Tutorial Letter 201/2/2017: Economics 1B

ECS1601/201/2/2017
Tutorial letter 201/2/2017
Economics 1B
ECS1601
Semester 2
Department of Economics
IMPORTANT INFORMATION:
This tutorial letter contains the answers to assignments 01 to 04
BARCODE
CONTENTS
Page
1 DISCUSSION OF ASSIGNMENT 01/2017 ................................................................................... 3

2 DISCUSSION OF ASSIGNMENT 02/2017 ................................................................................... 7
3 DISCUSSION OF ASSIGNMENT 03/2017 ................................................................................. 10
4 DISCUSSION OF ASSIGNMENT 04/2017 ................................................................................. 14
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1 DISCUSSION OF ASSIGNMENT 01/2017
Dear Student
In this tutorial letter, we provide you with the answers to the multiple-choice questions in Assignment 01,
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, Fourie, L & associates.
2015. Economics for South African students. 5th edition. Pretoria: Van Schaik.
1.1 The correct option is [5].

Refer to Figure 3.1 in the prescribed textbook. The three major in the economy are production,
income and spending. Therefore, none of options [1] to [4] is correct.
1.2 There is no correct option.

A stock variable has no time dimension and can only be measured at a specific moment. Capital,
wealth and population size have no time dimension and they can be measured at a specific moment;
therefore they are stock variables. On the other hand, income, profits, and savings are flow variables.
Flow variables have no time dimension and can be measured over a period of time.

Stock variables have no time dimension, while flow variables have a time dimension. Therefore,
stock variables are measured at a particular point in time, while flow variables are measured over a
period of time.

In economics, the four production factors are as follows:
 Natural resources (land), which are gifts of nature such as mineral deposits, water, arable land,
vegetation, animal life, the atmosphere, etc.
 Labour can be defined as the exercise of human mental or physical effort in the production of
goods and services. It includes all effort exerted with a view to obtaining reward in the form of
income. The efforts of goldminers, rubbish collectors, professional boxers, etc are all classified
as labour.
 Capital comprises of all manufactured resources, such as machines, tools, and buildings,
which are used in the production of other goods and services. Capital goods are not for their
own sake but to produce other goods.
 Entrepreneurs are the driving force behind production. Factors of production have to be
combined and organised by entrepreneurs who see opportunities and are willing to take risks
by producing goods in the expectation that they will be sold.

There are four types of remuneration associated with the different factors of production. The
remuneration for land is rent. The remuneration for labour is wages. The remuneration for capital is
interest and for entrepreneurship, it is profit. See section 3.4 in the prescribed textbook.

In the circular flow diagram, households make consumption expenditure and receive goods and
services. The households offer their factors of production for sale on the factor market where these
factors of production are purchased by firms. The firms combine the factors of production and
produce consumer goods and services. These goods and services are offered for sale in the goods
market, where they are purchased by the households. See section 3.7 in the prescribed textbook.
3
Income consists of the total earnings from all the factors of production. Read the discussion on
production, income and spending in Section 3.2 of the prescribed textbook.

Government spending (G) constitute an addition or injection in the economy, while taxes (T)
constitute a leakage or withdrawal from the circular flow of income between households and firms.
Refer to Figure 3.5 in the prescribed textbook.

Financial institutions are not directly involved in the production of goods. They act as links between
households and firms with surplus funds and other economic participants that require funds, for
example firms that wish to expand their production activities. See Section 3.7 in the prescribed
textbook.

Exports constitute an addition or injection in the circular flow of income and spending in the domestic
economy. A decrease in exports from South Africa will decrease revenues to South African
businesses (firms) and decrease income to South African resource suppliers (households).

Macroeconomics is concerned with the economy as a whole. See Box 1-3 in the prescribed textbook.

Specialisation occurs when workers are allocated specific tasks within a production process. In
market exchange, people may maximise the benefits in the economy. Option [1] is incorrect because
specialisation does not necessarily cause opportunity costs to be equalised. Option [3] is incorrect
because of the following reasons: although the principle of comparative advantage depends on
opportunity cost, comparative advantage is not the same as opportunity cost. Option [4] is incorrect
because the ability of a country to produce higher output due to other factors other than tax rates.
The term “opportunity cost” applies in economics as a whole, which includes macroeconomics and
microeconomics. Therefore, option [5] is incorrect.

Anglo American represents the business sector (firms), which means that it is responsible for
providing goods and services.
Nando’s is an example of a firm, and in the factor market firms pay households for the exchange of
factors of production.
In South Africa, households do influence the financial sector.
If the government pays for Nkandla’s security upgrades, firms will benefit for the services they
provide.

The functions of money are explained in Section 14.1 in the prescribed textbook.

A unit of account is an agreed measure for stating the prices of goods and services. In a money
economy the price of goods and services are expressed in monetary terms. Money (R200) thus
functions as a unit of account.

See section 14.3 in the prescribed textbook.

Refer to Box 14-1 in the prescribed textbook.
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1.18 The correct options are [1] and [5].
Surplus units refer to those who have excess funds (savers/lenders) and deficit units refer to those
who have a shortage of funds (borrowers). Financial intermediaries facilitate indirect lending by
serving as a link between savers and borrowers of funds. The JSE Limited provides a market where
securities can be issued and therefore, it facilitates direct financing – the surplus units buy shares
and bonds from the deficit units.

Setting the fiscal policy is not the function of the South Africa Reserve Bank (SARB). Setting the
fiscal policy is, however, the function of the National Treasury. All the other statements refer to
functions of the SARB – see Section 14.5 in the prescribed textbook.

The SARB uses an accommodation policy to provide liquidity to the banking system; an open market
policy is used to drain liquidity from the system. The SARB has the sole rights to issue and destroy
coins and banknotes. The SARB provides services to the government as its banker and advisor.
Although government keeps bank accounts with private banks, the SARB is still the main banker for
the government. The Minister of Finance in the National Treasury determines the income tax rate
and government expenditure. All the other statements except option [2] refer to functions of the
SARB. See section 14.5 in the prescribed textbook.

The speculative motive for holding money balances suggests that individuals will hold money to
reduce the risk associated with fluctuations in market prices of bonds. The speculative motive is
related to the function of money as a store of value. To understand the speculative demand for
money, we must consider the choice between holding money and holding bonds. See Section 14.6
in the prescribed textbook.

All the statements are incorrect, except for option [4], as a negative relationship exists between
interest rates and bond prices. When the interest rate is higher, the prices of bonds will be lower and
the lower the interest rate, the higher the prices of bonds will be. Therefore, statements [1] and [2]
are incorrect. Refer to Figure 14.2 – the quantity of money is determined by the interaction of the
interest rate and the demand for money. An increase in interest rates will decrease the quantity of
money demanded and a decrease in interest rates will increase the quantity of money demanded.
Therefore, statement [4] is correct.

Panel (a) of Figure 14.1 shows the demand for active balances, while Panel (b) shows the demand
for passive balances. Panel (c) of Figure 14.1 shows the total demand for money.

The term “interest rate” is used to refer to all interest rates as there are numerous interest rates in
the economy. The different interest rates move in harmony with each other. Suppliers of funds charge
interest rate to the borrowers. Therefore, option [2] is incorrect. When transacting, borrowers of funds
consider the interest rate. Thus, option [3] is incorrect. Option [4] is incorrect because interest rates
move in harmony with each other. The exchange rate is not an example of interest rate. Therefore,
option [5] is incorrect.
5
The discussion on “The stock of money: how money is created” shows that banks can create money
by lending to creditworthy borrowers. In order for banks to be able to create loans, they must keep
a fraction of their cash in reserve against the deposits made by customers. Read Section 14.7 in the
prescribed textbook.

The quantity of money is determined by the interaction of the demand for money and the interest
rate. See Figure 14.2 in the prescribed textbook.

All the options are part of the SARB monetary policy framework. Inflation targeting is the monetary
policy framework in which the SARB has set to achieve an inflation target of between 3 and 6 per
cent. The primary objective of the SARB is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. The SARB also determines the repo rate that influences
the interest rate charged by the banks.

The banks keep a minimum cash reserve requirement with the Reserve Bank. The cash reserve can
be used by the banks when they need cash (liquidity) or when there are shortages of funds in the
money market. Refer to Section 14.8 in the prescribed textbook.

Refer to Box 14-5 in the prescribed textbook. The size of money supply increases by the amount of
money that the bank lends to the borrower. Therefore, money supply has increased by R300.

If the SARB wants to expand the money supply, it decreases the interest rate and if it wants to
contract the money supply, it increases the repo rate. When the repo rate increases, the cost of
credit also increases.
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1. The correct answer is option [1].

The government provides goods and services to the public such as national defence, justice system
and infrastructure. For example, Eskom is still the sole provider of electricity in South Africa and is
wholly owned by the government.

A mixed economic system combines both the private and state enterprises to achieve social aims.
In a command economy, the government controls everything: what is produced, when it is produced,
the quantity as well as the price of the goods produced.

Sin taxes are levied on goods that are deemed harmful to society; such goods include tobacco,
alcohol, gambling, etc. The purpose of such tax is to increase the price in order to reduce
consumption or usage of such goods.

The government consists of public officials who are politicians: bureaucrats or civil servants who
have virtues, flaws and motives of their own and try to manipulate to serve self-interest. Politicians
tend to maximise votes while civil servants tend to maximise salaries and their status or power.

Nationalisation means that the government takes over ownership or management of an enterprise
while privitisation is the transfer of ownership of assets from the public sector to the private sector.
When the state buys more than 50% of the stake in a private entity it takes management of that
particular entity, it applies to a private entity buying a state-owned entity.
6. The correct option is option [3].

A contractionary fiscal policy, which results in an increase in taxes and a decrease in government
spending have the following effect: taxes increases result in household and firms having less money
to spend on goods and services, which leads to a decrease in aggregate demand, which then lead
to a fall in prices of goods and services.

Commercial banks are responsible for creating 97% of the money in the world. They create
money in the form of demand deposits when they grant loans. These refer to the electronic money
that appears when you check your bank balance and are done through accounting entries in the
balance sheet of the bank. See page 266 in your prescribed book.
E-filing is a free online process for the submission of tax returns and declarations as well as other
related matters . The online system was introduced at SARS to simplify the administration process,
as documents might go missing when changing hands.

Neutrality implies that taxes should not distort the allocation of resources or take away most of the
factors of production’s income as it would then be desirable for the owners to work less. Vertical
equity implies that economic participants in different financial positions should be taxed differently.
The practice of legally exploiting tax loopholes is called tax avoidance.

Both the government and the private sector have major to play roles in order to ensure or enhance
economic growth and development in South Africa. We have seen the introduction of different taxes
since 1994, for example, the recent sugar tax on soft beverages. Such taxes increases the tax
burden and hurt the poor in the economy.
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Opportunity cost of production means that a country can specialise and be more productive in the
production of a specific good than another, which is being ineffective in the production of such goods
or service in question.

The investment is regarded as foreign direct investment (FDI). It is direct because the investor is
seeking to control, manage or have a significant influence over the foreign enterprise, and it is
recorded under direct investment account of the balance of payments.

The current account records imports and export of goods and services; a positive balance on the
current account implies that exports were more than imports while a negative one implies that
imports were more than exports.

The low value of the rand means that it is cheaper for the United States to buy South African goods
and expensive for South Africans to buy goods from the United States. This leads to an increase in
exports and a decrease in imports.

The decrease in exports means that the will be a lower demand for the rand. The rand will therefore
depreciate against the dollar.

See figure 16-4 in the textbook, page 309.

For example, in order for MTN or Cell C to supply iPhones they have to buy using dollars, which
leads to a demand for dollars and the demand curve will shift to the right. See table 16-1, page 308.

Because SA firms are purchasing goods, the demand for dollars increases. See page 308 for
changes in supply and demand for dollars.

The macroeconomic objectives are economic growth, full employment, price stability, balance of
payment stability and equitable distribution of income.

Inflated values push up the prices of goods and services and can be misleading when GDP is
calculated.

GDP is the total value of all final goods and services produced within the boundaries of a country
during a specific period. The car parts are imports, which are not produced domestically but by the
rest of the world.

Price stability does not mean that all prices should always stay constant; it simply means that general
prices should stay as low as possible.
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GDP is equal to household consumption expenditure + investment spending by firms + government
expenditure + exports – imports.

There are certain goods that can be sold as second-hand goods in the markets, for example cars
that were bought the previous year and sold in the current year. Such goods should not be counted
when calculating GDP because that would lead to double counting.

GDP is the total value of all final goods and services produced within the boundaries of a country
during a specific period.

GNP measures total monetary value of total output by a country’s residents and is related to GDP.
GNP is equal to GDP plus residents’ income from overseas investment minus foreign residents’
investment income earned within the country.

GDE is the total value of spending within the boundaries of a country. It includes exports since those
are spending within the domestic economy and excludes imports as those are spending to the rest
of the world.

The Balance of Payment summarises the transactions with the rest of the world. It includes
government, South African households, firms and foreign households, government and firms during
a particular period.

There are three measures of inequality, namely the Gini coefficient, Lorenz curve and the quantile
ratio. As the quantile ratio rises, so does inequality.
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Dear Student
In this tutorial letter we provide the answers to the multiple-choice questions in Assignment 03, together
with brief explanations where necessary. In some 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 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.

The three major flows in the economy are production, income and spending. Goods and services
are produced, income is earned and the income is spent to buy goods and services that are
available. Income is always equal to production, and spending may be equal to, greater than or less
than production and income.

All the statements are correct, except option [3]. The Keynesian model assumes that the economy
only consists of households and firms and that there is no government sector. See box 17-2 in the
textbook.

The marginal propensity to consume (c) gives the slope of the consumption function.
The equation for consumption is 𝐶 = −𝐶+ 𝑐𝑌.
Therefore, the slope of the consumption function is 0.3.

Option [1] is incorrect. In the equation of consumption, −𝐶 is the symbol for autonomous consumption;
therefore, it is 15. Options [2] and [3] are also incorrect. When income is equal to 1, consumption
will be 15.3. The marginal propensity to save is equal to 1 – c, which is equal to 0.7. The correct
statement is option [4]. Savings is the amount of income that is not spent on consumption. To derive
the savings equation, we deduct consumption from income.
∴𝑌 = 𝐶 + 𝑌
∴𝑆 = 𝑌 − 𝐶
∴ 𝐶 = −𝐶+ 𝑐𝑌
∴ 𝑆 = 𝑌 − −𝐶+ 𝑐𝑌
∴ 𝑆 = − −𝐶+ (1 − 𝑐)𝑌

Investment is inversely related to the interest rate, which is the cost of borrowing. When the interest
rate increases, the opportunity cost of investment increases. When the interest rate is high,
consumers tend to decrease their spending and this will discourage firms from investing more in the
business. Investment is therefore related to the interest rate and not the level of income. Option [1]
is the correct option because the profit that a firm expects to make from a specific investment
depends on the cost of obtaining the capital goods and the revenue that these goods are expected
to yield in the future.

The 45-degree line represents all the points at which total spending is equal to total income. At any
point below the line, spending is greater than income; therefore, there is an excess demand for
goods and services. At any point above the line, spending is less than income; therefore, there is an
excess supply of goods and services. When the aggregate spending intersects the line, there is
equilibrium.
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−
Total spending is equal to consumption plus investment. 𝐴 = −𝐶+ −𝐼

1
The equation for the equilibrium level of income is: 𝑌0 = 1−𝑐 −𝐴
Where −𝐴 = −𝐶+ −𝐼
Therefore, the size of the money stock is not required to calculate the equilibrium level of income.

The multiplier is the ratio between the change in income and the change in autonomous spending,
ΔY
that is, ΔA. It can also be written as Δ𝑌 = 𝛼 (Δ −𝐴 ), which
states that the change in income is equal to the multiplier times the change in autonomous spending.

The paradox of thrift is when households decide to save more of their income. When households
save more, they have less income to spend on consumption. This will lead to a decrease in
consumption. Firms will invest less in capital goods, which will increase productivity and reduce the
production of goods and services since households will be spending less. Aggregate spending and
total income will also decrease and consequently there will be a decrease in economic growth.

Option [1] is incorrect because at R50 million, aggregate spending is equal to income. Option [2] is
also incorrect because induced consumption increases as income increases. So, when income is
zero, induced consumption is zero. Option [4] is also incorrect because autonomous consumption is
the level of consumption when income is equal to zero. Therefore, autonomous consumption is equal
to R5 million. The correct option is [3]: at an income level of R15 million, savings equals zero. This
is because savings is equal to income minus consumption.

The marginal propensity to consume is equal to change in consumption divided by the change in
income. Change in consumption is equal to 35-15 = 20; change in income is equal to 50-15 = 35.
Therefore, option [3] is correct since 20/35 = 0.6.

1 1
The multiplier is equal to 𝛼 = 1−𝑐 = 1−0.6
= 2.5.

Autonomous spending is equal to  −𝐴 = −𝐶+ −𝐼 , which is equal to 20.

When Y is more than R50 million, there is excess supply and when Y is less than R50 million, there
is excess demand. The equilibrium level of income is R50 million.

Government spending is related to political objectives rather than the level of income. There have
been instances where government spending was increased after income had decreased. Therefore,
there is no systematic relationship between government spending and income.

The multiplier equation is still the same as the one with just consumption and investment, which
1
is 1−c; therefore, it will be unaffected by the introduction on government spending.
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When the tax rate increases, there will be a decrease in disposable income, which means that
consumers will spend less and the equilibrium level of income will decrease. When tax is introduced,
the slope of the consumption function is given by 𝑐(1 − 𝑡), which is smaller than 𝑐 and reduces the
1
size of the multiplier. The multiplier with taxes is 𝛼 = 1−𝑐(1−𝑡).

Taxes are a withdrawal or leakage from the circular flow of income and spending. When government
imposes taxes on households, there is a decrease in the income flowing into firms from households.
The introduction of tax reduces the size of the multiplier.

𝑌0 is the equilibrium point in a closed economy without a foreign sector.

1 1
The multiplier is equal to: 𝛼 = 1−𝑐(1−𝑡) = 1−0.5(1−0.25)
= 1.6
Y = C + I + G = 85 + 75 + 70 = 230
The equilibrium level of income = 1.6 (230) = 368.

T = 0,25Y = 0,25(368) = 92
Government surplus = T – G = 92 – 70 = 22.

The fiscal policy tools are taxation and government spending. By adjusting government spending
and taxes, the government can influence the economic output. To stimulate production in the
economy, the government can increase government spending and/or decrease taxes. To increase
government spending, it can, for example, request new furniture for all the departments from a firm.
This will increase production and create more jobs in the economy. Alternatively, the government
can reduce tax. This will leave households with more disposable income to spend on goods and
services.

The demand for exports depends on economic conditions in the rest of the world, international
competitiveness and exchange rates. If there is no demand for our products from other countries,
we will not export any products. The depreciation or appreciation of the rand also has an effect on
the level of exports. If the rand appreciates against other currencies, our exports will be expensive.

Imports take place when we buy goods and services from abroad. Payments for imports are a
leakage or withdrawal from the circular flow of income and spending since they reduce aggregate
spending on domestically produced goods and services. When spending and the level of income in
the domestic economy increase, there is an increase in imports. This indicates that imports are
dependent on the level of income.

Imports reduce aggregate spending and, therefore, also total income. When spending and the level
of income in the domestic economy increase, there is an increase in imports. The import function is
the same as the consumption function. It is as follows: 𝑧 = −𝑍+ 𝑚𝑌, where m indicates the fraction of
any increase in domestic income that is spent on imports.

Exports are an injection into the domestic flow of income and spending. An increase in the tax rate
will decrease the size of the multiplier. Imports are a leakage from the flow of income and spending.
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When net exports increase, the aggregate spending will increase by shifting to the left.

Autonomous consumption is the level of consumption when income is equal to zero. Therefore,
when it increases, consumption will also increase by shifting to the left.

Induced consumption is the consumption that increases as income increases. As it increases, the
consumption function will increase but it will not shift; it will become steeper.
13

Option 1 is incorrect since it refers to the law of demand, which is the reason why the micro demand
curve is downward sloping. It is not an explanation for why the macro demand curve is
downward sloping.
Option 2 is incorrect since an increase in the general price level decreases the real value of the income
of households. The option would have been correct if it read as: If the general price level
increases, the real value of household income decreases and, therefore, it will decrease their
consumption spending.
Option 3 is incorrect since a depreciation leads to an increase in exports and a decrease in imports.
Option 4 is correct for the following reason: Behind aggregate demand is the demand for goods (C+I+G+
(X – Z). An increase in the price level increases the interest rate and, consequently, investment
spending (I) declines. This, in return, decreases aggregate demand, which is followed by a
decline in the level of output and income (Y). This then indicates a negative relationship
between the price level (P) and the level of output (Y), and the AD curve is, therefore,
downward sloping.

Option 1 is incorrect since a decrease in government spending and an increase in taxes will decrease
aggregate demand at each price level, causing the AD curve to shift leftward.
Option 2 is incorrect since a decline in autonomous investment implies that at each price level,
aggregate demand will be lower and, therefore, the AD curve will shift leftward.
Option 3 is incorrect since this will cause a downward movement along the AD curve. Remember that
changes in the price level cause movements along the AD curve.
Option 4 is correct since the decrease in the repo rate, which was the result of central bank action (an
exogenous variable), will increase investment and aggregate demand at each price level,
causing the AD curve to shift to the right. Note that if the decrease in the repo rate was the
result of a decrease in the price level, a downward movement will occur along the AD curve.

Options 1and 2 are incorrect since they relate to the AD curve and not the AS curve.
Option 4 is incorrect since a drought will decrease aggregate supply, in which case the AS curve will
shift leftward.
Option 3 is correct since a decline in productivity decreases aggregate supply, which is represented by
a leftward shift of the AS curve.

Option 1 is incorrect since the impact of the technological change will increase aggregate supply, which
is represented by a rightward shift of the AS curve.
Option 3 is incorrect since an increase in nominal wages will cause a leftward shift of the AS curve.
Option 4 is incorrect since the impact of the technological change will cause a rightward shift of the AS
curve, while the increase in nominal wages will cause a leftward shift of the AS curve.
Option 2 is correct. An increase in the productivity of labour due to the technological change will cause
an increase in aggregate supply at each price level, which is represented by a rightward shift
of the AS curve. An increase in nominal wages, on the other hand, will cause a decrease in
aggregate supply at each price level, which is represented by a leftward shift of the AS curve.

Option 1 is incorrect since an expansionary fiscal and/or expansionary monetary policy increases
aggregate demand, and this is represented by a rightward shift of the AD curve.
Option 3 is incorrect since an increase in autonomous consumption and investment spending increases
aggregate demand, which is represented by a rightward shift of the AD curve.
Option 4 is incorrect since an increase in wages shifts the AS curve and not the AD curve.
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Option 2 is correct since both a contractionary fiscal policy and a contractionary monetary policy
decrease aggregate demand at each price level, and it is represented by a leftward shift of the
AD curve.

Option 1 is incorrect since in the case of a contractionary monetary policy and a contractionary fiscal
policy, the price level increases and the level of output decreases. The trade-off in both cases
is, therefore, that an increase in the price level is accompanied by a decrease in the level of
output.
Option 3 is incorrect since the trade-off in both cases is that an increase in the price level is accompanied
by a decrease in the level of output.
Option 4 is incorrect since the trade-off in both cases is that an increase in the price level is accompanied
by a decrease in the level of output.
Option 2 is correct. Both a contractionary fiscal policy and a contractionary monetary policy cause an
increase in the price level and a decrease in the level of output. The trade-off in both cases is,
therefore, that an increase in the price level is accompanied by a decrease in the level of
output.

Options 2 and 4 are incorrect. To increase the level of output, an expansionary fiscal or
monetary policy is required.
Option 3 is incorrect since an expansionary fiscal policy and an expansionary monetary policy cause an
increase in the price level.
Option 1 is correct. An expansionary fiscal and/or monetary policy increases the level of output and the
price level. The cost of the increase in the level of output is, therefore, an increase in the price
level (this is the trade-off).

Option 1 is incorrect since a change in aggregate expenditure influences the AD curve and not the AS
curve.
Option 2 is incorrect since an increase in the cost of production shifts the AS curve downwards (to the
left) and not upwards (to the right) as indicated in figure A, and an increase in productivity shifts
the AS curve downwards (to the right) and not upwards (to the left) as indicated in figure B.
Option 4 is incorrect since an increase in the price of oil shifts the AS curve upwards (to the left). It only
applies to figure B and, therefore, does not apply to figure A.
Option 3 is correct since a decline in wages shifts the AS curve downwards (to the left) as indicated in
figure A, while an adverse supply shock, such as an increase in the price of oil, shifts the AS
curve upwards as indicated in figure B.

Option 1 is incorrect; it illustrates demand-pull inflation.
Option 2 is incorrect; it illustrates the impact of a decline in aggregate demand.
Option 3 is incorrect; it illustrates an increase in aggregate supply.
Option 4 is correct since stagflation occurs when an increase in the cost of production not only results
in higher prices but also lower production. This is indicated by an upward shift (to the left) of
the AS curve.

Options 1 and 2 are incorrect. A decrease in aggregate supply decreases the level of output,
while an increase in aggregate demand increases the level of output. The impact on the level
of output is, therefore, uncertain.
Option 4 is incorrect since a decrease in aggregate supply and an increase in aggregate demand both
increase the price level. The price level will, therefore, not be unchanged.
Option 3 is correct. A decrease in aggregate supply and an increase in aggregate demand both increase
the price level.
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Option 2 is incorrect. A decline in the interest rate leads to an increase in investment spending (↓i → ↑I)
and not a decline in investment spending.
Option 3 is incorrect. A decline in investment spending leads to a decline in aggregate demand (↓I →
↓A) and not an increase in aggregate demand.
Option 4 is incorrect. An increase in aggregate demand leads to an increase in the level of output (↑A
→ ↑Y) and not a decline in the level of output.
Option 1 is correct since an increase in the interest rate leads to a decline in investment spending, which
decreases aggregate demand and the level of output (↑i → ↓I → ↓A → ↓Y).

If investment spending is not very sensitive to the interest rate, a given decline in the interest
rate will lead to a relatively small increase in investment spending. Consequently, the monetary
transmission mechanism is weak since the increase in investment is small. Options 1, 3 and
4 are, therefore, incorrect.
Option 2 is correct.

Option 1 is incorrect. An increase in government spending shifts the AD curve rightward, but a rise in
the interest rate shifts the AD curve leftward.
Option 2 is incorrect. A decrease in government spending shifts the AD curve leftward, while a drop in
the interest rate shifts the AD curve rightward.
Option 3 is incorrect. A decrease in government spending and a rise in the interest rate shift the AD
curve leftward.
Option 4 is correct. An increase in government spending and a drop in the interest rate increase
aggregate demand, which is represented by a rightward shift of the AD curve.

Option 1 is incorrect. The decision lag for fiscal policy is longer than for monetary policy.
Option 2 is incorrect. The implementation lag is long for fiscal policy, while it is short for monetary policy.
Option 4 is incorrect. The impact lag is shorter for fiscal policy.
Option 3 is correct. The recognition lag is the same for both policies.

Option 1 is incorrect. While an expansionary monetary policy can be used to address the problem of
unemployment by increasing aggregate demand, it worsens the deficit on the current account
of the balance of payments since an increase in aggregate demand increases imports.
Option 3 is incorrect. While a contractionary fiscal policy and a contractionary monetary policy both
increase unemployment since aggregate demand is lower, the decrease in aggregate demand
decreases the deficit on the current account since imports are lower.
Option 4 is incorrect. A contractionary fiscal policy increases unemployment and does not decrease it.
Option 2 is correct. An expansionary fiscal policy decreases unemployment since it increases aggregate
demand. This increase in aggregate demand leads to an increase in imports and,
consequently, the deficit on the current account increases.

Inflation refers to a sustained increase in the general price level.
Option 4 is, therefore, correct, while options 1, 2 and 3 are incorrect.

The inflation rate is calculated as follows:
[(120 – 100)/100] x 100 = 20%
16
ECS1601/204

Options 1, 2 and 3 are incorrect. Prices are still rising at a rate of 6%.
Option 4 is correct since prices are rising at a rate of 6% and not 8%, which means they are increasing
at a slower (lower) rate.

Cost-push inflation originates from the supply side and is caused by an increase in cost factors
such as wages, profit margins and the cost of imported capital and intermediate goods.
Option 2 is incorrect since it refers to demand factors.
Option 3 is incorrect since a decrease in the cost of imported capital and intermediate goods decreases
the cost of production.
Option 4 is incorrect since a decrease in wages and salaries decreases the cost of production.
Option 1 is correct. An increase in profit margins, a decrease in productivity (without a decrease in
wages) and the negative impact of natural disasters on the supply of goods and services can
all be regarded as causes of cost-push inflation.

In the case of demand-pull inflation, an increase in the general price level is accompanied by
an increase in total production. In the case of cost-push inflation, an increase in the general
price level is accompanied by a decrease in total production. Options 1, 2 and 4 are,
therefore, incorrect and option 3 is correct.

The distribution effects of inflation are best described by borrowers benefiting at the expense
of lenders since the real value of money falls when prices increase. While inflation tends to
affect poor households more, it does not imply that the rich benefit at the expense of the poor.
Options 2, 3 and 4 are incorrect and option 1 is correct.

The unemployment pool increases if the inflow of people is more than the outflow of people.
Option 1 is incorrect since a decrease in the number of new entrants decreases the inflow.
Option 2 is incorrect since an increase in the number of people who are hired increases the outflow,
causing a decline in the unemployment pool.
Option 4 is incorrect since a decrease in the number of people who are laid off decreases the inflow,
causing a decline in the unemployment pool.
Option 3 is correct since an increase in the number of people looking for a job increases the inflow,
which increases the unemployment pool.

The unemployment rate is the number of unemployed people expressed as a percentage of
the labour force. Since the number of unemployed is 20 million and the labour force is 40
million, the unemployment rate is 20 million/40 million x 100 = 50%.
17
Option 1 is incorrect. Cyclical (demand-deficiency) unemployment occurs when a slump or recession in
the economy (as a result of a temporary lack of demand) gives rise to unemployment.
Option 2 is incorrect. Seasonal unemployment arises because certain occupations require workers only
for part of each year. It is in some cases related to the weather or the calendar, and very
specific steps have to be taken to accommodate workers during the periods when they do not
have employment.
Option 3 is incorrect. Frictional unemployment (sometimes also called search unemployment) arises
because it takes time to find a job or to move from one job to another. It can be regarded as
part and parcel of the way in which a market economy operates.
Option 4 is correct. Structural unemployment occurs when there is a mismatch between workers’
qualifications and job requirements, or when jobs disappear because of structural changes in
the economy. Structural unemployment is usually confined to certain industries, sectors or
categories of workers.

The Phillips curve relates the inflation rate to the unemployment rate. Lower inflation is related
to higher unemployment, and vice versa.
Option 2 is incorrect. A downward movement along the Phillips curve indicates that as the inflation rate
(rate of change in prices) falls, unemployment increases.
Option 3 is incorrect. A rightward shift indicates that at each inflation rate, the level of unemployment is
higher.
Option 4 is incorrect. A leftward shift indicates that at each inflation rate, the level of unemployment is
lower.
Option 1 is correct. An upward movement along the Phillips curve indicates that as the inflation rate
(rate of change in prices) increases, unemployment falls.

For the economic wellbeing of the people of a country to improve, there must at least be an
increase in the real GDP per capita.
Option 1 is incorrect. Since the increase in the price level (12%) was greater than the increase in the
nominal GDP (10%), the real GDP and the real GDP per capita declined<<AUTHOR: Correct?
AvE>>.
Option 2 is incorrect. While the real GDP was unchanged, the real GDP per capita declined since the
population increased by 1%.
Option 3 is incorrect. The increase in real GDP due to defence expenditure is regarded as a negative
factor that does not increase the economic wellbeing of the people of a country.
Option 4 is correct. Not only has the real GDP per capita increased, it is also disturbed evenly amongst
the population, indicating an improvement in the economic wellbeing of the people of a country.

The business cycle is more or less the regular pattern of expansion (recovery) and contraction
(recession) in economic activity around the path of trend growth.
One complete cycle, which usually lasts a number of years, consists of four elements:
 a trough
 an upswing or expansion (also called a boom)
 a peak
 a downswing or contraction (also called a recession)
Option 1 is incorrect. During the recovery phase, economic activity starts to increase and more
resources, but not all available resources, are used.
Option 3 is incorrect. During the expansion phase, economic activity continues to increase and more
resources, but not all available resources, are used.
Option 4 is incorrect. A through phase is a lower turning point during which the level of economic activity
and the use of resources are low.
Option 2 is correct. During the peak phase (upper turning point), economic activity is high and almost
all available resources are used.
18
ECS1601/204
During an upswing phase, cyclical unemployment will decrease and inflation will increase.
Cyclical unemployment decreases since economic activity is higher and inflation increases
since aggregate demand increases. Options 1, 2 and 4 are incorrect and option 3 is correct.

Options 1, 2 and 3 are all demand factors that influence economic growth.
Option 3 is a supply-side factor and, therefore, the correct option.

Option 1 is incorrect. Capital deepening occurs when the amount of capital per worker is increased, that
is, when the growth in the stock of capital is greater than the growth in the number of workers.
Option 2 is incorrect. Technological widening implies that more technology is used to accommodate an
increasing workforce.
Option 3 is incorrect. Capital widening occurs when the capital stock is increased to accommodate an
increasing labour force. In this case, the average amount of capital per worker remains
unchanged.
Option 4 is correct since the output per worker has increased without an increase in the capital stock.
We wish you all the best with your studies!
Your lecturers
19

Tutorial Letter 201/2/2017: Economics 1B

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ECS1601/201/2/2017

Tutorial letter 201/2/2017

1 DISCUSSION OF ASSIGNMENT 01/2017 ................................................................................... 3

1 DISCUSSION OF ASSIGNMENT 01/2017

1 DISCUSSION OF ASSIGNMENT 01/2017

1.1 The correct option is [5].

1.2 There is no correct option.

1.3 The correct option is [4].

1.4 The correct option is [4].

1.5 The correct option is [3].

1.6 The correct option is [5].

1.8 The correct option is [4].

1.9 The correct option is [1].

1.10 The correct option is [4].

1.11 The correct option is [5].

1.12 The correct option is [2].

1.13 The correct option is [4].

1.14 The correct option is [4].

1.15 The correct option is [4].

1.16 The correct option is [5].

1.17 The correct option is [2].

1.19 The correct option is [3].

1.20 The correct option is [2].

1.21 The correct option is [4].

1.22 The correct option is [4].

1.23 The correct option is [4].

1.24 The correct option is [1].

1.26 The correct option is [4].

1.27 The correct option is [5].

1.28 The correct option is [3].

1.29 The correct option is [2].

1.30 The correct option is [3].

2 DISCUSSION OF ASSIGNMENT 02/2017

1. The correct answer is option [1].

2. The correct answer is option [2].

3. The correct answer is option [3].

4. The correct answer is option [1].

5. The correct answer is option [2].

6. The correct option is option [3].

7. The correct answer is option [2].

9. The correct answer is option [4].

10. The correct answer is option [4].

12. The correct answer is option [2].

13. The correct answer is option [1].

14. The correct answer is option [1].

15. The correct answer is option [3].

16. The correct answer is option [3].

17. The correct answer is option [1].

18. The correct answer is option [1].

19. The correct answer is option [1].

20. The correct answer is option [4].

21. The correct answer is option [1].

22. The correct answer is option [5].

23. The correct answer is option [1].

24. The correct answer is option [4].

25. The correct answer is option [3].

26. The correct answer is option [4].

27. The correct answer is option [2].

28. The correct answer is option [1].

29. The correct answer is option [4].

30. The correct answer is option [3].

3 DISCUSSION OF ASSIGNMENT 03/2017

3.1 The correct option is [3].