WAEC SSCE - Economics - 2002 (Essay)

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(a) Fixed costs versus variable costs.

(b) When a firm will continue to operate at a loss in the short run. In the short run some costs are fixed and must be paid whether or not the firm produces. A firm should keep producing, even at a loss, as long as the price it receives at least covers its average variable cost. The reason is that by producing it earns revenue that covers all its variable costs and makes some contribution towards the unavoidable fixed costs; shutting down would still leave the whole of the fixed cost to be paid, so the loss would be larger.

The rule can be stated as:

• If \(P \geq AVC\): continue producing in the short run, because revenue covers variable cost and helps pay part of fixed cost.
• If \(P < AVC\): shut down, because each unit sold loses more than the fixed cost alone; producing makes the loss worse.

Worked illustration. Suppose fixed cost is \(N400\), and to produce 100 units the variable cost is \(N600\), so average variable cost is \(N6\) per unit. Total cost is \(N1000\), so average total cost is \(N10\) per unit.

• If the price is \(N8\): revenue \(= 100\times 8 = N800\). This is below total cost of \(N1000\), so there is a loss of \(N200\). But \(N8\) is above the \(N6\) average variable cost, so revenue covers the \(N600\) variable cost and contributes \(N200\) towards fixed cost. If the firm shut down it would lose the full \(N400\) fixed cost. Producing (loss \(N200\)) is better than shutting down (loss \(N400\)), so the firm continues.
• If the price fell to \(N5\): revenue \(= N500\), which does not even cover the \(N600\) variable cost. The firm should shut down, because producing would lose more than the \(N400\) fixed cost.

So a firm continues to operate at a loss in the short run only while price is at least equal to average variable cost. This is called the shut-down point: it lies at the minimum of the average variable cost curve.

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First find the equilibrium, where quantity supplied equals quantity demanded. Reading the table, at a price of \$2.00 per thousand kg both quantity supplied and quantity demanded equal 9 (000). So equilibrium price is \$2.00 and equilibrium quantity is 9,000 kg.

(a)(i) A fixed price of \$1.50 is below equilibrium, so it creates excess demand:

\[ \text{Excess demand} = Q_d - Q_s = 14 - 6 = 8\;(000) = 8{,}000\text{ kg} \]

(a)(ii) If the government fails to enforce the \$1.50 ceiling, the shortage will drive the price up until it returns to the equilibrium price of \$2.00, where the shortage disappears.

(b) A fixed price of \$3.00 is above equilibrium, creating a surplus of \( 16 - 3 = 13\;(000) \) kg. To maintain it the government must mop up the surplus, that is buy the 13,000 kg of excess maize (buffer-stock purchase) so that the extra supply does not force the price down.

(c) A fixed price of \$1.00 is below the equilibrium of \$2.00. Compared with equilibrium, quantity demanded rises from 9 to 19 (000) while quantity supplied falls from 9 to 3 (000). This produces a shortage of \( 19 - 3 = 16{,}000 \) kg of maize.

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(a) A market economy (also called a free enterprise, capitalist or laissez-faire economy) is an economic system in which the basic questions of what to produce, how to produce, and for whom to produce are decided mainly by the price mechanism, that is, by the free interaction of demand and supply, with private individuals and firms owning the means of production and the government playing little or no direct part.

(b) Features of a market economy:

• Private ownership of the means of production: land, capital and firms are owned by private individuals, not the state.
• Freedom of choice and enterprise: people are free to own property, choose their occupation, set up businesses and decide what to buy.
• The profit motive: production is driven by the desire of private owners to make profit.
• The price mechanism (market forces): prices set by demand and supply guide what is produced, how, and for whom; they act as signals and allocate resources.
• Competition: many producers and consumers compete, which influences prices and efficiency.
• Consumer sovereignty: consumers, through their spending, largely determine what is produced.
• Limited government intervention: the government mainly provides law, order and defence, leaving most economic decisions to the market.
• Existence of inequality: incomes and wealth are distributed unequally, according to ownership of resources and success in the market.

In such a system, self-interest and the price mechanism coordinate the millions of separate decisions of buyers and sellers.

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(a) Direct versus indirect taxes. A direct tax is a tax levied directly on the income or property of a person or organisation, where the person on whom it is imposed also bears the burden and pays it directly to the government. A indirect tax is a tax levied on goods and services, so that it is paid in the first place by producers or sellers but its burden can be shifted onto the final consumer through higher prices.

(b) Advantages of direct taxes:

• Equity (fairness): they can be made progressive, so that those with higher incomes pay a larger proportion, spreading the burden according to ability to pay.
• Certainty: the taxpayer knows how much to pay and when, and the government can estimate the revenue fairly accurately.
• Economical to collect: collection costs are relatively low because the tax is paid directly, often through employers.
• Elastic: revenue rises automatically as incomes rise, so the government's income grows with the economy.
• Reduces inequality: by taking more from the rich, it helps to narrow the gap between rich and poor.
• Does not directly raise prices: because it is not added to the price of goods, it does not by itself push up the cost of living.
• Civic awareness: since taxpayers feel the tax directly, it can make them more conscious of, and interested in, how public money is used.

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Agricultural productivity means output per unit of input, such as output per farmer or per hectare of land. In Nigeria (and similar developing economies) agricultural productivity is low for a combination of the following reasons.

• Use of crude and simple tools: reliance on the hoe and cutlass, with little mechanisation, keeps output per worker low.
• Poor and outdated methods of farming: traditional methods such as shifting cultivation and bush burning limit yields.
• Illiteracy and lack of training: many farmers are uneducated and lack access to modern farming knowledge and extension services.
• Shortage of capital and credit: farmers cannot afford improved seeds, fertiliser, machinery or irrigation.
• Inadequate use of modern inputs: limited access to fertilisers, improved seeds, pesticides and improved breeds.
• Land tenure system: fragmented holdings and communal or inheritance-based land ownership discourage large-scale, efficient farming.
• Poor storage and processing facilities: much produce is lost after harvest, reducing effective output.
• Inadequate infrastructure: bad roads, poor transport and lack of rural electricity make it hard to reach farms and markets.
• Pests, diseases and unreliable rainfall: crop and livestock losses and dependence on rain-fed farming lower and destabilise yields.
• Poor soil and environmental problems: declining soil fertility, erosion and drought reduce output.
• Rural-urban migration: the movement of young, able-bodied people to towns leaves an ageing farm workforce.
• Low and unstable prices: poor and fluctuating returns discourage farmers from investing and expanding.
• Inadequate government support: weak or poorly implemented agricultural policies and services.

Because these problems reinforce one another, output per farmer stays low. Raising productivity requires mechanisation, education and extension, credit, improved inputs, better infrastructure, and stable, rewarding prices.

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(a) A perfectly competitive market is a market structure in which there are very many buyers and sellers, each so small relative to the whole market that no single one can influence the market price. Every firm is a price taker: it accepts the price set by the interaction of total demand and total supply, and sells a homogeneous (identical) product.

(b) Conditions necessary for a perfectly competitive market:

• Large number of buyers and sellers: so many that each acts independently and no single buyer or seller can affect the market price.
• Homogeneous product: all firms sell an identical product, so buyers have no reason to prefer one seller over another.
• Free entry and exit: firms can enter the industry when profits are high and leave when they make losses, with no barriers.
• Perfect knowledge: buyers and sellers have full information about prices and products throughout the market, so the same good sells at one price.
• Perfect mobility of factors of production: resources can move freely to where they are best rewarded.
• No transport cost (and no product differentiation): so that a single uniform price rules in the whole market.
• No government or other interference: price is determined only by demand and supply, with no price control, taxes or subsidies distorting it.

Because of these conditions, a single ruling price prevails, each firm faces a perfectly elastic (horizontal) demand curve at that price, and firms can only decide how much to produce, not what price to charge. Perfect competition is largely a theoretical model; real markets rarely satisfy all the conditions, but it serves as a useful standard against which other market structures are judged.

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The wage rate is the price paid for labour. Its level is influenced by several factors, working through the demand for and supply of labour, and through institutions such as trade unions and government.

• Demand for labour: where labour is greatly needed (high demand), wages tend to be high; where demand is low, wages are low. The demand for labour is a derived demand, depending on the demand for the goods the labour produces.
• Supply of labour: when workers with a particular skill are scarce, wages are high; when they are abundant, wages are low.
• Productivity of labour: more productive workers add more to output, so employers can and will pay them more.
• Level of skill, training and qualification: jobs requiring long training, rare skills or high qualifications command higher wages.
• Bargaining power of trade unions: strong unions can negotiate higher wages for their members.
• Government legislation: a legal minimum wage and other labour laws set a floor and influence pay.
• Cost of living: in areas or times of high living costs, wages tend to be higher to maintain real income.
• Nature of the work: dangerous, unpleasant or difficult jobs may carry higher wages to attract workers.
• Ability of the employer or industry to pay: profitable firms and industries can pay more than struggling ones.
• Mobility of labour: where workers can move easily to better-paid jobs, wages tend to equalise; immobility keeps some wages low.
• Length of training and responsibility: jobs with heavy responsibility or long preparation usually attract higher pay.
• Custom, discrimination and social factors: tradition and unequal treatment can affect the wages of certain groups.

In practice the wage in any job reflects the interaction of these forces, especially the balance between the demand for and the supply of that kind of labour.

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A national debt is the total amount of money owed by the government of a country, made up of internal debt (owed to citizens and institutions at home) and external debt (owed to foreign lenders and institutions). A very large national debt can affect the economy in several ways, some harmful and a few beneficial.

Harmful effects:

• Heavy debt-servicing burden: large sums must be paid each year as interest and repayment, taking money that could have been used for development.
• Higher taxation: to service the debt, government may raise taxes, reducing people's disposable income and incentives.
• Reduced spending on essential services: debt repayment can crowd out spending on health, education and infrastructure.
• Balance of payments pressure (external debt): repaying foreign debt drains foreign exchange and can worsen the balance of payments.
• Loss of confidence and lower creditworthiness: a heavy debt can frighten off investors and make further borrowing harder and dearer.
• Inflation: if the government prints money or borrows heavily from the banking system to cover the debt, the money supply may rise and cause inflation.
• Crowding out of private investment: heavy government borrowing at home can raise interest rates and leave less credit for private firms.
• Loss of economic sovereignty: lenders such as the IMF may impose conditions that limit the government's freedom of action.
• Burden on future generations: external debt in particular passes the repayment burden to later generations.

Possible benefits (if the borrowed funds are well used):

• Borrowing can finance productive investment (roads, power, industries) that raises future output and incomes.
• Internal borrowing can mop up excess money and help control inflation.
• It allows the government to meet urgent needs without raising taxes sharply at once.

The overall effect therefore depends on the size of the debt relative to the economy and, above all, on how the borrowed money is used: debt that finances productive projects can help growth, while debt used for consumption becomes a heavy and unproductive burden.

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(a)(i) The raw material is the intermediate input. It is a good produced by one firm and used up by another in further production, rather than being sold to a final user.

(a)(ii) Intermediate inputs are excluded (deducted) when national income is computed, so as to avoid double counting. Their value is already contained in the sales value of the finished goods.

(a)(iii) Gross Domestic Product by the value-added method: \( \text{Value added} = \text{Sales} - \text{Raw materials} \).

\[ \text{Firm A} = 200 - 100 = 100 \qquad \text{Firm B} = 400 - 60 = 340 \]

\[ GDP = 100 + 340 = \$440{,}000 \;(\$440\text{ thousand}) \]

(b)(i) Total depreciation of the country:

\[ 16 + 40 = \$56{,}000 \;(\$56\text{ thousand}) \]

(b)(ii) Net Domestic Product \( = GDP - \text{depreciation} \):

\[ NDP = 440 - 56 = \$384{,}000 \;(\$384\text{ thousand}) \]

As a check, GDP also equals the sum of incomes (labour costs + depreciation + profits): \( (80+16+4) + (160+40+140) = 100 + 340 = 440 \), confirming the value-added result.

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The level of employment means the number of the working population actually engaged in productive work. It is influenced by several factors that affect the demand for and supply of labour, and the general state of the economy.

• Level of aggregate demand: when total spending on goods and services is high, firms produce more and employ more workers; low demand causes unemployment.
• Availability of capital and investment: more investment sets up more firms and projects, creating jobs; low investment limits employment.
• State of technology: labour-saving machines can raise output but may reduce the number of workers needed for a given output (technological unemployment).
• Availability of infrastructure: good roads, power and water encourage industries to set up and expand, raising employment.
• Size and skill of the labour force: the number of people willing and able to work, and whether their skills match the jobs available, affect how many can be employed.
• Government policy: fiscal and monetary policy, and programmes to create jobs, expand or contract employment.
• Level of industrialisation and diversification: a wider industrial base creates more and varied jobs.
• Availability of raw materials: steady supply of inputs keeps industries running and workers employed.
• Political stability and security: a stable, secure environment attracts investment and sustains employment.
• Wage levels: very high wages relative to productivity can discourage firms from hiring.
• Education and training: a well-trained workforce is more employable and attracts employers.
• Seasonal and structural factors: some jobs are seasonal, and shifts in the structure of the economy can create or destroy jobs.

In short, the level of employment depends mainly on the strength of demand in the economy and on the amount of investment, supported by adequate skills, infrastructure and stable government policy.

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Economic integration is an arrangement in which two or more countries agree to reduce or remove trade and other economic barriers among themselves and to cooperate economically, as in a free trade area, customs union, common market or economic community (for example ECOWAS in West Africa). Member countries can benefit in the following ways.

• Larger market: the combined market of member states is bigger, allowing firms to sell more and to produce on a large scale (economies of scale) at lower cost.
• Free movement of goods, labour and capital: removal of barriers lets goods, workers and capital move freely to where they are most needed and best rewarded.
• Increased trade among members: lower or zero tariffs encourage members to trade more with one another.
• Specialisation and better use of resources: each country can specialise in what it produces best, raising overall efficiency and output.
• Greater bargaining power: acting as a bloc, members can negotiate better terms with the rest of the world.
• Encouragement of industrialisation: the wider market and pooled resources make it worthwhile to set up large industries, sometimes jointly.
• Promotion of competition and lower prices: firms from different member states compete, improving quality and lowering prices for consumers.
• Transfer of technology and skills: cooperation spreads knowledge, technology and expertise among members.
• Joint infrastructure and projects: members can share the cost of large projects such as roads, power and communication links.
• Improved political relations and cooperation: closer economic ties promote peace, unity and cooperation among members.
• Employment opportunities: freer movement of labour and expanded industries create more jobs.

Through these gains, economic integration can raise output, incomes and living standards, and strengthen the members' position in the world economy.

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Indigenous firms (locally owned businesses) in West Africa tend to remain small. Several factors limit their growth in size.

• Shortage of capital: local firms often lack the funds and access to long-term finance needed to expand, buy machinery or build large premises.
• Small size of the market: low incomes and a limited number of buyers mean firms cannot sell enough to justify large-scale production.
• Poor infrastructure: inadequate roads, electricity and water raise costs and make large-scale operation difficult.
• Lack of skilled and managerial manpower: shortage of trained managers and technicians makes it hard to run and control a big firm.
• Low level of technology: reliance on simple, outdated tools keeps output and firm size small.
• Limited managerial and organisational ability: many are family or one-person businesses whose owners cannot delegate or manage a large organisation.
• Fear of loss of control: owners may avoid taking in partners or shareholders because they wish to keep sole ownership.
• Nature of the product: goods needing personal or custom attention cannot easily be produced on a large scale.
• Competition from large and foreign firms: bigger, better-financed competitors restrict the growth of small local firms.
• Government policy and multiple taxation: heavy taxes, poor incentives and unstable policy discourage expansion.
• Poor access to raw materials: irregular or costly supply of inputs limits the scale of output.
• Lack of infrastructure for storage and distribution: limits how far and how much a firm can sell.

Because of these constraints, most indigenous firms stay small, and only a few grow into large-scale enterprises.