Questions on Macro Economics

Que According to the Keynesian view of money, there are three reasons why people hold money. Briefly describe the three (3) motives for holding money and the main determinants of each of these money balances. (15/15) According to the Keynesian view of money, there are three motives for holding money. These motives are transactionary motives, precautionary and speculative motive. Transactionary motive This is the demand for money as a medium of exchange. Money is needed for day to day expenses or day to day purchases of goods and services.

Money is exchanged for goods and services that cater for the needs and wants of customers. The goods might involve the most basic ones such as food, water and shelter as well as clothing. Precautionary motive Money as a store of value can be used to cater for uncertainties. People desire money to cater for these uncertainties that might impact on their lives. Unexpected disasters such as death, floods, hailstorms and so on may increase the demand to hold money as a precaution. However certain economic conditions such as the rate of inflation may have special implications on the demand for money for precautionary motives.

If the interest rate is too high, the demand for money for precautionary motives increases. Speculative motive Money as a store of value can be demand as an outcome of speculation or expectations. Speculation has serious impacts on liquidity preference. The liquidity preference can be determined by several variables such as the rate of inflation and interest rate. If individuals or households for example expect a sharp increase in the price of commodities, the demand for money as a speculative motive decreases as the fear that the value of their money will be lost as a result of inflation.

If people expect a sharp decrease in the price of commodities, the demand to hold money will increase as they know that, they will be able to buy more. © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 4 of 22 The demand to hold money as a transactionary motive is known as active balance. Money held for precautionary and speculative motive is known as idle balance. In general there is an inverse relationship between holding money as idle balance and interest rate. The higher the interest rate the greater the liquidity preference or demand for money for precautionary and speculative motive. . 2 List the three (3) main injections into the circular flow of income and spending and two (2) leakages from the circular flow of income and spending. (5/5) Injections into the circular flow are: a. Payments made by the foreign sector to the country for exports. b. Investments by foreign firms into a country. c. Government subsidies and payments for goods and services. Leakages from the circular flow of income and spending are: a. Payments for imports to the foreign sector. b. Payment of taxed to the government. QUESTION 3 [20/20] 3. Keynesian Theory emphasised an active role for government in maintaining the full employment level of national incomes. An economy free of government intervention could not ensure a sufficient level of demand. If, however, government adjusted the level of injections and withdrawals, the level of economic activity could be controlled through the multiplier effect. Briefly describe what is meant by the multiplier effect. (5/5) The multiplier effect refers to changes in national or equilibrium income or output resulting from changes if expenditure components.

The result is always a multiple of the expenditure, which implies that the result is always higher that the initial charge in other words it is a multiple of the initial charge. A change in injection, say consumption (C), investment (I), Government expenditure (G) and exports (X) results in a bigger change on the level of national output or income. The multiplier works on the portion of the injection that is channelled into the circular flow. If therefore is affected by such withdrawals as savings, taxes and imports.

In an open economy, the multiplier is given by the following formula: 1 1 – C (1 – t) tm Where c, t and m represent the propensities to consumer and import which are withdrawals from the circular flow. 3. 2 Explain using an AS/AD diagram, the impact of an increase in productivity without an increase in remuneration on the aggregate demand and supply curves. Please ensure that you show all labelling on your graph. (15/15) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 5 of 22 The impact of an increase in productivity without an increase in remuneration on AD and AS curves. AD1 AD E2 Price P P2 P0 P1 E0 E1 AS AS1

AS AD1 AS1 AD Y 0 Y0 Y1 Y2 Total Output Y From the figure above, the original price is P0 and the national income is equivalent to Y0. The economy is in equilibrium at E0. An increase in productivity shifts the aggregate supply curve to the right from AS to AS1. With the new supply curve, the equilibrium shifts to E1 at a price P1 and income Y1. Thus an increase in productivity reduces the price down to P1 and increases national income to Y1 from Y0. If there was an increase in remuneration this would have shifted the aggregate demand curve to AD, AD1 and increased the average price with a resultant higher output.

QUESTION 4 4. 1 [20/20] Briefly discuss the problems facing less developed countries which explain why, as a group, LDCs tend to be poorer than developed countries. (15/15) LDC’s generally have a much higher population growth than Developed countries. Rapid population growth can create problems because new jobs have to be created in order to accommodate the increase in the labour force. If this cannot be achieved then unemployment will increase and this will also have an impact on the quality of the wellbeing of the society as well as pressure on © IMM Graduate School of Marketing

Good Answer Booklet MAC/ECO101 Page 6 of 22 education and health services – lacking in quality and quantity. The other problem faced by LDC’s is that the quality of the labour force tends to be low. A large number of LDC’s don’t have access to natural resources such as mineral deposits, energy sources and agricultural land for example in the tropics where the climate is not favourable for farming and in these areas crops and livestock diseases are common. Those with the mineral deposits may not be in the position to get access to capital in order for them to extract these minerals.

Most LDC’s use traditional methods of farming and land ownership systems as a result of this agricultural productivity are very low. In some societies the land is owned by the community and not by the individuals therefore and person may not be motivated to protect or improve the soil since others will benefit without having to bear a cost. Agricultural development is therefore impeded. The other problem that LDC’s face is that their infrastructure is generally poorly developed. Power generation systems, roads, communication systems as well as housing facilities are lacking.

This tends to affect access to the markets and also this makes it hard for firms in these countries to exploit economies of scale in the same way that those firms in developed countries do. There is also the problem of critical shortage of capital goods and access to finance in order to promote economic development. LDC’s do not have their own capital goods industries and they have to import them, and this will bring about another problem of shortage of foreign currency. LDC’s rely on foreign aid, foreign loans and foreign direct investments to purchase capital goods. 4. Name the four (4) key market-oriented policy instruments through which monetary policy is conducted in South Africa. (5/5) The four policy instruments are accommodation policy, open market policy, intervention in foreign exchange markets and public debt management. QUESTION 5 5. 1 [20/20] The South African Reserve Bank uses three different measures of the quantity of money, namely M1, M2 and M3. Explain what these measures (M1, M2 and M3) consist of. (6/6) M1 refers to all notes and coins in circulation as well as all demand deposits. M2 refers to M1 and also includes short to medium term deposits.

M3 is made up of M1 and M2 and also includes all long term deposits. 5. 2 Use demand and supply analysis to graphically illustrate and explain the economic impact of an import tariff on a good such as textiles. Your graph and explanation must show the situation in the absence of international trade and after the economy is opened up to international trade. (11/11) The graph below illustrates the economic impact of an import tariff on a good such as textiles: © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 7 of 22 P AD AS Price P0 E0 Pt SW

Pw AS 0 Q1 Q2 Q0 Q4 Q5 AD Q QUANTITY 5. 3. List three (3) components of the balance of payments. (3/3) In the absence of international trade in the textile market, aggregate demand (AD) and aggregate supply (AS) are at equilibrium at E0, where price is P0 and quantity is Q0. The economy is opened up to international trade. The world supply of textiles is now reflected by SW. this is a horizontal supply curve that reflects that at the world price of Pw, an unlimited quantity of textiles is available for supply. This is a large decrease in price from the equilibrium price of P0.

At the world price of Pw, the domestic suppliers are only able and willing to supply a quantity of Q1, however the domestic demand at Pn is for Q5. Thus at Pw, the domestic suppliers will supply a quantity of Q1, however the domestic demand at Pn is for Q5. Thus at Pw, the domestic suppliers will supply a quantity at Q1 whilst the remaining quantity demanded (Q5 – Q1) will be imported into the country from the international market. This will result in the domestic textile industry being severely affected as companies shut down and people loose their jobs. EXAM TOTAL: 100 IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 8 of 22 MACROECONOMICS (MAC) ECONOMICS 1 (ECO101) 30 MAY 2012 Answer ANY FIVE (5) questions QUESTION 1 1. 1. 1 Study the following Lorentz curve and then answer the questions: [20/20] i. What does the Lorentz curve illustrate? (3/3) The Lorentz curve illustrates the degree of inequality in the distribution of income in a population. What does line OB represent? Perfect equality in the distribution of income. Which line is the Lorentz curve? The line that runs from 0 through a, b, c, d to B. What is the shaded area called?

The area of inequality. (2/2) ii. iii. (2/2) iv. (2/2) v. Where will you find the greatest possible inequality? (2/2) This is where only one individual or household earns the entire income. This would be illustrated by a line running from 0 to A to B. With reference to the Lorentz curve above, how is the Gini coefficient calculated? (2/2) Gini coefficient would be calculated by dividing the area of the Lorentz curve (0, a, b, c, d, B) by the area of the right-angled triangle 0AB. When will the Gini coefficient be zero? When there is perfect equality in the distribution of income (OB). 1/1) vi. vii. viii. When will the Gini coefficient be one? © IMM Graduate School of Marketing (1/1) Good Answer Booklet MAC/ECO101 Page 9 of 22 When there is there is the greatest possible inequality total income accrues to one individual or household (line running from 0 to A to B) 1. 2 List five (5) causes of cost-push inflation. Increase in profit margins. Increase in the price of other inputs e. g. imported oil or capital goods. Wage and salary increase unaccompanied by an increase in productivity. Decrease in productivity. Deteriorations in the weather. 20/20] (5/5) QUESTION 2 2. 1 Which of the following are changes in injections and which are changes in withdrawals in South Africa’s circular flow of income? In each case, specify whether the change is an increase or decrease ceteris paribus. i. The local council funds a new metro project for the city. Change in injection Increase ceteris paribus. The government raises tax allowances. Change in withdrawal Decrease ceteris paribus. (2/2) ii. (2/2) iii. A leading South African company wins a major overseas contract. (2/2) Change in injection Increase ceteris paribus.

Government reduces child benefits. Change in withdrawal Decrease ceteris paribus. (2/2) iv. v. Depreciation in the exchange rate affects the popularity of holidays abroad. (2/2) Change in withdrawal Decreases ceteris paribus. 2. 2 The South African Reserve Bank regards financial stability as its most important objective. Identify and discuss two areas where the South African Reserve Bank plays a pivotal role in pursuit of this objective. (10/10) Financial Stability ? Bank notes and coins The SA Reserve Bank issues, destroys, prints produces bank notes and coins.

The mint company produces coins and the note company prints the © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 10 of 22 notes. It is done according to the demand of money needed to circulate in the economy. ? ? ? ? ? ? Supervision (Bank). The SA Reserve Bank issues licenses to other banks. The SA Reserve Bank has the responsibility to make sure other banks function correctly in the economy. Supervises and corrects other banks when needed. Offers liquidity to other banks. Acts as a clearing bank to other banks. [20/20] QUESTION 3 3. 1

The Aggregate Demand – Aggregate Supply model (AS/AD) is a guide for policymaking. Explain, using a AS/AD model, the effect on the Aggregate Demand (AD) as the result of an Expansionary Monetary and Fiscal Policy. First draw the diagram and then explain the effect on the Aggregate Demand (AD). (16/16) The diagram below shows the effects of Expansionary Monetary and Fiscal Policy in the AS/AD model. P ADI AS PRICE LEVEL P2 E1 P0 E0 AD AS AD ADI 0 Y1 Y2 TOTAL PRODUCTION, INCOME Y © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 11 of 22

Expansionary Monetary and Fiscal Policy entails the reduction in interest rates and increase in money supply. Increase in government expenditure or spending and lowering of taxes. By this, demand in the economy would have been increased, because participants in the economy have enough credits to spend hence prices of goods and services will increase. On the diagram, prior to the expansionary monetary and Fiscal policy production on the horizontal was of Y1, price level of P0 and equilibrium of E0. Due to Expansionary monetary and Fiscal policy production increased to Y2, price level to P2 and new equilibrium to E1.

The Aggregate demand curve has shifted to the right to ADI and the AS supply curve remains as it is, no effect. 3. 2 Identify four (4) types of unemployment. Four types of unemployment: Cyclical unemployment Seasonal unemployment Structural unemployment Frictional unemployment (4/4) QUESTION 4 4. 1 Distinguish between the following: i. Gross Domestic Product (GDP) [20/20] (4/4) GDP equation GDP = C + I + G + (x-z) It excludes imports. GDP is the total value of production within the boundaries of the country. ii. Gross Domestic Expenditure (GDE) (3/3) GDE = C + I + G Excludes exports. GDE is equal to GDP at market prices.

GDE is the total value of goods and services in the boundaries of the country. iii. Gross National Income (GNI) GNI = Primary income receipts. Primary income payments. GNI measures the standard of living. GNI = GNP 4. 2 In a system of market-determined exchange rate, how would the following affect the price of the rand in terms of the dollar? Explain your answer in terms of whether there is a shift in the demand or supply curves (or both) and which way the curve(s) shifts. (3/3) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 12 of 22 i. More capital goods are imported from China. 2/2) Demand curve shifts to the right, supply curve remains the same, Rand depreciates against the dollar. Net investments in South Africa increase. (2/2) Demand curve shifts to the right, supply curve shifts to the right, Rand appreciates against the dollar. Speculators believe the exchange rate will fall. (2/2) Demand curve shifts to the right, supply curve shifts to the left, the Rand depreciates against the dollar. Interest rates in South Africa fall relative to those abroad. (2/2) The demand curve shifts to the left, supply curve stays the same the Rand depreciates against the dollar.

South Africa experiences a high rate of inflation. (2/2) The demand curve shifts right, the supply curve shifts left the rand depreciates against the dollar. [20/20] ii. iii. iv. v. QUESTION 5 5. 1 The relationship between household expenditure and income is called the consumption function. Graphically illustrate the consumption function and describe three (3) important features of the consumption function. (11/11) The diagram below illustrates the consumption function: TOTAL SPENDING C2 C C1 C Y C Y 0 INCOME In the diagram above it illustrates that an increase in income will result in an increase in total spending.

Although there is an increase in total spending, the increase in total spending is less than the increase in © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Y4 Y5 Page 13 of 22 income. Spending or consumption will not begin at zero because our consumption function which is C is slightly above zero. 5. 2 List the five (5) macroeconomic objectives. Five macroeconomic objectives are as follows: Full employment. Economic growth Stability in price Balance of payment Equitable distribution of income 5. 3 Briefly explain the ‘Consumer Price Index’ (CPI). (4/4) (5/5)

Consumer Price Index is defined as the price index of the basket with goods and services of consumers. Consumer Price Index is used to measure inflation rate usually on an annual basis. Consumer Price Index is calculated by selecting goods and services that is expected to be consumed by average consumers in an economy. In the Consumer Price Index the importance of goods and services is determined by the weight allocated to each good and service in the basket. QUESTION 6 6. 1 Draw a figure explaining a typical business cycle. [20/20] (8/8) Economic activity + B Peak (boom) (upswing) – recovery recession (downswing) Time C A trough – – A business cycle consists of peaks and troughs. © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 14 of 22 – 6. 2 At point A the through – the economy will be in recession where the level of economic activity will be low, high inflation, no investments, high unemployment. At point B the peak caused by an upswing or when the economy recovers from the recession the economic level of activities will be at its highest, low inflation, high investments, high productivity. It is usually called a boom. Also unemployment will be low.

Then there is a downswing from the boom to recession and to the trough again. The cycle goes on and on. Suppose the price of a packet of 20 cigarettes is R12. 00. At this equilibrium price the quantity sold is 150 000 packets per week. Government now introduces an additional excise tax of R4. 00 per packet. Use the data to construct a graph to explain the effect of the introduction of this excise tax. First draw the graph and then explain the effect. Indicate the following on the graph and explain: i. ii. iii. The original equilibrium price and quantity The new equilibrium price and quantity The tax levied per packet 12/12) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 15 of 22 R Price of packet(R) S1 20 S1 D R4. 00 S 18 16 14. 40 14 E2 E0 12 E1 10. 40 10 S1 8 D 6 S 4 2 50 100 120 Quantity sold (in thousands) per week 150 200 – – At the beginning of a price of R12. 00 we are at equilibrium E0 with 150 000 packets being sold per week. With the introduction of an additional excise tax of R4. 00 per packet our supply curve moves to the left and cuts the demand curve of our new equilibrium E2 with price of R14. 40 and a quantity of 120 000 packets per week.

The supplier will be able sell at a price of about R10. 40 with a quantity of 120 000 packets per week. The tax levied per packet is shown by the distance between E1 and E2 and is the additional excess tax of R4. 00. The supplier will make sale at a lower price from R12. 00 to R10. 40 which is R1. 60 less and the consumer will buy at a higher price of R14. 40 which is R2. 40 more. EXAM TOTAL: 100 © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 16 of 22 MACROECONOMICS (MAC) ECONOMICS 1 (ECO101) 21 OCTOBER 2011 Answer ANY FIVE (5) questions QUESTION 1 1. [18/20] Discuss the circular flow of goods and services by drawing a diagram and then explaining this flow. (10/10) Firms Factors of production Goods and services Factor market Goods market Factors of production Goods and services Households From the above diagram we are able to see that households produce the factors of production, and sell them on the factor market. The factors of production are purchased from the factor market, by firms. Firms then take the factors of production, and turn them into goods and services, which are then sold on the goods market.

Households then purchase the goods and services from the goods market for consumption. 1. 2 Name the most important total of the balance of payments. The balance of gold and foreign exchange reserves. 1. 3 Provide four (4) reasons for your answer in 1. 2 above. (6/8) (2/2) The balance of gold and foreign exchange reserves is the most important total because the answer is obtained by adding the two major accounts (current and financial account) together. © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 17 of 22 This total shows the financial standing of a country compared to the rest of the world.

The total depicts if the country is importing or exporting more. And the total allows us to see which areas, in terms of financial stability, on which we can improve. QUESTION 2 2. 1 On what basic idea did Keynes base his model? [20/20] (2/2) Keynes based his model on the basic idea that production and income are determined by aggregate spending. In other words aggregate spending drives total production and income in the economy thus A 2. 2 Y The consumption function is concerned with total spending in the economy. Give six (6) important factors that affect consumption.

Consumption can be affected by the following factors: (6/6) 1. 2. 3. 4. 5. 6. Wealth Interest rates Level of taxation Expectations Distribution of income Age distribution of population (2/2) 2. 3 What is meant by ‘prices are given’ in terms of this model? In terms of the Keynesian model when they say “prices are given” they mean that prices are set outside the model, they are not generated in the model. 2. 4 The aim of a simple Keynesian macroeconomic model is to explain how national income is determined. Describe five (5) assumptions upon which this model is based. 10/10) The simple Keynesian model is based on various assumptions of which the following may be discussed: Firstly, it assumes that the economy consist of households and firms only. These are the basic decision-making and production units only. The model also assumes that there is no government thus the local, regional and central government is not part of the simple Keynesian model. There is no foreign sector. It assumes that it is a closed economy where there is no interaction with the rest of the world. © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 18 of 22

The forth assumption is that money supply and interest rates are given. The interest rates are determined outside the model. Therefore the model cannot influence the monetary sector operations. Lastly, the simple Keynesian model assumes that “prices are given”. All market prices are given and they are not generated in the model which implies that the model cannot be used to calculate the inflation rate. QUESTION 3 3. 1 [20/20] Explain the Gross Domestic Product (GDP) and give the formula for the calculation thereof. (5/5) Gross Domestic Product is the total value of goods and service within the country.

GDP is calculated by product, income and expenditure and excludes imports. GDP = C + 1 + G + (x – z) 3. 2 Explain the Gross Domestic Expenditure (GDE) and give the formula for the calculation thereof. (5/5) Gross Domestic Expenditure is the total value of spending on goods produced in the country. GDE is equal to GDP at market price. Excludes exports GDE = C + 1 + G 3. 3 Define the monetary policy. (2/2) Monetary policy can be defined as a measure of monetary authorities to influence quantity of money or interest. 3. 4 Give the four (4) key instruments used in the monetary policy. a. b. c. . Accommodation policy Open market policy Public debt management Intervention on foreign exchange rate [20/20] (2/2) (8/8) QUESTION 4 4. 1 When is a tax a general tax? A general tax is a tax levied on goods and services i. e. VAT. 4. 2 When is a tax a selective tax? A selective tax is a tax levied only on selected goods. i. e. alcohol. (2/2) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 19 of 22 4. 3 When is a tax proportional? (2/2) A proportional tax is when the tax paid (i. e. income tax) is proportional to the income earned. 4. 4 When is a tax progressive? (2/2)

A progressive tax is a tax that increases as income increases (i. e. income tax). 4. 5 When is a tax regressive? A regressive tax is a tax which reduces as income increases (i. e. VAT) 4. 6 What type of tax is ‘Value Added Tax’ (VAT) and why? (2/2) (2/2) Value Added Tax is a general tax. It is levied on most goods and services. 4. 7 Assume a bottle of wine costs R45. 95 and the government raises the tax on wine by R4. 00 per bottle. Answer the following questions: a) What will happen to the consumption of wine in the country? (2/2) The consumption of wine will decrease due to a drop in demand caused by the higher price. ) Give the three (3) groups that will share the burden of this increase in tax. (6/6) Employer – the employer will receive less profit per bottle of wine. Employee – there will be less demand which will lead to a decrease in supply / production which can create less jobs or wage cuts. Consumer – the consumer will pay more for a bottle of wine due to inflation in the price. [20/20] QUESTION 5 Suppose the market is in equilibrium at an exchange rate of €11 and a quantity of 14 billion eurodollars a day. Suppose there is a decrease in the supply of eurodollars. 5. Draw a graph showing the original equilibrium position. (5/5) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 20 of 22 A decrease in the supply of eurodollars D € S1 14 E1 S 12 Price of eurodollars (exchange rate) 11 E 8 6 4 D 2 0 2 4 6 8 10 12 14 16 Q Quantity of eurodollars per day (billions) 5. 2 Then on the same graph, show the effect of the decrease in the supply of eurodollars. (5/5) Provide a brief explanation of the effect shown in (5. 2). (10/10) 5. 3 Original supply curve at (SS), Demand at (DD) equilibrium at E (€11:14), price is at €11 and quantity at 14.

The new supply curve at SS1, equilibrium at E1, price at 14 and quantity at 12. When price appreciates the quantity demanded depreciates, and it forms a new equilibrium at an exchange rate of €14 and a quantity of 12. The supply of eurodollars decreases. QUESTION 6 6. 1 [16/20] Draw a Philips curve which shows the relationship between inflation and unemployment. (7/8) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 Page 21 of 22 Figure 2 ^P P Inflation Rate (%) 5 A 2 B U -2 3 6 Unemployment Rate (%) Define the concept of ‘stagflation’. 6. 2 (2/2)

Stagflation is the combination of an increased unemployment rate along with an increase in inflation. 6. 3 Draw a figure that shows the impact of ‘stagflation’ on the Philips curve. (8/8) Figure 3 ^P P 6 Inflation Rate (%) A 5 A U 4 Unemployment Rate (%) © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101 6 Page 22 of 22 6. 4 Give two (2) other factors which would cause the Philips curve to move in the same direction as the movement caused by ‘stagflation’. (1/2) Recession in a country. Production costs increase. EXAM TOTAL: 100 © IMM Graduate School of Marketing Good Answer Booklet MAC/ECO101

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