ECON211 chapter notes and flashcards

(1) Price stability — SARB targets CPI inflation within a 3–6% band. (2) Economic growth — sustaining real GDP growth above population growth. (3) Full employment — SA's structural unemployment rate exceeds 30% (expanded definition). (4) Balance of Payments equilibrium — a sustainable external position. (5) Equitable income distribution — reduction of SA's high Gini coefficient.

Y = C + I + G + (X − M). C = private consumption (largest component; ~60–65% of SA GDP). I = gross fixed capital formation (investment in machinery, buildings, infrastructure). G = government spending on goods/services (NOT transfer payments). (X−M) = net exports (negative when SA imports exceed exports — SA's typical position).

Nominal GDP uses current prices — rises with both output AND inflation. Real GDP uses constant base-year prices — measures only actual output changes. Always use Real GDP to compare growth over time. Real GDP = Nominal GDP ÷ (Price Level / 100).

S + T + M = I + G + X (Leakages = Injections). Leakages: savings (S), taxes (T), imports (M). Injections: investment (I), government spending (G), exports (X). At equilibrium, total leakages equal total injections.

Expansion → Peak → Contraction (recession) → Trough → Recovery. SA example: 2001–2007 expansion; 2020 Q2 trough (GDP fell 51.7% annualised — worst since 1945, caused by COVID-19 lockdown). SARB responded with repo cut from 6.25% to 3.5%.

C = a + b(1−t)Y. a = autonomous consumption (floor; positive at Y=0). b = MPC (0 < b < 1). t = tax rate. (1−t)Y = disposable income. Slope of C function = b(1−t).

KE = 1/(1 − b(1−t) + m). Larger when: b is high (spend more of each rand), t is low (less tax), m is low (less spent on imports). SA's open economy and high tax rates mean KE is typically 1.5–2.0 — much less than the simple 1/(1−b).

The 45° line shows all points where E = Y — the equilibrium condition. At any point on this line, total expenditure exactly equals total output. Equilibrium Y* is where the expenditure function crosses this 45° line.

Autonomous imports (ma): essential goods imported regardless of income level (oil, capital equipment). Induced imports (mY): imports that rise as income rises. m = MPM. Exports X are fully exogenous — a horizontal line, not a function of Y.

ΔY = KE × ΔG = 2.5 × 100 = R250. The expenditure function shifts UP by R100. Because of the multiplier effect, equilibrium Y* rises by R250 — each rand of government spending generates additional rounds of spending in the circular flow.

r ≈ i − π. Real rate = nominal rate minus inflation. SA 2024: i = 8.25% (repo), π = 5.5% → r ≈ 2.75%. Firms compare r with expected project returns. If a project yields 4% and r = 2.75%, it is profitable to borrow and invest.

(1) Transactions demand: hold money for daily purchases (rises with Y). (2) Precautionary demand: hold cash for emergencies (rises with Y). (3) Speculative demand: hold cash when bonds seem risky / rates expected to rise (falls as i rises). Together: MD/P = kY − li.

SHIFT (new curve): Income Y changes → transactions and precautionary demand change → entire MD curve moves left or right. MOVEMENT ALONG: Interest rate i or r changes → already shown by the slope of the curve — move up or down the existing MD curve. NEVER draw a new MD curve when only i changes.

SARB sells bonds → removes money from the banking system → MS/P decreases → MS vertical line shifts LEFT → at existing MD, there is excess demand for money → people sell other assets → r* rises to restore equilibrium → LM shifts LEFT (contractionary monetary policy).

Credit Multiplier = 1/R. SA: R = 2.5% → CM = 40. In theory, R1 of reserves supports R40 of deposits/loans. In practice: banks hold excess reserves, loan demand may be low, borrowers may default. Actual money multiplier is much less than 40.

r↑ → I↓ (investment function: I = Ia − hr). Lower I → lower E → lower equilibrium Y. So higher r is associated with lower Y. This negative relationship between r and Y traces the downward-sloping IS curve.

Y↑ → MD↑ (transactions and precautionary demand rise). At existing MS, there is excess demand for money. To restore money market equilibrium, r must rise. So higher Y requires higher r. This positive relationship between Y and r traces the upward-sloping LM curve.

Fiscal policy: r and Y move in the SAME direction (G↑ → r↑, Y↑; G↓ → r↓, Y↓). Monetary policy: r and Y move in OPPOSITE directions (Repo↓ → r↓, Y↑; Repo↑ → r↑, Y↓). Violating this rule means an error was made.

Crowding out occurs when G↑ raises r (via secondary effect), which then reduces private investment I. Government spending partially displaces private spending in credit markets. Occurs with fiscal expansion. Severity depends on LM slope: steeper LM = more crowding out = less effective fiscal policy.

IS shifts: G↑ or t↓ (fiscal policy), Ia↑ (investment confidence), X↑ (rand depreciates), consumer spending changes. LM shifts: MS changes (repo rate, OMOs, reserve requirements). Key rule: fiscal policy shifts IS, NOT LM. Monetary policy shifts LM, NOT IS.

BoP = CA + FA. SA: CA = typically DEFICIT (imports > exports + NFP + NCT). FA = typically SURPLUS (portfolio inflows finance the CA deficit). The FA surplus covers the CA deficit — but hot money is volatile and can exit suddenly, leaving SA exposed.

Steeper BP = low capital mobility. Flatter BP = high capital mobility. SA has HIGH capital mobility (large portfolio flows respond strongly to interest rate differentials). Therefore SA's BP curve is relatively FLAT. A small rise in r attracts large capital inflows → BoP balance is restored quickly.

ABOVE BP = BoP SURPLUS. Memory: 'Above = Abundant' (excess foreign exchange). BELOW BP = BoP DEFICIT. Memory: 'Below BP = Broke' (shortage of foreign exchange). If your IS-LM equilibrium lands above BP, the country has a BoP surplus at that (r, Y) combination.

Fixed regime: fiscal effective, monetary ineffective. Floating regime: monetary effective, fiscal ineffective. Mnemonic: 'Fix Fiscal, Float Monetary'. SA has a managed float (dirty float) → closer to floating → monetary policy (repo rate) has more stabilisation power than fiscal policy in SA.

Rand depreciates → SA exports cheaper for foreigners → X↑ → Net exports NX↑ → E↑ → IS shifts RIGHT → Y↑. Also: rand depreciates → imports more expensive → M↓ (volume falls) → NX improves further. Net: depreciation is expansionary (shifts IS right, raises Y). But: also raises import prices → inflation risk.

P↑ → MS/P↓ (real money supply falls) → LM shifts left → r↑ → I↓ → E↓ → Y↓. Each time P is assumed higher in IS-LM, we get a lower equilibrium Y. Plotting (P, Y) combinations traces the downward-sloping AD curve. AD slopes down through the INTEREST RATE channel, not a simple price-quantity relationship.

Stagflation = simultaneous inflation (P↑) and recession (Y↓). Caused by a NEGATIVE SUPPLY SHOCK that shifts SRAS left. Examples: oil price spikes (1973, 2022), load-shedding increasing firm costs. Demand policy cannot fix both problems simultaneously — cutting rates helps Y but worsens inflation; raising rates helps P but deepens recession.

SR: AD right → Y rises above Y*, P rises. Y > Y* → labour market tight → nominal wages rise → production costs up → SRAS shifts left → Y falls back toward Y*. LR: Y = Y* (back to potential). Only P remains permanently higher. Long-run demand neutrality: you cannot permanently raise output above potential through demand management.

After SRAS shifts left (stagflation): Accommodate (AD right) → Y quickly restored to Y*, but P even higher (validates the shock price level). Don't accommodate → Y stays below Y* (recession) until wages fall slowly and SRAS drifts right. Trade-off: price stability vs immediate output recovery. SA's dilemma: load-shedding shock; only real fix is a positive supply-side reform (fix Eskom → SRAS right → Y↑ AND P↓).

SRAS shifts LEFT (worse): input cost increases (oil price↑, electricity tariffs↑, wage settlements above productivity, rand depreciation raising import costs). SRAS shifts RIGHT (better): input cost decreases, technology improvements, energy cost reductions, labour market reforms. LRAS shifts right only through: capital accumulation, technology, labour force growth, institutional improvement.