Economics 1B Module Guide
Economics 1B Module Guide
Economics 1B Module Guide
Module Guide
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MANCOSA
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This Module Guide,
Economics 1B (NQF level 5)
will be used across the following programmes:
Preface.................................................................................................................................................................... 2
Unit 7: Unemployment........................................................................................................................................... 64
List of Content
List of Tables
Table 8.1: Economic growth from an increase in labour – More output but diminishing returns and lower
labour productivity ...................................................................................................................... 74
Table 8.2: Economic growth from an increase in capital – More output but diminishing returns and higher
labour productivity ..................................................................................................................... 75
Table 8.3: Fixed private Nonresistential Net capital Stock, 1960 – 2008 (Billions of 2005 dollars).............. 76
Table 8.4: Years of school completed by people over 25 years old, 1940 - 2008........................................ 77
Figure 1.2: A Simple Circular Flow Model of Income and Spending ............................................................ 14
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Economics 1B
Preface
A. Welcome
Dear Student
It is a great pleasure to welcome you to Economics 1B (ECO1B5). To make sure that you share our passion
about this area of study, we encourage you to read this overview thoroughly. Refer to it as often as you need
to, since it will certainly make studying this module a lot easier. The intention of this module is to develop both
your confidence and proficiency in this module.
The field of Economics is extremely dynamic and challenging. The learning content, activities and self- study
questions contained in this guide will therefore provide you with opportunities to explore the latest developments
in this field and help you to discover the field of Economics as it is practiced today.
This is a distance-learning module. Since you do not have a tutor standing next to you while you study, you
need to apply self-discipline. You will have the opportunity to collaborate with each other via social media tools.
Your study skills will include self-direction and responsibility. However, you will gain a lot from the experience!
These study skills will contribute to your life skills, which will help you to succeed in all areas of life.
MANCOSA does not own or purport to own, unless explicitly stated otherwise, any intellectual property rights in
or to multimedia used or provided in this Module Guide. Such multimedia is copyrighted by the respective creators
thereto and used by MANCOSA for educational purposes only. Should you wish to use copyrighted material from
this guide for purposes of your own that extend beyond fair dealing/use, you must obtain permission from the
copyright owner
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Economics 1B
Identify the major role players in the Major role players in the macro economy are identified
macro economy and explored to understand the dynamics of
macroeconomics
Importance of major role players in the macro economy
are explored as agents for resolving economic problems
concerning what to produce, how to produce and for
whom
Define and understand the following
GDP and GNP, Inflation, and the public sector are
macroeconomic variables:
described to execute the role of macroeconomics
GDP and GNP,
and how its aggregate changes in the economy
Inflation, and
Unemployment
Understand what is meant by: The Monetary sector and Public sector are explored to
The Monetary sector, and understand the need for both in the macroeconomics
The Public sector environment
Describe the main characteristics of the Theories relating to macroeconomics are investigated
following macroeconomic theories: to understand the importance of the economy
Free Market, Underlying economic theories are explored to
Marxist, and determine key characteristics and principles that inform
Keynesian macroeconomics
Understand what is meant by economic Key concepts and terminology central to economic
growth and economic development growth and economic development are explored and
understanding is reflected through appropriate use of
principles, theories and practices in the
macroeconomic environment
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Explain why countries trade with one Reasons, benefits and outcomes of trading are
another analysed to highlight the importance of
interrelationships between countries on a global scale
Define and qualitatively apply the Exchange rate concepts and principles are examined
concept of exchange rates and applied in order to realise the importance and role
of the exchange rate as part of the macroeconomics
process
The purpose of the Module Guide is to allow you the opportunity to integrate the theoretical concepts from the
prescribed textbook and recommended readings. We suggest that you briefly skim read through the entire guide
to get an overview of its contents. At the beginning of each Unit, you will find a list of Learning Outcomes and
Associated Assessment Criteria. This outlines the main points that you should understand when you have
completed the Unit/s. Do not attempt to read and study everything at once. Each study session should be 90
minutes without a break
This module should be studied using the prescribed and recommended textbooks/readings and the relevant
sections of this Module Guide. You must read about the topic that you intend to study in the appropriate section
before you start reading the textbook in detail. Ensure that you make your own notes as you work through both
the textbook and this module. In the event that you do not have the prescribed and recommended
textbooks/readings, you must make use of any other source that deals with the sections in this module. If you
want to do further reading, and want to obtain publications that were used as source documents when we wrote
this guide, you should look at the reference list and the bibliography at the end of the Module Guide.
E. Study Material
The study material for this module includes tutorial letters, programme handbook, this Module Guide, a list of
prescribed and recommended textbooks/readings, which may be supplemented by additional readings.
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Hill Education.
Mohr, P. & Fourie, L. (2015). Economics for South African Students. (5th edition) Pretoria: Van
Schaik
Case, K.E, Fair, R.C & Oster, S.M (2012). Principles of Macroeconomics. (10th ed.). Pearson.
MOHR, P., FOURIE, L. and ASSOCIATES (2004), Economics for South African Students. Pretoria:
JL van Shaik
SCHILLER, B. R. (2013). Essentials of Economics (13th Edition). New York: Irwin McGraw – Hill
SCHILLER, B. R. (2008), The Economy Today (11th Edition), Boston: McGraw – Hill
G. Special Features
In the Module Guide, you will find the following icons together with a description. These are designed to help
you study. It is imperative that you work through them as they also provide guidelines for examination
purposes.
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Economics 1B
A Think Point asks you to stop and think about an issue. Sometimes
THINK POINT you are asked to apply a concept to your own experience or to think
of an example.
You may come across Activities that ask you to carry out specific
tasks. In most cases, there are no right or wrong answers to these
ACTIVITY
activities. The purpose of the activities is to give you an opportunity
to apply what you have learned.
At this point, you should read the references supplied. If you are
READINGS unable to acquire the suggested readings, then you are welcome to
consult any current source that deals with the subject.
OR EXAMPLES
KNOWLEDGE You may come across Knowledge Check Questions at the end of
CHECK each Unit in the form of Knowledge Check Questions (KCQ’s) that
QUESTIONS will test your knowledge. You should refer to the Module Guide or
your textbook(s) for the answers.
CASE STUDY Guide. This activity provides students with the opportunity to apply
theory to practice.
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Unit
1: Introduction to Macroeconomics
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1.4. The Circular Flow of Income Describe the Circular Flow of Income Model
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 3, page 39
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1.1. Introduction
The aim of any economic activity is the production of goods and services for the satisfaction of (unlimited)
human wants. In order to satisfy these wants, firms produce the goods and services that households consume
– this takes place within a broader framework that policy-makers such as government, agencies such as the
South African Reserve Bank, create in conjunction with organized commerce, organised labour and civil society
organisations. The result is a legal framework and a set of economic policies that are in line also with our
Constitution.
This study unit firstly highlights the distinction between macroeconomics and microeconomics. While this
distinction is important for the ease of study, it is imperative that the student not consider the two as mutually
exclusive disciplines. Secondly, we briefly explore the five major components of macroeconomic policy and
mention some of the dilemmas encountered in policy formulation.
Finally, markets and the flow of income, expenditure, goods and factors of production in an economy are
discussed, using a simple circular flow model.
Microeconomics, on the other hand, focuses on the individual participants in the economy: producers (firms),
and households (workers, entrepreneurs and consumers). Microeconomic policies focus on specific markets
and how prices are established.
Conversely, sound economic decisions and policy formulation that impacts the microeconomic level can only
be made by giving due consideration to the macro economy.
Further Readings
https://courses.lumenlearning.com/boundless-
economics/chapter/differences-between-macroeconomics-and-
microeconomics/
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For example, to what degree were government policies to blame for the massive unemployment during the
world depression of the 1930s or for the simultaneous high unemployment and inflation of the 1970s and the
economic meltdown caused by the financial crises of 2008?
A brief overview of five major variables that are considered in formulating macroeconomic policy will now be
discussed.
The importance of full employment lies in the fact that unemployment causes social and political instability.
Governments in power are often discredited and blamed for high levels of unemployment.
Any form of unemployment should be seen as a loss in potential production, since the country could have
earned more if those who were unemployed were economically active. Clearly, a drop in the standard of living
occurs as production is lost.
Rising prices per se are not a problem, but the accompanying effects are undesirable. Among these effects are
the negative impact on savings, the skewed distribution of income, the country’s balance of payments and
social as well as political effects.
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Since economic growth and employment go hand in hand, these two policy objectives should be seen as one.
The government has to make provision for employment-generating policies and create a climate for investment
that will promote growth. Economic policies – such as the monetary and fiscal policies – can affect output
quickly (Samuelson & Nordhaus, 2002), but the impact of these policies on potential output trends operates
slowly over a number of years.
South Africa also imports technology in the form of machinery, equipment and other goods from abroad as well
as a range of consumer goods. To pay for these imports the country has to earn the necessary foreign currency
(dollars, pounds, euros, etc.) by exporting goods and services that it has a comparative advantage in.
In the short term, all foreign transactions are accounted for by the transacting parties, but some balance
between exports and imports is required in the longer term otherwise the terms of trade will become
unfavourable. From a policy point of view, the balance of payments and exchange rates should be maintained
at a fairly stable level.
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We now have the ongoing dilemma of having to choose between price levels and employment levels! Thus,
the aim of government (policy-makers) should be to maintain exchange rate stability and balance of payments
and equilibrium in the long term.
“South Africa’s current account deficit narrowed to 2.5 percent of GDP in 2017” reports
the World Bank (2018b:18). What could have been the causes of this?
While most people agree with the other four policies outlined above, not everyone will agree with the
redistribution policy. Some, for example, regard an unequal distribution of income as a means of stimulating
saving and investment which will benefit the poor. On the other hand, a highly unequal distribution of income
tends to generate social and political conflict. It can also have important effects on the structure and
development of the economy.
Macroeconomic policies do not stand in isolation. Sometimes, the different policies could be in conflict with
each other, making the choice of an appropriate policy extremely difficult. For example, a government may have
an economic policy geared towards economic growth – this may lead them towards reducing taxes. This in turn
may reduce their short-term income which could negatively affect their ability to spend on social grants.
In its National Development Plan, the South African government explicitly aims
to “Reduce inequality – The Gini coefficient should fall from 0.69 to 0.6”
(National Planning Commission, 2011). What does this mean?
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The circular flow model illustrates the mechanism by which income is generated from the production of goods
and services and how this income is spent on the factors of production which in turn forms the income to
households arising from the ownership of these factors. This is best understood by analysing figure 1.2.
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Activity 1.1
Which one of the following is unlikely to be an objective of macro-economic
policy?
a) Balance of payments stability
b) Low tariff levels
c) Economic growth
d) Full employment
e) Stable prices
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Firstly, let us consider households who are buyers, and firms who are producers and sellers of goods and
services in the goods and services market: Firms are buyers of factors of production and households become
sellers of factors of production in the factor market. The money flow is denoted by the inner anti-clockwise
arrows. So, the income flow or flow of rands for the use of factors of production to the households is denoted
by the inner line (bottom left anti-clockwise direction of the arrow), whereas the inner line (top right anti-
clockwise direction of the arrow) represents the flow of income to firms from the sale of goods and services in
the economy. The spending by firms on factors of production is denoted by the inner line (top left anti-clockwise
direction of the arrow), whereas the inner line (bottom right anti-clockwise direction of the arrow) represents the
flow of spending on goods and services in the economy. It is important to note that these flows are equivalent.
The next participant that we introduce into the model is the government. The government is responsible for
providing public goods and services, such as roads, bridges, etc. for usage by households and firms. In order
for government to provide these public goods and services, it receives tax revenue from households and firms.
Hence, again we have flow of income in the form of tax paid by firms and consumers and tax received by the
government. In addition, government provides subsidies to firms and households - flow of income.
Next, we introduce the financial sector, which mainly comprises of financial institutions, where consumers and
firms deposit funds and earn interest on savings. In addition, firms and consumers take loans to invest in capital
goods and assets, and have to pay interest on loans. Finally, we introduce the foreign sector. In the foreign
sector, importing countries pay using foreign exchange for imported goods and services, and exporting
countries earn foreign currency for exporting goods and services.
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This simple circular flow model of income, output and spending represents the workings of a simple economy,
and illustrates the economic interdependence of the major constituencies. It further highlights the
interrelationship between microeconomic analysis and macroeconomic analysis.
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
2: Measuring the Performance
of the Economy
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2.5 Nominal vs Real GDP Distinguish between Nominal and Real GDP
2.6 Some factors to consider when Identify and describe some of the shortcomings of GDP as
using GDP as a measure of a measure of economic performance
economic performance
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2.1. Introduction
There are various macroeconomic instruments that are used to assess the state of the economy of any country.
On the basis of these instruments are comparisons of economic growth and development made with other
economies (countries).
2.2.2 GDP statistics matter to business for at least four reasons Mohr, P. & Fourie, L. (2015).:
Forecasts for future aggregate or combined demand (we will discuss AD later on) are usually expressed
in terms of projected growth in GDP;
Assessments of the current state of the economy are based on the current and recent past level of GDP;
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Economic performance does have political and policy implications. Fast growth is perceived as an
electoral plus while weak growth an electoral minus; and
International comparisons of aggregate market size are based on GDP data. Country credit ratings stock
exchange prices and business outlook forecasts are all affected by economic data.
The three methods measure the monetary value of the circular flow at different points so should arrive at the
same amount. (See Chapter 1). You are not required to know how to do the calculation of these methods
for the purpose of this course.
To derive the GNP from the GDP, one has to subtract the factor incomes (rent, profit, wages and interest) of
foreigners earned by foreigners in South Africa from the factor income of permanent residents earned
abroad. For example, the salary of a mineworker from a neighbouring state will be included in the GDP but will
not be part of the GNP, whereas the tournament earnings of Ernie Els on the US/European tour will be included
in the GNP and not in the GDP.
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The difference between the payments that SA makes to ‘foreigners’ and the monies received by its permanent
residents abroad, is called the net factor payments to the rest of the world. In other words, the difference
between GDP and GNP = net factor payments.
According to Mohr & Fourie, (2015), GNP is a better measure of the income or standard of living of the
citizens of a country. If we want to know how South Africans as a group are faring, we therefore examine the
level and rate of change in real GNI (or GNP).
Activity 2.1
Suppose GDP = R276m and depreciation amounted to R42m, then NDP at market
prices = R234m. Therefore, one can conclude that in order for the country to maintain
its production capacity, R42m should actually be saved or R42m of new machines
should be acquired. What are the consequences to the economy if this is not done?
In this case, GDP would not reflect the true picture of a country’s well-being. To overcome this problem of price
inflation in GDP calculations, a distinction has to be drawn between nominal GDP and real GDP.
Real GDP, on the other hand, expresses the GDP at constant prices. In other words, it is the value of the current
output of the country expressed in terms of prices of a previous (base) year. Since the average business cycle
in SA is five years, the base year is changed every five years. Hence, real GDP is updated every five years
though comparisons can be made over longer periods since the data is available.
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2.6 Some factors to consider when using GDP as a measure of economic performance
GDP and the other national accounting totals are all subject to certain shortcomings. As a result, GDP is
sometimes jokingly referred to as the ‘grossly deceptive product’ or the ‘grossly distorted picture.’ The problems
associated with GDP include the following;
Non-market production: It is difficult to measure or estimate the value of activities that are not traded in
a market. This problem applies, for example, to the production of goods and services by the government.
Since most of these goods and services are not sold in market, they have to be valued at cost. A good
example of non-market production is farmer’s consumption of their own produce.
Unrecorded activity: A more serious problem is that many transactions or activities in the economy are
never recorded. Such transactions or activities are described by terms such as the unrecorded economy,
the underground economy, the shadow economy and the informal sector. Unrecorded activities range
from illegal activities such as smuggling, drug-trafficking and prostitution to unrecorded cash transactions,
barter transactions and transactions that escape the tax net and transactions that make use of alternative
or encrypted electronic currencies (such as bitcoin).
Data revision: Original estimates are frequently adjusted as new and better data become available. This
can be quite frustrating to analysts, since they are never sure whether or by how much the figures are
going to be revised. These are only estimates of the performance of the economy. There are many ‘in-
built’ mistakes which are hard to eliminate and the accuracy of the figures relies upon the information
provided by the company interviewed.
Economic Welfare: Some argue that GDP and other national accounting totals are not good measures
of economic welfare. They point out, for example, that unwanted by-products or negative externalities
such as pollution, congestion and noise are not considered. They argue that the value of these ‘bads’
should be subtracted from the value of ‘goods’ included in GDP. They also argue that it is inappropriate
to regard R1 billion spent on military equipment in the same light as R1 billion spent on health and
education. Moreover, it is difficult to account for productivity improvements and improvements in the quality
of goods and services over time.
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
3: The Monetary Sector
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3.2 The South African Reserve Bank Understand the functions of the South African Reserve
Bank (or any central bank)
3.4 The Demand for money What is interest rate and the different types
3.5 The monetary policy framework in Understand the instruments of monetary policy
South Africa
3.6 Other instruments Identify the number of other measures may be used by
the monetary authorities in pursuit of their goals
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th edition.
Pretoria. Van Schaik. Chapter 14
https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/
9328/01Full%20Quarterly%20Bulletin%20%E2%80%93%20June%202019.pdf
South African Reserve Bank Quarterly Bulletin 2019.
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3.1 Introduction
Money is one of the most important institutions in the economy. Money, it is said, talks, makes the man (or
woman) and makes the world go around. The Bible says that the love of money is the root of all evil. Everyone
is fascinated by money.
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The advantages of a monetary economy, where exchange takes place through the medium of money, are just
as obvious as the disadvantages of a barter economy. In a monetary economy a double coincidence of wants
between parties is no longer required. The farmer no longer has to look for a tailor who needs wheat. As long
as a buyer can be found for the wheat, the money received in exchange for the wheat can be used to buy
clothes. Money therefore serves as a lubricant or intermediary to smooth the process of exchange and to
make it more efficient.
In addition, the use of money as a unit of account enables us to obtain measures of the total value of all goods
and services produced in the economy, such as GDP. Money is not, however, the only possible unit of account.
Any other commodity or product can serve as a unit of account. The item used as the medium of exchange
(money) is simply the most convenient unit of account. The function of money as a unit of account is closely
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related to its function as a medium of exchange. What serves as a medium of exchange usually also fulfils the
function of an accounting unit?
By looking at the functions that money should fulfil one can see that many modern currencies are losing the
ability to meet all the requirements. As an extreme example let us consider the Zimbabwean dollar. At the height
of the inflationary period it was still used as a medium of exchange. There its functionality stopped – as an
accounting unit it lost its ability to compare prices from one period to the next (apart from the fact that there was
no space to write all the zeros and computer software bombed out). As a store of value, it was meaningless
and could not be used to settle debts in the future unless massive interest was levied). All official present-day
fiat currencies have the same problem though not as extreme.
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https://www.resbank.co.za/AboutUs/Functions/Pages/default.aspx
In 2017, The then Public Protector stunned the country when she proposed
that the primary constitutional mandate of the South African Reserve Bank be
broadened to “…to promote balanced and sustainable economic growth in the
Republic, whilst ensuring that the socio-economic well-being of the citizens is
protected” (Labson, 2017).
Given the primary objective and functions outlined above, do you feel that the
bank is currently not set up to meet the Public Protector’s proposed mandate?
If so, why?
Money is also created by the banks. Banks accepts cash or cash related deposits from the general public and
lend these funds to borrowers. Because of the fractional reserve system, they can lend out and receive as
deposits the “same” money unit more than once - which in effect creates money. The difference between the
lending rates and the deposit rates represents the income that banks receive for their intermediation role.
The money supply can also be influenced by transactions with foreign countries and by government
transactions. Foreign trade and international capital movements can also exert a significant influence on the
domestic money supply. If a local exporter earns foreign currency and exchanges it at his bank for a demand
deposit, the money supply will be directly increased. On the same principle, payment for imports will have a
negative effect on the money supply.
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Capital inflows have the same effect as exports while capital outflows decrease the money supply in the same
way as imports do. A country’s money supply generally increases when its gold and foreign exchange reserves
increase and falls when the gold and foreign exchange reserves decrease. (Mohr and Fourie: 2015,)
The demand for money does not relate to the amounts of money that people want. The demand for money is
concerned with the choices of those participants who earn an income or possess wealth. The opportunity cost
of holding any money balance is the interest that could have been earned had the money been used to purchase
bonds instead.
Money will only be held if it provides a service that is valued at least as highly as the opportunity cost of holding
it. The demand for money is therefore directly related to the functions that it performs. Two most important
functions of money are the medium of exchange and the store of value functions. On the basis of these two
functions we can distinguish two basic components of the demand for money:
o The transactions demand for money which arises from the medium of exchange function
o The demand for money as an asset which arises from the store of value function
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Monetary policy in South Africa is formulated and implemented by the South African Reserve Bank. Decisions
on the appropriate monetary policy stance are taken by the Monetary Policy Committee (MPC) of the SARB.
The MPC consists of the governor, deputy governors and a few senior officials of the Bank. Regular Monetary
Policy Forums are also held to provide a platform for discussion of monetary policy issues with a broad range
of stakeholders.
Activity 3.1
Carry out a research on the evolution of the monetary policy framework in South Africa
from 1960 to 2000
The South African Reserve Bank relies extensively on its accommodation policy to influence interest rates.
Open market policy is the main supporting instrument of the accommodation policy. Therefore, a detailed
description of the two is provided below;
Accommodation Policy
Banks are obliged to hold 2.5% of their total liabilities to the public in the form of cash reserves with the
Reserve Bank. If banks need funds, they borrow through the interbank market.
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Liquidity is provided to the banks by means of repurchase agreements (repos) between the Reserve bank and
its banking clients. The underlying assets eligible for these repos are government bonds, Treasury bills, Land
Bank bills and Reserve bank debentures of all maturities.
If the Reserve Bank is of the opinion that a particular position where a bank requires a facility were due to
unacceptable activities on the market that exist between banks (interbank), the banks would be accommodated
(hence the name) at a penalty rate of 0.5 percentage points above the repo rate. Changes in the repo rate lead
to adjustments in the interest rates at which credit is made available by the banks to their clients. The cost of
credit in the economy is, therefore, directly linked to the repo rate.
The South African Reserve Bank is reported to expect the new 15% VAT
to add 0.6 percentage points to inflation (World Bank, 2018b:17). If the
bank desired to reverse this effect, what kind of accommodation policy
would it need to implement, and how would this affect consumers?
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
4: The Public Sector
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4.1 The role of government in the Understand why governments believes it should be
economy: an overview involved in the economy
4.2 Government Intervention in the Describe how governments intervene in the economy
economy
Distinguish between nationalisation, privatisation and
commercialisation
4.3 Fiscal Policy and the budget Distinguish between fiscal and monetary policy and
describe the main elements of each
4.4 Expansionary and contractionary Understand the concept of aggregate demand and how
policies policies related to these affect the economy
4.5 Components of Aggregate Demand Outline the four components aggregate demand is made
up of
4.6 Taxation Understand the three basic criteria for good tax
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 15
Horton and El-Ganainy (2009) What Is Fiscal Policy?c
https://www.imf.org/external/pubs/ft/fandd/2009/06/pdf/basics.pdf
Ocran (2009) Fiscal Policy and Economic Growth in South Africa
https://www.researchgate.net/publication/228471669_Fiscal
_Policy_and_Economic_Growth_in_South_Africa
ytutor.co.uk/answers/33726/GCSE/Economics/What-is-the-difference-
between-a-contractionary-and-expansionary-fiscal-policy/. What is the
difference between a contractionary and expansionary fiscal policy?
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Economics is not only concerned with the efficient allocation of resources but also maximising the benefit to the
whole of society, including those who have been disadvantaged to maximise their potential and fulfil their needs
in an optimal way. The allocation of resources is efficient when it is impossible to reallocate the resources to
make at least one person better off without making someone else worse off. Also, that society’s welfare is
maximized when the marginal cost of each product is equal to its price in the long run and where the marginal
costs are being driven down through entrepreneurship, finding new and better ways of producing and
harnessing the creativity of human beings in solving the economic problem.
Market failure occurs when the market system is unable to achieve an efficient allocation of resources.
Issues such as pollution, the problem of the commons (and here overfishing is a good example of this) and
unethical corporate actions (Enron) are examples. In many cases that which is ascribed to market failure is
really the result of Government failure – where some intervention in the marketplace by government has led to
the resultant inefficient allocation of resources. The best example of this is the prevalence of Monopolies in the
SA economy as a result of restrictive legislation (the energy situation in 2009 – 2015 springs to mind).
Government intervention usually arises in an attempt to improve a situation where, certain short term social
objectives need to override what could make sense in the long term. Refer to the prescribed text, (Mohr and
Fourie, 2015:277), of incidences of market failure (where the government could try to correct these).
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different views exist as to how best serve the populace as a whole. Infrastructure is often financed by
the state but built and operated by the private sector, to achieve the best results.
A second way in which government can try to achieve its objectives is through its role as a market
participant. For example, government is the largest employer of labour in the economy and through its
wage policy and other employment practices it can try to achieve certain objectives (training of
technicians) and also set an example for other employers to follow in areas such as women
empowerment and employment of people with disabilities.
Government spending is a powerful tool. Both the level and the composition (or structure) of
government spending have a powerful impact on the economy. Apart from deciding which and what
quantity of goods and services to purchase, government also makes transfer payments, that is,
payments for which it receives nothing in return. Examples include old-age pensions, child support
grants, disability grants and various subsidies. Transfer payments are a powerful instrument that can
be used to change the distribution of income.
A fourth instrument at the disposal of government is taxation. Although the primary purpose of taxation
is to finance government expenditure, the level and structure of taxation can be used to achieve
various objectives. Taxation can be used to redistribute income, to promote certain desirable activities
and to penalise other socially undesirable activities. For instance, tax incentives (possibly in the form
of lower tax rates or tax holidays) are often provided to stimulate investment spending and small
business development, while tobacco products and alcoholic beverages are subject to additional taxes
to discourage use.
A fifth important instrument that government can use to affect economic outcomes is regulation.
Regulation refers to all laws, rules and regulations that affect private behaviour. Examples include the
labour laws (which govern the labour market); competition policy (which governs the goods markets);
the anti-tobacco law (which regulates smoking in public places); and fixing of maximum or minimum
prices and minimum wages. In many cases these regulations are enforced through a system of fines
and criminal penalties.
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Nationalisation
o Nationalisation means that the government takes over the ownership or management of private
enterprise (with compensation – if the owners are not compensated it will amount to the confiscation
of assets which is tantamount to theft).
o Proponents of nationalisation in South Africa often mistakenly argue that nationalisation was a
significant element in the solving of the poverty problem of the poor white in the 1930’s. They cite the
establishment of a national transport system, a national posts and telecommunications, Iscor and
Sasol as examples of successful nationalisation by the South African government. This is, however,
an incorrect interpretation. The establishment of state-owned industries is not the same as
nationalisation (i.e. the transfer of ownership from private enterprise to government).
o The understanding of the ills of a command economy has improved with the experiences of the late
20th century and the dismal performance of countries that have a low freedom index (2014,
freetheworld.com).
Privatisation
o Privatisation refers to the transfer of ownership of assets from the public sector to the private sector
(i.e. the sale of state-owned assets to the private sector).
1. The first concerns the problem of financing increasing government expenditure in a situation
where tax burdens are already very high. In South Africa, for example, privatisation is regarded
as a possible way of obtaining funds that can be used to reduce public debt and lower personal
income tax.
2. The second argument is based on the view that government ownership is always less efficient
than private ownership. According to this argument the role of the government in the economy
should be reduced and more scope should be created for private ownership and private initiative.
3. The third is based on the view that the losses of inefficient state-owned enterprises are important
source of budget deficits and other fiscal problems.
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Privatisation will attract foreign direct investment, thereby also augmenting the country’s foreign
exchange reserves.
To the extent that public enterprises do not pay tax, privatisation will broaden the tax base (since the
privatised enterprises have to pay tax)
Privatised enterprises will have greater access to investment capital and will be able to adapt more
easily to changing economic conditions.
The proceeds from privatisation will make funds available for spending on housing, education, health
and so on.
Privatisation will increase share ownership in the economy and serve as an instrument of black
economic empowerment.
At what cost or benefit to YOU would the privatisation of the South African
power utility giant ESKOM be?
Commercialisation
Commercialisation means the transformation of state-owned enterprises into commercial entities,
subject to commercial legal requirements and governance structures, while retaining state ownership.
In other words, the enterprise remains in the public sector but is run like a private company and is also
liable for tax. This is what has happened in recent years at Transnet, Eskom and other enterprises.
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The budget is essentially a reflection of political decisions about how much to spend, what to spend it on and
how to finance the spending. But the size and composition of government spending and the way in which it is
financed can have significant effects on important macroeconomic variables such as aggregate production,
income and employment and the price level, as well as on the distribution of income. These effects have to be
taken into account when the budget is prepared. Though it is often not the main intent, the government often
uses the budget (or fiscal policy) to attain economic objectives such as to stimulate economic growth and
employment, redistribute income, control inflation or address balance of payments problems.
Fiscal policy is often regarded as an effective means of influencing total spending (aggregate demand
for goods and services) in the economy. Mohr and Fourie (2015) refer to this as demand management.
Monetary policy, introduced in study unit 3, is also recognised as demand management. Whilst fiscal policy
deals with government spending, taxation and borrowing, monetary policy deals with manipulation of
interest rates. Whilst fiscal policy is controlled by government, monetary policy is controlled by the
central bank. These policies have to be applied in harmony; otherwise the one may counteract or negate the
effects of the other. There is, therefore, some liaison between the National Treasury, which is responsible for
the execution of fiscal policy and the South African Reserve Bank, which applies the monetary policy in South
Africa.
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4.6 Taxation
Taxes are compulsory payments to government and are the largest source of government revenues.
There are a number of criteria for good tax, here are three:
Neutrality;
Equity; and
Administrative simplicity.
Refer to Mohr and Fourie (2015:293) for detailed explanation on the criteria.
Taxes can be classified into two major categories, direct and indirect. Direct taxes are levied on persons or
companies, whilst indirect taxes are levied on transactions. Examples of direct taxes are personal income
tax, company tax and estate duty. Examples of indirect taxes in South Africa are VAT, customs duties and
excise duties.
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Activity 4.1
Which of the following would be classed as an expansionary fiscal policy?
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
5: Macroeconomic Theories
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5.2 Economic Schools of Thought Describe the main characteristics of the Free Market
Economy and the Marxist/Socialist Economy
5.3 Keynes versus Classical Economic Compare Keynesian Economic Theory with the Classical
Theories Free Market Economics
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 17
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5.1 Introduction
The term macroeconomics originated in the 1930s – when production, employment and prices collapsed in
much of the industrial world (The Great Depression).
The development of macroeconomics has been one of the major breakthroughs of twentieth-century economics
leading to a much better understanding of how to combat periodic economic crises and how to stimulate long-
term economic growth.
Every discussion of macroeconomic policy invariably starts with John Maynard Keynes (1883-1946). His
principal contribution was a new way of looking at macroeconomics and macroeconomic policy. This study unit
focuses primarily on the main contributions made by Keynes. To obtain a more holistic picture of
macroeconomic theory and to fully appreciate Keynes’ contribution, a good starting point would be a brief
overview of the main economic schools of thought.
According to free market economics, an economy works well when businesses make high profits, i.e., anything
which limits the making of profit (excluding force and fraud) is bad for the economy. For example, free marketers
oppose high taxes. They argue that if government coercively takes large amounts of tax from businesses,
companies will not want to continue to produce. They will lose motivation, since extra profits will be paid as tax.
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They also argue that everyone will benefit if companies are allowed to keep all of their profits to:
o Build new factories and produce more goods;
o Create more jobs; and
o Increasing employment means that people will have more money to spend; and
o There will be more money for the business to pay better salaries and higher dividends for owners.
They believe that the major obstacle to the success of their model is government intervention in the trade
activities of consenting parties. Free marketers oppose high taxes and nationalization (where government owns
and runs businesses). They believe that government should pass laws and take other measures that aim at
ensuring the environment is conducive for business – e.g. Property rights are protected, an open, fair and
accessible legal system is established, that special interest groups are not advantaged, no special privileges,
no onerous regulations and tariffs are implemented and sound money policies are followed. In such a society
force will not be used to attain social objectives, laws that force people to act against their personal preferences
or own self-interest are not promulgated.
Major Beliefs
Marxist economists disagree almost totally with free market theory. There are two basic points on which
they differ. They do not believe that:
Property rights should vest with individuals
Profit should drive an economy, that money should be eliminated; and
They do believe that the end justifies the means, even if it is to the disadvantage of some individuals or groups
– individuals should sacrifice their own interests for the greater good of society.
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They argue that human beings are not driven by self-interest. Because human beings are capable of problem
solving, they are capable of cooperation. Hence, an economy should be based on cooperation rather than
competition or self-interest.
Into this void stepped Keynes, promising not to institute a revolution but to save capitalism. He circulated a
simple thesis:
There were more factories and transportation networks than could be used at the current ability of individuals
to pay and that the problem was on the demand side.
But many economists still insisted that business confidence, not lack of demand, was the root of the problem,
and that the correct course was to slash government expenditure and to cut wages to raise business confidence
and willingness to hire unemployed workers. Yet others simply argued, “nature would take its course,” solving
the depression automatically by “shaking out” unneeded productive capacity.
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According to “classical” economic theory, adjustments in prices would automatically make demand tend to the
full employment level. Keynes argued that this self-correcting process never happened in the early 1930s when
employment and output fell sharply.
In the neo-classical theory, the two main costs are those of labour and money. If there was more labour than
demand for it, wages would fall until hiring began again. If there was too much saving and not enough
consumption, then interest rates would fall until either people cut savings or started borrowing. These two price
adjustments would always enforce Say’s Law, and, therefore, the economy would be at the optimal level of
output.
To Keynes, the determination of wages is more complicated. First, he argued that it is not real but nominal
wages that are set in negotiations between employers and workers. It is not a barter relationship.
Nominal wage is the amount paid in money terms while real wage is the value in terms of the purchasing
power i.e. real wage takes into account the effects of inflation.
First, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical
economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, unions, and
long-term contracts, and increasing labour-market flexibility. However, to Keynes, people will resist nominal
wage reductions, even without unions, until they see other wages falling and a general fall of prices.
He also argued that to boost employment, real wages had to go down: nominal wages would have to fall more
than prices. However, doing so would reduce consumer demand so that the aggregate demand for goods would
drop. This would, in turn, reduce business sales revenues and expected profits. Investment in new plant and
equipment -- perhaps already discouraged by previous excesses -- would then become riskier and less likely.
Instead of raising business expectations, wage cuts could make matters much worse.
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Recession – fall of a country’s GNP in three successive quarters – may involve falling prices which can lead
to a depression (where the country “can’t get up”).
Excessive saving results if investment falls, perhaps due to falling consumer demand, over-investment in earlier
years, or pessimistic business expectations, and if saving does not immediately fall in step.
Third, Keynes argued that saving and investment are not the main determinants of interest rates, especially in
the short-run. Instead, the supply of and the demand for the stock of money determine interest rates in the
short-run. Neither change quickly in response to excessive saving to allow fast interest-rate adjustments.
Finally, because of fear of capital losses on assets besides money, Keynes suggested that there may be a
“liquidity trap” setting a floor under which interest rates cannot fall. (In this trap, bond-holders, fearing rises in
interest rates (because rates are so low), fear capital losses on their bonds and thus try to sell them to attain
money (liquidity). Even economists who reject this liquidity trap now realize that nominal interest rates cannot
fall below zero (or slightly higher).
Even if this "trap" does not exist, there is a fourth element to Keynes's critique (perhaps the most important
part). Saving involves not spending all of one's income. It thus means insufficient demand for business output,
unless it is balanced by other sources of demand, such as fixed investment. Thus, excessive saving
corresponds to an unwanted accumulation of inventories, or what classical economists called a “general glut”.
This pile-up of unsold goods and materials encourages businesses to decrease both production and
employment. This, in turn, lowers people's incomes -- and saving.
For Keynes, the fall in income did most of the job, ending excessive saving and allowing the loanable funds
market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a recession does so.
Whereas the classical economists assumed that the level of output and income was constant and given at any
one time (except for short-lived deviations), Keynes saw this as the key variable that adjusted to equate saving
and investment.
Finally, a recession undermines the business incentive to engage in fixed investment. With falling incomes and
demand for products, the desired demand for factories and equipment (not to mention housing) will fall. This
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accelerator effect would shift the investment curve (I) to the left again. This recreates the problem of excessive
saving and encourages the recession to continue.
In summary, for Keynes, there is interaction between excess supplies in different markets, as unemployment
in labor markets encourages excessive saving -- and vice-versa. Rather than prices adjusting to attain
equilibrium, the main story is one of quantity adjustment allowing recessions and possible attainment of
underemployment equilibrium.
Keynes felt that either policy would exacerbate the underlying problem since it will raise saving, thereby lowering
demand for both products and labour. He suggested that active government policy – policies which acted
against the tide of the business cycle - is more effective in managing the economy. By that he meant:
Deficit spending when a nation’s economy suffers from recession or when recovery is delayed by
persistently high unemployment.
Note: When the expenditure of a government (its purchases of goods and services, plus its transfers (grants)
to individuals and corporations) is greater than its tax revenues, it creates a deficit in the government budget.
Suppression of inflation in boom times by:
o Increasing taxes; or
o Reducing government spending.
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Thus, a government could stimulate a great deal of new production with a modest outlay: if the government
spends, the people who receive this money, spend most on consumption goods and save the rest. This extra
spending allows businesses to hire more people and pay them, which, in turn, allows a further increase in
consumer spending. This process continues. At each step, the increase in spending is smaller than in the
previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium.
For example, SABMiller decides to spend R1billion to build a new factory in Gauteng. When SABMiller spends
R1billion, the amount spent goes to the workers and owners of construction companies and to the companies
that supply the materials and equipment to the construction industry. They receive the income in the form of
wages, salaries and profits. The investment spending of R1billion thus raises income of households and firms.
The households will buy goods and services in a supermarket who will also receive income to spend. Thus in
each round there is additional spending of income. The ratio between the eventual change in income and the
initial investment is called the multiplier.
Multiplier = 1 / MPS
= 1 (1 – MPC)
MPS is marginal propensity to save and is defined as the extra saving generated by one unit of extra income
MPC is marginal propensity to consume and is defined as the extra consumption generated by one unit of extra
income.
For example
If the government increases expenditure by R100 000. We assume that this money is going towards
constructing of a new freeway, also, we assume the government hires a firm to construct the road. The
company, in turn, pays workers’ wages. These workers then spend the money.
If the Marginal Propensity to Consume (MPC) is 0.8, which means that the consumer spends 80% of the
income. Therefore 0.2 (20%) is saved Marginal Propensity to Save (MPS),
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Therefore, the cumulative effect of the R100,000 added to the economy is R500,000 (R100 000 x 5)
Activity 4.1
For example, assume the government increases their total spending to R10
million on building of a new mall and the MPC is 0.80. Calculate the multiplier
effect
Keynes – The amount of investment was determined independently by long-term profit expectations and, to a
lesser extent, the interest rate. This approach opens the possibility of regulating the economy through money
supply changes via the monetary policy.
Changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run
impact on real output and employment, not on prices.
Prices, and especially, wages, respond slowly to changes in supply and demand. This results in
shortages and surpluses, especially in labour.
Keynesians do not think that the typical level of unemployment is ideal – partly because unemployment
is subject to the caprice of aggregate demand, and partly because they believe that prices adjust only
gradually.
Most Keynesians advocate an activist stabilization policy to reduce the amplitude of the business cycle
(this will be discussed in a later study unit).
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Many Keynesians are more concerned about combating unemployment than about conquering
inflation.
Keynesian theory was much denigrated in academic circles from the mid-1970s until the mid-eighties. It has
staged a strong comeback since then mainly because it was better able to explain the economic events of the
70’s and 80’s than its principal intellectual competitor, new classical economics. They were able to explain the
European depression of the eighties as follows:
Governments, led by the British and German central banks, decided to fight inflation with highly restrictive
monetary and fiscal policies. The anti-inflation crusade was strengthened by the European Monetary System,
which, in effect, spread the stern German monetary policy all over Europe.
The new classical school has no comparable explanation. In fact, they argue that European governments
interfere more heavily in labour markets (high unemployment benefits and restrictions on firing workers). But
most of these interferences were in place in the early seventies, when unemployment was extremely low.
5.4 A Simple Keynesian Macroeconomic Model without the government and foreign sector
For the purpose of this module, an examination of the simplest possible model will be conducted, i.e., this model
excludes the government and the foreign sector and only considers households and firms. The following table
(Mohr & Fourie, 2015:317) summarises the assumptions of this simple model and highlights the implications of
these assumptions.
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ASSUMPTIONS IMPLICATIONS
The economy consists of households and Total spending consists of consumption spending
firms and investment spending
Wages are given Model cannot be used to study the workings of the
labour market
The money supply and interest rates are Model cannot be used to study the financial markets
given and monetary policy
Spending (demand) is the driving force Production (supply) adjusts passively to changes in
that determines the level of economic spending (demand)
activity
In an economy that consists of households and firms only, there are only two types of spending:
Consumption spending (C) – spending by households on consumer goods and services; and
Investment spending (I) – spending by firms on capital goods.
The economy is in equilibrium when:
C + I = Y (Eqn. 2)
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Consumption as income ;
Consumption is positive even if income is zero this reflects the influence of non-income determinants
on income spending; and
When income , consumption also but is less than the in income since part of the additional
income is saved.
The above three characteristics of the consumption function are illustrated below
Induced consumption is that part of consumption which is determined by the level of income and is indicated
by the slope of the consumption function.
These two components of the total consumption spending are further illustrated in figure 5.2 below:
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What two things do people do with their income and how would this affect the slope
of the consumption function?
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To finally construct a simple macroeconomic model of income determination, to obtain aggregate spending, we
have to add C and I at each level of Y (refer to Eqn. 2 above). This is indicated in the figure below:
Activity 5.1
In the simplest (or introductory) form of the Keynesian model, which of the
following decisions can we analyse?
a) Interest rate fluctuations
b) Saving of households
c) Investment by government
d) Foreign investment by firms
e) Wage levels in firms
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From equation 1 above, it is known that there is equilibrium when Aggregate Spending (A) = Total Income (Y).
If you consider graph (c) in figure 5.4. above:
A straight line drawn at 45 to either axis will have the equation A =Y, i.e., at all points along this line
aggregate spending = total income; and
The point where the line A=Y intersects the line A = C + I is the equilibrium point which is denoted by
E in figure 5.5.
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Note:
The equilibrium level of income Yo is the level of income at which the aggregate spending function A intersects
the 45 line. At any level of income lower than Yo there is excess demand (A > Y) and at any level of income
higher than Yo there is excess supply (A < Y) along the aggregate spending function.
How would the inclusion of the government sector affect the aggregate
spending function?
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
6: Inflation
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6.2 The Causes of Inflation Define inflation and describe some of the causes and
effects of inflation
6.3 The Effects of Inflation Identify the three sets of effects of inflation
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 20
https://www.resbank.co.za/Lists/News%20and%20Publications/
Attachments/5197/04Notes%20on%20inflation.pdf. Notes on Inflation South
African Reserve Bank
https://www.imf.org/external/pubs/ft/fandd/2010/03/pdf/basics.pdf. What is
inflation
Madito and Odhiambo (2018). The main determinants of inflation in South
Africa: An empirical investigation.
https://www.researchgate.net/publication/329971169_The_main_
determinants_of_inflation_in_South_Africa_An_empirical_investigation
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6.1 Introduction
Inflation is often described as “public enemy number one.” However, an economy suffers from inflation when
there are constant significant increases in the general price level. Take note of the four aspects of the definition
(Mohr and Fourie, 2015:382). It is measured using an indicator known as the consumer price index (CPI). The
CPI reflects the cost of a representative basket of goods and services. Inflation is calculated by taking the
percentage change in the CPI over a period of time (not less than a year).
Activity 6.1
Identify the main causes of inflation in South Africa
Identify and explain the measures used to control inflation in South Africa
a) Demand-Pull Inflation
Occurs when the aggregate demand for goods and services increases while aggregate supply
remains unchanged – “too much money chasing too few goods.”
Refer to your textbook, Mohr and Fourie (2015:389) for a detailed description of the main sources of this
phenomenon. The excess demand pulls up the prices of goods and services as shown on figure 6.1.
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b) Cost-Push Inflation
Triggered by increases in the cost of production.
Increases in the cost of production pushes the price levels up, as illustrated on figure 6.2.
Refer to your textbook, Mohr and Fourie (2015:390) for a detailed description of the main sources of this
phenomenon.
The major problem with demand-pull and cost-push inflation is that both become intertwined in the inflation
process and it is difficult to distinguish between the two in practice. Neither one of the two can take place without
some increase in the money supply….and then there is time lag, the effect of the velocity of money and other
factors (discussed below) that affect the outcome.
Take this situation as an example: Let us say oil prices rise dramatically because of a war in the Middle East.
A country such as South Africa that imports its oil, now has to pay more – petrol prices rise and so do the prices
of all goods that are affected by it – though it is said that we have “imported inflation” this is not strictly true,
since it is a once off price shock and if the money supply stayed constant, expenditure will shift from other
products (people will buy less) which will cause the prices of the other products to drop in the same relation as
the rise in prices caused by the increase in the oil price so the general price levels (inflation) would theoretically
stay constant.
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Please refer to the prescribed text, (Mohr and Fourie, 2008:388-390) for details on this section. You are
required to understand the diagrams.
The rival interest groups each strive to gain larger shares of the “pie” by claiming higher money incomes,
and this results in inflation
Inflation is the symptom of a lack of effective economic and/or political mechanisms to achieve a prior
reconciliation of the conflicting claims on the national income
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Why does the South African government aim to keep inflation between 3-6%?
Why not have a target lower than that (like developed countries) of about 2%?
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
7: Unemployment
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7.2 The Costs of Unemployment Identify and describe some of the costs of unemployment
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 21
https://www.rba.gov.au/education/resources/explainers/pdf/unemployment-
its-measurement-and-types.pdf. Unemployment: Its measurement and
types
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7.1 Introduction
High and prolonged unemployment is a sign of a malfunctioning economy. Being unemployed is, for most
people, a highly distressing experience that causes damage in many ways that cannot be quantified.
Definition: According to the International Labour Organisation, unemployment (being unemployed) refers to
those of a working age, who in a specified period, are without work and are both available for, and have taken
specific steps to find work.
This definition is not comprehensive (McAleese: 2001) and has the following shortcomings since it implies that:
People who work part-time because they cannot find full time employment are fully employed; and
People functioning in the ‘shadow’ economy (e.g. informal traders) are considered to be unemployed.
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o Structural and Technical Unemployment – results when there is a drop in demand that is of a permanent
nature. For example, if many qualified labourers cannot be employed by an industry because the industry
has undergone structural changes. If, on the other hand, people become unemployed because of
technological changes such as automation, then this type of unemployment is referred to as technical
unemployment.
o Often legislation puts people out of work (restrictive tobacco legislation reduces work opportunities along
the whole value chain), minimum wage laws makes it particularly difficult for the entry level employee to
enter the job market. Equal pay for equal work makes it difficult for designated groups to compete. Other
labour laws increase the cost of employment and cause jobs to be “exported” (through importing the goods
that are too costly to produce locally).
o Seasonal Unemployment – This type of unemployment occurs when employees only work during a certain
time(s) of the year and, therefore, during other months they are regarded as unemployed.
o Disguised/Hidden Unemployment – is said to exist if people who were previously fully employed, have had
their hours (and, therefore, salaries) reduced because of poor business performance.
o Frictional Unemployment – Even under the most favourable conditions, a certain percentage of people will
always be unemployed. This ever-present unemployment is referred to as frictional unemployment (this
includes people who are temporarily between jobs).
Activity 7.1
Simon resigns his job as an economist in Durban and moves to Port Elizabeth to be
closer his parents. It takes Simon three months to find new employment as an
economist in Port Elizabeth. During these three months, Simon was:
a) structurally unemployed.
b) seasonally unemployed.
c) cyclically unemployed.
d) casually unemployed.
e) frictionally unemployed.
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Based on the Keynesian model you were introduced to in Unit 5, how should
the government respond in a situation where there are high levels of
unemployment?
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
STUDY UNIT
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Unit
8: Economic Growth and
Development
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8.3 The Business Cycle Define a business cycle and identify the different phases
of a business cycle
8.4 Causes of fluctuations in actual Explain the causes of fluctuations in economic growth
growth both in the short-term and the long-term
8.5 Different views on Business Cycles Describe the different views on business cycles
8.6 Sources of Economic Growth Discuss the various sources of economic growth
8.7 The Pros and Cons of Growth Discuss the pros and cons of economic growth
Mohr, P. & Fourie, L. (2015). Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 22
Haller (2012). Concepts of Economic Growth and Development.
Challenges of Crisis and of Knowledge
The World Bank (2018). South Africa Economic Update
Fin24 (2018). Explainer: The business cycle and GDP.
https://www.fin24.com/Economy/explainer-the-business-cycle-
and-gdp-20180703
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8.1 Introduction
This study unit examines two important issues in macroeconomics: Economic Growth and Economic
Development. The distinction between these two concepts is relatively new and is subject to widespread
debate. For the purposes of this module, we will not engage in a debate as to whether they should be treated
separately or as one. For convenience and clarity, we will examine them separately.
Such an increase is usually what is meant when we say there has been an improvement in the standard of
living. Most economists argue that economic growth is beneficial to a society because it enhances the material
well-being of the population. Critics of economic growth, on the other hand, assert that economic growth
destroys the environment, erodes traditional ways of living, and impoverishes the spiritual well-being of the
nation.
Economic growth is not a smooth process- it can vary significantly from year to year. This feature of economic
growth is related to a phenomenon called the business cycle.
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Business cycle is the periodic fluctuations of national output round its long-term trend.
It is important to note that the above illustration of a business cycle, as smooth and regular, is merely done to
make a clear distinction between the four phases. In practice, however, business cycles are highly irregular.
They are irregular in two ways:
The length of the phases. Some booms are short lived, lasting only a few months or so. Others are much
longer, lasting perhaps three or four years. Likewise, some recessions are short, while others are long;
and
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The magnitude of the phases. Sometimes, in phase 2 there is a very high rate of economic growth,
perhaps 5% p.a. or more. On other occasions, in phase 2, growth is much gentler. Sometimes, in phase
4 there is a recession, with an actual decline in output (e.g., in the early 80’s and 90’s). On other occasions,
phase 4 is merely a ‘pause’, with growth simply slowing down.
A rapid rise in AD will cause shortages. This will tend to stimulate firms to increase output, thereby reducing slack
in the economy. Likewise, a reduction in AD will leave firms with increased stocks of unsold goods. They will,
therefore, tend to reduce output.
AD and actual output, therefore, fluctuate together in the short-run. A boom is associated with a rapid rise in AD:
the faster the rise in AD, the higher the short-run rate of actual growth. A recession, by contrast, is associated by
a reduction in AD.
A rapid rise in AD, however, is not enough to ensure a continual high level of growth over a number of years.
Without an expansion of potential output (ceiling on a country’s output), rises in actual output must eventually
come to an end. Once spare capacity has been used up, once there is full employment of labour and other
resources, the rate of growth of actual output will be restricted to the rate of growth of potential output.
In the long-run
In the long-run, there are two determinants of actual growth:
The growth in AD. This determines whether potential output will be realized; and
The growth in potential output
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As you can see, output increases with additional hours of labour; however, notice that productivity, Y/L, declines
with increasing labour. The decrease in productivity, as more labour is supplied, is known as diminishing
returns. It happens because, while labour increases, the amount of capital is held fixed. Thus, more and more
labour is being applied to a given amount of physical capital. Imagine, a farmer's field with one hoe. With no
workers, output is zero because no one is working the field.
One worker will be able to plant and tend the field using the hoe (physical capital) and get some output. What
about hiring a second worker? Output may go up somewhat, but not by as much as the addition of the first
worker.
The decline in productivity with a given amount of capital and the addition of more workers is what worried early
economists such as Thomas Malthus and David Ricardo. They were concerned that, with a fixed amount of
land, as with a fixed amount of capital, diminishing returns will dictate that the output of food per capita would
begin to decline. The concern was that, over time, a rapidly growing population would outstrip its ability to feed
itself. Societal collapse and mass starvation was viewed as the inevitable result. Increases in physical capital
alone, however, are not sufficient to ensure increased economic well-being over time. The reason is that capital,
like labour, is also subject to diminishing returns. Look at the following table, which illustrates the effect of adding
capital to a given amount of labour:
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Although adding capital increases labour productivity (as shown in the last column), there are diminishing
returns to capital. Diminishing returns is the change in output with a given increase in one input, holding the
other inputs constant. When capital goes from 100 to 110 units, output increases by 10 (from 300 to 310). The
addition of another 10 units of capital (from 110 to 120) increases output by only nine (from 310 to 319). An
additional 10 units of capital (from 120 to 130) results in an additional eight units of output (from 319 to 327).
Thus, the additional gain in output from adding more capital diminishes.
However, in all modern economies that have experienced economic growth over time, capital has been
increasing. In fact, capital has increased at an even faster rate than labour. Consider the table below:
4Table 8.3 Fixed Private Non-residential Net Capital Stock, 1960 – 2008 (Billions of 2005 Dollars)
The growth rate of equipment has been higher than the growth rate of structures. This means there is more
equipment available for workers within factories and offices.
A healthy, well-educated, and well-trained population is more productive (and probably happier). One reason
that college graduates get higher incomes, on average, than people who have not attended college is because
they tend to be more productive. Increases in human capital are crucial to economic growth and increases in the
quality of life.
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In many industrialized societies, the availability and extent of education is increasing. Some enlightening figures
are shown in the following table:
5 Table 8.4 Years of School Completed by People Over 25 Years Old, 1940 - 2008
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Activity 8.1
Similar stories can be told about most of the items we use. In addition, we have much more spending power
than in the past, meaning that we have the ability to buy much more than we used to be able to. In the USA,
real per capita GDP in 1995 was more than twice what it was in 1950. Think of what this means. We have, on
average, the ability to buy twice as much as we could in 1950. Take a look around your room or your home.
The vast array of consumer items found there — sound systems, Satellite TVs, microwaves, dishwashers,
Smartphones and laptop computers — would have been unimaginable in the 1950s. Although they were
available, most homes had only one telephone, did not own even a single TV, and had kitchen appliances that
often consisted of little more than a toaster.
However, it is not just the increased availability of goods and services, and our increased ability to buy them
that makes us much better off. The dramatic increase in real per capita GDP means that, if we choose to limit
our purchases, we can have more savings or work less than we did in the past and still maintain the same
standard of living. By limiting purchases (and still, by the way, having more and better products), one can save
more money, spend more time with one’s family, and retire earlier than one could have in the past.
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The growth in real GDP per person also makes it easier to help those who are less fortunate than ourselves
because it is more affordable to do so. To see this, consider a society with a very low per capita income level.
With most people barely getting by, it is difficult to spare anything for those even less fortunate. However, with
higher levels of average real income, we can more easily help those with less.
There are many theories of economic development. You should be aware of Rostow’s stages of economic
development and the current research emanating from economic think tanks around the world such as the Cato
Institute, the Heritage Foundation and Fraser Foundation. The relationship between economic freedom and
economic growth can for example clearly be seen from the extensive research done by the Fraser Foundation
(http://www.freetheworld.com/).
Which of the discussed sources of economic growth can the South African government
take advantage of, to boost the level of output and how can it achieve this?
Consider the example of modern agriculture. Because of improvements in machinery and transportation,
economies of scale, and other factors, large farms are able to produce crops more cheaply than smaller farms.
As a result, there has been a dramatic decline in the number of smaller farms and farmers in recent years. For
many of these people, a way of life has been lost due to economic development. The flip side of this, however,
is that a much wider array of food is available at lower real prices than in the past. To say that economic
development should be slowed down or stopped in order to preserve a way of life for some is to also say that
millions of consumers should have to pay more for food. It remains, however, that changes in the way we live
and the types of work we do are the natural consequences of economic growth and development. For many,
these changes are unwelcome.
Another consequence of economic growth and development is an increase in the demand for the natural
resources. Many are concerned that the rates at which we are using the earth's resources are already too high
and will increase even more as less developed countries become more developed. In addition, there is concern
that this will result in increased pollution.
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For example, in the United Nations Framework Convention on Climate Change held in Kyoto, Japan during
December 1997, many environmentalists warned that increasing development in less developed countries will
increase greenhouse gas emissions and more rapidly accelerate global warming.
There are other criticisms levelled at economic development and growth. Although there are certainly
widespread benefits to such growth, it is important to remember that there is no free lunch. Changes in
traditional ways of living, increased environmental pressures, changes in income distribution, and other
negative consequences of growth exist. As growth continues, we must take into account some of its negative
consequences.
Economic development further entails an improvement in the quality of life of the majority of the population as
a result of (Mohr & Fourie, 2015):
Economic Growth;
Reduction of inequality; and
The eradication of absolute poverty.
The forecast anticipates per capita growth averaging 1,6 over 2006-2015 which is short of the growth
needed to reduce poverty to half the 1990 level
The number of poor is expected to rise from 313 million in 2001 to 340 million by 2015
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The region remains highly dependent on commodity exports and is still experiencing political instability.
There have been significant enrolment increases at the primary school level. This is an effort to achieve
Education for All in many African countries. Governments are, therefore, pressurized to expand secondary
education.
While other regions of the world are expecting better health services and outcomes over the next 20 years,
Sub-Saharan Africa alone is anticipating further deterioration in its health services and stagnation or
worsening of health outcomes, especially among the poor. There is a/an:
o Severe shortage in health workers;
o Over-reliance on donor support;
o Chronic poor nutrition and reproductive health;
o Resurgence of malaria and TB; and
o Unprecedented burden of HIV/AIDS.
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
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Unit
9: The Foreign Sector
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9.2 Why countries trade Discuss the reasons why countries trade
9.4 Investment in the global economy Discuss investment in terms of the global economy
9.5 The impact of trade tariffs Understand the economic impact of an import tariff
9.6 Foreign exchange rates Define and apply the concepts of exchange rates
Mohr, P. & Fourie, L. (2015) Economics for South African Students. 5th
edition. Pretoria. Van Schaik Chapter 12
Hill, C. W. L and Hult, G.T.M (2017) International business competing in
the global marketplace. 11th Edition. United States of America: McGraw.
Hill Education international edition
Daniels, J.D. Radebaugh, L.H. Sullivan, D.P (2019) International
business environments and operations. 16th edition. Global Edition:
Pearson
Cavusgil, S.T. Knight, G. Riesenberger, J (2017) International Business
the new realities.4th edition. Global Edition. Pearson.
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9.1 Introduction
Up to this point in the module, we have looked at the role of the government in the macro economy within the
country. But as you know, the economies of all countries trade with other countries. They may buy goods from
a neighbouring country or other countries or they may ship goods and raw materials to a distant continent.
Countries participate in the global economy for three primary reasons (Pape, 2000) i.e., to:
Trade;
Apply political pressure; and
Invest.
Many South African companies, such as Anglo-American and South African Breweries, have invested in countries
overseas. South Africa, together with other third world countries also try hard to encourage foreign companies to
invest locally. It is believed that foreign companies will bring money, technology and skills that are not available
locally.
The essence of comparative advantage is the idea that nations, like individuals can carry out a particular
economic activity (such as making a specific product) more efficiently than another activity., and therefore
should concentrate on what they are best at producing. If one person is an accomplished musician and the
other a computer wizard, it is more efficient to allow each person to specialize in one field rather than have
each of them produce their own music as well as their own computer programmes individually. By exporting
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each other’s services/skills to the other they will each benefit by ending up with more goods/service than if
they try making both goods/services individually. The same applies to nations.
Consider two countries, England and Portugal, each producing two commodities, wine and clothing, as
illustrated in the table below:
Suppose England takes two workers out of the wine industry and assigns them to work in the clothing industry.
This means that wine production falls by 6 units and clothing production increases by 6 units.
The 6 units of clothing are exported to Portugal. Given that, in Portugal, 1 unit of clothing exchanges for 1.5
units of wine, the exporters of English clothing return with 9 units of wine. The net result is that England has
gained 3 units of wine and Portugal is left exactly as well off as before.
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The implications of this example, in the context of international trade theory, is that:
A country can have an absolute advantage in all goods and yet gain from trade with a more efficient
partner;
Gain that is realized through imports and exports are useful solely as a means of obtaining imports;
The total gain from trade may be unevenly shared. In the above example England gets all the gain;
Countries benefit most from trade by obtaining high prices for their exports and paying the lowest prices
for their imports; and
Trade involves mutual gain.
To conclude this section, there is just one final point for you to ponder over!
International trade will only occur if comparative advantage exists, that is, if
the opportunity costs differ between countries. Do you agree? Discuss the
truth/ untruth of this statement with the aid of a suitable example. Refer to
Mohr and Fourie (2015:302).
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An exchange rate simply represents the price of one currency in terms of another currency. An increase in the
value (price) of one currency in terms of another currency (appreciation) automatically implies a decrease
(depreciation) in the value of the other currency.
Changes in exchange rates affect the relative prices of goods and services across countries. For example, an
increase in the value of a country's currency will make its goods relatively more expensive in foreign markets.
It will also have the effect of lowering the relative price of foreign goods sold domestically. In other words,
changes in exchange rates affect the flow of goods and services across nations.
A foreign exchange market is the international market in which one currency can be exchanged for other
currencies. The South African foreign exchange market consists of all the authorized currency dealers, including
all the major banks.
The main reason that people demand a given nation's currency is for the purchase of that nation's goods,
services, or financial assets. The main reason that people supply the currency of a given country is for the
purchase of another country's goods, services, or financial assets. However, private individuals, institutions,
and governments buy and sell currencies for speculative reasons and governments buy and sell currencies for
policy purposes. For example, in mid-1998, the U.S. Treasury bought large quantities of Japanese yen in order
to increase the demand for yen. To do so, the Treasury supplied dollars on the foreign exchange markets and
purchased yen. The result was an (short-run) increase in the value of the yen relative to the dollar.
A floating exchange rate is a rate determined in free markets by the law of supply and demand.
A fixed exchange rate is a rate set and maintained by the government in conjunction with its Central Bank
(e.g., South African Reserve Bank).
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Activity 9.1
Tariffs benefit domestic producers by
a) decreasing the wage rate for labour in the domestic industry.
b) reducing the prices of imported goods.
c) increasing sales of domestic goods.
d) increasing government revenue.
e) increasing domestic consumers’ real income.
In one of his first major decisions on trade policy, President Obama opted Friday to impose a tariff on tires
from China, a move that fulfils his campaign promise to "crack down" on imports that unfairly undermine
American workers but risks angering the nation's second-largest trading partner.
The decision is intended to bolster the ailing U.S. tire industry, in which more than 5,000 jobs have been lost
over the past five years as the volume of Chinese tires in the market has tripled. It comes at a sensitive time,
however. Leaders from the world's largest economies are preparing to gather in Pittsburgh in less than two
weeks to discuss more cooperation amid tensions over trade.
The tire tariff will amount to 35 percent the first year, 30 percent the second and 25 percent the third. Although
a federal trade panel had recommended higher levies -- of 55, 45 and 35 percent, respectively -- the decision
is considered a victory for the United Steelworkers union, which filed the trade complaint. "The president sent
the message that we expect others to live by the rules, just as we do," Leo W. Gerard, president of the union,
said Friday night.
China's government and its tire manufacturers, as well as tire importers and some U.S. tire makers with plants
overseas, had strenuously objected to the measure. "The President decided to remedy the clear disruption to
the U.S. tire industry based on the facts and the law in this case," the White House said in a statement
released Friday night.
Obama's decision signals a marked shift from the policy of the Bush administration, which had rejected taking
action in four similar cases it reviewed. The union complaint was filed under a law Congress passed in 2000
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that allows the United States to impose tariffs and other trade protections if a surge in Chinese imports
damages a U.S. industry.
China agreed to the provision while negotiating to join the World Trade Organization, but until Friday the
general "safeguard" provisions of the law had never been invoked. Critics warned that if the general
"safeguard," which expires in four years, was never used to protect American workers from Chinese imports,
then political support for free trade would be eroded.
"Since China joined the WTO, American workers have not been assured that the government would defend
them against unfair trade," Sen. Sherrod Brown (D-Ohio) said. The tariff, which will take effect Sept. 26,
represents the first such case under the law for Obama, and his decision has been highly anticipated.
During the campaign, he had pledged to "crack down on China" and "work to ensure that China is no longer
given a free pass to undermine U.S. workers," as his Web site put it. But his commitment to that point of view
was thrown into doubt during the primaries when a Canadian official said an Obama adviser had privately
characterized his tough stance on the North American Free Trade Agreement as political posturing.
Marguerite Trossevin, who represents a coalition of U.S. tire companies that import Chinese tires, said the
tariff decision is "very disappointing." She predicted price increases for U.S. consumers and losses for U.S.
tire importers. "For the U.S. tire distributors and consumers, there's going to be a heavy burden to bear," she
said. "It sends the message that special interests will get protection if they ask for it -- regardless of what that
means for broader trade policy."
China's Ministry of Commerce said in a statement early Saturday that the move violated WTO rules. "China
strongly opposes this serious act of trade protectionism by the U.S," the ministry said, according to the
Associated Press. Not surprisingly, there were conflicting predictions about what effect the tariff might have on
the U.S. industry.
Supporters said the measure would have only a negligible effect on the price of tires and would lead U.S.
manufacturers to invest in their U.S. plants. The tariff's detractors said higher tire prices could lead some
consumers to wait longer before replacing tires, creating a safety risk. Moreover, they said, the tariff won't
result in more jobs. Tires will simply come in from other low-cost countries, they say, and U.S. manufacturers,
keep making their cheaper tires in China.
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"U.S. tire manufacturers years ago decided to move production of low end tires off-shore," said David
Spooner, a lawyer representing the Chinese tire industry. "Frankly, a temporary tariff is not going to get them
to change their business plan."
Case Study
1. What was the main reason for U.S to impose tariffs on China
2. Explain the likely impact of the tariff on:
1. Chinese tyre manufacturers
2. US tyre manufacturers
3. US consumers
9.7 Summary
The increasingly global economy has made the nations of the world more economically interdependent. This
interdependence has made policy-making for all stakeholders (Governments, firms, individuals) more
challenging and demanding.
YOU ARE NOW READY TO ANSWER THE QUESTIONS FOUND IN THE WORKBOOK RELATING TO THIS
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Answer to activities:
1.1 b
2.1 Simply put, the economy would not be able to maintain its current production capacity well off into the future
resulting in a decline in economic activity.
4.1 d
5.1 b
6.1 d
7.1 e
8.1 c
9.1 c
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1. The tariff was designed to protect American producers from low-cost Chinese imports, thereby helping to create
jobs in the U.S. tire industry. However, it may also have raised the average price of tires to American consumers,
leaving them with less money to spend on other goods and services. For its part, the Obama administration clearly
believes that the gains, in terms of jobs saved or created, outweigh any losses from higher prices.
2. The additional tax, or tariff, on imported goods can discourage Chinese tyre manufacturers to sell their products
in US. The additional taxes make the Chinese tyres either too expensive or not nearly as competitive
as it would be if the tariff didn't exist. This can lead to fewer choices of goods and a lower quality for consumers.
The amount of tyres you have to choose from are all subject to the effects of tariffs.
US tyre manufacturers benefit by ultimately facing reduced competition in their home market, which leads to lower
supply levels and higher prices for consumers. As you can see from the graph below, S0 and D0 represent the
original supply and demand curves, which intersect at (P0, Q0). St shows what the supply curve is with the
introduction of the tariff. The market then settles at (Pt, Qt). Less of the good is produced, and consumers pay
higher prices.
When a consumer does purchase a higher-priced imported tyres with a tariff imposed on it, the consumer now has
less money to spend on other things. This forces consumers to either buy less of the imported tyres or less of
some other good, ultimately lowering the purchasing power of consumers. It is important to remember that although
consumers may pay higher prices because of tariffs and have limited options, the potential benefit is that domestic
sales of goods can increase, ultimately leading to higher domestic sales and more jobs for companies inside the
country
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Reference List
Case, K.E, Fair, R.C & Oster, S.M (2012). Principles of Miiroeconomics. (10th ed.). Pearson.
Mcaleese, Dermot (2001): Economics for Business. Financial Times/ Prentice Hall.
Mohr, P. & Fourie, L. (2008) Economics for South African Students. 4th edition. Pretoria: Pretoria. Van Schaik
Mohr, P. & Fourie, L. (2015) Economics for South African Students. 5th edition. Pretoria: Pretoria. Van Schaik
Orkin, F. (1998). Unemployment and employment in South Africa. Pretoria: Statistics South Africa.
Pape John (2000): Economics: An Introduction for South African Learners. Juta and Company Ltd.
The World Bank (2018a). Overcoming Poverty and Inequality in South Africa. An Assessment of Drivers,
Constraints and Opportunities. Washington DC.
The World Bank (2018b). South Africa Economic Update. Jobs and Inequality. Washington, DC.
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