Economic Environment NQF Level 2 FHB Serfontein STUDENT S BOOK
Economic Environment Student s Book TVET FIRST NQF Level 2 B Serfontein
TVET FIRST Economic Environment NQF Level 2 Student s book B. Serfontein Illustrations and design Macmillan South Africa (Pty) Ltd 2006 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 2007 15 17 19 20 18 16 9 11 13 15 17 19 21 23 24 25 26 22 20 18 16 14 12 10 8 Published by Macmillan South Africa (Pty) Ltd Private Bag X19, Northlands, 2116, Gauteng, South Africa Typeset in Palatino 11 pt Cover by BrandTalk, a subsidiary of African Access Design by BrandTalk, subsidiary of African Access Illustrations by Christeen Grant, Peter Davidson, Ken Etberg, Francois Naude, Ian Greenop, Doug Hughes, Heins Worst and Marietjie Steyn 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) 731 3300 Fax: (011) 731 3535 E-mail: customerservices@macmillan.co.za ISBN: 978 085320 505 0 e-isbn: 9781431020683 WIP: 1787M000 It is illegal to photocopy any page of this book without written permission from the publishers. ACKNOWLEDGEMENTS The publisher and author wish to thank the copyright holders for permission to reproduce the following items: The South African Reserve Bank for the use of the table form the Quarterly Bulletin March 2005;Business day for the use of an extract. Many thanks to the following publications for the use of their logos: The Cape Argus, The Sunday Times, The Mail & Guardian, MBendi Information Services, The Sowetan and Fin Week.
Contents Topic 1 1 Module 1: Basic economic principles 2 Unit 1: What is economics? 4 Unit 2: The role of consumers in the economy 14 Unit 3: Supply and demand 22 Unit 4: The production of goods and services 34 Unit 5: Economic systems 42 Unit 6: Money, banking and monetary policy 52 Unit 7: Fiscal policy 65 Topic 2 75 Module 2: Current affairs and the business sector/industry 76 Unit 8: The physical environment of a business sector/industry 77 Unit 9: The social environment of a business sector/industry 86 Unit 10: The economic environment of a business sector/industry 96 Unit 11: Businesses and people in the news 112 Topic 3 119 Module 3: The international trading environment 120 Unit 12: Domestic and international trade cycle 121 Unit 13: Principles of international trade 128 Unit 14: Importing and exporting in South Africa 136 Portfolio of Evidence Guideline 146
Topic 1 1
Module 1 Basic economic principles Overview Unit 1: What is economics? In this unit you will learn about the field of study of economics learn about the economic problem of limited resources and unlimited needs understand why scarcity forces us to make choices, and how these choices result in opportunity costs learn about the central economic questions that are studied in economics know why economics is a social science know the differences between microeconomics and macroeconomics know why economics is important for individuals, businesses and government Unit 2: The role of consumers in the economy In this unit you will learn the difference between needs and wants the characteristics of needs and wants about the different kinds of goods and services consumed in the economy about the role of consumption spending in the economy about the relationship between consumption and savings about the motives for saving about the determinants of savings about the role savings play in the economy Unit 3: Supply and demand In this unit you will learn what supply is what the factors are that determine the supply of a product how these factors influence the supply of a product about the law of supply what market supply is what demand is what the factors are that determine the demand for a product how these factors influence the demand for a product about the law of demand what market demand is how prices of products and services are determined 2 Topic 1, Module 1
Unit 4: The production of goods and services In this unit you will learn about the purpose of production the factors of production and their characteristics the production process how value is created through the production process the classification of production the importance of the different sectors for the South African economy Unit 5: Economic systems In this unit you will learn what the different economic systems are and their characteristics the characteristics of South Africa s mixed economy Unit 6: Money, banking and monetary policy In this unit you will learn about the characteristics of money the role of money in the economy the role of banks in the economy the role of the South African Reserve Bank in the economy monetary policy the impact of the interest rate on the economy Unit 7: Fiscal policy In this unit you will learn about fiscal policy the objectives of fiscal policy instruments and policy variables of fiscal policy how fiscal policy can be used to influence economic activity Module 1: Basic economic principles 3
Unit 1: What is economics? Introduction It is important that you understand what economics is and what the study of this subject involves in order to understand your role in the economy. In this unit we will define the term economics, needs and wants, the economic problem and micro- and macroeconomics. 1.1 Definition of economics Economics is the study of how we as a society use our limited (or scarce) resources to satisfy our unlimited needs and wants. What do we mean by unlimited needs and wants and scarce resources? Words & Terms Economics: the study of how our scarce productive resources are used to satisfy human needs and wants Needs: the essential things we must have for our well-being Wants: our human desire for goods and services that are nice to have 1.1.1 Unlimited needs and wants Every single human being has needs and wants. Psychologists (the people who study the way people think and act) say that every person in the world has a need for love, security and social recognition, as well as a need for necessities like food, shelter and water. However, people have a list of needs and wants that is usually much longer than this list! As people get older and change, their list gets longer and changes. So, we can say that people s needs and wants are continually increasing and changing. But have you ever noticed how, once you have satisfied a need or want, there is always something else you need or want? We all would like more food, more love, more free time, etc. strangely, not more homework! and what we have never seems to be enough. Even in very rich societies, you will find that people have wants and needs that are not fully satisfied. Unlimited needs and wants Limited resources 4 Topic 1, Module 1
1.1.2 Scarce resources People need resources to make and produce the goods and services that can satisfy their needs and wants. But, there will never be enough resources to make all those goods and services meet everyone s needs and wants. This means that the number of goods and services that people would like to consume will always be more than the number that can be produced. As a result, there will be a scarcity of goods and services. 1.2 The economic problem It is because of the scarcity of resources that societies are forced to make choices about which needs and wants to satisfy. Economics gives us the tools and knowledge necessary to make these kinds of choices. So, economics is about deciding how best to use the very limited resources available to best satisfy as many needs and wants as possible. This is the central problem that is studied in economics. Choices and opportunity cost The fact that we live in a world of scarcity means that we have to make choices all the time. But these choices are not always popular or easy to make. Choices come at a cost (something must be given up), and this something is the opportunity cost of a choice. A large part of the study of economics is based on the idea that individuals and societies make choices by comparing the benefits of different options, and choosing one option that has the highest benefit. The opportunity cost or the cost of a choice is the benefit (value) that is given up in terms of the next best alternative. Limited resources Which needs and wants to satisfy? Think about it There are over six billion people on our planet. Imagine the long list of needs and wants of each and every single one of these people! Just imagine trying to satisfy everyone s needs and wants with the resources available! For example, how much food do you think six billion people need? There is only so much land available that can be used to cultivate the crops to feed everyone. And to make matters worse, the amount of land available is getting smaller all the time as more and more land is being used for other things, e.g. industry, cities. Words & Terms Resources: the land, labour, capital and entrepreneurship needed to produce goods Scarcity: there are not enough resources to produce enough goods and services to fulfil all our needs and wants Opportunity costs Best alternative that has to be sacrificed The opportunity cost of a choice is the value of the best sacrificed alternative 1.3 The four fundamental questions Now you know that economics looks at how society uses limited resources to satisfy unlimited wants and needs. You also know that a scarcity of resources means that choices have to be made, and that Unit 1: What is economics? 5
every choice involves an opportunity cost in terms of the best alternative that is given up. Now it is time to take a closer look at the fundamental questions that are studied in economics. 1. What is to be produced, and in what quantities? Economic activities production and consumption are done to satisfy human wants and needs. Because we cannot produce all the goods and services that people want, we must decide which ones to produce and how much. 2. How are goods produced? There are many ways of making something, e.g. a car can be manufactured using only human labour (labour intensive) or using only robots and machines (capital intensive). This decision is usually based on what method is cheaper and more efficient. So, these decisions may change from country to country. For example, it may be more efficient to use capital-intensive techniques in Germany where labour is very expensive, but labour-intensive techniques in India where labour is cheap. 3. For whom are goods produced? Goods and services are usually produced for people who want goods or services and also have the income to pay for it. 4. Who makes economic decisions, and by what process? Economic decisions are made by the various participants in an economy, e.g. households, firms and government. The process that is used to make economic decisions is complex, and different countries use different systems. You will learn more about systems later. PRODUCE: What? How much? How? Important decision makers in the economy are households, firms and government 6 Topic 1, Module 1
1.4 Economics as a social science Economics deals with our needs and wants and how we attempt to satisfy them. This means that it studies people and their behaviour. Economics is therefore a social science. As a social science, it is related to the other social science disciplines, e.g. sociology (the study of societies and social problems), anthropology (the study of humankind and its customs), political studies (the study of government) and psychology (the study of the human mind and its functions). Because it is a science, it uses a logical and scientific approach to discovering how people behave. What do you think a scientific approach means? To understand a scientific approach, it is important that you recognise a few key steps: Economists observe and theorise on human behaviour to explain the world, predict outcomes and make policies. Based on this careful observation, economists can recognise patterns, whether of behaviour or of the results of behaviour. Economists can then state the pattern of behaviour as a theory, e.g. as the price of goods rises, the demand for it will fall. 1.5 Microeconomics and macroeconomics The study of economics can be divided into two main branches called microeconomics and macroeconomics. 1.5.1 Microeconomics The word micro means small. Microeconomics looks at the behaviour of the units of an economy the firms (businesses), households and individuals. It focuses on how these units make decisions, e.g. why households prefer one product to another, or how businesses decide to produce one product rather than another. Thus, microeconomics focuses on the markets their products, prices and outputs. In microeconomics we try to answer questions such as: What are the factors that influence the supply of a product by an individual firm? In unit 3 we take a closer look at the supply factors. What are the factors that influence the demand for a product by an individual consumer or a household? In unit 3 we take a closer look at what these factors are. How is the price of an individual product determined? We address this in unit 3. What influences the decision to import or export a specific product? We address this in unit 14. 1.5.2 Macroeconomics The word macro means large. Macroeconomics looks at the behaviour of the economy as a whole, e.g. the overall unemployment Words & Terms Social science: studies the human aspects of the world. It includes study areas such as economics, geography, history, political science, psychology, social studies and sociology Microeconomics: studies the individual parts of the economy, e.g. households and firms, how prices are determined and how prices determine the production, distribution and use of goods and services Macroeconomics: the study of economics in terms of whole systems, e.g. total production in a country, the general price level, unemployment Unit 1: What is economics? 7
or the overall inflation rate of an economy. Macroeconomics is not concerned about what the units are doing but how the whole system is functioning. In macroeconomics we try to answer questions such as: What are the causes of inflation and what can be done about it? What are the causes of unemployment and what can be done about it? What determines the consumption and savings behaviour of households? In unit 2 we take a closer look at this issue. How does monetary policy influence the economy? We deal with this in unit 6. How does fiscal policy influence the economy? In unit 7 we take a closer look at this important issue. Think of it like this Macroeconomics is like an aerial (above ground) photograph of a landscape where the whole picture can be seen, but the small details are invisible. Microeconomics is like a walk through the same landscape details can be seen up close, but the big picture is hidden. Macroeconomics Macroeconomics Economics Aggregate price level Unemployment Total level of production Total level of exports Microeconomics Microeconomics Individual prices Unemployment in the agricultural sector Production of motor cars Exports of gold Assessment activity 1.1 Look through newspapers and financial magazines and collect examples of microeconomic and macroeconomic issues. State why you would classify them as microeconomic or macroeconomic. Keep this assessment activity in your Portfolio of Evidence. 8 Topic 1, Module 1
It is important that you realise that macroeconomics is always supported by microeconomic processes. In other words, macroeconomics is always the outcome (the result) of microeconomic behaviour. So, be careful not to group these two branches separately, and always remember that they support each other. There are many other sub-branches in economics that you may come across, but these can usually be classified into the broad categories of microeconomics or macroeconomics. There are also many different kinds of specialised (expert) economics. Have you ever heard of any of these: development economics, which focuses on the problems of poor countries; econometrics, which focuses on statistical techniques in economics; mathematical economics, which focuses on mathematical techniques in economics; labour economics, which focuses on labour markets; public finance, which focuses on the role of government; and agricultural economics, which focuses on agricultural markets? 1.6 The importance of economics 1.6.1 The individual Economics is about all those decisions you make about everyday things. It is about the things that affect you, your family, your town, your country and your planet. Economics is also about explaining the things that happen in your everyday life. Have you noticed how the prices of goods and services you buy change? Why do you think this is? Questions like these are very important in economics. This is because part of the study of economics is to explain why prices change and, importantly, how these changes in price affect you and the businesses that provide these goods and services. Are you thinking about your future yet? What you do when you have finished studying is a very important decision because you need to start preparing yourself now for the labour market. This is another very important issue in economics because, in economics, people study the dynamics of markets, including the labour market, e.g. how they function and how wages are determined. Unfortunately, South Africa has a very high unemployment rate. This means that we have a very large number of people who are looking for work, but who are unable to find it. Economics studies the causes, effects and cures of unemployment. Can you now see how economics is about the issues that affect the quality of life of you, your family and friends everyone in fact? So, why are you studying economics? Everyone should study economics. For some people, the study of economics will allow them to make a real difference to building our economy and society. But for most of us, the study of economics will allow us to make better decisions and become better citizens. As a Unit 1: What is economics? 9
young South African, you have a very important role to play in participating in and contributing to the national debate about the economic challenges that face South Africa. To play this role, you need to be economically literate. You also need economics to help you to develop a better understanding of your own actions as a human being. As you know, you are always making decisions and choices. Sometimes these choices are not easy or popular, and sometimes the choices you make mean that you have to give up something else. This means that the choices that you have made or are still going to make involve a cost something is gained, but something else is lost. 1.6.2 Business In our economy it is businesses that are responsible for the production of goods and services. Every day millions of decisions are made by businesses about what to produce and how to produce it. Successful businesses provide the right product at the lowest possible cost. The study of economics provides businesses with information about the microeconomic and macroeconomic environments. A better understanding of the availability and prices of resources, how prices of goods and services are determined, how consumers make their decisions, how fiscal and monetary policy influence the economy and the determinants of international trade helps businesses to improve their decision making. Better decisions mean we are using our scarce resources more efficiently. The more effectively and efficiently resources are used, the more goods and services can be produced, and the more needs and wants can be satisfied. So, efficient and effective use of the factors of production contributes to economic growth and the wealth of an economy. Think about it Sometimes a decision on how to produce something is easy, e.g. it is not a good idea to build a house with gold bars. But most of the time, these decisions are more complicated, e.g. should the house be built with bricks, wood or concrete blocks? Because the factors of production (resources) are scarce, these decisions are important production must be efficient and we must use resources effectively. 1.6.3 Government Through taxation and its spending decisions the government affects the life of every individual in society and the way businesses operate. The study of economics helps governments to know what the likely impact of their actions might be on the economy. For example, government has to decide how it is going to raise revenue (money) through taxation. The study of economics tells government what the likely impact of different kinds of taxes will be on the behaviour of individuals and businesses. If, for instance, income taxes are too high, it encourages people to work less and so produce less. This is something that the government would like to avoid. The government must also decide how it will spend its limited resources, i.e. the revenue that it has raised through taxation. It then has to decide how to allocate this money to competing needs, e.g. how much it wants to increase its spending on housing and education, and what this will mean for how much it spends on something else, like defence. It cannot increase its spending on everything because it has limited resources available, just like you! The study of economics helps government to make better choices. 10 Topic 1, Module 1
Think about it Because of limited resources, a government s decision to spend more money on health services will mean that it has less money available to spend on things like housing Assessment activity 1.2 Limited resources Answer the following questions on your own. 1. Indicate whether the following statements are true or false: OR But what about a slightly different choice Imagine that government has discovered a rich gold deposit somewhere, and that it wants to develop a mine there. A mine will provide employment for the people who live near the area, but because a mine can destroy the natural and ecological balance of an area for many years to come, the decision is not quite so easy. Government needs to decide where its priorities lie, i.e. it needs to decide if the short-term benefits (employment) are more important than the long-term ones (protecting the natural balance of the area). Economics can help government to make this decision because it gives it the tools to quantify (measure) the costs and benefits of the mine, and allows it to make an informed decision about the best way forward. Statement True False a) Scarcity is only a problem when people s physical needs are not being met. b) Scarcity is a problem because unlimited wants must be satisfied with limited resources. c) Rich countries do not experience scarcity. d) It is only individuals that face an opportunity cost. e) If government provides free education to its citizens, there is still an opportunity cost associated with the provision of education. f) The opportunity cost of a choice is the value of all the alternatives that are given up. g) The scarcity problem has already been solved in Switzerland but not in Zimbabwe. h) Because resources are not scarce, we do not have to use them efficiently. 2. Briefly describe the economic problem that is studied in economics. 3. Explain why an opportunity cost still exists even if everything is provided free. 4. a) What are the fundamental questions that are studied in economics? b) Briefly explain the fundamental questions by using examples. 5. Explain why economics is regarded as a social science. Unit 1: What is economics? 11
6. Briefly distinguish between microeconomic and macroeconomic issues and give an example of each. 7. Which statements in the box below refer to macroeconomics and which ones refer to microeconomics? Statement Microeconomics Macroeconomics a) The determinants of the demand for fried chicken pieces. b) The determinants of the demand for all goods and services. c) Changes in the inflation rate. d) Changes in the price of cold drinks. e) The reasons why engineers are unemployed. f) The factors that determine the total production of goods and services of a country. 8. Study the picture below and answer the following questions: a) Which economic problem is presented in the picture? b) Is the above problem caused only by a lack of money? Give reasons for your answer. c) What are the possible solutions to the above problem? d) What do you think is the major economic problem in South Africa? Keep this assessment activity in your Portfolio of Evidence. Unit summary In this unit we introduced the field of study of economics and have shown how unlimited needs and wants on one hand and limited resources on the other force individuals and societies to make choices about which needs and wants to satisfy. We also introduced the important concept of opportunity cost, which tells us that the cost of a choice is the benefit (value) that is given up in terms of the next best alternative. We identified the four fundamental questions studied in economics, namely what to produce, how to produce it, for whom to produce it and by whom decisions are made. This was followed by explaining why economics is regarded as a social science and we commented briefly on how economists study human behaviour. We made an important distinction between microeconomics, which focuses on the economic behaviour of individual agents such as consumers, households, firms and other organisations, and macroeconomics, which focuses on the overall economic performance of an economy. We concluded the section with the importance of economics for individuals, businesses and government. 12 Topic 1, Module 1
Assess yourself Outstanding Competent Not yet competent Not achieved 80 100% 70 79% 60 69% 0 59% I am able to define economics. I am able to describe the economic problem. I am able to give an example of an opportunity cost. I am able to identify the four fundamental questions that are studied in economics. I am able to explain why economics is a social science. I am able to define microeconomics and provide an example. I am able to define macroeconomics and provide an example. I am able to give reasons why economics is important for individuals, businesses and government. Unit 1: What is economics? 13