MACRO ECONOMICS

"The ideas of economists and political philosophers, both when they are right and
when they are wrong, are more powerful than is commonly understood. Indeed,
the world is ruled by little else."​
— John Maynard Keynes

Oratilwe Teme
21.01.2025
12TH GRADE ECONOMICS
 Macroeconomics

Focuses on aggregate economic activity and investigates how the

economy works

●​ The macroeconomic approach focuses on the end results of all

repeated micro activities.
●​ It looks at the whole picture and is concerned with how the entire
economy performs.
●​ This would include total demand and supply in the economy,
domestic expenditure and production, total employment and
unemployment, and inflation.
●​ Macroeconomics simplifies through aggregating and combining
variables into a few broad groups

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https://youtu.be/PHe0bXAIuk0

How the economic machine works ☭

Summary of the Video Transcript: "How the Economic Machine Works in 30
Minutes"

In this video, an economic expert explains the fundamental mechanics of the

economy, emphasizing that it operates like a simple machine driven by human
transactions. The speaker presents a framework that has guided his
understanding of economic movements, particularly through financial crises over
the past three decades. He identifies three primary forces that shape economic
activity: Productivity Growth, the Short-Term Debt Cycle, and the Long-Term Debt
Cycle.

The video begins with a discussion of transactions as the building blocks of the
economy, noting that every exchange of money or credit for goods and services
generates economic activity. Credit is highlighted as a crucial component, acting
as a means to facilitate spending beyond immediate income, affecting economic
growth cycles.

The speaker outlines how the economy experiences cycles driven primarily by
credit availability, leading to periods of expansion and contraction. Key concepts
include:

- Transactions: Simplified exchanges that constitute economic activity.

- Credit's Role: How it's created and impacts borrowing and spending patterns.

- Debt Cycles: The short-term (5-8 years) and long-term (75-100 years) debt

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cycles, which ultimately dictate economic stability or instability.

The video also covers the implications of excessive borrowing leading to an

economic "deleveraging," where high debt burdens force cutbacks in spending,
resulting in recessions or depressions. The speaker identifies four mechanisms
to reduce debt burdens: cutting spending, debt reductions, wealth redistribution,
and central bank money printing, emphasizing the balance needed among these
approaches to avoid economic turmoil.

Finally, the expert concludes with three rules of thumb for managing
economic stability:

1. Do not allow debt to rise faster than income.

2. Do not let income surpass productivity growth.

3. Focus on increasing productivity in the long run.

Key Points / Takeaways

1. The economy operates through simple transactions driven by credit and

human behavior, creating cycles of growth and contraction.

2. Understanding the interplay between short-term and long-term debt cycles is

essential for anticipating economic trends and managing debt burdens.

3. Maintaining a balance between income growth and productivity is crucial for

long-term economic health, alongside prudent management of debt levels.

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 Open Economy Model
Circular Flow

The circular flow model of the economy is a simplified representation of

reality, showing how the economy works and the relationship between
income, production and expenditure in the economy as a whole.

●​ The circular flow model of an open economy shows the workings of

an economy that is open to foreign trade.
●​ Every economy faces the problem of scarcity
●​ We have limited resources available to try and satisfy our
unlimited needs and wants
●​ Every choice that we make on a daily basis will cause us to
experience trade-offs.
●​ People often forget opportunity cost in their assessments
●​ We have to make choices in such a way that efficiency in production
and exchange is achieved, keeping equitability in mind.

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 Participants

Households (consumer)

>Known as the primary economic participants, because they own

the four factors of production. ​
(capital, labour, natural resources and entrepreneurship)

>They sell the services of their factors of production to producers for

money income.

>They represent the biggest part of total demand, their needs and
wants have to be satisfied by goods & services.

>Without them businesses and governments have no reason to

produce anything, ​
also no imports or exports would be necessary.

>They interact with the government by receiving public goods &

services in return for taxes paid.

>They interact with the financial sector whenever they lend or

borrow money.

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 Businesses (Producers)

>They buy the services of factors of production in order to produce

goods & services.

>These goods & services are then sold to households and other
participants.

>They have to earn enough income to cover their operating costs.

>They interact with the government by receiving public goods &

services in return for taxes paid.

>They interact with the financial sector whenever they lend or

borrow money.

>They facilitate exports and imports.

Government (State)

>They need to provide public goods & services to households and

businesses.

>In order to do this they also need factors of production and goods
& services.

>They interact with the financial sector mainly through borrowing.

>They try to ensure macroeconomic stability.

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 Foreign sector

>Is both a source and destination for good & services, savings and
loans.

>This is where exports and imports take place.

>The revenue earned in this process represents foreign exchange.

>The foreign exchange market is part of the financial sector.

Financial sector

>This includes the money market, capital market and the foreign
exchange market.

>Banks, insurance companies and pension funds act as a link

between those who require funds ​
and those who have surplus funds available.

>Money provided to the financial sector by participants is known as

savings.

>Whenever borrowed money is used to buy capital goods, it is

regarded as investment.

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 Real Flow and Money Flow

All transactions take place in markets.

Every transaction is two-sided, for every sale there is a purchase.

Real flow​

●​ Goods & services are sold in the product market.​

●​ Factors of production are sold in the factor market.
●​ Public good & services flow from the government to households and
businesses.
●​ Exports leave the country and imports enter the country.

Money flow

●​ Households earn an income from selling the services of their factors

of production.
●​ Producers earn an income from selling the goods & services.
●​ Households and businesses have to pay taxes to the government.
●​ Payments for imports leave the country, while receipts from exports
enter the country.
●​ Any participant that interacts with the financial sector will result in a
money flow in both directions.

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 Leakages and Injections

Leakages (L)

●​ > Represents a withdrawal of money from the circular flow.

●​ > There is no opportunity for a further round of income.
●​ > Domestic expenditure on goods & services decreases. L = S + T +
M
●​ > Savings (S) is income that participants choose not to spend, but
rather to put aside for future use. We want to know the amount of net
savings.
●​ > Taxes (T) are paid to the government and results in a decrease in
disposable income. We want to know the amount of net taxes.
●​ > Import expenditure (M) results in money flowing out of the country,
as we are paying for items from abroad.

Injections (J)

●​ > Represents an inflow of money into the circular flow.

●​ > Additional money enters the economy and increases income (Y).
●​ > Domestic expenditure on goods & services increases. J = I + G + X
> Investment (I) is money that businesses spend, which they borrow
in one way or another. Buying property, equipment, intermediate
goods, raw materials or building up inventories.
●​ > Government expenditure (G) is money that the government spends
in order to provide social and economic services as well as
infrastructure.
●​ > Export income (X) results in money flowing into the country, as we
are receiving payment from abroad.

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 When L = J the economy is in equilibrium

When the economy is in disequilibrium L > J or L < J

Restoring the equilibrium causes changes to National Income.

●​ > When L < J National Income will increase, because the additional
demand will need to be satisfied.
●​ > When L > J National Income will decrease, because of a decrease
in demand.

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 Equations

In order to make use of mathematical and graphical models, we make the

assumption that L = J or S + T + M = I + G + X

Under such an assumption Income (Y) = Expenditure (E) = Production (P)

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 Markets
●​ Place where buyers and sellers meet to exchange goods and
services at a certain price.
●​ Not necessarily a physical place.
●​ All those buyers and sellers who influence the price of a
particular good or service.

Adam Smith suggested with his "invisible hand" theory

that market forces will always ensure that the correct quantity and price
prevail.

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Main functions

●​ Efficient allocation of resources.

●​ Bringing demand and supply together.
●​ Able to self-regulate.

Product and Factor Markets

Remember that these two markets are related, because of the derived
demand of factor services.

There will be no demand for factor services needed to produce a product if

there is no demand for the product to begin with.

Product market

> There are thousands of markets for consumer goods & services.

> Buying and selling of goods & services take place here.

> Durable goods, semi-durable goods, non-durable goods and services.

Factor market

> This is where the services of factors of production are traded.

●​ - Labour earns wages/salaries

●​ - Capital earns interest
●​ - Natural resources earn rent
●​ - Entrepreneurship earns profit

> It includes the labour markets, property markets and financial markets.

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Money and Capital Markets (Financial)

The financial market serves those who wish to borrow and those who wish
to save.

Money market

●​ Market for short-term and very short-term savings and loans. (3 years
and shorter)
●​ When parties make demand and short-term deposits and borrow over
the short-term.
●​ The kinds of securities that exchange hands include bankers
acceptances, short-term company debentures,
●​ treasury bills, Reserve Bank debentures and short-term government
bonds.
●​ The SARB is a key institution in this market.

Capital market

●​ Market for long-term savings and loans. (Longer than 3 years)

●​ Long-term funds and long-term securities are traded.
●​ Mortgage bonds, company shares and other debts are traded.
●​ The JSE is a key institution in this market.

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Foreign Exchange Market

●​ When a participant buys foreign currency or traveller's cheques.

●​ Consumers buy foreign currency when travelling.
●​ Businesses buy foreign currency to pay for imports or they receive
foreign currency as payment for exports.
●​ In South Africa all of this happens at banks.
●​ The foreign exchange market is also multinational in scope (London,
New York and Tokyo)
●​ The South African rand is traded freely on these markets and the
SARB can't control it.

Flows Through Different Markets

The flows of private and public goods & services are real flows,
accompanied by counter flows of expenditures and taxes.
●​ Factor services are real flows, accompanied by counter flows of
income.
●​ Imports and exports are real flows, accompanied by counter flows of
expenditure and revenue.

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 ●​ Production earns income for those who sell the services of their
factors of production
●​ Income is used to purchase goods & services that are produced.
●​ This ensures that production, income and expenditure amounts are
equal to one another.

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 National Account Aggregates

Introduction

●​ We use the circular flow model to study the economy.

●​ It shows us real flows and money flows.
●​ We need to measure these flows as well.
●​ Measuring economic performance gives the government and
society the opportunity to understand ​
how variables have performed and allows them to make informed
decisions.

Deriving National Account Aggregates

Remember that production is first evoked by needs and wants.

Thereafter income and expenditure come into play.

The aim of National Accounts

> To provide a systematic and comprehensive record of national

economic activities.

> It is never 100% accurate, there are many shortcomings when

determining National Income figures.

> South Africa uses the System of National Accounts (SNA) as

suggested by the UN.

Remember there is a distinction between national and domestic.

GDP v/s GNP

GDI v/s GNI

* GDE v/s GNE

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 Production method
●​ Businesses, government and the foreign sector participate in the
production process.
●​ Production takes place in the primary, secondary and tertiary sectors
where they focus on agriculture, mining, manufacturing and services.
●​ We do not merely add up the market values of all the outputs as that
would amount to multiple counting.
●​ By subtracting the intermediate inputs from final outputs, we find the
value that was added by each sector.

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 Income method
> We add up all the incomes earned by the owners of the factors of
production.

> Transfer payments are not included in the calculations.

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 Expenditure method
> It measures the total expenditure on final goods & services produced
within the borders of the country.

> Children grants and foster parent grants are included in consumption
expenditure by government

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 National Account Conversions
●​ To provide a systematic and comprehensive record of national
economic activities.
●​ South Africa uses the System of National Accounts (SNA) as
suggested by the UN.
●​ Our figures and their conversions comply with international best
practice.

Macroeconomic measurement (GDP, GDI and GDE) has a great deal to do

with the prices that we use.

- Nominal prices or Real prices

- Prices before taxes or Prices after taxes

Basic prices

> Certain goods & services enter our national account statements at basic
prices, because of some kinds of indirect taxes and subsidies.

> The amounts that are added in the different sectors include taxes on
production and exclude subsidies on production.

> Taxes on production are, e.g. payroll taxes, taxes on land & buildings,
and business or other licenses.

> Subsidies on production are, e.g. employment subsidies and subsidies

paid to prevent pollution.

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 Factor cost

> The same kinds of indirect taxes and subsidies that cause national
account aggregates to reflect basic prices are used to calculate aggregates
that show values at factor cost.

> Taxes on production and subsidies on production are reversed in the

calculation of basic prices.

GDI @ basic prices + subsidies on production - taxes on production =

GDI @ factor cost

Market prices

> Different kinds of indirect taxes and subsidies are used for the conversion
of basic prices to market prices.

> Taxes on products are, e.g. VAT, import duties and taxes on exports.

> Subsidies on products are, e.g. subsidies payable per unit exported and
subsidies on domestic products.

●​ GDI @ basic prices + taxes on products - subsidies on products

= GDI @ market prices
●​ GDP @ factor cost + taxes on production - subsidies on
production = GDP @ basic prices
●​ GDP @ basic prices + taxes on products - subsidies on
products = GDP @ market prices

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 Net figures

> Indicates that some amount has been taken away.

> Net operating surplus = after taxes

> Net income = after taxes

> Net exports = after subtracting imports

National and domestic figures

> National figures (GNI or GNP) relate to the aggregated income or

production by citizens of the country wherever they may be economically
active. (in South Africa or abroad)

> Domestic figures (GDI or GDP) relate to the aggregated income or

production within the borders of SA. (by South Africans and foreigners)

> Primary income from the rest of the world and Primary income to the rest
of the world need to be included in the calculations.

GDP @ market prices + primary income from the rest of the world -
primary income to the rest of the world = GNP @ market prices

Disposable National Income

> Current transfers from the rest of the world and Current transfers to the
rest of the world need to be included in the calculations.

GNP @ market prices + current transfers from the rest of the world -
current transfers to the rest of the world = Gross National Disposable
Income @ market prices

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 Nominal GDP v/s Real GDP

> Nominal GDP is also known as GDP @ current prices.

Volume of final goods & services X Price Inflation has not yet been taken
into consideration.

> Real GDP is also known as GDP @ constant prices. Inflation has been
taken into consideration. A certain base year is used. (2015)

Nominal GDP X 100 / 𝐺𝐷𝑃𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟 = Real GDP

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 Multiplier

Introduction
A multiplier is the number we multiply with.

In National Income the multiplier is the ratio of the change in the

equilibrium level of income ( Y) to an initial change in the level of
expenditure ( E).

Multiplier Effect

When a small initial change in expenditure (ΔE) produces a

proportionately larger change in income (ΔY).

Explaining the Multiplier Process

The essence of this concept is the idea that one person's spending is
another person's income.

The multiplier effect is cumulative and is a process, rather than

instantaneous.

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This change in induced expenditure will go on until the multiplier has
run its full course.

The value of the multiplier depends on the fraction of extra income that
is spent on consumption at each successive round.

We call this the marginal propensity to consume (MPC).

MPC will mostly be given, but we can calculate it if it is unknown.

MPC = ∆C/∆E

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 ●​ Money that is not spent is saved, so we also get something that we call
the marginal propensity to save (MPS).
●​ MPC + MPS = 1

3 methods to calculate the multiplier

K=ΔY/ΔE​ K=1/ 1-MPC ​K=1/MPS​

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 Aided With Circular Flow and Examples

The fact that we have used only savings and investment in our explanation of the
multiplier implies that we were looking at a 2-sector model.

We know that we have more leakages than only savings when we look at a 4-sector
model.

4-sector model

●​ When we include the other leakages as well, then 1 - MPC ≠ MPS

●​ Now we rather have 1 - MPC = MPS + MRT + MPM

MPM is the marginal propensity to import.

MRT is the marginal rate of taxation

K=ΔY/ΔE​ K=1/ 1-MPC ​K=1/MPS​+MRT+MPM

Injections (J) and leakages (L)

●​ Remember that the economy is in equilibrium when L = J or S + T + M

=I+G+X
●​ Restoring the equilibrium causes changes to National Income.
●​ When S + T + M < I + G + X then National Income will increase,
because the additional demand will need to be satisfied.
●​ When S + T + M > I + G + X then National Income will decrease,
because of a decrease in demand.

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 An increase in injections will increase income until J = L

●​ John Maynard Keynes used these variables to underpin the multiplier

and to explain how governments could manage employment and
growth by manipulating the levels of leakages and injections.
●​ We have to spend more in order for our economy to grow
(Demand-side policies).
●​ Government should increase their spending and decrease taxes
(Fiscal policy).

South Africa has a high MPC, so any injection (J) should have
wonderful effects.

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 Composition and Features
Introduction
Terms like growth, inflation, interest rates and unemployment relate to
the business cycle phenomenon.

Business cycles are successive periods of increasing or decreasing

economic activity.

Business cycles are recurrent but not periodic patterns of expansion

and contraction the level of economic activity that occurs within a
country.

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 Nature of Business Cycles
Changes in economic activity are recurring, but not periodic.

The events that initiate expansion or contraction in each particular cycle are
not exactly the same.

>Different circumstances and expectations ensure that producers and

consumers do not respond to the same extent or with the same speed to
the initiating forces.

>The length and amplitude of the upswing and downswing in every

business cycle will be different.

>No two business cycles are exactly the same.

>All business cycles are recognised by the following

●​ - Two periods (expansion and contraction)

●​ - Two turning points (peak and trough)

>Business cycles also reflect

●​ - Seasonal and random fluctuations in economic activity.

●​ - Long term growth trends.
●​ - Structural changes in demand and supply.

>The key variable in business cycles is real GDP.

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 Introduction
Business cycles are explained mainly in terms of Monetarist views
(exogenous) or Keynesian views (endogenous).

Exogenous Explanation

Monetarists believe that the growth path of the economy is determined by

the natural growth in the supply of available resources of production.

>If imbalances develop, the market forces of demand and supply

will always bring the market back to equilibrium.

>They feel that markets are inherently stable and any disequilibrium is
caused by exogenous factors that influence the economy from outside the
market system.

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> They believe that economic fluctuations are caused by inappropriate
government policies and undesirable changes in money supply.Other factors
include weather conditions, shocks and structural changes.

>Governments should not intervene in the markets. They should carefully

control money supply in the economy.

Endogenous Explanation

Keynesians believe that business cycles are part of the way market
economies operate.

>The level of economic activity constantly overshoots and undershoots

the economy's potential growth path.

>They feel that markets are inherently unstable and the price mechanism
fails to restore equilibrium.

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>They believe that economic fluctuations are caused by indirect links,
mismatches between demand and supply and disequilibria.

>Governments should intervene in the markets. They should smooth out

peaks and troughs as far as possible.

Types of Cycles
Kitchin cycles (3 to 5 years, caused by businesses adapting their inventory
levels).

>Jugler cycles (7 to 11 years, caused by changes in net investments).

>Kuznets cycles (15 to 20 years, caused by changes in the building and

construction industry).

>Kondratieff cycles (50 years and longer, caused by technological

innovations).

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 Government Policy

●​ Governments' primary aim with business cycle policies is to achieve

the best possible growth rates.​
●​ If they only focus on growth, inflation will sneak in and to get rid of
inflation would require sacrificing employment.
●​ Governments need to apply strong policies to smooth out business
cycles.
●​ Economic development is not possible without economic growth.

Monetary Policy
An increase in money supply will inevitably cause inflation.

The SARB can use the following instruments to ensure price stability

> Interest rates (Changing the repo rate)

> Cash reserve requirements (Changing the current 2,5% requirement)

> Open-market transactions (Buying and selling government securities)

> Moral suasion (Persuading banks to act in a desirable manner)

> Exchange rate policy (Free-floating system for South Africa)

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 Fiscal policy
Fiscal policy is very much connected to the multiplier effect.

Remember that the multiplier also works in a negative direction.

Two undesirable events can take place, that need to be addressed

●​ > Private sector demand becomes too low.

●​ > Private sector demand becomes too high.

In each event the government has the following options available under
fiscal policy

●​ > Increase or decrease government spending.

●​ > Increase or decrease taxes.
●​ > Changing government spending and taxes simultaneously

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 Combining Monetary and Fiscal Policies
The strongest effects are obtained from combining monetary and fiscal
policies when trying to affect aggregate demand.

If demand is too high

>The government and the central bank can, for instance,

●​ increase interest rates,

●​ increase cash reserve requirements,
●​ reduce government spending and
●​ increase taxes.

If demand is too low

>The government and the central bank can now do the exact opposite.

●​ Decrease interest rates,

●​ decrease cash reserve requirements,
●​ increase government spending and decrease taxes.

In both cases the effects will be very powerful, so fewer of the elements are
usually combined in order to have mild results.

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 New Economic Paradigm

Introduction
●​ Theories such as those of the Monetarists and the Keynesians are
extreme statements.
●​ They are only true under specific circumstances.
●​ Under real world circumstances governments have to pursue
economic growth
●​ irrespective of the fact that markets may be inherently stable or
inherently unstable.
●​ Most governments learn to apply policies that are not extreme and
are transparent.

Definition
●​ In recent years economists have become convinced that it is
possible for output to rise at a high rate for an extended period
of time without being tripped by supply constraints and without
provoking inflationary pressures.
●​ The new economic paradigm is embedded in demand-side and
supply-side policies.

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 Demand-side Policies
Monetary and fiscal policies focus on aggregate demand.

The demand-side approach on its own does not render ideal results.

Bottlenecks develop

> Inflation

> Balance of payments deficits

> Shortages of skilled labour

Aggregate supply also needs to be managed.

If the cost of increasing production is completely flexible,

then greater real output can be supplied at any given price level.

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Inflation
>If aggregate demand is stimulated and aggregate supply responds
promptly, then a larger real output becomes available without any price
increases.

>Supply is often fixed in the short term.

If aggregate demand increases, aggregate supply does not respond

and so real production increases along with prices.

>The solution is to create conditions that ensure more flexible supply. This
can be done through supply-side measures.

Unemployment
> Demand-side policies are effective in stimulating economic growth.

Economic growth increases the demand for labour ~ less unemployment.

But as unemployment falls, inflation starts to rise. (Illustrated on the

Phillips-curve)

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>We start off with a natural rate of unemployment (where there is no
pressure on wages).

>If the economy is stimulated and unemployment falls, wages increase,

causing inflation.

>There is a trade-off between unemployment and inflation.

>Supply-side measures can be used to shift the Phillips-curve to the left

●​ - Improved education
●​ - Effective training
●​ - Fewer legal restrictions on businesses
●​ - Fewer restrictions on immigration of skilled labour

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 Supply-side Policies
It is possible for the government to arrange things in the economy in such a
way that supply is more co-operative to increases in demand.

Reduction of costs

>This will mean that a greater output can be supplied at any given price
level.

>Governments can roll out measures to reduce cost of production directly

or indirectly

●​ - Modern infrastructure
●​ - Efficient administration
●​ - Cash incentives
●​ - Less red tape
●​ - No corruption

Improving the efficiency of inputs

>Greater efficiency of inputs can usually be achieved with incentive

schemes and measures

●​ - Tax rates
●​ - Capital consumption
●​ - Human resource development
●​ - Free advisory services

Improving the efficiency of markets

>Efficient markets ensure that changes in aggregate demand and

aggregate supply adjust promptly to new equilibrium levels.

>Measures include

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 Forecasting
Introduction

Economists analyse and explain events as they happen and they also
predict future behaviour.

Forecasting is the process of making predictions about changing conditions

and future events that may significantly affect the economy.

Indicators
The most basic forecasting is done by studying changes in time series
data.

Indicators, like real GDP, suggest how an economy is performing or is

likely to perform.

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Leading indicators

●​ >They peak before the peak in aggregate economic activity is

reached and they reach a trough before aggregate economic activity
reaches a trough.
●​ >They give advance warning of changes in aggregate economic
activity.

Coincident indicators

●​ >These follow leading indicators after some time has elapsed, but
they tend to confirm the turning points of the leading indicators.
●​ >They describe the real state of the economy.

Lagging indicators

●​ >They follow coincident indicators after a further time lapse.

●​ >If an upswing or downswing is weak, lagging indicators will point
that out.

Composite indicators

●​ >It is a summary of the various indicators of the same type into a

single value.
●​ >We get a composite-leading, composite-coincident or
composite-lagging indicator.
●​ >The three composite indicators are often used to calculate a single
composite indicator, that is a single number to benchmark a country's
economic performance.

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Length of Business Cycles
●​ Longer cycles show strength.​
●​ Cycles may overshoot.

Amplitude of Business Cycles

●​ Power of underlying forces

●​ The extent of change.

General Trend

We assume that behavioural patterns of the past will continue in the future
for a reasonable time.

>The trend indicates the general direction in which the indexes move. The
trend will change when the indicators change their behaviour patterns of
the past.

>Resistance points and channels do exist.

Extrapolation

Means to estimate something unknown from facts that are known. (Always
requires caution)

>Apply extrapolation to

●​ - The trend line

●​ - The trend of a curve

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Moving Averages

A method of repeatedly calculating a series of different average values

along a time series to produce a smooth curve.

It evens out fluctuations

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 Composition and Necessity
Introduction
In the circular flow we can see that the government is one of the main
participants in the economy.

Government spending is an important injection into the circular flow and

taxes is an important leakage from the circular flow.

Composition

Central government (National)

>Includes government departments and non-profit organisations financed

by them.

General government (Provincial and Local)

>Includes provincial governments of all 9 provinces and municipalities.

Public sector (SOEs)

>Includes state-owned enterprises and public corporations.

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 Necessity

Providing public goods & services

>Community goods

●​ - There needs to be a complete supply or non at all.

●​ - Nobody can be excluded from using them. (non-excludability)
●​ - Consumption by one person does not exclude consumption by
another. (non-rival)
●​ - Clearly they cannot be provided by the private sector.
●​ - Examples are street lights, policing, defence and flood control.

>Collective goods

- Free-riders can be excluded through fees, charges and tolls.

- Examples are parks, beaches, roads, bridges and drainage.

>Merit goods

●​ - Provided by the state because if provision was left to market forces,

it would've been undersupplied.
●​ - There is also a possibility that it would've been inadequately
consumed.
●​ - This is because of external costs involved.
●​ - Subsidies are also given for private sector institutions.
●​ - Examples are education, healthcare, libraries and town planning.

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Taking care of common resources

> Our environment consists of resources that no one owns and yet
everyone can use free of charge.

> Government has to intervene in order to protect the environment,

because individuals won't.

Managing the economy

>Government manages the collective interests of the people of its country.

●​ - They have to ensure a proper social and legislative environment

suitable for economic pursuits.
●​ - They have to apply credible economic policies in order to achieve
economic objectives.

Redistributing wealth and income

>South African government makes use of a progressive tax system.

>Social grants and social services are also being provided.

Encouraging competition

>Governments have to try and discourage monopolies.

>They have to promote perfect competition as far as possible.

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 Problems of Provision
Introduction
●​ Public sector provision gives rise to its own particular problems

Accountability
Means explaining one's decisions, actions and expenditures.

>The public requires assurances that

●​ The desired quantities and quality of goods & services are provided
for which taxes are raised.
●​ Powers granted are not being abused.

>The public sector is not driven by the profit motive.

>There is no direct accountability to taxpayers.

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 Efficiency
Efficiency is not guaranteed through accountability.

>Efficiency is measured in terms of Pareto efficiency.

>Inefficiency is caused by

●​ Bureaucracy
●​ Incompetence
●​ Corruption

Assessing Needs
Public goods & services are provided according to the needs of citizens.

>Price signals can't be used to determine the correct amount of supply.

>Housing is regarded as a social responsibility, so decision making

becomes very difficult.

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Pricing Policy
In supplying public goods & services the government generally has three
pricing options.

>Free-of-charge services

●​ The cost of providing public goods & services free of charge is met
from taxes.
●​ This applies to most community goods and collective goods.

>User-charges

For goods other than community goods, the option to charge and the
amount to charge depend on the following:

●​ Technical considerations
●​ Political considerations
●​ Economic considerations

>Subsidies

When relatively high fixed costs are involved, the following might be
needed:

●​ - Direct and indirect subsidies

●​ - Standing charges
●​ - Price discrimination

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Parastatals
State-owned enterprises are created in one of two ways.

●​ The government starts it.

●​ An existing one is nationalised.

Privatisation / Nationalisation
Privatisation is when more than 50% of the shares of an SOE is sold
to the private sector.

>Nationalisation is when a private enterprise sells more than 50% of

its shares to the government.

Arguments for privatisation

●​ >Proceeds of sales can be used for other projects.

●​ >A larger share of the economy is in private ownership.
●​ >Fiscal problems are eradicated.
●​ >There is opportunity for increased tax revenue.
●​ >It might attract foreign investments.
●​ Arguments against privatisation
●​ >Public interest will get ignored.
●​ >There might be increased unemployment.
●​ >Consumers might be exploited.

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 Objectives and Budgets
Introduction
Unless the economy is run well, the public sector will not be able to fulfil its
social responsibilities.

Objectives

There are five macroeconomic objectives in developing countries.

>Economic growth

●​ There needs to be an increase in real GDP.

●​ For economic development to occur the economic growth rate
●​ needs to be higher than the population growth rate.

>Full employment

●​ Attaining high levels of employment is one of the most important

economic objectives for any government.
●​ Full employment would mean that every person who would like to
work and is looking for a job should be able to find work or create
employment for themselves.

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>Exchange rate stability

●​ Depreciations and appreciations of a currency create a lot of

uncertainty in markets.
●​ South Africa is using a free-floating system.
●​ Monetary and fiscal policies can be used to influence stability.

>Price stability

●​ The SARB has set an inflation target of 3% - 6%.

●​ Our budget deficit is not helping.

>Economic equity

●​ A redistribution of income and wealth is essential in market

economies.
●​ Progressive income tax system is used to finance free social services
and to pay cash grants to the economically marginalised.

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Budgets
South Africa has two budget events on the calendar.

Medium-term budget policy statement (MTBPS)

>Presented during the last week of October.

>It is based on the medium-term expenditure framework (MTEF).

>Introduction of the MTEF removed some of the secrecy from the annual
budget.

Main budget
>The minister of finance finalises the budget in consultation with the
cabinet and the FFC.

>Financial, political and economic considerations all play a role.

>The planned revenue and expenditure for the next fiscal year are
presented during February each year.

>Our fiscal year is from 1 April to 31 March.

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58
 Fiscal Policy
Introduction
Fiscal policy is any attempt on the part of the government to influence the
economy with changes in expenditure and taxes in order to achieve
particular economic and social goals.

Features
It is goal bound.

The central government determines the economic and social goals for
the country.

The budget is used to realise these goals.

>It is demand biased.

Fiscal policy is the main instrument used in demand-side policies.

It is also used in realising supply-side policies.

>It is cyclical.

The business cycle has a direct effect on fiscal policy.

During expansion (Higher profits and income, higher demand and

expenditure, higher tax revenue, more government spending).

During contraction (The opposite happens).

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Composition
The instruments of fiscal policy are government spending and taxation.

●​ > If amounts are equal we have a balanced budget.

●​ > If expenditure is more we have a budget deficit.
●​ > If income is more we have a budget surplus.

Government spending
Governments spend in order to:

●​ > Provide public goods & services.

●​ > Pay interest on government debt.
●​ > Redistribute income.
●​ > Influence aggregate demand and aggregate supply.

Taxation
Direct and indirect taxes are used to:

●​ > Raise income for the government.

●​ > Discourage the consumption of demerit goods.
●​ > Discourage imports.
●​ > Redistribute income.
●​ > Convert external costs into private costs.
●​ > Influence aggregate demand.
●​ > Develop the economy.

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Borrowing
●​ A budget must always balance.
●​ If there is a deficit, loans need to be incurred.
●​ If there is a surplus, savings are set off against debt.

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 Effects
Income distribution

●​ >Progressive taxes (Income tax) ~ more even distribution.

●​ >Regressive taxes (VAT) ~ less even distribution.
●​ >Proportional taxes (Company tax) ~ unchanged distribution.

Consumption

●​ >Direct and indirect taxes affect consumption expenditure

(Disposable income).
●​ >Government spending affects consumption expenditure (Multiplier
effect).

Price level

●​ >Direct taxes will reduce inflation because of lower demand.

●​ Cost-push inflation needs to be kept in mind though.
●​ >Indirect taxes will raise the general price level.

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Incentives and disincentives

●​ >Subsidies and grants serve as incentives for the purposes they are
used for.
●​ >Direct taxes reduce the incentive to work, save or invest.
●​ >People are discouraged from entering the labour force, working
extra hours, taking promotions or declaring all income earned.
●​ >The Laffer curve illustrates the relationship between tax rates and
the amount of tax revenue collected by governments.
●​ It suggests that as tax rates increase from low levels the tax revenues
collected will also increase.
●​ At some point, however, further tax rate increases will lead to lower
tax revenues as the disincentive effects begin to take over.

The Laffer curve may not always be symmetrical.

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Discretion
Prudent fiscal policy lays down some rules and limits discretion.

●​ > Deficit rule (Should not exceed 3% of GDP).

●​ > Borrowing rule (Should only be used for capital expenditure).
●​ > Debt rule (Should not exceed 60% of nominal GDP).

64
 Reasons for Failure
Introduction
●​ Public sector failure is not when the ruling party makes empty
promises or when it loses an election.
●​ Public sector failure is when a government fails to manage an
economy and the resources under its control optimally.
●​ Failure by the public sector to provide public goods & services
results in the market providing them ~ at high prices.

Features
Ineffectiveness

●​ - Missing targets with regard to inflation, growth and employment.

●​ - Incompetence in using monetary and fiscal policy.
●​ - Failing to supplement them with other policies like labour policy,
industrial policy, commercial policy, development policy.

>Inefficiencies

●​ - Wasting resources such as taxpayers' money.

●​ - Not caring for the environment directly or indirectly.
●​ - Not honouring human rights.

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Reasons
Management failure

●​ - Ignorance in applying policies and the timing of it.

●​ - Lack of leadership, training and experience.
●​ - Personal and hidden agendas.
●​ - Questionable motives.

Apathy

●​ - The lack of accountability leaves citizens voiceless and leaves room

for apathy.

Lack of motivation

●​ - No real incentives for successful service delivery.

●​ - Little stipulation for quality and quantity of services.
●​ - No measurement of effectiveness or productivity.

Politicians

●​ - Pursuing vote-maximising strategies.

Bureaucrats

●​ - Try to maximise their income, power and status rather than

satisfying public needs.

Special interest groups

●​ - Those who try to further their own interests by means of bribes,

kickbacks and other favours.

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Effects
Allocation of resources

●​ - They are supposed to provide public goods & services that the
market can't/won't provide.
●​ - If there is public sector failure, then resources are not allocated in
the best way and wastage of resources is taking place.

Economic stability

●​ - Under public sector failure we will also see macroeconomic

instability.

Distribution of income

●​ - Under public sector failure the distribution of income will remain

unfair or even be worse than before.

Social stability

●​ - Under public sector failure the lives of people are destabilised and
human rights are being compromised.

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 Reasons for International Trade
Introduction
International trade is the exchange of goods & services across international
borders.

In the foreign sector exports and imports are core elements in international
trade.

Expenditure on imports (M) is a leakage.

Money received from exports (X) is an injection.

Demand Reasons
●​ Countries trade with other countries because they have a demand for
goods & services that they themselves don't produce or don't
produce enough of.
●​ South Africa doesn't produce enough oil, Namibia doesn't produce
any oil.

>Size of the population

●​ An increase in population growth will cause an increase in demand,

●​ which a country might not be able to satisfy fully.

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>Income levels

●​ Change in income levels causes a change in demand for goods &

services.
●​ More disposable income might not only be spent domestically.

>Wealth levels

●​ Change in wealth levels affect the demand for luxury goods &
services.
●​ More access to loans will also cause more demand for luxury items
and technologically advanced products.

>Preferences and tastes

●​ International travel exposes us to many different ideas, cultures and

products that we didn't know we had a demand for.

>Consumption patterns

●​ Developing countries and developed countries have different

consumption patterns.
●​ Developed countries usually benefit more from international trade
than developing countries.
●​ Africa's trade is only about 2% of world trade.

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Supply Reasons

●​ Uneven distribution of natural resources

●​ Each country has its own unique mixture of natural resources that
makes the production of certain goods & services possible.
●​ South Africa has a variety of natural resources that we don't bother to
add value to.

>Differences in climate conditions

●​ Some countries have favourable climate conditions for cultivating

certain crops.
●​ South Africa once again has no complaints here, except for the fact
that we don't have a lot of water.

> Differences in quantity and quality of labour

●​ The availability of highly skilled labourers will significantly affect

productivity.
●​ Some countries are well known for producing certain things that
require unique skills.
●​ Some countries are well known for their cheap labour and willingness
to work.

>Access to technological resources

●​ These countries will be able to produce goods & services at a lower

cost per unit.

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>Specialisation

●​ This will enable countries to benefit from economies of scale.

●​ Countries need to specialise in those things that they have a
comparative advantage in.

>Capital formation

●​ Developed countries usually enjoy an advantage over developing

countries.
●​ Countries need to make sure that they have capital deepening.

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Interaction of Supply and Demand

72
Effects of International Trade
Trade has the ability to make everyone better off.

>Specialisation

●​ Will increase living standards as each country ends up with more.

●​ Countries would have had a lot less variety without international trade
and specialisation.

>Mass production

●​ International trade gives producers bigger markets allowing them to

make use of mass production.
●​ Most manufactured products require mass production in order to be
affordable and profitable.

>Efficiency

●​ Unrestricted international trade increases competition which will have

a positive effect on efficiency.
●​ Lower prices and better quality can be expected by consumers.

>Globalisation

●​ Other elements of globalisation benefit from international trade as

well.
●​ Transport, communication and information technology for example.

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 Balance of Payments
Introduction
●​ Balance of payments is a statement of a country's trade and financial
transactions with the rest of the world.
●​ It is a comprehensive and systematic record of transactions between
one country and the rest of the world.
●​ The composition of it is prescribed by the IMF.

Value of Balance of Payments

●​ It will show whether a country is living within its means or beyond its
means.
●​ It can either show a surplus or a deficit.
●​ A deficit would mean that more money is flowing out of the country.
●​ A surplus will mean that more money is flowing into the country.

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Composition

75
 Correcting BoP Disequilibria
Introduction
●​ Disequilibrium on the balance of payments means an overall deficit or
surplus that impacts on official reserves (reserve assets).
●​ If disequilibrium persists continuously for a long period and becomes
worse, it is called a fundamental disequilibrium.
●​ The IMF was established to assist countries with such problems.

Lending and Borrowing

Countries with surpluses often lend money to countries with deficits.

>This is why so many developing countries have so much foreign debt.

>Member countries may also borrow from the IMF.

>Borrowing is not a long term solution.

Changes in Demand

●​ An increase in domestic demand causes imports to increase which

has a negative effect on the balance of payments.

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Export Promotion

●​ Encouraging the production of goods & services that can be

exported.

Import Substitution

●​ Producing goods & services domestically rather than to import them.

Interest Rates
Domestic demand can be changed by changing interest rates.

>Increased interest rates will lead to decreased spending.

>Foreign investors will also try to take advantage from higher interest rates.

Exchange Control

Domestic regulations allow central banks to ration foreign exchange.

>Those who require foreign exchange have to apply to the central bank.

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Import Controls
Include import tariffs, other duties and quotas.

>The WTO tries to lower tariffs and trade barriers for the sake of trade
liberalisation.

Changes in Exchange Rates

>Free-floating exchange rates

The currency appreciates and depreciates as a result of the working of

market forces.

Exchange rates will make imports and exports more expensive or cheaper.

>Managed-floating exchange rates

Central banks use their reserves to effect depreciations and appreciations.

In the long run currencies have to find their equilibriums.

>Fixed exchange rates

Currencies are revalued and devalued.

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 Foreign Exchange
Introduction
●​ A currency will only be accepted as a legal tender in the country of
origin.
●​ When South Africans plan on doing transactions with other countries,
they need to have the relevant currency.
●​ When foreigners plan on doing transactions with South Africa, they
need to have rands.
●​ All international transactions can only take place after a transaction
on the foreign exchange market happened first.

Foreign Exchange Rates

This is the price of one currency in terms of another currency.

It can be quoted

> As R1 = $0,0534576 (Indirect method)

> As $1 = R18,706414 (Direct method)

>Internationally the dollar serves as a base currency.

If $1 = R18,71 and $1 = €0,92 then we can figure out that €1 = R20,34

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Foreign Exchange Markets

A foreign exchange market is a market that is engaged in the buying and

selling of foreign currency.

>This market determines the foreign exchange rates for every currency

and is by far the largest market in the world.

>The leading markets are in London, New York and Tokyo.

In South Africa we have an Interbank Foreign Exchange Market.

Transactions are done :

●​ > Electronically
●​ > In writing
●​ > By phone

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Supply and Demand (Price Formation)

Speculators play an important role in the price formation of currencies

> They sell a currency in anticipation of a coming depreciation.

> They buy a currency in anticipation of a coming appreciation.

> They cause to happen what they anticipate.

Appreciation and Depreciation

Anything that causes a change in supply or demand of foreign exchange
will result in a change in the exchange rate.

>When we pay more for another currency the rand is weaker and we say
that the rand depreciated.

(At the same time the other currency appreciated.)

> When we pay less for another currency the rand is stronger and we say
that the rand appreciated.

(At the same time the other currency depreciated.)

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Revaluation and Devaluation

Devaluation

A deliberate downward adjustment to the value of a country's currency

relative to another currency.

It is a monetary policy tool of countries with a fixed exchange rate system.

Revaluation

A deliberate upward adjustment to the value of a country's currency relative

to another currency.

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Supply and Demand (Price Formation)

Speculators play an important role in the price formation of

currencies

> They sell a currency in anticipation of a coming depreciation.

> They buy a currency in anticipation of a coming appreciation.

> They cause to happen what they anticipate.

Appreciation and Depreciation

Anything that causes a change in supply or demand of foreign

exchange will result in a change in the exchange rate.

>When we pay more for another currency the rand is weaker and we
say that the rand depreciated.

(At the same time the other currency appreciated.)

>When we pay less for another currency the rand is stronger and we
say that the rand appreciated.

(At the same time the other currency depreciated.)

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84
Revaluation and Devaluation

Devaluation

●​ A deliberate downward adjustment to the value of a country's

currency relative to another currency.
●​ It is a monetary policy tool of countries with a fixed exchange rate
system.

Revaluation

●​ A deliberate upward adjustment to the value of a country's currency

relative to another currency

85