Economics Answer Note #108

Question 1 The central bank sets a reserve requirement of 42%. A commercial bank receives a deposit of R26991. Calculate the potential increase in the money supply. Answer According to the given information, the central bank has set a reserve requirement of 42%, which means that the commercial bank is required to keep 42% of the deposited amount as reserves and can use the remaining 58% for lending and other activities. Based on this, we can calculate the potential increase in the money supply using the money multiplier approach. First, we need to calculate the excess reserves that the commercial bank will hold. Excess reserves are the amount of reserves held by the bank over and above the required reserve ratio. In this case, the excess reserves would be 26991 * (1-0.42) = R15641.62. Next, we need to calculate the potential increase in the money supply using the money multiplier, which is determined by the inverse of the reserve requirement ratio. In this case, it would be 1/0.42 = 2.38. Therefore, the potential increase in the money supply would be R15641.62 * 2.38 = R37252.69. Question 2 Simon borrowed R10 000 from the bank at the end of 2022 at a fixed interest rate of 20%. At the end of 2023, the inflation rate was 25%. Inflation has been ________ to Simon; the real value of his loan plus interest payments changed to ________. beneficial; R9 600. beneficial; R4 800. costly; R12 500. costly; R10 500 Answer Based on the given information, the inflation has been costly to Simon. The real value of his loan plus interest payments changed to R12 500. Explanation: The inflation rate is the rate at which the general level of prices for goods and services in an economy is rising over a period of time. In this case, it was at 25% at the end of 2023. This means that the prices of goods and services have increased by 25% compared to the previous year. Now, let's look at the effect of inflation on Simon's loan of R10 000. With a fixed interest rate of 20%, Simon would have to pay an additional R2 000 (20% of R10 000) as interest on his loan. However, due to inflation, the purchasing power of R10 000 has decreased. This means that R10 000 worth of goods and services can now be bought for R12 500 based on the 25% increase in prices. As a result, Simon's loan of R10 000 now only has a real value of R8 000 (R10 000 - R2 000). Therefore, the real value of Simon's loan plus interest payments changed to R12 500, making it costlier for Simon due to the effects of inflation. Question 3 Suppose that the consumer price index of a country was 113.13 at Year X and 237.55 at the end of Year Y. What was the country’s inflation rate during Year Y. Answer In order to answer this question, we first need to understand what the consumer price index (CPI) is and how it is used to measure inflation. The CPI is a measure of the average change in prices of goods and services purchased by households in a specific country. It is commonly used as an indicator of inflation, which is the general rise in prices over time. Calculation of Inflation Rate: To calculate the inflation rate during Year Y, we will use the following formula: Inflation Rate = (CPI at end of Year Y - CPI at Year X) / CPI at Year X x 100 Substituting the values given in the question, we get: Inflation Rate = (237.55 - 113.13) / 113.13 x 100 = 109.23% Therefore, the inflation rate during Year Y in this country was 109.23%. Explanation: An inflation rate of 109.23% means that, on average, prices have increased by 109.23% in the country during Year Y compared to Year X. This indicates a significant increase in the cost of living for the citizens of this country. Question 4 Refer to the data in the table. GDP is: Government expenditure R15 Consumption R90 Gross Investment R20 Consumption of fixed capital R5 Exports R8 Imports R12 R116. R121. R125. R150. Answer GDP, or Gross Domestic Product, is a key indicator of a country's economic performance. It measures the total monetary value of all goods and services produced within a country's borders in a given time period. In the data provided, we can see that the GDP is equal to R116, which is calculated by summing up the various components of GDP. To further understand the components of GDP, we can refer to various academic Economics sources. According to the circular flow of income and expenditure model, GDP can be calculated by summing up four components: consumption, investment, government expenditure, and net exports (exports minus imports). The data provided in the table gives us the values of each of these components, except for net exports, which can be calculated by subtracting imports from exports. In this case, net exports would be equal to R8 - R12 = -R4. Useful sources for understanding and calculating GDP include introductory economics textbooks such as "Principles of Macroeconomics" by Mankiw and "Macroeconomics" by Blanchard. These sources can explain the concepts and calculations of GDP in a clear and comprehensive manner. Additionally, the websites of government agencies, such as the International Monetary Fund (IMF) and the World Bank, also provide data and information on GDP for various countries. In this specific case, we can also see that the value of GDP is slightly higher than the sum of its components, which is equal to R116 instead of R125. This is due to the presence of statistical discrepancy, which is the difference between the sum of the components and the actual measured GDP. This discrepancy can arise due to measurement errors or omitted economic activities. In conclusion, GDP is a vital measure of a country's economic performance, and its calculation includes summing up four components: consumption, investment, government expenditure, and net exports. By referring to academic economics sources and data provided by government agencies, we can gain a better understanding of GDP and its components. Question 5 Real GDP and nominal GDP differ because the real GDP: is adjusted for changes in the volume of intermediate transactions. includes the economic effects of international trade. has been adjusted for changes in the price level. excludes depreciation charges. Answer Real GDP (gross domestic product) and nominal GDP are two measures used to quantify a country's economic output. While both play a crucial role in measuring economic growth, they differ in their approach and interpretation. Nominal GDP is a measure of a country's output, which is calculated by using current prices as opposed to constant, or base year, prices. On the other hand, real GDP adjusts for changes in the price level by using a base year's prices as a benchmark. The difference between nominal and real GDP is known as the GDP deflator, which reflects the overall change in prices and inflation in an economy. Real GDP matters in measuring economic growth because it gives a more accurate picture of the economy's performance by removing the impact of price changes. For example, a country's nominal GDP may increase due to an increase in prices, but this does not necessarily reflect an actual increase in production or economic growth. Real GDP, however, takes into account changes in prices and provides a more accurate measure of a country's economic growth. The reason for this difference between real and nominal GDP lies in the fact that nominal GDP does not account for changes in the price level, while real GDP does. This is important because changes in prices can skew the GDP figure and give a false perception of economic growth. By adjusting for price changes, real GDP allows for a more accurate comparison of a country's economic performance over time. Furthermore, real GDP also excludes depreciation charges, which is a crucial factor in measuring economic growth. Depreciation refers to the wear and tear of physical assets in an economy and can significantly impact a country's productive capacity over time. By excluding these charges, real GDP provides a more accurate measure of a country's productive output.