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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)
...

 In mixed economy households, firms, government and foreign sector are
all participants
...

1
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 Can be an individual, whole family
...

 Consumption – the act of using or consuming goods and services
...

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
2
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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
...

Goods market – in macroeconomics we treat the goods market as if there were
only one market for all goods and services
...

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
...

o These goods and services are offered for sale on the goods market where
they are purchased by the households
...

o Firms purchase the factors of production in the factor market
...

o The households in turn spend their income by purchasing goods and
services in the goods market
...
Government
 Includes all aspects of local, regional, provincial and national government
...

 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
...

 Balance of payments = various flows between S
...

Exports = X, injection into economy, are goods produced within the
country and sold outside the country
...

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
...


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
...

 Barter economy is an economy that operates without money where goods
are exchanges for other goods
...
Medium of exchange - Money serves as a lubricant or intermediary to
smooth the process of exchange and to make it more efficient
...
Money as a unit of account – is an agreed measure for stating the prices
of goods and services
...
Money as a store of value – most common for holding wealth is money
...

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
...

M3 = M2 – plus all long term deposits of the domestic private sector with
monetary institutions
...
A are – South African Reserve Bank
 Demand deposits – are deposits that can be withdrawn immediately by
means of cheque
...

South African Reserve Bank (SARB)
 It is most important financial institution
...

 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
...

3
...
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
...

R = cash reserves
D = demand deposits
Any increase in demand deposits will raise the required minimum cash
reserves
...

 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
...

o The demand for money – is the amount that the various
participants in the economy plan to hold in the form of
money balances
...

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
...


Reasons for holding money are:
(a) Transaction motive – all participants in a money economy hold money as
a medium of exchange
...

(b) Precautionary motive (for unforeseen expendi

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




There is an inverse relationship between the interest rate and the quantity
of money demanded for speculative purposes
The total quantity of money demanded depends on the level of income
and the interest rate
...

Policy is formulated and implemented by the SARB

THE PUBLIC SECTOR





Central government – concerned with national issues
Regional government – concerned with regional issues
Local government – local issues
Public corporations – Eskom etc

Market failure – occurs when the market system is unable to achieve an efficient
allocation of resources, best available outcome was not achieved
...

(b) Public goods – failure of the market to provide sufficient quantities of
goods and services
...
A good is excludable if it is possible or not prohibitively costly and
is non-excludable if once it has been produced there is no way of stopping
anyone from consuming it
...
Common property
resources (wildlife, marine resources) = rivalrous but non-excludable
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(c) Externalities – external costs = negative externalities, external benefits =
positive externalities
...
Principle – agent problem managers have
more information of the business than its owners
...
Therefore common resources are
overexploited even to the extent of destruction (tragedy of the common)
...
This can be achieved by public
ownership or by public financing
(b) Market participant – government employs the largest employees in the
labour market and can therefore influence other employers through its
wage policy and employment practices
...

(d) Taxation – primary purpose is to finance government spending
...





Nationalisation – means th
reflect changes in society priorities but could also be the result of the
influence of powerful special interest groups
...
Political shocks and other major disturbances could exert strong upward
pressure on government spending
...
excessive or unrealistic expectations about what government can deliver
could exert upward pressure on real government spending
12
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The budget deficit or surplus is the difference between government
spending and current revenue –mainly taxes
...
If government finances part of its spending by borrowing from the central
bank this is called inflationary financing
...
taxes that distort relative prices inhibit the functioning of the market
mechanism and are not neutral
16
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17
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a tax is progressive is lower income groups pay a smaller % of their
taxable income in the form of tax than higher income groups

FOREIGN SECTOR
 One of the basic reasons for international trade is the fact that factors
of production (natural resources, labour, capital and entrepreneurship)
are not evenly distributed among the nations of the world
 Absolute advantage – this is when a country requires fewer
resources to produce a specific goods, they therefore have the
absolute advantage in that industry
...

Comparative or relative advantage – each country will tend to specialize in and
export those goods for which it has a comparative advantage
...
Heckscherohlin theory – each country will tend to export those goods that most
intensively use the country’s relatively abundant resources
...
Used to protect domestic firms against competition from
imports(protective tariffs) or to raise government revenue (revenue tariffs)
(b) Specific tariffs – is a fixed amount that is levied on each unit of the
imported commodity
...

(d) Revenue tariffs – usually imposed on items that are not produced in the
domestic economy
...

Economic impact of an import tariff:






Quantitative restrictions – import quotas - aims at influencing the
prices of imported goods and control the level of physical of
imports
...

Export subsidies
Infant industries
Employment
Government revenue
National security

Arguments against trade barriers:




Retaliation by trade partners
Welfare cost to society
Inefficiency

Trade policy on S
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It is a systematic statiscal account of all the
economic transactions between the residents of a country and the
residents of other countries in a specific period

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