Chapter 1

Distinguish between the following:

 positive and normative economics

- Positive economics studies the nature and the consequences of decisions taken.

- Positive economics attempts to predict what could be expected to happen if certain steps, specified
at the time are taken.

- Normative economics focuses on studies the question: ‘What ought to be the situation?’

- Once a situation is described, normative economics seeks criteria to determine whether that
situation is acceptable or whether it ought to be adjusted to become closer to what the criteria
require.

 general government and public sector

- General government embraces the three spheres of government in South Africa: central, provincial
and local government, and therefore forms the wing of the public sector that renders services
funded out of taxation.

- The public sector is the wider concept which adds the public enterprises or public corporations to
general government.

- Public enterprises are those institutions which deliver public services but on a commercially-based
system charging user charges.

- From a management point of view, public corporations are run by Boards of Directors that are
appointed by the government.

 resource use and resource mobilisation.

- Resource use is one way of measuring the magnitude of government expenditure and captures the
exhaustive expenditures of government and the non-exhaustive expenditure.
- Exhaustive expenditure refers to the expenditure on final goods and services while non-exhaustive
expenditure refers to the transfer payments to beneficiaries outside the public sector.
- In addition to exhaustive and non-exhaustive expenditure government also makes transfer
payments to households, business enterprises and the foreign sector.
- When these transfer payments are added to the exhaustive and non-exhaustive expenditure, the
so-called resource use by government, we get the total amount of resources mobilised by the
government.

What are the features of the developmental state?

 Explicit development objectives are formulated by the state.

 The state assumes powers and establishes institutions that can strive for achieving these objectives.

 Sufficient power, autonomy to act and the capacity to act are concentrated in the state to achieve
development objectives.

 The developmental state is further characterised by:

- An elite determined to see development taking place

- A powerful bureaucracy capable of driving the development process

 - Management of economic interests outside the public or state sector

- State intervention that distort relative prices when this is deemed necessary for the sake of
development.

Briefly review the salient changes in the size and composition of the South African public sector during
the past few decades. Which of the changes, in your opinion, are incompatible with the
requirements of a thriving economy?

 Choose at least the two decades before 1990 and make a comparison with the period after 1990 to date.

 Compare taxes as percentage of the GDP for the selected periods.

 Compare the trend in general government consumption with the trend in government investment.

 Consider the trend in subsidies and current transfers and determine what causes the rising trend.

 Compare the trend in resource use with the trend in resource mobilisation.

Give an overview of the various dimensions of the relationship between the public sector and the rest of the
economy.

Draw a circular flow diagram and then identify and describe

o Government as a supplier of public goods and services.

o The influences of government purchases of goods and services.

o The economic consequences of funding state expenditures.

o How a budget imbalance influences the balance between savings and investment.

o How the funding of a budget deficit affects macroeconomic stability.

o How the condition of the economy affects the government’s activities in the economy.
Chapter 2
Distinguish between allocative efficiency, X-efficiency, and economic growth (‘dynamic’ efficiency) and
briefly consider their relevance to South Africa.

 Allocative efficiency:

 Allocation in accordance with the explicit wishes of the population

 Consequent mix of goods optimal

 Under perfectly competitive conditions utility-maximising consumers respond to prices that reflect
full cost of production, in other words social costs

 Reflects interaction between utility-maximising consumers and profit-maximising producers

 Should there be no public sector such a situation will be achieved provided three conditions are
met:

- Pareto optimality in consumption – no reallocation of goods between two consumers is possible

without making the at least one consumer worse off.
- Pareto optimality in production – no reallocation of resources between to firms is possible without
decreasing the production of one of the firms.
- Consumers and producers achieve equilibrium simultaneously i.e. pareto optimal top-level
equilibrium.

 X-efficiency: Also named technical efficiency refers to the situation where resources are used in the most
efficient way attainable for the production of goods and services. It thus implies:

 That production will be on the production possibility curve (PPC), not inside it because then
resources can be used more efficiently, while a position outside the PPC is not attainable with the
given resources, but

 That X-efficiency alone is not enough to measure economic efficiency because production on the
PPC does not necessarily mean that people demand that combination of goods, therefore

 People need a way of expressing their desire for goods and services, which they can do in a well-
functioning price system.

 Allocative efficiency is important in SA because of the need to deliver private and public goods in a well-
balanced manner to a population of which the resources, like in other societies, outstrip the needs to be
satisfied.

 X-efficiency in SA is equally important because of the scarcity problem that requires every resource to be
used with great efficiency in order to satisfy the needs of a diverse society.

Distinguish between the allocative and distributive functions of government.

Allocative function:

 The market fails to allocate resources to the delivery of pure public goods. Society, however, needs
pure public and pure private goods, the latter to which the market can allocate resources. It is the
government’s function to allocate resources to the delivery of pure public goods
 The market likewise fails to allocate resources efficiently to the delivery of mixed goods
 - Elaborate on their characteristics and the market’s subsequent failure in allocating resources

 The market further fails in rewarding positive externalities and penalising negative externalities

- Government has to allocate resources to reward positive externalities and intervene to penalise
negative externalities.

 Allocation in the case of artificial monopolies

 Allocation in the case of natural monopolies.

Distributive function: The market distributes rewards in accordance with the existing distribution of resource
ownership. Therefore

 When this distribution is skew the distribution of rewards will also be skew

 Explain what is meant by skew

 This skewness or inequality in income distribution may not be acceptable to the community
 The government has to step in to bring about an adjustment in the original possession of production
factors or in the distribution of rewards following upon the existing distribution of ownership.

 In the case of the allocation function the government brings about adjustments in the way in which resources
are used, while

 In the case of redistribution the government adjusts either the possession of resources or the rewards that
follow upon the use of these resources.

Should governments have a stabilisation function?

 Assigning a stabilisation function to government is anchored in Keynesian macroeconomics which justifies a

stabilisation function on grounds of :

- Market economy inherently unstable

- Macroeconomic instability is one market failure

- Macroeconomic policies by government can stabilise the economy.

 Governments must thus and are able to apply ant-cyclical stabilisation policies.

 New classical macroeconomics believes adjustment is unnecessary and impossible because market
participants foresee possible government intervention and act before the application of such policies by
government.

- Keynesian Demand Management policy lacks a sound microeconomic foundation (Explain why)

 Neo-Keynesian school attempts to provide the microeconomics of macroeconomics and in that way justify
the government’s stabilisation function.

Distinguish between direct and indirect government intervention.

 Direct government intervention: Intervention by means of measures applied via the budget, which means:

- Intervention by means of state expenditure

- Intervention by means of raising state revenue, mainly through taxation

- Intervention by means of funding a budget deficit, mainly through state borrowing.

 Indirect government intervention: Intervention via legislation which regulates some or other aspect of
economic behaviour, like:

- The way the labour market works

- Elements of consumption and thus of production like ant-tobacco legislation

- The competitiveness of markets

- Allowing or disallowing private property rights.

Chapter 3

Discuss the phenomenon of ‘global’ or ‘regional public’ goods.

Can present themselves in the form of:

 Cross-border public or merit goods, examples

- Transport systems

- Defense systems

- Health-care systems

 Being public or merit goods they are delivered by the respective governments.

 In all cases:

- Beneficiaries must be identified

- How payment by beneficiaries will be shared:

 Usually requires agreements in the form of formulae between governments

involved.

 The reasoning can be extended from regional or global goods to externalities with a regional or global
influence, whether positive or negative.

- How do governments penalize creators of negative externalities from across the border? Likewise

- How do governments compensate creators of positive externalities from across the border?

- Penalties and compensation will require international agreements.

 Refer to international undertakings regarding green house gases and similar

phenomena.

Critically discuss the ’cap-and-trade’ approach to addressing the externality problem.

 Cap : The government caps the amount of pollution permitted.

 Trade:

- The government sells permits to polluters

- Polluters polluting less than what they have permits for may sell permits to other polluters in need

- As pollution declines the market price of permits will fall until at zero pollution they reach market
price of zero.

 Critical assumptions:
 - The government has perfect knowledge of about sources of pollution to compel polluters to obtain
permits

- The government knows how much pollution to issue permits for ( the capping).

Discuss Coase’s theorem and consider its usefulness as a means of solving the externality problem.

 The Coase Theorem rests on the existence of property rights which are:

- Well-defined

- Enforceable

- Transaction costs are negligible.

 Well-defined and enforceable require a good judicial system:

- a function of government.

 Negligible transaction costs require well-functioning markets:

- Government can establish such an environment.

 All this must result in the ability of an owner of a property right in non-pollution being able to sell such right to
a polluter in need of it.

 Usefulness depends on existence of the above conditions and the number of individuals who want to enforce
their property rights

- Class actions are used to enforce rights or compensation for violating rights on behalf of large
numbers of affected persons.

Chapter 4
Should natural monopolies be regulated?

 Deregulating a monopoly, in general, so that greater competition can prevail, can result in:

- Better allocative efficiency

- Better X- efficiency.

 Does this also apply to the natural monopoly in particular? Consider that:

- Minimum average cost occurs at a level of output = the whole market

- Profit maximising output occurs where MC = MR and points to a much smaller output being sold at
a price well above the socially efficient price determined by the intersection of MC and Demand
curves and coinciding with the minimum AC.

 Government intervention is thus required for those cases where the natural monopoly incurs positive
externalities on other industries.

- Government can take over the natural monopoly and apply marginal cost pricing

- Marginal cost pricing would require subsidising the difference between average cost at its lowest
point and the price determined by the intersection of demand and supply.

 The funding of such subsidies from taxation brings about distortions where these taxes
have their incidence because of their excess burden.
Critically discuss the case for and against privatising natural monopolies.

 Privatising natural monopolies hold the advantages of:

- Greater X-efficiency because it has no fall-back position on government resources

- Proceeds becoming available for reducing the national debt or for investment in physical
infrastructure.

 Privatised natural monopolies may lead to smaller outputs at higher prices. Therefore, privatised natural
monopolies are often regulated by:

- Capping prices or profits

- Employment guarantee schemes to prevent job losses

- Institutional arrangements to prevent negative distributive effects, like the already rich becoming the
owners of the privatised monopoly.

 Profit capping is less successful because of cost padding.

 Price capping leads to greater efficiency to keep costs down and improve profits.

 Profits and prices can both be capped when profits exceed a pre-determined level prices are adjusted
downwards.

 Greater X-efficiency from privatisation can result in outward shift of the PPC - economic growth, but
somewhat dampened by the cost of administering price capping.

Discuss the basic objectives and nature of competition policies with specific reference to the ‘structure-
conduct-performance’ hypothesis.

 Real world situations are more often cases of monopolistic competition or oligopolies than of monopolies or
perfect competition.

 The effect on output and on prices thus falls somewhere between the perfectly competitive and the
monopoly case.

 This “middle ground” is determined by the structure-conduct-performance hypothesis

- Structure determines

- Conduct which determines

- Performance, therefore:

 Highly concentrated structure encourages collusive behaviour which steers prices towards the monopoly.

 Competition policy is required to regulate the ability of a concentrated industry to result in monopoly
pricing.

 Not all concentrated industries will result in monopoly practices. Therefore

 Competition policy is aimed at breaking up the kind of conduct where dominance in a structure is abused to
achieve monopoly outcomes.

 Objectives of competition policy are thus:

- Lower prices
 - Expanded choices

- Technological progress

- Capital investment

- Redistribute income through lower prices

- Remove restrictive barriers to entry

 Improve opportunities for SMMEs.

Outline the new competition policy in South Africa.

 Government view on dominance in South African markets.

 Mergers leading to monopoly pricing.

 Prevent abuse of dominant position in the form of:

- Price fixing

- Production quotas

- Exclusivity agreements

- Collusive tendering.

Discuss Harold Demsetz’s ‘efficiency hypothesis’ and consider its implications for the conduct of
competition policy.

 Demsetz reverses structure-conduct-performance:

o Performance by being the low-cost producer is the result of conduct of an industry in which
competition prevails and in which the low-cost survivors form structure of the industry and
therefore deliver at prices lower than what they would have been with more but less efficient
firms.

 Competition policy should thus not identify concentrated structures as necessarily non-competitive.

 Rather, consider whether such concentrated industries erect barriers

to entry.

 With no barriers to entry, concentration is not necessarily bad.