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ECS3701 Assignment 02 S2 2022 Solutions
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ECS3701 ASSIGNMENT 02 S2 2022Monetary Economics
ECS3701
ECS3701 ASSIGNMENT 02 S2 2022
UNIQUE NUMBER: 182960
2.01 If you were a private investor, would you and/or financial intermediaries benefit from risk-
sharing? Explain which party will benefit and why.
Risk sharing defined as sharing with another party the burden of loss or the benefit of gain, from
a risk, and the measures to reduce a risk.
Financial intermediaries can help reduce the exposure of investors to risk through the process
of risk sharing. Low transaction costs allow financial intermediaries to share risk at low cost.
Risk sharing benefits financial intermediaries because they gain on the spread between the
returns they earn on risky assets and the payments they make on the assets they have sold.
Financial intermediaries promote risk sharing by helping individuals to diversify and thereby
lower the amount of risk to which they are exposed.
Investors benefit because they are able to invest in a diversified portfolio of assets. In keeping
with the “golden rule” do not keep your eggs in one basket. Risk sharing is also referred to as
asset transformation, because, risky assets are turned into safer assets for investors which also
benefits investors.
1
, ECS3701 ASSIGNMENT 02 S2 2022
2.02 What are the two causes of inflation in South Africa? Provide empirical evidence to support
your answer.
The two main causes of inflation are:
Demand-pull inflation
Cost-push inflation:
Demand-pull inflation
Occurs when the demand for certain goods and services is greater than the economy’s ability to
meet those demands. When this demand out strip supply, there is an upward pressure on prices
– causing inflation. For instance tickets for live show, because of limited number of seats and
demand for the live show greater than capacity, the price of tickets skyrockets.
If money supply increases faster than the rate of production results in demand-pull inflation
because too much money chasing too few goods. An increase in money supply usually happens
when central bank embarks on open market operation.
High employment goal can lead to inflationary fiscal and monetary policy in another way. If
policymakers mistakenly underestimate the natural rate of unemployment and set a target for
unemployment that is less than the natural rate of unemployment, triggers the stage for
expansionary monetary policy that produces inflation.
Cost –push inflation:
A result of an increase in prices when the cost of wages and materials goes up. These costs are
often passed down to consumers in the form of higher prices for those goods and services. For
example a raise in input cost like that of a lumber an input good for houses has an impact on the
increase in housing prices resulting in inflation.
An increase in the costs of firms is passed on to consumers resulting in a shift to the left in the
aggregate supply. Other causes of cost-push inflation are:
Rising wages
Usually a result of trade unions bargaining for higher wages a significant cost for many firms.
Imported prices:
A currency devaluation causes import costs to go up and import prices become more expensive
leading to inflation. In the case of a devaluation or depreciation, the rand becomes worthless
and ending up paying more for same imported goods.
Raw material prices:
An increase of 20% in the oil price have significant impact on most goods in the economy and
leads to cost-push inflation.
Policies and regulations can result in either a cost-push or demand-pull inflation. Suppose
government issues tax subsidies for certain products that can increase demand and if demand
excessed supply, costs could rise. Stringent building regulations and rent stabilisation policies
inadvertently increase costs, creating an inflationary environment by passing costs to residents
or artificially reduce the supply of housing.
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