WAEC SSCE - Economics - 2013 (Essay)
Question 1 Report
(a) Distinguish between cash ratio and special deposits.
(b) Explain how cash ratio and special deposits are used as instruments of monetary policy.
(c) Describe any two instruments of fiscal policy in West Africa.
(a) Cash ratio versus special deposits
The cash ratio (cash-reserve ratio) is the proportion of a commercial bank's total deposits that it is legally required to hold as cash reserves with the central bank. Special deposits are extra funds that the central bank calls upon commercial banks to lodge with it, over and above the normal reserves; these deposits are frozen and cannot be used for lending. In short, the cash ratio is a standing proportion of deposits, while special deposits are additional, deliberately immobilised sums.
(b) How they are used as monetary-policy instruments
Both work by altering the volume of funds banks have available for lending, and therefore the money supply:
- When the central bank raises the cash ratio, banks must keep a larger share of deposits idle, so their excess reserves and lending capacity fall; the money supply contracts. Lowering the ratio has the opposite, expansionary effect.
- When the central bank calls for special deposits, it removes cash from the banks and freezes it, directly reducing their ability to create credit and so tightening the money supply. Releasing special deposits eases credit.
Both are therefore used to curb excessive lending during inflation and to encourage lending during a slump.
(c) Two instruments of fiscal policy in West Africa
- Taxation: government varies direct and indirect taxes to influence demand; raising taxes reduces spending power to fight inflation, lowering them boosts demand.
- Government expenditure: government raises or lowers its own spending on projects and services to expand or contract aggregate demand (often combined with public borrowing and a budget surplus or deficit).
Answer Details
(a) Cash ratio versus special deposits
The cash ratio (cash-reserve ratio) is the proportion of a commercial bank's total deposits that it is legally required to hold as cash reserves with the central bank. Special deposits are extra funds that the central bank calls upon commercial banks to lodge with it, over and above the normal reserves; these deposits are frozen and cannot be used for lending. In short, the cash ratio is a standing proportion of deposits, while special deposits are additional, deliberately immobilised sums.
(b) How they are used as monetary-policy instruments
Both work by altering the volume of funds banks have available for lending, and therefore the money supply:
- When the central bank raises the cash ratio, banks must keep a larger share of deposits idle, so their excess reserves and lending capacity fall; the money supply contracts. Lowering the ratio has the opposite, expansionary effect.
- When the central bank calls for special deposits, it removes cash from the banks and freezes it, directly reducing their ability to create credit and so tightening the money supply. Releasing special deposits eases credit.
Both are therefore used to curb excessive lending during inflation and to encourage lending during a slump.
(c) Two instruments of fiscal policy in West Africa
- Taxation: government varies direct and indirect taxes to influence demand; raising taxes reduces spending power to fight inflation, lowering them boosts demand.
- Government expenditure: government raises or lowers its own spending on projects and services to expand or contract aggregate demand (often combined with public borrowing and a budget surplus or deficit).
Question 2 Report
(a) Highlight the difference between creeping inflation and hyper inflation.
(b) List any four negative effects of inflation.
(c) Outline four ways in which the government of your country can control inflation.
(a) Creeping inflation versus hyper-inflation
Creeping (mild) inflation is a slow, gradual and persistent rise in the general price level, usually in low single-digit percentages per year. It is manageable and can even accompany healthy economic growth. Hyper-inflation is an extremely rapid, severe and uncontrolled rise in prices, where the value of money collapses so quickly that prices may double within days or weeks. The essential differences are the speed and the severity: creeping inflation is slow and tolerable, hyper-inflation is galloping and destructive.
(b) Four negative effects of inflation
- It reduces the purchasing power of money, so real income falls.
- It hurts people on fixed incomes (pensioners, salary earners) and creditors, while borrowers who repay in cheaper money gain.
- It discourages saving, because money saved loses value over time.
- It creates uncertainty that discourages long-term investment and can worsen the balance of payments as exports become dearer.
(c) Four ways government can control inflation
- Monetary policy: the central bank raises the bank rate, sells securities through open-market operations, and raises the cash-reserve ratio to reduce the money supply.
- Fiscal policy: the government reduces its own spending and raises taxes to cut excess demand.
- Income (prices and wages) policy: restrain wage increases so that costs and demand do not push prices up.
- Output policy: increase the production and supply of goods and services (and encourage necessary imports) so that supply keeps pace with demand.
Answer Details
(a) Creeping inflation versus hyper-inflation
Creeping (mild) inflation is a slow, gradual and persistent rise in the general price level, usually in low single-digit percentages per year. It is manageable and can even accompany healthy economic growth. Hyper-inflation is an extremely rapid, severe and uncontrolled rise in prices, where the value of money collapses so quickly that prices may double within days or weeks. The essential differences are the speed and the severity: creeping inflation is slow and tolerable, hyper-inflation is galloping and destructive.
(b) Four negative effects of inflation
- It reduces the purchasing power of money, so real income falls.
- It hurts people on fixed incomes (pensioners, salary earners) and creditors, while borrowers who repay in cheaper money gain.
- It discourages saving, because money saved loses value over time.
- It creates uncertainty that discourages long-term investment and can worsen the balance of payments as exports become dearer.
(c) Four ways government can control inflation
- Monetary policy: the central bank raises the bank rate, sells securities through open-market operations, and raises the cash-reserve ratio to reduce the money supply.
- Fiscal policy: the government reduces its own spending and raises taxes to cut excess demand.
- Income (prices and wages) policy: restrain wage increases so that costs and demand do not push prices up.
- Output policy: increase the production and supply of goods and services (and encourage necessary imports) so that supply keeps pace with demand.
Question 3 Report
(a) Outline any four problems of barter economy.
(b) How has the introduction of money solved the problems outlined in 12(a) above?
(a) Four problems of a barter economy
- Double coincidence of wants: a person must find someone who both has what he wants and wants what he has, which is difficult and time-wasting.
- Lack of a common measure of value: there is no single unit in which to express and compare the worth of different goods.
- Indivisibility of certain goods: some goods (for example a cow) cannot be split to pay for a small item without losing value.
- Problem of storing value and deferred payment: perishable goods cannot store wealth, and it is hard to make or settle debts fairly over time.
(b) How money solved these problems
- As a medium of exchange, money removes the need for a double coincidence of wants: goods are sold for money, and money buys any other good.
- As a measure (unit) of value, money provides a common denominator so the value of all goods can be expressed and compared in prices.
- Because money is divisible into small units, goods of any size or value can be bought and change given easily.
- As a store of value and a standard of deferred payment, money lets people keep purchasing power for the future and make and settle debts conveniently.
Thus each function of money directly answers a specific weakness of barter.
Answer Details
(a) Four problems of a barter economy
- Double coincidence of wants: a person must find someone who both has what he wants and wants what he has, which is difficult and time-wasting.
- Lack of a common measure of value: there is no single unit in which to express and compare the worth of different goods.
- Indivisibility of certain goods: some goods (for example a cow) cannot be split to pay for a small item without losing value.
- Problem of storing value and deferred payment: perishable goods cannot store wealth, and it is hard to make or settle debts fairly over time.
(b) How money solved these problems
- As a medium of exchange, money removes the need for a double coincidence of wants: goods are sold for money, and money buys any other good.
- As a measure (unit) of value, money provides a common denominator so the value of all goods can be expressed and compared in prices.
- Because money is divisible into small units, goods of any size or value can be bought and change given easily.
- As a store of value and a standard of deferred payment, money lets people keep purchasing power for the future and make and settle debts conveniently.
Thus each function of money directly answers a specific weakness of barter.
Question 4 Report
(a) State two characteristics of monopolistic competition.
(b) With the aid of diagram(s), explain why a firm in monopolistic competition is unable to earn abnormal profits in the long run.
(c) Differentiate between natural monopoly and legal monopoly.
(a) Two characteristics of monopolistic competition
- Many sellers and buyers: there are numerous firms, each small relative to the market, so no single firm can dominate.
- Product differentiation: firms sell similar but not identical products (through branding, packaging, quality or service), which gives each firm a small degree of control over its own price.
(Other acceptable points: freedom of entry and exit in the long run, and heavy reliance on non-price competition such as advertising.)
(b) Why no abnormal profit in the long run
The key reason is freedom of entry into the industry. In the short run a firm can earn abnormal (supernormal) profit where price exceeds average cost. Because there are no barriers to entry, these profits attract new firms into the industry. As new firms enter and offer close substitutes, they take customers away from the existing firm. This causes the existing firm's demand (average revenue) curve to shift to the left and become more elastic.
Entry continues until abnormal profits are competed away. Long-run equilibrium is reached when the firm's average revenue curve is just tangent to its average total cost curve. At that tangency point price equals average cost, so the firm earns only normal profit, while it still produces at the profit-maximising output where marginal revenue equals marginal cost.
On the diagram: the downward-sloping AR curve touches the U-shaped AC curve at exactly one point directly above the output where MR = MC. Here \( P = AC \), so abnormal profit is zero. Any attempt by the firm to raise price loses too many customers to rivals; any tendency toward profit invites fresh entry.
(c) Natural monopoly versus legal monopoly
- Natural monopoly arises because of the technical nature of the industry: very large economies of scale and heavy fixed costs mean that a single firm can supply the whole market at a lower average cost than several firms could. Examples are electricity, water and railway supply.
- Legal monopoly exists because the law grants and protects exclusive rights to one producer, for example through patents, copyrights, or a government franchise or licence. Its power comes from statute, not from cost conditions.
Answer Details
(a) Two characteristics of monopolistic competition
- Many sellers and buyers: there are numerous firms, each small relative to the market, so no single firm can dominate.
- Product differentiation: firms sell similar but not identical products (through branding, packaging, quality or service), which gives each firm a small degree of control over its own price.
(Other acceptable points: freedom of entry and exit in the long run, and heavy reliance on non-price competition such as advertising.)
(b) Why no abnormal profit in the long run
The key reason is freedom of entry into the industry. In the short run a firm can earn abnormal (supernormal) profit where price exceeds average cost. Because there are no barriers to entry, these profits attract new firms into the industry. As new firms enter and offer close substitutes, they take customers away from the existing firm. This causes the existing firm's demand (average revenue) curve to shift to the left and become more elastic.
Entry continues until abnormal profits are competed away. Long-run equilibrium is reached when the firm's average revenue curve is just tangent to its average total cost curve. At that tangency point price equals average cost, so the firm earns only normal profit, while it still produces at the profit-maximising output where marginal revenue equals marginal cost.
On the diagram: the downward-sloping AR curve touches the U-shaped AC curve at exactly one point directly above the output where MR = MC. Here \( P = AC \), so abnormal profit is zero. Any attempt by the firm to raise price loses too many customers to rivals; any tendency toward profit invites fresh entry.
(c) Natural monopoly versus legal monopoly
- Natural monopoly arises because of the technical nature of the industry: very large economies of scale and heavy fixed costs mean that a single firm can supply the whole market at a lower average cost than several firms could. Examples are electricity, water and railway supply.
- Legal monopoly exists because the law grants and protects exclusive rights to one producer, for example through patents, copyrights, or a government franchise or licence. Its power comes from statute, not from cost conditions.
Question 5 Report
(a) Differentiate between direct and indirect taxation
(b) Highlight any five advantages of indirect taxation to developing countries
(a) Direct versus indirect taxation. A direct tax is levied directly on the income, wealth or profit of individuals and firms, and the burden (impact) cannot be shifted onto another person; the person assessed actually bears it. Examples are personal income tax, company (corporate) tax and capital gains tax. An indirect tax is levied on goods and services, and its burden can be shifted, wholly or partly, from the producer or seller onto the final consumer through a higher price. Examples are value added tax (VAT), import duties and excise duties.
(b) Five advantages of indirect taxation to developing countries
- Difficult to evade: since the tax is included in the price of goods, anyone who buys the good pays it, so evasion is hard.
- Convenient to pay: it is paid in small amounts as goods are bought, so the burden is hardly felt.
- Wide coverage: it reaches almost everybody, including those in the informal sector whose incomes cannot easily be assessed.
- Can discourage harmful goods: heavy duties on goods such as alcohol and tobacco reduce their consumption.
- Easy and cheap to collect: it is collected at a few points (ports, factories, points of sale), lowering administrative cost, and yields large, elastic revenue.
Answer Details
(a) Direct versus indirect taxation. A direct tax is levied directly on the income, wealth or profit of individuals and firms, and the burden (impact) cannot be shifted onto another person; the person assessed actually bears it. Examples are personal income tax, company (corporate) tax and capital gains tax. An indirect tax is levied on goods and services, and its burden can be shifted, wholly or partly, from the producer or seller onto the final consumer through a higher price. Examples are value added tax (VAT), import duties and excise duties.
(b) Five advantages of indirect taxation to developing countries
- Difficult to evade: since the tax is included in the price of goods, anyone who buys the good pays it, so evasion is hard.
- Convenient to pay: it is paid in small amounts as goods are bought, so the burden is hardly felt.
- Wide coverage: it reaches almost everybody, including those in the informal sector whose incomes cannot easily be assessed.
- Can discourage harmful goods: heavy duties on goods such as alcohol and tobacco reduce their consumption.
- Easy and cheap to collect: it is collected at a few points (ports, factories, points of sale), lowering administrative cost, and yields large, elastic revenue.
Question 6 Report
(a) What is competitive supply?
(b) With the aid of illustrations, differentiate between a supply schedule and a supply curve.
(c) Explain how the supply of a commodity is affected by the following:
(i) an improvement in technology;
(ii) a rise in input prices;
(iii) a rise in the prices of other commodities;
(iv) an increase in government subsidies on production.
(a) Competitive supply. Competitive supply exists when two or more commodities are produced using the same resources, so that producing more of one means producing less of the other because they compete for the same limited factors of production. For example, a farmer using the same land can grow either maize or yam, so more maize means less yam.
(b) Supply schedule versus supply curve. A supply schedule is a table showing the various quantities of a commodity that producers are willing to supply at different prices. A supply curve is the graphical representation of that schedule, plotted with price on the vertical axis and quantity on the horizontal axis; it normally slopes upward from left to right, showing that more is supplied at higher prices.
| Price (N) | Quantity supplied (units) |
|---|---|
| 1 | 10 |
| 2 | 20 |
| 3 | 30 |
| 4 | 40 |
Plotting these points and joining them gives an upward-sloping supply curve.
(c) Effects on the supply of a commodity
- (i) An improvement in technology: raises productivity and lowers cost, so supply increases (the curve shifts to the right).
- (ii) A rise in input prices: raises the cost of production, so supply decreases (the curve shifts to the left).
- (iii) A rise in the prices of other commodities: makes those other goods more profitable, so resources are switched away and the supply of this commodity falls (competitive supply).
- (iv) An increase in government subsidies: lowers the producer's effective cost, so supply increases (the curve shifts to the right).
Answer Details
(a) Competitive supply. Competitive supply exists when two or more commodities are produced using the same resources, so that producing more of one means producing less of the other because they compete for the same limited factors of production. For example, a farmer using the same land can grow either maize or yam, so more maize means less yam.
(b) Supply schedule versus supply curve. A supply schedule is a table showing the various quantities of a commodity that producers are willing to supply at different prices. A supply curve is the graphical representation of that schedule, plotted with price on the vertical axis and quantity on the horizontal axis; it normally slopes upward from left to right, showing that more is supplied at higher prices.
| Price (N) | Quantity supplied (units) |
|---|---|
| 1 | 10 |
| 2 | 20 |
| 3 | 30 |
| 4 | 40 |
Plotting these points and joining them gives an upward-sloping supply curve.
(c) Effects on the supply of a commodity
- (i) An improvement in technology: raises productivity and lowers cost, so supply increases (the curve shifts to the right).
- (ii) A rise in input prices: raises the cost of production, so supply decreases (the curve shifts to the left).
- (iii) A rise in the prices of other commodities: makes those other goods more profitable, so resources are switched away and the supply of this commodity falls (competitive supply).
- (iv) An increase in government subsidies: lowers the producer's effective cost, so supply increases (the curve shifts to the right).
Question 7 Report
(a) What is:
(i) peasant farming?
(ii) commercial farming?
(b) Describe five ways in which agriculture contributes to the economic development of your country.
(a)(i) Peasant farming is small-scale farming carried out mainly by a family on a small piece of land, using crude tools and simple methods, with output produced largely for the family's own consumption and only a small surplus for sale.
(a)(ii) Commercial farming is large-scale farming carried out for the purpose of sale and profit, using modern inputs (machines, improved seeds, fertilizers) and hired labour, with output produced mainly for the market.
(b) Five ways agriculture contributes to economic development
- Provision of food: it supplies the food needed to feed the growing population and maintain a healthy, productive labour force.
- Employment: it provides jobs and income for a large proportion of the population, especially in rural areas.
- Raw materials for industry: it supplies inputs such as cotton, cocoa, palm produce and rubber to local manufacturing industries.
- Foreign exchange earnings: the export of agricultural produce earns foreign exchange used to import capital goods.
- Source of government revenue: taxes, duties and marketing-board earnings from agriculture provide revenue for the government.
Agriculture also provides a market for industrial goods and a source of savings and capital for investment.
Answer Details
(a)(i) Peasant farming is small-scale farming carried out mainly by a family on a small piece of land, using crude tools and simple methods, with output produced largely for the family's own consumption and only a small surplus for sale.
(a)(ii) Commercial farming is large-scale farming carried out for the purpose of sale and profit, using modern inputs (machines, improved seeds, fertilizers) and hired labour, with output produced mainly for the market.
(b) Five ways agriculture contributes to economic development
- Provision of food: it supplies the food needed to feed the growing population and maintain a healthy, productive labour force.
- Employment: it provides jobs and income for a large proportion of the population, especially in rural areas.
- Raw materials for industry: it supplies inputs such as cotton, cocoa, palm produce and rubber to local manufacturing industries.
- Foreign exchange earnings: the export of agricultural produce earns foreign exchange used to import capital goods.
- Source of government revenue: taxes, duties and marketing-board earnings from agriculture provide revenue for the government.
Agriculture also provides a market for industrial goods and a source of savings and capital for investment.
Question 8 Report
The table below shows the scale of preference of a student - Mr Smith whose disposable income is $7.00. Use the information in the table to answer the auestoins that follow.
| Items needed | Price ($) |
| Textbook | 5.00 |
| Shirt | 2.00 |
| Shoes | 3.00 |
| Trousers | 3.00 |
| Notebook | 1.00 |
| School fees | 7.00 |
| Mattress | 10.00 |
(a)(i) What will Mr. Smith spend his money on?
(ii) Explain your answer in 2(a)(i).
(b)(i) What is the opportunity cost of Mr. Smith's decision in 2(b)(i)?
(ii) Explain your answer in 2(b)(i).
(c)(i) If Mr. Smith's disposable income increases to $10.0, what will he spend it on?
(ii) What is the opportunity cost of the decision in 2(c)(i)?
(d) Define "scale of preference" and "opportunity cost".
(e) What is the importance of a scale of preference?
Mr Smith's disposable income is \$7.00. A scale of preference lists wants in order of priority, and he satisfies the most pressing wants first.
(a)(i) He will buy the Textbook (\$5) and the Shirt (\$2), which together cost exactly \$7.
(ii) These are the two items highest on his scale of preference that his \$7 can afford; buying them exhausts his income while satisfying his most urgent wants.
(b)(i) The opportunity cost of that decision is the Shoes (\$3), the next item on his scale that he had to forgo.
(ii) Opportunity cost is the next best alternative sacrificed. Having spent all \$7 on the textbook and shirt, he gives up the shoes, so the shoes are the real cost of his choice.
(c)(i) If income rises to \$10, he can add the shoes: Textbook (\$5) + Shoes (\$3) + Shirt (\$2) = \$10.
(ii) The opportunity cost is now the Trousers (\$3), the next item forgone.
(d) Definitions
- Scale of preference: a list of an individual's wants arranged in the order of their relative importance or urgency.
- Opportunity cost: the next best alternative that is given up when a choice is made.
(e) Importance of a scale of preference
- It guides rational choice by ranking wants in order of priority.
- It ensures the most pressing wants are satisfied first with limited income.
- It promotes efficient allocation of scarce resources and avoids waste.
- It makes the opportunity cost of a decision clear.
Answer Details
Mr Smith's disposable income is \$7.00. A scale of preference lists wants in order of priority, and he satisfies the most pressing wants first.
(a)(i) He will buy the Textbook (\$5) and the Shirt (\$2), which together cost exactly \$7.
(ii) These are the two items highest on his scale of preference that his \$7 can afford; buying them exhausts his income while satisfying his most urgent wants.
(b)(i) The opportunity cost of that decision is the Shoes (\$3), the next item on his scale that he had to forgo.
(ii) Opportunity cost is the next best alternative sacrificed. Having spent all \$7 on the textbook and shirt, he gives up the shoes, so the shoes are the real cost of his choice.
(c)(i) If income rises to \$10, he can add the shoes: Textbook (\$5) + Shoes (\$3) + Shirt (\$2) = \$10.
(ii) The opportunity cost is now the Trousers (\$3), the next item forgone.
(d) Definitions
- Scale of preference: a list of an individual's wants arranged in the order of their relative importance or urgency.
- Opportunity cost: the next best alternative that is given up when a choice is made.
(e) Importance of a scale of preference
- It guides rational choice by ranking wants in order of priority.
- It ensures the most pressing wants are satisfied first with limited income.
- It promotes efficient allocation of scarce resources and avoids waste.
- It makes the opportunity cost of a decision clear.
Question 9 Report
(a) Explain any four benefits of industrial development in an economy
(b) Outline any four measures that will encourage industrial growth in your country.
(a) Four benefits of industrial development
- Employment creation: industries provide jobs, reducing unemployment and raising incomes.
- Increased national income and growth: industrial output adds to Gross Domestic Product and raises the standard of living.
- Diversification of the economy: industry reduces over-dependence on agriculture or a single export such as oil.
- Saving of foreign exchange: local production of goods formerly imported (import substitution) and export of manufactures saves and earns foreign exchange.
Industrial development also promotes technological progress and the growth of infrastructure.
(b) Four measures to encourage industrial growth
- Provision of infrastructure: reliable electricity, good roads and water reduce the cost of production.
- Provision of finance and credit: establishing development banks and giving loans at low interest to industrialists.
- Favourable tax policy and incentives: tax holidays, subsidies and duty-free import of machinery attract investors.
- Protection of infant industries: imposing tariffs and quotas on competing imports to allow local industries to grow.
Manpower training and ensuring a stable political climate also encourage industrial growth.
Answer Details
(a) Four benefits of industrial development
- Employment creation: industries provide jobs, reducing unemployment and raising incomes.
- Increased national income and growth: industrial output adds to Gross Domestic Product and raises the standard of living.
- Diversification of the economy: industry reduces over-dependence on agriculture or a single export such as oil.
- Saving of foreign exchange: local production of goods formerly imported (import substitution) and export of manufactures saves and earns foreign exchange.
Industrial development also promotes technological progress and the growth of infrastructure.
(b) Four measures to encourage industrial growth
- Provision of infrastructure: reliable electricity, good roads and water reduce the cost of production.
- Provision of finance and credit: establishing development banks and giving loans at low interest to industrialists.
- Favourable tax policy and incentives: tax holidays, subsidies and duty-free import of machinery attract investors.
- Protection of infant industries: imposing tariffs and quotas on competing imports to allow local industries to grow.
Manpower training and ensuring a stable political climate also encourage industrial growth.
Question 10 Report
(a) What is perfect competition?
(b) With the aid of diagrams, compare the short run equilibrium positions of a perfect competitor and an imperfect competitor.
(c) State any two features of an imperfect market.
(a) Perfect competition is a market structure in which there are very many buyers and sellers dealing in a homogeneous (identical) product, with freedom of entry and exit, perfect knowledge, and no single participant able to influence price. Each firm is therefore a price taker.
(b) Short-run equilibrium: perfect competitor versus imperfect competitor
Both firms maximise profit at the output where marginal cost equals marginal revenue (MC = MR), and both may earn abnormal profit, normal profit or a loss in the short run. The differences lie in the demand (average revenue) curve:
- For the perfect competitor, the firm faces a horizontal (perfectly elastic) demand curve at the ruling market price, so \( P = AR = MR \). Equilibrium output is where MC cuts this horizontal line from below.
- For the imperfect competitor (for example a monopolist or monopolistic competitor), the demand curve slopes downward, and marginal revenue lies below average revenue. Here price is read off the AR curve above the MC = MR output, so \( P > MR \).
On the diagrams the perfect competitor's price line is a flat line touched by MC; the imperfect competitor's AR and MR are two separate downward-sloping lines, with equilibrium output below MC = MR and price taken up on the AR curve.
(c) Two features of an imperfect market
- Product differentiation or a single/few sellers, so firms are price makers rather than price takers.
- Barriers to entry and imperfect knowledge among buyers and sellers.
Answer Details
(a) Perfect competition is a market structure in which there are very many buyers and sellers dealing in a homogeneous (identical) product, with freedom of entry and exit, perfect knowledge, and no single participant able to influence price. Each firm is therefore a price taker.
(b) Short-run equilibrium: perfect competitor versus imperfect competitor
Both firms maximise profit at the output where marginal cost equals marginal revenue (MC = MR), and both may earn abnormal profit, normal profit or a loss in the short run. The differences lie in the demand (average revenue) curve:
- For the perfect competitor, the firm faces a horizontal (perfectly elastic) demand curve at the ruling market price, so \( P = AR = MR \). Equilibrium output is where MC cuts this horizontal line from below.
- For the imperfect competitor (for example a monopolist or monopolistic competitor), the demand curve slopes downward, and marginal revenue lies below average revenue. Here price is read off the AR curve above the MC = MR output, so \( P > MR \).
On the diagrams the perfect competitor's price line is a flat line touched by MC; the imperfect competitor's AR and MR are two separate downward-sloping lines, with equilibrium output below MC = MR and price taken up on the AR curve.
(c) Two features of an imperfect market
- Product differentiation or a single/few sellers, so firms are price makers rather than price takers.
- Barriers to entry and imperfect knowledge among buyers and sellers.
Question 11 Report
The output and cost of production of rice (in bags) are presented in the table below. Use the information in the table to answer the questions that follow.
| Output of rice (in bags) | 0 | 1 | 2 | 3 | 4 |
| Total Variables Coat (TVC) $ | 0 | 5 | 7 | 10 | 20 |
| Total Cost (TC) $ | 7 | 12 | 14 | 17 | 27 |
(a) Calculate the
(i) Average Fixed Cost (AFC) at output levels 0,2 and 4
(ii) Marginal Cost (MC) at all levels of output
(b) If the price of a bag of rice were $10,
(i) calculate the profit/loss at all levels of output.
(ii) at what output level(s) is the maximum profit made?
(c) Draw the marginal cost curve (the use of graph sheet is essential).
(a)(i) Average Fixed Cost (AFC)
Fixed cost = Total Cost − Total Variable Cost. At every output level, fixed cost = $7.
| Output, Q (bags) | Fixed Cost ($) | AFC = FC/Q ($) |
|---|---|---|
| 0 | 7 | Undefined |
| 2 | 7 | 7/2 = 3.50 |
| 4 | 7 | 7/4 = 1.75 |
(a)(ii) Marginal Cost (MC)
Using successive changes in total cost:
| Output (bags) | MC ($) |
|---|---|
| 0 | 7 |
| 1 | 12 − 7 = 5 |
| 2 | 14 − 12 = 2 |
| 3 | 17 − 14 = 3 |
| 4 | 27 − 17 = 10 |
(b)(i) Profit or loss when price = $10 per bag
\(TR = P \times Q = 10Q\), while \(\text{Profit} = TR - TC\).
| Output (bags) | TR ($) | TC ($) | Profit/Loss ($) |
|---|---|---|---|
| 0 | 0 | 7 | −7 (loss) |
| 1 | 10 | 12 | −2 (loss) |
| 2 | 20 | 14 | 6 (profit) |
| 3 | 30 | 17 | 13 (profit) |
| 4 | 40 | 27 | 13 (profit) |
(b)(ii) Maximum profit of $13 is made at output levels of 3 bags and 4 bags.
(c) Marginal Cost Curve
The MC curve is obtained by plotting the points \((0,7), (1,5), (2,2), (3,3)\) and \((4,10)\), and joining successive points.
Answer Details
(a)(i) Average Fixed Cost (AFC)
Fixed cost = Total Cost − Total Variable Cost. At every output level, fixed cost = $7.
| Output, Q (bags) | Fixed Cost ($) | AFC = FC/Q ($) |
|---|---|---|
| 0 | 7 | Undefined |
| 2 | 7 | 7/2 = 3.50 |
| 4 | 7 | 7/4 = 1.75 |
(a)(ii) Marginal Cost (MC)
Using successive changes in total cost:
| Output (bags) | MC ($) |
|---|---|
| 0 | 7 |
| 1 | 12 − 7 = 5 |
| 2 | 14 − 12 = 2 |
| 3 | 17 − 14 = 3 |
| 4 | 27 − 17 = 10 |
(b)(i) Profit or loss when price = $10 per bag
\(TR = P \times Q = 10Q\), while \(\text{Profit} = TR - TC\).
| Output (bags) | TR ($) | TC ($) | Profit/Loss ($) |
|---|---|---|---|
| 0 | 0 | 7 | −7 (loss) |
| 1 | 10 | 12 | −2 (loss) |
| 2 | 20 | 14 | 6 (profit) |
| 3 | 30 | 17 | 13 (profit) |
| 4 | 40 | 27 | 13 (profit) |
(b)(ii) Maximum profit of $13 is made at output levels of 3 bags and 4 bags.
(c) Marginal Cost Curve
The MC curve is obtained by plotting the points \((0,7), (1,5), (2,2), (3,3)\) and \((4,10)\), and joining successive points.
Question 12 Report
(a) Distinguish between small scale prodution and large scale production
(b) Describe any five internal economies of large scale production.
(a) Small-scale versus large-scale production.
| Small-scale production | Large-scale production |
|---|---|
| Uses a small amount of capital. | Uses a large amount of capital. |
| Output produced is small. | Output produced is large (mass production). |
| Employs few workers with little division of labour. | Employs many workers with a high degree of division of labour. |
| Serves a small, local market. | Serves a large, wide (national or international) market. |
| Enjoys few or no economies of scale. | Enjoys substantial economies of scale. |
(b) Five internal economies of large-scale production
- Technical economies: the firm can use large, specialised and efficient machines, spreading their cost over a large output and lowering unit cost.
- Managerial economies: it can employ specialist managers each in charge of one function, raising efficiency.
- Financial economies: being large and reputable, it can borrow large sums easily and at lower interest rates.
- Marketing (commercial) economies: it buys raw materials in bulk at discounts and sells in large quantities, reducing buying and selling costs per unit.
- Risk-bearing economies: it can diversify its products and markets so that a loss in one area is offset by gains in another.
Answer Details
(a) Small-scale versus large-scale production.
| Small-scale production | Large-scale production |
|---|---|
| Uses a small amount of capital. | Uses a large amount of capital. |
| Output produced is small. | Output produced is large (mass production). |
| Employs few workers with little division of labour. | Employs many workers with a high degree of division of labour. |
| Serves a small, local market. | Serves a large, wide (national or international) market. |
| Enjoys few or no economies of scale. | Enjoys substantial economies of scale. |
(b) Five internal economies of large-scale production
- Technical economies: the firm can use large, specialised and efficient machines, spreading their cost over a large output and lowering unit cost.
- Managerial economies: it can employ specialist managers each in charge of one function, raising efficiency.
- Financial economies: being large and reputable, it can borrow large sums easily and at lower interest rates.
- Marketing (commercial) economies: it buys raw materials in bulk at discounts and sells in large quantities, reducing buying and selling costs per unit.
- Risk-bearing economies: it can diversify its products and markets so that a loss in one area is offset by gains in another.
