Economic Environment. NQF Level 4 STUDENT S BOOK. D Bekker, M Richards, FHB Serfontein & A Smith

Transcription

1 Economic Environment NQF Level 4 D Bekker, M Richards, FHB Serfontein & A Smith STUDENT S BOOK

2 Economic Environment Student s Book TVET FIRST NQF Level 4 D Bekker, M Richards, FHB Serfontein, A Smith

3 TVET FIRST Economic Environment Level 4 Student s Book TVET FIRST series D Bekker, M Richards, FHB Serfontein, A Smith 2008 Illustrations and design Macmillan South Africa (Pty) Ltd 2008 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, photocopying, recording, or otherwise, without the prior written permission of the copyright holder or in accordance with the provisions of the Copyright Act, 1978 (as amended). Any person who does any unauthorised act in relation to this publication may be liable for criminal prosecution and civil claims for damages. First published Published by Macmillan South Africa (Pty) Ltd Private Bag X19 Northlands, 2116 Gauteng South Africa Typeset in 11 on 13pt Palatino by Quay Design ISBN WIP 2125M000 e-isbn: It is illegal to photocopy any page of this book without written permission from the publishers. While every effort has been made to trace the copyright holders and obtain copyright permission from them, in some cases this has proved impossible due to logistic and time constraints. Any copyright holder who becomes aware of infringement on our side is invited to contact the publisher. Note: Any reference to Further Education and Training (FET) in this book should be taken to mean Technical and Vocational Education and Training (TVET). To order any of these books, contact Macmillan Customer Services at: Tel: (011) Fax: (011) customerservices@macmillan.co.za

4 Contents Module 1: Basic economic principles... 2 Module 2: Measure the macro economy Module 3: Trends in the world economy Module 4: Role of money and monetary policy Module 5: Fiscal policy Module 6: Module 7: Module 8: Module 9: Basic economic concepts central to local economic development in South Africa The role of government in the South Afican economy The nature of development economics with specific reference to South Africa Presentation to illustrate the key economic concepts central to local economic development Module 10: Module 11: Module 12: Module 13: The purpose of local economic development in South Africa Legislation that has an impact on local economic development The current challenges for local economic development The role of municipalities in local economic development

5 Module 14: International trade Module 15: Basic international finance Module 16: Compare import/export factoring with Letter of Credit Module 17: The process of initiating import/export factoring Module 18: Risk management principles associated with import/export factoring

6 Topic 1 Macro economic principles as they apply to the South African business environment 1

7 Module 1 Basic economic principles Overview In this module you will Explain the concepts of scarcity, choice, efficiency, use of marginal analysis and opportunity cost. Distinguish the concept of macro economics from that of micro economics. Identify the common errors in economic thinking and sources of disagreement amongst economists. Range: Bias, fallacy of composition, cause and effect between economic variables, levels and rate of change, value judgements, interpretation of facts and data, opinion, the impact of time perspectives and ceteris paribus. Explain the concepts of supply and demand and the elasticity of supply and demand with the use of a graphical illustration. Identify the impact of different economic systems Range: Market economy, command economy and mixed economy. Explain the role of the economy in producing goods and services. Range: Capital, entrepreneurship, labour and natural resources. 2 Topic 1

8 Introduction In this module you will learn about basic economic principles that are used by economists when they discuss or explain economic issues. For example you will learn about the concepts of scarcity, choice, efficiency and opportunity costs as they pertain to economics. You will also be introduced to marginal analysis. The difference between micro and macro economics will be briefly explained, and you will be introduced to some common errors in economic thinking. This is followed by an explanation of the laws of demand and supply as well as the elasticity of demand and supply. You will then also look at the impact of different economic systems, specifically the market economy, the command economy and the mixed economy. Lastly you will be looking at the role supply factors play in producing goods and services in the economy. Economics: the study of how limited resources are used to satisfy unlimited needs and wants Needs: the essential goods and services that we have to have in order to survive Wants: those goods and services that we would like to have 1.1 Concepts in economics Scarcity Economics is often defined as the study of using limited resources to satisfy unlimited needs and wants. This definition implies scarcity of resources. But what do we mean by scarcity? A dictionary definition of scarce is rare or in short supply. In economics we mean that the inputs or resources used to make products are limited whereas what people need or want is unlimited. Once people have their basic needs or necessities for survival met, for example food, water and shelter, then their needs for security, love and social recognition becomes important. Once these needs are met, people start wanting things because they derive pleasure from them or because they think owning them may give them status. These needs or wants are unlimited. The resources that are used to make goods and services are limited. There is a limit to some natural resources like the raw materials we take out of the ground. One day there will be no more coal, iron-ore or oil. It may still take a number of decades or even centuries before we start running out of these inputs for our production processes, but because these minerals take so long to be formed by nature they will eventually run out. Such resources are known as nonrenewable resources. Scarce: not often found; rare; in short supply Resources: land, labour, capital and entrepreneurship needed to produce the goods and services in an economy. The resource land includes all natural resources Natural resources: all the resources supplied by nature including water, air, land, minerals and the environment Non-renewable resource: resources that cannot be replaced or increased by nature or humans Think about it Most of us are becoming aware that oil is a limited resource mainly because of the price that we pay for petrol. In addition, oil is a nonrenewable resource. What is going to happen when the world runs out of oil? Module 1: Basic economic principles 3

9 A non-renewable resource is one that cannot be replaced in our lifetime. It just takes far too long for such a resource to develop. Oil takes a very long time to become oil. Once we have tapped the last drop of oil out of the planet s depths there will be no more oil, certainly not in our lifetime. When there is no more oil then humans will have to use some other source of energy to drive their vehicles. One alternative that is already being explored is biofuels. Renewable resources: those natural resources that are able to replace themselves if humans give them the chance to do so Acid rain: rain that has a high acid content often because of sulphur dioxide that is in the smoke emitted by some factories Global warming: the tendency for the atmosphere around the planet to warm up, because of the heat from the sun being trapped by pollutants in the air Potable water: water that is clean enough for human consumption There are other resources that are known as renewable resources, for example wheat, fish and trees. These are resources that are able to grow and replace what we have used in quite a short period of time. However, in order that these resources are able to renew themselves humans must use these resources wisely so that they have the time and opportunity to do this. If we catch fish that have not had a chance to grow to adulthood and spawn, then there will be no younger generation of fish to renew the resource. If we cut down trees without giving young trees a chance to grow big and make seeds, there will be no trees in the future. If we cut down all our wheat crops without letting some go to seed there will be no seeds to plant. There are other mostly renewable resources which we tend to take for granted because we do not pay for them and they just always seem to be there. The air that we breathe, the rain that falls and fills our rivers and the sun that shines and helps the plants to grow and provide us with food are all resources we barely notice. Some of these resources are becoming polluted. The air that we breathe in cities especially is not very clean anymore, the rain that falls is often acidic especially in urban areas, and according to scientists, global warming is becoming a real problem. The heat from the sun is not escaping from our atmosphere as fast as it is supposed to and the air is slowly warming up. This could affect and change our weather patterns, which in turn could negatively impact on the supply of food crops. Clean air, rain for our crops, healthy potable water and sunshine that helps plants to grow are all natural resources. Some of these natural renewable resources may become scarce if we do not use them wisely. What this means in some cases is that we have to give these renewable resources a chance to get rid of the pollutants that are a result of our human activities. 4 Topic 1

10 Choice Although economic theory argues that people would like to buy as many products as possible, one thing that limits your ability to buy is your income. Your income limits your demand for goods and services. What this means is that you have to make choices. What will you buy and what will you not buy even though you would like to have them? Producers also have to make choices. What type of products should a producer make? How will these products be made? Where should a producer locate a factory? How many people should the producer employ? Who will buy the products that are made? At what price should the producer sell the products? Bear in mind that any producer who makes or produces a product does so in order to earn their own income. It is therefore important that a producer or any business person is able to make a profit from their business. Not only do individuals have to make choices, society also has to make choices. One way in which society expresses some of its choices is through the voting process. In this way society ultimately chooses under which type of economic system the country will live and operate and therefore what macro economic goals are important. As a society we choose whether or not we live in a country that respects human rights and the rule of law. Efficiency Another thing that a producer has to bear in mind is that the production process must be efficient. The way in which the products are made must be at the least cost possible to the producer, because the producer has to compete with other producers. If one producer is wasteful and as a result the price of the product is higher than the competitors, who would you buy from? I think you will agree that you will rather buy from the more efficient producer, in other words from the one who uses resources efficiently and so can sell at a lower price. Choice: an act of deciding what to take/do and therefore also what to leave/not do Efficiency: use of inputs in a way that ensures the maximum output and profits Think about it Efficiency is an important concept in a market economy because producers have to pay for their inputs. Activity Indicate whether the following statements are true or false: a) Scarcity is one of the concepts used in economics because limited resources are used to satisfy unlimited wants and needs. b) Non-renewable resources are those resources which are able to renew themselves. c) Consumers, producers and society all are faced with choices. d) Producers who use their inputs efficiently are more competitive than those who are wasteful. 2. Correct the sentences you decided were false. 3. Choose one of the sentences you decided was true and write a few lines explaining why. Module 1: Basic economic principles 5

11 Opportunity cost: the cost of making a choice, the loss of not choosing the other Opportunity cost Another important concept that is used in economics is that of opportunity cost. Opportunity cost implies choice because if a person decides on one thing they have to give up something else. For example, if you would like to be a doctor and lawyer you will have to decide which it will be. You cannot be both at the same time! If you decide to be a doctor, then you give up the opportunity of being a lawyer. Your opportunity cost of being a doctor is that of being a lawyer. A person may have to choose between spending their time writing a book or frying chicken pieces and selling them because there is just not enough time to do both. If that person decides to write rather than fry and sell chicken pieces then the opportunity cost of writing the book is the possible income he or she may have earned from frying and selling chicken pieces. Examples: If you decide to go on holiday to Cape Town instead of going to Durban, your opportunity cost of going to Cape Town is what you give up. Question: What are you giving up in order to go to Cape Town? Answer: The chance or opportunity of going to Durban. If you decide to buy a new car instead of going on an overseas trip your opportunity cost of buying the new car is what you give up. Question: What is your opportunity cost of buying a new car? Answer: The overseas trip that you give up. It is all a matter of choice! Activity 1.2 Producers also face opportunity costs. If the machines at a factory are used to produce one type of motor vehicle then no other motor vehicle can be produced during that time. On a macroeconomic level, choices also have to be made with regards what products we produce in the country and what we import. In this respect government may become involved to direct the economy in a certain direction. If it decided to concentrate on the production of motor vehicles for export then the production of other products may not be possible. Government also makes choices in respect of how to spend taxpayers money. If money is spent on education then that same money cannot be spent on health issues. The opportunity cost of providing the education are the health issues that cannot be addressed. Assume that you decide to start you own business. What sort of business would you like to have? Running this business takes all your time and effort. Can you start another business at the same time all by yourself? Why not? Decide which business you will concentrate on. What is the opportunity cost of the business that you have decided on? 6 Topic 1

12 People will usually choose whatever gives them the most satisfaction (in the case of a consumer) or income (in the case of a producer this would be the profits). According to some economists, if we assume that people have the necessary information in order to make correct choices then they will not make mistakes. In other words in economics terminology, people (consumers and producers) are rational and if they have perfect information they will choose whatever gives them the most satisfaction, income or profits. Marginal analysis Economics assumes that in most cases each person prefers more of something rather than less. Economists explain this is by using a theory known as marginal analysis. According to marginal analysis, if your level of satisfaction increases by consuming one more of a good, then you will want to consume that extra one. If a producer can add to his or her profits by making and selling one more product then it is worth producing one more. Let s use eating ice cream as an example. Firstly we need to pretend that you can give a value or a number to the level of satisfaction derived from eating an ice cream. We call this value utils. The word utils comes from the word utility and the word utility is the official word that economists use instead of level of satisfaction. Let us now pretend that eating an ice cream will give you a utility of 200 utils. The marginal utility of the first ice cream is 200 utils. Eating an ice-cream provides one with a certain level of satisfaction Once you have finished that ice cream, you feel like another one. The level of satisfaction you get from eating this second ice cream is a bit less than the first ice cream. Let s make it 130 utils. According to marginal analysis, eating the second ice cream has increased your level of satisfaction by 130 utils. The marginal utility of the second ice cream is 130 utils. Remember that eating the first ice cream increased your utility by 200 utils. Your total level of satisfaction after eating two ice creams is therefore 330 utils ( = 330). Now you eat a third ice cream. You still enjoy it but not nearly as much as the first or even the second ice cream. Let us say the marginal utility you gained from eating this third ice cream is 25 utils. Your total utility after eating three ice creams is therefore 355 utils ( = 355). So each additional ice cream you consume adds to your total utility. As long as the marginal utility of eating ice creams is positive you will consume more ice creams. Rational: ability to think carefully about something and then to make the correct choice Perfect information: all the information available and needed to make the sensible or rational choice Marginal value of goods: the extra value added to the total value when one more of a good is consumed or produced Utils: the term used in economics to denote the level of satisfaction Utility: level of satisfaction Module 1: Basic economic principles 7

13 Disutility: a level of dissatisfaction Now you may be thinking what if I eat a fourth ice cream, I may be sick! Yes you are quite correct and economics has an answer for that! If you get sick after eating ice cream number 4 you will then be experiencing dissatisfaction or disutility! Dissatisfaction or disutility will reduce your total level of satisfaction. So you will stop eating ice creams after ice cream number three! However, if ice cream number 4 has a marginal utility of 1 for you, then you will eat number 4. Why? Because by consuming one more ice cream your total utility will increase by 1 util. Activity 1.3 Using the above example assume that ice cream number 4 has a marginal utility of 1. In the following table write in the marginal values for eating ice creams. Write in the total utility after each ice cream. Now assume that ice cream number 4 has a marginal disutility of -37utils. How will that change your total utility? Ice creams consumed Marginal utility in utils Total utility in utils Marginal analysis can also be used when we look at how producers or sellers make decisions. In this case we would look at whether or not a seller can add to total profits by producing and selling one more item. A lot of economic analysis is based on marginal analysis. What is important for you to understand is that economists look at the change in total utility or total profit after the consumer consumes one more of a product or after a seller sells one more of a product. The change in the total utility or profit is the marginal utility or marginal profit. Microeconomics: looks at the individual consumer or producer to understand what motivates their economic choices 1.2 Microeconomics versus macroeconomics In economics we look at the individual consumer or producer in order to understand what motivates their behaviour in terms of demand and supply. When we focus on the consumer or the producer as individuals we call it microeconomics. In microeconomics we look at what influences a consumer s decision to buy a certain product and how changes in price will affect such a decision. We also consider the effect of the profit motive on a producer s decision whether or not to produce a certain product. Price plays an important role in a producer s or supplier s decisions as the selling price will affect what profit is made. 8 Topic 1

14 It is also important as economists to look at what influences the economy as a whole. In macroeconomics we look at the total spending, the total income or the total production in the economy. The terms economists use are aggregate spending, aggregate income and the gross domestic product. Macroeconomists investigate what causes changes in the aggregate spending, income or production in the economy. Factors like the rate of inflation, the overall rate of unemployment, exchange rates and interest rates and how changes to these affect the economy as a whole are all examined. Issues that affect developing countries are unemployment and the related problem of poverty. Macroeconomists in developing countries must therefore also consider how fiscal policy can be applied to solve the problems faced by such countries. Macroeconomics: studies the economic system as a whole Aggregate spending: total spending in a country Aggregate income: total income in a country Aggregate production: total production in a country Activity Are the following statements true or false: a) Micro economics is the study of the individual s economic decisions. b) In micro economics we look at why a consumer would buy a certain product at a certain price. c) Macro economics is the study of the whole economic system. d) In macro economics we could look at why there is unemployment in a country and how this problem can be solved. e) In macro economics we study amongst other things, how fiscal policy can be used to alleviate poverty. 2. Explain why the study of the price and quantity of cold drinks is a micro economic issue while the total output and general price level are macro economic issues. 1.3 Common errors in economic thinking Fallacy of composition The fallacy of composition arises when an argument is based on the notion that what is true for the parts is also true for the whole. In economics, for instance, this takes the form of arguing that because something is true for a household or firm it is also true for the system as a whole. One might argue that it is good for a household to save and even to increase its savings. This is indeed true. The fallacy of composition occurs when one argues that because it is good for a household to save it is good for all households and the economy as a whole. This might not necessarily be the case. From a macroeconomic point of view an increase in savings by all households causes less consumption spending by households. As households spend less, firms respond by producing less. As firms produce less they employ fewer factors of production and the income of households declines. By saving more we end up with less income. As an example, take the case of a potato farmer. By planting and selling more potatoes the farmer will be able to increase his or her total revenue. If all potato farmers increase their production, the individual farmer as well as all the other farmers might end up with less income. As they increase Module 1: Basic economic principles 9

15 the market supply of potatoes the market price for potatoes will fall and this lower price might lead to lower total revenue for the farmers. In this instance, you can see that what is true for the micro level is not necessarily true for the macro level. Ceteris paribus Economics is a social science and unlike the natural sciences it cannot do experiments under controlled conditions. In a laboratory a scientist can control the environment and keep it constant. This makes it easier to measure the effect, for instance, of one chemical on another and to repeat the process to confirm results and prove formula. Economists do not have this luxury - we are confronted by a complex world in which many things change in the same instant all the time. It would be much easier if we could freeze everything else while we are busy with our experiment, but in this complex and ever-changing world of ours it is just not possible. What we do is to invoke the ceteris paribus condition which allows us to assume that all other factors remain constant or unchanged, so that we can better understand the impact of the one factor we re examining. It is an old Latin term meaning all other things being equal. As an example, when dealing with the law of demand we assume that all the other factors that influence the demand for a product are unchanged and then ask what will happen to the demand if the price changes. In this way we are able to trace and model the impact of a change in the price on the demand for a product. Rates and levels of change In economics we work with a lot of figures. We are sometimes interested in levels and sometimes in changes in these levels. If we want to know what the per capita gross domestic product (GDP) is in South Africa, we are interested in the level of per capita real GDP. If we want to know what happens to the per capita real GDP over time we are interested in the change in per capita real GDP. In the following table the level of per capita GDP and the change in the per capita GDP is provided. Year Level of per capita GDP (Rands) Change in per capita GDP TABLE 1.1: Level and change in real per capita GDP for South Africa Source: South African Reserve Bank, Quarterly Bulletin Time series 10 Topic 1

16 From the above table you can see that the level for per capita real GDP for 1992 was lower than the real per capita GDP in This is reflected in a negative change in the per capita real GDP of -4.2%. For 1994 the level of per capita real GDP was higher than the per capita real GDP for 1993 and this is reflected as positive change of 1.1%. As long as the change is positive the level increases. If the change is negative the level decreases. If you know the change in per capita real GDP for 1998 was -1.6% you also know that the level of real GDP for 1998 is lower than the level of real GDP for When working with rates of change it is also important to take into account the base from which it occurs. For instance, the average growth rate of Japan for the period was 1.6% while for Uganda it was 7.1%. Japan is, however, still a much richer country than Uganda even though its growth rate was much lower. This is because the growth in Uganda started from a very low base while that of Japan started from a much higher base. Cause and effect When one thing makes something else happen we have a cause and effect relationship. If the price of fried chicken pieces increases, the demand for it decreases. In this case the cause is the increase in price and the effect is the decrease in quantity. It is however important to note that just because two things occur together and are therefore correlated, it does not automatically mean that the one caused the other. A well know example of this confusion between correlation and causation is the observation that while the number of births in an imaginary town has been increasing over time, the number of storks has also increased. The fact that the number of births and the number of storks have increased means there is correlation between the two. However, it would be incorrect to conclude that storks bring babies. To establish causality more than just correlation is needed. You must have a logical theory that is able to explain the effect of one variable on another. The theory of the market provides an understanding of the cause and affect relationship in the market for fried chicken pieces. According to this theory an increase in the income of consumers causes an increase in the demand for fried chicken pieces. Between income and an increase in the demand for fried chicken pieces there is not only correlation but also causation. An increase in income is the cause and the increase in the demand for fried chicken pieces is the effect. But the relationship does not end here. An increase in demand causes an increase in the price of fried chicken pieces. The increase in demand is now the cause and the increase in price the effect. In addition, the increase in the price causes a decrease in the quantity demanded and increase in the quantity supplied. Rate of change: change in the variable over a specific period of time?? Did you know? The statement that the inflation rate has declined from 10% to 5% means that the price is still rising but at a lower rate. The level of prices is still 5% higher Correlation: the degree to which economic variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation Causation: when a change in one variable is not only correlated with, but actually causes a change in another variable Module 1: Basic economic principles 11

17 ?? Did you know? In spite of disagreement between economists there is some consensus about certain policy measures. About 90% of economists agree that: Tariffs and import quotas reduce general economic welfare Rent controls reduce the quantity and quality of housing About 80% of economists agree that: Cash payments increase the welfare of recipients more that transfers-in-kind A minimum wage increases unemployment amongst young and unskilled workers Disagreement amongst economists Economist and non-economists disagree about the causes of economic problems and appropriate solutions. Apart from the fact that economics is a relativity young science there are various reasons for this disagreement. These include: A disagreement about what ought to be Disagreement about the facts Biased thinking Different time perspectives In order to understand the world, economists developed simplified models that contain what they regard as the most important economic variables. They then use these models not only to explain the world but also to identify what policy measures can be used to improve the economy. Since there is no agreement about the correct model to use, a variety of different points of views and disagreement about economic issues arises in the world. President Ronald Reagan of the United States of America once commented on the different advice he got from economists by joking that if the game of Trivial Pursuit were designed for economists it would have answers for 100 questions. The different world views that are embedded in the different economic models results in the same set of facts being interpreted differently by different economists. When a Keynesian economist looks at the unemployment figures for a country he or she might conclude that the cause of this unemployment is an inadequate demand for goods and services and that the solution is increasing in the demand for goods and services. A classical economist looking at the same facts might conclude that the problem of unemployment is in reality a problem of poverty since the wages are too low and that the solution for the problem is to fight poverty and not simply to increase in the number of low earning jobs. Sometimes economists agree on the objective to achieve but disagree about the how it is to be done. There might be agreement that households should be taxed but disagreement on whether the tax should be an income tax or a consumption tax such as VAT. Economists might also be biased in their thinking and their providing of solutions to economic problems when they base their opinions on their own particular experience and values, interest and preference for a particular point of view. Workers tend to blame business for all their problems and businesses blame the labour force for their problems. Politicians blame the opposition or the past regimes for current problems. Consumers blame the suppliers for high prices and suppliers blame the government for the problems they experience. In this way of practising economics, objectivity is the first causality. Another source of disagreement is the time period used when economic problems are analysed. The focus could be on short term fixes or long terms goals. This is particularly important when the issue of economic growth, unemployment and inflation are analysed. 12 Topic 1

18 Activity Indicate whether the following statements are true or false: a) The fallacy of composition occurs when it is argued that what is true for a part is also true for the whole. b) In economics it is possible to repeat experiments in order to determine the impact of one variable on another. c) If the economic growth rate for a country is positive we can conclude that the level of economic activity has increased. d) If the inflation rate falls from 8% to 5% it means that prices are now 3% lower. e) If two things are correlated it always implies that the one event causes the other event. f) All economists use the same economic model and therefore agree on how to analyse economic problems. 2. Give some reasons why economists might disagree on how to solve the unemployment problem in South Africa. 1.4 The concepts of demand and supply The demand for a product and its price There are a number of factors that influence the demand for a product. These include the income of consumers, the number of consumers, the taste and preferences of consumers, the price of related goods and the price of the product itself. Module 1: Basic economic principles 13

19 Price of the product and the quantity demanded A very important factor in determining the quantity of a product or services demanded is the price of that product or service. This relationship is often presented with the aid of a graph called the demand curve. To explain this demand curve we will make use of the demand for fried chicken pieces by the Dlamini household. Activity 1.6 In groups, discuss the following questions before reporting-back to the class: 1. What will happen to the quantity of fried chicken pieces demanded by the Dlamini household if the price of fried chicken pieces increases? Explain your answer. 2. What will happen to the quantity of fried chicken pieces demanded by the Dlamini household if the price of fried chicken pieces decreases? Explain your answer. The law of demand As the price of fried chicken pieces increases, the Dlamini family will demand a lower quantity because they will be less able to afford it. But, as the price of fried chicken decreases, the family will be able to afford to buy more fried chicken pieces. Thus, they will demand a higher quantity. Take note: The relationship between the price and the quantity demanded of a product is a very important relationship in economics. In fact, it is so important that economist call it a law the law of demand. The law of demand states that if all other things remain the same, but the price of a product increases, the quantity demanded thereof will decrease. Similarly, if the price of a product decreases, the quantity demanded thereof will increase. The resulting conclusion is that between the price of a product and the quantity demanded a negative or inverse relationship exists. Read the definition of the law of demand again. It also says if all other things remain the same. This refers to the ceteris paribus condition you learned about previously. This means that the relationship between price and quantity will always be the same if all the other variables that may influence the demand for a product do not change. In other words, when you thought about how a change in the price of fried chicken pieces affects the quantity demanded by the Dlamini family, you assumed that their income, taste and the number of family members stayed the same. You also assumed that the prices of other, related goods did not change either. 14 Topic 1

20 Activity 1.7 Complete the following statement on the law of demand: Given that all other things remain the (i), if the price of a product increases, the quantity demanded thereof will (ii), and if the price of a product decreases, the quantity demanded thereof will (iii). This indicates that a (iv) or (v) relationship exists between the price of a product and the quantity demand thereof. Using a demand schedule The law of demand can be expressed using a demand schedule. A demand schedule is a table that shows the quantity demanded of a product at each price. Look at the example below. The left hand column shows different prices for fried chicken pieces. These prices are referred to as the independent variables as they determine the quantity demanded. The right hand column shows the quantity of fried chicken pieces that the Dlamini family would demand at each price. These quantities are called the dependent variables because they depend on the price of fried chicken pieces. Price of fried chicken per piece (Rand) Quantity of fried chicken pieces demanded (per week) Price of fried chicken pieces and quantity demanded According to the above table, at a price of R5 per fried chicken piece, the family will demand four pieces of chicken per week; and at a price of R4, they will demand eight pieces per week. Looking at the demand schedule above, you can see that the lower the price of fried chicken pieces goes, the higher the quantity demanded is; and that the higher the price of fried chicken pieces goes, the lower the quantity demanded is. Thus, the demand schedule clearly shows the law of demand. Drawing a demand curve It is also possible to demonstrate the law of demand using a graph. Look at the graphs below. The first graph shows the axes of a graph, namely the vertical and horizontal axes. The vertical axis shows the price (P) of the product or service and in this example, is labelled Module 1: Basic economic principles 15

21 Price of a fried chicken piece. This is the independent variable. The horizontal axis indicates the quantity demanded (Qd) and is in this example is labelled Quantity demanded of fried chicken pieces (per week). This is the dependent variable. Using the information in the above schedule the following demand curve can be drawn. Price of a fried chicken piece (Rand) Vertical axis Horizontal axis Quantity demanded of fried chicken pieces (per week) Price of a fried chicken piece (Rand) Slopes downwards Quantity demanded of fried chicken pieces (per week) A demand curve: a graph that shows how the quantity demanded for a product during a specified period of time will change as the price of that product changes The demand curve is labeled DD. The demand curve shows how many pieces of fried chicken (the quantity demanded) the family plans to buy at each price. The demand curve slopes downwards from left to right. This slope shows the law of demand as the price of fried chicken pieces decreases, the quantity demanded by the family increases. Thus, the graph shows P Qd. Similarly, an increase in the price of fried chicken pieces can be illustrated using an upward movement along the demand curve. Thus, an upward movement will show P Qd. 16 Topic 1

22 Price of a fried chicken piece (Rand) Upward movement Quantity demanded of fried chicken pieces (per week) An upward movement along the demand curve occurs when the price increases It is important to note that a change in the price of fried chicken pieces causes a downward or upward movement along the demand curve (DD) and not a shift of the demand curve itself. This is because the demand curve shows the relationship between the price of a product and the quantity demanded of it at each price. Think about it A well-known economist was once asked what he thought is the most important lesson for an economics student to remember. His answer was that the most important lesson to remember is that a demand curve is a downward sloping curve that shows how a lower quantity is demanded at a higher price than at a lower price. Activity Use the following demand schedule to copy and complete the graph to show Peter s demand for cold drinks. Price of a can of cold drink (Rand) Quantity of cold drinks demanded (per week) With a partner, discuss the following questions: a) What does the demand curve (DD) look like? b) Indicate on the graph how many cold drinks Peter demands at a price of R5 per can? c) Indicate on the graph how many cold drinks Peter demands at a price of R2 per can? Price of a cold drink (Rand) Price of a can of cold drink and quantity demanded Quantity demanded of cold drinks (per week) Module 1: Basic economic principles 17

23 d) In which direction does the demand curve go to indicate a decrease in the price of cold drinks? e) Why does Peter demand more cold drinks when the price of cold drinks decreases? f) In which direction does the demand curve go to show an increase in the price of cold drinks? g) Why does Peter demand fewer cold drinks when the price of cold drinks increases? The downward sloping demand curve for fried chicken pieces by the Dlamini family is also valid for most other goods and services that are consumed by households in the economy. The demand curves for meat, bread, shampoo and books are all downward sloping indicating that the higher the price the lower the quantity demanded. The market demand curve is the demand curve for all potential customers. It is also downward sloping indicating that as the price rises, the quantity demanded falls and as the price declines the quantity demanded rises. The law of supply The relationship between the price of a product and the quantity supplied is very important in economics. This relationship is called the law of supply. The law of supply states that given that all other things remain the same, if the price of a product increases, the quantity supplied thereof will increase; and if the price of a product decreases, the quantity supplied thereof will decrease. A positive relationship: a change in one variable will be in the same direction as a change in the other variable As with the law of demand, in the law of supply the relationship between price and quantity supplied assumes that there are things that remain the same in this case, technology, the prices of inputs, the cost of production, and the price of alternative products. Unlike with the law of demand, in the law of supply, the relationship between the price of a product and the quantity supplied thereof is a positive relationship both variables either go up or go down. They always move in the same direction. In a positive relationship, a change in one variable goes in the same direction as a change in the other variable 18 Topic 1

24 Activity 1.9 Complete the following statement: The law of supply states that given that all other things remain the (i), if the price of a product increases, the quantity supplied thereof will (ii), and if the price of a product decreases, the quantity supplied thereof will (iii). This indicates a (iv) relationship between the price of a product and the quantity supplied thereof. Using a supply schedule Like the law of demand, the law of supply can also be expressed using a supply schedule. A supply schedule is a table that indicates the quantity of a product supplied at each price. Look at the example below. The left hand column states the price of a piece of fried chicken this is the independent variable because it determines the quantity supplied. The right hand column shows the quantity of fried chicken pieces that Chick Roast is willing to supply at each price this is called the dependent variable because it depends on the price of fried chicken pieces. A supply schedule: a table that shows the quantity supplied at each and every price Price of fried chicken per piece (Rand) Quantity of fried chicken pieces supplied (per week) Price of fried chicken pieces and quantity supplied Can you see how at R5, Chick roast will supply 20 pieces of fried chicken per week, and at R4, it will supply 16 pieces of fried chicken per week? Activity 1.10 Study the following supply schedule which represents the supply of cold drinks by Coco Drinks. Answer the questions that follow. Price of a can of cold drink (Rand) Quantity of cold drinks supplied (per week) Price of a can of cold drink and quantity supplied Module 1: Basic economic principles 19

25 1) How many cans of cold drink is Coco Drinks willing to supply at a price of: a) R6 per can b) R5 per can c) R4 per can d) R3 per can e) R2 per can 2) How many more cans of cold drink is Coco Drinks willing to supply if the price of cold drink cans increases from R5 to R6? 3) How many fewer cans of cold drink is Coco Drinks willing to supply if the price of cold drink cans decreases from R5 to R3? 4) As the price of cold drink cans increases, what happens to the quantity supplied? 5) As the price of cold drink cans decreases, what happens to the quantity supplied? A supply curve: a graph that shows how the quantity supplied for a product during a specified period of time will change as the price of that product changes. Using a graph It is also possible to demonstrate the law of supply using a graph. To do this, you use the information in the supply schedule. Look at the graph below. The information from the supply schedule is plotted along the axes and the supply curve is drawn by joining the plotted points. The supply curve shows the quantity of fried chicken pieces supplied at each price. Price of a fried chicken piece (Rand) Slopes upwards Quantity demanded of fried chicken pieces (per week) The supply curve slopes upwards from left to right. This shows that as the price increases, the quantity supplied also increases The fact that the supply curve slopes upwards indicates that there is a positive relationship between the price of fried chicken and the quantity of fried chicken supplied. An increase in the quantity of pieces supplied is shown by an upward movement along the supply curve. 20 Topic 1

26 Price of a fried chicken piece (Rand) Upward movement Quantity demanded of fried chicken pieces (per week) An upward movement along the supply curve occurs when the price increases. Similarly, a decrease in the price of fried chicken pieces will be shown as a downward movement along the supply curve. This is shown on the graph below. Price of a fried chicken piece (Rand) Down movement Quantity demanded of fried chicken pieces (per week) A downward movement along the supply curve occurs when the price decreases. Activity Use the following supply schedule to complete a graph with a supply curve. Price of a can of cold drink (Rand) Quantity of cold drinks supplied (per week) Price of a can of cold drink and quantity supplied Module 1: Basic economic principles 21

27 2. Answer the following questions: a) Describe the supply curve. b) Highlight on your graph how many cans of cold drink Coco Drinks is willing to supply at R5 and at R2. c) Draw an arrow to show the direction of the supply curve when the price increases. d) Draw an arrow to show the direction of the supply curve when the price decreases. The upward sloping supply curve as shown for fried chicken pieces by Chick Roast is also valid for most other goods and services that are supplied in the economy. This indicates that the higher the price the higher the quantity supplied and the lower the price the lower the quantity supplied. The market supply curve, that is the supple curve for all potential suppliers, is also upward sloping indicating that as the price rises, the quantity supplied increases and as the price declines the quantity supplied falls. Price elasticity of demand Businesses know that a change in the price of their product will cause a change in the quantity demanded. In most instances an increase in the price will cause a decrease in the quantity demanded while a decrease in the price will cause an increase in the quantity demanded. They face a downward sloping demand curve and the law of demand is in operation. They might not know the exact form of the demand curve, but they know that the law of demand applies to them. Think about it An increase in the price causes a decrease in the quantity demanded and a decrease in the price causes an increase in the quantity demanded What do you think will happen to total revenue if an increase in the price does not cause a significant decrease in the quantity? Does this mean they should never increase the price of their products but rather always think of ways and means to decrease the price of their products? The answer to this question depends on what will happen to the total revenue of the firm if it raises or decreases the price of its products. Total revenue (TR) is equal to price (P) times quantity (Q). 22 Topic 1

28 Imagine the following scenario: Case Study It is 2010 and Bafana Bafana is set to play in the final match of the Soccer World Cup. The soccer stadium in which the final match is to take place has a capacity of seats. If the tickets sell for R100 each the total revenue from this match will be R100 x = R10 million. What if the price of the tickets is R150? If they still sell tickets the total revenue will be x R150 = R15 million. Can you see how an increase in the price, given that they still sell the same number of tickets, increases their total revenue from R10 million to R15 million? But what if for some reason they are only able to sell tickets at a price of R150? In this case, their total revenue is x R150 = R13, 5 million, which is still an increase of R3, 5 million. Can you see how their total revenue increases even if they sell fewer tickets? And what if they decide to sell the tickets at a lower price than R100, say for R90? They will most probably sell all tickets, but their total revenue will decline to R9 million. In this case the demand is said to be price inelastic. This means that buyers do not significantly change their behaviour if the price of the product changes. How much do you think they should charge for a ticket? What will happen if an increase in the price does in fact cause a significant decrease in the quantity? At the same match, there are a number of food vendors and outlets which sell fast food including hamburgers, hot dogs, boerewors rolls, fried chicken pieces and chicken burgers. Chick Roast is an outlet that sells fried chicken pieces. If they sell a fried chicken piece at R4 per piece, they will sell pieces. Their total revenue will be R4 x pieces = R If they sell a fried chicken piece for R4,40 per piece, and they sell pieces, their total revenue would be R4,40 x 8000 = R As they increase their price, their total revenue would decline from R to R In this example, we would say that the demand for fried chicken pieces is price elastic. This means that buyers do significantly change their behaviour if the price of the product changes. This relationship between a change in price and a change in the quantity demanded is captured by the price elasticity of demand. In the case study of the final match of the Soccer World Cup, the number of tickets demanded was unresponsive to changes in the price of tickets. In economics this is referred to as price inelastic demand. In the case of fried chicken pieces, the quantity of fried chicken pieces demanded was very responsive to a change in its price. In economics this is referred to as a price elastic demand. Module 1: Basic economic principles 23

29 Activity In groups, discuss whether you would expect demand to be price elastic or price inelastic in each of the following examples: a) The demand for petrol. b) The demand for hamburgers. c) The demand for anti-retroviral medication. d) The demand for fried chips. Price elasticity of supply According to the law of supply, an increase in the price of a product increases the quantity supplied and businesses face an upward sloping supply curve. An increase in the price of a product causes an increase in the quantity supplied and a decrease in the price causes a decrease in the quantity supplied. P Qs P Qs Price elasticity of supply provides us with a measure of how sensitive or responsive the quantity supplied is to a change in the price. Just like with price elasticity of demand, it is possible to distinguish between an elastic supply and an inelastic supply. In the case of an elastic supply the change in price has a significant impact on the quantity supplied; a small increase in the price leads to a large increase in the quantity supplied. In the case of an inelastic supply a change in price does not have a significant impact on the quantity supplied; a large increase in price leads to a small increase in quantity supplied. 24 Topic 1

30 1.5 The impact of different economic systems The basic questions that are studied in economics are: What is to be produced and in what quantities? How are the goods to be produced? For whom are the goods produced? Who makes economic decisions and how? Market economy In a pure market economy the decisions of what products to produce, how to produce them and for whom to produce them are dictated by the forces of supply and demand which in turn establish prices. Economic activity is therefore regulated by the pricing mechanism. Consumers buy what they want according to what they can afford and according to the price they are prepared to pay. Producers produce and sell according to what they are able to sell and still make an acceptable profit. The main objective for any production in a market economy is profit. Changes in the price of any good or services result in consumers and producers having to reconsider their decisions or choices according to their situation. No single producer or group of producers can influence these decisions. No single consumer or group of consumers is powerful enough to dictate to other consumers or the producers. A further defining aspect of a market economy is that factors of production are owned by individuals, not the state. The state s role is limited to certain functions including the provision of national defence and national health services. According to the theory of the market economy, the forces of supply and demand work to ensure that the resources used in the production processes are used efficiently, and the goods that are provided by the system are also distributed fairly amongst consumers. The argument is that if the market system works properly most people should have jobs and therefore be able to buy what they need. This type of system is also called the free-market system because the forces of supply and demand are allowed to work freely in the market. There is no interference from government. Any interference by government is not only unnecessary when these market forces work well but would probably result in inefficiency. The result of inefficiency is waste. Waste could well lead to some companies going bankrupt resulting in job losses. Unfortunately economic reality does not always match the economic theory. In some instances the market system can also be the cause of inefficiencies because the market sometimes fails to produce the product that people need. We will look at market failures in more detail in a later module (see module 6). Inequality in the distribution of income and wealth is also a problem under a market system because the interests of the individual are more important than the interests of the community. Market economy: an economic system that is regulated by the forces of supply and demand which interact to establish prices Market failure: when the market fails for various reasons to provide products that consumers need or want Inequality: unequal distribution of income and wealth Module 1: Basic economic principles 25

31 Command economy: an economic system under which the state makes all the decisions related to the economic process Command economy In a pure command economy, the government or the state decides what products must be produced, how the products must be produced and for whom they are produced. The motive behind this type of system is to provide all the citizens of a country with what they need. Moral considerations are supposed to be the driving force behind production and consumption decisions. The government decides what the citizens of a country need and want. The government also decides who will produce these products, where the factories will be located, what raw materials will be used in the production process and ultimately what price the consumer will pay for each good. Another name for this type of system is a centrally planned system. Under such a system all the factors of production are owned by the state. In addition, in a command economy housing, water and electricity, transport, health and education are provided free of charge. People have to work for a government department or in a state run factory in order to compensate the government for providing them with their basic needs. The people who are in charge of running the factories have to make sure that they provide the necessary products as ordered. Unlike a market economy, in a command economy the need to make a profit is not the main reason why a producer will start a factory and carry on producing goods. This is the type of system that was used in socialist countries. One of the positive results of living under a socialist system was often a very good education. One of the negative results though, was that this education and subsequent employment was often not what an individual may have chosen. That was decided by the state. What the individual wanted to do or enjoyed doing was not often considered. One of the goals of this type of system is equity. Everyone earns more or less the same income. Although the idea can often be appealing, the problem that occurred in reality was that everyone ended up being rather poor, except for some politicians. Most people had their basic needs met but there was very little in the way of choice when it came to goods in the shops. An important thing we learn from both the market and the command system is that neither system is perfect. Experience has taught us that it is a good idea to take the best from both systems. This is what we have tried to do in South Africa. Activity In small groups, discuss the differences between a pure market and a pure command economy or system. Create a presentation using the following as a starting point: Who decides what must be produced in these two systems? Who decides how goods must be produced in these two systems? Who decides what consumers may or may not buy in these two systems? 26 Topic 1

32 Name one good aspect of both the market and the command economy or system. Looking at the reality, name one negative aspect of both the market and the command economy. Do you think that South Africa can have an economic system that takes the best from both the market and command economies? 2. Some of you may be asked to make your presentation to the rest of the class. Mixed economy In South Africa we have what is called a mixed economy. Although the market dictates most production and consumption decisions in the economy, many goods and services are provided by the state. For example we have public hospitals, clinics and schools. A person who has no money at all can still receive medical attention at a clinic or a public hospital. A child whose parents cannot pay school fees is still allowed to attend school. In a later module you will look at the Minister of Finance s budget. You will see that the government allocates quite a large proportion of the budget to education and health. A mixed economy tries to address the needs of those people who are really struggling. In this way we have some of the characteristics of a command economy. In most cases though, we have to pay for the goods or services that we need or want. However, we do not always pay the full price. Tertiary education is a good example of this. Although people who study through a university pay a lot of money in fees to the institution, much of the money needed to run a university still comes from the government. In a mixed economy, if you decide you want to buy a new TV set or a new cell phone, the government is not going to help you pay for it! Here you are at the mercy of the market system. If you have some form of income then you can go to the shop and buy the product that you want. If you do not have the money to pay for the product then you cannot have it. In South Africa we have an economy that is market oriented but with some government intervention. But when is an economy a mixed economy and not a market or a command economy? In Diagram 1.1 you will see an illustration of the difference between theory and reality. In theory we may have a pure market economy, illustrated by the arrow head on the left of the straight line. The arrow head on the right hand side of the straight line illustrates the theoretical pure command economy. In between we may find a variety of practical examples. Diagram 1.1 Mixed economy: an economic system that has characteristics of both a market and a command economic system Mixed but more market 50/50 Mixed but more command USA RSA Sweden China (1990s) USSR Pure market Mixed Pure command Economy economy economy Module 1: Basic economic principles 27

33 The economies of some countries may be more market-oriented but may include a little bit of command style. Such an economy would be placed on the left hand side of the line but not quite on the arrow head. An example of this may be the USA. The old socialist countries like the USSR and China before the 1970s, would have been placed close to the right hand arrow head but also not on it. A country like Sweden which is a market economy but which also has a very strong social welfare system may be illustrated by the midpoint, shown as 50/50. Other countries may have a more command economy while market forces play an important role in the economy for example China during the 1990s, and such a country could be illustrated just slightly to the right of the midpoint. South Africa s economy is a market economy but government plays an important role in development issues. South Africa (RSA) could be placed just to the left of the midpoint. It is for this reason that it is important that you understand what markets are and how the forces of supply and demand interact in the market. South Africa is classified as a developing country and the role played by government will therefore not be the same as it would be in a developed country like the USA. It is important that you understand the role of government in a developing country. Unfortunately even a mixed economy is not perfect and fails many people. There are still people who are poverty stricken and who do not get enough to eat and who cannot find employment. There are also other problems that are not solved by having a mixed economy. The environment is still being polluted and in some cases misused, and global warming has become a very real and frightening threat to the future of humanity. We will look at these different problems in the later modules. Activity 1.14 You will complete this activity in two groups. Debate the following statement: A mixed economy is always the best option for a country. Your lecturer will tell you whether your group is in favour or against the statement. Divide the class into small groups. Your lecturer will also explain how a debate works and allow you time to research your group s point of view before the debate. One aspect you may want to research is the problems that even a mixed economy cannot solve. 1.6 The role of the economy in producing goods and services To produce goods and services a country must have production capacity. A country s capacity to produce goods and services is directly related to the availability and quality of the factors of production. Remember that these are natural resources, capital, labour and 28 Topic 1

34 entrepreneurship. These are the supply factors that influence economic growth and economic development. The greater the quantity of factors of production a country has, the higher the potential output of the country. It is possible to increase the potential output of a country by ensuring an increase in the productivity of the factors of production. With the same volume of factors of production, the potential output increases if these factors are used more efficiently. Natural resources Natural resources are all those resources supplied by nature and used in the production of goods and services. These resources can be regarded as a gift of nature since we did not have to do anything to create them. They include things such as agricultural and residential land, water, wildlife, natural beauty, vegetation, air, climate, sunshine, mineral deposits and soil nutrients. An important characteristic of natural resources is that the supply is fixed. It is not possible for us to increase the supply of these natural resources by our own efforts. It is possible, however, to discover new natural resources and improve the quality of some of these natural resources. Through exploration we can discover new deposits of oil. Through irrigation projects and the use of fertiliser we can turn more land into productive agricultural land. While South Africa is in the fortunate position of having a wide variety and quantity of mineral resources, these resources are non-renewable. Once they are used they cannot be replaced. The rates at which they are exploited are therefore a cause for concern. In the past, the exploitation of our mineral resources was the single most important contributor to economic growth. It would be a mistake to continue to base our economic growth and economic development strategies on the exploitation of our mineral wealth. Future economic growth and development will have to depend more on other factors as the mineral supply is depleted. Labour Labour is any human effort that is put into the production of goods and services with the aim of receiving a reward. Labour includes both physical and mental effort. There are mainly three factors that determine the quantity and supply of labour available in a country: The population growth rate (the birth rate minus the death rate) If the birth rate exceeds the death rate, the size of the population increases. Since there are more people, there is more labour. The effect of an increase in the population growth rate is not felt immediately but only when the children reach working age. Module 1: Basic economic principles 29

35 The labour force participation rate This figure gives us an idea of the proportion of the population that is economically active. The economically active population (EAP) comprises every person in the working age group between the ages of 15 and 65 who is willing and able to work. This excludes those people of working age that are not available for work, such as students, fulltime home workers, retired people, and those that are unwilling or unable to work. Migration This is the movement of groups of people from one locality to another and we differentiate between immigration and emigration. Quantity of labour Workers who move from one country or area to another immediately add to the labour force of the destination country or area. According to official data provided by Statistics South Africa, immigration was an important source of skilled labour for South Africa in the past, but the trend has changed and we are now experiencing an outflow of skilled labour. Even more important than the quantity of labour is the quality of labour. Quality of labour The quality of labour refers to the skills, knowledge and health of workers. The quality of labour is often referred to as human capital. Many economists believe that the difference in living standards between countries is mainly a result of the differences in the quality of their human capital. The better the quality of human capital in a country, the higher the productivity of labour, and the more goods and services are produced to satisfy needs and wants. Factors that impact positively on the quality of the labour force are: education, training and retraining, managerial skills, health, nutrition and attitude to work. In the past, South Africa paid far too little attention to the development of its human capital. Education and training, particularly of non-whites, was neglected. Consequently, South Africa is now suffering from an over-supply of unskilled labour and a shortage of skilled labour. Capital Capital comprises all manufactured resources such as machines, tools and buildings that are used in the production of other goods and services. A distinction can be made between the capital required to build up the production structure of a country and the capital required to build up the infrastructure of a country. 30 Topic 1

36 Production Capacity Infrastructure Capacity The production capacity directly contributes to the production of goods and services, while the infrastructure capacity contributes indirectly to the production of goods and services. Both are important for economic growth and economic development. The capital goods required to build up the production structure are those goods that directly contribute to the production of goods and services, such as factories, buildings, machines and tools. The more machines, factories and tools we have, the more goods and services we can produce. The better the quality of these capital goods, the more productive we can be. The more productive we are, the higher our economic growth will be. Appropriate capital goods also improve the productivity of labour. It is believed that some countries fail to develop because they do not have the necessary capital goods to start modern manufacturing and production processes. The infrastructure of a country contributes indirectly to the production of goods and services. For effective production to take place in a country, it needs to have roads, electricity, water, sanitation, educational institutions, telecommunications networks and law and order. These are things that government undertakes to develop and maintain. To achieve economic growth and economic development, we also need to create new capital goods continuously and replace outmoded and worn-out capital on a regular basis. Sufficient funding must be available to finance the creation and replacement of capital goods. Important sources of finance are the personal savings of households, firms, government and loans from the rest of the world. All savings form the basis of investments. Formulating policies to improve economic growth and economic development must therefore take financing into account. One of the causes of underdevelopment is the low rate of savings in developing countries. The fact that most of the capital goods used in the production of goods and services in South Africa are imported from the rest of the world must be taken into account when economic growth and development Module 1: Basic economic principles 31