ECS1601/201/2/2019

Tutorial Letter 201/2/2019

Economics 1B
ECS1601

Second Semester

Department of Economics

IMPORTANT INFORMATION:
This tutorial letter contains important
information about your module.

BARCODE
 CONTENTS

1 DISCUSSION OF ASSIGNMENT 01/2019 ...................................................................................... 3

2 DISCUSSION OF ASSIGNMENT 02/2019 ..................................................................................... 4
3 DISCUSSION OF ASSIGNMENT 03/2019 ...................................................................................... 6
4 DISCUSSION OF ASSIGNMENT 04/2019 ...................................................................................... 9

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Dear Student

In this tutorial letter we provide you with the answers to the multiple-choice questions in Assignments 01
to 04, with brief explanations where necessary. In most cases, however, we merely refer you to the
prescribed textbook and/or the study guide. If you have any questions about the answers that are provided,
please discuss them with your fellow students and your e-tutor on the e-tutor website.

All references, unless otherwise indicated, are to the prescribed textbook:

Mohr, P & Associates. 2015. Economics for South African students. 5th edition. Pretoria: Van Schaik.

1 DISCUSSION OF ASSIGNMENT 01/2019

1.1 The correct option is [2]. Refer to pages 46 – 49 for a discussion on the four spending entities in the
economy.

1.2 The correct option is [2]. Refer to pages 42 – 45 for a description of the four factors of production.

1.3 The correct option is [1]. Refer to pages 42 – 44 for a discussion on labour as a factor of production.

1.4 The correct option is [2]. Refer to pages 46 – 48 for a discussion of the role of firms in the economy.

1.5 The correct option is [3]. Refer to page 41 and Box 3-1 for a discussion on the difference between
stocks and flows with examples of both.

1.6 The correct option is [4]. Refer to page 50 for a discussion of the role of households in the factor
market. Also, refer to figure 3-3 of the circular flow of goods and services.

1.7 The correct option is [2]. Refer to page 53 and figure 3-8 of the major elements of the circular flow
of income and spending. The difference between exports and imports is called net exports, which
can be either positive or negative.

1.8 The correct option is [4]. Refer to page 41 and figure 3-1 outlining the three major flows in the
economy.

1.9 The correct option is [4]. Refer to page 52 and figure 3-7 for a discussion of the role of financial
institutions in the circular flow of income and spending.

1.10 The correct option is [3]. Refer to page 51 and figure 3-4 for an outline of the circular flow of income
and spending.

1.11 The correct option is [2]. Refer to pages 256 – 260 for the difference between a barter and monetary
economy and the different measurements of money used in South Africa.

1.12 The correct option is [4]. Refer to pages 262 – 264 and Table 14-1 for the difference between the
demand for active and passive balances and the main determinant of each.

1.13 This question was removed. Refer to the announcement on MyUnisa on this question.
1.14 The correct option is [3]. Refer to pages 257 – 258 and Box 14-1 for a discussion on what money is.

1.15 The correct option is [3]. Refer to page 259 for a discussion on the three measurements of money
in South Africa.

1.16 The correct option is [4]. Refer to page 264 – 265 and figure 14-1 for a discussion on how a change
in the interest rate will affect the demand for money for passive balances or speculative purposes.
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1.17 The correct option is [4]. Refer to pages 261 – 262 for a discussion of the services rendered to the
government by the South African Reserve Bank. (SARB).

1.18 The correct option is [1]. Refer to pages 262 – 264 on how interest rates influence the demand for
money in the economy.

1.19 The correct option is [4]. Refer to page 268 - 271 and Box 14-7 for a discussion of monetary policy
in South Africa.

1.20 The correct option is [1]. Refer to pages 268 – 271 for a discussion on Monetary Policy in South
Africa and the monetary policy instruments used by the South African Reserve Bank to combat
inflation.

2 DISCUSSION OF ASSIGNMENT 02/2019

2.1 The correct answer is option [1].

In the monetary economy, money serves a function of exchange. Therefore, a double coincidence of wants
is no longer required, as it did under the barter economy. Money is also a common form for holding wealth.
However, the disadvantage of holding money is that at times of high inflation money loses its purchasing
power and therefore, is not the most beneficial way of storing wealth. Refer to section 14.1 The function
of money.

2.2 The correct answer is option [5].

M1 includes coins and notes as well as all demand deposits of the domestic private sector with monetary
institutions. All components of M1 are generally available as a medium of exchange (or means of
payment). M2 consists of M1 plus all other short-term and medium-term deposits, which are not readily
available as a medium of exchange. M3 is equal to M2 plus long-term deposits, and it is regarded as the
best measure of developments in the monetary sector. Refer to section14.3 Money in South Africa.

2.3 The correct answer is option [3].

The Reserve Bank acts as a banker to other banks. It also provides liquidity or lends money to banks
experiencing liquidity problems. The main instrument used when Reserve Bank extends credit or provide
liquidity to other banks is the repo rate. Refer to section 14.8 Monetary policy.

2.4 This question was removed. Refer to the announcement about assignment four on myUnisa.

2.5 This question was removed. Refer to the announcement about assignment four on myUnisa.

2.6 The correct answer is option [4]

Money supply increase when banks create deposits by making loans. The money creation process
depends on the interest rate and cash reserves. South African Reserve Bank (SARB) regulates the amount
of money that is created by banks by affecting the demand for loans via repo rate (i.e., interest rate or
price of loan) and by setting the cash reserve which banks are obliged to hold with the Reserve Bank.
Banks are obliged to hold a certain percentage of their total liabilities to the public in the form of cash
reserves. That is, the total amount of loans created will be determined by cash reserve.

To decrease the money supply, the SARB could increase the interest rate or sell the securities. When
interest rate increase, the cost of borrowing will rise and discourage borrowing. Therefore, the money
supply will decrease.

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When banks buy securities from SARB, they use cash to pay for these securities. This reduces banks’
cash reserve and therefore the total amount of loans they create, which lead to a decrease in the money
supply will decrease.

2.7 The correct answer is option [5].

The demand for money is dependent on the changes in income. That is, a change in income will influence
the demand for money, including for demand for money for speculative motives. For instance, when
income increase, people tend to demand more money for both transactions and speculative motives.
Interest rate is inversely related to the demand for money, including demand for money for precautionary
motive. For example, when interest rate increase, people tend to hold less money and more bonds in order
to earn interests.

2.8 The correct answer is option [4].

Fiscal policy is the use of taxes and government spending to affect economic activity. It can be used to
affect the level of income and the aggregate demand for goods and services in the economy. For example,
any change in taxes and government spending will affect the quantity of goods and services demanded in
the economy. Refer to section 15.8 Fiscal policy and the budget.

2.9 The correct answer is options [3].

Private market systems generally produce relatively efficient outcomes, but they often do not produce
equitable and sufficient outcomes. Market failure occurs when the market system is unable to achieve an
efficient allocation of resources. Since we cannot rely on the market system only to achieve efficiency, the
need for government intervention arises. The explanation of how government intervenes is provided in
section 15.5, from page 286 to 287.

2.10 The correct answer is option [3].

The difference between government spending and tax revenue is called the budget deficit. The budget
surplus results when tax revenue is greater than government spending.

2.11 The correct answer is option [4].

If the government wishes to reduce the budget deficit, it can either cut spending or raise taxes (to increase
tax revenue).

2.12 The correct answer is option [4].

Public goods are goods that are shared or consumed by large groups of consumers including both payers
and those who do not want to pay. Mostly, the government provides public goods. One of the
characteristics of a public good or service is non-exclusion. It is difficult and costly to exclude anyone from
consuming a public good. Table 15-1(four types of good) list excludable and non-excludable goods.

Tax avoidance refers to the practice of exploiting tax loopholes to pay lower tax or not pay tax at all. This
is legal, but it lowers the government’s tax revenue.

2.13 This question was removed. Refer to the announcement about assignment four on myUnisa.

2.14 The correct answer is option [4].

Absolute advantage is not a prerequisite for international trade. Trade can also be beneficial when one
country is more efficient in the production of both goods. All that is required for both countries to benefit
from trade is that the opportunity costs of production differ between the two countries (refer to feedback
for question 2.15 and 2.16 below). Thus, comparative advantage is a prerequisite for international trade.

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One of the main reasons why countries trade is because they have different factors of production. In the
case of natural resources, no country possesses every natural resource available in earth. Refer to section
16.2 why countries trade.

2.15 The correct answer is option [4].

It takes 100 men to produce 100 cement or 150 paint in country X, while in country Y it takes 100 men to
produce 40 cement and 120 paint. Based on this information, it takes fewer resources in Country X to
produce cement and paint. Therefore, Country X has an absolute advantage over Country Y in the
production of both goods.

To produce one unit of cement, Country X has to give up 1,8 units of paint. Therefore, the opportunity cost
of one unit of cement in Country X is equal to 1,8 units of paint. To produce one unit of cement in Country
Y, 3 units of paint have to be given up. Therefore, the opportunity cost of producing one unit of cement in
Country Y is 3 units of paint. The country that has to give up the least paint to produce one unit of cement
(i.e. the country where the opportunity cost of producing cement is the lowest) should specialise in cement.
Therefore, Country X has a comparative advantage in cement.

2.16 The correct answer is option [3].

We can also determine that Country Y has a comparative advantage in producing paint. To produce one
unit of paint, Country X has to give up 0,67 units of cement. Country Y has to give up 0,33 units of cement
to produce one unit of paint. Therefore, the opportunity cost of producing paint is lower for Country Y and
thus Country Y will specialise in producing paint.

2.17 This question was removed. Refer to the announcement about assignment two on myUnisa.

2.18 The correct answer is option [3].

Demand for a dollar would increase if more South Africans travelling to the USA. This is because they will
need dollars to transact while in USA. Options [1],[2] and [4] will lead to a decrease in supply of dollar.
Refer to section 16.4 Exchange rates.

2.19 The correct answer is option [3].

When SARB buys the dollars in the foreign exchange market, the demand for dollar will increase and shift
the demand curve for dollar to the right. The price of a dollar in terms of the rand will increase, indicating
a depreciation of the rand against dollar.

2.20 The correct answer is option [1].

An appreciation of the rand against the dollar means that the price of one dollar in terms of the rand has
decreased. This will stimulate the imports priced in dollar and dampens the exports priced in rand. When
rand appreciates against the dollar, imports become cheaper and exports more expensive. When the
country’s imports are more than its exports, the balance of payment will worsen.

3 DISCUSSION OF ASSIGNMENT 03/2019

3.1 The correct option is [3].

According to the simple Keynesian model aggregate demand is the driving force that determines the level
of economic activity (production). Options [1], [2] and [4] are incorrect.

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3.2 The correct option is [1].

According to Say’s, total income and production will always equal total spending, all leakages will
automatically find their way back into the circular flow of income and spending. Refer to section 17.1 of
the textbook.

3.3 The correct option is [4].

The simple Keynesian model cannot be used to study inflation, monetary policy and explain the working
of the labour market. Refer to box 17-2

3.4 The correct option is [1].

The consumption function includes both autonomous consumption and induced consumption.
Autonomous consumption is independent of the level of income, while induced consumption depends on
income and the marginal propensity to consume.

3.5 The correct option is [2].

𝐶 = C + cY
C = 500 + ¾ (1000) = 1250

3.6 The correct option is [3].

¾ 𝑥 1000 = 750

3.7 The correct option is [1].

The level of investment is negatively related to interest rates, as interest rates increase, investment
spending decreases and vice versa. Refer to section 17.4 of the textbook.

3.8 The correct option is [3].

Option [1] is incorrect, aggregate demand is greater than aggregate supply when the aggregate spending
function is above the 45- degree line. Option [2] is incorrect, disequilibrium is at any point where the 45-
degree line does not intersect with the aggregate spending function. Option [4] is also incorrect, excess is
supply when the aggregate spending function is below the 45- degree line and excess demand is when
the aggregate spending function is above the 45- degree line.

3.9 The correct option is [1].

To obtain the equilibrium level of income, the autonomous aggregate spending is multiplied by the
multiplier.

3.10 The correct option is [2].

1
𝑌0 = 1−0.75 (2000 + 6000)
1
= (8000)
0.25
= 4 (8000)
= 32000

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3.11 The correct option is [4].
1 1 1
𝛼 = 1−𝑐 = 1−0.75 = 0.25 = 4.

3.12 The correct option is [1].

A decrease in investment will decrease aggregate spending leading to a decrease in the equilibrium level
of income.

3.13 The correct option is [1].

Government spending is a politically issue, that is, it is independent on the level of income, thus in the
Keynesian model government spending is thus autonomous.

3.14 The question was removed and students was credited for this mistake as none of the alternatives is
correct.

3.15 The correct option is [4].

1
𝑌0 = 1−0.857 (1−0,125)
(300 + 200 + 600 − 100)

1
= 1−0.857 (0,875)
(1000)

1
= 1−0.75
(1000)

1
= 0.25
(1000)

= 4 (1000)

= 4000

3.16 The correct option is [2].

A=C+I+G+X–Z
= 300 + 200 + 600 – 100
= 1000

3.17 The correct option is [3].

In this question, we provided the MPS, to calculate the multiplier; we first need to determine the MPC

MPC + MPS = 1
MPC = 1 – MPS
MPC = 1 – 1/7
MPC = 6/7 or 0,857

Once you have determined the MPC, compute the multiplier

1 1 1 1 1 1
𝛼 = 1−𝑐 (1−𝑡) = 1−0.857 (1−0,125) = 1−0.857 (0,875)
= 1−0.75
= 0.25
= 0.6 = 4

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3.18 The correct option is [2].

MPC + MPS = 1
MPC = 1 – MPS
MPC = 1 – 1/7
MPC = 6/7 or 0,857

3.19 The correct option is [4].

𝑌𝑓 − 𝑌0 6000 − 4000 2000

= = = 500
𝛼 4 4
3.20 The correct option is [1].

A decrease in net exports will decrease aggregate spending, leading to a fall in the equilibrium level of
income. Options [2] and [3] are incorrect, an increase in the tax rate will decrease the size of the multiplier.
Option [4] is also incorrect, an increase in net exports will increase the equilibrium level of income.

4 DISCUSSION OF ASSIGNMENT 04/2019

4.1 The correct option is [3]. The AD-AS model deals with the general price levels and the total
production of goods and services in the economy, instead of the price and quantity of a single good
or service.

Option [1] is incorrect, the AS curve illustrates the various levels of output which will be supplied at
different price levels. Option [2] is incorrect; the AD curve indicates the levels of total expenditure or
aggregate demand at various prices. Option [4] is incorrect. The change in the general price level is
determined within the AD-AS model. Refer to section 19.1 (The aggregate demand-aggregate supply
model).

4.2 The correct option is [2]. An increase in wages leads to a rise in the cost of production in the domestic
economy, illustrated by an upward (leftward) shift of the AS curve. Refer to table 19-2 (Impact of key
changes on the aggregate supply curve).

Option [1] is incorrect. A decrease in the general price level will lead to a downward movement along
the curve. Option [3] is incorrect. An increase in taxes will decrease the total spending or aggregate
demand in the economy, illustrated by a leftward shift the AD curve. Option [4] is incorrect. A
decrease in the costs of producing and providing goods and services in the economy will lead to an
increase in aggregate supply and downward shift (to the right) of the AS curve. Refer to section 19.1
(The aggregate demand-aggregate supply model).

4.3 The correct option is [2]. Refer to table 19-1 and 19-2 (Impact of key changes on the aggregate
demand curve and aggregate supply curve). Government spending has an impact on the AD curve.
Any change in government spending will affect the quantity of goods and services demanded in the
economy and will be reflected in a shift of the AD curve. Options [1], [3] and [4] are incorrect because
they affect the costs of production and hence the aggregate supply. Refer to section 19.1 (The
aggregate demand-aggregate supply model).

4.4 The correct option is [4]. A change in imports affects net exports. As imports decrease, net exports
increase. This will be reflected by a rightward shift of the AD curve. Refer to table 19-1 and section
19.1 (The aggregate demand).

4.5 The correct option is [3]. When the economy is experiencing inflation that is accompanied by
increased unemployment, we have here a situation of stagflation, which is illustrated by a leftward
(upwards) shift of the AS curve. Therefore, a solution is to take steps to lower costs of production
and/ or increase productivity. Theoretically, this can be realized through anti-inflationary incomes

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 policy. Lower costs of production and/ or improved productivity can be illustrated by a downward
(rightward) shift of the AS curve indicating a fall in the price level (or inflation) and unemployment
rate.

Options [1] and [4] are incorrect. Monetary and fiscal policy influence the AD curve and they cause
a policy dilemma. Refer to section 19.1 (The aggregate demand-aggregate supply model)

4.6 The correct option is [4]. The monetary transmission mechanism shows how changes in the
monetary sector are transmitted to the rest of the economy. In symbols, the transmission mechanism
can be summarized as follows: ∆i→∆I→∆A→∆Y , where i is the interest rate, I is investment
spending, A is aggregate spending, and Y is total production and income. Thus, transmission
mechanism shows a chain of events of how a change in interest rate affect investment spending,
aggregate spending, and total production and income. Figure 19-7 illustrates the monetary
transmission mechanism. Figure (a) shows that there is inverse relationship between interest rate
and investment spending. That is, as interest rate decrease, investment spending increases. Figure
(b) indicates that an increase in investment spending, through the multiplier, lead to an increase in
aggregate spending and total production and income. Figure (c) illustrates that an increase in
aggregate spending, which causes an increase in aggregate demand, results in increases in the
price level as well as in total production and income.

4.7 The correct option is [3]. A simultaneous decrease in output and price level in the economy is
illustrated by a leftward shift of the AD curve. From the alternatives given, only contractionary
demand management policies (i.e., contractionary fiscal or monetary policy) will lead to a leftward
shift of the AD curve. Contractionary fiscal policy refers to a decrease in government spending or
increase in taxes, while contractionary monetary policy refers to an increase in interest rate. Both
policy actions reduce the aggregate demand in the economy, illustrated by a leftward shift of the AD
curve.

Both option [1] and [2] will tend to result in lower aggregate supply and this will be reflected in a
leftward shift of the AS curve. Option [4] will tend to result in lower costs of production, increase in
aggregate supply and this will be reflected by a rightward shift of the AS curve. Refer to the section
on changes in aggregate demand, pages 365 to 366.

4.8 The correct option is [3]. Demand-pull inflation occurs when aggregate demand in the economy
increases while aggregate supply remains unchanged. As aggregate demand increase, while
aggregate supply remains unchanged, price level increases (i.e., inflation). That is, excess demand
(which occurs when demand is greater than supply) pulls up the prices of goods and services. In the
AD-AS model, this will be reflected by a rightward shift of the AD curve. Therefore, any factor and/or
policy action that causes the AD curve to shift to the right will also cause demand-pull inflation, ceteris
paribus. This includes expansionary policy action such as an increase in government spending, a
decrease in taxes, and a decrease in interest rate. Other factors include an increase in investment
spending, consumer spending and export earnings.

Option [1] is incorrect. Demand-pull inflation is reflected by a rightward shift of the AD curve, which
is accompanied by an increase in price level and employment (or a decrease in unemployment).
Option [2] is incorrect. Demand-pull inflation can be combated by restrictive monetary and fiscal
policies. The restrictive monetary policy entails increasing interest rates, and restrictive fiscal policy
entails reducing government spending and/or increasing taxation. Option [4] is incorrect. A situation
of Stagflation is shown by a leftward shift of the AS curve. Therefore, cost-push inflation provides a
good explanation for the phenomenon of stagflation since it is also illustrated by a leftward shift of
the AS ¬curve (see figure 20-2). Refer to section 20.4 (the causes of inflation).

4.9 The correct option is [4]. Refer to figure 20-2. Both cost-push inflation and stagflation are reflected
by a leftward shift of the AS curve, which is accompanied by a higher price level and unemployment.

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Option [1] is incorrect. To address cost-push inflation, measures must be taken to avoid increases
in the costs of production and/or to increase productivity. One of the possible solutions is to apply
the incomes policy. The benefit of incomes policy is that it reduces price level while increasing
employment (or reducing unemployment). Therefore, option [2] and [3] are incorrect.

4.10 The correct statement is [2]. Refer to section 21.1 (types of unemployment).

4.11 The correct statement is [3]. Refer to section 21.1 (types of unemployment).

4.12 The correct option is [3]. Refer to section 21.1 (types of unemployment).

4.13 This question was removed. Refer to the announcement about assignment four on myUnisa.

4.14 The correct statement is [4]. Economic growth refers to an increase of real output (GDP) or real GDP
per capita. When calculating economic growth two bases that are used are real GDP (GDP at
constant prices) and real GDP per capita (GDP at constant prices, adjusted for population growth.
Refer to section 22.1 (some problems associated with GDP and calculation economic growth)

4.15 The correct statement is [2]. GDP is first measured at current prices. To measure economic growth,
we use GDP at constant prices (or real GDP). Therefore, GDP at current prices (or nominal GDP)
must be transformed to GDP at constant prices (or real GDP). This is done to eliminate the effects
of inflation.

4.16 The correct option is [3]. Nominal GDP in 2016 = (1000*2) + (500*10) = 7,000.

4.17 The correct option is [4]. Since 2016 is a base year, we use 2016 prices to calculate real GDP for
2017. Real GDP in 2017 = (1,100*2) + (525*10) = 7,450.

4.18 The correct answer is [4].

The nominal GDP for 2016 is 7,000 and for 2017 is 7,500 (=(1,100*3) + (525*8)).

The nominal GDP growth rate is calculated as follows:

= (nominal GDP 2017-nominal GDP 2016)/(nominal GDP 2016)

= (7,500-7,000)/7,000=7,14%

4.19 The correct option is [2]. Refer to section 22.2 (the business cycles)

4.20 The correct answer is [2]. Refer to section 22.3 (sources of economic growth)

We wish you all the best in your preparation for the examination.

From the ECS1601 team

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