MI0255916 Economics 1B (Principles of Macro economics)

1141102-12405 Assignment(ECON1B-6/S2 10/2017)

Assignment due date: 29 Aug 2017 - 13:00PM
Exam date: 30 Oct 2017
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SECTION A
Question 1

1.1.

GDP Expenditure Method: C + G + I + (X-Z).

= 1 710 000 + 300 000 + 390 000 + 120 000.

= R2 520 000.

1.2.

GDP Income Approach: NI + Indirect business taxes + Depreciation .

N I= W + R + I+ PR.
= 2 082 000 + 44 400 + 286 800 + 232 800 + 153 600
= 279 9600.

GDP = NI + Indirect business + Depreciation

= 279 9600 + 310 800+ 399 600
= 3 510 000.

1.3.

Net Domestic Product : GDP Depreciation.

= R 3 510 000 - 399 600
= R 3 110 400.

1.4.

GNI: GDP at market price + Primary income from the rest of the world - Primary income to the rest of the world.

= 3 510 000 + 180 000 3 120

= 3 686 790.

1.5.

Biltong Juice
Country A 600 300
Country B 100 200

Country A can produce 6 units of biltong or 3 units of juice, while Country B can produce 1 unit of biltong or 2 units
of juice. This means that it takes more resources in Country A to produce 6 units of biltong or 3 units of juice than it
does in Country B that produces 1 unit of biltong or 2 units juice. As a result, Country B has a comparative
advantage over Country A in the production of both goods. The opportunity cost principle needs to be used to

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calculate the cost of producing biltong and juice. With constant opportunity costs in place, this means that the cost
of Country B producing 1 unit of biltong is 2 units of juice. Whereas, in Country B, 2 units of biltong need to be
sacrificed to produce 1 unit of juice. It costs relatively less to produce juice in Country B than in Country A, this
means Country B sacrifices less units of biltong to produce juice than Country A. The opportunity cost of producing
1 unit of biltong in Country A is and the opportunity cost in Country B is 2. Therefore, it costs relatively less to
produce biltong in Country A than in Country B. Considering Country A has an absolute advantage over Country B
in the production of both goods however it does not have a relative advantage in both. In absolute terms Country A
is twice as efficient in producing biltong than Country B while on the other hand Country B is more efficient in
producing juice.

1.6.

20 Euros = (20 X 1.2)

= $24 for a Big Mac in France.

Therefore, 20 Euros = (24/0.8)

= R30.

R19 = (19 X 0.80)

= $15.20 in South Africa.

Therefore R19 = (15.20\1.2)

= 12.67 Euros.

This means that the (Rand) is undervalued compared to the (Euro) which is overvalued in comparison. This means
that the Euro is a stronger currency than the Rand and you will get more money value for Euro than Rand for when
exchanged. We can see this by comparing the dollar value in South Africa to the dollar value in France of a Big
Mac.

Question 2

2.1.

GDP = C + I + G + (X-Z).

GDP = 1 425 000 + 325 000 + 250 000 + (-100 000)

= R1 900 000.
2.2.

C = C + cY

Total Consumption Spending = Autonomous Consumption + (Marginal propensity to consume x Income)

1 675 000 =C + (0.60 x 2 020 000)

C = 1 675 000 1 212 000

C = 463 000

Autonomous Consumption = R463 000.

2.3.

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Z = Z + mY

Autonomous imports = Autonomous component + (Marginal propensity to import X Income)

Therefore, Net imports = Exports Imports

(-100 000 = 260 000 Imports)

(-100 000 260 000 = Imports)

(-360 000 = Imports)

Therefore imports = R360 000.

360 000 = Z + (0.10 X 2 020 000)

360 000 202 000 = Z

= R158 000.

Therefore, the autonomous component of the import function is R158 000.

2.4

= 1/1-mpc (1/1-c)
= 1/1-0.60
= 5/2
= 2.5

2.5.

Current GDP = 1 900 000

Target GDP = 3 000 000
Difference = 3 000 000 - 1 900 000
= 1 100 000.

Target GDP = C + G + I + (X-M).

GDP = 1 425 000 + (250 000 + 1 100 000) + 325 000 + (-100 000)
= 1 425 000 + 1 350 000 + 325 000 + (-100 000)
= 3 100 000 + (-100 000)
= 3 000 000.

2.6.

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SECTION B
Question 1

Deflation can be defined as the reduction of prices in an economy. This is because the value of money increases
but often long periods of deflation can result in an increase in unemployment and a decrease in economic growth
because consumer spending decreases. However, there are many economic problems associated with deflation
that can impact an economy and consumers negatively.

Reference (http://www.economicshelp.org/blog/978/economics/definition-of-deflation).

Issues associated with deflation include: Real wage unemployment, the real value of debt increases, discouraged
consumer spending, increased real interest rates, the difficulty for relative prices and wages to adjust. Deflation can
also become difficult to end which is also an issue.

Problem #1: Real wage unemployment This occurs when labour markets experience sticky wages which
means that workers earnings do not adjust quickly but rather slow to the conditions of the labour markets. As a
result, this can slow down the process of an economy recovering from a recession. This usually occurs because
workers do not want their wages to be reduced and often resist the adjustment which leads to an increase in real
wages in periods of deflation and an increase in unemployment.

Problem #2: The Real value of debt increases This occurs when deflation increases because deflation causes
an increase in the real value of money and the real value of debt. This makes it more difficult for people who owe
money to pay back their debts because consumers use a higher percentage of their net income to make debt
repayments. This means that firms, businesses and organisations will turn over a reduced amount of revenue
which impacts consumers negatively as they will receive a reduced amount of wagers. This means that consumers
will have less money to spend and invest with. This issue also makes it difficult for countries to reduce their debt
exposure and even more difficult to reduce their debt to GDP ratios.

Problem #3: Discouraged consumer spending Deflation leads to price reduction in an economy and this
encourages people to postpone the purchasing of goods and services because they will be cheaper in the future.
Consumers are discouraged from buying luxury goods such as an Xbox ONE etc. As a result, deflation leads to
reduced consumer spending and lower economic growth.

Problem #4: Increased real interest rates Interest rates cannot fall below zero. During deflation periods, real
interest rates are higher which means that saving money will lead to a good return. For example, If there is a
deflation of 5% then this means we have a real interest rate of +5% and saving money will give you a good return.
Deflation causes tightening of the monetary policy which is preferably not wanted. Countries that do not have
quantitive easing (when a central bank purchases securities from the market or government to lower interest rates
and increase money supply using a monetary policy) will suffer and be negatively impacted heavily. This issue also
causes a decline in economic growth and an increase in unemployment.

Problem #5: Difficulty for relative prices and wages to adjust If average prices and wages are increasing by

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a certain percentage, then it is harder to get the relative change in prices or wages because some will rise less and
others will rise higher if inflation is 0%. For example, if prices or wages are increasing by 5% then it is easier for
some goods to rise by 1% while others rise at 7% if inflation is 0%.

Problem #6: Deflation can be difficult to end It can be seen from experience that it is difficult to change
inflation expectations and regain normal growth after deflation has occurred, we can see this by Japan's financial
crisis in the 90s.

Other problems associated with inflation include debt burdens on consumers and governments because expected
inflation rates drop and repayments of debts become much slower than expected. Governments will also struggle
to reduce debt to GDP ratios because deflation causes tax revenue to rise slower than normal.

Tight monetary policies are harming to the economic recovery of countries and European countries suffer more
because they do not have quantitative easing which helps countries in these situations.

Policies to overcome deflation include monetary policy and unconventional monetary policy which consists of
quantitive easing, fiscal policy and devaluation.

Monetary policy This occurs when there is deflation and the Central Bank decides to cut interest rates in hopes
to boost spending and aggregate demand. For example, cutting the price of mortgage repayments will allow the
consumer to spend more money. The Central Bank of an economy controls the supply of money and targets
interest or inflation rates to make sure that the currency of the economy is stable.

Reference (https://www.thebalance.com/what-is-monetary-policy-objectives-types-and-tools-3305867).

In addition to the monetary policy, there are two more components that form part of the policy which include the
accommodation policy and open-market policy.

Accommodation policy: This policy states that the banks of an economy are expected to hold a percentage of
their total liabilities to the public in the form of cash reserves. If a bank experiences a shortage of cash reserves,
then it is allowed to exchange financial assets for cash. If there is a shortage of cash reserves in all banks then the
banks can claim back funds by using the repossession system.

Open-market policy: This policy consists of the sales or purchases of domestic financial assets by the Central
Bank, for example, a government bond. This policy ensures that there is an influence on interest rates and the
quantity of money in relation to the reserve banks. If there is a liquidity shortage amongst banks then they will be
allowed to make use of the repossession system and approach the central bank for funds. The central bank sells
securities or government bonds to other banks in order to reduce their cash reserves. Banks are then expected to
make use of the central bank's financing facilities through repurchase agreements. Once this is complete the
central bank's accommodation policy will be more effective.

Unconventional monetary policy These include many sub-division policies such as quantitative easing, fiscal
policy and devaluation.
Quantitative easing: This occurs when the central bank purchases securities or government securities from the
market in hopes to increase the money supply and lower interest rates.

Fiscal policy: This policy allows the government to adjust spending levels and tax rates to impact and monitor a
countries economy. This policy is based on Keynesian economics and allows the government to influence
macroeconomic production levels by increasing or decreasing public spending and tax levels. By doing this,
inflation is limited, employment increases and the value of money is stable. This is an important policy for an
economy.

The Japan experience dealt with an aggressive policy measure such as the Monetary policy whereby the Japanese
Central Bank of the economy took control of the economies supply of money and targeted the interest and inflation
rates of the economy to ensure that the currency of the economy remains stable.

Reference (https://www.youtube.com/watch?v=KIp-WLLyXOo).

In conclusion, deflation is a negative rate of inflation as there is a fall in price levels, because, the value of money
increases. Deflation is not bad, however, long periods of deflation can result in many economical problems such as
high unemployment rates, making debts more difficult to pay off and a decrease in consumer spending power.

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Reference list:

Source. Page/Duration.
https://www.youtube.com/watch?v=KIp-WLLyXOo Full video.
http://www.economicshelp.org/blog/978/economics/definition-of- Full article.
deflation/
Understanding Macroeconomics textbook Page 70, 147-151, 20-42, 48-64.
https://www.youtube.com/watch?v=UGsaCLS7vns Full video.
https://www.youtube.com/watch?v=FBOW_7hSEkE Full video.
https://www.resbank.co.za/MonetaryPolicy/Pages/MonetaryPolicy- Full page.
Home.aspx
https://www.thebalance.com/what-is-monetary-policy-objectives- Full article.
types-and-tools-3305867

Internal use only

Question Mark Internal External

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