EKN Class Notes

Lecture 1
Economic indicators

Gdp, ppi, cpi, inflation rate, r, M, exchanges rates, budget deficit, national
debt.

Criteria for judging the performance of the economy.

 Economic growth
 Full employment
 Price stability: Inflation kept around 4,5%. Inflation has a negative
effect on demand. Increase interest rates as effect of high inflation,
in hopes of encouraging saving, investment, increase economic
growth therefore suppressing inflation rate. Inflation must be kept
under control in SA bc of high unemployment rate. 0 Inflation? Look
at supplier side, if a supplier breaks even there is no opportunity for
growth, he cannot buy new technology. Which brings us to Deflation
and Disinflation. Disinflation= Positive, has decreasing rates but still
positive. Deflation= Negative, decreasing rates at a negative, can
be damaging to economy.
 Balance of payments stability
 An equitable distribution of income= Equitable income is fair. Equal
is not fair bc not everyone has the same circumstances, also
demotivates people to be productive and improve skills.

Sources of economic data

 NATIONAL TREASURY
o www.treasury.gov.za
o Budget Review
 DEVELOPMENT BANK
 FINANCIAL PRESS
o Finweek
o Fin24
o Business Day
 INTERNATIONAL DATA
o IMF
 International Financial Statistics
 Government Finance Statistics
 Balance of Payments Statistics
 Direction of Trade Statistics
 WORLD BANK
o World Development Report
 UNITED NATIONS
 o Human Development Report
 THE ECONOMIST

Interpreting economic data

– Torture the data until it confesses? Handle with care – p. 8-9

– Definition
– Period that relates
– Adjustment for inflation?
– How calculated, by whom?
– Levels and rates of change
– Correlation & causation
– International comparisons

Real v Nominal

Percentages v Percentage point

Stocks, flows and ratios.

Averages

Lecture 2: National Accounts

Constituent Accounts (NIPA)

• Account 1: GDP and Expenditure key variable is GDP

• Account 2: National Disposable Inc & Appropriation

• Account 3: Gross Capital formation and Financing

• Account 4: Transactions with ROW

The economic circuit

Talking about 4 econ subjects. They are the decision makers we encounter
on the day-to-day flow. Smallest is Households, they are defined as to a
common source of income. Eg. 1 household under 3 roof or 6 households
under 1 roof. Second, we have Business enterprises which households
provide them with labor, capital, land, and entrepreneur, converted into
goods and services sold on the market. In return remuneration for
households. Dotted is financial flow, Solid is real. Government is 3 rd, which
is Government expenditures and tax. 4th is the ROW. This is a closed
Circuit, and every debt will have a credit.
VERYY IMPORTANT: MEMORISE!!

Account 1: Gross domestic product and expenditure account/

Production account

Supply (Income/Production) First Demand (Expenditure)

– Compensation of – Final Consumption
employees= labor Expenditure by
– Net operating surplus= HOUSEHOLDS (C).
Capital, land, entrepreneur. – Final consumption
– Consumption of fixed cap= expenditure by GENERAL
Provision for depreciation GOVERNMENT (G)=
– Gross value added at Individual: only one can
factor cost= SUM of consume at the specific
everything above. time e.g. social grants +
– Other taxes on Collective: Defense force.
production=taxes on – Gross capital formation
creating G&S, property, (I)= Gross fixed formation
taxes on payroll like UIF and + Change in Inventories
Skills Development. (Inv): WIP and Raw
– (LESS) Other subsidies on materials
production – Residual Item
– Gross value added at – Gross Domestic
basic prices= GV + Taxes Expenditure
- Subsidies – Exports of G&S (X)
– Taxes on products=VAT – (LESS) Imports of G&S (Im)
– (LESS) Subsidies on
 products= per item
Gross domestic product at
market prices= GV + Taxes – Gross Domestic product at
Subsidies market prices

Account 2: National income, disposable income, and its

appropriation

Appropriation Income
 Final consumption  Consumption of employees
expenditure by households  LESS: net payments of
 Final consumption compensation of non-
expenditure by general residents (if not given set as
government 0)
 Total final consumption  National compensation of
expenditure (same as G+C residents
in Acc 1)  Gross operating surplus: net
 Gross saving surplus + consumption of
 Appropriation of fixed capital
disposable income  LESS: net payments of
property income to the ROW
 Gross national operating
surplus
 Gross national income at
factor cost
 PLUS: taxes on production
and imports
 LESS: subsidies on
production and imports
 Gross national income at
market prices
 Net current transfers from
the ROW
 LESS: Residual item
 Gross national disposable
income

Account 3: Gross formation and financing thereof at current

prices

Outlays (What has been done) Saving (Sources of financing)

 Gross fixed capital  Savings: H+B+G
formation  = Net Savings
 Change in inventories-  + Consumption of fixed
positive: increased capital
inventories can be caused by  = Gross savings
slow growth of the economy  Net capital movements from
or a lot of projects that are the rest of the world
 unfinished. Early indicator.  Change in gold and other
 = Gross Capital Formation reserves. Positive: Reserve
holdings have decreased.
Negative: Marked up excess
of reserves. (Can guarantee
that if positive in acc 3 will
be negative in acc 4)
 = Financing of gross
capital formation:
Property, res and non-res,
transport equipment.

Account 4: The balance of payments

Receipts (Net Capital Inflow= neg Payments

receipt)
 Exports of G&S: Trade  Imports of G&S
balance would be a surplus if  Primary factor income
Ex is more than Im. payments: non-working
 Primary factor income abroad, capital, resources
receipts: adding of all  Balance on the current
employees working aboard account: Negative is a
and property inc. deficit.
 Net current transfer receipts  = Current payments to
from the rest of the world: the ROW
Negative receipt/ payment.  Net capital movements to
Can put in brackets. ROW
 = Current receipts from  Change in gold reserves: If
the rest of the world positive in acc 3, will be
 Balance on the currents negative in acc 4
account: Carried over from  = Payments
payments but the sign is
kept the same!!
 = Receipts

Primary income= property inc

Net increase reserve= The balance in the bank increased.

Class Exercise
Account 1

– Compensation of – Final
employees= Consumption
labor 1 825 Expenditure by
– Net operating 975 HOUSEHOLDS
surplus= Capital, (C).
 land, – Final
entrepreneur. consumption 5 039
– Consumption of expenditure by 711
fixed cap= GENERAL
Provision for 1 825 GOVERNMENT
depreciation 975 (G)= Individual:
– Gross value only one can
added at factor consume at the
cost= SUM of 126 125 specific time e.g.
everything social grants +
above. Collective:
– Other taxes on Defense force.
production=taxes – Gross capital
on creating G&S, formation (I)=
property, taxes (9 515) Gross fixed
on payroll like UIF formation +
and Skills Change in -21 957
Development. 1 942 Inventories
– (LESS) Other 585 (Inv): WIP and
subsidies on Raw materials 1 931
production – Residual Item 635
– Gross value 628 389 – Gross (1 550
added at basic Domestic 539)
prices= GV + (14 909) Expenditure
Taxes - Subsidies – Exports of G&S
– Taxes on (X)
products=VAT 2 556 – (LESS) Imports of
– (LESS) Subsidies 065 G&S (Im)
on products= per
item

Gross domestic Gross Domestic

product at market product at market
prices= GV + Taxes – prices
Subsidies

**Change in gold reserve has increased: money was taken out>>

therefore would be a positive for Account 3 and negative for account 4.

**Property income to ROW- P income from ROW= xxxx – Net payments of

compensation to non res= Income to ROW

Lecture notes: Flows-of-funds account.

 Flows-of-funds account
 Row 5/6= negative is a net borrower
 Positive= net lender
Balance of payments:
…a systematic statistical summary or record of all economic transactions
between residents in the reporting country (e.g. South Africa) and the rest
of the world during a particular period (quarter or year).

It includes all transactions by individuals, firms and government agencies

and covers the exchange of physical goods, services, assets, gifts and all
financial claims.

Four main sub-accounts:

(I) Current account (current & inc trans)

– Transactions in goods
– Transactions in services
– Transactions in factor or primary income
– Current(unrequited)transfers.

(II) Capital transfer account

transactions associated with acquisition/disposal of fixed assets.

(iii) Financial account (transactions in assets like shares (stocks),

bonds, fixed property and other fin trans, e.g. loans (liabilities)). This
account only reflects IDENTIFIED capital movements

– Direct investment
– Portfolio investment
– Financial derivatives
– Other investment
– Reserve assets

(iv) Unrecorded transactions (serves to balance the whole account in

practice)
– include transactions on the current ,capital transfer and financial
accounts.

– Left= Inflow
– Right= Outflow

S-84

– The first 4 items: Inflow.

– If value is neg then outflow if positive inflow.
– Merchandise exports= only goods, services excluded.
– Net gold exports, imply net gold imports. SA refines gold for other
countries; therefore, we have gold imports.
– Services receipts: labor services offered abroad.
– Income receipts: Payments for capital, entrepreneurship, and foreign
natural resources.
– Interest payments are under income payments, SA Creditor foreign
country interest will be recorded under income receipts and the
Capital amount is reflected in the financial account.
– Less merchandise imports: The “less” implies negative. It will
decrease therefore is outflow.
– Current transfer: negative- always, because of the net outflow of
money that gets paid.
– Balance on current account is the same as account 4.
– Memo item: Trade balance is- net exports of goods (Merchandise
exports) + net exports of gold minus Imports of goods (merchandise
imports). Account 4 left- Account 4 right= Trade balance.
– **VERY IMPORTANT** Xg&s? / Zg&s? Trade balance (500) + Net
Exports of services (80)= 580……….

Account 4
– Exports of G&S…………. – Imports of g&s
580 (bc its positive)

– Capital account: technically a outflow but recorded as positive

– Financial account: FDI= Foreign Net direct investment vs Portfolio
investment
Net Direct investment: Investment by foreigners in undertakings in
South Africa in which they have individually or collectively in the
case of affiliated organisations or persons at least 10 per cent of the
voting rights. We want this bc its stable, bankable investment. You
can have a say on how it is done. SA gets skills, new technology etc,
better for the long-term.
Portfolio investment: investment by South African residents in
undertakings abroad in which they have individually or collectively
in the case of affiliated organisations or persons at least 10 per cent
of the voting rights. Be volatile.
– Net incurrence of liabilities (DI): Shares that bought by foreigners in
SA (Inflow)
– Net acquisition of financial assets (DI): viewed from buyers’ point of
view, SA’s that bought shares in the company. If you buy more
shares than you liquidated it would be neg, if its positive more
money has come into the country thus, they sold more shares that
they bought.
– Net incurrence of liabilities (PI): Negative, outflow. Foreigners have
sold more shares.
– Assets: purchases that we have made / Liabilities: purchases from
foreigners.
– Leave out financial derivates.
 – Reserve assets: If it increases its neg, decreases are positive. Plug
into account 3 as is.
– Balance of financial account: 4 accounts above combined. If you
add reserve assets + BoFA+ Unrecorded transactions=138330, you
will get a balance that’s closer to the current account. Must have a
surplus on the FA to help with the deficit of the CA.
– NB!! Take the figure of the memo item, include unrecorded
transactions, include + reserve assets+ capital transfers.
– 98 593+ 13 276+236= 112 105 (this is how you calculate the
current acc balance, just add the opposite sign)
– Example: Give the Trade Balance (250) and given the Net
imports (-50) if given minus he substituted the Less… Net export
of G&S?
250-50=200

Acc 4:
Xgs……………..200 IMgs……………….(bracket
value)

Foreign Trade

SA imports capital and intermediate goods and exports primary goods

(mining and agricultural). Our biggest Imports come from China.

Measures of openness

 (X+Z)/ GDP…… Not really an accurate measure.

 AVE [(X/GDP), (Z/GDE)] ……. Imports are incl in GDE, Exports over
GDP in Acc 1. Then you will get the average for openness.
 Marginal import ratio (imports/output) may be relatively high,
indicating a vulnerability to developments in the international
sphere.
 The Open Market Index measures: Observed openness to trade,
trade policy, ………….…., ……...

Terms of Trade

 T= (Px/ Py) x 100 (ratio between imports and export prices)

 Indication of volume/ quantity of imported goods that can be
obtained per unit of goods exported.
 Thus, T increases= overall economic welfare also increases. (You
want your export prices higher than your import prices).

Exchange Rates

 Price in one country’s currency ito another company’s currency

 Exchange rates:
 Bilateral (R/$) Multilateral
 Nominal= approving  Nominal
means Rand is getting  Real
stronger  PPP exchange rates
 Real

 Methods of calculating exchange rates

Direct Indirect
 Most widely used.  Indicates the foreign price
 Indicates how much of a of the domestic currency.
domestic currency can be  Quoted rates nominal and
exchanged for one unit. bilateral.

Depreciation Devaluation
Free floating exchange rate Fixed exchange rate like China.
Exports are cheaper, but imports
are more expensive which causes
locals to buy more locally.

Nominal and Real exchange rates

When moving from nominal to Real you take inflation into consideration.
Real exchange rate is always in Index form (>,< 100). If less than a 100
then still needs appreciation , overvalued, but if more than a h100 then it
is undervalued.

Research assignment

 Have regular meetings.

 Work in teams of 2.
 Start with a template: choose the style, headings, requirements up
to us. The graphs must also have the same theme, no copy and
pasting of graphs.
 Go look at other countries, what they are doing to address the
problem and what policies they have in place.
 Graph of employment.

Supply and Use Tables

 Supply Table is at BASIC PRICES

 Use Table is at MARKET PRICES : includes GVA and Taxes Less subs.

Inflation (Growth and inflation very Important!)

Laspeyres index: The Laspeyres Index is a formula used to measure the
change in the price level of a basket of goods and services over time. It is often
used in economics to calculate inflation or to compare the cost of living between
two periods.

The index is named after German economist Étienne Laspeyres and uses the
quantities of goods and services from a base period, with prices from both the
base period and the current period.

Key Points:

1. Base period weights: It assumes that consumers buy the same quantity
of goods in both the base and current periods, meaning it doesn’t account
for changes in consumption patterns.
2. Overestimation of inflation: Since the quantity of goods is fixed, it can
overestimate inflation, as it doesn't reflect the substitution effect, where
consumers might switch to cheaper alternatives if prices rise.

Paasche index: The Paasche Index is another price index used to measure
changes in the cost of goods and services over time, like the Laspeyres Index,
but with a key difference in how it weights the quantities of goods. The Paasche
Index uses current-period quantities instead of base-period
quantities when comparing price levels.

Named after German economist Hermann Paasche, this index helps to

calculate inflation, cost of living, or overall price changes by comparing the
current prices of goods and services with their prices in a base period, while
accounting for changes in consumption patterns.

Key Points:

1. Current period weights: The Paasche Index reflects the quantities of

goods consumed in the current period, meaning it adjusts for shifts in
 consumer behaviour ;and preferences. This helps account for the
substitution effect, where consumers might switch to cheaper goods as
prices rise.
2. Tends to underestimate inflation: Since it reflects updated
consumption patterns, the Paasche Index can underestimate the true
rise in costs, as it assumes consumers are always making adjustments to
minimize the impact of rising prices by switching to less expensive
options.
3. More realistic in certain cases: By accounting for the changes in
consumption patterns, the Paasche Index might give a more realistic
picture of the current economic conditions, especially when significant
price shifts occur and consumers adjust their behavior.

Comparison with the Laspeyres Index:

 Laspeyres Index: Uses base-period quantities, which means it

assumes that consumers are still buying the same amount of goods as
they did in the past. This can overestimate inflation, as it doesn’t
consider that people will buy less of something if its price goes up.
 Paasche Index: Uses current-period quantities, which means it
adjusts for changing consumption patterns. This can underestimate
inflation because it assumes consumers are perfectly substituting more
expensive goods with cheaper alternatives.

Ideal Use:

Neither index is perfect on its own. The Laspeyres Index tends to overstate
inflation, while the Paasche Index tends to understate it. For this reason, a
combination of the two indices, called the Fisher Index (or Fisher Ideal
Index), is often used to provide a balanced view.

Fisher Index: The Fisher Index, also known as the Fisher Ideal Index, is a
price index that combines both the Laspeyres Index and the Paasche
Index to create a more accurate and balanced measure of price changes over
time. It is named after the American economist Irving Fisher, who developed it
to address the limitations of using either the Laspeyres or Paasche indices
individually.

Why Use the Fisher Index?

 Laspeyres Index tends to overestimate inflation because it uses base-

period quantities, ignoring the fact that consumers might adjust their
buying behaviour when prices change.
 Paasche Index tends to underestimate inflation because it uses
current-period quantities, assuming that consumers have already adjusted
their behaviour to minimize the impact of price changes.

The Fisher Index is calculated as the geometric mean of these two indices,
striking a balance between the two extremes, and providing a more neutral and
accurate picture of price changes.
Key Features:

1. Geometric mean of Laspeyres and Paasche: By taking the geometric

mean of both indices, the Fisher Index eliminates the upward bias of the
Laspeyres Index and the downward bias of the Paasche Index. This
provides a middle ground, offering a better reflection of the true change in
prices.
2. More accurate measure of inflation: Because it balances the
assumptions about consumer behaviour inherent in both indices (fixed
consumption vs. changing consumption), the Fisher Index is often
considered a more accurate measure of inflation or price change than
either index alone.
3. Balanced approach to price measurement: It captures both the fact
that people adjust their consumption when prices change and the fact that
this adjustment is not always perfect or immediate. As a result, it avoids
the extremes of over- or under-estimating inflation.

5 steps are also important!

1. Baskets
2. Base period
3. Weights (L, P or F)
4. Collection of datall
5. Calculation

Look at table 2 of pg 9 of the publication