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ECS 1601

Study Unit 4B: The foreign


sector

Read
section 17.3
in textbook
pg. 384 390

4.3 The balance of


payments

Watch 1601
DVD, for more
on the current
account

Current Account
An important good traded in South Africa is gold
Services trade included transport, construction,
etc.
Income receipts are shown separately. That is
income earned by South Africans in other
countries in the world.
Income payments are money earned by nonSouth Africans in South Africa
Current transfers; money, gifts, services,
etc. traded for nothing in return

4.3 The balance of


payments

Watch 1601
DVD, for more
on the
financial
account

Financial account
Direct investment
Investments made in order to over take
management
Portfolio investment
Purchasing assets such as bonds or shares
Other investments
All investment that are not classified as either a
direct or portfolio investment
Unrecorded transactions are used to balance the
financial account

4.3 Gold and foreign reserves


Exports = country GETS foreign currency
Imports = country PAYS foreign currency
If EXPORTS < IMPORTS (meaning the country pays more
foreign currency than it earns) then foreign reserves
decreases
If EXPORTS > IMPORTS (meaning the country gets more
foreign currency than it pays) then foreign reserves increases
A portion of South Africas foreign reserves are held in gold
The amount of gold South Africa has indicates the position of the
balance of payments
Gold and foreign reserves ensures a smooth flow of international
trade because currency can leave/stay in the country for days,
weeks or years (thus, it prevents large fluctuations)

4.3 The balance of payments and


economic activity and policy in
South Africa
Exports are major driving of economic growth.
The government is eager to stimulate exports.
Exports of gold have contributed to South
Africas development
South Africa also spends a lot on imported
goods.
Developing countries imports intermediary
goods in order to increase the capacity of the
economy
South Africa also imports a lot of consumer
goods, which is highly unstable

Read
section 17.4
in textbook
pg. 390 400

4.4 Exchange rates

Watch 1601
DVD, for more
on the
exchange
rates

If you want to import a car from Germany.


You have to buy the car in euros ().
Thus, you have a demand for euros.
If an American wants to visit South Africa,
they will have to buy Rands in exchange
for dollars ($), so they supply dollars.
The exchange rate is how much of
one currency you need in order to
buy another.

4.4 Exchange rates


Assume one dollar costs R10, that is the
Rand-dollar exchange rate.
If the exchange rate changes as follows:
It means, the Rand depreciated against
the dollar
At the same time, it means the dollar
appreciated against the Rand
But, who decided what the exchange rate
is?

$1=R11
$1=R10

4.4 Exchange rates

ANSWER: the market


decide what the
exchange rate should be.
To be specific, the foreign
exchange market.
See the following market
for dollars in South
Africa.
Take a minute to study
the axes

R/$

Price of dollar (exchange rate)

Study table
17-4 and 175 on in the
textbook
pg. 393

0
Quantity dollar (Q$)

4.4 Exchange rates


There is a demand for
dollars in South Africa.
The demand comes
from every household,
firm or government
institution that wants
to buy goods or
services from America
or wants to visit
America as a tourist.

Price of dollar (exchange rate)

R/$

D
0
Quantity dollar (Q$)

4.4 Exchange rates


There is a supply of
dollars in South Africa.
The supply comes from
every AMERICAN
household, firm or
government institution
that wants to buy
goods or services from
South Africa or wants
to visit South Africa as
a tourist.

Price of dollar (exchange rate)

R/$
S

D
0
Quantity dollar (Q$)

4.4 Exchange rates


The demand and supply
of dollars in South Africa
determines the exchange
rate.
The equilibrium price is
the exchange rate
($1=R8)
And the equilibrium
quantity is the amount of
dollar that will be traded
for rands at that specific
rate ($ 10 billion per day)

Price of dollar (exchange rate)

R/$
S

E1

D
0

10
Quantity dollar (Q$)
(in billions per day)

4.4 Exchange rates


After a crime wave in South
Africa is reported in the
American news, a lot of
tourists decide to not visit
South Africa any more. This
affects the supply of dollars
The new equilibrium is at E2,
with a exchange rate of
$1=R9 and $8 billion traded
daily in South Africa
This means that the Rand
depreciated against the dollar
(that also means the dollar
appreciated against the Rand)

Price of dollar (exchange rate)

R/$
S

E2

E1

D
0

10
Quantity dollar (Q$)
(in billions per day)

4.4 Exchange rates


The market can cause the
exchange rate to fluctuate a
lot.
If the SARB has enough
foreign reserves, they can
intervene in order to stabilise
the exchange rate.
For example the SARB can
supply dollars, which will have
the following affect
The exchange rate is now only
R8.50 for $1 in stead of R9 for
$1, thus the SARB stabilised
the exchange rate a bit

Price of dollar (exchange rate)

R/$

S
S

9
8.5
8

E2
E3

E1

D
0

8 9 10
Quantity dollar (Q$)
(in billions per day)

Read
section 17.5
in textbook
pg. 400 401

4.5 Terms of trade

Important is the ratio between export


prices and import prices
The relationship between export prices
and import prices are called terms of
trade
If export prices fall relative to import
prices, a country becomes poorer. Why?
Because the country has to use more of
its factors of production to increase
exports in order to afford the imports

Can you

Define and explain absolute advantage?


Define and explain comparative advantage?
List the sources of comparative advantage?
Distinguish between a specific tariff and
an ad valorem tariff?
Distinguish between the current account and the
financial account of the balance of payments?
Define and explain what the exchange rate is?
List the sources of demand and the sources of
supply the dollar in South Africa?
Define terms of trade?

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4.
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