Economics

 Economics is the study of how society (individuals, businesses, governments

and other organizations) choose to use scarce resources to satisfy their
numerous needs and wants in a manner that is efficient and equitable.

Needs

Are basic things that society cannot survive without

They are essential for the survival of a person
. Examples of needs include food, shelter and clothing.
A condition where a person is unable to satisfy his/her needs is referred to as
absolute poverty.

Wants

Are luxury things that society can survive without

They are not all that important for a person to survive.
Examples of wants are cars, televisions and cell phones.
A condition where a person is unable to satisfy her/his wants is referred to as
relative poverty.

Scarcity of resources

This refers to limitation (shortage) of resources.

Resources are factors of production and these are not available in unlimited
quantities.

Making choices

Society has to make choices because resources are not enough to satisfy all
their wants and needs. Wants are unlimited while resources are limited.
Our everyday lives are about making choices, eg we choose to travel by train
instead of a taxi.

Opportunity cost

Making choices results in opportunity cost.

Opportunity cost is the loss that we suffer as result of making a choice.

Measuring opportunity cost

The opportunity cost of any decision can be measured by looking at the

alternative forgone.
The opportunity cost of any decision is the next best alternative that is
forgone, eg if the choices to be made are ranked as A, B, C and D, the
opportunity cost of choosing A is equal to B, the opportunity cost of choosing
B is equal to C and the opportunity cost of choosing C is equal to D.
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Efficiency

Refers to how well resources (money, time, labour and other materials) have
been used.
Economics teaches use to use resources efficiently (in the best possible
manner)

Equitable

Means being fair and just.

Since resources are limited are scarce they must be used to benefit society as
a whole.

Branches of economics
The study of economics can be done under the following fields:

Development economics

The study of policies (methods) that can be used to improve the lives of the
people (standards of living).
It is about how the welfare of the people can improve.

Econometrics

The study of the use of mathematics and statistics in economics.

It deals with equations, models, forecasting and testing of economics theories.

Economic history

The study of how economics developed as a subject.

It focuses on early economics theories and those who developed them, eg
Adam Smith.

Environmental economics

The study of how economics affects the environment.

It focuses on the effects of economic activity on the environment, eg global
warming.

International economics

The study of globalization in economics.

It deals with issues of economic integration among the countries of the world,
eg the impact of trade on the countries of the world.

Labour economics

The study of the role of labour in economics.

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 It deals with issues like the composition of the population as determining the
supply for labour.

Monetary economics

 The study of the role of money and banks in the economy.

 It deals with issues like credit, interest rates and the role of central banks.

Public economics

 The study of the role of the state (government) in the economy.

 It deals with issues like taxation and provision of public goods.

Approaches to the study of economics

Microeconomics

 The microeconomic approach is the study of the smaller economy in single

units.
 It studies individual decision making units, individuals and firms.
 To understand the behavior of society we must understand the behavior of
the individual and in order to understand the behavior of the industry we must
first understand the behavior of the firm.
 Topics studied under microeconomics include, price formation, demand and
supply.

Macroeconomics

 The macroeconomic approach is the study of the broader economy in

aggregates.
 This focuses on the bigger economy, eg the population and the industry.
 Topics studied in macroeconomics include the circular model, business
cycles and unemployment.

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Methods of economics
Positive statements

 These are statements of fact about how the economy operates.

 These can be proven right or wrong.
 An example of a positive statement is, “A cut (decrease) in income tax
increases consumer (disposable) spending income”

Normative statements

 These are opinions about how things should be done in an economy.

 They reflect people’s own judgments.
 They are subjective as people can have different opinions about how things
must be done.
 An example of a normative statement is, “ People who earn higher income
must pay more tax than those who earn lower income”

Economics as a social science

 Economics is a social science because it studies human behavior.

 Human behavior is studied using:

Research methods

Research includes:

 Collection of data, presentation of data and explanation of results

Use of models

 A model is a simplified representation of what happens in reality.

Importance of models

 They simplify what might be complex.

 They show links (relationships) between economic variables.
 They summarize what might be long into short diagram.
 Examples of models include diagrams, graphs, charts, tables and
mathematical equations.

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Difficulties faced in the study of economics as a social science
 Economics faces a number of challenges in coming out with accurate
conclusions in the study of economic theories.
 Firstly natural sciences have laboratories to test their theories but economics
does not have such laboratories.
 Economic theories have to be tested in real life situations.
 Studying human behavior is difficult since human behavior contently
changes.
 Natural sciences are able to separate variables and study them differently but
in economics it is impossible to separate variables.
 All the variables have to be studied at the same time.
 Measurements used in economics are not exact, eg measuring utility.
 The laws that are used in economics are not precise, eg the law of demand.

The setting of economics within the commercial field

 As a commerce subject economics is related to other commercial subjects.
 These subjects include:
 Accounting, Business studies, Commercial law, Financial mathematics.
 Subjects in other fields were economics is relevant include:
 Statistics, Mathematics, Information technology, Law, Politics, Sociology and
Geography.

Career opportunities in economics

 The study of economics opens doors to the following careers:
 Banking, Finance, Government administration, Tourism sector, Logistics,
Economist and economics teacher.

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The basic economic problem
 The basic economic problem is the problem of scarcity.
 The problem is that while people’s wants and needs are unlimited (numerous)
the resources needed to satisfy these wants and needs are limited.

Absolute scarcity

 This is a kind of scarcity where there is a shortage of resources to produce

goods and services.
 This means that there is a shortage of goods and services.

Relative scarcity

 This is the kind of scarcity where goods and services are available but people
lack the means to afford them.
 It means that while goods and services are available people do not have
money to buy them.

Alternative choices

 People are able to have a choice when they are alternatives to choose from.
 Where there are fewer goods and services people have limited choices and
where there are many goods and services, people have many choices

Opportunity cost

 Making a choice means another alternative has not been chosen.

 The cost of the alternative that was not chosen (sacrificed) is called the
opportunity cost.
 The opportunity cost is measured by the next best alternative that has been
given up.

Economic goods

 These are goods that can be bought and sold.

 They have both utility value and exchange value.
 Such goods:
 Are owned either by individuals, businesses or the state.
 Are scarce.
 People are prepared to pay for them.
 Determine the wealth of an individual.
 Examples of economic goods are cars, furniture, clothing and cell phones.

Free goods

 These are goods that do not command a price.

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  No one owns them.
 They are plenty and found in unlimited quantities.
 They have only utility value and no exchange value.
 People are not willing to pay for them.
 Possession of them does not give wealth.
 Examples of free goods are air, rain, wind, the sun and the sea.

Production
 Is the process of creation of utilities
 It is making goods and services available

Goods

 Are tangible (can be seen and touched) things that satisfy human wants and
needs, eg tables, food, clothing and cars.

Services

 Are intangible things that satisfy human wants and needs eg entertainment,
transport, communication and tourism.

Factors of production

 These are resources that are needed in order for production to take place.
 There are FOUR factors of production.

Natural resources/Land

 Natural resources are all the gifts from nature which are freely given by
nature, eg soil, trees, rivers, game, fish and birds.
 Such resources are scarce
 Supply is fixed
 They have to be transformed before they become useful
 Natural resources can either be renewable or non renewable.
 Renewable resources are those that can be re – regenerated or used more
than once, eg water.
 Non – renewable resources are those that are only used once and they are
finished, eg minerals.

Human resources/Labour

 Labour is the physical and mental effort put by humans in production It is the
human input in production.
 Labour can be skilled, semi – skilled or un – skilled.

Capital

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  Capital is a man – made resource which includes all those goods that produce
other goods as well as money used to start and run a successful business.
 Capital makes work easier and faster.

Entrepreneurship

 Entrepreneurship is the skill or ability needed to start and run a business.

 The person who has such a skill is called the entrepreneur.

Payment/Reward to the factors of production

 For use of each of the factors production a payment is made.

 This payment is called income to the factors of production.

Factor of production Income

Land Rent

Labour Salaries/Wages

Capital Interest

Entrepreneurship Profit

Classification/Stages of production
 Production takes place in THREE main stages.

Primary stage

 The first stage of production which deals with the extraction (collection) of raw
– materials, eg farming, forestry, mining and fishing.
 Output from the primary sector is in the form of raw – materials.

Secondary stage (sector)

 The second stage of production which deals with turning (changing) raw –
materials into fished or semi – finished goods.
 Secondary sector activities include manufacturing, processing, refining and
construction.

Tertiary stage (sector)

 The last stage of production which deals with the distribution of goods and
services to their final users.
 It is also called the services sector because it offers only services.

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  Tertiary sector activities include Retailing, transport, communication and
banking.

Exchange

The term exchange refers to the buying and selling of goods and services.

 It is also known as trade.

Reasons for trade

Production of surplus

 Surplus production is when we produce more than we require.

 It is extra production.
 This surplus production is sold to those who do not have.

Specialization

 Specialization or division of labour is a condition were workers concentrate on

one area of production.
 When societies specialize they do not produce everything for themselves so
there is need to exchange what one produces with those who produce what
one does not produce.

Importance of Specialization (Advantages)

Leads to mass production

 Production increases when a person repeats the same task several times.
 The person becomes an expect, and therefore can work faster.

Leads to better quality

 A person who has become an expect produces better quality goods and
services.

Makes introduction of machines possible

 Machines can be easily used where people are repeating the same task.

Lowers prices

 An increase in output leads to a decrease in prices.

Economic questions

 These are basic economic questions which all countries of the world must
answer.

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What?

 Every economy must decide what must be produced, eg should we produce

food or guns?

How?

 We should decide how to produce for example should we use machines or

humans?

Form whom?

 We should decide who should benefit from the production, should we produce
for the youth or for the elderly?

Consumption

 Is the use of goods and services.

Consumer goods

 Goods and services that are used by consumers are called consumer goods.
 Consumer goods are also called final goods

Consumers spend their money on the following goods and services:

 Durable goods – Those that are used over a long period of time, eg,
furniture, cars and houses.
 Semi – durable goods – Those that are used over a short period of time,
eg, clothing.
 Non – durable goods – Those that are consumed and destroyed in the
process of consumption, eg, food.
 Services – Can only be enjoyed for the period in which they are given,
eg, entertainment.
 Capital goods
 These are goods that produce other goods, eg machines, equipment, tools,
buildings, land, computers and motor vehicles.
 These goods are bought by businesses.
 Capital goods are also known as intermediate goods
 Buying or increasing the stock of these goods is called investment.

Importance of investment

 It increases demand for capital goods.

 It leads to employment creation
 It increases production
 It increases the productivity of labour.

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Public goods

 These are goods and services that are jointly consumed (used by society as
a whole).
 These goods are provided by the state.
 These include:

Community goods

 These are public goods where it is impossible to charge a fee, eg policing,

street lighting and defence.

Collective goods

 These are public goods where it is possible to charge a levy so that those who
do not pay are excluded, eg toll gates, parks and community halls.

Merit goods

 These are services provided by the state, eg education, health care and social
security.

Human rights

 These are freedoms enjoyed by citizens in a country

Basic human rights include:

 The right to equality before the law

 The right to free expression
 The right to choose to an occupation
 The right to own property

Violation of human rights

 Economics experienced the violation of worker rights during the industrial

revolution

These included:

 Employing children as young as eight years

 Women doing work that was beyond their physical strength and dignity
 Workers working long hours often more than 14 hours a day with no time for
break
 Working in dirty, smelly, with poor ventilation, poor vision and unsafe factories
 Workers also experienced poor living conditions where they were housed in
slums without proper shelter, limited access to clean water and sanitation

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Promotion of human rights

 Countries today have constitutions that promote the basic human rights

Labour rights in South Africa are promoted by the following Acts:

 The Labour Relations Act

 The Basic Conditions of Employment Act
 The Occupational Health and Safety Act
 The Employment Equity Act

Effects of economics on the environment

The environment is the surrounding within which we live.

The serious threats to the environment today include:

 Global warming (green house effect)

 Pollution
 Can be in the form of air, water, land and noise pollution.
 Pollution is caused by industrial waste, chemical waste, solid waste and liquid
waste.
 Environmental damage (degradation) is caused by human activities.
 In developing countries the problem is created by increasing populations.
 These cause deforestation and poor farming methods
 In developed countries the problem is created by increasing consumption
 This leads to too much production resulting in emission of toxic waste (carbon
dioxide)

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The Circular flow model
 A model is a simplified representation of what happens in reality.
 A circular flow model is a model which indicates the flows (movements) of
Income, expenditure, goods, services and factor services (factors of
production)

The two sector model

 Income, expenditure, goods, services and factor services (factors of

production)

Income Households
Expenditure

Factors of production Goods & Services

Factor market Product market

Factors of production Businesses Goods & Services

Expenditure Income

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  This is a model that consists of two sectors, Households and Business.
 The government is not shown as a separate participant in a two sector model
because the government acts as both a producer and a consumer. The
government is a producer because it provides public goods and the
government is a consumer when it buys goods and services from businesses.
 The model represents a closed economy
 A closed economy is an economy that does not include the foreign sector.

The THREE sector model

 When the government is shown as a separate participant in a closed

economy the model becomes a THREE sector model.

Income Expenditure
Households
Factors of production Goods & Services

Tax (T)

Public goods

Government

Expenditure (G) Tax (T)

Public goods Expenditure (G)

Factor market Product

market

Factors of production Goods & Services

Businesses

Expenditure Income

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The four sector model

Income Expenditure
Households
Factors of production Goods & Services

Tax (T)

Public goods

Government

Expenditure (G) Tax (T)

Public goods Savings(S) Expenditure (G)

Factor market Product

Financial
Sector
market

Factors of production Investment (I) Goods & Services

Businesses

Expenditure Income

Imports Exports

Expenditure on imports (M) Income from exports (X)

Foreign Sector

 This model consists of four sectors ( participants ), Households,

Businesses, Government and the Foreign sector.
 It represents an open economy.
 An open economy is an economy that includes the foreign sector ( a country
that trades with other countries)

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The Flows
Real flows

 movement of goods, services and factors of production (actual things)

Money flows

 movement of income and expenditure, eg, salaries, wages, rent, interest and
profit.

The two flows move in opposite directions because for every real flow there must be
a money flow.

The Roles of sectors (participants)

Households/Consumers

 Are the primary participants who start the activities of the circular flow.
 They own factors of production, eg, labour ,land, capital and
entrepreneurship.
 They buy goods and services.
 They pay taxes to the state.

Businesses/Firms/Producers

 Are the producers of goods and services.

 They buy factors of production.
 They pay taxes to the government.

The State/Government

 Regulates economic activity by passing laws that must be followed buy the
economic participants.
 Provides public goods and services, eg schools, parks, healthcare and
policing used by households and infrastructure eg roads, bridges and power
stations used by businesses.
 Buy goods and service.
 Hire factors of production.

The foreign Sector

 Consumes exports
 Provides imports.

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Markets
 A market is the interaction of buyers and sellers which results in a price.

Markets includes,

The product Market/Market for goods and services.

 A market for the interaction of the buyers and sellers of goods and services.
 It is also known as the consumer market.
 It is a market for consumer goods and services.
 Goods are defined as tangible items such as food, clothing and cars that
satisfy human wants and needs.
 Services are defined as non tangible actions, eg entertainment, transport,
communication, banking, insurance and finance.
 It is where goods and services are exchanged, eg, retail, wholesale and
services markets.
 Goods exchanged include, durable, semi – durable, non – durable goods as
well as services.

The factor market/Market for factors of production.

 A market for the interaction of buyers and sellers of factors of production.

 It is also known as the resources market.
 Households sell factors of production on this market and receive rent for
natural resources, wages for labour, interest for capital and profit for
entrepreneurship.
 It is where factors of production are bought and sold, eg, labour, capital, and
natural resources.
 Examples of the factor market include, the labour market (labour), property
market (land/natural resources) and financial market (capital).

The Financial market/Financial Sector

 A market for the interaction of buyers and sellers of capital.

 The market acts as a link between households, business sector and other
participants with surplus funds.
 It is where borrowers (investors) and lenders (savers) interact.
 It consists of banks, insurance companies and pension funds.
 It acts as a link between households and firms who have surplus money and
others in the economy who require funds.
 The money which households and firms provide to the financial sector is
known as savings.
 The spending on capital equipment by firms is regarded as investment.

The financial market includes,

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The money market

 A market for short term borrowing and lending, eg treasury bills and overnight
borrowing.

The capital market

 A market for long term borrowing and lending, eg bonds.

The foreign exchange market

 A Market for the interaction of buyers and sellers of foreign exchange ( foreign
currency)
 The market exists in every commercial bank.

Leakages and Injections

Leakages

 Are withdrawals from the circular flow.

 Represent money that leaves the circular flow.
 The effect of leakages is to reduce national income.
 Leakages include,

Savings (S)

 when households and firms decide not to spend all their money, but to put
some aside for future use, that money moves out of circulation.

Taxes (T)

 When households and businesses pay tax to government, money moves out
of the circular flow.

Imports (M)

 When payments for imports are made, money moves out of the circular flow.
 Leakages (L) = S+T+M

Injections

 Are additions to the circular flow.

 Represent money which joins the circular flow from outside sources
 The effect of injections is to increase national income.
 Injections include,

Government Spending (G)

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  When the state spends in the product or factor market, money joins the
circular flow.

Investment (I)

 When businesses increase their stock of capital, money joins the circular flow

Exports (X)

 Income received from the sale of exports adds to the money in circulation.
 Injections (J) = G+I+X

National Account Aggregates.

 National Account Aggregates measure the total value of the economy.

 Give the totals of the economy in terms of production, income and
expenditure.
 National Account Aggregates include,

The Gross Domestic Product (GDP)

 The total value of all final goods and services produced within the boarder
of the country in a given period of time, eg one year.

Methods of calculating GDP

Production Method (GDP) (P)/Gross Value Added (GVA)

 Measures total domestic production by adding together the total value of

output produced by the THREE sectors of production.
 The value addition method, Gross Value Added (GVA) is used, which
means the value of intermediate (semi – finished) goods is subtracted
from the value of final goods.
 This is done to avoid double counting the value of the goods.

Gross value added in R billion

Primary Sector 324 365

Secondary Sector 556 708

Tertiary Sector 1 789 431

Gross Value Added @ Basic prices

Add Taxes on products 312 863

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 Less Subsidies on products 19 106

Gross Value Added @ Market prices

Gross value added @ basic prices

 The total value contributed by the three sectors of production (Primary,

Secondary and Tertiary).

Taxes on products

 The taxes charged on the final goods and services, eg VAT.

 Taxes on products are added to the gross value added @ basic prices
because they add (increase) to the value of production (GDP)

Subsidies on products

 The financial assistance given by the state to producers in order to

reduce the prices of goods and services.
 Subsidies are given on essential (basic) goods and services, eg,
electricity, water and basic foodstuff to make them affordable majority
of the people.
 Subsidies on products are subtracted from the gross value added @
basic prices because they reduce the value of production.

Gross Value Added @ Market Prices

 The total value of domestic production (GDP)

Income Method (GDP) (I)

 measures total domestic income.

 Represent income earned by the domestic factors of production.
 Its components include:

Income in R million

Compensation of employees 882 379

Net operating surplus 629 116

Consumption of fixed capital 252 598

Gross Value Added @ Factor Cost

Add: Taxes on production 35 374

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 Less: Subsidies on production 7 388

Gross Value Added @ Basic Prices

Add: Taxes on products 23 000

Less: Subsidies on products 5 891

Gross Value Added @ Market Prices

Compensation of employees

 This is income earned by labour.

 This includes salaries, wages, commission, bonus, fees and any other
earnings by labour.

Net operating surplus

 This includes profit earned by enterprises, rental income as well as interest on

capital.

Consumption of fixed capital

 This represents depreciation of fixed assets as they are used.

Gross value added @ factor cost

 This represents the total cost of factors of production (Earnings by all the
factors of production)

Taxes on production

 these are taxes on the production process, eg taxes on raw- materials, direct
labour as well as other semi – finished ( intermediate ) goods.

Subsidies on production

 these are subsidies paid on the production process.

Gross value added @ basic prices

 the total value of production after adding taxes on production and subtracting
subsidies on production on the gross value added @ factor cost.
 Represent the total value of the production process.

Taxes on products

 These are taxes on final goods and services, eg VAT.

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Subsidies on products

 these are subsidies paid on final goods and services.

Gross value added @ market prices (GDI)

 The total value after adding taxes on products and subtracting subsidies on
products on the gross value added @ basic prices.
 Represents the total income earned by the domestic factors of production
(GDI).

Expenditure Method (GDP) (E)

 measures total domestic expenditure by all the sectors of spending

 It gives total expenditure on all locally produced goods and services.

Expenditure on GDP in R million

Final Consumption expenditure by Households (C) 990 773

Final Consumption expenditure by General Government (G) 305 733

Gross Capital Formation (I) 282 130

Residual Item -164

Gross Domestic expenditure

Add: Exports of goods and services (X) 430 169

Less: Imports of goods and services (M) 437 559

Expenditure on Gross Domestic Product (GDP) @ Market

prices

Final Consumption Expenditure by Households (C)

 This represents total spending by households when they buy goods and
services.
 Households spend their money on the following goods and services:
 Durable goods – Those that are used over a long period of time, eg,
furniture, cars and houses.
 Semi – durable goods – Those that are used over a short period of time,
eg, clothing.
 Non – durable goods – Those that are consumed and destroyed in the
process of consumption, eg, food.

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  Services – Can only be enjoyed for the period in which they are given,
eg, entertainment.

Final Consumption Expenditure by General Government (G)

- This represents spending by government across all its spheres.

 This includes spending on:
 Infrastructure development – This is money spent by the state in building
new infrastructure eg, roads or upgrading the existing one.
 Consumption spending – This is money spent by the state when buying
goods and service, eg, buying stationery for school learners.
 Social Spending – This is money spent by the state to provide public goods
and services (service delivery), eg ensuring that clinics, hospitals and schools
are operating.
 Transfer payments – This is money spent by the state to provide social
security (social grants), eg, old age pension, child support grant, disability
grant and foster care grant.

Gross Fixed Capital Formation (I)

 This represents investment by businesses when they increase their stock of

capital.
 It includes expenditure by business enterprises when they buy assets.

Residual item

 This represents a balancing amount between the sectors.

Gross domestic expenditure

 This represents total spending by domestic sectors of the economy

(Households, Businesses and Government)

Exports of goods and services

 This represents expenditure on locally produced goods by the foreign sector.

This is added to gross domestic expenditure because such spending adds to
domestic expenditure.

Imports of goods and services

 This represents spending by local consumers on goods and services that are
produced outside the country.
 This is subtracted from gross domestic expenditure because such spending
occurs outside the domestic economy.

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Gross domestic expenditure @ market prices (Expenditure on gross domestic
product) GDE

 This represents total spending on locally produced goods and services.

Total domestic expenditure (E)=C+G+I+(X-M)

The three methods of calculating GDP give the equal value of GDP.

GDP=GDI=GDE

 GDP and GDI are equal because incomes are earned in the process of
production, therefore, income and production must be equal.
 GDP and GDE are equal because we spend on what was produced,
therefore, production and expenditure must be equal.

Gross National product (GNP)

 Is the total value of all final goods and services produced by citizens of a
country, who may be in inside or outside the country in a period of a year.

National Income in R million

GDP @ Market prices 2 964 261

Add: Primary income from the rest of the world 38 118

Less: Primary income to the rest of the world 104 689

Gross National Product @ Market prices (GNP)

 It gives total production by citizens within the country and outside the country.

Primary income from the rest of the world

 is total income earned by South African factors of production that operate

outside South Africa, eg Income earned by MTN in Nigeria.
 Such income is added to GDI because it forms part of South Africa’s income.

Primary income to the rest of the world

 This is income that is earned by non – South African factors of production

that operate here in South Africa, eg income earned by Anglo American.
 Such income is subtracted from GDI because it does not form part of South
Africa’s national income.

Why GDP is greater than GNP

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  South Africa’ GDP is always greater than GNP because primary income from
the rest of the world is lower than primary income to the rest of the world.
 This means the contribution by South Africa’s factors of production outside
South Africa is lower than the contribution by non – South African factors of
production that operate here in South Africa.

25
Business Cycles
 Business cycles are sustained and significant periods of increasing or
decreasing economic activity.
 They are sometimes called economic fluctuations and reflect an upswing or
downswing in the in the level of economic performance.

The phenomenon

 This is the concept of business cycles which are upswings and downswings
in the economy (cyclical patterns).

A typical business cycle

The nature of business cycles/Composition/Features/Characteristics.

Periods

 There are TWO periods of business cycles:

Expansion period

 Sometimes called the upswing in the business cycles, is that period of

increasing economic activity.

Contraction period

 Sometimes called the downswing in economic activity, is that period of

decreasing economic activity.

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Turning points

There are TWO turning points in a business cycle:

Peak

 The upper turning point of the business cycle indicating the highest point of
expansion (upswing).

Trough

 The lower turning point of the business cycle, indicating the lowest point of
contraction (downswing)

Phases

There are FOUR phases of business cycles :

Recovery phase

 That phase in the business cycle where the economy starts to signs of
improving from a downswing.

Characteristics of the phase

 Businesses start to service their machinery in preparation for increased

production.
 Interest rates are low, so businesses are able to borrow capital and
consumers are able to buy on credit.
 Spending starts to increase.
 Production starts to increase.
 Business losses are reduced.
 Retrenchments (job losses) stop.

Prosperity Phase

 A phase characterized by general optimism (hoping for the best) within the
economy.
 It is a phase which comes after a recovery has been sustained.

Characteristics of the Prosperity Phase

 Production increases significantly.

 Employment increases.
 Incomes increase leading to an increase in aggregate demand.
 Businesses make profit.
 Businesses borrow capital to increase their investment.

27
  Consumption increases as consumers buy more goods and services
on credit.
 The later part of prosperity (Boom) settles in where everything seems
to get to extreme.
 Production, salaries/wages, consumption and prices rise to alarming
levels.
 Inflation settles in and there are signs that the economy will soon reach
a peak.
 The central bank and the state reign in with restrictive monetary and
fiscal policy to cool down the economy.

Recession

 A phase where economic activity starts to decrease.

 The phase is characterized by general cool down of the economy.

Characteristics of the recession phase.

 Prices, taxes and interest rates are high therefore aggregate demand starts to
decrease.
 Production starts to decrease and employment starts to decrease.
 Incomes decrease.
 Businesses start to show losses.
 Job losses (retrenchments) start and there are signs that things will get worse.

Depression phase –

 period where economic activity gets to its lowest

 The period is characterized by general pessimism (fearing for the worst)
within the economy.

Characteristics of the depression phase.

 Production, employment and incomes decrease significantly.

 Spending by consumers get to its lowest and only consists of spending on
non – durable goods.
 Spending on capital and durable goods is almost non – existent.
 Some consumers fail to pay back their credit and have their property, eg
cars and houses repossessed.
 Businesses suffer huge losses and many people lose jobs.
 Unemployment gets to its highest and prices fall.
 Inflation gets to its lowest and central bank and the state start to stimulate
the economy by applying an expansionary monetary and fiscal policy.
 Slowly consumers start to buy on credit and there are signs that the
economy is heading for a recovery.

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Explanations/Reasons/Causes of business cycles
 There are TWO explanations to the occurrence of business cycles:

The Exogenous/Monetarist Explanation

 Economists who believe (present) this explanation are called monetarists.

 Their belief is that markets are inherently stable.
 They are able to coordinate economic activities and that any departures from
equilibrium are caused by outside factors (exogenous factors)
 They present the following reasons as the exogenous factors that lead to
business cycles:

Inappropriate government policy on money supply

 When governments manipulate money supply this may lead to an oversupply

or shortage of money.
 This may lead to economic conditions like higher inflation or too much
unemployment which eventually become business cycles.

Structural changes

 Changes in technology and production techniques may create unemployment

for people when they cannot fit in the new technology and this can lead to
business cycles.

Shocks

 Unforeseen events, eg unfavourable climatic conditions like, drought, floods,

earthquakes and storm may lead to a decrease in supply which may cause
business cycles.
 Shocks include sudden and massive increases in interest rates, commodity
prices, eg oil prices and a huge depreciation of a country’s currency.
 Monetarists advise that in order for business cycles to be avoided,
governments should be kept out of economic operations.

Endogenous/Interventionist Explanation

 Economists who believe in this explanation are called Keynesians.

 They argue that markets are inherently unstable.
 They believe that business cycles are part of the operations of the market
economic system since they are caused by factors inside the market
system (endogenous factors) Such endogenous factors are:

Mismatches

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  If there are mismatches, eg between savings and investment then the
economy can get into cycles

Indirect links

 If links within the economy, eg between government spending and taxes are
not correct then the economy can get into cycles.

Disequilibria

 Failure by market forces (demand and supply) to coordinate effectively may

lead to business cycles.
 Keynesians believe that governments must intervene (involve themselves) in
the economy to correct ills (problems) created by market failure.

Business cycle indicators

Leading economic indicators

 These are indicators that change before the economy changes

 They lead the business cycle through a fixed period
 They reach the peak before the peak in aggregate economic activity and they
reach the trough before the trough in economic activity
 They give consumers, business leaders and policy makers a glimpse of
where the economy might be heading
 When these indicators rise, the level of economic activities will also rise in a
few month’s time

Co- incident indicators economic indicators

 They simple move at the same time as the economy moves

 They reach a peak during the peak in aggregate economic activity and they
reach a trough during the trough in economic activity
 It indicates the actual state of the economy
 If they are improving it means that general economic conditions are
improving and if they are worsening it means that general economic
conditions are deteriorating.

Lagging Economic indicators

They do not change direction until after the business cycle has change its’
direction
They follow coincident indicators with some delay
They reach a peak after the peak in aggregate economic activity and they
reach a trough after the trough in economic activity

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 They serve to confirm the behavior of co-incident indicators
If they do not confirm an upswing or downswing, it means the upswing or
downswing is weak and will end at an early stage

Measuring business cycles

 Business cycles are measured by their length

The Length of the business cycle

 Is the time it takes for business cycle to move through one complete cycle
Measured from one point to another similar point, eg from peak to peak or
from trough to trough or one phase to another similar phase, eg from
recession to recession
 It is Useful to know the length because the length tends to remain relatively
constant over time
 If a business cycle has the length of 10 years it can be predicted that 10
years will pass between successive peaks or troughs in the economy
 Longer cycles show strength
 Cycles can overshoot.

Effects/Impact of business cycles

Aggregate demand and supply

 Business cycles affect aggregate demand and aggregate supply.

 During a downswing aggregate demand decreases because incomes
decrease due to higher unemployment.
 When aggregate demand decrease, aggregate supply also decreases.
 During an upswing both aggregate demand and aggregate supply increase.

Economic growth

 Economic growth decreases during a downswing because production is low.

 During an upswing economic growth increases.

Employment

 Employment decreases during a downswing.

 This means unemployment increases.
 Unemployment is highest during a depreciation
 During an upswing unemployment deceases.

Price levels/Inflation rate

 Price levels increase during an upswing.

 Inflation is highest during a prosperity and lowest during a depression.

31
Exchange rate

 During an upswing demand increases.

 This may include demand for imports.
 This results in increase in imports and a decrease in exports.
 The balance on the current account of the balance of payments decreases
leading to an increase in the exchange rate.
 The value of the local currency decreases or depreciates.

Impact on the economically Vulnerable

 Business cycles cause hardships to people who are economically vulnerable.

 Theses, include, children, women disabled, poor people, rural people and
pensioners.
 A downswing leads in children going hungry due to lack of food.
 Higher inflation results in pensioners suffering because they are on fixed
incomes.
 Higher prices makes goods and services to be un affordable to the poor

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Economic Growth, Development and
Globalization
 The early communities were living a nomadic way of life where they had no
settlements but wondered around in search of food.

Self – sufficiency and dependency on agriculture

 The adoption of agriculture meant that people gave up their nomadic way of
life and started planting crops and domesticating animals.
 Agriculture became a major economic activity.
 Early societies attempted to be self sufficient. They produce just enough food
for themselves.
 There was little or surplus produced.
 Tool making was another economic activity.
 They produced iron tools using primitive methods.
 Tools were used for hunting and agriculture.
 Trade small trade occurred since there was little surplus produced that could
be traded.
 Trade was in the form of barter.

Language, skills and learning

 As communities grew bigger and more organized, they developed a language

that facilitated communication.

Wealth and settlement

 The growth of agriculture led to wealth accumulation and the need to have
permanent settlements.

Surplus production and the development of trade

 Increased farming led to production of surplus which could be used for trade.
 As trading activities increased centers of trade were established where goods
could be exchanged.

Evolution of markets

 As surplus production increased trade increase and markets became bigger.

 Agricultural products, shoes, furniture, building material, clothing, household
utensils, farm equipment and tools were examples of goods that were traded.
 Increased trade led to the emergence of travelling merchants.
 These were people who took journeys exchanging goods and services.

33
Transport system

 The increase in the volume of trade and the emergence of travelling

merchants led to the development of transport system.
 Merchants travelled from Europe by ship.

Growth of towns and cities

 Markets turned into towns because they were centers of trade.

 When these towns grew bigger they became cities.

Specialization of labour

 Workers began to specialize in specific tasks to increase output.

 Some people made goods, others worked on metals and others made
clothing.

Guilds

 Merchants in different trades organized themselves into groups that will

promote their trade.
 These were called guilds.
 Guilds were like unions of employers ( traders, craftsman and professionals)
 Guilds were responsible for production in their specific trade and set up
wages in each trade.

Mercantile laws

 Merchants developed a system of laws based on custom and best practice

which were called mercantile law.
 These laws were enforced through mercantile courts.

Development of business forms

 The need to acquire capital from banks meant that merchants should
organize themselves into business forms.
 The earliest form of business was the sole proprietorship.
 When sole proprietors came together they formed partnerships.

Technological progress

 Production methods developed.

 Water and wind were used as sources of energy.
 Water was used to drive water mills and wind was used to turn wind mills.

34
Savings

 Refer to income that is not spent but put aside for future use.
 Savings are done by individuals, businesses and government.
 Money that is saved is used for investment.
 In the earlier times savings were used in the invention of coins and notes.
 Today forms of savings include different accounts run by commercial banks
as well as stokvels.

Government Regulation of markets

 State regulation means passing of laws by government.
 The purpose of state regulation of markets is to ensure that markets are
efficient.

Government involvement in trade

 When individual trade declined, government took over and promoted trade
between continents.
 Governments supported their people to trade across continents.
 Government intervention included imposing taxes, tariffs, customs duties,
creation of monopolies and physical restrictions on imported goods.

Voyages of discovery

 These were journeys taken by traders to discover new markets.

 These explorers established a sea route to India and the far East.
 These early explorers included Columbus, Vasco de Gama, Cabot and
Magellan.
 Items mostly traded include spices and precious metals.

The rise of Mercantilism

 The European explorers encouraged their governments to extend their laws

to the places where they were trading.
 This led to the rise of colonization where European countries took over
territories outside Europe and ruled over these territories.

Taxation and mobilization of finance for Investment

 Taxes were raised from the time government became involved in the
economy.
 Taxes included:

Individual tax

 The earliest form of individual tax was called a poll tax.

35
  Income tax was imposed on the wealthy office holders and other
professionals
 Excise duty was charged on important commodities like grain and meat
 Inheritance tax was imposed to provide for retirement benefits.

Merchants

 Traders were taxed heavily

 They had to pay toll tax when transporting goods from one region to another
region.
 Customs duties where charged on both imports and exports.

Businesses

 They paid taxes on land and property.

Mobilization of funds to build infrastructure

 Infrastructure refers to the physical structures that support society, such as

roads, ports, government buildings, military installations, water supply,
sewers and water drainage.
 Taxes raised by governments were used for infrastructure development.

Comparative economic systems

Feudalism

 This was an economic system based on land ownership as a key means of

production.
 Peasants (small farmers) and serfs (land workers) had no rights.
 Powerful land owners (Landlords) controlled governments which provided
peace and security.

Mercantilism

 The system was based on trade through voyages of discoveries.

 Exports were seen as giving a nation power and imports were discouraged at
all cost.
 Collection of precious metals, eg gold and silver through exports was the main
focus.

Communism

 The system was based on sharing the means of production.

 The system was based on the absence of classes in society.

Capitalism

36
  This was a foundation of the free enterprise system where private individuals
owned the means of production.
 In this system factors of production are privately owned.

Public Finance and the emergency of economic policy

 Public finance involves government revenue and government expenditure.

 Economic policy refers to the strategies and measures adopted by a
government to manage the economy and achieve state objectives.
 Government revenue is generated from taxes.
 A tax is a compulsory payment to government by economic participants.
 Taxes can either be direct or indirect Methods of taxation include progressive,
regressive and proportional taxing.
 Government spending can be in the form of Infrastructure spending, Social
spending, Consumption spending and transfer payments.

Industrial development
 Industrial development was driven by manufacturing development.

Manufacturing

 Manufacturing was promoted by the beginning of the Industrial revolution in

Europe.
 During this period large scale production was driven by innovation in building
new machines that replaced production by hand.
 With the introduction of machines there was greater division of labour
(specialization).
 This increased output.

Technological progress

 New technology was adopted in mining, engine building, spinning, weaving

and farming.
 Manufacturing brought new materials, chemicals, medicines, forms of
transportation and communication.

Energy

 Animal driven machines were now powered by steam engines.

 This brought changes in the textile industry.
 In the transport sector steam engines brought steam locomotives, steam
ships and steam tractors were used in agriculture and mining.
 Steam energy was followed by electricity.
 Electricity was generated from coal, gas, water and uranium (nuclear)

37
Mechanization of production

 Mechanization started with the industrial revolution which affected the textile
industry.

Urbanization and migration

 Industrialization came with increased urbanization.

 Urbanization is the growth of urban populations.
 The expansion of factories gave rise to the working class.
 These factory workers needed to be housed which led to the growth of towns
and cities.
 More people migrated from farms to work in the new factories which further
increased urbanization. Evolution of Economic Institutions

38
Population and labour force
 The word that is used to describe the population is the word demographics.
 It describes the population in terms of size, gender, age and race.

Population size

 Is the number of people within a geographic area usually, a country.

 The population size is obtained by way of a census.
 A census is the process of counting people within a country.
 In South Africa, the last census was done in 2011.
 According to that census South Africa’s population numbered 52,26 Million
and today the population is estimated to be 58,8.

Population growth rate

 Is the increase in the size of the population

 The Natural population growth rate is affected by the fertility and mortality
rate.

Fertility (birth) rate

 Is the average number of children born alive to a woman during her child
bearing age of 15 to 49 years

Mortality (death) rate

 Is the average number of people who die in a given year

 Where the fertility rate is higher than the mortality rate, population growth
increases and where the fertility rate is lower than the mortality rate
population growth decreases.

The demographic cycle

 Natural population growth rates go through the following phases:

Phase 1

 The phase was characterized by a very high birth rate.

Reasons

 The communities were poor.

 They lacked education
 There were poor health facilities
 There were no birth controls.

39
  Lack of birth control led to a higher birth rate and lack of health facilities led to
a higher death rate hence the population was low.
 Phase 1 was characterized by low natural growth rate and young populations.

Phase 2

 Was characterized by increasing natural growth rate.

Reason

 There were no birth controls so the fertility rate was high.

 Living conditions and health facilities began to improve so the death rate
decreased, thus phase 2 was characterized by increasing populations.

Phase 3

 Has TWO parts: In the early stages people’s incomes and standards of living
improve and they get more education.
 They begin to value smaller families and they start on birth controls,
however, birth controls are not largely adopted while the death rate rapidly
decreases due to improved health.
 At this stage the population remains high.
 In second stage of phase 3 birth controls are largely adopted and the birth
rate decreases rapidly more than the death rate.
 This results in a decrease in the population growth rate.

Phase 4

 The phase is characterized by decreasing populations

Reasons

 The majority of the population understands the need for smaller families so
birth controls are largely used.
 The birth rate falls rapidly.

Phase 5

 The phase is characterized by very low populations.

Reason

 Birth rates are low and death rates are also low.
 The population stabilizes at low natural growth rate and the populations are
aging populations.

40
Migration
 Is the movement of people from one place to another
 Migration affects population size.
 Immigration is the movement of people into the country.
 Immigration leads to an increase in the size of the population.
 Emigration is the movement of people out of the country.
 Emigration leads to a decrease in the size of the population.

Impact of HIV/AIDS on the population

 Higher levels of HIV/AIDS in a country lead to a decrease in the size of the

population.
 This is because HIV/AIDS reduces life expectancy.
 Life expectancy is the average number of years that a new born infant is
expected to live given the prevailing mortality conditions.
 The impact of HIV/AIDS on the South African population saw life expectancy
decrease to as low as 53 years around the year 2005.
 This was down from above 62 years in the earlier years.
 However, with the roll out of the HIV/AIDS treatment campaign (use of ARVs)
life expectancy has steadily increased back to around 62 years.

The labourforce
 Also known as the workforce consists of people between the ages of 15 to 65
years who are able and willing to work.
 This is called the economically active population (EAP)

Age composition of the EAP

 The EAP is that portion of the population who are between 15 years and 65
years who want to work and able to work.
 EAP consists of both men and women.

The EAP includes:

 People who are formally employed

 People who are informally employed
 People who are self – employed
 People who are unemployed

Employment rate

 Is the number of employed persons expressed as a percentage of the EAP

41
  If the EAP = 100 People
 Employed persons = 70
 Then the employment rate = 70/100 x 100
= 70%

Unemployment rate

 Is the number of unemployed persons expressed as a percentage of the EAP

 If the EAP = 100 Unemployed persons = 30
 then the unemployment rate = 30/100 x 100
= 30%

42