PAPER 1

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Circular Flow Model (Open)

The circular-flow model of the economy is a simplification showing how the economy works and the relationship between income, production and spending in the economy.

Includes the foreign sector.

Participants:

Households / Consumers:

Flow of money and goods and services between consumers and businesses.

Households own the services of factors of production and offer them on the factor market.

Households earn an income, in the form of wages, by selling their factors of production to businesses.

Businesses / Firms:

Businesses use factors of production to produce goods and services

They offer these goods and services on the product market

Households use the income they earned to purchase the goods and services

Thus businesses earn an income

State / Government (relationship with households):

The households provide the state with labour and in return receive an income (salaries/wages).

The state provides households with public goods and services, e.g. parks, hospitals.

Households pay income taxes to the state.

Thus the state earns an income

State / Government (relationship with Businesses):

The business sector provides the state with goods and services for which the state pays.

The state provides the business sector with public goods and services, e.g. roads, electricity.

Businesses pay company taxes to the state.

Thus the state earns an income.

Foreign Sector (ONLY IN OPEN ECONOMY):

There is a flow of goods (imports) to the business from the foreign sector.

Businesses that import these goods, pay for it (expenditure)

There is also a flow of goods (exports) from the business in the country to the foreign sector.

Businesses export their goods and services to other countries and earn money for it (income)

Financial sector:

Consists of banks, insurance companies and pension funds.

Links households and firms who have surplus money to others who require funds.

The money which households and firms provide to the financial sector is known as savings.

Businesses can borrow money from financial institutions to purchase capital goods (investments).

Real Flow:

Consists of all goods and services (incl. public), factors of production, exports and imports.

Money Flow:

All income for households, businesses, government and foreign sector.

EQUATIONS:

Leakages (L):

The withdrawal of money from the economic cycle.

Domestic purchases on goods and services decrease.

Consists of:

Taxes (T) - less disposable income.

Imports (M) - Not all consumption is produced domestically.

Savings (S) - part of income which is not spent.

Equation:

L = S + T + M

Injections (J):

Refers to the injection of money into the economic cycle

Additional money that enters the economy and increases income.

Domestic purchases on goods and services increase.

Consists of:

Government Spending (G)

Exports (X)

Investments (I)

Equation

J = I + G + X

Equilibrium and disequilibrium:

The economy is in equilibrium when leakages are equal to injections.

The economy is in disequilibrium when leakages are more than injections or injections are more than

leakages.

National Income increases when Injections are more than Leakages (J > L):

Contributes to additional demand, which needs to be satisfied.

Leads to an increase in the production of goods and services.

Thus greater income generated

National income decreases when Injections are less than Leakages (J < L):

Contributes to decreased demand

Leads to a decrease in the production of goods and services.

Thus less income is generated

The formula to calculate total income:

Y = C + I + G + (X - M)

Income (Y) is equal to Expenditure (E)

Interpretation of graph:

Expenditure (E) is the vertical axis.

Income (Y) is the horizontal axis.

E = Y and it is separated by a scale line.

It halves the 90° angle into two equal portions of 45° each.

Aggregate expenditure (AE) = C + I + G + (X - M)

This curve shows the amount which consumers (households), producers (firm), government (state)

and foreign sector plans to spend at every level of income.

Also equals aggregate demand.

If planned AE increases to E1:

- This means more money is injected into the economy than what is leaked out.

- This causes an increase of Y to Y1.

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Markets:

Goods / Product markets:

Goods are defined as any tangible items such as food, clothing etc, that satisfy some human

wants or needs.

Services are defined as non-tangible actions and includes retail, transport

and financial markets.

Consists of:

Capital goods - Building and Machinery

Consumer goods

- Durable (Car)

- Semi-durable (Tyres)

- Non-durable (Petrol)

Factor Market:

Includes the labour, property and financial markets.

Households sell factors of production on the factor market:

Rent for natural resources

Wages for labour

Interest for capital

Profit for entrepreneurship.

Money markets:

Short term loans and very short term funds are saved and borrowed by consumers and business enterprises.

Products sold in this market are bank debentures, treasury bills and government bonds.

The SARB is a key institution in the money market.

Capital markets:

Long term funds are borrowed and saved by consumers and business enterprises.

Products sold in this market are mortgage bonds and shares.

The Johannesburg Security Exchange (JSE) is a key institution in the capital market.

Foreign exchange markets:

Market businesses buy/sell foreign currencies to pay for imported goods and services.

These transactions occur in banks through electronic money transfers

The price to pay for another currency is called the exchange rate.

Exchange rates are determined by the forces of demand and supply, and influenced by the volume of exports and imports.

The most important foreign exchange markets are in London / New York / Tokyo.

Autonomous consumption

Expenditures consumers must make, even when they have no disposable income.

When a consumer is low on income, they will need to use their savings or borrow money to pay these expenses.

An example is rent or food.

Marginal propensity to consume

Marginal propensity to consume (MPC) refers to the proportion of extra income that a person spends instead of save.

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National Accounts:

The aim of National accounts:

To provide a systematic and comprehensive record of national economic activities.

Explain the purpose of the System of National Accounts (SNA) as outlined by the United Nations (UN)

The SNA's purpose is to follow international economic guidelines in order to report accurate statistics to international organizations in order to fairly compare South Africa to other countries

Composition of national accounts

Gross Domestic Product (GDP)

The total value of all final goods and services produced within the

borders of a country for a specific amount of time (usually a year).

Gross National Product (GNP)

The total value of all final goods and services produced by the permanent residents of a country for a specific period, no matter where in the world they are.

3 Methods to calculate GDP

1. The production method (value added approach / method):

GDP is determined by calculating the sum of the value added at each stage of the production process.

Yields GDP at basic prices.

Quantity multiplied by market or production price.

The value of intermediate goods and services are not included in the calculation.

2. Income method (approach):

GDP measures the total remuneration earned by the owners of factors of production, within the borders of a country, for their services over a period (usually a year).

Provides GDP at factor cost.

3. Expenditure method (approach):

GDP measures the total value of expenditure on final goods and services, at market prices, within the geographical borders of the country in a specific period of time.

The spending of the three participants in the economy are added together.

National Account Conversions:

South Africa uses the NATIONAL ACCOUNT SYSTEM (SNA) SYSTEM

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Basic Prices:

Indirect prices and subsidies are related to production process and not individual products.

• With the production method, taxes on production are a cost(-) and subsidies on production are an income(+).

• Taxes on production are payroll taxes (SITE and PAYE), recurring taxes on land & buildings,

Business licenses and other licenses.

• Subsidies on production include employment subsidies and subsidies paid to prevent pollution.

Factor Cost

GDP at basic prices - taxes on production + subsidies on production = GDP

at factor cost (factor income).

Market Prices

Basic prices to market prices: GDP at basic prices + taxes on products - subsidies on products (opposite of factor costs but with products)

Factor cost to market prices: GDP at factor cost + taxes on production - subsidies on production

Conversion of Domestic to National figures (GDP to GNI)

Domestic figures is the income and production happening within the borders of the country.

National figures is the income or production by south african's no matter where they are in the world.

Nominal figures

Inflation has not yet been taken into consideration.

Known as national product at current price.

Real figures

Inflation according to consumer price index (CPI) has been taken into account.

Known as national product at constant prices.

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The Multiplier

An increase in spending (injection) produces a proportionately larger increase in national income

Always more than 1

The multiplier in a two-sector model (Households and Firms):

Derived from marginal propensity to consume (mpc)

The larger the mpc the bigger the multiplier (vice-versa)

In the graph above

• E = Original equilibrium

• Y = Original income

• AE = Aggregate Demand is illustrated by C + I + G

• ∆ I = ∆ G

• Investment spending (I) is added

• Total spending at each level of income (Y) increases with the amount of Investment

• Government Investment increases

• The AE curve shifts upward to AE1

• The multiplier causes that Y increase to Y1

• Planned spending determines aggregate demand

Explanation of the Multiplier Effect

• The multiplier relates to how much national income changes as a result of an injection or withdrawal

(such as an investment)

• Initially there is an increase in injections into the economy (investment, government spending or

export income), which would lead to a proportionate increase in national income

• The extra spending would have knock-on effect and create even more spending

• The size of the multiplier will depend on the level of leakages

(E.g.) assume firms increase investment spending by R1000. This is done by ordering capital goods

from domestic firms to the value of R1000.

• Total spending has increased by R1000. Total production has increased by R1000, which also

leads to an increase in R1000 in income. The increase in spending = the increase in production

which = an increase in income.

• When households earn income (R1000) leakages can occur, through income tax, savings and

spending on imports.

• If this amounts to R300, then spending on domestic goods will increase by R700. At this stage the

multiplier starts to kick in.

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COMPOSITION AND CHARACTERISTICS/FEATURES OF BUSINESS CYCLES

Business Cycle Definition

The phenomenon of successive periods of increasing and decreasing economic activity.

Nature of business cycles

Changes in economic activity are recurring but never of the same magnitude

The duration and amplitude of every business cycle will be different

Characteristics of business cycles

• The length of the business cycle is measured from peak to peak or from trough to trough.

• The entire period from the peak to the trough is known as the downswing.

• The entire period from the trough to the peak is known as the upswing.

• The period immediately before and through the upper turning point of the cycle is called the boom.

• The period immediately before and through the lower turning point is known as the slump.

• The distance of the peaks and troughs from the trend line is known as the amplitude. It shows the

severity of cyclical fluctuations

Phases of business cycles

Recovery phase

Starts once a trough is reached and the level of economic activity starts to gradually increase

Greater demand for goods and services

Leads to an increase in production

More jobs are created

Business confidence rises and there is increased spending by firms and households

Increased economic activity and the country enters into a period of prosperity.

Prosperity phase

Great degree of optimism in the economy

Bank credit is extended so investment increases

Employment levels rise, this results in an increase in salaries and wages and spending increases as

household’s disposable income increases

Imports increase

A peak is reached

Due to large amount of money in circulation, inflation occurs

Leads to a recession

Recession phase

A recession phase is when there is negative economic growth rate for two consecutive quarters

Introduced by a decrease in the profits of businesses due to inflation and over production

Firms retrench workers since fewer goods and services are produced, increasing

unemployment

Gives rise to a feeling of pessimism

Income of households decrease and spending declines.

A decrease in economic activity resulting in a decrease in GDP

As the contraction phase worsens, households and firms obtain less credit and loans from banks

Results in a depression

Depression phase

Money is in short supply, leading to a further decline in spending

Negative impact on investment spending

Economic activity is at its lowest, thus a trough is reached

Competition for employment leads to serious levels of unemployment

Cost of production decreases

This encourages foreign trade and leads to a recovery

Also called the Sunspot Theory

Believes that markets are inherently stable

Deviations from the equilibrium state are caused by exogenous factors (factors outside of the

market system)

When disequilibrium exist in the economy, market forces (supply and demand) kick in and bring the economy back to equilibrium

Governments should not interfere in the markets.

The straight bold line indicates the natural growth of the economy.

Causes of economic fluctuations

1. Inappropriate government policies

2. Undesirable changes in money supply

3. Weather conditions, e.g. droughts and floods

4. Shocks, e.g. sudden increases in the price of fuel or a war

5. Structural changes in the economy (e.g. electronic development)

Also known as the Keynesian approach or Interventionism

Holds the view that markets are inherently unstable

Level of economic activity tends to be continually above or below its potential

Governments must intervene in the economy

They intervene through Monetary and Fiscal policies

Business cycle is an inherent feature of market economy.

The potential growth path is indicated by the thin black line

The cyclical bold line around the thin black line indicates the real path of the economy

Types of business cycles

Business cycles

±60 months

Clear expansions and contraction periods

Kitchin cycles

Between 3 to 5 years

Happens when businesses adapt their inventory levels

Jugler cycles

7 to 11 years

Caused by changes in net investments by business and the government.

Kuznets Cycles

15 to 20 years

Caused by changes in the building industry

Also called building cycles

Kontratieff Cycles

Last 50 years and longer

Caused by technological innovation, wars and discoveries of new deposits (eg gold)

GOVERNMENT POLICIES USED TO SMOOTH OUT BUSINESS CYCLES

Fiscal policy

used to stimulate a depressed economy

Stimulate private sector demand

Increase in unemployment is an indicator

1. Decrease Taxation (↓T)

Households and producers have more disposable income

An increase in consumption spending (C) which leads to an increase in demand

The economy is stimulated, leading to employment.

2. Increase government spending (↑G)

Achieved with borrowed money due to deficit on the budget.

Total spending increase and demand increase.

The economy is stimulated and employment increase.

3. Increased government spending and decreasing taxes simultaneously

Double strength effect.

Govt spending increases

Consumers and producers have more disposable income

Demand increases

Employment increases

Reduce private sector demand

Inflation is the indicator

1. Reduce government spending (↓G)

Unspent money is preserved (Frozen)

Total spending decreases

Demand decreases

Inflation will decrease

2. Increase taxation (↑T)

Tax income is preserved (frozen)

Consumers and producers have less disposable income to spend on goods and services

Demand decreases.

Inflation will decrease

3. Reduce government spending and simultaneously increasing taxation

Double strength effect

Government spending decreases

Consumers and producers have less money to spend on goods and services

Demand decreases

Inflation decreases

Monetary policy

Monetary policy uses interest rates and money supply to expand or contract aggregate demand

1. Interest Rates

Overheated economy / Boom

Increase interest rates

Decrease money supply

This will make credit more expensive discourage consumer credit

Demand will decrease

Recession / Slump

Decrease interest rates

Increase money supply

This will make credit cheaper and will promote consumer credit

Demand will increase

Stimulates economy

2. Cash reserve requirements:

Banks are required by law to keep cash reserves at the SARB

SARB can increase or decrease these cash reserve requirements

Overheated economy / Boom

An increase in the cash reserve requirements - decreases the supply of capital to commercial

banks, thus banks have less money to lend to consumers

Demand will decrease

Recession / Slump

A decrease in the cash reserve requirements – Increase in the supply of capital to

commercial banks, so that banks have more money to lend to consumers.

Demand will increase

3. Open market transactions:

The SARB can directly increase or decrease the amount of money in the economy.

Overheated Economy / Boom

They can sell government bonds on the open market to reduce money supply

Recession / Slump

They can buy government bonds on the open market to increase money supply

4. Moral persuasion

The SARB can enter into discussion with banks to morally persuade them to limit credit and cooperate to fight inflation

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Definition of forecasting

Making predictions about changing conditions and future events that may significantly affect the economy

Leading economic indicators

Indicators that change before the economy changes

When these indicators rise, the level of economic activities will also rise in a few months’ time (E.g. inventory)

Lagging economic indicators

Do not change direction until after the business cycle has changed its direction

They serve to confirm the behaviour of co-incident indicators (eg Investment in capital goods

Co-incidental economic indicator

Move at the same time as the economy

Indicates the actual state of the economy (eg value of retail sales)

Composite indicators

A single value consisting of a group of various indicators. Forms the no. of years it takes for the economy of get from one peak to the next

Longer cycles show strength and shorter cycles show weakness

Amplitude

The amplitude measures the distance from the trend line to the peak or trough

A large amplitude during an upswing indicates strong underlying forces – results in longer cycles

Trend line

Represents the average position of a cycle

Indicates the general direction in which the economy is moving

Trend line usually has a positive slope, because production capacity increases over time

Extrapolation

It is when forecasters use past data to make predictions

Moving average

A statistical tool that analysis changes in the business cycle

LABELLING OF BUSINESS CYCLE

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PUBLIC SECTOR

Levels of Government

Central Level

President who governs the country

Provincial Level

Minister manages their province

Local Level

Mayor manages their community

Public Corporations/(SOEs - State owned enterprises)/Parastatals

Eskom

Necessity of the public sector

To supply public goods

Mostly in the form of services

Funded by government spending and taxes

Public goods and services consist of

- Community Goods (eg Police)

Non- excludability - anyone can use them for free

Non- rivalry - If one person uses it, it does not stop another person from doing so

- Collective goods (eg Beaches)

People who do not want to pay can be excluded by levying fees

- Merit goods (eg Education)

Merit goods benefit society more than private goods

If the public sector does not provide them, then there will be an undersupply

They generate little income

- Non-Merit goods (eg Cigarettes)

Harmful and oversupplied

Government impose taxes and regulations to discourage consumption

To conserve resources (eg air that we breathe)

Government set laws in order to protect the environment and economy

PROBLEMS OF PUBLIC SECTOR PROVISIONING

1. Accountability

Accountability means that it's expected of a person to explain their expenditure

State enterprises are not directly accountable to the taxpayers

People want to be sure that the government officials do not abuse their power

through corruption, nepotism and incompetence

State officials often act to benefit themselves, instead of the public

State officials do not have to set profit or loss statements.

2. Efficiency

Inefficiency means that goods and services are not produced in the desired quantity and quality

Public goods and services are efficiently produced when the Pareto efficiency is achieved

Pareto efficiency: It is impossible to make someone better off without making the other worse

off

3. Assessing of Needs

In the private sector, supply and demand forces determine the prices of goods and services

These forces communicate the needs of consumers to businesses

State Enterprises are not run by the forces of supply and demand

Government provides goods and services according the needs of people

It is difficult for government to determine the needs, that is why public goods and

services are sometimes over or under supplied

4. Pricing policy

The state does not operate within the market system of demand and supply

Prices can be overvalued or undervalued

5. Semi State Enterprises (SSE) (Parastatals)

As a result of Nationalisation, Government Controlled Enterprises (GCEs) are created due to the

necessity for service delivery

Many GCEs obtained exclusive rights and later became Monopolies

They encountered large losses and it placed a huge financial burden on government (i.e tax payers)

Some of these SSEs function inefficiently which also puts pressure on the economy

6. Privatisation

Refers to the transfer of functions, activities and ownership from the public sector to the private sector

Aims of Privatisation

To improve the overall efficiency and performance of the economy

To broaden the economic base so tax levels can be reduced

Stimulate the growth in the private sector

Reduce size of public sector

Arguments in favour

Broadens the tax base which leads to an increase in government income

Improves the efficiency of the economy

Attracts foreign investment

Reduces pressure on government’s budget

Promotes Black economic empowerment

Reduces personal income tax and government debt

Arguments against

Public monopolies are replaced by Private Monopolies

Contributes to unemployment

No capital investment

7. Nationalisation

Refers to the transfer of functions, activities and ownership from the private sector to the public sector

Regulation

Refers to the deliberate actions to put laws to regulate economic activities

Deregulation

Refers to the removal of all unnecessary restrictions placed on economic activities by government

MACRO-ECONOMIC OBJECTIVES OF THE GOVERNMENT

Economic Growth

Refers to an increase in the production of goods and services

Measured in terms of Real GDP

Economic growth rate must be higher than population growth

Leads to a higher standard of living

Job creation

It is when all the people who want to work, who are looking for work must be able to get work

Informal sector activities must be promoted because it is an area where employment increases

High levels of employment are the most important economic objective of the government

Exchange Rate Stability

Fiscal and Monetary policies must be used to keep the exchange rate relatively stable

The SARB changed the Exchange rate from a Managed floating to a Free floating exchange rate

Price Stability

Stable prices often leads to job creation and economic growth

The SARB inflation target is 3% - 6%

Repo rate control is the main instrument in stabilization policy

Economic Justice

Redistribution of income and wealth is essential

South Africa uses a Progressive Income Tax system to finance Basic economic services (eg cash grants)

Progressive taxation means that higher income earners pay more tax

BUDGETS

Definition

A document with projected income and expenditure

The most important item on the economic calendar

Signed by the President: Becomes Law

Importance of the Budget

Long term planning: Departments need to know before the time of their future involvement

Certain sectors need to know in advance so that they can adapt their capacity

Minister of Finance finalises the budget

Financial Considerations

Cabinet decides whether taxes should be increased or decreased

Economic Considerations

Cabinet must know the requirements of the economy and taxes and spending must meet

these requirements

Political Considerations

Political parties use the budget to implement their policies

Different Types of Budgets

Medium Term Budget Policy Statements (MTBPS)

Delivered in October

The Minister of Finance informs Parliament of any economic changes since February

Medium Term Expenditure framework (MTEF)

Multi-year public expenditure plan used to set out future budget requirements for existing services, aswell as resource implications of future policies and programmes

Conditional grants

The deficit rule

Shortages on the budget should not be more than 3% of GDP

The borrowing rule

Borrowing must only be used for capital expenditure

The debt rule

Public debt should not exceed 60% of nominal GDP

FISCAL POLICY

Description

It is any attempt by the State to influence the economy with changes in government expenditure and taxes

to achieve economic and social goals

Characteristics

Goal bound

Central government determine the economic and social goals through the budget

Provincial and local governments execute the approved budget

Demand biased

Fiscal policy is the main demand-side policy that is used

Elements of fiscal are also used to realise supply-side objectives

It is cyclical

Businesses have a direct effect on fiscal policy

During an upswing:

• Profits increase.

• Aggregate demand and expenditure increase.

• Income tax and profits increase.

• Taxation on goods and services increase.

• Government income increases.

• Government has more money to spend

Main variables

Instruments of fiscal policy are taxation and government spending

When income and expenditure are equal = balanced budget

When expenditure is more than income = deficit

Government Spending

Government spends money to provide public and merit goods and services free of charge or at a

subsidised price

To redistribute income

Taxation

Governments impose tax for the following reasons

• To raise income to cover expenditure

• To discourage the use of demerit goods

• To prevent pollution

• To discourage imports

• To redistribute income

• To influence the level of aggregate demand and aggregate supply

State Debt

Main Budget must always balance:

• If there is a deficit, loans are made to balance the budget

• If there is a surplus, then the money is used to pay off state debt

• Loans add to loan debt also known as public debt

Effects of Fiscal policy

• During an upswing fiscal policy contract

• During a downswing fiscal policy expands

Income Redistribution

Regressive taxation

Causes an uneven distribution of income

Lower income groups pay more taxes than higher income groups

Progressive taxation

Ensures a more even distribution of income

Higher income groups pay more taxation than lower income groups

Proportional taxation

Income distribution is unchanged

Everybody pays the same tax rate

Incentives/Disincentives

Taxation

Direct taxation (income and company tax) reduce incentives to work, save, invest and take risks

High progressive income tax rates discourage people to enter the labour market, accept

promotions and work long hours

Reasons

• Less people want to work because of high taxation

• Some people will evade paying taxes

• If taxation is 100% then nobody will want to work, because ALL income goes to the State

• If Taxation decreases to t2:

- Leads to less tax evasion

- Leads to less tax evasion

- Encourages people to work harder / Save more / Invest more

• Economist use this to justify a reduction in the level of taxation

• The turning point of the Laffer curve is the same for all countries

PUBLIC SECTOR FAILURE

Description

When the public sector fails to manage the resources under its control optimally

Key features

Ineffectiveness

Missing targets (eg regarding inflation, growth and employment)

Incompetence in using monetary and fiscal policy

Inefficiencies

Wasting resources, such as taxpayers’ money

Reasons for public sector failures

Management Failures

Politicians tend to promote policies and spend money on projects if they can get votes in

return

These policies often lead to the inefficient allocation of resources

Many Public-sector entities lack capacity due to a lack of skills

Leads to unspent funds, which are sent back to treasury

Lack of Motivation

Frontline workers rarely receive incentives for successful service delivery

There are little stipulations on productive and quality service delivery leading to limited service delivery, low quality and high costs

Bureaucracy

Individuals and enterprises influence government to act in their interest (eg profitable regulations and contracts)

These promote the welfare of certain groups at the expense of the others

Politicians

Those who aim to be re-elected pursue vote-maximizing strategies to secure or retain their political offices. These are empty promises

Special interest groups

Attempts by groups such as farmers to influence government to their own advantage

Effects of public sector failure

Poor allocation of resources

When the government fails to allocate resources efficiently leading to resources being wasted

Economic instability

Government failure can lead to macroeconomic instability as the government will be unable to use the fiscal policy effectively

Distribution of income

If government doesn't use the tax system effectively there will be an unfair distribution of

income in the economy

Social instability

​​​​​​​When the public sector fails to deliver the required social services to the poor

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FOREIGN EXCHANGE MARKETS

Definition of international trade

The exchange of goods or services across international borders

Demand reasons for international trade

Size of the population

An increase in population leads to an increase in demand. If a country cannot satisfy this increase, goods need to be imported

Income Levels

An increase in the per capita income of people – More disposable income that can be spent on goods and services

Imports to satisfy increased demand

Change in the wealth of the population

An increase in wealth leads to a greater demand for goods

People have access to loans - can purchase luxury goods

If countries cannot supply these luxury goods – must be imported

Developed countries gain more from international trade than developing countries

Preferences and tastes

Plays a part in determining prices

The difference in consumption patterns

Determined by the level of economic development in the country

e.g. a poorly developed country will have a high demand for basic goods and services but a

lower demand for luxury goods.

Supply reasons

Natural resources

Unevenly distributed across the globe

Each country has natural resources that make it possible for them to produce certain goods and services more efficiently and at a lower price (eg Mining in SA)

Climatic conditions

Differences in climatic conditions between countries make it possible for some countries to produce

certain goods at a lower price than other countries ((eg Brazil is the biggest producer of coffee in the world)

Labour resources

Some countries have highly skilled labour with high productivity rates.

This enables them to produce goods and services at a lower price than they are produced in other

countries

Some countries have developed a skill for the production of a certain commodity (The Swiss - watch making)

Technological resources

Improved production processes, the availability of equipment and machinery all influence the supply of goods and services, widening the

differences between countries (eg Japan)

Enables them to produce at a lower unit cost

Specialization

A country with a specialization can take advantage of economies of scale and produce the goods at a cheaper unit cost (eg Japan and electronics)

Often results in mass production due to division of labour and mechanization

The same products become cheaper in some countries due to comparative advantages

Capital

More prevalent in developed countries

Some countries do not have the capital to produce the goods themselves, leading to imports

Lack of physical infrastructure in developing countries hinders local production

The effects of international trade

Specialisation

Increases the standard of living

Certain countries would not have certain goods without International trade (eg Namibia and oil)

Only the rich would have been able to access the global market

Mass production

When domestic demand is added to foreign demand

Required in the production of manufactured goods to make it affordable and profitable (eg computers)

Efficiency

International trade increase competition

Competition increases efficiency because it eliminates unnecessary costs

Leads to lower prices

Lower prices mean that the same income can buy more goods and services

Causes an increase in standard of living

Balance of payments composition

Current Account

International transactions in terms of production, income and expenditure

Capital Transfer Account

International transactions in terms of ownership of fixed assets

Financial Account

International investment in and out the country by foreigners and South Africans

Unrecorded transactions

Any omissions

Ways to make corrections on the Balance of payments

Borrowing money from the IMF

Increase in tax which reduces disposable income and decreases demand of imports.

Increase in import tariffs

Currency Depreciation - makes imports more expensive and exports cheaper

Devaluation

When foreign reserves are low, countries lower their currency value

Attracts investment and lowers imports (leakages)

Revaluation

When foreign reserves become too high, countries increase their currency value

Increases imports and lowers investments (leakages)

Foreign Exchange Control

Various forms of control imposed by government on the purchase or sale of foreign currencies by private

residents.

Exchange Rate Systems

Free Floating

The value of the currency is determined purely by market forces of D & S

Managed floating exchange rate system

When exchange rates are determined by market forces but under limits set by Central Bank

Fixed exchange rate system

The value of the currency is fixed

Avoid uncertainties

Terms of Trade

Definition

Compares a country’s export prices with its imports prices by means of indexes

Formula is E/I x 100

Effect on economy

Improvement of terms of trade

Improvement in welfare

Increase in export prices

Decrease in import prices

Deterioration of terms of trade

Means a country is poorer

Decrease in export prices

Increase in import prices