ECS3701 FULL EXAM PACK NEW MODIFIED
CURRENTLY TESTED AND APPROVED
GRADED A+ 2026 NEW UPDATE
Question 1
1.1 Name the two partial equilibrium approaches to the determination of interest rates
The bond supply and demand framework
The liquidity preference framework
1.2 Mention the two ways in which the credit channel of the monetary transmission
mechanism affects the economy
The monetary policy effect
balance sheets of households and firms
1.3 Using the two ways mentioned above discuss the credit channel through which an
expansionary monetary policy can influence the real output and price level(16)
The monetary policy effect is represented as:
↓repo rate → ↑bank deposits → ↑bank loans → (↑Inv, ↑C) → ↑Y
This channel operates, firstly, through bank lending. Certain borrowers will not have access
to credit markets unless they borrow from banks. Expansionary monetary policy increases
bank reserves and bank deposits, thus increasing the amount of loans available. This
increase in loans will cause fixed capital formation and consumer spending to rise.
A significant implication is that monetary policy through this channel will have a greater
effect on those more reliant on bank loans, such as smaller firms, since larger firms have
Page 0 of 69
,recourse to obtaining funds by issuing new share capital. As circumstances and restrictive
regulatory frameworks change to allow banks greater ability to raise funds, the potency of
this channel will be reduced.
Secondly, credit affects the balance sheets of households and firms and also arises from
asymmetric information in credit markets:
↓repo rate → ↑price expectations → ↑cash flow → ↓adverse selection →
→ ↓moral hazard → ↑lending → (↑Inv, ↑C) → ↑Y
Question 2
2.1 Define cost push inflation and demand pull inflation
Cost-push inflation – results from either a temporary negative supply shock or a push by
workers for wage hikes beyond what productivity gains can justify.
Demand-pull inflation – results from policymakers pursuing policies that increase aggregate
demand.
2.2 A cost -push inflation can be initiated by a demand pull inflation. Is this statement
true. Explain
A cost-push shock, which acts like a temporary negative supply shock, shifts the short-run
aggregate supply curve up and to the left of the 𝐴𝑆2, and as the economy moves to point
2’. To keep aggregate output at 𝑌𝑝and lower the unemployment rate, policy makers shift
the aggregate demand curve to 𝐴𝐷2 so that the economy will return quickly to potential
output at point 2 and an inflation rate of 𝜋2. Further upward and leftward shifts of the short-
run aggregate supply curve to 𝐴𝑆3and so on cause the policy makers to keep on increasing
aggregate demand, leading to a continuous increase in inflation – a cost-push inflation
Page 1 of 69
, NB diagram page 95 in study notes
2.3 Discuss the four main categories of people whose real income are adversely
affected by inflation(12)
The first category are those who lack the bargaining power to increase their nominal incomes
in accordance with the inflation rate or– the unemployed, the ununionized, pensioners, and
small business owners. Inflation therefore tends to hit the weakest in society hardest.
The second category consists of those people who hold money because inflation reduces the
purchasing power of that money - those with money in their purses or their bank accounts,
which is all of us. But again, it is the poorest in society who are worst hit by this effect, because
the greatest proportion of their wealth lies in the money they receive as weekly or monthly
wages. By contrast, a significant proportion of the wealth of richer people is in goods and assets
(homes, land, shares, etc), the nominal value of which normally keeps pace with inflation. In
that way, the wealth of richer people is better protected against inflation.
The third category consists of creditors – people who have lent money to others. Because
inflation means that the purchasing power of money steadily declines over time, creditors are
repaid in money units of lower purchasing power. This effect, however, happens only if interest
rates are not adjusted upwards to compensate for this loss, as they often are. Only when
inflation causes a decline in the real interest rate on debt (roughly determined as the nominal
interest rate minus the inflation rate) do creditors lose as a result of inflation or, for that matter,
do debtors gain from inflation.
4. The fourth category of people includes all of us, to the extent that inflation causes us to fall
into a higher income tax bracket. South Africa, like most countries in the world, has a
progressive income tax system, meaning that on successive additions to income (called
brackets) a higher percentage of income tax is levied. Because inflation raises the nominal
value of our income, it can force us into higher tax brackets even while the real value of our
income remains the same (this is known as the "bracket creep").
Page 2 of 69
, 3. Explain the following terms
i. Inflation targeting
Monetary policy strategy that involves public announcement of a medium-term
numerical target for inflation.
ii. Interest rate risk
The riskiness of earnings and returns that is associated with changes in interest rates iii.
Monetary Policy
Monetary policy can be defined as the measures taken by the monetary authorities to influence
the quantity of money or the rate of interest with a view to achieving stable prices, full
employment and economic growth. Monetary policy in South Africa is conducted by the South
African Reserve Bank
iv. Money
Money or money supply is defines as anything that is generally accepted in payment for goods
or services or in the repayment of debts. Money is linked to changes in economic variables that
affect all of us and are important to the health of the economy.
3.2 Differentiate between hierarchical and dual mandates of monetary policy
Hierarchical versus Dual Mandates
Hierarchical mandates is when an economic goal, such as price stability, is put first and the say
that as long as it is achieved other goals can be pursued.
Page 3 of 69
CURRENTLY TESTED AND APPROVED
GRADED A+ 2026 NEW UPDATE
Question 1
1.1 Name the two partial equilibrium approaches to the determination of interest rates
The bond supply and demand framework
The liquidity preference framework
1.2 Mention the two ways in which the credit channel of the monetary transmission
mechanism affects the economy
The monetary policy effect
balance sheets of households and firms
1.3 Using the two ways mentioned above discuss the credit channel through which an
expansionary monetary policy can influence the real output and price level(16)
The monetary policy effect is represented as:
↓repo rate → ↑bank deposits → ↑bank loans → (↑Inv, ↑C) → ↑Y
This channel operates, firstly, through bank lending. Certain borrowers will not have access
to credit markets unless they borrow from banks. Expansionary monetary policy increases
bank reserves and bank deposits, thus increasing the amount of loans available. This
increase in loans will cause fixed capital formation and consumer spending to rise.
A significant implication is that monetary policy through this channel will have a greater
effect on those more reliant on bank loans, such as smaller firms, since larger firms have
Page 0 of 69
,recourse to obtaining funds by issuing new share capital. As circumstances and restrictive
regulatory frameworks change to allow banks greater ability to raise funds, the potency of
this channel will be reduced.
Secondly, credit affects the balance sheets of households and firms and also arises from
asymmetric information in credit markets:
↓repo rate → ↑price expectations → ↑cash flow → ↓adverse selection →
→ ↓moral hazard → ↑lending → (↑Inv, ↑C) → ↑Y
Question 2
2.1 Define cost push inflation and demand pull inflation
Cost-push inflation – results from either a temporary negative supply shock or a push by
workers for wage hikes beyond what productivity gains can justify.
Demand-pull inflation – results from policymakers pursuing policies that increase aggregate
demand.
2.2 A cost -push inflation can be initiated by a demand pull inflation. Is this statement
true. Explain
A cost-push shock, which acts like a temporary negative supply shock, shifts the short-run
aggregate supply curve up and to the left of the 𝐴𝑆2, and as the economy moves to point
2’. To keep aggregate output at 𝑌𝑝and lower the unemployment rate, policy makers shift
the aggregate demand curve to 𝐴𝐷2 so that the economy will return quickly to potential
output at point 2 and an inflation rate of 𝜋2. Further upward and leftward shifts of the short-
run aggregate supply curve to 𝐴𝑆3and so on cause the policy makers to keep on increasing
aggregate demand, leading to a continuous increase in inflation – a cost-push inflation
Page 1 of 69
, NB diagram page 95 in study notes
2.3 Discuss the four main categories of people whose real income are adversely
affected by inflation(12)
The first category are those who lack the bargaining power to increase their nominal incomes
in accordance with the inflation rate or– the unemployed, the ununionized, pensioners, and
small business owners. Inflation therefore tends to hit the weakest in society hardest.
The second category consists of those people who hold money because inflation reduces the
purchasing power of that money - those with money in their purses or their bank accounts,
which is all of us. But again, it is the poorest in society who are worst hit by this effect, because
the greatest proportion of their wealth lies in the money they receive as weekly or monthly
wages. By contrast, a significant proportion of the wealth of richer people is in goods and assets
(homes, land, shares, etc), the nominal value of which normally keeps pace with inflation. In
that way, the wealth of richer people is better protected against inflation.
The third category consists of creditors – people who have lent money to others. Because
inflation means that the purchasing power of money steadily declines over time, creditors are
repaid in money units of lower purchasing power. This effect, however, happens only if interest
rates are not adjusted upwards to compensate for this loss, as they often are. Only when
inflation causes a decline in the real interest rate on debt (roughly determined as the nominal
interest rate minus the inflation rate) do creditors lose as a result of inflation or, for that matter,
do debtors gain from inflation.
4. The fourth category of people includes all of us, to the extent that inflation causes us to fall
into a higher income tax bracket. South Africa, like most countries in the world, has a
progressive income tax system, meaning that on successive additions to income (called
brackets) a higher percentage of income tax is levied. Because inflation raises the nominal
value of our income, it can force us into higher tax brackets even while the real value of our
income remains the same (this is known as the "bracket creep").
Page 2 of 69
, 3. Explain the following terms
i. Inflation targeting
Monetary policy strategy that involves public announcement of a medium-term
numerical target for inflation.
ii. Interest rate risk
The riskiness of earnings and returns that is associated with changes in interest rates iii.
Monetary Policy
Monetary policy can be defined as the measures taken by the monetary authorities to influence
the quantity of money or the rate of interest with a view to achieving stable prices, full
employment and economic growth. Monetary policy in South Africa is conducted by the South
African Reserve Bank
iv. Money
Money or money supply is defines as anything that is generally accepted in payment for goods
or services or in the repayment of debts. Money is linked to changes in economic variables that
affect all of us and are important to the health of the economy.
3.2 Differentiate between hierarchical and dual mandates of monetary policy
Hierarchical versus Dual Mandates
Hierarchical mandates is when an economic goal, such as price stability, is put first and the say
that as long as it is achieved other goals can be pursued.
Page 3 of 69
