ECS1601 - gimmenotes

ECS1601/103/3/2018

Tutorial Letter 103/3/2018

Economics 1B

ECS1601

Semester 1

Department of Economics

IMPORTANT INFORMATION

This tutorial letter contains the following

Information on lecturers

Information on myUnisa and e-tutors

Information on 2018 examination

A workbook to help you practice diagrams, calculations and explanations

Define tomorrow

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CONTENTS

A. LECTURERS FOR THIS MODULE ................................................................................................. 3

B. MyUNISA AND E-TUTOR WEBSITE .............................................................................................. 3

C. INFORMATION ON THE 2018 EXAMINATION .............................................................................. 5

D. EXERCISES ON LEARNING UNITS .............................................................................................. 6

D1 EXERCISES ON LEARNING UNIT 2 ..................................................................................... 6

D2. EXERCISES ON LEARNING UNIT 3 ................................................................................... 13







D9. EXERCISES ON LEARNING UNIT 10 ................................................................................. 66

D10. EXERCISES ON LEARNING UNIT 11 ................................................................................. 68

E. DISCUSSION OF EXERCISES ON LEARNING UNITS ................................................................ 69

E1. DISCUSSION OF EXERCISES ON LEARNING UNIT 2 ...................................................... 69

E2. EXERCISES ON LEARNING UNIT 3 ................................................................................... 76



E5. DISCUSSION OF EXERCISES ON LEARNING UNIT 6 ...................................................... 96

E6. DISCUSSION OF EXERCISES ON LEARNING UNIT 7 .................................................... 109



E9. DISCUSSION OF EXERCISES ON LEARNING UNIT 10 .................................................. 138

E10. DISCUSSION OF EXERCISES ON LEARNING UNIT 11 .................................................. 140

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A. LECTURERS FOR THIS MODULE

Your lecturers for ECS1601 are as follows:

Module leader: Ms Malefa Malefane (012) 433 4641

Ms Kafayat Amusa (012) 433 4637 Mr Thabang Malatji (012) 433 4613

Mr Charles Leotlela Mr Claud Byneveld

There is a lecturer on duty for ECS1601 every weekday from 8:00 to 15:30 but sometimes we have to attend meetings. If you cannot find any lecturer, please contact the administrative personnel at 012 433 4661. The numbers for Mr Leotlela and Mr Byneveld were not available at the time of publishing, and will be made available on the ECS1601-18-S1 webpage as soon as it becomes available. The e-mail address for ECS1601 is as follows:

First semester 2018 [email protected]

Second semester 2018 [email protected]

All e-mail enquiries will be attended to within 48 working hours. Your lecturers will also communicate with you on myUnisa, so please visit your myLife e-mail address on a regular basis or click on the Announcement tab on the ECS1601 webpage (for the first semester this will be called ECS1601-18-S1 and for the second semester this webpage will be called ECS1601-18-S2. You can also use the Discussion Forum tab on the ECS601 webpage on myUnisa to ask questions. A lecturer will regularly answer your questions on the discussion forum. Students are also invited to assist each other on this discussion forum. Remember that you are always expected to act courteous and ethical when communicating with your fellow students and with lecturers.

B. MYUNISA AND E-TUTOR WEBSITE

Please visit the ECS1601 website on myUnisa. Every week as you progress through the study programme we shall post a slide show to help you work through the study material for that week. Difficult concepts are explained in more detail on these slides. We also post a quiz containing questions on the learning material for that week. These questions are similar to the questions that you can expect in the exam. You can try these questions and then discuss the answers with your fellow students on your e-tutor group. Student will be allocated to an e-tutor during the course of the semester. You will also find your e-tutor webpage on myUnisa. In the first semester it will be named ECS1601-17-S1-xxE where the xx refers to your e-tutor group number. For the second semester the e-tutor sites will be named ECS1601-17-S2-xxE, and the xx will once again refer to the e-tutor group number. E-tutors have been appointed to help you with any academic problem that you may encounter. You can expect the following from your e-tutor:

A weekly e-mail sent to your myLife address containing information that the e-tutor regards as important

Regular posts on the discussion forum to motivate you and provide additional questions on the study material

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Feedback on your questions or if you provided answers to a particular question, e.g. a question in the quiz, feedback to your answer.

Academic support: if you have any questions about the contents of the module, please discuss this with your e-tutor and fellow students on the Discussion forum.

You are encouraged to use the discussion forum on the e-tutor site to discuss questions and issues on the study material with your fellow students. Should you find that your e-tutor is not providing these services, please contact one of your lectures so that we can investigate the issue and solve the problem. The discussion forum on the main ECS1601 webpage will only be monitored until all students have been allocated to e-tutor groups.

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C. INFORMATION ON THE 2018 EXAMINATION

The exam paper will consist of two main sections each counting 50% of the total of 100. Section A will contain questions for which you have to provide short written answers and Section B will contain 30 multiple choice questions that you will answer on a mark reading sheet. The assignments for ECS1601, the activities in the learning units and the quizzes that will be released on myUnisa contain examples of multiple choice questions. Examples of the questions for which you have to provide written answers are provided in the activities in the learning units and in the quizzes that will be released on myUnisa. We have also compiled this workbook which contains examples of the types of questions you can expect in Section A of the exam. Section D contains the questions with space for answering the questions, and the answers are provided in Section E. You are expected to answer the question in the workbook as soon as you have completed a learning unit. You should then use the answers in Section D to evaluate your answers. If you do not understand the answers you have to revise the work in that learning unit, and you should seek help from your e-tutor, face-to-face tutor (if you have joined a group) or your lecturer. It is very important that you are able to answer this type of questions as half of the examination paper will consist of this type of question. You can expect the following types of questions in Section A of the exam:

Questions where you have to provide definitions for certain concepts

Questions where you have to provide a list e.g. a list of characteristics, a list of functions etc.

Questions where you have to provide an explanation of economic concepts, theory or policy

Questions where you have to use a model to explain economic concepts, an economic situation, economic policy etc.

Questions where you have to use a diagram of a model to explain economic concepts, an economic situation, economic policy etc. (You have to understand how to draw the diagrams yourself.)

Questions where you have to interpret a diagram of an economic model, an economic situation, economic policy etc.

Questions where you have to do calculations regarding economic variables or economic models

Questions where you have to apply economic theory to explain a certain situation or how a certain economic problem may be corrected

Section D of this tutorial letter contains examples of most of the above type of questions. It is therefore essential that you work through the workbook as you progress through the learning units.

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D. EXERCISES ON LEARNING UNITS

This part of the tutorial letter provides you with the opportunity to practise the diagrams, calculations and explanations that you have to master for ECS1601. Use this section as follows:

Read the question carefully.

Answer each question in the space provided.

Evaluate your answer using the suggested answers in section 2.

D1 EXERCISES ON LEARNING UNIT 2

1.1 Complete the following table: (10)

Function of money Medium of exchange Store of value

Motive for holding money for this

function

Symbol used to depict this motive for

holding money

Does this form part of the active or

passive demand for money?

Main determinant of this motive for

holding money

Is the relationship positive or

negative?

1.2 (a) Draw a diagram that illustrates the relationship between the interest rate level and the demand for active balances. (2)

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1.2 (b) Draw a diagram that illustrates the relationship between the interest rate level and the demand

for passive balances. (2)

1.3 (a) Complete the following: (2)

Total demand for money = + .

1.3 (b) Draw a diagram that illustrates the total demand for money. (2)

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1.4 Indicate which component of money demand (active balances or passive balances) will be affected by each of the following. Also, indicate the direction of change in the demand for money (increase or decrease) and whether a shift of the demand curve for money, or a shift along the curve, will take place. (12)

Change Component of money

demand that will be

affected

Direction of change in

money demand

Indicate if a shift of

the demand for

money curve will

take place or if a

shift along the

demand for money

curve will take

place

(a) Increase in income

level

(b) Decrease in income

level

(c) Increase in interest

rate

(d) Decrease in interest

rate

1.5 Explain why a negative relationship exists between the interest rate level and the passive demand

for money. (9)

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1.6 (a) Explain how the interest rate level is determined in the economy. (3) (b) Explain the role of banks in the money-creation process. (7)

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1.7 (a) Illustrate how an increase in the income level will affect the money market. (7)

1.7 (b) Illustrate how a decrease in the income level will affect the money market. (7)

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1.7 (c) Illustrate how an increase in the interest rate level will affect the money market. (7)

1.7 (d) Illustrate how a decrease in the interest rate level will affect the money market. (7)

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1.8 Explain why the South African Reserve Bank (SARB) may decide to increase the repo rate and how this increase in the repo rate will affect the money market. (10)

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D2. EXERCISES ON LEARNING UNIT 3

2.1 (a) Use the information in the following table and indicate whether the tax (A, B and C) is an example of regressive, proportional or progressive tax. Write your answer down in column 4.(3)

Show all your calculations to determine the correct answers in the space indicated below.

1 2 3 3 4

Income Amount paid to

tax Income

Amount paid to

tax Income

Amount paid to

tax

Indicate type of tax

A

R3 000

R150

R5 000

R250

R10 000

R500

B R300 R600 R1 500

C R240 R240 R240

Calculations:

2.2 (b) Indicate the correct answer. (1) Tax X indicated in the diagram (see next page) is an example of __________.

o regressive tax o proportional tax o progressive tax

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(b) Provide a reason for your answer. (1)

2.3 (c) Indicate the correct answer. (1) Tax Y indicated in the diagram is an example of ___________.



2.4 (d) Indicate the correct answer. (1) Tax Z indicated in the diagram is an example of _________.


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D3. EXERCISES ON LEARNING UNIT 4 3.1 The following table shows the total quantity of computers and amount of petrol that country A and

country B can produce in a day, given their resources. Use the information in the following table to complete the second table and answer the questions that follow: (4)

Computers Petrol

Country A 500 computers 30 000 litre

Country B 400 computers 20 000 litre

Cost to produce one computer

in terms of petrol

Cost to produce one litre of petrol in terms of computers

Country A

Country B

(a) Which country has an absolute advantage in the production of computers? Provide a reason for

your answer. (2)

(b) Which country has an absolute advantage in the production of petrol? Provide a reason for your

answer. (2)

(c) Which country has a relative advantage in the production of computers? Provide a reason for

your answer. (2)

(d) Which country has a relative advantage in the production of petrol? Provide a reason for your

answer. (2)

(e) Which country should produce computers? Provide a reason for your answer. (3)

(f) Which country should produce petrol? Provide a reason for your answer. (3)

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3.2 The following information is provided for country X: Imports = $500 000 Exports = $400 000 Will GDP exceed GDE? Explain your answer. (5)

3.3 Draw a diagram that illustrates the demand for dollars in South Africa. Explain the slope of the

curve. (4)

Explanation:

3.4 Draw a diagram that illustrates the supply of dollars in South Africa. Explain the slope of the curve.(4)

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Explanation:

3.5 Draw a diagram that illustrates how the rand/dollar exchange rate is determined. Show the

equilibrium exchange rate and explain why it is the equilibrium exchange rate. (10)

Explanation:

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3.6 Suppose trade regulations have changed, which results in a significant increase in exports from South Africa to America. Using a diagram, illustrate how this change will affect the exchange rate of the rand to the dollar. (7)

Explanation:

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3.7 Use a diagram to explain how an increase in the number of South African tourists, visiting the United States, will affect the exchange rate of the rand to the dollar. (7)

Explanation:

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3.8 (a) The following diagram depicts a change in the rand/dollar exchange rate. Explain whether the rand appreciated or depreciated and how and why this change will influence imports, exports and the balance of payments. Also, explain how it will affect domestic prices. (8)

(b) Explain what the monetary authorities can do to counteract the change in the rand/dollar exchange rate and why this may be difficult to accomplish. (5)

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3.9 Explain how the central bank can counteract the effect of an appreciation of the rand against the dollar. (5)

3.10 Explain what it means when a country’s terms of trade decreases and what the implications of

such a change will be. (6)

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D4. EXERCISES ON LEARNING UNIT 5 4.1 Indicate which of the following statements are true or false. (5)

No Statement True False

a An increase in real GDP implies that economic growth has taken place.

b An increase in the unemployment rate implies that unemployment has increased.

c An increase in the CPI implies that inflation has taken place.

d An increase in the balance of payments deficit implies that a country has attained (or is closer to attaining) external stability.

e An increase in the Gini coefficient implies that income is being distributed more equitable in a country.

4.2 Farmer A buys beetroot seed for R5 000 from farmer B and plants these seeds. The beetroot

grows well and six months later, the farmer sells the beetroot on the market for R15 000 to a factory that produces beetroot salad. The salad factory sells the beetroot salad to a shop for R23 000. The shop sells it to the consumers for R28 000.

(a) Using the production method, calculate the value added to GDP by the above transactions. (2) (b) Using the expenditure method, calculate the value added to GDP by the above transactions. (2) (c) Using the income method, calculate the value added to GDP by the above transactions. (2) Show all calculations.

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4.3 Indicate which of the following statements are true or false: (14)


a Value of total sales = Total primary income + Value of intermediate goods and services

b Value of total sales + Total primary income = Total primary income

c Goods, which were sold during the current period, but were produced during earlier periods, are included in the current GDP.

d GDP is a stock concept.

e Gross domestic product – Depreciation = Net domestic product

f GDP @ market prices – Taxes on products + Subsidies on products ≡ GDP @ basic prices

g GDP @ basic prices + Other taxes on production – Other subsidies on production ≡ GDP @ factor cost

h GDP @ factor cost – Other taxes on production + Other subsidies on production ≡ GDP @ basic prices

i GDP @ basic prices + Taxes on products – Subsidies on products ≡ GDP @ market prices

j GNI = GDP + Primary income receipts from the rest of the world + Primary income payments to foreigners

k GDP = GNI – Primary income receipts from the rest of the world + Primary income payments to foreigners

l GDP = C + I + G + X + Z

4.4 Use the figures obtained from the SARB Quarterly Bulletin for March 2016, shown in the following

table, to calculate the aggregates indicated below.

2014 2015

R million

Gross value added at factor cost 3 341 472 3 488 407

Taxes on production 71 649 81 531

Subsidies on production 8 021 9 380

Taxes on products 404 939 444 871

Subsidies on products 12 972 14 476

(a) Calculate GDP at basic prices for 2014 and 2105. (5) (b) Calculate GDP at market prices for 2014 and 2015. (5)

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4.5 Use the information obtained from the SARB Quarterly Bulletin for March 2016 in the following

tables to answer the questions that follow: (a) By how much did the nominal GDP grow from 2014 to 2015? (2) (b) By how much did the real GDP grow from 2014 to 2015? (2) (c) Which of nominal or real GDP would be better to use for measuring economic growth? Explain

your answer. (5)

2014 2015

R million

GDP @ current prices 3 867 719 4 031 394

GDP @ constant 2010 prices 3 020 879 3 031 041

4.6 Use the information obtained from the SARB Quarterly Bulletin in the following tables to answer

the questions that follow:

2014 2015

R million

Final consumption expenditure by households 2 299 426 2 428 813

Gross capital formation 771 641 810 929

Final consumption expenditure by general government 772 808 778 571

Exports of goods and services 1 186 640 1 233 094

Imports of goods and services 1 257 292 1 273 535

Residual item 23 844 13 081

Primary income from the rest of the world 82 235 98 016

Primary income to the rest of the world 183 779 198 382

(a) Calculate the GDE for South Africa for 2014 and 2015. (7)

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(b) Calculate the GDP for South Africa for 2014 and 2015 using the expenditure approach. (6)

(c) What percentage of domestic GDP did each different type of expenditure constitute for 2015? (10)

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(d) Comment on the relative sizes of the different types of expenditure. (5)

(e) Explain what gross capital formation refers to. (4)

(f) Calculate the GNI at market prices for 2014 and 2015. (4)

(g) Did South Africa import more goods and services than it exported, or was it the other way

around? Do you think this is important? Explain your answer. (6)

(h) Did South Africa receive more primary income from the rest of the world or did it pay more

primary income to the rest of the world? (6)

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4.7 The following figures were obtained from the Quarterly Labour Force Survey (quarter 2, 2015 edition) compiled by Statistics South Africa:

April to June 2015 (thousands)

Population aged 15 to 64 years 35 955

Labour force

Employed Formal sector (including agriculture and private households) Informal sector

Unemployed

Not economically active

Discouraged work-seekers Other (not economically active)

20 887

15 657 12 996

2 661

5 230

15 068

2 434

12 633

(a) Calculate the unemployment rate according to the strict definition of unemployment. (2)

(b) Calculate the unemployment rate according to the expanded definition of unemployment. (2)

4.8 The following figures, showing the CPI for all goods and services, were obtained from the

June 2016 edition of the SARB Quarterly Bulletin:

Year Total CPI (Base is December 2012)

2013 103,4

2014 109,7

2015 114,7

(a) Calculate the inflation rates for 2014 and 2015. (4)

(b) By how much did purchasing power change from 2013 to 2015? (4)

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4.9 The following figures are provided for imaginary country Zumenia for the year 2015. The currency is Zum.

(a) Complete the table by calculating the amounts for the blocks numbered from (a) to (d): (4)

Item description Zum millions

Merchandise exports 973 776

Net gold exports 67 662

Service receipts 191 656

Income receipts 98 016

Merchandise imports 1 075 850

Payment for services 197 643

Income payments 198 382

Current transfers -33 533

Balance on current account (a)

Capital transfer account 243

Financial account

Net direct investment -45 632

Net portfolio investment 55 347

Net other investment 123 575

Balance on financial account (b)

Unrecorded transactions 31 794

Change in net gold and other foreign reserves owing to balance of payments transactions

(c)

Change in liabilities related to reserves 15

SDR allocations and valuation adjustments 27 198

Net monetisation/demonetisation of gold 15

Change in gross gold and other foreign reserves (d)

(b) Calculate net merchandise exports for Zumenia for 2015. (2)

(c) Did Zumenia experience an inflow of foreign currency or an outflow of Zums in 2015? Indicate

the amount. (2)

(d) Did residents of Zumenia earn more in foreign countries than the amount of Zums earned by

foreigners in Zumenia? Indicate the amount. (2)

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4.10 The following table provides information on the distribution of income in Zumenia for 2015:

Percentage of population Percentage of total income earned

Poorest 20% 4

Next 20% 6

Next 20% 10

Next 20% 20

Richest 20% 70

(a) Use the information in the above table to draw a Lorenz curve for Zumenia. (8)

(b) Comment on the distribution of income in Zumenia. (2)

4.11 The following table show the Gini coefficients for a few selected countries for 2015:

Country Gini coefficient

Seychelles 65,8

South Africa 65,0

Namibia 61,3

Botswana 61,0

United States 41,1

Austria 26,0

Sweden 25,0

Source: World Bank (2015) (a) Which country in the above table has the most unequal distribution of income? (1)

(b) Which country in the above table has the most equal distribution of income? (1)

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(c) Draw Lorenz curves for South Africa and Austria on the same set of axes. Indicate very clearly which curve represents the distribution of income in South Africa and which in Austria. (5)

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D5. EXERCISES ON LEARNING UNIT 6 5.1 Draw a 45° line on the following set of axes: (1)

5.2 Study the following diagram and fill in >, < or = in the blocks.

(a) At point E: A□Y

(b) At point B: A□Y

(c) At point C: A□Y

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5.3 You have the following information about consumption in Zumenia: Autonomous consumption = Zums 50 million The marginal propensity to consume = 0,6 Use this information to draw a consumption function called C on the following set of axes. Indicate

autonomous consumption clearly. (7)

Space for calculations:

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5.4 In the previous question, the axes were calibrated and the diagram you had to draw was to scale. However, the diagrams you will be expected to draw will normally not have calibrated axes and you will not have to draw the diagram to scale. Draw the same consumption function, which you have drawn for question 6.3, on the following set of axes. Clearly label your axes, and indicate the level of autonomous consumption and the level of income where the consumption function crosses the 45º line. (5)

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5.5 Take a look at the following diagram (not to scale) and answer the question that follow:

(a) What is the level of autonomous consumption? (1)

(b) Calculate the marginal propensity to consume. (2)

(c) Write down the consumption function. (3)

(d) Write down the savings function. (3)

(e) Calculate the equilibrium income level (Ye). (3)

(f) Calculate the level of (a) consumption and (b) saving at the equilibrium income level. (4)

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(g) Draw the savings function, which you wrote down in (d), on the following diagram: (3)

5.6 Show on the following Keynesian diagram how a decrease in the marginal propensity to consume

will influence the economy: (2)

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5.7 Show on the following Keynesian diagram how an increase in autonomous consumption expenditure will influence the economy: (2)

5.8 Explain why the investment function in figure (a) has a negative slope and why the investment

function in figure (b) is a horizontal line. (7)

(a) (b)

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5.9 Show on the following two diagrams how the change in investment, due to an increase in the interest rate level, will be illustrated: (3)

(a) (b)

5.10 The following information is provided for Zumenia:

𝐶̅ = 𝑍𝑢𝑚𝑠 10 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐼 ̅ = 𝑍𝑢𝑚𝑠 5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛l 𝑐 = 0,8 Show this information on a diagram that illustrates the Keynesian model. Clearly indicate what

the equilibrium income level will be in Zumenia. (5)

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5.11 The following information is provided for the country Hartsonia:

𝐶̅ = 𝐻𝑎𝑟𝑡𝑠 15 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐼 ̅ = 𝐻𝑎𝑟𝑡𝑠 7 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑐 = 0,6 Due to an increase in the interest rate level in Hartsonia, the level of investment decreases to

Harts 5m. Use the Keynesian model to illustrate how this increase in the interest rate level and the subsequent decrease in investment will influence the economy of Hartsonia. Indicate the original equilibrium income level as well as the new equilibrium income level clearly on the diagram. (7)

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5.12 The following diagram illustrates an increase in investment due to a decrease in the interest rate level. Explain how the economy moves from point E0 to point A, to point B, to point C and eventually, to point E1. (18)

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5.13 Explain where equilibrium would be in the following diagram if Say’s law were true. Also, explain Keynes’ view on this and show how Say and Keynes’ viewpoints differ and the implications thereof. (9)

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5.14 The monetary authorities decide to increase the interest rate level in the Republic of Robonia. Indicate how this decision will influence the following, using three separate diagrams:

(a) the money market (4) (b) the level of investment (4) (c) the income level in the Keynesian model (5) (a)

(b)

(c)

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D6. EXERCISES ON LEARNING UNIT 7 6.1 Draw a diagram that illustrates that government expenditure is autonomous with respect to

income. Explain what this means. (4)

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6.2 The following information is provided for Zumenia:


𝐼 ̅ = 𝑍𝑢𝑚𝑠 5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

�̅� = 𝑍𝑢𝑚𝑠 3 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑐 = 0,8 (a) Show this information on a diagram that illustrates the Keynesian model. (3) (b) Clearly indicate what the equilibrium income level will be in Zumenia. (2) (c) Does the introduction of government expenditure in the Keynesian model affect the size of the

multiplier? Explain your answer. (2)

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6.3 The following information is provided for Hartsonia:


𝐼 ̅ = 𝐻𝑎𝑟𝑡𝑠 7 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

�̅� = 𝐻𝑎𝑟𝑡𝑠 9 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑐 = 0,6 Hartsonia is experiencing unemployment at the current equilibrium income level. The government

decides to increase government expenditure to H12m in order to try to curb the unemployment problem. Using the Keynesian model, illustrate how this increase in government expenditure will influence the economy of Hartsonia. Indicate the original equilibrium income level as well as the new equilibrium income level clearly on the diagram. (11)

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6.4 The following diagrams show (a) consumption spending and (b) aggregate spending as well as the equilibrium income level in the country Cusiona. Up to now, the participants in this economy have not paid any taxes. However, the government of Cusiona has now decided to introduce a proportional income tax equal to 20 per cent of income. Indicate in (a) how this will affect the consumption function and in (b) how this will affect the aggregate spending function and the equilibrium income level. (6)

(a)

(b)

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6.5 The upward shift of the A curve in the following diagram is due to a decrease in the proportional tax rate.

(a) Explain why the A curve shifts upwards from A to A’. (3) (b) Explain the increase in the income level from Ye to Y1. (6)

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6.6 Take a look at the following diagram and answer the questions that follow:

(a) Indicate which curve represents exports and explain the shape of this curve. (2) (b) Indicate which curve represents imports and explain the shape of this curve. (7) (c) Indicate the significance of the point where the two curves intersect and explain what YB means.

(6)

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6.7 Section (a) of the diagram below shows the export and import curves for the economy of Zumenia. Based on these two curves, draw the net exports curve for this economy in (b). Clearly indicate the income level, where balance of payments equilibrium will exist. (3)

6.8 Suppose exports from Zumenia increases. Indicate how this increase will affect the export

function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Explain how the balance of payments will be affected by this change. (5)

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6.9 Suppose government expenditure increases in Zumenia. Indicate how this increase will affect the export function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Also, indicate how the balance of payments will be affected by this change. (4)

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6.10 Suppose the marginal propensity to import increases in Zumenia. Indicate how this will affect the import function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Also, indicate how the balance of payments will be affected by this change. (7)

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6.11 Show how a decrease in autonomous imports will influence the income level in the Keynesian model. (4)

6.12 Suppose the economy is in equilibrium below the full employment level of income. Using the

Keynesian model, explain (not illustrate) how fiscal policy measures may be used to try to decrease unemployment. (21)

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D7. EXERCISES ON LEARNING UNIT 8 7.1 Draw an aggregate demand curve on the following set of axes and explain the reasons for the

slope of the curve: (21)

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7.2 Illustrate an increase in aggregate demand on the following set of axes, and explain the factors that can result in an increase in aggregate demand. (17)

7.3 (i) Explain how monetary and fiscal policy may influence the position of the aggregate demand

curve. (20) (ii) Distinguish between expansionary and contractionary monetary and fiscal policy. (10)

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7.4 Draw a short-term aggregate supply curve on the following set of axes and explain the reasons

for the slope of the curve: (9)

7.5 Draw a long-term aggregate supply curve on the following set of axes and explain the reasons for

the slope of the curve:

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7.6 Illustrate a decrease in aggregate supply on the following set of axes and explain the factors that

can result in a decrease in aggregate supply: (7)

7.7 Use the AD–AS model to explain how an increase in the tax rate will affect the economy. (13)

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7.8 Use the AD–AS model to illustrate and explain the problem of stagflation. (12)

7.9 Explain with the aid of a diagram why monetary and fiscal policy will not be effective in solving

the problem of stagflation. (15)

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7.10 Use causality chains to explain the transmission mechanism. (5)

7.11 Explain under which circumstances monetary policy will be most effective to stimulate demand

and increase the income level in the AD–AS model. (6)


Name of lag Definition Relative length of monetary and fiscal policy and

reasons for this

Recognition lag

Decision lag

Implementation lag

Impact lag

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7.13 Consider the following diagram:

(i) Explain what YB, Y0 and Yf mean in the diagram. (6)

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(ii) Explain what will happen to the position of YB when autonomous exports increase. Use a diagram to illustrate your answer. (7)

(iii) Explain why the AS curve becomes vertical at income level Yf. (4)

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7.14 (i) Suppose the economy is in equilibrium at an income level below the full employment level of income and that a deficit exists on the balance of payments. Illustrate this situation using the AD–AS model. (7)

(ii) Now explain, using the same model and on the same diagram, how expansionary fiscal policy will affect the income level, unemployment, the price level and the balance of payments. (13)

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D8. EXERCISES ON LEARNING UNIT 9 8.1 Clearly distinguish between the consumer price index, the production price index and the implicit

GDP deflator. (6)

8.2 The following table shows the CPI and PPI for the months of 2014 and 2015, as well as the

average for the two years:

Month CPI 2014 CPI 2015 PPI 2014 PPI 2015

January 106,3 111,0 110,6 114,5

February 107,0 111,2 111,7 114,6

March 107,7 112,1 112,5 116,0

April 108,0 112,9 113,3 116,7

May 108,6 113,5 113,5 117,6

June 109,0 114,1 114.0 118,1

July 109,4 114,8 114,6 118,4

August 109,9 115,0 114,7 118,6

September 110,2 115,2 115,1 119,2

October 110,5 115,7 115,3 120,2

November 110,9 116,2 115,5 120,5

December 111,1 116,9 115,8 121,3

Average for year

109,7 114,7 113,9 118,0

(i) Calculate the inflation rate for June 2015, using the CPI and the month-on-month method. (3) (ii) Calculate the change in the PPI from June 2014 to June 2015. (3) (iii) Calculate the inflation rate for 2015 based on the CPI and the annual average for the CPI. (3) (iv) Calculate the change in the PPI for 2015 based on the annual average. (3)

(i) (ii) (iii) (iv)

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8.3 Use diagrams to explain the difference between demand-pull inflation and cost-push inflation. (10)

Demand-pull inflation Cost-push inflation

8.4 Explain with the aid of a diagram why demand management policies may not be effective to solve

cost-push inflation in a developing economy. (10)

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D9. EXERCISES ON LEARNING UNIT 10 9.1 Draw the Philips curve and explain the relationship illustrated by the Philips curve.

9.2 Illustrate and explain stagflation using the AD–AS model and the Philips curve. (24)

AD–AS model Philips curve

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9.3 Explain what an incomes policy involves and whether it can be regarded as a solution to stagflation. (10)

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D10. EXERCISES ON LEARNING UNIT 11 10.1 Write an essay on the supply and demand factors of economic growth. (25)

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E. DISCUSSION OF EXERCISES ON LEARNING UNITS

This part of the workbook provides the correct answers to the exercises in section 1. Use these answers as follows:

Study the correct answer.

Evaluate your own answer based on the suggested answers provided.

If your answer is incorrect, study the suggested section in the study guide and the accompanying section in the prescribed textbook again

Where available, view the video clip that explains this answer.

Discuss the sections that you still don’t understand or your new insights with your e-tutor and fellow students on the e-tutor group.

E1. DISCUSSION OF EXERCISES ON LEARNING UNIT 2


Function of money Medium of exchange Store of value

Motive for holding money for this function

Transactions demand Speculative demand

Symbol used to depict this motive for holding money

L1 L2

Does this form part of the active or the passive demand for money?

Active demand Passive demand

Main determinant of this motive for holding money

Income level (Y) Interest rate level (i)

Is the relationship positive or negative?

Positive (When the income

level increases, the

transaction demand for

money increases, and vice

versa.)

Negative (When the interest

rate level increases, the

transaction demand for

money decreases, and vice

versa.) 1.2 (a) Draw a diagram that illustrates the relationship between the interest rate level and the demand

for active balances. (2)

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1.2 (b) Draw a diagram that illustrates the relationship between the interest rate level and the demand for passive balances. (2)

1.3 (a) Complete the following: (2)

Total demand for money = Active demand for money + Passive demand for money

1.3 (b) Draw a diagram that illustrates the total demand for money. (2)

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1.4 Indicate which component of money demand (active balances or passive balances) will be

affected by each of the following. Also, indicate the direction of change in the demand for money (increase or decrease) and whether a shift of the demand curve for money, or a shift along the curve, will take place. (12)

Change Component of

money demand that

will be affected

Direction of change

in money demand

Indicate if a shift of the

demand for money curve

will take place, or if a shift

along the demand for

money curve will take place

(a) Increase in income

level

Active demand Increases Rightward shift of the curve

(b) Decrease in income

level

Active demand Decreases Leftward shift of the curve

(c) Increase in interest

rate

Passive demand Decreases Upward shift along the

curve

(d) Decrease in interest

rate

Passive demand Increases Downward shift along the

curve

1.5 Explain why a negative relationship exists between the interest rate level and the passive demand

for money. (9)

We can use a diagram to explain the negative relationship:

The interest rate (i) is the return on bonds.✔ Bonds are financial instruments that can be held

instead of money on which interest is earned, for example, if you have a bond with a nominal value of

R10 000 and the interest rate on it is 10% per year, you will earn 10

100× 𝑅10 000 = 𝑅1 000 interest on

it, if you hold it for a full year.

However, if you need cash, it may be not always be possible to sell this bond immediately. Therefore,

individuals and businesses constantly have to decide between holding bonds (and earning interest)

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and holding cash (or liquidity).✔ We call the interest that you can earn by holding bonds the

opportunity cost of holding money.✔

When the interest rate level is high✔ (e.g. i1), much interest income will be lost if you hold money

instead of bonds. Therefore, the demand for bonds will be high (because you can earn high interest

on it) and the demand for money will be low✔ (the opportunity cost of holding money is high), for

example M1.

When the interest rate level is low✔ (e.g. i2), less interest income will be lost if you hold money

instead of bonds. Therefore, the demand for bonds will be lower (because you can earn less interest

on it) and the demand for money will be higher✔ (the opportunity cost of holding money is lower),

for example M2. 1.6 (a) Explain how the interest rate level is determined in the economy. (3) (b) Explain the role of banks in the money-creation process. (7)

(a) The SARB determines the repurchase rate or repo rate.✔ This is the rate at which the

SARB provides liquidity or cash to the banks. The repo rate determines the interest rate at

which banks provide loans or the cost of credit.✔ This cost of credit also determines the

general interest rate level in the economy.✔ This is the interest rate (i) that is shown in the

money market diagram.

(b) Refer to the following diagram:

As explained in part (a) above, the repo rate determines the interest rate (i) at which banks

provide loans or the cost of credit. The demand for money (L) in the economy at the current

level of interest rate will determine the money supply (M).✔ When the interest rate level is

higher (e.g. i1), it is more expensive to make use of credit and therefore, the demand for bank

loans will be lower.✔ Banks will thus provide fewer loans, which will lead to less money being

created and the money supply (M1) being lower.✔ When the interest rate is lower (e.g. i2), it is

less expensive to make use of credit and therefore, the demand for bank loans will be higher.✔

Banks will provide more loans, more money will therefore be created and the money supply (M2)

will be higher.✔

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1.7 (a) Illustrate how an increase in the income level will affect the money market. (7)

Explanation: When income increases from Y1 to Y2, the active demand for money increases.✔

Therefore, the demand for money curve L shifts to the right to L(Y1). ✔ The total demand for money

at interest rate level i0 increases from M0 to M1, thus the money supply increases from M0 to M1. ✔

1.7 (b) Illustrate how a decrease in the income level will affect the money market. (7)

Explanation: When income decreases from Y0 to Y1, the active demand for money decreases.✔

Therefore, the demand for money curve L shifts to the left to L(Y1).✔ The total demand for money

at interest rate level i0 decreases from M0 to M1, thus the money supply decreases from M0 to M1

.✔

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1.7 (c) Illustrate how an increase in the interest rate level will affect the money market. (7)

Explanation: When the interest rate level increases from i0 to i1, the opportunity cost of holding

money increases,✔ and therefore, the passive demand for money decreases (people prefer to hold

less money and more bonds).✔ Therefore, the quantity of money demanded decreases. The money

supply decreases from M0 to M1.✔

1.7 (d) Illustrate how a decrease in the interest rate level will affect the money market. (7)

Explanation: When the interest rate level decreases from i0 to i1, the opportunity cost of holding

money decreases,✔ and therefore, the passive demand for money increases (people prefer to hold

more money and fewer bonds).✔ Therefore, the quantity of money demanded increases. The money

supply increases from M0 to M1.✔

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1.8 Explain why the South African Reserve Bank (SARB) may decide to increase the repo rate and

how this increase in the repo rate will affect the money market. (10)

The intermediate objective of the SARB is to ensure that the inflation rate remains within the

predetermined target range of 6% to 9%.✔ The operational variable (i.e. the tool that the SARB

uses) to attain this target is the short-term interest rate level, which is determined by the

level of the repo rate.✔ When the inflation rate is expected to increase, the SARB will increase

the repo rate.✔ We can use a diagram to explain how the money supply will be affected:

When the repo rate increases, the interest rate at which banks provide credit to consumers

and businesses also increases (e.g. from i0 to i1).✔ At a higher interest rate (i1), the demand for

credit will be lower;✔ therefore, the banks will be able to provide fewer loans and thus less

money will be created. The money supply (M1) will decrease.✔

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E2. EXERCISES ON LEARNING UNIT 3

2.1 (a) Use the information in the following table and indicate whether the tax (A, B and C) is an example of regressive, proportional or progressive tax. Write your answer down in column 4. (3)

Show all your calculations to determine the correct answers in the space indicated below:

1 2 3 3 4

Income Amount paid to

tax Income

Amount paid to

tax Income

Amount paid to

tax

Indicate type of tax

A

R3 000

R150

R5 000

R250

R10 000

R500 Proportional

tax✔

B R300 R600 R1 500 Progressive

tax✔

C R240 R240 R240 Regressive

tax✔

Calculations:

To determine if a tax is progressive, regressive or proportional we have to calculate the percentage

of each tax paid by each income earner as follows:

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑖𝑛𝑐𝑜𝑚𝑒 𝑝𝑎𝑖𝑑 𝑡𝑜 𝑡𝑎𝑥 =𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡𝑎𝑥 𝑝𝑎𝑖𝑑

𝐼𝑛𝑐𝑜𝑚𝑒×

100

1

Using the above formula, we can do the following calculations:

Tax

Income level

R3 000 R5 000 R10 000

A 150

3 000×

100

1= 5%

250

5 000×

100

1= 5%

500

10 000×

100

1= 5%

B 300

3 000×

100

1= 10%

600

5 000×

100

1= 12%

1 500

10 000×

100

1= 15%

C 240

3 000×

100

1= 8%

240

5 000×

100

1= 4,8%

240

10 000×

100

1= 2,4%

Because the percentage of income paid to tax A remains the same (5%) regardless of the income

level, tax A is called a proportional tax.

Because the percentage of income paid to tax B increases as income increases, tax B is called a

progressive tax.

Because the percentage of income paid to tax C decreases as income increases, tax C is called a

regressive tax.

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2.2 (a) Indicate the correct answer. Tax X indicated in the diagram is an example of __________.

Ο regressive tax

● proportional tax✔

Ο progressive tax

(b) Provide a reason for your answer.

The percentage of income paid to tax remains the same, regardless of the income level.✔ 2.3 (a) Indicate the correct answer. Tax Y indicated in the diagram is an example of __________.

Ο regressive tax

Ο proportional tax

● progressive tax✔


The percentage of income paid to tax increases as the income level increases.✔

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2.4 (a) Indicate the correct answer. Tax Z indicated in the diagram is an example of ___________.

● regressive tax✔

Ο proportional tax

Ο progressive tax


The percentage of income paid to tax decreases as the income level increases.✔

E3. EXERCISES ON LEARNING UNIT 4 3.1 The following table shows the total quantity of computers and amount of petrol that country A and

country B can produce in a day, given their resources. Use the information in the following table to complete the second table and answer the questions that follow. (4)

Computers Petrol

Country A 500 computers 30 000 litre

Country B 400 computers 20 000 litre

Cost to produce one computer

in terms of petrol

Cost to produce one litre of petrol in terms of computers

Country A 30 000

500= 60 𝑙𝑖𝑡𝑟𝑒✔

500

30 000= 0,0167𝑐𝑜𝑚𝑝𝑢𝑡𝑒𝑟✔

Country B 20 000

400= 50 𝑙𝑖𝑡𝑟𝑒✔

400

20 000= 0, 02 𝑐𝑜𝑚𝑝𝑢𝑡𝑒𝑟✔

(a) Which country has an absolute advantage in the production of computers? Provide a reason for

your answer. (2)

Country A✔

It can produce more computers in a day than country B can.✔

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(b) Which country has an absolute advantage in the production of petrol? Provide a reason for your answer. (2)

Country A✔

It can produce more petrol in a day than country B can.✔

(c) Which country has a relative advantage in the production of computers? Provide a reason for

your answer. (2)

Country B✔

It has to give up less petrol to produce one computer than country A has to.✔

(d) Which country has a relative advantage in the production of petrol? Provide a reason for your

answer. (2)

Country A✔

It has to give up fewer computers to produce one litre of petrol than country B has to.✔

(e) Which country should produce computers? Provide a reason for your answer. (3)

Country B✔ It has a relative advantage in the production of computers✔ and it would be

beneficial to both countries if country B produced computers and country A produced

petrol, as country A can then buy computers from B, and country B can buy petrol from

A.✔ (f) Which country should produce petrol? Provide a reason for your answer. (3)

Country A✔ It has a relative advantage in the production of petrol✔ and it would be

beneficial to both countries if country B produced computers and country A produced

petrol, as country A can then buy computers from B, and country B can buy petrol from

A.✔

3.2 The following information is provided for country X: Imports = $500 000 Exports = $400 000 Will GDP exceed GDE? Explain your answer. (5)

GDP = C + I + G + X – Z✔

GDE = C + I + G✔

Imports (Z) are larger than exports (X).✔ Therefore, GDE will exceed GDP,✔ that is, a net

quantity of goods are imported to provide in the country’s demand, as portrayed by GDE. ✔

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3.3 Draw a diagram that illustrates the demand for dollars in South Africa. Explain the slope of the curve. (4)

Explanation: When you have to pay more rand for one dollar, dollars are relatively more expensive

and therefore, the quantity of dollars demanded will be low.✔ When you can buy dollars for

cheaper (i.e. you pay less rand for one dollar), it means that dollars are less expensive and the

quantity of dollars demanded will be higher.✔

3.4 Draw a diagram that illustrates the supply of dollars in South Africa. Explain the slope of the curve.(4)

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Explanation: When you receive a higher price for dollars, that is, pay more rand for one dollar,

people and institutions that hold dollars will be more willing to sell the dollars in exchange for

rand. Therefore, the quantity of dollars that are supplied will be high.✔ When the rand price of

dollars is low, it will be less advantageous for holders of dollars to sell it, as they will receive less

rand in exchange for dollars. Therefore, the quantity supplied of dollars will be less.✔

3.5 Draw a diagram that illustrates how the rand/dollar exchange rate is determined. Show the

equilibrium exchange rate and explain why it is the equilibrium exchange rate. (10)

Explanation:

The economy is in equilibrium at an exchange rate of R/$17. This means that you will pay R17 for

one dollar. This is the equilibrium exchange rate because the quantity of dollars supplied (20 000)

is exactly equal to the quantity of dollars demanded (20 000).✔

At a higher exchange rate, for example an exchange rate of R/$20, the quantity of dollars that

will be supplied (25 000) will exceed the quantity of dollars that is demanded (15 000).✔This

excess supply will result in a decline in the price of dollars, that is, you will pay less rand for a

dollar, until you are back at equilibrium at an exchange rate of R/$17.✔

At a lower exchange rate, for example an exchange rate of R/$14, the quantity of dollars that

will be demanded (25 000) will exceed the quantity of dollars that is supplied (15 000).✔ This

excess demand will result in an increase in the price of dollars, that is, you will pay more rand for

a dollar, until you are back at equilibrium at an exchange rate of R/$17.✔

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3.6 Suppose trade regulations have changed, which results in a significant increase in exports from South Africa to America. Using a diagram, illustrate how this change will affect the exchange rate of the rand to the dollar. (7)

Explanation:

When exports from South Africa to the USA increase, South African exporters will receive more

dollars as payment for the increased exports. The supply of dollars increases.✔ This is illustrated

by a rightward shift of the supply curve from S to S’.

Due to the increase in the supply of dollars, there will be an excess supply of dollars, which will

result in a decline in the exchange rate.✔ This means that you will now pay less rand for one dollar,

that is, for the same quantity of rand, you will receive more dollars. We say that the rand

appreciated or the rand became stronger.

The exchange rate will therefore decrease and the quantity of dollars, at which the market is in

equilibrium, will increase.✔

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3.7 Use a diagram to explain how an increase in the number of South African tourists, visiting the United States, will affect the exchange rate of the rand to the dollar. (7)

Explanation:

When the number of South African tourists, visiting the USA, increases, they will need dollars

and therefore, the demand for dollars will increase.✔ This is illustrated by a rightward shift of

the demand curve from D to D’.

Due to the increase in the demand for dollars, there will be an excess demand for dollars, which

will results in an increase in the exchange rate.✔ This means that you will now pay more rand for

one dollar, that is, for the same quantity of rand, you will receive fewer dollars. We say that the

rand depreciated or the rand became weaker.

The exchange rate will therefore increase and the quantity of dollars, at which the market is in

equilibrium, will also increase.✔

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3.8 (a) The following diagram depicts a change in the rand/dollar exchange rate. Explain whether the rand appreciated or depreciated, and how and why this change will influence imports, exports and the balance of payments. Also, explain how it will affect domestic prices. (8)

(b) Explain what the monetary authorities can do to counteract the change in the rand/dollar exchange rate and why this may be difficult to accomplish. (5)

(a) The rand/dollar exchange rate increased, thus the rand depreciated and became weaker. This

means that you will now pay more rand for a dollar than before the change.✔

Because the rand is weaker, South African goods will now be relatively cheaper for Americans

than previously;✔ therefore, the demand for South African goods by Americans will increase and

exports will then increase.✔

Because the rand is weaker, American goods will now be relatively more expensive for South

Africans than previously;✔ therefore, the demand for American goods by South Africans will

decrease and imports from the USA to South Africa will decrease.✔

The balance of payments will increase due to the increase in exports and the decrease in

imports.✔

Due to higher price of imported goods,✔ the domestic price level will increase, that is, a

depreciation of the rand may contribute to a higher inflation rate.✔

(b) To counteract the depreciation of the rand, the central bank will have to supply additional dollars

to the market, to enable the supply curve to shift back to S.✔ To do this the central bank will

need to have adequate foreign exchange reserves available. It is doubtful, however, that the

central bank will have adequate reserves available to counteract such depreciation.✔ Another

option is to increase domestic interest rates.✔ If the domestic interest rate level increases

relative to that of the rest of the world, it will mean that more foreign exchange will flow into

the country;✔ therefore, the supply of foreign exchange (dollars) will increase, illustrated by a

rightward shift of the supply of dollars curve back to S. This will then counteract the depreciation

of the rand.✔

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3.9 Explain how the central bank can counteract the effect of an appreciation of the rand against the dollar. (5)

When the rand appreciates, the central bank can buy dollars, that is, the demand for dollars

increases.✔ This can be illustrated by a rightward shift of the demand for dollars curve.✔

Another option is to decrease domestic interest rates.✔ A drop in the interest rate will mean

that domestic interest rates will be lower than foreign rates; therefore, foreign currency will

flow out of the country.✔ This will also increase the demand for dollars (in exchange for rand),

thereby counteracting an appreciation of the rand.✔

3.10 Explain what it means when a country’s terms of trade decreases and what the implications of

such a change will be. (6)

The terms of trade of a country refer to the relationship between import prices and export

prices✔ and these terms are expressed as follows:

𝑇𝑒𝑟𝑚𝑠 𝑜𝑓 𝑡𝑟𝑎𝑑𝑒 =𝐸𝑥𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥

𝐼𝑚𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥× 100✔

When the terms of trade decrease, it means that export prices have decreased relative to import

prices.✔ This makes it more difficult for the country to afford its imports,✔ as it will have to

export more goods and use more of its scarce resources to afford the same imports as

previously.✔ This will result in a welfare loss.✔

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E4. EXERCISES ON LEARNING UNIT 5 4.1 Indicate which of the following statements are true or false. (5)


a An increase in real GDP implies that economic growth has taken place. X

b An increase in the unemployment rate implies that employment has increased.

X

c An increase in the CPI implies that inflation has taken place. X

d An increase in the balance of payments deficit implies that a country has attained (or is closer to attaining) external stability.

X

e An increase in the Gini coefficient implies that income is being distributed more equitable in a country.

X

4.2 Farmer A buys beetroot seed for R5 000 from farmer B and plants these seeds. The beetroot

grows well and six months later, the farmer sells the beetroot on the market for R15 000 to a factory that produces beetroot salad. The salad factory sells the beetroot salad to a shop for R23 000. The shop sells it to the consumers for R28 000.

(a) Using the production method, calculate the value added to GDP by the above transactions. (2) (b) Using the expenditure method, calculate the value added to GDP by the above transactions. (2) (c) Using the income method, calculate the value added to GDP by the above transactions. (2) Show all calculations.

(a) Production method (for method✔)

Farmer A R5 000

Farmer B R10 000

Factory R8 000

Shop R5 000

Total ✔ R28 000

(b) Expenditure method (for method✔)

Price paid by final consumers ✔ R28 000

(c) Income method (for method✔)

Income of farmer A R5 000

Income of farmer B R10 000

Income of the factory R8 000

Income of the shop R5 000

Total income ✔ R28 000

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4.3 Indicate which of the following statements are true or false: (14)


a Value of total sales = Total primary income + Value of intermediate goods and services

X

b Value of total sales + Total primary income = Total primary income X

c Goods, which were sold during the current period but were produced during earlier periods, are included in the current GDP.

X

d GDP is a stock concept. X

e Gross domestic product – Depreciation = Net domestic product X

f GDP @ market prices – Taxes on products + Subsidies on products ≡ GDP @ basic prices

X

g GDP @ basic prices + Other taxes on production – Other subsidies on production ≡ GDP @ factor cost

X

h GDP @ factor cost – Other taxes on production + Other subsidies on production ≡ GDP @ basic prices

X

i GDP @ basic prices + Taxes on products – Subsidies on products ≡ GDP @ market prices

X

j GNI = GDP + Primary income receipts from the rest of the world + Primary income payments to foreigners

X

k GDP = GNI – Primary income receipts from the rest of the world + Primary income payments to foreigners

X

l GDP = C + I + G + X + Z X

m GDE = GDP + X – Z X

n GDE = C + I + G X

4.4 Use the figures obtained from the SARB Quarterly Bulletin for March 2016, shown in the following

table, to calculate the aggregates indicated below.

2014 2015

R million

Gross value added at factor cost 3 341 472 3 488 407

Taxes on production 71 649 81 531

Subsidies on production 8 021 9 380

Taxes on products 404 939 444 871

Subsidies on products 12 972 14 476

(a) Calculate GDP at basic prices for 2014 and 2105. (5) (b) Calculate GDP at market prices for 2014 and 2015 (5)

(a) GDP at basic prices:

2014 2015

R million

Gross value added at factor cost✔ 3 341 472 3 488 407

PLUS: Taxes on production✔ 71 649 81 531

MINUS: Subsidies on production✔ 8 021 9 380

GDP at basic prices ✔ 3 405 100 ✔ 3 560 558

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(b) GDP at market prices:

2014 2015

R million

GDP at basic prices✔ 3 405 100 3 560 558

PLUS: Taxes on products✔ 404 939 444 871

MINUS: Subsidies on products✔ 12 972 14 476

GDP at market prices ✔ 3 797

067

✔ 3 990

953 4.5 Use the information obtained from the SARB Quarterly Bulletin for March 2016 in the following

tables to answer the questions that follow: (a) By how much did the nominal GDP grow from 2014 to 2015? (2) (b) By how much did the real GDP grow from 2014 to 2015? (2) (c) Which of nominal or real GDP would be better to use for measuring economic growth? Explain

your answer. (4)

2014 2015

R million

GDP @ current prices 3 867 719 4 031 394

GDP @ constant 2010 prices 3 020 879 3 031 041

(a) R4 031 394m − R3 867 719m

𝑅3 867 719m×

100

1=

𝑅163 675𝑚

𝑅3 867 719m×

100

1= 4,232% ✔✔

(b) R3 031 041m − R3 020 879m

𝑅3 020 879m×

100

1=

𝑅2 728 162𝑚

𝑅3 020 879m×

100

1= 0,9031% ✔✔

(c) The change in real GDP would be a better indication of the increase in economic growth✔ because

the effect of inflation has been eliminated from the real figures.✔ The increase in GDP at current

prices can be due to an increase in the price level and/or an increase in real production.✔ The

increase in real GDP is larger than the increase in nominal GDP because the effect of the price

increase has been removed by using fixed 2010 prices.✔

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4.6 Use the information obtained from the SARB Quarterly Bulletin in the following tables to answer the questions that follow:

2014 2015

R million


Gross capital formation 771 641 810 929

Final consumption expenditure by general government 772 808 778 571

Exports of goods and services 1 186 640 1 233 094

Imports of goods and services 1 257 292 1 273 535

Residual item 23 844 13 081

Primary income from the rest of the world 82 235 98 016

Primary income to the rest of the world 183 779 198 382

(a) Calculate the GDE for South Africa for 2014 and 2015. (6)

The GDE can be calculated as follows: 2014 2015

R million

Final consumption expenditure by households✔ 2 299 426 2 428 813

Plus: Gross capital formation✔ 771 641 810 929

Plus: Final consumption expenditure by general government✔ 772 808 778 571

Residual item✔ 23 844 13 081

Gross domestic expenditure ✔ 3 867 719 ✔ 4 031 394

(b) Calculate the GDP for South Africa for 2014 and 2015 using the expenditure approach. (7)

Using the expenditure approach, the GDP at market prices can be calculated as follows: 2014 2015

R million


Plus: Gross capital formation✔ 771 641 810 929

Plus: Final consumption expenditure by general government✔ 772 808 778 571

Plus: Exports of goods and services✔ 1 186 640 1 233 094

Minus: Imports of goods and services✔ 1 257 292 1 273 535

Plus: Residual item✔ 23 844 13 081

GDP @ market prices ✔ 3 797 067 ✔ 3 990 953

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(c) What percentage of domestic GDP did each different type of expenditure constitute for 2015?

(10)

The percentage that final consumption expenditure by households contributed to total

expenditure on GDP at market prices can be calculated as follows: 𝐹𝑖𝑛𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑏𝑦 ℎ𝑜𝑢𝑠𝑒ℎ𝑜𝑙𝑑𝑠

𝐺𝐷𝑃 @ 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒𝑠×

100

1=

R2 428 813m

R3 990 953m×

100

1= 60,86%✔✔

The percentage that gross capital formation or investment contributed to total expenditure on

GDP at market prices can be calculated as follows: 𝐺𝑟𝑜𝑠𝑠 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑓𝑜𝑟𝑚𝑎𝑡𝑖𝑜𝑛 𝑜𝑟 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡


100

1=

R810 929m

R3 990 953m×

100

1= 20,32% ✔✔

The percentage that final consumption expenditure by government contributed to total

expenditure on GDP at market prices can be calculated as follows: 𝐹𝑖𝑛𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑏𝑦 𝑔𝑜𝑣𝑒𝑟𝑛𝑚𝑒𝑛𝑡


100

1=

R778 571m

R3 990 953m×

100

1= 19,51%✔✔

The percentage that exports of goods and services contributed to total expenditure on GDP at

market prices can be calculated as follows: 𝐸𝑥𝑝𝑜𝑟𝑡𝑠 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠


100

1=

R1 233 094m

R3 990 953m×

100

1= 30,9% ✔✔

The percentage that imports of goods and services constituted of total expenditure on GDP at

market prices can be calculated as follows: 𝐼𝑚𝑝𝑜𝑟𝑡𝑠 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠


100

1=

R1 273 535m

R3 990 953m×

100

1= 31,92%✔✔

(d) Comment on the relative sizes of the different types of expenditure. (5)

Consumption expenditure formed the largest part of GDP (60,86%) in 2015.✔ Investment (gross

capital formation) and government expenditure contributed nearly an equal percentage of close

to 20% each.✔✔ The contributions made by exports and imports were also very close to each

other, with imports forming nearly 32%✔ of GDP and exports just less than 31%.✔ Note that

imports are subtracted from the other components to obtain expenditure on GDP because this is

money that was spent on goods and services produced outside the economy.✔

(e) Explain what gross capital formation refers to. (4)

Gross capital formation consists of gross fixed capital formation plus changes in inventories.✔

Gross fixed capital formation refers to purchases of capital goods such as buildings, machinery

and equipment.✔ Changes in inventories refer to the goods and services produced during a certain

period, but which are not sold yet,✔ and to goods and services produced during an earlier period,

but which are sold in the current period.✔

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(f) Calculate the GNI at market prices for 2014 and 2015. (4)

We use the GDP at market prices, calculated in section (b) above, to calculate the gross national

income at market prices:

2014 2015

R million

GDP @ market prices 3 797 067 3 990 953

Plus: Primary income from the rest of the world✔ 82 235 98 016

Minus: Primary income to the rest of the world✔ 183 779 198 382

Gross national income at market prices ✔ 3 695 523 ✔ 3 890 587

(g) Did South Africa import more goods and services than it exported, or was it the other way

around? Do you think this is important? Explain your answer. (5)

South Africa imported more goods and service than it exported.✔ This means that a net outflow

of foreign capital took place.✔ South Africa imports many capital goods and services; therefore,

such imports are essential to ensure that the economy can maintain and increase its production

capacity.✔ However, if it were possible to increase exports in order to exceed imports, it would

benefit the country, as it would mean that a net inflow of foreign capital would take place – which

could then be spent in the country and would encourage economic growth.✔ If it is possible to

replace the goods and services, which are imported, with locally produced goods, it will also

benefit economic growth, as it will mean that more employment opportunities may be created and

income received by the domestic population will be increased, which should boost economic

growth.✔

(h) Did South Africa receive more primary income from the rest of the world or did it pay more

primary income to the rest of the world? (6)

South Africa paid more primary income to the rest of the world than it received from the rest

of the world.✔ Given that we have a high unemployment rate, this may not be the ideal situation,

as it would be better to employ more South Africans instead of foreigners to ensure that a larger

part of the South African population receives an income.✔ However, many foreigners are

employed because they may have scarce skills which our country needs.✔ In this case, it would be

beneficial to train and educate South Africans to attain these scarce skills.✔ If the foreigners,

who earn an income inside the country, also spend their income in the country, it would be of less

concern than if the foreigners, who earn an income inside South Africa, take this income back to

the country where they are citizens.✔ This is because we would like to increase expenditure on

our domestic production in order to boost economic growth.✔

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4.7 The following figures were obtained from the Quarterly Labour Force Survey (quarter 2, 2015 edition) compiled by Statistics South Africa:

April to June 2015 (thousands)

Population aged 15 to 64 years 35 955

Labour force

Employed Formal sector (including agriculture and private households) Informal sector

Unemployed

Not economically active

Discouraged work-seekers Other (not economically active)

20 887

15 657 12 996

2 661

5 230

15 068

2 434

12 633

(a) Calculate the unemployment rate according to the strict definition of unemployment. (2)

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =Number of unemployed persons

Total labour force× 100 ✔

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =5 230 000

20 887 000× 100 = 25% ✔

(b) Calculate the unemployment rate according to the expanded definition of unemployment. (2)

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =Number of unemployed persons,including discouraged work seekers

Total labour force,including discouraged work−seekers× 100 ✔

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =5 230 000+2 434 000

20 887 000+2 434 000× 100 = 32,9% ✔

4.8 The following figures, showing the CPI for all goods and services, were obtained from the

June 2015 edition of the SARB Quarterly Bulletin:

Year Total CPI (Base is December 2012)

2013 103,4

2014 109,7

2015 114,7

(a) Calculate the inflation rates for 2014 and 2015. (4)

The inflation rate for 2014 can be calculated as follows:

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑃𝐼 𝑓𝑟𝑜𝑚 2013 𝑡𝑜 2014 = (𝐶𝑃𝐼 (2014)

𝐶𝑃𝐼 (2013)− 1) × 100 = (

109,7

103,4− 1) × 100 = 6,093% ✔✔

The inflation rate for 2015 can be calculated as follows:

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑃𝐼 𝑓𝑟𝑜𝑚 2013 𝑡𝑜 2014 = (𝐶𝑃𝐼 (2015)

𝐶𝑃𝐼 (2014)− 1) × 100 = (

114,7

109,7− 1) × 100 = 4,558% ✔✔

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(b) By how much did purchasing power change from 2013 to 2015? (4)

Decline in purchasing power from 2013 to 2015:

𝐶𝑃𝐼 (2013)

𝐶𝑃𝐼 (2015)=

103,4

114,7= 0,90✔✔

The purchasing power of the rand fell✔ from 2013 to 2015. Only 90% of the same basket, which

could be purchased in 2013, could be purchased with the same nominal amount in 2015.✔ Thus, if

your basked cost R100 in 2013, you would only be able to buy 90% of the same basket with R100

in 2015. The real value of R100 in 2013 thus declined to R90 in 2015.

4.9 The following figures are provided for the imaginary country Zumenia for the year 2015. The

currency is Zum. (a) Complete the table by calculating the amounts for the blocks numbered from (a) to (d): (4)

The + or – signs added in front of the figures in the table below indicate if this amount should be

added or subtracted. The table can be completed as follows:

Item description Zum millions

Merchandise exports +973 776

Net gold exports +67 662

Service receipts +191 656

Income receipts +98 016

Merchandise imports –1 075 850

Payment for services –197 643

Income payments –198 382

Current transfers –33 533

Balance on current account (a)✔ –174 298

Capital transfer account +243

Financial account

Net direct investment –45 632

Net portfolio investment +55 347

Net other investment +123 575

Balance on financial account (b)✔ –40 765

Unrecorded transactions +31 794

Change in net gold and other foreign reserves owing to balance of payments transactions

(c)✔ –8 971

Change in liabilities related to reserves 15

SDR allocations and valuation adjustments 27 198

Net monetisation/demonetisation of gold 15

Change in gross gold and other foreign reserves (d)✔ 18 257

(b) Calculate net merchandise exports for Zumenia for 2015. (2)

Net merchandise exports = Merchandise exports – Merchandise imports✔

= Zum 973 776m – 1 075 850m = Zum – 102 074m✔

This means that Zumenia imported more goods than it exported. (c) Did Zumenia experience an inflow of foreign currency or an outflow of Zums in 2015? Indicate

the amount. (2)

Zumenia experienced an inflow✔ of foreign currency equal to Zum 18 257m (that is the change in

gross gold and other foreign reserves, right at the end of the table).✔

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(d) Did residents of Zumenia earn more in foreign countries than the amount of Zums earned by foreigners in Zumenia? Indicate the amount. (2)

Net amount earned by Zumenians in foreign countries = Income receipts – Income payments

= Zum 98 016m – Zum 198 382m = Zum – 100 366m✔

Foreigners earned Zum 100 366m more in Zumenia than the amount earned by Zumenians in

foreign countries.✔ 4.10 The following table provides information on the distribution of income in Zumenia for 2015:

Percentage of population

Percentage of total income earned

Cumulative percentage of population

Cumulative percentage of total income earned

Poorest 20% 4 20 4

Next 20% 6 40 10

Next 20% 10 60 20

Next 20% 20 80 40

Richest 20% 60 100 100

(a) Use the information in the above table to draw a Lorenz curve for Zumenia. (8)

To draw this curve you first have to calculate the cumulative percentages for the population as

well as the total income earned, as shown in the grey blocks in the table above.

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(b) Comment on the distribution of income in Zumenia. (2)

The line AB shows a perfect distribution of income.✔ The Lorenz curve for Zumenia lies rather

far from this line towards the right, which shows a rather unequal distribution of income.✔ 4.11 The following table shows the Gini coefficients for a few selected countries for 2015:

Country Gini coefficient

Seychelles 65,8

South Africa 65,0

Namibia 61,3

Botswana 61,0

United States 41,1

Austria 26,0

Sweden 25,0

Source: World Bank (2015) (a) Which country in the above table has the most unequal distribution of income? (1)

Seychelles✔

(b) Which country in the above table has the most equal distribution of income? (1)

Sweden✔ (c) Draw Lorenz curves for South Africa and Austria on the same set of axes. Indicate very clearly

which curve represents the distribution of income in South Africa and which in Austria. (5)

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E5. DISCUSSION OF EXERCISES ON LEARNING UNIT 6 5.1 Draw a 45° line on the following set of axes: (1)

5.2 Study the following diagram and fill in >, < or = in the blocks. (3)

Note: At any point to the left of the

45º line, A will be larger than Y. At any point on the 45º line, A will be equal to Y. At any point to the right of the 45º line, A will be smaller than Y.

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5.3 You have the following information about consumption in Zumenia: Autonomous consumption = Zums 5 million The marginal propensity to consume = 0,6 Use this information to draw a consumption function called C on the following set of axes. Indicate

autonomous consumption clearly. (7)

To draw the consumption function you have to determine the following:

where the C function will cross the vertical axis

what the slope of the line should be

where the C function will cross the 45º line

Where will the C function cross the vertical axis? Note that at an income level (Y) of 0, consumption is

equal to Zums 5 million. This is autonomous spending and it is indicated by C̅.

What is the slope of the line? The marginal propensity to consume is equal to 0,6. When income is 0, it

means that, for every one unit by which income (Y) increases, consumption increases by 0,6. Thus, when

income increases from 0 to Zums 10 million, consumption increases by Zums 0,6 x R10 million = Zums 6

million, thus to Zums 11 million (Z5m + Z6m = Z11m). This is indicated by point Z on the diagram.

Connecting 𝐶̅ and point X forms the consumption function (C). Where will the C function cross the 45º line? The C function will cross the 45º line where aggregate

spending (A) is equal to income (Y). As you can see, this is at an income level of Zums 12,5 million. You can also calculate this level where total spending (in this case, we only include consumption) is equal to total income by multiplying the multiplier by the autonomous spending:

∝=1

1 − 𝑐=

1

1 − 0,6=

1

0,4= 2,5

The income level at which consumption is equal to income: = ∝× C̅ = 2,5 × Zums 5 million = Zums 12,5 million

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5.4 In the previous question, the axes were calibrated and the diagram you had to draw was to scale. However, the diagrams you will be expected to draw will normally not have calibrated axes and you will not have to draw the diagram to scale. Draw the same consumption function, which you have drawn for question 6.3, on the following set of axes. Clearly label your axes, and indicate the level of autonomous consumption and the level of income where the consumption function crosses the 45º line. (5)

When you are asked to draw a Keynesian diagram, always make sure you do the following:

Label the axes (A on the vertical axis and Y on the horizontal axis) and write in 0 at the origin.✔

Draw the 45º line and indicate it as such (we usually use dotted lines for the 45º line).✔

Indicate the level of autonomous consumption (𝐶̅ = Zums 5 million).✔

Draw a consumption function with a positive slope.✔

Indicate the income level where the consumption function crosses the 45º line, using dotted lines

(at Ye=Zums 12,5 million).✔

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5.5 Take a look at the following diagram (not to scale) and answer the questions that follow:

(a) What is the level of autonomous consumption? (1)

Autonomous consumption is the level of consumption when the income level is 0,

thus 𝐶̅ = R110m.✔ (b) Calculate the marginal propensity to consume. (2)

When income (Y) increases from 0 to R50m, consumption increases from R110m to R150m, thus

by R40m, that is 𝑐 =∆𝐶

∆𝑌=

𝑅40𝑚

𝑅50𝑚= 0,8✔✔

(c) Write down the consumption function. (3)

The general form of the consumption function is 𝐶 = 𝐶̅ + 𝑐𝑌.

Autonomous consumption (𝐶̅) is equal to R110m (see (a)).

The marginal propensity to consume (C) is equal to 0,8 (see (b)).

Thus the consumption function is C = R110m + 0,8Y✔✔✔

(d) Write down the savings function. (3)

The general form of the savings function is 𝑆 = 𝑆̅ + 𝑠𝑌.

Autonomous saving (𝑆̅) is equal to −C̅, thus − R110m.

The marginal propensity to save (C) is equal to 1 − 𝐶, thus 1 − 0,8 = 0,2. Thus, the consumption function is S = −R110m + 0,2Y.✔✔✔

(e) Calculate the equilibrium income level (Ye). (3)

To calculate the equilibrium income level (Ye) we first have to calculate the multiplier:

∝=1

1 − 𝑐=

1

1 − 0,8=

0

0,2= 5

To calculate the equilibrium income level (Ye) we now multiply the multiplier (∝) with the level of

autonomous consumption (𝐶̅): 𝑌𝑒 = ∝ × �̅� = 5 × 𝑅110𝑚 = 𝑅550𝑚.✔✔✔

(f) Calculate the level of (i) consumption and (ii) saving at the equilibrium income level. (4)

(i) C = R110m + 0,8Y = R110m + 0,8 x R550m = R110m + R440m = R550m✔✔

(ii) S = −R110m + 0,2Y = −R110m + 0,2 x R550m = −R110m + R110m = 0✔✔

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(g) Draw the savings function, which you wrote down in (d), on the following diagram: (3)

5.6 Show on the following Keynesian diagram how a decrease in the marginal propensity to consume

will influence the economy: (2)

The decrease in the marginal propensity to consume means that consumption decreases by a

smaller amount when income increases. Therefore, the slope of the consumption function (and

thus the aggregate spending function) becomes less steep. The level of autonomous spending (�̅�)

does not change, therefore the aggregate spending curve swivels down to A’. Due to the decrease

in consumption, aggregate spending decreases and therefore production in the economy will

decrease. The economy will move to a new equilibrium at a lower income level Y2.

Make sure you have indicated the downward swivel of the A curve correctly using an arrow, and

also the decrease in the income level.

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5.7 Show on the following Keynesian diagram how an increase in autonomous consumption

expenditure will influence the economy: (2)

The level of autonomous consumption increases, therefore the consumption function shifts

upwards by the amount by which autonomous consumption increases (Δ𝐶̅). Due to the increase in

consumption, aggregate spending increases and therefore, production in the economy will

increase. The economy will move to a new equilibrium at a higher income level Y2.

Make sure you have indicated the upward parallel shift of the A curve correctly using an arrow,

and also the increase in the income level. 5.8 Explain why the investment function in figure (a) has a negative slope and why the investment

function in figure (b) is a horizontal line.

(a) (b)

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The investment function in panel (a) shows the relationship between the interest rate level and

investment.✔ When the interest rate decreases, for example from i1 to i2 in figure (a), it becomes

less expensive to borrow money.✔ Therefore, more investment projects will be viable at the lower

interest rate level and investment will increase from I1 to I2.✔ The investment function in figure

(a) has a negative slope to illustrate this negative relationship between the interest rate level

and the level of investment.✔

The investment function in figure (b) shows that investment is assumed to be autonomous in the

Keynesian model.✔ It shows that the level of investment does not change when the income level

changes.✔ At any income level, investment is equal to 𝐼,̅ which is why the investment function in

figure (b) is a horizontal line.✔

5.9 Show on the following two diagrams how the change in investment, due to an increase in the

interest rate level, will be illustrated: (3)

(a) (b)

Diagram (a) illustrates that when the interest rate level increases from i0 to i1, the level of

investment decreases by ΔI from I0 to I1. This is because fewer investment projects will be

viable at a higher interest rate level, as it will be more expensive to borrow (therefore investment

decreases).

In the Keynesian model, investment is regarded as autonomous. Therefore, the decrease in

investment due to an increase in the interest rate is illustrated as a downward shift of the

investment function I. Investment decreases by ΔI from I0 to I1. 5.10 The following information is provided for Zumenia:


𝐼 ̅ = 𝑍𝑢𝑚𝑠 5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛l 𝑐 = 0,8 Show this information on a diagram that illustrates the Keynesian model. Clearly indicate what

the equilibrium income level will be in Zumenia. (5)

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The correct figure is shown below. To draw a Keynesian diagram you have to follow the following

steps:

1. Name the axes (A and Y) and the origin (0).

2. Draw the 45º line and clearly indicate that this is the 45º line.

3. Draw the aggregate spending curve and name it (A).

4. Indicate the level of autonomous expenditure (�̅�). Here it will be equal to

�̅� = 𝐶̅ + 𝐼 ̅ = 𝑍10𝑚 + 𝑍5𝑚 = 𝑍15𝑚.

5. Indicate the equilibrium income level (Ye). To calculate the equilibrium income level we first

have to calculate the size of the multiplier:

∝ =1

1−𝑐=

1

1−0,8=

1

0,2= 5

6. Now calculate the equilibrium income level (Ye) by multiplying the multiplier by the level of

autonomous spending (�̅�): 𝑌𝑒 = ∝ × �̅� = 5 × 𝑍15𝑚 = 𝑍75𝑚

Clearly indicate this level of income on the diagram as the equilibrium income level (Ye).

The diagram should look as follows:

5.11 The following information is provided for the country Hartsonia:


𝐼 ̅ = 𝐻𝑎𝑟𝑡𝑠 7 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑐 = 0,6 Due to an increase in the interest rate level in Hartsonia, the level of investment decreases to

Harts 5m. Use the Keynesian model to illustrate how this increase in the interest rate level and the subsequent decrease in investment will influence the economy of Hartsonia. Indicate the original equilibrium income level as well as the new equilibrium income level clearly on the diagram. (7)

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We shall follow the exact same steps for answering this question that we followed for 5.10, but

we shall add two more steps: a seventh step, where we will calculate the new equilibrium level, and

an eighth step, where we will illustrate the decrease in investment on the Keynesian cross

diagram:




4. Indicate the level of autonomous expenditure (�̅�). Here it will be equal to:

�̅� = 𝐶̅ + 𝐼 ̅ = 𝐻15𝑚 + 𝐻7𝑚 = 𝐻22𝑚.

5. Indicate the equilibrium income level (Ye). To calculate the equilibrium income level we first

have to calculate the size of the multiplier:

∝ =1

1 − 𝑐=

1

1 − 0,6=

1

0,4= 2,5


autonomous spending (�̅�): 𝑌𝑒 = ∝ × �̅� = 2,5 × 𝑍22𝑚 = 𝑍55𝑚


7. Autonomous investment decreases by H2 million to H5 million. Therefore autonomous

expenditure (�̅�) will now be equal to H15m + H5m = H20m. The multiplier stays the same, thus

the new equilibrium income level Y1 will be ∝ × �̅� = 2,5 × 𝑍20𝑚 = 𝑍50𝑚.

8. The A curve will shift parallel down to A’ and the new equilibrium income level Y1 is at a lower

income level at Z50m. The decrease of H2m in investment therefore results in a decrease in

income equal to H5m (𝛥𝑌 = ∝ × ∆𝐼 ̅ = 2,5 × 𝐻2𝑚 = 𝐻5𝑚). Note that you should clearly indicate

all directions of change using arrows. The diagram should look as follows:

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5.12 The following diagram illustrates an increase in investment due to a decrease in the interest rate level. Explain how the economy moves from point E0 to point A, to point B, to point C and eventually, to point E1. (18)

Due to a decrease in the interest level, more investment projects are viable and therefore

investment increases by ΔI.✔ Total autonomous spending thus increases, illustrated by the

upward shift of the A curve to A ’.✔ The economy moves from point E0 to point B due to the

increase in autonomous investment.✔

At point B, spending (A) exceeds income (Y) (illustrated by the fact that point B lies above the

45º line).✔ Retailers and producers will find that their inventories will decrease✔ due to the

increased demand. To supply in the excess demand, producers will increase production.✔ To

increase production more factors of production will have to be employed and therefore, income

increases.✔ This is illustrated by the shift from point B to point C.✔

Due to the increased income, persons in the economy will now increase consumption✔ (by the

marginal propensity to consume multiplied by the increase in income from B to C).✔ Aggregate

demand in the economy therefore increases, which is illustrated by the shift from point C to point

F.✔

At point F, spending still exceeds income✔ (point F still lies above the 45º line). Retailers and

producers will still be experiencing a decrease in inventories✔ due to the excess demand and will

increase production,✔ which will increase income.✔ This process will continue until the economy is

at point E1, where aggregate demand and income are equal once again.✔

The increase in income (ΔY) is larger than the initial increase in investment (ΔI)✔ due to this

multiplier process.✔

Make sure that you are able to describe the multiplier process.

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5.13 Explain where equilibrium would be in the following diagram if Say’s law were true. Also, explain Keynes’ view on this and show how Say and Keynes’ viewpoints differ and the implications thereof. (9)

If Say's law applies, the economy will always be in equilibrium (i.e. income or supply will be equal

to demand or total spending) at the full employment level of income (Yf).✔ That is because,

according to Say, supply creates its own demand.✔ This means that everything that will be

produced will be sold.✔

However, during the Great Depression (1929–1933), it became clear that this was not true.✔

Keynes then formulated his theory, which he called "the general theory of employment, interest

and money". According to Keynes, the level of demand determines supply,✔ as illustrated in the

above diagram. The level of aggregate spending, which is represented by the A curve, determines

the level of income in the economy.✔ When aggregate spending increases (i.e. the A curve in the

diagram shifts upward), the level of income will also increase.✔ This means that insufficient

demand could result in the economy being in equilibrium at an income level below full employment,

such as Ye.✔ If demand is increased (which would be illustrated by an upward shift of the A

curve), production will be increased due to the excess demand, and this will increase income so

that it moves closer to Yf, which represents the full employment level of income.✔

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5.14 The monetary authorities decide to increase the interest rate level in the Republic of Robonia. Indicate how this decision will influence the following, using three separate diagrams:

(a) the money market (4) (b) the level of investment (4) (c) the income level in the Keynesian model (5) (a)

(b)

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(c)

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E6. DISCUSSION OF EXERCISES ON LEARNING UNIT 7 6.1 Draw a diagram that illustrates that government expenditure is autonomous with respect to

income. Explain what this means. (4)

The diagram should look as follows:

The horizontal line shows that government expenditure (G) does not change when income (Y)

increases.✔ It is autonomous and equal to �̅�, regardless of the income level.✔ 6.2 The following information is provided for Zumenia:


𝐼 ̅ = 𝑍𝑢𝑚𝑠 5 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

�̅� = 𝑍𝑢𝑚𝑠 3 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝑐 = 0,8 (a) Show this information on a diagram that illustrates the Keynesian model. (3) (b) Clearly indicate what the equilibrium income level will be in Zumenia. (2) (c) Does the introduction of government expenditure in the Keynesian model affect the size of the

multiplier? Explain your answer. (2)

The correct figure is shown below. To draw a Keynesian diagram, which included government spending,

you have to follow the same steps as you did for question 5.10 above. The steps included consumption

and investment only, but now you have to add government spending to autonomous expenditure (�̅�).




4. Indicate the level of autonomous expenditure (�̅�). Here it will be equal to

�̅� = 𝐶̅ + 𝐼 ̅ + �̅� = 𝑍10𝑚 + 𝑍5𝑚 + 𝑍3𝑚 = 𝑍18𝑚.

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5. Indicate the equilibrium income level (Ye). To calculate the equilibrium income level we first have

to calculate the size of the multiplier:

∝ =1

1−𝑐=

1

1−0,8=

1

0,2= 5


autonomous spending (�̅�): 𝑌𝑒 = ∝ × �̅� = 5 × 𝑍18𝑚 = 𝑍90𝑚


(a) and (b):

(c) As indicated in the discussion above, the introduction of government expenditure does not affect

the size of the multiplier.✔ Government expenditure is autonomous and it only affects the level

of autonomous expenditure.✔

6.3 The following information is provided for Hartsonia:


𝐼 ̅ = 𝐻𝑎𝑟𝑡𝑠 7 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

�̅� = 𝐻𝑎𝑟𝑡𝑠 9 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑐 = 0,6 Hartsonia is experiencing unemployment at the current equilibrium income level. The government

decides to increase government expenditure to H12m in order to try to curb the unemployment problem. Using the Keynesian model, illustrate how this increase in government expenditure will influence the economy of Hartsonia. Indicate the original equilibrium income level as well as the new equilibrium income level clearly on the diagram. (11)

We will follow the exact same steps for answering this question that we followed for 6.2 above,

but we will add two more steps: a seventh step, where we will calculate the new equilibrium level,

and an eighth step, where we will illustrate the decrease in investment on the Keynesian cross

diagram:

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4. Indicate the level of autonomous expenditure (�̅�) before the increase in government

expenditure. Here it will be equal to

�̅� = 𝐶̅ + 𝐼 ̅ + �̅� = 𝐻15𝑚 + 𝐻7𝑚 + 𝐻9𝑚 = 𝐻31𝑚.

5. Indicate the equilibrium income level (Ye). To calculate the equilibrium income level we first have

to calculate the size of the multiplier:

∝ =1

1 − 𝑐=

1

1 − 0,6=

1

0,4= 2,5

6. Now calculate the equilibrium income level (Y) by multiplying the multiplier by the level of

autonomous spending (�̅�): 𝑌𝑒 = ∝ × �̅� = 2,5 × 𝑍31𝑚 = 𝑍77,5𝑚


7. Government expenditure increases by H3 million to H12 million. Therefore, autonomous

expenditure (�̅�) will now be equal to H31m + H3m = H34m. The multiplier stays the same, thus

the new equilibrium income level Y1 will be ∝ × �̅� = 2,5 × 𝑍34𝑚 = 𝑍85𝑚.

8. The A curve will shift parallel upward to A’ and the new equilibrium income level Y1 is at a higher

income level at Z85m. The increase of H3m in investment therefore results in an increase in

income equal to H7,5m (𝛥𝑌 = ∝ × ∆𝐼 ̅ = 2,5 × 𝐻3𝑚 = 𝐻7,5𝑚). Note that you should clearly indicate

all directions of change using arrows. The diagram should look as follows:

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6.4 The following diagrams show (a) consumption spending and (b) aggregate spending as well as

the equilibrium income level in the country Cusiona. Up to now, the participants in this economy have not paid any taxes. However, the government of Cusiona has now decided to introduce a proportional income tax equal to 20 per cent of income. Indicate in (a) how this will affect the consumption function and in (b) how this will affect the aggregate spending function and the equilibrium income level. (6)

Note that the slopes of both the consumption function (C) and the aggregate spending function

(A) become flatter due to the introduction of the proportional income tax. The slopes of the C

and A functions are the same as the effect of the introduction of the tax on aggregate spending

due to its effect on consumption. The income level decreases from Ye to Y1. The diagrams should

look as follows:

(a)

(b)

6.5 The upward shift of the A curve in the following diagram is due to a decrease in the proportional

tax rate. (a) Explain why the A curve shifts upwards from A to A’. (3) (b) Explain the increase in the income level from Ye to Y1. (6)

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(a) When the tax rate decreases, the disposable income level increases.✔

Due to the increase in disposable income, induced consumption increases.✔ This is the reason

for the upward shift of the aggregate spending curve to A’.✔

(b) The economy is now at point B in the diagram. At this point, aggregate spending exceeds the

income level (Ye), that is, there is a situation of excess demand.✔ Producers and retailers

will experience a decrease in inventories,✔ which will lead to an increase in production.✔

When production is increased, income increases.✔ This increase in income results in another

round of increase in consumption, once again resulting in a situation of excess demand, which

leads to another round of increase in income.✔ This is called the multiplier process✔ and it

will continue until aggregate demand and the income level are again equal at an income level

of Y1.✔

6.6 Take a look at the following diagram and answer the questions that follow:

(a) Indicate which curve represents exports, and explain the shape of this curve. (2) (b) Indicate which curve represents imports, and explain the shape of this curve. (7) (c) Indicate the significance of the point where the two curves intersect and explain what YB means.

(6)

(a) The curve labelled X represents exports.✔ The curve is horizontal, which indicates that exports

are regarded as autonomous, that is, it remains at �̅� regardless of the income level.✔

(b) The curve labelled Z represents imports.✔ Imports consist of an autonomous component (equal to

�̅�)✔ and an induced component (equal to mY).✔ The level of autonomous imports is the quantity

that will be imported, regardless of the income level. Autonomous imports (�̅�) will determine the

point where the import function intersects the vertical axis.✔ The slope of the import function

is determined by the marginal propensity to import (m).✔ The marginal propensity to import

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indicates by how much imports will increase for a given increase in the income level.✔ The positive

slope of the Z curve indicates that imports will increase when income increases.✔

(c) The point, where the X and Z curves intersect, is the income level YB, where imports will be equal

to exports.✔ This means that the balance of payments will be in equilibrium.✔

If the economy is in equilibrium to the left of YB, exports (X) exceed imports (Z) and a surplus

will be experienced on the balance of payments.✔ This implies that foreign capital will flow into

the country.✔

If the economy is in equilibrium to the right of YB, imports (Z) exceed exports (X) and a deficit

will be experienced on the balance of payments.✔ This implies that foreign capital will flow out of

the country.✔

6.7 Section (a) of the diagram below shows the export and import curves for the economy of Zumenia.

Based on these two curves, draw the net exports curve for this economy in (b). Clearly indicate the income level, where balance of payments equilibrium will exist. (3)

At YB, a balance of payment equilibrium exists, thus exports and imports are exactly equal.

Therefore, net exports (X–Z) are equal to zero at this point. At any point to the left of YB,

exports will exceed imports and therefore net exports will be positive. At any point to the right

of YB, imports will exceed exports and therefore net exports will be negative. The completed

diagram should look as follows:

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6.8 Suppose exports from Zumenia increases. Indicate how this increase will affect the export function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Explain how the balance of payments will be affected by this change. (5)

Note that you are required to indicate the new exports curve (X’), the new net exports curve (X-

Z’) and the new aggregate spending curve (A’). Also, clearly indicate the directions of the shifts

using arrows and clearly indicate the new income level, where the balance of payments equilibrium

will exist (YB’), as well as the new income level (Y1). The completed diagram should look as follows:

As can be seen in the diagram (next page), the income level where the balance of payments will

be in equilibrium increases to YB’. The equilibrium income level increases to Y1. As the diagram is

drawn, the economy will still experience a balance of payments deficit at Y1 because the

equilibrium income level is to the right of YB’. However, it may also happen that the economy can

be in equilibrium at YB or that a balance of payment surplus may be experienced at the new

equilibrium income level. This will depend on the size of the multiplier, which is not indicated here.

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6.9 Suppose government expenditure increases in Zumenia. Indicate how this increase will affect the

export function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Also, indicate how the balance of payments will be affected by this change. (4)

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In the case of an increase in government expenditure, panels (a) and (b) will not be affected at

all, as an increase in government expenditure does not affect the export or import functions. The

income level, where the economy will be in equilibrium, will remain at YB. The aggregate spending

function will shift upwards to A’ in panel (c). The equilibrium income level increases to Y1. As the

new equilibrium income level lies further to the right of YB,✔ the balance of payments deficit has

increased.✔

6.10 Suppose the marginal propensity to import increases in Zumenia. Indicate how this will affect the

import function and the income level, where the balance of payments will be in equilibrium (in panel (a)), as well as the net export function (in panel (b)) and the aggregate spending function (in panel (c)). Also, indicate how the balance of payments will be affected by this change. (7)

See next page for diagram. Autonomous imports remain the same, but the marginal propensity to

import increases. Therefore, the import function still cuts the vertical axis at the same point (�̅�),

but the slope of the import function becomes steeper (as indicated by Z’ in panel (a)). The income

level, where the balance of payments will be in equilibrium, is now at a lower income level, as

imports are higher at every income level. The net export function shifts downwards to (X-Z)’ in

panel (b), as the level of imports at every income level is now higher, while exports have remained

at the same level. The aggregate spending function in panel (c) shifts downwards to A’, as the

increase in imports decreases aggregate spending on domestically produced goods at every level

of income. This results in a decrease in income to Y1. As the diagram is drawn, there is still a

balance of payments deficit ✔ at Y1, as Y1 lies to the right of the new income level, where the

balance of payments will be in equilibrium (YB’).✔

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6.11 Show how a decrease in autonomous imports will influence the income level in the Keynesian model. (4)

6.12 Suppose the economy is in equilibrium below the full employment level of income. Using the

Keynesian model, explain (not illustrate) how fiscal policy measures may be used to try to decrease unemployment. (21)

Fiscal policy measures include a change in government spending✔ and/or a change in the tax rate.✔

An increase in government spending will result in an increase in aggregate spending.✔ Due to the

increased expenditure in the economy, producers and retailers will experience an unexpected

decrease in inventories.✔ They will therefore increase production.✔ The increase in production

results in an increase in income.✔ Due to higher income, induced consumption will increase,✔ which

will increase aggregate spending even more.✔ This will lead to another round of increases in

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production and income until the economy is in equilibrium again at a higher income level.✔ At the

higher income level, more people will be employed, thereby reducing unemployment.✔ Note that

the total increase in income is larger than the initial increase in government spending due to the

multiplier effect.✔

A decrease in the tax rate will mean that consumers' disposable income will increase.✔ Therefore,

induced consumption will increase,✔ resulting in an increase in aggregate spending.✔ From here

on, the effect on the economy is exactly the same as for an increase in government spending: Due

to the increased expenditure in the economy, producers and retailers will experience an

unexpected decrease in inventories.✔ They will therefore increase production.✔ The increase in

production will result in an increase in income.✔ Due to higher income, induced consumption will

increase even more, which will increase aggregate spending even more.✔ This leads to another

round of increases in production and income until the economy is in equilibrium again at a higher

income level.✔ At the higher income level, more people will be employed, thereby reducing

unemployment.✔ Note that the total increase in income is larger than the initial increase in

consumption spending (which was due to the decrease in taxes) due to the multiplier effect.✔

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E7. DISCUSSION OF EXERCISES ON LEARNING UNIT 8 7.1 Draw an aggregate demand curve on the following set of axes and explain the reasons for the

slope of the curve. (21)

The three main reasons for the

downward slope of the aggregate

demand curve from left to right

are the wealth effect,✔ the

interest rate effect,✔ and the

international trade effect.✔

The wealth effect: When the

price level P decreases (e.g. from

P1 to P2), consumers can buy more

goods and services with the same

amount of income.✔ Therefore,

consumption✔ and aggregate

spending increase.✔ Income (Y)

will also increase (in this case,

from Y1 to Y2).✔ Therefore, a

negative relationship exists

between the price level P and the

income level (Y).✔

The interest rate effect: When the price level P falls (e.g. from P1 to P2), the monetary

authorities will be inclined to allow a drop in interest rates.✔ When interest rates decrease,

investment spending will increase.✔ Therefore, aggregate spending and income (Y) increase✔ (in

this case, from Y1 to Y2). This also explains the negative relationship between the price level P

and the income level (Y).✔

The international trade effect: When the price level P falls (e.g. from P1 to P2), the monetary

authorities will be inclined to allow a drop in interest rates.✔ When domestic interest rates

decrease, it may be more profitable to invest funds in other economies, as the local interest rates

will now be relatively lower than foreign rates.✔ Therefore, capital will flow out of the country.✔

This results in an increased demand for foreign currency, for example an increase in the demand

for dollars.✔ The price of dollars in rand terms will therefore increase.✔ This is a depreciation

of the local currency (rand). Therefore, imports will now be more expensive for South Africans,

while South African goods will be relatively cheaper compared to foreign goods.✔ Therefore,

imports decrease✔ and exports increase,✔ resulting in an increase in aggregate demand and thus

an increase in the income level (in this case, from Y1 to Y2).✔ This once again explains the negative

relationship between the price level P and the income level (Y).✔

7.2 Illustrate an increase in aggregate demand on the following set of axes, and explain the factors

that can result in an increase in aggregate demand. (17)

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An increase in aggregate demand is

illustrated by a rightward shift of

the AD curve from AD to AD’.✔

Aggregate demand can increase due

to any one or a combination of the

following factors:

an increase in autonomous

consumption✔

an increase in induced

consumption✔

Factors, which may lead to an

increase in induced consumption,

include the following:

o a decrease in the tax rate

(which increases disposable

income and therefore, induced

consumption)✔

o an increase in the marginal

propensity to consume✔

o a decrease in the marginal

propensity to save✔

an increase in investment✔

Factors, which may increase investment, includes the following:

o a decrease in the interest rate✔

o an increase in investor confidence✔

an increase in government spending✔

an increase in net exports (exports – imports)✔

Any factors that result in an increase in net exports will increase aggregate demand.

Factors, which may increase net exports, include the following:

o an increase in autonomous exports✔

o a decrease in autonomous imports✔

o a decrease in the marginal propensity to import✔

o a depreciation of the domestic currency✔

This makes domestic goods relatively cheaper and may therefore increase exports,

but it also makes foreign goods relatively more expensive, which should therefore

decrease imports.✔ 7.3 (i) Explain how monetary and fiscal policy may influence the position of the aggregate demand

curve. (20) (ii) Distinguish between expansionary and contractionary monetary and fiscal policy. (10)

(i) Monetary policy affects the level of the repo rate,✔ which affects the general interest rate level

in the economy. An increase in the repo rate will lead to an increase in the interest rate level.✔

This will lead to an increase in investment✔ -- thus an increase in aggregate demand✔ -- and it can

be illustrated by a rightward shift of the aggregate demand curve.✔ A decrease in the repo rate

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will lead to a decrease in the interest rate level.✔ This will lead to a decrease in investment✔ --

thus a decrease in aggregate demand✔ -- which can be illustrated by a leftward shift of the

aggregate demand curve.✔

Fiscal policy can affect the tax rate✔ and/or the level of government spending.✔ When the tax

rate increases, it will cause a decrease in disposable income.✔ A decrease in disposable income

results in a decrease in consumption spending✔ -- thus a decrease in aggregate demand.✔ This

can be illustrated by a leftward shift of the aggregate demand curve.✔ A decrease in the tax

rate will result in an increase in disposable income.✔ This results in an increase in aggregate

demand, which is illustrated by a rightward shift of the aggregate demand curve.✔

When government spending is increased,✔ it increases aggregate demand, which can be illustrated

by a rightward shift of the aggregate demand curve.✔ A decrease in government spending

decreases aggregate demand,✔ which can be illustrated by a leftward shift of the aggregate

demand curve.✔

(ii) Expansionary policy is any policy that results in an increase in aggregate demand,✔ and it will thus

stimulate production and economic growth, resulting in higher prices.✔ Expansionary fiscal policy

includes a decrease in the tax rate✔ and an increase in government spending.✔ Expansionary

monetary policy includes a decrease in the repo rate.✔

Contractionary policy is any policy that results in a decrease in aggregate demand,✔ and it can

therefore be used to dampen the economy and try to reduce price increases.✔ Contractionary

fiscal policy includes an increase in the tax rate✔ and a decrease in government spending.✔

Contractionary monetary policy includes an increase in the repo rate.✔

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7.4 Draw a short-term aggregate supply curve on the following set of axes and explain the reasons for the slope of the curve: (7)

When the price level increases from

P1 to P2, real wages decrease.✔

Because production cost is now

lower,✔ firms will employ more

labour✔ and increase production.✔

Therefore, the income level in the

economy increases (from Y1 to Y2).✔

Because a higher price level is

associated with a higher level of

production, and thus a higher income

level, the aggregate supply curve

slopes upwards from left to right.✔

7.5 Draw a long-term aggregate supply curve on the following set of axes and explain the reasons for

the slope of the curve. (9)

When the price level increases from P1

to P2, real wages decrease.✔ In the

short term, the lower production cost

will result in firms employing more

labour and increasing production.✔

However, in the long term, labour will

demand an increase in their nominal

wage✔ and therefore, the real wage

will increase again✔ and production

will return to the original level (Yf),✔

which is also the full employment level

of income.✔ In the long term, the

economy will remain in equilibrium at

the full employment level of income

(Yf).✔ That is why the long-term

aggregate supply curve is vertical at

Yf.✔

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7.6 Illustrate a decrease in aggregate supply on the following set of axes and explain the factors that can result in a decrease in aggregate supply. (7)

A decrease in aggregate supply is illustrated

by a leftward shift of the AS curve from AS

to AS’.✔

Aggregate supply can decrease due to any one

or a combination of the following factors:

o Prices of factors of production (e.g.

wages) increase.✔

o Prices of imported capital and

intermediate goods (e.g. crude oil),

which are used in the production

process, increase.✔

o Production decreases.✔

o Weather conditions deteriorate.✔

7.7 Use the AD–AS model to explain how an increase in the tax rate will affect the economy. (13)

An increase in the tax rate will decrease

consumers' disposable income.✔ This

will result in a decrease in consumption✔

and thus in aggregate demand.✔ This

decrease in aggregate demand is

illustrated by a leftward shift of the

AD curve to AD’.✔

When aggregate demand decreases,

producers and retailers will experience

an increase in inventories✔ and will

therefore decrease production.✔ The

decrease in production results in a

decrease in income from Ye to Y’.✔

As production is decreased, fewer

expensive factors of production may be

employed, which makes it possible to

produce at lower cost and sell goods at

a lower price.✔ Therefore, the price

level decreases from P1 to P2.✔

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7.8 Use the AD–AS model to illustrate and explain the problem of stagflation. (12)

Stagflation refers to a simultaneous

increase in the price level (e.g. from P1 to P2

in the diagram)✔ and a decrease in the

income level (from Y1 to Y2 in the diagram).✔

This will take place when aggregate supply

decreases,✔ illustrated by a leftward or

upward shift of the AS curve to AS’.✔ It

may be caused by any factor that increases

production costs,✔ for example an increase

in the wage rate,✔ increased profit

margins,✔ and adverse supply shocks, such

as an increase in the price of crude oil.✔

7.9 Explain with the aid of a diagram why monetary and fiscal policy will not be effective in solving

the problem of stagflation. (15)

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Stagflation refers to a simultaneous increase in the price level (e.g. from P1 to P2 in the diagram)

and a decrease in the income level (from Y1 to Y2 in the diagram)✔ due to a decrease in aggregate

supply (illustrated by a leftward shift of the AS curve to AS’).✔

Monetary and fiscal policy both influence aggregated demand.✔ If monetary policy or fiscal policy

is used to increase aggregate demand (i.e. a decrease in the repo rate, a decrease in the tax rate

and/or an increase in government spending),✔ as illustrated by a rightward shift of the AD curve

to AD’,✔ the income level will increase again (e.g. move back to Y1 in the diagram),✔ but this will

worsen the problem of inflation, as the price level will increase even further to P3.✔

If monetary or fiscal policy is used to decrease aggregate demand (i.e. an increase in the repo

rate, an increase in the tax rate and/or a decrease in government spending),✔ it can be illustrated

by a leftward shift of the AD curve to AD'.✔ The economy will move to equilibrium at a lower

price level (P1), thus the problem of inflation is dealt with.✔ However, the income level decreases

even further to Y3, thus worsening the unemployment problem.✔

7.10 Use causality chains to explain the transmission mechanism. (5)

7.11 Explain under which circumstances monetary policy will be most effective to stimulate demand

and increase the income level in the AD–AS model. (6)

When investment demand is more interest elastic,✔ a given decrease in the interest rate will have

a larger effect on investment.✔ Therefore, aggregated demand will increase more than when

investment demand is more interest elastic.✔

The flatter the AS curve,✔ the larger the increase in income due to a given shift of the aggregate

demand curve.✔ The increase in the income level will thus be larger if the AS curve is flatter.✔

Thus, the more interest elastic investment is and the flatter the AS curve, the more effective

monetary policy will be to stimulate demand.

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Name of lag Definition Relative length of monetary and fiscal policy and reasons for this

Recognition lag Lag between changes in economic

activity✔ and the recognition or

realisation that the change has

occurred✔

It is the same for monetary policy

and fiscal policy.✔ Data has to be

collected, analysed and

interpreted.✔ Decision lag Lag between the realisation that

action is required✔ and the time

when a decision has been taken on

how to react✔

Longer for fiscal policy than for

monetary policy✔

Fiscal authorities only set a new

budget once a year,✔ while

monetary authorities meet a few

times a year (currently 6 times a

year in South Africa).✔ Implementation lag

Lag between the time when a

decision has been taken on how to

react✔ and the actual

implementation of the policy

decision✔

Long for fiscal policy, very short

for monetary policy✔

It takes long to implement changes

in government spending and taxes,

as a whole budget process has to be

completed to implement such

changes.✔ It is short for monetary

policy because once a decision has

been taken to change the repo rate,

the decision is effective

immediately.✔ Impact lag Lag between the implementation of

a policy decision✔ and the moment

when the change starts to have an

effect on economic behaviour✔

Longer for monetary than for fiscal

policy✔

A change in the repo rate takes long

to influence the real variables in

the economy, as the effect has to

work through the monetary

transmission mechanism.✔ Once a

change in fiscal policy has been

implemented, it has immediate

effect, for example a change in

taxes influences people immediately

once implemented and a change in

the budget of a government

department has immediate effect

once implemented.✔

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7.13 Consider the following diagram:

(i) Explain what YB, Y0 and Yf mean in the diagram. (6)

YB is the income level, where the balance of payments is in equilibrium,✔ that is, when imports are

equal to exports.✔

Y0 is the income level, where the economy is in equilibrium,✔ that is, where aggregate demand

equals aggregate supply and no forces will lead to an increase or a decrease in production.✔

Yf represents the full employment income level,✔ that is, the level at which income needs to be in

order to ensure that all labourers in the economy, who wish to work, can find a job.✔

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(ii) Explain what will happen to the position of YB when autonomous exports increase. Use a diagram to illustrate your answer. (7)

When autonomous exports increase, the X

curve shifts upwards to X’.✔ The level of

income (YB), where exports are equal to

imports, will now be higher, at YB’.✔ The

balance of payments will therefore be in

equilibrium at a higher income level (YB’),

which is closer to the full employment level

of income (Yf)✔ in the diagram at the

bottom.

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(iii) Explain why the AS curve becomes vertical at income level Yf. (4)

The AS curve becomes vertical at the full employment level of income.✔ All resources are

employed at this level and therefore, production and income cannot be increased beyond this

level,✔ unless resources increase and/or technology improves.✔ Once this point of full

employment (Yf) has been reached, an increase in aggregate demand will result in an increase in

the price level only.✔ That is why the AS curve becomes vertical at Yf. 7.14 (i) Suppose the economy is in equilibrium at an income level below the full employment level of

income and that a deficit exists on the balance of payments. Illustrate this situation using the AD–AS model. (7)

(ii) Now explain, using the same model and on the same diagram, how expansionary fiscal policy will affect the income level, unemployment, the price level and the balance of payments. (13)

(i) The diagram initially looks as follows:

The equilibrium income level (Ye) is to the left of the full employment level of income, which

illustrates that income has to increase by YeYf to reach the full employment level of income.✔ The

equilibrium income level (Ye) is to the right of the income level (YB), where there will be a balance

of payments equilibrium.✔ At any income level to the left of YB, the economy will experience a

surplus on the balance of payments, that is, exports will exceed imports.✔ At any income level to

the right of YB, the economy will experience a deficit on the balance of payments, that is, imports

will exceed exports.✔ Because the economy is currently in equilibrium at Ye, which lies to the right

of YB, the diagram illustrates a deficit on the balance of payments.

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(ii) Expansionary fiscal policy can include a decrease in the tax rate, which will increase consumption

spending✔ and/or an increase in government spending.✔ The increases in consumption spending

and government spending will result in an increase in aggregate demand,✔ which can be illustrated

by a rightward shift of the AD curve to AD’ as follows:✔

The increase in aggregate demand results in an increase in production and therefore, the income

level increases, as illustrated by the increase from Ye to Y2.✔ Y2 is closer to the full employment

level of income; therefore, unemployment is now lower than before the expansionary policy.✔ Due

to the increase in income, the level of imports in the economy will increase while exports are not

affected by the domestic income level.✔ Therefore, the deficit on the balance of payments will

increase, as illustrated by the fact that the new equilibrium income level, Y2, lies further to the

right from YB than before the expansionary policy.✔ Because production has increased, more

expensive factors of production are employed, illustrated by an upward movement along the AS

curve from E1 to E2.✔ This results in a higher price level, as illustrated by the increase in the

price level from P1 to P2.✔

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E8. DISCUSSION OF EXERCISES ON LEARNING UNIT 9 8.1 Clearly distinguish between the consumer price index, the production price index and the implicit

GDP deflator. (6)

The consumer price index shows the cost of a representative basket of consumer goods and

services✔ measured at the current prices that consumers will pay for those goods, that is, it

includes VAT.✔ The production price index measures the cost of a representative basket of goods

when they leave the factory (i.e. VAT is excluded)✔ and it includes consumer goods, intermediate

goods and capital goods but no services.✔ The implicit GDP deflator is an indicator of the

difference between nominal GDP and real GDP,✔ and therefore includes all goods and services

produced in the country.✔

8.2 The following table shows the CPI and PPI for the months of 2014 and 2015, as well as the

average for the two years.

Month CPI 2014 CPI 2015 PPI 2014 PPI 2015

January 106,3 111,0 110,6 114,5

February 107,0 111,2 111,7 114,6

March 107,7 112,1 112,5 116,0

April 108,0 112,9 113,3 116,7

May 108,6 113,5 113,5 117,6

June 109,0 114,1 114.0 118,1

July 109,4 114,8 114,6 118,4

August 109,9 115,0 114,7 118,6

September 110,2 115,2 115,1 119,2

October 110,5 115,7 115,3 120,2

November 110,9 116,2 115,5 120,5

December 111,1 116,9 115,8 121,3

Average for year

109,7 114,7 113,9 118,0

(i) Calculate the inflation rate for June 2015, using the CPI and the month-on-month method. (3) (ii) Calculate the change in the PPI from June 2014 to June 2015. (3) (iii) Calculate the inflation rate for 2015 based on the CPI and the annual average for the CPI. (3) (iv) Calculate the change in the PPI for 2015 based on the annual average. (3)

(i) (ii) (iii) (iv) 114,1−109,0

109,0 × 100✔✔

118,1−114,0

114,0 × 100✔✔

114,7−109,7

109,7 × 100✔✔

118,0 − 113,9

118,0 x 100✔✔

= 4,679✔ = 3,597✔ = 4,558✔ = 3,475✔

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8.3 Use diagrams to explain the difference between demand-pull inflation and cost-push inflation. (10)

Demand-pull inflation Cost-push inflation

✔for original AS and AD curves correctly labelled

✔for upward shift of AD to AD’

✔for increase in income to Y1

✔for increase in price level to P1

✔for original AS and AD curves correctly

labelled

✔for leftward shift of AD to AS’

✔for decrease in income to Y2

✔for increase in price level to P2

Demand-pull inflation is caused by an increase in

aggregate demand.✔ This is illustrated by a

rightward shift of the AD curve to AD’. The price

level increases from P0 to P1 and the income level

increases from Y0 to Y1.

Cost-push inflation is caused by a decrease in

aggregate supply.✔ This is illustrated by a

leftward shift of the AS curve to AS’. The price

level increases from P1 to P2 and the income level

decreases from Y1 to Y2.

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8.4 Explain with the aid of a diagram why demand management policies may not be effective to solve cost-push inflation in a developing economy. (10)

✔for original AS and AD curves correctly labelled

✔for upward shift of AS to AS’ and new equilibrium at E2

✔for leftward shift of AD to AD’ and new equilibrium at E3

Cost-push inflation (as illustrated by a

leftward shift of the AS curve to AS’) has

resulted in an increase in the price level

(from P1 to P2) and a decrease in production,

which led to a decrease in the income level

(from Y1 to Y2).✔ If demand management

policies are used to decrease the inflation

rate, aggregate demand will have to

decrease.✔ Contractionary policies, which

will decrease demand, include an increase in

the tax rate, a decrease in government

spending and/or an increase in the repo

rate.✔ This can be illustrated by a leftward

shift of the AD curve (from AD to AD’).✔

Such a decrease will result in a lower price

level (in this case, prices decrease to P4).✔

However, the production level and income

level decline even further (to Y3).✔ In a

developing country, this is not acceptable,

as production and income have to be

increased to improve the standard of living

of the population of the country.✔

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E9. DISCUSSION OF EXERCISES ON LEARNING UNIT 10 9.1 Draw the Philips curve and explain the relationship illustrated by the Philips curve. (9)

The Philips curve shows the

relationship between the inflation

rate✔ and the unemployment rate.✔

When aggregate demand increases and

the economy grows, unemployment

decreases,✔ but the inflation rate will

increase (as illustrated by the

movement from point A to point B on

the Philips curve).✔ If policy is used to

decrease the inflation rate, the

unemployment rate will increase, and

vice versa.✔ This means that low

inflation can only be attained at the

cost of higher unemployment, and vice

versa.✔

9.2 Illustrate and explain stagflation using the AD–AS model and the Philips curve. (24)

AD–AS model Philips curve

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Stagflation refers to a situation where a decrease in supply (e.g. due to higher production costs)✔

leads to an increase in prices✔ and a decrease in production.✔ In the AD-AS model, we can illustrate

this by an upward shift of the AS curve to the left.✔ Equilibrium shifts from E1 to E2. Due to the

increased production costs, prices increase from P1 to P2✔ in the diagram of the AD-AS model. At

the higher price level, the amount that consumers and producers can buy is less, and therefore, the

quantity that can be bought decreases.✔ This is illustrated by an upward movement along the AD

curve from E1 to E2.✔ Due to the decreased demand, producers and retailers experience an

unplanned increase in inventories✔ and will decrease their production.✔ Income will therefore

decrease from Y1 to Y2 in the diagram.✔

We can also illustrate stagflation by a rightward shift of the Philips curve.✔ The Philips curve shows

that a decrease in unemployment✔ will be at the cost of a higher price level employment.✔ However,

when production costs increases, the Philips curve shifts to the right,✔ and the economy moves

from point A to point B, where a higher inflation rate✔ is now also accompanied by a higher

unemployment rate.✔

9.3 Explain what an incomes policy involves and whether it can be regarded as a solution to

stagflation. (10)

An incomes policy means that the government intervenes✔ in the determination of wages and salaries✔

and places limits on increases.✔ The limits may be guidelines or compulsory control measures.✔ This

may decrease inflation✔ and ensure that unemployment does not continue increasing.✔

Such a policy is, however, very difficult to implement successfully.✔ All industries will not experience

similar changes in technology and productivity,✔ and this may also be difficult to measure and

interpret.✔ Therefore, such a policy is difficult to apply and maintain.✔

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E10. DISCUSSION OF EXERCISES ON LEARNING UNIT 11 10.1 Write an essay on the supply and demand factors of economic growth. (25)

Supply factors that influence economic growth relate to the factors of production.✔ The availability

and quality✔ of the different factors of production✔ determine the production capacity or potential

output of the economy.✔

The different supply factors are as follows:

Natural resources:✔ A country’s endowment will determine the availability of natural resources.✔

However, improvements in technology may result in discovery of more resources and/or better use

of available resources.✔

Labour:✔ Both the quality and the quantity of labour plays a role here.✔ The quality of labour can

be improved with good teaching and training.✔ Physiological factors such as motivation and attitude

towards work will also play a role in the productivity of labour.✔

Capital:✔ Capital can be increased by widening the amount of capital available (i.e. the average

amount of capital per labourer remains the same)✔ or by deepening the amount of capital (i.e. the

average amount of capital per labourer becomes smaller), which means that production becomes

more capital intensive.✔

Entrepreneurship:✔ Entrepreneurs have to be available to identify opportunities and combine the

other factors of production in the production process.✔ Entrepreneurs are the driving force of

economic growth and if this is lacking in a country, it may be necessary for the government to act

as an entrepreneur.✔

The different demand factors are the following:

Domestic demand:✔ This consists of consumption demand, investment demand and government

expenditure.✔ If demand is lacking, it will not help if all the supply factors are in place.✔ Policies

may be needed to stimulate domestic demand, such as a decrease in the tax rate or interest

rates.✔

Exports:✔ International demand for locally produced goods may be a strong driving factor of

economic growth.✔ The exchange rate is an important factor influencing the demand for

exports.✔

Import substitution:✔ If products and services, which were traditionally imported, can be

produced locally,✔ it can boost economic growth by increasing the demand for locally produced

goods.✔

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