Economics Lecture Review: Circular Flows, Macroeconomic Indicators, Policy, and International Trade

Economic Perspective

A way of thinking that assumes individuals and institutions make rational decisions by comparing marginal benefits with marginal costs, taking action only if the marginal benefit is greater than or equal to the marginal cost.

Opportunity Cost

The value of the next best alternative forgone when economic resources are used for one purpose rather than another.

Utility

The satisfaction that individuals aim to increase when acting in rational self-interest.

Microeconomics

The branch of economics that studies individual decision-making, focusing on consumers, individual firms, prices, quantities, and specific market interactions.

Macroeconomics

The branch of economics concerned with the overall economy at national and global levels, focusing on aggregates such as GDP, unemployment, interest rates, inflation (CPI), and exchange rates.

Positive Economics

An economic approach focusing on what is, dealing with factual statements and cause-and-effect relationships that can be tested against data.

Normative Economics

An economic perspective focusing on what should be, incorporating value judgements, policy prescriptions, and terms such as 'should' or 'ought'.

Functional Distribution of Income

The division of household earnings across wages, self-employment, and business income, showing how national income is earned among resource owners.

Palma Ratio

An inequality metric measuring how much the richest 10% spend relative to the poorest 40% (which was 8.6 in 2006 and fell to 7.9 in 2015 in South Africa).

Principal-Agent Problem

A conflict of interest occurring when managers (agents) pursue short-term personal goals, such as bonuses or quarterly earnings, rather than maximising long-term wealth for shareholders (principals).

Merit Goods

Goods such as education, healthcare, and clean water that generate positive externalities for society beyond the individual user and tend to be underproduced by private markets.

Demerit Goods

Goods such as drugs, alcohol, and gambling that generate negative externalities for society beyond the consumer and tend to be overproduced by private markets.

Non-Excludability

A characteristic of public goods where it is difficult or practically impossible to prevent non-paying individuals from accessing or benefiting from the good once provided.

Non-Rivalrous Consumption

A characteristic of public goods where one individual's consumption or use of the good does not reduce its availability or usefulness to others.

Free-Rider Problem

The failure of private markets to provide non-excludable goods because individuals consume the benefit without paying, concealing their true willingness to pay.

Real Flow

The physical movement of economic factors of production from households to firms, and final goods and services from businesses to households.

Money Flow

The circular movement of monetary payments through the economy, including factor incomes (wages, rent, interest, profits) paid to households and consumption spending paid to firms.

Production Possibilities Curve (PPC)

A model illustrating the maximum combinations of two goods or services that an economy can produce when all available resources are fully and efficiently employed.

Law of Increasing Opportunity Cost

The economic principle stating that as the output of a particular good increases, the opportunity cost of producing additional units rises because resources are not equally adaptable to all uses, creating a bowed-out PPC.

Lorenz Curve

A graphical representation showing the cumulative distribution of national income compared against a 45-degree line of perfect equality.

Gini Coefficient

A statistical dispersion metric of income inequality calculated as $\text{Area A} \div (\text{Area A} + \text{Area B})$, ranging from $0$ (perfect equality) to $1$ (absolute inequality).

Gross Domestic Product (GDP)

The total market value of all final goods and services produced within a country's geographical borders over a given period, typically one year, before deducting capital depreciation.

Double Counting

The erroneous inclusion of intermediate goods and services alongside final products when calculating GDP, distorting the true measurement of aggregate output.

Expenditure Approach to GDP

A method of measuring GDP by summing total spending on final output in the economy using the identity $GDP = C + I + G + X - M$.

Gross National Income (GNI)

An income metric reflecting total earnings of a country's citizens regardless of where production takes place, calculated as $GNI = GDP - \text{Income Payments to RoW} + \text{Income Receipts from RoW}$.

Real GDP

A measure of aggregate economic output valued at constant base-year prices, isolating changes in physical production by removing the influence of price changes.

GDP Price Index

A comprehensive price indicator measuring average price-level changes for all goods and services counted in GDP, used to deflate nominal output to real output.

GDP Per Capita

A measure of average output per person in an economy calculated as $\text{GDP} \div \text{Population}$.

Genuine Progress Indicator (GPI)

An alternative economic metric that adjusts GDP by incorporating the costs of income inequality, pollution, crime, and resource depletion, while adding uncounted benefits such as volunteer and household work.

Strict Definition of Unemployment

The classification of an individual aged 15 to 64 who is without work, currently available for work, and has taken active steps to find paid work or self-employment during the preceding four weeks.

Expanded Definition of Unemployment

A measure of joblessness that includes both strictly unemployed workers and discouraged work seekers who want to work but stopped taking active job-search steps.

Discouraged Work Seeker

An individual of working age who is without employment, wants to work, but has stopped actively looking for a job because of bleak prospects.

Labour Force Participation Rate

The proportion of the working-age population (ages 15–64) that is economically active, meaning they are either employed or actively seeking employment.

Employment Rate (Absorption Rate)

The percentage of the working-age population (ages 15–64) that is successfully employed in paid work or self-employment.

Frictional Unemployment

Temporary joblessness experienced by workers who are searching for better employment, transitioning between positions, or entering the labour force for the first time.

Seasonal Unemployment

Joblessness resulting from periodic, predictable fluctuations in weather, harvest cycles, tourism schedules, or calendar holidays.

Structural Unemployment

Long-term unemployment caused by a fundamental mismatch between the skills, qualifications, or geographic location of job seekers and the requirements of available jobs.

Cyclical Unemployment

Unemployment resulting from macroeconomic contractions and downturns in the business cycle when aggregate demand for goods and services declines.

Marginal Revenue Product (MRP)

The change in total revenue that results from hiring one additional unit of labour, expressed mathematically as $MRP = MPL \times MR$.

Money

Any asset or item that is generally accepted by society as a medium of exchange, a unit of account, and a store of value in the settlement of debts.

Medium of Exchange

The primary function of money that allows it to facilitate trade and overcome the double coincidence of wants inherent in barter economies.

Unit of Account

A standard monetary unit used to measure, state, and compare the relative market values and prices of different goods, services, and debts.

Store of Value

The capacity of an asset to maintain its nominal purchasing power over time, allowing economic agents to transfer consumption into the future.

M0 (Monetary Base)

The narrowest measure of money consisting of physical cash and coins in circulation plus commercial bank reserves held at the South African Reserve Bank.

M1 (Narrow Money)

The measure of money comprising M0, demand deposits (cheque accounts), travellers' cheques, and other highly liquid transaction balances.

Transactions Demand for Money

The stock of liquid cash and balances held by households and firms to fund regular day-to-day purchases, primarily determined by the level of GDP.

Speculative Demand for Money

Money held as an asset or store of wealth rather than being invested in interest-bearing bonds, which varies inversely with the nominal interest rate.

Repo Rate

The primary monetary policy interest rate at which the South African Reserve Bank provides short-term liquidity and loans to commercial banks.

Open Market Operations (OMO)

The buying and selling of government securities in the secondary market by the central bank to regulate commercial bank reserves and adjust the money supply.

Required Reserve Ratio

The minimum percentage of total customer deposits that commercial banks are legally mandated to retain as cash reserves at the central bank.

Horizontalist View

The monetary theory asserting that the central bank sets the policy interest rate exogenously and provides as much liquidity as the financial system demands.

Verticalist View

The monetary theory stating that the central bank strictly and exogenously determines the fixed quantity of base money in circulation.

Autonomous Consumption

The baseline level of consumer spending that occurs independently of the level of disposable income, representing spending when income is zero ($C_0$).

Induced Consumption

The portion of consumer expenditure that varies directly with changes in disposable income, determined by the marginal propensity to consume ($cY_d$).

Marginal Propensity to Consume (MPC)

The proportion of an additional unit of disposable income that a household allocates to consumption spending ($c = \Delta C / \Delta Y_d$).

Marginal Propensity to Save (MPS)

The fraction of an additional unit of disposable income that a household saves rather than spends, satisfying the identity $MPC + MPS = 1$.

Expenditure Multiplier

The numerical factor by which a change in autonomous spending alters total equilibrium national income, calculated as $\frac{1}{1 - c}$.

Adverse Selection

A market failure stemming from asymmetric information prior to a transaction, where low-quality products or high-risk participants dominate the market.

Moral Hazard

The tendency of an individual or firm to take on greater risks or shirk care after securing an agreement or insurance protection because someone else bears the loss.

Logrolling

The legislative practice where politicians trade votes to secure mutual approval for projects that might otherwise lack majority political support.

Pigovian Tax

A per-unit levy placed on an activity that produces negative externalities, intended to internalise external costs and align private costs with social marginal costs.

Benefits-Received Principle

The taxation philosophy arguing that individuals and businesses should pay taxes in direct proportion to the government benefits and public services they receive.

Ability-to-Pay Principle

The tax concept stating that tax liabilities should be apportioned according to a taxpayer's income or wealth level, requiring wealthier citizens to contribute more.

Progressive Tax

A tax structure where the average tax rate increases as the taxpayer's income increases, placing a proportionally higher financial burden on higher earners.

Regressive Tax

A tax structure where the average tax rate decreases as taxable income increases, absorbing a larger percentage of income from low-income earners (e.g., VAT).

Direct Quote

A foreign exchange quotation expressing the local currency price required to purchase one unit of foreign currency (e.g., $1\,\$ = \text{R}10$).

Indirect Quote

A foreign exchange quotation expressing the amount of foreign currency obtained for one single unit of domestic currency (e.g., \text{R}1 = 0.10\,\).

Flexible Exchange Rate System

A currency regime where exchange rates are determined strictly by market forces of demand and supply without official central bank intervention.

Fixed Exchange Rate System

A currency system where a nation pegs its domestic currency value to an anchor currency or basket, defended via direct central bank foreign reserve interventions.

Managed Floating Exchange Rate

A hybrid currency framework where the exchange rate is primarily market-driven but subject to periodic central bank intervention to curb extreme volatility.

Current Account

The section of the Balance of Payments that records transactions involving exports and imports of merchandise, trade in services, net primary factor income, and current transfers.

Financial Account

The Balance of Payments component recording cross-border capital and investment transactions, including foreign direct investment, portfolio flows, and reserve asset transactions.

Real Balances Effect

The inverse relationship between the general price level and aggregate expenditure, where falling prices increase the purchasing power of nominal wealth and stimulate consumption.

Interest Rate Effect

The economic mechanism whereby a lower price level reduces the demand for money balances, lowering interest rates and increasing business investment and aggregate output.

Foreign Purchases Effect

The mechanism by which lower domestic prices make domestic goods relatively cheaper compared to foreign goods, boosting exports, reducing imports, and expanding aggregate demand.

Short-Run Aggregate Supply (SRAS)

An upward-sloping schedule demonstrating total output supplied at various price levels when nominal input prices and wages remain rigid or sticky.

Long-Run Aggregate Supply (LRAS)

A vertical supply schedule located at potential output, reflecting that real production depends on technology and physical resources when wages and prices have fully adjusted.

Demand-Pull Inflation

A continuous rise in the aggregate price level triggered when total spending increases beyond the economy's productive capacity, shifting Aggregate Demand rightward.

Cost-Push Inflation

A rise in the general price level originating from an increase in per-unit production costs or resource prices, shifting Short-Run Aggregate Supply leftward.

Stagflation

A macroeconomic condition characterized by stagnant economic growth, high cyclical unemployment, and accelerating price inflation occurring simultaneously.

Inflationary Gap

A short-run macroeconomic disequilibrium occurring when equilibrium real GDP exceeds potential output (LRAS), generating upward pressure on resource costs and price levels.

Recessionary Gap

The shortfall in real output occurring when the economy's short-run equilibrium GDP falls below its long-run potential full-employment GDP level.

Inflation

A continuous, considerable, and general increase in the price level of goods and services across the entire economy over time.

Deflation

A persistent decrease in the general price level across the economy over time.

Disinflation

A reduction or deceleration in the rate of inflation, where prices are still rising but at a slower pace.

Consumer Price Index (CPI)

A price index measuring the average change over time in prices paid by typical urban consumers for a fixed market basket of consumer goods and services.

Headline Inflation

The total, unadjusted inflation rate calculated from the complete CPI basket, including volatile expenditure items like fuel, food, and electricity.

Core Inflation

An inflation measure that strips out volatile components—specifically food, non-alcoholic beverages, fuel, and electricity—to isolate underlying price trends.

Wage-Price Spiral

A compounding inflationary feedback cycle where rising living costs prompt workers to demand wage increases, driving up corporate production costs and forcing firms to hike prices further.

Inflation Targeting

A monetary policy framework wherein a central bank uses interest rates to keep forecasted CPI inflation within an explicit, publicly announced quantitative band.