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ECS102_notes1 - Wet-3r ‘'— f— ilm's Notcbool’w owe...

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Unformatted text preview: Wet-3r ‘-'—\ f— ilm's Notcbool’w owe to He, scsroz Mmg\m_ K . mg T l W Ev the obi KB“ boonave _..LHAPT _ 6mm to "ng Kate; . m r; (egevevngs THE IN'IERDEPENDENCE BETWEEN THE MAIOR SECTORS, MARKETS AND FLOWS IN THE MIXED ECONOMY FOR EXAMS ONLY CERTAIN SECTIONS OF THE CHAPTER ARE PRESCRIBED At the end of the chapter you should be able to: Identify the three major flows in the economy Distinguish between a flow and a stock Explain the interdependence between households and firms Explain the interaction between households and firms by means of the circular flow of goods and services and the circular flow of income and spending Identify the various economic participants I Identify the various injections into and leakages from the circular flow of income and spending I Explain the interaction of the different sectors in the economy by means of the circular flow of income and spending I In this chapter you are introduced to the in the economy. I Households: I Firms I Government I And the foreign sector I You will also be introduced to the major markets and flows. I And will be shown how these elements {are interrelated in a mixed economy. I The major markets are: I Markets forfioods and services I The factor markets I And the financial markets ecsmz -' 2 3.1 3.2 The major flows are: I Production I Income 30! I And spending (totals en ' in the econom consists ofs ndin by households firms ovemment and the forei sector. Production, Income and spending I PrOduction is not pursued for its own sake. I The ultimate aim is to use or consume the products to satisfy human wants wages, interest, rent, and profit) I This income is then Spent to purchase goods and services ,7 @Mn \ .t I See fig 3.1 47 (63) r \/ mm—u-I—ng— grim-39C {‘Jmifia. I One aspect of the economic problem that is not included in the diagram is how the income is distributed among the various participants in the economy. (will be encountered again later in the book.) I Production creates income (by using the different factors of production e. g I Production income and spending are all flows. ‘ I We need to distinguish between m (which are measured at a m'cular time. e. g The 1531.ng gel/gelding at BhQQ_23 Februgy 2004 called stock Mable) I And flows (which are measured over a riod. e.g. Flow into the Veal dam is measured as 850 cubic meters per second on 23 February 2004, called - flow variables). See box 3-1 for examples of stocks and flows pg 4-4 (48) Apart from production, income and smnding the other iin-tant economic activity that links the different sectors in an economy is exchange. I The two sets of markets are goods markets and factor markets. The interdependence between households and firms I Households can be defined as all the people who make joint economic decisions or are subjected to others who make such decisions for them .\ 50% ll \léifljtr s‘_,(_>§'37s..k.ild:lf {:J\‘t'}f;_3;gtmp\ @{rfl V ‘-————-—-—- ECS 102 Can an individual. a family or any group of people who have a jomt income and Elie Héclsions together. Every person in the economy belongs to a household. Members of the household consume the goods. The act of gonsuming the goods and services is called consumption Consumption goods are abbreviated to C In a market economy it is the households or consumers who largely determine what should be produced. In a mixed economy most of the factors of production are owned by households. These factors of production are sold to firms who combine them and produce goods and semces. '" In return for selling their labour. capital, land and entrepreneurship household; receive Income as menfionefi earliEf. lrenE Es and salaries, interest and profit) A-_—u———_—r With this income households buy goods and services Finns: Defined as the unit that employees these factors of production to produce goods and services Whereas households are engaged in consumption firms are engaged in production. In a market economy it is the rms, which largely decide how goods and services will be pro'dfitd. In economic analysis it is assumed that firm act rationally and want to maximise their profit Profit = Revenue — Costs I...— All individuals who own or work for a firm are also members of households. They therefore have to make two types of decisions. (1) They make consumer decisions EC5102 3.3 (2) But when at work they make business decisions relating to objectives One of the factors purchased by firms is capital such as machinery and equipment The act of purchasing capital goods is called investment or capital formation Investment is abbreviated to I o Goods market In microeconomics we focus on each of the markets individually e.g. market for tomatoes In macroeconomics we treat all goods and services as one market. Lumping all the goods markets together is called "aggregation" a Factor market These include labdur, capital, land etc' - The'circulur flow of goods and services: see fig 3-2 W” o The circular flow of income and spending: see fig 3- P8 Introducing the government Government is a broad term that includes all aspects of local, regional, and national government. In economics we refer to the public sector, which includes everything that is owned by the government as a representative of the people. In their official capacities, the President, the Minister of finance. all other politicians and all civil servants are part of the government U ECS 102 - But in their private capacities they are all members of households as we. 0 In contrast to firms and households we assume that they act rationally and consistently, not so with the government. 0 The objectives pursued by the ANC are vastly different from those pursued by the Nationalist Party Government. The primary function of a government is to establish a framework within which the economy works. Government also participates in the circular flow of production, income and spending. The Government purchases factors of production from households in the factor markef— ““““ "WWT‘W ““““““““““ T" In return it provides firms and households with public goods and services suc asroa . e , . servt'c'e's. ‘ These services are financed by taxes on income and expenditure by households and firms. The government also transfers some of the tax revenue directly to needy people like pensioners and disabled. Government economic activity thus involves three important flows (1) Government expsnditure on goods and services (including factor services). Denoted by symbol _G_ (2) Taxes levied on households and firms. Denoted by symbol T *— (3) Transfer payments. Transfer of income and expenditure from cefin maiwauils and groups (wealthy) 5) other individuals and groups (poor). . (4) Because transfer payments do not directly affect the overall size of the production, incomes and spending Flows the focus on government spending G and T - Govemmentspending constitutes an injection into the flow 0 spending - And taxes constitute a withdrawal or leakage. wows-:11»..s‘f’f ' " " ECSIOZ 3.4 3.5 0 See fig 3-4 pg 49 (55) Introducing the foreign sector. ____________ South Africa has links with the outside world. It is thus an open economy. The flows of gods and services between the domestic economy and the foreign sector are: Exports: denoted as X Imports: denoted as}— South Africa's exports consist mainly of gold and other minerals. Its imErts are mainly capital and intermediate goods that are used in the production process Efptms constitute an addition or injection into the circular flow of income and spending in the domestic'Economy Impgrts thus constitute a leakage or withdrawal from the circular flow of 1ncome and expenditure se'é Fig 3-5 pg 51 (57) financial institutions in the circular flow of income and spending A A These include banks like FNB, Nedbank, fignflflm, insurance companies like Old - Mutual. pension funds such as Iscor. pension fund as we" as Hie miners etc. 0 Another reason why government does not necessarily act consistently is because they are motivated by self-interest. Success at the next elections. 0 So there is a bias towards implementing policies, which will yield them the most votes. These institutions are not directly involved in the production of goods and services. v They act as links between households or firms that have surplus funds and other partrctpants who requrre finds. For example to expand your Eustness. ECS 102 7 - Surplus units are those people in a position to save because they spend less than W I Deficit units: opposite. ' I- When savings occur there is a leakage or withdrawal from the circular flow of incomE‘Efifi' spending. 0 When firms invest or purchase capital goods this results in an 59' lection or addition into iEe circular flow of income and expenditure. 4— 0 To keep it simple fig 3.6 pg 52 (52) excludes the factor market, goods market, government and foreign sector. 3 The financial institutes act as intermediary between those who save and those who wls to Invest. L————-— 3.6 Total production, income and spending revisited. E 0 Total expenditured: C+I+G+X-Z ECSIOZ 8 CM! ER 4 MEQQBEG TEER EHOBMQE 91'" THE EQQNOMY FOR EXAM PURPOSES QONCENTQTE 0N SECTION 4.1, 4.2 AND 4.3 AND ONLY PARTS OF THE OTHER SEQ! IONS. This chapter explains how the performance of the economy is measured. I Major macroeconomic goals or objectives are outlined. 0 Explain the various criteria. concepts and techniques which are used to assess the performance of the economy We ecu-aw; 4.1 objectives: There are five (1) Economic Ewth: In a growing economy the total production of goods and services w increase from one period to the next. If the population is growing and there is no economic growth then average living standards cannot increase. 9? (2) Full em in merit: Ideally all factors of production should be fully Q/f employed especially labour. Unemployment has serious costs to both the people and the society as a whole, both psychologically and financially. (loss of self esteem. increase family abuse and crime) (3) Price stability: In a market economy prices should change in response to supp y an emand. The process of increases in the ggneral level of prices is called inflation. The objective of price stability is to hot: rices as low as possible. To see what is happening to prices there must 53' a measure or yardstick of movements of all prices in the economy. The most important yardstick is Consumer Price Index or CPI. (4) Balance of Primate: because South Africa interacts with the rest of the world through exporting and importing it must be able to deal in foreign exchange. Vbfi‘eucrozs M Vocalist: Eng-2&2. (5) Equitable distribution of income: This is a normative iSsue. This is km W distribution of income tends to generate social and political conflict. It can also have important effects on the structure and development of the country. 4.2 Measuring the level of econoruic activity: gross domestic product ECSIOZ The first step in measuring economic growth is to determine a country’s total production of goods and services in a specific period. This complicated task is performed in South Africa by the national accounting sections of Statistics South Africa and the South African Reserve bank (SARB) j He central concept in the national accounts is the gross domestic product (GDP) Thegross domestic product is the total value of all the final goods and s'eT-v-ices produced within the boundaries of a country in a particular PE—"O - “Snail! one lean) ~~ --—-r»»~—------ GDP is one of the most important barometers' of the performance of the economy. We have to examine the various elements of the definition of GDP. The first most important element is value. A value must be assigned to all the different goods and services that are produced. For examples we can’t add up skirts, medical, mining. housing without assigning a value to it. The solution is to use the prices of the various goods and services to obtain value. The second important element is the word final. One of the major problems that the national accounts. has to deal with is the problem of double accounting. See example on pg 64 (88) To avoid the problem of double accounting, the national accountants use the concept of value added by each of the participants in the production process. See table 4-1 pg 64 (89) Notice that the value of the shopkeeper’s sales is exactly the same as the final consumers also amounts to R2l 000. Hence the term final. Double accounting can also be avoided by only counting the value of those sales where a good or services reaches the final consumer. if gs, "more coo ECSIO2 10 Such sales involve final goods and services that have to be distinguished from intermediate goods and services. Intermediate goods do not_fo_r1;n_ part of GDP. Note it is the ultimate use of a product, which determines whether it is a final good or intermediate. if flour bought by consumer to bake bread it is final good But if a baker buys flour to make bread for final consumption. It is an intermediate good. If the flour is not sold during the period in question then it becomes part of inventories. This becomes investment in the national accounts. A final method is igggmes canted during the various stages of the production process by the owners of the factors of production. See pg 64 (89). Note the income earned during each stage is eg ual tthe value added during each stage. - There are three methods of calculating 0 The production method (value added) u The expenditure method (final 5 and services) 0 The incomes method (incomes of the Ifactors of production. - The three methods measure the same thing although at different points in the circulation. - See pg 55 (91) Measurement at market prices, basic prices and factor cost (or income) - The three sets of calculating GDP will only yield the same result if the same set of prices is used in all calculations. C There are three sets of prices (1) Market Prices $2 (2) Basrc prices / (3) Factor cost. easnreme ECSIOZ 11 The differences are glue to taxes and subsidies on goods and services Indirect taxes (taxes on production and products, VAT, Sin Taxes (50% of market price of a packet of cigarettes in SA is excise duty and VAT. Indirect taxes thus have the effect of making market prices for goods and services higher than their basic prices. Subsidies: The opposite happens here. The result is that market prices are lower than basic prices at factor cost. Subsidy on bread made it cheaper than the cost of production. The national accounts distinguish between two types of tax and subsidy on production and products 0 Taxes on products: VAT, excise duties, sin tax I Other taxes on production: Taxes on land, buildings. professional services. I Subsidies on products: direct, payable per unit exported, to encourage exports. - Other subsidies: employment eg. learner-ships at the moment. c The following identifies apply see pg 67 (94) of carton fines and ns t ' es GDP at current (nominal prices face value of rand). See box 4-1 pg 68 (96) GDP at constant prices (real prices, purchasing power) It makes little sense to compare monetary values between different years, especially in light of inflation ECSIOQ 12 4.3 Other measures of production, income and expenditure GDP measures total income and production within the borders of a country Economists want to know what happens to income and standard of living for all South Africans. This is measured by the Gross National Income (GNI). Take GDP add all the income. profits etc abroad of all the permanent residences abroad and minus income, profits etc all the foreign organisations within SA (see pg 71 (99) Primary income payments: the remuneration earned by Foreign — owned factors of production in our economy. Primary income receipts: the remuneration of South African factors of production earned in the rest of the world. Foreign involvement in the domestic economy has always been larger titan the involvement by South African factors of pmdriirtion in the rest of the world. In South Africa GNI has always been smaller than GDP Economists use both GDP and GNI when analysing or measuring the state of the economy. GDP best measure the level of economic activity of a country and ot‘ the potential for creating jobs. GNI (or GNP) measures the standard of living or income of the citizens of a country. To get around this the national accountants and SARB covert GDP at current Expenditure 01‘ GDP prices to GDP at constant or real GDP . 0 One of the three approaches for measuring GDP was the expenditure method 0 A base year is chosen. In SA it is 1995. - The national accounts add up all the spending of: 0 Each year is expressed in 1995 prices 0 The households: Consumption C 0 Once adjustment was made it was found that there was a difference of 3% between 2002 and 2003. In current or nominal prices the increase was 11.8%. 0 The difference can be attributed to inflation. See table 4-2 pg 69 (9?) Firms: Investments 1 0 Government: G w L) ECSIOZ 13 ECSIOZ 14 6 And the foreign sector: exports X, onparrs Z a The difference between GDP and GDE is reflected in the exports and imports. 0 GDP = expenditure on GDP | I Note if GDP is greater than GDE than exports are greater than imports. The opposite occurs if GDE is greater than GDP. = C + I + G + X - Z I - GDP at market prices = GDE + X — Z I See table 4-3 pg 72 for SA spending on GDP . 0 GNI (GNP) at market prices = GDP at market prices — net primary .income 0 Gross capital formation needs clarification ' payments - Capital Furmation or investment is the additions to the country capital - . - \v m- a mm L. 0M 6 stock or purchase of capital goods 4 4 Measuring employment and unemployment a Iticéi c e 133% my a wd‘ . . .. . manner. A 0 Gross capital formation is subdivided in the national accounts into two . 0 In prinCIple It Is qulte easy to measure employment and unemployment. components. It To measure employment you just have to find out how many people have ‘ jobs at the time the measurement is done. - Fixed capital formation such as buildings, machinery and equipment I You must find out how many people are willing and able to Work but do not have jobs at that time. 0 Changes in inventories: Goods produced in a period that have .3. not been sold or goods produced in an earlier period but only sold - The number of unemployed persons can then be expressed as a percentage during current period. Can be positive or negative ' of the total number of people who are willing and able to work. - Note imports are not included in GDP because they are produced in o This percentage is called unemployment. the rest of the world. — In practice employment and unemployment in the economy are quite - Expenditure on GDP includes only that spent on South African difficult to measure. goods and services. ' 0 One needs to ascertain when exactly a person is employed Gross Domestic Expenditure (GDE) 0 What about part - time or seasonal workers? Are housewives employed or ‘ - GDE = GDP at market prices unemployed? What about someone who does not have a job but is not _ actively looking for one? What about street vendors, drug dealers or even 0 That is die total spending within the borders of the country prostitutes. - Economists are interested in GDE because it represents all the spending within the o These all make it difficult for the government agencies to measure. borders 0 Employment and unemployment will be discussed in chapters 5 and 22 9 It includes imports but excludes exports since spending on exports occurs outside the borders of a country. 4.5 Measuring prices: the consumer price index. (CPI). This section forms art «5?? O GDE = C + I 4G (Includes imports but excludes exports) of unit 9. “bar .3 5.; \m {on} M; \er'ans .; \I-J \t‘i ¢i\.c..t_._.'tc,at.lce:. $9 0 GDP = C + I + G + (X -— Z) (Includes exports but excludes imports) O Inflation is usually measured by calculating the rate of change in the consumer price index. - NO 0? anivigdoifllj tried: ECSIOZ s;- 4.6 l gr; 3 4.7 MEA 15 (EUR Em: You need to be able to defi...
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