Economics 1B Module Guide

ECONOMICS 1B
Module Guide
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MANCOSA
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This Module Guide,
Economics 1B (NQF level 5)
will be used across the following programmes:
 Bachelor of Commerce in Accounting

 Bachelor of Business Administration
 Bachelor of Public Administration
 Bachelor of Commerce in Entrepreneurship
 Bachelor of Commerce in Financial Management
 Bachelor of Commerce in Supply Chain Management
 Bachelor of Commerce in Retail Management
 Bachelor of Commerce in Information and Technology Management
 Bachelor of Commerce in Marketing Management
 Bachelor of Commerce in International Business
 Bachelor of Commerce in Project Management
ECONOMICS 1B
List of Content ......................................................................................................................................................... 1
Preface.................................................................................................................................................................... 2
Unit 1: Introduction to Macroeconomics .................................................................................................................. 7
Unit 2: Measuring the Performance of the Economy............................................................................................. 17
Unit 3: The Monetary Sector ................................................................................................................................. 23
Unit 4: The Public Sector ...................................................................................................................................... 32
Unit 5: Macroeconomic Theories .......................................................................................................................... 41
Unit 6: Inflation ...................................................................................................................................................... 58
Unit 7: Unemployment........................................................................................................................................... 64
Unit 8: Economic Growth and Development ......................................................................................................... 69
Unit 9: The Foreign Sector .................................................................................................................................... 82
Case Study: U.S. to Impose Tariff on Tires from China ........................................................................................ 88
Reference List ....................................................................................................................................................... 93
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List of Content
List of Tables
Table 5.1: Assumptions and implications of the Keynesian model .............................................................. 52
Table 8.1: Economic growth from an increase in labour – More output but diminishing returns and lower
labour productivity ...................................................................................................................... 74
Table 8.2: Economic growth from an increase in capital – More output but diminishing returns and higher
labour productivity ..................................................................................................................... 75
Table 8.3: Fixed private Nonresistential Net capital Stock, 1960 – 2008 (Billions of 2005 dollars).............. 76
Table 8.4: Years of school completed by people over 25 years old, 1940 - 2008........................................ 77
Table 9.1: Unit of output per person at work ................................................................................................ 85
List of Figures and Illustrations
Figure 1.1: The three major flows ................................................................................................................ 13
Figure 1.2: A Simple Circular Flow Model of Income and Spending ............................................................ 14
Figure 1.3: The financial sector and foreign sector ...................................................................................... 15
Figure 6.1: Demand-pull inflation ................................................................................................................. 61
Figure 6.2: Cost-push inflation ..................................................................................................................... 61
Figure 8.1: The business cycle .................................................................................................................... 72
Figure 8.2: Different views on business cycles ............................................................................................ 74
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Economics 1B
Preface
A. Welcome
Dear Student
It is a great pleasure to welcome you to Economics 1B (ECO1B5). To make sure that you share our passion
about this area of study, we encourage you to read this overview thoroughly. Refer to it as often as you need
to, since it will certainly make studying this module a lot easier. The intention of this module is to develop both
your confidence and proficiency in this module.
The field of Economics is extremely dynamic and challenging. The learning content, activities and self- study
questions contained in this guide will therefore provide you with opportunities to explore the latest developments
in this field and help you to discover the field of Economics as it is practiced today.
This is a distance-learning module. Since you do not have a tutor standing next to you while you study, you
need to apply self-discipline. You will have the opportunity to collaborate with each other via social media tools.
Your study skills will include self-direction and responsibility. However, you will gain a lot from the experience!
These study skills will contribute to your life skills, which will help you to succeed in all areas of life.
The module is a 15 credit module at NQF level 5
We hope you enjoy the module.
MANCOSA does not own or purport to own, unless explicitly stated otherwise, any intellectual property rights in
or to multimedia used or provided in this Module Guide. Such multimedia is copyrighted by the respective creators
thereto and used by MANCOSA for educational purposes only. Should you wish to use copyrighted material from
this guide for purposes of your own that extend beyond fair dealing/use, you must obtain permission from the
copyright owner
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Economics 1B
B. Learning Outcomes and Associated Assessment Criteria of the Module

LEARNING OUTCOMES OF THE MODULE ASSOCIATED ASSESSMENT CRITERIA OF THE MODULE
 Understand what is meant by  Foundational knowledge of macroeconomics is explored

macroeconomics and an understanding is reflected through the correct
use of terminology, concepts, principles, components
and theories
 Macroeconomics impact on the economy and the market
system are investigated to understand the importance of
macroeconomic principles and policies
 Identify the major role players in the  Major role players in the macro economy are identified
macro economy and explored to understand the dynamics of
macroeconomics
 Importance of major role players in the macro economy
are explored as agents for resolving economic problems
concerning what to produce, how to produce and for
whom
 Define and understand the following
 GDP and GNP, Inflation, and the public sector are
macroeconomic variables:
described to execute the role of macroeconomics
 GDP and GNP,
and how its aggregate changes in the economy
 Inflation, and
 Unemployment
 Understand what is meant by:  The Monetary sector and Public sector are explored to
 The Monetary sector, and understand the need for both in the macroeconomics
 The Public sector environment
 Describe the main characteristics of the  Theories relating to macroeconomics are investigated
following macroeconomic theories: to understand the importance of the economy
 Free Market,  Underlying economic theories are explored to
 Marxist, and determine key characteristics and principles that inform
 Keynesian macroeconomics
 Understand what is meant by economic  Key concepts and terminology central to economic
growth and economic development growth and economic development are explored and
understanding is reflected through appropriate use of
principles, theories and practices in the
macroeconomic environment
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 Explain why countries trade with one  Reasons, benefits and outcomes of trading are
another analysed to highlight the importance of
interrelationships between countries on a global scale
 Define and qualitatively apply the  Exchange rate concepts and principles are examined
concept of exchange rates and applied in order to realise the importance and role
of the exchange rate as part of the macroeconomics
process
C. Learning Outcomes of the Units

You will find the Unit Learning Outcomes on the introductory pages of each Unit in the Module Guide. The
Unit Learning Outcomes lists an overview of the areas you must demonstrate knowledge in and the practical
skills you must be able to achieve at the end of each Unit lesson in the Module Guide.
D. How to Use this Module

This Module Guide was compiled to help you work through your units and textbook for this module, by breaking
your studies into manageable parts. The Module Guide gives you extra theory and explanations where
necessary, and so enables you to get the most from your module.
The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts from the
prescribed textbook and recommended readings. We suggest that you briefly skim read through the entire guide
to get an overview of its contents. At the beginning of each Unit, you will find a list of Learning Outcomes and
Associated Assessment Criteria. This outlines the main points that you should understand when you have
completed the Unit/s. Do not attempt to read and study everything at once. Each study session should be 90
minutes without a break
This module should be studied using the prescribed and recommended textbooks/readings and the relevant
sections of this Module Guide. You must read about the topic that you intend to study in the appropriate section
before you start reading the textbook in detail. Ensure that you make your own notes as you work through both
the textbook and this module. In the event that you do not have the prescribed and recommended
textbooks/readings, you must make use of any other source that deals with the sections in this module. If you
want to do further reading, and want to obtain publications that were used as source documents when we wrote
this guide, you should look at the reference list and the bibliography at the end of the Module Guide.
E. Study Material
The study material for this module includes tutorial letters, programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings, which may be supplemented by additional readings.
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F. Prescribed and Recommended Textbook/Readings

There is at least one prescribed and recommended textbooks/readings allocated for the module.
The prescribed and recommended readings/textbooks presents a tremendous amount of material in a simple,
easy-to-learn format. You should read ahead during your course. Make a point of it to re-read the learning
content in your module textbook. This will increase your retention of important concepts and skills. You may
wish to read more widely than just the Module Guide and the prescribed and recommended textbooks/readings,
the Bibliography and Reference list provides you with additional reading.
The prescribed and recommended textbooks/readings for this module is:

 Berg, D. and Ward, D. (2016). Economics for Business. Fifth Edition. United Kingdom: McGraw-
Hill Education.
 Mohr, P. & Fourie, L. (2015). Economics for South African Students. (5th edition) Pretoria: Van
Schaik
 Case, K.E, Fair, R.C & Oster, S.M (2012). Principles of Macroeconomics. (10th ed.). Pearson.
 MOHR, P., FOURIE, L. and ASSOCIATES (2004), Economics for South African Students. Pretoria:
JL van Shaik
 SCHILLER, B. R. (2013). Essentials of Economics (13th Edition). New York: Irwin McGraw – Hill
 SCHILLER, B. R. (2008), The Economy Today (11th Edition), Boston: McGraw – Hill
G. Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to help
you study. It is imperative that you work through them as they also provide guidelines for examination
purposes.
Special Feature Icon Explanation
The Learning Outcomes indicate aspects of the particular Unit you

LEARNING have to master.
OUTCOMES
The Associated Assessment Criteria is the evaluation of the

ASSOCIATED
students’ understanding which are aligned to the outcomes. The
ASSESSMENT
Associated Assessment Criteria sets the standard for the
CRITERIA
successful demonstration of the understanding of a concept or skill.
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A Think Point asks you to stop and think about an issue. Sometimes
THINK POINT you are asked to apply a concept to your own experience or to think
of an example.
You may come across Activities that ask you to carry out specific
tasks. In most cases, there are no right or wrong answers to these
ACTIVITY
activities. The purpose of the activities is to give you an opportunity
to apply what you have learned.
At this point, you should read the references supplied. If you are
READINGS unable to acquire the suggested readings, then you are welcome to
consult any current source that deals with the subject.
PRACTICAL Practical Application or Examples will be discussed to enhance
APPLICATION understanding of this module.
OR EXAMPLES
KNOWLEDGE You may come across Knowledge Check Questions at the end of
CHECK each Unit in the form of Knowledge Check Questions (KCQ’s) that
QUESTIONS will test your knowledge. You should refer to the Module Guide or
your textbook(s) for the answers.
You may come across Revision Questions that test your

REVISION understanding of what you have learned so far. These may be
QUESTIONS attempted with the aid of your textbooks, journal articles and
Module Guide.
Case Studies are included in different sections in this Module
CASE STUDY Guide. This activity provides students with the opportunity to apply
theory to practice.
You may come across links to Videos Activities as well as
VIDEO ACTIVITY instructions on activities to attend to after watching the video.
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Unit
1: Introduction to Macroeconomics
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Unit Learning Outcomes
CONTENT LIST LEARNING OUTCOMES OF THIS UNIT:
1.1. Introduction  Introduce topic areas for the unit
1.2. Macroeconomics versus  Distinguish between macroeconomics and

Microeconomics microeconomics
1.3. An Overview of Macroeconomic  Provide an overview of the five major components of

Policies macroeconomic policy
1.4. The Circular Flow of Income  Describe the Circular Flow of Income Model
Prescribed / Recommended Readings
 Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 3, page 39
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1.1. Introduction
The aim of any economic activity is the production of goods and services for the satisfaction of (unlimited)
human wants. In order to satisfy these wants, firms produce the goods and services that households consume
– this takes place within a broader framework that policy-makers such as government, agencies such as the
South African Reserve Bank, create in conjunction with organized commerce, organised labour and civil society
organisations. The result is a legal framework and a set of economic policies that are in line also with our
Constitution.
This study unit firstly highlights the distinction between macroeconomics and microeconomics. While this
distinction is important for the ease of study, it is imperative that the student not consider the two as mutually
exclusive disciplines. Secondly, we briefly explore the five major components of macroeconomic policy and
mention some of the dilemmas encountered in policy formulation.
Finally, markets and the flow of income, expenditure, goods and factors of production in an economy are
discussed, using a simple circular flow model.
1.2. Macroeconomics versus Microeconomics

Macroeconomics is concerned with the economy as a whole. It focuses on aspects such as the stability of
the general price level (commonly known as inflation), the maintenance of full employment, economic growth,
the distribution of income, government spending, and the nation’s money supply.
Microeconomics, on the other hand, focuses on the individual participants in the economy: producers (firms),
and households (workers, entrepreneurs and consumers). Microeconomic policies focus on specific markets
and how prices are established.
Understanding the basics of microeconomics is a necessary prerequisite to understanding the functioning of

the macro economy. Macroeconomic relationships cannot be analysed without understanding the behaviour of
the individuals and businesses which make up the economy.
Conversely, sound economic decisions and policy formulation that impacts the microeconomic level can only
be made by giving due consideration to the macro economy.
Further Readings
https://courses.lumenlearning.com/boundless-
economics/chapter/differences-between-macroeconomics-and-
microeconomics/
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1.3. An Overview of Macroeconomic Policies

Macroeconomics is policy oriented. It asks questions such as the following:
 To what degree can government policies affect output and employment?
 To what degree is inflation the result of unfortunate government policies?
 What government policies are optimal in the sense of achieving the most desirable behaviour of
aggregate variables, such as the level of unemployment or the inflation rate?
 Should government policy attempt to achieve a target level for foreign exchange rates?
For example, to what degree were government policies to blame for the massive unemployment during the
world depression of the 1930s or for the simultaneous high unemployment and inflation of the 1970s and the
economic meltdown caused by the financial crises of 2008?
A brief overview of five major variables that are considered in formulating macroeconomic policy will now be
discussed.
1.3.1. Full Employment

At a certain level of output in an economy, it can be said that all factors of production are being fully utilised
(Pape, 2000). In such a situation, all workers would be employed, all machinery would be in use and all usable
land would be involved in production. This is called full employment – all factors of production are in full use.
The importance of full employment lies in the fact that unemployment causes social and political instability.
Governments in power are often discredited and blamed for high levels of unemployment.
Any form of unemployment should be seen as a loss in potential production, since the country could have
earned more if those who were unemployed were economically active. Clearly, a drop in the standard of living
occurs as production is lost.
1.3.2. Price Stability

Price stability does not mean that all prices should always stay constant. It is common knowledge that the price
of goods and services generally increase from one year to the next. The process of increases in the money
supply and the rises in the general level of prices is called inflation. When economists talk of price stability
they mean keeping inflation as low as possible. An inflation rate of 1% to a maximum of 2% is regarded in most
Western economies as a “healthy” inflation rate.
Rising prices per se are not a problem, but the accompanying effects are undesirable. Among these effects are
the negative impact on savings, the skewed distribution of income, the country’s balance of payments and
social as well as political effects.
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1.3.3. Economic Growth

In a growing economy, the total production of goods and services will increase from one period to the next (as
measured by the Gross Domestic Product or GDP). If the population is growing and there is no economic
growth, average living standards cannot increase, and it will not be possible to create enough jobs for the
growing population.
Since economic growth and employment go hand in hand, these two policy objectives should be seen as one.
The government has to make provision for employment-generating policies and create a climate for investment
that will promote growth. Economic policies – such as the monetary and fiscal policies – can affect output
quickly (Samuelson & Nordhaus, 2002), but the impact of these policies on potential output trends operates
slowly over a number of years.
1.3.4. External Stability or Balance of Payments

Countries do not live in isolation. They trade with foreign countries in order to increase their wealth. South
Africa’s growth rate is also dependant on the foreign sector. For example, if the American economy experiences
a boom, it will demand more South African goods which will consequently lead to an increase in local output,
resulting in economic growth in South Africa.
South Africa also imports technology in the form of machinery, equipment and other goods from abroad as well
as a range of consumer goods. To pay for these imports the country has to earn the necessary foreign currency
(dollars, pounds, euros, etc.) by exporting goods and services that it has a comparative advantage in.
In the short term, all foreign transactions are accounted for by the transacting parties, but some balance
between exports and imports is required in the longer term otherwise the terms of trade will become
unfavourable. From a policy point of view, the balance of payments and exchange rates should be maintained
at a fairly stable level.
If exports exceed imports:

 The exchange rate would initially favour the exporting country;
 As the local currency becomes stronger, foreign countries will refrain from buying goods/services;
because the
 Goods will become too expensive in the countries exported to, resulting in a drop in foreign demand.
Local output will decrease, resulting in growing unemployment but general price levels would
however fall which should lead to a growth in the economy.
If imports exceed exports

 The exchange rate will initially favour foreigners that export to a local country;
 Demand for local goods will decrease; but as the local currency becomes weaker; the
 The price of imported goods will become more expensive, but employment will pick up
because of the increase in demand for the relatively cheaper local goods.
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We now have the ongoing dilemma of having to choose between price levels and employment levels! Thus,
the aim of government (policy-makers) should be to maintain exchange rate stability and balance of payments
and equilibrium in the long term.
Think Point 1.1
“South Africa’s current account deficit narrowed to 2.5 percent of GDP in 2017” reports
the World Bank (2018b:18). What could have been the causes of this?
1.3.5 Equitable or Redistribution of Wealth (Income)

This would entail a policy where the wealthier people of a country have to contribute more (mainly through taxes)
towards the underprivileged without harming the incentive to work.
While most people agree with the other four policies outlined above, not everyone will agree with the
redistribution policy. Some, for example, regard an unequal distribution of income as a means of stimulating
saving and investment which will benefit the poor. On the other hand, a highly unequal distribution of income
tends to generate social and political conflict. It can also have important effects on the structure and
development of the economy.
Macroeconomic policies do not stand in isolation. Sometimes, the different policies could be in conflict with
each other, making the choice of an appropriate policy extremely difficult. For example, a government may have
an economic policy geared towards economic growth – this may lead them towards reducing taxes. This in turn
may reduce their short-term income which could negatively affect their ability to spend on social grants.
To summarise, the goals of macroeconomic policy are:

 A high and growing level of national output;
 High employment with low unemployment; and
 A stable or gently rising price level.
Think Point 1.2
In its National Development Plan, the South African government explicitly aims
to “Reduce inequality – The Gini coefficient should fall from 0.69 to 0.6”
(National Planning Commission, 2011). What does this mean?
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1.4. The Circular Flow of Income

The circular flow of income shows the flow of inputs, outputs and payments between households and firms
within an economy. This model captures the essence of macroeconomic activity. The economy is seen as
nothing more than:
 A flow of goods from Producers to Consumers through the goods market;
 Production resources from Households to Firms through the factor market; and
 Financial payments flowing in the opposite direction through the above markets.
1Figure 1.1: The three major flows

Mohr & Fourie (2015:41)
The circular flow model illustrates the mechanism by which income is generated from the production of goods
and services and how this income is spent on the factors of production which in turn forms the income to
households arising from the ownership of these factors. This is best understood by analysing figure 1.2.
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Activity 1.1
Which one of the following is unlikely to be an objective of macro-economic
policy?
a) Balance of payments stability
b) Low tariff levels
c) Economic growth
d) Full employment
e) Stable prices
2Figure 1.2: A Simple Circular Flow Model of Income and Spending
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Firstly, let us consider households who are buyers, and firms who are producers and sellers of goods and
services in the goods and services market: Firms are buyers of factors of production and households become
sellers of factors of production in the factor market. The money flow is denoted by the inner anti-clockwise
arrows. So, the income flow or flow of rands for the use of factors of production to the households is denoted
by the inner line (bottom left anti-clockwise direction of the arrow), whereas the inner line (top right anti-
clockwise direction of the arrow) represents the flow of income to firms from the sale of goods and services in
the economy. The spending by firms on factors of production is denoted by the inner line (top left anti-clockwise
direction of the arrow), whereas the inner line (bottom right anti-clockwise direction of the arrow) represents the
flow of spending on goods and services in the economy. It is important to note that these flows are equivalent.
The next participant that we introduce into the model is the government. The government is responsible for
providing public goods and services, such as roads, bridges, etc. for usage by households and firms. In order
for government to provide these public goods and services, it receives tax revenue from households and firms.
Hence, again we have flow of income in the form of tax paid by firms and consumers and tax received by the
government. In addition, government provides subsidies to firms and households - flow of income.
3Figure 1.3: The financial sector and foreign sector

Next, we introduce the financial sector, which mainly comprises of financial institutions, where consumers and
firms deposit funds and earn interest on savings. In addition, firms and consumers take loans to invest in capital
goods and assets, and have to pay interest on loans. Finally, we introduce the foreign sector. In the foreign
sector, importing countries pay using foreign exchange for imported goods and services, and exporting
countries earn foreign currency for exporting goods and services.
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This simple circular flow model of income, output and spending represents the workings of a simple economy,
and illustrates the economic interdependence of the major constituencies. It further highlights the
interrelationship between microeconomic analysis and macroeconomic analysis.
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
2: Measuring the Performance
of the Economy
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2.1 Introduction  Introduce topic areas for the unit
2.2 The concept of Gross Domestic  Define Gross Domestic Product

Product (GDP)
2.3 Gross National Product (GNP)  Define Gross National Product
2.4 Net Domestic Product (NDP)  Define Net Domestic product
2.5 Nominal vs Real GDP  Distinguish between Nominal and Real GDP
2.6 Some factors to consider when  Identify and describe some of the shortcomings of GDP as
using GDP as a measure of a measure of economic performance
economic performance
 Mohr, P. & Fourie, L. (2015). Economics for South African Students.

5th edition. Pretoria. Van Schaik Chapter 13
 Stats SA (2019). Gross domestic product First quarter 2019
 http://www2.econ.iastate.edu/classes/econ102/falk/lecture_7_gdp.pdf
Measuring GDP and economic growth
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2.1. Introduction
There are various macroeconomic instruments that are used to assess the state of the economy of any country.
On the basis of these instruments are comparisons of economic growth and development made with other
economies (countries).
2.2 The concept of Gross Domestic Product (GDP)

The primary reason for calculating GDP is that it measures the performance of a country’s economy during a
specified period. This value is then compared with previous years’ output (GDP) to establish the country’s
performance over time.
2.2.1. GDP Defined

Definition: GDP refers to the total market value of final goods and services produced in an economy during a
specific period of time (normally a year).
This definition is made up of 4 elements:

 Market Value - refers to the market price of the various new goods and services produced in the specified
time period;
 Final goods and services – these are used or consumed by individuals, households and firms. An
intermediate good, on the other hand, is purchased to be used as inputs in producing other goods and
is not counted (to avoid the problem of double counting);
 Economy-refers to the geographic area (country borders) within which all the goods and services are
produced; and
 Specific time period – Normally a year or quarter during which only the new goods and services are
produced.
Think Point 2.1

If economists are not careful, they can easily overestimate the value of GDP by
double counting. What is double counting and what strategy does the
government of your country have in place to avoid this problem?
2.2.2 GDP statistics matter to business for at least four reasons Mohr, P. & Fourie, L. (2015).:
 Forecasts for future aggregate or combined demand (we will discuss AD later on) are usually expressed
in terms of projected growth in GDP;
 Assessments of the current state of the economy are based on the current and recent past level of GDP;
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 Economic performance does have political and policy implications. Fast growth is perceived as an
electoral plus while weak growth an electoral minus; and
 International comparisons of aggregate market size are based on GDP data. Country credit ratings stock
exchange prices and business outlook forecasts are all affected by economic data.
2.2.3 Methods for calculating GDP

There are three methods (Mohr & Fourie: 2015:236) of calculating GDP:
I. Production Method (value added)

This method is the summation of the value added at each phase of production. Since only the added value is
counted no double counting can take place.
II. Expenditure Method (final goods and services)

This approach adds up the value of all transactions once they have reached their final destination. It combines
the spending by consumers (C) on consumer goods, the spending of firms on capital goods (I), government
spending (G) and the nett spending on imported goods (X – Z) (Exports minus Imports), or the spending by
foreigners on South African goods).
III. Income Method (incomes of the factors of production)

This approach is related to the production approach since costs incurred for the factors of production for
businesses are in fact income to households for these factors of production. For example, rent and wages
are factor costs for a business but are income for the landlord and employee, respectively.
The three methods measure the monetary value of the circular flow at different points so should arrive at the
same amount. (See Chapter 1). You are not required to know how to do the calculation of these methods
for the purpose of this course.
2.3 Gross National Product (GNP)

Definition: GNP refers to the production resulting from the employment of the permanent residents of South
Africa wherever they might be.
To derive the GNP from the GDP, one has to subtract the factor incomes (rent, profit, wages and interest) of
foreigners earned by foreigners in South Africa from the factor income of permanent residents earned
abroad. For example, the salary of a mineworker from a neighbouring state will be included in the GDP but will
not be part of the GNP, whereas the tournament earnings of Ernie Els on the US/European tour will be included
in the GNP and not in the GDP.
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The difference between the payments that SA makes to ‘foreigners’ and the monies received by its permanent
residents abroad, is called the net factor payments to the rest of the world. In other words, the difference
between GDP and GNP = net factor payments.
According to Mohr & Fourie, (2015), GNP is a better measure of the income or standard of living of the
citizens of a country. If we want to know how South Africans as a group are faring, we therefore examine the
level and rate of change in real GNI (or GNP).
2.4 Net Domestic Product (NDP)

Definition: NDP = GDP – depreciation. Allowance is therefore made for depreciation of assets.
Activity 2.1
Suppose GDP = R276m and depreciation amounted to R42m, then NDP at market
prices = R234m. Therefore, one can conclude that in order for the country to maintain
its production capacity, R42m should actually be saved or R42m of new machines
should be acquired. What are the consequences to the economy if this is not done?
2.5 Nominal vs Real GDP

As pointed out earlier, a comparison of the current GDP value with that of previous years provides a reasonable
assessment of the country’s performance. An increase in GDP could have been caused by increased prices
(inflation) and not necessarily higher output.
In this case, GDP would not reflect the true picture of a country’s well-being. To overcome this problem of price
inflation in GDP calculations, a distinction has to be drawn between nominal GDP and real GDP.
Nominal GDP =  (current prices of products x their current quantities)
Real GDP, on the other hand, expresses the GDP at constant prices. In other words, it is the value of the current
output of the country expressed in terms of prices of a previous (base) year. Since the average business cycle
in SA is five years, the base year is changed every five years. Hence, real GDP is updated every five years
though comparisons can be made over longer periods since the data is available.
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Real GDP =  (base year prices of products x their current quantities)
2.6 Some factors to consider when using GDP as a measure of economic performance
GDP and the other national accounting totals are all subject to certain shortcomings. As a result, GDP is
sometimes jokingly referred to as the ‘grossly deceptive product’ or the ‘grossly distorted picture.’ The problems
associated with GDP include the following;
 Non-market production: It is difficult to measure or estimate the value of activities that are not traded in
a market. This problem applies, for example, to the production of goods and services by the government.
Since most of these goods and services are not sold in market, they have to be valued at cost. A good
example of non-market production is farmer’s consumption of their own produce.
 Unrecorded activity: A more serious problem is that many transactions or activities in the economy are
never recorded. Such transactions or activities are described by terms such as the unrecorded economy,
the underground economy, the shadow economy and the informal sector. Unrecorded activities range
from illegal activities such as smuggling, drug-trafficking and prostitution to unrecorded cash transactions,
barter transactions and transactions that escape the tax net and transactions that make use of alternative
or encrypted electronic currencies (such as bitcoin).
 Data revision: Original estimates are frequently adjusted as new and better data become available. This
can be quite frustrating to analysts, since they are never sure whether or by how much the figures are
going to be revised. These are only estimates of the performance of the economy. There are many ‘in-
built’ mistakes which are hard to eliminate and the accuracy of the figures relies upon the information
provided by the company interviewed.
 Economic Welfare: Some argue that GDP and other national accounting totals are not good measures
of economic welfare. They point out, for example, that unwanted by-products or negative externalities
such as pollution, congestion and noise are not considered. They argue that the value of these ‘bads’
should be subtracted from the value of ‘goods’ included in GDP. They also argue that it is inappropriate
to regard R1 billion spent on military equipment in the same light as R1 billion spent on health and
education. Moreover, it is difficult to account for productivity improvements and improvements in the quality
of goods and services over time.
Think Point 2.2
What economic variables (measures) do you think best represent the

economic welfare of an economy?
STUDY UNIT
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Unit
3: The Monetary Sector
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3.1 Introduction  Provide an overview of money and its various elements
3.2 The South African Reserve Bank  Understand the functions of the South African Reserve
Bank (or any central bank)
3.3 The Supply of Money  Understand the functions of money
3.4 The Demand for money  What is interest rate and the different types
3.5 The monetary policy framework in  Understand the instruments of monetary policy
South Africa
3.6 Other instruments  Identify the number of other measures may be used by
the monetary authorities in pursuit of their goals
 Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th edition.
Pretoria. Van Schaik. Chapter 14
 https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/
9328/01Full%20Quarterly%20Bulletin%20%E2%80%93%20June%202019.pdf
South African Reserve Bank Quarterly Bulletin 2019.
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3.1 Introduction
Money is one of the most important institutions in the economy. Money, it is said, talks, makes the man (or
woman) and makes the world go around. The Bible says that the love of money is the root of all evil. Everyone
is fascinated by money.
3.1.1 What is money?

 Money is anything that is generally accepted as payment for goods and services or that is accepted
in settlement of debt. The unique feature is that the marginal value of money does not decrease when
additional units are added.
3.1.2 Different kinds of items used as money.

 Through the ages various goods have served as money. For example, cocoa beans, beads, seashells,
tea, cattle, silver and cigarettes have all served as money at one time or one situation or another.
3.1.3 Money in South Africa

 The South African Reserve Bank who administers the South African currency and sets monetary
policy, uses three different measures of the quantity of money. These measures are labelled M1, M2
and M3 respectively (Mohr and Fourie: 2015, 259)
 The conventional measure (M1)
 M1 is defined solely on the basis of the function of money as a medium of exchange
 M1 includes coins and notes (in circulation outside the banking sector) as well as all demand deposits
(including cheque and transmission deposits) of the domestic private sector with monetary institutions.
A broader definition of money (M2)
 M2 is equal to M1 plus all other short-term and medium-term deposits of the domestic private sector
with monetary institutions
 The most comprehensive measure of money (M3)
 For many years M1 and M2 were the only measures used to quantify the money supply, but nowadays
great significance is attached to the M3 measure
 M3 is equal to M2 plus all long-term deposits of the domestic private sector with monetary institutions
3.1.4 Characteristics of money

Gold for centuries has emerged as the ultimate money despite a concerted attempt to dethrone it – the reason
is that of all substances it meets the characteristics of an ideal medium of exchange and store of value:
 Uniformity – One part has exactly the same characteristics than another
 Divisibility – It can be divided into infinitely small units
 Durability – It does not corrode
 Portability – The value to weight ratio is high
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3.1.5 The functions of money

 Money as a medium of exchange
 Money as a unit of account
 Money as a store of value
 Money can be used to settle debts in the future
 Money as a medium of exchange:

In the absence of money, we would have to utilize bartering or a barter system. The challenge with trading via
bartering is the establishment of a coinciding value of the two goods being exchanged. For each thing one
needs, one has to find someone who can and will exchange their goods for your goods. For example, a wheat
farmer who needs clothing for his family first has to find a tailor who needs wheat. Then the exchange can take
place. If no tailor who happens to want wheat can be found, the farmer will be obliged to exchange the wheat
for something else that the tailor does require. In other words, before the exchange of two goods can take place,
there has to be a double coincidence of wants between the parties concerned. A barter economy is therefore
characterised by numerous unnecessary exchange transactions which are cumbersome and inefficient. For
each thing you need, you have to find someone who can, and will, exchange his or her goods (i.e. the things
you need) for your goods.
The advantages of a monetary economy, where exchange takes place through the medium of money, are just
as obvious as the disadvantages of a barter economy. In a monetary economy a double coincidence of wants
between parties is no longer required. The farmer no longer has to look for a tailor who needs wheat. As long
as a buyer can be found for the wheat, the money received in exchange for the wheat can be used to buy
clothes. Money therefore serves as a lubricant or intermediary to smooth the process of exchange and to
make it more efficient.
 Money as a unit of account

A unit of account is an agreed measure for stating the prices of goods and services. In a money economy the
prices of all goods and services are expressed in monetary terms. Money thus functions as a unit of account.
We need a common measure of the cost of various goods and services to be able to decide how best to spend
our income. The fact that income and prices are all expressed in rand and cents enables us to calculate what
we can afford. If we know that a beer costs R12 and a soft drink costs R8, then we can also immediately
calculate the opportunity cost of a beer in terms of the number of soft drinks that we have to sacrifice for a beer.
In addition, the use of money as a unit of account enables us to obtain measures of the total value of all goods
and services produced in the economy, such as GDP. Money is not, however, the only possible unit of account.
Any other commodity or product can serve as a unit of account. The item used as the medium of exchange
(money) is simply the most convenient unit of account. The function of money as a unit of account is closely
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related to its function as a medium of exchange. What serves as a medium of exchange usually also fulfils the
function of an accounting unit?
 Money as a store of value:

Money is also a store of value. In any society there is a need to hold wealth (or surplus production) in some
form or another. A common form for holding wealth is money, since it can always be exchanged for other goods
and services at a later date. Wealth can, however, also be held in other forms, such as fixed property, real
assets, stocks and shares. The advantage of using money as a store of value lies in the fact that it is usually
more convenient and can be used immediately in exchange for other assets. We therefore say that money is
the most liquid form in which wealth can be kept. But it is not always advantageous to use money as a store of
value. In times of high inflation money loses its purchasing power and is not a good store of value. A person
who keeps all her wealth in the form of money while there is inflation will soon realise that her wealth is not
retaining its value.
By looking at the functions that money should fulfil one can see that many modern currencies are losing the
ability to meet all the requirements. As an extreme example let us consider the Zimbabwean dollar. At the height
of the inflationary period it was still used as a medium of exchange. There its functionality stopped – as an
accounting unit it lost its ability to compare prices from one period to the next (apart from the fact that there was
no space to write all the zeros and computer software bombed out). As a store of value, it was meaningless
and could not be used to settle debts in the future unless massive interest was levied). All official present-day
fiat currencies have the same problem though not as extreme.
3.2 The South African Reserve Bank

 South Africa’s central bank is the South African Reserve Bank (SARB), which was established early
in the 1920’s.
 The Constitution of the Republic of South Africa clearly states that;
o The primary object of the South African Reserve Bank is to protect the value of the currency
in the interest of balanced and sustainable economic growth in the Republic.
o The SARB, in pursuit of its primary object must perform its functions independently and
without fear, favour or prejudice, but there must be regular consultation between the Bank
and the cabinet members responsible for financial matters.
 The Reserve Bank is the monetary authority in South Africa and its current functions can be grouped
into the following four major areas of responsibility;
o Formulation and implementation of monetary policy.
o Service to the government.
o Provision of economic and statistical services.
o Maintaining financial stability
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Further readings on the functions of SARB
https://www.resbank.co.za/AboutUs/Functions/Pages/default.aspx
Think Point 3.1
In 2017, The then Public Protector stunned the country when she proposed
that the primary constitutional mandate of the South African Reserve Bank be
broadened to “…to promote balanced and sustainable economic growth in the
Republic, whilst ensuring that the socio-economic well-being of the citizens is
protected” (Labson, 2017).
Given the primary objective and functions outlined above, do you feel that the
bank is currently not set up to meet the Public Protector’s proposed mandate?
If so, why?
3.3 The supply of money

The creation of money (as we know it to today) is the result of a credit transaction between the Treasury and
the Central Bank and Commercial Banks – The treasury issues bills and bond which the Central Bank buys by
issuing money (either cash and coin or guarantees).
Money is also created by the banks. Banks accepts cash or cash related deposits from the general public and
lend these funds to borrowers. Because of the fractional reserve system, they can lend out and receive as
deposits the “same” money unit more than once - which in effect creates money. The difference between the
lending rates and the deposit rates represents the income that banks receive for their intermediation role.
The money supply can also be influenced by transactions with foreign countries and by government
transactions. Foreign trade and international capital movements can also exert a significant influence on the
domestic money supply. If a local exporter earns foreign currency and exchanges it at his bank for a demand
deposit, the money supply will be directly increased. On the same principle, payment for imports will have a
negative effect on the money supply.
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Capital inflows have the same effect as exports while capital outflows decrease the money supply in the same
way as imports do. A country’s money supply generally increases when its gold and foreign exchange reserves
increase and falls when the gold and foreign exchange reserves decrease. (Mohr and Fourie: 2015,)
3.4 The demand for money

The demand for money is the amount that the various participants in the economy plan to hold in the form of
money balances.
The demand for money does not relate to the amounts of money that people want. The demand for money is
concerned with the choices of those participants who earn an income or possess wealth. The opportunity cost
of holding any money balance is the interest that could have been earned had the money been used to purchase
bonds instead.
Money will only be held if it provides a service that is valued at least as highly as the opportunity cost of holding
it. The demand for money is therefore directly related to the functions that it performs. Two most important
functions of money are the medium of exchange and the store of value functions. On the basis of these two
functions we can distinguish two basic components of the demand for money:
o The transactions demand for money which arises from the medium of exchange function
o The demand for money as an asset which arises from the store of value function
Reasons for holding money.

 Transaction motive
 Precautionary motive
 Speculation motive
3.4.1 The interest rate:

 Interest rates may generally be described as the prices of loanable funds (the cost of money). The
suppliers of funds would like to earn an income on the funds invested or lent out, while borrowers are
usually willing to pay a price for the right to use these funds.
Types of interest rates

 Repo rate (which plays a dominant role in the money supply process).
 The interbank lending rate
 The prime rate of banks
 Various rates deposits e.g. fixed interest rates
 Mortgage rates
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 Rates on government stock etc.

Though all the rates differ and there are sound economic reasons for these difference, the rates
nevertheless tend to move in harmony with each other. Therefore, the term interest rate is regarded
as a representative rate for all the individual rates encountered in practice.
3.5 The monetary policy framework in South Africa

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.
Monetary policy in South Africa is formulated and implemented by the South African Reserve Bank. Decisions
on the appropriate monetary policy stance are taken by the Monetary Policy Committee (MPC) of the SARB.
The MPC consists of the governor, deputy governors and a few senior officials of the Bank. Regular Monetary
Policy Forums are also held to provide a platform for discussion of monetary policy issues with a broad range
of stakeholders.
Activity 3.1
Carry out a research on the evolution of the monetary policy framework in South Africa
from 1960 to 2000
3.5.1 The instruments of monetary policy

The key market-oriented policy instruments are;
 Accommodation policy (or the refinancing of the liquidity requirements)
 Open market policy
 Public debt management
 Intervention in foreign exchange markets
The South African Reserve Bank relies extensively on its accommodation policy to influence interest rates.
Open market policy is the main supporting instrument of the accommodation policy. Therefore, a detailed
description of the two is provided below;
 Accommodation Policy
Banks are obliged to hold 2.5% of their total liabilities to the public in the form of cash reserves with the
Reserve Bank. If banks need funds, they borrow through the interbank market.
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Liquidity is provided to the banks by means of repurchase agreements (repos) between the Reserve bank and
its banking clients. The underlying assets eligible for these repos are government bonds, Treasury bills, Land
Bank bills and Reserve bank debentures of all maturities.
If the Reserve Bank is of the opinion that a particular position where a bank requires a facility were due to
unacceptable activities on the market that exist between banks (interbank), the banks would be accommodated
(hence the name) at a penalty rate of 0.5 percentage points above the repo rate. Changes in the repo rate lead
to adjustments in the interest rates at which credit is made available by the banks to their clients. The cost of
credit in the economy is, therefore, directly linked to the repo rate.
Think Point 3.2
The South African Reserve Bank is reported to expect the new 15% VAT
to add 0.6 percentage points to inflation (World Bank, 2018b:17). If the
bank desired to reverse this effect, what kind of accommodation policy
would it need to implement, and how would this affect consumers?
 Open market policy

Open market transactions consist of the purchase or sale of domestic financial assets by the Central bank
in order to exert a specific influence on interest rates and the quantity of money. Refer to section 15.10
of the prescribed text for further understanding.
3.6 Other instruments

In addition to the policy instruments mentioned above, the monetary authorities in pursuit of their goals may
use a number of other measures. These include non-market oriented instruments measures such as;
o Credit ceilings
o Deposit rate control
o Changes in the terms of hire purchase agreements
STUDY UNIT
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Unit
4: The Public Sector
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4.1 The role of government in the  Understand why governments believes it should be
economy: an overview involved in the economy
4.2 Government Intervention in the  Describe how governments intervene in the economy
economy
 Distinguish between nationalisation, privatisation and
commercialisation
4.3 Fiscal Policy and the budget  Distinguish between fiscal and monetary policy and
describe the main elements of each
4.4 Expansionary and contractionary  Understand the concept of aggregate demand and how
policies policies related to these affect the economy
4.5 Components of Aggregate Demand  Outline the four components aggregate demand is made
up of
4.6 Taxation  Understand the three basic criteria for good tax
 Understand the difference between direct taxes and

indirect taxes
edition. Pretoria. Van Schaik Chapter 15
 Horton and El-Ganainy (2009) What Is Fiscal Policy?c
https://www.imf.org/external/pubs/ft/fandd/2009/06/pdf/basics.pdf
 Ocran (2009) Fiscal Policy and Economic Growth in South Africa
https://www.researchgate.net/publication/228471669_Fiscal
_Policy_and_Economic_Growth_in_South_Africa
 ytutor.co.uk/answers/33726/GCSE/Economics/What-is-the-difference-
between-a-contractionary-and-expansionary-fiscal-policy/. What is the
difference between a contractionary and expansionary fiscal policy?
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4.1 The role of government in the economy: an overview

In Chapter 2 of the prescribed text, Mohr and Fourie (2015), it is suggested that nowadays all economies can
be classified as mixed economies, in which the government, the private sector and market forces all play
an important role. In this section, an appropriate mix of markets and government intervention is investigated.
Economics is not only concerned with the efficient allocation of resources but also maximising the benefit to the
whole of society, including those who have been disadvantaged to maximise their potential and fulfil their needs
in an optimal way. The allocation of resources is efficient when it is impossible to reallocate the resources to
make at least one person better off without making someone else worse off. Also, that society’s welfare is
maximized when the marginal cost of each product is equal to its price in the long run and where the marginal
costs are being driven down through entrepreneurship, finding new and better ways of producing and
harnessing the creativity of human beings in solving the economic problem.
Market failure occurs when the market system is unable to achieve an efficient allocation of resources.
Issues such as pollution, the problem of the commons (and here overfishing is a good example of this) and
unethical corporate actions (Enron) are examples. In many cases that which is ascribed to market failure is
really the result of Government failure – where some intervention in the marketplace by government has led to
the resultant inefficient allocation of resources. The best example of this is the prevalence of Monopolies in the
SA economy as a result of restrictive legislation (the energy situation in 2009 – 2015 springs to mind).
Government intervention usually arises in an attempt to improve a situation where, certain short term social
objectives need to override what could make sense in the long term. Refer to the prescribed text, (Mohr and
Fourie, 2015:277), of incidences of market failure (where the government could try to correct these).
4.2 Government Intervention in the economy

The great strength of the market system is its ability to generate very efficient outcomes in the majority of cases
through a system of decentralised decision-making in which each individual participant tries to maximise his or
her benefit. Not surprisingly, however, markets do not perform well in the short term when broader social goals
are at stake. Much of the justification for government’s role in the economy can be traced to the inability of the
market system to achieve broader goals such as equitable income distribution as quickly as the persons in
power need in order to maintain their political credibility.
4.2.1 How does government intervene?

 Public provision of goods and services: This can be achieved by public ownership or by public
financing of production undertaken by the private sector. Some services such as policing, national
defence, and the justice system are seen as public goods and fall within the legitimate ambit of the
state. Services such as schools and hospitals fall into an area where there are many models and
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different views exist as to how best serve the populace as a whole. Infrastructure is often financed by
the state but built and operated by the private sector, to achieve the best results.
 A second way in which government can try to achieve its objectives is through its role as a market
participant. For example, government is the largest employer of labour in the economy and through its
wage policy and other employment practices it can try to achieve certain objectives (training of
technicians) and also set an example for other employers to follow in areas such as women
empowerment and employment of people with disabilities.
 Government spending is a powerful tool. Both the level and the composition (or structure) of
government spending have a powerful impact on the economy. Apart from deciding which and what
quantity of goods and services to purchase, government also makes transfer payments, that is,
payments for which it receives nothing in return. Examples include old-age pensions, child support
grants, disability grants and various subsidies. Transfer payments are a powerful instrument that can
be used to change the distribution of income.
 A fourth instrument at the disposal of government is taxation. Although the primary purpose of taxation
is to finance government expenditure, the level and structure of taxation can be used to achieve
various objectives. Taxation can be used to redistribute income, to promote certain desirable activities
and to penalise other socially undesirable activities. For instance, tax incentives (possibly in the form
of lower tax rates or tax holidays) are often provided to stimulate investment spending and small
business development, while tobacco products and alcoholic beverages are subject to additional taxes
to discourage use.
 A fifth important instrument that government can use to affect economic outcomes is regulation.
Regulation refers to all laws, rules and regulations that affect private behaviour. Examples include the
labour laws (which govern the labour market); competition policy (which governs the goods markets);
the anti-tobacco law (which regulates smoking in public places); and fixing of maximum or minimum
prices and minimum wages. In many cases these regulations are enforced through a system of fines
and criminal penalties.
4.2.2 Nationalisation and Privatisation

One of the aspects of the role of the public sector that has been debated vigorously in South Africa is the issue
of nationalisation and privatisation (i.e. the desirability of public vs private ownership)
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 Nationalisation
o Nationalisation means that the government takes over the ownership or management of private
enterprise (with compensation – if the owners are not compensated it will amount to the confiscation
of assets which is tantamount to theft).
o Proponents of nationalisation in South Africa often mistakenly argue that nationalisation was a
significant element in the solving of the poverty problem of the poor white in the 1930’s. They cite the
establishment of a national transport system, a national posts and telecommunications, Iscor and
Sasol as examples of successful nationalisation by the South African government. This is, however,
an incorrect interpretation. The establishment of state-owned industries is not the same as
nationalisation (i.e. the transfer of ownership from private enterprise to government).
o The understanding of the ills of a command economy has improved with the experiences of the late
20th century and the dismal performance of countries that have a low freedom index (2014,
freetheworld.com).
 Privatisation
o Privatisation refers to the transfer of ownership of assets from the public sector to the private sector
(i.e. the sale of state-owned assets to the private sector).
o The case for privatisation is usually based on three broad arguments.
1. The first concerns the problem of financing increasing government expenditure in a situation
where tax burdens are already very high. In South Africa, for example, privatisation is regarded
as a possible way of obtaining funds that can be used to reduce public debt and lower personal
income tax.
2. The second argument is based on the view that government ownership is always less efficient
than private ownership. According to this argument the role of the government in the economy
should be reduced and more scope should be created for private ownership and private initiative.
3. The third is based on the view that the losses of inefficient state-owned enterprises are important
source of budget deficits and other fiscal problems.
The arguments for privatisation include the following;

 State-owned enterprises are bureaucratic, inefficient, and unresponsive to consumer wishes and often
a burden on the tax payer. They are also characterised by a lack of creativity and innovation by
management, poor investment decisions, poor financial control, a lack of accountability to taxpayers
and low levels of productivity. Privatisation, it is argued, will eliminate these shortcomings.
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 Privatisation will attract foreign direct investment, thereby also augmenting the country’s foreign
exchange reserves.
 To the extent that public enterprises do not pay tax, privatisation will broaden the tax base (since the
privatised enterprises have to pay tax)
 Privatised enterprises will have greater access to investment capital and will be able to adapt more
easily to changing economic conditions.
 The proceeds from privatisation will make funds available for spending on housing, education, health
and so on.
 Privatisation will increase share ownership in the economy and serve as an instrument of black
economic empowerment.
Arguments against privatisation include the following;

 Privatised firms will not necessary be exposed to greater competition and be more efficient than state-
owned firms. In the extreme case, privatisation may simply entail the replacement of a state monopoly
with a private monopoly if the same protections are afforded the organisation.
 Whereas state-owned firms are expected to, privately owned firms will not take a broader view of the
public interest. For example, the provision of postal services, rail transport, telephone services and
electricity to rural areas often entails losses which have to be recouped from the more profitable
provision to metropolitan and urban areas. If these services are privatised, the services to the rural
areas may be terminated or become more expensive if the government does not subsidise the users
of such services.
Think Point 4.1
At what cost or benefit to YOU would the privatisation of the South African
power utility giant ESKOM be?
Commercialisation
 Commercialisation means the transformation of state-owned enterprises into commercial entities,
subject to commercial legal requirements and governance structures, while retaining state ownership.
In other words, the enterprise remains in the public sector but is run like a private company and is also
liable for tax. This is what has happened in recent years at Transnet, Eskom and other enterprises.
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4.3 Fiscal Policy and the budget

The government purchases goods and services, raises taxes and borrows funds to finance its expenditure. It
is, therefore, necessary that government have policies with regard to the level of government spending, taxation
and borrowing. This is known as the fiscal policy. The main instrument of fiscal policy is the budget and the
main policy variables are government spending (capital and social spending) and taxation (direct and indirect).
The budget is essentially a reflection of political decisions about how much to spend, what to spend it on and
how to finance the spending. But the size and composition of government spending and the way in which it is
financed can have significant effects on important macroeconomic variables such as aggregate production,
income and employment and the price level, as well as on the distribution of income. These effects have to be
taken into account when the budget is prepared. Though it is often not the main intent, the government often
uses the budget (or fiscal policy) to attain economic objectives such as to stimulate economic growth and
employment, redistribute income, control inflation or address balance of payments problems.
Fiscal policy is often regarded as an effective means of influencing total spending (aggregate demand
for goods and services) in the economy. Mohr and Fourie (2015) refer to this as demand management.
Monetary policy, introduced in study unit 3, is also recognised as demand management. Whilst fiscal policy
deals with government spending, taxation and borrowing, monetary policy deals with manipulation of
interest rates. Whilst fiscal policy is controlled by government, monetary policy is controlled by the
central bank. These policies have to be applied in harmony; otherwise the one may counteract or negate the
effects of the other. There is, therefore, some liaison between the National Treasury, which is responsible for
the execution of fiscal policy and the South African Reserve Bank, which applies the monetary policy in South
Africa.
Think Point 4.2

South Africa’s fiscal policy (in part form a portion of its social assistance transfers) is
documented at having reduced the Gini coefficient by an unprecedented 10.5 percentage
estimate from developed or developing countries (World Bank, 2018a:73). At what cost (in
terms of opportunity cost) might this have come?
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4.4 Expansionary and contractionary policies

One of the functions of governments in a mixed economy is to counteract economic instability. When the
economy is in a recession, the tendency is, therefore, to apply expansionary fiscal and monetary policies to
stimulate economic activity. On the fiscal side, this means taxes are reduced and government spending is
increased, and vice versa.
4.5 Components of Aggregate Demand

Aggregate demand is the total quantity of output demanded at alternative price levels in a given period of time,
ceteris paribus. A recession occurs when aggregate demand declines and it persists when aggregate
demand remains below the country’s capacity to produce.
Aggregate demand is made up of four components:

 Consumption (C);
 Investment (I);
 Net Exports (X-M); and
 And Government Spending (G).
The government can alter aggregate demand by:

 Purchasing more or fewer goods and services;
 Raising or lowering taxes;
 Changing the level of income transfers (payments to individuals for which no current goods or services
are exchanged, such as social pension, welfare, unemployment benefits); and
 Increasing government spending turns into income for the people who provide goods and services to
the government.
4.6 Taxation
Taxes are compulsory payments to government and are the largest source of government revenues.
There are a number of criteria for good tax, here are three:
 Neutrality;
 Equity; and
 Administrative simplicity.
Refer to Mohr and Fourie (2015:293) for detailed explanation on the criteria.
Taxes can be classified into two major categories, direct and indirect. Direct taxes are levied on persons or
companies, whilst indirect taxes are levied on transactions. Examples of direct taxes are personal income
tax, company tax and estate duty. Examples of indirect taxes in South Africa are VAT, customs duties and
excise duties.
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Activity 4.1
Which of the following would be classed as an expansionary fiscal policy?
a) An increase in the money supply

b) A reduction in the number of goods exempted from VAT
c) An increase in government taxation
d) An increase in government expenditure
e) An increase in the VAT rate
STUDY UNIT
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Unit
5: Macroeconomic Theories
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5.2 Economic Schools of Thought  Describe the main characteristics of the Free Market
Economy and the Marxist/Socialist Economy
5.3 Keynes versus Classical Economic  Compare Keynesian Economic Theory with the Classical
Theories Free Market Economics
5.4 A Simple Keynesian  Understand the simple Keynesian Model of a Closed

Macroeconomic Model without the Economy without a government or the foreign sector
government and foreign sector
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5.1 Introduction
The term macroeconomics originated in the 1930s – when production, employment and prices collapsed in
much of the industrial world (The Great Depression).
The development of macroeconomics has been one of the major breakthroughs of twentieth-century economics
leading to a much better understanding of how to combat periodic economic crises and how to stimulate long-
term economic growth.
Every discussion of macroeconomic policy invariably starts with John Maynard Keynes (1883-1946). His
principal contribution was a new way of looking at macroeconomics and macroeconomic policy. This study unit
focuses primarily on the main contributions made by Keynes. To obtain a more holistic picture of
macroeconomic theory and to fully appreciate Keynes’ contribution, a good starting point would be a brief
overview of the main economic schools of thought.
5.2 Economic Schools of Thought

According to John Pape (2000), there are essentially three economic schools of thought:
5.2.1 Free market economics (sometimes referred to as: orthodox theory, neo-classical theory, conservative
economics, free enterprise economics, neo-liberalism, bourgeois economics or capitalistic
economics);
5.2.2 Marxist economics (or socialist economic theory or communist economic theory or radical economic
theory); and
5.2.3 Keynesian economics (or the theory of the mixed economy or interventionist economics).
5.2.4 The Free Market School

 Major Beliefs
There are three central beliefs in free market economics:

o Human beings are motivated mainly by profit and self-interest (personal gain);
o Business should be given a free hand in all economies; and
o Competition between different businesses should be promoted (encouraged).
o It is by acting in one’s own self-interest that people will produce goods and services and trade.
According to free market economics, an economy works well when businesses make high profits, i.e., anything
which limits the making of profit (excluding force and fraud) is bad for the economy. For example, free marketers
oppose high taxes. They argue that if government coercively takes large amounts of tax from businesses,
companies will not want to continue to produce. They will lose motivation, since extra profits will be paid as tax.
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They also argue that everyone will benefit if companies are allowed to keep all of their profits to:
o Build new factories and produce more goods;
o Create more jobs; and
o Increasing employment means that people will have more money to spend; and
o There will be more money for the business to pay better salaries and higher dividends for owners.
They believe that the major obstacle to the success of their model is government intervention in the trade
activities of consenting parties. Free marketers oppose high taxes and nationalization (where government owns
and runs businesses). They believe that government should pass laws and take other measures that aim at
ensuring the environment is conducive for business – e.g. Property rights are protected, an open, fair and
accessible legal system is established, that special interest groups are not advantaged, no special privileges,
no onerous regulations and tariffs are implemented and sound money policies are followed. In such a society
force will not be used to attain social objectives, laws that force people to act against their personal preferences
or own self-interest are not promulgated.
 Type of Economic System Supported

Free marketers are capitalists, i.e., they support a society where classical liberal concepts are followed –
the key tenet of the capitalist economic system is consent and furthermore, that works according to the
idea of private ownership of the factors of production and private property rights.
 Countries where Practised (to some degree)

USA, Switzerland, Singapore
5.2.5 Marxist Economics

The German writer, Karl Marx (1800s) together with Friedrich Engels, wrote extensively and had a big influence
on the spread of socialism and communism. These ideas have had a profound effect of the world economy, but
also caused the death of millions of people under the communist and socialist dictators like Hitler (National
Socialism), Stalin, Mao Tse Tung, Pol Pot and others. Since the 1990’s these ideas have lost favour in most
industrialised countries, though pockets of this thinking remain in the more so-called “mixed” economies.
 Major Beliefs
Marxist economists disagree almost totally with free market theory. There are two basic points on which
they differ. They do not believe that:
 Property rights should vest with individuals
 Profit should drive an economy, that money should be eliminated; and
They do believe that the end justifies the means, even if it is to the disadvantage of some individuals or groups
– individuals should sacrifice their own interests for the greater good of society.
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They argue that human beings are not driven by self-interest. Because human beings are capable of problem
solving, they are capable of cooperation. Hence, an economy should be based on cooperation rather than
competition or self-interest.
 Type of Economic System Supported

They believe in a socialist economic system.
 Countries where Practised

Former Soviet Union, Cuba, People’s Democratic Republic of Korea (North Korea), and previously some
other eastern European countries. Though China and South Vietnam have communist rulers, they have
liberalised their economies dramatically. China has since the takeover of Hong Kong created numerous
Free Trade Zones along the east coast which are driving the economic revival; Vietnam have instituted
the Doi Moi economic programme that has put land back in private ownership and have instituted many
other reforms such as the owning of property by foreigners – both these countries have however faced
serious human rights violation allegations.
5.2.6 Keynesian Theory

 Background
In the late 1920’s, the world economic system began to break down after the shaky recovery that followed World
War 1. With the global drop in production, critics of the global standard, market self-correction, and production-
driven paradigms of economics moved to the fore. Dozens of different schools contended for influence. Further,
some pointed to the Soviet Union as a successful planned economy which had avoided the disasters of the
capitalist world and argued for a move toward socialism. Others pointed to the alleged success of fascism in
Mussolini’s Italy.
Into this void stepped Keynes, promising not to institute a revolution but to save capitalism. He circulated a
simple thesis:
There were more factories and transportation networks than could be used at the current ability of individuals
to pay and that the problem was on the demand side.
But many economists still insisted that business confidence, not lack of demand, was the root of the problem,
and that the correct course was to slash government expenditure and to cut wages to raise business confidence
and willingness to hire unemployed workers. Yet others simply argued, “nature would take its course,” solving
the depression automatically by “shaking out” unneeded productive capacity.
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5.3 Keynes versus Classical Economic Theories

Keynesian economics is a theory of total spending in the economy – aggregate demand – and of its effects on
output and inflation.
According to “classical” economic theory, adjustments in prices would automatically make demand tend to the
full employment level. Keynes argued that this self-correcting process never happened in the early 1930s when
employment and output fell sharply.
In the neo-classical theory, the two main costs are those of labour and money. If there was more labour than
demand for it, wages would fall until hiring began again. If there was too much saving and not enough
consumption, then interest rates would fall until either people cut savings or started borrowing. These two price
adjustments would always enforce Say’s Law, and, therefore, the economy would be at the optimal level of
output.
5.3.1 Wages and Spending

Even in the worst years of the depression, the classical theory defined economic collapse as simply a lost
incentive to produce. Mass unemployment was caused only by high and rigid real wages. The proper solution
was to cut wages.
To Keynes, the determination of wages is more complicated. First, he argued that it is not real but nominal
wages that are set in negotiations between employers and workers. It is not a barter relationship.
Nominal wage is the amount paid in money terms while real wage is the value in terms of the purchasing
power i.e. real wage takes into account the effects of inflation.
First, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical
economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, unions, and
long-term contracts, and increasing labour-market flexibility. However, to Keynes, people will resist nominal
wage reductions, even without unions, until they see other wages falling and a general fall of prices.
He also argued that to boost employment, real wages had to go down: nominal wages would have to fall more
than prices. However, doing so would reduce consumer demand so that the aggregate demand for goods would
drop. This would, in turn, reduce business sales revenues and expected profits. Investment in new plant and
equipment -- perhaps already discouraged by previous excesses -- would then become riskier and less likely.
Instead of raising business expectations, wage cuts could make matters much worse.
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5.3.2 Excessive Saving

To Keynes, excessive saving, i.e., saving beyond planned investment, was a serious problem encouraging
recession or even depression.
Recession – fall of a country’s GNP in three successive quarters – may involve falling prices which can lead
to a depression (where the country “can’t get up”).
Excessive saving results if investment falls, perhaps due to falling consumer demand, over-investment in earlier
years, or pessimistic business expectations, and if saving does not immediately fall in step.
Third, Keynes argued that saving and investment are not the main determinants of interest rates, especially in
the short-run. Instead, the supply of and the demand for the stock of money determine interest rates in the
short-run. Neither change quickly in response to excessive saving to allow fast interest-rate adjustments.
Finally, because of fear of capital losses on assets besides money, Keynes suggested that there may be a
“liquidity trap” setting a floor under which interest rates cannot fall. (In this trap, bond-holders, fearing rises in
interest rates (because rates are so low), fear capital losses on their bonds and thus try to sell them to attain
money (liquidity). Even economists who reject this liquidity trap now realize that nominal interest rates cannot
fall below zero (or slightly higher).
Even if this "trap" does not exist, there is a fourth element to Keynes's critique (perhaps the most important
part). Saving involves not spending all of one's income. It thus means insufficient demand for business output,
unless it is balanced by other sources of demand, such as fixed investment. Thus, excessive saving
corresponds to an unwanted accumulation of inventories, or what classical economists called a “general glut”.
This pile-up of unsold goods and materials encourages businesses to decrease both production and
employment. This, in turn, lowers people's incomes -- and saving.
For Keynes, the fall in income did most of the job, ending excessive saving and allowing the loanable funds
market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a recession does so.
Whereas the classical economists assumed that the level of output and income was constant and given at any
one time (except for short-lived deviations), Keynes saw this as the key variable that adjusted to equate saving
and investment.
Finally, a recession undermines the business incentive to engage in fixed investment. With falling incomes and
demand for products, the desired demand for factories and equipment (not to mention housing) will fall. This
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accelerator effect would shift the investment curve (I) to the left again. This recreates the problem of excessive
saving and encourages the recession to continue.
In summary, for Keynes, there is interaction between excess supplies in different markets, as unemployment
in labor markets encourages excessive saving -- and vice-versa. Rather than prices adjusting to attain
equilibrium, the main story is one of quantity adjustment allowing recessions and possible attainment of
underemployment equilibrium.
5.3.3 Government Policy – Active Fiscal Policy

Fiscal Policy, as mentioned previously, describes the behaviour of governments in raising money to fund
current spending and investment for collective social purposes and of transfer payments to citizens and
residents of the territory for which the government is responsible.
Classical theorists wanted to balance the government budget through:

 Slashing expenditure; or
 If this was not possible to raising taxes.
Keynes felt that either policy would exacerbate the underlying problem since it will raise saving, thereby lowering
demand for both products and labour. He suggested that active government policy – policies which acted
against the tide of the business cycle - is more effective in managing the economy. By that he meant:
 Deficit spending when a nation’s economy suffers from recession or when recovery is delayed by
persistently high unemployment.
Note: When the expenditure of a government (its purchases of goods and services, plus its transfers (grants)
to individuals and corporations) is greater than its tax revenues, it creates a deficit in the government budget.
 Suppression of inflation in boom times by:
o Increasing taxes; or
o Reducing government spending.
5.3.4. The Multiplier Effect

The Multiplier Effect is defined as the change in income due to the permanent change in the flow of expenditure
that caused it. In other words, the multiplier effect refers to the increase in final income arising from any new
injections.
The effect on demand of any exogenous (refers to an action or object coming from outside a system) increase
in spending, such as an increase in government outlays is a multiple of that increase - until potential is reached.
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Thus, a government could stimulate a great deal of new production with a modest outlay: if the government
spends, the people who receive this money, spend most on consumption goods and save the rest. This extra
spending allows businesses to hire more people and pay them, which, in turn, allows a further increase in
consumer spending. This process continues. At each step, the increase in spending is smaller than in the
previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium.
For example, SABMiller decides to spend R1billion to build a new factory in Gauteng. When SABMiller spends
R1billion, the amount spent goes to the workers and owners of construction companies and to the companies
that supply the materials and equipment to the construction industry. They receive the income in the form of
wages, salaries and profits. The investment spending of R1billion thus raises income of households and firms.
The households will buy goods and services in a supermarket who will also receive income to spend. Thus in
each round there is additional spending of income. The ratio between the eventual change in income and the
initial investment is called the multiplier.
Calculation of the multiplier effect
Multiplier = 1 / MPS
= 1 (1 – MPC)
MPS is marginal propensity to save and is defined as the extra saving generated by one unit of extra income
MPC is marginal propensity to consume and is defined as the extra consumption generated by one unit of extra
income.
For example
If the government increases expenditure by R100 000. We assume that this money is going towards
constructing of a new freeway, also, we assume the government hires a firm to construct the road. The
company, in turn, pays workers’ wages. These workers then spend the money.
If the Marginal Propensity to Consume (MPC) is 0.8, which means that the consumer spends 80% of the
income. Therefore 0.2 (20%) is saved Marginal Propensity to Save (MPS),
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The Multiplier = 1 / (1-0.8) = 5
Therefore, the cumulative effect of the R100,000 added to the economy is R500,000 (R100 000 x 5)
Activity 4.1
For example, assume the government increases their total spending to R10
million on building of a new mall and the MPC is 0.80. Calculate the multiplier
effect
5.3.5 Interest Rates

Classical Model – The supply of funds (savings) determined the amount of fixed business investment. The
interest rate adjusts so that the quantity of funds saved is equal to the quantity of money invested.
Keynes – The amount of investment was determined independently by long-term profit expectations and, to a
lesser extent, the interest rate. This approach opens the possibility of regulating the economy through money
supply changes via the monetary policy.
5.3.6 A Summary of the central Themes of Keynesian Economics

According to Blinder (1987), six principal tenets are central to Keynesianism – the first three describe how the
economy works and the next three are distinguishing features (from other economic theorists) on economic
policy:
 Aggregate demand is influenced by a host of economic decisions – both public and private – and
sometimes behaves erratically. The public decisions are mainly on monetary and fiscal policy.
 Changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run
impact on real output and employment, not on prices.
 Prices, and especially, wages, respond slowly to changes in supply and demand. This results in
shortages and surpluses, especially in labour.
 Keynesians do not think that the typical level of unemployment is ideal – partly because unemployment
is subject to the caprice of aggregate demand, and partly because they believe that prices adjust only
gradually.
 Most Keynesians advocate an activist stabilization policy to reduce the amplitude of the business cycle
(this will be discussed in a later study unit).
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 Many Keynesians are more concerned about combating unemployment than about conquering
inflation.
Keynesian theory was much denigrated in academic circles from the mid-1970s until the mid-eighties. It has
staged a strong comeback since then mainly because it was better able to explain the economic events of the
70’s and 80’s than its principal intellectual competitor, new classical economics. They were able to explain the
European depression of the eighties as follows:
Governments, led by the British and German central banks, decided to fight inflation with highly restrictive
monetary and fiscal policies. The anti-inflation crusade was strengthened by the European Monetary System,
which, in effect, spread the stern German monetary policy all over Europe.
The new classical school has no comparable explanation. In fact, they argue that European governments
interfere more heavily in labour markets (high unemployment benefits and restrictions on firing workers). But
most of these interferences were in place in the early seventies, when unemployment was extremely low.
5.4 A Simple Keynesian Macroeconomic Model without the government and foreign sector
For the purpose of this module, an examination of the simplest possible model will be conducted, i.e., this model
excludes the government and the foreign sector and only considers households and firms. The following table
(Mohr & Fourie, 2015:317) summarises the assumptions of this simple model and highlights the implications of
these assumptions.
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1Table: 5.1: Assumptions and implications of the Keynesian model
ASSUMPTIONS IMPLICATIONS
The economy consists of households and Total spending consists of consumption spending
firms and investment spending
There is no government The model cannot be used to analyse government

spending and taxes
There is no foreign sector The model cannot be used to analyse exports,

imports, exchange rates, trade policy and exchange
rate policy
Prices are given Model cannot be used to study inflation
Wages are given Model cannot be used to study the workings of the
labour market
The money supply and interest rates are Model cannot be used to study the financial markets
given and monetary policy
Spending (demand) is the driving force Production (supply) adjusts passively to changes in
that determines the level of economic spending (demand)
activity
In an economy that consists of households and firms only, there are only two types of spending:
 Consumption spending (C) – spending by households on consumer goods and services; and
 Investment spending (I) – spending by firms on capital goods.
The economy is in equilibrium when:
Aggregate Spending (A) = Aggregate Income (Y) (Eqn. 1)

Now Aggregate spending (A) consists of consumption spending (C) and investment spending (I).
i.e. A = C + I
In other words, an economy is in equilibrium when:
C + I = Y (Eqn. 2)
Consumption Spending (C)

Consumption spending is the largest component of total spending. The relationship between consumption
expenditure by households and total income is called the consumption function. The consumption function has
three important characteristics:
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 Consumption  as income ;
 Consumption is positive even if income is zero this reflects the influence of non-income determinants
on income spending; and
 When income , consumption also  but is less than the  in income since part of the additional
income is saved.
The above three characteristics of the consumption function are illustrated below
Figure 5.1: The consumption function

Autonomous consumption is that part of consumption which is independent of the level of income, i.e.,
consumption that is financed by other sources of income, e.g., savings or credit. This is given by the Y intercept
(C1) in figure 5.1 above.
Induced consumption is that part of consumption which is determined by the level of income and is indicated
by the slope of the consumption function.
These two components of the total consumption spending are further illustrated in figure 5.2 below:
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Fig 5.2: Autonomous and induced consumption

Think Point 5.1
What two things do people do with their income and how would this affect the slope
of the consumption function?
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Investment Spending (I)

Investment spending is more variable and less predictable than consumption spending. Because of its volatility,
investment spending is often the main cause of fluctuations in economic activity. To complicate matters, I is not
primarily a function of income. In fact, it is independent of the level of income as indicated by figure 5.3 below:
Fig 5.3: Investment and the level of income

However, I is determined by:

 The expected profitability from the investment. The greater the expected profit, the greater the investment;
 The interest rate both for borrowing capital or investing capital;
 The opportunity cost of using the funds; and
 The level of risk and or uncertainty.
To finally construct a simple macroeconomic model of income determination, to obtain aggregate spending, we
have to add C and I at each level of Y (refer to Eqn. 2 above). This is indicated in the figure below:
Activity 5.1
In the simplest (or introductory) form of the Keynesian model, which of the
following decisions can we analyse?
a) Interest rate fluctuations
b) Saving of households
c) Investment by government
d) Foreign investment by firms
e) Wage levels in firms
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Fig 5.4: The aggregate spending function
From equation 1 above, it is known that there is equilibrium when Aggregate Spending (A) = Total Income (Y).
If you consider graph (c) in figure 5.4. above:
 A straight line drawn at 45 to either axis will have the equation A =Y, i.e., at all points along this line
aggregate spending = total income; and
 The point where the line A=Y intersects the line A = C + I is the equilibrium point which is denoted by
E in figure 5.5.
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Fig 5.5: The equilibrium level of income
Note:
The equilibrium level of income Yo is the level of income at which the aggregate spending function A intersects
the 45 line. At any level of income lower than Yo there is excess demand (A > Y) and at any level of income
higher than Yo there is excess supply (A < Y) along the aggregate spending function.
Think Point 5.2
How would the inclusion of the government sector affect the aggregate
spending function?
STUDY UNIT
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Unit
6: Inflation
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6.2 The Causes of Inflation  Define inflation and describe some of the causes and
effects of inflation
 Understand the four different approaches to inflation
6.3 The Effects of Inflation  Identify the three sets of effects of inflation
 https://www.resbank.co.za/Lists/News%20and%20Publications/
Attachments/5197/04Notes%20on%20inflation.pdf. Notes on Inflation South
African Reserve Bank
 https://www.imf.org/external/pubs/ft/fandd/2010/03/pdf/basics.pdf. What is
inflation
 Madito and Odhiambo (2018). The main determinants of inflation in South
Africa: An empirical investigation.
https://www.researchgate.net/publication/329971169_The_main_
determinants_of_inflation_in_South_Africa_An_empirical_investigation
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6.1 Introduction
Inflation is often described as “public enemy number one.” However, an economy suffers from inflation when
there are constant significant increases in the general price level. Take note of the four aspects of the definition
(Mohr and Fourie, 2015:382). It is measured using an indicator known as the consumer price index (CPI). The
CPI reflects the cost of a representative basket of goods and services. Inflation is calculated by taking the
percentage change in the CPI over a period of time (not less than a year).
6.2 The Causes of Inflation

Inflation is a complex, dynamic process which cannot be ascribed to a single cause. To avoid pointing a finger
at any one party (such as the government or the trade unions), it is best to look at approaches used to explain
this process. There are four approaches identified and each provides a framework for formulating policies that
can be used to combat inflation.
Activity 6.1
Identify the main causes of inflation in South Africa
Identify and explain the measures used to control inflation in South Africa
6.2.1 The Monetarist Approach

6.3 Regards inflation as a purely monetary phenomenon
6.4 Sustained high rates of monetary growth cause high inflation, while low rates of monetary growth will
eventually produce low inflation
6.5 Shortcomings of this approach – It assumes that changes in the quantity of money does not affect real
variables such as output and employment
6.2.2 The Demand Pull and Cost-Push Approach
a) Demand-Pull Inflation
 Occurs when the aggregate demand for goods and services increases while aggregate supply
remains unchanged – “too much money chasing too few goods.”
Refer to your textbook, Mohr and Fourie (2015:389) for a detailed description of the main sources of this
phenomenon. The excess demand pulls up the prices of goods and services as shown on figure 6.1.
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4Figure 6.2: Cost-push inflation
5Figure 6.1: Demand-pull inflation
b) Cost-Push Inflation
 Triggered by increases in the cost of production.
 Increases in the cost of production pushes the price levels up, as illustrated on figure 6.2.
Refer to your textbook, Mohr and Fourie (2015:390) for a detailed description of the main sources of this
phenomenon.
The major problem with demand-pull and cost-push inflation is that both become intertwined in the inflation
process and it is difficult to distinguish between the two in practice. Neither one of the two can take place without
some increase in the money supply….and then there is time lag, the effect of the velocity of money and other
factors (discussed below) that affect the outcome.
Take this situation as an example: Let us say oil prices rise dramatically because of a war in the Middle East.
A country such as South Africa that imports its oil, now has to pay more – petrol prices rise and so do the prices
of all goods that are affected by it – though it is said that we have “imported inflation” this is not strictly true,
since it is a once off price shock and if the money supply stayed constant, expenditure will shift from other
products (people will buy less) which will cause the prices of the other products to drop in the same relation as
the rise in prices caused by the increase in the oil price so the general price levels (inflation) would theoretically
stay constant.
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Please refer to the prescribed text, (Mohr and Fourie, 2008:388-390) for details on this section. You are
required to understand the diagrams.
c. The Structuralist approach

According to this approach, inflation is the result of the interaction between three interrelated sets of factors
(Mohr & Fourie, 2015:390):
 Underlying factors – provides the background against which the inflation process occurs;
 Initiating factors – trigger or intensify a particular inflation process; and
 Propagating factors – transmits the initiating impulse(s) through the economy and over time, and, in
so doing, generates/sustains the process of rising prices.
This approach retains the distinction between demand-pull and cost-push inflation but places it in a much
broader context. Because this approach is so broad, some economists argue that it does not provide an
adequate explanation of inflation or an adequate basis for forecasting what might happen to inflation.
d. The Conflict Approach

Analysts are not in agreement whether the issues dealt with here are causes or results. In all cases where these
phenomena have been observed there was a disjoint between the money supply and production, income and
spending levels. According to this approach, inflation then is a symptom of a fundamental disharmony in society
which results in a continuous imbalance between the rate of growth in the real national income and the rate of
growth of the total effective claims on this income.
 The rival interest groups each strive to gain larger shares of the “pie” by claiming higher money incomes,
and this results in inflation
 Inflation is the symptom of a lack of effective economic and/or political mechanisms to achieve a prior
reconciliation of the conflicting claims on the national income
Think Point 6.1
Do you think that inflation is a serious problem that should be accorded a

high priority by policymakers? Discuss the various costs of inflation.
The main costs are discussed on pages 384-387 of the textbook.
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6.3 The Effects of Inflation

The costs of inflation are not immediately obvious. Three sets of effects of inflation will be examined:
i. Distribution Effects
 Inflation benefits debtors (borrowers) at the expense of creditors
 Inflation tends to redistribute income wealth from the elderly to the young
 Redistribution from the private sector to the government
ii. Economic Effects

 Anticipating inflation – Decision makers become more concerned with anticipating inflation than with
seeking profitable new production opportunities
 Speculative practices – People try to outwit each other by speculating in shares, foreign currency
(exchange), price of precious metals etc. instead of engaging in productive investments (new factories,
machinery and other equipment)
 Discourages saving – By reducing the value of existing savings, inflation may also discourage saving in
traditional forms (fixed deposits, pension fund contributions etc.)
 Balance of payment problems – Inflation increases the costs of export industries and import-competing
industries. If the inflation rate in SA is higher than that of our major trading partners and international
competitors, then South Africa’s international competitiveness could be adversely affected
iii. Social and Political Effects

 Price increases make people unhappy and different groups in society blame one another for increases
in the cost of living
Think Point 6.2
Why does the South African government aim to keep inflation between 3-6%?
Why not have a target lower than that (like developed countries) of about 2%?
STUDY UNIT
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Unit
7: Unemployment
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7.1 Introduction  Define unemployment
7.2 The Costs of Unemployment  Identify and describe some of the costs of unemployment
7.3 Types of Unemployment  Describe the different types of unemployment
 https://www.rba.gov.au/education/resources/explainers/pdf/unemployment-
its-measurement-and-types.pdf. Unemployment: Its measurement and
types
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7.1 Introduction
High and prolonged unemployment is a sign of a malfunctioning economy. Being unemployed is, for most
people, a highly distressing experience that causes damage in many ways that cannot be quantified.
Definition: According to the International Labour Organisation, unemployment (being unemployed) refers to
those of a working age, who in a specified period, are without work and are both available for, and have taken
specific steps to find work.
This definition is not comprehensive (McAleese: 2001) and has the following shortcomings since it implies that:
 People who work part-time because they cannot find full time employment are fully employed; and
 People functioning in the ‘shadow’ economy (e.g. informal traders) are considered to be unemployed.
Think Point 7.1
In 1998, STATS SA adopted a new official definition of unemployment known as

the strict definition (Orkin, 1998:1), which excludes people of a working age, that
are unemployed but have not taken steps to find work within four weeks prior to
the interview. To what advantage or disadvantage would this be to an economy?
7.2 The Costs of Unemployment

o Economic Costs
 Lost output resulting in potential GDP (the real GDP the economy would produce if its labour and other
resources were fully utilised)
 Unemployment insurance payments – payment for workers who are not working. These funds could
be utilised for other purposes
o Non-economic Costs
 Increased crime and (labour) unrest; and
 The unemployed can become despondent and ‘rusty’.
7.3 Types of Unemployment

o Cyclical Unemployment - Any temporary drop in aggregate demand of a country results in cyclical
unemployment. This leads to a recession – drop in real GDP – in the country. The drop in real GDP can be
caused by a drop in consumption, government spending, investments or exports.
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o Structural and Technical Unemployment – results when there is a drop in demand that is of a permanent
nature. For example, if many qualified labourers cannot be employed by an industry because the industry
has undergone structural changes. If, on the other hand, people become unemployed because of
technological changes such as automation, then this type of unemployment is referred to as technical
unemployment.
o Often legislation puts people out of work (restrictive tobacco legislation reduces work opportunities along
the whole value chain), minimum wage laws makes it particularly difficult for the entry level employee to
enter the job market. Equal pay for equal work makes it difficult for designated groups to compete. Other
labour laws increase the cost of employment and cause jobs to be “exported” (through importing the goods
that are too costly to produce locally).
o Seasonal Unemployment – This type of unemployment occurs when employees only work during a certain
time(s) of the year and, therefore, during other months they are regarded as unemployed.
o Disguised/Hidden Unemployment – is said to exist if people who were previously fully employed, have had
their hours (and, therefore, salaries) reduced because of poor business performance.
o Frictional Unemployment – Even under the most favourable conditions, a certain percentage of people will
always be unemployed. This ever-present unemployment is referred to as frictional unemployment (this
includes people who are temporarily between jobs).
Activity 7.1
Simon resigns his job as an economist in Durban and moves to Port Elizabeth to be
closer his parents. It takes Simon three months to find new employment as an
economist in Port Elizabeth. During these three months, Simon was:
a) structurally unemployed.
b) seasonally unemployed.
c) cyclically unemployed.
d) casually unemployed.
e) frictionally unemployed.
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Think Point 7.2
Based on the Keynesian model you were introduced to in Unit 5, how should
the government respond in a situation where there are high levels of
unemployment?
STUDY UNIT
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Unit
8: Economic Growth and
Development
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8.2 Economic Growth defined  Describe what is meant by economic growth
8.3 The Business Cycle  Define a business cycle and identify the different phases
of a business cycle
 Describe the three different views of the business cycle
8.4 Causes of fluctuations in actual  Explain the causes of fluctuations in economic growth
growth both in the short-term and the long-term
8.5 Different views on Business Cycles  Describe the different views on business cycles
8.6 Sources of Economic Growth  Discuss the various sources of economic growth
8.7 The Pros and Cons of Growth  Discuss the pros and cons of economic growth
8.8 Economic Development  Describe the concepts economic development and

developing countries
 Haller (2012). Concepts of Economic Growth and Development.
Challenges of Crisis and of Knowledge
 The World Bank (2018). South Africa Economic Update
 Fin24 (2018). Explainer: The business cycle and GDP.
https://www.fin24.com/Economy/explainer-the-business-cycle-
and-gdp-20180703
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8.1 Introduction
This study unit examines two important issues in macroeconomics: Economic Growth and Economic
Development. The distinction between these two concepts is relatively new and is subject to widespread
debate. For the purposes of this module, we will not engage in a debate as to whether they should be treated
separately or as one. For convenience and clarity, we will examine them separately.
8.2 Economic Growth defined

Economic growth is defined as the annual rate of increase in total production or income in the economy. When
the rate of economic growth increases faster than the population growth rate, there is an increase in per capita
GDP. Put differently, economic growth occurs when a nation’s production possibility frontier (PPF) shifts
outward.
Such an increase is usually what is meant when we say there has been an improvement in the standard of
living. Most economists argue that economic growth is beneficial to a society because it enhances the material
well-being of the population. Critics of economic growth, on the other hand, assert that economic growth
destroys the environment, erodes traditional ways of living, and impoverishes the spiritual well-being of the
nation.
Economic growth is not a smooth process- it can vary significantly from year to year. This feature of economic
growth is related to a phenomenon called the business cycle.
8.3 The Business Cycle

Actual growth tends to fluctuate. In some years, there is a high rate of economic growth: the country experiences
a boom. In other years, economic growth is low or even negative: the country experiences a recession. This
cycle of booms and recessions is known as the business cycle which is illustrated in figure 8.1 below
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6Figure 8.1: The business cycle

Business cycle is the periodic fluctuations of national output round its long-term trend.
There are four phases of the business cycle:

1. The upturn. In this phase, a stagnant economy begins to recover and growth in actual output resumes;
2. The expansion. During this phase, there is rapid economic growth: the economy is booming. A fuller use
is made of resources and the gap between actual and potential output narrows;
3. The peeking out. During this phase, growth slows down or even ceases; and
4. The slowdown, recession or slump. During this phase, there is little or no growth or even a decline in
output. Increasing slack develops in the economy.
It is important to note that the above illustration of a business cycle, as smooth and regular, is merely done to
make a clear distinction between the four phases. In practice, however, business cycles are highly irregular.
They are irregular in two ways:
 The length of the phases. Some booms are short lived, lasting only a few months or so. Others are much
longer, lasting perhaps three or four years. Likewise, some recessions are short, while others are long;
and
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 The magnitude of the phases. Sometimes, in phase 2 there is a very high rate of economic growth,
perhaps 5% p.a. or more. On other occasions, in phase 2, growth is much gentler. Sometimes, in phase
4 there is a recession, with an actual decline in output (e.g., in the early 80’s and 90’s). On other occasions,
phase 4 is merely a ‘pause’, with growth simply slowing down.
8.4 Causes of fluctuations in actual growth

In the short-run
The major determinants of variations in the rate of actual growth in the short-run are variations in the growth of
aggregate demand (AD) -total spending on goods and services made within a country.
A rapid rise in AD will cause shortages. This will tend to stimulate firms to increase output, thereby reducing slack
in the economy. Likewise, a reduction in AD will leave firms with increased stocks of unsold goods. They will,
therefore, tend to reduce output.
AD and actual output, therefore, fluctuate together in the short-run. A boom is associated with a rapid rise in AD:
the faster the rise in AD, the higher the short-run rate of actual growth. A recession, by contrast, is associated by
a reduction in AD.
A rapid rise in AD, however, is not enough to ensure a continual high level of growth over a number of years.
Without an expansion of potential output (ceiling on a country’s output), rises in actual output must eventually
come to an end. Once spare capacity has been used up, once there is full employment of labour and other
resources, the rate of growth of actual output will be restricted to the rate of growth of potential output.
In the long-run
In the long-run, there are two determinants of actual growth:
 The growth in AD. This determines whether potential output will be realized; and
 The growth in potential output
8.5 Different views on Business Cycles

There are three views (Mohr & Fourie, 2015:413) on the causes of business cycles (Fig 8.2):
 The classical view – the economy is inherently stable (indicated by the thick black line) and business cycles
are caused by exogenous (outside the market system) disturbances;
 The Keynesian view – the economy is inherently cyclically unstable (indicated by the thick wavy line).
Business cycles are endogenous to private market economies; and
 The Structuralist view – views business cycles as random occurrences.
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7Figure 8.2: Different views on business cycles

Mohr & Fourie (2015 :413)
8.6 Sources of Economic Growth

In order to have an increase in a society's standard of living, as measured by real per capita GDP, the rate of
aggregate output must increase faster than the population. An increase in the labour force will lead to an
increased aggregate output. With more workers, more output can be produced. In addition, an increase in
capital will increase output because with more capital available, a given number of workers will be able to
produce more output. This brings up another important factor. In order for real per capital GDP to increase,
there needs to be an increase in output per worker. In other words, there must be an increase in productivity.
Let us look in more detail at each of these key factors: the labour supply, the amount of physical capital, and
productivity.
8.6.1 An increase in labour supply

As was just mentioned, an increase in the number of workers will lead to an increase in output. However,
whether output per worker goes up or not is an open question. Take a look at the following table, which illustrates
how total output increases with an increase in the amount of labour supplied:
2
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Case et al., (2012:236)
As you can see, output increases with additional hours of labour; however, notice that productivity, Y/L, declines
with increasing labour. The decrease in productivity, as more labour is supplied, is known as diminishing
returns. It happens because, while labour increases, the amount of capital is held fixed. Thus, more and more
labour is being applied to a given amount of physical capital. Imagine, a farmer's field with one hoe. With no
workers, output is zero because no one is working the field.
One worker will be able to plant and tend the field using the hoe (physical capital) and get some output. What
about hiring a second worker? Output may go up somewhat, but not by as much as the addition of the first
worker.
The decline in productivity with a given amount of capital and the addition of more workers is what worried early
economists such as Thomas Malthus and David Ricardo. They were concerned that, with a fixed amount of
land, as with a fixed amount of capital, diminishing returns will dictate that the output of food per capita would
begin to decline. The concern was that, over time, a rapidly growing population would outstrip its ability to feed
itself. Societal collapse and mass starvation was viewed as the inevitable result. Increases in physical capital
alone, however, are not sufficient to ensure increased economic well-being over time. The reason is that capital,
like labour, is also subject to diminishing returns. Look at the following table, which illustrates the effect of adding
capital to a given amount of labour:
Case et al., (2012:237)
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Although adding capital increases labour productivity (as shown in the last column), there are diminishing
returns to capital. Diminishing returns is the change in output with a given increase in one input, holding the
other inputs constant. When capital goes from 100 to 110 units, output increases by 10 (from 300 to 310). The
addition of another 10 units of capital (from 110 to 120) increases output by only nine (from 310 to 319). An
additional 10 units of capital (from 120 to 130) results in an additional eight units of output (from 319 to 327).
Thus, the additional gain in output from adding more capital diminishes.
However, in all modern economies that have experienced economic growth over time, capital has been
increasing. In fact, capital has increased at an even faster rate than labour. Consider the table below:
4Table 8.3 Fixed Private Non-residential Net Capital Stock, 1960 – 2008 (Billions of 2005 Dollars)
Case et al., (2012:237)
The growth rate of equipment has been higher than the growth rate of structures. This means there is more
equipment available for workers within factories and offices.
8.6.2 Increases in human capital

In addition to increases in the amount of physical capital available to the workforce, increases in human capital
are also crucial to increased productivity and economic growth. Human capital are investments made in human
health, education, and training. For example, by going to college (even taking this course), you are building your
human capital.
A healthy, well-educated, and well-trained population is more productive (and probably happier). One reason
that college graduates get higher incomes, on average, than people who have not attended college is because
they tend to be more productive. Increases in human capital are crucial to economic growth and increases in the
quality of life.
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In many industrialized societies, the availability and extent of education is increasing. Some enlightening figures
are shown in the following table:
5 Table 8.4 Years of School Completed by People Over 25 Years Old, 1940 - 2008
Case et al., (2012:238)
8.6.3. Increases in productivity

As we have seen, increases in productivity are essential for continued economic growth. What enhances
productivity increases? Much of what we have already discussed increases the productivity of labour, such as
gains in the availability of capital, education, and training. In addition, technological change and innovation
increases the productivity of both capital and labour. Think of what technological change has meant to college
students, for example. Think of how much more productive you can be in writing papers with a personal
computer compared to the days of manual typewriters. Innovation, other than technological change, can also
affect productivity. The increasing use of just-in-time production techniques and other managerial innovations,
for example, has increased productivity in the manufacturing sectors of many industrialised countries in recent
decades. In addition, economies of scale can affect productivity. Think of the relatively recent development of
large, multiplex movie theatres. Ticket takers and snack-bar employees, rather than serving customers of just
one movie, now serve several screens. Each employee, therefore, serves more customers during the course
of a shift.
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Activity 8.1
Investment in human capital

a) shifts the aggregate supply curve to the left.
b) increases structural unemployment.
c) increases labour productivity.
d) shifts the Phillips curve to the right.
8.7. The Pros and Cons of Growth

8.7.1. The pro-growth argument
Try to imagine what life was like in the past and compare it to today. Today, we can get from one place to
another rapidly by taking to the freeway/highway in cars that are far superior to what was available in the past.
Today's cars are much safer, more comfortable, and more environmentally sensitive than cars available in the
past. For example, in the past, cars were noisy, guzzled fuel, were rarely equipped with seat belts, had no air
conditioning, frequently needed maintenance, and emitted noxious fumes from their tailpipes. In contrast, we
now have air bags plus retractable seat belts, passenger compartments designed to remain intact during
collisions, effective climate controls, much smoother rides, dramatically improved fuel efficiency, and much
lower emissions. For example, since the mid-1970s, automobile emissions have fallen dramatically in spite of
a substantial increase in the total number of kilometres driven. All the result of the fact that through economic
growth we now can afford to pay for reduced emissions and reduced pollution.
Similar stories can be told about most of the items we use. In addition, we have much more spending power
than in the past, meaning that we have the ability to buy much more than we used to be able to. In the USA,
real per capita GDP in 1995 was more than twice what it was in 1950. Think of what this means. We have, on
average, the ability to buy twice as much as we could in 1950. Take a look around your room or your home.
The vast array of consumer items found there — sound systems, Satellite TVs, microwaves, dishwashers,
Smartphones and laptop computers — would have been unimaginable in the 1950s. Although they were
available, most homes had only one telephone, did not own even a single TV, and had kitchen appliances that
often consisted of little more than a toaster.
However, it is not just the increased availability of goods and services, and our increased ability to buy them
that makes us much better off. The dramatic increase in real per capita GDP means that, if we choose to limit
our purchases, we can have more savings or work less than we did in the past and still maintain the same
standard of living. By limiting purchases (and still, by the way, having more and better products), one can save
more money, spend more time with one’s family, and retire earlier than one could have in the past.
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The growth in real GDP per person also makes it easier to help those who are less fortunate than ourselves
because it is more affordable to do so. To see this, consider a society with a very low per capita income level.
With most people barely getting by, it is difficult to spare anything for those even less fortunate. However, with
higher levels of average real income, we can more easily help those with less.
There are many theories of economic development. You should be aware of Rostow’s stages of economic
development and the current research emanating from economic think tanks around the world such as the Cato
Institute, the Heritage Foundation and Fraser Foundation. The relationship between economic freedom and
economic growth can for example clearly be seen from the extensive research done by the Fraser Foundation
(http://www.freetheworld.com/).
Think Point 8.1
Which of the discussed sources of economic growth can the South African government
take advantage of, to boost the level of output and how can it achieve this?
8.7.2. The anti-growth argument

Economic growth does not, however, come without costs. As technology, productivity, and efficiency improve,
it is those sectors of the economy that are less efficient or less productive that are likely to suffer.
Consider the example of modern agriculture. Because of improvements in machinery and transportation,
economies of scale, and other factors, large farms are able to produce crops more cheaply than smaller farms.
As a result, there has been a dramatic decline in the number of smaller farms and farmers in recent years. For
many of these people, a way of life has been lost due to economic development. The flip side of this, however,
is that a much wider array of food is available at lower real prices than in the past. To say that economic
development should be slowed down or stopped in order to preserve a way of life for some is to also say that
millions of consumers should have to pay more for food. It remains, however, that changes in the way we live
and the types of work we do are the natural consequences of economic growth and development. For many,
these changes are unwelcome.
Another consequence of economic growth and development is an increase in the demand for the natural
resources. Many are concerned that the rates at which we are using the earth's resources are already too high
and will increase even more as less developed countries become more developed. In addition, there is concern
that this will result in increased pollution.
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For example, in the United Nations Framework Convention on Climate Change held in Kyoto, Japan during
December 1997, many environmentalists warned that increasing development in less developed countries will
increase greenhouse gas emissions and more rapidly accelerate global warming.
There are other criticisms levelled at economic development and growth. Although there are certainly
widespread benefits to such growth, it is important to remember that there is no free lunch. Changes in
traditional ways of living, increased environmental pressures, changes in income distribution, and other
negative consequences of growth exist. As growth continues, we must take into account some of its negative
consequences.
Think Point 8.2
Do the above “costs” of economic growth outweigh the benefits?
8.8 Economic Development

Economic development refers to the improvement of living conditions in the less developed countries
(developing countries). So, what then is meant by a developing country? The most important characteristic of
a developing country is that it has a low per capita income. In addition, people in developing countries usually
have poor health and short life expectancy, low levels of literacy, and suffer from malnutrition Navarro (2015)
Economic development further entails an improvement in the quality of life of the majority of the population as
a result of (Mohr & Fourie, 2015):
 Economic Growth;
 Reduction of inequality; and
 The eradication of absolute poverty.
Most of the world’s population live in developing countries.
8.8.1 Sub – Saharan Africa

According to the World Development Indicators 2005(www.worldboank.org):
 Slow growth in Sub-Saharan Africa has meant increases in both the poverty rate and the number of the
poor in the 1990s, leaving this region with the largest proportion of people living below $1 a day
 The forecast anticipates per capita growth averaging 1,6 over 2006-2015 which is short of the growth
needed to reduce poverty to half the 1990 level
 The number of poor is expected to rise from 313 million in 2001 to 340 million by 2015
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 The region remains highly dependent on commodity exports and is still experiencing political instability.
 There have been significant enrolment increases at the primary school level. This is an effort to achieve
Education for All in many African countries. Governments are, therefore, pressurized to expand secondary
education.
 While other regions of the world are expecting better health services and outcomes over the next 20 years,
Sub-Saharan Africa alone is anticipating further deterioration in its health services and stagnation or
worsening of health outcomes, especially among the poor. There is a/an:
o Severe shortage in health workers;
o Over-reliance on donor support;
o Chronic poor nutrition and reproductive health;
o Resurgence of malaria and TB; and
o Unprecedented burden of HIV/AIDS.
 Successes in this region include:

o Uganda and Ghana have sustained remarkable growth and together with Cameroon have achieved
some success in achieving their poverty targets (reduction); and
o Limited success in disease control (vitamin A), fertility reduction and improved health policy
STUDY UNIT
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Unit
9: The Foreign Sector
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9.2 Why countries trade  Discuss the reasons why countries trade
 Differentiate concepts of absolute advantage and relative

advantage
9.3 Application of political pressure  Outline the concept of political pressure
9.4 Investment in the global economy  Discuss investment in terms of the global economy
9.5 The impact of trade tariffs  Understand the economic impact of an import tariff
9.6 Foreign exchange rates  Define and apply the concepts of exchange rates
 Understand the factors that influence the exchange rate

of a country
9.7 Summary  Summarise topic areas covered in unit
 Mohr, P. & Fourie, L. (2015) Economics for South African Students. 5th
 Hill, C. W. L and Hult, G.T.M (2017) International business competing in
the global marketplace. 11th Edition. United States of America: McGraw.
Hill Education international edition
 Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International
business environments and operations. 16th edition. Global Edition:
Pearson
 Cavusgil, S.T. Knight, G. Riesenberger, J (2017) International Business
the new realities.4th edition. Global Edition. Pearson.
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9.1 Introduction
Up to this point in the module, we have looked at the role of the government in the macro economy within the
country. But as you know, the economies of all countries trade with other countries. They may buy goods from
a neighbouring country or other countries or they may ship goods and raw materials to a distant continent.
Countries participate in the global economy for three primary reasons (Pape, 2000) i.e., to:
 Trade;
 Apply political pressure; and
 Invest.
9.2 Why countries trade

It is far better for an individual to specialize in the activities that he or she does best, rather than attempt to do
everything. This principle is equally important to countries. By trading, certain countries are able to obtain goods
and services which their own economy cannot produce or does not possess.
Many South African companies, such as Anglo-American and South African Breweries, have invested in countries
overseas. South Africa, together with other third world countries also try hard to encourage foreign companies to
invest locally. It is believed that foreign companies will bring money, technology and skills that are not available
locally.
9.2.1 Absolute advantage

Absolute advantage occurs when one country produces more of a product than another using the same amount
of resources. Assume that South Africa and Botswana produce wool and DVD players. One worker in South
Africa can produce 100 kg wool and 4 DVD players whilst one worker in Botswana can produce 200 kg wool
and 2 DVD players. We say the South Africa has an absolute advantage in production of DVD players and
Botswana has an absolute advantage in production of wool.
9.2.2 Comparative Advantage

By means of glasses, hotbeds and hot walls, very good grapes can be raised in Scotland, and very good wine,
too, can be made of them at thirty times the expense for which at least equally good wine can be bought from
foreign countries (Smith, 1776).
The essence of comparative advantage is the idea that nations, like individuals can carry out a particular
economic activity (such as making a specific product) more efficiently than another activity., and therefore
should concentrate on what they are best at producing. If one person is an accomplished musician and the
other a computer wizard, it is more efficient to allow each person to specialize in one field rather than have
each of them produce their own music as well as their own computer programmes individually. By exporting
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each other’s services/skills to the other they will each benefit by ending up with more goods/service than if
they try making both goods/services individually. The same applies to nations.
The theory of comparative advantage states that:

Each country will tend to specialize in and export those goods for which it has a comparative advantage.
Consider two countries, England and Portugal, each producing two commodities, wine and clothing, as
illustrated in the table below:
6Table: 9.1: Unit of output per person at work

Portugal England
Wine 6 3
Clothing 4 3
Further assume that:

 Perfect competition prevails in all markets;
 There are constant returns to scale;
 There are zero transport costs; and
 There is only one factor of production – Labour.
From the table above it can be seen that:

 A worker in England can produce 3 units of wine or 3 units of clothing, i.e., one unit of clothing will exchange
for one unit of wine;
 Either a worker in Portugal can produce 6 bottles of wine or 4 units of clothing i.e. one unit of clothing will
exchange for 1.5. units of wine;
 The Portuguese are therefore more productive in absolute terms in both industries than their English
counterparts; and
 Clothing is more expensive (and wine cheaper) in Portugal than England.
Suppose England takes two workers out of the wine industry and assigns them to work in the clothing industry.
This means that wine production falls by 6 units and clothing production increases by 6 units.
The 6 units of clothing are exported to Portugal. Given that, in Portugal, 1 unit of clothing exchanges for 1.5
units of wine, the exporters of English clothing return with 9 units of wine. The net result is that England has
gained 3 units of wine and Portugal is left exactly as well off as before.
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The implications of this example, in the context of international trade theory, is that:
 A country can have an absolute advantage in all goods and yet gain from trade with a more efficient
partner;
 Gain that is realized through imports and exports are useful solely as a means of obtaining imports;
 The total gain from trade may be unevenly shared. In the above example England gets all the gain;
 Countries benefit most from trade by obtaining high prices for their exports and paying the lowest prices
for their imports; and
 Trade involves mutual gain.
To conclude this section, there is just one final point for you to ponder over!
Think Point 9.1
International trade will only occur if comparative advantage exists, that is, if
the opportunity costs differ between countries. Do you agree? Discuss the
truth/ untruth of this statement with the aid of a suitable example. Refer to
Mohr and Fourie (2015:302).
9.3 Application of political pressure

Some countries use trade with other countries as a way of affecting or controlling another country’s political
decisions. A classic example has been the trade sanctions imposed on South Africa during the 1980s up until
1994. During this era, other countries were prohibited from engaging in business transactions (in certain
business areas) with S.A. because of the existence of apartheid. In this case, trade was used as a way of
applying political pressure rather than simply for economic reasons.
9.4 Investment in the global economy

For industrialised countries, investment overseas can help increase profits for local companies. Many large
companies that operate internationally invest overseas to gain access to cheaper labour or move closer to
sources of raw materials.
9.5 The impact of trade tariffs

Import tariffs are duties or taxes imposed on products imported into a country. They are used to protect
domestic firms against competition from imports or to raise government revenue. For the two categories of
tariffs: ad valorem and specific, refer to Mohr and Fourie (2015:304). You may ignore the welfare effects of an
import tariff for purposes of this course.
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Economics 1B
Think Point 9.2
What policy instruments can the South African government use to

influence the level of trade with itself and its trading partners?
9.6 Foreign exchange rates

Foreign trade involves payment in foreign currencies such as the euro (), pound sterling (£), US dollar ($) and
Japanese Yen (¥). South African importers have to pay in these currencies for the goods and services they buy
and are, therefore, obliged to exchange South African rands for these currencies.
An exchange rate simply represents the price of one currency in terms of another currency. An increase in the
value (price) of one currency in terms of another currency (appreciation) automatically implies a decrease
(depreciation) in the value of the other currency.
Changes in exchange rates affect the relative prices of goods and services across countries. For example, an
increase in the value of a country's currency will make its goods relatively more expensive in foreign markets.
It will also have the effect of lowering the relative price of foreign goods sold domestically. In other words,
changes in exchange rates affect the flow of goods and services across nations.
A foreign exchange market is the international market in which one currency can be exchanged for other
currencies. The South African foreign exchange market consists of all the authorized currency dealers, including
all the major banks.
The main reason that people demand a given nation's currency is for the purchase of that nation's goods,
services, or financial assets. The main reason that people supply the currency of a given country is for the
purchase of another country's goods, services, or financial assets. However, private individuals, institutions,
and governments buy and sell currencies for speculative reasons and governments buy and sell currencies for
policy purposes. For example, in mid-1998, the U.S. Treasury bought large quantities of Japanese yen in order
to increase the demand for yen. To do so, the Treasury supplied dollars on the foreign exchange markets and
purchased yen. The result was an (short-run) increase in the value of the yen relative to the dollar.
A floating exchange rate is a rate determined in free markets by the law of supply and demand.
A fixed exchange rate is a rate set and maintained by the government in conjunction with its Central Bank
(e.g., South African Reserve Bank).
87 MANCOSA
Economics 1B
Activity 9.1
Tariffs benefit domestic producers by
a) decreasing the wage rate for labour in the domestic industry.
b) reducing the prices of imported goods.
c) increasing sales of domestic goods.
d) increasing government revenue.
e) increasing domestic consumers’ real income.
Case Study: U.S. to Impose Tariff on Tires from China
By Peter Whoriskey and Anne Kornblut

Washington Post Staff Writers
In one of his first major decisions on trade policy, President Obama opted Friday to impose a tariff on tires
from China, a move that fulfils his campaign promise to "crack down" on imports that unfairly undermine
American workers but risks angering the nation's second-largest trading partner.
The decision is intended to bolster the ailing U.S. tire industry, in which more than 5,000 jobs have been lost
over the past five years as the volume of Chinese tires in the market has tripled. It comes at a sensitive time,
however. Leaders from the world's largest economies are preparing to gather in Pittsburgh in less than two
weeks to discuss more cooperation amid tensions over trade.
The tire tariff will amount to 35 percent the first year, 30 percent the second and 25 percent the third. Although
a federal trade panel had recommended higher levies -- of 55, 45 and 35 percent, respectively -- the decision
is considered a victory for the United Steelworkers union, which filed the trade complaint. "The president sent
the message that we expect others to live by the rules, just as we do," Leo W. Gerard, president of the union,
said Friday night.
China's government and its tire manufacturers, as well as tire importers and some U.S. tire makers with plants
overseas, had strenuously objected to the measure. "The President decided to remedy the clear disruption to
the U.S. tire industry based on the facts and the law in this case," the White House said in a statement
released Friday night.
Obama's decision signals a marked shift from the policy of the Bush administration, which had rejected taking
action in four similar cases it reviewed. The union complaint was filed under a law Congress passed in 2000
MANCOSA 88
Economics 1B
that allows the United States to impose tariffs and other trade protections if a surge in Chinese imports
damages a U.S. industry.
China agreed to the provision while negotiating to join the World Trade Organization, but until Friday the
general "safeguard" provisions of the law had never been invoked. Critics warned that if the general
"safeguard," which expires in four years, was never used to protect American workers from Chinese imports,
then political support for free trade would be eroded.
"Since China joined the WTO, American workers have not been assured that the government would defend
them against unfair trade," Sen. Sherrod Brown (D-Ohio) said. The tariff, which will take effect Sept. 26,
represents the first such case under the law for Obama, and his decision has been highly anticipated.
During the campaign, he had pledged to "crack down on China" and "work to ensure that China is no longer
given a free pass to undermine U.S. workers," as his Web site put it. But his commitment to that point of view
was thrown into doubt during the primaries when a Canadian official said an Obama adviser had privately
characterized his tough stance on the North American Free Trade Agreement as political posturing.
Marguerite Trossevin, who represents a coalition of U.S. tire companies that import Chinese tires, said the
tariff decision is "very disappointing." She predicted price increases for U.S. consumers and losses for U.S.
tire importers. "For the U.S. tire distributors and consumers, there's going to be a heavy burden to bear," she
said. "It sends the message that special interests will get protection if they ask for it -- regardless of what that
means for broader trade policy."
China's Ministry of Commerce said in a statement early Saturday that the move violated WTO rules. "China
strongly opposes this serious act of trade protectionism by the U.S," the ministry said, according to the
Associated Press. Not surprisingly, there were conflicting predictions about what effect the tariff might have on
the U.S. industry.
Supporters said the measure would have only a negligible effect on the price of tires and would lead U.S.
manufacturers to invest in their U.S. plants. The tariff's detractors said higher tire prices could lead some
consumers to wait longer before replacing tires, creating a safety risk. Moreover, they said, the tariff won't
result in more jobs. Tires will simply come in from other low-cost countries, they say, and U.S. manufacturers,
keep making their cheaper tires in China.
89 MANCOSA
Economics 1B
"U.S. tire manufacturers years ago decided to move production of low end tires off-shore," said David
Spooner, a lawyer representing the Chinese tire industry. "Frankly, a temporary tariff is not going to get them
to change their business plan."
Source: Hill and Hult (2017)
Case Study
1. What was the main reason for U.S to impose tariffs on China
2. Explain the likely impact of the tariff on:
1. Chinese tyre manufacturers
2. US tyre manufacturers
3. US consumers
9.7 Summary
The increasingly global economy has made the nations of the world more economically interdependent. This
interdependence has made policy-making for all stakeholders (Governments, firms, individuals) more
challenging and demanding.
STUDY UNIT
MANCOSA 90
Economics 1B
Answer to activities:
1.1 b
2.1 Simply put, the economy would not be able to maintain its current production capacity well off into the future
resulting in a decline in economic activity.
3.1 Your search should end up in articles such as Casteleijn, 2001.
4.1 d
5.1 b
6.1 d
7.1 e
8.1 c
9.1 c
91 MANCOSA
Economics 1B
Answer to case study

Unit 9
1. The tariff was designed to protect American producers from low-cost Chinese imports, thereby helping to create
jobs in the U.S. tire industry. However, it may also have raised the average price of tires to American consumers,
leaving them with less money to spend on other goods and services. For its part, the Obama administration clearly
believes that the gains, in terms of jobs saved or created, outweigh any losses from higher prices.
2. The additional tax, or tariff, on imported goods can discourage Chinese tyre manufacturers to sell their products
in US. The additional taxes make the Chinese tyres either too expensive or not nearly as competitive
as it would be if the tariff didn't exist. This can lead to fewer choices of goods and a lower quality for consumers.
The amount of tyres you have to choose from are all subject to the effects of tariffs.
US tyre manufacturers benefit by ultimately facing reduced competition in their home market, which leads to lower
supply levels and higher prices for consumers. As you can see from the graph below, S0 and D0 represent the
original supply and demand curves, which intersect at (P0, Q0). St shows what the supply curve is with the
introduction of the tariff. The market then settles at (Pt, Qt). Less of the good is produced, and consumers pay
higher prices.
When a consumer does purchase a higher-priced imported tyres with a tariff imposed on it, the consumer now has
less money to spend on other things. This forces consumers to either buy less of the imported tyres or less of
some other good, ultimately lowering the purchasing power of consumers. It is important to remember that although
consumers may pay higher prices because of tariffs and have limited options, the potential benefit is that domestic
sales of goods can increase, ultimately leading to higher domestic sales and more jobs for companies inside the
country
MANCOSA 92
Economics 1B
Reference List
Case, K.E, Fair, R.C & Oster, S.M (2012). Principles of Miiroeconomics. (10th ed.). Pearson.
Casteleijn, A.J.H (2001). South Africa’s Monetary Policy Framework. Mimeo
Fraser Institute – Annual Report 2014, www.freetheworld.com
Labson, S. (2017). [online] Available at: https://www.fin24.com/Opinion/the-sa-reserve-banks-constitutional-

mandate-and-why-its-good-to-be-a-boring-bank-20170627-2 [Accessed 14 Jan. 2019].
Mcaleese, Dermot (2001): Economics for Business. Financial Times/ Prentice Hall.
Mohr, P. & Fourie, L. (2008) Economics for South African Students. 4th edition. Pretoria: Pretoria. Van Schaik
Mohr, P. & Fourie, L. (2015) Economics for South African Students. 5th edition. Pretoria: Pretoria. Van Schaik
National Planning Commission (2011). National Development Plan 2030. Pretoria.
Orkin, F. (1998). Unemployment and employment in South Africa. Pretoria: Statistics South Africa.
Pape John (2000): Economics: An Introduction for South African Learners. Juta and Company Ltd.
Samuelson, Paul A. & Nordhaus, William D. (1998) Economics. McGraw-Hill.
The World Bank (2018a). Overcoming Poverty and Inequality in South Africa. An Assessment of Drivers,
Constraints and Opportunities. Washington DC.
The World Bank (2018b). South Africa Economic Update. Jobs and Inequality. Washington, DC.
93 MANCOSA
Economics 1B
MANCOSA 94

Economics 1B Module Guide

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ECONOMICS 1B

 Bachelor of Commerce in Accounting

List of Content ......................................................................................................................................................... 1

Unit 1: Introduction to Macroeconomics .................................................................................................................. 7

Unit 2: Measuring the Performance of the Economy............................................................................................. 17

Unit 3: The Monetary Sector ................................................................................................................................. 23

Unit 4: The Public Sector ...................................................................................................................................... 32

Unit 5: Macroeconomic Theories .......................................................................................................................... 41

Unit 6: Inflation ...................................................................................................................................................... 58

Unit 8: Economic Growth and Development ......................................................................................................... 69

Unit 9: The Foreign Sector .................................................................................................................................... 82

Case Study: U.S. to Impose Tariff on Tires from China ........................................................................................ 88

Reference List ....................................................................................................................................................... 93

MANCOSA – BBA YEAR 1 i

Table 5.1: Assumptions and implications of the Keynesian model .............................................................. 52

Table 9.1: Unit of output per person at work ................................................................................................ 85

List of Figures and Illustrations

Figure 1.1: The three major flows ................................................................................................................ 13

Figure 1.3: The financial sector and foreign sector ...................................................................................... 15

Figure 6.1: Demand-pull inflation ................................................................................................................. 61

Figure 6.2: Cost-push inflation ..................................................................................................................... 61

Figure 8.1: The business cycle .................................................................................................................... 72

Figure 8.2: Different views on business cycles ............................................................................................ 74

The module is a 15 credit module at NQF level 5

We hope you enjoy the module.

B. Learning Outcomes and Associated Assessment Criteria of the Module

 Understand what is meant by  Foundational knowledge of macroeconomics is explored

C. Learning Outcomes of the Units

D. How to Use this Module

F. Prescribed and Recommended Textbook/Readings

The prescribed and recommended textbooks/readings for this module is:

Special Feature Icon Explanation

The Learning Outcomes indicate aspects of the particular Unit you

The Associated Assessment Criteria is the evaluation of the

PRACTICAL Practical Application or Examples will be discussed to enhance

APPLICATION understanding of this module.

You may come across Revision Questions that test your

Case Studies are included in different sections in this Module

You may come across links to Videos Activities as well as

VIDEO ACTIVITY instructions on activities to attend to after watching the video.

Unit Learning Outcomes

CONTENT LIST LEARNING OUTCOMES OF THIS UNIT:

1.1. Introduction  Introduce topic areas for the unit

1.2. Macroeconomics versus  Distinguish between macroeconomics and

1.3. An Overview of Macroeconomic  Provide an overview of the five major components of

Prescribed / Recommended Readings

1.2. Macroeconomics versus Microeconomics

Understanding the basics of microeconomics is a necessary prerequisite to understanding the functioning of

1.3. An Overview of Macroeconomic Policies

1.3.1. Full Employment

1.3.2. Price Stability

1.3.3. Economic Growth

1.3.4. External Stability or Balance of Payments

If exports exceed imports:

If imports exceed exports

Think Point 1.1

1.3.5 Equitable or Redistribution of Wealth (Income)

To summarise, the goals of macroeconomic policy are:

Think Point 1.2

1.4. The Circular Flow of Income

1Figure 1.1: The three major flows

Mohr & Fourie (2015:51)

2Figure 1.2: A Simple Circular Flow Model of Income and Spending

3Figure 1.3: The financial sector and foreign sector