Lesson 1, Topic 1
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1.3 Demonstrate An Understanding Of The Function Of The Market Mechanisms In A New Venture

ryanrori June 15, 2020

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1 Explain The Free Market System In Terms Of Perfect & Imperfect Competitive Markets 

1.1 An Explanation Is Given Of The Characteristics Of Different Economic Systems

Economics and economic thought lies at the heart of most human interactions. Your understanding of how a modem economy works (or should work) forms the basis of how you behave as part of the economy. The better you understand it the better your decisions will be in your interactions with others. It is therefore of utmost importance that you know how markets function within the broader economy.

The free market system

All resources in the possession of private persons and production are exercised by private companies in order to make a profit. The forces of demand and supply determine the price of goods and services e.g. the more apples available the lower the price. The more people demand apples, the higher the price.

Advantages of the free market system:

  • Customers obtain the products they want by demand and supply
  • No massive bureaucracy
  • Profits ensure effectiveness, enough production and the right type of product.
  • Competition ensures low prices and new technology.
  • Monopolies do not last – other companies will step in.

Disadvantages of the free market system:

  • Unequal distribution of wealth.
  • Profits become more important than people.
  • Certain products and services will not be produced.
  • Competition can cause waste and ineffectiveness.
  • Monopolies do exist in real life.
  • Pollution, noise, smell, etc. becomes worst.

 

All normal adults would get to a point where they have to enter some kind of market in order to make a living. Many persons enter the labour market where a person trades (sells) his skills and competencies for money. There are in reality many “markets” where values are traded.

It is because of the existence of the market that the entrepreneur (who has the critical role of “seeing around the comer”) scans the horizon and anticipates where, in the marketplace, the need will be tomorrow and take actions to profit from opportunities to trade and satisfy new needs before and as they arise. This action of the entrepreneur helps to level things out and ensures that markets are less volatile than would be the case otherwise.

In the real world markets are by nature imperfect, there will be at any point many prices prevailing for a single homogenous article. For example at one shop (shop A) an article may sell at R10,00 and at the shop next door (shop B) the same article may sell at R12,00. Economists will argue that if information was freely available, nobody will shop at shop B and the owner will have to reduce his price if he hopes to sell any items.

In situations where the price differential is large – for example in country A a ton of maize may cost $100 and in country B it may cost $50 and the transport cost for a ton from B to A is $20; in this case the entrepreneur could initially make $30 per ton profit. by moving maize from B to A. We say initially because the increase in supply will tend to cause the price to come down from the $100 level. Why?

Relationship between supply and price.

The production period is divided into three stages to determine how the supply of a product will change if the price changes.

  1. Immediate Period

The price has little influence on supply because of the time involved in adjusting supply to the price change. For example, should the price of mountain bikes change immediately, then supply will be limited to the amount available on the market.

  1. Short time

In this case the mountain bikes can be sold at higher prices on the market. The factory will increase production to share in the higher profits. The time is too short to install new machines or to erect new buildings. The factory’s only choice is to employ additional workers and provide for working shifts and overtime.

What will the action of the cycling shop be if there is a decrease in

3. Long time

Here, supply can be fully adapted to the price changes. The factory can install new machinery or expand and even employ new labourers and make use of more raw materials. Increasing prices will lead to an increase in production and supply.

  • Do the changes in the demand for product during the Christmas season influence the price of the product?
  • How will the business provide for the larger quantities they will sell?
  • How will employment be influenced by the Christmas period?
  • Give a reason why the prices of a certain product will decrease?
  • Create a collage from your advertisements.

Give a suitable heading.

Development and significance of markets (with reference to SA):

Free Market also means deregulated – so one of the factors that have dogged the SA economy has been the heavy hand of the state – first the colonial rules and regulations, then Apartheid and now the inability of the state to relinquish many of the controls that the previous government imposed. One of the many issues that need to be addressed if we want accelerated growth and employment in South Africa is the heavy tax burden placed on firms that need that money to reinvest and expand. It is a fallacy to think that by taking the money and spending it on social development programmes one gets the same economic growth and impact.

There are however political reasons for the current high tax scenario – as George Bernard Shaw put it: “A government which robs Peter to pay Paul can always depend on the support of Paul.” In the long term however we pay the price of this through sluggish market conditions low economic growth and poverty.

1.2  An Explanation Is Given Of The Characteristics Of Different Economic Systems 

There are essentially two economic systems: Free Market and Collectivism (planned Economies) – the one based on individual liberty and people relate to one another through trade and the other where force is used to expropriate resources to meet the needs of the society. Some people may contend that there is a third, the so called mixed economy. This is not a “type” but an unhealthy hybrid – it may be reality, but just as oil and water do not mix, free trade and coercion do not really mix.

A true market economy has certain features:

  • The government allows and protects the private ownership of property.
  • The government protects the right of voluntary exchange and trade amongst individuals and other legal entities
  • The government creates a framework of peace and stability through an effective policing and accessible legal system as well as maintaining effective foreign relationships and an appropriate military structure for defensive purposes.
  • The basis of trade in their property and their labour is that they essentially can do what they like as long as they do not use force or fraud in their dealings. So they are not permitted to endanger others, damage their property or act in ways that are fraudulent. If they have reneged on a deal or agreement or are thought to have done so, the matter is resolved within the framework of an accessible legal system.
  • In a society that has a moral political system the government plays an important role as the protector of property rights and individual liberties (a free press, free speech and so on).
  • In such a society the government leads by example by not itself having levels of taxation (expropriating wealth without the consent of the owner). Indeed in such a society the need for taxation would be small since the role of government is one of protecting the rights of its citizens rather that providing goods and services to the population – that role is left to entrepreneurs that do it because it is in their self interest to do so. People in such a society will also then be spending more time creating wealth and less on hiding it from the taxman.
  • If there is a need for social programmes any benefits agreed on should flow directly to the individuals in need and managed as far as possible by local communities.
  • Centralised bureaucratic structures do not work since most of the aid tends to be sucked up by the system itself with few benefits flowing to those who need it.
  • The government also has the role to ensure that the monetary system of the country is sound, it means that money retains its value (no inflation).

Corruption is reduced in a society where the government does not grant special privileges in the form of special licenses, subsidies, tax breaks, tariff protection and import control mechanisms. Administrative discretion (with the inevitable result of corruption) is minimised.

In an economically liberalised society there are no unrealistic building regulations, trade restrictions, land use restrictions or restrictions on the subdivision of land.

Also it seems right that decisions that affect a local community are taken by that community.

Communism:

The theory of the Communists may be summed up in the single sentence: Abolition of private property.

Communism, a theory and system of social and political organisation that was a major force in world politics for much of the 20th century. As a political movement, communism sought to overthrow capitalism through a workers’ revolution and establish a system in which property is owned by the community as a whole rather than by individuals. In theory, communism would create a classless society of abundance and freedom, in which all people enjoy equal social and economic status. In practice, communist regimes have taken the form of coercive, authoritarian governments that cared little for the plight of the working class and sought above all else to preserve their own hold on power.

The state owns all the resources and accepts the responsibility for the needs and desires of the people and organises production to satisfy these needs. Prices are determined by the state and not the powers of the market (no demand and supply).

Advantages of the communist system:

  • All basic necessities (goods and services) are produced for everyone.
  • No bureaucratic wasting of money – merely ensures that the system works.
  • People do not need profit as inspiration – to work for the community is good enough: limits pollution etc.
  • No wastage on luxury articles until all people have basic requirements and no aimless wasting from competition.
  • Controls the economy – no unemployment.

Disadvantages of the communist system:

  • Difficult to estimate the needs and desires of the people
  • The bureaucracy needed to organise production is huge and ineffective.
  • No profit means laziness and people do not try as hard as they can.
  • People lose their freedom of choice.
  • Technology develops at a slow pace and prices are kept high because of no competition.

The mixed system:

The resources are usually in the possession of private individuals who are then responsible for the organisation of goods and services while the state possesses and controls the basic industries, and spends money to assist people with regards to health, education, unemployment etc. The idea is to combine the advantages of the other two systems. People are free to choose what is to be produced and used, but the state ensures that problems are minimised while maximising social welfare.

Goals of the mixed system.

  • To produce goods and services that are ignored by the free-market system.
  • To provide more efficiency than other systems.
  • To prevent great unevenness of wealth and to provide everyone with a minimum standard of living and equal opportunities.
  • To protect people against monopolies.
  • To control pollution and social problems.
  • To obtain full employment and low inflation.
  • To assist the regions
  • To improve trade.
  • To achieve constant economic growth.

 

1.3  Competition Is Illustrated By The Listing Varying Prices Of The Same Product / Service 

Competition is an integral part of the free market system. It is because of competition that new products are developed, new ways of solving problems are discovered and that results in more and more people that benefit from the wealth creation activities of others entrepreneurs, business people, inventors, researchers, scientists and all the others that contribute their efforts to the free market economic system.

There are however some organisations that need the state to protect them from the competitive services and products from private organisations . Examples in South Africa are the Post Office, SABC, Roads Authorities, State hospitals, Government schools etc.. Some organisations like ESKOM are just afraid of what would happen if the energy market was opened up to competition, some say that they need the protection to be able to provide services to the uneconomic regions of the country, however some are being contracted out such as the management of toll roads and private prisons. The main reason for the existence of government controlled monopolies is political power and the influence politicians desire over the lives of people. Government schools seem to be the best example here – better schooling could be delivered through private schools and a government sponsored voucher system – but ideological control will have to given up.

The same product costs different amounts in different places. Take a 1 kg box of branded soap powder. At a large chain store in the city it may cost R20.00 At the cafe around the comer the same pack may cost R23.00 while at the 24-hour convenience store it will be R28.00, while at the spaza store down the road it may be R25.00. Oh yes, and at Makro it may cost R17.00 a pack, but then you have to take four! Each of the shops has a unique competitive advantage that ensures that the price asked is the most optimal for that particular market. If the above prices were the actual prevailing prices over a given period, can you think what would happen if anyone of them doubled their prices?

Yes, people would buy the product at the other outlets. Relatively small (but significant) differences will be tolerated by consumers, but outside a given range they will switch to another shop. Competition ensures that prices stay within a given range.

 

Activity 1:  Explain the role of competition in a free market system in your workbook. (Give examples of state owned, monopolies and private businesses.)
Activity 2Explain the varying prices of the same products/services to illustrate how competition works in the marketplace, do this exercise in your workbooks.

1.4  Reasons For Imperfect Competitiveness Are Described With Examples Thereof

There is no such thing as a perfect market. The concept only exists in economist’s textbooks. The real market is as perfect as it can get if there is no government intervention in the market – why? Because in a free market the entrepreneur will ensure that markets stay in balance. Let us say in one market the price of a commodity is R30 per kg, the price of the same product is R20 per kg in another market and the price to transport goods from one market to another is R 4.00. An entrepreneur would immediately spot that money could be made by purchasing on the R20 market and selling on the R30 market and making a R6 profit after transport costs. This process is called arbitrage and forms the basis of all entrepreneurial activity. By doing this prices on the R20 market will tend to rise (because demand increases) and prices on the R30 market will come down (because supply increases) there will thus be a tendency for the markets to move closer together – the closest they will get (all other things being equal) however will be in the region of R23/27 (because of the R 4 transport costs).

Let us say there was a sales tax of R2 on the product, the closest the markets will get would be R22/28. So government intervention makes the market more imperfect. The same things happen across borders where one not only has to contend with import duties but also bureaucracy and other imposed impediments.

 

Activity 3 : Describe the reasons for imperfect competitiveness.

1.5  The Advantages & Disadvantages Of Competition Are Explained With Examples For The Consumer & Business

The advantages are simple – it elicits the best performance from all role players. As said previously it is the mainspring for improved products leading to a higher standard of living for all. The disadvantages, I guess, is that it is unforgiving – if you don’t improve you lose out.                            

            

Activity 4 : Explain the advantages and disadvantages of competition in your own words. For this activity you can go to your local library, use magazines articles and/or make use of the internet.

1.6 A Description Is Given Of The Interaction Of Role Players In The Economic System

 

Activity 5: For this activity you can go to your local library, use magazines articles and/or make use of the internet. Write an A4 page defying and describing the different role players in the economic system of South Africa.  Add it at the back of your workbook.

1.7 The Conditions For The Existence Of Perfect & Imperfect Markets Are Explained In Relation To The South African Context

 

Group Activity 6: For this activity you can work in groups of three/four.  Discuss in your groups what you think the perfect market would be.  Then also discuss the imperfect market.  In your discussion you must take the economic system of South Africa in mind.  Write down your conclusions and add it at the back of your workbooks.

2 Analyse The Interaction Of Demand & Supply In Price Determination

2.1 An Explanation Is Given Of The Laws Of Demand & Supply

ASSESSMENT CRITERION RANGE

The explanation includes the consequences of these laws for new ventures.

Two of the most important factors affecting your price are supply and demand. Hutt 7 Stull (1192:291) provide useful definitions for these terms.

Supply is the amount of a product or service that a business provides at a given time and a given price.

Demand is the amount of a product or service that customers are willing and able to buy at a given time at a given price.When the demand for a product increases, the price of that product usually goes up. For example, let us assume you open an exclusive wine shop stocking fine wines and liqueurs. When the KWV brandies win prizes at international competitions the demand for them rises, and so your price for them will probably rise as the supply is fairly limited.

A change in supply also affects the price, however. When the supply of Chardonnay wines from the wine estates and producers increases, the price of Chardonnay wine drops.

Interaction of demand and supply:

Why do prices go up as supply goes down? The phenomenon that prices tend to be higher when demand is high in relation to supply and low when supply is high in relation to demand is called the Law of Supply and Demand. An example of this phenomenon can be found when looking at the prices of vegetables on the market – at the beginning and end of the season the price tends to be high (supply is restricted). A similar thing happens with the price of meat over the Christmas period (demand is high and supply is smaller because of abattoirs being closed and other reasons).

Who determines prices?

As much as we would like to think that it is the owner of a product that sets the price it is simply not true – just as the two blades of a pair of scissors are necessary to cut – it is the interplay between supply (the sellers) and demand (the buyers) that determines the price. If, at a given price there are many buyers, this will be a clear signal for the seller to either place more goods on the market or to increase prices. If the seller is making a good profit and supply is not a problem he will most probably place more of the product on the market and continue to make money.

Two things can happen:

  1. others also start selling the product at the same price or lower (they can do this because there is a profit to be made and there is a demand) or;
  2. the market gets saturated and demand drops – this will also have the effect of sellers lowering prices in order to keep their profits at the same level as before (a smaller profit or margin but more sales).

Now there are many factors that drive economic activity – one is the virtually insatiable need for goods and services by humans and the human ability to devise goods and services to meet the needs of others. It seems that since time immemorial humans have had the tendency to trade with others to fulfil their wants (It seems more efficient than stealing what you want!). It is in this producing and trading process that value is created in a society. Remember value is a perception in peoples mind based on the reality they are living in and making money is just a shorthand way of saying “producing goods and services that are traded voluntarily to people that place a value on it”.

Here is a simple example of how trade produces value.

Two groups of children are playing on adjoining fields – the one group is set up to play cricket – stumps, cricket bats, pads etc… but they only have a soccer ball.

The other group is set up to play soccer – the posts and the soccer field marked out. .. but they only have – a cricket ball!

They then decide to exchange balls and immediately, because of this trade, both groups are better off Value has increased (Economists will say that need satisfaction has taken place and the “society” is better off.)

Simply by trading balls each group will have improved their respective situations – this is how value is also created in the larger society: VOLUNTARY TRADE between people where both parties gain. The economic cake can also only get larger through trade and any obstacle in the way of trade only leaves the society poorer. Can you think of some of the obstacles that are placed in the way of trade and who and why would anyone want to do this if it is not in the interest of the people?

Conclusion:

For a society to attain maximum need satisfaction by its inhabitants it needs to ensure that trade is not hampered by administrative regulations, trade barriers, unfair tariffs and the whims of politicians.

The other prerequisite for growth is the ability of a society to protect the property rights of its citizens. The economic collapse of Zimbabwe (2004) can be directly attributed to its inability to protect the property rights of its citizens.

Liberty and freedom are the conditions of man within a contractual society. Social cooperation under a system of private ownership of the means of production means that within the range of the market the individual is not bound to serve an overlord. As far as he gives and serves other people, he does so of his own accord in order to be rewarded and served by the receivers.

“What impels every man to the utmost exertion in the service of his fellow men and curbs innate tendencies toward arbitrariness and malice is in the market, not compulsion and coercion on the part of the gendarmes, hangmen and penal courts; it is self-interest. The member of a contractual society is tree because he serves others only in serving himself” (Ludwig von Mises – Human Action).

You buy one cup of coffee a day. The amount of coffee bought by you can be expressed as 1 cup per day or seven cups per week or 365 cups per year. Demand is not the same as needs. How many times have you desired to buy something “if you only had the money” or “if only it wasn’t so expensive”? Scarcity causes many of our needs to remain unsatisfied. The quantity the consumer plans to buy in a given period of time.

2.2 An Explanation is Given Of The Relationship Between The Variables Of Demand & Supply Curves

Simple supply and demand curves

A typical supply and demand curve is illustrated in the diagram below.

The slope of the demand curve (downward-to-the-right) indicates that a greater quantity will be demanded when the price is lower. On the other hand, the slope of the supply curve (upward-to-the-right) tells us that as the price goes up, producers are willing to produce more goods. The point where these curves intersect is the equilibrium point. At a price of P producers will be willing to supply Q units per period of time and buyers will demand the same quantity. P in this example, is the equilibrating price that equates supply with demand.

In the figures, straight lines are drawn instead of the more general curves. This is typical in analysis looking at the simplified relationships between supply and demand because the shape of the curve does not change the general relationships and lessons of the supply and demand theory. The shape of the curves far away from the equilibrium point are less likely to be important because they do not affect the market clearing price and will not affect it unless large shifts in supply or demand occur. So straight lines for supply and demand with the proper slope will convey most of the information the model can offer. In any case, the exact shape of the curve is not easy to determine for a given market. The general shape of the curve, especially its slope near the equilibrium point, does however have an impact on how a market will adjust to changes in demand or supply. See the section below on elasticity.

The section below outlines how prices and quantities not at the equilibrium point tend to move towards the equilibrium.

Effects of being away from the equilibrium point

Assume that some organisation (say government or industry cartel) has the ability to set prices. If the price is set too high, such as at P1 in the diagram above, then the quantity produced will be Qs. The quantity demanded will be Qd. Since the quantity demanded is less than the quantity supplied there will be an oversupply (also called surplus or excess supply). On the other hand, if the price is set too low, then too little will be produced to meet demand at that price. This will cause an undersupply problem (also called a shortage).

Now assume that individual firms have the ability to alter the quantities supplied and the price they are willing to accept, and consumers have the ability to alter the quantities that they demand and the amount they are willing to pay. Businesses and consumers will respond by adjusting their price (and quantity) levels and this will eventually restore the quantity and the price to the equilibrium.

In the case of too high a price and oversupply, (in the diagram above) the profit maximising businesses will soon have too much excess inventory, so they will lower prices (from P1 to P) to reduce this. Quantity supplied will be reduced from Qs to Q and the oversupply will be eliminated. In the case of too low a price and undersupply, consumers will likely compete to obtain the goods at the low price, but since more consumers would like to buy the goods at the price that is too low, the profit maximising firm would raise the price to the highest they can, which is the equilibrium point. In each case, the actions of independent market participants cause the quantity and price to move towards the equilibrium point.

Demand curve shifts

When more people want something the quantity demanded at all prices will tend to increase. This can be referred to as an increase in demand. The increase in demand could also come from changing tastes, where the same consumers desire more of the same goods than they previously did. Increased demand can be represented on the graph as the curve being shifted right, because at each price point, a greater quantity is demanded. An example of this would be more people suddenly wanting more coffee. This will cause the demand curve to shift from the initial curve D0 to the new curve D1. This raises the equilibrium price from P0 to the higher P1. This raises the equilibrium quantity from Q0 to the higher Q1. In this situation, we say that there has been an increase in demand which has caused an extension in supply.

Conversely, if the demand decreases, the opposite happens. If the demand starts at D1, and then decreases to D0, the price will decrease and the quantity supplied will decrease – a contraction in supply.

Notice that this is purely an effect of demand changing. The quantity supplied at each price is the same as before the demand shift (at both Q0 and Q1). The reason that the equilibrium quantity and price are different is that the demand is different.

Supply curve shifts

When the suppliers’ costs change the supply curve will shift. For example, assume that someone invents a better way of growing wheat so that the amount of wheat that can be grown for a given cost will increase. Producers will be willing to supply more wheat at every price and this shifts the supply curve S0 to the right, to S1 – an increase in supply. This causes the equilibrium price to decrease from P0 to P1. The equilibrium quantity increases from Q0 to Q1 as the quantity demanded increases at the new lower prices. Notice that in the case of a supply curve shift, the price and the quantity move in opposite directions.

Conversely, if the quantity supplied decreases, the opposite happens. If the supply curve starts at S1, and then shifts to S0, the equilibrium price will increase and the quantity will decrease.

Notice that this is purely an effect of supply changing. The quantity demanded at each price is the same as before the supply shift (at both Q0 and Q1). The reason that the equilibrium quantity and price are different is the supply is different.

Elasticity

An important concept in understanding supply and demand theory is elasticity. In this context, it refers to how supply and demand change in response to various stimuli. One way of defining elasticity is the percentage change in one variable divided by the percentage change in another variable (known as arch elasticity because it calculates the elasticity over a range of values – This can be contrasted with point elasticity that uses differential calculus to determine the elasticity at a specific point). Thus it is a measure of relative changes.

Often, it is useful to know how the quantity supplied or demanded will change when the price changes. This is known as the price elasticity of demand and the price elasticity of supply. If a monopolist decides to increase the price of their product, how will this affect their sales revenue? Will the increased unit price offset the likely decrease in sales volume? If a government imposes a tax on a good, thereby increasing the effective price, how will this affect the quantity demanded?

Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How would the demand for a good change if income increased or decreased? This is known as the income elasticity of demand. For example how much would the demand for a luxury car increase if average income increased by 10%? If it is positive, this increase in demand would be represented on a graph by a positive shift in the demand curve, because at all price levels, a greater quantity of luxury cars would be demanded.

Another elasticity that is sometimes considered is the cross elasticity of demand that measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complement and substitute goods. Complement goods are goods that are typically utilised together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other and if the price of one good rises, one may purchase less or instead purchase its substitute.

Cross elasticity of demand is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. For an example with a complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -20%/10% or, -2.

Vertical supply curve

It is sometimes the case that the supply curve is vertical, that is the quantity supplied is fixed, no matter what the market price. For example, the amount of land in the world can be considered fixed. In this case, no matter how much someone would be willing to pay for one more acre of land, the extra cannot be created. Also, even if no one wanted all the land, it still would exist. These conditions create a vertical supply curve, giving it zero elasticity (ie.- no matter how large the change in price, the quantity supplied will not change).

In the short run near vertical supply curves are even more common. For example, if the Super Bowl is next week, increasing the number of seats in the stadium is almost impossible. The supply of tickets for the game can be considered vertical in this case. If the organisers of this event underestimated demand, then it may very well be the case that the price that they set is below the equilibrium price. In this case there will likely be people who paid the lower price who only value the ticket at that price, and people who could not get tickets, even though they would be willing to pay more. If some of the people who value the tickets less sell them to people who are willing to pay more (i.e. scalp the tickets), then the effective price will rise to the equilibrium price.

The graph below illustrates a vertical supply curve. When the demand 1 is in effect, the price will be P1. When demand 2 is occurring, the price will be P2. Notice that at both values the quantity is Q. Since the supply is fixed, any shifts in demand will only affect price.

Other market forms

 In a situation in which there are many buyers but a single monopoly supplier that can adjust the supply or price of a good at will, the monopolist will adjust the price so that his profit is maximised given the amount that is demanded at that price. This price will be higher than in a competitive market. A similar analysis using supply and demand can be applied when a good has a single buyer, a monopsony, but many sellers. Where there are either few buyers or few sellers, the theory of supply and demand cannot be applied because both decisions of the buyers and sellers are interdependent – changes in supply can affect demand and vice versa. Game theory can be used to analyse this kind of situation. See also oligopoly.

The supply curve does not have to be linear. However, if the supply is from a profit maximising firm, it can be proven that supply curves are not downward sloping (i.e. if the price increases, the quantity supplied will not decrease). Supply curves from profit maximising firms can be vertical, horizontal or upward sloping.

Standard microeconomic assumptions cannot be used to prove that the demand curve is downward sloping. However, despite years of searching, no generally agreed upon example of a good that has an upward sloping demand curve has been found (also known as a giffen good). Non-economists sometimes think that this would not be the case for certain goods. For example, some people will buy a luxury car because it is expensive. In this case the good demanded is actually prestige, and not a car, so when the price of the luxury car decreases, it is actually changing the amount of prestige so the demand is not decreasing since it is a different good. Even with downward sloping demand curves, it is possible that an increase in income may lead to a decrease in demand for a particular good, probably due to the existence of more attractive alternatives that become affordable: a good with this property is known as an inferior good.

An example: Supply and demand in a 6 person economy (or new venture)

Supply and demand can be thought of in terms of individual people interacting at a market. Suppose the following six people participate in this simplified economy:

  • Alice is willing to pay R10 for a sack of potatoes.
  • Bob is willing to pay R20 for a sack of potatoes.
  • Cathy is willing to pay R30 for a sack of potatoes.
  • Emily is willing to sell a sack of potatoes for R15.
  • Fred is willing to sell a sack of potatoes for R25.

There are many possible trades that would be mutually agreeable to both people, but not all of them will happen. For example, Cathy and Fred would be interested in trading with each other for any price between R25 and R30. If the price is above R30, Cathy is not interested, since the price is too high. If the price is below R25, Fred is not interested since the price is too low. R25, so she will not trade with Fred at all. In an efficient market, each seller will get as high a price as possible, and each buyer will get as low a price as possible.

Imagine that Cathy and Fred are bartering over the price. Fred offers R25 for a sack of potatoes. Before Cathy can agree, Emily offers a sack of potatoes for R24. Fred is not willing to sell at R24, so he drops out. At this point, Dan offers to sell for R12. Emily won’t sell for that amount so it looks like the deal might go through. At this point Bob steps in and offers R14. Now we have two people willing to pay R14 for a sack of potatoes (Cathy and Bob), but only one person (Dan) willing to sell for R14. Cathy notices this, and doesn’t want to lose a good deal, so she offers Dan R16 for his potatoes. Now Emily also offers to sell for R16, so there are two buyers and two sellers at that price (note that they could have settled on any price between R15 and R20), and the bartering can stop. But what about Fred and Alice? Well, Fred and Alice are not willing to trade with each other since Alice is only willing to pay R10 and Fred will not sell for any amount under R25. Alice can’t outbid Cathy or Bob to purchase from Dan so Alice will not be able to get a trade with them. Fred can’t underbid Dan or Emily so he will not be able to get a trade with Cathy. In other words, a stable equilibrium has been reached.

A supply and demand graph could also be drawn from this. The demand would be:

  • 1 person is willing to pay R30 (Cathy).
  • 2 people are willing to pay R20 (Cathy and Bob).
  • 3 people are willing to pay R10 (Cathy, Bob, and Alice).

The supply would be:

  • 1 person is willing to sell for R5 (Dan).
  • 2 people are willing to sell for R15 (Dan and Emily).
  • 3 people are willing to sell for R25 (Dan, Emily, and Fred).

And here is the graph:

Supply and demand match when the quantity traded is two sacks and the price is between R15 and R20. Whether Dan sells to Cathy, and Emily to Bob, or the other way round, and what precisely is the price agreed cannot be determined. This is the only limitation of this simple model. When considering the full assumptions of perfect competition the price would be fully determined since there would be enough participants to determine the price. For example, if the “last trade” was between someone willing to sell at R15.50 and someone willing to pay R15.51, then the price could be determined to the cent. As more participants enter, the more likely there will be a close bracketing of the equilibrium price.

It is important to note that this example violates the assumption of perfect competition in that there are a limited number of market participants. However this simplification shows how the equilibrium price and quantity can be determined in an easily understood situation. The results are similar when unlimited market participants and the other assumptions of perfect competition are considered.

Larger quantities will be sold at lower prices and smaller quantities at higher prices. This relationship is called the LAW OF DEMAND.

Why will a higher price cause a decrease in the quantity demanded? The answer is that every product can be replaced by another product.

When the price of a certain product increases too much, the consumer will have to buy less of that product and more of a cheaper substitute that is equally good.

 

Activity 7 : Do the following exercise in your workbooks this exercise will demonstrate demand and supply to you:

 

Assume that you and your two mates, Betty and Richard, played video games at the café yesterday. If each video game cost R5 per turn you would not be able to play often because it is too expensive.

Had the video games cost less, e.g. R1 per turn, you would be able to play more games.

The following table indicates the quantity of video games that you will be willing to play per day at various prices.

Indicate, graphically, the total quantity of video games demanded per day at the different prices:

The graph indicates the relationship between the price of the video games and the quantity demanded per day. In total they are prepared to play 21 video games per day at a price of R1 per turn.

If the price per video game is R4.00 the demand for games per day will be less, only 9. This indicates the negative relationship between the demand for goods and the price of goods (the law of demand). An increase in price will lead to a decreased quantity demanded.

You ask your classmates how many videos they would be willing to hire per weekend at the following prices:

a) Construct a total demand curve of your classmates for the hire of videos.

b) What is the total quantity that can be hired per weekend at R25,00?

c) How is the law of demand illustrated?

d) How much money is spent per weekend if the videos cost R15,00 each?

 

Supply

It is the quantity of a product that a producer or entrepreneur supplies for sale at a given point of time. Supply measures the quantity supplied (per day, week or year) at a given price. The quantity supplied by the producer or entrepreneur is determined by the relationship of the price to the cost of production or the cost price of the product.

The higher the selling price, the greater the quantity supplied by the entrepreneur to ensure maximum profit.

 

Activity 8 : Complete the graphs for each of these products according to how you think the demand for these products will change during the year.

2.3 The Relationship Between Demand, Supply & Price Is Discussed With Reference To Own Products or Service

Questions about pricing are among the most commonly asked by new business owners. Pricing is one of the most important issues facing any business. Even when there is a high demand for a particular product or service, it still has to be reasonably priced to become truly successful. How products and services are priced has a great impact on how well they sell.

Relationship between supply and price.

The production period is divided into three stages to determine how the supply of a product will change if the price changes.

  1. Immediate Period

The price has little influence on supply because of the time involved in adjusting supply to the price change. For example, should the price of mountain bikes change immediately, then supply will be limited to the amount available on the market.

  1. Short time

In this case the mountain bikes can be sold at higher prices on the market. The factory will increase production to share in the higher profits. The time is too short to install new machines or to erect new buildings. The factory’s only choice is to employ additional workers and provide for working shifts and overtime.

  1. Long time

Here, supply can be fully adapted to the price changes. The factory can install new machinery or expand and even employ new labourers and make use of more raw materials. Increasing prices will lead to an increase in production and supply.

 

Activity 9 : Do the assignment in your workbooks and answer the questions that follow.

Collect advertisements of various products that are bought by customers during the Christmas season. Answer the following questions on each advertisement that you have collected.

  1. Do the changes in the demand for the product during the Christmas season influence the price of the product?
  2. How will the business provide for the larger quantities they will sell?
  3. How will employment be influenced by the Christmas period?
  4. Give a reason as to why the prices of certain products will decrease?
  5. Create a collage from your advertisements.
  6. Give a suitable heading.

 

Price formation and Market equilibrium

The means by which prices are formed are now available.

If both the supply and demand curve of goods is drawn on one diagram – this is how it will look:

The problem now is how a market price is formed. The answer is relatively simple.

At a relatively high price – say 110: at this price the quantity supplied will be 1400 units, but the quantity demanded will only be 290 – at this price there will be unsold inventory (excess supply). This implies that suppliers would rather reduce the price and sell more of the product. This excess supply will continue up to a price of 80 at which 640 will be sold. Why? To answer this question one needs to see what happens at very low prices. At very low prices – say 50, the quantity demanded will be 1400 units but the quantity supplied will only be 290 – at this price there will be unsatisfied buyers and they will be offering more for the product. This situation will continue again to the level of 80 at which 640 will be sold. At any higher price there will be a stronger tendency for prices to come down and at any lower price there will be a stronger tendency for prices to go up. This level is called the equilibrium price.

 

Activity 10 : Answer the following questions in your workbook.
  • What is meant by the equilibrium price?
  • Should there be a link between the demand, supply and price? Motivate your answer.

2.4 Factors That Lead To Changes In The Demand & Supply Curve Are Listed In Own Specific Context 

The following factors lead to changes in demand and supply:

  • The availability of substitutes for your product
  • The income level and purchasing power of the buyers of the product or service.
  • The degree of need for the product.
  • The effectiveness of advertising.
  • Whether or not the demand is derived from the demand of another product.
  • Competition in the market.

 

Activity 11: Discuss the factors that can lead to a change in supply and demand in your own venture in your workbooks.

2.5  Factors Of Production Are Explained In Terms Of The Roles & Contribution To The Economy

 

Activity 12 : Go to your local library and do research on the factors of production.  Write at least an A4 page on your findings and add it to the back of your workbook.

2.6 Money Is Explained In Terms Of Its Role In The Economy 

 

Group Discussion 1:

In groups of four discuss the role of money in our economy.

Write down your conclusions and add it to the back of your workbook

3 Analyse The Factors That Influence Economic Activity

3.1 The Effects Of Cyclical Movements In A Market System Are Evaluated An Context Of A New Venture

Business cycle is the term used by economists to designate a periodic increase and decrease in an economy’s production and employment.

The small businessperson should also be aware of cyclical movements in the market that he/she is operating within. For example if you are in the business of purchasing property for rental to others, then you should time your purchases of your properties when there are many sellers and few buyers. This means that prices will be relatively low; as opposed to buying when everybody is buying and there is less stock available.

These cyclical trends happen in any market especially when there is some state intervention in that market that prevents the market from operating freely. You should know where in the cycle the market is when trading in that market.

 

These cycles are referred to as a “boom” and “bust” in the literature – the downward parts are also referred to as recessions.

3.2 A Description Is Given Of The Concept Of Inflation & Its Impact On The New Venture

 

Activity 13 : Discuss the impact of inflation on your specific venture in your workbook.

3.3 Reasons Are Identified For The Decline In The Value Of Money

What money is and how inflation occurs

There was a time when people bartered the goods that they produced. In other words they exchanged goods and services directly. One can see the problem with this. Let us say I make shirts and you make shoes. I want a pair of shoes, but your shirts are still fine, then I have to wait until you want a shirt before I can get shoes!

Then there is also the question of parity – six shirts may have the same value as one pair of shoes. What are you going to do with six shirts?

These problems led some groups to find products that were desirable by everyone. Although shells and beads were used – gold and silver tended to be used more and more. Later the physical coins of gold and silver were replaced by promissory notes that were issued by people that kept other peoples’ gold in safekeeping. These became the banks of today. Today most transactions are concluded using financial instruments (cheques, internet transfers and so on). Do remember that the underlying value of the money is determined by the specific amount of goods and services that can be purchased with a given amount of money.

Governments have noticed that if they create more money people don’t notice it over the short term – they think that a given amount of money still represents a given amount of goods, and because they may think that something is relatively cheap (because they now have more of the created money in their pockets) they are prepared to pay more; and also because there is more money in circulation people compete for the available goods and services and so too drive up the price of the goods and services. Governments do this to “stimulate the economy”, but in the process they do a lot of damage – the prudent people that save for their old age or “for a rainy day” find that their saved money is worthless when they need it most. So in a sense a country that inflates its currency is robbing from the savings and pension funds of the people.

So, inflation occurs when money loses its value. Money loses its value when there is more money in circulation in relation to the available goods and services. Since most money systems are controlled by governments one can say that inflation is the result of bad monetary policies. Governments often believe that they can get something for nothing – that increasing the money supply is actually the same as producing wealth. Wealth however is dependent on the amount of goods and services available – productivity; and while it may have short term benefits for the government it has a bad effect on the economy over the long term.

3.4  An Explanation Is Given For The Role Of Foreign Currency & Exchange Rates In the General Economy

Every international trade transaction leads to an international payment transaction. If someone in South Africa imports goods from the United States, a payment in dollars must be made at some stage. To pay in dollars, the South African has to exchange rands for dollars. The rate at which the rands are exchanged for dollars is known as the exchange rate.

Definition: The exchange rate is the price of the currency of a country (such as dollars) expressed in terms of the currency of another country (Such as rand)

Before we discuss the various types of exchange rates, take note of the following terms commonly used in connection with rates of exchange, namely nominal and real rates of exchange, and spot and forward rates of exchange.

Nominal rates of exchange refer to rates of exchange quoted at a specific time, for example R1 = $0,3060 at 09:00 on 25 June 1993.

Real rates of exchange refer to nominal rates of exchange adapted to price changes. For example, in 1980 the nominal rate of exchange between the South African rand and the US dollar was R1 = 128,40 American cents. At that time the price ratio between the two countries was at par – the Consumer Price Index (CPI) of the United States was equal to the CPI of South Africa = 100). In 1985 the nominal rate of exchange changed to R1 = 34,96 American cents (i.e. R1 = $0,3496), while the price ratio changed from 100 to 67, in favour of America. The real rate of exchange was 34,96 + 67,76 x 100 = 51,59. This implied that the rand was ‘undervalued’ in terms of the dollar. Real rates of exchange are mainly used for analysis.

Spot rates of exchange are exchange rates at which foreign currency for spot (immediate) delivery is bought and sold. The spot rate of exchange is determined by demand and supply on foreign exchange markets, subject to the intervention by the Reserve Bank (buying and selling dollars).

Forward exchange refers to an arrangement whereby foreign exchange can be bought and sold on a term basis. The foreign currency can be obtained on a given future date at an agreed price. The contracting parties commit themselves to buy or sell a given amount of foreign exchange on a specific future date at an agreed rate (forward cover) stipulated at the time the contract is concluded. A three months forward rate of exchange (buying rate of R1 = $0,3236 on 1 June 1993 meant that the South African importer had to pay only R3,0902 per dollar for a certain amount of dollars on 1 September 1993.

R1 = $0,3236:

     R1__

$0,3236

So $1=          R3,0902

In practice the forward cover is usually higher (at a premium) or lower (at a discount) than the spot rate of exchange depending on future prospects. The main aim of forward exchange transactions is to cover importers and exporters against future foreign exchange fluctuations. The difference between spot and forward exchange rates often gives rise to foreign exchange speculation.

Rates of exchange can be either fixed rates or floating rates.

Fixed rates of exchange

When rates are fixed, the monetary authorities announce a statutory exchange rate. It is often called a parity rate (par of exchange or gold parity of exchange). We distinguish between the following forms of fixed rates of exchange:

The value of currencies (e.g. rand, dollar, pound, etc.) was linked to a certain quantity of gold (defined by law as so many grains or grams of fine gold). The value of one currency in terms of another currency, i.e. their rates of exchange, could be determined quite simply via these quantities of gold. For example, if the pound sterling was fixed at 112,982 grains of fine gold and the US dollar at 23,2 grains of fine gold, the rate of exchange (parity of exchange or mint par of exchange) was 112,982 + 23,2, i.e. £1 = $4,87.

International payments were made through the exchange rate market. If the demand for dollars was greater than the demand for pound sterling, the price of sterling dropped. However, there was a limit to this ‘drop’. Once the price reached a certain low, it would be more profitable for banks to exchange their sterling reserves at the Bank of England for gold bars than send the gold bars to the United States to be exchanged for dollars at the official valuation. An additional supply of dollars would then reach the market and in this way end the fall in the value of sterling. The price of sterling could not remain below the gold export point for long, because at this point gold itself became an outflow from Britain. Likewise, there was a ‘gold import point’. When there was a higher sterling rate, banks were encouraged to supplement the sterling supply by exchanging dollars for gold and then buying sterling.

The difference in price between mint par of exchange and the gold import point (or m par of exchange and the gold export point) was the cost of transporting gold from one country to another. It was profitable to trade with gold only if the difference in the rate of exchange between two countries was greater than the transport costs (and other costs) of gold. The gold points determined the limits of the rates of exchange between two currencies and between all currencies on the gold standard. In this way the international gold standard maintained a fairly constant (fixed) rate of exchange between countries.

(b) Stable but adjustable rates of exchange (the Brettan Woods system). Besides other fixed exchange rate systems such as the gold bullion standard and the gold exchange standard, the other important exchange rate system was the Bretton Woods system. In 1944 the nations of the world met in Bretton Woods where they established the International Monetary Fund (IMF). The IMF promoted a system of stable but adjustable rates of exchange. This ensured a system of fixed rates of exchange from 1946 to 1971. With this system every member country was obliged to declare the par value of its currency in terms of gold or the US dollar of $35 per fine ounce of gold. Furthermore, member countries were obliged to use suitable measures (monetary or fiscal) to ensure that the cash exchange rate of their currencies was maintained within margins of one per cent (or either side of par value).

The par value system of rates of exchange resembled the gold standard because it ensured fixed rates of exchange, not the free movement of gold. Under the gold standard the government legally fixed the gold content of a currency, but according to the rules of the IMF, the par value of a currency could be changed only if there was a fundamental imbalance in a country’s balance of payments.

The margins within which the rates of exchange were allowed to fluctuate (which were extended from 1 percent to 2,25 percent above and below par value) were very similar to the gold import point and the gold export point under the gold standard.

To stabilise the rates of exchange and encourage international trade, member countries of the IMF contributed to a common foreign exchange pool. If a country’s currency is under pressure because of a temporary deficit in its balance of payments, the IMF assists this country with loans (drawings) on specified conditions. In this way, a member country can try to correct the deficit.

As opposed to fixed exchange rates (where a country’s monetary unit has a specified value in terms of other currency or gold) the value of a currency under floating exchange rates can fluctuate continuously. The exchange rate is allowed to settle at a level determined by demand and supply. We distinguish between the following two forms of floating rate of exchange, namely free floats and controlled or managed floats.

Free floats: Within a system of free (or ‘clear’) floating exchange rates, the value 0 currency is determined by the forces of the market (demand and supply). There is no intervention by the authorities at all. The rate of exchange can vary if there is a change in the demand or supply of foreign exchange. The rate of exchange (as the ‘price’ of a country’s currency in terms of other currencies) is a deduced price. It is derived from the demand for the currency and its supply abroad. International trade and capital transactions determine the demand and supply of a country’s currency and also the rate of exchange. Any change in international transactions (volume and price) influences the rate of exchange.

Provided the government does not intervene in the foreign exchange market, the rate exchange will be determined in the same way as any other ‘price’ in the perfect market.

Nowhere is there a free-floating exchange rate system that reacts to the forces of the market only. Most countries that advocate floating exchange rates use variations of the system. Examples are controlled floating (where the central bank intervenes to retain the rate of exchange at a ‘desirable’ level) and ‘group floating’ – also named the ‘snake’ (where a number of currencies float jointly). This snake system applies to countries of the European Union (former European Community), which is moving in the direction of an integrated European Monetary System (EMS). The idea is for every member country to express its currency in terms of the European Currency Unit (ECU). This would float as an entity on the world currency market.

Unlike fixed exchange rates, the floating exchange rate varies in value in response to the forces of the market (demand for and supply of foreign exchange).

Controlled floating. Because of market forces, floating areas of exchange can lead the appreciation or depreciation of currencies. As the government controls the rates of exchange, completely floating currencies are not to be found in any country. Controlled floating rates of exchange (also called ‘dirty’ floating rates) are rates that may respond to the influences of market forces within certain limits. Before these limits are reached, the central bank intervenes in the foreign exchange market by buying or selling foreign exchange. Normally the monetary authorities intervene only when abnormally large movements in exchange rates are experienced. By using its own reserves and exchanging reserve liabilities, the Reserve Bank varies the supply of foreign exchange on the market. In this way, it influences the rate of exchange.

The nature of controlled floating depends largely on market forces. Even when the central bank regards it necessary to control (influence) the rate of exchange, it does so by influencing the market forces (demand or supply). This is done by buying or selling foreign exchange from its reserves, which influences the demand or supply of foreign exchange.

Unlike the members of the European Union, South Africa decided on an independent floating. This means that, independent of any other monetary unit, the rand established its exchange level. The EU countries have a group floating system. Their currencies float as a group in relation to other currencies of the world. This means that the currencies of the E countries are linked. When the currencies of a group of countries are linked in this way, it is called ‘basket linking’ (‘snake floating’). The basket contains the currencies of the EU countries.

Fixed rates

South Africa’s exchange system

South Africa has a dual or two-fold foreign exchange system consisting of the ordinary commercial rand and the financial rand. The commercial rand is applicable to all international trade between South Africa and the rest of the world, i.e. to all transactions that are recorded in the current account of the balance of payments. The financial rand, which comprises a form of currency control (with regard to the repatriation of assets of non-residents) is applicable to certain transactions of non-residents (the buying and selling of a proprietary interest in South African assets).

  1. Commercial rand

The commercial rand is the official exchange rate between the rand and other foreign currencies, and is applicable to international transactions entered into by South African citizens. In reality it comprises a series of exchange rates, most important of which is the US dollar. All other exchange rates are calculated as cross rates by using the rand/dollar rate and other relevant exchange rates. For example, if R1,00 = $0,50 and $2,00 = £1,00

Commercial exchange rates are usually quoted in foreign currencies per rand. An important exception is the pound sterling, where the exchange rate is quoted in South African cents per pound sterling (£).

The commercial rand is a market-determined rate reacting to market forces (demand for and supply of rands) but subject to Reserve Bank intervention.

  1. Financial rand

The financial rand is a special investment currency that replaced the security rand in 1979. It was repealed on 7 February 1983 and reintroduced on 2 September 1985. The financial rand broadens the investment opportunities of non-residents, who are permitted to use it for investment (buying and selling of South African assets) not only in stocks, but in all kinds of assets. Non-residents can purchase a proprietary interest, in the broadest sense of the word, at a favourable rate. It is an attractive incentive to invest in South Africa. In this way foreign exchange is obtained, not only to strengthen the reserve position of South Africa, but also to contribute towards the development of new activity, the provision of employment and the advancement of technology. The financial rand rate is determined by the demand and supply of South African assets by non-residents.

An appreciation of the financial rand denotes increased foreign confidence, because it reflects an increase in the demand (by non-residents) for South African assets relative to the supply of such assets. A depreciation of the financial rand denotes a decline in foreign confidence and in the demand for South African assets.

The financial rand is quoted only in US dollars and is usually considerably lower than the commercial rand rate. On 5 November 1985 the financial rand reflected a discount of nearly 38 percent on the commercial rand. This can be regarded as an indication of the risk that foreign investors attached to investments in South Africa at that time.

Foreign investors can buy shares in South African companies at the financial rand rate. The dividends earned on these shares are payable at the commercial rand rate, which increases the normal dividend receipts of non-residents.

Exchange rates change continuously. The current exchange rates are regularly televised, broadcast, published in daily newspapers, financial weeklies and the Quarterly Bulletin of the Reserve Bank. The monthly average of the commercial rand versus the currencies of South Africa’s major trading partners is published in the Quarterly Bulletin. The monthly financial rand rate and financial discount are also published in the bulletin.

Demand for and supply of foreign exchange

The purchase and sale of goods on foreign markets results in a need for an exchange market where monetary currencies of countries can be exchanged at definite rates. The exchange market is similar to an ordinary market where goods and services are bought and sold at specific prices. In an exchange market, different national currencies are bought and sold at certain prices (rates of exchange). The purchase and sale of currency is known as currency trade and the buyers and sellers of currency are banks and other authorised currency dealers. They act as intermediaries (agents) in the demand for and supply of foreign currency.

The following example serves to illustrate the practical operation of an exchange market: Suppose a dealer in Cape Town buys German cameras worth R100 000 from a manufacturer in Bonn, Germany. When the seller and the buyer settle the deal, the businessman from Cape Town instructs his bank to settle the account in Germany. The Cape Town bank debits its client’s (the dealer’s) bank account with R100 000 and instructs its agent in Bonn (usually per cablegram) to pay the equivalent of R100 000 in Deutschmark to the exporter. At this stage, rands are exchanged for marks at the ruling rate of exchange (the Rand/Deutschmark rate). The principal banks have foreign exchange balance with their agents (international banks) in various countries to facilitate exchange transactions for their clients. The exchange market consists of international dealers who exchange different currencies (exchange rate transactions). During this process, rates of exchange are established between currencies such as the Rand, Pound Sterling, Mark, Yen, Krone and Franc. The rate of exchange of the different monetary currencies is in equilibrium, and this rate is establish by the interaction of supply and demand.

Like any other price, the rate of exchange is determined by the demand for and the supply of foreign exchange. The rate of exchange between two currencies will be in equilibrium when the demand for foreign exchange is equal to its supply. Unless it is a result of government interference, a change in the rate of exchange is caused by a change in the demand or supply, or even a change in both.

The demand for foreign exchange is determined by the following:

  • Importing goods.
  • Services from foreign countries to the country concerned (shipping, services, insurance, etc.)
  • Payment of interest and dividends on foreign capital
  • Payments of instalments on repayments of overseas loans
  • Transfer of capital to foreign countries (short and long-term investments)
  • Tourists or representatives spending money in foreign countries
  • Other payments of foreign countries which may take place from time to time

 

The supply of foreign exchange is caused by the following:

  • Exporting goods
  • Rendering services to foreign countries (shipping services, insurance, etc.)
  • Receiving interest and dividends on capital invested in foreign countries
  • Inflow of foreign capital for reasons of security, short and long-term investments
  • Expenditure of money by foreign powers, tourists, representatives or overseas missions
  • Raising new loans in foreign countries
  • Other receipts of foreign currencies from time to time

It is demand and supply that affect the rate of exchange to a large extent. Fluctuations in the    demand and supply of goods and services cause variations in the price of these.

 

Activity 14: Answer the questions in your workbook:
  1. What do we mean if we talk about the exchange rate?
  2. Name two types of exchange rates?
  3. Discuss the role of foreign currency and exchange rates in the economy in your own words in your workbook

3.5 An Explanation Is Given Of The Role Of The Interest / BA Rate, Gross Domestic Product & Balance Of Payments In The Operations Of The New Venture

The workforce in SA is employed across a wide spectrum, including the primary, secondary and tertiary sectors.

The value of goods, products and services that are produced within the boundaries of the RSA during a particular year, is expressed as a final figure, known as the gross domestic product. (GDP) This GDP figure is compared with the GDP of other countries so that economists and geographers can compare the standard of living of the people of different countries. If a country is highly developed, only a small portion of the population works in the primary sector, considerably more are active in the secondary sector, while the majority are involved in the tertiary sector. In term of finance, the contributions made to the GDP by the various sectors also differ considerably. The primary sector yield the smallest amount and the tertiary sector the largest amount.

South Africa maintains extensive economic ties with the rest of the world and its dependence on other countries is greatest in the area of international trade. The importance of foreign trade to South Africa’s economy is evident from:

  • The relationship between its exports (goods and non-factor services like freight, insurance, tourism, etc.) and gross domestic product. This relationship decreased to 28,5 percent in 1989 from 36,5 percent in 1980.
  • The relationship between imports (goods and non-factor services) and gross domestic expenditure (GDE). This relationship decreased to 23,2 percent in 1989 from 28,2 percent in 1980.

Although the figures indicate a decline in the relative importance of the foreign sector, South Africa still ranks among the 25 most important trading nations of the West. In other words South Africa has a particularly open economy. For reasons of economic management it is of the utmost importance to be able to judge a country’s trading position with other countries. Hence it is essential to keep proper records of the transactions between South Africa and the rest of the world. The economic communication between one country, for example South Africa, and others is reflected in the balance of payments. It can be viewed as a country’s bank account with the rest of the world. All transactions that allow foreign money (exchange) to flow into South Africa are treated as credits (+), for example visible exports (goods, gold and other minerals); invisible exports (services rendered to foreign countries); and inflows of foreign capital (investments in and loans to South Africa). All transactions that allow foreign money (exchange) to flow out of South Africa are treated as debits (-), for example, visible imports (goods); invisible imports (services rendered by the rest of the world to South Africa); and outflows of foreign capital (investments in and loans to foreign countries).

The balancing item on the balance of payments is the gold reserves and other foreign exchange reserves.

A surplus on the balance of payments account raises South Africa’s level of gold and foreign exchange reserves and is described as a favourable balance (reserves have been received): South Africa earns more than has to be paid out. An unfavourable balance denotes a deficit or loss in foreign exchange reserves: South Africa pays out more than has been earned.

Definition: The balance of payments is a systematic record of all the transactions of a country’s inhabitants with the rest of the world over a given period.

The main component of the balance of payments is the current account. This includes exports, imports, gold production (which is really an export but shown separately because of its unique position in South Africa) and receipts and payments for services. Transfers (net receipts +) include migrant funds such as gifts, retention of taxes on dividends and interest paid abroad. The second component of the balance of payments is the capital account that consists of long-term and short-term capital movements. The third component of the balance of payments is the official reserve account.

Interest rates

Interest rates are effectively the “prices’ governing lending and borrowing. The borrower pays interest to the lender at a certain percentage of the capital sum, as the price for the use of the funds borrowed. As with other prices, supply and demand effects apply. For example, the higher the rates of interest that are charged, the lower the demand for funds from borrowers will be.

BA rate

The B A rate is the benchmark short term interest rate.

4 Describe The Development & Significance Of Markets

OUTCOME RANGE

The description must have particular reference to South Africa

4.1 International Trade As A Result Of Uneven Distribution Of Resources Is Investigated In Terms Of Opportunities For New Ventures

Internationalisation alternatives include joint ventures, direct foreign investment, franchising, licensing, establishment of international production plants, importing and exporting. Importing and exporting are the most common methods by which business initially engages in international activity. Exporting implies the delivery of specific products or services to defined foreign markets, the acquisition and application of knowledge and skills to transfer products or services to those markets, and the provision of financial infrastructure to support transactions.

The eventual choice of international trade depends on:

  • Whether current and future growth potential justifies concentrated marketing efforts.
  • The competitive advantage
  • The absence of major price sensitivity in the market.
  • Relative absence of problems relating to payment, for example limitations of transfer in currency.

It is very important to first establish that there is uneven distribution of resources and that there is a real need for your product as international trade can be time consuming.

 

Activity 15: Investigate international trade for your product or service, if the product or services is not suitable for international trade, find another product to do your research on. Do this exercise on a separate worksheet as an assignment for your portfolio of evidence.

4.2 Socio-economic Factors Are Identified That Underline The Importance Of New Ventures In South Africa

Poverty is a major socio-economic issue all over the world. It has various manifestations, including the following:

  • lack of income and productive resources sufficient to ensure sustainable livelihoods
  • hunger and malnutrition
  • ill health
  • limited or lack of education and other basic services
  • increased morbidity and morality from illness; homelessness and inadequate housing
  • unsafe environments
  • social discrimination

The alleviation of poverty is one of the national and international priorities for achieving sustainable development. Among all population groups, urbanisation has lead to the decline in the importance of the extended family and the emergence of the nuclear family. A number of South African sociological studies have investigated the existence of a great variation in family structures and the term household is usually preferred as the unit for social analysis.

A further development is the growing number of single parent families among all population groups. With a growing population, the emergence of smaller households means that the number of households must be increasing, which in turn will increase consumption. Migrant labour is a further factor in the social and environmental pressures in South Africa. Labour for the South African mines and industries was mostly drawn from remote rural areas. Families remained in areas designated to them. Woman and children had to depend on the small income that was sent “home” every month. If woman can be empowered to start their own ventures it would bring food to the table in many instances.

4.3 Growth Sectors That Exist In South Africa Are Identified & Classified For Possible New Ventures

Currently the following have been identified as growing industries in South Africa:

Travel                                          Toys                                   Entertainment

Transport                                     Security                             Mail Ordering

Consulting                                   Accommodation                 Information

Education                                    Health care                        International Trade

Repairs and maintenance           Second Hand Trade          Personal Services

Technology                                  On-line shopping               Tourism