STUDY UNIT 1 INTRODUCTION

Transcription

1 STUDY UNIT 1 INTRODUCTION LEARNING OUTCOMES: i. Have a general ntin f what ecnmic indicatrs are all abut ii. Knw the main criteria fr assessing the perfrmance f the ecnmy iii. Be aware f sme f the main surce f ecnmic data iv. Be aware f sme f the pitfalls in manipulating and interpreting ecnmic data 1.1. ECONOMIC INDICATORS LO1: Have a general ntin f what ecnmic indicatrs are all abut Ecnmic Indicatr It refers t a statistic (data) that shws the behaviur f an ecnmic variable, usually ver time. Sme f the examples f ecnmic indicatrs include: Real Grss Dmestic Prduct (GDP) Emplyment Exchange Rates Mney Supply Balance f Payment (BOP) Cnsumer Price Index (CPI) Prducer Price Index (PPI) Ecnmic indicatrs are als the key statistics f the ecnmy that reveal the directin the ecnmy is heading. REASONS FOR MONITORING INDICATORS: Asses general perfrmance f the ecnmy Effectiveness f ecnmic plicy Make ecnmic frecasts Cmpare ecnmic plicies between cuntries. Speculatrs mnitr t decide whether t buy r sell scks. T expand business and explre new markets

2 1.2 ASSESSING CRITERIA FOR ASSESSING THE PERFORMANCE OF THE ECONOMY LO2: Knw the main criteria fr assessing the perfrmance f the ecnmy MAIN CRITERIA FOR CRITERIA FOR ASSESSING THE PERFORMANCE OF THE ECONOMY a) Ecnmic Grwth Hw des ne measure perfrmance f the ecnmy in relatin t the grwth target REAL GDP is used t measure the ecnmic grwth It refers t an inflatin-adjusted measure that reflects the value f all gds and services prduced in a given year, express in base-year prices. Als knwn as GDP at cnstant price b) Price Stability Inflatin shuld be kept as lw as pssible Cnsumer Price Index used t measure inflatin It is an index f the prices f a representative basket f cnsumer gds and services In SA, the SARB uses cnsumer price index excluding mrtgage csts (CPIX) t measure inflatin. c) Full Emplyment Hw is the emplyment perfrmance f the ecnmy measured The aim f prviding everyne wh is willing t wrk at the current wage rate with a jb. Cmbating f unemplyment Creating jbs and reducing unemplyment level in a cuntry d) Balance f Payment (BOP) Stability A statement that summarizes an ecnmy s transactins with the rest f the wrld fr a specified time perid. e) Equitable distributin f incme and wealth A fair share f the natinal 'cake' ie wealth, mre equitable than wuld be in the case f an entirely free market. Hw is incme distributed amngst individuals r husehlds? 1.3 SOURCES OF ECONOMIC DATA LO3: Be aware f sme f the main surce f ecnmic data

3 SOME OF THE MAIN SOURCE OF ECONOMIC DATA Statistics Suth Africa SARB Newspapers and financial magazines Wrld Bank data Quantec data IMF data 1.4 MANIPULATING AND INTERPRETING ECONOMIC DATA LO4: Be aware f sme f the pitfalls in manipulating and interpreting ecnmic data INTERPRETING ECONOMIC DATA Interpreting data requires an understanding f the data, knwledge f which data t use and an awareness f the limitatins f the data. Belw are Sme Basic hints when ecnmic data is being interpreted: The definitins the indicatrs shuld always be checked carefully Determine the perid t which the data relates. Always make sure data is seasnally adjusted. Ascertain the gegraphic cverage f the data. Check if the data has been adjusted fr inflatin. Check data surce wh prduced the data, gvernment r private cmpany. Check whether the data will be revised r if still needs t be revised. Fr bservatins ver time, it may be useful t plt the data n a graph. Determine what ther yard sticks will aid interpretatin. Bear in mind that crrelatin des nt result in causatin. 1.5 SOME BASIC CONCEPTS AND TECHNIQUES. Real and Nminal Values Nminal Value: Are calculated using prices f the current year (including inflatin in prices) Als knwn as current value since they are cnstructed using prices that are current Nminal value = PQ Real Values:

4 Are calculated using ther (ld) prices (nes that d nt have inflatin) Als knwn as cnstant values, since they are cnstructed treating prices as cnstant ver time. Real value = PQ/ P = Q Vlume, Price and Value Value (PQ) = price (P) x quantity (Q) Or Vlume (Q) = value (PQ) / price (Q) Percentages Changes The percentage difference between tw numbers is calculated by expressing the abslute difference between the tw numbers as a ratin f the riginal number. Increase frm 20 t 25 Slutin: (25-20)/ = 25% Basis Pints It is a term mainly used in the financial markets. A Basis Pint is ne hundredth f a Percentage Pints: e.g 1 Basis pints = 0.01 Percentage Pints therefre 100 Basic pints = 1 percentage Pint Levels and Rates f Change There is a tendency t cnfuse levels with rates f change when interpreting ecnmic data. i.e. a high level shuld nt be cnfused with a high rate f change. Stcks and Flws Stcks A stck tells us abut the fixed amunt f an ecnmic variable at a particular pint in time. Is measured at a specific pint in time e.g number f peple emplyed at given time Stcks Capital stck, mney stck, saving balance and wealth f an individual. Flws These are mvements f ecnmic variables such as prductin, incme, spending etc Ecnmist measure flws ver a perid f time, irrespective f hw shrt.

5 Averages A single number which expresses the central r representative value f the data Measure f central tendency Simple average r arithmetic mean Is the sum f values divided by the number f values Weighted Averages Calculated when the different bservatins are nt equally imprtant. This is imprtant when price indices and ther indices are cmpiled. Mving Averages Used t smth erratic mvements in time series t btain a general trend. The mving average fr a specific perid is the average r previus, current and future values, with the current value as the centre number f values used t calculate the averages. Disadvantage is mving averages are slw t respnd t genuine change in ecnmic directin. The Median The value f the middle item when items are arranged in an increasing r decreasing rder f magnitude.

6 STUDY UNIT 2 TOTAL PRODUCTION, INCOME AND EXPENDITURE: THE NATIONAL ACCOUNTS LEARNING OUTCOMES: i. Explain what the natinal incme and prduct accunts are all abut ii. Use examples t explain the difference between identities and equatins iii. Explain why ttal prductin, ttal incme and expenditure n ttal prduct are all equal in the natinal accunts iv. Define grss dmestic prduct (GDP) and explain the significance f each cmpnent f the definitin v. Distinguish between final gds and intermediate gds vi. Define grss gegraphic prduct (GGP) vii. Use the prductin, incme and expenditure methds t calculate the cntributin t GDP f a specific set f transactins viii. Define and discuss the main cmpnents f expenditure n GDP ix. Be aware f the differences between valuatin at factr cst, basic prices and market prices x. Explain the difference between nminal GDP and real GDP xi. Discuss sme prblems assciated with GDP xii. Explain the difference between GDP and GNI (grss natinal incme) xiii. Explain the difference between expenditure n GDP and grss dmestic expenditure (GDE) xiv. Explain the significance f the difference between GDE and GDP explain the main saving cncepts xv. Use the SARB Quarterly Bulletin t btain data n all the natinal accunting cncepts explained in this chapter 2.0 NATIONAL INCOME AND PRODUCT ACCOUNTS (NIPA) LO1: Explain what the natinal incme and prduct accunts are all abut The Natinal Incme and Prduct Accunts (NIPAs) display the value and cmpsitin f natinal utput and the distributins f incmes generated in its prductin It is als the fficial gvernment system f cllecting, prcessing, and reprting assrted prductin and incme measures used t track aggregate activity in the macr-ecnmy

7 2.2 IDENTITIES AND EQUATIONS LO2: Use examples t explain the difference between identities and equatins IDENTITIES AND EQUATIONS There are tw types f equality: namely identical equality (r identity) and a cnditinal equality (r equatin). The difference between an identity and an equatin is that any value (s) f the unknwn variable (s) will satisfy an identity while an equatin is satisfied by a unique value r set f values. An equatin cntains unknwn quantities e.g 4x + 1 = 11 while an identity is smething that is always true fr any values f the variables that are invlved; e.g 2(x + y) 2x + 2y 2.3 TOTAL PRODUCTION, TOTAL INCOME AND EXPENDITURE LO3: Explain why ttal prductin, ttal incme and expenditure n ttal prduct are all equal in the natinal accunts Expenditure n prducts (Prductin) gives rise t incme which gives rise t spending. Fr the ecnmy at large the value f ttal prduct always equals the value f ttal incme. Prduct = Incme = Expenditure n Prduct. 2.4 GROSS DOMESTIC PRODUCT (GDP) LO4: Define grss dmestic prduct (GDP) and explain the significance f each cmpnent f the definitin GDP Refers t the ttal value f all final gds and services prduced within the gegraphic bundaries f a cuntry in a particular perid (usually ne year) Significance f Each Cmpnent f the Definitin i. Value Using the price f gds and services the natinal accuntants can btain a value f prductin. ii. Final - Used t avid duble cunting, nly final gds and services are taken int accunt

8 iii. Within the gegraphical bundaries f the cuntry i.e. all prductin within the gegraphic area f the cuntry e.g Suth Africa. iv. During a particular perid v. Grss - indicates that n prvisin has been made fr cnsumptin f fixed capital (depreciatin) 2.5 FINAL GOODS AND INTERMEDIATE GOODS LO5: Distinguish between final gds and intermediate gds Final Gds Refers t thse gds which are used either fr cnsumptin r fr investment Final gds are neither resld nr used fr any further transfrmatin in the prcess f prductin. Final Gds include: Gds purchased by cnsumer husehlds as they are meant fr final cnsumptin (like bread purchased by husehlds). Gds purchased by firms fr capital frmatin r investment (like machinery purchased by a firm) Intermediate Gds Gds that are purchased t be resld r used as inputs in prducing ther gds Intermediate Gds include: Gds purchased fr resale (like milk purchased by a Dairy Shp). Gds used fr further prductin (like milk used fr making sweets). 2.6 GROSS GEOGRAPHIC PRODUCT (GGP) LO6: Define grss gegraphic prduct (GGP) Prvides a measure f the ttal and sectral ecnmic activity happening n an annual basis within the lcal municipalities f Suth Africa. It reflects the market value in Rands f all final gds and services prduced and sld within a lcal municipality. 2.7 METHODS TO CALCULATE GDP LO7: Use the prductin, incme and expenditure methds t calculate the cntributin t GDP f a specific set f transactins

9 METHODS TO CALCULATE GDP i. Expenditure methd Is the sum f all final expenditures n gds and services within an ecnmy ii. Incme methd Is the sum f the incmes earned thrugh the prductin f gds and services iii. Prductin methd r Output Apprach Calculated as the value added during each rund f manufacturing. Calculated by summing the value f sales f gds and adjusting (subtracting) fr the purchase f intermediate gds t prduce the gds sld Prductin Methd: Prductin takes place in the primary, secndary and tertiary sectrs Hwever, we cannt merely add up all the market values f all utputs f participants because such a calculatin wuld amunt t duble cunting. By subtracting intermediate gds frm final gds we find the value that was added by each sectr Incme Methd: GDP adds tgether the incme earned y the wners f the factrs f prductin

10 Cmpensatin f emplyees (1) cnsists mainly f grss salaries and wages Net perating surplus (2) includes mainly the ttal value f gds and services that are prduced less cst. Cst has 3 elements: Cst f intermediate gds and services Cst f remuneratin f emplyees Cst f the cnsumptin f fixed capital The net perating surpluses shw prfits and surpluses befre taxatin Expenditure Methd GDP = C + G + I + (X Z) 2.8 MAIN COMPONENTS OF EXPENDITURE ON GDP LO7: Define and discuss the main cmpnents f expenditure n GDP Expenditure Methd GDP = C + G + I + (X Z) C (Cnsumptin) is nrmally the largest GDP cmpnent in the ecnmy, cnsisting f private (husehld final cnsumptin expenditure n services, nndurable gds, and durable gds) in the ecnmy. G (Gvernment spending) is the sum f gvernment expenditures n final gds and services. It includes salaries f public servants, purchase f weapns fr the military, and any investment expenditure by a gvernment. I (Capital frmatin thus Investment) include, fr instance, business investment in equipment, but des nt include exchanges f existing assets. Grss capital frmatin divided int Grss fixed capital frmatin and Change in inventries.

11 Capital frmatin refers t additins in the cuntry s capital stck. N prvisin is made fr cnsumptin (depreciatin) and fixed capital frmatin refers t purchase f capital gds. Change in Inventries - reflect gds prduced that have nt been sld. Residual Item is a statistical discrepancy which arises frm different appraches used t estimate GDP. X (Exprts) Expenditure n exprts M (Imprts) expenditure n imprts 2.9 VALUATION AT FACTOR COST, BASIC PRICES AND MARKET PRICES LO9: Be aware f the differences between valuatin at factr cst, basic prices and market prices There three sets f prices that can be used t calculate GDP market prices basic prices factr cst (r factr incme) Relatinship between factr cst, basic prices and market prices: GDP at basic prices = GDP at factr csts + ther taxes n prductin subsidies n prductin GDP at basic prices = GDP at market prices taxes n prducts + subsidies n prducts GDP at market prices = GDP at basic prices + taxes n prducts - ther subsidies n prducts GDP at factr csts = GDP at basic prices ther taxes n prductin + ther subsidies n prductin NOMINAL GDP AND REAL GDP LO10: Explain the difference between nminal GDP and real GDP REAL GDP It refers t an inflatin-adjusted measure that reflects the value f all gds and services prduced in a given year, express in base-year prices. Als knwn as GDP at cnstant price

12 NOMINAL GDP A GDP figure that has nt been adjusted fr inflatin. Als knwn as GDP at current price 2.11 PROBLEMS ASSOCIATED WITH GDP LO11: Discuss sme prblems assciated with GDP Prblems Assciated With GDP Nn-market prductin Gds and services nt sld in the market such as gds and services prduced by gvernment, farmer s cnsumptin, DIY wrk and vlunteer wrk. Unrecrded activity These refer t smuggling, drug trafficking, prstitutin, hawking, flea market trading etc. If unrecrded activity remains the same changes in GDP will reflect in the aggregate level f ecnmic activity. Data revisins Unavidable revisin f certain data after they were riginally published. GDP as a measure f wellbeing r welfare A larger physical flw f gd f services des nt necessarily increase wellbeing f residents. Unwanted by prducts f prductin such as pllutin, cngestin, nise and stress are nt measured. Distributin f incme Natinal accunting data say nthing abut the distributin f ttal incme within the cuntry DIFFERENCE BETWEEN GDP AND GNI LO12: Explain the difference between GDP and GNI (grss natinal incme) GDP represents dmestic thus the value prduced within a cuntry s brders, whereas the Grss natinal Incme is the value prduced by all the citizens. GDP is a measure f a cuntry s verall ecnmic utput while GNI is the ttal value that is prduced within a cuntry, which cmprises f the Grss Dmestic Prduct alng with the incme btained frm ther cuntries (dividends, interests). GDP helps t shw the strength f a cuntry s lcal incme whilst GNI helps t shw the ecnmic strength f the citizens f a cuntry.

13 In nutshell: GNI is the ttal dmestic and freign utput claimed by residents f a cuntry, cnsisting f grss dmestic prduct (GDP) plus factr incmes earned by freign residents, minus incme earned in the dmestic ecnmy by nn-residents GNI = GDP + primary incme receipts primary incme payments Natinal Incme and Prductin Accunts Ntice the relatinships between the varius cmpnents f the table. R Millins Cmpensatin f emplyees Net perating surplus Cnsumptin f fixed capital Grss value added at factr cst Plus: Other taxes n prductin Less: Other subsidies n prductin Grss value added at basic prducts Plus: Taxes n prductin Less: Other subsidies n prductin Grss dmestic prduct at market prices Final cnsumptin expenditure by husehlds Final cnsumptin expenditure by general gvernment Grss fixed capital frmatin Residual item -921 Grss dmestic expenditure (GDE) Plus: Exprt f gds and services (X) Less: imprt f gds and services (Z) Expenditure n grss dmestic prduct (GDP at market prices) Plus: primary incme frm the rest f the wrld Less: primary incme t the rest f the wrld Grss natinal incme at market prices (GNI) Plus: Current transfers frm the rest f the wrld Less: Current transfers t the rest f the wrld Grss natinal dispsable incme at market prices

14 2.13 EXPENDITURE ON GDP AND GROSS DOMESTIC EXPENDITURE (GDE) LO13: Explain the difference between expenditure n GDP and grss dmestic expenditure (GDE) GDP = C + I + G + X M whilst GDE = C + I + G GDE indicates the ttal value f spending riginating within the brders f a cuntry GDP includes freign sectr thus exprts and imprts whilst GDE des nt freign sectr thus exprts and imprts 2.14 SIGNIFICANCE OF THE DIFFERENCE BETWEEN GDE AND GDP LO14: Explain the significance f the difference between GDE and GDP explain the main saving cncepts The difference between GDP and GDE is reflected in the difference between exprts and imprts. If GDP > GDE, it fllws that exprts are greater than imprts. GDE > GDP means M>X, this means the value f prductin in the dmestic ecnmy exceeds the value f spending within the cuntry. SAVING Refers t the amunt left ver when the cst f a persn's cnsumer expenditure is subtracted frm the amunt f dispsable incme that he r she earns in a given perid f time Refers t the difference between incme and expenditure. Grss saving cnsists f: savings by husehlds, cmpanies, general gvernment and cnsumptin n fixed capital. Net saving = grss saving less cnsumptin n fixed capital Crprate Net Saving = Ttal current incme less expenditure r business enterprises Private saving = Sum f saving by husehlds and cmpanies. Gvernment saving (Net) = current incme f gvernment less current expenditure Cnsumptin f fixed capital is the amunt set aside t replace capital equipment used up in the prductin prcess. Cntractual saving refers t the act f saving against agreed cntracts Discretinary saving is all current dispsable incme that is nt spent r saved cntractually.

15 STUDY UNIT 3 ECONOMIC GROWTH LEARNING OUTCOMES: i. Explain the difference in grwth rates btained by using real GDP and real GNI respectively ii. Explain why it is necessary t cnvert nminal data t real data and t adjust aggregate data fr ppulatin changes befre ecnmic grwth is calculated iii. Explain why ecnmic grwth shuld in principle be calculated ver a perid f several years iv. Explain the advantages f using a lgarithmic scale (ie a semi-lgarithmic graph) rather than arithmetic scales t represent ecnmic grwth graphically v. Use data frm the SARB Quarterly Bulletin t analyse ecnmic grwth frm the expenditure side and the prductin side 3.0 ECONOMIC GROWTH 3.1 GROWTH RATES: REAL GDP AND REAL GNI RESPECTIVELY LO1: Explain the difference in grwth rates btained by using real GDP and real GNI respectively DIFFERENCE IN GROWTH RATES OBTAINED BY USING REAL GDP AND REAL GNI GDP = C + I + G + X M GNI = GDP + primary incme receipts primary incme payments NB*** T See the difference in terms f figures - Check the Table Titled: Ntice the relatinships between the varius cmpnents f the table. 3.2 REASON FOR CONVERTING NOMINAL DATA TO REAL DATA LO2: Explain why it is necessary t cnvert nminal data t real data and t adjust aggregate data fr ppulatin changes befre ecnmic grwth is calculated NOMINAL GDP - GDP at current price whilst REAL GDP - GDP at cnstant price Why Adjust Fr Inflatin

16 Fr cmparisn purpses if ne has t cmpare GDP fr tw perids measured n a nminal basis (current price Rands), ne wuld expect GDP t increase ver time simply by virtue f the general increase in the price level f gds and services. Thus large prtin f this increase in nminal GDP reflects inflatin rather than an increase in real utput Hwever, what ecnmist, plicymakers etc really interested in finding ut is hw ecnmic activity is prgressing ver time. Therefre stripping ut the effect f inflatin frm current price Rand GDP estimates t prduce real estimates gets abut perfrmance f the ecnmy 3.3 ECONOMIC GROWTH CALCULATED OVER A PERIOD LO3: Explain why ecnmic grwth shuld in principle be calculated ver a perid f several years Year-ver-year measures statistical changes frm ne perid, usually a mnth r a quarter, against the same perid last year. The year-ver-year grwth rate is a percentage calculatin that tells yu hw much the quantity measured has increased r decreased ver the past twelve mnths. Year-ver-year is usually a mre effective way f lking at perfrmance than mnth-tmnth, r quarter-t-quarter. It is annualized s it can be cmpared t the previus year 3.4 ADVANTAGES OF USING A LOGARITHMIC SCALE RATHER THAN ARITHMETIC SCALE LO4: Explain the advantages f using a lgarithmic scale (ie a semi-lgarithmic graph) rather than arithmetic scales t represent ecnmic grwth graphically Semi-lgarithmic graph helps t avid the illusin f increased variability and identify pssible structural breaks in a grwth trend. One f disadvantage f Arithmetic scale is that it wrks fine when the data range is small, but will distrt the picture when the range is big

17 Semi-lgarithmic graphs, immense help while pltting lng-term charts and when the price pints shw significant vlatility even while pltting shrt-term charts. Semi-lgarithmic graph make sure that the percentage increase between tw data values is depicted clearly (n pssibility f distrtin) An example illustrating the difference between the tw: On a nrmal graph (arithmetic scale), the vertical distance n the axis between and is the same distance between and , representing a change Thus a particular distance between tw pints represents the same abslute difference in value, n matter where thse tw pints are n the axis On a lgarithmic axis, the distance between and will be equal t the distance between and because in bth cases a mve frm the lwer t the higher value is a 25% change. ie a particular distance n the axis represents the same % change. (Yu can check this fr yurself n graphs) 3.5 SARB QUARTERLY BULLETIN TO ANALYSE ECONOMIC GROWTH LO5: Use data frm the SARB Quarterly Bulletin t analyse ecnmic grwth frm the expenditure side and the prductin side It acts as a secndary data surce. Data fr variables such as ecnmic grwth (Real GDP), cnsumptin spending, gvernment spending, investment, etc can be btained frm there. Peple such as plicymakers, ecnmists will be able t analyse the data thrugh running regressins and frecast the future perfrmance f ecnmy r ecnmic grwth.

18 STUDY UNIT 4 BUSINESS CYCLE LEARNING OUTCOMES: i. Define the business cycle ii. Distinguish between the reference cycle and specific cycle iii. Distinguish between time-series data and crss-sectin data iv. Describe the fur types f variatin in a time series v. Explain what seasnal adjustment is all abut vi. Define and explain the use f leading, cincident and lagging indicatrs vii. Describe varius appraches t frecasting ecnmic activity 4.0 BUSINESS CYCLE 4.1 BUSINESS CYCLE LO1: Define the business cycle Refer t successive perids f increasing (expansin/upswing) r decreasing (cntractin/dwnswing) ecnmic activities. Als knwn as successive perids f ecnmic fluctuatins Related t changes in business cnditins One cycle usually last ne year and has fur elements: trugh, upswing (expansin), peak and dwnswing (cntractin). TYPICAL BUSINESS CYLCE 0 Time (Years)

19 UPSWING (EXPANSION) It cnsists tw phases namely: recvery and prsperity (bm). Sme f the things experienced at upswing (expansin) are as fllwing: level f ecnmic activity increases; mre gds and services are being prduced interest rates decreases; inflatin rates increases husehld expenditure increases PEAK The ecnmy is using mst f its resurces such as skilled labur and capital turning pint at the end f the upswing (expansin) perid there is an upward pressure n prices and the balance n the current accunt wrsens as a results f higher imprts DOWNSWING (CONTRACTION) It cnsists tw phases namely: recessin and depressin. Sme f the things experienced at dwnswing (cntractin) are as fllwing: level f ecnmic activity decreases; less gds and serves are being prduced interest rates increase; inflatin decreases spending declines TROUGH turning pint at the end f the dwnswing (cntractin) perid the pint at which the level f unemplyment will be at its highest 4.2 REFERENCE CYCLE AND SPECIFIC CYCLE LO2: Distinguish between the reference cycle and specific cycle REFERENCE CYCLE refers t a full cycle in aggregate ecnmy activity In this case that is when peple want t knw whether the ecnmy is in an expansinary r in a recessin In shrt they are inquiring int the psitin f the ecnmy in terms f the reference cycle. SPECIFIC CYCLE Refers t a full cycle exhibited by such an individual time series. A reference cycle is actually an average f a large number f specific cycles.

20 4.3 TIME-SERIES DATA AND CROSS-SECTION DATA LO3: Distinguish between time-series data and crss-sectin data TIME SERIES Is a set f bservatins cllected at usually discrete and equally spaced time intervals (weekly, mnthly, quarterly, annually). Fr example the daily clsing values f Dw Jnes Index CROSS-SECTION DATA Are set f bservatins that are cming frm different individuals r grup at a single pint in time Fr example, clsing prices f a grup f 20 different tech stcks n 3 December 1997 BETWEEN TIME-SERIES DATA AND CROSS-SECTION DATA The majr difference between the tw is that: Time series data are cllected at regular intervals ver time r rdered accrding t time whilst crss sectinal data are fr a single pint in time r particular perid and rdered t criteria (such as gender, educatin level etc)ther time. PANEL DATA Is a crss-sectin r grup f peple, firms etc that are bserved peridically 4.4 VARIATION IN A TIME SERIES LO4: Describe the fur types f variatin in a time series TIME SERIES CAN EXHIBIT FOUR TYPES OF VARIATIONS: Trend (T) is the lng term pattern r mvement f a time series Cyclic Variatins r Cycles (C) are nn-peridic recurring fluctuatins arund lng-run trend which are usually assciated with business cycles. Seasnal Variatins (S) ccur within a year and are variatins in the level f the variable which ccur frm year t year eg hlidays, tax deadline, weather cnditins etc Randm r Irregular Variatins are the erratic and unpredictable variatins in time series data as a result f unpredictable disturbances. 4.5 SEASONAL ADJUSTMENT LO5: Explain what seasnal adjustment is all abut

21 SEASONAL ADJUSTMENT Is the prcess f estimating and remving seasnal effects frm a time series in rder t better reveal certain nn-seasnal features By remving the repeated impact f these effects, seasnally adjusted data highlight the underlying lng-term trend and shrt-run innvatins in the series. Examples f seasnal effects include a July drp in autmbile prductin as factries retl fr new mdels and increases in heating il prductin during September in anticipatin f the winter heating seasn. 4.6 LEADING, COINCIDENT AND LAGGING INDICATORS LO6: Define and explain the use f leading, cincident and lagging indicatrs INDICATORS Mst basic frecasting is dne by studying changes in the numerical values f indicatrs ie time series data. LEADING INDICATORS They shw us in advance what is ging t happen They are befre the aggregate ecnmic activity ie precede the reference turning pints e.g include number f new mtrcars sld, net new cmpanies registered, physical vlume f mining prductin (excluding gld) etc COINCIDENT INDICATORS They mve tgether with the aggregate ecnmic activity ie cincide with the reference turning pints They prvide us with current infrmatin n the state f the ecnmy e.g include registered unemplyed, real retail sales, real merchandise imprts, real GDP (excluding agriculture), physical vlume f manufacturing prductin etc LAGGING INDICATORS They are behind the aggregate ecnmic activity ie ccur after the reference turning pints They serve t cnfirm what has happened e.g include emplyment in nn-agricultural sectrs, hurs wrked in cnstructin, number f cmmercial vehicles sld, unit labur csts in manufacturing etc

22 4.7 APPROACHES TO FORECASTING ECONOMIC ACTIVITY LO7: Describe varius appraches t frecasting ecnmic activity FORECASTING Refers t the prcess f making predictins abut changing cnditins and future events that may significantly affect the ecnmy. APPROACHES TO FORECASTING ECONOMIC ACTIVITY Extraplatin means t estimate smething unknwn, frm facts r infrmatin that is knwn. E.g estimate a natin s ppulatin 5 years frm nw by using current data Ecnmic indicatrs: Leading; Cincident and lagging indicatrs Ecnmetric frecasting mdels Time series mdels STUDY UNIT 5 EMPLOYMENT AND UNEMPLOYMENT LEARNING OUTCOMES: i. Define the ecnmic active ppulatin ii. Define the labur frce participatin rate iii. List the basic surces f infrmatin n frmal emplyment in Suth Africa iv. Distinguish between frmal emplyment and infrmal emplyment v. Define the emplyment cefficient vi. Define labur absrptin capacity vii. Distinguish between the strict and expanded definitins f unemplyment viii. Describe hw unemplyment is estimated ix. Define underemplyment 5.0 EMPLOYMENT AND UNEMPLOYMENT 5.1 ECONOMIC ACTIVE POPULATION LO1: Define the ecnmic active ppulatin ECONOMICALLY ACTIVE POPULATION Includes peple frm 15 t 64 years f age wh are either emplyed r unemplyed and wh are seeking emplyment. EAP depends n factr such as:

23 The age distributin f the ppulatin the greater the prtin f the ppulatin in the age grup the greater the labur frce. Retirement rules and the availability f scial security Scial, cultural, religius and ther cnventins abut the rle f wman in sciety The availability f husehld appliances, childcare centres and ther institutins The level f develpment and the structure f the ecnmy 5.2 LABOUR FORCE PARTICIPATION RATE LO2: Define the labur frce participatin rate LABOUR FORCE PARTICIPATION RATE (LRPR) Refers t the percentage f the ppulatin that is in the labur frce = 100 Labur Frce = Number f Emplyed + Number f Unemplyed 5.3 BASIC SOURCES OF INFORMATION ON FORMAL EMPLOYMENT IN SOUTH AFRICA LO3: List the basic surces f infrmatin n frmal emplyment in Suth Africa LIST BASIC SOURCES OF INFORMATION ON FORMAL EMPLOYMENT IN SOUTH AFRICA Statistics Suth Africa (Stats SA) Quarterly Labur Frce Survey (QLFS) Quarterly Emplyment Survey (QES 5.4 FORMAL EMPLOYMENT AND INFORMAL EMPLOYMENT LO4: Distinguish between frmal emplyment and infrmal emplyment FORMAL EMPLOYMENT Where peple wrk t receive a regular wage r salary and are assured certain rights and benefits e.g. paid hlidays, sickness leave, bnuses, medical aid etc. Wages and salaries are taxed. A frmal wrker is regarded as an emplyee

24 INFORMAL EMPLOYMENT Cmprising the ttal number f infrmal jbs, whether carried ut in frmal sectr enterprises, infrmal sectr enterprises, r husehlds, during a given reference perid. The persn ding the wrk has little r n jb security, des nt have a cntract and might nt have the same emplyer fr mre than a few weeks r mnths Des nt have a unifrm r dress cde, might be a seasnal r temp wrker, mves frm emplyer t emplyer They d nt want t pay tax An infrmal wrker is ften a cntractr rather than an emplyee THREE PRIMARY REASONS WHY PEOPLE ENGAGE IN THE INFORMAL SECTOR: 1. They d nt want t pay tax. 2. They cannt find emplyment in the frmal sectr. 3. They are engaged in illegal activities. 5.5 EMPLOYMENT COEFFICIENT LO5: Define the emplyment cefficient EMPLOYMENT COEFFICIENT This measures the degree f respnsiveness f emplyment t ecnmic grwth. It is calculated by dividing the percentage change in frmal emplyment by the real GDP grwth rate fr successive perid f abut 5 years. A lng perid shuld be used as emplyment des nt react immediately t changes in prductin r emplyees can be lcked int cntracts. There tends t be a lag f up t tw years between changes in prductin and emplyment. 5.6 LABOUR ABSORPTION CAPACITY LO6: Define labur absrptin capacity LABOUR ABSORPTION CAPACITY Refers t the rati r percentage f new entrants t the labur frce that are able t find emplyment in the frmal sectr f the ecnmy

25 (%) = ( ) 100 The marginal labur absrptin capacity differs frm the labur absrptin rate. The labur absrptin rate is calculated as the ratin between the number f emplyed peple and the ttal wrking-age ppulatin. 5.7 UNEMPLOYMENT LO7: Distinguish between the strict and expanded definitins f unemplyment UNEMPLOYMENT RATE The percentage f unemplyed peple in the labur frce Mathematically: Unemplyment rate = X 100 BETWEEN THE STRICT AND EXPANDED DEFINITIONS STRICT DEFINITION OF UNEMPLOYMENT States that the unemplyed are thse peple within the ecnmically active ppulatin, wh: i. did nt wrk during seven days prir t the interview, ii. want t wrk and are available t start wrk within a week f the interview, and iii. have taken active steps t lk fr wrk r t start sme frm f selfemplyment in the fur weeks prir t the interview. EXPANDED DEFINITION OF UNEMPLOYMENT It simply excludes criterin (iii) given in the strict (fficial) definitin Includes everyne wh desires emplyment, irrespective f whether r nt they actively tried t btain a jb e.g even discuraged wrk-seekers. 5.8 METHODS OF INFORMATION USED TO ESTIMATE UNEMPLOYMENT LO8: Describe hw unemplyment is estimated METHODS OF INFORMATION USED TO ESTIMATE UNEMPLOYMENT CENSUS METHOD Used t determine the ecnmic status f the ppulatin, the prblem is that is used t estimate the cuntry s ppulatin rather than btaining infrmatin n unemplyment.

26 Estimates are a by-prduct f the census exercise and nly generated every 5 10 years. REGISTRATION METHOD A persn is classified as a registered unemplyed persn if that persn is f wrking age, ut f wrk, available fr wrk and registered as a wrk-seeker with the department. The main issue is it is vluntary and unpublished data since Sep Only thse eligible fr unemplyment benefits and hpe the department will be able t place them in emplyment take truble t register. It therefre des nt reflect level f unemplyment. SAMPLE SURVEY METHOD Current Ppulatin Survey - Oct 1977, sample basis t btain estimates f black unemplyment and discntinued in Octber Husehld Survey (OHS) Started 1993, aimed at prviding insights int perspectives n the mst imprtant elements f the cuntry s unemplyment prfile. Labur Frce Survey (LFS) Feb 2000, a twice-yearly rtating panel husehld survey designed t measure the dynamics f emplyment and unemplyment in the cuntry. Quarterly Labur Frce Survey (QLFS) July 2008, a survey f +/ husehlds. 25% f the husehlds rtate ut f the sample and replaced by new husehlds. QLFS generates data by industry, sex, ccupatin, frmal, infrmal, race etc. 5.9 UNDEREMPLOYMENT LO9: Define underemplyment UNDEREMPLOYMENT A measure f emplyment and labur utilizatin in the ecnmy that lks at hw well the labur frce is being utilized in terms f skills, experience and availability t wrk. A situatin in which a wrker is emplyed, but nt in the desired capacity, whether in terms f cmpensatin, hurs, r level f skill and experience. VISIBLE UNDEREMPLOYMENT

27 Occurs when a persn invluntarily wrks less than full time and includes parttime wrkers, casual wrkers and seasnal wrkers wh wuld prefer t be in full time emplyment. Inadequate emplyment as a result f an insufficient amunt f wrk. INVISIBLE UNDEREMPLOYMENT Is the result f a misallcatin f labur e.g. As a result f under-utilisatin f skills r lw prductivity. STUDY UNIT 6 INFLATION LEARNING OUTCOMES: i. Define a price index ii. Discuss the five basic steps in cnstructing a price index iii. Shift the base perid f an index iv. Link tw indices with different base perids v. List a few basic prblems assciated with fixed-weight (Laspeyres) price indices vi. Define the cnsumer price index (CPI) and discuss the basic steps in the cnstructin f the Suth African CPI vii. Discuss the interpretatin and uses f the CPI viii. Use the CPI t deflate r inflate a time series r index ix. Use CPI data t calculate inflatin rates x. List sme f the subindices f the CPI xi. Define the prductin price index (PPI) xii. Discuss the differences between the CPI and PPI xiii. Define an implicit price deflatr explain hw an implicit price deflatr is calculated xiv. Discuss the differences between the GDE deflatr, GDP deflatr and GNI deflatr xv. Discuss the advantages and disadvantages f implicit price deflatrs cmpared t explicit price indices identify sme frequent errrs in interpreting r reprting n price indices 6.0 INFLATION Refer t a sustained increase in the general price level. 6.1 PRICE INDEX

28 LO1: Define a price index PRICE INDEX Percentage number that shws the extent t which a price (r a 'basket' f prices) has changed ver a perid (mnth, quarter, year) as cmpared with the price(s) in a certain year (base year) taken as a standard = BASIC STEPS IN CONSTRUCTING A PRICE INDEX LO2: Discuss the five basic steps in cnstructing a price index FIVE BASIC STEPS IN CONSTRUCTING A PRICE INDEX BASKET SELECTION The chice f items r cmpnents BASE YEAR SELECTION The chice f a base perid WEIGHTING The assigning f weights t the different items r cmpnents PRICE COLLECTION The systematic gathering f infrmatin n prices usually n a mnthly basis ie cllectin f data CALCULATION OF PRICE INDEX NUMBER The CPI and PPI are calculated accrding t Laspeyres using fixed weights fr the different items. The advantage is that a series f Laspeyres index numbers have a cmmn denminatr and cmparable in the strict sense. Hwever, since fixed weights are used, a Laspeyres price index tend t verstate price index and understate price decreases and therefre has an upward bias. 6.3 SHIFTING THE BASE PERIOD OF AN INDEX LO3: Shifting the base perid f an index Mst index numbers are subjected t revisin frm time t time due t different reasns.

29 There are tw imprtant reasns fr shifting the base: The previus base has becme t ld and is almst useless fr purpses f cmparisn. By shifting the base it is pssible t state the series in terms f a mre recent time perid. It may be desired t cmpare several index number series which have been cmpared n different base perid; particularly if the several series are t be shwn n the same graph. This may necessitate a shift in the base perid. SHIFTING THE BASE FOR A SIMPLE PRICE INDEX = h h LINK TWO INDICES WITH DIFFERENT BASE PERIODS LO4: Link tw indices with different base perids Splicing r chaining is used t link tw differently based indices. It can nly be dne if the ld and the new series have at least ne ver lapping perid. Years are btained by technically shifting the base perid t BASIC PROBLEMS ASSOCIATED WITH FIXED-WEIGHT PRICE INDICES LO5: List a few basic prblems assciated with fixed-weight (Laspeyres) price indices PROBLEMS ASSOCIATED WITH PRICE INDICES Laspeyres tend t have an upward bias. Bias will be small if n drastic changes in the cmpsitin f the basket. Quality may change but n direct methd f hw it is measured. New prducts in the market may have a majr influence n spending patterns. The difference between advertised prices and actual transactin prices. Discunts are ften varied in respnse t changes in market cnditins. Certain gds are custm made which is assciated in particular with the PPI A price index is an average and thus cnceals mre than it reveals. 6.6 CONSUMER PRICE INDEX (CPI) LO6: Define the cnsumer price index (CPI) and discuss the basic steps in the cnstructin f the Suth African CPI CONSUMER PRICE INDEX

30 It measures changes in the price level f a market basket f cnsumer gds and services purchased by husehlds. Inflatin is measured using CPI. The percentage change in this index ver a perid f time gives the amunt f inflatin ver that specific perid, i.e. the increase in prices f a representative basket f gds cnsumed The CPI is a fixed-weight r Laspeyres index. STEPS IN THE CONSTRUCTION OF THE SOUTH AFRICAN CPI The Suth African CPI is cnstructed by Statistics Suth Africa. There are five steps: the selectin f gds and services t be included in the basket the assignment f weights t each gd r service t indicate its relative imprtance in the basket the chice f a base year fr calculating the CPI the chice f a frmula fr calculating the CPI the cllectin f prices each mnth t calculate the value f the CPI fr that mnth 6.7 INTERPRETATION AND USES OF THE CPI LO7: Discuss the interpretatin and uses f the CPI INTERPRETATION OF THE CPI The index number needs t be cmpared t be useful and allws users t calculate mvements ver time. The indexes shw hw prices have changed relative t a value f in the index reference perid. Fr instance if Cnsumer Price Indexes have an index reference perid f the financial year 2011/12 = An index f 110, fr example, means there has been a 10 percent increase in price since the index reference perid; Similarly an index f 90 means a 10 percent decrease since that index reference perid. Mvements f the index frm ne date t anther can be expressed as either pints r percentage changes. USES OF THE CPI The CPI has many imprtant uses, including the fllwing: Ecnmic indicatr - the CPI is the mst widely used measure f inflatin

31 Deflatr f ther ecnmic series - The CPI and its cmpnents are used t adjust ther ecnmic series fr price changes and t translate these series int inflatin-free rands ie cnstant prices Reference fr escalatin agreements Or As a means f adjusting Rand (mney) values labur cntracts and ther payments agreements that are indexed t inflatin rely n the CPI 6.8 CPI: DEFLATE OR INFLATE LO8: Use the CPI t deflate r inflate a time series r index DEFLATING A TIME SERIES OR INDEX Means cnverting a nminal (current-price) time series t a real (cnstant-price) time series r index. In ther wrds the effect f price increases is remved. Real values are btained by dividing each nminal value by the crrespnding price index number and multiplying the result by 100. Year Average mnthly earnings in manufacturing at current prices (R) CPI (2008 = 100) Calculatin Average mnthly earnings at cnstant 2008 prices (R) (4 698/62.5) x (5 216/66.1) x (5 653/72.1) x (5 980/76.3) x (6 575/77.4) x (6 972/80.0) x (7 152/83.7) x (7 957/89.7) x (8 855/100.0) x INFLATING A TIME SERIES OR INDEX Cnverting the real (cnstant-price) t btain the nminal (current-price) value. Nminal values are btained by multiplying each real value by the crrespnding price index number and divide the result by CPI DATA TO CALCULATE INFLATION RATES LO9: Use CPI data t calculate inflatin rates USE OF CPI DATA TO CALCULATE INFLATION RATES

32 Once CPI data are published, varius methds can be used t calculate inflatin. = 100 MONTH ON SAME MONTH OF PREVIOUS YEAR This rate is reprted in the media each mnth and rates calculated this way are subject t fluctuatins. A majr drawback is it suffers frm the base effect in that what happened ne year ag has as much impact what happened in the latest perid. Cmparing the index number fr a particular mnth with the index number f a crrespnding mnth the previus year and express as a percentage. If December 2009 was 109,2 and December 2008 was 102.7, inflatin rate is calculated as fllws:... =. %.. =. % ANNUAL AVERAGE ON ANNUAL AVERAGE (OR 12-MONTH AVERAGE) The prcedure is t cmpare the average f all the mnthly indices in a particular year with the crrespnding average fr the previus year. Shrt term fluctuatins are eliminated as based n all 24 mnth figures. It als gives a better indicatin f the intensity f the inflatin prcess ver a lng perid. Any 12-mnth average can be calculated. This frmat eliminates the effect f technical factrs. MONTH ON PREVIOUS MONTH AT AN ANNUAL RATE Cmpares a particular mnths figure with that f the immediately preceding mnth and the express the change at an annual rate. Obtain the ratin f the tw successive mnthly figures, rise t the pwer f 12, subtract 1 and multiply 100 t get a percentage. If December 2009 is and Nvember 2009 is 108.9, inflatin rate is calculated as such: [(. / 108.9) 12 1] x 100 = 3.4% NB**Calculating inflatin rate this way is nt significant unless CPI data have been seasnally adjusted but a significant degree f variatin will remain.

33 QUARTERLY AVERAGE ON PREVIOUS QUARTERLY AVERAGE AT AN ANNUAL RATE Obtain the rati f the tw cnsecutive quarterly averages, raise this t the pwer 4, subtract 1 and multiply by 100. This is als subject t fluctuatins but can be alleviated using the seasnally adjusted averages. If third quarterly average fr 2009 is and furth quarterly average is 109.0, inflatin rate is calculated as such: [(. / 108.5) 4 1] x 100 = 1.9% 6.10 SUBINDICES OF THE CPI LO10: List sme f the subindices f the CPI SUBINDICES OF THE CPI EXPENDITURE GROUPS Stats SA publishes CPI fr 5 different expenditure grups as spending patterns vary between grups. It is useful when a change in cst f living f different expenditure grups needs t be estimated. The data can nly be used t cmpare changes in the CPI; they cannt be used t cmpare difference in the level f the cst f living. GEOGRAPHIC AREAS Stats SA publishes CPI fr each f the nine prvinces. Data again can nly be used t cmpare changes in the CPI nly and cannt be used t cmpare the living expenses f husehlds between prvinces The headline inflatin measure serves as the basis fr calculating inflatin targets is the CPI fr all urban areas. ADMINISTERED AND REGULATED PRICES. Stats SA publishes price indices fr regulated prices. An administered price is defined as a price that is set cnsciusly by an individual prducer f grup f prducers and/r any price that can be determined r influenced by gvernment withut reference t market frces PRODUCTION PRICE INDEX (PPI) LO11: Define the prductin price index (PPI)

34 PRODUCTION PRICE INDEX (PPI) It measures prices at the level f the first significant cmmercial transactin. i.e. imprt gds measured when they enter the cuntry and manufactured gds measured when they leave the factry. There are 3 SEPARATE PPI s namely: fr dmestic utput, fr imprts fr exprts The data is used by the private sectr fr cntract price adjustment, and as deflatrs in the cmpilatin f the natinal accunts. The PPI is estimated n a mnthly basis and refers t the first seven days f the mnth except fr mining and agriculture where it is mnthly. PPI is a Laspeyers (fixed-weight) price index, the basket and weights are based n statistics f prductin and freign trade DIFFERENCES BETWEEN THE CPI AND PPI LO12: Discuss the differences between the CPI and PPI DIFFERENCES BETWEEN THE PPI AND CPI xvi. xvii. xviii. PPI estimates the cst f prductin whilst CPI estimates the cst f living CPI pertains t cnsumer gds and services, PPI pertains t gds nly. VAT is included in CPI and excluded in PPI The prices f imprted gds have a greater and mre explicit bearing n the PPI than n the CPI IMPLICIT PRICE DEFLATOR LO13: Define an implicit price deflatr explain hw an implicit price deflatr is calculated IMPLICIT PRICE DEFLATOR/GDP PRICE DEFLATOR Refers t an index that is used t gauge the extent f price level changes r inflatin in the ecnmy. It is btained by dividing a current price value by its real cunterpart (the chain vlume measure) ie Implicit Price Deflatr = Nmial GDP Real GDP

35 6.14 GDE DEFLATOR, GDP DEFLATOR AND GNI DEFLATOR LO14: Discuss the differences between the GDE deflatr, GDP deflatr and GNI deflatr GDE DEFLATOR Grss dmestic expenditure is an implicit index f the dmestic price level and is btained by dividing the GDE at current prices but the GDE at cnstant prices. GDE deflatr = X 100 GDP DEFLATOR is derived the same way as GDE deflatr but includes exprts and excludes imprts. GNI DEFLATOR GNI deflatr = X 100 NB**On tp f that an adjustment is made fr changes in terms f trade (rati between exprt prices and imprt prices). GDP DEFLATOR Changes in imprt prices are nt reflected in the GDP deflatr but have a definite impact n dmestic price levels. Therefre GNE and GNI deflatr are preferred t the GDP deflatr due t the shrtcming when the imprt and exprt prices are increasing at significantly different rates. GNI DEFLATOR GNI is a better measure fr price level when terms f trade fluctuate ADVANTAGES AND DISADVANTAGES OF IMPLICIT PRICE DEFLATORS LO15: Discuss the advantages and disadvantages f implicit price deflatrs cmpared t explicit price indices identify sme frequent errrs in interpreting r reprting n price indices ADVANTAGES OF IMPLICIT PRICE DEFLATORS

36 Implicit price deflatrs such as the GDE deflatr, GDP deflatr and GNI deflatr prvide a mre cmprehensive cverage f the price level than the explicit price indices. Implicit price deflatrs are well suited t internatinal cmparisns because f the greater standardisatin f cncepts and unifrmity f methds f estimatin in the natinal accunts than in respect f the CPI and PPI. The implicit price deflatrs are based n current weights (i.e. they are Paasche indices) and therefre reflect annual expenditure, in cntrast t the CPI and PPI which are based n fixed base-perid weights. DISADVANTAGES OF IMPLICIT PRICE DEFLATORS Cnsumers, pliticians and plicy makers are primarily interested in the prices f a limited basket f cnsumer gds and services and d nt particularly care abut what is happening t the prices f ther final gds and services which are captured in the deflatrs. Implicit price deflatrs nly measure pure price changes between the base perid and the current perid. Cmparisns fr perids ther than the current perid and base perid reflect changes in the cmpsitin f utput r spending as well as price changes. This is because current perid weights are used, which implies that there is a difference basket in each perid. The data are nly available n a quarterly basis, with a time lag, and are always subject t revisin.

37 STUDY UNIT 7 INTERNATIONAL TRANSACTIONS LEARNING OUTCOMES: i. Define the balance f payments and its main subaccunts ii. List the main categries f items recrded in the current accunt f the balance f payments iii. List the main categries f items recrded in the financial accunt f the balance f payments iv. Explain the difference between a change in net gld and ther freign reserves and a change in grss gld and ther freign reserves v. Explain why the balance f payments always balances vi. Explain hw different types f transactins are recrded in the balance f payments vii. Explain what is meant by the penness f an ecnmy and mentin sme indicatrs r measures f penness viii. Define the terms f trade and explain their significance ix. Explain the difference between: direct and indirect qutatin f exchange rates; bilateral and effective exchange rates; real and nminal exchange rates; exchange rate appreciatin and depreciatin and spt and frward exchange rates x. Calculate bilateral real exchange rates and interpret the results xi. Explain hw nminal and real effective exchange rates are calculated xii. Define purchasing pwer parity (PPP) and explain the difference between abslute PPP and relative PPP xiii. Calculate bilateral PPP exchange rates and interpret the results 7.0 BALANCE OF PAYMENTS (BOP) 7.1 BALANCE OF PAYMENTS LO1: Define the balance f payments and its main subaccunts BALANCE OF PAYMENTS Refers t a systematic recrd f all the transactins f a cuntry s inhabitants with the rest f the wrld ver given perid f time The IMF publishes a Balance Of Payments Manual t standardize all balance f payments and it cntains the rules abut which transactins are allwed.

38 A favurable balance f payments usually implies a surplus which means that mre funds are flwing in than leaving ie inflw > utflw Unfavurable balance f payments usually implies a deficit which means that mre funds are leaving f the cuntry than flwing in ie utflw > inflw MAIN SUBACCOUNTS Balance Of Payments Cnsists Of Five Subaccunts: CURRENT ACCOUNT The current accunt recrds the value f all transactin f gds and services. It cnsists f: 1. Merchandise exprts i.e. trade in all physical gds 2. Net gld exprts 3. Ttal value f service receipts i.e. all trade in services 4. Incme receipts i.e. incme earned by SA residents in the rest f the wrld 5. Merchandise imprts, payments fr services and incme payments i.e. the equivalent f N. 1,2 and 4 abve but flwing in the ppsite directin 6. Capital transfers i.e. mney, gds and services transferred withut receiving anything in return The balance n the current accunt is the net ttal f all the abve items. A deficit is financed by net inflws n the financial accunt. Nte: TRADE ACCOUNT = merchandise exprts, net gld exprts and merchandise imprts CAPITAL TRANSFER ACCOUNT This cnsists mainly f the mvement f mney in r ut f the cuntry by immigrants r emigrants. It includes als fr example a grant given by a freign gvernment fr a husing prject in Suth Africa. FINANCIAL ACCOUNT The Financial Accunt is the secnd main sub-accunt f the Balance f Payments. It recrds internatinal transactins in financial assets and liabilities. It has three main cmpnents: 1. Direct investment i.e. transactins related t the acquisitin f share capital in freign cuntries. 2. Prtfli investment i.e. purchase f investments and bnds where the investrs and nly interested in the returns n investment 3. Other investments i.e. an extra categry which recrds all transactins nt cvered by direct investment r prtfli investment r reserve assets

39 Balance n Financial Accunt which is btained by net direct investment, net prtfli investment and net ther investments UNRECORDED TRANSACTIONS Unrecrded transactins are the errrs and missins that ccur in cmpiling the individual cmpnents f the balance f payments accunt. Unrecrded transactins serve t ensure that the BOP actually balance and can be significant. Nte: a debit and credit system is used t recrd the balance f payment transactins i.e. the net sum f all credit and debit entries shuld equal the change in the cuntry s net gld and ther freign reserves. OFFICIAL RESERVES ACCOUNT. In Suth Africa this is called Gld and Other Freign Reserves. It cnsists f gld, special drawing rights (SDR s) issued by the IMF and freign exchange reserves. Basically the amunt f freign currency the SARB has in its pssessin at a given pint in time. The cmbined current accunt, capital transfer accunt, financial accunt and unrecrded transactins yield the change in the cuntry s net gld and ther freign reserves wing t the balance f payments transactins. In principle, the change in net gld and ther reserves cnstitutes the balancing item in the balance f payments as a whle. The change in the cuntry s grss gld and ther reserves during a particular perid is btained by adding the fllwing three mre items t the change in the net reserves: The change in the liabilities related t reserves (the net result f the fficial shrt-term lans btained t blster the reserves and any payment f such lans) SDR allcatins and valuatin adjustments Net mnetisatin/demnetisatins f gld (add r withdraw gld frm the use f mney) 7.2 ITEMS RECORDED IN THE CURRENT ACCOUNT LO2: List the main categries f items recrded in the current accunt f the balance f payments

40 ITEMS RECORDED IN THE CURRENT ACCOUNT OF THE BOP 1. Merchandise exprts i.e. trade in all physical gds 2. Net gld exprts 3. Ttal value f service receipts i.e. all trade in services 4. Incme receipts i.e. incme earned by SA residents in the rest f the wrld 5. Merchandise imprts, payments fr services and incme payments i.e. the equivalent f N. 1,2 and 4 abve but flwing in the ppsite directin 6. Capital transfers i.e. mney, gds and services transferred withut receiving anything in return 7.3 ITEMS RECORDED IN THE FINANCIAL ACCOUNT LO3: List the main categries f items recrded in the financial accunt f the balance f payments ITEMS RECORDED IN THE FINANCIAL ACCOUNT OF THE BOP 1. Direct investment i.e. transactins related t the acquisitin f share capital in freign cuntries. 2. Prtfli investment i.e. purchase f investments and bnds where the investrs and nly interested in the returns n investment 3. Other investments i.e. an extra categry which recrds all transactins nt cvered by direct investment r prtfli investment r reserve assets 7.4 CHANGE IN NET GOLD AND OTHER FOREIGN RESERVES AND A CHANGE IN GROSS GOLD AND OTHER FOREIGN RESERVES LO4: Explain the difference between a change in net gld and ther freign reserves and a change in grss gld and ther freign reserves There is a difference between changes in net and grss freign reserves. The change in net gld and ther freign reserves reflects the cmbined balance n the current, capital transfer and financial accunts and the unrecrded transactins. This is why it is described as the change wing t balance f payments transactins. The authrities can, hwever, supplement the reserves by brrwing specifically fr this purpse.

41 This increases the cuntry s reserves, but the increase is nly a grss change since the lans btained have t be repaid as sn as the balance f payments imprves. When the lans are repaid, the grss reserves decline accrdingly. 7.5 BALANCE OF PAYMENTS ALWAYS BALANCES LO5: Explain why the balance f payments always balances All transactins that lead t a receipt f payments frm freigners are entered as credits (+) in the balance f payments while transactins that lead t a payment t freigners are entered as debits (-). Every internatinal transactin is recrded twice in the balance f payments, nce as a credit and nce as a debit. Hence sum f all credit and debit entries shuld equal 7.6 HOW DIFFERENT TYPES OF TRANSACTIONS ARE RECORDED IN THE BOP LO6: Explain hw different types f transactins are recrded in the balance f payments HOW DIFFERENT TYPES OF TRANSACTIONS ARE RECORDED IN THE BOP

42 7.7 OPENNESS OF AN ECONOMY LO7: Explain what is meant by the penness f an ecnmy and mentin sme indicatrs r measures f penness OPENNESS OF AN ECONOMY The penness f a cuntry s ecnmy indicates the extent f a cuntry s invlvement in the glbal ecnmy, particularly internatinal trade MEASURES OF OPENNESS It is ften measured by expressing value f exprts, value f imprts, r the cmbined value f imprts and exprts as a percentage f GDP. Expressing EXPORTS AS A RATIO PERCENTAGE OF GDP thus inevitably als invlves sme imprts being expressed as a rati f an aggregate f which they d nt frm a part f. It is best t use: a) Exprts as a percentage f GDP b) Imprts as a percentage f GDP c) An average f (a) and (b). Large ecnmies like Japan and the US are relatively clsed ecnmies but high abslute levels f imprts and exprts but are relatively lw t their GDP & GDE s. MARGINAL IMPORT RATIO (i.e. change in imprts per unit change in utput/expenditure) may be high if the average imprt rati (i.e. rati between the level f imprts and the level f utput/expenditure. A cuntry with a high marginal imprt rati is particularly vulnerable t develpments in the internatinal sphere. 7.8 TERMS OF TRADE LO8: Define the terms f trade and explain their significance TERMS OF TRADE The terms f trade are an indicatin f the vlume r quantity f imprted gds that can be btained per unit f gds exprted. A rati between exprts and imprt prices and calculated by dividing an exprt price index and a imprt price index and multiplying by 100. = 100 T = terms f trade; Px = Exprt price index; Py = Imprt price index SIGNIFICANCE

43 Reasn fr terms f trade is that the value f exprts earning and payments fr imprts depends n the price and vlume f exprts and imprts. When exprts decline, a greater vlume f exprts have t be prduced and sld t keep earnings cnstant. If the terms f trade imprve, the cuntry is better ff since fewer exprts are required t affrd the same vlume f imprts as befre (mre imprts can be bught with the same vlume f exprts). 7.9 EXCHANGE RATES LO9: Explain the difference between: direct and indirect qutatin f exchange rates; bilateral and effective exchange rates; real and nminal exchange rates; exchange rate appreciatin and depreciatin and spt and frward exchange rates EXCHANGE RATES Refers t the price f ne cuntry s currency in terms f anther cuntry s currency. Exchange rates can be quted directly r indirectly. DIRECT METHOD The exchange rate it shws hw much f the lcal currency has t be exchanged fr ne unit f a freign currency i.e. the dmestic price f the freign currency. fr example $1 = R5 INDIRECT METHOD The exchange rate is expressed as the amunt f the freign currency that is required t purchase ne unit f dmestic currency i.e. the freign price f dmestic currency. fr example R1 = $0.20 BILATERAL AND EFFECTIVE EXCHANGE RATES BILATERAL EXCHANGE RATE Pertains nly t trade between tw cuntries. Fr example USD/ZAR where the United States Dllar is the base currency EFFECTIVE EXCHANGE RATE Is a weighted average rate at which is derived by weighting the exchange rates between the rand and the main currencies, using the different cuntries shares in suth Africa s freign weight trade. REAL AND NOMINAL EXCHANGE RATES NOMINAL EXCHANGE RATES The exchange rate quted at any particular time is the nminal exchange rate.

44 REAL EXCHANGE RATES Can be calculated by taking price mvements int accunt by adjusting the nminal exchange rate by the rati f tw cuntries prices. EXCHANGE RATE APPRECIATION AND DEPRECIATION APPRECIATION AND DEPRECIATION Depreciatin fall in value f exchange rate means exchange rate becmes weaker and the Rand is als getting weaker Appreciatin increase in value f exchange rate means exchange rate becmes strnger and the Rand is als getting strnger Fr example exchange rate changes frm $1 = R12.20 t $1 = R14.30, rand depreciates against the dllar and vice-versa. A depreciatin in exchange rate makes exprts mre cmpetitive and imprts mre expensive Depreciatin helps Suth Africa exprters and imprves SA grwth prspects. SPOT AND FORWARD EXCHANGE A spt exchange rate is the rate at which the freign exchange is bught and sld fr immediate delivery Frward exchange rate pertains t freign exchange bught and sld fr delivery at a future date BILATERAL REAL EXCHANGE RATES LO10: Calculate bilateral real exchange rates and interpret the results Relate t tw cuntries' currencies hwever ther bilateral exchange rates may be simply cmputed frm triangular relatinships: Fr instance if the Rand:Dllar exchange rate is R7.50:$1 and the Rand:Eur is R10.25: 1, Hw many dllars will yu need fr ne eur? Slutin: Step 1 is t find the value f 1Rand t $ 1 If R : $ 1, then R 1 $ Step 2: determining hw many Eur d yu need in rder t get 1Rand If R10.25 = 1, then R1 = 1 =

45 Step3: Since we nw knw the rate f R1 t $ (R1:$0.133) and R1 t (R1: 0.098) Therefre we can safely say $0.133 = Hence divide bth sides by in rder t find the number f dllars we need t get ne eur this gives us $1.36 = PURCHASING POWER PARITY (PPP) LO12: Define purchasing pwer parity (PPP) and explain the difference between abslute PPP and relative PPP PURCHASING POWER PARITY Between tw cuntries is the number f units f ne cuntry s currency which endws the hlder with the same purchasing pwer as ne unit f the ther cuntry s currency. PPP can refer t either parity between a cuntry and a specific trading partner in which it is a bilateral cmparisn r t parity between the cuntry and a grup f trading partners i.e. a multilateral cmparisn. ABSOLUTE PPP Is the equilibrium exchange rate between tw currencies set by the rati between the price levels in the tw cuntries i.e if similar gd cst mre in the US than in SA, the rand is undervalued and vice-versa. RELATIVE PPP States that changes in exchange rates reflect the difference in relative inflatin rates. Relative is cncerned with the rati f the equilibrium exchange rate in the current perid relative t the equilibrium exchange rate in the base perid.

46 STUDY UNIT 8 WAGES, PRODUCTION AND INCOME DISTRIBUTION LEARNING OUTCOMES: i. Distinguish between nminal incme and real incme ii. Use a price index (eg the CPI) t deflate a nminal incme series t btain a real incme series (in mnetary terms r in the frm f an index) and t interpret the results iii. Explain wage differentials r relative wages iv. Define the minimum living level and supplementary living level v. Define prductivity, labur prductivity, capital prductivity and multifactr prductivity vi. Mentin five ways in which prductivity can be increased vii. Define the labur and capital intensity f prductin viii. Define the capital-utput rati, incremental capital-utput rati and capital-labur rati ix. Define unit labur cst and shw hw it relates t earnings per wrker and labur prductivity x. Explain the link between the grwth in unit labur cst, n the ne hand, and the grwth in wages and labur prductivity, n the ther hand xi. Explain the Lrenz curve, using an example xii. Define the Gini cefficient and shw hw it relates t the Lrenz curve xiii. Cmment n the degree f inequality f the distributin f incme in Suth Africa xiv. Define the quantile rati 8.0 WAGES, PRODUCTION AND INCOME DISTRIBUTION 8.1 NOMINAL AND REAL INCOME LO1: Distinguish between nminal incme and real incme Nminal incme refers t the amunt received while real incme refers t the purchasing pwer f the incme. When prices are changing, nminal incmes have t be adjusted fr price changes t btain real incmes. Real incme is measured in cnstant price (Rands) whilst nminal incme is measured in current prices (Rands). Real wage = nminal wage inflatin Thus nminal wage = real wage + inflatin

47 Fr example: if Nminal incme being the same, if prices g dwn by say 3%, then my buying pwer ges up by 3%. S my real incme has increased by 3%. Nminal incme being the same, if prices g up by say 10%, then my buying pwer ges dwn by 10%. S my real incme has drpped by 10%. 8.2 REAL WAGE LO2: Use a price index (eg the CPI) t deflate a nminal incme series t btain a real incme series (in mnetary terms r in the frm f an index) and t interpret the results REAL WAGES Real wages in any year = Nminal wage in that year CPI in that year X 100 T btain real wages ne needs t adjust nminal wages by the CPI ie (a / b x 100). Year (a) Nminal Wage (b) CPI (c) Real Wage (R) (R) (2008 = 100) Real wage increase frm because the percentage increase in nminal wage was greater than the percentage increase in the price level. 8.3 WAGE DIFFERENTIALS OR RELATIVE WAGES LO3: Explain wage differentials r relative wages WAGE DIFFERENTIALS Refers t the difference in wages between wrkers with different skills in the same industry r between thse with cmparable skills in different industries r regins Analysts are interested in wage differential, relative wages r the structure, i.e. they want t knw hw the remuneratin f an individual wrker r grup f wrkers cmpares t that f ther individuals r grups. 8.4 MINIMUM LIVING LEVEL AND SUPPLEMENTARY LIVING LEVEL LO4: Define the minimum living level and supplementary living level MINIMUM LIVING LEVELS

48 Dentes the minimum financial requirements f members f a husehld t maintain an acceptable living standard, which is abve the Pverty Line. Hwever it will vary in accrdance with husehld size the larger the husehld, the larger the incme required t keep its members ut f pverty. SUPPLEMENTARY LIVING LEVEL This is equal t the Minimum Living Level plus sme ther items which can supplement such as UIF, as pensin, medical aid cntributins, sme extra tiletries and washing materials, prvisin fr nn-wrk transprt and sme recreatinal expenses etc 8.5 PRODUCTIVITY, LO5: Define prductivity, labur prductivity, capital prductivity and multifactr prductivity PRODUCTIVITY Refers t a rati which measures the amunt f utput prduced given the amunt f factrs f prductin (inputs). Prductivity rati = LABOUR PRODUCTIVITY Is the rati between utput and the labur input used t prduce that utput It can be expressed as utput per wrker r utput per hur. = CAPITAL PRODUCTIVITY Is a measure f utput per unit f capital input It is btained by dividing utput by the capital input and MULTI-FACTOR PRODUCTIVITY = ( ) ( ) It relates utput t a cmbinatin f inputs used in the prductin f that utput, such as labur and capital r capital, labur, energy, materials, and purchased business services (KLEMS) Als knwn as ttal factr prductin

49 = OR = ( ) 8.6 WAYS TO INCREASE PRODUCTIVITY LO6: Mentin five ways in which prductivity can be increased WAYS TO INCREASE PRODUCTIVITY Prductivity increases when the fllwing happens regarding inputs and utput: Output increases while input remains cnstant Output increases while inputs decreases Output increases faster than inputs (utput increases and input increases less than utput) Output remains cnstant while inputs decreases Output decreases at a slwer rate than inputs (utput decreases and input decreases mre than utput) 8.7 LABOUR AND CAPITAL INTENSITY OF PRODUCTION LO7: Define the labur and capital intensity f prductin LABOUR INTENSITY OF PRODUCTION A business prcess r industry that relies mainly n large amunt f labr (labur) t prduce its gds r services. The degree f labr intensity is typically measured in prprtin t the amunt f capital required t prduce the gds/services; The higher the prprtin f labr csts required, the mre labr intensive the business. Labur csts higher than capital csts Firms benefit frm access t surces f lw-cst labur Examples f capital intensive industries are fd prcessing (e.g. ready meals), htels & restaurants, fruit farming / picking etc 15,5 1,5 per mnth

50 CAPITAL INTENSITY OF PRODUCTION A business prcess r an industry relies mainly n large amunts f mney (capital) and ther financial resurces t prduce a gd r service. A business is cnsidered capital intensive based n the rati f the capital required t the amunt f labr that is required. Capital csts higher than labur csts Firms benefit frm access t lw-cst, lng-term financing Examples f capital intensive industries are il extractin & refining, car manufacturing etc 8.8 CAPITAL INTENSITY RATIO LO8: Define the capital-utput rati, incremental capital-utput rati and capital-labur rati Capital intensity can be measured in three ways: CAPITAL OUTPUT RATIO Is the real fixed stck as a rati f real utput, i.e. number f units f capital t prduce ne utput INCREMENTAL CAPITAL-OUTPUT RATIO Measures the rati between the change in capital stck and the change in utput. It indicates the amunt f additinal capital t prduce an additinal unit f utput. CAPITAL-LABOUR RATIO Is the rati between the real capital stck and the number f wrkers 8.9 UNIT LABOUR COST LO9: Define unit labur cst and shw hw it relates t earnings per wrker and labur prductivity UNIT LABOUR COST (ULC) Measure the average cst f labur per unit f utput Fr the ecnmy as a whle, it can be btained by dividing ttal labur cst by real GDP r real utput. At micr level it measures the price f labur fr a single unit f utput, such as a single prduct. In general an increase in unit labur cst means lwer prductivity.

51 HOW ULC RELATES TO EARNINGS PER WORKER AND LABOUR PRODUCTIVITY Unit f labur cst is an imprtant indicatr f cst pressures, cmpetitiveness r the cst-efficiency f labur. The link between prductivity and unit f labur cst is that it is equal t the price f labur earning per wrker) divided by labur prductivity (utput per wrker). Labur prductivity = Q/N Where Q = utput; N = number f wrkers Unit labur cst = wn/q Where w = wage rate earnings per wrker; N = number r wrkers; wn = Cst f labur and Q = utput 8.10 LINKAGES LO10: Explain the link between the grwth in unit labur cst, n the ne hand, and the grwth in wages and labur prductivity, n the ther hand Grwth rate in labur cst is apprximately equal t the grwth rate f earnings per wrker minus the grwth rate f utput wrker. Grwth in unit labur cst = grwth in wages grwth in labur prductivity. The abve equatin illustrates that unit labur cst will remain unchanged if the percentage increase in wages is matched by a similar percentage increase in labur prductivity. Lw prductivity grwth is nt an issue frm an inflatin r cmpetitiveness perspective, prvided wages are kept in check LORENZ CURVE LO11: Explain the Lrenz curve, using an example LORENZ CURVE Is a simple graphic device which illustrates the degree f inequality in the distributin f incme in the ecnmy T cnstruct the Lrenz curve illustrating the distributin f incme, the different individuals r husehlds in the ecnmy first have t be ranked frm prest t richest. This is dne n a cumulative percentage basis.

52 The cumulative percentages f the ppulatin are pltted alng the hrizntal axis. The vertical axis shws the cumulative percentage f ttal incme. The straight line shws the line f equality (perfect equality) The shaded area shws the Gini index whilst the curve shws Lrenz curve 8.12 GINI COEFFICIENT LO12: Define the Gini cefficient and shw hw it relates t the Lrenz curve GINI COEFFICIENT Gini cefficient is a measure f inequality f a distributin and btained by dividing the area f inequality shwn by the Lrenz curve by the area f the right-angle triangle frmed by the axes f the diagnal. It ranges frm 0 t 1 where 0 crrespnds t Perfect incme equality (i.e. everyne has the same incme) and 1 crrespnds t Perfect incme inequality (i.e. ne persn has all the incme, while everyne else has zer incme) Frm the graph abve the shaded area shws the Gini index

53 The Gini index is the Gini cefficient expressed as a percentage, and is equal t the Gini cefficient multiplied by DEGREE OF INEQUALITY OF THE DISTRIBUTION OF INCOME IN SOUTH AFRICA LO13: Cmment n the degree f inequality f the distributin f incme in Suth Africa Suth Africa is ne f the mst unequal cuntries in the wrld, where the gap between the rich and pr is huge. This stems bviusly frm the apartheid legacy, but als frm the neliberal prmarket and pr-rich plicies that have dminated the wrld, including SA, since the 1980s-1990s. SA has a Gini cefficient f QUANTILE RATIO LO14: Define the quantile rati QUANTILE RATIO Is the cllective term fr quartiles, quantiles, deciles and percentiles, which divide a distributin int fur, five, ten and a hundreds equal parts. A quantile rati is the rati between the highest x% and the lwest y% f a distributin The higher the quantile rati the greater degree f inequality.

54 STUDY UNIT 9 FINANCIAL INDICATORS LEARNING OUTCOMES: i. Distinguish between the main mnetary aggregates and explain what they are used fr ii. Distinguish between simple interest and cmpund interest and calculate bth iii. Explain the relatinship between cmpunding and discunting and perfrm bth peratins iv. Distinguish between the mney market and the bnd market and list sme key interest rates in each market v. Explain the difference between an interest rate and a discunt rate vi. Explain the relatinship between basis pints, percentage pints and percentages vii. Explain the difference between nminal and real interest rates viii. Define the price-earnings rati, earnings yield and dividend yield f an rdinary share in a cmpany listed n the jse and explain the significance f and pssible relatinships between these indicatrs ix. Define a share price index x. Explain the relatinship between ecnmic indicatrs and the financial markets 9.0 FINANCIAL INDICATORS 9.1 MONETARY AGGREGATES LO1: Distinguish between the main mnetary aggregates and explain what they are used fr MONEY Is anything which is generally accepted as payment fr gds and services r in the discharge f debt, medium f exchange, stre f value and unit f accunt MONETARY AGGREGATES SARB distinguishes between fur mney aggregates: 1. M1A 2. M1 Cnsists f cin and bankntes in circulatin plus cheque and transmissin accunts f the dmestic private sectr with mnetary institutins. All assets in M1A can be used t effect payment t third parties.

55 Is M1A plus ther depsits held by the dmestic private sectr and still relates t the functin f mney as a medium f exchange. 3. M2 Is M1 plus any ther shrt-term and medium-term depsits held by the dmestic private sectr 4. M3 Is M2 plus lng-term depsits held by the private dmestic sectr M3 is the bradest and least liquid f mney aggregates and serves as the basis fr mney supply guidelines. The main advantage f M3 is that is less susceptible t changes in individual prtflis as a result f financial innvatins r t the change in expectatins and the structure f interest rates. Mney aggregates are stck variables; mnetarists see a direct link between the rate f increase in the mney supply and the rate f increase in prices (inflatin) and are a pssible indicatin f future trends in interest s rates. 9.2 INTEREST RATE LO2: Distinguish between simple interest and cmpund interest and calculate bth INTEREST RATE Refers t the cst/price f brrwing mney, expressed as a percentage f the lan amunt. The rate is expressed as a % per annum. COMPARISON BETWEEN SIMPLE INTEREST AND COMPOUND INTEREST SIMPLE INTEREST COMPOUND INTEREST is calculated as a % f the principle sum nly Is calculated as a % f the principle plus any accrued interest The results yields less returns The results yields cmparatively high returns Principal amunt is cnstant Principal amunt ges changing during the entire brrwing perid Interest is charged n principal nly Interest is charged n principal plus accumulated interest PV x r x n PV (1 + r)ᵑ Grwth rate f mney remains unifrm Grwth rate f mney increases rapidly Calculatin f simple interest is easy Calculatin f cmpund interest is cmplex.

56 Frmula fr: Simple interest PV x r x n Where, PV = Principal Amunt; r = rate f interest; n = number f years Frmula fr: Cmpund interest PV (1 + r)ᵑ Where, PV = Principal Amunt; r = rate f interest; n = number f years Interest calculated at different intervals, e.g. daily, weekly, mnthly, quarterly, semiannually and annually. 9.3 RELATIONSHIP BETWEEN COMPOUNDING AND DISCOUNTING LO3: Explain the relatinship between cmpunding and discunting and perfrm bth peratins RELATIONSHIP BETWEEN COMPOUNDING AND DISCOUNTING Cmpunding finds the future value f a present value using a cmpund interest rate. Discunting finds the present value f sme future value, using a discunt rate. They are inverse relatinships. COMPARISON COMPOUNDING DISCOUNTING Meaning Determines the future value f present Determines the present investment value f future cash Cncept If we invest sme mney tday, what will be the amunt we get at a future date What shuld be the amunt we need t invest tday, t get a specific amunt in future Use f Cmpund interest rate Discunt rate Knwn Present value Future value Frmula FV = PV(1 +r)^n PV = FV / (1 +r)^n Frmula fr: Cmpunding FV = PV(1 +r)^n Where FV = Future value; PV = Present value; r = rate f return n investment; n = number f years Frmula fr: Cmpund interest PV = FV / (1 +r)^n Where PV = Present value; FV = Future value; r = Discunt rate; n = number f years

57 9.4 MONEY MARKET AND THE BOND MARKET LO4: Distinguish between the mney market and the bnd market and list sme key interest rates in each market MONEY MARKET Is the lending and brrwing shrt-term financial instruments and thus interest is f a shrt-term nature. It includes the rep rate, prime-verdraft rates, the Treasury bill, the JIBAR rate and call mney rates. CAPITAL (BOND) MARKET Is the market fr lending and brrwing f lng-term financial instruments and thus interest rates are lng-term. It includes the interest-bearing securities (r bnds), shares and negtiable dcuments all wrked accrding t the cupn rate, rate n gvernment bnds and rate n the bnds f public crpratins. Capital markets the mst cmmn thing used are stcks and bnds, whereas with the mney markets the mst cmmn things used are cmmercial paper and certificates f depsits. 9.5 INTEREST RATE AND A DISCOUNT RATE LO5: Explain the difference between an interest rate and a discunt rate INTEREST RATE Refers t the cst/price f brrwing mney, expressed as a percentage f the lan amunt. The rate is expressed as a % per annum. DISCOUNT RATE Refers t the interest rate used in discunted cash flw (DCF) analysis t determine the present value f future cash flws Treasury bills are issued at discunt rate, which means they are issued at a discunted value t their maturity date. The higher the price f a discunted rate the lwer the yield will be

58 9.6 BASIS POINTS, PERCENTAGE POINTS AND PERCENTAGES LO6: Explain the relatinship between basis pints, percentage pints and percentages RELATIONSHIP BASIS POINTS, PERCENTAGE POINTS AND PERCENTAGES Percentages Changes The percentage difference between tw numbers is calculated by expressing the abslute difference between the tw numbers as a ratin f the riginal number. Increase frm 20 t 25 Slutin: (25-20)/ = 25% Basis Pints It is a term mainly used in the financial markets. A Basis Pint is ne hundredth f a Percentage Pints: e.g 1 Basis pints = 0.01 Percentage Pints therefre 100 Basic pints = 1 percentage Pint 9.7 NOMINAL AND REAL INTEREST RATES LO7: Explain the difference between nminal and real interest rates NOMINAL INTEREST RATES Is the interest rate that des nt take inflatin int accunt It is the interest rate that is quted n bnds and lans. Is a simple cncept t understand; fr example, if yu brrw $100 at a 6% interest rate, yu can expect t pay $6 in interest withut taking inflatin int accunt. The disadvantage f using the nminal interest rate is that it des nt adjust fr the inflatin rate REAL INTEREST RATES Is the interest rate that des take inflatin int accunt Real interest rate adjusts fr the inflatin and gives the real rate f a bnd r a lan. Real interest rate = Nminal interest rate Inflatin This rate gives the real rate that lenders r investrs are receiving after inflatin is factred in;