ad valorem tax allocation function of government asymmetric information average tax rate budget (government) budget deficit budget surplus benefit principle of taxation bracket creep business cycle capital gains tax commercialisation common property resources composition of government spending contractionary (restrictive) policy criteria for a good tax demand management decision lag direct taxes effective incidence excludability expansionary (or stimulatory) policy

ECS102-8 economics Part2 Yr1

external benefits external costs externalities financing of government spending fiscal policy government intervention government spending growth in government spending implementation lag indirect taxes interest on public debt marginal tax rate nationalisation personal income tax privatisation progressive tax proportional taxes public debt public good public sector recognition lag regressive taxes statutory (or legal) incidence tax incidence taxes value-added tax (VAT)

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CHECKLIST

Important Boxes/concepts/graphs/pages: graph –17.1 pg 426 import tariffs effect on supply/prices etc. graph pg 443 17.3 dollar /rand rate table 17.4+17.5 pg 445

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1-Role of Government in the Economy : An Overview: 16.1p384 •

1. 2. 3.

4.

The 'Public sector' in SA consists of: o 'General Government'  Central Gov.-defence,foreign affairs  Provincial Gov-housing,health services,education(TEPD)  Local Gov-muncipal-sewerage etc o Public Corporations-escom,transnet, TERM Market system :"invisible hand"coordinates millions-Efficient system-ie:"Free market system' of economy type allocates resources in best possible way.But not necessarily Equity equity or fairness / and efficient -market system is money votes count only-problem. Reasons for Gov. Intervention in Economy: a. Non-efficiency-Market failure ,if system sometimes fails. b. Non-equitable –(fairness eg: income ,poverty) outcomes.-but can be trade off with efficiency. c. Provide recognise property rights,contract law,law an order,services-water+lights etc. Reasons for Non-intervention- market forces are seen as being better solvewhat,how,for whom

-2-Fiscal Policy and the Budget. 1. Term Fiscal Policy: Government policy on level and composition of government spending,taxation and borrowing.(from fiscus-roman treasury) 2. Main Instrument OF gov policy :Budget 3. The Fiscal Variables are : a. (G) = Gov. Spending and b. (T) = Taxation. 4. Budget speech parliment,feb for april end yr.,one most important events in economic calendar. 5. Fiscal policy/The Budget can be used to address influence: a. The 5 Economic Major Objectives(where monetary policy only 3 of) :Economic GrowthTotal Prdctn b. Distribution of Income c. Balance of payment problems d. Price level-Inflation ECS102-8 economics Part2 Yr1

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e. Full Employment i. AND ALSO BASICLY :Total Spending ii. Income-(Y) iii. Employment 6. .Term Demand management:an instrument of Fiscal policy is classified as an instrument of Demand management because it is an effective means of influencing Total Spending in the economy.Monetary policy is also such.(Definition: can be used to manage/regulate the total demand for goods and services in the economy.) 7. TERM Expansionary Fiscal &monetary policies:If economy in Recession,to stimulate economic activity-means -1-Reduce or Not increase Tax -2-Raise Spending. 8. TERM Contractionary or Retrictive Fiscal &monetary policies:If economy expanding too rapidly and -1-Inflation -2-Balance of Payments problems experienced:means Gov. must-1- Taxes Increase and/or Reduce Spending. 9. Term Lags/Delays-one of basic difficulties assosiated with attempts stabilise economy. 10. Term Budget Deficit /Surplass:Difference between Gov. spending and Income. 11. Fiscal policy can influence microeconomics as well:specific markets/products tax,subsidy or town.

-3-Government Spending-16.8p401 1. Gov. involvemnt in economy often measured by level spending,but many other types involvemnt too. 2. "Crowding out effect"-when Gov.spending increases and crowds out private sector. 3. Gov spending can be classified a. economically i. consumption spending :for final consumption = 3% ii. investment spending :investment in capital goods = 19% b. functionally:Changed from from War/Internal strife defense/policing type and economic services (mining,agriculture,exporter support) spending to social spending. 4. Gov, spending has increased form 12% to 22% from 1960 to now.This worrisome because of how to finance this(Tax).Number other countries had similar experience.REASONS: a. Changing consumer preferences. :peoples Income went up ,then demand for Gov. services rise so gov spend more on consumption as well. (Income elasticity of gov services greater 1,so as income up ,greater % of income on service.) b. Political and other shocks. :War spending and internal strife spending on law+order., c. Redistribution of income.: Shift in spending to uplift previously disadvantaged peoples,majority d. Misconceptions and Entitlement.People think gov.services cheap,expect more-if politician listens then spending go up alot,not a little. e. Population growth and Urbanisation.:housing,water+lights,sewerage,roadsinfrastructure+AIDS.

-4-Financing of Government Spending 16.9,p403 1) There are 3 ways of financing Gov.Spendinga) Income from Property(2% totl.)– incl.Escom,+Profit fishing,agriculture+Rent-Mining Licence fees. b) Borrowing –Budget deficit. ,domesic/Intnl.capital market(gov.bonds) or Central bank. (overdraft) ..-1-Incr. Public Debt.+-2-Inflationary Financing c) Taxes ECS102-8 economics Part2 Yr1

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2) Term Budget Deficit /Surplass:Difference between Gov. spending and Gov. Income . 80/90's >gov.Invstmt. Future generation must pay for todays borrowing,OK for capital(=returns),not OK for consumption. 3) Term Inflationary Financing: gov.borrowing because increases money supply. 4) Term Public debt: 34%90's-45% gdp:from gov.borrowing-eg 1990,increases Interest on gov debt.to 20c per R Tax today.

-5-Taxation 16.10 1) Largest source Gov revenue-97%

-1-Criteria for a good tax: -Adam Smith-equitable,convenient,economic,certain a) Neutrality :The cost(damage) of taxes must be kept as low as possible:but can also be used to fix i) -1-Distort Relative Prices:allocation of resources+welfare-make some things more expensive than others.-Relative prices ii) -2-Disincentive to owners-FOP:eg workers(work less)+factories not produce certain. b) Equity:People must be taxed equally :two principles to this i) Ability to pay principle: Must pay according to ability (1)Horizontal equity-same income taxpayers to pay equally (2)Vertical equity -Richer must pay more than poorer people. ii) Benefit principle:or User Charges-each user pay benefits they get from Gov.-eg toll rd.,h20, c) Administrative Simplicity:Keep costs low + easy admin (tax loopholes +complicated taxes) i) Costs: (1)Compliance costs: user pay accountant to do tax return. (2)Administration costs.: Gov.costs tax collector 2) Term Tax Avoidance: legal find loopholes-cause frustration those who cannot 3) Term Tax Evasion: illegal-make +sell t-shirts on flea market,not declare taxes. 4) term Relative Prices:price of one good relative to another

-2-Different Types of Tax: 1) term:Direct Tax (or "Taxes on Income +Wealth"):Personal+Company+Estate Duty. 2) term:Indirect tax (or "taxes on Goods and Services") :on transactions :vat.,customs,excise. 3) term:General tax:on variety of things,not specific eg VAT. 4) term :Selective tax:on specific things eg: fuel or tobacco or alcohol. 5) term Specific Excise Tax:Per unit:eg R4 on each beer 6) term Ad Valorem tax:% of value eg 5% 7) based on ratio of tax to income a) term :Progressive Tax:Rich pay higher "!! % !!" than poor.eg RSA b) term :Proportional Tax:Rich pay same levels as Poor(in %) eg company tax c) term :Regressive Tax: takes less as income levels increase eg VAT(% of income paid out)

-6-Taxation in RSA. 1) 3 main types of tax in RSA:' a) Personal Tax:Most important in SA today,on 'taxable income',from table with minimum start/rate ECS102-8 economics Part2 Yr1

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i) term Marginal Tax Rate:rate each additional rand (rate for each level is taxed(=on tax table ii) term Average/Effective Tax Rate:ratio between rate and income iii) last years SA less tax brackets(15to 6)+base broadened(More fringe benefits taxed) iv) term Capital Gains Tax:sales of fixed property-to compensate nominal/real gains only above 10 000-difficult to administer,+increases horizontal equity+integrity Personal .Tax Base.(per inc.level) b) Company Tax:-was Proportional tax:at 30% flat rate i) term Secondary tax :on shares dividends to shareholders.7.5% c) VAT: 'regressive tax', thus some goods zero rated for vat. d) Today: personal=#1,vat=2,companies=3,excise =4,customs =5 from before companies 2,

-7-Tax Incidence-ie: Who really Pays the Taxes? 1) Fly –paper theory:taxes stick where Gov. puts them-but not exactly true 2) term Incidence-not who pays the tax,who is burdened by it actually. 3) term Statutory or Legal Incidence of Taxes: Gov. can specify who must hand tax over to them. 4) term Effective Incidence of Tax :who actually pays cannot be determined by who hands Rands over to Gov.1-because everyone shifts tax forward/backward to customers etc+ 2-changdecision 5) The degree to which a tax can be shifted depends on the price elasticities of the goods/services-high=not easy,low=easy

The Impact of a Specific Excise Tax: 1) Two types of Excise Tax: a) term Specific Excise Tax:Per unit:eg R4 on each beer b) term Ad Valorem tax:% of value eg 5% 2) Example:A specific Excise tax on cigarretes will have a burden on : a) Companies:they must pay Gov. extra (egR4.00) per cigarette packet.

i) They willtry to pass the full tax on to the consumer but may not be able to because it depends on price elasticity of goods And also general supply in market.,so they might have to pay some of tax themselves as price decrease. ii) less demand from high prices will cause a loss of {qty2*price1} – minus{qty1*price2) because companies only pass on maybe half of tax to the consumer,they bear some too ,plus also supply drops. b) Employees:less sales=less employees needed or must accept lower wages(can also shift supply right again cause cheaper to make smokes+can sell cheaper then=more demand new 'E') c) Customers loose:must pay more for cigarettes (exept what companies bear of tax burden on tax..,maybe 40% etc.) Example: Effect of a Specific Excise Tax on Cigarettes:Burden -1-Consumer/ -2Company/-3-Employees

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The supply curve ss will shift to left(per qty. higher price).:causing all 3 parties to bear burden of excise tax.(see number /point 2 above) PS:Try read 16.2 as per study guide extra reading-also check economies of scale etc.

ECONOMICS part 2 Yr1 ECS102-8 CHAPTER 5 : THE FOREIGN SECTOR.(MACROECONOMICS) absolute advantage ad valorem tariffs appreciation balance of payments current account current account deficit current account surplus demand for foreign exchange (eg dollars) depreciation direct investment equilibrium exchange rate

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financial account deficit financial account surplus floating exchange rates foreign exchange market foreign reserves gold and other foreign reserves import tariffs open economy portfolio investment relative (comparative) advantage specific tariffs supply of foreign exchange (eg dollars)

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terms of trade trade balance

CHECKLIST

Important Boxes/concepts/graphs/pages:

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-1-WHY Countries Trade: 1) NOTES ON INTRO: Rsa recent yrs bad balance payments,globalisation today,large countries trade less than small-more diverse resources,Adam.Smith-says 'can be prudent to trade intnly'. 2) most successful countries are strongly open economy+can compete successfully. 3) The more open a country is the more vulnerable to changes in econ.conditions of other countries. 4) Term a Open Economy:If a significant part GDP 'exported':,And significant domestic spending is on 'imports' or:"degree of integration";the more integrated,the more open. 5) gains from trade:low price +wider product choice. 6) Self-sufficiency-or autarky used to be popular amoungst politicians. 7) Countries trade because they have different Natural resource wealth(minerals),need others+=some do industrial goods production(high skills etc,others do import) 8) Reasons for trade , 2 main reasons: i) term Equal Advantage:Eg france+germany-Diff. in taste :-price+demand higherso trade goes toward there. ii) term Absolute Advantage: .If one worker: in Japan can produce 10 cameras or 50 kg wool,and in Australia 5 cameras or 100kg wool,japan has absolute advantage in cameras,australia in wool,and visa versa. . .The Advantage of trade +specialization here: if countries specialize and trade they can each consume 50 kg wool +5 cameras,which is impossible if they did not trade+specialise. iii) term Comparative Advantage: Law of Comparative (or Relative) Advantage:two countries can gain from trade if the opportunity costs of production or the relative prices differ between the two countries. {You must,for each type, to find out who has comp.advantage,divide other product by that ones 'number of'.This gives the 'cost' of that one .Now compare 'costs' to check which has less-that one has comp.advantage. } Example:(1)IF

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Opportunity costs different,even if one can produce more of all goods using fewer resources(eg labour) Both countries will benefit from trade if the opportunity costs of production (or relative prices)differ between the two countries Eg:If japan foregoes(opportunity cost )Wine it costs them 7500DVD players,but in RSA 2000 DVD players must be sacrificed ,so it costs relatively less to produce wine in RSA.So japan is in "absolute" terms 2.75 times more efficient than RSA in making dvds but only marginally more efficient in making wine,So RSA is relatively(not absolutely) more efficient(or less inefficient)in producing wine. But they will only effect such specialisation and trade if each can trade at a higher ratio than their opportunity cost: ie It is in the interest of Japan to exchange DVD players for wine with South Africa where it will get a liter of wine for only 2 DVD players. It is also in the interest of South Africa to exchange wine for DVD players with Japan since it can get 5 DVD players instead of only 2 DVD players

1) SOURCES OF COMPARATIVE ADVANTAGE: a) Technology: "Product life cycle of international trade theory" ;korea cheap labour copies germany technology now exporter instead of importer as before. b) Abundant Resources:Not all countries posess same'FOP' "Hecksher-Ohlin theory":Countries will tend to export those goods that most intensively use the countries relatively more abundant resouces.eg:Capital/Labour. c) Differences in taste and demand: If tastes for fish in A are more than in B,then A could be more expensive(greater demand) than in B,and more bigger/market for.Eg;social,religious,climatic,cultural. :ALSO:poornecessities;less luxury.will trade with poor;rich(developed) will trade with rich -all make luxuries.

Intra industry trade: -most international trade can be explained by comparative advantage principle or product life cycle theory.-BUT lots of trade is inter-industry trade rg:both export/import watches to each other. -inter is mostly in differentiated goods(toyota+mercedes) but also in homogenous(seasonal AGRICULTURE –costs) -,imperfect competition +demand side factors(increases choice to consumer)+economies of scale(specialisation).+market overlap(to wealthy in other country)-gains from trade:low price +wider product choice.

-2-Trade Policy 1. Inter.Trade causes greater prod.of trade goods+greater welfare+low price +more variety BUT: 2. term:Trade policy: Governments (1)PROTECT domestic firms against imports+(2) CONTROL volume of imports by means of trade barriers eg:import tariffs.(3)Also encouraging exports by assist with marketing,giving subsidies etc. for expert etc.

TYPES OF GOVERNMENT CONTROLS FOR Int .Trade. 1. 2. 3. 4.

Import Tariff Import Quotas(Quantitative Restrictions.) Subsidies Other Non-tariff bariers: a. Exchange controls b. Exchange rate policy.

1-Import Tariff:

1. term:Protective tariff: to protect local industry ECS102-8 economics Part2 Yr1

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2. term Revenue tariff : To earn revenue for government only.(eg goods not made here-computer) 3. Two categories of tariffs: a. term Ad-Valorem -% of value of item b. term Specific tariffs-Specific amount:eg R5 on each unit of wine. 4. THE ECONOMIC IMPACT OF AN IMPORT TARIFF SEE GRAPH PAGE 426 TEXTBOOK.: Explanation of graph: 1. q1= domestic supply.at price Pw 2. Number of Imports=difference q5 minus q1 (q1 = domestic supply possible at lower word rate.) 3. horizontal line Sw-Pw is world supply at price Pw. 4. Here: Imports Cause lower a. -1-Employment b. -2-Decrease Domestic Production c. -3-Weaken Balance Payments 5. Here imports cause better: a. Cheaper prices consumers b. If textiles imported-Clothing producers can raise their production. c. THUS NET RESULT OF 'these textile' IMPORTS UNCERTAIN(some production also raised) 6. IF GOV. imposes an Import tariff at Pt- will cause a. increase domestic production +supply to Q2(help employment) b. decrease imports to Q4 c. Better position Balance of Payments. d. Brings Revenue for Gov. e. HOWEVER-COULD BE UNWISE MOVE-because with lowering effect on 'raised clothing production' and all factors taken into consideration="NET RESULT UNCERTAIN"

-2-Import Quotas(Restrictions): 1. Form of DIRECT INTERVENTION. 2. Will have basicly same effect as tariff-Pt in graph above.!! 3. Seller benefit by higher prices(less supply) , Gov does not benefit from revenue tariffs. 4. Gov can -1-auction licences -2-sell licences -3-issue licences 5. Most quotas in RSA abolished as required WordTradeOrganisation.

-3-Subsidies:

1. Does not raise prices of eg:maize by a tariff to poor consumers-mostly the wealthy pay tax and will thus pay bear burden more than the poor.

-4-Admin. Barriers: 1. eg:extra red tape,special licences,give gov.contracts to local only,special technical conditions. 2. Will probably remain hinderence to word trade for long still.

-5-Exchange Controls: •

Eg: only so much froreign exchange allowed for the E.U. /america etc.(frequently done Dev.Cnty)

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-6- Exchange Rate policy •

Gov. influences exchange rate in other ways-some argue this is most effective method available today where the rate is the ruling factor for imports.

-2-Arguments for the use of Trade Barriers: • •

Can benefit SOME employees,producers ALOT –BUT can benefit LOTS of consumers A LITTLE. Labour +Capital Immobile-opening free trade can cause bankruptcy

-1-Balance of Payments • •

TO fix SHORT TERM Bal.of Pay. problems-But in LONG TERM other countries will retaliate impose-cause doubtful benefits then. Depends on Price elasticity of demand whether tariffs will work or not to restrict trade.

-2-Dumping 1) Firm sells at lower price overseas than in domestic marketsa) If price elasticity overseas is different to domestic b) term Predatory Dumping :firm uses high local prices to subsidise exports and undercut competitors—can be difficult to prove,can be relative/comparative advantage or local politiking c) term Countervailing Duties:used to counteract dumping. d) Or low prices are charged only overseas to expand production and realise economies of scale,high local to manage.

-3-Export Subsidies to promote Export • • •

If one country subsidises-then other country will impose countervailing duties/measures.to equal if A subsidises-Taxpayers A pay for :consumers B win+producers B loose + eg iscor /america says they are subsidised.

-4-Infant Industries • • •

best known +oldest argument To allow fledgling local industries with possible 'comparative advantage' to grow strong to compete with overseas established industry can cause inefficiency,esp. in developed countries not allways helped,difficult pick winners,

-5-Employment • • •

trade barriers neede to protect jobs foreign competition BUT-high unit labour cost for low overseas wages should equal out,and exploit to Int Labour.Org fiscal/monetary policy argued more efficient job creators-not loose competitive egdeinefficiency.

-6-Government REVENUE. 1) Esp.for developing countries-critical revenue.20%-25%-DEVELOPED- ONLY 2%

-7-National Security •

Not get too dependant-ie for times of war.

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Arguments against Trade barriers. -generally final result is unpredictable on the whole with all reasons for or against included..-

-1-Retaliation by Trade Partners: •

gains from could be offset by losses in tit for tat war

•

higher prices for consumers-

-2-Welfare Cost to Society:

-3-Inefficiency of producers:

Trade Policy in RSA 2) 1920-1970 –import substitution infant industry protection+bal.of payments -quotas+imp tariffs 3) 1970-1994-export drive –reduce import costs of intermediate products+export subsidies. 4) 1994-97 subsidies +other barriers (tarriffs etc)fased out for GATT/ WTradeOrg. agreements 5) free Trade areas-EU2000 and SADC 1996

Gold in the Internationqal monetary system; • • •

First before 1914 –all currencies backed by gold(to * 4 )+payments in gold other countries 1944-new system-'Bretton Woods'ofgold not backing currenciesbut as common denominator for valuing currenciessystem; and goldsettlebetween countries1971 –new system-floating exchange rate determined by demand/supply of currencies.

The GATT,The Uruguay round and WTO-world trade organisation. -from gatt to wto 1994-more details/items eg agricultue+clothing and -non-discrimination(most favoured nation status-equal)+national treatment(Imp.same asdomesticgoods)

The Balance of Payments. 1) Term Bal. of Paym. is a summary record of a countries transactions with rest of world over a period oftime 2) The balancing Item in bal.of paym.='change in countries gold+other foreign reserves' inTHEORY, but in practice='Unrecorded transactions' account 3) 4 different types of Balance of Payments account: a) term Current account.-(or called Trade balance) [ primary income receipts+exports{-}primary income payments+imports ]+plus current transfers(no 'quid pro quo' in return donations, taxes,immigrate) i) consists of merchandise both ways/services both ways /gold RSA /Primary income both ways–(prim. Income =1 employee+2 investment incl interest from loans both ways)./curr.transfers ii) Current account deficit OK if it can be financedby financial account surplass,or if not then confidence from other countries–debt on capital goods better than consumer, so surplass not necessarily a 'must have' b) term Capital transfer account. ECS102-8 economics Part2 Yr1

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c) term Financial account. –International transactions in Fin.Assets and liabilities incl.borrowing and lending ofmoney eg-loans,shares i) before 1999-called capital account. ii) outflows called 'capital outflows' iii) Consists of (1)term Direct investment-with controlling share (2)term Portfolio investment-not with controlling share (3)other investment-eg:loans,currency,deposits,short term trade credit d) term Unrecorded transactions.-all omissions and unrecorded transactions-serves to balance double entry system.

The Balance of Payments and Economic activity and Policy in RSA. 1) RSA export important –strong thus led to major development here. 2) To boost exports: a) Keep costs of domestic production down b) Subsidise process of marketing and help find markets c) keep Rand at low level to other currencies.(can cause bad inflation from higher import prices) 3) Our exports good when other economies not in recession. 4) If reserves too low-import tariffs and quotas for stop imports./or reduce domestic demand in other ways which also reduce employment,production etc in country.(RSA often does+must the latter or other countries retaliate.) 5) RSA 1985-1993 financial account deficit forced Gov. to reduce domestic demand.(no loans IMF then) 6) TODAY better because of sanctions gone , but bal.pay+domestic econ.activity +economic policy most important aspects of RSAeconomic life and will remain so.

Gold and other Foreign Reserves: • • •

•

If not enough foreign currency-gold must be sold by Gov. to buy some currencyto pay for imports portion of RSA gold production retained by Gov. each year. Gold and other foreign reserves are the most important total in the balance of payments: o 1-reflect overall balance of payments position o smooth ups and downs in pay/receipts all the time. o stop fluctuations of exchange rate o show authorities ability to stimulate economy without getting payment difficulties . Gross reserve include borrowings from International M Fund for Reserves to pay but net isexclude

The Int.M.Fund.+World Bank. -makes loans for foreign exchange payment problems. -extracts IMF conditionality-what Gov.must change in relationship to its economy every time. Voting rights by quota-eg usa-18% -World Bank-economies buy shares in it to join.-Only lends to developing countries eg dams.+privatesec

Exchange Rates: 1) Exports get paid (ultimately) for in Rand from abroad etc and imports in yen/dollar etc. ECS102-8 economics Part2 Yr1

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2) term Exchange rate is a Ratio- represents price of one currency in terms of another. 3) term Foreign exchange market : international market where currencies can be exchanged.Include in SA all authorised foreign currency dealers;RSA major Banks and others. RSA 8.4billion$/day 4) term Appreciation:price of one currency goes up in relation to another one. 5) term Depreciation:price of one currency goes down in relation to another one 6) Methods of quoting exchange rates: a) term Direct method:most countries(RSA too)-shows ? much local for 1 foreign eg R10 to $1(ie:price of a commodity since foreign exchange is just a commodity like bread) b) term Indirect method:some –shows ? much foreign for 1local eg R1 to $0.1

The foreign exchange market: 1) The Rand –Yen/Pound etc rate is derived from the R-$ exchange rate,and worked out from there.

REASONS FOR THE DEMAND FOR DOLLARS: 2) Demand Curve has Inverse/negative slope :the lower the price, the more is demanded. 3) term Derived demand the lower the price ,the more demand is derived from this price change. i) RSA IMPORTERS ii) RSA tourists for overseas iii) RSA Investors buying overseas assets eg shares iv) Overseas investors selling local investments eg:shares and convert proceeds to US Dollars. v) Speculators in currency wanting to buy other currencies. 4) The Rule is : the higher price of dollars,the less will be demanded+ visa versa.-also the more american goods will be demanded if price of $ low-thus causeing more demand for $ 5) On graph pg 443 if above price of equilibrium-excess supply/ if below E excess demand for Dollars.

REASONS FOR THE SUPPLY FOR DOLLARS: 6) Supply curve has a positive slope:more price =more supply 7) term Derived supply the higher the price ,the more supply is derived from this price change. i) SA exporters exporting ii) Foreign buyers of Stocks and Gov.Stocks. iii) SA investors selling foreign assets. iv) Foreign tourists. v) Speculators. 8) The rule for supply is higher prices-more supply.

THE EQUILIBRIUM EXCHANGE RATE: NOTE:Label the price and quantity with dotted line as p1/q1 etc-for points as per studyguide alsoE1/E2. : ALSO remenber to WRITE an EXPLANATION for each diagram explaining :RAND 'APPRECIATES . or DEPRECIATES'

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----if just the price above e = excess supply of $ then–if price changeMOVEMENTon both curve ----if just the price below e = excess demand of $ then –if price changeMOVEMENTon both curve Change Graph change RAND DOLLAR Demand for Qty $ increases(at each Demand curve SHIFT Depreciat Appreciat price) right es es Supply of Qty $ Increases (at each Supply curve SHIFT Appreciat Depreciat price) right es es Demand for Qty Dollars falls(at each Demand SHIFT left Depreciat Appreciat price) es es Supply of Qty $ falls(at each price) Supply SHIFT left Appreciat Depreciat es es Table of effect on domestic prices and current account and export/import from Rand/Dollar Appreciation/Depreciation. ChangeinR$ exchange Export Import Current Domestic rate prices in $ prices R account prices rand depreciate decrease increase improves rise rand appreciate Increase decrease worsens fall

Intervention in the Foreign Exchange Market: 1) If Gov. does not control exchange rate-can be very volatile from -1-other central bank manipulation for policy reasons and since -2-demand and supply are not syncronised on a daily basis. 2) term:Managed Floating:Central bank manipulation of exchange rates.A central bank can only intervene to stabilise a depreciating currency if it has sufficient foreign exchange reserves to do so.:Ie:Central bank supplies a extra demand for $(eg importers want) to stop right shift of curve.Or SARB buys extra supply of $(eg tourists want for world cup)to stop shift in supply curve.This is to keep the currency stable and protect vulnerable exporters etc. 3) term Expectations or Market sentiment: if everyone believes $ price going upexporters delay,foreign tourists and investors delay (demand rands down,supply $ down)and speculators buy $(demand $ up) cause immediate shift in curves and ECS102-8 economics Part2 Yr1

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immediate price change.To stop speculators SARB sometimes makes high interest rates to stop them lending to buy $ .

Exchange Rate Policy 1) Exchange rates are amoung most impotant of prices affecting:economic growth,employment,inflation,balance of payments. 2) term Floating currency Some countries have pegged currencies to $,others employ managed floating-(floating currency). 3) With floating currency-3 options:-1-do nothing-market forces do -2-managed ffloating -3use interest rates-if SARB cause interest rates up-then foreign capital flows in for lending out and speculators have high interest rates to stop them lending to buy $ . 4) term:PPP-purchasing power parity:if currencies have same purchasing power in different countries.eg:if basket goods cost 1$ in USA and R10 HERE,PPP=1 to 10.Got to do with currencies being undervalued/overval.. against others eg people say rand is overvalued to dollar etc.

The Terms of Trade: 1) termTerms of Trade : Index of ratio between weighted average of export price and weighted average of import price =export price index/import price index*100 ..if exports prices decrease and imports prices increase ,then country must produce much more to be able to afford to pay for the imports,or wont be able to .Also visa versa.The terms of trade index shows the relationship between the two. 2) If the Terms of trade lower=bad /higher =favourable if =1 equal 3)

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ECONOMICS part 2 Yr1

ECS102-8 CHAPTER 6 : INCOME DETERMINATION IN A SIMPLE KEYNESIAN MACROECONOMIC MODEL(MACROECONOMICS) CHECKLIST

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Important Boxes/concepts/graphs/pages:

-1- Production Income and Spending: 1. term "A" = Spending :Tot./Aggregate Demand,Spending,Expenditure. 2. term "Y" = Production. :(also GDP and even GNI) Tot./Aggregate/ + National Output,Income,Production,Supply. 3. term "Yf" = Full Employment level of Production 4. In National Accounts -1-Total-inc.,spend. and prod. measuredEx-Post(after occured)2-(+A =Y)-3-GDP not = GNI like in macr.theory. 5. In Macroeconomic theory -1-They are measured To Predict policy-Not EX post-2-(+ A not=Y)-3-GDP=GNI=Y 6. Total FOP Income considered= TOTAL Production in Macroeconomic theory + national accounts: BUT: 7. Total Spending NOT equal to tot Prod & tot Income in Macro.Theory because if all income NOT spent(if some saved). 8. term Production Equilibrium: situation where no tendency to change,none participants have any incentive to change behaviour,things will remain same. if total prod=income=spending then if all spent no incentive for extra production because spending is just sufficient to purchase the current product. 9. 3 possibilities for Spending <=> Production : Equilibrium. +Results of the 3. a. A>Y --Spending > Production =Production & Income will increase b. A
Reasons for spending> production: a. savings (from last year used to buy now) b. credit Reasons for spending < production. a. saving term Says Law : Y –causes- A old school belief of some economists,:SUPPLY WILL CREATE IT'S OWN DEMAND.(JEAN-BABTISTE SAY) –there are automatic mechanisms which keep the economy at full-employment level of income or

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13.

that restore this balance.+allsave/leakback .Advocates:Gov. Intervention in Economy to stimulate Tot demand unneeded. . .Equilibrium at: Yf = full employment level of income-where all FOP are employed fully. .Direction of Causality:Y –to –A term Keynesian Model :A –causes- Y Demand Demand or Spending various happenings,incl. great depression caused belief to change:John Maynard Keynes in "general theory of employment,interest &money" wrote .Advocates: Gov. must intervene at times to stimulate 'Aggregate Demand'. .Equilibrium at: A=Y or:C+I =Y Aggregate (spending)demand must = Total income.,can occour at any level iof income,will not necessarily tend towards full employment by itself,could need Gov. intervention for under employment or over employment(overtime) . Direction of Causality:A –to –Y

The Basic Assumptions of the Model: Economy consists of : HOUSEHOLDS & FIRMS only No Gov No Foreign Sector

Prices,Wages,Interest Rates,Money Supply given 1. 2. 3. 4.

Only Consumption Spending &Investment Spending No Gov. Spending or Taxes No Exports,Imports,Exchange rates,Exchange Rate Policy,Trade policy, Model cannot be used to study the financial markets or monetary policy

term Exogenous variables :variables outside an economic model.not included in models determining but do influence the model from outside. A=C+I =Y (Consumption is by -only Households +Investment is by -only Firms) Supply is plans of firms,demand is plans or decisions of households(but in MACROECONOMICS not only PLANS but ALSO actual things bought are counted. Important point:Macroeconomic Theory are devices to Explain(sectors economy) ,Predict(sectors) ,Policy(analyse effects), of various sectors of economy Ex Ante . It deals with 'Plans and Intentions',not Ex Poste events in past like the national accounts.

Consumption Spending:----------------------------------1. 2. 3. 4. 5. 6.

term 4 major types of Consumer goods&services: durable,non-durable,semidurable,services. Non-durable- 50% of consumption, Most stable of all ,.Semi-du...+durable–much more erratic-influenced by change in income and credit households final consumption=60% GDP,98% disposable income85% current income of househ.. term Current income –total income accruing to households term Disposable Income - Income–minus Tax. If plotted on diagram - strong correlation between income &consumption spending.

The Consumption Function 1.

term Consumption Function :relationship between TOTAL Households Consumption Income &TOTAL Spending.Has 3 important characteristics: a. Consumption increases/decreases as Income increases/decreases(direct relationship)

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b. Consumption Positive even if Income Zero(shows influence non-income determinants on spending) c. Consumption increases Less than an Income increase. (part Saved)

1 GRAPH OF The consumption function.:SHOWS ALL 3 CHARACTERISTICS •

The Line C is called :the Consumption function • C-BAR is the autonomous consumption.Bar above C indicates it isautonomous/independant fromY •

• •

(1)SHOWS CONSUMPTION INCREASE FOR INCOME INCREASE.Note:Put dotted lines and p1/P2 c1/C2to show a change in C(consumption) .. versus a change in Y(income,production or output).Because C changes less than Y it shows some increase in income is usually saved ,not all is spent • (2)SHOWS term Automomous Consumption is If Income = 0 then the intercept Cbar- (with bar on top-autonomous Y) is the spending /consumption independant of YIncome.(eg savings or credit)Regarded as a MINIMUM level of consumption. • (3)SHOWS term Induced Consumption is shown by the slopeC. Because C changes less than Y it shows some increase in income is usually saved ,not all is spent . term Marginal Propensity to Consume:= "c"=change Y(income) over change C (consumption) Shows the proportion of EXTRA income that will be used for Consumption ratio between change in consumption and change in income-one of most important ratios in macroeconomics.It is equal to the Slope of the consumption function curve.Lies between 0
GRAPH OF AUTONOMOUS AND INDUCED CONSUMPTION. • • • • • •

just show : 1-a box shaded for the autonomous consumption from C intercept to right and explain. 2-the triangle below curveand above box for induced consumption. 3-The equation of the curve:=C=Cbar +cY 4-the slope by a triangle /box with 'c' as slope and' 1 ' at bottom SEE page 465 fig 18.2

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The position of the consumption function . 1. Position determined by level of autonomous consumption.If Consumption function shiftsintercept changes. 2. position determined by-all non income factors=general age population,holdings of fin.assets,credit cost +availability.

The Equation for Consumption Function. 1. Autonomous consumption: "C-BAR" is the autonomous consumption.Bar above C indicates it is autonomous/independant from Y.Value of Cbar determines the position of curve from intercept on the vertical axis. 2. Induced consumption: depends on 2 things: a. marginal propensity to consume(which gives the slope) b. level of income(Y) c=change(C2-C1) in C / change(Y2-Y1) in Y

SAVING; 1. TERM "S"= SAVING 2. Because Y=C+S(income = consumption plus saving) thus NOT SPENDING=auto=SAVING. 3. marginal propensity toconsume+marginal propensity to savemust=1:so if mpc=0.75,then mps=0,25 4. if above is true then anything influening one will influence other-and thus -Cbar =Sbar :why?pg469t

Investment Spending: 1. Investment spending is smaller than consumption spend and most volatile of all spending types. 2. term capital formation:investment spending called this in 'national accounts'. 3. Investmnt spending is NOT a function of Income. –(show this by a horizontal line on graph T.Income down T.Investment top ) BUT investment spending does determine income

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In the simple Keynesian model investment is regarded as autonomous, in other words, it is independent from the level of income and output. It is influenced by factors such as business expectations and confidence, the interest rate and the expected returns from investment projects. An improvement in profit expectations or business sentiment causes an increase in autonomous investment. In the diagram the investment schedule shifts upwards and the vertical intercept of the investment schedule is higher. THE Equation for the investment function above(income) is I=I'bar'

The Investment Decision: 1. Firms invest in Capital goods to:ONLY earn a profit.-the greater profit-the greater investment. 2. Profit depends on Cost of obtaining capital Goods,+ and Revenue goods expected to yield . 3. Money for capital 'That is Not Borrowed' could be invested-so profit from capital allways competes with interest rates.,whether credit or not. 4. investment is related to the Interest rate,not Income : There is an INVERSE relationship between RETURN on Investment Spending and Interest Rate. SEE GRAPH:page 470 18.3—Right shift if better business expectations/sentiment,left shift if worse.----movement if interest rates change. 5. factors which promote investment:expectations ,confidence ,interest rates,returns 6. Investment risky :because price goods may fall,insufficient demand goods,tech. obsolete,wear. 7. term Real Investment=capital goods for production purposes only no shares etc 8. term Financial Investment =eg shares,bonds,deposits 9. Keynes believed that changes in desired investment by businesses were one of the major factors that caused changes in the level of output. Investment spending is an inherently risky affair. The level of investment spending thus depends on the willingness of firms or entrepreneurs to take chances. Their willingness, in turn, depends on their expectations about future economic and business conditions. 10. Investment spending, through its impact on aggregate demand, is an important determinant of the level of income and output Figure 2 The Investment Function Graph:The level of investment I is inversely proportional to the interest rate' i ', cet.par.(this is not =equation I=Ibar,but just I : see next graph)

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Interest Rate

11.

=I

Investment Spending

Equation for Investment Function: 1. I="Ibar" represents the investment function :bar to show investment is autonomous to income(Y). 2. See Income/investmnt graph above for this equation=------------horizontal line---------------

The Simple Keynesian Model of a Closed Economy without Gov. Total Spending or (Aggregate Demand.) Term Aggregate spending is the total demand for goods and services in the economy and is given by the following equation:

This is one of the key concepts introduced by John Maynard Keynes in The general theory of employment, interest and money.

A = C + I + G + (X - Z)

It is still today the core of most macroeconomic theories C - consumption about the determination of the expenditure overall level of employment I - investment expenditure (and thus the level of national G - government expenditure income produced) in a X - exports country's economy during a Z - imports given year. 1. In the simple Keynesian (more) and IS-LM models aggregate spending is the main determinant of the level of output and producers of goods and services change their production plans according to changes in the existing and expected aggregate spending. 2. Total production =Total Income But not equal to Tot Spend.in macroeconomics(in Nat. Acc. it is= ECS102-8 economics Part2 Yr1

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3. term IN THE 3 GRAPHS BELOW "THE CONSUMPTION FUNCTION GRAPH " IS ADDED TO THE INVESTMENT FUNCTION GRAPH TO GET Aggregate SPENDING FUNCTION GRAPH. 4. the cons.funct. will increase by cY as consumption increases,:+ the Cbar intercept. 5. Once graphs are added:The vertical intercept is now equal to Cbar + Ibar = Abar . 6. Now-At each level of income and output, aggregate spending A = Abar +cY. (A=Cbar+Ibar) 7.

The 45

0

Line

1. According to Keynes theory:Equilibrium is where Y=A or where Tot Demand =Tot Production 2. According to Says theory :Equilibrium is where all FOP are at 'Full Employment level.' 3. If a line is drawn at 45deg through Origin A/Ygraph and both axes same scale:it must=Keynes Equilibrium where Y=A : 4. ABOVE 45deg line = A> Y (axes scale same) so Excess DEMAND --Inventories will FALL= 5. Below Y0 OR A0 = above 45 BUT below Aggregate Spending Function =Excess DEMAND 6. BELOW 45deg line = A< Y (axes scale same) so Excess SUPPLY ----Inventories will RISE 7. Above Y0 ORA0 = below 45 BUT above Aggregate Spending Function = Excess SUPPLY 8. Point 1 :Equal demand production =equilibrium.(see the below graph.) 9. Point 2:demand > supply =excess demand 10. Etc.

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The Equilibrium level of Income: • •

Equilibrium –A0 or Y0 occours when demand=supply or PLANNED spending=PLANNED production or Aggregate spending =Aggregate production. If the Investment function increases or the Level of Autonomous Consumption (intercept up axis)increases then the equilibrium intercept with the 45 deg will increase( for Production/Income.AXIS And Aggregate Spending/Demand AXIS).

USING GRAPHS see graph pg 476 1. term "Aggregate Spending Function" A = C+I or ( A=Abar cY ) 2. If we combine "Aggregate Spending Function"graph (1) with 45 deg graph (2) we find the 45deg intercept:All points above/between =excess demand | All points below /between = excess supply 3. term Y0 = INCOME equilibrium 45 deg intercept . –see dotted line indicating on graph. 4. term A0 = DEMAND/ equilibrium 45 deg intercept . –see dotted line indicating on graph. 5. In the diagram it is shown as income level where the { "Aggregate Spending Function" A = C+I or ( A=Abar cY ) } intercepts the 45 deg line.(0A0=0Y0) At any other level income it is either excess demand or excess supply and thus an -unplanned change in inventories:rise/fall 6. IF : Excess DEMAND :FIRMS REACT by expanding their production. 7. IF : Excess SUPPLY :FIRMS REACT by contracting their production. AGGREGATE SPENDING on vertical axis / and AGGREGATE INCOME /PRODUCTION on horizontal. for GRAPH;

USING WORDS 1. Where aggregate spending(A) = aggregate income(or production) there is equilibrium between 2. 2. Where aggregate spending(A) > aggregate income(or production) there is a. 1-excess demand b. 2-firms inventories will fall c. 3-firms will thus raise production 3. Where aggregate spending(A)< aggregate income(or production)....Visa Versa.

USING SYMBOLS/EQUATIONS 1. 2. 3. 4. 5.

A=C+I C=Cbar +cY Thus A =I + Cbar + cY BUT Y=A SO : SO :

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6. 7.

: work out both sides separately :you get: Y0=ANSWER or the 45 deg intercept(is also A0)

USING NUMBERS: The formula for equilibrium output: An example Assuming the following values, the equilibrium level of income can be calculated as follows: C = 200 I = 300 c = 0,8

The Algebraic Version of the simple Keynesian Model:

EXAMPLE WITH NUMBERS ADDED: The formula for equilibrium output: An example Assuming the following values, the equilibrium level of income can be calculated as follows: C = 200 I = 300 c = 0,8

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Aggregate demand is equal to consumption C + investment I. Consumption C is equal to autonomous consumption + the marginal propensity to consume times c the level of output Y. Using the values provided C = 200 + 0,8Y. Investment I is equal to autonomous investment I = 300. Aggregate demand is therefore equal to autonomous consumption + the marginal propensity to consume times c the level of output Y + autonomous investment. Substituting C, c and I with the values provided, A = 200 + 0,8Y + 300. By combining the autonomous components and calling it autonomous demand A, the aggregate demand function A is equal to 500 + 0,8Y. Substituting A with 500 + 0,8Y, the equilibrium condition is Y = 500 + 0,8Y. Rearranging terms so that Y is on the left side, the equilibrium level of income Y0 can be solved. According to this formula the equilibrium level of income is determined by the marginal propensity to consume c and the level of autonomous spending A. •

• • • •

For equilibrium of Y and A ,we can also write in special characters: Y0 =#@# Abar orY0 =1/1-c(Cbar +Ibar) THE FORMULA FOR THE EQUILIBRIUM LEVEL OF INCOME CONTAINS TWO ELEMENTS: -1- {A bar or =C bar+I bar} -2- { 1/(1-c)} IMPORTANT:These two elements are used later in calculations.

-7-Impact of a Change in Investment Spending:The Multiplier 1. Only Need to understand for Exams: a. What the multiplier means b. How it can be calculated from the formula c. Why it's size depends on the marginal propensity to consume d. How it can be represented graphically.

-1-What the multiplier means: 1. This Multiplier is one of central concepts in macroeconomics:#@#*Change in I =change in Y 2. term The Multiplier : =#@# SPECIAL letter see Pg 483-#@#=1/1-c = change in Y / over change in A :the Ratio between the eventual change in income and the initial investment is called the Multiplier . The size of the multiplier depends on the fraction of the additional income generated in each round that is spent in the next round ,that is ECS102-8 economics Part2 Yr1

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3. 4. 5. 6. 7.

,on the marginal propensity to consume.(c) . ....{For AN investment of R100,if the R100 is multiplied by the ('marginal propensity to consume' or 'c=C/Y' or c = a change in consumption /a change in Income) ,that is what part/portion of the original amount that will statisticly ,be re-spent by the receivers of the income((((in form of FOP payments))))Then of that % re-spent on "C-consumption" , 're-spent amount'* c is again re-spent.Eventually process works itself out. } Remember Intercept A bar =C bar +I bar For equilibrium of Y and A ,we can also write in special characters: Y0 =#@# Abar or =1/1-c(Cbar +Ibar) The "marginal propensity to consume" is only c because we deal with households +firms ONLY. Saving,Tax,Imported goods make multiplier less. 'Paradox of Thrift'-if all households save,less will be spent(less demand) and thus less produced(supply).

-2-How it can be calculated from the formula 1. Formula for multiplier is: change Y = 1/1-c (change I) 2. Thus multiplier is 1/1-c

-3-Why it's size depends on the marginal propensity to consume •

The greater c the greater the multiplier because the greater c the more of each phase of income is again spent-less is saved.

-4-How it can be represented graphically GRAPHIC REPRESENTATION of MULTIPLIER PROCESS: page 480 t • First step to UP is the actual investment itself causing a demand for : the goods &serv. the investment was initially aimed at(eg the soccer stadium) • Second step to RIGHT is producers producing the goods for the step 1 demand+getting paid • 3 step is marginal propensity to consume to UP is eg 4/5 * 'got paid amount from stadium' to go up +create new demand waiting for producers to fulfill. • 4 step is producers produce for demand +get paid...to RIGHT then carries on and on Change in autonomous spending An increase in autonomous spending, for instance investment spending, causes a parallel upward shift, equal to the increase in investment of the aggregate demand schedule. The vertical intercept changes to A1and the aggregate demand function is A = A1 + cY. At the initial level of income, aggregate demand now exceeds the level of output by the change in investment spending. This is represented by point a. Due to this excess demand, inventories decrease and producers increase their production and consequently the income of households increases. This is indicated by the increase in income and production on the horizontal axis. The increase in production and income is equal to the increase in investment. Out of this increase in income households increase their consumption spending and aggregate demand increases by the marginal propensity to consume, ECS102-8 economics Part2 Yr1

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times the change in income. This is indicated by point b. At point b aggregate demand still exceeds income and output but the gap between aggregate demand and output is smaller as indicated by the vertical distance between point b and the 450-line. The process continues As long as aggregate demand exceeds the level of output, inventories decline, producers increase their production, income of households increases, consumption spending rises, causing a further increase in aggregate demand. Note that the gap between aggregate demand and the level of income and output is smaller after every round of an increase in output. This process continues until a new equilibrium is reached where aggregate demand is equal to the level of output. This occurs at point E1 with an equilibrium level of income and output Y3 .

The multiplier effect Comparing point E1 with point E2, it is clear that the increase in investment spending causes an increase in the equilibrium level of income and that the increase in the equilibrium level of income and output is greater than the increase in the initial investment spending. This is due to the multiplier which is equal to1/1-c. The change in income, due to the increase in investment spending, is equal to the multiplier times the change in autonomous investment. (more)

Put a section with all this at beginning of the notes after contents:::: All Multipliers and index ratios: Chapter 1:

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ECONOMICS part 2 Yr1

ECS102-8 CHAPTER 7 :KEYNESIAN MACROECONOMIC MODELS INCLUDING THE GOVERNMENT and THE FOREIGN SECTOR. CHECKLIST

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1-Introduction: 1) As the leakages increase so multiplier becomes smaller. 2) Extra FLOWS added to model: a) G=Gov. Spending b) T=Taxes c) X=Exports d) Z=Imports 3) ASSUMPTIONS WHICH STILL APPLY: a) (A) Interest rates given(exogenous):(cannot analyse changes in fin. markets) b) (B)Prices Exogenous.(cannot analyse inflation ie:CPI) c) (C)Wages Exogenous. 4) Economic theory has 3 purposes: a) 1-to explain -2-to predict ?happen if something changes 3-analyse economic policy.

2-Introducing The Government into our Model: 1) We must consider impact of Gov.Spending (G) and Taxes (T) on a) The level of Aggregate Spending (A) :=(+Gbar) b) The Multiplier (#@#) :=(T decreases it) =1/1-c(1-t) c) Equilibrium Income(Y) 2) term Determinants : We must consider how determinants(G)Gov. spending & (T)Taxes can be used as policy instruments to influence (Y) =Income. : T &G are main ingredients of BUDGET and main instruments of FISCAL POLICY. 3) We are Mainly interested in influence on INCOME :Y.

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1-Government Spending:(G) Government Spending VS Income: G vs I 1) During 70-90' Gov spending increasedhousing,defence,education,health,safety &security. 2) term Gov.Spending is a Political Issue-causes SHIFT in curve and thus is Autonomous to Income(Y):Thus G=G bar (ie:autonomous.) 3) horizontal line,independant ,political issue,autonomous,upward shift,vertical intercept. 4) Summary:addition of (G ) a) raises level of Aggregate Spending b) leaves multiplier unchanged c) raise equilibrium level income Y0 cet.par.

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Equilibrium level of government spending: Gov.Spending added to (A)Total Spending VS Income: A vs I 1) Adding government spending G, which is independent of Y, causes an upward shift, equal to G, of the aggregate spending curve. The equilibrium level of income increases from Y1 to Y2. 2) Government spending is part of aggregate spending (A = C + I + G) and has a direct impact on the equilibrium level of income and output. 3) Government spending G is the purchasing of goods and services by the government and is an instrument of fiscal policy that can be used to influence the level of output and income in the economy. 4) The aggregate spending function without government spending is: A = C + I = A + cY. Autonomous spending is A = C + I and is represented by the vertical intercept A1 5)

Equilibrium level of Gov.Spending; Gov. Spending influences the multiplier effect. 1) 2) 3) 4) 5)

The addition of G will increase income(Y) by G * Multiplier To calc: EQUILIBRIUM CONDITION: we start with Y=A(where eqilibrium is) so :Y=C+I+G because (A=C+Ibar+Gbar) So: Y=(Cbar+cY)+I+G

6) Thus:to solve above equation: 7) Y-cY=Cbar+Ibar+Gbar 8) so:Y(1-c)=Cbar+Ibar+Gbar 9) THUS: Y0=1/1-c(Cbar+Ibar +Gbar) 10) General formula can still be written: Y0=#@# (Abar) 11) Where Y0 is equilibrium of A and Y 12) .Where:#@#=multiplier , Abar = total autonomous spending 13) Gov. Spending is a powerful tool to raise level of production and income and increase employment. However addition of prices,wages ,interest rates and the foreign sector makes tool less powerful from other influences.

All the Formulas from Sub-Heading: 14) 15) 16) 17)

Y=A(the equilibrium 45 deg line)******** so :Y=C+I+G because (A=C+Ibar+Gbar)********* and :C=Cbar +cY (consumption curve equation)******* So: Y=(Cbar+cY)+I+G

18) 19) 20) 21)

Thus:to solve above equation: Y-cY=Cbar+Ibar+Gbar so:Y(1-c)=Cbar+Ibar+Gbar THUS: Y0=1/1-c(Cbar+Ibar +Gbar)********

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22) 23) 24) 25)

General formula can still be written: Y0=#@# (Abar)****** Where Y0 is equilibrium of A and Y .Where:#@#=multiplier , Abar = total autonomous spending

2-Taxes(T) 1) To Spend Gov. must levy taxes. 2) Taxes are a Leakage and Gov.Spending is an injection into circular flow of goods and services in the economy. 3) term Disposable Income :(or after tax income)-taxes reduce disposable income-and reduce 'C' 4) term Direct/Indirect Influence- Income &Spending:Taxes reduce C indirect,spending=Sdirect 5) personal income Tax and Vat are the 2 most important Max sources of tax in rsa for gov. 6) term A Proportional tax rate for the entire economy per year is realistic-Only Progressive/regressive per bracket. 7) term extrogenous variable :Tax rate is politicly determined ,also tax REVENUE =extrogenous. 1) Graphicly the introduction of a tax rate SWIVELS the CURVE downward,or upward for a lesser tax rate. 2) In the simple Keynesian model taxes T are a certain proportion t of income Y. The proportion is called the tax rate t. The slope of the curve is determined by the tax rate

Disposable income/Tax Calculation for Formula. a) b) c) d) e) f) g) h) i) j)

term Tax Rate: T=tY (where t=tax rate%-proportional !!!!!)****** Yd =Y-T (Disposable income = Tot. Income –Tot. Tax subtracted)******** So: Yd=Y-tY (because T=tY) So: Yd=Y(1-t) ******* NOW WE MUST MODIFY 'Consumption function' to leave out taxed part of Y- so for disposable income :C=Cbar +cYd (Y(d) is disposable income)********* So: C=Cbar +cYd so:C=Cbar+c(Y-Yt) (because Yd=Y-tY from point(c)above) so:C=Cbar+c(1-t)Y ***** term:The new marginal propensity to consume is c(1-t) with taxes included. term The slope of this curve is c(1-t) which is allways smaller than c,slope was "c" originally without introduction of taxes.

Multiplier with Taxes:

Multiplier without Taxes= #@#= 1/1-c 1) Multiplier with Taxes = #@#=1/1-c(1-t) (Tax Reduces size of Multiplier through reducing size of Marginal Propensity to Consume.) ECS102-8 economics Part2 Yr1

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2) Graph Consumption function or & Aggregate Spending function 'SWIVELS' downwards from extra tax/gets flatter.,or up from less

3) The introduction of a proportional tax thus: a) LEAVES AUTONOMOUS spending unchanged. b) REDUCES THE MULTIPLIER #@# c) REDUCES THE EQUILIBRIUM LEVEL OF INCOME Y0, Cet.Par.

The Equilibrium level of Income in an Economy with a Government Sector. 1) increases the level of Vertical Intercept :All the completely Autonomous spending: from Abar = Cbar + Ibar to Abar = Cbar + Ibar + Gbar 2) The original aggregate spending curve without a government sector is indicated by A1 with an equilibrium income of Y1. With the introduction of government spending, the aggregate spending curve shifts parallel upwards to A2. With the introduction of a proportional income tax, the aggregate spending curve becomes flatter, as indicated by A3. The eventual equilibrium level of income is indicated by Y3.

Formulas: for sub-heading: 1) 2) 3) 4) 5)

from A = C + I to A = C + I + G. Y=A (equil. condition) A=C+ Ibar+Gbar (aggregate spending) C=Cbar +c(1-t)Y (consumption function) SUBSTITUTING: a) Y=A b) Y=C+Ibar +Gbar c) Y=(Cbar +cYd)+Ibar+Gbar d) Y=(Cbar +c(1-t)Y))+Ibar+Gbar e) Y-c(1-t)Y=Cbar =Ibar+Gbar f) Y=(1-c(1-t))=Cbar +Ibar +Gbar g) Y0=1 /1-c(1-t) *****(Cbar+Ibar+Gbar). h) The equilibrium level of income can also allways be obtained by : #@# multiplied by Abar (P.S. Abar is also vertical intercept or Autonomous spending.)

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6) term Induced Consumption= induced by an increase in income :induced to spend so much more.

Fiscal Policy: Yf=(Y full)= Income equilibrium level at which full employment is reached. 1) term FISCAL POLICY : We must consider how determinants(G)Gov. spending & (T)Taxes can be used as policy instruments to influence important economic variables such as (Y) =Income or Production : T & G are main ingredients of BUDGET and main instruments of FISCAL POLICY. 2) The Gov. can Increase /Decrease Equilibrium level of Income or Production. BY: a) Direct:Increase /Decrease Gov.Spending and multiplier will effect large change. b) Indirect:Increase /decrease taxes and raising induced consumption spending and multiplier. 3) The formula for How much Gov.must spend to make a certain change= a) ....^ Y =@ ^ G (like prev.example but now with 'G':^Y=@^I)(where ^='change'and @=#@#) b) so:^G=^Y/@ --work out from there... 4) Specific exercise:If the Gov. wishes to close the gap between full employment (=Yf as an example) and lower levels by incresing spending –they must work pout how much with above formula.=^Y=@^G :so:^G=^Y/@. where multiplier will increase %income morethan %spending. 5) 1) The Formula is : formula.=^Y=@^G :so:^G=^Y/@. 2) The level of full employment is presented by the YF line. The economy is in equilibrium at point E1 which is point of less than full employment and unemployment is experienced 3) Using fiscal policy, that is the use of government spending G and taxes T, it is possible to increase aggregate demand in order to reach full employment. 4) An increase in government spending increases autonomous spending and via the multiplier it increases aggregate demand and the level of output. In the diagram the aggregate demand curve shifts upwards and a new equilibrium is reached at the level of full employment. 5)

2 -Introducing The foreign Sector into the Model:The Open Economy. Introduction: 1) Matters kept simple by assume X&Z are autonomous(unaffected by change in Income) 2) The change in a) level aggregate spending:A b) multiplier ECS102-8 economics Part2 Yr1

Imports (Z) :

Exports (X) will affect positively (+) Will NOT affect this Page 78

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@ c) Equilibrium level income :Y

Will affect by multiplier effect+

Exports &Imports: 3) Exports &Imports Autonomous to INCOME(Y)=horizontal line=expressed X=Xbar /or/Z=Zbar 4) BUT imports can be induced-ie they can be affected by (Y)income 5) The positive relation between imports and economic activity in sa is one of stongest macroeconomic relationships in the country. 6) EXPORTS are an Injection into economy & IMPORTS are a leakage. 7) The Formula for Imports/Exports is: A +C + Ibar+Gbar+(Xbar –Zbar) 8) term Net Exports usually referred to as =(X-Z) Graphs of the horizontal line of import/export function against tot.income or production.

9) If Net IMPORTS greater-Net Spending/demand less(from multiplier local re-spending)///// if Net Exports greater net Spending more. (THIS IS TOPSY TURVY----WATCH OUT HERE ALL VISA VERSA) 10) --Multiplier * Net exports-- give change in income equilibrium for any one spot calculation-either-or+

Formulas for expots/imports.

6) Net Exports usually referred to as =(X-Z) 7) from A = C + I to A = C + I + G.+(X-Z) 8) Y=A (equil. condition) 9) A=C+ Ibar+Gbar +(Xbar-Zbar) (aggregate spending) 10) C=Cbar +c(1-t)Y (consumption function) 11) SUBSTITUTING: a) Y=A b) Y=C+Ibar +Gbar+(Xbar-Zbar) c) Y=(Cbar +cYd)+Ibar+Gbar+(Xbar-Zbar) d) Y=(Cbar +c(1-t)Y))+Ibar+Gbar+(Xbar-Zbar) e) Y-c(1-t)Y=(Cbar +Ibar+Gbar+(Xbar-Zbar)) f) Y=(1-c(1-t)) *(Cbar +Ibar +Gbar+(Xbar-Zbar)) g) Y0=1 /1-c(1-t) *****(Cbar+Ibar+Gbar+(Xbar-Zbar)) 1) In diagram a the autonomous net export function is given. In diagram b the impact of autonomous net exports on aggregate spending and equilibrium income will be illustrated ECS102-8 economics Part2 Yr1

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2) In diagram b the aggregate spending curve A0 represents aggregate spending C + I + G and the corresponding equilibrium level of income Y0 without a foreign sector. 3) When the foreign sector is added, the vertical intercept changes. 4) If net exports are negative, as indicated by (X-Z)1, autonomous aggregate spending A declines and the aggregate spending curve shifts downwards and the equilibrium level of income decreases 5) It can also be visa versa depending on which way 'Net exports' leans to positive or negative.

Fiscal Policy inthe Open Economy: • • •

Once understnd imports not Autonomous-Gov.spending gets less powerful.(&multiplier gets smaller.) Also-bal . of payments account:expansionary fiscal policy should raise income and imports and reduce net exports.This can adversely affect current account. 'Net exports'(inp-exp) is basicaly the Current Account in Gov. accounts.

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ECONOMICS part 2 Yr1

ECS102-8 CHAPTER 8 : MORE ON MACROECONOMIC THEORY AND POLICY CHECKLIST

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The Aggregate Demand Aggregate Supply Model 8.1sp511t 1. REMEMBER ALL GRAPHS HEADINGS FOR AXIS's ARE ONLY:TOTAL PRODUCTION/INCOME AND TOTAL PRICE LEVEL and (ie MACRO economic=!!!!!! TOTAL!!!!! NOT MICRO) all Curves MUST be Labeled :AS0-AS0 ////AS1-AS1 and AD1-AD1 etc(NOT S1-S1 or D1-D1!!!!!!!!!!!) 2. .When you go further than "Keynesian models" you must include:Interest(monetary sector),Wages +variable prices. THEN the most popular model today for this is the :AdAs model. 3. "Ad-As"=Aggregate demand & Aggregate Supply models.=Macroecon.-NOT Microecon.---Demand /Supply curves 4. AdAs-deals with: a. General level of PRICES : eg From :C.P.I. ----NOT single goods prices b. Total Prod. goods& serviceseg:From :GDP.-----NOT single goods production 5. BUT Macroeconomy cannot just be seen as SuM of all Micro-econ. part,dosnt work. 6. Production still assumed =Income same as keynesian model. but prices =spending here l Differences Keynesian Prices given Wages given

Differences AdAs model Prices Variable Wages Variable

interest rates &money supply Given Spending (/-Demand) is driving Force determines economic activity

Interest rates Variable +money supply can change level econ. activity determined by Demand +Supply

Production is only Nominal because price level cannot change-any spending + means prod +,(eg :not maybe prod less because price maybe also less )

production is REAL production

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Implications for AdAs can study inflation supply can change separate to demand-wage change impact on production,income ,employment/unempl. ,&inflation be studied can used study monetary sector &monetary policy Changes from supply side can are also taken into account(maybe prices low or no raw materials available) PY =nominal production P= REAL production

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7. This is Law of demand&supply:Price Increase= Demand DOWN &Supply UP and Visa Versa 8. NON-PRICE DETERMINANTS= cause Shifts in curves//PRICE Determinants causes Movements on

THE DIAGRAM OF ADAS CURVE:. 9. The AD-AS model is the most popular model in macroeconomics. 10. The aggregate demand curve (AD) slopes downwards from left to right, indicating an inverse relationship between price level /and total expenditure (or aggregate demand). (more) 11. The aggregate supply curve (AS) is primarily governed by the cost of production and normally slopes upwards from left to right. (more)

The Aggregate Demand Curve. 1. Determined by anything that influences Aggregate spending in economy: a. Same as in Keynesian model:BY:i (=interest rate)+C,I,G,T,X,Z (householdconsumptionetc) b. Also by anything that influences these factors. i. (i)=interest rate ii. (C) =Household consumption iii. (I)= Investment iv. (G) v. (T) vi. (X) vii. (Z) 2. MOST IMPORTANT factor =(i)= interest rate:influences (C)consumption &(I)investment spending 3. NON-PRICE DETERMINANTS= cause Shifts in curves//PRICE Determinants causes Movements on 4. FISCAL POLICY= a. Taxes + b. Gov. Spending 5. MONETARY POLICY=Interest rates 6. Contractionary Gov. Policy = A Demand curve SHIFT LEFT (less D for any one price) 7. Expansionary =Gov. Policy= A Demand curve SHIFT RIGHT(more D for any one price)

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Change in non-price factors

Shift of the AD curve

PRICE CHANGES

Movement on curve

EXPANSIONARY POLICY

Shift Right/Upward

CONTRACTIONARY POLICY Shift Left/Downward Autonomous consumption C increases

R

Investment spending I increases R Government spending G increases Taxes T decrease

R R

Interest rate i decreases (which causes an increase in investment R spending) Net exports (X-Z) increase

R

Autonomous consumption C decreases

L

Investment spending I decreases L Government spending G decreases Taxes T increase

L L

Interest rate i increases (which L causes a decrease in investment spending) Net exports (X-Z) decrease

Shift Left

Changes in Aggregate Demand: 1. 3 different types of slopes of Supply curve cause; a. In recession:=where Aggregate SUPPLY curve is very Flat=+ demand causes +production but same PRICE, b. In Very good times= of Full Employment +demand causes same (or little) production but –PRICE(production cannot expand=full capacity) c. In medium times =normal sloping supply curve BUT THE PROBLEM is; i. + Increase in Demand: will cause a +in production (and + Employment) +increase in price (and + Inflation) ii. – Decrease in Demand: will cause the opposite. 2. Thus if Gov. tries a contractionary policy-cause unemployment///BUT if Gov. tries Expansionary policy-cause inflation +price increase. a. THUS gov. must choose which is worst-unemployment or price/inflation to make a choice. 3. term Demand Management: the management of 'demand' by the Gov. using Monetary and Fiscal policy. 4. term Trade off:the Government plays with DEMAND by using : (i) / (G) / (T) . by using Monetary & Fiscal policy: trade off between Demand + or – for Gov .Either price /inflation UP & Employment UP OR price/inflation DOWN & EmploymentDown ECS102-8 economics Part2 Yr1

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The Aggregate Supply Curve 1. Supply Curve primarily Governed by COSTS of PRODUCTION=Price FOP +Productivity 2. The AS curve derived for given set factor prices (rent, wages and salaries, interest and profit) and prices of imported capital and intermediate goods, and for a given level of productivity,change in any of these factors causes shift of the AS curve 3. Supply Curve NOT usually affected by Expansionary +Contractionary Policies of Gov or the SUPPLY curve.(exept for interest rate does affect costs of production.) 4. PRICE factors cause : MOVEMENT on SUPPLY CURVE 5. NON-PRICE factors cause :SHIFT of SUPPLY CURVE. Changes Prices of factors of production increase Prices of imported capital and intermediate goods (eg OIL) increase

Shift of the AS curve

Productivity decreases

L

Weather conditions deteriorate

L

Prices of factors of production decrease Prices of imported capital and intermediate goods(eg OIL) decrease

left(or Upward) L

R(or Downward) R

Productivity increases

R

Weather conditions improve

R

The Slope of the Aggregate Supply Curve: 1. keynes not concerned about Inflation when consider fix Great Depression –because curve flat at beginning –can have NO PRICE INCREASE for MUCH production increase in supply curve. 2. The AS curve can also be depicted as having a flat part, a rising part and a vertical part.

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Page 86 of 106 The level of full employment( of all FOP) is represented by YF.,Y1 = point to which no price increase/prod.incr. The flat part AS curve represents economic conditions that very depressed –there is a substantial excess production capacity. This implies that production can be expanded without putting significant pressure on the price level. In other words, expanding production from the origin to Y1 does not require an increase in the price level. The rising part of the AS curve indicates that there is little or no excess capacity in the economy, that is when most factors of production are almost fully employed. In this part of the curve, an increase in production is associated with an increase in the price level. The vertical part of the AS curve indicates that full employment has been reached and production cannot be expanded beyond this level.

Changes in Aggregate Supply 1. term:Stagflation: Stagnation +Inflation :{{{{ Stagflation occurs when an increase in the cost of production not only results in higher prices but also in lower production, income and employment and higher unemployment. This was a term coined in the 1970s for the twin economic problems of stagnation and inflation}}} From an upward SHIFT in Supply curve specificly due to :is caused by any increase in production costs of TOTAL PRODUCT ie GDP etc. eg:{price of oil/other inputs/etc} or {wages without corresponding production increase},or {profit margins}---causes (1) LESS Employment,(2) LESS Production =STAGNATION and HIGHER PRICES = INFLATION.

2. 3. term :Supply Shocks:Where A SUPPLY curve SHIFTS UPWARD:ie could cause stagflation—presents Gov. difficult decision—If expansionary Policy used to increase Demand to in turn increase employment(stop stagnation part of stagflation)-then Inflation will go even more up because higher demand curve SHIFT Up =Higher Equilibrium.BUT if Contractionary policy is used then opposite (eg oil crisis of 73'sexpan.=worst since 50's war korea inflation //then of 79's –contr.-worst unemp. =recession since ww2) SOLUTION= TO: lower wages+production costs ,including an Anti-inflationary "INCOMES POLICY"(very difficult-keep wages growth balanced with productivity growth.)-this will cause OPPOSSITE SHIFT(right /downward) of Supply curve.

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The Monetary Transmission Mechanism 1. term:Monetary Transmission Mechanism.:it is the way or mechanism in which changes the Monetary sector are transmitted to the restof the economy:escpecially changes in the interest rate=(i) Affected:aggregate demand,supply,production,income,price level. 2. In countries where money supply undeveloped-old 'Gov.money-supply' not interest reasons used. 3. In TODAY we say Changes in the Monetary sector are triggered by changes in the Interest Rate=(i) which is for all practical purposes seen as controled by Gov. policys.

Links between Interest Rates , Investment Spending and Rest of Economy . 1. when reserve bank adjusts repo rate-all othershort term interest rates eg;prime overdraft rates ,of banks change in same direction.Our models represent all these with a single interest rate=(i)

THE MONETARY TRANSMISSION MECHANISM DIAGRAMS (3 OF) •

From Diagram 1 TOP LEFT- It goes to diagram 2 bottom=KEYNES Method and also to Diagram 2 bottom right =AdAs Method.

•

A change in the interest rate leads to a change in investment spending, which in return causes a change in aggregate spending (demand) and consequently total production and income change.

•

The impact a change in the interest rate has on the level of output, will depend on the kind of model that is used. 1. Diagram top left illustrates a change in investment spending due to a change in interest rates.FROM THIS DIAGRAM WE GO TO EITHER ONE OR BOTH OF THE OTHER Following two: 2. In the simple Keynesian model, where prices and wages are given, it has the full multiplier effect; ie {:#@# * ^I = change in Y }( change in (i)- causes change in (I) - causes change in (A) - causes change in (Y) or in words :a change in interest rates causes a..^.in Investment causes a.. ^..Aggregate Spending causes..^.in Aggregate Income/ or Production. 3. In the AD-AS model, where prices and wages are flexible, the multiplier effect is smaller because part of change in production/income is here taken up by a change in Price.Here in Symbols which we must know how to write out: ^ i –(arrow)-^ I--^A-ECS102-8 economics Part2 Yr1

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^ AD--^Y and-- ^P or in words :a change in interest rates causes a ^ in Investment spending AND a ^ in Aggregate spending which both then causes a^ in Aggregate Demand causes a ^ in Both (1) Production / Income and (2)a change in Prices.(split in P or Y depends on Slope of demand curve)

EXEPTIONS TO THE RULE: 1. If investment demand curve(Diag.1 ) is ---vertical,or completely inelastic---then it will not affect the Investment spending or any of the rest at all. 2. If the slope of Demand curve is flatter-more effect will happen to QTY than to PRICE thus a Expansionary policy will have more effect on stimulating economy(not inflation) BUT:Steeper=Contractionary more effective-more Price/(inflation down quick) less QTY/Jobs1left 2left bottom 3right

Monetary and Fiscal Policy in the AdAs Framework. Expansionary and Contractionary Monetary and Fiscal policy. 1. term Demand management:Fiscal +Monetary policy together is called this sometimes. 2. term Neutral Monetary &Fiscal Policy:wher Gov. does none of Expans. or Contractio. Policy. 3. If the slope of Demand curve is flatter-more effect will happen to QTY than to PRICE thus a Expansionary policy will have more effect on stimulating economy(not inflation) BUT:Steeper=Contractionary more effective-more Price/(inflation down quick) less QTY/Jobs-

Monetary and Fiscal Policy lags 1. Four types of delays/lags in Mon. &Fisc. policy are possible: ECS102-8 economics Part2 Yr1

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a. term Recognition lag:Takes time to recognise & measure changes in Economy-eg compileGDP ...Same both Policies b. term Decision lag:Time taken to make decisions by Gov. .. Fiscal(politics/tax/Spending)-LONG ,Monetary(SARBeconomists,meetoften4/yearSHORT c. term The Implemantation lag:Takes time for Gov. to put decision into effect ... ..Fiscal-Long-tax 1ce/year,politics etc,Monetary Short-professionals,eg :repo rate same d. term the Impact lag:=OUTSIDE LAG(inside lag is all other 3)time for effect to show in economy after implementation:Monetary-Long:12-18-24 mnths repo rate full effect lag,Fiscal=Shorter(Eg: Gov. spend) -This is why economists call for more neutral gov. policy+just a balanced budget-the lag can cause the wrong effect to happen (at wrong time)

The relative effectiveness of monetary and fiscal policies: 1. 2. 3. 4. 5.

Both policies should be used together to influence economy. Both policies are important instruments in stabilising demand. Fiscal policy: better to stimulate a depressed economy. Monetary Policy; better to dampen a overheated economy term:Intitutional features:Fiscal=political=more used buoy demand//monetary=Reserve Bank=more conservative

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CHAPTER 9 : INFLATION:

Introduction • •

often described as public enemy no. 1. since ww2-prices of all goods increased alot

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Definition of Inflation: 1. term: INFLATION: A Continuous and Considerable rise in Prices in General. a. 4 Aspects to This Definition of Inflation: i. Neutral Definition:Not state Causes(To stop wrong policies from think only 1cause ii. Continuous /ie :a Process, (not only 1 increase in price but many constant ones) iii. Considerable: if only 1% 0r 2 % per year could mean a quality better incr. etc.-not necessarily inflation-for inflation it must be quite considerable. iv. General/ or average price level increase-not just 1 good(notfrom eg asupply-/demand+)

The Measurement of Inflation: The Consumer Price Index. 12. 13.

14.

15.

Economists are interested in :1-what is happening to prices of goods&services in general-2-inflation-3-info on price movements for nominal&real(ratio to other prices)3-purchasing power TERM INDEX NUMBER:expresses value of some series over given period as % of it's value in a base period.eg the CPI-consumer price index is an INDEX NUMBER. a. Specific Indices :for relative changes:-for only one good-not weighted average of lots -Convert all of different years prices to percentages of one of the years prices ,to compare these %'s to each other ie:price/base price*100/1=% of base price.,thus the answer is egYear B is 127 % of base year A price,BUT an increase of 27% and the new price is 127% of the old price-but increase is only 27%!!!!!!!!NOTE!!!! b. General or Composite Indices :for combine different series:CPI is a composite index where a lot of different indexes are compiled(eg % change in bread price is one in series,% for meat another) and this series of prices are combined AGAIN BY according to a weighted average(how much bread eaten to meat)to get final composite or general index. TERM Purchasing power- first year/last year = eg 0.87= the 'Real' value of or what a certain amount of money can buy.To calculate:The % of the first/base years price over the % of currrent years price .(how much this years go in last years=?70%)EG: 2000=100%=base year,this year 2003 = 115% of that:answer =100%/divided by 115%= 0.87: so to work out a answer you say 0.87 * 5 baskets in 2000 will give purchasing power of 4.35 baskets at current years prices. Price increases ie Inflation erodes the real value or purchasing power of a fixed nominal amount.

16.

TERM CPI Consumer Price Index:=115 % or 120% is an index of the prices of a representative "basket " of consumer goods and services: it thus represents the cost of the shopping basket of goods & services of a typical RSA household.CPI is normally =115% or 132% or so (not 6.2% like inflation:ie the change from one years to the next .)Capital & Intermediate goods excluded.

17.

term Inflation RATE=6% or 9%: If you divide this years CPI by Last years CPI * 100 (the percentage of last years prices).Inflation is allways expressed as an annual rate.You get the inflation rate ie:not 127%-105%----BUT 127% /105% *100=6% or 9% TO construct the CPI ,Stats SA must :

18.

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19. 20. 21. 22.

23.

a. Select the "goods and services" to be included in the "Shopping Basket." : ..To select-Stats SA does survey of household every 5 years. b. TERM Determine Weight of each good/sevice: ..Stats SA does a survey 5 yrly to determine relative importance in Av. Consumers Basket. c. TERM Decide on a BASE YEAR for calculating CPI : ..Base year is year in which the Survey(5 yearly) is done d. Decide on FORMULA for calculating CPI ..Standard price index formula used,Weight of item decides it's effect on CPI, e. Collect prices each month to calculate CPI. A_....RSA 1500 different goods&services,in -1- 40 groups/subgroups,for which a CPI is calculated for each one -2- 5 expenditure groups,pensioners,9 provinces+14 major urban areas.+metro+other urban areas+rural Services =50 % of the CPI B_Prices are collected by questionaire sent to 2200 retailers-110 000 quotations per month and info. double checked.,Prices used are first 7 days of month. CPI available 2nd half of following month. Used to calculate inflation. large base 1500goods means cpi is fairly accurate. PPI=Production price index= prices when leave factory,Imports when enter country,Not services,includes capital & intermediate goods.-when ppi increase cpi follows some months later.-Supposed to be Cost of production.eg Rand depreciatesinported capital goods +intermediate goods increase- ppi increase immediately-Cpi few months later-2002 cpi increase main reason!! Inflation Rate Calc. using :Implicit GDP/or GNE or/GNI deflator:Nominal/real GDP used to calc. inflation.,using prices change themselvesBetter to use GNI or GNE implicit deflator to calc. inflation because they do not exclude imports like gdp.

The Effects of Inflation: 1. There are 3 effects of Inflation: i. term Distribution Effects:Distribution of Income & Wealth amongst various participants in economy.: do not hurt overall performance of economy-only some players,can be counteracted by linking tax /debt/pensions to CPI . 1. Inflation benefits borrowers (debtors) at the expense of lenders (creditors) unless interest rate higher than inflation :Basic Rule is :loss of real value in all amounts loaned by the lender: Because when he gets his money back he does not receive full value of 10 000ie: CPI 1998/CPI 1999 * 10 000 = actual value received, unless if interest rate is more than inflation.(&visa versa.) a. term Real Interest Rate= The difference between nominal interest rate and inflation rate. (negative=less than inflation, + = more than inflation) Between debtors & creditors-if interest rate higher than inflation rate redistribute from borrower to lender,BUT if Interest Rate less than inflation then borrower wins more redistribution.: .............. Redistribution of Income=If interest beats inflationredistribution of income falls away and :Redistribution of wealth happens: wealth is redistributed:ie the repayment of wealth causes borrower to loose. eg:Gov securities,Bonds,some pensions& some insurance policies. ECS102-8 economics Part2 Yr1

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b. People with mortgages are debtors who benefit from inflation because the real values of their loans decreases as prices(inflation) increase. 2. Inflation distributes From elderly to young: because young borrow more and (houses etc.) and elderly have fixed nominal incomes(pension/or interest),so young win from assets bought with borrowing have more value from inflation,and elderly's fixed nominal incomes loose value,so flow-away 3. From to Private Sector to Gov. :Gov. is allways a Net borrower and so inflation benefits Gov.(at expense of holders of public stock. depends on Real interest rate) 4. From Taxpayer to Gov.: a. term Bracket Creep-or The Fiscal Dividend:(from moving to higher tax bracket)taxpayers nominal incomes rise even if real income stay same from inflation,but Gov. gets more More Tax due to PROGRESSIVE income tax system.higher wages so RATE higher b. Economic effects: i. Entrepeneurs/managers get more concerned with inflation than new production opportunities ii. Speculative investment at cost of production investment iii. Reduce Saving-not going to be worth much iv. Balance of Payment problems:exports become more expensive- so less exports-,also import competing industries more expensive....so more imports:To fix this one depreciates the rand,but in RSA mainly capital & intermediate goods imports so production costs will rise.RSA inflation rate must stay in tune with most important trading countries of the worlds inflation rates or Problems like this. c. Social & Political Effects: causes unrest-taxi fares up-difficult keep up with all purchases - groups blame each other-eg Lenin

Hyperinflation-the Greatest Cost of Inflation.  people try to be compensated for higher cost of inflation:want higher wages,rents,"Expectations" cause- producers raise prices to manage to purchase inputs for production,or to benefit from inflation,people rush to buy goods before prices go up-causes higher prices from more demand etc.  DEFLATION:can cause factory close/layoffs –cannot recoup expenses from inputs,farmers also cannot recoup costs,borrowers etc loose-money paid for house etc is double current price etc

The Causes of Inflation: Demand- Pull and Cost-Push inflation. 1. Difficult distinguish between the two-become intertwined in inflation process. 2. Both cannot : a. ignores possible linkages between the Aggregate Demand&Supply b. Only explain price level-not process of inflation.

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Demand-Pull Inflation. 1. When aggregate(macroeconomics)-demand UP but Aggregate supply remains unchanged-prices go up.-'too much money chasing too few goods"-Causes prices to go up. 2. Can be caused by any of components of AGGregate Demand: a. (C)-consumption spending-lower interest rates(cheaper credit) b. (I)investment sending-eg from lower interest rates,or better business sentiment. c. (G)Government spending-eg provide better services to population,or to combat unemployment. d. (X)export earnings- higher earnings cause more spending by earners. 3. MONEY SUPPLY increase :Allways accompanied by increase in money supply.allways related to increases in aggregate demand components. 4. Restrictive Monetary and Fiscal policies by Gov. used to keep Demand-Pull inflation in check.: Can cause Unemployment-decreased Production,decreased,income a. MONETARY:Higher interest rates to make credit more expensive,& reduce availability of credit to various sectors(I)/(C) of the economy.-left Shift+ b. FISCAL:reduce Gov. spending,and /or increase taxation.-cause leftward shift 5. Illustrated by AdAs model.:increase in aggregate demand cause a shift to right of demand curve. Further increases in aggregate demand shift the AD curve to the right, for instance to AD4. At an equilibrium point of E4, the price level is higher but the level of output is still at the level of full employment YF. Increases in aggregate demand beyond the level of full employment can only lead to price increases because prod.cannot increase=Yf (full employment of FOP).

Cost–Push Inflation: IF production costs increasethen Supply Curve Shifts to left from higher prices at each Qty.supplied. c. 'E'quilibrium goes up-Prices UP & Production&Income down.(+unemployment)

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3. Stagflation:Stagnation in: production/income and Inflation from: higher prices. 4. Cost–push inflation caused by: a. Wages increase-(60% of cost of GDP) b. Cost of imported Capital & Intermediate goods (eg Oil,) from currency depr. or price incr c. Increase in Profit margins. d. Decreased productivity. e. Natural Disasters. 5. Measures To take to reduce this: a. CANNOT be Combated by restrictive Fiscal & Monetary policy's. b. incomes policy=to keep wages low

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ECONOMICS part 2 Yr1

ECS102-8 CHAPTER 10 : UNEMPLOYMENT:

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Unemployment: • •

Unemployment & Inflation are referred to as the twin evils of Macro-economics. RSA : 20/30% 94' - 30/40% 2002' -25% 2007 unemployment of Labour force / Economicly active/able Participants.:high & rising unemployment is most serious of RSA social troubles.

The Employment Pool: 1. Stock Concept-Level or Rate of Unemployment is a stock. 2. Flows -People Entering & Leaving the unemployment pool. 3. 4 reasons to enter unemployment pool: a. New entrant still looking for b. leave specially to look for another job-but still searching c. laid off(retrenched till demand picks up) d. firm closes-no hope of re-employment. 4. 3 reasons to exit unemployment pool a. hired b. recalled from a lay-off c. get discouraged and stop looking for work.

Measuring Unemployment. 1. Very difficlt to measure unemployment because of:seasonal/housewives/those not seeking work but able/criminals/hawkers-self-employed etc. ....so different. estimates done can easy differ alot. 2. term Rate of Unemployment=The % of the EAP –Economically Active Population – (those Willing & Able to work or the Workforce/or Labour force)NOT working. 3. Various ways of Obtaining Data on Unemployment. a. Official Census Data : bad side –1-Once per 5 years -2-Lag before publication of data. b. Unemployment Register :bad side :only very few register-ie those collecting UIF. c. Subtract (1) subsistence agriculture (2) informal sector(hawkers) (3) In d. Formally employed FROM: EAP(econ. activ. popul.). e. Statistics S.A. estimate-bad- controversy between strict or expanded definition usage.Went from strict 'pre-94 –to expanded '94 etc.,TODAY publish both of! 4. term Strict Definition of Unemployment : (1)over 15 (2) available 7 days prior interview for Self-employment OR Paid employment. (3) took steps to find /search 4 weeks prior interview for S or P work. 5. term Expanded Definition of Unemployment: OMITS (3) above-ie:only WANT work–not look

The Costs of Unemployment: 1. Two main costs of unemployment are: a. TO Individuals : i. Ill health,hunger,cold death ii. loss of income iii. Confidence& self esteem&shock&frustration,criminality,loss of skills b. TO Costs to Society at large: i. Crime,Unrest,Riots,Demonstrations. ECS102-8 economics Part2 Yr1

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ii. Overthrow Government eg Hitler etc. iii. Opportunity Costs of assisting the unemployed.(loose out public goods & services) iv. Money cost to society of assisting the unemployed. v. Labour Cannot be saved & used later like other FOP. 2. In RSA NOT First world country with Good unemployment benefits-so here very meagre.

Types of Unemployment: 1. Most basic distinction in Types of unemployment: Strictly all is theoretically Involuntary ONLY a. term Voluntary Unemployment..: not want/feel like working b. term Involuntary Unemp....:cannot find work 2. term Economist usually Distinguish between 4 Main types of Unemployment.: a. Frictional Unemployment:Left one job to find another one –but still looking +New Entrants to job market also included here.:not serious-allways will have some b. Seasonal:Eg: Fruit pickers are out of work in off-season for fruit. c. Cyclical(or demand deficiency) Unemp....: Laid off-(retrenched -till demand picks up again,then can get re-employed.) d. Structural: serious because cannot be remedied by simply increasing Aggr. demand-needs retraining or relocation to where skills in demand i. Structural decline in industries: eg:RSA Gold mining less of. ii. Lack of skills/education(even if econ. booming-no find job!) iii. Technologically unemployed.iv. Changing Consumer preferences- no more production/jobs for that stuff. v. Foreign competition:eg textiles china vi. Discrimination :eg for whites/not blacks

Policies to Reduce Unemployment. 1. Must be tackled from Both Supply & Demand side. 2. In RSA last 2 decades unemployment from both Supply-350000 new entrants/Yr, and Demand-stagnating & declining economy.,&capital goods-labour relative cost(labour up). 3. Causes of unemployment: a. supply sidei. Population growth ii. Immigration iii. Oversupply of unskilled labour /Shortage of skills b. demand side i. as with forms of. 4. Policies to reduce unemployment: a. SUPPLY SIDE: i. Less people : Reduce population growth ii. Less people : Stricter immigration control iii. Reduce oversupply of unskilled labour by teaching them skills. b. DEMAND SIDE: i. raise aggregate demand for goods & services by: 1. Raise G: a. if this is financed by BORROWING :will RAISE interest rates& negate the effect (i up! =wrong) ECS102-8 economics Part2 Yr1

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ii. iii. iv. v. vi. vii. viii.

b. if financed by TAXES: will negate effect =less Iinvestment c. If financed by increasing money supply-can cause inflation 2. Lower : i -INTEREST RATE & TAXES =limited because will cause Inflation & Balance of payment problems. 3. Raise EXPORTSa. by decrease production costs b. maintain realistic exchange rate 4. (also can raise ,I,C or raise 'Net' Exports or raise C bar) LABOUR INTENSIVE ENTERPRISES: make production more: 1. actually promote these types of production. Promote small business & informal sector(claimed more labour intensive than large enterprises) Create gov. employment programs:eg :build dams(very temporary) Subsidies & Tax benefits. Keep relative price of labour low to capital goods(-interest FOP)machines Keep strikes less Labour legislation relax-more employer friendly

Unemployment in the Keynesian & AD-AS Models. 1. Both graphs assume that Level of Production IS positively related to Employment . 2. Law of Diminishing Returns:can cause increase in production to only help to a point in unemployment –because as employment increases so production increases ,but at a diminishing rate,until it goes backwards. 3. Slope of production function is = marginal product of labour =thus declines as employment increases. a. Why production increase (Y!!) (!! ie:called Economic Growth here too !!) alone is a neccessary but insufficient condition for reducing unemplmnt.: Structural and Frictional & Seasonal lags cannot be done away with by increasing prod. i. Frictional unemployment ii. seasonal unemployment iii. new entrants: to market may be too many -be more than the rate of incr. in Prod. iv. Skills- if workers Not have needed skills may still unemploy even in economic growth. v. Capital goods/Technology type increase in production increase emplmnt. For GRAPH BELOW:Yf= production/income at FULL EMPLOYMENT Nf= employment at FULL EMPLOYMENT the curve of the production function shows the law of diminishing returns: the rate . of increasing returns from more people employed will slowly decrease as more are . ... employed.

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If an increase in in the level of output from Y1 to Y2 is accompanied by an increase in capital intensive production methods the following occurs: The production function shifts upwards. At each level of output less labour is required than before. To produce a level of output of Y2, N1 number of workers are required and the level of unemployment is unchanged. In this case jobless growth has occurred.

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CHAPTER 11 : Economic Growth:

Introduction: Economic development is a separate subdiscipline in economics apart from economic growth. ,whereas for years it was seen as the same thing by economists.

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Definition and Measurement of Economic Growth. 24. 1. 2. 3. 4.

term : Definition of Economic Growth: Economic Growth:annual rate of increase in aggregate production & income in the economy.,to be qualified in real terms and per capita terms. MUST :Real and not nominal GDP ... . /production/income should be used and PREFERABLY: be expressed on a per capita scale . to distinguish it from population growth ,but latter is not allways done. Real GNI is also used as a measure of economic growth,is better if big swings in terms of trade are occuring at the time ,since it is adjusted for terms of trade by national accountants. GDP best to measure domestic production output itself. ps-tricky question:(4 types could be :Real -1-gdp+ -2-gni and per capita real -3-gdp+4-gni)

Some problems associated with GDP as measure of economic growth: 1. Jokingly called 'grossly deceptive product' or 'grossly distorted picture'-due to: 2. The problems associated with GDP include the following: a. Non-Market Production : i. Eg:farmers consumption of own produce. ii. government output:cannot valued at market prices ,but at cost prices-eg wage empl b. Unrecorded Activity i. informal sector/,shadow economy/,underground sector/, ii. include crimnal-smuggle,drug,prostitution,Also tax evasion.,Also unlicenced Hawkers iii. Rough estimates are however included since 1994 in GDP c. Data revisions i. Frustrating to analysts:figures are often revised as new & better data becomes available-GDP figure can change d. Economic welfare: i. GDP :Not good measures of economic welfare:negative externalities :eg:pollution,noise,congestion., ii. Also R1 Mil spent on military orR1mil spent on health not equatable. iii. Allowance Depletion scarce Natural Resources. iv. Quality of goods not stated. v. Distribution of income per capita could be uneven-even if average higheg:kuwaitoil 1. ( separate point :M.E.W.-measure of economic welfare-gdp is irregulary & periodicly adjusted in some countries to portray the MEW,but not in RSA.)

Calculating Economic Growth: 1. ANNUAL BASIS. 2. Calculation : eg 1,8 ,3% 3. EG:for 2003- is shown as a percentage increase from the 2002 price eg :5% a. 2003 –:ie,% by how much % 2003 is more than %2002. i. FirstBoth years data convert to 2002 prices ie:REAL GDP/GNI ii. Second- (2003-2002 ) / 2002 * 100/1 = %change from 2002 prices=Economic Growth Measure 4. ECS102-8 economics Part2 Yr1

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The Business cycle: • • •

The long term trend in economic activity ,(albeit growth or level) is broken up by short term swings up & down called: upswings(expansion)(booms) and downswings(contraction)(recession) . A business cycle has 4 'elements': trough,upswing,peak,downswing, A business cycle always starts on a trough And nds on a trough.

Sources of Economic Growth: 1. Note:supply factors= FOP ,while demand factors=components of aggregate spending: 2. Supply-increase prod.capacity /Demand-increase demand for goods&services -aggregate spending capacity.

Supply Factors: a. increase in quantity &/or quality of fop. b. NATURAL RESOURCES:Can :-1-Explore for gold or 2- if Depletion use other FOPmanufacture(entrepeneur+labour etc.)/ or render services(labour) c. LABOUR: Influenced by: i. Human capital-quality ie: Training/Skills +Health+Hygine +Nutrition +Attitude. ii. Size-net migration rate AND births / OR -could increase working hours-. d. CAPITAL: i. Economic Growth :Depends on Quantity &Quality of countries capital – eg:machinary,buildings,roads,dams.(also -1-finance & -2-in RSA foreign exchange) ii. Quantity :Increase in the capital stock may take form of either: 1. CAPITAL WIDENING: ECS102-8 economics Part2 Yr1

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a. Average capital /worker stays same- more capital because more workers. 2. CAPITAL DEEPENING: a. Average capital/worker increases –increase in 'capital intensive' (intensity of ) production- more capital used for every worker. iii. Quality : must have technology to compete imports-also need skilled labour:INTERDEPENDANCE of: labour,capital,technology.(technology=5th FOP). e. ENTREPENEURSHIP : i. Gov. can act as one in beginning stages if shortage of them. ii. Also unneccesary rules & regulations to stifle growth remove.

Demand Factors: 1. Increase in Supply NOT sufficient for growth-ther must also be an increase in DEMAND. 2. HOWEVER : ANY increase in domestic AGGREGATE DEMAND SHOULD also BE ACCOMPANIED by an increase in AGGREGATE SUPPLY or it could cause inflation (just higher prices from demand –no big supply increase) AND Balance of Payments problems (from INCREASED IMPORTS) 3. INWARD INDUSTRIALISATION : this is a strategy for economic growth which focuses on domestic demand eg:demand for electricityr & houses :In RSA this type growth policy was used where urbanisation by rural poor is seen as catalyst to -1- increasing demand by redistributing income to them (then spend more),-2-in turn demanding more gov. services & demand for goods-but must also add the supply side to this policy or causes above-inflation& balance payment problems. 4. Economic Growth( in DOMESTIC ECONOMY) is Caused by :individual parts of aggregate demand. a. C:Consumption. i. :is primarily a function of INCOME b. G:Government : i. determined by Gov. Policy. c. I:investment : i. is primarily a function of expected profitability of investment projects and therefore also interest rates.(remember multiplier) to supply all this investment demand. d. E: increase exports i. –-1-favourable slightly undervalued exchange rate -2-keep production costs down -3- stimulate exports by subsidies -4- gov assist with marketing&finance&other for exporters. e. Less of Z: Import substitution. i. Decrease imports by producing them locally: ii. METHODS :BY import tariffs/quotas protect local producers in the initial stages iii. DRAWBACKS: 1. Over –Protection,not withdrawn timely enough, can cause inefficient /uncompetative local producers. 2. Firms can Overfocus on local market & do not develop exports & become internationaly competative. 3. Level of imports could stay same and composition could just change-from dependant on consumer goods to dependant on capital goods.-eg:RSA. ECS102-8 economics Part2 Yr1

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PRINT FROM PAGE 88- 97 Must re-print all multipliers/indexes etc after 'contents/index section' And diagrams file in study week. Do a search in study guide & also own notes for above words:multiplier & index .

ECS102-8 economics Part2 Yr1

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