Inflation and Macroeconomics Analysis

Demand-pull inflation is inflation caused by an increase in aggregate demand (AD). In Keynesian theory, increased employment results in increased aggregate demand (AD), which leads to further hiring by firms to increase output.

$C:\Users\mokokacr\Desktop\Inflation_interest_demand_Pull_Inflation_graph_1.png$

Source: http://www.econmentor.com/hs-advanced/macroeconomics/inflation/demand-pull-inflation/text/741.html#Demand Pull Inflation

Aggregate supply remaining constant, aggregate demand shift to the right or outward from AD to AD1 which causes:

The price level increase from P* to P1 with new equilibrium point from A to B
Aggregate output/ income increase from Q* to Q1
Increase in employment

1.2 Cost-push-inflation

Cost Push Inflation results when there is an increase in input prices, leading to a decline in the aggregate supply (AS) curve.

$C:\Users\mokokacr\Desktop\Inflation_interest_Cost_Pull_Inflation_graph_1.png$

Source: http://www.econmentor.com/ap-macro/stabilization-economic-growth/phillips-curve/demand-pull-and-cost-push-inflation/text/2038.html#Demand Pull and Cost Push Inflation.

Aggregate demand remaining constant, aggregate supply shift to the left or inward from AS to AS1 which causes:

The price level increase from P* to P1 with new equilibrium point from A to B
Aggregate output/ income decrease from Q* to Q1 causing stagflation.
Decrease in employment.

1.3 Various factors contributed towards inflation

Weaker exchange rate on some goods categories caused the increase inflation in July from 5.7 percent to 5.8 per cent, which raises the price of imports and reduces the price of exports. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases, thereby increasing the overall level of aggregate demand, economic growth and employment in South Africa.

Petrol price which decrease by 26.6 per cent in February while food price inflation measured 6, 5 per cent in February, down from 6, 6 per cent in January. As a result increase in food prices, housing utilities and transport prices and lower agricultural products, with firm unwilling to produce goods thereby decrease the overall level of aggregate supply, economic growth and employment in South Africa.

Rand depreciation results in inflows of bonds and equities decreasing and outflow increasing. Because of the weak of rand against the other foreign countries, the bond and equities exports increase and the imports decreases, hence the demand increase.

Production cost- increases wages if laborers demand higher salaries, rise in price of raw materials because of scarcity of raw materials and to continue to maintain (or increase) profit margins, the company passes the increased costs of production on to the consumer, making retail prices higher the company has to allocate more resources to pay for the creation of its goods or services.

Rising labour costs - caused by wage increases that exceed improvements in productivity. If the cost of labor rise is because need more resources to pay for the creation of its goods or services, Wage and salary costs often rise when unemployment is low

2. GLOBAL DEVELOPMENTS

China GDP GOWTH| South Africa GDP GROWTH

Historical Data Chart

Source: http://www.tradingeconomics.com/south-africa/gdp-growth

Real GDP growth formula is

Y = C + I + G + (X – Z)

Whereby: Y = Consumption, I = Investment spending, G = Government Spending, X = Exports and Z = Imports.

$C:\Users\mokokacr\Desktop\aggregate_demand_shifts.png$

Source: http://www.freeeconhelp.com/2011/10/what-causes-aggregate-demand-curve-to.html

Shift in the demand curve to the right from AD to DA’

Increases the consumption C and Investment spending I, increase government spending, net exports(X-Z) increases, price level increases, real GDP growth increases and interest rate decrease

Shift in the demand curve to the left from AD to DA”

Decreases the consumption C and Investment spending I, decrease government spending, net exports(X-Z) decreases, price level decreases, real GDP growth decreases and interest rate increase

$C:\Users\mokokacr\Desktop\aggregate-supply-2.jpg$

Source:http://tutor2u.net/economics/revision-notes/as-macro-aggregate-supply.html

Shift in the supply curve to the left from SRAS1 to SRAS3

Increase in the price of factors of production e.g. wages, increase in the price of imported capital, increase intermediate goods e.g. oil, decrease in production and weather condition deteriorate.

Shift in the supply curve to the right from SRAS1 to SRAS2

Decrease in the price of factors of production e.g. wages, decrease in the price of imported capital, decrease intermediate goods e.g. oil, increase in production and weather condition improve

South real GDP growth has being expanding at average of 4.5 percent from 2004 to 2008 because they are able to exports more of their natural resources to foreign countries, which resulted in the increase in demand of South African goods increasing, with inflation rate decreasing and employment rate increasing. However after the recession in 2008, increases in wages, oil prices, food prices and more. Increase in imports and decrease in SA products, resulting in decreasing in supply of South African goods, inflation rate increasing and unemployment increased. A severe downturn in China means that emerging market exporters – including African ones, to China will see demands for their commodities drop. It will also knock prices for raw materials – Africa’s biggest exports (and off course industrial materials such as steel). For now, in spite of China’s slowing growth, its demand for African metals and minerals are still high.

Impact on business organisation

The business organisation has been impacted in a big way, as a result it is now looking at ways to save and cut costs by reducing the employee numbers and closing down some of their shops that are not making profit. It is also restructuring management and closing down its rented buildings

3. THE RAND EXCHANGE RATE

3.1 The law of demand

The rand exchange rate is a price of South African currency in terms of the price of another country currency in the foreign exchange market. The law of demand for foreign exchange market states:

If exchange rate appreciates, other things remaining the same

Quantity of SA rand demanded decreases and there is a movement up along the demand curve and higher the prices of SA produced goods and decrease in exports because people prefer to buy goods/services from foreign countries.

If exchange rate depreciates, other things remaining the same

Quantity of SA rand demanded increases and there is a movement down along the demand curve and lower the prices of SA produced goods and increase in exports because people from foreign countries prefer to buy SA produced goods/services.

3.2 The law of supply

The law of supply for foreign exchange market states:

If exchange rate appreciates, other things remaining the same

Quantity of SA rand supplied increases and there is a movement up along the supply curve of SA rand, higher the prices of SA produced goods and increase in imports.

If exchange rate depreciates, other remaining the same

Quantity of SA rand supplied decreases and there is a movement down along the supply curve of SA rand, lower the prices of SA produced goods and decrease in imports.

3.3 Factors impacted on the rand exchange rate during the last six months.

Relative interest rate- The SA announcement of interest rates rise, it will become more attractive for foreign countries to deposit money or invest in SA. You will get a better rate of return from saving in SA banks. Higher interest rates cause an appreciation in rand and depreciation in foreign currency and demand for rand and the supply of foreign currency will shift to the right. For example: SA banks will be maximizing their profit.

Change in tastes- consumers preferences for the foreign products, this will shift the demand of rand to the left and rand will depreciate, decrease exports and change the exchange rate. For example of product and manufacturing, there will be increase in importing and decrease in exporting. For example SA clothing companies are not doing good, SA people are preferring China clothing because they are cheap so SA produced clothes are not selling much.

Change in competiveness- If SA goods become more attractive and competitive this will also cause the value of the exchange rate to rise and the supply of more foreign currency in the exchange market. The supply of foreign currency curve will shift to the right, causing rand to appreciate and foreign currency to depreciate. For example there are SA Telecommunications advanced technologies attracted most of the African countries and SA telecommunications are exporting or selling services to African countries and because of strike consumer will option for alternative competitor.

Relative income changes-SA currency depreciate because its growth of national income decrease due to the wage settlements strikes that impacted on the exports and imports. The rand depreciated and the foreign countries appreciated so more foreign good were purchased as an alternative and exports decreased- foreigners scared to invest in SA. For example national expenditure decreased, SA people cannot afford to buy because of no income and in mining and steel sectors if affected their profit.

Balance of Trade –depreciation of currency tend to increase exports and decrease imports and think that the will reduce a countries trade deficit but the country balance of trade may get worse before it gets better.

3.4 Strategy that I could implement to minimize the risks associated with exchange rate volatility

South African government and Reserve bank uses the flexible exchange rate policy which permits the exchange rate to be determined by demand and supply with no direct intervention in the foreign exchange market by central bank. Even though flexible exchange rate automatically work to eliminate payment imbalances but it does have disadvantages that is uncertainty and diminished trade, terms-of-trade changes and instability. Exchange rate fluctuates from time to time in order to minimise the risks associated with exchange rate volatility to any organisation will have control and manage the risks that is:

1. Increased current consumption and SA indebtedness- to manage and control the balance of trade by making sure that there is a balance in exports and imports. This helps improve the government spending by fiscal policy and improve the economic growth.

2. Forward foreign exchange rate contract is an agreement to buy or sell a given amount of foreign currency at a certain point in time at an exchange rate fixed today. Our company is import intensive and requires taking FEC to cover the exchange rate exposure thereby minimising the risk.

3. Developing well-developed hedging facilities and institutions that is the financial and operational hedges that can protect its exporters against exchange risk, ensuring sustainable economic growth through increased exports should be substantiated by a stable and competitive exchange rate, viable fiscal and monetary policies.

4. WAGE SETTLEMENT

4.1 Wage rate determination

The wage rate in the labour market is determined by market forces that is labour supply and demand. The labour demand represent the amount of labour that the firms want to employ at each given wage rate and labour supply represent the amount of labour that the households want to supply at each given wage rate. When labour demand and supply curve intersect it result in equilibrium wage rate, more/full employment and increase in economic growth.

4.1.1 Wage rate demand

When the platinum mine strike and the prolonged steel and engineering sector strike are the relevant factors that impacted on wage settlement during the last twelve months.

$C:\Users\mokokacr\Desktop\Wages-increase-demand.png$

Source: http://www.economicsonline.co.uk/Competitive_markets/The_labour_market.html

When the strike was still ongoing the demand curve of labour will shift to the right from D to D1 which result:

Quantity of labour increase from Q to Q1, wage rate increase from W to W1, increase in employment and increase in economic growth

4.1.2 Wage rate supply

$C:\Users\mokokacr\Desktop\Wages-fall-supply-STRIKE.png$

Source: http://www.economicsonline.co.uk/Competitive_markets/The_labour_market.html

The trade union withdraws labour through a strike, the supply curve of labour will shift to the left from S to SI which result:

• Quantity of labour decrease from Q to Q1, wage rate increase from W to W1, decrease in employment and decrease in economic growth.

4.2 Factors that impacted on the wage settlements

Rising production cost because alternative material was imported resulting in less production
Decrease in firms income growth
Rising labour costs - caused by wage increases that exceed improvements in productivity. Wage and salary costs often rise when unemployment is low.
Firms to raise prices and achieve to better profit margins
Increase is unemployment and retrenchments in firms.
Increase in product prices

4.3 The strategy that I can implement to mitigate the risks that could arise in the future following the recent wage settlements

Deregulate labour market like European Union because this is said to be an important objectives of European Union to increase competiveness for example to make it easier to hire and fire.

Reducing the power of trade unions this should

Increase efficiency of firms for example less time lost to strikes.
Reduce unemployment if labour markets are competitive

5. INTEREST RATE

The transmission mechanism of monetary policy is the way in which interest rate changes affect economic activity and inflation. The main impact is through the level of aggregate demand. Higher interest rates limit people's ability to spend and so reduce aggregate demand. However, there are a variety of other effects as well through expectations, asset prices and the exchange rate. In South Africa, the reserve banks goal is to keep the price level stable and to achieve a stable financial environment in order to allow the economy to grow sustainably. They adjust the monetary policy instrument namely repo rate to reach its inflation target.

5.1 How change in interest rates impact on business organization

If reserve bank lowers the repo rate it will impact the business organisation in the following:

Decrease the cost of borrowing because the interest payments of credits and loans are less expensive, business will decreased incentive to save rather spend money because it less attractive to save in a deposit account because of the interest less gained.
Increasing exports and decreasing imports because of more money left in customers' pockets this will increase their ability to buy products and service and more profit for the firms.
Increase in aggregate demand because firms and consumers are encouraged and more willing to take out risky investments and consumption.
Real GDP growth and the inflation rate increases

If reserve bank raises the repo rate it will impact the business organisation in the following:

Increase the cost of borrowing because the interest payments of credits and loans are expensive, business will increased incentive to save rather than spend because it more attractive to save in a deposit account because of the interest gained.
Decreasing exports and increasing imports because of les money in customers' pockets this will reduce their ability to buy products and service and less profit for the firms.
Decrease in aggregate demand because firms and consumers are discouraged and less willing to take out risky investments and consumption.
Real GDP growth and the inflation rate decreases

I think the MPC made the correct decision to leave the repurchase rate at 5.75 per cent per annum because it is still between the ranges 3 to 6 as per the South African monetary policy. Reserve bank does not need to increase or decrease the repo rate because it need to lower the rate to solve the unemployment and recession problems that SA is experiencing and at the moment in the country there is no recession and unemployment still the issue that is addressed. Repo rate decrease is when commercial bank obtain additional reserves by borrowing from Reserve bank and resulting in money supply rises and aggregate demand rises and if it increase the repo rate to solve the inflation issue that as the country we are experiencing, increase in repo rate is when commercial bank obtain lower reserves by borrowing from Reserve bank, money supply falls and aggregate demand falls.

6. Bibliography

Parkin, M et al (Kohler, Lakay, Rhodes, Saayman, Schoer, Scholtz & Thompson), 2010. Economics: global and Southern African perspectives. African edition. Cape Town: Addison Wesley.
J. J Van Rensburg, et al, 2011, “Economics Southern African Edition, McGraw-Hill Higher Education.
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www.tradingeconomics.com/south-africa/gdp-growth [accessed: 06 May 2015].
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http://tutor2u.net/economics/revision-notes/as-macro-aggregate-supply.html [accessed: 05 May 2015].
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