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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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ECS1601/1 vii
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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ECS1601/1/20112013 3
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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ECS1601/1 5
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
Interdependence of the
major sectors, markets and
flows in the mixed economy
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6 Economics 1B
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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ECS1601/1 7
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
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 3.2 of the prescribed book
ACTIVITY 1.2
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ECS1601/1 9
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.
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 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
Section 3.3 of the prescribed book
STUDY
Section 3.4 of the prescribed book
ACTIVITY 1.3
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10 Economics 1B
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 3.5 of the prescribed book
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ECS1601/1 11
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
Section 3.6 of the prescribed book
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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ECS1601/1 13
(6) F
(7) T
ACTIVITY 1.2
TRUE/FALSE STATEMENTS
(1) T(2) T
(3) T
(4) T
(5) F
(6) T
(7) T
(8) T
ACTIVITY 1.3
TRUE/FALSE STATEMENTS
(1) T
(2) T
(3) T
ACTIVITY 1.4
TRUE/FALSE STATEMENTS
(1) F
(2) T
(3) F(4) F
ACTIVITY 1.5
TRUE/FALSE STATEMENTS
(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
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
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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Read the following newspaper excerpt:
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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A rate cut? The repo rate? Monetary policy? Yes, the time has arrived to have a closer
look at the financial sector.
After you have worked through this study unit, you should be able to
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.
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 15.1 of the prescribed book
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
Section 15.2 of the prescribed book
Box 15-1 of the prescribed book
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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.
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 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
Section 15.3 of the prescribed book
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ECS1601/1 21
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).
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 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
Section 15.4 of the prescribed book
STUDY
Section 15.5 of the prescribed book
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.
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 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
Section 15.6 of the prescribed book
Box 15-4 of the prescribed book
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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.
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 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
Section 15.7 of the prescribed book
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
Note: The solution to the question marked with an asterisk (*) is provided at the end
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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ECS1601/1 25
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
Section 15.8 of the prescribed book
STUDY
Section 15.10 of the prescribed book
ACTIVITY 2.8
Section 15.9 of the prescribed book is not prescribed for this module
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26 Economics 1B
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
TRUE/FALSE STATEMENTS
(1) T
(2) T
(3) T
(4) T
(5) F
(6) T
(7) T
(8) F
ACTIVITY 2.2
TRUE/FALSE STATEMENTS
(1) F
(2) T
ACTIVITY 2.3
TRUE/FALSE STATEMENTS
(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
TRUE/FALSE STATEMENTS
(1) T
(2) T
ACTIVITY 2.6
TRUE/FALSE STATEMENTS
(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
TRUE/FALSE STATEMENTS
(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
TRUE/FALSE STATEMENTS
(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
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
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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Read the following newspaper excerpt:
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.
After you have worked through this study unit, you should be able to
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)
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 16.1 of the prescribed book
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
Section 16.4 of the prescribed book
STUDY
Section 16.5 of the prescribed book
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
Section 16.6 of the prescribed book
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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.
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 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
Section 16.7 of the prescribed book
ACTIVITY 3.5
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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.
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 16.8 of the prescribed book
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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).
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 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
Section 16.9 of the prescribed book
ACTIVITY 3.7
STUDY
Section 16.10 of the prescribed book
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40 Economics 1B
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Section 16.11 of the prescribed book
ACTIVITY 3.8
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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 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.
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Note: The solution to the question marked with an asterisk (*) is provided at the end
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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ACTIVITY 3.1
TRUE/FALSE STATEMENTS
(1) T
(2) F
(3) T
(4) T
(5) T
(6) F
ACTIVITY 3.3
TRUE/FALSE STATEMENTS
(1) T
ACTIVITY 3.4
TRUE/FALSE STATEMENTS
(1) T
ACTIVITY 3.5
TRUE/FALSE STATEMENTS
(1) F
(2) T(3) T
(4) F
ACTIVITY 3.6
TRUE/FALSE STATEMENTS
(1) F
(2) T
(3) T
(4) T
(5) T
ACTIVITY 3.7
TRUE/FALSE STATEMENTS
(1) T
(2) F
(3) T
(4) F
SOLUTIONS
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44 Economics 1B
ACTIVITY 3.8
TRUE/FALSE STATEMENTS
(1) T
(2) F
(3) T
(4) F
(5) T
(6) F
(7) T
(8) T
ACTIVITY 3.9
TRUE/FALSE STATEMENTS
(1) T
(2) F(3) T
(4) T
(5) T
(6) T
ACTIVITY 3.10
TRUE/FALSE STATEMENTS
(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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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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NOTES
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ECS1601/1/20112013 47
STUDY UNIT 4
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
Why countries trade
Trade policy
The balance of
payments
Exchange rates
Terms of trade
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ECS1601/1 49
Read the following newspaper excerpt:
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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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.
After you have worked through this study unit, you should be able to
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.
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 more open a countrys economy is, the more vulnerable
it is to changes in economic conditions in other countries.
CONTENTS
STUDY
Section 17.1 of the prescribed book
Box 17-2 of the prescribed book
ACTIVITY 4.1
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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.
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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
Note: The solution to the question marked with an asterisk (*) is provided at the end
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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(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.
Indicate whether the following statements are true(T) orfalse(F):
Note: Answers are provided at the end of this study unit.
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