Learning Outcomes (LO) Answers

/ Questions (Q)
Important concepts Self-sufficiency – a country specializes in producing all of its goods and services it needs
- Self-sufficiency
- Open economy Open economy – when a significant percentage of its GDP is exported and a significant part of domestic spending is
- Absolute advantage on imported goods and services
- Comparative advantage
- Law of comparative Absolute advantage – when a country is more sufficient in the production of ONE good or service than the other
advantage (relative country.
advantage)
- Equal advantage Comparative advantage - when a country is more efficient in the production of BOTH goods or services than the
- Trade policy other country
- Balance of payments
- Current account Law of comparative (relative) advantage – each country will tend to specialize in and export those goods for which it
- Financial account has a comparative advantage
- Exchange rate According to Adam Smith - all that is required by both countries to benefit from trade is that the opportunity costs of
- Appreciation production must differ between the TWO countries
- Depreciation
- Foreign Exchange market Equal advantage – when the opportunity costs of producing the two goods are the same in BOTH countries and
therefore there is no incentive to trade

Trade policy – measures the government implements to control or limit the amount of imports into the country

Balance of payments – a record of all the transactions between domestic entities and foreign entities during a
particular period (usually a year)

Current account – A record of all export and imports of goods and services and income payments to and from foreign
sector

Financial account – A record of all purchases and sales of financial assets and acquiring of financial liabilities between
the foreign and domestic sectors

Exchange Rate – price of one currency in terms of another currency (rate at which currencies are exchanged)
 Appreciation – increase in the value or price of one currency in terms of another currency

Depreciation – decrease in the value or price of one currency in terms of another currency

Foreign Exchange market – International market where a currency can be exchanged for another currency

Q: Why do countries trade? NOTE:

 Assume there is only TWO countries and TWO goods being traded.
 Assume a barter economy where a double coincidence of wants occur

The main reason why countries trade is that there is a gain in trading – meaning there is a basis for trade.
A basis for trade will only exist if the opportunity cost of producing these two products are different in each one of
the two countries.
Therefore:
1. Countries trade if there is a comparative advantage to trade with the other country – if the opportunity costs
to produce these products are different.
2. If the trading or exchange ratio lies somewhere between the opportunity cost ratios in the two countries

South Africa Opportunity cost Germany Opportunity cost

1 Car OR 6 barrels of wine To produce 1 car 6 2 cars OR 8 barrels of wine To produce 1 car 4 barrels
barrels of wine must be of wine must be sacrificed
sacrificed. Therefore:
Because resources are
Because resources are 1 car OR 4 barrels of wine scarce and must be
scarce and need to be allocated
allocated
The comparative advantage of South Africa The comparative advantage of Germany
Production of barrels of wine Production of cars

Sacrifices 6 barrels of wine to produce 1 car therefore Sacrifices 4 barrels of wine to produce 1 car therefore the
the opportunity cost of producing 1 car is greater opportunity cost of producing a car is lesser relative to SA.
relative to Germany.
 1 1
To produce 1 barrel of wine will cost the cost of To produce 1 barrel of wine will cost the cost of
6 4
producing a car producing a car
The opportunity cost of producing a barrel of wine is The opportunity cost of producing a barrel of wine is 0.25
0.1667

What should South Africa Export? What should Germany Export?

Wine Cars
How many wine barrels should SA export to How many cars should Germany export to maintain a
maintain a gain in trading? gain in trading?
5 barrels 1 car
What should SA Import? What should Germany Import?
Cars Wine

For each 1 car imported SA can exchange 5 barrels of For every 1 car exported, Germany would receive in
wine having 1 barrel in excess. exchange, 5 wine barrels having 1 barrel in excess

Q: Can TWO countries still gain Yes, but BOTH countries must have an absolute advantage in ONE of the goods to have a gain in the basis of trading.
from trading if both countries
have an absolute advantage? If one country has an absolute advantage in producing BOTH goods, then there is no basis for trading.

Q: True or false

Absolute advantage is a False – it is not a prerequisite for international trade

prerequisite for international
trade?

Comparative advantage is a True

prerequisite for international
trade?
Equal advantage is a prerequisite False – if there is an equal advantage it means there is no gain because the two countries have the same opportunity
for international trade? cost

Q: Do countries in reality trade Firms trade with other firms in different countries – not countries with countries
with other countries or is it firms
that trade with other firms in
other countries?

Q: What is the motive for firms Self-interest – profit maximization

to trade with other firms in
different countries?

Is it really for economic No – economic activity is stimulated through implication not by intent.
stimulation? The government is responsible to manage foreign exchanges to protect domestic firms from foreign competition and
to control the volume of imports entering the country. This ensures that domestic jobs are protected to an extent.

Q: Name and explain the SIX 1. Import tariffs – taxes or duties paid on imported goods to protect against foreign competition and may cause
different trade policies the a welfare loss to domestic society
government can implement to 2. Import quotas – control the quantity of imports into the country to protect domestic industries
control the amount of imports 3. Subsidies – granted to home producers to protect domestic industries by lowering their competitive
into the country. advantage
4. Non-tariff barriers – contractual limitations to favour domestic firms like special licensing requirements high
technical standards and specifications for foreign firms to meet etc.
5. Exchange controls – limits the amount of foreign exchange available to pay for imports
6. Exchange rate policies – influence the domestic exchange rate to affect imports and exports
What is the balance of Record of a country’s transactions with the rest of the world
payments?
These transactions includes those between households, firms AND the government of SA with the households and
firms and government of other countries

NOT specific to the government only

Q: Name the components of the 1. Current account

balance of payments 2. Financial account

Q: Explain the use of the current The current account records purchases and sales of goods and services and includes:
account and what is included in - All the sales of goods and services to the rest of the world (exports)
it - All the purchases of goods and services from the rest of the world (imports)
- All the primary income receipts and payments

The components that make up this account:

- Merchandise exports and imports
- Net gold exports
- Service receipts and payments
o Service receipts – total value of all services receipts during the period – the money spent by
foreigners in South Africa
o Service payments – total value of all service payments during the period – the money spent by SA
when travelling abroad
- Income receipts and income payments
o Two categories of income flows:
 Compensation of employees – wages/salaries and other benefits
 Investment income – dividends, interest or profits
- Current transfers
o Money, goods, or services that are transferred without anything tangible received in return

Trade balance = Merchandise exports + net gold reserves – Merchandise imports

 Income receipts – income earned by South African residents in other countries (Income FROM the rest of the world)
Income payments – income earned by non-residents in South Africa (income TO the rest of the world)

Q: What does a surplus and Surplus – the value of exports > value of imports
deficit on the current account
represent? Deficit – the value of exports < value of imports

Q: Explain the use of the The financial account is an accounting statement that shows the financial flows in and out of the country either in the
financial account and what is form of assets or liabilities
included in it - All the funds going into the country
- All the funds going out of the country
- Sale and purchases of assets such as bonds and shares (financial assets)

There are 4 components to this account:

1. Direct investment – all transactions in which the investor has the purpose of gaining control or management
over an enterprise
2. Portfolio investment – purchasing of assets for the sole purpose of financial benefit or gain (return on
investment)
3. Financial derivatives – purchasing of shares or bonds for the purpose of financial gain (return on investment)
4. Other investments – investments that do not form part of direct or portfolio investments or financial
derivatives and include loans currency and deposits. An essential category of this is short-term trade credit.
5. Reserve assets – foreign currency liabilities of the SARB with non-resident institutions and loans from the
International Monetary Fund that are required to finance the balance of payments needs and for market
interventions to influence the exchange rate

Short-term trade credit – used to finance imports and exports

Q: What does a surplus and Surplus – financial inflows > financial outflows (net inflow of foreign capital)
deficit on the Financial account
represent? Deficit – financial inflows < financial outflows (net outflow of foreign capital)
Q: What does the sum of the Change in the country’s gold and foreign exchange reserves and serves as a balancing item on the balance of
balance of the current account payments
and financial account represent?

Q: What is the main difference The current account records the flow of real GOODS and SERVICES to and from the foreign sector – Real flow
between the current account
and the financial account? The financial account records the flow of funds incurred during the buying and selling of financial assets and incurring
of financial liabilities to and from the foreign sector – Nominal flow

Q: Merchandise exports and Trade balance

imports together with the net
gold exports are called the …

Q: what is the difference Income receipts – primary income from the rest of the world i.e. compensation of employees like wages, salaries and
between income receipts and other benefits earned by individuals from countries other than those they are a resident in
income payments?
Income payments – primary income to the rest of the world i.e. investment income like dividends, interest, profits
and other forms of income earned from the provision of financial capital

Q: How is the balance of the Merchandise exports + Net gold exports + service receipts + income receipts – merchandise imports – payments for
current account calculated? services – income payments + Current transfers (net receipts +)

Q: How is the Gross National

Income calculated? GNI=GDP+ ¿ primary income from the rest of the world – Primary income TO the rest of the world

GNI=GDP+ Income Receipts−Income Payments

Q: what does a negative balance An increase in the reserve assets

of the reserve assets infer?
Q: what does a positive balance A decrease in the reserve assets
of the reserve assets infer?
Q: The direct investments, Net balance – outflows (debits) have been deducted from the inflows (credits)
portfolio investments, financial
derivatives, and other
investments are all shown as a …
balance
Q: How is the net balance of the Net direct investment + net portfolio investments + net financial derivatives + net other investments + change in
financial account calculated? reserve assets

Q: What do unrecorded Since a double-entry system is used to record the balance of payment transactions, the sum of all international
transactions reflect? transactions (debits and credits) reflected in the current, financial and capital accounts must add up to zero.

But this is not always the case

The errors and omissions in compiling the individual components of the balance of payments to ensure that the
balance of payments actually balances
Q: What is the reserve asset The current account balance = Net capital +- financial account excl reserve assets including unrecorded transactions +
account with respect to the net reserve asset transactions
current account and the financial
account The amount included for reserve assets reflects the difference between the current account and the financial account

Q: In which market is currency The Foreign exchange market

exchanged?
Q: Is the South African foreign Yes
Exchange market a financial
intermediary?