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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
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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
...

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
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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
...

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
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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
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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
...

 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
...

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
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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
...

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 expenditure)
(c) Speculative motive - inverse relationship between the quantities of money
demanded for speculation purposes and the level of the interest rate
...

(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
...

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
...
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
...
5 percent above liabilities
...

(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
...

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 demanded curve
Monetary policy can be defined as the measures taken by the monetary
authorities to influence the quantity of money or the rate of interest with a
view to achieving stable prices, full employment and economic growth
...

5 reasons for market failure:
(a) Monopoly and imperfect competition – options are – do nothing, impose
price controls, tax the full excess profits, and regulate monopoly through
competition policy
...
A good is rivalrous in consumption if no two persons
can consume the same unit of a good and is non-rivalrous in consumption
if its consumption by one person does not reduce its consumption by
others
...
Normal goods or pure private goods (fruit,
shirts, computers) = rivalrous and excludable
...

mixed goods (museums , cinemas)= excludable & non-rivalrous , public
goods (street lights , basic research)= non rivalrous and non-excludable
...

(d) Asymmetric information – to make informed choices the households and
firms must have all information
...


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(e) Common property resources – belong to no one and no one can be
excluded from using them, however one person’s use of them reduces the
availability to other persons
...

FURTHER REASONS FOR GOVERNMENT INTERVENTION:
(a) income distribution – free markets tend to generate unequal income
distribution
(b) macroeconomic growth and stability – free markets tend to fall short of
achieving rapid economic growth , full employment and price stability and
therefore government intervention in needed
(c) merit goods – can be defined as goods that are regarded as so beneficial
to society that everyone should be in a position irrespective of their
income to receive or consume them
(d) allocative function – achieving more efficient allocation of resources
(e) stabilization function – measure taken by government to promote
macroeconomic stability
(f) distributive function – steps taken by government to achieve a more
equitable or socially acceptable distribution of income than that generated
by market forces
HOW DOES THE GOVERNMENT INTERVENE?
(a) Public provision – of goods and services
...

(c) Government spending – government makes transfer payments – this is
payment for which it receives nothing
...

GOVERNMENT FAILURE:
Governments also fail with their intervention
...

Commercialization or corporatization – means the transformation of state
owned enterprises into commercial entities, subject to commercial legal
requirements and governance structures
...
Its main instrument is the
budget and main policies are government spending and
taxation
...

 Budget deficit = difference between government spending
and taxation
...

Government spending:
Important components of total spending are:
(a) Changing consumer preferences :
(b) redistribution of income
(c) misconceptions and entitlement
(d) population growth and urbanization
Financing of government spending:
(a) income from property – interest , dividends , etc
(b) Taxes – compulsory payments to government (types of taxes – direct and
indirect taxes, general and selective taxes, progressive, proportional and
regressive taxes
...
This deficit is financed by
borrowing
...
Taxes are compulsory and are the largest
source of government revenue
...

Types of taxes
 Direct and indirect taxes:
o Direct tax – taxes on income and wealth and indirect tax is taxes on
goods and services or taxes on production and products
...
(Tobacco and alcohol)
 Progressive and proportional and regressive taxes:

14

o
o
o

o
o
o

o Progressive – ratio of tax paid to taxable income increases as
taxable income increases – higher bracket income earned higher
percentage tax is paid
proportional – ratio tax paid to taxable income is the same at all levels
of income
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Personal income tax – most important form of direct tax in S
...

Marginal tax rate is the rate at which each additional rand of income is
taxed
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Average tax is also called the effective tax rate
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Company tax – STC – proportional tax – this tax is levied on all profits
distributed to shareholders in the form of dividends
VAT – most important indirect tax in S
...
– regressive tax
...
general government consists of central , provincial and local government
2
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3
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4
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5
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6
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7
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Government could use the budget to try to influence variables such as
total production, income, employment and to redistribute income in the
economy
...
Changes in level and composition of government spending sometimes
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
...
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:
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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:
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Retaliation by trade partners
Welfare cost to society
Inefficiency

Trade policy on S
...
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
...
Net gold exports are reflected separately because gold is
our most important export and plays a very significant role in the
international monetary system
...
A)
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(b) capital transfer account – relatively insignificant
(c) Financial account – records all international transactions in assets and
liabilities
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(iii)
Other investment – residual category all other financial transactions
loans, currency, and deposits
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(d) Unrecorded transactions – all errors and omissions that occur in compiling
the other individual components of the bop are recorded here
...

o gold and other foreign reserves – most important total in the
balance of payments because – they reflect the overall balance of
payments position , since payments and receipts of foreign
currency do not necessarily coincide(large difference from week to
week) , foreign reserves are required to ensure a smooth flow of
international trade and finance
...
Change in net gold and other foreign
reserves = combined balance of balances(BOP)
...

Appreciation – increase in price of a currency in relation to another
Depreciation – decrease in the price of a currency in relation to another
...

 Equilibrium exchange rate – is the rate at which the quantity of dollars
demanded equal the quantity of dollars supplied
...

 A central bank can only intervene to stabilize a depreciating currency
of it has sufficient foreign reserves to do so
...

 Terms of trade – ratio between export prices (expressed as an index)
and import prices (also expressed as an index)

MEASURING THE PERFORMANCE OF THE ECONOMY
Macroeconomic objectives (5):
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Economic growth
Full employment
Price stability
Balance of payments stability (or external stability)
Equitable distribution of income

GDP – gross domestic product: is the total value of all final goods and services
produced within the boundaries of a country in a particular period (usually one
year)
...

 When GDP is measured the prices used for that specific period must be
used
...

 GDP at market prices - taxes on products + subsidies on products
= GDP at basic prices
...

 GDP at factor cost + other taxes on production – other subsidies on
production = GDP at basic prices
 GDP at basic prices + taxes on production – subsidies on products
= GDP at market prices
 GNI – gross national income = subtract from GDP all profits,
interest and other income earned by residents of other countries
(eg, profit earned by foreign investors in South African companies
...
A gold mines) – add – all above of all
South African investors in overseas companies and South African
workers working abroad
...

 Capital formation – additions to the countries capital stock, purchase of
capital goods
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 GDE – gross domestic expenditure – indicates the total value of spending
on goods and services produced in the country
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Measuring inequality of the distribution of income:
(a) Lorenz curve – simple graphic device which illustrates the degree of
inequality in the distribution of income
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 Equilibrium is a situation in which there is no tendency for change
...
Things will therefore remain the same (as long as
the underlying forces do not change)
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ASSUMPTION
The economy consists of households and firms
only
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The model cannot be used to analyse
government spending or taxes
Cannot be used to analyse, imports, exports,
exchange rate, trade policy & exchange rate
policy
...

Production (supply) adjusts passively to
changes in spending (demand)

Consumption function – relationship between consumption expenditure by
households and total income
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Consumption = c, income = y

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Autonomous consumption = is that part of consumption that is
independent of the level of income
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Marginal propensity to consume (c) – the ratio change between the
change in consumption and the change in income
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Factors that affect consumption:
(a) interest rate
(b) expectations
(c) wealth
(d) income distribution
(e) Other factor – non income factors – level of taxation
...

Main cause of fluctuations in economic activity
...
Investment thus relates to
capital as a Factors Of Production
...

 The higher the interest rate the lower the expected return – ceteris
paribus
...

The multiplier
 The ratio between the eventual change in income and initial investment is
called the multiplier
...


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 The ratio between the change in income and the change in autonomous
spending is called the multiplier
...

Paradox of thrift
 Refers to the fact that while an individual or single household can increase
its income by saving more, the same result does not hold for society as a
whole
...

Government spending: G
 There is no systematic relationship between government spending and
income – G & Y
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Government spending increases the level of aggregate spending – G
Leaves the multiplier unchanged
Raises the equilibrium level of income ceteris paribus
It follows that increases in government spending can be used to raise the
level of production and income
...
Taxes constitute a withdrawal or leakage
...

 Contractionary fiscal policy – increase in the repo rate
...

 Exogenous – under the control of the monetary authorities
 Endogenous – in the sense being determined by the interaction between
the interest rate and the demand for money
...
Recognition lag – lag between changes in economic activity and
recognition or realization that the changes have occurred
...
the decision lag – ministers and officials from different departments
have to meet to discuss matters and this takes time
3
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Impact lag – a further period lapses before they actually affect
economic behaviour
...

Fiscal policy has generally been more successful in stimulating a depressed
economy, while monetary policy can be employed with greater assurance to
dampen an overheated economy in which inflationary pressures are severe
...

Measurement of inflation:
 CPI – most common used indicator of general price levels
...
For any particular year there are
therefore 12 figures
...

(c) Social and political effects – price increases makes people unhappy and
they then start blaming each group
...
MV = PY
M = the quantity of money
V = the velocity of circulation of money
P = the average price level
Y = the real value of goods and services produced
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Cost push inflation is triggered by increases in the cost if production
...


MULTIPLE Q & A FROM PAST ASSIGNMENTS AND EXAM
PAPERS:
 Most basic function of money is that it functions as a medium of exchange
 When inflation is experienced , money loses some of its usefulness as a
store of value
 The repo rate is the interest at which the reserve bank lends to
commercial banks
...

 Government transaction can exert an influence on the money supply
...

 if government finances part of its spending from borrowing from the central
bank , it is called inflationary financing
 tax evasion is illegal
 personal income tax is S
...

 criteria for good tax are neutrality , equity , compliance costs
 excise taxes are levied on selected products produced locally
 a specific tariff imposed on the imports of motor vehicles will increase the
level of domestic production of motor vehicles
 The law of relative advantage states that 2 countries will benefit from trade
if the opportunity costs of production differ between the 2 countries
...

 The trade balance is the difference in the value of S
...


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a farmer in free state buys a tractor from his neighbor – transaction not
recorded in BOP
In the simple Keynesian model equilibrium is attained where aggregate
demand is equal to aggregate supply
...

according to say’s law supply will create its own demand , at equilibrium
there is full employment
according to the Keynesian model equilibrium does not necessarily imply
full employment
if c = 2/3 then the multiplier is = 3
taxes decrease the size of the multiplier
if aggregate spending is 1200 and aggregate production is 1300 there is
unplanned increase in inventories
negative net exports will shift the aggregate demand curve downwards
if the equilibrium level of income is below the full employment level , full
employment can be reached by increasing autonomous consumption
a change in marginal propensity to consume will change the size of the
multiplier
a decrease in the tax rate will increase induced consumption
Investment is negatively related to the interest rate
...

Negative net exports will shift the aggregate demand curve downwards
...

a simultaneous increase in the price level and the level of production could
be the result of an increase in investment spending
inflation is the continuous and considerable increase in prices in general
demand-pull inflation can be caused by expansionary monetary and fiscal
policy measures
a depreciation of SA rand will increase the price of imported goods
cost-push inflation is triggered by increases in the cost of production
high inflation in SA can damage the countries international
competitiveness
cost-push inflation leads to higher prices , decreased production and
higher unemployment
an increase in the aggregate demand for goods and services can reduce
cyclical unemployment
the costs of unemployment can be reduced through the availability of
unemployment benefits and other social welfare programmes
An increase in aggregate demand for goods and services can reduce
cyclical unemployment
...

a flow variable is measured over specific period
stocks can change as a result of flows
in the circular flow of income and spending savings result in a decrease in
the volume of the income flow
financial institution acts as intermediary between those who save and
those who wish to invest
provincial government = government

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macroeconomic objectives = external stability , full employment ,
economic growth , equitable distribution of income and price stability
GDP defined as the value of all final goods and services produced in the
domestic economy during a specific period
3 ways of calculating GDP = income , expenditure and production
methods
only transactions that represent production of new goods and services are
included in the GDP
When prices increase nominal GDP increases even if the production of
new goods and services does not increase
...

The balance of payments is an important indicator of the state of an
economy
...

The demand for money for speculation purposes is determined by the
interest rate
...
A
to combat unemployment steps must be taken to stimulate the demand for
labour
stricter immigration control could help to combat the unemployment
problem in S
...
A platinum
mine
gdp can be estimated by calculating the total of all factor incomes
an inflation rate is calculated as the percentage change in a price index
from one period to another
the weights used in the calculation of the consumer price index take
account of the relative importance f different goods in the pattern of
consumer expenditure
the real value of money is measured in terms of what it can purchase
a R650 price tag on a pair of shoes is an example of money functioning as
a unit of account

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the repo rate is interest rate at which the reserve bank lends to
commercial banks
VAT systems important purpose is raising government revenue
personal income tax in S
...
A balance of payments will improve
autonomous investment means that investment is independent of the level
of income
if aggregate spending exceeds aggregate production in the simple
Keynesian model unplanned decrease in inventories will occur
a decrease in the budget surplus will lead to an increase in the level of
economic activity
in the simple Keynesian model induced consumption is a function of the
income level
in the simple Keynesian model with a government and foreign sector
government spending is autonomous because it is essentially a political
issue
the assumptions of the AD-As model imply that the model can be used to
study monetary policy
in the AD-AS model a decrease in investment will result in a decrease in
the price level
cost push inflation can be reduced by increasing productivity
stagflation refers to an increase in the price level accompanied by
decreases in real output and employment
the government can worsen inflationary situation if it borrows more from
the reserve bank to finance its expenditure
debtors tend to benefit during an inflationary period since the real value of
their debt tends to fall
cyclical employment refers to employment which occurs during recessions
the opportunity cost involved when a country takes fiscal policy measures
to stimulate economic growth is an increase in the inflation rate
an expansionary fiscal policy would be most likely to reduce
unemployment of the marginal propensity to save is low
a business cycle refers to a recurring sequence of changes in business
activity

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Questions from past exam papers:
1
...

2
...
Money as a unit of account – is an
agreed measure for stating the prices of goods and services
...
It’s
convenient and can be used immediately in exchange for other
assets
...
Mention the three broad ways in which government spending can be
financed
4
...
Distinguish between real and financial transactions
6
...
Explain the difference between direct taxes and indirect taxes – direct
taxes – also called taxes on income and wealth , are levied on
persons and organizations such as companies
...
Indirect taxes –
also called taxes on goods and services or taxes on products and
production are levied on transactions , eg purchase of goods and
services and are usually paid by those who consume the goods and
services (VAT)
8
...
What are the implications of these 2 assumptions
9
...
Explain why policy makers cannot solve the stagflation dilemma using only
demand management policies
11
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12
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FLOW VARIABLE –
can be measured over a period of time (income, profit, loss,
investment)
...
Distinguish between nominal GDP and real GDP
14
...
Describe the cost of unemployment to the society at large – unlike other
factors of production, labour cannot be saved and used later
...

Unemployment is also damaging to the social and political structure
...
In S
...
Unemployment can also lead to an overthrow of
democratic institutions and processes
...
List 3 problems associated with GDP as a measure of total production in
the economy
17
...
Service
to the government (banker and advisor, custodian of gold and
foreign exchange reserves, administration of exchange control
...
maintaining financial
stability – (bank supervision , the national payment system , banker
to other banks , banknotes and coins
...
Define monetary policy - Monetary policy can be defined as the
measures taken by the monetary authorities to influence the quantity
of money or the rate of interest with a view to achieving stable
prices, full employment and economic growth
...
Name 3 important withdrawals from the circular flow of income and
spending
20
...
Mention 3 methods which are used to estimate GDP - production
method (value added), expenditure method – (final good and
services), income method – (incomes of the FOP)
22
...
Explain why government spending is classified as autonomous spending
in the Keynesian model
24
...
What are the determinants of induced consumption in the Keynesian
model of a closed economy with a government sector
26
...
Explain what measures can be taken to get rid of cost-push inflation
28
...
A foreign exchange market – if the demand for
dollars increase because of an increase will cause a change in the
exchange rate, ceteris paribus
...
Name 3 measure used to measure inequality of distribution of income Lorenz curve ,Gini coefficient ,quantile ratio

32
30
...
Gdp is
one of the most important barometers of the performance of the
economy
...
Explain why credit cards are not considered as money – credit cards are
not a medium of exchange
...

32
...
the
decision lag – ministers and officials from different departments
have to meet to discuss matters and this takes time
...
Time to implement these decisions
...

34
...
Main sources are domestic
demand (it is always possible to increase domestic demand by
increasing government spending) , exports (international trade is an
important factor in economic growth

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