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Economics 1B notes and exercises

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 Production creates income and this income is then spent to purchase
products
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 One problem is how the income is distributed among the various
participants in the economy
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 Stock variable – can only be measured at a particular point in time and
has no time dimension (wealth, assets, liabilities, capital, population, and
balance on savings account)
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 In mixed economy households, firms, government and foreign sector are
all participants
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1
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 Can be an individual, whole family
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 Consumption – the act of using or consuming goods and services
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In a market economy it is the households or consumers that largely
determine what should be produced
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Households sell their factors of production to firms that convert them into
goods and services
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 Different types of firms are – individuals or sole proprietorship, cc,
companies, partnerships
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 Investment or capital formation = the act of purchasing capital goods
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Goods market – in macroeconomics we treat the goods market as if there were
only one market for all goods and services
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Circular flow of goods and services – the households offer factors of
production for sale on the factor market where these factors are purchased by
the firms
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o These goods and services are offered for sale on the goods market where
they are purchased by the households
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o Firms purchase the factors of production in the factor market
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o The households in turn spend their income by purchasing goods and
services in the goods market
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Government
 Includes all aspects of local, regional, provincial and national government
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 Government includes all politicians, civil servants, government agencies
and other bodies belonging to or under the control of government
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 Government spending is an injection to the circular flow
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 Exports are an injection (sell)
 Imports are a withdrawal (buy)
Symbols
C – Consumer spending -injection
I – Investment
-injection
G – Government spending -injection
X – Exports
-injection
S – Savings
-leakage
T – Taxes
-leakage
Z – Imports
-leakage
Total expenditure = C + I+G+(X-Z)

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4
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 S
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 Balance of payments = various flows between S
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Exports = X, injection into economy, are goods produced within the
country and sold outside the country
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Financial institutions in the circular flow of income and spending – surplus units
= individuals are in a position to save because they spend less (savings is a
withdrawal), deficit units = individuals that spend more than they earn
(investment is a leakage
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2 basic participants are households and firms
Stock variable – eg balance in a savings account on a particular day
Consumption is a flow variable
Capital a stock variable
Members of a household are called consumers
Consumers are rational in other words they will always try to maximize
their satisfaction given the means at their disposal
Households responsible for the spending on consumer goods
Capital goods are purchased by firms
2 sets of markets in the economy – goods markets (market for tomatoes)
and factor markets (labour market)
Firms purchase in the factor markets and sell in the goods market
Households sell in the factor markets and purchase in the goods markets
Major flows associated with the government are – government spending ,
taxes and transfer payments
Taxes = leakage from circular flow of income and spending
Government spending = injection into the circular flow of income
The foreign sector is linked to the domestic flow of income and spending
through imports and exports
Savings , imports , taxes = withdrawal
Investment , exports ,government spending = injection
C = spending by households on consumer goods and services
I = spending by firms on capital goods
G = spending by government on goods and services
X = Spending by foreigners on SA goods and services - (minus) S
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THE MONETARY SECTOR
 Money can be defined as anything that is generally accepted as payment
of goods and services or that is accepted in settlement of debt
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 Barter economy is an economy that operates without money where goods
are exchanges for other goods
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Medium of exchange - Money serves as a lubricant or intermediary to
smooth the process of exchange and to make it more efficient
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Money as a unit of account – is an agreed measure for stating the prices
of goods and services
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Money as a store of value – most common for holding wealth is money
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Most liquid form in which wealth can be kept
4
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Legal tender – means that old notes or coins cannot be refused if they are
tendered as payment
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M3 = M2 – plus all long term deposits of the domestic private sector with
monetary institutions
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A are – South African Reserve Bank
 Demand deposits – are deposits that can be withdrawn immediately by
means of cheque
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South African Reserve Bank (SARB)
 It is most important financial institution
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 Must also perform its function independently and without fear, favour or
prejudice but there must be regular consultation between the bank and the
cabinet member responsible for national financial matters
...
formulation and implementation of monetary policy – repo rate tender
system is the main instrument
2
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3
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maintaining financial stability – (bank supervision , the national payment
system , banker to other banks , banknotes and coins)

The reserve asset position and the credit multiplier
 Each bank has to ensure that it always has sufficient cash reserves
available to provide for cash withdrawals, must provide for the claims of
other banks, which may exceed its own claims
...

 To maintain confidence in the banking system, the monetary authorities
lay down legal requirements stipulating the amount of cash reserves to be
held against the total liabilities of a bank
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R = cash reserves
D = demand deposits
Any increase in demand deposits will raise the required minimum cash
reserves
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 Any increase in demand deposits as a result of an increase in the
provision or use of overdraft facilities forces banks to acquire additional
reserves which have to be borrowed from the SARB at the repo rate
...
As the credit falls so too will the size
of M1
...
Payments for
exports will have a negative impact on the quantity of money
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o The demand for money – is the amount that the various
participants in the economy plan to hold in the form of
money balances
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o 2 basic components of the demand for money are – (a)
the transaction of demand for money which arises from the
medium of exchange function,(b) demand for money as an
asset which arises from the store of value function
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Reasons for holding money are:
(a) Transaction motive – all participants in a money economy hold money as
a medium of exchange
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(b) Precautionary motive (for unforeseen expenditure)
(c) Speculative motive - inverse relationship between the quantities of money
demanded for speculation purposes and the level of the interest rate
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(e) Passive balance = speculative motive
Demand for money or liquidity preference - L = f (Y, i)
I – interest rate
L = quantity of money demanded

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Y = national income
Interest rate – generally described as the price of loanable funds
...

Demand for money is a function of income and the rate of
interest
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Main features of SA monetary policy:
(a) ultimate objective is balanced and sustainable economic growth
(b) intermediate objective is a pre-announced inflation target
(c) operational variable – is short term interest rates , which are governed by
changes in the repo rate
(d) Monetary control system is a classical cash reserve system
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5% of their total liabilities
to the public in the form of cash
...
(mainly government bills and
government bonds)
(c) Other instruments - public debt management, intervention in foreign
markets
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5 percent above liabilities
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(a) cash reserve deposits with SARB
(b) banknotes and coins
(c) gold coin and bullion

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(d) short term treasury bills
(e) short term land bank bills
(f) securities of the reserve bank
(g) government bonds

MULTIPLE CHOICE
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Barter economy – is an economy that goods are exchanged for other
goods
The use of money eliminates the need for a double coincidence of wants
associated with a barter economy
The essential function of money is that it serves as a medium of exchange
When inflation is experienced , money loses some of its usefulness as a
store of value
Money is a financial asset
During inflation it is often more advantageous to keep certain assets than
to keep only money
Demand deposits can be withdrawn immediately by writing a cheque and
therefore demand deposits form part of the quantity of money
3 measures of quantity of money are = M1, M2 & M3
M1 = narrowest measure of money = coins notes and demand deposits
Cash reserve of any S
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3 methods of calculating GDP:
(a) production method (value added)
(b) expenditure method – (final good and services)
(c) income method – (incomes of the Factors of Production)

19
 Prices used to calculate GDP
...
– Market prices, basic prices and factor cost or factor income
...

 GDP at basic prices – other taxes on products + other subsidies on
production = GDP at factor cost
...

& all wages and income of foreigner workers (eg, Lesotho or
Mozambique workers in S
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 GNI = GDP + PRIMARY INCOME RECEIPTS – PRIMARY
INCOME PAYMENTS
 GNI = GDP – NET PRIMARY INCOME PAYMENTS TO THE REST
OF THE WORLD
Expenditure of GDP:
3 methods of calculating GDP:
(a) Production method – measures value added by all participants of the
economy
(b) Income method – measures income received by the different FOP
(c) Expenditure method – measures the spending on final goods and services
by the different participants
 GDP = C + I + G + X – Z (consumption expenditure by household +
investment spending + government spending + expenditure on exports –
expenditure on imports
...
Gross capital formation = no provision has been made for
the consumption of fixed capital
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GDE = C + I + G
 CPI – consumer price index – is an index of the prices of a representative
basket of consumer goods and services
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(b) Gini coefficient
(c) quantile ratio
INCOME DETERMINATION IN A SIMPLE KEYNESIAN MACROECONOMIC
MODEL:
 Macroeconomics is aimed at explaining the functioning of the economy,
predicting what might happen and analyzing economic policy
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Equilibrium occurs when none of the participants have any incentive to
change their behaviour
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The aim of the Keynesian macroeconomic model is to explain how national
income is determined
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There is no government
There is no foreign sector

Prices are given
Wages are given
The money supply and interest rates are given
Spending(demand) is the driving force that
determines the level of economic activity

IMPLICATION
Total spending consists of consumption
spending and investment spending
...

Cannot be used to study inflation
Cannot be used to study the workings of labour
market
Cannot be used to study the financial markets
or monetary policy
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3 characteristics:
(a) consumption increases as income increases – positive relationship
between consumption spending and income
(b) Consumption is p

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