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Master of Business Administration
MBA NQF NINE(9)
ECONOMICS : 2017 WORKSHOP 2
Lecturer : SEAN R0SS
Time: 0800hrs to 1200hrs
Date: 25/02/2017
WORKSHOP INFORMATION : MBA ECONOMICS
•
There is a case study analysis component in the lecture outline (but this is not for you
to do), you will just have to split the students into about 5/6 groups, each group then
answers Section A (i.e. questions 1 and 2) as a collective.
•
Each group gets all the 6 question papers (this is for them to familiarise themselves
with the case study for the other groups as well, so that they can ask pertinent
questions during the presentation by the groups), but each group only answers a
specific question paper e.g group A, answers June 2016 paper, group B, answers June
2015 paper etc.
•
Each group will give a presentation (PowerPoint) as well as have a word version of their
answers/analysis of the case study. (this will be presented at the next lecture).
•
There will be two (2) group registers, kindly ensure that each group fills out the group
register and nominate a group leader. (the group leader keeps one of the registers, the
other one should be handed over to Mr Matsongoni via Wendy).
•
Ideally the splitting into groups should happen early in the lecture, so that the groups
can interact/meet up during the tea break.
WORKSHOP INFORMATION : MBA ECONOMICS
1.
Workshop One - Overview of the Complete Module – Microeconomics
2.
Workshop Two - Overview of the Complete Module – Macroeconomics
3.
Workshop Three - Case Study Analysis and Assignment Guidelines
4.
Workshop Four - Group Presentation(s) and Exam Preparation
 For the respective dates see the MBA Course and Assignment Handbook (CAAH)
ECONOMICS RECAP
Economics = “Is the study of the use of scarce
resources to satisfy unlimited human wants”
Economics is the study of how people utilize limited resources to
satisfy their unlimited wants.
Leads to scarcity and choice:
Everyone has to make a choice
(between chocolate and pizza) as their
resources are limited or scarce
(limited budget)
• Scarcity is NOT poverty, and rich people also experience scarcity
• Because resources are scarce, sometimes one has to choose
between 2 or more goods. You can’t have everything you want.
• When making choices between goods, measure the costs of
choosing one good as opposed to another
• This is called opportunity cost
• Every time a choice is made opportunity cost is incurred
• Economists also consider both explicit as well as implicit costs
Opportunity Cost is thus the value of the best forgone
opportunity.
Scarcity, Choice and opportunity cost
• Wants
Wants are the desires that a person has for goods and services –
she/he has a lot of wants
Collective wants – Wants that people have as a group
• Needs
Needs are things that a person needs for survival such as food,
shelter, clothing etc
• Demand
a person can demand something if she has the ability to buy it,
i.e. if she has money to afford a certain item
The Production Possibilities Curve
(PPC)
• Also called the Production Possibilities
Frontier
• The PPC indicates any 2 goods that are
attainable when resources are fully employed.
• Opportunity cost – The cost of sacrificing one good for
another. a person will have to sacrifice some pizza so she can
have chocolate as well.
• Trade off – The exchange of one thing in
return for another, a compromise
Production, Income and
Spending
Spending
Production
Production,
income and
spending
are all
flows
Income earned in the
production process is spent
to purchase products
Production
creates
income
Income
3.2 Source of production: The factors
of production
There are 4 Main factors of production
NATURAL
RESOURCES
LABOUR
CAPITAL
ENTREPRENEURSHIP
Natural Resources (Land)
Labour
Capital
Entrepreneurship
Technology
• Sometimes defined as a 5th factor of
production
• Invention is the discovery of new knowledge
while incorporation of this knowledge is
called innovation
• The application of inventions also requires
entrepreneurs to identify the opportunities
and exploit them
• It can be argued that technology forms part
Market Equilibrium
Demand for
Coffee
Supply of
Coffee
10
100
20
20
80
40
30
60
60
40
40
80
50
20
100
50
40
30
Price
Price of
Coffee
Demand
20
Supply
10
Equilibrium quantity is where the
demand and supply curves
intersect
And where the price of coffee
is R30, according to the table
0
0
50 60
Quantity
100
MACRO OR MICRO??
• Microeconomics = When you are examining
individual parts of an economy
• Macroeconomics = When you are dealing with
the economy as a whole
• In an economy there is a high degree of
interdependence
6. KEY MACROECONOMIC CONCEPTS
WHY LEARN MACROECONOMICS ?
1.
2.
3.
The macro-economy affects society’s well-being.
The macro-economy affects your well-being.
The macro-economy affects election outcomes.
Boom or depression?
 Will tomorrow’s world be more prosperous than today?
 Will jobs be plentiful?
 Will the cost of living be stable?
 Will the government and nation remain in deficit?
MACROECONOMICS OBJECTIVES
Price stability (inflation)
Boost economic growth
Full employment / low unemployment
Balance of payments stability
Equitable distribution of income
MACROECONOMIC OBJECTIVES
In order to measure…
…economic growth, economists use
the increase in economic activity. The amount of
economic activity is expressed in GDP.
We will also look at measuring production, income and
expenditure.
…full employment , economists use the unemployment rate.
…price stability, economists use the consumer price index.
…external stability,economists use the balance of payments.
…equitable distribution of income, economists use the Lorenz curve,
Gini coefficient or the quantile ratio.
6 (a) INFLATION (PRICE STABILITY)
Inflation is defined as the continuous and considerable rise of prices in general.
The CPI is used to measure inflation
 CPI is a measurement of the cost of a representative basket of consumer goods and services.
Inflation rate is the % change in CPI from one period to another
(Always expressed as an annual rate)
Inflation is an increase in the average level of prices, not a change in any specific price.
The Average Price
The average price is determined by finding the average price of all output.
A rise in the average price is called inflation.
A fall in the average price is called deflation.
Redistributive Effects of Inflation
Although inflation makes some people worse off, it makes some people better off. (Borrowers
and Lenders)
CAUSES OF INFLATION
The cause of inflation is rooted in supply and demand.
Types of inflation
Demand pull inflation
Demand-pull inflation results from excessive pressure on the demand side of the economy.
“Too much money chases too few goods” enabling producers to raise prices.
Cost push inflation
The pressure on price could also originate on the supply side.
Higher production costs put upward pressure on product prices.
DEMAND-PULL INFLATION CNT’D
Demand –pull inflation occurs when aggregate demand for goods and services increases.
This is illustrated by the rightward shift of the AD curve from AD1 to AD2,AD3 and AD4. As
long as there is still excess capacity in the economy, the increases in the price level will be
accompanied by increases in production and income.
However, when full employment is reached further shifts in the AD curve (from AD3 to AD4)
lead to price increases only.
MANAGING DEMAND-PULL INFLATION
To combat demand-pull inflation, the authorities have to keep the aggregate demand for goods and
services in check.
This can be done by applying restrictive monetary and fiscal policies.
Restrictive monetary policy entails raising interest rates and limiting the increase in the money supply.
This raises the cost of credit and also reduces the availability of credit to the various sectors of the
economy.
Restrictive fiscal policy entails a reduction in government spending and / or increased taxation.
These policies will tend to reduce aggregate demand.
DEMAND-PULL INFLATION
COST-PUSH INFLATION
As the term indicates, cost-push inflation is triggered by increases in the cost of production.
Increases in production costs push up the price level.
There are five main sources of cost-push inflation.
Sources of cost-push inflation
increases in wages and salaries. Wages and salaries are the largest single cost item in any
economy – in South Africa the renumeration of labour constitutes about 50 per cent of the cost
of producing the gross domestic product.
Another important source is the cost of imported capital and intermediate goods.
These goods are essential to the functioning of the domestic economy, particularly the
manufacturing sector.
When the prices of imported goods such as oil, machinery and equipment increase, the
domestic costs of production are raised.
These increases could be the result of price increases in the rest of the world or of a
depreciation of the domestic currency against the currencies of the exporting countries.
COST-PUSH INFLATION
Another source is increases in profit margins. Like wages, interest and rent, profit is also
included in the cost of production.
When firms push up their profit margins they are therefore raising the cost of production (
and the prices that consumers have to pay).
Another source is decreased productivity. If the various factors of production become less
productive while still receiving the same remuneration, the costs of producing each unit of
output increases.
Another source is natural disasters, such as droughts or floods, which occur periodically.
They raise the costs of production and the prices of agricultural and other related products.
Cost-push inflation can also be illustrated with aid of the AD-AS model.
Cost-push is reflected in an upward (or leftward) shift of the AS curve, as shown in the next
slide.
COST-PUSH INFLATION
COST-PUSH INFLATION CNT’D
Cost-push inflation occurs when the cost of producing at each level of total production Y
increases. This is illustrated by an upward (leftward) shift of the AS curve from AS1 to AS2.
Increases in the price level are accompanied by reductions in aggregate production or income
Y (and therefore also by increases in unemployment).
In the diagram the price level increases from P1 and P2 and the level of income falls from Y1
and Y2.
Cost-push is caused by factors which push up the costs of production. To avoid cost-push
inflation, measures have to be taken to avoid increases in the costs of production.
Increase in wages and salaries and profits have to be kept under control.
Increases in productivity can also help to avoid or combat cost-push inflation
ANTI-INFLATIONARY POLICY
The monetarist approach
Monetarists want the central bank to control inflation by controlling the rate of increase in the
money supply.
They believe that inflation can be avoided by restricting the rate of increase in the money
supply to a rate approximately equal to the growth in real output.
Moreover, even if it were technically possible to control the rate of increase in the quantity of
money, it does not necessary follow that a restrictive monetary policy will affect only nominal
variables such as inflation.
 Output, employment and other real variables might also be affected. A related problem is
that the velocity of circulation of money is probably not as stable as the monetarists would have
us believe.
ANTI-INFLATIONARY POLICY
The structuralist approach and the conflict approach
This point to the need for an incomes policy to combat inflation. Incomes policies, however,
are subject to various practical problems.
Indexation
Means that prices, wages, pensions and so on are linked to prices (for example, the CPI) to
eliminate the distribution effects of inflation.
 Formal indexation has been applied in countries like Brazil and Israel. When the inflation rate
rises to very high levels (say 100% or more) government often have no alternative but to
introduce indexation in all spheres of the economy in an attempt to counteract the distribution
effects of inflation.
Formal indexation can help communities to cope with high inflation or hyperinflation in the
short run. Indexation can only be resorted to in emergency conditions.
ANTI-INFLATIONARY POLICY
Inflation Targeting
Its key features are thus;
The announcement of quantitative targets
The primacy of price stability as the objective of monetary policy
A broad-based, pragmatic approach to the analysis of inflation
Transparency
Accountability
6 (b) ECONOMIC GROWTH
Economic growth is the expansion of the economy’s production possibilities—an outward
shifting of the PPF.
Economic growth is traditionally defined as the annual rate of increase in total production or
income in the economy.
First production or income should be measured in real terms.
Real GDP—real gross domestic product—is the value of the total production of all the
nation’s farms, factories, shops, and offices, measured in the prices of a single year.
 We measure economic growth by the increase in real GDP.
Second it should be expressed on a per capita basis.
Positive economic growth actually occurs only when total real production or income is
growing at a faster rate than the population.
FLUCTUATIONS IN ECONOMIC GROWTH
In the short-run
Variations in growth of aggregate demand (AD).
In the Long run
The growth in AD determining whether potential output will be realised.
The growth in potential output.
Economic growth
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.
Business Cycle
The business cycle is an irregular and non-repeating up-and-down movement of business
activity that takes place around a generally rising trend and that shows great diversity.
ECONOMIC GROWTH – BUSINESS CYCLES CNT’D
Every business cycle has two phases:
1. A recession
2. An expansion
and two turning points:
1. A peak
2. A trough
Figure 1.1 shows a
business cycle.
An expansion ends at
a peak and a
recession ends at a
trough.
ECONOMIC GROWTH
A recession is a period during which real GDP decreases for at least two successive
quarters.
An expansion is a period during which real GDP increases.
BENEFITS AND COSTS OF ECONOMIC GROWTH
Benefits and Costs of Economic Growth
The main benefit of long-term economic growth is expanded consumption possibilities,
including more health care for the poor and elderly, more research on cancer and AIDS, better
roads, more and better housing and a cleaner environment.
The costs of economic growth are forgone consumption in the present, more rapid depletion
of non-renewable natural resources, and more frequent job changes.
SOURCES OF ECONOMIC GROWTH
These sources can be grouped into two broad categories; supply factors and demand factors.
Economic growth requires an expansion of production capacity of the economy, as well as an
expansion of the demand for goods and services produced in the economy.
Both the supply factors and demand factors are therefore necessary for sustained economic
growth.
SUPPLY FACTORS
What sources have a positive effect on supply? These sources will cause AS to shift right
and total production (thus, GDP) will increase:
Natural resources
Labour
Growth
Quality (education)
Net migration
Capital
Capital widening: capital equipment increases to accommodate bigger labour force
Capital deepening: capital intensity of production increases
Entrepreneurship
DEMAND FACTORS
The supply factors listed above all contribute to the country’s production capacity, or the
potential output of the economy.
Whether or not this potential will be realized will depend upon whether there is sufficient
demand for the goods and services that can be produced.
In other words, an increase in the quantity and quality of the factors of production is not
sufficient to ensure economic growth.
There also has to be an adequate and growing demand for goods and services produced in the
country.
DEMAND FACTORS-CONTINUED
What sources have a positive effect on demand? These sources will cause AD to shift right and
total production (thus, GDP) will increase:
 Domestic demand
↑ Consumer spending
↑ Investment spending
↑ Government spending
Exports
Import substitution
ECONOMIC DEVELOPMENT
Economic development refers to the improvement of living conditions in the LDCs. It entails an
improvement in the quality of life of the majority of the population as a result of economic
growth, the reduction of inequality and the eradication of absolute poverty.
FEATURES AND PROBLEMS OF DEVELOPING COUNTRIES
Population growth
Natural resources
Agriculture practices
capital
Infrastructure
6 (c)UNEMPLOYMENT
 According to ILO, 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.
REASONS FOR UNEMPLOYMENT
New entrants
Job leavers
Job losers
Re-entrants
TYPES OF UNEMPLOYMENT
Cyclical – unemployment caused by a drop in aggregate demand of a country e.g.
recession period – drop in real GDP in SA. Not enough jobs to go around due to
inadequate demand for goods and services.
Structural – unemployment caused as a result of the decline in industries and the
inability of former employees to move into jobs being created in new industries
Seasonal – unemployment caused because of the seasonal nature of
employment e.g. tourism, skiing, beach lifeguards, etc
Disguised/Hidden – exists if people who were previously fully employed, have
had their hours reduced because of poor business performance
Frictional – unemployment caused when people move from job to job to claim
benefit in the meantime (includes people who temporarily between jobs)
ECONOMIC AND SOCIAL CONSEQUENCES OF
UNEMPLOYMENT
The private costs for the unemployed
 Loss of income and Fall in real living standards
 Increased health risks
 Stress and reduction in quality of diet
 Social exclusion because of loss of work and income
 Loss of marketable skills (human capital) and motivation
 The longer the duration of unemployment, the lower the chances of finding fresh
employment - the unemployed become less attractive to potential employers
Economic Consequences for Businesses
 Negative consequences
 Fall in demand for goods and services
 Fall in demand for businesses further down the supply chain
 Consider the negative multiplier effects from the closure of a major employer in a
town or city
ECONOMIC AND SOCIAL CONSEQUENCES OF
UNEMPLOYMENT
Consequences for the Government (Fiscal Policy)
 Increased spending on unemployment benefits and other income –related state welfare
payments
 Fall in revenue from income tax and taxes on consumer spending
 Fall in profits – reduction in revenue from corporation tax
 May lead to rise in government borrowing (i.e. a budget deficit)
Consequences for the economy as a whole
 Lost output (real GDP) from people being out of work – the economy will be operating
well within its production frontier
 Unemployment seen as an inefficient way of allocating resources – labour market
failure?
 Some of the long-term unemployed may leave the labour force permanently – fall in
potential GDP
 Increase in the inequality – rise in relative poverty
REDUCING UNEMPLOYMENT
Unemployment = supply of labour > demand for labour
Decrease in population can improve the unemployment rate in the long run
Stricter immigration policies can help
Education can help the unemployed to get the necessary skills to get jobs
If aggregate demand increases, total production increases and new job
opportunities are created
Government can increase spending in order to ↑AD
Stimulating C or I can also ↑AD
Promoting exports will ↑NX and
therefore ↑AD
Also, increasing the labour intensity in the economy can decrease unemployment
special unemployment programmes
Promoting small businesses and the informal sector
Give employers tax incentives or subsidies as incentive to employ more people
6D: INEQUALITY
• Distribution of income is how total wealth is
divided amongst all the citizens of a country
and it is extremely difficult to measure.
• Three are three ways to measure it:
– Lorenz curve
– Gini coefficient
– Quantile ratio
1. Assume there is a
country with only 5
people, who, in total
earned $ 100.
2. Let’s first draw the
outlines of a Lorenz
curve.
3. It is a weird-looking
graph, but let’s name
the axes and you will
understand!
Cumulative percentage of income (%)
Measuring inequality:
Lorenz curve
100
80
60
40
20
0
20
40
60
80
100
Cumulative percentage of population (%)
4. Then the 5 people
should be arranged
from the person
earning the least to
the person earning the
most. For example:
–
–
–
–
–
John earns $5
Peter earns $10
Susan earns $15
David earns $25
Sophia earns $45
Cumulative percentage of income (%)
Measuring inequality:
Lorenz curve
100
80
60
40
20
0
20
40
60
80
100
Cumulative percentage of population (%)
13.7 Measuring inequality:
Lorenz curve
Let’s look at John. He is the bottom 20%
of the population and he earns 5% of the
total income.
Let’s look at the poorest 40% of the
country. That is John plus Peter. Together
they earn 15% of the total income.
Let’s look at the first 60% of the country.
That is John + Peter + Susan. Together
they earn 30% of the total income.
Let’s look at the first 80% of the country.
That is John + Peter + Susan + David.
Together they earn 55% of the total
income.
Let’s look at the total 100% of the
population. That is John + Peter + Susan
+ David + Sophia. Together they earn
100% of the total income.
Connect the red dots.
Colour the area of deviation.
Cumulative percentage of income (%)
John earns $5
Peter earns $10
Susan earns $15
David earns $25
Sophia earns $45
100
80
60
55
40
30
20
15
5
0
20
40
60
80
100
Cumulative percentage of population (%)
1. The Lorenz curve is
used to calculate the
Gini coefficient.
2. Divide the pink area…
3. … by the area of this
triangle
4. It gives a value
between 0 and 1:
– 0 means a perfect equal
society and 1 means a
perfect unequal society.
5. To get the Gini index,
multiply by 100.
Cumulative percentage of income (%)
13.7 Measuring inequality:
Gini coefficient
100
80
60
40
20
0
20
40
60
80
100
Cumulative percentage of population (%)
13.7 Measuring inequality: Quantile ratio
• Quantile ratio: divide % income of x% richest persons
by % income earned by y% poorest persons.
• In our previous example John was the poorest 20% of
the country and Sophia was the richest 20%.
• John earned $5 of $100, meaning John earned 5% of
the total income of the country.
• Sophia earned $45 of $100, meaning Sophia earned
45% of the total income of the country.
• Example of a quantile ratio: divide the percentage
income received by the richest 20% by the income
received by the poorest 20%.
• Quantile ratio =
% 𝑖𝑛𝑐𝑜𝑚𝑒 𝑜𝑓 𝑟𝑖𝑐ℎ𝑒𝑠𝑡 20%
% 𝑖𝑛𝑐𝑜𝑚𝑒 𝑜𝑓 𝑝𝑜𝑜𝑟𝑒𝑠𝑡 20%
=
45
5
=9
• A higher quantile ratio means higher inequality.
8. MACRO POLICY AND EQUILIBRIUM
• Aggregate supply and demand curves summarize the market activity of the whole
(macro) economy
• Equilibrium (macro): The combination of price level and real output that is
compatible with both aggregate demand and aggregate supply
Aggregate
supply
PRICE LEVEL
P1
E
Macro equilibrium
PE
Aggregate
demand
D1
QE
S1
8.1 The AD-AS model
Recall the demand and
supply models from
microeconomics
The aggregate demand
(AD) and aggregate supply
(AS) model are similar, but
the AD-AS model is a
macro-economic model,
so we have to change a
couple of things:
Price (P)
S
D
0
Quantity (Q)
ARGUMENTS
FOR THE AND
USE AGGREGATE
OF TRADE BARRIERS
AGGREGATE DEMAND
SUPPLY
•
•
Shifts in aggregate supply can be caused by changes in costs of production due to import
prices, natural disasters, changed tax policies, or other events
Shifts in aggregate demand can be caused by changes in export demand, expectations, taxes,
or other events
SELECTING POLICY TOOLS
• There are a host of tools available
 Classical laissez faire
 Fiscal policy
 Monetary policy
 Supply-side policy : Human development policy, agricultural policy, etc
 Trade policy - investment policy
8.1 The AD-AS model
It is not the supply of one
good or service….
but the supply of all goods
and services, which is called
aggregate supply (AS).
It is not the demand for one
2
good or service…
but the demand for all goods
and services, which is called
aggregate demand (AD).
AS
S
Price (P)
1
D
AD
0
Quantity (Q)
It is not the quantity of one
3 good or service….
but the quantity of all goods
and services, which is the
same as total production or
income.
4 It is not the price for one
good or service…
but the prices for all goods
and services, which the same
as the general price level.
AS
Price (P)
Price level
8.1 The AD-AS model
AD
0
Total production,
Quantityincome
(Q)
8.1 Aggregate Demand (AD)
AD = C + I + G + NX
(just like the expenditure line in the Keynesian model)
Slope of the AD curve
Reasons why a fall in the price level tends to raise the quantity of goods and
services demanded in the economy.
Wealth effect
Interest rate
effect
International
trade effect
Consumers become wealthier, which
stimulates the demand for consumer goods
and services C .
Interest rates fall, which stimulates the
demand for investment goods I.
The currency depreciates, which stimulates
demand for net exports (X-Z).
8.1 Changes to AD
Increase in P causes
a leftward move
along the AD curve
Price level
Remember: an
increase or
decrease in the
price level will only
cause a movement
along the AD curve
Decrease in P causes
a rightward move
along the AD curve
P₂
P₁
P₃
AD
Y₂
Y₁
Y₃
Total production, income
What will cause the
AD curve to shift to
the right?
• ↑𝐶
• ↑I
• ↑G
• ↓T
• ↑ NX
• ↓𝑖
Price level
8.1 Changes to AD
AD1
AD
0
Total production, income
In the short run, the AS curve slopes
upward from left to right.
Why does the AS curve slope
upward?
The AS curve is primarily focused on
the cost of production.
At any time there is a certain level of
nominal wages in the economy.
An increase in prices from P1 to P2
results in a decrease in real wages
(remember nominal wages are set).
Therefore, producers will now
employ more labourers and increase
production from Y1 to Y2.
A higher level of prices is associated
with a higher level of production, and
the AS curve slopes upward.
Price level
8.1 Aggregate Supply (AS)
AS
P2
P1
0
If you don’t
understand how
an increase in
prices results in a
decrease in real
wages, ask your
e-tutor.Y1
Y2
Total production, income
8.1 Changes to AS
What will cause the
AS curve to shift to the
left?
• ↑ Wages
• ↑ Price of
intermediary goods
The same
amount of
• ↑ Price of imported
production Y1
goods
can now only be
produced at a
• ↓ Productivity
higher price
• Deteriorating weather
level.
conditions (for
example, floods or
earthquakes that
destroy infrastructure)
AS1
AS
P2
Price level
Study Table
19.2 in textbook
pp 364
P1
0
Y1
Total production, income
POLICY TOOLS
•
The laissez –faire approach requires no tools, as the economy naturally self-adjusts to fulfill
employment.
• Trade policy can be used to affect international trade and money flows and shift the
aggregate demand and / or the aggregate supply curve.
• FISCAL POLICY : government’s tax and spending activities affect not only the level of output
and prices but the mix of output as well.
 Can government spending and tax policies ensure full employment ?
 What policy actions will help fight inflation?
 What are the risks of government intervention ?
 The government can alter aggregate demand by:
 Purchasing more or fewer goods and services
 Raising more or fewer goods and services.
 Changing the level of income transfers.
In sum person, the fiscal policy is the use of government taxes and spending to alter
macroeconomic outcomes. The national budget is a tool than can shift aggregate demand and
therefore alter macroeconomic outcomes.
MONETARY POLICY
•
•
Some economist argue that monetary policy is more effective than fiscal policy , others
contend the reverse is true.
Monetary policy : the use of money and credit controls to influence macroeconomic
outcomes.
•
INTEREST RATE POLICY: Change in interest rates affect consumer, investor, government and
net export spending.
•
ECXHANGE RATE POLICY i.e. fixed, managed and floating e.t.c
MONEY
• Alternative to an economy with money is a barter
system where people would exchange goods for other
goods. For example, you can exchange apples for milk.
• For example if David has a lot of apples from the tree
in his garden, but he needs milk, he can trade his
apples for milk.
• The problem is that he needs to find someone that has
a lot of milk and NEEDS or WANTS apples.
– This is called double coincidence of wants
Demand for money
What can make a person wealthy?
• Real assets such as property
• Valuable assets such as paintings
and jewelry
• Financial assets; money and bonds
• However:
The demand for money is the amount that
people want to hold in the form of money.
Why do we have a demand for cash? If we
invested all our money, we can earn maximum
interest. Cash earns NO INTEREST.
For example:
David has R1 000 in his wallet. If David invested
the R1 000 (at an interest rate of 10% for a year)
he would have had R1 100. But he did not invest
it; he kept it in his wallet.
Thus, David foregone the R100 interest and that
is why we say, the opportunity costs of holding
money in your wallet is the interest rate.
If David could have earned an extra R100, why did he choose to hold the R1
000 in cash and not to invest it? John Maynard Keynes has three reasons:
1.
2.
3.
He has a transaction demand for money: meaning, he wants to buy
goods and services. David can only buy goods and services with money
and not with a bond or an investment.
David is unsure of the future, he therefore has a precautionary demand
for money. If his car breaks down or he cellphone is stolen he has to
have money for unforeseen transactions.
The speculative motive to hold money has to do with the opportunity
cost of holding money. Let’s say David would like to invest some money
every month. The first month, there is interest rate of 1%. David realises
that if he invests at such a low interest rate, he will have almost no
return (it is a weak investment) and the opportunity cost of having cash
is very low!
The next year, however, the interest rate is 20% and David rushes to
invest all the money he can because this is a great investment. He does
not want to have money in his wallet with such high opportunity costs.
2.8 Monetary policy
• Monetary policy can refer to steps 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.
Who arepolicy
the monetary
authorities?
• In South Africa, monetary
refers
to
The SARB formulates and implements
policy rate,
in South which
Africa. The
decisions concerning monetary
the repo
Monetary Policy Committee (MPC) of the
determines the interest
rate
level.
SARB takes
decisions
on the repo rate level.
The MPC consists of the governor and
deputy governor of the SARB and a few
senior officials.
The SARB
• What are the four major areas of responsibility
of the SARB?
1) Formulation and implementation of monetary
policy
2) Service to the government
3) Provision of economic and
statistical services
4) Maintaining financial stability
The monetary policy framework in South
Africa
• The ultimate objective is balanced and
sustainable economic growth.
• The intermediate objective is a pre-announced
inflation target (currently between 3 and 6 %).
• The operational variable is the short-term
interest rate level, which is determined by the
level of the repo rate.
• The monetary control system is a classical cash
reserve system.
When the interest rate is higher (e.g. i1)
And the increase in the money supply is
smaller
When there is less money available, it is
more difficult for producers and retailers
to put up prices.
Interest Rate (i)
The demand for credit is less
i1
i2
L
Thus, the inflation rate comes down.
0
M1
M
2
Quantity of money
(L,M)
Monetary policy in South Africa refers to the measures taken by
the monetary authorities to influence the interest rate level to
achieve stable prices, full employment and economic growth.
Next we look at monetary policy.
GOVERNMENT
We need the government in the economy for four main
reasons:
1. Sometimes the market outcome is not efficient, and
the government has to intervene to correct such
failures.
2. The government has to enforce certain rules to
enable the private sector to do business, e.g. property
rights, enforcement of contracts etc.
3. Markets can fail, and the government should try to
correct market failures.
4. When markets are not fair, the government should
enforce equity in society, such as helping the poor.
Government intervention
The government can intervene in five ways:
1. Delivery of public goods and services
– Public owned and financed.
– Government pays private firm to
deliver public good or services.
– The government ‘teams-up’ with
a private firm, called a PPP
(public-private partnership).
2. Participate in the market. The government buys
goods and services and employs people.
Continued
3. Government spending - the government can
influence the economy when deciding what they
want to buy. Government can make transfer
payments; that is when they make a payment
without receiving anything in return.
4. Taxation is a powerful instrument. For example,
if the government wants a more equal
distribution of income, they can tax the rich
more and the poor less.
5. The government uses Regulations and laws to
affect the economic outcome
Nationalisation and
privatisation
• Nationalisation means the government takes
ownership of private companies.
– State-owned companies such as Eskom is NOT
nationalisation!
– Important: Nationalisation is the TRANSFER of
private ownership to public ownership.
• Economists agree that nationalisation leads to
economic failure, as it results in inefficiencies,
political interferences, etc.
Continued
• Privatisation means private companies takes
ownership of public enterprises. Why?
1. If government expenditure decrease, then
income tax can be decreased.
2. Private ownership is more efficient.
3. Inefficient state owned enterprises costs the
government a lot! Privatisation relieves
government from some expenditures
(improve budget deficits).
3.5 Fiscal policy and
the budget
• Fiscal policy is about what the government
spends, what they borrow and how they tax the
public.
– Government budget: Like your personal budget, the
government also has a budget.
– The budget is a political decision on how much to
spend, on what to spend it and how to finance the
spending.
• Fiscal policy is an instrument of demand
management – it can be used to regulate the
total demand for goods and services in the
economy.
Minister of Finance,
Nhlanhla Nene
3.5 Continued
• EXPANSIONARY FISCAL POLICY MEANS:
If the economy is weak (recession), it is like a slow moving car:
The government should step on the petrol (meaning, they should
spend more). And the economy will gain speed!
How can the government increase spending in the economy?
If income tax decreases, people will have more money in their
pockets and consumption will increase!
• CONTRACTIONARY FISCAL POLICY MEANS:
If the economy is doing good (high growth rates):
Government should spend less or increase income taxes because
the ‘car’ (economy) is going fast enough on its own!
And you don’t want it to go TOO FAST!
3.5 Continued
• The difference between government spending and
taxation is called the budget deficit/surplus
• If taxes (revenues) exceeds government spending,
there will be a budget surplus
• If government spending exceeds taxes (revenues),
there will be a budget deficit
• Contractionary fiscal policy will thus restrict economic
activity and decrease the budget surplus or increase
the budget deficit (G decreases and/or T increases)
• Expansionary fiscal policy will thus stimulate economic
activity and decrease the budget surplus or increase
the budget deficit (G increases and/or T decreases)
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