Ecos StudyGuide1 Unisa

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2010 University of South Africa

All rights reserved

Printed and distributed by the

University of South AfricaMuckleneuk, Pretoria

Compiled by the Department of Economics

ECS1601/1/2011-2013

InDesign,

98627082

Although every effort has been made to trace the copyright holders, this has not always been possible. Should

any infringement have occurred, the publisher apologises and undertakes to amend the omission in the event of a

reprint.


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ECS1601/1/20102012 iii

Page

INTRODUCTION vii

STUDY UNIT 1 3

Interdependence of the major sectors, markets and flows in a mixed

economy 5

STUDY UNIT 2 15

The monetary sector 17

STUDY UNIT 3 31

The public sector 33

STUDY UNIT 4 47

The foreign sector 49

STUDY UNIT 5 61

Measuring the performance of the economy 63

STUDY UNIT 6 77

Income determination in a simple Keynesian macroeconomic model 79

STUDY UNIT 7 103

Keynesian models including the government and the foreign sector 105

STUDY UNIT 8 129

More on macroeconomic theory and policy 131

STUDY UNIT 9 143

Inflation 145

STUDY UNIT 10 155

Unemployment and the Phillips curve 157

STUDY UNIT 11 165

Economic growth 167

SELF-EVALUATION EXERCISES 177

SOLUTIONS TO SELF-EVALUATION EXERCISES 182

GLOSSARY 185

CONTENTS


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iv Economics 1B


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BANK

In this introduction we would like to explain the

purpose of the module. Information on the

prescribed book is given and we tell you how the

study guide is structured and how it should be used.

HOUSEHOLDS

FOREIGN SECTORGOVERNMENT

FIRMS

FINANCIAL SECTOR

INTRODUCTION

1. The purpose of the module

2. Module outcomes

3. Critical cross field outcomes

4. The prescribed book

5. The study guide

6. How to use the study guide

7. Important verbs

8. Using diagrams


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Welcome to the second part of your introduction to economics. We hope that you will

find this module mentally stimulating and worthwhile.

The purpose of the module is to gain insight into macroeconomic theory and variables

such as total production and income of a country, economic growth, unemployment,

inflation, and the balance of payments.

After you have studied this module, you should be able to:

explain the functioning of the economy as a whole assess the performance of the economy

As a student enrolled for a tertiary qualification, you will be exposed to a formative

learning experience that should not only educate you in the chosen discipline but also

form your character.

The formative nature of the qualification is described in the critical cross-field outcomes

that all tertiary qualifications aim to achieve. Critical cross-field outcomes refer to broadgeneric outcomes encompassing various areas, which all qualifications and standards

should aim to promote.

After you have completed this tertiary qualification, you should be able to:

identify and solve problems in such a way that you display responsible decision

making using critical and creative thinking

work effectively with others as a member of a team, group, organisation or com-

munity

organise and manage yourself and your activities responsibly and effectively

collect, analyse, organise and critically evaluate information

communicate effectively using visual, mathematical and/or language skills in the

modes of oral and/or written persuasion

use science and technology effectively and critically, showing responsibility

towards the environment and health of others

demonstrate an understanding of the world as a set of related systems by

recognising that problem solving does not happen in isolation

In order to contribute to your full personal development as a student (and to that of

every other student) as well as the social and economic development of society as a

INTRODUCTION

PURPOSE OF THE MODULE

MODULE OUTCOMES

CRITICAL CROSS-FIELD OUTCOMES


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viii Economics 1B

whole, any programme of learning should have the underlying intention of making an

individual aware of the importance of:

reflecting on and exploring a variety of strategies to learn more effectively

participating as responsible citizens in the life of local, national and global

communities

being culturally and aesthetically sensitive across a range of social contexts

exploring education and career opportunities

developing entrepreneurial opportunities

The following book is prescribed for this module:

The main requirements for the study of economics are a willingness to think and an

active approach to learning. Economics is not a subject that can simply be memorised

it has to be understood. This means that you will always have to think about what you

are studying and that you must try to understandthe work. The solution is to study

actively. Use a pen and paper to work out each argument by drawing diagrams, doing

calculations, and writing down the logic of the argument. It is not sufficient simply to

read the prescribed book and underline or highlight the key concepts.

Do not skip any of the chapters prescribed. These chapters follow a logical pattern. If

you skip some chapters, you will not be able to follow or understand the reasoning in

the study guide as a whole.

The study guide has been designed in such a way as to guide you through the prescribed

book in a systematic and informative way and to help you get to know the economists

analytical toolkit. Therefore, you cannot study the prescribed book without consulting

the study guide. We have tried as far as possible not to duplicate any of the prescribed

book material in the study guide.

You will be required to study only some parts of the prescribed book. The prescribed

sections are clearly indicated in this study guide. Those sections of the prescribed book,

which are not referred to in this study guide, do not form part of the prescribed material.

We will provide you with some guiding remarks or activities (questions) to ensure thatyou have grasped the content of the passages you have read. We may also provide you

with additional material or explanations.

Mohr, P, Fourie, L & Associates. 2004. Economics for South African students. 3rd

edition. Pretoria: Van Schaik.

or

Mohr, P, Fourie, L & Associates. 2008. Economics for South African students. 4th

edition. Pretoria: Van Schaik.

THE PRESCRIBED BOOK

THE STUDY GUIDE


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ECS1601/1 ix

The study guide has three basic functions:

It outlines the contents of the module, in other words, it indicates which parts of

the prescribed book are compulsory for the examination.

It indicates how you should approach each chapter and shows the most important

topics and diagrams (figures) you have to master.

It provides a series of questions you must answer to assess your progress and to

prepare for the examination.

The study guide is divided into 11 study unitsthat cover the compulsory chapters of

the prescribed book.

Each study unit comprises the following sections:

Economics in action

In this section, we indicate how economics influences our everyday lives. Under this

heading, we introduce you to relevant issues in our field of study as we encounter themin newspapers, in discussions on the bus or in the taxi, or in debates with friends, for

example, on the latest change in the petrol price. The idea of this section is therefore to

stimulate some critical and creative thinking! In this way, you should try to contextualise

the topic(s) covered in the study unit. Sometimes this section may present you with a

clear problem statement of the topic under consideration. It concludes with a number of

outcomes you should have mastered after you have studied the study unit.

Contents

The contents section guides you through the study material. Each subsection has a

heading and study instruction. If the study instruction tells you to study a section, youneed to make sure that you know the particular section well because your knowledge and

understanding of the topic covered in the subsection will be tested in the examination.

Some of us learn by memorising definitions or formulas. However, only by actually doing

something, you will realise that you candescribe or define it! Therefore, after each

section or subsection we will introduce you to activities to help you practise your newly

acquired knowledge, skills and values. At the end of each study unit we will provide

answers to some of the questions (marked with an asterisk*) to guide you to the most

appropriate answer.

To be successful in economics, it is essential that you take responsibility for your learningand practise your newly acquired skills.

Economics in action (looking back)

In this section, we refer you back to the introductory or Economics in action section.

We want to find out whether your views on the topic under consideration have changed

now that you have studied the prescribed material.

Further reading

If you want more information on the topic dealt with in the study unit, you can consult

the further reading material. This section does not form part of the prescribed studymaterial.


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x Economics 1B

Solutions

Take care to work through the solutions. You should then get an idea of whether you

have mastered the particular sections.

Checklist

The checklist is based on the study unit outcomes listed in the study guide. In otherwords, it indicates the things you should be able to do. The outcomes are divided into

different categories: Concepts, Explanations, Diagrams and Calculations. These should

give you a good indication of the kind of questions you can expect from each study unit.

Next to the items in the checklist are a number of check boxes: Well, Satisfactory,

Must redo and Need help. If you think you are able to do something really well,

for instance, explaining the monetary transmission mechanism, mark the Well box. If

you think you are able to explain it but are unsure about certain aspects or find it a bit

difficult, mark Satisfactory. If you are a bit lost but know something about the topic

and will benefit from spending more time on it, mark Must redo. If you really do not

know what is going on, mark the Need help box. In so doing you will get an indication

of what you know well, what you are coping with, on which of the sections you need

to spend more time, and with what you need help. Do not hesitate to contact one of

the lecturers should you need help. See Tutorial Letter 101 for the contact details of the

lecturers. (Do not leave this until the evening before the examination.)

We suggest the following steps in using the study guide:

Before starting to work on a study unit, first find and mark all the compulsory

material in your prescribed book, as indicated in the different sections on that

study unit.

Read the outcomes stated in the introductory Economics in action.

Read and/or study the introductory remarks and explanations about the prescribed

section in the study guide.

Study the compulsory section in the prescribed book.

Do the activities at the end of each section.

Once you have studied a section, return to the study guide and repeat the process

by progressing to the next prescribed section. Follow this procedure until you

reach the section Economics in action (looking back).

Complete the checklist. Repeat the activities where necessary or contact your

lecturer(s) if you need help.

Repeat the procedure for each of the other study units.

HOW TO USE THE STUDY GUIDE


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ECS1601/1 xi

As a student you should know exactly what is expected when certain verbs are

mentioned in an activity or examination question. The verbs generally used in economics

are as follows:

Verb Description

compare Identify the similarities or differences between facts, viewpoints,

concepts or ideas

contrast/distin-

guish/what is

the difference

be-tween?

Point out the differences between certain objects or concepts

define Give a short and concise description of a subject or topic

describe Name the characteristics of an object or topic

discuss Discuss a topic by examining its various aspects

explain Explain and clarify to ensure that the reader clearly understands

you

explain with the

aid of (a) dia-

gram(s)

Draw a fully annotated diagram. Make sure all the axes and

curves are labelled. Then explain the diagram in such a manner

that the reader can follow and understand it, in other words, tell

the reader what is happening in the diagram

give/ident ify/list/

name

Give only the facts without any discussion

illustrate (Usually) explain your answer with the aid of a diagram (or figure)

summarise State the main points in a brief account

To be able to use a diagram (or figure) correctly, you must learn to read, to draw and to

explain a diagram:

Read: This means you have to understand the determinants (or factors) of each curve

and how they affect the specific curve.

Draw: Each diagram, and all its axes and curves, must be labelled. The initial point

of equilibrium must be indicated. If it changes, this must also be noted on the

diagram.

Explain: You should be able to explain the diagram in words.

IMPORTANT VERBS

USING DIAGRAMS


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xii Economics 1B

Module outcomes Study unit

Outcome 1:

Explain the functioning of the

economy as a whole

1: Interdependence of the major sectors,

markets and flows in a mixed economy

2: The monetary sector

6: Income determination in a simple Key-

nesian macroeconomic model

7: Keynesian models including the govern-

ment and the foreign sector

8: More on macroeconomic theory and

policy

3: The public sector

4: The foreign sector

Outcome 2:

Assess the performance of the

economy

9: Inflation

5: Measuring the performance of the

economy

10: Unemployment and the Phillips curve

11: Economic growth

LAYOUT OF THE MODULE


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In this part of the module we sketch a complete

picture of the circular flow of income and spending in

the economy.

HOUSEHOLDS

FOREIGN SECTORGOVERNMENT

FIRMS

FINANCIAL SECTOR

PART 1The macroeconomic environment

Study unit 1:

Interdependence of the major sectors, markets

and flows in a mixed economy

Study unit 2:

The monetary sector

Study unit 3:

The public sector

Study unit 4:

The foreign sector

Study unit 5:

BANKBANK


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STUDY UNIT 1

The macroeconomic

environment

Outcome 1: Explain

the functioning of the

economy as a whole

Interdependence of the

major sectors, markets

and flows

The monetary sector

The public sector

The foreign sector

Measuring the

performance of the

economy

Production, income and

spending

Interdependence of

households and firms

Introducing the

government

Introducing the foreign

sector

Introducing the financial

sector

Total production,

income and spending


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4 Economics 1B


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Read the following newspaper excerpt:

Optimism and hard factsTo complement enthusiasm over next years soccer World Cup, 2010 hasbeen branded a year of economic recovery. Economists and politicians havehigh expectations that SA and the world will recover from the effects of thefinancial crisis that tipped the world into a frightening recession.

Local optimism is more evident than it has been for months, even years, andhas received a boost from improved manufacturing output figures. Retail salesfigures, which disappointed in October, are also closer to stabilisation. ReserveBank data out last week showed that the current account deficit dropped to3,2% of GDP, from 3,4% previously.

But this year has been characterised by rising unemployment, low importsand exports, and contracting economic activity and none of that will changequickly. There are also concerns about inherent weaknesses in the state of

the economy.

Business Unity SA (Busa) deputy CEO Raymond Parsons says 2010 will stillbe a challenging year for business. Though there are clear signs of a recovery,

there are time lags, so when the actual turning point will occur is uncertain.

Busa has raised concerns that Eskoms 35% electricity tariff increase applicationwill be a setback for recovery in 2010. The economy could do without thisshock, says Parsons. Eskoms application could be modified beyond whatit has already been, and we may see this as the application process unfolds.

Another concern is the Reserve Banks figures on gross fixed capital formation,a measure of investment, which has dropped by 4,1%, after a 0,9% declinein the second quarter. That is the sharpest fall since the second quarter of1999, when it dived 15%, and comes in spite of governments extensiveinfrastructure programme. Investment activity partly linked to the soccer

World Cup has been a significant buoy for the economy during the recession.

The dip is largely a result of halted or postponed private-sector investment,which fell 14,1%. But of equal concern is the slower investment by state-owned enterprises. Eskom, for example, has had to postpone some of itsextensive capex spending because of expected financial constraints.

The construction sector has felt the pinch. Group Five CEO Mike Upton says:Government has displayed its commitment to infrastructure, even if thatmeans it has to increase its debt. But we havent seen that increase translateinto new contracts yet.

The lag in activity puts severe pressure on jobs.

ECONOMICS IN ACTION


major sectors, markets and

flows in the mixed economy


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It has been said, In economics, everything is related to everything else, often in more

than one way. But what does it mean? The newspaper article above gives us pointers

to the complexity and interrelationships that exist in the economy.

In this study unit, we use circular flow models to introduce the different participants inthe economy. The major flows in the economy and the high degree of interdependence

form the basis of our understanding of macroeconomics.

After you have worked through this study unit, you should be able to

identify the three major flows in the economy

distinguish between a flow and a stock

explain the interdependence of households and firms

explain the interaction of households and firms by means of the circular flow ofgoods and services and the circular flow of income and spending

identify the various economic participants

identify the various injections into and leakages from the circular flow of income

and spending

explain the interaction of the different sectors in the economy by means of the

circular flow of income and spending

There are other inhibiting factors. The strong rand has affected SAs manu-facturing sector, particularly exports. It has also hit the bottom lines of SAcompanies with international operations. Debates about government orReserve Bank intervention to stabilise the volatile currency rage on.

Looking beyond the recession, Parsons makes a valuable point. In 2007, theeconomy was already heading for a soft landing. The global crisis converted

that dip into a hard landing.He says the constraints on growth that led to 2007s economic easing

whether derived from macroeconomics, industrial development, labourmarkets or trade policy still exist today.

Labour-absorption strategies, for example, have still not been implemented tocurb SAs high unemployment rate. The need to boost manufactured exports,

which grew as little as 2,7% even when the rand was weak, has also beenemphasised. And growing rates of savings and investment should also be highon the agenda.

For stronger and sustainable growth, SA has to re-examine its strategies tosort out these weaknesses.

They are the same constraints that were identified almost three years agoby the Harvard group of economists, the OECD and the Commission onGrowth & Development, headed by Michael Spence, says Parsons. Until theseinherent weaknesses are addressed, he believes SAs economy will continue

to grow at far less than its potential. By Razina Munshi. Published on the webby Business Dayon December 18, 2009.


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1.1 Production, income and spending

The three basic macroeconomic flows are introduced in this section. The magnitudes of

these flows are discussed in study unit 2 under the heading Three methods to calculate

the GDP. The three methods to measure the GDP (spending, income and production)

actually involve measuring the same flow, but they are calculated at different points in

the circular flow. You should know what the difference between a stock and a flow is.

Indicate whether the following statements are true(T) orfalse(F):

Note: Answers are provided at the end of this study unit.

T F(1) The three major flows in the economy as a whole are total

production, total income and total spending.

(2) The two basic sets of participants in any economy are house-

holds and firms.

(3) Production is a stock and income is a flow.

(4) The balance on your savings account on a particular day is a

stock variable.

(5) Consumption is a flow variable.

(6) Investment is a stock variable.

(7) Capital is a stock variable.

Short questions

(a) What is the difference between production and income? (4)

(b) Name the three major flows in the economy as a whole and explain how they are

related. (6)

(c) What is the difference between a stock variable and a flow variable? Give oneexample of each. (4)

CONTENTS

STUDY

Section 3.1 of the prescribed book

Box 3-1 of the prescribed book

ACTIVITY 1.1


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8 Economics 1B

1.2 Interdependence of households and firms

Study this section to ensure that you know how households and firms, the two basic

sectors in a market economy, are interrelated the circular flow of goods and services

and the circular flow of income and spending.

ACTIVITY 1.2



T F

(1) Members of households are called consumers.

(2) Consumers are rational, in other words, they will always

try to maximise their satisfaction given the means at their

disposal.

(3) Households are responsible for the spending on consumer

goods.

(4) Capital goods are purchased by firms.

(5) Firms are mainly involved in consumption while households

are mainly involved in production.

(6) There are two sets of markets in the economy: goods mar-

kets (for example, the market for tomatoes) and factor mar-

kets (for example, the labour market).

(7) Firms purchase in the factor markets and sell in the goods

markets.

(8) Households sell in the factor markets and purchase in the

goods markets.

Short questions

(a) What are the two basic sets of markets in the economy? (4)

(b) Explain the goods and services circular flow by means of a figure. (4)

(c) Explain the income and spending circular flow by means of a figure. (4)

STUDY


ACTIVITY 1.2


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1.3 Introducing the government

This section introduces you to the government. Make sure that you know what the

government sector entails and how it is related to households and firms. Note that

government spending is an injection into the circular flow of income and spending, while

taxes are a withdrawal from it.



T F

(1) The major flows associated with government are government

spending, taxes and transfer payments.

(2) Taxes are a leakage (or withdrawal) from the circular flow of

income and spending.

(3) Government spending is an injection into the circular flow of

income.

Short question

(a) Illustrate the linkages between government, households and firms using the

circular flow model of income and spending. (6)

1.4 Introducing the foreign sector

In this section, the foreign sector is added to the model, which means that exports and

imports have to be included too. It is important to note that exports are an injection

into the circular flow of income and spending, while imports are a withdrawal from it.

STUDY


STUDY


ACTIVITY 1.3


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10 Economics 1B



T F

(1) An open economy is an economy in which no government

intervention exists.

(2) The foreign sector is linked to the domestic flow of income

and spending through imports and exports.

(3) Exports are a leakage (or withdrawal) from the circular flow

of income and spending.

(4) Imports are an injection into the circular flow of income.

Short question

(a) Illustrate the linkages between the foreign sector and government, households

and firms using the circular flow model of income and spending. (8)

1.5 Introducing the financial sector

The last sector to be added to our circular flow model is the financial sector, which

serves as a link between those who save and those who require finance for investment

spending.

ACTIVIY 1.5



T F

(1) Investment is a leakage (or withdrawal) from the circular

flow of income and spending.

(2) Saving is an injection into the circular flow of income.

ACTIVITY 1.4

ACTIVITY 1.5

STUDY



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Short question

(a) Illustrate how the financial sector fits into the circular flow of income and

spending. (10)

1.6 Total production, income and spending: A summary

This section summarises the components of total spending in the economy. Make sure

that you know what the symbols C, I, X, G, Z, Tand Srepresent.

(a) List

(i) three important injections into the basic circular flow of income and

spending

(ii) three important leakages or withdrawals from this flow (6)

(b) List the components of the total spending on goods and services produced in the

economy and summarise them by using an equation. (6)

Now that you have worked through this study unit and have gained a better understanding

of how the macroeconomy can be simplified with the aid of a circular flow model, has

your picture changed of how the different sectors in the economy interact?

As stated in the introduction to this study guide, this section is not for examination

purposes.

Read the following newspaper excerpt. Do you think the advisers take too narrow a

view of the different interrelationships in the economy?

ACTIVITY 1.6

STUDY


ECONOMICS IN ACTION

(LOOKING BACK)

FURTHER READING


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12 Economics 1B

ACTIVITY 1.1

TRUE/FALSE STATEMENTS

(1) T

(2) T

(3) F

(4) T(5) T

Readers tips to Pravin

Fin24.com readers were quick to respond to the treasurys Budget tipsinvitation, dishing out suggestions on how incentives may work towardssolving national issues.

Eskoms power supply woes were on numerous readers minds, includingMohamed Loonat, who said the power utilitys rebate system for solar geyseris ineffective.

Why not make it mandatory for short-term insurers to replace all geysersas and when they burst with solar geysers of an acceptable quality? askedLoonat. That way, Eskom saves money being paid out of its finances, and thesolar geyser roll-out is done on a mass scale, in an orderly fashion and withminimal red tape or delays.

It also means no additional cost to customers, and the insurance companybears the cost it would have anyway for replacing the burst geysers.

Hermann Botha, claiming to speak for retired individuals, said governmentshould do more to encourage working South Africans to save.

Please increase the [tax] limit which a person can deduct for makinginvestments. The [low] interest rate is hitting our pockets badly and we needhelp. I am sure this is also one way to encourage people to save.

Similarly, a reader said tax deductions on savings aimed at education costsshould be tax deductable.

I think that if this were the case there would be a big drive by parents toinvest in their childrens education, the reader said. This will lessen theburden on government and ensure that our children do not get into debt

traps via student loans even before they have started their working careers.

Ashraf Khan had the following suggestion for ensuring the stadiums are fullduring the 2010 Fifa World Cup: Good day Pravin, greetings from Doha. Can

you please issue a ruling that all money paid for World Cup tickets will be taxdeductible? he asked.

Charlie Nicolls said government can save a lot of money by cutting onduplication. For example, he said having to fork out on provincial governmentsis unnecessary. Surely the simpler route is to have a national government thathas its ear close to what the public want, he said. Why do we need all thisduplication and enormous cost?

Finance Minister Pravin Gordhan will deliver the National Budget in parliamenton Wednesday. By Nicole Rego. Published on the web by Fin24.com onFebruary 16, 2010.

SOLUTIONS


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(6) F

(7) T

ACTIVITY 1.2


(1) T(2) T

(3) T

(4) T

(5) F

(6) T

(7) T

(8) T

ACTIVITY 1.3


(1) T

(2) T

(3) T

ACTIVITY 1.4


(1) F

(2) T

(3) F(4) F

ACTIVITY 1.5


(1) F

(2) F


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14 Economics 1B

Well Satis-

factory

Must

redo

Need

help

Concepts

I am able to

identify the three major flows in the

economy

distinguish between a flow and a

stock

identify the two basic sets of markets

in the economy

identify the various economic partici-

pants/list the components of total

spending

identify the various injections into

and leakages from the circular flow

of income and spending

Diagrams

I am able to show the following

with the aid of a diagram

the interaction of households and

firms by means of the circular flow of

goods and services and the circular

flow of income and spending

figures 3-2 and 3-3

the interaction of the different

sectors in the economy by means

of the circular flow of income and

spending figures 3-4 to 3-7

CHECKLIST


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ECS1601/1/20112013 15

STUDY UNIT 2

The macroeconomic

environment

Outcome 1: Explain


economy as a whole



and flows

The monetary sector

The public sector

The foreign sector

Measuring the

performance of the

economy

Functions of money

Different kinds of

money

Money in South Africa

Financial intermediaries

The South African

Reserve Bank

The supply of money

The demand for money

Equilibrium in the

money market

Instruments of

monetary policy


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Inflation figures add weight to case for further rate cut

Further job losses in the third quarter and news that inflation remained safely

below the Reserve Banks 3 percent to 6 percent target range for the secondmonth in a row have strengthened the case for a rate cut.

However, despite the two sets of data released on Tuesday by Statistics SA,the market is not expecting a further cut in the repo rate when the banksmonetary policy committee meets next month.

Forward rate agreements contracts which run for three months starting atsome point in the future show market players see little chance of any changein the repo rate from 7 percent in the first half of next year, according to IanCruickshanks, Nedbank Capitals head of strategic research.

The bank cut its repo rate by 5 percentage points over the past year, restoringit to the level it was at before the series of rate hikes began in June 2006.

New bank governor Gill Marcus left the repo rate unchanged last month andeconomists are divided on whether there should be another cut.

Azar Jammine, the chief economist at Econometrix, and Annabel Bishop, theInvestec group economist, argued that a high base effect in coming monthswould push inflation back through the ceiling for some time.

Bishop said: The situation will be exacerbated when Eskom institutes its stillhefty tariff hike in the middle of next year, should the 35 percent be approved.

On the need to stimulate growth, she argued that the global recoveryseemingly under way should drive growth with the demand side and jobcreation lagging.

But Brait economist Colen Garrow said the bank should look through thenoise, including the price spikes which are likely to occur during the 2010World Cup, and cut rates again to stimulate growth.

He said: There will be a lot of pressure on policymakers next year to dothings differently. He was referring to demands from Cosatu to extend thebanks mandate to include economic growth, rather than its single mandateto preserve the rands value by targeting inflation. The union federation hascalled for the repo rate to be cut as low as 3 percent.

Though they disagree on the need for a further rate cut, both Jammine andGarrow argue that the target range should be raised temporarily to 7 percent,to allow for the impact of Eskoms electricity price hikes. The utility has askedfor a 35 percent hike in each of the next three years. Bishop supports this

view.

ECONOMICS IN ACTION

The monetary sector


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18 Economics 1B

A rate cut? The repo rate? Monetary policy? Yes, the time has arrived to have a closer

look at the financial sector.


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

2.1 Functions of money

We start our investigation of the monetary sector with a closer look at money. Study the

functions of money in detail.



But Cruickshanks argued against the option, which would put the ceiling atmore than twice the inflation rate expected in major trading partner countries.And he said that to change the target would compromise its credibility.

Meanwhile, the strong rand still has a benign effect on the inflation outlook.Bishop said: Its trade-weighted strength has contributed to the inflationtarget being attained.

She predicts the rand will average R7.20 a dollar in the first quarter of nextyear, from R7.40 this quarter, which will push the consumer price index backwithin target in March.

Ironically there is pressure from Cosatu and others to weaken the currency,a measure which would stoke inflation and reduce the scope for relaxingmonetary policy. By Ethel Hazelhurst. Published on the web by BusinessReport on December 16, 2009.

CONTENTS

STUDY


ACTIVITY 2.1


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T F

(1) An economy in which goods are traded for other goods is

called a barter economy.

(2) The use of money eliminates the need for a double coin-

cidence of wants associated with a barter economy.

(3) The essential function of money is that it serves as a medium

of exchange (or means of payment).

(4) When inflation is experienced, money loses some of its use-

fulness as a store of value.

(5) Individuals can hold their wealth in the form of money only,

in other words money is the only possible store of value.

(6) Money is a financial asset.

(7) During inflation it is often more advantageous to keep

certain assets other than only money.

(8) Wealthy people generally keep most of their assets in the

form of money.

Short questions

(a) What is the difference between a monetary economy and a barter economy?

(2)

(b) List the three basic functions of money and explain briefly what each one means.

(6)

(c) Define money. (3)(d) Differentiate between money, income and wealth. (3)

2.2 Different kinds of money

This section deals with the different kinds of money. It is important to note that originally

the intrinsic value and exchange value of money were the same (for example, a gold

coin). At present, the intrinsic value of money is nothing (the paper value of a note is

nothing), but the exchange value is high (think about a R200 note). In other words, its

value is based on confidence.

STUDY




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20 Economics 1B

Indicate whether the following statements aretrue(T) orfalse(F):

Note:Answers are provided at the end of this study unit.

T F

(1) The South African money supply is fully backed by the

amount of gold in the vaults of the SARB.

(2) Demand deposits can be withdrawn immediately by writing

out a cheque (which is generally accepted as payment) and

therefore demand (or cheque) deposits form part of the

quantity of money.

Short questions

(a) List four properties a commodity must have in order to serve as money. (4)

(b) Why are credit cards not seen as money? (2)

2.3 Money in South Africa

The different measures of the quantity of money used by the SARB are introduced in

this section. You must be able to define M1, M2 and M3. Note that demand deposits are

greater than coins and banknotes in equation 15-1.



T F

(1) The quantity of money in South Africa consists largely of

coins and banknotes.

(2) In South Africa, there are at least three different measures of

the quantity of money: M1, M2 and M3.

(3) M1 is the narrowest measure of money and consists of coins,

notes and demand deposits.

(4) M1 relates to the function of money as a medium of exchange.

ACTIVITY 2.3

ACTIVITY 2.2

STUDY



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Short question

(a) What is the main difference between M1, M2 and M3? (2)

2.4 Financial intermediaries

The place of the financial sector in the economy, as introduced in section 3.5 of the

prescribed book, is revisited in this section. Take note of the main function of financial

intermediaries (to act as an intermediary between the surplus units and deficit units in

the economy).



T F

(1) The major function of a financial intermediary such as a bank

is to act as a link between the surplus units in the economy

and the deficit units.

(2) Interest is the amount that a borrower has to pay a lender

for the use of the funds concerned.

Short questions

(a) Distinguish between real and financial transactions. (2)

(b) Explain the basic function of a financial intermediary. (3)

2.5 The South African Reserve Bank

The functions of the South African Reserve Bank (SARB) are explained in this section.

The central bank plays an important role in the South African economy and you must

know what its main functions are.

STUDY


STUDY


ACTIVITY 2.4


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22 Economics 1B

Short questions

(a) List four of the functions of the SARB. (4)(b) Explain what is meant by a clearing bank. (2)

(c) Explain the term lender of last resort. (3)

2.6 The supply of money

The various factors that can influence the supply of money are discussed in this section.

You must take note of how banks can create money. Though you will not be asked to do

calculations using equations 15-2 and 15-3, you must be able to explain the role of the

credit multiplier in the money creation process. The conclusion reached in this section,

that the supply of money in South Africa is essentially a function of the demand for

money, will be revisited when we discuss the money market.



T F

(1) The cash reserve requirement of any South African bank is

held in a non-interest-bearing account with the SARB.

(2) The money creation process is based on the ability of banks

to lend part of the deposits they receive to other customers.

(3) Banks can create demand deposits by granting credit to their

clients in the form of overdraft facilities.

(4) When a person deposits cash in a cheque account there is no

immediate change in the quantity of money.

(5) The greater the monetary base, the more opportunities

there are for creating money.

(6) Transactions with foreign countries do not influence the

domestic money supply.

ACTIVITY 2.5

ACTIVITY 2.6

STUDY




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T F

(7) Payments for imports have a negative impact on the quantity

of money.

(8) When a countrys foreign reserves increase, its money

supply generally decreases.

(9) Government transactions can influence the money supply.

Short questions

Note: The solution to the question marked with an asterisk (*) is provided at the end

of this study unit.

(a) *Briefly explain how money can be created through the granting of credit (in the

form of overdraft facilities). (5)

(b) What is the main determinant of the credit multiplier? (2)

2.7 The demand for money

The various aspects of the demand for money are summarised in table 15-2 and figure

15-1. Study this section in detail.



T F

(1) The opportunity cost of holding money is the interest that

could have been earned by holding interest-bearing assets

(for example, bonds) instead.

(2) The demand for money arises from the functions of money

as a medium of exchange and as a store of value.

(3) The quantity of money demanded for transaction purposes

is related to the function of money as a medium of exchange.

(4) The demand for money for speculative purposes arises from

the function of money as a store of value.

STUDY


Table 15-2 The demand for money (or liquidity preference): a summary

ACTIVITY 2.7


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24 Economics 1B

T F

(5) There is a positive relationship between the quantity of

money demanded for speculative purposes and the level of

income.

(6) Since money is the most liquid of all assets, the demand for

it is also called liquidity preference.

(7) The quantity of money demanded for transactions and

precautionary purposes is also called the demand for active

balances and is related to the level of income in the economy.

(8) If the interest rate is high, the quantity of money demanded

for speculative purposes will also be high.

(9) The demand for passive balances refers to the precautionary

demand for money.

(10) There is an inverse relationship between the interest rate

and the quantity of money demanded for speculative pur-

poses.

(11) The total quantity of money demanded depends on the level

of income and the interest rate.

(12) An increase in income will result in an increase in the

quantity of money demanded at each interest rate, which

can be illustrated by a rightward shift of the money demand

curve.

Short questions


of this study unit.

(a) What is the opportunity cost of holding money? (2)

(b) Define the demand for money. (2)

(c) Name the three motives for holding money distinguished by John Maynard

Keynes. (3)

(d) What is the main determinant of

(i) the quantity of money demanded for transaction purposes?

(ii) the quantity of money demanded for precautionary purposes?

(iii) the quantity of money demanded for speculative purposes? (3)

(e) Distinguish between active balances and passive balances and name the main

determinant of the quantity demanded of each type. (5)

(f) *Use diagrams to illustrate how the total demand for money (or liquidity

preference) in the economy is made up. (6)


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2.8 Equilibrium in the money market

In the previous section, we established that the demand for money is a function of both

income and the rate of interest. We also saw that the money supply (or quantity of

money) depends largely on the cost of credit (that is, the interest rate). In this section,

the money market is derived. Study it carefully.

Short questions

(a) Explain a demand-determined money supply. (6)

(b) Using a diagram, explain equilibrium in the money market. (6)

2.9 Instruments of monetary policy

Monetary policy can be defined as the measures that monetary authorities take to

influence the quantity of money or the rate of interest with a view to achieving stable

prices, full employment and economic growth. In South Africa, the SARB formulates and

implements monetary policy.

You should be able to define monetary policy, distinguish between direct or non-market-

oriented measures and market-oriented measures, and provide examples of each type.

Pay particular attention to accommodation policy and open-market policy.

STUDY


STUDY


ACTIVITY 2.8

Section 15.9 of the prescribed book is not prescribed for this module


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26 Economics 1B



T F

(1) In South Africa, monetary policy is formulated and imple-

mented by the SARB which is the countrys monetary

authority.

(2) The use of open-market policy and accommodation policy

are classified as market-oriented monetary policy measures.

(3) An increase in the rate of value-added tax from 14 to 15 per

cent can be classified as a market-oriented monetary policy

measure.

(4) The rate at which the SARB grants accommodation to the

banks is called the repo rate.

(5) Changes in the repo rate are part of the SARBs accommo-

dation policy.

(6) If the SARB wishes to apply a contractionary monetary

policy, it can raise the repo rate.

(7) When the price of bonds increases, the market rate of

interest also increases.(8) There is an inverse relationship between the price of bonds

and the market interest rate.

(9) An increase in the supply of bonds will raise the price of

bonds and lower the interest rate.

Short questions

(a) Define monetary policy and name any three instruments of monetary policy. (5)

(b) List three market-oriented instruments of monetary policy in South Africa. (3)

(c) Identify two direct or non-market-oriented instruments of monetary policy. (2)

(d) Define the repo rate and explain how it can be used as an instrument of a contra-

ctionary monetary policy. (6)

(e) Define accommodation policy and explain how it should be applied if the central

bank wishes to stimulate economic activity. (6)

(f) Explain what open-market policy means. (3)

(g) Explain briefly how open-market policy can be used to stimulate economic activity

in the economy. (3)

ACTIVITY 2.9


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ECS1601/1 27

Now that you have worked through this study unit and have gained a better understanding

of what money and the monetary sector are all about, do you still think the issues raised

at the start of this study unit are so confusing?

Remember that this section is not for examination purposes.

Read section 15.9, The monetary policy framework in South Africa, of the prescribed

book. Do you think that the SARB is going to achieve its ultimate objective of balanced

and sustainable economic growth?

ACTIVITY 2.1


(1) T

(2) T

(3) T

(4) T

(5) F

(6) T

(7) T

(8) F

ACTIVITY 2.2


(1) F

(2) T

ACTIVITY 2.3


(1) F

(2) T

(3) T

(4) T

Section 15.11 of the prescribed book is not prescribed for this module.

ECONOMICS IN ACTION

(LOOKING BACK)

FURTHER READING

SOLUTIONS


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28 Economics 1B

ACTIVITY 2.4


(1) T

(2) T

ACTIVITY 2.6


(1) T

(2) T

(3) T

(4) T

(5) T

(6) F

(7) T

(8) F(9) T

SHORT QUESTIONS

(a) Start by explaining that money consists of notes and coins (C) and demand

deposits (D). Demand deposits can be activated by writing out cheques and are

very convenient ways of holding money. A major feature of the financial system

is that banks can create demand deposits by granting credit to their customers

(in the form of overdraft facilities). They can do this because they only have to

keep a fraction of customers deposits in the form of cash reserves. Therefore,

if customer A deposits R1 000 at a bank and the required cash reserve ratio is20%, the bank only has to keep R200 and can lend the remaining R800 to other

customers. In this way, banks can create credit to the amount of a multiple of

their cash reserves.

ACTIVITY 2.7


(1) T

(2) T

(3) T

(4) T

(5) F

(6) T

(7) T

(8) F

(9) F

(10) T

(11) T

(12) T

SHORT QUESTIONS

(f) All that is required here is a reproduction of figure 15-1 in the prescribed book

accompanied by a short written explanation. You should mention that the total


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ECS1601/1 29

demand for money consists of the demand for active balances, which depends

on the income level (not the interest rate), and the demand for passive balances,

which is inversely related to the interest rate. Proceed by providing two fully

annotated diagrams (as in figure 15-1).

ACTIVITY 2.9


(1) T

(2) T

(3) F

(4) T

(5) T

(6) T

(7) F

(8) T

(9) F

Well Satis-

factory

Must

redo

Need

help

Concepts

I am able to

list the functions of money

define money

list the properties of money

list the functions of the SARB

define the demand for money

identify the motives for holding

money and the main determinant of

each

define monetary policy

list the market-oriented monetary

policy instruments

list the non-market-oriented mon-

etary policy instruments

define the repo rate

Explanations

I am able to

explain the difference between M1,

M2 and M3

CHECKLIST


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30 Economics 1B

Well Satis-

factory

Must

redo

Need

help

differentiate between money, in-

come and wealth

explain why credit cards are not seen

as money

explain the basic function of a finan-

cial intermediary

explain a demand-determinant money

supply

Diagrams

I am able to

(i) show on a diagram(ii) explain with or without the

aid of a diagram

the demand for money figure 15-1

the effect of a change in income on

the demand for money figure 15-1

the effect of a change in the interest

rate on the demand for money

figure 15-1

money market equilibrium figure

15-2

the effect of a change in income on

money market equilibrium figure

15-2

the effect of a change in interest

rate on money market equilibrium

figure 15-2


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ECS1601/1/20112013 31

STUDY UNIT 3

The macroeconomic

environment

Outcome 1: Explain


economy as a whole



and flows

The monetary sector

The public sector

The foreign sector

Measuring the

performance of the

economy

Role of government in

the economy

How does government

intervene?

Government failure

Nationalisation and

privatisation

Fiscal policy and the

budget

Government spending

Financing of

government spending

Taxation

Taxation in South Africa

Tax incidence


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ECS1601/1 33


Taxes. Yes, what a dreadful word. But we can hardly discuss the role of government in

the economy without raising the question of taxes. Why do we have to pay taxes? Surely,

government can find alternative ways to finance the promised free education, housing

and basic services? In this study unit, we will investigate the different aspects of the public

or government sectors role in the economy, particularly the level and composition of

government spending, the financing of government spending, taxation and fiscal policy.


explain briefly why government is involved in economic activity

explain how government intervenes in the economy

discuss government failure discuss nationalisation and privatisation

explain how government spending can be financed

Sin tax hike no deterrent for some

Drinkers and smokers seemed unconcerned by the increase in the cost of

their tipple and puff.

Beer drinkers will pay 6.5c more for a 340ml bottle, wine will increase by 12cper 750ml, spirits by R2.22 per 750ml and a packet of 20 cigarettes will go upby R1.24.

Why do they try to discourage people from drinking and smoking? Why cantpeople make up their own minds? was the response from draftsman Ziyaadvan Greenen, who was enjoying a R2 loose cigarette and a R12 draught ata Joburg CBD bar.

Its all a scheme. I dont know what the motive is, but its a scheme by thegovernment, he said of the plot to target sin taxes.

Steven Setsiphane said the continued increase in the price of cigarettes hadforced him to smoke fake cigarettes. I rather buy the fong kong. Its bad, butits what I can afford, he said.

The National Council Against Smoking, however, bemoaned the meagreincrease and a policy which keeps tobacco taxes low and so favours thetobacco companies at the expense of public health and government revenues.

It criticised the fact that in South Africa tax amounted to only 50 percent of thecost of cigarettes compared to countries like Ireland, where tax constituted 79percent of a packet - which cost the equivalent of R93 there. By BeauregardTromp. Published on the web by Business Report on February 18, 2010

ECONOMICS IN ACTION

The public sector


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34 Economics 1B

explain the criteria for a good tax

discuss the various types of taxes

explain what has happened to the tax burden in South Africa

explain what is meant by the term tax incidence

explain the impact of an excise tax (with and without the use of a diagram)

define and explain fiscal policy

3.1 Role of government in the economy: An overview

In chapter 2 of the prescribed book, we suggested that nowadays all economies can be

classified as mixed economies in which the government, the private sector and market

forces all play an important role. The appropriate mix of markets and government

intervention is investigated in this section.

The role of government in the economy can be summarised by distinguishing between

three broad functions of government:

the allocative function, which refers to the role of government in correcting

market failure and achieving a more efficient allocation of resources

the distribution function, which refers to the steps government takes to achieve a

more equitable or socially acceptable distribution of income than that generated

by market forces

the stabilisation function, which refers to the measures government takes to

promote macroeconomic stability (for example, full employment, price stability

and balance-of-payments stability)



T F

(1) General government consists of central, provincial and local

government.

(2) Adam Smith argued for extensive government interventionin the economy because of market failure.

CONTENTS

STUDY


ACTIVITY 3.1


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T F

(3) The existence of externalities prevents the attainment of a

socially efficient allocation of resources in the economy.

(4) Market systems tend to generate unequal distributions of

personal income.

(5) The allocation function of government refers to actions by

government to promote an efficient allocation of resources

in the economy.

(6) The stabilisation function of government refers to measures

taken to promote political stability in the country.

Short question

(a) Give two reasons for government intervention in the economy. (2)

3.2 How does government intervene?

Having had a look at the reasons for government intervention in the economy, we now

turn to the question of how government intervenes. You should be able to discuss the

different options available to government.

Short question

(a) Discuss the instruments available to government to achieve its objectives. (10)

3.3 Government failure

Contrary to popular belief, government can also fail. In this section, we examine some

of the forms of government failure.

STUDY


STUDY


Sections 16.2 and 16.3 of the prescribed book are not prescribed for this

module.

ACTIVITY 3.2


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36 Economics 1B

Indicate whether the following statement is true(T) orfalse(F):

Note:The answer is provided at the end of this study unit.

T F

(1) Government failure arises when politicians, bureaucrats and

other interest groups put their own interests before those

of society as a whole.

Short question

(a) Discuss the different forms of government failure. (8)

3.4 Nationalisation and privatisation

In this section, the desirability of nationalisation compared to privatisation is investigated.

Ensure that you are familiar with the arguments for and against each.

Indicate whether the following statement is true(T) orfalse(F):

Note: The answer is provided at the end of this study unit.

T F

(1) Privatisation could improve efficiency, but it might have an

adverse impact on employment.

Short questions

(a) Distinguish between nationalisation and privatisation, and give a practical example

of each. (4)

(b) Briefly discuss the arguments for and against nationalisation and privatisation. (8)

ACTIVITY 3.4

ACTIVITY 3.3

STUDY



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3.5 Fiscal policy and the budget

This section introduces fiscal policy, one of the most important types of economic

policy, which is analysed in part IV of the prescribed book. You should be able to define

fiscal policy and distinguish between fiscal policy and monetary policy. Note also the

meaning of demand management, expansionary (or stimulatory) policy and restrictive

(or contractionary) policy.



T F

(1) The annual budget sets out the joint fiscal and monetary

policy of the government and the SARB for the coming

financial year.

(2) Changes in taxes and government expenditure representfiscal policy decisions.

(3) Government could use the budget to try to influence vari-

ables such as total production, income and employment and

to redistribute income in the economy.

(4) Government should implement restrictive fiscal policy

measures during a recession.

Short questions

(a) Define fiscal policy and list the major instruments of fiscal policy. (5)

(b) Distinguish clearly between fiscal policy and monetary policy. (4)

(c) Suppose the government wishes to stimulate economic activity by applying

expansionary monetary and fiscal policy. Name one monetary policy step and one

fiscal policy step which can be taken. (2)

STUDY


ACTIVITY 3.5


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38 Economics 1B

3.6 Government spending

Note how government spending has increased in South Africa. You should be able to

explain the causes of this trend. Also, note the changes in the composition of government

spending.



T F

(1) Government spending in South Africa consists largely of

spending on capital goods (that is, investment spending).

(2) Changes in the level and composition of government spend-

ing sometimes reflect changes in social priorities but could

also be the result of the influence of powerful special interest

groups.(3) Political shocks and other major disturbances could exert

strong upward pressure on government spending.

(4) Excessive or unrealistic expectations about what government

can deliver (for example, in the form of improved education,

health and housing) could exert upward pressure on real

government spending.

(5) Both a rapidly growing population and a high rate of

urbanisation tend to exert upward pressure on government

spending.

Short question

(a) Give four reasons for the growth in government spending in South Africa since

1960. (4)

ACTIVITY 3.6

STUDY



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3.7 Financing of government spending

Study the different ways in which government spending can be financed. Note how public

debt and the interest on public debt have increased (the latter to a point where almost

20 cents out of each rand of tax revenue are used to finance the interest payments).



T F

(1) The budget deficit (or surplus) is the difference between

government spending and current revenue (mainly taxes).

(2) The budget deficit is usually financed through taxation.

(3) If government finances part of its spending by borrowing

from the central bank, this is called inflationary financing.

(4) A budget surplus occurs when government purchases ofgoods and services exceed the tax revenue it has received.

Short questions

(a) Identify the three broad ways in which government spending can be financed. (3)

(b) Define the budget deficit. (2)

3.8 Taxation

Criteria for a good tax

Study the three criteria for a good tax.

Different types of tax

You should be able to distinguish between direct taxes and indirect taxes and give examplesof each. You should also be able to distinguish between progressive, proportional and

regressive taxes and provide examples of each.

STUDY


ACTIVITY 3.7

STUDY



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40 Economics 1B



T F

(1) Taxes that distort relative prices inhibit the functioning of

the market mechanism and are not neutral.

(2) Taxes should always be aimed at changing the economic

behaviour of taxpayers.

(3) An admission fee at a public swimming pool is an example of

user charging.

(4) Tax avoidance refers to the practice of using illegal ways ofavoiding taxes.

(5) Tax evasion is illegal.

(6) Direct taxes are levied directly on goods and services.

(7) A tax is progressive if lower income groups pay a smaller

percentage of their taxable income in the form of tax than

higher income groups pay.

(8) A tax is regressive if it takes a greater percentage of the tax-

able income of lower income groups than of higher income

groups.

Short questions

(a) List the three basic criteria for a good tax. (3)

(b) Explain the difference between direct taxes and indirect taxes, and give an

example of each. (4)

(c) Explain the difference between progressive and regressive taxes, and give an

example of each. (4)

3.9 Taxation in South Africa

You must be able to distinguish between marginal and average tax rates. Note how the

overall tax burden and the personal income tax burden have increased in South Africa inrecent decades. Please note that the tables are provided to illustrate certain trends. You

are not expected to study the data (figures) contained in these tables!

STUDY


ACTIVITY 3.8


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ECS1601/1 41


Note:

Answers are provided at the end of this study unit.

T F

(1) The South African government raises most of its tax revenue

through personal income tax and value-added tax.

(2) Company tax is the most important source of tax revenue in

South Africa.

(3) The marginal tax rate is the rate at which every additional

rand is taxed (for example, in the case of personal income

tax).

(4) Personal income tax in South Africa is a progressive tax.

(5) Company tax in South Africa is an example of a proportional

tax.

(6) Value-added tax is a regressive tax.

Short question

(a) Explain the difference between a marginal tax rate and an average tax rate (in

respect of personal income tax). (2)

3.10 Tax incidence: Who really pays taxes?

This section contains an analysis of the incidence of an excise tax. This application of

demand-and-supply analysis should be studied in detail.



T F

(1) Government can always specify precisely who will ultimately

bear the burden of a tax.

STUDY

Section 16.12 of the prescribed book except the subsection on the welfare implications

of a specific excise tax

ACTIVITY 3.9

ACTIVITY 3.10


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42 Economics 1B

T F

(2) The statutory or legal incidence of a tax often differs from its

effective incidence.

(3) It is always easy to identify the effective incidence of a

tax since the person who pays the Receiver of Revenue is

actually the one who bears the burden of the tax.

(4) The degree to which the burden of a tax can be shifted

depends on the price elasticities of the demand and supply

of the goods and services in question.

(5) An increase in the excise tax on beer will affect only the

consumers and producers of beer.

(6) An increase in the excise tax on wine could affect workers in

the wine industry.

Short questions


of this study unit.

(a) Explain the difference between the statutory (or legal) incidence of a tax and the

effective incidence thereof. (4)

(b) *Use a diagram to explain the incidence of a specific excise tax on a good. Name

the three parties who have to share the burden of the tax and clearly indicate the

impact on each party. (10)

Having worked through this study unit, do you also get the feeling that the Minister of

Finance must be an ex-Unisa student? We are sure that you will listen to and watch the

delivery of the next budget speech with great interest (and with comments to spare).

Remember that this section is not for examination purposes.

Read section 16.2, Market failure (as justification for government intervention, of the

prescribed book. Do you agree with the reasons given to justify government involvement

in the economy? If not, how do you think the problems raised in this section can be

overcome?

ECONOMICS IN ACTION

(LOOKING BACK)

FURTHER READING


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ECS1601/1 43

ACTIVITY 3.1


(1) T

(2) F

(3) T

(4) T

(5) T

(6) F

ACTIVITY 3.3


(1) T

ACTIVITY 3.4


(1) T

ACTIVITY 3.5


(1) F

(2) T(3) T

(4) F

ACTIVITY 3.6


(1) F

(2) T

(3) T

(4) T

(5) T

ACTIVITY 3.7


(1) T

(2) F

(3) T

(4) F

SOLUTIONS


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44 Economics 1B

ACTIVITY 3.8


(1) T

(2) F

(3) T

(4) F

(5) T

(6) F

(7) T

(8) T

ACTIVITY 3.9


(1) T

(2) F(3) T

(4) T

(5) T

(6) T

ACTIVITY 3.10


(1) F

(2) T

(3) F

(4) T

(5) F

(6) T

SHORT QUESTIONS

(b) Here you have to provide a diagram similar to the one in figure 16-3 in the

prescribed book. Remember to label the axes and curves and to distinguish

clearly between the original supply curve (before the imposition of the tax) and

the new supply curve (after the imposition of the tax). Mention that the burden

will be shared by the consumers of the product, the owners or shareholders of

the firms in the industry and the workers employed in the industry, and indicate

the distribution in your particular diagram. Again, the marks will be divided

roughly equally between the diagram and the accompanying explanation.


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ECS1601/1 45

Well Satis-

factory

Must

redo

Need

help

Concepts

I am able to

define fiscal policy

name the instruments of fiscal policy

Explanations

I am able to

explain briefly why government is

involved in economic activity

explain how government intervenes

in the economy

explain government failure

explain nationalisation and privati-

sation

explain how government spending

can be financed

explain the criteria for a goods tax

explain the difference between

direct and indirect taxes

progressive, proportional and

regressive taxes

explain what is meant by the term

tax incidence

explain the difference between the

legal and the effective incidence of

an excise tax

Diagrams

I am able to show and explain

the following with the aid of a

diagram

the impact of an excise tax figure

16-3

CHECKLIST


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46 Economics 1B

NOTES


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ECS1601/1/20112013 47

STUDY UNIT 4

The macroeconomic

environment

Outcome 1: Explain


economy as a whole



and flows

The monetary sector

The public sector

The foreign sector

Measuring the

performance of the

economy

Why countries trade

Trade policy

The balance of

payments

Exchange rates

Terms of trade


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48 Economics 1B


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ECS1601/1 49


Rand volatility remains a concern treasury official

The volatility of the exchange rate remains a concern, Lesetja Kganyago,

Director General of the National Treasury said on Tuesday.

The volatility of the rand made it difficult for small and medium sized exportersto invest in production capacity or for importers to plan for the costs of capitalgoods or consumption goods, he told a forum on the exchange rate and theeconomy in Pretoria.

Larger firms, and those involved in both importing and exporting, were lessconcerned about the exchange rate, he said.

This points to the need for more targeted intervention in helping firmsmanage the overall costs of hedging -- this would be a more fruitful strategythan attempting to balance the costs and benefits of a larger macro approach.

Kganyago said ways of moderating volatility needed to be found over suitabletimeframes, primarily by supplying sufficient financing for foreign reservepurchases by the SA Reserve Bank.

Financial policy must also facilitate the development of hedging instrumentsand the deepening for foreign exchange and financial markets moregenerally, while gradual accumulation of additional foreign reserves enhancesthe markets assessment of South Africas creditworthiness and the centralbanks ability to smooth excesses in rand volatility.

Kganyago said while some commentators had proposed a fixed exchangerate regime as the solution for South Africa, this would be very hard toimplement and carried a range of economic costs.

Such a regime would require South Africa to give up its monetary sovereigntyand adopt the same monetary policy stance to the country whose exchangerate is being targeted, even if it is not appropriate for domestic economicconditions, he said.

Moreover, the exchange rate would no longer be a shock absorber for changesin the terms of trade.

If we had had a fixed rate regime at the time of rising imported food prices,our domestic inflation rate would have been much higher and South Africansmuch poorer.

Kganyago said the Greek experience clearly showed that bad economicmanagement and lack of productivity magnified the eventual crisis caused byinappropriate fixed exchange rate regimes. Sapa. Published on the web byBusiness Report on March 23, 2010.

ECONOMICS IN ACTION

The foreign sector


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50 Economics 1B

In 2002, the Myburgh Commission was set up to investigate the reasons for the sharp

decline in the value of the rand. Needless to say, the Commission could not pinpoint the

reasons for the decline in the value of the rand. Recently, with the strengthening of the

rand, cries are going up from various sectors in the economy that the foreign exchange

market should be stabilised. Do you have any suggestions? In this study unit, we will

investigate the interaction between the foreign sector and the domestic economy. We

will focus on the reasons for international trade, the main components of the balance ofpayments, and the exchange rate.


explain the concepts of absolute advantage and relative advantage

explain the economic impact of an import tariff

compare the arguments for and against the use of trade barriers

distinguish between the current account and the financial account of the balance

of payments

explain the meaning and significance of South Africas gold and other foreign

reserves

explain the exchange rate between the United States dollar and the South African

rand as well as any changes that might occur

explain an appreciation or depreciation of the rand against the dollar (and vice

versa)

4.1 Why countries trade

In this section, we will investigate the reasons for trade between countries. Study the

three advantages of trade distinguished: absolute advantage, comparative advantage and

equal advantage. Also, note the sources of comparative advantage.



T F

(1) The more open a countrys economy is, the more vulnerable

it is to changes in economic conditions in other countries.

CONTENTS

STUDY



ACTIVITY 4.1


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ECS1601/1 51

T F

(2) A country is said to have an open economy if a significant

percentage of GDP is exported and a significant part of

domestic spending is on imported goods and services.

(3) Adam Smith argued that countries should try to be as self-

sufficient as possible.

(4) One of the basic reasons for international trade is that not all

countries have the same factors of production (for example,

natural resources).

(5) South African citizens would be better off economically if

the country did not engage in international trade at all.

(6) The law of relative (or comparative) advantage states that

two countries will benefit from trade if the opportunity

costs of production (or relative prices) differ between the

two countries.

(7) Absolute advantage is a prerequisite for trade.

(8) Equal advantage is a prerequisite for trade.

(9) Comparative (or relative) advantage is a prerequisite for

trade.

Statements (10) to (15) are based on the following information: Susan can knit four

jerseys or sew eight dresses per week, while Jackie can knit three jerseys or sew four

dresses per week.

(10) Susan has an absolute advantage in knitting jerseys.

(11) Susan has an absolute advantage in sewing dresses.

(12) Susan has a relative (or comparative) advantage in knitting

jerseys.

(13) Susan has a relative (or comparative) advantage in sewing

dresses.

(14) Jackie has a relative (or comparative) advantage in knitting

jerseys.

(15) Jackie should specialise in knitting jerseys while Susan should

specialise in sewing dresses.(16) If country A can produce 2 400 tractors or 3 million tons of

maize per year and country B can produce 1 500 tractors or

3 million tons of maize per year, then A should specialise in

producing tractors, while B should specialise in producing

maize.


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52 Economics 1B

Short questions

(a) Use the following information to illustrate the law of comparative advantage:

Guns Roses

Country A 20 80

Country B 10 20

(6)

(b) List the main sources of comparative advantage. (3)

4.2 Trade policy

The subsection on import tariffs contains another application of microeconomic theory,

namely an analysis of the imposition of an import tariff. You should note the difference

between specific tariffs and ad valorem tariffs. Also, note that the subsection on the

welfare effects of an import tariff is not prescribed for this module. You have to be able

to argue for and against the use of trade barriers.



T F

(1) A specific import tariff is a fixed amount levied on each unit

of an imported good.

(2) An ad valorem import tariff is a percentage levied on theprice of an imported good.

(3) Import tariffs benefit domestic consumers.

(4) An import tariff can be used to protect a domestic industry

against foreign competition.

Short questions


of this study unit.

(a) Distinguish between a specific tariff and an ad valorem tariff. (2)

ACTIVITY 4.2

STUDY

Section 17.2 of the prescribed book except the subsection on the welfare effects of

an import tariff


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ECS1601/1 53

(b) *Use a diagram to explain the impact of the imposition of a specific import tariff

on domestic production and imports. Clearly indicate the position

(i) before international trade

(ii) after international trade but without a tariff

(iii) after the imposition of the tariff (10)

(c) What are the arguments for and against the use of trade barriers? (10)

4.3 The balance of payments

These sections provide more information on the balance of payments. You have to be

able to distinguish between the current account and the financial account of the balance

of payments. Study the subsection on the balance of payments and economic activity in

South Africa.



T F

(1) All economic activities taking place within the borders of a

country are recorded in the balance of payments.

(2) The balance of payments is a summary record of a countrys

transactions with the rest of the world during a particular

period.

(3) The flow of goods between South Africa and the rest ofthe world i

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