ECS1601/201/1/2016

Tutorial Letter 201/1/2016

Economics 1B

ECS1601
Semester 1
Department of Economics

IMPORTANT INFORMATION
This tutorial letter contains a discussion of the
questions in Assignment 01.

CONTENTS
1

DISCUSSION OF ASSIGNMENT 01/2016 ...................................................................................... 3

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Dear Student
In this tutorial letter, we provide you with the answers to the multiple-choice questions in Assignment 01,
with brief explanations where necessary. In most cases, however, we merely refer you to the prescribed
textbook and/or the study guide. If you have any questions about the answers that are provided, please
discuss them with your fellow students and your e-tutor on the e-tutor website.
1

DISCUSSION OF ASSIGNMENT 01/2016

All references, unless otherwise indicated, are to the prescribed textbook: Mohr, P, Fourie, L &
associates. 2015. Economics for South African students. 5th edition. Pretoria: Van Schaik.
1.

The correct option is [4].

Firms are sellers in the goods market and buyers in the factor markets while households are
sellers in the factor markets and buyers in the goods market. The households offer their factors of
production for sale in the factor market. Firms purchase these factors to produce goods and
services. These goods are then offered for sale in the goods market where households will
purchase them.

2.

The correct option is [2].

A stock variable is a variable that can be measured at a particular point in time while a flow
variable is a variable that can be measured over a period. Investment is measured per unit over a
period; therefore, it is a flow variable. The weekly consumption of beer is a flow variable because it
has a time dimension and is measured on a weekly basis.

3.

The correct option is [5].

The two sets of markets in the simple economy are the goods market and the factor market. The
goods market is the market for goods and services. In the factor market, the various factors of
production are sold. In the circular flow of goods and services, households sell the factors of
production to firms in the factor market. Firms use the factors of production to produce goods and
services that are sold in the goods market to households.

4.

The correct option is [4].

All the statements are correct, except for option [4]. Money is not a factor of production; therefore,
money cannot be used to produce goods and services. To produce goods and services we need
the factors of production such as capital, labour and natural resources. Money is used to facilitate
the exchange of goods and services.

5.

The correct option is [4].

There are four types of remuneration associated with the different factors of production. The
remuneration for land is rent. The remuneration for labour is wages. The remuneration for capital is
interest and for entrepreneurship, it is profit. See section 3.4.
3

6.

The correct option is [2].

The aggregate spending on South African goods and services consists of spending by the four
sectors: private consumption (C), government spending (G), investment spending (I), and net
exports (NX), which are exports minus imports. Option [5] is not correct, as spending on imports by
households, firms and government has to be subtracted from spending by foreigners to determine
spending on locally produced goods.

7.

The correct option is [4].

Both of the statements are incorrect. The factors of production are capital, land, labour and
entrepreneurship. Rent is income for land and money is something that facilitates the exchange of
goods and services. Net exports are equal to the spending by foreigners on South African goods
and services (exports) minus spending by South Africans on imported goods and service (imports).

8.

The correct option is [5].

An injection is a variable that increases the circular flow of income and spending, and a leakage is
a variable that decreases the circular flow of income and spending. Exports are not a leakage but
an injection since they represent spending by foreigners on goods produced in South Africa.
Investment is also an injection because when firms produce capital goods, they are increasing the
spending and income flows in the economy. Saving is a leakage since it decreases consumption
spending (it is transferred to a bank) and consequently, total spending declines. Imports are a
leakage because they constitute spending on goods and services produced in other countries.
Taxes are leakages since they decrease income and consequently, total spending declines.

9.

The correct option is [5].

All the statements are correct, except for option [5]. The role of financial institutions is to facilitate
the flow of funds in the economy and not to act as buyers of factors of production. To facilitate this
function they also need to purchase factors of production but that is not their main role. They act as
the link between households or firms that have surplus funds and other participants that require
funds. Firms purchase factors of production from households.

10.

The correct option is [2].

Injection is the money going into the economy, including investment, government spending and
exports. Imports are a leakage, not an injection, because they represent spending on goods and
services outside the country.

11.

The correct option is [1].

In the factor market, the factors of production such as capital, land, entrepreneurship and labour
are sold. These factors are sold by households to firms. Therefore, in the factor market,
households provide resources to firms.

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12.

The correct option is [2].

The increase of 17 billion in taxes will be a leakage or withdrawal from the circular flow since taxes
by government decrease the income flow, which causes the spending flow to decrease.

13.

The correct option is [3].

Specialisation means that each person specialises in something in a certain stage of the
production of goods and services. This enables the specialising firm to produce in larger quantities.
When firms produce goods and services in which they excel and exchange them with goods and
services of other firms, it gives consumers access to a variety of quality goods. Specialisation
increases competition among firms, leading to a decrease in the prices of goods and services. For
these reasons, prices should not increase when specialisation takes place; to the contrary, they will
probably decrease due to higher productivity.

14.

The correct option is [1].

Money can be used as a measure to state the prices of goods and services. It can also be used as
a form of holding wealth and as a measure for the income of the factors of production. The unique
function of money, however, is that it is used as a medium of exchange. It is a generally acceptable
means of payment.

15.

The correct option is [4].

Money as a medium of exchange consists of coins and notes in circulation and demand deposits.
Demand deposits include balances in cheque and debit card accounts. Although cheques and
debit cards are not money, the positive balance in a consumers bank account is money.

16.

The correct option is [3].

M1 includes all articles generally available as a means of payment. It includes coins and notes as
well as demand deposits. Demand deposits include cheque and transmission deposits. Gold and
stocks are not generally acceptable mediums of exchange, but they can be used as a store of
value. Credit cards are a means of making purchases, but actually, they are a convenient way in
which to make use of short-term credit.

17.

The correct option is [4].

M2 is equal to M1 plus other demand deposits plus all other short-term and medium-term deposits
of the domestic private sector with monetary institutions.
Thus: R87 014 million + R549 323 million + R495 702 million + R917 655 million
= R2 049 694 million.

18.

The correct option is [2].

Surplus units refer to those who have excess funds (savers/lenders) and deficit units refer to those
who have a shortage of funds (borrowers). Financial intermediaries facilitate indirect lending by
serving as a link between savers and borrowers of funds. The JSE Limited provides a market
where securities can be issued and therefore, it facilitates direct financing the surplus units buy
shares and bonds from the deficit units.

19.

The correct option is [3].

Setting the income tax rate is not the function of the South Africa Reserve Bank (SARB). The
Minister of Finance in the National Treasury determines the income tax rate. All the other
statements refer to functions of the SARB see section 14.5.

20.

The correct option is [4].

The SARB uses an accommodation policy to provide liquidity to the banking system; an open
market policy is used to drain liquidity from the system. The SARB does not accept deposits from
individuals. The SARB has the sole rights to issue and destroy coins and banknotes. The SARB
provides services to the government as its banker and advisor. Although government keeps bank
accounts with private banks, the SARB is still the main banker for the government.

21.

The correct option is [1].

Statement [1] is incorrect because as the level of income increases, the amount of money that
individuals hold will increase, as they will need more for their transactions. The opportunity cost of
holding money is the interest rate a person could earn from holding assets instead of money.
Higher interest rates lead to lower passive demand for money and lower interest rates lead to
higher passive demand for money. Therefore, statement [2] is correct. Statement [3] is correct:
Given a certain interest rate level, the current income level will determine the position of the
demand-for-money function, and therefore the quantity of money. Refer to figure 14.2 the
quantity of money is determined by the interaction of the interest rate and the demand for money.
An increase in the interest rate will decrease the quantity of money created, as a smaller amount of
money is demanded. Thus, statement [4] is also correct.

22.

The correct option is [3].

All the statements are correct, except for option [3], as a negative relationship exists between
interest rates and bond prices. When the interest rate is higher, the prices of bonds will be lower
and the lower the interest rate, the higher the prices of bonds will be. Therefore, statements [1] and
[2] are correct. Refer to figure 14.2 the quantity of money is determined by the interaction of the
interest rate and the demand for money. An increase in interest rates will decrease the quantity of
money demanded and a decrease in interest rates will increase the quantity of money demanded.
Therefore, statements [4] and [5] are correct.

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23.

The correct option is [3].

The SARB uses the interest rate to influence the money supply. When the interest rate is lowered,
the quantity of money demanded will increase and the money supply will be increased.

24.

The correct option is [4].

The repo rate is the rate at which the SARB provide loans to other banks. South African banks can
borrow money from the SARB and they will be charged the repo rate. Commercial banks make a
profit by lending out money to their best customers at a higher interest rate called the prime rate.
Equilibrium in the money market is reached when the quantity of money demanded is equal to the
quantity of money supplied.

25.

The correct option is [4].

The demand for money is the amount that the various participants in the economy plan to hold in
the form of money balances. The money that an individual holds has an opportunity cost, which is
the interest that could have been earned had the money been used to purchase bonds. The
amount of money that an individual will choose to hold is determined by the interest rate level, the
income level and the price level. When people have a higher income, they will consume more,
resulting in an increase in the money demanded. An increase in prices will lead to consumers
being able to buy fewer goods and services with the same amount of money, and to maintain
consumption, they will need to hold more money. There is no independent money supply;
therefore, the quantity of money depends on the demand for money and the interest rates, and it is
called a demand-determined money stock or endogenous money. Thus, statement [4] is incorrect;
money supply does not influence the quantity of money demanded.

26.

The correct option is [4].

All the statements are correct, except for statement [4]. As interest rates rises, the opportunity cost
of holding money also increases. A negative relationship exists between interest rates and the
demand for money. If interest rates were high, it would be advisable to hold less wealth in the form
of money and more in the form of investments such as bonds that pay interests. Thus, statement
[2] and [3] are correct. Statement [4] is incorrect, as the quantity of money is negatively related to
interest rates. When interest rates are high, people will reduce their holding of money for
transaction purposes since the opportunity cost of holding money is high.

27.

The correct option is [5].

All the options are part of the SARB monetary policy framework. Inflation targeting is the monetary
policy framework in which the SARB has set to achieve an inflation target of between 3 and 6
percent. The primary objective of the SARB is to achieve and maintain price stability in the interest
of balanced and sustainable economic growth. The SARB also determines the repo rate that
influences the interest rate charged by the banks.

28.

The correct option is [2].

If the SARB wishes to create or enlarge the banks liquidity shortage, it sells government bonds to
the banks, thereby reducing their cash reserves. This forces the banks to make use of the SARB
financing facilities through repurchase agreements. If the SARB wants to stimulate the creation of
bank deposits, it can use the open market policy to ease liquidity conditions and lower interest
rates by buying government bonds.

29.

The correct option is [4].

All three policies will not be advisable if the aim is to bring down the inflation rate. They would
encourage more lending by the commercial banks, which will result in more borrowing and
spending. If the inflation rate were above the target, it would be advisable for the SARB to pursue
policies that would force consumers to spend less. The most likely step would be to increase the
repo rate.

30.

The correct option is [2].

If the SARB wants to expand the money supply, it decreases the interest rate and if it wants to
contract the money supply, it increases the repo rate. An increase in money supply growth may
lead to inflation. When interest rates are increased, the money supply growth should decrease, as
it will be expensive for consumers and investors to borrow. This should keep inflation down.

We wish you all the best with your studies!

Your ECS1601 lecturers
Department of Economics