WAEC SSCE - Economics - 1999 (Essay)

Akọwa Nkọwa

A balance of payments deficit occurs when a country's total payments to the rest of the world exceed its total receipts, mainly because imports and other outflows exceed exports and other inflows. The main causes in a developing country such as Nigeria include:

• High import bills: heavy importation of manufactured goods, machinery, food and luxuries.
• Narrow, over-dependent export base: reliance on one or few primary products (for example crude oil) whose prices are unstable in the world market.
• Fall in world prices of exports or a decline in demand for them, reducing export earnings.
• Unfavourable terms of trade: export prices falling relative to import prices.
• Inflation at home: high domestic prices make exports uncompetitive and imports more attractive.
• Debt-service payments: large interest and principal repayments on foreign loans.
• Profit and dividend repatriation by foreign firms operating in the country.
• Capital flight and heavy invisible payments such as freight, insurance and foreign travel or medical treatment.
• Over-valued exchange rate that cheapens imports and dearens exports.
• Fall in domestic production forcing greater reliance on imports.

The central reasoning is that the country spends more foreign exchange on imports and other outflows than it earns from exports and inflows, and this gap is widened by over-dependence on unstable primary exports.

Akọwa Nkọwa

A joint stock company is an incorporated business owned by shareholders who contribute capital by buying shares and enjoy limited liability. It has a separate legal personality from its owners.

Advantages:

• Limited liability: a shareholder can lose only the amount invested; personal assets are protected.
• Large capital: selling shares to many people (and, for public companies, to the general public) raises far more capital than a sole trader or partnership can.
• Continuity (perpetual succession): the company continues to exist despite the death, retirement or withdrawal of any shareholder.
• Transferability of shares: shares, especially in a public company, can be sold easily on the stock exchange.
• Specialised management: the company can employ expert directors and managers, improving efficiency.
• Economies of scale arising from large-scale operation lower average costs.

Disadvantages:

• Difficult and costly formation: legal formalities such as registration, memorandum and articles of association make it expensive to set up.
• Separation of ownership from control: shareholders own the firm but managers run it, which can lead to decisions not in owners' interests.
• Lack of secrecy: published accounts reveal information to competitors.
• Double taxation and heavy regulation: company profits and dividends may both be taxed and the firm faces strict legal controls.
• Slow decision-making because of the large size and bureaucratic structure.
• Possible conflict of interest among directors, managers and shareholders.

Akọwa Nkọwa

(a) A customs union is a form of economic integration in which member countries remove tariffs and other trade barriers on trade among themselves and, in addition, adopt a common external tariff against goods coming from non-member countries. It goes further than a free trade area, which only abolishes internal tariffs without a common external tariff.

(b) Three advantages:

• Larger market: free trade among members widens the market, allowing firms to enjoy economies of scale.
• Trade creation: members buy from the most efficient producer within the union, improving specialisation and efficiency.
• Stronger bargaining power against the rest of the world, plus increased investment and closer economic and political cooperation among members.

Two disadvantages:

• Trade diversion: the common external tariff may divert trade away from a cheaper outside producer to a dearer member producer, reducing efficiency.
• Loss of revenue and sovereignty: members lose customs revenue from internal trade and must surrender some control over their own trade policy to the union.

Akọwa Nkọwa

When the government fixes prices away from the free-market equilibrium, the economic consequences depend on whether the fixed price is below or above equilibrium.

Price fixed below equilibrium (a maximum or ceiling price), often to protect consumers of essential goods:

• Excess demand (shortage): quantity demanded exceeds quantity supplied, so goods run out.
• Emergence of a black market: scarce goods are resold illegally at prices above the controlled price.
• Hoarding and rationing: sellers hold back goods and formal rationing or queuing may be introduced to share the limited supply.
• Fall in quality as sellers cut standards, and a fall in supply as production becomes less profitable.

Price fixed above equilibrium (a minimum or floor price), often to protect producers, for example a guaranteed price for farmers or a minimum wage:

• Excess supply (surplus): quantity supplied exceeds quantity demanded.
• Government or agencies may have to buy and store the surplus, raising costs.
• Resources are misallocated into over-production, and a minimum wage above equilibrium can create unemployment.

The key point is that a controlled price prevents the market from clearing, so either a persistent shortage or a persistent surplus results, together with side-effects such as black markets, rationing and misallocation of resources.

Akọwa Nkọwa

West African countries can promote (encourage the growth of) indigenous, locally owned industries through the following measures:

• Provision of finance: establishing development banks and giving loans, grants and credit guarantees to local entrepreneurs.
• Protection from foreign competition: imposing tariffs, quotas or import bans on goods that compete with infant local industries.
• Provision of infrastructure: supplying roads, electricity, water and communications that reduce the cost of production.
• Tax incentives: granting tax holidays, tariff concessions on imported machinery and other reliefs to new industries.
• Manpower training: setting up technical and vocational schools to supply skilled workers and managers.
• Patronage of local products: government and citizens buying home-made goods, and public campaigns to encourage this.
• Provision of raw materials and industrial layouts or estates with ready facilities.
• Enabling policies and stability: maintaining a stable political and economic climate and clear investment laws.
• Research and extension services to improve product quality and technology.
• Indigenisation policies reserving certain enterprises for citizens.

The reasoning is that local industries are usually young and weak, so deliberate government support in finance, protection, infrastructure and skills is needed until they can compete and contribute to output and employment.

Akọwa Nkọwa

A monopoly is a market in which a single firm is the sole seller of a product that has no close substitutes, protected by barriers to entry.

Advantages of monopoly:

• Economies of scale: being large, the firm can produce at lower average cost and may pass part of the saving to consumers.
• Funds for research and development: supernormal profits can finance innovation and improved products.
• Avoids wasteful duplication: in the case of natural monopolies such as water or electricity supply, a single network is more efficient than several.
• Stability and continuity: the firm can plan long-term investment without the uncertainty of intense competition.
• Can practise price discrimination that may allow some low-income consumers to be served.

Disadvantages of monopoly:

• Higher prices and lower output: the monopolist restricts output to raise price above the competitive level, reducing consumer welfare.
• Exploitation of consumers through high prices and, sometimes, poor quality.
• Inefficiency (X-inefficiency): lack of competition removes the pressure to keep costs low.
• Loss of consumer choice since there is only one supplier.
• Price discrimination can charge some buyers more for the same good.
• Possible poor service and slower innovation where the firm feels no competitive threat.

Akọwa Nkọwa

Natural resources are the free gifts of nature (minerals, land, forests, rivers, wildlife) available for production. In an economy such as Nigeria's they contribute in the following ways:

• Source of government revenue: royalties, rents and taxes from oil, gas and solid minerals form a large part of public income.
• Foreign exchange earnings: exports of crude oil and other resources earn the foreign currency used to pay for imports.
• Employment: mining, oil, agriculture, fishing and forestry provide jobs for many people.
• Raw materials for industry: minerals and agricultural produce feed local manufacturing, for example crude oil for refineries and petrochemicals.
• Provision of energy: oil, gas and hydro resources supply power for homes and industries.
• Basis for industrialisation and infrastructure: resource revenue finances roads, schools, hospitals and industrial projects.
• Food and export crops: fertile land supplies food and cash crops such as cocoa and rubber.
• Attraction of foreign investment into extractive and processing industries.
• Contribution to national output (GDP) and to overall economic growth.

Thus natural resources support the economy through revenue, foreign exchange, employment, raw materials, energy and growth, provided they are efficiently exploited and the earnings well managed.

Akọwa Nkọwa

The small-scale trader (petty trader, market woman, roadside seller) is very important in West African countries for several reasons:

• Distribution to consumers: small traders move goods from wholesalers and producers to the final consumer, reaching rural and remote areas that large firms ignore.
• Sale in small units: they break bulk and sell in tiny quantities (a cup of rice, one cigarette, a sachet of oil) that suit the low incomes of most buyers.
• Employment and self-reliance: trading requires little capital and few skills, so it provides a livelihood for millions and reduces unemployment.
• Convenience and nearness: shops and stalls are located close to homes and open long hours, saving consumers time and transport costs.
• Provision of credit: familiar traders often sell on trust or short-term credit to regular customers.
• Encouraging local production: they create a ready market for the output of local farmers and craftsmen.
• Low capital requirement makes trade an entry point into business and a source of savings for larger ventures.
• Government revenue through market tolls, licences and taxes.

In economies with widespread poverty, poor transport and large informal sectors, small-scale traders are the backbone of everyday distribution and a major source of income and employment.

Akọwa Nkọwa

(a) Completion of the demand schedule

Using \(Q_d = 12 - 2P\):

For example, when \(P=4\), \(Q_d=12-2(4)=4\).

(b) Individual demand curve

Plot the points \((Q_d,P)\): \((0,6)\), \((2,5)\), \((4,4)\), \((6,3)\), \((8,2)\), \((10,1)\) and \((12,0)\), and join them with a straight line.

(c) The maximum quantity the individual can buy per unit of time is 12 units. This occurs when \(P=0\).

(d) Quantity demanded and price have an inverse relationship. As price rises, quantity demanded falls; as price falls, quantity demanded rises. In the function, every increase of 1 unit in price reduces quantity demanded by 2 units.

Akọwa Nkọwa

Inflation is a persistent rise in the general price level. Its effects on the economy are both positive and negative.

Positive effects (usually of mild, creeping inflation):

• Encourages production and investment: rising prices raise expected profits, so producers expand output and investment.
• Benefits debtors: borrowers repay loans in money of lower real value.
• Reduces unemployment in the short run: increased spending and production can raise employment.
• Higher government revenue: rising money incomes and prices increase tax yields.
• Benefits holders of real assets such as land and property, whose values rise.

Negative effects (especially of high or galloping inflation):

• Falling real income and purchasing power: money buys less, and fixed-income earners such as pensioners suffer most.
• Discourages saving because the real value of savings falls.
• Harms creditors: lenders are repaid in money worth less than they lent.
• Worsens the balance of payments: exports become dearer and less competitive while imports look cheaper.
• Redistributes income unfairly from the poor and fixed-income groups to traders and property owners.
• Creates uncertainty and speculation, discouraging long-term planning and productive investment.
• Can lead to social and political unrest as living costs rise.

The overall verdict is that mild inflation may stimulate output, but severe or unpredictable inflation is damaging to saving, income distribution and external competitiveness.

Akọwa Nkọwa

(a) Economic resources versus non-economic resources

• Economic resources (free-of-nothing, i.e. scarce goods): resources that are scarce relative to demand, so they command a price and their use involves an opportunity cost, for example land, labour, capital and minerals.
• Non-economic (free) resources: resources so abundant that they satisfy all wants at zero price and carry no opportunity cost, for example air, sunshine and, in some places, sea water.

(b) Want versus demand

• Want: a mere desire or wish to have a good or service; it need not be backed by the ability or willingness to pay.
• Demand: a want backed by both the willingness and the ability to pay a price at a particular time. Demand is therefore effective (backed by money), whereas a want alone is not.

(c) Money cost versus real cost

• Money cost: the amount of money actually spent to produce or acquire a good, that is, the payments made for factors and materials expressed in money terms.
• Real cost: the effort, sacrifice and alternatives forgone in producing a good, that is, the opportunity cost measured in terms of the other goods or satisfactions given up rather than in money.

Akọwa Nkọwa

Total product (TP) and marginal product (MP) are linked by \(MP_n=TP_n-TP_{n-1}\), so \(TP_n=TP_{n-1}+MP_n\). Using this to fill the gaps:

(a) With no fertilizer applied the total output is 1,000 bags.

(b) Total product: (i) at 4 tonnes, \(1{,}500+400=1{,}900\) bags; (ii) at 5 tonnes, \(1{,}900+250=2{,}150\) bags; (iii) at 6 tonnes, \(2{,}150+125=2{,}275\) bags.

(c) Marginal product: (i) at 7 tonnes, \(2{,}350-2{,}275=75\) bags; (ii) at 8 tonnes, \(2{,}380-2{,}350=30\) bags; (iii) at 9 tonnes, \(2{,}330-2{,}380=-50\) bags.

(d)(i) Marginal product rises up to 4 tonnes (MP = 400) and then falls, so diminishing marginal returns set in after the 4th tonne of fertilizer.

(d)(ii) Total output is highest at 8 tonnes (2,380 bags) and then falls, so total output begins to decrease after the 8th tonne of fertilizer.