Economics / Grade 12 Topic 1 Notes Nkangala District/ 2025

ECONOMICS NOTES

TOPIC 1: CIRCULAR FLOW

GRADE: 12

YEAR: 2025

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Economics / Grade 12 Topic 1 Notes Nkangala District/ 2025

KEY
Real flows:
Money flows:

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 Economics / Grade 12 Topic 1 Notes Nkangala District/ 2025

TOPIC 1: CIRCULAR FLOW

Circular flow is a model that show the relationships between income, production and
expenditure. Circular flow is a representation of how the economy works.

UNIT 1: PARTICIPANTS IN AN OPEN ECONOMY

 An open economy is an economy that engages in international trade. Therefore, an
open economy has four participants which are:

 Households
 Households are the primary (main) participants in the economy because they own
all factors of production.
 The four factors of production are land, labour, capital, and entrepreneurship; their
incomes are rent, salaries and wages, interest, and profits.
 Households sell their production factors on the factor market mainly to the
government, and firms.
 They pay taxes to the government, from which they receive social services such as
education and health.
 They are the main consumers of goods and services which they buy mainly from
the business sector

 Business Sector/firms/ producers

 Businesses buy factors of production on the factor market to produce goods and
services.
 They use the factors of production to produce goods and services for which they
pay incomes such as wages and salaries
 Businesses sell goods and services on the product market to households and
government
 They pay taxes to the government from which they receive public goods such as
infrastructure

 Government/ Public sector / State

 Government refers to different levels of governance namely local, provincial, and
national level
 It receives factors of production from households on the factor market from the
household for which it pays wages and salaries.
 It uses the factors of production bought to produce public goods and services such
as education and health.
 It also buys goods and services from the business sector on the product market.
 It receives tax revenue from households, firms, and foreign sector with which it
supplies public goods
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 Foreign sector
 Foreign sector consists of all other countries in the world which can engage in
business transactions with South Africa
 Foreign sector sells goods and services to the domestic market and this are called
imports
 South African firms sell goods and services to the foreign sector and this are called
exports
 Exports bring money in to the country while imports takes it out of the country.

Financial sector
 The financial sector consists of banks, insurance companies, JSE and Pension
Funds.
 It acts as a link between households and firms who have surplus money and others
in the economy who require funds.
 The money that households and firms provide to the financial sector is referred to
as savings.
 Businesses can borrow money from financial institutions and use it to purchase
capital goods.
 This spending on capital equipment by firms is referred to as investment.

REAL AND MONEY FLOWS IN THE CIRCULAR FLOW

The three most important flows in circular flow are production, expenditure, and
income. These flows consist of real and money flows.

 Real flows
 Factors of production: from households to firms and government.
 Goods and services: from firms to consumers and government.
 Public goods: from the government to firms, households and foreign sector
 Imported goods: from the foreign sector to the business sector.
 Exported goods: from the business sector to foreign countries.

 Money flows
 Incomes for factors of production: remuneration from firms and government sector
to the households.
 Import payment: money from business sector to foreign sector.
 Export earnings: money earned from foreign sector to the business sector
 Taxation: compulsory payment from business sector, households, foreign sector to
government.
 Payment for goods and services: money from government and households to the
firms.
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LEAKAGES AND INJECTIONS IN THE CIRCULAR FLOW

 Leakages (L = T + S + M)
 Leakages are all economic activities that withdraw (take out) money from the circular
flow. These are:
 Taxation (T): Tax is a compulsory payment by the citizens to the government without
any direct benefit in return.
 Households pay income tax to the government on their incomes earned from selling
factors of production.
 The government also taxes expenditures on goods and services e.g. VAT.
 Money leaves the circular flow to the government.
 Savings (S): refers to part of the income that is not consumed (spent). The money
leaves the circular flow to financial institutions such as banks.
 Import payment (M): this is money spent on foreign goods and services, therefore
the money is withdrawn from the economy (circular flow) to foreign countries.

Injections (J = G + I + X)
Injections are all economic activities that add money to the economy (circular flow).
These are:
Government expenditure (G): this is money spent by the government on providing
public goods and services e.g. education, roads, etc. This increases the total spending
on goods and services in the country (for government to build a road some goods and
services will have to be bought).
 Government expenditure represents the spending of tax revenue received by the
government. This shows that taxes (leakage) come back into the circular flow as
government spending.
 Investments (I): This represents money spent by firms to buy capital goods such as
machinery, land, and equipment.
 Producers/firms obtain loans from the financial sector to buy such capital goods.
 This shows that savings (L) come back into the circular flow as Investments (J).
 Export earnings (X): money earned from other countries when goods and services
are sold by domestic firms. This represents earnings of foreign exchange which is
important for the payment of imports.
 Export earnings show that the money spent on imports often comes back into the
circular flow as payments for exports. This is because one country can sell one
product to South Africa but it may also buy another product from South Africa.
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UNIT 2: FOUR TYPES OF MARKETS IN THE CIRCULAR FLOW.

(Discuss in detail the markets within the FOUR-SECTOR model) Possible essay

 Product /goods/output market

 It is a market where goods and services are bought and sold.
 Firms, government, and foreign sectors supply goods and services.
 These goods and services represent real flow in a circular flow.
 Consumers, firms, government, and foreign sectors buy goods and services.
 The payments for goods and services represent the money flow.

 Factor market/resource market/input market

 It is a market where factors of production are traded (bought and sold).
 Households are the owners of factors of production and they sell them to firms, the
government, and the foreign sector.
 The factors of production are labour, entrepreneurship, capital, and land and they
are exchanged for wages, profit, interest, and rent.
 Financial market
 These markets render financial services to the other participants in the economy.
 It gathers surplus funds and lends it to those who need funding.
 Two kinds of financial markets are money and capital markets.
 Money market is a market for short-term loans and savings (three years and shorter)
 It includes inter-banking lending for a period as short as overnight.
 The securities traded include short-term deposits, short-term debentures, and
treasury bills.
 Capital market is a market for long-term savings and loans.
 In South Africa, JSE is a key institution in this market as it trades in shares.
 Examples of securities traded in this market are long-term deposits, mortgage
bonds, shares, and unit trusts.
 Foreign exchange market
 It is a market where currencies are exchanged for one another e.g. Rands for
Dollars.
 It originates when one country imports goods from another country and domestic
currency has to be exchanged to pay for such imports.
 It is a multi-national market as the currencies of all the countries are traded in this
market.
 Foreign exchange can be bought and sold at banks and foreign exchange agencies.

UNIT 3: NATIONAL ACCOUNT AGGREGATES

 The National Accounts Aggregate is a summary of a record of a country’s economic

activities, which are production, income, and expenditure.
 Therefore, a country‘s GDP can be calculated using the production method, income
method, and expenditure method.
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 Production method / Value added method/ (GDP (P))

 Production takes place in primary, secondary, and tertiary sectors.
 The value that is added (created) by each sector is added together. That is why this
method is called the value-added method.
 Only final products are counted because, if intermediate goods can be added there
will be double counting of the value of some products.
 Double counting is when the value of a product is counted twice in production e.g.
as an input (flour) and as a final product (bread).

Gross value added in R millions R million

Primary sector 289 504
Secondary sector 510 520
Tertiary sector 1 605 591
GDP at basic prices ?
+ Taxes on products 268 902
- Subsidies on products 13 083
GDP at market prices ?

 Income method
 When firms produce goods and services they employ factors of production.
 Therefore, the value of income in the economy is equal to GDP at factor cost. /GDP
at factor prices.
 These factor costs are:
 compensation of employees: refers to wages and salaries paid to workers for their
labour,
 Net operating surpluses: are rent, interest on capital and profit of entrepreneurs
before taxation.
 Consumption of fixed capital: refers to the depreciation value of fixed asset used in
production e.g. machinery, vehicles.

Income in R million R million

Compensation of employees 1201990
Net operating surplus 821783
Consumption of fixed capital 350982
Gross value added (GDP) at factor ?
cost
other taxes on production 46213
Subsidies on production 8478
Gross value added at basic prices ?
Plus: taxes on products 263988
Less: subsidy on products 15044
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GDP at market prices ?

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 Expenditure method (GDP (E))

- Expenditure on GDP measures the total money spent on final goods and services
produced within the country in a year.
- Expenditures by all participants in an open economy are added together
 Residual item is the amount that is used to bring the value of the GDP to a balance
in cases where errors occurred.
 It makes up for shortfalls that can come as a result of omissions and miscalculations
because GDP figures are large.
 It can be either a positive figure or a negative figure
 If the GDP figures have been overestimated the residual item takes a negative sign,
meaning it is used to reduce the GDP figure.
 If the GDP figures are under-estimated, the residual item takes a positive sign
meaning it is added to make up for the shortfall

Expenditure on GDP R millions

Final consumption expenditure by 1575930
households (C)
Final consumption expenditure by general 573470
government (G)
Gross capital formation 517009
Residual item 298
Gross domestic expenditure ?
+ Export of goods and services (X) 727721
Less: Import of goods and services (M) 732994
Expenditure on GDP at market prices ?

NB: The three methods should give the same value of GDP for the given period.

NATIONAL ACCOUNT CONVERSIONS

 All countries in the world (including South Africa), use the same methods of
measuring (calculating) GDP which is referred to as System of National Accounts.

System of National Accounts (SNA)

 The System of National Accounts (SNA) is an internationally agreed standard of
measuring the level of economic activity.
 The SNA is recommended by the United Nations and, hence used in all countries.
 It measures economic information such as production, income and expenditure.
 It enables the economic information of different countries to be comparable.
 The economic data collected through the use of SNA can give information on the level
of development of a country.

 There are three kinds of prices used in national accounts namely: basic prices, factor
costs (factor prices), and market prices.
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 Basic prices: They are the initial prices in the production of final goods and services
before considering any taxes and subsidies.
 They represent the amount received by the producer from a consumer when a unit of
their products is bought (market price – taxes + subsidies).
 Factor cost (price): the total cost of factors of production used to produce particular
goods and services (rent, wages/salaries, rent, profit)
 Other taxes on production: taxes related to labour employed e.g. payroll taxes, or
taxes related to other assets used in production e.g. licenses.
 Other subsidies on production: for example, employment subsidies given to
producers to enable them to employ more workers.
 Market prices: prices paid by the consumers to obtain particular products after tax on
products and subsidies on products are considered.
 Tax on products: Indirect taxes on final goods and services e.g. VAT, customs duties,
excise duties, etc. They are paid by the consumer of final goods and services
 Subsidy on products: e.g. subsidy on a particular product to lower consumer price.

NOMINAL GDP vs REAL GDP

 Nominal GDP: is also referred to as GDP at current prices OR current GDP).
 It is the monetary value of all finished goods and services produced within a country
expressed at the prices of the year of production (current year)
 It is obtained by multiplying the quantity of final goods produced by their prices.

 Real GDP: is also referred to as GDP at constant prices.

 It is the monetary value of all final goods and services produced within the country
as expressed in constant prices (prices of a base year).
 It can be obtained by multiplying the quantity of the current year by the prices of the
base year.
 The GDP figures have been adjusted for inflation, meaning the effect of inflation has
been removed.
 To remove the effects of inflation, the GDP deflator can also be used to compare
the prices of the current year to the prices of the base year.
 Real GDP is used to measure economic growth.

CONVERTING DOMESTIC FIGURES TO NATIONAL FIGURES

GDP TO GNI
GDP at market price value
+ (plus) primary income from the rest of the world)
- (minus) primary income to the rest of the world
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Example:
R millions
GDP at market prices 2661 434
+ Primary income (factor income) from the rest of the world 40123
- Primary income (factor income) to the rest of the world 98930
= GNI at market prices 2602627

 Gross domestic product is the market value of all finished goods and services
produced within the borders of a country in a year.
 Gross national income is the total income earned by the permanent residents of a
country in a year.

CONVERTING GDP TO GNP

GDP at market prices value
+ Primary income from the rest of the world
- Primary income to the rest of the world
Example:
R millions
GDP at market prices 2661 434
+ Primary income (factor income) from the rest of the world 40123
- Primary income (factor income) to the rest of the world 98930
= GNP at market price 2602627

CONVERTING GNP TO GDP

GNP at market prices value

– (Minus) primary income from the rest of the world
+ (Plus) primary income to the rest of the world
Example:
R millions
GNP at market prices 2602627
- Primary income (factor income) from the rest of the world 40123
+ Primary income (factor income) to the rest of the world 98930
= GDP at market prices 2661434

 Gross national product is the market value of all finished goods and services
produced by the permanent residents of a country over a year.
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UNIT 4: THE MULTIPLIER

A multiplier process is whereby a small change in expenditure results in a

proportionally larger increase in income/output.
 Multiplier the ratio of change in income to the ratio on change in injections.
 Multiplier process happens in the circular flow (economy) when a change in the level
of injections leads to change in level of output/ national income.

 CALCULATION OF THE MULTIPLIER

 The size of the K is dependent on how much of the extra Y is consumed.
Consumption function: C= Ċ + cY or AE = Ā + cY

 Ċ or Ā = autonomous consumption / consumption (spending) that is not dependent

on income.
 This consumption is never zero even when an individual has no income.
 cY= induced consumption is consumption that dependent on income.
 cY consists of mpc and Y (income). This is the part of the consumption function that
determines the size of the multiplier.

 TWO-SECT ECONOMY
 A simple economy where participants are Households and Firms
 Aggregate expenditure (AE)= C + I
 Leakage = S and Injection = I
 In multiplier, Income Y is = 1, so mpc + mps must always equal to 1(consumption
plus leakage )

SCENARIO

In a two sector economy, the citizens spend 75% of their income, the
autonomous consumption (Ā) is 25m. The initial equilibrium income (Ye) is
100. A particular firm invest an amount of 20 m in steel production in the
economy.

 In a two-sector economy people either save or spend their income.

 The size of α or K can be determined using MPC or MPS formulae.
 In the economy above, the size of the multiplier will be:
 K= 1/ (1-MPC) OR K= 1/MPS
= 1/ (1- 0.75) = 1/ 0.25
= 1/ 0.25 = 4
= 4
This means any ΔJ will multiply 4 times before its effect come to an end (before the
new equilibrium income is reached).
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 Original equilibrium income (Ye).

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 Economics / Grade 12 Topic 1 Notes Nkangala District/ 2025

 Ye= 1
(1 – mpc) x Ᾱ
= (1 – 0.75) x 25
= 1 x 25
0.25
= 4 x 25
= 100

NEW equilibrium income (Ye1)

Ye1 = 1
(1 – mpc) x Ᾱ
1
= (1 – 0.75) x 45
1
= 0.25 x 45
= 4 x 45
= 180
GRAPHICAL REPRESENTATION

AE =Y

e1 AE = 25 + 0.75Y

(Ā1) 45

(Ā ) 25
45

100 180

NATIONAL INCOME
DETERMINING THE SIZE OF MULTIPLIER USING OTHER FORMULA

K= ∆Y
∆E
= 180 – 100
45 – 25
= 80
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DETERMINING THE CHANGE IN INJECTIONS/EXPENDITURE WHEN CHANGE IN Y AND K

ARE KNOWN

∆J/ or ∆E = ∆Y
K
= 180 – 100
4
= 80
4
= 20

DETERMINING THE CHANGE IN INCOME WHEN THE K AND THE CHANGE IN INJECTIONS
ARE KNOWN

∆Y = K x ∆J
= 4 x 20
= 80

 MULTIPLIER IN A THREE SECTOR ECONOMY

 A three-sector economy has three participants namely: households, firms and
government. In other words, it is a closed economy.
 The formula for calculating the multiplier (size) is
 K= 1
(MPS + MRT)

 MPS: Marginal propensity to save

 MRT: Marginal rate of taxation
 NB: taxation is a part of the formula because in a three sector economy there are
two leakages which are savings (mps) and taxation (mrt)
SCENARIO
In a three-sector economy if the citizens saves 25% )0.25), the government‘s marginal
tax rate is 15%. What will be the size of the multiplier? Mpc 0,6

 K =1
 (MPS + MRT)
 = 1
 (0, 25 + 0, 15)
 = 1
 0.4
 = 2.5
 The effect of the second leakage which is tax is that it further reduces the amount
available for consumption (MPC). Therefore, the size of multiplier will be reduced
compared to the one in the two sector economy.
 It will be impossible for the MPC to be as high as before the introduction of tax.
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MULTIPLIER IN FOUR -SECTOR ECONOMY

 In a four–sector (open) economy there are three leakages which are savings, taxes
and imports. These leakages are part of the formula to calculate the size of the
multiplier which is:
K= 1
(MPS +MRT + MPM)

 MPM : Marginal Propensity to Import

 MPS: Marginal Propensity to Save
 MRT: Marginal Rate of Tax

Scenario
If in an open (four -sector) economy the citizens save 25%, the rate of importing goods is

8% and the government ‘marginal tax rate is 15%, what is the multiplier?

K= 1
(MPS +MRT+MPM)
= 1
= (0, 25 + 0, 15 + 0, 08)

= 1
0.48
= 2.1
 The effect of the third leakage (MPM), makes the MPC to decrease to a level lower
than in the three-sector economy.
 This is because the consumption of imports lead to the decrease in the consumption
of locally produced goods. In other words, the MPM in addition to MPS and MRT
leads to large reduction of MPC and therefore, a smaller size of the multiplier.
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