Answer to Question #146665 in Macroeconomics for Prince Chauke

Question

Question 4

Explain, with the aid of a graph, the effect on the rand/dollar exchange rate and the equilibrium
quantity of dollars if there is a decrease in imports from the USA to South Africa.
In your answer comment on the effect of this on the current account balance as well as on
domestic prices.
(Note: 5 marks for the graph and 5 marks for the explanation of the graph)

Question 5

Explain, with the aid of a graph, the demand‐pull inflation. In your answer, consider the following:
 Graphical illustration of the demand‐pull inflation (5)
 Provide any three of your own examples/scenario that might cause the demand‐pull
inflation (6)
 Recommend the policy tools to use in order to curb each type of inflation mentioned
above (4)

Answer 1

Question 4

When imports from USA to South African decrease, the demand for USD declines. Eventually, Rand appreciates in value and the equilibrium quantity of USD exchanged decreases. The graph below summarize.

Due to decrease in US imports to South Africa, the demand for USD falls as shown by a leftward shift of demand curve from D1 to D2. The equilibrium quantity of USD exchanged falls from Q1 to new equilibrium Q2. The equilibrium exchange rate Rand per $1 decreases from P1 to P2.

As imports decline, South Africa's current account balance improves as the gap between value of exports and value of imports falls. The appreciation of the Rand against USD also reduces the cost of imported goods to South Africa, reducing imported inflation. Thus, current account balance improves and inflation decreases.

Question 5

a) Demand pull inflation is caused by an expansion in demand when the economy is in full employment. The graph below illustrates damand pull inflation.

On the graph, aggregate demand increases from AD1 to AD2. An inflationary gap is created; actual real GDP (Ye) exceeds full employment real GDP (Yf).

b) Demand pull inflation may take place if the following events take place when the economy is in full employment equilibrium:

1. Employee real wages increase, causing an increase in aggregate demand.

2. Local currency depreciates in value, leading to an increase in demand for local imports

3. Government increases its expenditure on goods and services

c) curing demand pull inflation requires contractionary monetary and fiscal policies.

1. Maximum wage legislations, price ceilings, must be instituted to reduce wage increments. Government can increase income tax to cut real wages and household purchasing power.

2. The government can implement exchange rate controls by appreciating the local currency to reduce imports demand

3. Government should cut on its expenditure on goods and services.