BBA3 Econ SG 2024 - PDF Study Guide

BACHELOR OF BUSINESS ADMINISTRATION Economics III This study guide highlights key focus areas for you as a student. Since the field of study in question is so vast, it is critical that you consult additional literature. Copyright © Regenesys, 2024 All rights reserved. No part of this publication may be reproduced, stored or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording or otherwise) without written permission of the publisher. Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages. CONTENTS 1. STUDY MATERIAL................................................................................................................................... 1 2. PRESCRIBED RESOURCES................................................................................................................... 1 2.1 BOOKS.............................................................................................................................................. 1 2.2 ARTICLES......................................................................................................................................... 2 2.3 LEGISLATION AND GOVERNMENT PUBLICATIONS.................................................................... 5 2.4 MULTIMEDIA..................................................................................................................................... 5 3. INTRODUCTION....................................................................................................................................... 7 3.1 LEARNING OUTCOMES................................................................................................................... 7 3.2 MACRO- AND MICRO-ECONOMICS............................................................................................... 8 3.2.1 INTRODUCTION TO THE STUDY OF ECONOMICS............................................................ 9 3.2.2 MACROECONOMICS........................................................................................................... 10 3.2.3 MONETARY AND FISCAL POLICIES.................................................................................. 14 3.2.4 MICROECONOMICS............................................................................................................ 19 3.2.5 MICROECONOMIC POLICIES............................................................................................. 28 3.2.6 ASSESSING AND EVALUATING IMPACT........................................................................... 31 3.2.7 ECONOMIC GROWTH AND DEVELOPMENT..................................................................... 32 3.2.8 KEY POINTS......................................................................................................................... 32 3.3 SOCIOPOLITICAL AND ECONOMIC TRENDS.............................................................................. 34 3.3.1 INTRODUCTION................................................................................................................... 35 3.3.2 SOCIO-ECONOMIC CHALLENGES..................................................................................... 36 3.3.3 SOCIOPOLITICAL TRENDS................................................................................................. 41 3.3.4 ECONOMIC TRENDS........................................................................................................... 45 3.3.5 KEY POINTS......................................................................................................................... 47 3.4 ECONOMETRICS........................................................................................................................... 49 3.4.1 INTRODUCTION................................................................................................................... 49 3.4.2 ECONOMIC VARIABLES...................................................................................................... 50 3.4.3 ECONOMIC FUNCTIONS (SIMPLE LINEAR REGRESSION)............................................. 52 3.4.4 ECONOMETRIC RELATIONSHIPS...................................................................................... 55 3.4.5 ECONOMETRIC MODEL (MULTIPLE LINEAR REGRESSION).......................................... 56 3.4.6 KEY POINTS......................................................................................................................... 64 3.5 PUBLIC FINANCES......................................................................................................................... 65 3.5.1 THE ROLE OF GOVERNMENT IN THE ECONOMY........................................................... 66 3.5.2 PURPOSE OF PUBLIC FINANCE MANAGEMENT............................................................. 69 3.5.3 MUNICIPAL FINANCE MANAGEMENT ACT....................................................................... 75 3.5.4 NATIONAL TREASURY........................................................................................................ 80 3.5.5 DIAGNOSTIC TOOL FOR ASSESSING PFM SYSTEMS.................................................... 83 3.5.6 BALANCE OF PAYMENTS................................................................................................... 85 3.5.7 KEY POINTS......................................................................................................................... 86 3.6 INTERNATIONAL FINANCIAL MARKETS...................................................................................... 87 3.6.1 INTRODUCTION................................................................................................................... 87 3.6.2 FINANCIAL INSTITUTIONS.................................................................................................. 88 3.6.3 INTERNATIONAL FINANCIAL MARKETS............................................................................ 91 3.6.4 IMPACT ON LOCAL ECONOMIES....................................................................................... 99 3.6.5 GLOBALISATION AND ITS CHALLENGES....................................................................... 101 3.6.6 KEY POINTS....................................................................................................................... 101 4. REFERENCES...................................................................................................................................... 103 5. VERSION CONTROL............................................................................................................................ 108 List of Tables TABLE 1: REGULATION OF WORKING CONDITIONS................................................................................ 30 TABLE 2: REGULATION OF TAX LEVELS AND BREAKS............................................................................ 30 TABLE 3: WORLD LIFE EXPECTANCY TRENDS......................................................................................... 38 TABLE 4: TOP TEN GLOBAL COUNTRIES RANKED BY GDP.................................................................... 51 TABLE 5: ECONOMIC FUNCTIONS: RELATIONSHIP BETWEEN ICE CREAMS AND TEMPERATURE... 53 TABLE 6: WORKERS WAGE CALCULATION............................................................................................... 59 TABLE 7: GOVERNMENT TAX REVENUE.................................................................................................... 60 TABLE 8: SHELL'S SHARE PRICE................................................................................................................ 61 TABLE 9: MARKETING SALES...................................................................................................................... 63 TABLE 10: SUMMARY OF THE PFMA.......................................................................................................... 71 TABLE 11: SELECTED PUBLIC FINANCE ENTITIES................................................................................... 75 TABLE 12: MFMA CHAPTER SUMMARY...................................................................................................... 77 TABLE 13: INDICATORS AND DIMENSIONS............................................................................................... 84 List of Figures FIGURE 1: BACKWARD-BENDING SUPPLY CURVE.................................................................................. 23 FIGURE 2: THE INDIAN ECONOMY (REPRESENTED BY GDP 1960-2020).............................................. 51 FIGURE 3: RESTAURANT TABLE SIZE AND BILL VALUE......................................................................... 67 FIGURE 4: INTERACTION BETWEEN GOVERNMENT, HOUSEHOLDS AND FIRMS................................ 68 FIGURE 5: THE PFM SYSTEM...................................................................................................................... 73 FIGURE 6: COMPARISON OF STOCK EXCHANGES.................................................................................. 93 1. STUDY MATERIAL Your material includes: This study guide; Prescribed reading and viewing; Digital assessments at the end of the course; and An individual assignment. These resources provide a starting point for your studies. You are expected to make good use of your textbooks, the additional resources provided via online links, and wider reading that you, as a higher education student, will source yourself. 2. PRESCRIBED RESOURCES Various resources are prescribed to help you complete this course. 2.1 BOOKS The following textbook is recommended and should be used to complete the course: Parkin, M. (2019). Economics (13th ed.). Pearson International. You can order a hard or soft copy of this book through the library, or through the reputable academic bookstore Please ensure that you order or download your textbooks before you start the course. © Regenesys Business School 1 2.2 ARTICLES Amnesty International. (2020). South Africa: Broken and unequal education perpetuating poverty and inequality. https://www.amnesty.org/en/latest/news/2020/02/south-africa-broken-and-unequal-education-perpetuating-poverty- and-inequality/ (Retrieved January 9, 2024). Andrews, M., Cangiano, M., Cole, N., de Renzio, P., Krause, P., & Seligmann, R. (2014). This Is PFM. CID Working Paper 285. https://www.hks.harvard.edu/sites/default/files/centers/cid/files/publications/faculty-working- papers/285_Andrews_This+is+PFM.pdf (Retrieved January 9, 2024). Beutin, N. (2017). Share economy 2017. The new business model. PWC. https://www.pwc.de/de/digitale- transformation/share-economy-report-2017.pdf (Retrieved January 9, 2024). Bremner, C., & Boumphrey, S. (2017). How should businesses respond to the rising demand for experiential consumption? LinkedIn. https://www.linkedin.com/pulse/how-should-business-respond-rising-demand-consumption- sarah-boumphrey (Retrieved January 9, 2024). Bunse, S., & Fritz, V. (2012). Making public sector reforms work: Political and economic contexts, incentives, and strategies. World Bank. https://openknowledge.worldbank.org/handle/10986/12019 (Retrieved January 9, 2024). Cervellati, M., & Sunde, U. (2011). Life expectancy and economic growth: The role of the demographic transition. Forschungsinstitut zur Zukunft der Arbeit. https://docs.iza.org/dp4160.pdf (Retrieved January 9, 2024). Department of Labour. (2022). Draft national labour migration policy for South Africa. https://www.labour.gov.za/DocumentCenter/Publications/Public%20Employment%20Services/National%20Labour% 20Migration%20Policy%202021%202.pdf (Retrieved January 9, 2024). Eagle, J. (2022). The Big Mac index: A measure of purchasing power parity & burger inflation. Visual Capitalist. https://www.visualcapitalist.com/cp/big-mac-index-purchasing-power-parity-burger-inflation/ (Retrieved January 9, 2024). Federal Reserve Board. (2017a). What is macroeconomics? https://www.federalreserve.gov/faqs/what-is- macroeconomics.htm (Retrieved January 9, 2024). Ferguson, H. B., Bovaird, S., & Mueller, M. P. (2007). The impact of poverty on educational outcomes for children. Paediatrics and Child Health, 12(8), 701–706. https://doi.org/10.1093/pch/12.8.701 (Retrieved January 9, 2024). Haussman, R., Sturznegger, F., Goldstein, P., Muci, F., & Barrios, D. (2022). Working paper: Macroeconomic risks after a decade of microeconomic turbulence: South Africa (2007–2020). UNU Wider. https://www.wider.unu.edu/publication/macroeconomic-risks-after-decade-microeconomic-turbulence (Retrieved January 9, 2024). Hayes, A. (2022b). Multiple linear regression (MLR) definition, formula, and example. Investopedia. https://www.investopedia.com/terms/m/mlr.asp (Retrieved January 9, 2024). © Regenesys Business School 2 Heppel, E., & Rathbone, M. (2020). The gift as philosophical critique of the social grant system in South Africa. Acta Academica, 52(1), 121–130. http://www.scielo.org.za/pdf/aa/v52n1/08.pdf (Retrieved January 9, 2024). Hobson, B. (2020). Two major factors that could drive the Royal Dutch Shell share price. Yahoo! Finance. https://uk.finance.yahoo.com/news/two-major-factors-could-drive-082855540.html (Retrieved January 9, 2024). IMF. (2014). What is Keynesian economics? https://www.imf.org/external/pubs/ft/fandd/2014/09/basics.htm#:~:text=Keynesians%20believe%20that%2C%20bec ause%20prices,constant%2C%20then%20output%20will%20increase (Retrieved January 9, 2024). Ingram, D. (n.d.). How does a political trend affect a small business? Chron. https://smallbusiness.chron.com/political-trend-affect-small-business-64909.html (Retrieved January 9, 2024). International Labour Organisation. (n.d.). Labour migration in Africa. https://www.ilo.org/africa/areas-of-work/labour- migration/WCMS_670561/lang--en/index.htm (Retrieved January 9, 2024). Kristensen, J. K., Bowen, M., Long, C., Mustapha, S., & Zrinski, U. (2019). PEFA, public financial management, and good governance. World Bank. https://www.researchgate.net/publication/339032919_PEFA_Public_Financial_Management_and_Good_Governanc e (Retrieved January 9, 2024). Mapira, D., Gerald, G., & Enerst, M. C. (2017). Factors affecting labour and leisure time decision: Evidence from small and medium enterprises in Masvingo Urban. Journal of Business and Financial Affairs, 6(1). https://www.hilarispublisher.com/open-access/factors-affecting-labour-and-leisure-time-decision-evidence-fr- omsmall-and-medium-enterprises-in-masvingo-urban-2167-0234-1000253.pdf (Retrieved January 9, 2024). Miladinov, G. (2020). Socioeconomic development and life expectancy relationship: Evidence from the EU accession candidate countries. Genus, 76(2). https://genus.springeropen.com/articles/10.1186/s41118-019-0071-0 (Retrieved January 9, 2024). National Treasury. (1998). Fiscal policy and the budget framework. http://www.treasury.gov.za/documents/mtbps/1998/3.pdf (Retrieved January 9, 2024). National Treasury. (2022). Economic outlook. http://www.treasury.gov.za/documents/national%20budget/2022/review/Chapter%202.pdf (Retrieved January 9, 2024). Ouliaris, S. (2020). Econometrics: Making theory count. Finance & Development magazine. https://www.imf.org/external/pubs/ft/fandd/basics/econometric.htm (Retrieved January 9, 2024). Rodrigo, G. C. (2020). Micro and macro: The economic divide. Finance & Development magazine. https://www.imf.org/external/pubs/ft/fandd/basics/bigsmall.htm#:~:text=Little%2Dpicture%20microeconomics%20is %20concerned,that%20economists%20call%20aggregate%20variables (Retrieved January 9, 2024). © Regenesys Business School 3 Rossouw, J., & Joubert, S. J. (2022). South Africa’s fiscal squeeze: Warning signs ignored for too long. The Conversation.com. https://theconversation.com/south-africas-fiscal-squeeze-warning-signs-ignored-for-too-long- 177188 (Retrieved January 9, 2024). Tepper, T. (2022). Monetary policy: How banks regulate the economy. Forbes.com. https://www.forbes.com/advisor/investing/monetary-policy/ (Retrieved January 9, 2024). Usborne, S. (2017, May 13). Just do it: The experience economy and how we turned our backs on ‘stuff’. The Guardian. https://www.theguardian.com/business/2017/may/13/just-do-it-the-experience-economy-and-how-we- turned-our-backs-on-stuff (Retrieved January 9, 2024). Wade, K., & Jennings, M. (n.d.). The impact of climate change on the global economy. Schroders Talking Point. https://mybrand.schroders.com/m/05314293f702fa9c/original/Wade-Climate-Change-Global-Economy.pdf (Retrieved January 9, 2024). Welham, B., Krause, P., & Hedger, E. (2013). Linking PFM dimensions to development priorities. Institute of Development Studies. https://cdn.odi.org/media/documents/8392.pdf (Retrieved January 9, 2024). Winchester, M. S., King, B., & Rishworth, A. (2021), 'It's not enough. Local experiences of social grants, economic precarity, and healthy inequity in Mpumalanga, South Africa. Wellbeing, Space and Society, 2(1), 1. https://www.sciencedirect.com/science/article/pii/S2666558121000178?via%3Dihub (Retrieved January 9, 2024). World Bank. (2012). Public financial management reforms in post-conflict countries: Synthesis Report. https://gsdrc.org/document-library/public-financial-management-reforms-in-post-conflict-countries-synthesis-report/ (Retrieved January 9, 2024). World Economic Forum. (2022). Gloomy and more uncertain. IMF World Economic Outlook. https://www.imf.org/en/Publications/WEO/Issues/2022/07/26/world-economic-outlook-update-july-2022 (Retrieved January 9, 2024). Yared, T. (2021). Conflict dynamics in Ethiopia: 2019–2020. Institute for Security Studies. https://issafrica.s3.amazonaws.com/site/uploads/ear-44.pdf (Retrieved January 9, 2024). Zaointz, O. nd. Multiple linear regression. Read Statistics Using Excel. https://www.real-statistics.com/multiple- regression/ (Retrieved January 9, 2024). © Regenesys Business School 4 2.3 LEGISLATION AND GOVERNMENT PUBLICATIONS National Treasury. (1999). Public Finance Management Act. http://www.treasury.gov.za/legislation/PFMA/ (Retrieved January 9, 2024). National Treasury. (2005). Treasury Regulations for departments, trading entities, constitutional institutions and public entities. http://www.treasury.gov.za/legislation/pfma/regulations/gazette_27388%20showing%20amendments.pdf (Retrieved January 9, 2024). National Treasury. (2011). Financial management and MFMA implementation in Local Government Budgets and Expenditure Review. http://www.treasury.gov.za/publications/igfr/2011/lg/08.%20MFMA%202011%20LGBER%20- %20Final%20-%209%20Sept%202011.pdf (Retrieved January 9, 2024). National Treasury. (2012). Draft treasury regulations (Notice 1005 of 2012). http://www.treasury.gov.za/public%20comments/Draft%20Treasury%20Regulations/Draft%20Treasury%20Regulati ons.pdf (Retrieved January 9, 2024). National Treasury. (2013b). Public Finance Management Act: Amendment to Treasury regulations. http://www.treasury.gov.za/legislation/pfma/regulations/37042_15-11_NationalTreasuryCV01.pdf (Retrieved January 9, 2024). 2.4 MULTIMEDIA All in One. (2016, September 30). Micro economic variables and their functions [Video]. YouTube. https://www.youtube.com/watch?v=pfZXcEVtmz8 (Hint: Watch with subtitles switched on). (Retrieved January 28, 2024). BHP. (2019, November 12). Global economic trends [Video]. YouTube. https://www.youtube.com/watch?v=LdKRw46AqhQ (Retrieved January 9, 2024). Clifford, J., & Hill, A. (2015, August 24). Macroeconomics: Crash course economics # 5 [Video]. YouTube. https://www.youtube.com/watch?v=d8uTB5XorBw (Retrieved January 9, 2024). Clifford, J., & Hill, A. (2015, December 12). Microeconomics: Crash course economics # 18 [Video]. YouTube. https://www.youtube.com/watch?v=3midaQqm7NM (Retrieved January 9, 2024). Dataminingincae. (2015, August 30). Video 1. Introduction to simple linear regression [Video]. YouTube. https://www.youtube.com/watch?v=owI7zxCqNY0 (Retrieved January 9, 2024). EconplusDal. (2017, February 25). Financial markets [Video]. YouTube. https://www.youtube.com/watch?v=b9H6WO4yNvY (Retrieved January 9, 2024). © Regenesys Business School 5 Edumecate. (2020, March 6). Economic influences on business [Video]. YouTube. https://www.youtube.com/watch?v=pC8UZcKKAeQ (Retrieved January 9, 2024). Edumecate. (2020, March 6). Political influences on business [Video]. YouTube. https://www.youtube.com/watch?v=jCzu9avjaaI (Retrieved January 9, 2024) GSDRC. (2015a, July 7). Public financial management – Andrew Lawson: Purpose [Video]. YouTube. https://www.youtube.com/watch?v=VJRzOrx-N38 (Retrieved January 9, 2024). GSDRC. (2015b, July 7). Public financial management – Andrew Lawson: Improving it [Video]. YouTube. https://www.youtube.com/watch?v=rMNYF_EXKfE (Retrieved January 9, 2024). Halliday, S. (2020, April 3). The dictator game [Video] [YouTube]. https://www.youtube.com/watch?v=_SAmPG040ms (Retrieved January 9, 2024). Marr, B. (2021, November 1). The 8 biggest business trends In 2022 [Video]. YouTube. https://www.youtube.com/watch?v=hR82OnxdUsA (Retrieved January 9, 2024). Netflix. (2020, April 17). Explained: The stock market [Video]. YouTube. https://www.youtube.com/watch?v=ZCFkWDdmXG8 (Retrieved January 9, 2024) Trading 212. (2019, October 28). Introduction to the commodity markets [Video]. YouTube. https://www.youtube.com/watch?v=JD8KNwtx61c&t=39s (Retrieved January 9, 2024). Trost, A. (2020, December 2). #21 multiple regression analysis [Video]. YouTube. https://www.youtube.com/watch?v=lCG7VlGL9iY (Retrieved January 9, 2024). © Regenesys Business School 6 3. INTRODUCTION Economics has many facets, schools of thought, theories and models, but can be divided into two broad areas of study: microeconomics and macroeconomics. Our course begins with microeconomics, which deals with markets and the decision-making processes of individuals and economic units from individuals to businesses. We then move to macroeconomics, which deals with aggregate economic quantities such as national output and income. 3.1 LEARNING OUTCOMES On completing this course, you should be able to: Evaluate the effect of macro- and microeconomic policies on the business environment; Explain the effect of global and domestic social-political and economic trends; Use simple econometrics models to understand relationships between economic variables; Discuss and apply public finance concepts, models, and theory; and Appraise the impact of international financial markets on the local economy. The number of notional learning hours set out in the table under each section heading provides guidance on how long to spend studying each section of this course. Set yourself a schedule to ensure that you spend a suitable time on each section, complete the assignment, and give yourself enough time to prepare for the examination. © Regenesys Business School 7 3.2 MACRO- AND MICRO-ECONOMICS Timeframe Minimum of 20 hours Learning outcome Evaluate the effect of macro- and microeconomic policies on the business environment Recommended Parkin, M. (2019). Economics (13th ed.). Pearson International. book Federal Reserve Board. (2017a). What is macroeconomics? https://www.federalreserve.gov/faqs/what-is-macroeconomics.htm (Retrieved January 9, 2024). Haussman, R., Sturznegger, F., Goldstein, P., Muci, F., & Barrios, D. (2022). Working paper: Macroeconomic risks after a decade of microeconomic turbulence: South Africa (2007–2020). UNU Wider. https://www.wider.unu.edu/publication/macroeconomic-risks- after-decade-microeconomic-turbulence (Retrieved January 9, 2024). Mapira, D., Gerald, G., & Enerst, M. C. (2017). Factors affecting labour and leisure time decision: Evidence from small and medium enterprises in Masvingo Urban. Journal of Business and Financial Affairs, 6(1). https://www.hilarispublisher.com/open-access/factors- affecting-labour-and-leisure-time-decision-evidence-fr-omsmall-and-medium-enterprises- in-masvingo-urban-2167-0234-1000253.pdf (Retrieved January 9, 2024). National Treasury. (1998). Fiscal policy and the budget framework. Recommended http://www.treasury.gov.za/documents/mtbps/1998/3.pdf (Retrieved January 9, 2024). articles National Treasury. (2022). Economic outlook. http://www.treasury.gov.za/documents/national%20budget/2022/review/Chapter%202.pdf (Retrieved January 9, 2024). Rodrigo, G. C. (2020). Micro and macro: The economic divide. Finance & Development magazine. https://www.imf.org/external/pubs/ft/fandd/basics/bigsmall.htm#:~:text=Little%2Dpicture%2 0microeconomics%20is%20concerned,that%20economists%20call%20aggregate%20vari ables (Retrieved January 9, 2024). Rossouw, J., & Joubert, S. J. (2022). South Africa’s fiscal squeeze: Warning signs ignored for too long. The Conversation.com. https://theconversation.com/south-africas-fiscal- squeeze-warning-signs-ignored-for-too-long-177188 (Retrieved January 9, 2024). Tepper, T. (2022). Monetary policy: How banks regulate the economy. Forbes.com. https://www.forbes.com/advisor/investing/monetary-policy/ (Retrieved January 9, 2024). Clifford, J., & Hill, A. (2015, August 24). Macroeconomics: Crash course economics # 5 [Video]. YouTube. https://www.youtube.com/watch?v=d8uTB5XorBw (Retrieved January 9, 2024). Clifford, J., & Hill, A. (2015, December 12). Microeconomics: Crash course economics # 18 Recommended [Video]. YouTube. https://www.youtube.com/watch?v=3midaQqm7NM (Retrieved January multimedia 9, 2024). Edumecate. (2020, March 6). Economic influences on business [Video]. YouTube. https://www.youtube.com/watch?v=pC8UZcKKAeQ (Retrieved January 9, 2024). Halliday, S. (2020, April 3). The dictator game [Video] [YouTube]. https://www.youtube.com/watch?v=_SAmPG040ms (Retrieved January 9, 2024). © Regenesys Business School 8 We define macro- and micro-economics, see how these are implemented through various Section overview policies, and assess this implementation’s impact on the business environment. 3.2.1 Introduction to the Study of Economics Economics is a social science concerned with using scientific methods to understand how scare resources are exchanged in a society. The purpose of economics is to understand how an economic system works, assess its strengths and weaknesses and to resolve economic problems. When practiced, economics include various reasoned approached to study economic phenomena with each approach representing a particular economic perspective or ‘school of thought’. The most common way to try and understand and solve economic problems is to develop a simplified (when compared to the complexity of the real world) models or theories. In this course you will gain a better understanding of micro- and macroeconomics, the various models used in econometrics and the role of public finance and government in the economy (Dickinson University, nd; Durham University, 2020). It is important to study economics as it informs decisions through forecasting and using data and modelling. Economic issues influence our daily lives, e.g. interest rates and wealth, inequality and emerging markets. Economics provides answers to the various issues that impact households and wider communities. Companies are heavily reliant on economics to determine their strategies and to ensure their sustainability. By understanding both domestic and international perspectives companies will potentially enhance their chances of success (Durham University, 2020). Economics can be divided into two realms: Macroeconomics looks at the economy as a whole system. It focuses on broad issues such as growth of production, the number of unemployed people, inflation, government deficits, gross domestic product and levels of exports and imports. The object of analysis is usually a nation and how all markets interact to generate big phenomena called aggregate variables. In macroeconomics government is a major object of analysis, for example, to determine the role of government in facilitating economic growth. Macroeconomics often extend to the international sphere as domestic markets are linked to foreign markets through investment, trade and capital flows; while Microeconomics focuses on the actions of individual agents within the economy, like households, workers, and businesses and is concerned with how supply and demand interact in individual markets for goods and services. The object of analysis is usually a single market, e.g. whether process increases in the agricultural industries are driven by supply or demand changes. While not as common, microeconomics can have an international component, as single markets are not confined to single countries, e.g. the global petroleum market. (IMF, 2020) Microeconomics and macroeconomics are not separate subjects but rather complementary perspectives on the overall subject of the economy. In economics, the micro decisions of individual businesses are influenced by whether the macroeconomy is healthy. For example, firms will be more likely to hire workers if the overall economy is growing. In turn, the performance of the macroeconomy ultimately depends on the microeconomic decisions made by individual households and businesses. © Regenesys Business School 9 3.2.2 Macroeconomics “Macroeconomics is a field of economics that takes a wider view and looks at economies on a much larger scale—regional, national, continental, or even global. Macroeconomics has a broad focus, such as the impact of fiscal policy, big picture causes of unemployment or inflation, and how government actions impact nationwide economic growth.” (Rasure, 2021) It is the study of whole economies concerned with large-scale or general economic factors and how they interact in economies. Macroeconomists study questions like “What is productivity growth?; what makes the business cycle fluctuate?; how are prices determined?; and what are the determinants of productivity?” (Federal Reserve Board, 2017) John Maynard Keynes is considered as the founding father of modern macroeconomics. His 1936 book The General Theory of Employment, Interest and Money established macroeconomics as a discipline with its main concern being the instability of aggregate variables. Early economics focused on equilibrium in individual markets, but Keynes introduced the notions of simultaneous consideration of equilibrium in three interrelated sets of markets, namely labour, goods and finance. He introduced disequilibrium economics, which is the study of departures from general equilibrium. Keynes’ approach was adopted by other economists and developed into what is now known as macroeconomics (Rodrigo, 2020). Macroeconomics is concerned with monetary and fiscal policy. These are the actions of central banks to achieve macroeconomic policy objectives like full employment, stable economic growth and price stability. Fiscal policy refers to the spending and tax policies of the relevant government (Federal Reserve Board, 2017). © Regenesys Business School 10 Imagine that you are sitting at an event with a large audience such as a live concert or a basketball game. A few people decide that they want a better view, and so they stand up. When these people stand up, however, they block the view for other people, and the others need to stand up as well if they wish to see. Eventually, nearly everyone is standing up, and as a result, no one can see the performance as well as they could have had they stayed seated. Under classical economist Adam Smith, who postulated that the idea of the ‘invisible hand’ would result in “an end which was no part of his intention... By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. ”” Broadly, it was thought for much of early economics that individuals pursuing their own self-interest would ultimately lead to a market efficient outcome. It was Keynes who countered this in the General Theory of Unemployment, Interest and Money, that “free markets have no self-balancing mechanisms that lead to full employment.”. This references macroeconomic thought, but have similar applicability across macroeconomic and microeconomics. The rational decision of some individuals at the micro level – to stand up for a better view – ended up being self-defeating at the macro level. Macroeconomics is a rather massive subject, which we will study from three different perspectives: Goals: What are the macroeconomic goals? Frameworks: What are the frameworks economists can use to analyse the macroeconomy? Policies: Finally, what are the policy tools governments can use to manage the macroeconomy? Goals In thinking about the overall health of the macroeconomy, it is useful to consider three primary goals: economic growth, employment, and inflation. Economic growth ultimately determines the prevailing standard of living in a country. Economic growth is measured by the percentage change in real (inflation-adjusted) gross domestic product. A growth rate of more than 3% is considered good. Employment, as measured by the unemployment rate, is the percentage of people in the labour force who do not have a job. When people lack jobs, the economy is wasting a precious resource, namely labour, and the result is lower goods and services produced. Unemployment, however, is more than a statistic – it represents people’s livelihoods. While measured unemployment is unlikely to ever be zero. A measured unemployment rate of 5% or less is considered low (good). Inflation is a sustained increase in the overall level of prices and is measured by the consumer price index. If many people face a situation where the prices that they pay for food, shelter, and health care are rising much faster than the wages they receive for their labour, there will be widespread unhappiness as their standard of living declines. For that reason, low inflation—an inflation rate of 1–2%—is a major goal. © Regenesys Business School 11 Economic indicators Gross domestic product (GDP) is used as the primary indicator of macroeconomics, The size of an economy at a specific point in time is represented by the absolute GDP. It is usually calculated and released by the government on either a quarterly or annual basis. GDP = Consumption + Investments + Government Expenditure + (Exports - Imports) Spending stimulates growth and individual consumption drives businesses; business investments promote growth and government spending maintains social welfare. The net exports (exports – imports) measures the impact of trade, thus if next exports are positive it represents a trade surplus which is good for growth while negative net exports represent a trade deficit which is less so. Economic growth can be calculated when GDP is compared over time, for example, in the case of year-over-year increases (Corporate Finance Institute, 2022). Inflation is the increase of overall price levels that decreases purchasing power. It occurs mainly due to an increased demand for products and services that then raises prices. Inflation represents growth, however too much inflation could be harmful as purchasing power decreases more than the inflated process. This leads to a decrease in overall spending and devaluing the currency (Corporate Finance Institute, 2022). Unemployment is those people are without a job but are actively seeking one. Those who are retired or disabled and unable to work are not included. According to the strict definition of unemployment, unemployed persons are those who are not in paid employment or self- employment, are 15 years and older, and are available for paid employment or self-employment during the seven days preceding the interview. It also considers those who took specific steps during the four weeks preceding the interview to find employment or self-employment. The expanded definition of unemployment omits the final requirement that the person should have taken specific steps the during four weeks preceding the interview to find employment or self- employment (Mohr, 2020). Frameworks In microeconomics, we used the theories of supply and demand; in macroeconomics, we use the theories of aggregate demand (AD) and aggregate supply (AS), which are studies from two perspectives on macroeconomics, namely: Neoclassical perspective, ie when “supply comes first, and creates its own demand”; and Keynesian perspective, ie when “demand comes first, and creates its own supply”. In terms of the neoclassical perspective, each time a good or service is produced and sold, it generates income that is earned for someone: a worker, a manager, an owner, or those who are workers, managers, and owners at firms that supply inputs along the chain of production. The forces of supply and demand in individual markets will cause prices to rise and fall. The bottom line remains, however, that every sale represents income to someone, and so a given value of supply must create an equivalent value of demand somewhere else in the economy. If supply always creates exactly enough demand at the macroeconomic level, then it is hard to understand why periods of recession and high unemployment should ever occur. To be sure, even © Regenesys Business School 12 if total supply always creates an equal amount of total demand, the economy could still experience a situation of some firms earning profits while other firms suffer losses. Nevertheless, a recession is not a situation where all business failures are exactly counterbalanced by an offsetting number of successes. A recession is a situation in which the economy as a whole is shrinking in size, business failures outnumber the remaining success stories, and many firms end up suffering losses and laying off workers. However, despite this problem, the neoclassical perspective does seem a good approximation for the long run. Over periods of some years or decades, as the productive power of an economy to supply goods and services increases, total demand in the economy grows at roughly the same pace. However, over shorter time horizons of a few months or even years, recessions or even depressions occur in which firms, as a group, seem to face a lack of demand for their products. The Keynesian perspective is based on the work of John Maynard Keynes, who wrote The General Theory of Employment, Interest, and Money during the Great Depression of the 1930s. He pointed out that, during the Depression, the capacity of the economy to supply goods and services had not changed much. U.S. unemployment rates soared higher than 20% from 1933 to 1935, but the number of possible workers had not increased or decreased much. Factories were closed and shuttered but machinery and equipment had not disappeared. Technologies that had been invented in the 1920s were not forgotten in the 1930s. Thus, Keynes argued that the Great Depression – and many ordinary recessions – were not caused by a drop in the ability of the economy to supply goods as measured by labour, physical capital, or technology. He argued the economy often produced less than its full potential, not because it was technically impossible to produce more with the existing workers and machines, but because a lack of demand in the economy as a whole led to inadequate incentives for firms to produce. In such cases, he argued, the level of GDP in the economy was not primarily determined by the potential of what the economy could supply but rather by the amount of total demand. Keynes’ law seems to apply fairly well in the short run of a few months to a few years when many firms experience either a drop in demand for their output during a recession or an increase in demand resulting in trouble in producing enough during an economic boom. However, demand cannot tell the whole macroeconomic story either. After all, if demand was all that mattered at the macroeconomic level, then the government could make the economy as large as it wanted just by pumping up total demand through a large increase in the government spending component or by legislating large tax cuts to push up the consumption component. Economies do, however, face genuine limits to how much they can produce. Limits are determined by the quantity of labour, physical capital, technology, and the institutional and market structures that bring these factors of production together. These constraints on what an economy can supply at the macroeconomic level do not disappear just because of an increase in demand. As such, any economic approach focused only on the supply side or only on the demand side can be only a partial success. Both supply and demand need to be considered. Furthermore, since the Keynesian perspective applies more accurately in the short run and the neoclassical perspective applies more accurately in the long run, the trade-offs and connections between the three goals of macroeconomics may be different in the short run and the long run. © Regenesys Business School 13 Policy tools National governments have two tools for influencing the macroeconomy: The first is monetary policy, which involves managing the money supply and interest rates; and The second is fiscal policy, which involves changes in government spending or purchases, and taxes. Clifford, J., & Hill, A. (2015, August 24). Macroeconomics: Crash course economics # 5 [Video]. YouTube. https://www.youtube.com/watch?v=d8uTB5XorBw (Retrieved January 9, 2024). Focus on Africa: Nigeria’s Economic Outlook (World Bank, 2021) (a) Although this course is mainly focused on the South African economy, it is also beneficial for you to apply what you have learnt to the rest of the continent. You can read the African Development Bank’s report on “Nigeria’s Economic Outlook, 2021” at https://www.afdb.org/en/countries-west-africa-nigeria/nigeria-economic-outlook and answer the following questions: 1. On a macro-economic level, what are some of the significant issues related to the Nigerian economy? 2. In your view, what are some of the causes of the significant issues in the Nigeria economy? Can almost everything be blamed on the Covid-19 pandemic? 3.2.3 Monetary and Fiscal Policies The organisation responsible for conducting monetary policy and ensuring that a nation’s financial system operates smoothly is called the central (or reserve) bank. Most nations have central banks or currency boards. Some prominent central banks around the world include the European Central Bank, the Bank of Japan, the Bank of England, and the Federal Reserve (or just “the Fed”) in the United States. In India and South Africa, the central bank is known as the South African Reserve Bank, whereas in Nigeria, this is the Central Bank. Central banks are designed to perform these important functions: To conduct monetary policy; To promote stability of the financial system; To provide banking services to commercial banks and other depository institutions; and To deal with risks to financial stability. (IMF, 2022) © Regenesys Business School 14 A key responsibility of central banks is to conduct monetary policy so as to achieve price stability (thus low and stable inflation) and to assist in managing economic fluctuations. The policy frameworks in which central banks operate have undergone major changes in recent decades. Monetary policy is conducted by adjusting the supply of money, most commonly through open market operations. This could occur through, for example, a sale and repurchase agreement where central banks take money from commercial banks. This would steer short-term interest rates that will influence longer-term rates and overall economic activity (IMF, 2022). Monetary policy “Monetary policy is a set of tools that a nation's central bank has available to promote sustainable economic growth by controlling the overall supply of money that is available to the nation's banks, its consumers, and its businesses. The goal is to keep the economy humming along at a rate that is neither too hot nor too cold. The central bank may force up interest rates on borrowing in order to discourage spending or force down interest rates to inspire more borrowing and spending. The main weapon at its disposal is the nation's money. The central bank sets the rates it charges to loan money to the nation's banks. When it raises or lowers its rates, all financial institutions tweak the rates they charge their customers, from big businesses borrowing for major projects to home buyers applying for mortgages.” (Brock, 2022) Monetary policy is how central banks manages money supply to achieve their goals and in South Africa the South African Reserve Bank (SARB) uses interest rates to influence inflation levels. The inflation target is set by National Treasury in consultation with the Reserve Bank and this target acts as a benchmark against which price stability is measured. The Reserve Bank independently makes monetary policy to achieve this set target. The basic aim of monetary policy is to determine how much money an economy should have in circulation. These policies may be different in countries, but most major countries strive to achieve low and stable inflation and have publicly announced inflation targets. To ensure that the value of the rand is protected, the Reserve Bank uses inflation targeting to maintain consumer price inflation between 3% and 6%. This results in the value of the currency being protected relative to domestic consumer prices. Monetary policy is implemented through the establishing of short-term policy rates knowns as the repo rate. This rate affects the borrowing costs of the financial sector, which, in turn, affects the broader economy. The repo rate is so called because banks give the Reserve Bank an asset (such as a government bond) in exchange for cash. They can later repurchase (repo) that asset at a lower price, which reflects the interest they paid (i.e. repo rate) to have the cash (SARB, nd). Inflation targeting was formally introduced in February 2000. This framework in which the central bank uses monetary policy tools, especially the control of short-term interest rates, to keep inflation in line with a specific target. South Africa has an inflation target range of 3%-6% and thus far the inflation-targeting approach adopted by the Reserve Bank has been the most successful (SARB, nd). © Regenesys Business School 15 The 2022 Case of Inflation Local The Reserve Bank announced an interest rate hike of 75 basis points to a repo rate of 6.25% in mid-September 2022. This is the sixth time in a row that the Reserve Bank has raised the interest rate, totalling a 275 basis points raise in the repo rate since November 2021. Bank governor Lesetja Kganyago stated that “a failure to deal with inflation now would be detrimental to the economy down the line. And that is what our focus is". The Reserve Bank highlighted that although they did not alter their predictions for the 2022 economic growth and inflation markedly, it was concerned with risks to the inflation outlook, such as further price shocks form Russia’s war in Ukraine and electricity and wage agreements (Gumbi & Miridzhanian, 2022). In mid-October 2022 it was reported that South Africa’s consumer price inflation had cooled down to 7.5% in September from 7.6% in August 2022. This was slightly better than what economists had expected, but annual food and non-alcoholic beverage inflation had increased from 11.9% in September from 11.3% in August 2022. The price of bread and cereals have increased by 19.3% when compared to the same time in 2021. StatsSA did however note that food prices were slowly cooling down. The prices of sunflower oil decreased by 8% in one month and meat inflation cooled down by 0.2%. However, price inflation that are concerning is that of personal care products, clothing and footwear (News24, 2022). Task 1. Do you think the Reserve Bank did the right thing by raising interest rates repeatedly to try and stay within our inflation targets? Motivate your answer. International On 17 August 2022, Britain’s’ consumer-price index rose by 10.1% in the 12 months to July. This is the highest rate of inflation since the 1980s and is raising concerns that inflation is out of control (The Economist, 2022). Task 2. Do some research and explain why the United Kingdom has its highest inflation in 40 years. Traditional monetary policy follows the principle that the central bank monitors inflation, within a target band. If the central bank deems the inflation rate to be at risk of breaching the target rate in the near future, it may adopt contractionary monetary policy. In this case, the central bank raises the interest rate. This in turn causes commercial banks to raise interest rates on credit it lends to households. This make household credit relatively more expensive, causing households to demand less credit, and results in less money available to spend. Further, the increase in the interest rate raises the return lenders receive results in an increased demand for the rand – this raises the value of the rand and lowers imported inflation. If, however, the central bank lowers the interest rate it charges the commercial banks. adopting expansionary monetary policy, the process works in reverse. The commercial banks can reduce their prime lending rates, which in turn will make credit relatively cheaper for households. Hence, the supply of money will increase and there will be more money circulating in the economy, which has the effect of raising the inflation rate. © Regenesys Business School 16 The central banks tend to decrease their interest rates when inflation begins to approach the lower end of the target band. The target band is designed to keep inflation low and stable. Inflation approaching zero runs the risk of the phenomenon of deflation, where the price of goods decreases over time. This is equally detrimental to an economy, as economic activity decreases as households delay spending in the belief that prices will be lower tomorrow. During the Covid-19 pandemic, the fallout greatly reduced activity in many economies. In response to the Covid-19 pandemic central banks had taken unprecedented policy actions to ease monetary policy globally, to provide ample liquidity to core funding markets and to maintain the flow of credit. Many emerging market central banks used foreign exchange interventions and deployed asset purchases programmes to mitigate stress on currencies and local bond markets (IMF, 2022). Fiscal policy “Fiscal policy refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth. Fiscal policy is often contrasted with monetary policy, which is enacted by central bankers and not elected government officials.” (Hayes, 2022a) The South African government’s fiscal policy aims to support structural reforms of the economy that are consistent with long-run growth, equitable distribution of income, and employment creation. It promotes investment and export expansion while enabling government to finance public services, development, and redistribution in a cost-effective and sustainable budget framework. The South African fiscal policy seeks to: “ ensure a sound and sustainable balance between Government’s spending, tax and borrowing requirements; improve domestic savings to support a higher level of investment and reduce the need to borrow abroad; keep government consumption spending at an affordable level, contributing to lower inflation and a sustainable balance of payments; support an export-friendly trade and industrial strategy to improve South Africa’s competitiveness; ensure that pay increases within the public sector are market related and productivity related, and are fiscally sustainable. (National Treasury, 1998) © Regenesys Business School 17 To meet fiscal policy goals, governments deploy two tools to maximise economic outcomes, namely collecting taxes and spending them. By collecting taxes, the government can drive financial assets to areas where in the economy where they are needed most. These taxes are, for example, gathered through income tax, value-added tax (VAT) and customs duties (each of these will be explained later in this course). When the government collects taxes it has the financial means to establish fiscal policy. Government spending could be on infrastructure, public service remuneration, social grants, defence or public works (O’Connell & Schmidt, 2021). The 2022 case of Inflation A working paper published by the renowned Harvard economist Ricardo Haussman and other researchers noted the current economic crisis that has put South Africa on a path of fiscal unsustainability. In this paper it is clear that South Africa embarked on an unsustainable fiscal trajectory over the past decade, with fiscal pressures such as unsustainable growth in public service remuneration and social grant expenditure being reviewed. This expenditure occurred while economic growth underperformed. According to Haussman et al (2022) and Rossouw and Joubert (2022) South Africa faces a serious fiscal dilemma and hard choices. They pose the question “Who should have listened and who should have cared in the period running up to the current fiscal crisis?” The researchers list these key factors as contributing to our fiscal crisis: The impact of extensive growth in civil service remuneration and social grant expenditure was hidden in unrealistically high annual growth projections used by National Treasury in the annual budget documentation; Expenditure continued to grow unabated while revenue figures kept being lower than expected; The number of social grant recipients increased (especially with the inclusion of the R350 Covid-19 relief grant) placing a heavy burden on an already overstretched fiscus; Public service remuneration increased which impacted government borrowing and its interest burden; and Promises made by politicians and demands by citizens for more expenditure that cannot be accommodated within the budget limitations of the government. (Rossouw & Joubert, 2022; Haussman et al, 2022) Expansionary fiscal policy increases the level of aggregate demand, either through increases in government spending or reductions in taxes (or both). Expansionary fiscal policy can do this by: Increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; Increasing investments in economic activity by raising after-tax profits through cuts in business taxes; and Increasing government purchases through increased spending by government on final goods and services, and/or raising grants and transfers to provincial / state and municipal / local governments to increase their expenditures on final goods and services. © Regenesys Business School 18 Contractionary fiscal policy does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investments, and decreasing government spending, either through cuts in government spending or increases in taxes (or both). Nigeria Economic Outlook (World Bank, 2021) (b) 1. Read the African Development Bank’s report on “Nigeria Economic Outlook, 2021” at https://www.afdb.org/en/countries-west-africa-nigeria/nigeria-economic-outlook 2. If you were the governor of the Central Bank of Nigeria, then what would you see as your most urgent macroeconomic problem? 3. If you were the governor of the Central Bank of Nigeria, then how would you use the macroeconomic policy options available to you to deal with your most urgent macroeconomic problem? 3.2.4 Microeconomics “Microeconomics is the field of economics that looks at the economic behaviours of individuals, households, and companies. Microeconomics is specific and smaller in scale, looking at the behaviour of consumers, the supply and demand equation in individual markets, and the hiring and wage-setting practices of individual companies.” (Rasure, 2022) What determines how households and individuals spend their budgets? What combination of goods and services will best fit their needs and wants, given the budget they have to spend? How do people decide whether to work, and if so, whether to work full-time or part-time? How do people decide how much to save for the future, or whether they should borrow to spend beyond their current means? The answers to all these questions relate to individuals and households, involving various theories of consumer behaviour and theories of the company. Because people live in a world of scarcity, they cannot have all the time, money, possessions, and experiences they wish. Neither can society. So, people must make choices, and behave in ways consistent with their choices. Advanced supply and demand analysis involves a deeper understanding and application of the basic economic principles of supply and demand. It incorporates additional factors and considerations to provide a more nuanced and accurate representation of market dynamics. Consider the typical consumer’s budget problem. Consumers have a limited amount of income to spend on the things they need and want. © Regenesys Business School 19 Suppose Alphonso has $10 in spending money each week that he can allocate between bus tickets for getting to work and the burgers that he eats for lunch. Burgers cost $2 each, and bus tickets are 50 cents each. So, in any given week, Alphonso can buy five burgers or 20 bus tickets, or any combination of these that meets his needs. Economists use the term “opportunity cost” to indicate what must be given up to obtain something that is desired. For Alphonso, the opportunity cost of a burger is the four bus tickets he would have to give up. Since people must choose, they inevitably face trade-offs in which they have to give up things they desire to get other things they desire more. Here are some advanced concepts and aspects related to supply and demand: Elasticity measures the responsiveness of quantity demanded or supplied to changes in price. Understanding elasticity is crucial for predicting how changes in price will impact the overall quantity bought or sold. Elastic goods or services are highly responsive to price changes, while inelastic ones show less responsiveness. § Cross-price elasticity measures how the quantity demanded of one good responds to a change in the price of another good. Positive cross-price elasticity indicates substitutes, while negative cross-price elasticity indicates complements. § Income elasticity measures how the quantity demanded or supplied changes in response to changes in consumer income. It helps categorise goods as normal (positive income elasticity) or inferior (negative income elasticity). Price discrimination involves charging different prices to different customers or groups for the same good or service. Companies may implement price discrimination to maximise profit based on varying levels of demand elasticity among different customer segments. Government policies and regulations affect supply and demand. Price floors, price ceilings, and taxes can all influence market dynamics. In some markets, buyers and sellers may not have access to the same information, leading to information asymmetry. This can affect pricing and market efficiency. Supply and demand also work on a global scale, considering factors such as international trade, tariffs, and geopolitical events that can influence the availability and pricing of goods and services. Technological disruptions include understanding how new technologies can create new markets or disrupt existing ones. Behavioural economics integrates insights from psychology and sociology into supply and demand analysis. This involves understanding how cognitive biases and social factors influence consumer behaviour and market outcomes. Dynamic pricing models consider real-time data, market conditions, and consumer behaviour to optimise prices dynamically. This is common in industries such as e-commerce and transport. © Regenesys Business School 20 Microeconomics seeks to understand the behaviour of individual economic agents, such as individuals and businesses. Economists believe that individuals’ decisions, such as what goods and services to buy, can be analysed as choices made within certain budget constraints. Generally, consumers are trying to get the most for their limited budget. In economic terms they are trying to maximise total utility, or satisfaction, given their budget constraint. An economic explanation for why people make different choices begins with the belief that the choices people make are influenced by economic, as well as non-economic, concerns. As such, people’s choices are influenced by their incomes, by the prices of goods and services they consume, and by factors like where they live. People make choices about what to buy, how much to work, and how much to save, for example, based on the three budget constraints The consumption choice budget constraint; The labour-leisure budget constraint; and The intertemporal budget constraint. The consumption choice budget constraint What happens to the choices people make when there are straightforward financial changes? If your salary was to increase by 10%, what would you choose to do with that extra money? Or if the price of fuel for your vehicle was to go up 10%, would you cut back on the driving you do or on some of your other expenses instead? All of these choices are theoretically possible, depending on your personal preferences. When income rises, the most common reaction is to purchase more goods, although exactly how much more of each good will vary according to personal taste. Conversely, when income falls, the most typical reaction is to purchase less goods. Goods and services are called normal goods when a rise in income leads to a rise in the quantity consumed of that good and a fall in income leads to a fall in quantity consumed. However, depending on people’s preferences, a rise in income could cause consumption of one good to increase while consumption of the other good declines. Goods where demand declines as income rises (or conversely, where the demand rises as income falls) are called inferior goods. The typical response to higher prices of goods or services is that a person chooses to consume less of the product with the higher price. This occurs for two reasons, and both effects can occur simultaneously: The substitution effect occurs when a price changes and consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price; and The income effect is that a higher price means, in effect, the buying power of income has been reduced (even though actual income has not changed), which leads to buying less of the good (when the good is normal). © Regenesys Business School 21 The key is that a change in the price of any one product will not only or primarily affect the good whose price is changed, as the quantity consumed of other goods will also be affected; it is not isolated and does not remain the same. In short, a higher price typically causes reduced consumption of the good in question, but it can affect the consumption of other goods as well. The labour-leisure budget constraint People do not obtain utility (ie satisfaction) just from the products they purchase – they also obtain pleasure from leisure time (leisure time is time not spent at work). As such, people have another choice to make, ie how much time they want to work (which will determine their income) and how much time they wish to spend in leisure pursuits. The labour-leisure decision-making process is not always predictable; there is a range of possible reactions when people receive higher wages – it is not always true that if people are paid higher wages, then they will work a greater quantity of hours. Most workers are on the job 35 to 48 hours per week but significant proportions work more or less than this amount. Workers’ wages and salaries come to about three-quarters of their total compensation; the rest may take the form of benefits such as health insurance (medical aid), vacation pay, pension subsidies, and other benefits. How do workers make decisions about the number of hours to work? The economic logic is precisely the same as in the case of a consumption choice budget constraint but the labels are different on a labour-leisure budget constraint. Simply put, a worker who gets a pay rise can make a range of different choices: Start working more hours and receive even more pay; Keep working the same hours and receive more pay; or Start working fewer hours and continue to receive the same pay as before, etc. Each worker’s personal preferences and priorities will determine which choice they make. And the worker may not even be making their choice consciously – if they say in their own mind “I’d really rather work a little less and have more leisure, even if it means less income,” or “I’d be willing to work more hours to make some extra income,” then gradually move in the direction of their felt preferences over time, each worker will maximise their own utility (satisfaction). In effect, each worker can choose whether to receive the benefits of a wage increase in the form of more income, or more leisure, or some mixture of these two. With this range of possibilities, it would be unwise to assume that any particular worker, or group of workers, will necessarily react to a wage increase by working substantially more hours. Maybe they will; maybe they will not. The one spanner in the works of the labour-leisure relationship is government regulation. Some countries have labour laws, while others do not. Some labour laws in the countries that have them regulate working hours, while others do not. So a typical American works 1,824 hours per year, an average Japanese worker about 1,759 hours per year, and an average German worker about 1,443 © Regenesys Business School 22 hours per year. In other words, an average German works for 381 hours less per annum than an average American, or about 9 weeks less per year. Are German workers lazier than American and Japanese workers? Or do they make a voluntary choice to work less than Americans and Japanese workers? Yes and no – while the classic labour – leisure relationship may explain some of the difference, no explanation would be complete without mentioning the regulations on working hours that apply in many European countries. In general, however, over the longer-term, the supply curve for labour within the same country (ie subject to the same government regulations), tends to be “backward-bending” over the longer term, meaning that professionals who receive higher levels of pay tend to make the choice to work less. FIGURE 1: BACKWARD-BENDING SUPPLY CURVE (Principles of Economics, nd) The backward-bending supply curve for labour does not apply to all workers. It tends to be limited to higher-paid professionals, such as actuaries, doctors, engineers, and the like, as well as business owners. Some surveys show that one of the attractions for a person to take the plunge and start their own business is that, after the long and hard hours in the early days, they know that they will gradually start to work less in the longer-term as their business becomes better established and is run on a day-to-day basis by a competent team of full-time managers. In conclusion, when making a choice along the labour-leisure budget constraint, an individual worker or a household will choose the combination of labour, leisure, and income that provides them with the most utility (satisfaction). The result of a change in wage levels can be workers choosing to work higher hours (within whatever their government regulations allow), the same work hours, or even fewer work hours in some cases. © Regenesys Business School 23 The intertemporal budget constraint The word intertemporal means “over time” and refers to financial choices that people make at different times in their lives, with the understanding that choices made earlier on may influence the range of options available to them later. These time-based choices are easier to understand in the context of someone’s life cycle: In your 20s, you may be concerned about establishing yourself, and might invest your money in education, housing, transport, and starting a family; In your 40s, you may be concerned about enjoying a good life, fine dining, travelling, and sending your children to university; and In your 60s, you may be concerned about your health and your retirement, ie living for another quarter century with no new income. Obviously, your intertemporal financial choices and patterns of spending will differ quite significantly at different stages in your life, and the differences between these choices are often symbolised in the household savings rate. Everybody may want to save (for varying reasons) but it might not occupy the same priority at different stages in your life. Financial saving may focus on a variety of investment choices, such as bank accounts, stocks, bonds, mutual funds, owning a house, or owning gold coins however, these specific differences are not the focus. The focus is on savings in total; that is, how a household determines how much to consume in the present and how much to save. Savings behaviour varies considerably across households. One factor is that households with higher incomes tend to save a larger percentage of their income. This pattern makes intuitive sense; a financially comfortable family has the flexibility in its budget to save 20–25% of income, while a less financially privileged family struggling to keep food on the table will find it harder to put money aside. Another factor that causes personal saving to vary is personal preferences. Some people may prefer to consume more now and let the future look after itself. Others may wish to enjoy a lavish retirement, complete with expensive vacations, or to create a financial legacy that they can pass along to their grandchildren. These savings-related behaviours differ according to value and personalities, and there are savers and spendthrifts among the young, middle-aged, and old, and among those with high-, middle-, and low-income levels. Consciously or unconsciously, people ask themselves questions like these: Would I prefer to consume a little less in the present, save more, and have more future consumption?; or Would I prefer to consume a little more in the present, save less, and have less future consumption? By considering marginal changes toward consumption at difference stages in our lives, we can each make the choice that provides us with the highest level of utility (satisfaction), based on our needs, rates of return, and family values. © Regenesys Business School 24 The choices of households are determined by an interaction between prices, budget constraints, and personal preferences but not even economists believe that people walk around mumbling about their marginal utilities (discretionary money they can spend to achieve satisfaction in their lives) before they walk into a shopping mall, accept a job, or make a deposit in a savings account. However, economists do believe that individuals tend to seek their own satisfaction by deciding to try a little less of one thing and a little more of another. Behavioural economics: An alternative viewpoint As we know, people sometimes make decisions that seem irrational and not in their own best interest. People’s decisions can seem inconsistent from one day to the next and they even deliberately ignore ways to save money or time. The traditional economic models assume rationality, which means that people take all available information and make consistent and informed decisions that are in their best interest. (In fact, economics professors often delight in pointing out so-called “irrational behaviour” each semester to their new students, and present economics as a way to become more rational.) In contrast, a new group of economists, known as behavioural economists, argue that the traditional method leaves out something important: people’s states of mind. For example, one can think differently about money if one is feeling revenge, optimism, or loss. These are not necessarily irrational states of mind but part of a range of emotions that can affect anyone on a given day. Additionally, actions under these conditions are indeed predictable if the underlying environment is better understood. As such, behavioural economics seeks to enrich the understanding of decision-making by integrating the insights of psychology into economics. It does this by investigating how given dollar amounts can mean different things to individuals depending on the situation. This can lead to decisions that appear outwardly inconsistent, or irrational, to the outside observer. The way the mind works, according to this view, may seem inconsistent to traditional economists but is actually far more complex than an unemotional cost-benefit adding machine. A traditional economist would say that if you lost a $10 bill today, and also got an extra $10 in your salary, you should feel perfectly neutral. After all, –$10 + $10 = $0. You are the same financially as you were before. However, behavioural economists have done research that shows many people will feel some negative emotion—anger, frustration, and so forth—after those two things happen. We tend to focus more on the loss than the gain. This is known as loss aversion, where a $1 loss pains us 2.25 times more than a $1 gain helps us, according to the economists Daniel Kahneman and Amos Tversky in a famous 1979 article in the journal Econometrica. This insight has implications for investing, as people tend to “overplay” the stock market by reacting more to losses than to gains. Indeed, this behaviour looks irrational to traditional economists but is consistent once we understand better how the mind works, these economists argue. © Regenesys Business School 25 Traditional economists also assume human beings have complete self-control. But, for instance, people will buy cigarettes by the pack instead of the carton even though the carton saves them money, to keep the levels of temptation, and thus of usage, down. They purchase locks for their refrigerators and overpay on taxes to force themselves to save. In other words, we protect ourselves from our worst temptations but pay a price to do so. This brings to mind game theory. Game theory is a branch of mathematics and economics that analyses strategic interactions among rational decision-makers. It is widely used in various fields, including economics, political science, biology, and, notably, in understanding strategic behaviour in games. Game theory provides a framework for understanding decision-making in strategic situations and has applications in various fields, including economics, political science, and business, where strategic interactions are common. A classic example of game theory, the Prisoner's Dilemma is a scenario in which two suspects are interrogated separately, and the best outcome for both occurs if they both remain silent. In this case, the prosecution lacks enough evidence to secure a conviction, and both suspects would receive a lighter sentence or possibly go free. Despite the mutually beneficial outcome of remaining silent, each suspect has a personal incentive to betray the other. If one suspect remains silent while the other confesses (betrays), the one who confesses may receive a more lenient sentence or even immunity, while the silent suspect might face a harsher punishment. However, each has an incentive to betray the other for personal gain, leading to a suboptimal outcome. If both suspects follow this logic and betray each other, the overall outcome is suboptimal. Both end up with a worse result than if they had both remained silent. One way behavioural economists are responding to this is by setting up ways for people to keep themselves free of these temptations. This includes what are called “nudges” toward more rational behaviour rather than mandatory regulations from government. For example, up to 20% of new employees do not enrol in retirement savings plans immediately, because of procrastination or feeling overwhelmed by the different choices. Some companies are now moving to a new system, where employees are automatically enrolled unless they “opt out.” Almost no-one opts out in this program and employees begin saving at the early years, which are most critical for retirement. Another area that seems illogical is the idea of mental accounting or putting dollars in different mental categories where they take different values. Economists typically consider dollars to be fungible, or having equal value to the individual, regardless of the situation. You might, for instance, think of the $25 you found in the street differently from the $25 you earned from three hours working in a fast-food restaurant. The street money might well be treated as “mad money” with little rational regard to getting the best value. This is in one sense strange, since it is still equivalent to three hours of hard work in the restaurant. Yet the “easy come-easy go” mentality replaces the rational economiser because of the situation, or context, in which the money was attained. In another example of mental accounting that seems inconsistent to a traditional economist, a person could carry a credit card debt of $1,000 that has a 15% yearly interest cost, and simultaneously have a $2,000 savings account that pays only 2% per year. © Regenesys Business School 26 That means she pays $150 a year to the credit card company, while collecting only $40 annually in bank interest, so she loses $130 a year. That doesn’t seem wise. The “rational” decision would be to pay off the debt, since a $1,000 savings account with $0 in debt is the equivalent net worth, and she would now net $20 per year. But curiously, it is not uncommon for people to ignore this advice, since they will treat a loss to their savings account as higher than the benefit of paying off their credit card. The dollars are not being treated as fungible, so it looks irrational to traditional economists. Which view is right, the behavioural economists’ or the traditional view? Both have their advantages, but behavioural economists have at least shed a light on trying to describe and explain behaviour that has historically been dismissed as irrational. If most of us are engaged in some “irrational behaviour,” perhaps there are deeper underlying reasons for this behaviour in the first place. Thus, when making a choice along the intertemporal budget constraint, a household will choose the combination of present consumption, savings, and expected future consumption that provides the most utility (satisfaction). The result of a higher rate of return (or higher interest rates) can be a higher quantity of saving, the same quantity of saving, or a lower quantity of saving, depending on preferences about present and future consumption. Related to our behaviour with money, behavioural economics is now an established branch of economics that seeks to understand and explain the “human” factors that drive what traditional economists see as people’s irrational spending decisions. Take a look at – Clifford, J., & Hill, A. (2015, December 12). Microeconomics: Crash course economics # 18 [Video]. YouTube. https://www.youtube.com/watch?v=3midaQqm7NM (Retrieved January 9, 2024). Nigeria Economic Outlook (World Bank, 2021) (c) Read the African Development Bank’s report on “Nigeria Economic Outlook, 2021” at https://www.afdb.org/en/countries-west-africa-nigeria/nigeria-economic-outlook In the context that: Nigeria’s economy entered a recession in 2020, when the overall real GDP shrank by 3%; and Nigeria’s inflation rose to 12.8%, fuelled by higher food prices, the removal of fuel subsidies, and an increase in electricity tariffs; Then the Central Bank of Nigeria cut the repurchase/repo/interest rate by 100 basis points (1%). Question What can you foresee as some of the ripple effects of making money cheaper? For example, if the interest rates come down by 1%, then X will happen. And if X happens, then this will probably lead to Y happening. And then it’s also likely that Z will happen too. Brainstorm the many possible X – Y – Z results of this drop in interest rates. © Regenesys Business School 27 3.2.5 Microeconomic Policies The study of microeconomics often differs from macroeconomic in several ways. Microeconomic studies the behaviours of the consumer, and attempts to make policy adjusts based on perceived behaviour. This is based on the assumption that people make rational decisions to maximise their utility. Regulating working conditions There are a few ways in which any government’s regulation of working conditions can have microeconomic impacts, for example the regulation of working hours, and the regulation of a minimum wage. Regulating working hours: For example, a government has the power to regulate working hours. But how will different people and households respond to these regulations? And what, if any, impact will such regulation have on macroeconomic issues such as employment levels? It is possible that the fewer hours that workers are allowed to work per week will result in increasing levels of employment and more equitable levels within society. For example, remembering that a typical American works 1,824 hours per year, and an average German worker about 1,443 hours per year, suppose that a company wishes to construct a new factory, which, to produce at an optimum level, will need about 320,000 hours of work per annum. If situated in America, then this factory would possibly generate about 175 “average” jobs for Americans, but if situated in Germany, then the same factory would possibly generate about 220 “average” jobs for Germans. Regulating minimum wage: As another example, a government has the power to set minimum wage levels, and the sectors of the economy in which they apply. Determining tax levels and breaks In addition, a government also has the power to determine the tax levels to be paid and the tax breaks to be enjoyed, by consumers within their jurisdiction. Determining tax levels: Higher tax rates will leave consumers with less disposable income, while lower tax rates will leave consumers with higher levels of disposable income. How will people and companies react to these changes? And what impact might their reactions possibly have on the national economy? Recognising that workers have a range of possible reactions to a change in wages casts some fresh insight on a perennial political debate: the claim that a reduction in income taxes, which would, in effect, allow people to earn more per hour (encouraging people to work more). The leisure-income budget set points out that this connection will not hold true for all workers. Some people, especially part-timers, may react to higher wages by working more. Many will work the same number of hours. Some people, especially those whose incomes are already high, may react to the tax cut by working fewer hours. © Regenesys Business School 28 Of course, cutting taxes may be a good or a bad idea not just because of its impact on work incentives but the specific claim that tax cuts will lead people to work more hours is only likely to hold for specific groups of workers and will depend on how and for whom taxes are cut. Determining tax breaks: Many governments around the world encourage their citizens to invest during their working years to provide for themselves during their retirement, ie the governments try to promote personal saving habits. To achieve this, governments may allow certain tax deductions on citizens’ contributions towards their retirement savings. However, you should by now be a little sceptical about political proposals to encourage higher savings by governments providing savers with a higher rate of return. While it would seem obvious that a rise in interest rates makes it attractive for people to invest more now, expecting to enjoy higher future consumption by having their savings grow better with more interest over time, we know that there is a range of possible outcomes. Impact of microeconomic policies Microeconomics is influenced indirectly by the government, which impacts the possible behaviour of the millions of people, households, and businesses within its national economy through several possible microeconomic-related policies, such as regulating working conditions and determining tax levels and breaks. However, the impact of these policies is determined by the behaviour and choices of consumers, who are influenced by: The consumption choice budget constraint; The labour-leisure budget constraint; and The intertemporal budget constraint. As such, the tables that follow refer to the expected behaviour among consumers, remembering that not all consumers will ever all make the same choices. © Regenesys Business School 29 TABLE 1: REGULATION OF WORKING CONDITIONS Working conditions Economic goals Increase economic growth Decrease unemployment Manage inflation Government’s micro-economic- Regulate maximum working hours Regulate minimum wage related actions Expected impact on individual’s People work less hours per week Employers pay higher salaries behaviour Impact on business environment Unemployment decreases Unemployment increases Impact on national economy Economic activity increases Economic activity decreases Impact on inflation Inflation starts to increase Inflation starts to decrease TABLE 2: REGULATION OF TAX LEVELS AND BREAKS Tax levels and breaks Economic goals Increase economic growth Decrease unemployment Manage inflation Government’s micro-economic- Lower personal income taxes Introduce tax breaks for retirement savings related actions Expected impact on individual’s People spend more according People save more towards their retirement behaviour to their choices Impact on business environment Increases sales Decreases sales in the short-term (people who choose to save more have less disposable income); but Increases sales in the long-term (if you have more money as a pensioner, you will consume more later in your life) Impact on national economy Economic activity increases Economic activity decreases in the short- term but increases in the long-term Impact on inflation Inflation starts to increase Inflation remains constant or may even start to decrease Remember, that these tables above are indicative of one possible expected choice of behaviour by consumers. Since consumers are all in different situations, with different values and priorities, they will never make the same combination of choices in terms of their consumption choices as they may be constrained by their budgets, or their choices in working time versus leisure time, or even their choices over time during the different stages of their lives. © Regenesys Business School 30 Take a look at – Edumecate. (2020, March 6). Economic influences on business [Video]. YouTube. https://www.youtube.com/watch?v=pC8UZcKKAeQ (Retrieved January 9, 2024). 3.2.6 Assessing and Evaluating Impact If the three goals of economic policy in general are to: Increase economic growth; Decrease unemployment; and Manage inflation Then how do we measure and assess or evaluate the impact of economic policy choices? There are two different ways of evaluating policy choices, namely: Ideology-based evaluation – a government can hold fast to a political or economic ideology, and compare the choices it has been making to the requirements of its ideology; or Evidence-based evaluation – a government can measure a variety of economic indicators and learn from its interpretation of these indicators what impact(s) its policy choices are having on its national economy. The results of these two different types of evaluation paradigms can be the polar opposites of each other. Think of a country that is suffering from low economic growth, high levels of unemployment, and inflation that is eroding people’s ability to live a decent life – how might this situation be evaluated? From the ideology-based perspective, a government that is gripped by socialist or communist ideology may regard this as a success, as the policies that have caused these economic problems will quite possibly be orthodox socialist or communist policies that are consistent with the government’s ideology (this position makes more sense from the perspective of behavioural economics). From the evidence-based perspective, a government that can make decisions based on measurements of indicators will note these negative outcomes and change their policy choices as the current ones are producing poor results. The methods of measuring and interpreting economic data for use in the evidence-based decision- making paradigm will be discussed in more detail in Section 6.6 of this study guide, which deals with econometric models. Suffice it to say, there are few governments throughout history that have managed to move successfully from an ideology-based economic view to an evidence-based economic view without the government itself needing to be changed first. © Regenesys Business School 31 One of the few such instances is the modern version of the Chinese Communist Party, whose former leader, Deng Xiaoping, famously said “It doesn't matter whether a cat is black or white, as long as it catches mice.” In its proper context at the time, this meant that as long as long as economic policies wor

BBA3 Econ SG 2024 - PDF Study Guide

Document Details

Tags

Related

Summary

Full Transcript

Upgrade to continue