Chapter 2 Flashcards
What are the 3 different types of economies?
1) Centrally planned / command economy
2) Free-market / capitalist economy
3) Mixed economy
What are the characteristics of a centrally planned economy?
Most of the key decisions on production are taken by central planning authority (state and agencies)
What are the characteristics of free market economy?
Firms and households interact through the price system to determine allocation of resources to the production of goods and services
What are the characteristics of a mixed economy?
State provides some goods and services and private companies provide other goods and services
What is investment spending and its characteristics?
It is an injection into the economies circular flow. It is made up of gross fixed capital formation and change in inventories.
Gross fixed capital formation: spending on residential and non-residential buildings, construction works and machinery and other equipment
Change in inventories: Can be positive or negative (falls when demand is high and productions trails behind)
What causes leakages from circular flow of and economy?
Savings
Imports
Taxes
What causes injections into the circular flow of an economy?
Investment spending
Exports
Government spending
What are the categories of aggregate demand?
1) Consumer/household spending
2) Government spending / public expenditure
3) Investment spending on capital goods
4) Export of goods and services less expenditure on imports of goods and services
When is the fiscal policy loosening?
When tax rates are lowered and public expenditure (Government spending) is increased
When is the fiscal policy tightening?
When tax rates are increased or public expenditure (Government spending) is decreased
Who is responsible for the execution of the fiscal policy in South Africa?
The South African National Treasury
What are the different elements of the monetary policy?
Reserve requirements
Open market operations
Bank/discount rate policy
Direct controls
How does shares react to the business cycle?
Expansion and lower turning point: performs the best.
Upper turning point: Very volatile
Contraction: Prices decline
How does bonds react to the business cycle?
Contraction and lower turning point: Performs the best
Expansion and upper turning point: Performs less well
How does property react to the business cycle?
Lower turning point and expansion: Performs well
Contraction: Doesnt perform well
How does cash react to the business cycle?
Contraction: More attractive
How does commodities react to the business cycle?
Expansion: Performs well
Contraction: Doesnt perform as well
How does precious metals react to the business cycle?
Upper turning point: Performs best
Contraction: Doesnt perform as well
What are the economic indicators?
GDP *
CPI *
BOP (Balance of Payments)*
PPI
Investment spending
Government spending
’* Most important to know
What does GDP measure?
The total value of all goods and services produced in a country in a period
What does GDP reflect?
The total economic activity after adjusting for inflation.
By who are key decisions made on production in a central planning authority?
Decisions are made by the state and its agencies
How is the allocation of resources to the production of goods and services determined in a free-market economy?
Through the price system
What attributes to leakages into an economy’s circular flow?
Savings, Imports and Taxes
What attributes to injections into the economy’s circular flow?
Investment spending, exports, government spending
What are the main categories of aggregate demand?
1) Consumer/household spending - Most important factor in determining the level of aggregate demand
2) Government spending (public expenditure)
3) Investment spending on capital goods
4) Exports of gods and services less expenditure on imports of goods and services
According to what economic objectives is a economy generally judged?
- Acceptably high rate of non-inflationary growth
- High and steady level of employment of the labour force
- Stable general price level
- Equitable distribution of income
What is the fiscal policy?
It is the policy that determines the level of government spending and taxation policies that influences the overall level of economic activity
When is aggregate demand weakened?
When government spending is weakened and taxation is increased (Fiscal policy is tightening)
When is the fiscal policy said to be loosening?
When tax rates are lowered or public expenditure is increased
What variables does the monetary policy influence?
Rate of interest and money supply
Does interest rates fall or rise when the money supply is increased?
Interest rates tend to fall if the money supply is increased
What are the most important tools of the monetary policy?
Reserve requirements - how much a bank is required to hold in reserve
Open-market operations - purchase and sale of government and other securities by the central bank
Bank/discount rate policy - Rate at which the central bank lends funds to the banking system
What are the 4 elements of an inflation targeting framework?
Price stability
Numerical inflation target
A time horizon to attain/return to the inflation target
Review whether the target will be met
Explain what happens during the expansion phase of the business cycle
Aggregate demand increases.
Firm inventories are run down.
Production increases at a faster rate than aggregate demand as inventories are rebuilt.
Businesses employ unemployed workers who spend their income on consumer goods.
This generates more demand and businesses employ more people.
Explains what happens during the upper turning point of the business cycle
The business encounters capacity constraints.
If they expect continued increasing demand, they will invest in capital goods.
Consumer demand will increase on the back of the increased demand for capital goods.
Production eventually reaches a ceiling due to supply constraints and bottlenecks.
Explain what happens during the contraction of the business cycle
Demand falls
Producers of capital goods lay off workers
Increased unemployment results in decreased consumer spending
Contraction gains momentum
Explain what happens during the lower turning point of the business cycle
Interest rates fall
This makes new investments profitable
Consumer demand increases which increases investment demand which lifts the economy
Which asset classes perform best during the expansion phase?
Shares, Property, Commodities
Which asset classes perform best during the upper turning point phase?
Precious metals
Which asset classes perform best during the contraction phase?
Cash, Bonds
Which asset classes perform best during the lower turning point phase?
Shares, Property
What are the different economic indicators?
GDP
CPI
PPI
Government spending
BOP ( Balance of payments )
Investment spending
Consumption expenditure by households
What is GDP and what does it reflect?
The total value of all goods and services produced in a country in a particular period
It reflects the total economic activity after adjusting for inflation
What happens when GDP is high?
It could lead to inflation if the economy is close to full capacity.
This could lead to rising interest rates
This could lead to bond prices falling
This could lead to higher corporate profits ( higher share prices ) but inflation fears impact share prices negatively.
Exchange rate is appreciated
What is consumption expenditure by households?
It is the total amount of money spent by households in an economy
What is the investment spending indicator made up of?
1) Gross fixed capital formation: Spending on residential and non-residential buildings, construction works and machinery and other equipment
2) Change in inventories
Which economic indicator is a leading indicator of the business cycle?
Investment spending
What does the consumer price index (CPI) measure?
It measure the levels of and changes in a particular basket of prices
What does CPI indicate?
The level of inflation
What does Producer Price Index track?
The prices at the first stage of distribution or at the point of the first commercial transaction
What is the Balance of Payments?
It is a tabulation of a country’s transactions with foreign countries and international institutions over a period
What are the different account in the BoP (Balance of Payments)
Financial account - reflects international capital flows
Current account - records exports
Gold and other foreign reserves position - reflects overall balance of payments position of a country
What does the globalisation of financial markets refer to?
It refers to the increasing integration of economies around the world
