EKN 120: Economics 120 (Macro) Study Guide

Economics 120 (Macro) focuses on how economies behave as a whole—output, employment, inflation, interest rates, government policy, and international linkages—rather than individual firms or markets. This study guide is designed for exam preparation in the context of South African universities and colleges, with practical emphasis on how macro theory is applied to the South African policy environment. Use it to build conceptual foundations, then strengthen problem-solving with worked examples and exam-style practice.

Section 1: Macroeconomics Foundations for EKN 120—Key Models, Measurement, and Problem-Spotting

Macro foundations in an “Economics 120 (Macro)” course typically begin by clarifying what macroeconomists measure, how they model the economy, and why certain indicators matter for policy. In South Africa, where unemployment, inflation volatility, electricity supply constraints, and exchange-rate movements are salient, the ability to interpret macro data correctly is often what separates a high pass from a top mark.

Understanding the “Macroeconomy” and Macro Questions

At the macro level, the main variables you’ll encounter are:

Economic growth (real GDP growth)
Employment/unemployment (labor market slack, unemployment rates)
Inflation (often CPI inflation, sometimes core inflation)
Interest rates and money supply (policy rate, liquidity conditions)
Government policy (fiscal stance: taxation and spending)
External sector (exchange rate, trade balance, capital flows)

Typical exam questions test whether you can:

Define key terms precisely (e.g., nominal vs real GDP).
Explain cause-and-effect using models (e.g., AD-AS shifts).
Interpret data tables/graphs (e.g., inflation rising while unemployment falls).
Evaluate policy trade-offs (e.g., fiscal expansion vs debt sustainability).

National Income Accounting: The Backbone of Macro

Most macro courses begin with the circular flow of income and the measurement of national output using GDP. You need to be comfortable with definitions and identities.

GDP Components (Expenditure Approach)

In the expenditure approach:

[
Y = C + I + G + NX
]

Where:

(Y) = real output (GDP)
(C) = consumption
(I) = investment (private domestic investment)
(G) = government spending
(NX) = net exports ( (X – M))

Key exam skill: When you’re given a policy change or shock, you must identify which component changes.

Example (typical macro reasoning):

A drought reduces agricultural output and household incomes → consumption (C) falls.
Businesses delay expansion due to uncertainty → investment (I) falls.
Imports rise relative to exports due to exchange-rate appreciation → (NX) falls (more negative).

Nominal GDP vs Real GDP and Price Indices

Nominal GDP uses current prices; it grows partly because prices rise.
Real GDP removes inflation effects by using base-year prices.
GDP deflator and CPI are related but not identical; CPI is a household-based cost-of-living index, while the GDP deflator measures prices of goods and services produced domestically.

Common exam pitfall: Students often treat CPI inflation as identical to “GDP deflation.” You should remember they can differ because the baskets differ.

The Real Business Cycle vs Keynesian vs Monetary Perspectives (High-Level)

While your course may not go deep into competing macro schools, you must generally know:

Keynesian view: Output and employment can deviate from potential due to demand-side problems; fiscal and monetary policy can stabilize.
Monetarist/monetary view: Inflation is heavily influenced by money growth and monetary conditions.
Supply-side/AD-AS view: Long-run outcomes depend on productivity, labor supply, capital accumulation, and the structure of the economy.

Exams often ask you to connect these views to a policy question:

“If inflation is high, what should the central bank do?”
“If unemployment is high, is the problem demand-side or structural?”

Circular Flow, Leakages, and Injections

In a simplified closed economy model:

Injections: investment (I), government spending (G)
Leakages: saving (S), taxes (if considered leakages in extended circular flow)

In an open economy:

Additional leakages: imports (M)
Additional injections: exports (X) (and net capital inflows via the financial account in macro frameworks)

You should be able to interpret “what leaks from the economy” versus “what injects demand.”

Potential Output, the Output Gap, and Why It Matters

A crucial concept in many EKN 120 curricula is potential output (Y^*) and the output gap:

[
\text{Output gap} = Y – Y^*
]

When (Y > Y^*), the economy is “overheating,” often associated with upward inflation pressure.
When (Y < Y^*), there’s slack; unemployment may be higher, and inflation may ease.

Why this matters in policy exams: If a government expands fiscal spending while the economy is already above potential, inflation and import demand rise; if there is slack, fiscal stimulus may increase output with less immediate inflation.

Inflation: Measurement and the Core Logic Behind It

Inflation can be defined as a sustained rise in the general price level. But exams test understanding of:

demand-pull inflation (too much spending relative to output),
cost-push inflation (higher costs, e.g., wages or imported inputs),
expectations (if inflation expectations rise, wages and prices adjust).

For South Africa, cost-push channels are often important because:

imported fuel and food components can influence CPI,
exchange rate depreciation raises import prices,
wage bargaining can interact with productivity and cost pressures.

Balance of Payments Intuition (Open Economy Link)

Many macro modules in South African institutions introduce the basics of:

current account (trade in goods/services, income flows)
capital account and financial account (investment flows)

Even if the course does not ask for complex balance-of-payments computations, you should know the macro intuition:

A deteriorating trade balance may be linked to exchange-rate movements, income changes, and global demand.
Large capital inflows can finance deficits but can reverse quickly in risk-off periods.

Worked Micro-to-Macro Example: From Policy to Components

A standard exam-style scenario:

Scenario A: Government increases social grants and public works spending.

(G) rises (directly)
Some of the grant/transfer spending increases household consumption → (C) rises via the multiplier effect.
Import demand may rise if marginal propensity to import is high → (NX) falls (more imports).

Question you should answer in exams: Which macro variable changes first? Which changes through second-round effects? What determines the magnitude (marginal propensities, crowding out, supply constraints)?

You should use a structured answer:

Identify affected components: (C, I, G, NX).
Determine whether it’s a demand shock or supply shock.
Explain short-run effects vs long-run effects.
Discuss trade-offs: inflation vs output, debt vs growth, exchange rate vs external competitiveness.

Section 2: Aggregate Demand (AD), Aggregate Supply (AS), and Macroeconomic Equilibrium—Applying the Models to South Africa

A core exam focus is likely AD-AS analysis and the macroeconomic equilibrium logic that connects shocks to output and price levels. In South Africa’s context, energy constraints, policy uncertainty, and external shocks (oil prices, commodity prices, exchange rate changes) make model application essential.

The Aggregate Demand (AD) Curve: What It Represents

In the simplest Keynesian-style macro view, AD reflects total spending in the economy at different price levels. A higher price level tends to reduce real money balances, raising interest rates and lowering spending—so AD is typically downward sloping.

A more complete reasoning includes channels:

Consumption channel: real wealth effects, interest rates
Investment channel: borrowing costs and profitability expectations
Net exports channel: exchange rate effects (in many open-economy extensions)

Exam-style prompt: “AD shifts right due to higher government spending. Explain effects on output and price level.”

Your response should follow a logical chain:

AD increases → higher desired spending.
In the short run, firms respond with higher output (and possibly higher prices depending on AS shape).
Over time, wages and prices adjust; if stimulus pushes demand beyond capacity, inflation accelerates.

The Short-Run Aggregate Supply (SRAS) vs Long-Run Aggregate Supply (LRAS)

A standard AD-AS framework uses:

SRAS: upward sloping (due to sticky wages/prices, capacity constraints, input costs)
LRAS: vertical at potential output (Y^*) (prices and wages adjust fully over time)

Interpreting SRAS Shocks

SRAS shifts when costs or productivity change:

Higher wage demands not matched by productivity → SRAS shifts left (higher costs).
Oil price increase → costs of production rise → SRAS left.
Electricity supply disruptions raise production costs and reduce effective capacity → SRAS left.

In South Africa, a left shift in SRAS can occur due to:

global oil/food shocks affecting costs,
domestic constraints like energy reliability,
policy uncertainty affecting investment and supply decisions.

Equilibrium and Dynamics: Short-Run vs Long-Run

A frequent exam question asks you to:

identify the immediate macro impact,
then describe long-run adjustment.

Example logic: Demand Expansion

AD shifts right → output rises above potential in short run → prices rise.
In the long run, wages and prices adjust; output returns to (Y^*).
Inflation remains higher (depending on model details).

Example logic: Supply Shock

SRAS shifts left → output falls → prices rise.
In the long run, output returns to potential but the price level remains higher.

Important South Africa link: Supply shocks producing “stagflation-like” patterns (lower growth plus higher inflation) are a common story in macro discussions, and examiners often reward students who can show the SRAS left shift mechanism.

Multiplier Effects and Link to AD-AS

If your course includes the Keynesian cross or multiplier reasoning, connect it to AD.

Fiscal expansion increases spending.
With a positive multiplier, total demand rises by more than the initial spending increase (depending on leakage via saving and imports).

But the multiplier is not constant. In an open economy:

imports are a leakage from domestic demand.
a higher marginal propensity to import reduces the effective multiplier.

Exam-valuable comparison:

Closed economy multiplier: larger total effect.
Open economy multiplier: smaller domestic output effect because part of additional demand goes to imported goods.

Monetary Policy within AD-AS (Core Intuition)

Even if EKN 120 emphasizes AD-AS more than IS-LM, you’ll likely still cover monetary policy through:

interest rate changes,
money supply/liquidity conditions,
expectations about inflation.

A tighter monetary policy generally:

reduces spending (consumption and investment),
may slow inflation,
can reduce output temporarily (depending on SRAS conditions).

Trade-off discussion: A sharp monetary contraction may reduce inflation but increase unemployment via lower demand.

Worked AD-AS Problems (Template for High Marks)

Template Answer Structure

Identify shock: AD or SRAS.
Determine direction: right/left (or increase/decrease).
Predict short-run outcome: output and price level move.
Predict long-run outcome: output returns to (Y^*) (LRAS) while price level adjusts.
Explain policy implications.

Example 1: Government Spending Increase

Shock: AD → right
Short run: (Y) rises, (P) rises
Long run: (Y) returns to (Y^*), (P) stays higher

Add South Africa application: If supply capacity is constrained (SRAS already left-shifted due to energy constraints), the price rise may be stronger relative to output gains.

Example 2: Import Cost Shock (Exchange Rate Depreciation)

Shock: SRAS → left (costlier imported inputs, higher inflation)
Short run: (Y) falls, (P) rises
Long run: (Y) returns to (Y^*), (P) remains higher

Exam detail that earns credit: You should mention that higher inflation may affect expectations and wage bargaining, reinforcing the elevated price level.

Potential Output and Policy Credibility

Policy credibility matters because expectations shape inflation and consumption/investment decisions.

If households believe inflation will remain high, they may demand higher wages and firms may price more aggressively.
If central bank policy is credible, expectations may remain anchored, making inflation control less costly in terms of output losses.

South Africa’s exam essays often benefit from discussing credibility and communication as part of stabilization policy—without needing overly political language.

Common Exam Mistakes in AD-AS

Confusing SRAS and LRAS movements: SRAS changes imply cost/productivity/input shocks; LRAS is tied to potential output.
Ignoring the time dimension: Many marks are allocated for short-run vs long-run effects.
Not linking to real-world drivers: Examples like oil shocks, electricity disruptions, or exchange rate changes strengthen answers.

Section 3: Fiscal Policy, Monetary Policy, and Stabilization—Mechanisms, Multipliers, and Trade-Offs in the South African Setting

EKN 120 (Macro) typically places strong emphasis on policy tools and how macro models translate policy actions into changes in output, inflation, and employment. This section builds the mechanism skills you need for exam essays: “what policy does,” “how it works,” and “what it risks.”

Fiscal Policy: Tools and Transmission Channels

Fiscal policy refers to changes in:

government spending (G),
taxation (T),
transfers (often handled as part of government spending or in consumption via income effects).

Expansionary Fiscal Policy: What Happens?

Common transmission channels:

Direct demand effect: higher (G) increases aggregate demand.
Income effect on consumption: lower taxes or higher transfers raise disposable income → higher (C).
Multiplier effect: through repeated rounds of spending, with leakage through saving and imports.
Interest rate/crowding out channel (if applicable): in models with capital markets, increased government demand might raise interest rates and reduce private investment.

Key exam argument: The size and sign of crowding out depends on:

whether the economy is operating below potential (slack implies less crowding out),
the openness of the economy (imports reduce domestic demand spillover),
the state of financial markets and risk premia.

Fiscal Policy Trade-Offs: Deficits, Debt, and Inflation

Expansionary fiscal policy can improve growth in the short run, but may:

increase budget deficits,
raise public debt,
possibly contribute to inflation if demand outpaces supply.

In South Africa, macro discussions often include concerns about debt sustainability and the credibility of fiscal frameworks. Even if your exam does not require formal debt models, you should be able to explain the conceptually relevant chain:

higher deficits → higher borrowing → potential interest cost increases → higher deficit in later periods (if not stabilized).

Worked Multiplier Example (Numerical Template)

Suppose:

Government increases spending by R 100 billion.
Marginal propensity to consume (MPC) = 0.8.
Assume a simple open-economy “leakage” via imports is minimal for this simplified multiplier (if your course uses a closed economy multiplier, this is fine; if open-economy leakage is included, include it explicitly).

A common simplified Keynesian multiplier is:

[
k = \frac{1}{1 – MPC}
]
[
k = \frac{1}{1 – 0.8} = \frac{1}{0.2} = 5
]

Total change in output:

[
\Delta Y = k \Delta G = 5 \times 100 = 500 \text{ billion}
]

Exam extension: Now suppose imports are significant; the effective multiplier is smaller. You can state:

if a portion of additional income spills into imports, domestic demand is dampened.
thus output gain may be less than in a closed-economy calculation.

Even when numbers like R 100 billion are not given in your exam, the method is the same: identify MPC, compute the multiplier, then interpret the magnitude.

Fiscal Policy and Supply-Side Effects (Beyond Demand Management)

A high-mark exam essay often contrasts:

short-run stabilization (AD effects),
vs long-run growth via supply-side improvements.

In South Africa, supply-side reforms often discussed academically include:

education and skills investment,
infrastructure improvements (including energy reliability),
reforms that improve business environment and productivity.

You should connect these to LRAS:

productivity improvements shift LRAS right (higher potential output).
even if inflation is a concern, supply-side measures can reduce inflationary pressure by increasing capacity.

Monetary Policy: Interest Rates and Inflation Control

Monetary policy usually refers to actions by a central bank (e.g., adjusting the policy interest rate) to influence:

borrowing costs,
money/credit conditions,
aggregate demand,
inflation expectations.

Contractionary Monetary Policy

If inflation is too high:

central bank raises interest rates.
consumption and investment slow due to higher financing costs.
AD shifts left → output decreases short run, inflation falls.

Important nuance: If inflation is caused by a supply shock (SRAS left), monetary policy may reduce demand but cannot “fix” the supply issue quickly. You should be able to discuss that policy addresses the demand-driven component but may worsen output further when supply is constrained.

Monetary-Fiscal Coordination and Policy Mix

Exams often reward students who can discuss:

“What if inflation is driven by both demand and supply?”
“How would fiscal and monetary policy be combined?”

A typical policy mix logic:

When demand is too high: monetary tightening + less expansionary fiscal stance.
When supply constraints dominate: monetary tightening may reduce inflation but supply reforms (fiscal/institutional) are necessary to improve SRAS and potential output.

Liquidity, Credit, and Financial Conditions (Conceptual)

Even if your course doesn’t require technical finance, the macro link is:

tighter policy conditions may reduce credit creation,
investment and durable consumption respond to interest rates and credit availability.

South Africa relevance: Credit conditions can tighten when risk increases or when inflation expectations become unanchored, reinforcing the transmission from monetary policy to AD.

Automatic Stabilizers

Automatic stabilizers are fiscal mechanisms that change with the business cycle without new legislation:

progressive income taxes (tax revenue falls when income falls),
unemployment benefits/transfers (rise when unemployment rises).

They dampen fluctuations:

in recessions, taxes fall and transfers rise → AD partially supports output.
in booms, taxes rise and transfers fall → AD partially cools.

This concept often appears in short-answer questions.

Currency, Exchange Rates, and Imported Inflation

In open-economy macro, exchange rate depreciation tends to:

raise the domestic price of imports,
increase cost of living and production inputs,
shift SRAS left in cost terms (cost-push channel).

Thus, if South African inflation is partly driven by exchange-rate depreciation, monetary policy and exchange-rate dynamics interact.

Exam response strategy: Mention both channels:

demand channel (interest rate affects spending),
cost channel (exchange rate affects input prices).

Policy Effectiveness: The “What Determines the Impact” Checklist

For both fiscal and monetary policies, a strong exam answer includes determinants:

How far the economy is from potential output (output gap)
MPC and MPC-related leakages (including import propensity)
Speed of adjustment (wage and price rigidity)
Expectations and credibility
Supply constraints (SRAS position)
Global conditions (external shocks, commodity prices)
Financial market health (transmission through credit)

Section 4: Labour Markets, Unemployment, Inflation Dynamics, and Long-Run Growth—Explaining the Links Between Output, Jobs, and Prices

EKN 120 (Macro) usually covers unemployment and the relationship between inflation and employment (often through Phillips curve reasoning) and then extends to long-run growth and productivity. Exams often mix definitions with application to real economic situations.

Labour Markets in Macro: Key Concepts

You should distinguish:

labour force: employed + unemployed who actively seek work,
employment: working for pay or profit,
unemployment: not employed but actively seeking work,
participation rate: labour force as a share of working-age population.

Types of Unemployment

Frictional unemployment: short-term search mismatch.
Structural unemployment: skills mismatch, geographic mismatch, sectoral shifts.
Cyclical unemployment: due to demand shortfalls.
Seasonal unemployment: linked to seasonal labor demand.

High-mark exam answers classify unemployment by cause, then link it to policy:

cyclical unemployment → demand management (fiscal/monetary)
structural unemployment → training, education, labor market reforms (supply-side)

Unemployment and Output: Okun’s Law Intuition

Many macro syllabi include an Okun’s law style relationship:

when unemployment rises above its natural rate, output tends to be below potential.
when unemployment falls, output tends to exceed potential.

Even when not requiring formula-level details, you should express the direction:

unemployment is a sign of slack and depressed output.

The Phillips Curve and the Inflation-Unemployment Trade-Off

A basic Phillips curve idea:

lower unemployment is associated with higher inflation (short run),
higher unemployment is associated with lower inflation (short run).

In the extended view, expectations matter:

if people expect high inflation, the unemployment-inflation trade-off weakens.
in the long run, unemployment returns to a “natural” rate (or stable unemployment rate) while inflation can adjust.

Exam framing: Use it to argue why temporary policy can reduce unemployment briefly, but persistent stimulus can lead to higher inflation without sustained unemployment gains.

Expectations and Credibility

Expectations are a major link between policy and inflation.

If inflation expectations rise, wage negotiations and price setting adjust upward.
Stabilization requires not only policy action but also credibility.

In essays, you can add:

A credible central bank can reduce inflation with smaller output costs.
If credibility is low, inflation becomes “self-reinforcing.”

Long-Run Growth: The Drivers of Potential Output

Long-run macro is typically about economic growth and determinants of potential output:

accumulation of physical capital,
human capital/skills,
technology and productivity (total factor productivity),
institutions and incentives,
population and labor force growth.

A typical course framework ties long-run growth to LRAS shifts:

LRAS right → higher sustainable output and employment (depending on labor market).

Solow-Type Intuition (If Included)

Some courses include a simplified Solow growth model intuition:

output grows with capital and labor,
diminishing returns to capital mean growth slows unless technology improves,
savings/investment increases capital stock but does not indefinitely drive growth without technological change.

Even without detailed equations, exams might ask:

why technology is crucial for long-run growth,
why sustained improvements require productivity, not only increased investment.

Productivity and Employment

A strong conceptual link:

productivity growth can raise wages sustainably if workers’ skills and technology improve.
but if productivity rises while demand is weak, unemployment may still rise in the short run.

Thus, macro policy must consider:

short-run stabilization (demand),
long-run reforms (supply/policies that raise productivity and labor market matching).

Worked Scenario: Inflation Rising While Unemployment Falls

Consider an exam scenario:

inflation increases,
unemployment declines.

This suggests either:

demand-side expansion (AD shifts right),
or a supply constraint that raises prices but still sees unemployment fall due to specific sectoral dynamics.

Your job is to decide which is most consistent with macro models:

If both unemployment and output rise: demand pressure likely.
If unemployment rises while inflation rises: supply shock (SRAS left) more likely.

Then propose policy responses:

demand pressure → tightening monetary policy / avoid overheating fiscal expansion.
supply shock → supply-side measures; monetary policy may still help but could worsen output.

South African Labour Market Context (Exam-Useful Framing)

Without assuming specific current-year statistics (which can vary), you can safely discuss themes commonly studied:

unemployment is structurally high relative to many peers,
youth employment challenges,
skills mismatch,
informality and labor market segmentation,
the role of education/training and labor market policy.

In exam answers, avoid exact numbers unless your lecture notes provided them. Focus on mechanisms:

structural unemployment requires structural solutions,
cyclical unemployment can respond to demand management.

Section 5: International Trade, Exchange Rates, Balance of Payments, and Macro Policy in an Open Economy—Global Shocks and South African Applications

Open economy macro is essential in Economics 120 courses because no economy operates in isolation. For South Africa, exchange rates, imported fuel and food, commodity prices, and capital flows are central to macro outcomes. This section builds the ability to connect global shocks to domestic variables using standard macro logic.

Open Economy: Extending the AD-AS Framework

In an open economy, aggregate demand includes:

exports (X),
imports (M),
net exports (NX = X – M).

Thus:
[
Y = C + I + G + (X – M)
]

Exchange Rates and Net Exports

A depreciation of the domestic currency generally:

makes exports cheaper to foreigners → (X) rises,
makes imports more expensive → (M) falls,
therefore (NX) improves (becomes less negative or more positive).

However, the timing is not instantaneous:

contracts, shipping time, and import dependency (fuel/inputs) can delay effects.
if imports are essential for production, higher import costs may raise costs and reduce supply (SRAS left).

This creates a dual effect:

depreciation can increase demand for domestic production (improving NX),
but can also worsen inflation through higher import prices (SRAS/cost channel).

Trade Shocks and Demand Management

Example: Global Recession Reduces Foreign Demand

foreign income falls → exports fall → (X) falls.
(NX) decreases → AD shifts left.
output falls, unemployment rises (short run).

Policy response options:

fiscal expansion can support demand (if supply conditions allow),
monetary policy may lower interest rates to stimulate demand,
but if inflation is already high due to cost-push (e.g., currency weakness), policy must be carefully balanced.

Capital Flows, Interest Rates, and Risk Premiums (Conceptual)

In open macro, interest rate differentials influence capital flows:

higher domestic interest rates can attract capital inflows.
inflows can strengthen the currency, affecting net exports and imported inflation.

But risk premia can dominate:

in “risk-off” global periods, capital may flee even if interest rates are high, depending on perceived stability.

Exams may ask you to explain outcomes rather than compute:

“What happens to the exchange rate and inflation if capital inflows reverse?”
You should use the chain:
1. capital outflow → currency depreciates,
2. depreciation → imported inflation rises,
3. cost increases → SRAS left and/or price level rises.

Balance of Payments and the Sustainability Logic

You should understand the macro relevance of:

current account deficits,
financing via capital inflows,
the risk if financing is unstable.

A basic sustainability logic:

persistent deficits may require continual external financing.
if financing dries up, the currency weakens, imports fall, adjustment occurs through lower domestic demand (and possibly output).

In exams, “sustainability” is often evaluated through qualitative reasoning:

deficits financed by stable long-term investment vs volatile short-term flows.

Monetary Policy in an Open Economy: Exchange Rate as a Transmission Channel

If central bank raises rates:

currency may strengthen (more inflows),
imports cheaper → inflation lower,
but exports may weaken via higher exchange rate.

Thus policy affects both AD and SRAS:

demand is influenced by rates and financial conditions,
inflation is influenced by exchange rate (import prices).

Fiscal Policy and the Exchange Rate

Fiscal expansion may lead to:

higher interest rates domestically (if capital markets react),
currency appreciation,
which can worsen net exports,
partially offsetting the fiscal stimulus.

This is the “crowding out through exchange rates” idea. Whether it dominates depends on:

exchange rate regime,
openness of economy,
capital mobility,
initial macro conditions.

Worked Example: Exchange Rate Depreciation and Inflation

Consider this exam-style numerical illustration to practice reasoning (even if your course uses different parameter values, the method is the same).

Assume:

imported intermediate inputs represent a significant share of production costs,
exchange rate depreciation increases the domestic-currency cost of imports.

Suppose imported input costs rise by 10% due to depreciation. If firms pass some costs to prices, CPI inflation can rise.

Then, in AD-AS:

SRAS shifts left due to higher costs,
short run: output decreases, prices rise,
long run: output returns to (Y^*), but price level is higher.

In your exam response, you should explicitly state:

depreciation affects inflation through the cost channel (SRAS),
monetary policy may reduce AD to limit second-round inflation,
but supply-side improvements are needed if the underlying cost shock persists.

Policy under External Shocks: Choosing Stabilization Priorities

External shocks frequently face South Africa in macro discussions:

global oil and food price movements,
commodity price shifts affecting export revenues,
international risk conditions impacting capital flows.

A good exam essay frames policy choices in terms of priorities:

If inflation is primarily demand-driven:
- reduce demand growth (monetary tightening, restrain fiscal stance).
If inflation is primarily supply-driven:
- use supply-side and targeted policies,
- avoid overly aggressive demand contraction that worsens unemployment.
If external financing risk is high:
- maintain credible macro frameworks to stabilize currency expectations,
- avoid policies that increase risk premia.

Exam-Style Short Questions: How to Score Quickly

Common short question prompts might include:

“Explain how depreciation affects net exports.”
“Distinguish current account and capital account.”
“Show the effects of an oil price shock in AD-AS.”

High scoring approach:

Use correct direction arrows (AD right/left, SRAS right/left).
State the immediate output and price changes.
Include long-run adjustment when asked (LRAS returns to potential).

Worked AD-AS Open Economy Integration Example

Scenario: Exchange rate depreciates sharply; import prices rise; inflation accelerates. At the same time, exports become more competitive and foreign demand is stable.

Possible model interpretation:

SRAS shifts left due to higher costs (imported inputs).
AD might partially shift right through improved net exports, but this may be weaker if inputs are costly and if production constraints bind.

Thus the net effect could be ambiguous without additional info:

output could fall if SRAS effect dominates,
inflation rises if cost-push dominates.

Answer structure in exams:

Identify cost channel: SRAS left.
Identify trade channel: NX improves (AD tendency right).
State conditional outcome: depends on magnitude of SRAS vs AD components.
Provide policy implication: supply-side and monetary stance should target inflation while protecting output when possible.

Final Exam Mindset: Coherence Across Sections

A top-performing exam script maintains coherence:

Use national income identity consistently.
Use AD-AS correctly and with time dimensions.
Connect policy instruments to model channels (demand, costs, expectations, exchange rate).
Use labour market concepts to interpret unemployment changes.
Use open economy logic to interpret inflation and net exports.

Summary Checklist for EKN 120 (Macro) Exam Success

National income identity: (Y = C + I + G + NX).
AD-AS mastery: specify which curve shifts (AD vs SRAS), direction, and short-run vs long-run outcomes.
Policy mechanisms: fiscal (C/G/T, multiplier, crowding out), monetary (interest rates, expectations, AD channel), open economy exchange rate effects.
Labour markets: identify type of unemployment and match it to policy type (demand vs supply/structural).
Inflation dynamics: demand-pull vs cost-push vs expectations; explain trade-offs and credibility.
Open economy shocks: exchange rate depreciation, import costs, net exports improvement, capital flow risk.

If you want, paste your university/college syllabus topics or previous exam question prompts, and this guide can be tuned into a targeted revision plan with likely question formats and model answers aligned to your institution’s emphasis.