Economics One & Two 2017 Solutions (Advanced Level)
Economics One
SECTION A
Answer at least two (2) questions from this section.
1. (a) Briefly explain the following concepts:
(i) Economic goods
Answer: These are consumable items that are useful to people but scarce in relation to their demand,
so that human efforts are required to obtain it. The following are their types







Public
Merit
Capital
Consumer/final
Intermediate
Primary
Commodity
Characteristics of economics goods





They are relatively scarce
They not freely provided by nature
They are transferable in terms of ownership
They possess utility
They have exchange value
(ii) A transformation curve.
Answer: Is a locus point which show maximum combination of goods and services that an economy
can produce when all the available resources were fully utilized. It is also known as PRODUCTION
POSSIBILITY CURVE(PPC) or PRODUCTION POSSIBILITY FRONTIER(PPF).
Cotton ●B
A=Inefficiency/underutilization
●E
●F
B and C=Opportunity Cost
E and D=Choice and Efficiency
●A
●D
F=Scarcity (Unattainable Point)
●C
Sisal
Main assumptions of the Transformation curve (PPF or PPC)




The economy can produce only the two goods.
The scarce resources available are fully utilized and
can be shifted in between the two goods for their
production.
The time period is short.
The economy is closed.
(iii) Wants
Answer: These are unsatisfied human desires which are competing for satisfaction and enhance
fulfillment when they are met. The following are their types



Necessities: These are human wants that are needed for our living or
surviving. Example of these are clothes, food, shelter, water, etc.
Comforts: These are extra wants of the human necessaries.
Luxuries: These are goods that give human beings pleasure and
prestige in the society
Wants
Necessities
Necessaries for life
Necessaries for efficiency
Comforts
Luxuries
Convetional necessaries
Harmfull Luxuries
Harmless(Non-harmfull) Luxuries
(iv) Marginal utility
Answer: It is an additional satisfaction or benefit that consumer derives from consuming an
additional unit of a commodity or service.
Number of Comics(X)
0
1
3
4
Total Utility (TU)
0
100
200
300
Marginal Utility (MU)
100
100
100
MU=∆TU/∆X
∆TU=Change in Total Utility
∆X=Change in Consumption rate
(b) Distinguish a command economy from a free market economy (provide six
points)
Answers:
Command economy (Centralized, Collective or Socialism) is type of economic
system whereby major means of production such as land, industries, etc. are owned by
the state and regulated by central planning authority.
Characteristics of Command economy
 There is no freedom of choice
 Major means of production are owned collectively
 Absence of competition
 Evenly distribution of wealth (income)
 The presence of central planning authority
Free market economy (Capitalism, Open or Laissez-Fair) is the type of economic
system whereby major means of production such as land, industries, etc. are privately owned with little
government intervention.
Characteristics of free market economy






There is freedom of choice
Major means of production are privately owned
There is price mechanism
Presence of profit motive
There is little government intervention
Private competition
The following are their differences
i.
ii.
iii.
They differ in the way they carry out their functions such as
price determination of goods and services whereby under free
market economy prices are determined by market forces of
demand and supply while under command economy prices are
determined by central planning.
They differ in terms of freedom of choice whereby under free
market economy there is freedom of among economic agents
(consumer and producer) while under command economy
there is no freedom of choice in which the government decide
what goods and services are to be produced and consumed.
They differ in terms of competition whereby under free market
economy there is private competition as the result of presence
iv.
v.
vi.
vii.
viii.
ix.
of private initiatives and profit motives while under under
command economy there is no private competition because
the government decide what goods and services are to be
produced as well as what to be consumed.
They differ in terms of ownership of major means of production
such as land, industries, companies, etc. whereby under free
market economy all major means of production are privately
owned while under command economy all major means of
production are owned and regulated by the government.
They differ in terms of their socio-political systems whereby
free market economy normally operates under multiparty
political system while command economy normally operates
under single party-political system.
They differ in terms of role of the government in the economy
whereby under free market economy the government has a
limited role in the economy compare to command economy
where the government under central planning authority
control the economy by determining what goods and services
are to be produced and consumed.
The transition from free market economy to command
economy requires nationalization of major means of
production such as land, industries, companies, etc. while the
transition from command economy to free market economy
requires privatization of major means of production.
They differ in terms of the type of economic institution set up
and pattern of control.
They differ in the relation between social classes and nature by
which labor power is joined to the means of production.
2. (a) Assess the significance of competitive market in the economy. (Give five
points).
Answers:
Competitive market (Monopolistic) is the type of market structure whereby there
are large number of sellers and buyers with highest degree of competition and the goods and services
available in the market are closely related but are differentiated through measures such as brand names,
packings, advertisement, etc.
Characteristics of competitive market (Monopolistic)


There is large number of sellers and buyers with
highest degree of competition.
The products sold and bought are closely related but
are differentiated through measures such as brand
names, packings, advertisement, etc.





There is high freedom of choice.
Each firm under Monopolistic Market Competition is a
monopolist of its product i.e. each firm has a power to
prevent its competitors from copying some specific
aspect of its own E.g. Brand names, Trademarks
There is presence of high selling costs incurred during
sales promotions, cross transportation, and other
advertisement measures.
Firms under competitive market face downward
sloping demand curve rather than be price takers.
There free entry and exit for firms to enter or leave the
industry (market) that is to say the number of firms in
the industry will be adjusted until the economic profit
are driven to zero.
The following are its significances
i.
ii.
iii.
iv.
v.
It promotes production of high-quality goods and
services due to presence of large number sellers with
highest degree of competition.
It promotes freedom of choice since output
produced by the firms in the industry is very large due
to presence of very large number of sellers producing
differentiated products which gives the buyers
freedom to buy goods and services of their choice.
It promotes employment opportunities since there
freedom of entry to the industry by firms and exit
from the industry.
The prices charged are very low since firms under
monopolistic market are price takers and each firm
try to lower the price so as to fetch wider market of
their goods and services despite the high selling cost
incurred through advertisement measures.
It promotes innovation and invention as each firm in
the industry will try to differentiate its products from
other firms so as to win wider market in the market
competition.
(b) Identify five roles played by price in a free market situation.
Answers:
Price: It refers to the measure or exchange value in terms of money of the available
goods and services available in given time period as well as market. Price can be classified in three forms
which are



Market price which is the ruling price of the given
commodity in the market at a given time.
Normal price (Equilibrium) which is price at which
quantity supplied is equal to quantity demanded. It is the
long run equilibrium price of the goods and services.
Reserve price which is the price below which a seller is
not willing to sell his product or the least possible
acceptable price for the seller i.e. the lowest price the
seller can accept for his commodity. The following are
the its determinant
 Future demand.
 Durability or perishability
of the commodity.
 Liquidity preferences
 Changes in future price
 Future changes in cost of
production.
 Storage costs or carrying
charges.
 Time taken before new
supply is out on market.
Uses or roles of Price in the free market situation
i.
ii.
iii.
iv.
v.
vi.
It is used to determine the money value of the goods and
services since exchange is through coins and notes as free
market does not support barter system of exchange.
It used to determine the technique of production to be
used in production process whether labor intensive or
capital-intensive technique.
It provides automatic adjustment between demand and
supply of the goods and services available so as to avoid
shortage or surplus in the market.
It is used to determine income distribution based on
profit motives in free market economy.
It encourages competition among the individual
producers as free market situation promotes private
initiatives (business and entrepreneur initiatives).
It is used by consumers in making consumption decision
based on the conditions of consumer surplus and
marginal utility.
3. (a) Define minimum wage legislation.
Answer:
Minimum wage legislation: It refers to the wage set by the government through
its agency above equilibrium market wage rate for which no employer is supposed to pay his/her
employees below that set wage level.
(b) Giving five points, describe the advantages of minimum wage legislation.
Answers:
i.
ii.
iii.
iv.
v.
It reduces and minimizes exploitation of workers by their
employers who normally pay their workers the amount of
wage which is below market equilibrium wage for profit
maximization motives, therefore minimum wage
legislation will require employers to pay wage level that
is above market equilibrium wage hence exploitation will
be reduced.
It reduces and minimizes the cost of living on the side of
workers who previously were paid wages which were not
too low compare to the cost of living, hence their
purchasing power were also too low, but receiving
amount of wage which are above market equilibrium
wage it will raise workers purchasing power as well as
lowering down the cost living.
It reduces income inequalities which was created by
employers acts of paying their employees wages which
were below market equilibrium wage, therefore
minimum wage legislation will force the employers to pay
wages above market equilibrium wage and this will raise
the share of profit between employers and employees as
well as lowering down the income gap existed between
employers and employees.
It helps to solve voluntary unemployment which might
have been caused by wages level in the labor market
being too low and made those unemployed individuals
not ready to work despite being fully equipped for job
vacancies that were available, therefore minimum wage
legislation will make wage level being raised above
market equilibrium wage and raise the incentives of
those who were voluntarily unemployed to search for
jobs.
It may help to increase workers efficiency in working
places as workers will be more motivated to increase
their ability to produce greater quantity and quality of the
goods and services per given working hours as the result
of the pay rise under minimum wage legislation ever
since wage rise has become workers working incentive.
vi.
vii.
viii.
It may reduce and minimize workers strikes and boycotts
which were once caused by employer acts of paying their
worker wages below equilibrium wage, hence minimum
wage legislation will raise workers’ wages level and at last
reduces bargaining power of the workers for pay rise.
It may boost aggregate demand for goods and services as
minimum wage legislation will cause wage level to be
raised by employers hence workers purchasing power to
raise up as the result their aggregate demand for goods
and services will rise and this will boost economic
activities in the economy.
It helps workers to attain at least minimum standard
living as a raise in the wage level due to minimum wage
legislation will enable workers to afford to meet and
maintain daily basic needs such as clothing, shelter,
water, food, etc.
(c) Explain four disadvantages of raising the wages above the equilibrium wage
rate.
Answers:
i.
ii.
iii.
iv.
Setting of the wages above market equilibrium wage rate
may force those employers who can not afford to pay that
amount of wage level to their workers, to employing labor
serving technology such as machines and this will cause
laying of some workers to reduce cost of production hence
unemployment.
Setting of wages above equilibrium market wage rate may
result to inflationary rise in prices of goods and services as
producers/employers will try to shift the burden to
consumers due to increased cost of production as they are
forced to pay high amount of wage, hence consumer will be
covering that increased cost of production indirectly
through prices of goods and services they are purchasing
which have gone up.
Setting of wages above market equilibrium wage may cause
plant closure as well as production suspension in certain
industries for those firms with employers who cannot afford
to pay minimum wage as result of increased cost of
production.
Setting of wages above market equilibrium wage rate may
cause downturn of the business cycle as it may cause fall in
output level, fall in profit level, fall in aggregate demand as
well as divergence between Marginal Propensity to
Consume (MPC) and Marginal Propensity to Save (MPS)
which at last causes economic recession.
4. (a) Outline five limitations of the theory of price mechanism.
Answers:
Price mechanism: It refers to the theory which apply under free market situation
whereby major economic decisions such as price determination, resource allocation, social choice, etc.
are determined by market forces of demand and supply for goods and services.
The main assumptions of Price mechanism theory.







No or little government intervention.
Presence of freedom of choice.
Free entry and exit from the competition industry.
Perfect mobility of labor.
Perfect private competition.
Perfect knowledge about market conditions.
Profit maximization motives.
The limitations of the price mechanism.
i.
ii.
iii.
iv.
It encourages income inequalities since distribution of
wealth is based on profit motives hence most of the
income gained go to those who have make higher profits
inside their business initiatives hence causes income gap
between social classes in the society i.e. those who have
and those have nots.
It does not take into consideration social costs (negative
externalities) such as environmental pollutions like air
pollution, noise pollution, land pollution, water pollution,
etc. as it operates under free market economy where
producers are motivated to maximize profits at any cost
without considering negative impacts of their production
activities to third parties in the society.
It discourages production merit goods particularly
services such as education and health services which does
not maximize profit under free market situation where
producers are motivated to profit maximization activities
through price mechanism hence other goods and services
which maximize profit will be prioritized rather than the
merits goods.
Private competition may lead to wastage of scarce
economic resources as producers under free market
situation may use cost full advertisement measures where
v.
vi.
necessary or not necessary to win competition over other
producers as the result it may lead wasteful competition.
Allowing too much market forces to operate in the
economy with little or no government control may cause
economic instabilities such as unemployment the period
of inflationary rise in prices of goods and services.
Allowing too much operation of market forces in making
economic decision may lead to production of harmful
conspicuous goods and services on profit maximization
grounds due to little or no government regulation in the
production activities(economy).
(b) With the aid of diagrams, explain the following cases of elasticity:
Answers:
Elasticity refers to the degree of responsiveness of the change in one variable due to
change in another variable. Elasticity of supply refers to the degree of responsiveness of change in
quantity supplied due to change in factors affecting supply.
i.
Inelastic supply: It refers to situation where greater change
in price result to small change quantity supplied of goods
and services.
Price of sugar
Supply curve of sugar
25000 Tshs.
10000 Tshs.
0
ii.
10Kg
11Kg Quantity supplied of sugar
Elastic supply: It refers to the situation when small change
in price result to greater change in quantity supplied of
goods and services.
Price of rice
Supply curve of rice
12250 Tshs.
10000 Tshs.
0
iii.
10Kg
40Kg Quantity supplied of rice
Unitary elastic supply: It refers to the situation whereby
percentage change in price is equal to percentage change
in quantity supplied of goods and services.
Price of rice
Supply curve of rice
20000 Tshs.
10000 Tshs.
0
iv.
10Kg
20Kg
Quantity supplied of rice
Perfectly elasticity of supply: It refers to the situation
where change in price have no effect on change in quantity
supplied of goods and services.
Price of sugar
10000 Tshs.
Supply curve of sugar
0
v.
10Kg
40Kg
Quantity supplied of sugar
Perfectly inelastic of supply: It refers to the situation where
change in price have neutral effect on change in quantity
supplied of goods and services. E.g. Land is perfectly
inelastic supplied.
Price of land (Rent)
Supply curve of land
20 Million Tshs.
10 Million Tshs.
0
10 Acres
Quantity supplied of land
SECTION B
Answer at least two (2) questions from this section.
5. (a) Describe five measures that a country can adopt to control recession in trade
cycle.
Answers:
Economic recession refers to the phase in the trade cycle whereby there is
subsequent fall in different attributes of the economy such as profit level, output level, income level,
employment level, etc.
Economic indicators of the economic recession.






Fall in level of domestic output production.
Fall in level of domestic sales revenue.
Fall in level of profit.
Fall level of income.
Fall in aggregate demand for goods and services.
Fall in level of employment opportunities (rise in level of
unemployment in the economy).
 Fall in level of economic welfare of the people/standard of
living.
 Fall in export revenue.
 Fall in import purchases.
Measures that can control economic recession in trade cycle.
i.
ii.
Expansionary monetary policies such as reduction in bank
rate to commercial banks by central bank so as to allow
lending of large amount of credit to the public also through
measures such as selective credit control where credit
supply will be prioritized to productive sector of the
economy hence increases money supply in circulation and
create employment opportunities which will boost
aggregate demand for goods and services as the result
causes rise in income level as well as level of output
creation hence economic recession is controlled.
Expansionary fiscal policies such as increasing government
expenditure through direct tax reduction and increase in
workers salaries and wages whereby this will help to
increase workers purchasing power and to boost their
aggregate demand for goods and services and therefore
this will encourage production activities in different
iii.
iv.
v.
vi.
economic
sectors
creating
more
employment
opportunities as well as rise in income level hence
economic recession is controlled.
Price control through government agencies who are
required to set minimum price legislation for some type of
goods and services where necessary to protect producer
from being underpaid as the result this will contain the
level of output creation, profit as well as income level and
hence economic recession is controlled.
Trade policies should be adopted such as export promotion
measures advertisements and relaxation of export tariffs
and import substitution industries which stimulate
domestic output creation/production in secondary and
primary economic activities creating more employment
opportunities, boosting aggregate demand for goods and
services, raising levels of income, etc. hence economic
recession is controlled.
Foreign Direct Investment policy which will allow more
foreigners to invest in different economic sectors such as
Agricultural sector, Mining sector, Industrial sector, etc.
whereby this will create more employment opportunities
and as the result it will boost aggregate demand for goods
and services causing rise in levels of income hence
economic recession is controlled.
Devaluation policy also may also control recession as
devaluation normally makes imports expensive and export
cheap and as the result this will boost export sector which
will increase more output creation as export goods and
services are able to find market in foreign market since
they are cheap and at last creating more employment
opportunities in domestic export sector causing rise in
level of income and hence economic recession is
controlled.
(b) Explain five factors for upswing and downswing of the level of economic
activities.
Answers:
Trade cycle/business cycle refers to the downswing and upswing of level of
economic activities in the economy or it may refer to the alternating period of rising and falling of level of
economic activities in the economy.
Major factors affecting business cycle/trade cycle.
i.
ii.
iii.
iv.
v.
Climatic factors whereby favorable climatic conditions will
boost Agricultural sector hence more supply of raw materials
to Agri-based industries such as textiles industry hence higher
production, investment, income as well as employment
opportunities hence upswing of the level of economic activities
but unfavorable climate will affect negatively Agricultural
sector as well as Agri-based industries hence level of
investment, employment opportunities as well as income will
fall causing downswing of the level of economic activities.
Technological factors whereby invention and innovation of the
new techniques of production in different economic sectors
will boost level output creation, employment opportunities,
investment as well as aggregate demand level causing upswing
of the level of economic activities while little or no invention
and innovation new techniques of production in the economy
causes fall in level of investment, income as well as level
output creation causing downswing of the level of economic
activities.
Psychological factors based on waves of pessimism and
optimism whereby when the businessmen are optimistic
about the future after a long period of depression they will
tend to invest more currently causing rising in level of
employment opportunities, income level, aggregate demand
as the result upswing of the level of economic activities while
when businessmen are pessimist about the future after along
period of boom they will tend to reduce investment causing
fall in level of output creation, investment as well as profit level
causing downswing of the level of economic activities.
Monetary factors based on supplied side of money whereby
when central bank allow operation of expansionary monetary
policies this will increase money supply in the economy causing
increase in aggregate demand for goods and services, increase
in investment level as well as employment opportunities
causing upswing in level of economic activities while
contractionary monetary policies reduces supply of money in
the economy causing fall in level of purchasing power of the
consumers and their aggregate demand will fall causing fall in
investment level, employment level as well as causing
downswing in the level of economic activities.
Fiscal factors based on government expenditures whereby
expansionary fiscal policies increases government
expenditures through tax reduction as well wage rise causing
increase in aggregate demand for goods and services and
hence investment and employment level will rise causing
upswing of the level of economic activities while
contractionary fiscal policies reduces government
expenditures on welfare and development activities hence
levels of aggregate demand and employment opportunities
will fall causing downswing of the level of economic activities
in the economy.
6. A firm is operating under the conditions of imperfect competitive industry. The
costs and revenue are given as follows:
TC = 2Q + 5
AR = 8 – Q
Where:
TC = Total Cost
AR = Average Revenue
Q = Quantity of output produced/sold
If this firm is incurring a loss of 77 Tshs;
(a)Compute the level of output at which the firm is producing.
Solution.
TR = Total Revenue
TR = AR × Q
AR = 8 – Q
TR = (8 – Q) × (Q)
TR = 8Q – Q2
Profit/Loss = TR – TC
−77 = (8𝑄 − 𝑄2) – (2𝑄 − 5)
−77 = 6𝑄 − 𝑄 2 −5
Q2 −6𝑄 − 72 = 0
−𝑏±√𝑏2 −4𝑎𝑐
2𝑎
−(−6)±√(−6)2 −4(1)(−72)
Q=
2(1)
Q= 12, Q= −6
∴
The quantity at which the firm is producing is 12units.
(b) Give six reasons that may have caused this firm to incur losses.
Answers:
i.
ii.
iii.
iv.
v.
vi.
If the firm is incurring higher internal cost of production
such as payments to factors of productions like laborers,
raw materials, technical constraints and other business
expenses such as transport costs, than the sales revenue it
receives or earns this may cause the firm to incur negative
profit/loss.
Overproduction which occurs when firms fail to accurately
estimate demand for the goods and services and therefore
output produced becomes in excess compare to the market
ability to consume, as the result some products remain
unsold or may be sold at lower price compare to the cost
used for its production and this may cause the firm to fail
to reach targeted sales and at last loss.
Production constraints such as like lack of raw materials,
shortage of power and fuel, shortage of appropriate skilled
labors as well as lack Professional managers, as the result
the firm may produce underproduce, produce lower quality
products, and may lack new products innovation and
invention at last Marginal Cost (MC) become higher than
Marginal Revenue (MR) hence negative profit/loss is
incurred.
Lack of adequate finance/capital to keep business running
so as to cover variable costs such as payment to factors of
production, if the profit earned is not enough to rejuvenate
the working capital and the producer has no or few sources
of earning money outside his business to add to his working
capital there is higher possibility of his firm to reach shut
down point i.e. obtaining loss from his business.
Natural factors such as earthquakes, floods, etc. which may
physically destruct firms’ physical assets such as buildings
which may take too long time to be reconstructed because
of their higher construction costs hence here the producer
may incur loss.
External factors such as political instabilities like civil wars,
workers fraud, government regulations, economic
instabilities like inflation and cybercrimes like financial
hackings which may make firms fail to obtain expected
revenue as well as massive destruction of the firms’
physical assets, and as the result Marginal Revenue (MR)
becomes less compare to Marginal Cost (MC) hence loss.
7. (a) Outline any six ways through which the population size of a country can be a
hindrance to the economic development.
Answers:
i.
ii.
iii.
iv.
Population size determines the size of the workforce or
manpower whereby most of the countries with large
population size such as U.S.A have large size of workforce
which can be induced in different economic activities and
enhance higher growth rate of economic development
while most of the countries with small population size such
as Sub-Saharan African countries have low size of the
workforce which can be induced in production activities
and hence this hinders economic development.
Population size determines the size of the internal market
of the goods and services produced in the country economy
and therefore most of the countries with large population
size such as China have wider internal market for the goods
and services from different individual and government
business initiatives and hence higher growth rate of
economic development while most of the countries with
small population size such as Sub-Saharan African countries
have narrow internal market for its domestic goods and
services and hence this hinders economic development.
Population size determines the degree of specialization and
division of labor whereby most of the countries with large
population size such as China have large size of labor force
and hence higher degree of specialization and division of
labor and hence this enhance higher growth rate economic
development while most of the countries with small
population size such as Sub-Saharan African countries have
narrow size of the labor force and hence small degree of
specialization and division of labor in production activities
in different economic sector of the countries’ economy and
hence hinders economic development.
Population size determines level of technological
innovations and inventions whereby most of the countries
with large population size such as Japan have higher rate of
technological innovations and inventions and hence higher
growth rate of economic development while most of the
v.
vi.
countries with small population size such as Sub-Saharan
African countries have low level of technological
innovations and inventions to enhance economic activities
in different sectors of the countries’ economy and hence
hinders economic development.
Population size determines level production and economic
activities whereby most of the countries with large
population size such as U.S.A have large size of the
workforce which stimulate economic activities and
promote economic development while most of the
countries with small population size such as Sub-Saharan
African countries have low size of the labor force which
undermines economic activities in different sectors of the
countries’ economy and hence hinders economic
development.
Population determines level of trade and exchange
activities whereby most of the countries with small
population size such as Sub-Saharan African countries have
low size of the workforce as well as economic activities
which lowers the scope of trade and exchange activities and
it hinders economic development while most of the
countries with large population size such as China have
wider scope of internal trade and exchange activities and
hence It promotes economic development.
(b) Explain four measures which can be adopted to control a higher population
growth rate.
Answers:
i.
ii.
iii.
Encouraging the use of family planning methods such as
the use of contraceptives whereby the government
through its agency should strive towards making public
aware of Family planning methods basing on its main
significances to the healthy of the family so as to improve
families’ standard of living and hence this will reduce the
chance for the existence of the extended families as well
as controlling higher population growth rate.
Discouraging bad cultural practices such as early
marriages and polygamy whereby the government should
strive towards amending the existing laws and enact new
laws to abandon the societal practices that contribute to
the higher rate of population growth so as to control it.
Provision of socio-economic incentives to small/nuclear
families such as reduction in health services charges,
iv.
reduction in communication services charges whereby the
government can provide to its public workers with small
families as well as providing an order to private sector to
also provide the incentives to their workers with small
families, so as to encourage her citizens to have the desire
of having small families and hence higher population
growth rate is controlled.
Introduction of Population Policy particularly Explicit
Population Policy which are normally and eventually
introduced by the government so as to make her citizen
aware of her intentions to control population growth rate,
whereby normally the government may apply different
measures for her own population control policy such as
setting of maximum number for each family in the country
to have like One Child Policy of China or may use
resettlement schemes, and this may control population
growth rate.
8. (a) Evaluate five factors that influence the level of money supply in Tanzania.
Answers:
Money supply refers to the money that is current in circulation in an economy in a
given time period.
Factors influence money supply in the economy.
i.
ii.
iii.
iv.
The level of credit creation by commercial banks whereby
the higher the level of credit creation by commercial banks
the higher the money supply while the lower the level of
credit creation by commercial banks the lower the money
supply.
Balance of Payment (B.O.P) position whereby favorable
Balance of Payment indicates that more capital inflow in
the economy hence higher money supply while unfavorable
Balance of Payment indicates that more capital outflow out
the economy hence lower supply of money in the economy.
Monetary policies of the central bank whereby when the
central bank apply expansionary monetary policies to the
economy such as reduction of bank rate, purchasing
government securities from the public, etc. it will increase
money supply in the economy while application of the
contractionary monetary policies to the economy by
central bank may reduce money supply in the economy.
Fiscal policies by the government which are based on
government expenditures whereby application of the
v.
expansionary fiscal policies will increase government
expenditures as well as money supply in the economy while
application of the contractionary fiscal policies to the
economy will reduce government expenditures as well as
money supply.
Level of economic activities, the higher the performance of
the economic activities in different sectors of the economy
the higher the money supply while the poorer the
performance of the economic activities in different sectors
of the economy the lower the supply of the money in the
economy.
(b) Critically examine the quantity theory of money (provide four points).
Answers:
Quantity theory of money: States “The proportional increase in money supply will
cause increase in general level of price of goods and services provided that velocity of money in circulation
and volume of transactions remains constant/unchanged”.
MV (Supply side of money) = PT (Demand side of money)
Main assumptions of the quantity theory of money.
i.
ii.
iii.
iv.
The velocity of money that is current in circulation in the
economy should remain unchanged i.e. there should be no
alteration in velocity of money supply that may either
increase or decrease the velocity of money supply in the
economy.
The volume of transactions should remain unchanged
whereby the volume of purchasing and selling of the goods
and services by the public should not be altered so as to
prevent increase or decrease in volume of transactions in
the economy.
There should be full employment of the resources and the
factors of production in the different production units of
the economy.
There should be no barter trade whereby all the exchange
activities should be done through the use of money.
THE END
Prepared by Trust .M. Lema
Economics Two
SECTION A
Answer at least two (2) questions from this section.
1. (a) Define aggregate demand.
Answers:
Aggregate demand refers to the total amount expenditure made by the household
in purchasing domestic goods and services as well as investment expenditures made by the firm in
purchasing capital goods like machines.
𝑨𝒈𝒈𝒓𝒆𝒈𝒂𝒕𝒆 𝑫𝒆𝒎𝒂𝒏𝒅(𝑨𝑫) = 𝑪𝒐𝒏𝒔𝒖𝒎𝒑𝒕𝒊𝒐𝒏 + 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝑵𝒂𝒕𝒊𝒐𝒏𝒂𝒍 𝑰𝒏𝒄𝒐𝒎𝒆 (𝒀)/𝑨𝒈𝒈𝒓𝒆𝒈𝒂𝒕𝒆 𝑫𝒆𝒎𝒂𝒏𝒅(𝑨𝑫) = 𝑪 + 𝑰
(b) Describe four determinants of the aggregate demand.
Answers: Determinants of the aggregate demand are both determinants of consumption
and determinant of investment.
Determinants of Aggregate demand.
i.
ii.
iii.
iv.
Interest rate on saving and borrowing whereby higher interest
rate on saving will encourage people to save more of their
disposable level of income to the commercial banks rather
purchasing goods and services, and higher interest rate on
borrowing discourage borrowing for investments hence low
aggregate demand while low interest rate on saving
discourages saving and encourages more consumption, and
low interest rate on borrowing encourages borrowing for
investments hence high aggregate demand.
Taxation, whereby higher taxation discourages investments
and consumption (aggregate demand) while low tax rate
encourages investments and consumption (aggregate
demand).
Price changes, unstable prices of goods and services
discourages investments and consumption (aggregate
demand) while stable prices of goods and services will
encourage investments as well as consumption (aggregate
demand).
The range of goods and services available, the higher the
availability of capital and consumer goods and services the
higher the aggregate demand (consumption and investments)
v.
vi.
while the lower the availability of capital and consumer goods
and services the lower the aggregate demand (consumption
and investments).
Level of production, the higher the level of production
activities in different sectors of the economy the higher the
aggregate demand (investment and consumption) while the
lower the level of production activities in different sectors of
the economy the lower the aggregate demand (consumption
and investment).
Availability of credit facilities such as working incentives
(bonuses, meals, transport allowances, etc.) and subsidies, the
higher the availability of credit facilities the higher the
aggregate demand (consumption and investments) while the
lower the availability of credit facilities the lower the
aggregate demand (investment and consumption).
(c) Briefly explain the meaning of the following concepts:
(i) Leakages
Answer: It refers to that part of the income generated inside the circular flow of
income but spent outside it i.e. not spent by household in buying goods and services and it has contraction
effect on the national income. E.g. saving, taxes, capital outflow, old age pensions, imports.
(ii) Injections
Answer: It refers to the income that is generated outside circular flow of national
income but spent inside it i.e. it adds income to the circular flow of national income and it has
expansionary effect on the national income. E.g. export, capital inflow, investment, government
expenditures.
INJECTIONS
Investments
Government Expenditures
Exports
Undistributed Corporate Profit (U.C.P)
LEAKAGES
Savings
Taxes
Imports
Social Security’s contributions (S.S.C)
(iii) Deflationary gap
Answer: It refers to the situation in the economy whereby aggregate supply of goods
and services exceed aggregate demand for goods and services at full employment level of national income
(resources). It may be referred to as (positive output gap).
AD/AS
𝑨𝑺 = 𝑪 + 𝑺
●
Deflationary gap
𝑨𝑫 = 𝑪 + 𝑰
●
𝑨𝑫 = 𝑨𝑺
45°
0
Ye
Yf
National income(Y)
Where Ye = Equilibrium national income.
Yf= National income at full employment level of resources.
AD = Aggregate Demand.
AS = Aggregate Supply.
C =Consumption.
S = Saving.
I = Investment.
(iv) Inflationary gap
Answer: It refers to the situation in an economy when aggregate demand for goods and
services exceeds aggregate supply of goods and services at full employment level of national income
resources. It may also be regarded as negative output gap.
𝑨𝑺 = 𝑪 + 𝑺
AD/AS
𝑨𝑫 = 𝑪 + 𝑰
𝑨𝑫 = 𝑨𝑺
●
Inflationary gap
●
45°
0
Ye
Where C =Consumption.
Yf
National Income
S = Saving.
I = Investment.
AS = Aggregate Supply.
Ye = Equilibrium national income. Yf= National income at full employment level of resources.
AD = Aggregate Demand.
(v) Balanced Budget Multiplier. (B.B.M)
Answer: It refers to the number of times a given change in balanced estimated
government expenditures to government revenue multiplies itself to give a final change in national
income.
𝑩𝒂𝒍𝒂𝒏𝒄𝒆𝒅 𝑩𝒖𝒅𝒈𝒆𝒕 𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒊𝒆𝒓( 𝑩. 𝑩. 𝑴) =
∆𝑵𝒂𝒕𝒊𝒐𝒏𝒂𝒍𝑰𝒏𝒄𝒐𝒎𝒆
∆𝑩𝒂𝒍𝒂𝒏𝒄𝒆𝒅 𝑩𝒖𝒅𝒈𝒆𝒕
2. (a) Suggest four measures which can be adopted in managing the public debt.
Answers: Public debt: It refers to the money that the government of the certain country
has borrowed from either external source such as Multinational Organizations like World Bank (WB),
International Monetary Fund (IMF) and from other Countries or from internal source such as Banking,
Non-banking institutions through capital and money market as well as from individual entrepreneurs
within that particular country for social, economic and political purposes of the country.
Measures to manage public debt (Public Debt redemption).
i.
ii.
iii.
iv.
v.
Utilization of the surplus revenue that might be created as
the result of surplus budget planning where the expected
revenues are higher than expected expenditures of the
government hence that excess part of the revenue in the
fiscal budget can be utilized effectively to repay debts so as
to redeem or manage public debt of the particular country
through her central bank which is the banker to the
government.
By conversion means, whereby the government may order
her central bank to borrow debts with low interest rate so as
to repay the previously debts borrowed which have high
interest rate as the way to manage or redeem public debt.
Through sinking fund, whereby the government through her
central bank may create specific account so that each a
specific fund from the fiscal budget is deposited to that
specific government account, and after some years that fund
can be used to repay the government debts hence public
debts are redeemed or managed.
Through using the accumulated foreign reserves, whereby
the government can order her central bank to use the
accumulated foreign revenue reserves such as foreign
currencies to repay the existing government debts and hence
public debts are redeemed or managed.
Through negotiations for debt cancellation whereby the
government through her officials may ask the lenders of the
loan to wave off the whole debt or part of it as well as to
vi.
vii.
viii.
reduce the interest rate for the debts which may be hard to
maintain or repay back hence this is the way to redeem or
manage the debt.
Through privatization process whereby the government may
privatize her government owned enterprise to private
institutions, whereby normally is undertaken through Assets
Sale Privatization method so that the government can obtain
revenue that may at least be sufficient for debt repayment
and hence public debts are redeemed or managed.
Through capital levy whereby the government may order her
tax authority institution to impose specific tax to rich
entrepreneurs within the country so that that the
government can obtain excess revenue that may be at least
sufficient for debt repayment and hence public debt
management or redemption.
Through selling government securities, whereby government
stock of securities available in the central bank such as
treasury bills and bills of exchange may be sold to the public
and private institutes such financial institutions as well as
companies, so that the government can obtain revenue that
may help in debt redemption and hence public debt
redemption or management.
(b) Examine four ways of classifying the public debt.
Answers:
i.
Funded and Unfunded debts.
Funded debts refer to the long-term(5,10,15 or 20 years) debts which their date
of repayment of the debts and their interest rate are not known and consist of bonds with definite
redeemable date on the part of government while Unfunded debts refer to the short term(3,6,9 or 12
months) debts which their date repayment of the debts and their interest rate are not known they consist
of those debts with low interest rate.
ii.
Long term and Short-term debts.
Long term debts refer to the debts which are repaid after a long period of time,
a period which may cover 20 to 50 years while Short term debts refer those debts which are repaid after
a short period of time, a period that may cover 1 to 5 years.
iii.
Productive and Unproductive debts.
Productive debts refer to the debts which are used to finance expenditures of
the government that stimulate economic activities (Development Expenditures) within the country e.g.
expenditures on building economic infrastructures of the country such as roads, railways, air terminals as
well as power supply within the particular country while Unproductive debts refer to those debts which
are used to finance expenditures of the government that are directed to improve socio-economic
wellbeing of her people (Recurrent Expenditures) e.g. expenditures on social services such as educational
services as well as health services.
iv.
Redeemable and Unredeemable debts.
Redeemable debts refer to the debts which the government promises to repay
the principle and the interest rate of the debts at some future dates and their maturity date is fixed while
Unredeemable debts refer to the debts which the government has not made any promises regarding the
exact date of date repayment, and such debt has no maturity date giving a chance for the government to
repay the debts regularly.
How do economists classify the burden of the debt?
Answers:
i.
ii.
iii.
iv.
The burden of external debt, for the case of external debt its
burden will always fall on the foreign exchange reserves of the
government kept in the central bank whereby the government
will be forced to repay her public debts through the foreign
exchange reserves such as foreign currencies kept in the central
bank.
The burden of internal debt, for the case of internal debt its
burden will always fall on citizens of that particular country
whereby the government will order the tax authority institution
to impose effective tax rate to her citizens so that sufficient
revenues will be collected for debt repayment.
The burden of productive debt, in case of productive debt its
burden will normally fall on the income generated by the
productive economic activities in the economy to which the
debt was financing, since the money borrowed is injected to the
development expenditures of the government rather than the
recurrent expenditures.
The burden of unproductive debt, in case o unproductive debt
will normally fall on citizens of the particular country through
taxation as the money borrowed can not yield income for debt
repayment since it is used to finance recurrent expenditures of
the government rather than development expenditures.
3. (a) “The more liquid an asset is the less profitable it becomes.” Justify this
contention by devising five ways used by the commercial banks to reconcile the two
conflicting motives of liquidity and profitability.
Answers:
i.
ii.
Lending at different interest rate and lending on short term
basis, whereby by lending at different interest rate will widen
the chance of the commercial banks to maximize profit rather
than lending at the same interest rate to different borrowers
with different loan demands which won’t be profitable while
lending on short term basis will enable commercial banks to get
their money back from borrowers immediately so that the can
have enough liquid assets to meet daily customers cash
demand.
(b) Describe how each of the following monetary policy instruments works to
control money supply in the economy:
(i) Open market operations.
Answers: Open Market Operation (OMO) It refers to the sale and purchase of the
government securities to and from the public by the government through commercial banks with the
guidance from the central bank, whereby during inflation where money supply in the economy is very
high the government orders the central bank to sell government securities to the public through
commercial banks so as to reduce money supply in circulation in the economy while during deflation when
money supply in the economy is too low the government orders the central bank to purchase the
government securities from the public through the commercial banks so as to increase money supply in
circulation in the economy.
(ii) Bank rate or discount rate.
Answers: Bank rate It refers to the rate of interest charged by the central bank for the
loans borrowed to the commercial banks when they are in temporary financial difficulties, whereby during
inflation when there is excess money supply in the economy the central bank will normally raise the bank
rate so as to reduce borrowing capacity of the commercial banks which will reduce their lending capacity
to the public hence money supply is reduced in the economy while during deflation where money supply
in the economy is too low the bank rate will normally be reduced by the central bank so as to increase
borrowing capacity of the commercial banks as well as their lending capacity to the public hence money
supply is increased in the economy.
(iii) Reserve requirement ratio.
Answers: Reserve requirement ratio it refers to the minimum amount of fund that
commercial banks are required to keep in the central bank, whereby during inflation when there is excess
money supply in the economy the central bank tends to increase the reserve requirement ratio so as to
reduce the lending capacity of the commercial banks to the public and hence money supply in the
economy is reduced while during deflation where money supply in the economy is too low the reserve
requirement ratio will be reduced by the central bank so that so as to raise the lending capacity of the
commercial banks to the public and hence the money supply in circulation in the economy will be
increased.
(iv) Selective credit control.
Answers: Selective credit control it refers to the situation whereby the central bank
orders the commercial banks to either reduce or increase lending and volume of credits they offer to the
public so as to regulate the current situation of the money supply in the economy, whereby during
inflation where money supply in the economy is too high the central bank will normally orders the
commercial banks to reduce lending and volume of credits to the public so that money supply in the
economy to be reduced while during deflation where money supply in the economy is too low the central
bank will normally orders the commercial bank to increase the volume of credits to the public through
offering loans with affordable interest rate in order to increase the level of money supply in the economy.
(v) Moral suasion.
Answers: It refers to the situation where the central bank persuades and advices the
commercial banks to either increase or reduce the volume of credits(loans) they offer to the public so that
money supply in circulation in the economy can be altered, whereby during inflation where money supply
is excess in the economy the central bank may persuades and advices the commercial banks to reduce he
volume of credits(loans) they offer to the public so as reduce money supply in circulation in the economy
while during deflation where money supply in circulation in the economy is too low the central bank will
normally advices or persuades the commercial banks in the country to increase the volume of
credits(loans) so as to raise level of the money supply in circulation in the economy.
4. (a) Define the following economic concepts:
(i) Transport.
Answers: It refers to the situation which involves the movement and transferring of the
goods and people from one particular area to another area within a given period of time.
(ii) Communication.
Answers: It refers to the situation whereby different individuals from the same places
or different places exchange different ideas, information, opinions, etc. in a given range of time.