mba eco v6 e f a

Contact details: Regenesys Business School

Tel: +27 (11) 669-5000 Fax: +27 (11) 669-5001

Email: [email protected] www.regenesys.co.za

MASTER OF BUSINESS ADMINISTRATION

Economics

Version Control: 6_e_f Date of Publication: March, 2014 Publisher: Regenesys Management Place of Publication: Sandton

Document Change History Date Version Initials Description of Change 27 August 2013 5_f FVS Formatting 18 March 2014 6 CT Update to:

New textbook (Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited)

Revised learning outcomes for 2014 Emerald articles Updating of charts

20 March 2014 6_f FVS Formatting 24 March 2014 6_e_f LS Editing

This Study Guide highlights key focus areas for you as a student. Because the respective topic of study is so vast, it is critical that you consult additional literature.

Copyright Regenesys, 2014

All rights reserved. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording or

otherwise) without written permission of the publisher. Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages.

CONTENTS

1 WELCOME TO REGENESYS .................................................................................................................... 1 2 INTRODUCTION ......................................................................................................................................... 2

2.1 TEACHING AND LEARNING METHODOLOGY ............................................................................... 2 2.2 ALIGNING ORGANISATIONAL, TEAM AND INDIVIDUAL OBJECTIVES ........................................ 3

3 ICONS USED IN THIS STUDY GUIDE ...................................................................................................... 4 4 STUDY MATERIAL FOR THE MODULE .................................................................................................... 5 5 RECOMMENDED RESOURCES ............................................................................................................... 5

5.1 RECOMMENDED READING ............................................................................................................. 5 5.2 RECOMMENDED ARTICLES ............................................................................................................ 6 5.3 MULTIMEDIA ..................................................................................................................................... 7 5.4 ADDITIONAL SOURCES TO CONSULT ........................................................................................... 7

6 LEARNING OUTCOMES ............................................................................................................................ 9 7 CONTENT SCOPE AND LEARNING GUIDANCE ................................................................................... 10

7.1 INTRODUCTION TO ECONOMICS ................................................................................................ 11 7.1.1 WHAT IS ECONOMICS? ..................................................................................................... 11 7.1.2 SCARCITY, CHOICE AND OPPORTUNITY ....................................................................... 12 7.1.3 THE PRODUCTION POSSIBILITIES CURVE ..................................................................... 12 7.1.4 THE THREE CENTRAL ECONOMIC QUESTIONS ............................................................ 13 7.1.5 ECONOMIC SYSTEMS ....................................................................................................... 14 7.1.6 INTRODUCTION TO ECONOMIC THEORIES ................................................................... 18 7.1.7 ECONOMIC AGGREGATES ............................................................................................... 21

7.2 THE SOUTH AFRICAN ECONOMY ................................................................................................ 27 7.2.1 PERFORMANCE OF THE SOUTH AFRICAN ECONOMY ................................................. 27 7.2.2 SOUTH AFRICAS INTERNATIONAL ECONOMIC POSITION .......................................... 28 7.2.3 BANKING STABILITY IN SOUTH AFRICA ......................................................................... 30 7.2.4 SOUTH AFRICAS FACTOR ENDOWMENT ...................................................................... 31 7.2.5 SOUTH AFRICAS LINKS WITH THE REST OF THE WORLD .......................................... 32

7.3 DEMAND AND SUPPLY .................................................................................................................. 36 7.3.1 DEMAND ............................................................................................................................. 36 7.3.2 SUPPLY ............................................................................................................................... 40 7.3.3 MARKET EQUILIBRIUM ...................................................................................................... 42 7.3.4 CONSUMER SURPLUS AND PRODUCER SURPLUS ...................................................... 43 7.3.5 CHANGE IN DEMAND ........................................................................................................ 44 7.3.6 CHANGE IN SUPPLY .......................................................................................................... 45 7.3.7 SIMULTANEOUS CHANGES IN DEMAND AND SUPPLY ................................................. 45 7.3.8 GOVERNMENT INTERVENTION ....................................................................................... 46

7.4 ELASTICITY AND TOTAL INCOME ................................................................................................ 47 7.4.1 THE PRICE ELASTICITY OF DEMAND .............................................................................. 47 7.4.2 INCOME ELASTICITY OF DEMAND .................................................................................. 49 7.4.3 CROSS ELASTICITY OF DEMAND .................................................................................... 49 7.4.4 THE PRICE ELASTICITY OF SUPPLY ............................................................................... 49

7.5 THE SOUTH AFRICAN LABOUR MARKET .................................................................................... 53 7.5.1 THE LABOUR MARKET VERSUS THE GOODS MARKETS ............................................. 53 7.5.2 A PERFECTLY COMPETITIVE LABOUR MARKET ........................................................... 54 7.5.3 IMPERFECT LABOUR MARKETS ...................................................................................... 57 7.5.4 WAGE DIFFERENTIALS ..................................................................................................... 58

7.6 INTRODUCTION TO ECONOMIC POLICY ANALYSIS .................................................................. 61 7.6.1 THE NEED FOR GOVERNMENT INTERVENTION ............................................................ 61 7.6.2 ECONOMIC TOOLS USED IN ECONOMIC POLICY ANALYSIS ....................................... 64 7.6.3 FURTHER CONSIDERATIONS OF ECONOMIC POLICY ANALYSIS ............................... 65

7.7 THE MONETARY SECTOR ............................................................................................................. 66 7.7.1 THE FUNCTIONS OF MONEY ............................................................................................ 66 7.7.2 DIFFERENT KINDS OF MONEY ......................................................................................... 67 7.7.3 MONEY SUPPLY IN SOUTH AFRICA ................................................................................ 67 7.7.4 FINANCIAL INSTITUTIONS ................................................................................................ 70 7.7.5 THE SUPPLY OF MONEY .................................................................................................. 72 7.7.6 THE DEMAND FOR MONEY .............................................................................................. 74 7.7.7 EQUILIBRIUM IN THE MONEY MARKET ........................................................................... 75 7.7.8 THE INSTRUMENTS OF MONETARY POLICY ................................................................. 76 7.7.9 BANK SUPERVISION .......................................................................................................... 78

7.8 THE FOREIGN SECTOR ................................................................................................................. 80 7.8.1 WHY COUNTRIES TRADE ................................................................................................. 80 7.8.2 TRADE POLICY ................................................................................................................... 82 7.8.3 THE EXCHANGE RATES .................................................................................................... 83 7.8.4 THE TERMS OF TRADE (TOT) .......................................................................................... 84

7.9 AN INTRODUCTION TO APPLIED ECONOMETRICS ................................................................... 86 7.9.1 ECONOMETRIC TECHNIQUES ......................................................................................... 86 7.9.2 ECONOMETRIC CONCEPTS ............................................................................................. 87 7.9.3 PRACTICAL APPLICATION OF ECONOMETRICS ............................................................ 87

7.10 INFLATION AND CAPITAL BUDGETING ....................................................................................... 89 7.10.1 DEFINITION OF INFLATION .............................................................................................. 89 7.10.2 THE MEASUREMENT OF INFLATION .............................................................................. 89 7.10.3 THE EFFECTS OF INFLATION .......................................................................................... 91 7.10.4 THE CAUSES OF INFLATION ............................................................................................ 91 7.10.5 ANTI-INFLATION POLICY .................................................................................................. 92 7.10.6 CAPITAL BUDGETING ....................................................................................................... 93

7.11 THE IMPACT OF GLOBALISATION ................................................................................................ 95 7.11.1 THE DEFINITION OF GLOBALISATION ............................................................................ 95 7.11.2 THE IMPACT OF GLOBALISATION ON SOUTH AFRICA ................................................. 96 7.11.3 BENEFITS OF INTERNATIONAL PORTFOLIO DIVERSIFICATION ................................. 97 7.11.4 OFFSHORE FINANCING .................................................................................................... 98

8 REFERENCES ........................................................................................................................................ 100

List of Tables

TABLE 1: WELL-KNOWN ECONOMIC THEORIES ....................................................................................... 18 TABLE 2: COMPARISON OF THE VARIOUS ECONOMIC SCHOOLS OF THOUGHT ................................ 19 TABLE 3: SIMULTANEOUS CHANGES IN DEMAND AND SUPPLY ............................................................ 45 TABLE 4: REAL-LIFE ELASTICITY ................................................................................................................ 48 TABLE 5: LABOUR VERSUS GOODS MARKET ........................................................................................... 54 TABLE 6: FUNCTIONS OF MONEY ............................................................................................................... 66 TABLE 7: BASEL III ......................................................................................................................................... 72 TABLE 8: ECONOMETRIC CONCEPTS ........................................................................................................ 87

List of Figures

FIGURE 1: THE PRODUCTION POSSIBILITIES CURVE .............................................................................. 12 FIGURE 2: CIRCULAR FLOWS IN A MARKET ECONOMY .......................................................................... 22 FIGURE 3: HIRING VS. SKILLED LABOUR 2012 (WORLDWIDE) ................................................................ 29 FIGURE 4: SOUTH AFRICAN CURRENT ACCOUNT (2008 TO 2014) ......................................................... 34 FIGURE 5: AN INDIVIDUALS WEEKLY DEMAND FOR TOMATOES .......................................................... 37 FIGURE 6: CHANGE IN DEMAND ................................................................................................................. 38 FIGURE 7: TWO SUBSTITUTES BUTTER AND MARGARINE .................................................................. 39 FIGURE 8: TWO COMPLEMENTS CASSETTES AND VCRS .................................................................... 39 FIGURE 9: RELATIONSHIP BETWEEN PRICE AND QUANTITY SUPPLIED .............................................. 41 FIGURE 10: THE EFFECT OF RISING PRICES ............................................................................................ 42 FIGURE 11: DEMAND, SUPPLY AND MARKET EQUILIBRIUM ................................................................... 43 FIGURE 12: CONSUMER SURPLUS AND PRODUCER SURPLUS AT MARKET EQUILIBRIUM ............... 44 FIGURE 13: SOUTH AFRICA MONEY SUPPLY M0 (2004 TO 2014) ........................................................... 67 FIGURE 14: SOUTH AFRICA MONEY SUPPLY M1 (2004 TO 2014) ........................................................... 68 FIGURE 15: SOUTH AFRICA MONEY SUPPLY M2 (2004 TO 2014) ........................................................... 69 FIGURE 16: SOUTH AFRICA MONEY SUPPLY M3 (JAN 2000 TO MAR 2013) ........................................... 69 FIGURE 17: THE MONEY MARKET ............................................................................................................... 76

Regenesys Business School 1

1 WELCOME TO REGENESYS

Have a vision. Think big. Dream, persevere and your vision will become a reality. Awaken your potential knowing that everything you need is within you.

Dr. Marko Saravanja

At Regenesys, we assist individuals and organisations to achieve their personal and organisational goals, by enhancing their management and leadership potential. We approach education and development holistically, considering every interaction not only from an intellectual perspective but also in terms of emotion and spirituality. Our learning programmes are designed to transform and inspire your mind, heart and soul, and thus allow you to develop the positive values, attitudes and behaviours, which are required for success. Having educated over 95 000 students based in highly reputable local and international corporations across over 100 countries since Regenesys' inception in 1998, we are now one of the fastest-growing and leading institutions of management and leadership development in the world. Regenesys ISO 9001:2008 accreditation bears testimony to our quality management systems meeting international standards. Regenesys is accredited with the Council on Higher Education. Our work is rooted in the realities of a rapidly changing world and we provide our clients with the knowledge, skills and values required for success in the 21st century. At Regenesys, you will be treated with respect, care and professionalism. You will be taught by business experts, entrepreneurs and academics who are inspired by their passion for human development. You will be at a place where business and government leaders meet, network, share their experiences and knowledge, learn from each other, and develop business relationships. You will have access to a campus, in the heart of Sandton, with the tranquillity of a Zen garden, gym and meditation room. We encourage you to embark on a journey of personal development with Regenesys. We will help you to awaken your potential and to realise that everything you need to succeed is within you. We will be with you every step of the way. We will work hard with you and, at the end celebrate your success with you. Areas of Expertise


2 INTRODUCTION

Welcome to the module on Economics a core component of the MBA programme. The broad purpose of this module is to facilitate your understanding of the fundamental principles, concepts and processes of economics. This module teaches you about the relationships between various parts of the economy and uses various economic models to illustrate these relationships. It covers application to traditional economic areas, such as macroeconomics, microeconomics, international trade, and monetary economics; as well as applied areas, such as economic policy analysis and econometrics. Students are encouraged to use this Study Guide as a starting point to engage with the given subject matter and should be read in conjunction with the prescribed texts and other current reading materials.

2.1 TEACHING AND LEARNING METHODOLOGY

Regenesys uses an interactive teaching and learning methodology that encourages self-reflection and promotes independent and critical thinking. Key to the approach utilised is an understanding of adult learning principles, which recognise the maturity and experience of participants, and the way that adult students need to learn. At the core of this is the integration of new knowledge and skills into existing knowledge structures, as well as the importance of seeing the relevance of all learning via immediate application in the workplace. Practical exercises are used to create a simulated management experience to ensure that the conceptual knowledge and practical skills acquired can be directly applied within the work environment of the participants. The activities may include scenarios, case studies, self-reflection, problem solving and planning tasks. Training manuals are developed to cover all essential aspects of the training comprehensively, in a user-friendly and interactive format. Our facilitators have extensive experience in management education, training and development.

Please read through this Study Guide carefully, as it will influence your understanding of the subject matter and the successful planning and completion of your studies.


2.2 ALIGNING ORGANISATIONAL, TEAM AND INDIVIDUAL OBJECTIVES

This course will draw on a model developed by Regenesys Management, which demonstrates how the external environment, the levels of an organisation, the team and the components of an individual are interrelated in a dynamic and systemic way. The success of an individual depends on his/her self-awareness, knowledge, and ability to manage successfully these interdependent forces, stakeholders, and processes. The degree of synergy and alignment between the goals and objectives of the organisation, the team and the individual determines the success or failure of an organisation. It is therefore imperative that each organisation ensures that team and individual goals and objectives are aligned with the organisations strategies (vision, mission, goals and objectives, etc.); structure (organogram, decision-making structure, etc.); systems (HR, finance, communication, administration, information, etc.); culture (values, level of openness, democracy, caring, etc.). Hence, an effective work environment should be characterised by the alignment of organisational systems, strategies, structures and culture, and by people who operate synergistically.

Regenesys Integrated Management Model


3 ICONS USED IN THIS STUDY GUIDE

Icons are included in the Study Guide to enhance its usability. Certain icons are used to indicate different important aspects in the Study Guide to help you to use it more effectively as a reference guide in future. The icons in this Study Guide should be interpreted as follows:

Definition

The definitions provide an academic perspective on given terminology. They are used to give students a frame of reference from which to define a term using their own words.

Examples

The example icon is used to indicate an extra/additional text that illustrates the content under discussion. These include templates, simple calculation, problem solution, etc.

Video clip or presentation

This icon indicates a URL link to a video clip or presentation on the subject matter for discussion. It is recommended that students follow the link and listen/read the required sources.

Interesting source to consult

The source icon is used to indicate text sources, from the Internet or resource centre, which add to the content of the topic being discussed

In a nutshell

This icon indicates a summary of the content of a section in the workbook and to emphasise an important issue.

Calculations

This icon indicates mathematical or linguistic formulae and calculations.

Self-reflection

Students complete the action of self-reflection in their own time. It requires students to think further about an issue raised in class or in the learning materials. In certain instances, students may be required to add their views to their assignments.

Tasks

The task icon indicates work activities that contact students must complete during class time. These tasks will be discussed in class and reflected upon by students and facilitators. E-learning students can use these tasks simply to reinforce their knowledge.

Note

This icon indicates important information of which to take note.


4 STUDY MATERIAL FOR THE MODULE

You have received material that includes the following:

Study Guide Recommended reading Assignment

These resources provide you with a starting point from which to study the contents of this module. In addition to these, other resources to assist you in completing this module will be provided online via the link to this module. Guidance on how to access the material is provided in the Academic Handbook that you received when you registered for this qualification.

5 RECOMMENDED RESOURCES

A number of recommended resources have been identified to assist you in successfully completing this module.

5.1 RECOMMENDED READING

The following textbook is recommended and must be used to complete the module:

Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited.

Please ensure you order, or download your textbook, before you start with the module.

Given the analytical nature of the subject, it is highly recommended that you refresh your understanding of graphs used in economic models (refer to the Appendix on pp 15-27 of the recommended textbook).


5.2 RECOMMENDED ARTICLES

The following journal articles are recommended for the successful completion of this module:

Abboushi, S. 2014, 'Solar trade tariffs', Competitiveness Review, 24 (1), 59-65.

Ali, S., Rabbi, F., Hayat, U., and Ali, N. 2013, 'The composition of public expenditures and economic growth: evidence from Pakistan', International Journal of Social Economics, 40 (11), 1010-1022.

Buder, F., Feldman, C., and Hamm, U. 2012, 'Why regular buyers of organic food still buy many conventional products', British Food Journal, 116 (3), 390-404.

Dowlah, C. 2014, 'Cross-border labor mobility', Journal of International Trade Law and Policy, 13 (1), 2-18.

Ezeani, E. 2013, 'WTO post Doha: trade deadlocks and protectionism', Journal of International Trade Law and Policy, 12 (3), 272-288.

Trainer, F. 2014, 'Ethics and the Economy', Humanomics, 30 (1), 41-58.

Additional sources available on the Internet:

Andrew, T., and Alex, F. n.d. 'A Teaching Note on Offshore Financial Centers', Journal of Advancements in Business Education. https://www.sbrconferences.com/uploads/Vol1-Faseruk_Alex.pdf (accessed 20 March 2014).

Department of Trade and Industry, 2013, 'South Africa's Trade Agreements' http://www.thedti.gov.za/parliament/ITED.pdf (accessed 19 March 2014).

Financial Times, 2013, 'Inflation Targeting', http://lexicon.ft.com/Term?term=inflation-targeting (accessed 18 March 2014).

Ghosh, J. 2013, 'The Global Economic Chessboard and the Role of the BRICS: Brazil, Russia, India, China, South Africa', http://www.globalresearch.ca/the-global-economic-chessboard-and-the-role-of-the-brics-brazil-russia-india-china-south-africa/5357502 (accessed 19 March 2014).

Marcus, G, 2014, 'Quarterly Economic Review', South African Reserve Bank, Quarterly Bulletin March 2014, https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/6140/01Full%20Quarterly%20Bulletin%20%E2%80%93%20March%202014.pdf (accessed 20 March 2014).

Naidoo, J. (n.d.). 'The impact of HIV/AIDS on crime in South Africa', http://www.sarpn.org/documents/d0001964/HIVAIDS_crime_SA_Naidoo.pdf (accessed 18 March 2014).

Weiss, L. 2013, 'The myth of free-market capitalism versus the rest', http://speri.dept.shef.ac.uk/2013/01/15/myth-free-market-capitalism-rest/ (accessed 18 March 2014).


The following links provide useful country data:

Indexmundi, 2012, 'South Africa Economy Overview', http://www.indexmundi.com/south_africa/economy_overview.html (accessed 18 March 2014). (Note: Go to the website main page and select a country of your choice).

Third World Planet, 2014, 'Third World Planet: The Third World Economies' http://www.thirdworldplanet.com (accessed 18 March 2014) (Note: Click on the side bar to view the different economies, e.g. The Indian Economy)

Trading Economics, 2014, http://www.tradingeconomics.com (accessed 18 March 2014). (Note: Selections available include countries, indicators, and markets)

Additional articles that may prompt discussions and further assist you in completing this course will be saved on Regenesys Online under the relevant module. Please visit the site regularly to access these additional sources.

5.3 MULTIMEDIA

Ernst and Young, 2012, 'Globalization', [video clip], http://www.youtube.com/watch?v=JvCyRoY6azk (accessed 18 March 2014).

5.4 ADDITIONAL SOURCES TO CONSULT

As a higher education student, you are responsible for sourcing additional information that will assist you in completing this module successfully. Below is a list of sources that you can consult to obtain additional information on the topics to be discussed in this module:

Emerald This is an online database containing journal articles that are relevant to your modules. Please refer to the attached Emerald manual to assist you to download required articles. Information on how to access Emerald is provided to you in your Academic Handbook. You will receive access to the database once you register as a student.

NetMBA: This is one of several web addresses that provide a selection of MBA constructs and discussion. It is one of the better of these addresses. http://www.netmba.com/

MindTools: MindTools.com is a very useful source of ideas, constructs, management models, etc. with even more useful commentary and description. http://www.mindtools.com/

Brunel Open Learning Archive:

A Brunel University support-site that provides an easily accessible library of ideas, concepts, constructs techniques, tools, models, etc. http://www.brunel.ac.uk/


ProvenModels: ProvenModels' Digital Model Book presents digitalised management models categorised in a clear, consistent and standardised information structure to improve the usability and reusability of management literature. Management models are important generalisations of business situations when applied in context and are powerful tools for solving business issues. http://www.provenmodels.com/

12manage.com: This is a website on which one can access numerous models as well as global comments on the models and principles. This could also serve as a place where you could voice your ideas and get feedback from all over the world. http://www.12manage.com/

The Free Management Library:

The Free Management Library can be used to improve your organisation, and for your own personal, professional and organisational development. This is by far the most comprehensive overview of all aspects of strategic planning covering all stages of the process. http://www.managementhelp.org/np_progs/sp_mod/str_plan.htm

The Charity Village: A series of twelve very short articles, by Ron Robinson, an independent Canadian consultant, appeared on Charity Village between November 2001 and October 2002. These articles are refreshing in that they do not advocate a one best way for all types of non-profit organisations. They discuss various way of approaching the strategic planning process. https://charityvillage.com/topics/management/planning/strategic-planning.aspx?page1424=2

Trading Economics For statistical data per country. Indicators include, for example, GDP, credit ratings, population lists, jobless data, etc. http://www.tradingeconomics.com

There are many more sites and articles available that can help you to successfully complete this module. You are encouraged to post the website addresses or URLs of any additional interesting sites that you come across on the Regenesys Learning Platform. In this way, you can assist other students to access the same wonderful information that you have discovered.

A word of caution not all information available on the Internet is necessarily of a high academic standard. It is therefore recommended that you always compare information that you obtain with that contained in accredited sources such as articles that were published in accredited journals.


6 LEARNING OUTCOMES

Upon completing this module, students should be able to:

Evaluate the different types of economic systems, the ideologies on which they are based, and their application to an organisation

Explain and evaluate the impact of macroeconomic and microeconomic policies on a country

Understand and analyse the effects of inflation on capital budgeting decisions and the cost of debt

Explain how prices are established in the market as well as the restrictions on the market mechanism

Explore the relationship between elasticity and total income Discuss and critique the various financial institutions, their functions and the nature of their

business Describe and evaluate the benefits of international portfolio diversification Explore critically a countrys labour market and its key development challenges Understand and critically examine the impact of globalisation Identify and evaluate reasons why international trade takes place and the advantages of

international trade Understand the application of econometrics to economic phenomenon


7 CONTENT SCOPE AND LEARNING GUIDANCE

A number of topics will be covered to assist you in successfully achieving the learning outcomes of this module. It is important to study each of these sections to ensure that you expand your knowledge in the subject and are able to complete the required assessments. The sections that will be dealt with include: Section 1 Introduction to Economics

Section 2 The South African Economy

Section 3 Demand and Supply

Section 4 Elasticity and Total Income

Section 5 The South African Labour Market

Section 6 Introduction to Economic Policy Analysis

Section 7 The Monetary Sector

Section 8 The Foreign Sector

Section 9 An Introduction to Applied Econometrics

Section 10 Inflation and Capital Budgeting

Section 11 The Impact of Globalisation

A more detailed framework of what is required for each of these topics follows under each section heading. A number of questions to probe discussion and guide you towards comprehension and insight are also provided.

The timetable under each section heading provides guidance on the time to be spent to study each section. It is recommended that you follow the given timetable to ensure that you spend the appropriate amount of time on each section. Following the timetable will ensure that you have covered the required sections relevant to each assignment and have appropriate time to prepare for the examination.


7.1 INTRODUCTION TO ECONOMICS

Timeframe: Minimum of 14 hours

Learning Outcome: Evaluate the different types of economic systems, the ideologies on which they are based and their application to an organisation

Recommended Book:

Chapters 1, 2 and 21 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited.

Recommended Articles: Trainer, F. 2014, 'Ethics and the Economy', Humanomics, 30 (1), 41-58.

Section Overview: This section looks at the definition of economics and the fundamental principles of economics. It also examines the three central economic questions and how they are solved by the major economic systems.

7.1.1 What is Economics?

Reflect on your understanding of the term economics. You may have studied economics in matric or in further studies. In your own words, define what you understand by economics.

In the 1930s, prominent 20th Century British economist, Lionel Robbins (1898-1984) set the tone for most modern definitions of economics as the science that studies human behaviour as a relationship between ends and scarce means that have alternative uses (van Schaik, 2008:5).

"Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices."

(Parkin, 2014:2) The definition above develops Robbins idea by bringing to fore the fundamental issues of individuals, businesses, governments, societies and choices, scarcity, and incentives (a broader, more systemic view of economics). Fundamentally, we have unlimited wants on the one hand and limited resources on the other.

Distinguishing between Wants, Needs and Demand

Choices have to be made with regard to which wants to satisfy using the limited resources. A want is a human desire for goods and services, it is unlimited and you can do without it. A need is a necessity; it is essential for survival and is not absolutely unlimited. A demand is only made for a good or service if the necessary means to purchase it are available.


7.1.2 Scarcity, Choice and Opportunity

The term scarcity means that the resources available are simply not enough to satisfy the human wants; i.e. the basic fact of economic life. Choice is concerned with the decisions that are made in the allocation of limited resources to competing alternatives. In the process of resource allocation, some alternatives are preferred over others. The opportunity cost of a choice is the value of the best-foregone alternative. Every time a choice is made, opportunity costs are incurred.

Task Questions

1. After reading Pages 32-33 of your prescribed textbook (Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited), explain why the production possibility frontier (PPF) in a simple two-commodity world is conventionally depicted as bulged out or concave to the origin.

2. Under what circumstances might a linear PPF be plausible?

7.1.3 The Production Possibilities Curve

The concepts of scarcity, choice and opportunity costs can be illustrated using the production possibility curve as shown in the figure that follows. The production possibilities curve indicates the combinations of any two goods or services that are attainable when the available resources (e.g. in a business) are fully and efficiently employed. In the diagram that follows, movement to the right from A to C illustrates an increase in the production of Product B, while the production of Product A decreases. There is a trade-off between Products A and B (we must give up something to get something else). This implies that, at points A, B and C, different levels of Product A and B can be produced. Point Y is unattainable and point X shows that the business is not at full capacity.

FIGURE 1: THE PRODUCTION POSSIBILITIES CURVE

(Investopedia, 2012b)


Parkin (2014:33) explains production efficiency as follows:

We achieve production efficiency if we produce goods and services at the lowest possible cost. This outcome occurs at all the points on the PPF."

(Parkin, 2014:33)

7.1.4 The Three Central Economic Questions

Task Questions

1. What do you understand by the basic economic questions of what, how and for whom to produce goods and services? Refer to Pages 3-6 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited.

The three central economic questions are:

What goods and services will be produced? (Output Questions)

Goods such as houses, cars, food etc. are tangible, and services such as legal services, financial services, medical services etc. are intangible. The goods can be categorised into consumer or capital, final or intermediate, private or public, economic or free, and homogeneous or heterogeneous (Mohr and Fourie, 2008: 18-19). Goods and services are produced to satisfy human wants.

How will each of the goods and services be produced? (Input Questions)

The production of goods and services requires resources. These resources (factors of production) can be grouped into four categories: Natural resources, labour, capital, and entrepreneurship and technology. The natural resources consist of the free gifts of nature such as water, land, minerals, vegetation etc. Labour is the human effort in the production of goods and services. Capital refers to all the man-made resources that are used in the production of other goods and services such as machines, tools, buildings etc. Entrepreneurship involves the identification of opportunities and a combination of labour, capital and natural resources to produce the desired goods and services. The person who drives the process of entrepreneurship is called an entrepreneur. Technological advancement improves the entrepreneurship process.


For whom will the various goods and services be produced? (Distribution Questions)

The goods and services are produced mainly for those who have the means to demand them. The goods and services are distributed to various sectors and participants in the economy. The distribution issue is a highly emotional question, especially in societies where the distribution is unequal.

Task Questions

1. To what extent can the solutions to the what and for whom questions be seen as interdependent in a market economy?

7.1.5 Economic Systems

There are basically three economic systems that are used to solve the central economic questions.

The Traditional System

This involves the production of the same goods and services that are distributed in the same way by each successive generation. This system is slow to change, rigid and resistant to innovation. Very few economies are still using this economic system countries still using this type of system are often rural and farm-based (the Inuit tribe of northern Canada is an example of a society that still uses a traditional economy).

The Command System

The economy is controlled by a central authority, which decides what to produce, how to produce and to whom to distribute (factors of production are government owned). It is argued that this system is one of the more inefficient systems and within it there is much waste. Present day examples of this are North Korea and Cuba.

The Market System

This is the most commonly applied economic system to the economic problem. A market is any contact or communication between potential buyers and sellers of a good or service.


Some characteristics of a market are listed below:

There must be at least one potential seller and one potential buyer The seller must have something to sell The buyer must have the buying power The market price must be determined The agreement must be guaranteed by law or tradition

In a market system, only those goods and services with a market value will be produced. The goods and services are produced in the cheapest possible way. The goods and services only go to those who have the means to buy them. Most modern economies are mixed economies and have a market that has a degree of government intervention. If the market economy is allowed to function freely, it will only produce those goods and services for which a market value exists and which can be sold at a price; but what about other goods, for example, street lights or unpolluted air and clean beaches? All consumers want to enjoy these goods and services but, because these are public goods and not exclusive ones, the market system will not produce them. Hence the need for government interference. Read the following case study and then answer the questions that follow.

Case Study: The Collapse of Lehman Brothers On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. Lehman's demise also made it the largest victim, of the U.S. subprime mortgage-induced financial crisis that swept through global financial markets in 2008. Lehman's collapse was a seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to $10 trillion in market capitalisation from global equity markets in October 2008, the biggest monthly decline on record at the time. The History of Lehman Brothers Lehman Brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman in Montgomery, Alabama, in 1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers. While the firm prospered over the following decades as the U.S. economy grew into an international powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived them all the railroad bankruptcies of the 1800s, the Great Depression of the 1930s, two world wars, a capital shortage (when it was spun off by American Express in 1994), and the Long Term Capital Management collapse and Russian debt default of 1998. However, despite its ability to survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step.


The Prime Culprit In 2003 and 2004, with the U.S. housing boom well under way, Lehman acquired five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services, which specialised in Alt-A loans (made to borrowers without full documentation). Lehman's acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of growth than other businesses in investment banking or asset management. The firm secured $146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion on revenue of $19.3 billion. Lehman's Colossal Miscalculation In February 2007, the stock reached a record $86.18, giving Lehman a market capitalisation of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman's profitability, the firm reported record revenues and profit for its fiscal first quarter. In the post-earnings conference call, Lehman's chief financial officer (CFO) said that the risks posed by rising home delinquencies were well contained and would have little impact on the firm's earnings. He also said that he did not foresee problems in the subprime market spreading to the rest of the housing market or hurting the U.S. economy. The Beginning of the End As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds, Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in three states. Even as the correction in the U.S. housing market gained momentum, Lehman continued to be a major player in the mortgage market. In 2007, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85-billion portfolio, or four times its shareholders' equity. In the fourth quarter of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance. Hurtling Toward Failure Lehman's high degree of leverage the ratio of total assets to shareholders equity was 31 in 2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns the second-largest underwriter of mortgage-backed securities Lehman shares fell as much as 48% on concern it would be the next Wall Street firm to fail. Confidence in the company returned to some extent in April, after it raised $4 billion through an issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at the time. However, the stock resumed its decline as hedge fund managers began questioning the valuation of Lehman's mortgage portfolio.


On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being spun off by American Express, and reported that it had raised another $6 billion from investors. The firm also said that it had boosted its liquidity pool to an estimated $45 billion, decreased gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by 20%, and cut down leverage from a factor of 32 to about 25. Too Little, Too Late However, these measures were perceived as being too little, too late. Over the summer, Lehman's management made unsuccessful overtures to a number of potential partners. The stock plunged 77% in the first week of September 2008, amid plummeting equity markets worldwide, as investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its asset management unit and spinning off commercial real estate assets. Hopes that the Korea Development Bank would take a stake in Lehman were dashed on September 9, as the state-owned South Korean bank put talks on hold. The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike in credit-default swaps on the company's debt. The company's hedge fund clients began pulling out, while its short-term creditors cut credit lines. On September 10, Lehman pre-announced dismal fiscal third-quarter results that underscored the fragility of its financial position. The firm reported a loss of $3.9 billion, including a write-down of $5.6 billion, and also announced a sweeping strategic restructuring of its businesses. The same day, Moody's Investor Service announced that it was reviewing Lehman's credit ratings, and also said that Lehman would have to sell a majority stake to a strategic partner in order to avoid a rating downgrade. These developments led to a 42% plunge in the stock on September 11. With only $1 billion left in cash by the end of that week, Lehman was quickly running out of time. Last-ditch efforts over the weekend of September 13 between Lehman, Barclays PLC and Bank of America, aimed at facilitating a takeover of Lehman, were unsuccessful. On Monday September 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its previous close on September 12. Conclusion Lehman's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government's decision to let Lehman fail, as compared to its tacit support for Bear Stearns (which was acquired by JPMorgan Chase) in March 2008. Lehman's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15.

(Investopedia, 2012a)


Task Questions

1. Assume you were the chief economist advising CEO Richard Fuld in August 2007. What advice would you have given him, taking into consideration the given economic system, the companys financial position and the investment portfolios?

7.1.6 Introduction to Economic Theories

The table below presents well-known economic theories established over time.

TABLE 1: WELL-KNOWN ECONOMIC THEORIES

Modern Schools of Thought (since late 18th century) Classical (Adam Smith) Marxism (Karl Marx and Friedrich Engels) Keynesian (John Maynard Keynes) Neoclassical (William Jevons, Carl Menger and

Leon Walras) New classical (Robert Lucas)

Global Trade Comparative advantage Heckscher-Ohlin trade model New Trade theory Optimal currency area The impossible trinity (Trilemma) Purchasing power parity

Economic Cycles Keynesian Monetarism The Phillips curve Permanent income hypothesis Rational expectations Time consistency Financial accelerator Financial instability hypothesis Lender of last resort

Markets The invisible hand Marginalism The tragedy of the commons Property rights Polluter pays principle Adverse selection Moral hazard Efficient market hypothesis Rent seeking

Economic Systems Capitalism (and state capitalism) Communism Socialism Mixed economy Shock therapy

Choice Rational choice theory Game theory Public choice Expected utility theory Prospect theory

Tax and Spend Policies Tax incidence Excess burden Supply-side economic Crowding out

Growth Neoclassical growth New growth theory Creative destruction Human capital The rule of law Limits of growth

(Adapted from Marron, 2010)


Whilst an explanation of each of the above is beyond the scope of this study guide, students are encouraged to use reputable sources to expand their knowledge of these important theories. For discussion purposes we have included a synopsis of the modern schools of thought.

TABLE 2: COMPARISON OF THE VARIOUS ECONOMIC SCHOOLS OF THOUGHT

The Classical School

Adam Smith, who is known as the father of economics, made the most important contribution to the classical school of thought. The classical school of thought influenced the scientific and industrial revolutions. The following are characteristics of the classical school: The forces of the free market should organise the economy and governments

interference should be minimal Self-interest leads to collective interest, profits, development and natural harmony

of interests in the society The development of laws and economic principles:

o The law of diminishing returns o Role of capital accumulation in economic growth o Consumer freedom and autonomy o Market as a platform for harmonising individual and societal interests and

needs o Theory of comparative advantage

Marxism

Marx believed that class exploitation, class privilege and class monopoly were morally unacceptable. He believed in a natural law of social evolution, which involved the growing socialisation of the process of production. This, he believed, carried with it a corresponding evolution in the field of human relations, destined to result in a complete democratisation of economic affairs and the achievement of a classless society. The main contributions of Marx and characteristics of Marxism are presented below: Contribution towards the Theory of Value in economics although the idea of

workers being the source of all value is disputed by contemporary economists; Business cycles and economic fluctuations Growth of monopolies Theory of exploitation arguing that the conditions of workforce continues to

deteriorate, resulting in workers overthrowing capitalism because of exploitation Analysis of capital accumulation arguing that accumulation leads to decreasing

profits and unemployment due to improved technology Theory of class conflict based on the notion of class conflict and capital

accumulation


Keynesian School of Thought

The main characteristics of the Keynesian school of thought: The macro-economic approach, considering factors such as employment,

consumption, savings, income, investment and outputs It promotes governments fiscal intervention to improve employment, price stability

and economic growth Government spending (and deficit) should be increased to stimulate the economy; Money supply should be increased to reduce interest rates and promote

investment Taxes should be reduced to encourage people to work, produce, save and invest

Neoclassical School

The proponents of the neoclassical school argue that the value of goods is not determined by the production cost (as argued by the classical school) but by their usefulness to the consumer or end-buyer. The main characteristics of neoclassical school of thought are: The minimalist role of government in economy The assumption that people act rationally, balancing present and future needs Economic forces strive for equilibrium and, after disturbances, a new equilibrium is

found The role of an individual (or a firm) as a focal point in economic decision-making The application of analytical, abstract, deductive methods in economic analysis The main contribution was related to interpreting value in terms of both demand and supply and not just focusing on one of these aspects. A contribution was also made in the area of business competition and monopolies. One of the most famous books from this school is Alfred Marshalls Principles of Economics (1890).

New Classical School

Built largely on the Neoclassical School, the New Classical School emphasises the importance of microeconomics and models based on behaviour. Proponents of this school assume that all agents try to maximise their utility and have rational expectations. They also believe that the market clears at all times. Mainly, these economists believe that unemployment is largely voluntary and that discretionary fiscal policy is destabilising, while inflation can be controlled with monetary policy.

(Economics Online, 2014)


Task Questions

1. Explain the following terms: Scarcity Choice Opportunity cost

2. Explain how the following economic systems can be used to answer the three central economic questions: Market economic system Command system Traditional system

7.1.7 Economic Aggregates

Gross Domestic Product Defined

To understand the concept of GDP, and its relationship with economic growth, ensure that you read the following chapter in your prescribed textbook:

Chapter 21 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited.

Economists measure a countrys wealth by measuring the gross domestic product (GDP).

GDP is "the market value of the final goods and services produced within a country in a given time period."

(Parkin, 2014:490)

This definition suggests that GDP includes four parts (see Figure 2 below and extended description):

Market value Final goods and services Produced within a country In any given time period

Consider the following figure and the connections it depicts.


FIGURE 2: CIRCULAR FLOWS IN A MARKET ECONOMY

(Parkin, 2014:491) The definition can be unpacked as follows:

GDP is the market value: The prices people are willing to pay for the relevant goods or services;

Of the: GDP attempts to measure the aggregate value of all output. It only counts legal activities;

Final: GDP only measures final goods. (If a car is produced in South Africa, economists measure the value of the car as part of GDP and not the component parts of the car);

Goods and services: GDP includes both tangible goods, e.g. food, clothing and cars; and intangible services, such as haircuts, house-cleaning and doctor visits;

Produced: GDP includes only goods and services currently produced. Does not include re-sales and transactions produced in the past;

Within a country: GDP measures the value of production within the geographic confines of a country. This is regardless of the nationality of the producer; and

In a given period of time: GDP is usually measured for a year but is also recorded quarterly; i.e. every three months.


Components of GDP

To understand how the economy uses its scarce resources, economists measure GDP by the spending in an economy. To do this, GDP (which we denote as Y) is divided into four components: consumption (C), investment (I), government purchases (G) and net exports (NX) (which is the difference between exports and imports). We can derive the identity as follows:

Y = C + I + G + (X-M)

Where:

Chapter 1 Y is GDP Chapter 2 C is the spending by households on goods and services, with the exception of

purchases of new housing Chapter 3 I is spending on capital equipment, inventories and structures; including household

purchases of new housing Chapter 4 G is spending on goods and services by National, Provincial and Local government NX, or net exports (X-M), is the spending on domestically produced goods by foreigners

(exports) minus spending on foreign goods by domestic residents (imports)

Calculating GDP Growth

The GDP Growth Rate shows a percentage change in the seasonally adjusted GDP value in the certain quarter, compared to the previous quarter. Because of climatic conditions and holidays, the intensity of the production varies throughout the year. This makes a direct comparison of two consecutive quarters difficult. In order to adjust for these conditions, many countries calculate the quarterly GDP using so called seasonally adjusted method. The Gross Domestic Product can be determined using three different approaches: the product, the income, and the expenditure technique, which should give the same result. In sum, the product technique sums the outputs of every class of enterprise. The expenditure technique works on the principle that every product must be bought by somebody, therefore the value of the total product must be equal to people's total expenditures in buying products and services. The income technique works on the principle that the incomes of the productive factors must be equal to the value of their product, and determines GDP by finding the sum of all producers' incomes.

(Trading Economics, 2013a)


Real versus Nominal GDP

Economists note that, if total spending rises from one year to the next, one of two things must be true: (1) The economy is producing a larger output of goods and services, or (2) goods and services are being sold at higher prices. When studying changes in the economy over time, economists want to separate these two effects. In particular, they want a measure of the total quantity of goods and services the economy is producing not affected by changes in the prices of those goods and services. To do this, we use a measure called real GDP, which answers a hypothetical question: What would be the value of the goods and services produced this year if we valued these goods and services at the prices that prevailed in some specific year in the past?

Nominal GDP is "the value of final goods and services produced in a given year when valued at the prices of that year. Nominal GDP is just a more precise name for GDP." Whereas: Real GDP is "the value of final goods and services produced in a given year when valued at the prices of a reference base year. By comparing the value of production in the two years at the same prices, we reveal the change in production."

(Parkin, 2014:495) Consider the following example (Parkin, 2014:495).

Calculation of Nominal GDP and Real GDP

ITEM QUANTITY (millions) PRICE

(dollars) EXPENDITURE

(millions of dollars) (a) In 2005 C T-shirts 10 5 50 I Computer chips 3 10 30 G Security services 1 20 20 Y Real and nominal GDP in 2005 100 (b) In 2012 C T-shirts 4 5 20 I Computer chips 2 20 40 G Security services 6 40 240 Y Nominal GDP in 2012 300 (c) Quantities of 2012 valued at prices of 2005 C T-shirts 4 5 20 I Computer chips 2 10 20 G Security services 6 20 120 Y Real GDP in 2012 160


From the example we can see that in 2005 (the reference base year) real GDP equals nominal GDP and was $100 million. Then in 2012, the nominal GDP increased to $300 million. However the real GDP is shown in part (c), which is calculated by using the quantities of 2012 in part (b) but the prices of 2005 in part (a). Real GDP is therefore only $160 million. As Parkin (2014:496) points out, economists use estimates of real GDP for two main purposes:

To compare the standard of living over time To compare the standard of living across countries

Task Questions

Read the limitations of GDP in your prescribed textbook (pp. 499-500 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England: Pearson Education Limited) and then discuss the argument proposed by Joseph Stiglitz, "that GDP is dangerously misleading and needs to be replaced by a measure that he calls Green Net National Product (or GNNP)." Use the two views given in the table below to support your argument:

Joe Stiglitz maintains The mainstream view GDP has passed its sell by date A gross measure is wrong because it ignores the

depreciation of assets A domestic measure is wrong because it ignores the

incomes paid to foreigners who exploit a nation's resources

A green measure is needed to take account of the environmental damage that arises from production

GNNP subtracts from GDP incomes paid to foreigners, depreciation, the value of depleted natural resources, and the cost of a degraded environment

The existence of a market price for carbon emissions makes it possible to measure the cost of these emissions and subtract them from GDP

A bad accounting framework is likely to lead to bad decisions

America's "drain America first" energy policy is an example of a bad decision. It increases GDP but decreases GNNP and makes us poorer.

As a measure of the value of market production in an economy, GDP does a good job.

GDP is used to track the ups and downs of economic activity and it is a useful indicator for making macroeconomic stabilisation policy decisions

GDP is not used to measure net national economic well-being nor to guide microeconomic resource allocation decisions

There is no disagreement that a net national measure is appropriate for measuring national economic well-being

There is no disagreement that "negative externalities" arising from carbon emissions and other pollution detract from economic well-being

The omissions from GDP of household production and underground production are bigger problems than those emphasised by Stiglitz

It isn't clear that depleting oil and coal resources is costly and misguided because advanced in green energy technology will eventually make oil and coal of little value. The stone-age didn't end because we ran out of stone, and the carbon-age won't end because we run out of oil and coal!

(Parkin, 2014:500)


Conclude this section by reading the following journal article by Trainer (2014) and by completing the tasks that follow.

Trainer, F. 2014, 'Ethics and the Economy', Humanomics, 30 (1), 41-58.

Task Questions

1. Reflect critically on the journal article. Do you agree with Trainer's view that there is a lack of social responsibility on the part of economists? Substantiate your position.

2. Training (2014:51) states that the supreme goal of economics is to increase sales as much as possible (and without limits) as opposed to a satisfactory quality of life for all. What evidence is there of this in your country cite examples? Do you support this assertion?

3. Critically evaluate the following statement (Training, 2014:51) "It [economics] legitimises the market as the supremely effective and efficient way of allocating things and of determining what will be done or developed. This gives those who are rich and powerful the freedom to produce and to take what they want, by outbidding others." How might the views of Trainer (and other proponents of sustainability) impact on current thinking about the market system and growth economies? Refer to Trainer's "The Simple Way" and explore the economic validity of his argument.


7.2 THE SOUTH AFRICAN ECONOMY


Learning Outcome: Explain and evaluate the impact of macroeconomic and microeconomic policies on a country

Recommended Book: Chapters 6, 16 and 17 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England:

Pearson Education Limited.

Recommended Articles:



Trading Economics, 2014, www.tradingeconomics.com (accessed 18 March 2014). (Note: Selections available include countries, indicators, and markets)

Weiss, L. 2013, 'The myth of free-market capitalism versus the rest', http://speri.dept.shef.ac.uk/2013/01/15/myth-free-market-capitalism-rest/ (accessed 18 March 2014).

Indexmundi, 2012, 'South Africa Economy Overview', http://www.indexmundi.com/south_africa/economy_overview.html (accessed 18 March 2014) (Note: Go to the website main page and select a country of your choice)


Section Overview:

This section deals with the South African economy; in particular, the recent growth, employment and inflation records, the position of the balance of payments, its international economic position, factor endowment and economic links with the rest of the world. The section also examines the microeconomic and macroeconomic policies governing economic activities in the country.

7.2.1 Performance of the South African Economy

Reflect on South Africa's economic performance before and after it gained independence in 1994.


Between 1990 and 1993, the South African economy performed poorly and recorded negative economic growth, a decrease in the standard of living, a rise in unemployment and inflation, and had serious balance of payment problems. The situation has improved significantly after political reform in 1994. When measuring the performance of the economy, it is important that comparisons are made between a wide range of indicators. To achieve this go to the following websites and select the countries and economic indicators as required:

Trading Economics, 2014, www.tradingeconomics.com (accessed 18 March 2014). (Note: Selections available include countries, indicators, and markets)

Indexmundi, 2012, 'South Africa Economy Overview', http://www.indexmundi.com/south_africa/economy_overview.html (accessed 18 March 2014) (Note: Go to the website main page and select a country of your choice)


Task Questions

1. Using the above resources, discuss how South Africas economy compares with other economies emerging and developed?

7.2.2 South Africas International Economic Position

Certain criteria are used by international organisations, such as the World Bank and the United Nations, to rank countries economies in the world. South Africa is categorised as emerging/developing with a population of 52m (Global rank No. 23). South Africa climbed one place to 14th in terms of global rankings in the Emerging Economies survey, maintaining its position as the highest ranked African economy, ahead of Nigeria (who climbed to 17th) (Grant Thornton, 2013a). However, a recent Grant Thornton survey (2013b) has revealed that South Africa urgently needs to become more attractive to foreign investors if it wants to be a viable contender as a global hotspot.

Overall 57% of international business leaders considering global expansion are looking at the five biggest emerging economies China, India, Russia, Brazil and Mexico compared with 38% looking at Western Europe and 33% at North America. In contrast, privately held businesses ranked the African continent at 13% with South Africa achieving a 12% response as a potential investment hotspot for 2013.

(Grant Thornton, 2013b)


South Africas growth rate is expected to reach 5.7% (up from 5%) for 2013. However, it is anticipated that rising prices and wage bills will fuel inflation. Grant Thorntons survey (2013b) indicates that SA businesses will continue to be constrained by the perennial shortage of skilled workers (mismatch of talent to job requirements). Figure 3 reflects a comparison between hiring practices and the availability of skilled workers worldwide. South Africa is located in the quadrant of more hiring and lacking skilled workers. The following indicators show a negative trend (Lloyds, 2013):

Ease of doing business: 39th (down from 2012: 35th) Competitiveness: 52nd (down from 2012: 50th) Freedom from corruption: 62nd (down from 2012: 55th)

FIGURE 3: HIRING VS. SKILLED LABOUR 2012 (WORLDWIDE)

(Grant Thornton, 2012b)


Task Questions

It is argued that the South African government is committed to a mixed economy, but much speculation and pressure exists over the precise implications of this for South Africa and international business. It is fuelled by the fact that the mixed economy is a loose concept rather than a rigorous economic model. For example, the term itself could be applied to the economic arrangements of countries as different as India, South Korea, Nicaragua, Zimbabwe, Sweden, Britain and Germany. 1. In light of the above, how would you describe the mixed economy in South Africa today? Is it, for example a mixed

economy oriented toward capitalism or socialism? What are the implications of this? Use economic terms to substantiate your argument.

2. Some economists believe that the act of nationalisation is so difficult and costly that the same ends could be achieved through taxing the private sector, controlling key prices, and regulating firms operations. Others have noted that it only changes the ownership of firms but does not necessarily change the way they operate or ensure that they meet national goals. Discuss these assertions.

7.2.3 Banking Stability in South Africa

South Africas banking sector has been rated among the top 10 globally, and its financial system continues to grow. South Africa has moved to a so-called twin peaks model of regulation by the South African National Treasury involving the separate prudential regulator (housed at SARB) and the market conduct regulator (Financial Services Board) aimed at creating a more resilient and stable financial system.

Macroprudential and microprudential: The term macroprudential regulation or supervision refers to the analysis of strengths and vulnerabilities of financial systems as a whole (systemic risk). Macroprudential assessments cover a wide range of economic and financial circumstances and information, such as gross domestic product growth and inflation, the structure of a financial system, and qualitative information on the institutional and regulatory framework. The term microprudential refers to the safety and soundness of individual financial institutions.

(Treasury, 2013)


7.2.4 South Africas Factor Endowment

This section gives a brief overview of South Africas position regarding natural resources, labour, capital and entrepreneurship. South Africa is well endowed with certain factors of production and poorly endowed with others, as outlined below:

Natural Resources

South Africa is part of Sub-Saharan Africa, which is poor in agricultural activity. The climate is a major problem as it is characterised by droughts, hail-damage, floods etc. However, South Arica is endowed with significant natural resources, which include rivers, lakes, fertile soils, precious minerals, etc. These natural factor endowments have given the country a significant comparative and competitive advantage over the last 5-10 decades. The future policy imperatives of government and industry are to fully beneficiate all natural resources such as precious minerals as part of their export strategy. South Africa has beautiful forests that attract tourists, a small fishing industry and a large variety of minerals. The minerals form the backbone of its economy.

Capital

This refers to all man-made (manufactured) assets that are used in the production of other goods and services such as machines, power plants, buildings, roads, bridges, dams etc. South Africa has a poor capital base; hence, most of its capital goods are imported.

Labour

People are every organisations most prized resource and, even at national level, the importance of the human resource or human capital can never be overemphasised. South Africas main challenge, as we have seen, is a lack of skilled labour, which has been worsened by the high prevalence of HIV/AIDS. The greatest challenge facing the South African economy is the need to increase its supply of skilled labour, thereby increasing the productive capacity of the country.

Entrepreneurship

An entrepreneur is a person who identifies opportunities and takes calculated risks by combining the factors of production in order to develop new markets in the pursuit of profit. Entrepreneurial activity is vital for economic development and South Africa is not particularly well endowed with entrepreneurship (Global Entrepreneurship Monitor, 2012).


7.2.5 South Africas Links with the Rest of the World

The South African economy is open to the rest of the world; that is, it has strong links with other economies of the world. Mining products dominate the composition of South Africas imports and exports because of the rich endowment of natural minerals in the country (Mohr and Fourie, 2008:85). South Africas major trading partners are Germany, the USA, the UK, Japan and, more recently, Brazil, Russia, India, and China.

BRICS is a unique grouping with shared opportunities and common challenges (formalized with the first meeting of the Foreign Ministers of Brazil, Russia, India and China in New York on the margins of the United Nations General Assembly in September 2006). In a short span of time, the grouping has come a long way in developing a number of mechanisms for consultation and cooperation in a number of sectors. South Africa joined the Grouping at the third Summit in Sanya, China in April 2011.

(BRICS, 2012)

The South African Trade Policy

Customs tariff investigations, trade remedies and import and export control fall within the domain of the International Trade Administration Commission of South Africa (ITAC). The aim of ITAC (as stated in the International Administration Act 71 of 2002) is:

To foster economic growth and development in order to raise incomes and promote investment and employment in South Africa and within the Common Customs Union Area by establishing an efficient and effective system for the administration of international trade subject to this Act and the Southern African Customs Union (SACU) Agreement.

(ITAC, 2014) Read the following documents, which set out South Africa's Trade Agreements and discuss South Africa's participation in BRICS.




Task Questions

1. Debate the impact of South Africas trade agreements and BRICS membership on aggregate macro-economic indicators as well as on firms and households.

Balance of payments

All countries measure domestic transactions with the rest of the world through the balance of payments.

A countrys balance of payments records its international trading, borrowing, and lending in three accounts:

Current account Capital and financial account Official settlements account

The sum of the balances of these three accounts always equals zero. That is to pay for a current account deficit, a country must either borrow more from abroad than it lends abroad or use its official reserves to cover the shortfall.

(Parkin, 2014:633) As an example, consider the U.S. Balance of Payments Account in 2011 (Parkin, 2014:633).

Current Account Billions of dollars Exports of goods and services +2 103 Imports of goods and services -2 663 Net interest income +227 Net transfers -133 Current account balance -466 Capital and financial account Foreign investment in the U.S. +1 040 U.S. investment abroad -501 Statistical discrepancy -89 Capital and financial account balance +450 Official settlements account Official settlements account balance 16


The Organisation for Economic Co-operation and Development provides statistical data on each country (www.stats.oecd.org) as well as Trading Economics (www.tradingeconomics.com). For the purposes of discussion we have included the latest current account data for South Africa below.

FIGURE 4: SOUTH AFRICAN CURRENT ACCOUNT (2008 TO 2014)

(Trading Economics, 2014b)

Task Questions

Read the following article and then debate the validity of the argument in the context of South African economic policy and the 2008 economic crisis. Weiss, L. 2013, 'The myth of free-market capitalism versus the rest', http://speri.dept.shef.ac.uk/2013/01/15/myth-free-market-capitalism-rest/ (accessed 18 March 2014).

Successful development strategies have always involved proactive state intervention; mainstream thinking needs to start acknowledging this.

As governments rushed in to prop up collapsing economies in response to the 2008 financial meltdown, the myth of free-market capitalism was suddenly put to the test and found wanting. But its been the rapid rise of China and other emerging giants, India and Brazil the so-called BICs that has done more to challenge the Washington Consensus idea that state activism is always inimical to economic prosperity. While some economists and political scientists fall back on labels like state capitalism to make sense of the alliance of free markets and unfree politics in China, others have revived the idea of state guided capitalism, a model once associated with Japan at the height of its economic prosperity.


These labelling efforts are based on the assumption that the developmental experience of the emerging giants is somehow wholly different from the earlier industrialisation of the advanced countries. Yet nothing could be further from the truth. In spite of some obvious differences that arise from history and international context, both developing and developed countries share at least one major feature in common namely, state efforts to protect and promote industrial development. State guidance of the economy, in the broadest sense, is the shared history of all countries that have successfully industrialised. When climbing the ladder of development, even Britain and the United States used tariffs to protect infant industry, copied or appropriated foreign intellectual property wherever possible, and placed a variety of controls on capital and technology markets. At various times, for example, Britain banned the transfer of technology including the migration and overseas recruitment of skilled workers, as well as the export of all tools and machines and implements related to the textile industries. Since these and other industry protecting policies are precisely the ones developing countries are told they must avoid or abandon, they have evoked the image of kicking away the ladder. So what is different today? One difference of course is the greater technological complexity of the modern economy, encapsulated in the notion of knowledge-intensive or high-tech industry. Another is the emergence of global value chains. Contrary to the belief that these changes make state activism less relevant to economic advancement (a belief that policymakers take more or less seriously across different parts of the developed world), globalisation has helped to reinforce and valorise the states economic role. One striking and historically repetitious example of the states valorisation can be seen in the way the destabilisation of national economies by financial globalisation has provoked a vast panoply [display] of state responses. Another example is the boom in sovereign wealth funds as resource rich nations hedge against vulnerability to global fluctuations in commodities markets. And still a third important example is the states race to secure high-technology and ensure a place in the growth sectors of the future. Thus the knowledge-intensive sectors (in particular, IT, biotech, nanotechnology, and clean energy) have become the new arena of (a high-tech) infant industry policy but this time instituted by and for the advanced countries. Although free-market orthodoxy may seem to reign, the reality is that these sectors do not need the simple tariff protection against imports of yesteryear; rather, the knowledge-rich sectors need more costly and complex support, including investment subsidies at the high-risk end of development. It should come as no surprise, then, that its the advanced countries that are currently the frontrunners in this particular race. So it would be hard to maintain that the use of state tools by the BICs such as Chinas state-guided investment and five-year plans, or Brazils state-owned oil corporation Petrobras as an instrument for developing a national oil industry is in some way inconsistent with the experience of the now-developed countries; or indeed that it is at odds with the practice of advanced countries in seeking to maintain their technological lead. It is not that one set of countries practise free market capitalism while another set practise state guided capitalism. Its closer to the truth to point to the differing ways in which all economies whether emerging or advanced draw on state involvement in guiding and shaping development. And its recognition of this point that is long overdue in mainstream economic and political thinking.


7.3 DEMAND AND SUPPLY


Learning Outcome: Explain how prices are established in the market as well as the restrictions on the market mechanism

Recommended Book: Chapters 3, 8 and 9 in Parkin, M. 2014, Economics, Global Edition, 11th ed., England:

Pearson Education Limited. Recommended Articles: Abboushi, S. 2014, 'Solar trade tariffs', Competitiveness Review, 24 (1), 59-65.

Section Overview: This section looks at the establishment of prices in the market and restrictions on the market mechanism. It also examines the theories of demand and supply and how the forces of demand and supply influence prices.

7.3.1 Demand

What are the laws of demand and supply and how do we illustrate them?

Demand is the outcome of decisions regarding wants and affordability (Parkin, 2010:61). If you intend to buy something, you need to have the means to purchase it. When we talk of demand, we refer to the quantity of goods or services that the potential buyers are willing and able to buy at various given prices. It is a flow concept that is measured over time. Demand can be expressed in words, schedules, curves and equations.

Individual Demand

Individual demand refers to demand for a household. A household is all the people who live together and who make joint economic decisions or who are subjected to others who make such decisions for them (Mohr & Fourie, 2008:43).

Determinants of Individual Demand

The quantity of a good demanded by an individual, in a particular period, depends on the price of the good, the prices of related goods, the income of the individual, taste and the number of people in the household.


The Law of Demand

Other things being equal (i.e. ceteris paribus), the higher the price of a good

mba eco v6 e f a

Documents