UNIT 2 - INTRODUCTION: THE ECONOMIC ENVIRONMENT
Learning objectives
• To know the factors which determine the level of economic activity
• To know the stages of the economic cycle and the role of government in
determining economic policy
• To know the function of central banks
• To understand the impact of economic data, e.. GDP, BOP, budget deficit etc
Types of Economy
• State-controlled economies
– State determines what is produced and how distributed (also known as planned or
command economy)
• Market economies
– Supply and demand is allowed to determine how resources are allocated
• Mixed Economies
– Combines a market economy with elements of state control
• Open Economies
– Few barriers to trade or controls over foreign exchange
Types of Economy
ECONOMIC BLOCK MEMBER COUNTRIES
The Southern African Angola, Botswana, Lesotho, Malawi, Mauritius,
Development Community Mozambique,
(SADC) Namibia, South Africa, Swaziland, Tanzania, Zambia and
Zimbabwe.
The Economic Community of Benin, Burkina Faso, Cabo Verde, Cote d'Ivoire, The Gambia,
West African States (ECOWAS) Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria,
Senegal, Sierra Leone and Togo
Economic Community of Angola, Burundi, Cameroon, Central African Republic, Chad,
Central African States (ECCAS) The Democratic Republic of Congo, Equatorial Guinea,
Gabon,
Republic of the Congo, São Tomé and Príncipe.
Intergovernmental Authority Djibouti, Ethiopia, Kenya, Somalia, South Sudan, Sudan and
on Development (IGAD) Uganda (Eritrea is currently inactive).
Common Market for Eastern Burundi, Comoros, The Democratic Republic of Congo,
and Southern Africa (COMESA) Djibouti, Egypt, Eritrea, Ethiopia, Kenya, Libya, Madagascar,
Malawi, Mauritius, Rwanda, Seychelles, Sudan, Swaziland,
Uganda, Zambia and Zimbabwe.
Types of
Economy
• Which economic policy does
Zambia follow?
Economic Cycle and Economic Policy
• Role of government to manage economy through taxation, economic and
monetary policy
• Stabilisation policies:
– Attempt to reduce the impact of fluctuations in economic activity
– Fiscal policy: adjustments using government spending and taxation
– Monetary policy: adjustments to interest rates and money supply
• Macro economic objectives:
– Full employment
– Economic growth
– Low inflation
– Balance of payments equilibrium
Economic Cycle and Economic Policy
• Stages in the economic cycle
– Peak
– Contraction
– Trough
– Expansion
Economic Policy
Fiscal Policy Monetary Policy
• Action by government to spend money • Regulation of economy through control
or collect money in taxes of monetary system
– The budget – Money supply
– Taxation – Interest rates
Role of Central Banks
• banker to banks • Setting official short-term
• Banker to government interest rate
• Managing national debt • Controlling money supply
• Regulating domestic banking system • Issuing notes and coins
• Lender of last resort • Holding nations gold and FX
• Providing depositors’ protection reserves
scheme • FX markets regulation
Central Banks
Federal • Statutory duty of promoting price stability and sustainable economic growth
Reserve • FOMC meets every six weeks to set rates
• Lender of last resort
European • Responsible for setting monetary policy for the entire Euro zone with the sole
Central Bank objective of maintaining internal price stability
• Its objective of keeping inflation, as defined by the Harmonised Index of
Consumer Prices (HICP), “close to but below 2% in the medium term” is
achieved by influencing factors such as the external value of the euro and
growth in the money supply
Bank of • Manages inflationary targets by interest rate setting through the Monetary
England Policy Committee
• Responsible for all other traditional central bank activities with the exception
of managing the national debt and providing a depositors protection scheme
for bank deposits
Credit Creation
Credit creation and the money multiplier:-
• Banks are only required to hold a small proportion of their deposits as
reserves to meet day-to-day withdrawals - known as the reserve ratio
• They can lend out the significant remainder, assuming that bank
depositors’ required ratio of cash holdings to deposits does not
exceed this ratio
• As a sizeable proportion of each loan made from bank deposits is re-
deposited and then extended as another loan, so credit is created and
the money supply expands
Credit creation by a single bank
Depositor Primary Deposits Required Credit
Reserves ratio Creation
RRR= 20%
1. (Person A) K1000 200 K800
(initial Primary Deposit)
2. (Person B) 800 160 640
3. (Person C) 640 128 512
4. (Person D) 512 102 410
- - - -
- - - -
Total 5000 1000 4000
Credit creation by a single bank
• Credit multiplier = 1/RRR
• Credit multiplier = 1/20% = 5
• 5*K1000 = K5,000
• An initial deposit of K1,000 has the potential to increase Bank deposits
to K5,000
Inflation
Impact of Inflation
Measures of inflation (CPI)
Deflation
Disinflation
Real interest rates
Key Economic Indicators
GDP
– Measure of a country’s output
• Consumer spending
• Plus Government spending
• Plus Investment
• Plus Exports
• Less Imports
= GDP
GDP = C + I + G + NX
Key Economic Indicators
Balance of Payments
• A summary of all the transactions between a country and the rest of the worl
BALANCE OF PAYMENTS
Trade balance • Visible trade balance- difference between value of imported and exported
goods
• Invisible trade balance- difference between value of imported and exported
services
Current Account • Used to calculate total value of goods and services that flow into and out of a
country
• Comprises trade balance figures for visibles and invisibles trade
• To these are added other receipts such as dividends and remittances from
abroad
Capital Account • Records international capital transactions related to investment in business,
real estate, bonds, stocks etc
• FDI and FPI
Key Economic Indicators
Government Debt
• The amounts owed by the government
Budget deficit
• Shortfall between tax receipts and government spending
Level of Unemployment
• extent to which those seeking employment cannot find work is an important
indicator of the health of the economy
Exchange rates can be fixed or floating rate systems
QUESTIONS?
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END OF CHAPTER QUESTIONS
1. What is the key feature of a command or state-controlled economy? (2.1)
2. Which international organisation has the role of reducing trade barriers? (2.4)
3. What are the main functions of a central bank? (4.1)
4. What are the negative effects of inflation? (5.1)
5. What economic measure is used as an indicator of the health of the economy?
(5.2)
6. Explain the three main components of the BOP (5.3)
