ECS1601_Exam Pack_2021.

ECS1601 - Economics IB. ECS1601_Exam_Pack_2021. The 3 major flows in the economy as a whole are total production, total income and total spending. • 2 basic participants are households and firms • Stock variable eg balance in a savings account on a particular day • Consumption is a flow variable • Capital a stock variable • Members of a household are called consumers • Consumers are rational in other words they will always try to maximize their satisfaction given the means at their disposal • Households responsible for the spending on consumer goods • Capital goods are purchased by firms • 2 sets of markets in the economy goods markets (market for tomatoes) and factor markets (labour market) 1 • Firms purchase in the factor markets and sell in the goods market • Households sell in the factor markets and purchase in the goods markets • Major flows associated with the government are government spending , taxes and transfer payments • Taxes = leakage from circular flow of income and spending • Government spending = injection into the circular flow of income • The foreign sector is linked to the domestic flow of income and spending through imports and exports • Savings , imports , taxes = withdrawal • Investment , exports ,government spending = injection • C = spending by households on consumer goods and services • I = spending by firms on capital goods • G = spending by government on goods and services • X = Spending by foreigners on SA goods and services - (minus) S.A imported goods and services (Z) • TOTAL EXPENDITURE = C + I + G + X – Z . THE MONETARY SECTOR Money can be defined as anything that is generally accepted as payment of goods and services or that is accepted in settlement of debt. (Money is what money does). Barter economy is an economy that operates without money where goods are exchanges for other goods. Functions of money (chapter 15.1) 1. Money as a medium of exchange (primary function of money) – plays an integral part of our daily lives → It allows us to move beyond a barter economy – which is the economy that function without the use of money(i.e. exchange of goods for other goods) where there has to be a ‘’double coincidence of wants’ ’ for exchange to take placeThe system is cumbersome and inefficient → Thus monetary economies are much better, and serves as an intermediary (or medium of exchange). → Money therefore serves as a ‘ ’lubricant or intermediary’ ’ to smooth the process of exchange → Make the exchange process more efficient → This is the ’first and most basic function of money’ The functions of money: 1. Medium of exchange - Money serves as a lubricant or intermediary to smooth the process of exchange and to make it more efficient. 2. Money as a unit of account – is an agreed measure for stating the prices of goods and services. 3. Money as a store of value most common for holding wealth is money. Its convenient and can be used immediately in exchange for other assets. Most liquid form in which wealth can be kept 1 4. Income = reward earned in the production process, wealth = consists of assets that have accumulated over time. Money is a unit of account (secondary function of money) – an agreed measure for stating the prices of goods and services. The prices of goods and services are expressed in monetary terms It is a common measure of the cost of various goods and services to enable us decide how best to spend our income. Also allows us to obtain measures of the total value of all goods and services produced in the economy (i.e. work out the economy’ s GDP). Not only the possible unit of account as any other commodity or product can be used, but it is simply the most convenient unit of account It is closely related to its function as a medium of exchange (i.e. what serves as a medium of exchange usually also serves as a unit of account) Money as a unit of account can lose some of its usefulness during inflation Money as a store of value The most common form of holding wealth is money It is usually more convenient and can easily be used in exchange for other assets at a later date (i.e. the most liquid form to which wealth can be kept) Other assets/objects can also be used, though, which is better at times of high inflation, when money LOSES value Thus one can see that money is not the only store of value, and is not always the BEST store of money either. The store of value of money also serves as a ‘ ’ standard of deferred payment’ ’ (i.e. measure of value for future payments, which would be agreed to in ‘ ’ Rands and Cents’ ’ ) The means by which credit is granted Differentiate between Money, Income and Wealth Money is anything that is generally accepted as payment for goods and services or that is accepted in settlement of debt Income is the reward earned in the production process and is usually measured in monetary terms Wealth consists of assets that have accumulated over time. It can also take the form of money. In other words, money forms part of wealth, but wealth consists of other assets as well and which ofcourse, is calculated in monetary terms (i.e. monetary value) The properties of money • Uniformity • Durability • Divisibility • Ability to be carried Why credit cards are not seen as money • Demand deposits are NOT created when someone is issued with a credit card • They are just a convenient way to make a purchase by making a short term loan from a bank or other financial institution • When you purchase with a credit card, the bank pays for the item, and you pay the bank at the end of the month 1 • NOTE: Cheques and Debit cards also not money, but they allow people to transfer money from their own demand deposit to someone else to pay for something, and are thus a way of making transfer. • The South African money supply is NOT fully backed by the amount of gold in the vaults of the SARB. • Demand deposits can be withdrawn immediately by writing out a cheque (which is generally accepted as payment) and therefore demand (or cheque) deposits form part of the quantity of money Legal tender means that old notes or coins cannot be refused if they are tendered as payment. Money in South Africa (chapter 15.3) The difference between M1, M2 and M3 M1 – includes coins, bank notes and demand deposits only M2 – includes short-term and medium-term deposits (quasi money) and is more than one and a half times the value of M1 M3 – which includes long-term deposits, is regarded as the best measure of developments in the monetary sector M1, M2 and M3 are the different ways in which the SARB measures the quantity of money • M1 = the conventional measure is defined solely on the basis of the function of money as a medium of exchange includes coins, and notes as well as all demand deposits including cheque and transmission deposits • M2 = M1 plus all other short term and medium term deposits of the domestic private sector with monetary institutions. • M3 = M2 plus all long term deposits of the domestic private sector with monetary institutions. → Monetary authorities in S.A are South African Reserve Bank → Demand deposits are deposits that can be withdrawn immediately by means of cheque. M = C + D (QUANTITY OF MONEY = CASH + DEMAND DEPOSITS) The Conventional measure (M1) • Defined on the basis of the functions of money as a medium of exchange • Includes all articles generally available as a medium of exchange (or means of payment) M1 includes coins and notes (in circulation outside the monetary sector) as well as all demand deposits (including cheque and transmission deposits) of the domestic private sector with monetary institutions 1 NOTES: 1. only money in the hands of public can be used as a means of payment – thus the provision( “ in circulation outside the monetary sector” ) 2. Demand deposits refer to deposits that can be withdrawn immediately by means of a cheque, against which cheques may be written out. Can be written as equation: M = C + D Where: M = quantity of Money, C = cash (coins and notes in circulation outside the monetary system) D = demand deposits (which is by far the largest component, usually around 90%) A broader definition of money (M2) M2 is equal to M1 plus all other short-term and medium-term deposits of the domestic private sector with monetary institutions 1 • Short-term to medium term deposits are immediately available as a medium of exchange • They are invested for a certain period ( 30 days for short term, and 6 months for medium term • Can only be drawn earlier at considerable cost • But are SIMILAR to M1 and are thus seen as quasi-money (or near money) Note: M2 can therefore be defined as Money (M1) plus Quasi-money The most comprehensive measure of money (M3) M3 is equal to M2 plus all longer-term deposits of the domestic private sector with monetary institutions • Have maturity of longer than 6 months • Monetary authorities view this as most reliable indicator of developments in the monetary (or financial) sector • Can also use M3 to evaluate success of monetary policies and guidelines • Is a reflection of the store of value function and not only function of money as a medium of exchange FINANCIAL INTERMEDIARIES One main function is to act as an intermediary between the surplus units and deficit units in the monetary economy. South African Reserve Bank (SARB) It is most important financial institution. Primary function is to protect the value of the currency in the interest of balanced and sustainable economic growth in the republic. Must also perform its function independently and without fear, favour or prejudice but there must be regular consultation between the bank and the cabinet member responsible for national financial matters. The role of the South African Reserve Bank The SARB’s Constitutional Mandate:To protect the value of the currency in the interest of balanced and sustainable economic growthOnce the Financial Sector Regulation Bill (FSRB) is signed into law by the President, it will formally mandate the SARB to protect and enhance financial stability in South Africa, in addition to its primary price stability mandate 4 Functions of SARB 1. formulation and implementation of monetary policy repo rate tender system is the main instrument 2. Service to the government (banker and advisor, custodian of gold and foreign exchange reserves, administration of exchange control. 3. provision of economic and statistical services 4. maintaining financial stability (bank supervision , the national payment system , banker to other banks , banknotes and coins) 1 The reserve asset position and the credit multiplier → Each bank has to ensure that it always has sufficient cash reserves available to provide for cash withdrawals, must provide for the claims of other banks, which may exceed its own claims. → Confidence of creditors must be maintained. → To maintain confidence in the banking system, the monetary authorities lay down legal requirements stipulating the amount of cash reserves to be held against the total liabilities of a bank. → Any increase in the banks demand deposits increases the amount that the banks have to hold in the form of cash reserves with the reserve bank. R = cash reserves D = demand deposits Any increase in demand deposits will raise the required minimum cash reserves. • Increase in cash reserve requirements = reduction in credit multiplier The present system of monetary control in SA seeks to control the amount of demand deposits by influencing the cost of additional cash reserves rather than by variations in the cash reserve ratio or by seeking to control the actual amount of the banks aggregate cash reserve holdings. Any increase in demand deposits as a result of an increase in the provision or use of overdraft facilities forces banks to acquire additional reserves which have to be borrowed from the SARB at the repo rate. The higher the repo rate the more expensive credit becomes and the smaller the demand for credit will be. As the credit falls so too will the size of M1. 1 Other factors that can influence the money supply: Transactions with foreign countries, government transactions, foreign trade, international capital movements. Payments for exports will have a negative impact on the quantity of money.  Foreign transactions a country’s money supply generally increases when it’s gold and foreign exchange reserves increase and falls when gold and foreign exchange reserves decrease.  The demand for money is the amount that the various participants in the economy plan to hold in the form of money balances. The opportunity cost of holding any money balance is the interest that could have been earned had the money been used to purchase bonds instead.