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3.2 p47 The Interdependance between Households and Firms.
1. 2 Major sectors of economy are :Households and Firms, of:
2. 5 Major Sectors of economy-
2.1. households
2.2. firms
2.3. government
2.4. foreign sector
2.5. financial sector
HOUSEHOLDS
1. Households:all the individuals who live together and make joint economic decisions,or others make for
them./individuals,consumers/interchangably used terms.
1.1. joint income+-
1.2. primitive times no Gov,foreign sector,firms etc
1.3. members are consumers-consumption
1.4. Are the basic units in an economic system
1.5. Own the FOP and sell these factors to Firms,receive income and buy consumer goods +services,consumed to
satisfy human wants/needs.
2. In mixed economy-Households own most FOP/own labour/own capital goods/eg;anglo american-owned by
shareholders.
CONSUMERS:
3. Total consumption Expenditure(or aggregate C.E)=total consumption /spending in economy(on consumer goods and
services by households).
3.1. Symbol="C"
4. In market economy consumers determine what should be produced.
5. In economic analysis we assume consumers are rational-Max satisfaction for means at their disposal.
6. FOP cannot satisfy human wants directly-thus sell to firms to convert.-Income from fop flows from.
FIRMS
1. Definition of firms:The unit that employs FOP to produce goods and services that are sold in the goods market.
2. Characteristics of firms:
2.1. basic productive unit in the economy
2.2. are actually artificial units
2.3. ultimately owned /operated by individuals/households-eg shareholders
2.4. Assumption is that rational-aim to max profit.
2.5. Profit=total revenue-explicit cost
2.6. "I"=capital formation or investment. (in capital goods)
2.7. purchase fop on the 'factor markets'
2.8. Decide what+/how+/+to whom distribute from 3-central questions in economics.
TYPES OF FIRMS:P50 BOX
Individual /Sole proprietorship
1.1. All decisions +ownership vested in single person
1.2. Main weakness unlimited liability-owner responsible all debts+liabitities of firm.
1.3. Relatively easy to form /dissolve
1.4. Suited activities require personal supervision,where: scale of operations,and financing requirements not large.
1.5. Has no separate existence from owner-assets of firm are assets of owner.
1.6. Limited liability to raise funds for expansion
1.7. eg : shops,hairdressers,farms,plumbing services.
Partnerships:
1.8. Suited to all activities needing specialised abilities-benefit from specialisation.
1.9. Differs little from sole proprietorship.
1.10. Action of partners binding on other partners including unlimited liability.
1.11. Partners are joint owners of firm.
1.12. Exept for a bit better financing possibilities ,same liability +other of sole proprietorship.
1.13. eg:attorneys ,accountants,doctors,etc.
Companies
1.14. Identity in eyes of law separate from owner.
1.15. Least risky form because liability usually limited to value of shares owned.
1.16. Attract better financing through eg: shares ,bonds,bank credit.
1.17. Separation of owner /mangement can create problems.
1.18. Specialists can be employed to manage firm.
1.19. Can be sometimes abused by unscrupulous people.
1.20. Significant red tape to establish.
1.20.1. TWO TYPES: PRIVATE company:
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a. Max 50 members
b. Right to transfer shares restricted
c. Only must have 1 member
d. (Pty)Ltd in RSA:Proprietry limited.
e. eg:Alusaf (Pty Ltd),Clicks stores(Pty Ltd),Johnson tiles(Pty Ltd)
1.20.2. PUBLIC company.
a. Not fewer than 50 shareholders
b. Any max shareholders
c. Company that wishes to raise finance through the issuing of shares thus shares easily transferable.
d. Shares easily transferable
e. Many listed on JSE
f. eg:Anglo american,Remgro,Old Mutual,Sappi
1.21. many foreign owned or multinational companies operate in RSA eg:siemens,microsoft,shell,ibm.
Close Corporations.
1.22. Since 1985 RSA new type.
1.23. Display cc after name ,must by law.
1.24. Easier to establish than private or public companies.
1.25. max 10 min 1 members.
1.26. Each member "% Specified interest in close corporation."
1.27. Can only dispose of interest with permission of other members.
1.28. Created to afford advantages of companies without having to register as a fully fledged company under the
companies act.
1.29. By 1990 more CC's than companies in RSA
Other forms of Business enterprise :
1.30. Co-operatives(eg agriculture)
1.31. Trusts
1.32. Public enterprise (Gov.eg eskom,sabc)
1.33. Informal sector:spaza,hawker,shebeen,subsistence farmers.
Market Types;
Goods Market.
1.1. market for goods and services-consumers mostly buy.
Factors market
1.2. all factors of production markets
1.3. production /producers/firms mostly buy.
1.4. include labour market+capital goods market.
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The Circular flow of Income and Spending.
1. It's direction is OPPOSITE to Goods and Service flow.
2. Usually a MONETARY flow.
3. INCOME types from FACTORS OF PRODUCTION:
3.1. Labour =Wages and Salaries
3.2. Natural resources=Rent
3.3. Capital =Interest
3.4. Entrepeneur =Profit
3.5. Profit from fop also to households income,also rent,+interest+wages.
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FACTOR GOODS
MARKET MARKET
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4
Central gov.
all gov. depts also
CSIR,SABS,
universties
general government:
incl.provincial gov.=9 provinces
admin+local gov=muncipalities+district
councils
Public sector=
pubic corporations-eskom,transnet,sabc,rand water,post office,armscor,
(can be regarded as firms for purposes of our flow diagrams)
+all of other government parts=ALL OF
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10. Taxes are a leakage/withdrawal from circular flow of income between households + firms.
1. 4th major sector-foreign sector-consists of rest of world +international fin.istitutions governing flow of funds and
goods & services between countries.
2. 2 broad categories:developing countries+industrial countries
A. industrial countries: europe mostly-germany,italy,france,USA,Australia
B. developing countries:africa/asia etc-most south american +RSA=middle income,most poorestafrica-worst-
sierra leone,burundi,ethiopia
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3. World bank classifies its members into 4 groups(levels of income):low income,lower middleincome,upper middle
income,high income.
4. Industrial=all high income,Developing=all re
5. 'Open Economy'-strong links with rest of world-exp/imp/multinationals.
6. 'globalisation'-recent yearst middle/lows economic links between countries grown stronger.
i. economic/or political development can result in massive flows of funds between countries.
ii. many firms tend to look at whole world as market for their goods
iii. become very easy to shift funds between countries
iv. global village where firms from different parts of world must compete with each other.
7. A countries economic links with rest of world are often crucial determinants of level and pace of economic activity
in the domestic economy.
8. "Z" = Imports –rsa mainly capital &intermediate goods
9. "E"= Exports-rsa mainly gold & minerals
10. For exports the 'Spending ' originates in rest of world.-thus constitute an 'injection' into circular flow of income
=spending in domestic economy.
11. For imports 'spending' originates local, constitutes leakage from circ. flow inc.+spend.
12. Flow of income +spending is also in opposite direction to FOP and Goods +Services.
13. Most important international economic orgaisations:International Monetary Fund,World Bank,World Trade
Organisation.
14. Rsa most important trade partners =industrial countries=60%exports,66% imports----Africa to rsa=3% imports,18%
exports
Financial Institutions in the circular flow of income andspending.3.5t
Diagram: FINANCIAL INSTITUTIONS IN THE CIRCULAR FLOW OF INCOME AND SPENDING.
FIRMS
saving Investment
jjjjjjjjjjjjjjjjjjj
. Spending and Income
j Spending and Income
FINANCIAL
Saving
SECTOR
Total Production,Income,Spending-Revisited
1. Aggregate /Total producton=all prod in economy
2. Aggregate /Total Income = Rent-nat.resources + Interest-Capital + wages-labour + profit-entrepeneur
3. Aggregate/Total Spending= by 4 major sectors in economy=1-households-2-firms-3-government-4-foreigners
where(if one is trying to work out spending on (SA GOODS AND SERVICES) = spending on {SA GOODS AND
SERVICES Only}= E-Z = (spending by foreigners on rsa (E)Exports MINUS spending by rsa consumers on
(Z)Imports
4. Total Expenditure = C+I+G+ (X-Z)
5. (T)Taxes and (S)Savings and (Z)Imports represent = Leakages or Withdrawals.
Abbreviations of major Terms:
I=Investment in capital goods(machines,bridges,robots etc).
C=Households spending on consumer goods and services.
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G=Government spending on goods and services.
E=foreign spending on RSA goods and services.
Z=RSA spending on foreign goods and services.
S = Saving
S=
Total Expediture=
Total Expenditure on SA Goods&Services=(less imports)
Z FIRMS
G
C I
Foreign C Governmen
Sector C FINANCIAL SECTOR t
S
T
X HOUSEHOLDS
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SPECIAL SHORTENED NOTES:
1. TERM CPI Consumer Price Index:eg:127%is an index of the prices of a representative "basket " of consumer
goods and services: it thus represents the cost of the shopping basket of goods & services of a typical RSA
household.price (index=price/base price=eg127%).*100/1=% of base price
2. Inflation rate ={ cpi 2002 – cpi 2001 / cpi 2001 * 100 }
3. TO construct the CPI ,Stats SA must :
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a.
Select the "goods and services" to be included in the "Shopping Basket." : ..To select-Stats
SA does survey of household every 5 years.
b. Determine Weight of each good/sevice: ..Stats SA does a
survey 5 yrly to determine relative importance in Av. Consumers Basket.(how much of each do they use?)
c. Decide on a BASE YEAR for calculating CPI :
..Base year is year in which the Survey(5 yearly) is done
d. Decide on FORMULA for calculating CPI ..Standard
price index formula used,Weight of item decides it's effect on CPI,
e. Collect prices each month to calculate CPI. A_....RSA
1500 different goods&services,in -1- 40 groups/subgroups,for which a CPI is calculated for each one -2- 5
expenditure groups,pensioners,9 provinces+14 major urban areas.+metro+other urban areas+rural
B_Prices are collected by questionaire sent to 2200 retailers-110 000 quotations
per month and info. double checked.,Prices base on first 7 days of month.
#4 MACROECONOMIC OBJECTIVE: Balance of Payments
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CHAPTER 3 : THE MONETARY SECTOR.(MACROECONOMICS)
The Functions of Money:
1. TERM:Definition of Money:Money is any thing that is generally accepted for payment for goods and services or in
settlement of debt.
1-Money as a meduium of exchange:
1. An agreed/common unit of comparison of the cost of goods,anything can be a unit of account.2nd in importance to
no1 -exchange med- above.,Inflation can cause it to loose usefulness as unit of comparison a bit in terms of 'Real'
values.
3-Money as a Store of Value:
1. Standard of deferred payment(and interest),and
2. means whereby credit is granted.
What Money is Not:
1. Money is NOT : 1-Wealth(=assets,+ money) or 2-Income,Is not a Flow,is a Stock which can finance a much larger flow
of income.
Different Kinds of Money.
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TERM 1-Coventional measure:M1
1) M=C+D (Money quantity =Cash+demand deposits with monetary sector :only of domestic private sector-( see
:cheques etc accepted as payment.)
2) TERM :Demand deposits =91% of m 1 money in SA,refer to deposits can be withdrawn immediately.
TERM 2-M2
1) M2 =M1+all other short term and medium term deposits of the domestic private sector with monetary
institutions(more than 1.5 times m1 in SA) Short term=less than 30 days ,Medium term=less than 6 months.can only
withdraw sooner at a cost=Quasi money =nearly
TERM 3-M3
1) M3 =M2 + all long term deposits of the domestic private sector with monetary institutions.-maturity value longer than
6 months.
2) Most comprehensive measure of money.,also regarded as most reliable indicator.
3) Emphasis is more on store of value function as we move from m1-m2-m3,m3 most store function.
Financial Intermediaries.
1) Term Financial intermediaries main function is : to act as an intermediary between surplus units and deficit units in
the monetary economy.
2) TERMIndirect/Direct Financing:Indirect-through financial intermediatry/Direct –person to person
3) TERM Financial Transactions :Distinguished from real transactions by fact no goods/other services involved.
(distinction between 2 divides economy into real and financial sector)
4) TERM Real transactions :All transactions where goods and services are involved.(divides fin/real)
5)
6)
7) When the government borrows money, it uses treasury bills and government stock or bonds as security.
8) TERM Security or Credit instrument issued. In exchange for funds, a piece of paper issued,this document
stipulates the interest rate at which funds are loaned as well as when and how the loan is to be repaid. Examples of
credit instruments are bills of exchange, promissory notes, and bankers' acceptances. Government uses treasury bills
and gov.stocks and bonds.
9) Financial intermediatries includes:Insurers,pension funds,banks,unit trusts,finance companies,SARB.
10) TERM Interest is amount borrower must pay lender for use of funds concerned.
11) Banks can create money by granting overdrafts which is M1 money class.=D (of C+D=M1),and banks can do this
because need only keep % of deposits in reserve bank ,so can lend rest out.
12) TERM monetary base Also known as high-powered money. It usually refers to the stock of cash (notes and coins)
and includes the cash in the hands of the non-banking public, vault cash of banks and cash deposits with the Reserve
Bank
1) SARB t,primary goal in the South African economic system as "The achievement and maintenance of financial
stability".
2) TERM Monetary Policy-Definition:the measures taken by the monetary authorities to influence the 1--1-Quantity of
money or -2- Rate of interest to :
a) ..To achieve:-1- Stable prices -2- Full employment -3- Economic growth.(mis 1diff.earnings/2For.ex.
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3) 5 main functions of SARB
1) Issuing banknotes and coins Sole right in SA Bank purchases assets(gold etc) to get cash in general circulation
a) Acting as banker for other banks + clearing bank + lender of last resort
b) Acting as banker for the government.
c) Acting as custodian of countries gold and other foreign reserves.
d) formulating and implementing monetary policy. eg currently price stability main one in SA
Acting as banker for other banks
1) SARB holds minimum cash reserves for banks that they are required to hold.
2) TERM clearing bank :Acts as for banks by meeting the claims and obligations of banks by using their reserves.
3) TERM lender of last resort :to banks.(if banks need funds over and above that obtainable otherwise :eg from other
banks.)
4) financing of fin.inst. changed alot since 1990's-first rediscounting of assets+overnight loans,then:
5) TERM :(REPO)Repurchase tender system-Interest rate of SARB to Banks,(also how much is lent per time can be
controlled)
The Supply of Money.
2) For this we assume:M1=m=c+d,only banks hold demand deposits& a central bank controls banks.
Banks: in the money creation process.(role in supply)
1- Money is created by banks and not printing presses because accept surplas,lend to deficit
2- Only institutions allowed accept deposit from public, Banks activities regulated by Act,Monitored by SARBank.
3- The most notable feature of banks is able write a cheque to draw against account,or transfer on demand,therefore it
they be treated as money.-very convenient so little interest paid.
4- MONEY / Demand deposits can be created in tho ways:
a. Deposit=(^='change in') ^M=^C+^D so = -C1000+D1000=M0
b. Overdraft facilities. ^M=^C+^D so = C0 +D1000=M1000 -bank created credit
2-Reserve Asset position and Credit Multiplier:
1. TERM :Cash reserves : IN SA 2.5% of Total Liabilities WITH RESERVE BANK at 0 interest ;amount banks experience
know have pay
2. TERM CREDIT multiplier:=formula is 1/b R=D
a. b = % of deposits banks must keep in 'reserve bank' in RSA = 2.5%
b. R = b* D ( D = amount of a demand deposit invested in bank)
c. (deposit M=C+D)
d. (In RSA 1/b is 40) :
e. If a bank increases the reserve it keeps at the reserve bank(R) ,by multiplying that ammount by the Cred.
Multipl. you get the eventual amount of bank deposits , (D) ,that can be created by that increasing the
'cash reserve'.
f. ALSO: If someone deposits money in a bank,you can ALSO call that amount "R" , and by multiplying that
amount by the Cred. Multipl. you get the eventual amount of bank deposits,including the original one ,that
can be created by that deposit eventually.This works like that because only a certain percentage of each
deposit can be lent out to someone ,the rest must be banked by law in the reserve bank.Now if a bank
lends a % out of every deposit they receive ,those who lent this money pay others who re-deposit that
amount with other banks,which continues the cycle until no more bank deposits can be created from one
original deposit.
3. TERM:Classical cash reserve system :where gov. does control economy by changing the rate to be held in reserve
bank.TodayNot
BUT Under the present system the money supply process in SA is a function of demand for credit ,and this is
determined by the level of the interest rate of banks lending out money,and not by the amount of credit banks are able
and willing to extend. This reduces gov.control over size of money supply(reserve rate wont affect)
Definition: Repo rate :defined as the sale of an existing security at an agreed price
with an agreement by he seller to purchase back the same security on a specified future
date -7 days normally-at the same price p;us an agreed interest rate.
3 :5 total different FACTORS influencing the Supply of Money
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a. A countries money supply increase when gold & foreign reserves increase and decrease visa versa.
3. 5-Gov. spending increases supply of money by reducing amount of
4. 6-taxes,which take money out of suppy,being kept in the ARB
-TERM inflationary financing:Gov. lending from reserve bank can cause inflation to rise.
EXTRA BOX:Bonds,the Bond market and Capital.
1. TERM A BOND is a Financial Instrument that promises the issuer (the borrower)will regularly pay the holder(lender)
Interest and will repay the capital amount on a certain date.eg:Gov. issues bonds to finance its expenditure.The
features in a bond are.
a. The Principle:The amount the issuer will repay the bondholder when bond expires.
b. The Maturity Date:the expiry date-must pay all date.
c.The Coupon rate:Interest at annual rate.-usually fixed rate,and dates the interest must be paid are also
specified.
2. Bonds can be traded/sold : eg. on Bond exchange of JSE called Bond Exchange of SA. Bond market forms part of
capital market which is a market for long term financial instruments.
3. On capital Market 4 main types of long term financial instruments are traded.
a. Fixed-Interest-Bearing Securities (or bonds).
b. Variable Interest Securities
c. Shares
d. Negotiable Documents.
4. Interest rates determined in capital market (eg on gov. bonds with different maturities) are long term rates and
determined by market forces of supply and demand.
5. TERM Perpetuity:a special kind of bond where no maturity date is set-only a fixed amount of money is set to be paid
each year as interest and buyer makes no promise to buy it back.
6. The most important relationship in the market for interest bearing securities is the inverse relationship between the
price of bonds and the interest rates on them.bond prices high when interst rates low and visa versa-is inverse
reationship.
The Demand for Money.
1. Holders of wealth must decide in which form to keep:eg financial assets,land ,art,antiques
2. TERM demand for money is: the amount holders of wealth decide to hold as money balances.
3. TERM Financial assets: there are 2 types
a. Bonds(interest bearing assets)
b. money
4. TERM Fixed property:Means real estate.
5. :The Opportunity Cost of holding any money balance is the actual interest that could have been earned had the
money been used to purchase bonds instead.
6. TERM Liquidity Preference :The Reasons for holding money instead of bonds are :ByKeynes in30's
a. TERM :Transactions motive:for paying for goods,wages weekly so hold money between,the more money you
earn,more need to pay for –so transactions need for money is function of national income.
b. TERM :transactions demand : Precautionary Motive:for emergencies,also function of national income.
c. TERM store of value demand : Speculative Motive:-keynes most important add to monetary economics.If
Interest rates high then opportunity cost is high for money so people have less demand for money for spec.
purposes and rather invest it in bonds.Also there is a negative /inverse relationship between qty money
Demanded for speculation and interest rates.
7. TERM Active Balance: for 1-transactions or 2-precautionary motive.-main determinant-Income
8. TERM Passive(or idle) Balance : for speculative motive. –main determinant-Interest rate
9. Equation for demand for money: L=f(Yi) L-Liquidity preference/Y-National Income/i-Interest Rate
10. Graph of DEMAND FOR MONEY:
a. Active balance Curve:=f(Y) Income controlling factor:Vertical line,shift right income increase/visaversa.
b. Passive balance Curve:=f(i) negative slope reflects inverse relationship between interest rate and Qty demanded
of money. ie:cash held with purpose of investing if rates are high enough will=0.At certain interest (i1)rate no
funds will be demanded for spec.purposes.(i1)(this should be on diagram where curve meets vertical line and
interest is highest .
c. The Joint or total money demand curve or Total Liquidity Preference graph(same as passive graph but label curve
"L= L1+L2" ( is merely the horizontal addition of the two other graphs/is made up of the other two graphs)
i. The negative slope reflects inverse relationship between interest rate and Qty Demanded- for speculation
purposes ie:cash held with purpose of investing if rates are high enough will=0
ii. The position of curve:affected mainly by demand for active balances.-from income level.Increase in Income levels
will shift LL curve to right,decrease LL to left.
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iii. See pg 370 textbook for diagrams.
1. TERM:Demand-Determined money supply.: That there is no independant money supply curve,but the money
supply(or Qty. of money) is determined by the demand for money(due to 'transaction' and 'precaution' reasons)
and the interest rate(cost of credit).
2. This approach differs from traditional explanantion of equilibrium in money market,which was based on
assumption that authorities can control the supply of money-ie that there is an independant money supply curve.
3. According to this approach, the money supply is determined by the interaction of the demand for money and the
interest rate,because it is not possible to determine a suooly curve for money due to the miney creation process
being too complex.
4. The interest rate in return is determined mainly by the monetary authorities,by means of the Repo rate .
5. LL represents the demand for money curve which indicates the quantity of money demanded at various interest
rate levels. If the monetary authorities set the interest rate (for instance through accommodation policies) at i2
the quantity of money demand is L1. Since the supply of money is determined by the demand for it, the money
supply is M1 which is equal to L1. At a lower interest rate of i1, both the quantity of money demanded and supplied
increases to L2 and M2. There is no independent money supply curve since the money supply depends on the
demand for money and the cost of credit
THE MONEY MARKET:
The supply of money is determined by the interaction of interest rate and demand for money.see up(5)
Simulaneous control over the supply of money andthe Interest Rate-Authority Controlling Supply
1. The above/todays approach differs from traditional explanantion of equilibrium in money market,which was based
on assumption that authorities can control the supply of money-ie that there is an independant money supply
curve.
2. But-if authority sets interest rate at certain level by adjusting REPO rate,then they loose control of the money
supply because it will now be determined by the Interest rate only.
3. The traditional approach was:see diagram page 372 text if money supply curve mm(vertical line) is increased it
shifts right ,then interest rates will fall(see new intercept).and visa versa.
The Instruments of Monetary Policy.
• In Rsa a high priority is currently given to market orientated policy instruments.
• The MARKET ORIENTATED Key Instruments of Monetary Policy are:
1. Accomodation policy.
2. Open market policy.
3. Public Debt management
4. Intervention in foreign exchange markets.
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• Other NON-MARKET RELATED Instruments of Monetary policy are:
1. Credit ceilings
2. Deposit rate control(DISCONTINUED IN rsa)
• Other types unclassified;
1. Changes in terms of HP agreements.
2. Changes in exchange control regulations.
3. Also Moral suasion is used;SARB can influence banks by consulting with them.
1-Accomodation policy.
1. TERM:Accomodation policy of SARB :mainly comprises changes in repo rate and other conditions on which
cash is made available to banks.Changes in repo rate cause changes in cost of credit to banking public,thus can
control the supply of money in economy.
2. If banks short cash-they can
a. Change other fin.assets to cash
b. borrow on interbank market.
c. If none above possible-can obtain funds from SARB as "lender of last resort" by Repo agrmnts.
3. TERM:Repo Agreement or repurchase agreements:the sale of an existing security (financial asset) at an
agreed price,coupled with an agreement by the seller to purchase back the same security at the same price,and
including an agreed amount of interest as cost of obtaining funds also specified on agreement,on a specified
date(usually in 7 days time). .The underlying securities which may be used for this purpose
are :Gov.bonds,Land bank/treasury bills,reserve bank debentures.(first leg is flow 1 way,second leg is flow other
way)
4. Introduced 1998,repurchse agreement between SARB and it's banking clients, .
5. Repos are at present the main source of funds for banks as a measure of last resort-thus control.
Open market policy.
1. TERM Open Market Policy is where the SARB sells or buys domestic financial assets(mainly Gov. Bonds or
Treasury bills) in order to exert a specific influence on interest rates and the Quantity. of money.
a. SARB- buy from banks at low prices (to force 'buy') and debit /increase their cash reserve in payment
,thus allowing banks to create more money by lending out or ,visa versa SARB sells domestic financial
assets to banks to in turn decrease the amount of money they can use to create a supply of money by
lending out ...
b. There is an inverse relationship been prices of such securities and the Yield/Interest that can be earned on
them,so ,if high prices of purchase,then yield is lower and visa versa etc,thus banks must sell low to be
able to get buyers or visa versa to get sellers. ...Thus if banks buy at high prices,they will send
interest rates up,and if sell at low prices they will send interest rates down,sothis can also be used to
support the accomodation policy of the SARB,
c. ...in RSA this is used to :Sell cheap bonds ,to cause banks to use Repo system,to make accomodation
policy of SA more effective.
2. TERM domestic financial assets: treasury bills and government bonds ,or land bank bills or municipal stock
etc.
3.
Public Debt management
• Market-orientated
Intervention in foreign exchange markets.
• Market-orientated
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CHAPTER 4-PUBLIC SECTOR
1. Term Fiscal Policy: Government policy on level and composition of government spending,taxation and
borrowing.(from fiscus-roman treasury)
2. Main Instrument OF gov policy :Budget
3. The Fiscal Variables are :
a. (G) = Gov. Spending and
b. (T) = Taxation.
4. Budget speech parliment,feb for april end yr.,one most important events in economic calendar.
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5. Fiscal policy/The Budget can be used to address influence:
a. The 5 Economic Major Objectives(where monetary policy only 3 of) :Economic Growth-Total Prdctn
b. Distribution of Income
c. Balance of payment problems
d. Price level-Inflation
e. Full Employment
i. AND ALSO BASICLY :Total Spending
ii. Income-(Y)
iii. Employment
6. .Term Demand management:an instrument of Fiscal policy is classified as an instrument of Demand
management because it is an effective means of influencing Total Spending in the economy.Monetary policy is
also such.(Definition: can be used to manage/regulate the total demand for goods and services in the economy.)
7. TERM Expansionary Fiscal &monetary policies:If economy in Recession,to stimulate economic
activity-means -1-Reduce or Not increase Tax -2-Raise Spending.
8. TERM Contractionary or Retrictive Fiscal &monetary policies:If economy expanding too rapidly and
-1-Inflation -2-Balance of Payments problems experienced:means Gov. must-1- Taxes Increase and/or Reduce
Spending.
9. Term Lags/Delays-one of basic difficulties assosiated with attempts stabilise economy.
10.
Term Budget Deficit /Surplass:Difference between Gov. spending and Income.
11. Fiscal policy can influence microeconomics as well:specific markets/products tax,subsidy or town.
-3-Government Spending-16.8p401
1. Gov. involvemnt in economy often measured by level spending,but many other types involvemnt too.
2. "Crowding out effect"-when Gov.spending increases and crowds out private sector.
3. Gov spending can be classified
a. economically
i. consumption spending :for final consumption = 3%
ii. investment spending :investment in capital goods = 19%
b. functionally:Changed from from War/Internal strife defense/policing type and economic services
(mining,agriculture,exporter support) spending to social spending.
4. Gov, spending has increased form 12% to 22% from 1960 to now.This worrisome because of how to finance
this(Tax).Number other countries had similar experience.REASONS:
a. Changing consumer preferences. :peoples Income went up ,then demand for Gov. services rise so gov spend
more on consumption as well. (Income elasticity of gov services greater 1,so as income up ,greater % of income
on service.)
b. Political and other shocks. :War spending and internal strife spending on law+order.,
c. Redistribution of income.: Shift in spending to uplift previously disadvantaged peoples,majority
d. Misconceptions and Entitlement.People think gov.services cheap,expect more-if politician listens then spending
go up alot,not a little.
e. Population growth and Urbanisation.:housing,water+lights,sewerage,roads-infrastructure+AIDS.
-4-Financing of Government Spending 16.9,p403
1) There are 3 ways of financing Gov.Spending-
a) Income from Property(2% totl.)– incl.Escom,+Profit fishing,agriculture+Rent-Mining Licence fees.
b) Borrowing –Budget deficit. ,domesic/Intnl.capital market(gov.bonds) or Central bank.(overdraft) ..-1-Incr. Public
Debt.+-2-Inflationary Financing
c) Taxes
2) Term Budget Deficit /Surplass:Difference between Gov. spending and Gov. Income .80/90's >gov.Invstmt. Future
generation must pay for todays borrowing,OK for capital(=returns),not OK for consumption.
3) Term Inflationary Financing: gov.borrowing because increases money supply.
4) Term Public debt: 34%90's-45% gdp:from gov.borrowing-eg 1990,increases Interest on gov debt.to 20c per R Tax
today.
-5-Taxation 16.10
1) Largest source Gov revenue-97%
-1-Criteria for a good tax:
-Adam Smith-equitable,convenient,economic,certain
a) Neutrality :The cost(damage) of taxes must be kept as low as possible:but can also be used to fix
i) -1-Distort Relative Prices:allocation of resources+welfare-make some things more expensive than others.-
Relative prices
ii) -2-Disincentive to owners-FOP:eg workers(work less)+factories not produce certain.
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b) Equity:People must be taxed equally :two principles to this
i) Ability to pay principle: Must pay according to ability
(1) Horizontal equity-same income taxpayers to pay equally
(2) Vertical equity -Richer must pay more than poorer people.
ii) Benefit principle:or User Charges-each user pay benefits they get from Gov.-eg toll rd.,h20,
c) Administrative Simplicity:Keep costs low + easy admin (tax loopholes +complicated taxes)
i) Costs:
(1) Compliance costs: user pay accountant to do tax return.
(2) Administration costs.: Gov.costs tax collector
2) Term Tax Avoidance: legal find loopholes-cause frustration those who cannot
3) Term Tax Evasion: illegal-make +sell t-shirts on flea market,not declare taxes.
4) term Relative Prices:price of one good relative to another
-2-Different Types of Tax:
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chapter 5
1. term:Trade policy: Governments (1)PROTECT domestic firms against imports+(2) CONTROL volume of imports
by means of trade barriers eg:import tariffs.(3)Also encouraging exports by assist with marketing,giving subsidies
etc. for expert etc.
1. term:Protective tariff: to protect local industry
2. term Revenue tariff : To earn revenue for government only.(eg goods not made here-computer)
3. Two categories of tariffs:
a. term Ad-Valorem -% of value of item
b. term Specific tariffs-Specific amount:eg R5 on each unit of wine.
a) term Predatory Dumping :firm uses high local prices to subsidise exports and undercut competitors—can be
difficult to prove,can be relative/comparative advantage or local politiking
b) term Countervailing Duties:used to counteract dumping.
1) Term Bal. of Paym. is a summary record of a countries transactions with rest of world over a period oftime
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a) term Current account.-(or called Trade balance) [ primary income receipts+exports{-}primary income
payments+imports ]+plus current transfers(no 'quid pro quo' in return donations, taxes,immigrate)
b) term Capital transfer account.
c) term Financial account. –International transactions in Fin.Assets and liabilities incl.borrowing and lending
ofmoney eg-loans,shares
i) Consists of
(1) term Direct investment-with controlling share
(2) term Portfolio investment-not with controlling share
(3) other investment-eg:loans,currency,deposits,short term trade credit
d) term Unrecorded transactions.-all omissions and unrecorded transactions-serves to balance double entry
system.
1) term Exchange rate is a Ratio- represents price of one currency in terms of another.
2) term Foreign exchange market : international market where currencies can be exchanged.Include in SA all
authorised foreign currency dealers;RSA major Banks and others. RSA 8.4billion$/day
3) term Appreciation:price of one currency goes up in relation to another one.
4) term Depreciation:price of one currency goes down in relation to another one
5) Methods of quoting exchange rates:
a) term Direct method:most countries(RSA too)-shows ? much local for 1 foreign eg R10 to $1(ie:price of a
commodity since foreign exchange is just a commodity like bread)
b) term Indirect method:some –shows ? much foreign for 1local eg R1 to $0.1
1) term Derived demand the lower the price ,the more demand is derived from this price change.
2) term Derived supply the higher the price ,the more supply is derived from this price change.
1) term:Managed Floating:Central bank manipulation of exchange rates.A central bank can only intervene to stabilise
a depreciating currency if it has sufficient foreign exchange reserves to do so.:Ie:Central bank supplies a extra
demand for $(eg importers want) to stop right shift of curve.Or SARB buys extra supply of $(eg tourists want for world
cup)to stop shift in supply curve.This is to keep the currency stable and protect vulnerable exporters etc.
2) term Expectations or Market sentiment: if everyone believes $ price going up-exporters delay,foreign tourists and
investors delay (demand rands down,supply $ down)and speculators buy $(demand $ up) cause immediate shift in
curves and immediate price change.To stop speculators SARB sometimes makes high interest rates to stop them
lending to buy $ .
1) term Floating currency Some countries have pegged currencies to $,others employ managed floating-(floating
currency).
2) With floating currency-3 options:-1-do nothing-market forces do -2-managed ffloating -3-use interest rates-if SARB
cause interest rates up-then foreign capital flows in for lending out and speculators have high interest rates to stop
them lending to buy $ .
3) term:PPP-purchasing power parity:if currencies have same purchasing power in different countries.eg:if basket
goods cost 1$ in USA and R10 HERE,PPP=1 to 10.Got to do with currencies being undervalued/overval.. against others
1) If the Terms of trade lower=bad /higher =favourable if =1 equal
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