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FACTOR AND GOODS MARKET
In a market economy the household determine what to produce and firms determine how they are produced Labour is owned by CUI
TWO Fundamental markets goods and factors market we assume consumers are rational, means they always want to maximize their satisfaction given the means at their disposal
Households own their factors of production and in turn sell them to the firms in the factors market for income and as an exchange they spend this income in the goods market.
GOVERNMENTSpending is an injection to the flow of income and spending Taxes are a withdrawal
The government purchase the factors of production from households and goods from firms. Provides public goods and services to households and firms
Government spending is financed by taxes paid by households and firms
FOREIGN SECTORExports are an injectionImports are leakage
Goods and services are imported by firms from the rest of the world and payment constitutes as a leakage from the flow income and spending, goods and services are exported to the rest of the world and payment constitutes as an injection into the flow of income and spending.
FINANCIAL INSTITUTIONS
Act as linkage between firms or households with surplus funds and other participants that need funds. Savings = leakageInvestment= injection
Households and firms don’t spend all their income, part of the income is saved the saving flows to the financial sector which lends funds to firms to finance investment spending
TOTAL PRODUCTION, SPENDING AND INCOME
C+I+G()+X-ZExports , investment, government expenditure is injection
Imports, taxes, savings all withdrawals C-households consumptionI-investments capital formation by firmsG- government spendingX-exportsZ-imports
UNIT 2MONETARY SECTOR
Factions of moneyMoney as medium of exchange
Money serves as a lubricate to smooth the process of exchange and to make it more efficient. Thus generally acceptable means of payments.
Money as a unit of accountEnables us to calculate and obtain measures of the total value of all goods and services produced in the economyMoney can’t lose some of its usefulness in this form during inflation.
Money as a store of valueServes as a standard of deferred paymentMeaning that money is the measure of value of future payments
Income -reward earned in the production processWealth -consists of assets that have been accumulated over time DIFFERENT characteristics OF MONEY
Intrinsic value of money is based on confidenceProperties of money
DurableUniformityDivisibilityCan be carried
Kinds of moneyM1-
the conventional measureIncludes coins and notes and demand deposits, in circulation outside the monetary sectorAnd all the demand deposits of the private domestic sector with monetary institutions.
M2-broader definition of money(quasi money- near money)M2= M1+ all other short-term and medium-term deposits of the domestic private sector with monetary institutions its more than 1 /2 of M1
M3M3=M2+ all long -term depositsMost reliable indicator of development in financial sectorA reflection of the store of value function not only the function of money as a medium of exchange.
SOUTH-AFRICAN RESERVE BANK
Is a monetary authorityFunctions
Formulation and implementation of monetary policiesInstruments used
Through the repo rate, refinancing system or accommodation policyBy providing daily liquidity needs to private banks and ensuring they borrow a substantial amount to ensure the system remains effective
Cash reserve requirements and open market
Both used to drain excess liquidity from money market in order to ensure a liquidity shortage at all times.
Service to the government
Banker for the government and advises on monetary and financial matters,
Custodian of gold and foreign exchange reserves responsible for the formation of exchange rateUsed as One of the main barometers of the state of the economy and prospects for the future economy
Administration of exchange controlResponsible for exchange control that restricts the movement of foreign exchange, to protect an economy from disruptive fluctuation in capital movements and international economic shocks
Maintaining financial stability Bank supervision Purpose to achieve a sound efficient banking system, by issuing banks with licenses and
monitoring their activities The national payment system Aim is reduce interbank settlements risk with the objective of reducing the potential of systematic
crisis emanating settlement default from banks. Banker to other banks Acts as a custodian of minimum cash reserves used by banks to create the demand deposits. Clearing bank-Used to clear banks mutual claims and obligation to one another Lender-of-last-resort banks experiencing liquidity problems. Bank notes and coins Right to issue, destroy, make demand is guided by the public. Provision of economic and statistical services
Used by analysts, policy makers and researchers.
THE SUPPLY OF MONEYIs demand driven∆M=∆C+∆D
Demand deposits can be created in the following waysCheque booksOverdraft facilities create a credit and keep a fraction of the customers deposit in a form of cash reserves, which increase money supply in the country.
CREDIT MULTIPLIERCash reserves available to provide for cash withdrawalsWhich is 2 and half of their total liabilities to the public demand deposits in an non-interest bearing account with the reserve bank∆R=b(∆D)b=required cash reserves ratioIncrease in D =increase in reservesIncrease in cash reserves =reduction in the credit multiplier
Factor that influence the money supplyGovernment and foreign countries transactionsForeign trade and international capital movements
So a country's money supply generally increases wen its gold and foreign exchange reserves increase and falls when they decrease.
THE DEMAND FOR MONEY
FUNCTION MOTIVE ACTIVE/PASSIVE MAIN DETERMINANT
Medium of exchange Transactionalprecautionary
demand for Active (idle) balances
Income
Store of value Speculative Passivebalance
Interest rate
The demand of money is the amount that the various participants in the economy plan to hold in the form of money balances
Components of demand for moneya. The transactions demand is a function of national incomeb. The demand for money as an asset
MOTIVE for keeping moneyTransactional-participate in transactionsPrecautionary- for unforeseen expenditure Speculative- there is a negative relationship between the quantity of money demanded for speculative purposes and the level of the interest rate. The demand of money is a function of the income level and the rate of level.
Equilibrium in the money marketDemand-determined money supply
When the money supply depends on the demand for money and the cost of credit.The interest rate is largely influenced by the monetary authorities through their accommodation policyWhich means the quantity of money is determined by the interaction by the interest rate and the demand for money .There is no independent money curve.
The money market 15-2 page 329
A REDUCTION IN THE INTEREST RATE WILL COURSE A RIGHT SHIFT TO THE QUANTITY of MONEY GRAPH. Ceteris paribusBecause the quantity of money is determined by the interaction of the interest rate and demand for money.
THE INSTRUMENT OF MONETARY POLICYMarket oriented
Accommodation policyThis is an instrument by which SARB can regulate the quantity of money through variations in the cost of credit.
Changes in the repo rate lead to adjustments in the interest rates at which credit is made available by the banks to their clients.Classical cash reserve system as the banks are obligated to hold 2.5 per cent of their total liabilities to the public in the form of cash reserves.
When a bank experience shortage of funds they can either borrow from the overnight interbank system ,however if all banks are experiencing the same problem, the reserve bank becomes the lender of last resort.
Through the repo system, if banks still experience shortage they would be accommodated by way of a supplementary square-off auction.Increase repo rate = contractionary monetary
Open market policy
Consist of the sale or purchase of domestic financial assets by the central bank in order to exert a specific influence on interest rates and the quantity of money .
SARB want to increase money they buy government bonds from banks and repayments will be the
increase of their cash reserves. Decrease money-central banks sell their government bonds and it reduces their cash reserves
leads reduction of money supply, there is an inverse relationship between the price of a bond and the interest that can be earned on it. These transactions help to support the Accommodation policy
Main feature is that the sale of government bonds may be undertaken in order to bring about a shortage of cash reserves in the banking system so that banks will be forced the use of the repo system of the SARB through refinancing agreements .
Bank supervisionin respect of their capital and liquid asset holdings.
NON -MARKET-ORIENTE MEASURES. Credit ceilings and deposit rate control Intervention in foreign exchange markets Public debt management Moral suasion, through advice and persuasion
ConclusionTransmission mechanism
The link between the monetary sector and the real sector.Describes how changes in the quantity of money and interest rates work their way through the economy eventually to influence the price level, production income and other important variables.
Monetary policyThe measure that monetary authorities take to influence the quantity of money or the interest rate with a view to achieving stable prices, full employment and economic growth.
UNIT 3THE PUBLIC SECTORROLE OF GOVERNMENT
Allocation function, To ensure equity considerations(distribution of wealth and income) Distribution function To examine efficiency considerations (market failure), which occurs when the
market system is unable to achieve an efficient allocation of resources, and that the best available outcomes has not been achieved
Stabilization function measures taken to promote macroeconomic stabilityHOW DOES GOVERNMENT INTERVENE?
What instruments government use to achieve their objectives?Public provisionOf goods and services through public ownership or financing of PPPMarket participantsEmployer of labor and through its wage policyAs a procurement agent of goods and services from the private sectorGovernment spendingTransfer of payments for aids, subsidiesCan be used to change distribution of incomeTaxationUsed to finance government expenditureFor redistribution of incomeTo promote certain desirable activities and to penalise undesirable activities.Used to internalise the externalities of environmental pollutionsRegulationAll laws are enforced by a system of fines and criminal penalties.
GOVERNMENT FAILURE
Behaviour of vote-maximizing politiciansBehaviour of bureaucrats Rent-seeking behaviour of interest groups
NATIONALISM AND PRIVATISATION
NationalizationIs the transfer of ownership from private enterprise to government.Is considered a failure and its attractive to bureaucrats and politicians wit self-enriching motivesThat it was a solution for the poor white man.
PrivatizationState owned enterprises are bureaucratic and inefficient and unresponsive to customers’ needs and often burden the taxpayers with the expenses.
Privatization will attract direct foreign investments thereby augmenting the country's foreign reserves.Will broaden the tax base if public enterprises don’t pay taxWill have more access to capital and are able to adapt to change in the environmentProceeds will make funds for the governmentWill increase share ownership in the market and act as a tool for black economic empowerment.
Arguments against
Privatizationmight be the replacement of a state monopoly with a private monopoly.State -owned firms are supposed to take account of any possible external costs or benefits, the same does not apply to private owned enterprises.Private enterprises will not take the broader view of the public interest, and essential services might be terminated or become expensive.
Fiscal policy and the budgetFiscal policy
A policy in respect of the level and composition of government spending, taxation and borrowing, controlled by the governmentThe main instrument= budgetMain variables= government spending and taxation
Demand management an instrument that can be used to regulate the total demand of goods and services in the economy.
Monetary policyThe manipulation of the interest rate and is conducted by the central bank.Recession= expansionary fiscal and monetary policyMeaning government spending raised and taxes reduced or left constant.
Budget deficit the difference between government spending and taxationWill tend to increase and the expansion would be rapid do to regulate the actionA restrictive/ contractionary fiscal and monetary policy is used
Government spending is decreased and taxes raisedFiscal policies can be used for isolated markets. GOVERNMENT SPENDING
Can be classified economically or functionallyCourse
Changing consumer preferencePolitical and other shocksRedistribution of incomeMisconception and entitlementPopulation growth and urbanization
Financing Income from propertyInters derived from the divided income that us derived from governments full or partial ownership of enterprises.Profit from sale of agricultural forestry and fishing productsRent and other license fee user chargersTaxes
Main source of revenueBorrowingIncreases public debtBorrow from central bank by using its overdraft facility, increase money supply = inflationary financingBorrow form capital market by issuing bonds.
Criteria of good tax
EquitableNeutralityAdministrative simplicity
Different types of taxes
Direct tax (taxes on income and wealth) levied on individuals and companies
Indirect tax(taxes on goods and services) levied on transactions like VAT(general), customs duties and excise duties.( selective)
Progressive; people with higher income pay more taxes (personal income tax)
Proportional average tax rate is the same as everyone (basic company tax)
Regressive taxes takes larger percentage from low-income individuals (VAT)
Taxation in south-AfricaPersonal income
Direct tax and most important revenue boosterMarginal tax rate;
is the rate at which each additional rand of income is taxed.Average tax rate;
the ratio between the amount of tax paid and taxable incomesCompany tax
On companies’ profits.Value added tax
Taxed on goods and services The rise in the overall tax burden
Whomever the government as chosen tooCannot be established by determining who actually ands over the money to the government.Companies try to shift the burden from shareholder, employees, and owners to the consumers.Impact of a specific excise tax
SPECIFIC EXCISE TAXFixed amount that's levied on each unit of a product
AD VALOREM TAXLevied as a percentage of the value of the product, like VATThe extend at which companies can pass the burden to consumer depends on the price elasticity of the demand and supply of the product.
Thus the burden is shared by three groupsConsumers, when buying the products.Suppliers less production less profits.Employees. Wage or job cuts
page 364 graphs.
UNIT 4There are 3 advantages for countries to trade between each other.
Reason is that most factors of production are not evenly distributed among the nations of the world and that all countries do not have
Absolute advantageWhen both countries produce the products but , one produce more over the other, the that country has an advantage over the other
Comparative [or relative] advantageWhen an opportunity cost of production differ between the two countries. Countries will exports goods that they have a comparative advantage. Provided a mutual trade ratio occurs. equal advantageWhen the opportunity costs are the same in both countries, and there is no basis of trade
Sources of comparative advantageTechnology Superiority means more output per unit of input
The danger of this type of conclusion is that , with time the producers in less advanced countries will imitate the technology, and if other factors are lower than the principal country the principal country loses its comparative advantage and might have to export from the latter country = product life cycle theory of international trade
Resource endowmentsCountries will tend to export those goods that most intensively use the country's relatively abundant resources.
Differences in taste or demand contribute to determine the supply or exports of products
Trade policiesSpecific tariffs
A fixed amount that is levied on each unit of the imported commodityAd valorem tariff
Tariff that is levied as a percentage of the value of the imported item.Revenue tariffs
Levied on goods that are not produced in the domestic economy .Protective tariffs
Used to protect the domestic economy from foreign economy.
Page 377 figure17-1
Other measuresQuantitative restrictions(import quotas)
Seek to control the physical levels imported into the country, direct intervention in the market mechanismthe benefit of the higher go to the seller of the goods thus the need for control
SubsidesOther non-tariff barriers Discriminatory administrative practices
Exchange controlsReduction of the flow of certain goods by restricting the amount of foreign exchange available for their purchase and helps with reserving foreign currency.
Exchange rate policySeen to be more effective instrument in influencing trade.
Argument for use of barriersBalance of payments
Method is used to try and correct the deficits in the balance of payment ,however success depends on price elasticity of demand for imports.
Dumping Firms sell products to foreign markets at lower prices than their domestic markets. Or at lower prices than other export markets and it’s difficult to proof.
Exports subsidiesFree trade is desirable only if there is fair play but if the countries government subsidies all of its country's exports this courses retaliatory measures. Because if A is subsidized consumer B benefit in the expense of country A tax money but producer B lose out .
Infant industriesBest known argument for protection.Many developing countries have a potential comparative advantage in manufacturing, but cannot compete with well-developed manufactures from foreign countries thus the need for foreign protection by government by supporting new manufactures until they are established.
But Economist argue thatProtection contribute to monopolistic conditions in the domestic marketServers no purpose unless it makes the industry efficientFosters the development of inefficient industries Firms tend to become complacent and reluctant to adapt to changeGovernments blinded by politics ,unable to know how needs protection.
Employment Used to protect jobs and industries from foreign competitionDisadvantage is that it may delay the structural changes required to render the industry competitive.
What is true for one country is not true for the other = (fallacy of composition) restrictions might not work for everyone.
Government revenueWith import tariffs revenue can be raised more cheaply than through more elaborate kind of taxes.National security.The decision lies with the politician and economists can only advice on policy matters.
Against Welfare cost to society
Tariffs impose a cost on society introduction will increase the price paid by domestic consumers, a fall in the consumer surplus and loss of welfare to the society.
Retaliation by trade partnersCreate a tit-for-tat situation with no real winner.
Inefficiency Because they protect certain industries, it means that these industries have less incentive to reduce their costs and increase their efficiencyThe net gains and losses from trade barriers are largely unpredictable.Consumers in the protected economy lose since prices are higher than they would be Producer in the protected economy gain since demand for products increasesForeign producer lose , deprived of the market.
Balance of payments
Is a systematic statistical account of all economic transactions between the residents of a country and the resident of other countries in a specific period. The net gold exports are shown separately instead of being included in merchandise exports.
Consist of 4 accountso Current accounts (balances the deficit of financial account)o Financial accounts( reserve, sustained by net inflow of foreign capital and domestic savings)
record the borrowing and lending of funds of international transactionsGold and other foreign reserves
They reflect the overall balance of payment positionRequired to prevent large fluctuation in exchange rates between domestic currency and foreign currency.Indicator of the authorities scope to stimulate the economy without running into payment difficulties.
How to promote exports
o Monitor domestic production costs so that goods can be supplied on international markets at competitive prices.
o Assist potential exporters to find international markets and subsidies some of their costs.o Allow or engineer a depreciation of the rand against other currencies, thereby making
exports more competitive.o Demand for imports increase, demand for foreign exchange increase. And if these is less
supply of the foreign currency the rand will depreciate , these will assist exporters but will increase import prices which fed into the domestic inflation.
o To promote international trade ,the (SARB) has to avoid sharp fluctuation in the exchange rates between the rand and other currencies.
o Surplus reserves of foreign currency = intervention, if it’s a deficit then the demand for imports must be cut back.
o Tariffs and quotas can be used, however they may constitute a contravention of international trade agreements, course a retaliation and raising cost of domestic production.
o Reduce domestic demand is effective ,results in the fall in imports but will mean that domestic production , income and employment have to be sacrificed.
o SA has relied on such measures to solve its balance of payments.Exchange rate
THE DEMAND FOR DOLLARSdollar holdersThe demand for dollars is the same as the supply of randsThere are sources of dollarImportersSouth-African residents, purchase dollar productsAmerican investorsSouth -African touristsSpeculators who anticipate the decline
THE SUPPLY OF DOLLARS,dollar seekerThe source of supplyExporterForeign buyers, purchase of South-African assetsForeign tourists in South-AfricaSpeculators anticipate a rise in the value of the rand relative to the dollar.
Demand for dollars is a derived demandThe exchange rate determines the domestic price of the goods services and assets and the foreign price of domestic liabilities and therefore affects the quantity of foreign currency demanded.
Supply of rand positively related to dollar/rand exchange rate and supply curve has a positive slope
Changes in supply and demand
currency depreciation and appreciationChange in supply or demand will be reflected by a shift of the relevant curveChange in the exchange rate causes a movement along the demand curve as well as a movement along the supply curve
A decrease in the supply of dollarsCHANGES IN SUPPLY AND DEMAND
+ dollar-dollar
+ Supply-supply
= a shift of the demand curve to the right= a shift of demand curve to the left
= shift supply curve to the right= shift supply to the left
DepreciatesAppreciates
AppreciateDepreciate
AppreciatesDepreciates
DepreciateAppreciate
IMPACT OF CHANGES IN RAND/DOLLAR EXCHANGE RATE FOR SOUTH-AFRICA.
Change in R/US exchange rateRand depreciates against dollarRand appreciates against dollar
Export pricesDecreaseIncrease
Import pricesIncreaseDecrease
Current accountImprovesWorsens
Domestic priceRiseFall
SARB
Can only intervene to stabilize a depreciating currency if it has sufficient foreign exchange reserves to do so.
Managed floating When the bank ,monitors the development in foreign exchange markets and decides on action plan.By either selling or buying foreign exchange.
UNIT 5Macroeconomic objectives
o Economic growth Measurement requires a yardstick for measuring the total production of goods and
serviceso Full employment
People suffer materially and psychologically and pose a threat to political and social stability
o Price stabilityObjective to keep prices as low as possible and the yardstick used consumer price index
o Balance of payments stability or external stabilityAnd exchange rates should be fairly stable
o Equitable distribution of incomeSubjective or normative issue
These objectives serve as criteria's of assessing the performance of the economy.
Measuring the level of economic activityGDP
Is the total value of all final goods and services produced within the boundaries of a country in a particular period.1st determine a country's total production of goods and services and must be combined into one measure of total production or output done by SARB and STATS SA, by their national accounting section.They add different market values together to give a combined measure of products.
GDP is a flow the element gross means no provision of the depreciation of assets has not been provided, thus it’s important to make such provision by subtracting the provision for depreciation from the gross total to give the net total.
Net amount is most correct measure of economic growth, but the gross measure is most used. GDP AT BASIC PRICES= GDP at market price- taxes on products + subsidies on products. GDP AT FACTOR COST = basic - other taxes on production + other subsidies on production. GDP AT MARKET = basic prices +taxes on products- subsidies on products. GDP AT BASIC PRICES = factor cost + other taxes on production- other subsides on production.
Measurement at current prices and at constant prices
Current prices (nominal GDP) face value , monetary values.Constant prices (real GDP) actual value in terms of what it can buy.
Problems experiencedDouble counting
To avoid this problem the accountants use (VAT)Count each transaction
Counting the value of sales where a good or service reaches its final destinationConsidering only the incomes earned during the various stages of the production process by the owners of factors of production.
Three METHODS of calculating GDPProduction- value addedExpenditure -final goods and servicesIncome -income of the factors of production
Value of total = total primary income(income, profits, wages ,rent, interest) + value of intermediate goods services.
Thus output in monetary terms must be equal to the total monetary income derived from itBut provision should be made for the depreciation of goods by subtracting it from production valuesBy subtracting the consumption of fixed capital from the gross total, changes it to net total.Depreciation reflects the amount needed to be reserved to sustain the economy's production capacity at the same level.Gross national income or gross national products.
GNI IS EQUAL TO GDPGDP Best used to measure the level of activityGNI measure the income or standard of living of the citizens
TO derive GNI FROM GNPa. Subtract all profits, interest and other income from domestic investment which accrue to
residents of other countries.b. All wages and salaries of foreign workers engaged in domestic productionc. All profits, interest and other income from investments abroad which accrue to permanent
residentsd. Wages earned by permanent residents outside South-Africa
GNI= GDP + primary income receipts- primary income payments.GNI = GDP - net primary income payments to the rest of the world
Where net income = primary income payments-primary income receiptsGDE is always equal to GDP at market pricesIt indicates the total value of spending on goods and services produced in the country plus imports excluding exports.GDP= C+I+G+(X-Z)GDE=C+I+G
THE difference between GDP and GDE is the difference between imports and exports Measuring unemployment and employmentUnemployment rate
Is an percentage expression of people who are able and willing to work but can’t find employment
Measuring the consumer price indexEconomists need information of price movements so that they can distinguish between nominal and real valuesWhen prices increase purchasing power decreaseConsumer price index is an index of the prices of a representative basket of consumer goods and services.When constructing the basket stats SA takes into accountGoods selected
Assign weight based on relative importance in the basketDecide on a base yearFormulaCollect prices each month to calculate the value of the CPI for that month.
Measuring : the balance of paymentsConsists of two major accounts
Current accountsRecords the exports and imports of the country with the rest of the world, as well as all the primary income receipts and payments.
Surplus means exports exceeds imports at the period reviewedDeficit imports exceed exportsFinancial account
Records all transaction going in and out of the accountSurplus - net inflow of foreign capitalDeficit- outflows exceed the inflows = net outflow of foreign capital.
Adding of the two accountsWill give us the change in the country's gold and foreign exchange reserves.
Measuring income inequalityLorenz curveGini coefficientQuantile ratio.
Unit 6
Production, income, spending.SAY'S LAW Y->A ( believes that total production created demand)KEYNES LAW A->Y ( demand determines supply)
KEYNESIAN MODELBelieves that the equilibrium condition is still that aggregate demand(A) equal total income(Y). Equilibrium can occur at any level of income AND that government intervention is essential to stimulate or dampen spending.
How can spending be greater than production?Households can use money saved from previous period to finance their spending or buy on credit.
When is total spending less than total income?When part of the money saved never finds its way back into circular flow of PIS
Total spending less than income?Demand for goods is less than the total production
Spending can be equal to production and income.Spending may be greater than production and income.Spending maybe less than production and income.
A=YA>Y
A<Y
Basic assumption of Keynes model.
The economy consist of households and firms only.There is no governmentThere is no foreign sectorPrices, wages and interest are given.
Spending determines the level of activity(production) CONSUMPTION SPENDING
Is the relationship between consumption expenditure by households and total income.3 characteristics
Consumption increase as income increasesConsumption is positive even if income is zero, this reflects the influence of non-income determinants of consumption spending.When income increase consumption increases, but the increase in C is less THAN I
AUTONOMOUS CONSUMPTIONIs the distance from origin 0 to C1Its independent of the level of income.
Factors that determine autonomous consumptionDistribution of incomeAvailability and cost of consumer credit.Consumers' savings
Non-incomeThe age distribution of the populationLevel of taxation
OTHERExpectations, wealth, interest rate
INDUCED CONSUMPTIONIs dependent on the level of incomeThe marginal propensity to consume
Thus C=c +cry
INVESTMENT SPENDING Do page 416-421 Is more variable ad less predictable and is the most volatile.Often the main cause of fluctuation in economic activityRefers to man-made means of production (capital formation)It’s not primarily a function of income.There is no positive or inverse relationship between total investment and total income.
Investment is autonomous with respect to incomeIt determines income, but it’s not determined by income.There is an inverse relationship between interest rate and the expected return investment spending.
THE MULTIPLIER
α=11−c
∆Y=α(∆Ā)
The ratio between the eventual change in income and the initial investment The size of the multiplier depends on the fraction of the additional income generated in each round that is spent in the next round, that is on the marginal propensity to consume.
Page 423 the multiplier process graph The equilibrium level of income can therefore always be obtained by multiplying the total of all the autonomous components of aggregate spending by the multiplier.Multiplier for equilibrium
Y 0= 11−c
(C+ I )
MARGINAL PROSPENSITY TO CONSUME
c =ΔCAY
Indicates the proportion of an increase in income that will be used for consumptionIt never be greater than one.
The equilibrium level of income page 420
The impact of a change in investment spending: the multiplier Increase in investment expenditure immediately causes a shift from E1 to point (z)= there is an
excess demand for goods Production will increase to meet the excess demand, therefore moving to point (y) in the figure. At point (y) income has also increased, which means that consumption expenditure will as a result
of the marginal propensity to consume, increase and move to point (x)
UNIT 7
KEYENSIAN MODEL INCLUDING THE GOVERNMENT AND FOREIRGN SECTOR
1. The impact of the introduction of government spending on multiplier-(is related to marginal propensity to consume{c}-slope of the curve)
Government spending doesn’t affect the size of the multiplier. Equilibrium level of income
The impact will depend on the relative sizes of the level of government spending and tax rate
Aggregate spending It raises the level of aggregate spending(injection)
2. Explain the difference between income and disposable incomei. Income is what a household receives in exchange for their services.ii. Disposable income, is what is left after tax for consumption.
3. The impact of the introduction of a proportional income tax on 19-5 private consumption expenditure figure 19.4
Reduces consumption as disposable income reduces. Autonomous spending
It raises the level of aggregate spending by the amount of Government spending The multiplier
Reduces the size The equilibrium level of income
4. Explain using a diagram Impact of a change in government spending or of a change in the tax rate on equilibrium level of income 19-5
5. The impact of fiscal policy(use of economic variable like government and tax) on the equilibrium level of income.
Increase in government spending is one of the fiscal policy instrument, can raise the equilibrium level of income.
Tax rate affects the disposable income at each level of income and affects consumption spending.
A lower tax rate = larger multiplier.(the increase in the slope of the aggregate spending curve).19-6
1. The impact of change in autonomous exports and induced imports on the equilibrium level of income 19-8.
Autonomous imports(Z) Don’t depend on income Imports are a leakage and are subtracted from the total expenditure The size of multiplier not affected Positive relationship between income and imports.
Induced imports (mY)(including the impact of the marginal propensity to import, on the multiplier)
Imports are a function of income Level of income increase in the domestic market increases imports. Extent of import increase depends on marginal propensity to import. Size of multiplier decrease
Calculate
Autonomous spendingSimple Keynesian model without Gov.: Ā= C+ḹIn a closed economy with Gov.Ā= C+ḹ+G� In Open economy with Gov. + foreign sectorĀ= C+ḹ+G�+(X−Z)
The multiplier
Without Government: α11−c
IN A CLOSED economy- government: α 11−c (1−t)
With governmentAnd the foreign sector:α1
1−c (1−t )+m
The equilibrium level of income Y 0=αĀ
The required change in government spending to achieve full employment.
∆G� = ∆Yα
UNIT 8MACRO THEORY AND POLICYList the basic assumptions of AD-AS modelPrices are variableWage's, Interest rate are variable and money supply can change.The level of activity is determined by the interaction of total supply and demand.
Define 1. The AD curve
Aggregate demand curve is determined by everything that influence total expenditure.C,I, G, T,X,Z. most important interest rates.
2. AS curveConcerned with the cost of producing the total output of goods and services. Influenced byFactors of prices, wages, profit margin, intermediate goods and imported goods rent and interest.
3. Stagnation Describes a situation of stagnation and inflation, whereby an increase in the cost of producing the total product results in higher prices, lower production, income and employment and higher unemployment.
4. Use aggregate demand (AD) and aggregate supply(AS) curve to analyze the impact of an expansionary fiscal(government and taxes) policy on prices and production in the economy when income is below the full-employment level.(f-20-3)
Expansionary monetary policyIs implemented when the central bank (SARB)
reduces the interest rate at which it provides credit to the banks Illustrated by the rightward (upward) shift of the AD curveApplied when the government increases government spending or reduces taxes.Increase total production but at the expense of an increase in price level.
5. Supply shockThe upward shifts of the AS curve
6. Use AD and AS curve to analyze the impact of a supply shock on prices and production in the economy.20-4
Decrease in supply-leftward(upward) shift of the AS curve,An increase in the price levelA decrease in the level of productionImplies an increase in unemployment.
1. Explain with a diagram why policy makers cannot solve the stagflation dilemma using only demand management. 20-4
Demand managementIs a collective term for monetary and fiscal policy that impact on the aggregate demand in the economy,Can be used to combat stagnation elements and inflation elements but not at the same time = stagnation
Increase in price level -can be counteracted by contractionary monetary and fiscal policies But this would result in a further reduction in production, income and employment.Leftward/(downward) shift of AD curve.
Decrease in production, income, employment -can be counteracted by applying expansionary monetary and fiscal policies which will increase price level
Rightward (upward )shift AD CURVE
1. The trade-off principle(Phillips curve)22-2 and 22-3
To achieve a lower interest rate by trading it off against greater unemployment.By using income policies to contain both inflation and unemployment(stagflation)
2. Define the transmission mechanismIs the way in which changes in the monetary sector are transmitted to the rest of the economy.
Symbols:
3. Explain why the link in interest and investment spending is important in the monetary mechanismSymbols of the link
If changes in the interest rate do not affect investment spending, the chain breaks down. If investment demand is completely interest inelastic a change in the interest rate will not have any impact on investment spending
Use the AD/AS model and explain with the aid of diagrams, how an increase in the interest rate will affect the level of prices, production and income.20-6a and 20-6c
Increase in interest rates
Summery in symbols↑i→↓I → ↓A → ↓AD→ ↓P and ↓Y.An increase in the interest rate
will lead to a decrease in investment.Spending decreases, leading to a decrease in aggregate demand(the AD curve shifts to the left)While prices, production and income will also decrease.
Decrease in interest rates(same graphs but steeper)
Will lead to an increase in investment spending.Spending and AD will increase by a small margin.
THE SHIFT TO THE RIGHT of the AD curve will thus be small and the effect on income will be minimal.
Explain The implications of the assumption of AS-AD model
The model can only be used to study inflationAggregate supply can change independently from aggregate demandImpact of changes in general level of wages on production, income, employment and inflation can be analysed.Model can be used to study the impact of changes in monetary sector, including monetary policyChanges can originate on both the supply and demand side of the economy and the interaction between the two has to be taken into account.
Distinguish between fiscal and monetary policyExpansionary monetary policy
Is implemented when the central bank (SARB) reduces the interest rate at which it provides credit to the banks Illustrated by the rightward (upward) shift of the AD curveApplied when the government increases government spending or reduces taxes.Increase total production but at the expense of an increase in price level. 20
Contractionary monetary policyBank raises the interest rate, illustrated by leftward (downward) shift of AD curve.Government spending is reduced and taxes are increased
Discuss the 4 lags associated with the fiscal and monetary policy.The recognition lag
Lag between changes in economic activity and recognition that the changes had occurred.The length is the same for monetary and fiscal policy.
The decision lagLong for fiscal policyShorter for monetary policy.
The implementation lag fiscal policy longermonetary policies extremely short
The impact lagFiscal policies -shorterLonger for monetary policies.This type of policy also known as the outside lag which together constitute inside lag.
Diagrams The impact of key changes on the AD curve figure 20.3 table 20-1
Impact of key changes on AS curve F20-4-5
Discuss the policy dilemma aid of a diagram, the policy dilemma in an open economy.20-9Measures taken to raise the level of production and income(reduce unemployment)
Will increase the deficit on the current account of the balance of payments.Measures taken to reduce the level of income(to reduce the current deficit)
Will increase unemployment.Solution
Can be resolved if current account deficits are financed by inflow from foreign inflows of capital, unlikely so weHave to maintain some balance between exports and imports.
UNIT 9
INFLATIONDefine inflation
Refers to Continuous and considerable increase in prices in general.Continuous process of increasing prices
Casual definitionIs seen as too much money chasing too few goods-over supply of money.
Define the CPI reflects the cost of the representative basket of consumer goods and services.
Use CPI data to calculate inflation rateBy calculating the percentage change in the CPI from one year to the next.
1 month on the same month during the previous year2 annual average on annual average
inflationra te= Recent year−base yearbase year
×100
DEFINE PPI -Production price index, measures prices at the level of the first significant commercial transaction.It includes capital and intermediate goods but excludes services.Measures the cost of production rather than cost of living.
Discuss the difference between CPI and PPI
CPI Cost of living Baskets consist of consumer goods and
services Capital and intermediate goods are
PPL Cost of production Baskets consist of goods only Capital and intermediate goods
are included
excluded Prices include Vat and interest rates are
taken into account Prices of imported goods are not shown
explicitly
Prices exclude vat and interest rates
Prices of imported goods shown explicitly.
Define the implicit GDP deflatorCalculates the inflation rate but doesn’t reflect cost of livingIts implicit because it is a side-effect of the calculation of economic growth.Is the ratio between nominal and real GDP.
DrawbackIt reflects the changes in export prices whilst excluding imports prices
Compare the different measures of inflationPPI-cost of productionCPI- cost of livingGDP deflector indicate inflation rate
When used together , they don’t show the same results and the average index- tend to become smaller over time.
Explain the reasons of calculating core Inflation rate Is estimated by excluding items from the CPI basket on basis that their prices are volatile,
and are subject to temporary influences ,Gov. interventions and policy. To capture the underlying inflationary pressures in the economy.
Example Fresh and frozen(highly volatile)
Fruits, nuts, vegetables, meat and fish. Interest rates on mortgage/overdraft/personal loans.
(to eliminate the effects of changes in monetary policy). Value-added tax
(to eliminate the distorting effects of changes in VAT)Explain why policymakers regard inflation as a problem
Distribution effect Inflation affects the
Redistribution between creditors and debtors.Debtors benefit at the expense of creditors.1. when the real value of money falls, the prices increase.2. If interest rate is lower than the inflation rate, the creditor receives less
real interests.so the real value of the lenders wealth declines and the interest income he receives is not enough to compensate for the inflation.
Redistribution of income and wealth from the elderly to the young.As young people tend to borrow-mortgage bonds and elders tend to save in banks-pensions.
Redistribution from the private sector to the government.Government gains at the expense of holders of public debt.Bracket creep- from the taxpayers to government via progressive income tax.
Economic effects
Anticipating inflationMay result in lower economic growth and higher unemploymentDecision makers in the private sector are more concerned about it, than to seek profitable opportunities.
Speculative practices and discourage savingsOutwitting each other in shares discouraging fixed deposit savings and pension fund contributions.
Balance of payments problemsIncrease in cost of exports industries
Loss of international competiveness.
Social and political effectsRegarded public enemy number one
Leads to feeling of uncertainty and despair.Complicated budgeting process for households.Creates a climate of conflict and political unrest.
Difference between demand-pull Demand- pull :
occurs when the aggregate demand for goods and services increase while the supply remains unchanged.The excess demand pulls up the prices of goods and services.
Cause of demand-pull.-increase in money supplyConsumption spending-H
Cheaper credit interest ratesAvailability of credit
Investment spending-F-Improvement in business sentimentsLower interest rates
Government spendingCombat unemploymentProvision of better service to the population.
Export earningsImprovement of economic conditions in the rest of the world.Increase in prices of important export products.
Have to apply restrictive monetary and fiscal policiesEntails raising interest rates and limiting the increase in the money supply.Entails reduction in government spending or increased taxation.
This will reduces the availability of credit to the various sectors and reduce aggregate demand.Course prices to fall and thus, employment, production, income will fall.
Cost-push inflationIncrease in the cost of production that push up the price level.
Apply income policiesGovernment intervenes in the determination of wages and salaries ,entails workers and firms to limit their profit margins/ wage increase.Formulations of guidelines or compulsory control measures.
Courses Increase in wages and salariesCost of imported capital and intermediate goods
Depreciation of domestic currencyIncrease of imported goods.
Increase in profit marginsBy passing the cost to consumers.
Decreased productivityWhilst remuneration remain the same cost of output increases.
Natural disastersRaise agricultural prices.
Measures against cost-pushControl the increase in wages and salaries and profits.Increase productivity.
The impact of measure taken to get rid of demand-pull and cost-push inflation.Describe what methods can be used to get rid of cost-push inflation
Unit 10Unemployment and the Phillips curve
Define the rate of unemploymentAccess how many people want to work and can’t find a job. The number of unemployed persons can then be expressed as a percentage of the total number of people who are willing and able to work
Identify the cost of unemployment Loss of income, shock and frustration. Hunger, cold, ill health and even death. Psychological costs, demoralizing, loss of confidence. Divorces , suicides and criminal activity. Loss of experience, skills and human development Loss to society, political structures, financial strain on government.
Explain
The difference between the different types of unemployment.Frictional
Cyclical/demand-deficiency. Related to the fluctuation in the general state of the economy
When there is a lack demand for goods and services, increase in unemployment due to recession.
Structural Confined to certain industries, occurs when there is a mismatch between workers
qualifications and job requirements. Lack of education Changes in production method- technologically unemployed. Changes in consumer preferences Foreign competition-globalization. Structural decline in certain industries. Discrimination
Seasonal Hired only at certain seasons of the year- father Christmas.
Frictional unemployment/ search employment. Temporal unemployment whilst you search.
Suggest policies to tackle the unemployment problem.Supply side
Limit population growth Limit immigration opportunities Improve the quality of labor
Demand side Increase the labor intensity of production. Stimulate consumption and investment Increase the demand of domestically produced goods and services. Increase demand for exports. Special employment programs Small business and informal sector
Diagrams
The Phillips curve figure 22-2-3
Calculate The unemployment rate(stock)
Unemployed people/100 times the labor force (EAP)
Unit 11.Define economic growth
Annual rate of increase I total production or income in the economy Provided the income/production measured in real terms. Figures are adjusted for population growth.
List the problems associated with the use of GDP Non-market production
It’s difficult to measure the value of activities that are not sold in the market
Un-recorded activity Informal sector- drugs and tax evasion.
Data revision New data becomes available frequently
Economic welfare Doesn’t take into account pollution, congestion and noise. Difficulty to account for changes in quality of goods. Don’t take into account the distribution of production and income.
Define business cycleIs a pattern of upswing and downswing cycles that can be discerned in economic activity over a number of years.
Name the elements of a business cycle Trough Upswing-expansion/boom. Peak Downswing-contraction/recession.
Business cycle diagram
Identify sources of economic growth from the supply sideNatural resourcesLabourCapitalEntrepreneurship
Identify sources of economic growth from the demand side.Domestic demandExport demandsImport substitution
Explain the importance of using real per capita when measuring economic growthDiagram