WAEC SSCE - Economics - 2010 (Essay)

Maelezo ya Majibu

(a) Two functions of money.

• (i) Measure of value (unit of account). Money serves as a common denominator in which the value or price of every good and service is expressed. Because all prices are quoted in the same money unit, buyers and sellers can compare the values of different goods easily and keep accounts.
• (ii) Store of value. Money can be saved and held now and used to buy goods and services in the future. It allows people to keep their wealth in a convenient, liquid form and to separate the act of selling from the act of buying over time.

(b) How inflation affects these two functions. Inflation is a persistent rise in the general price level, which means a fall in the purchasing power of money.

• On money as a measure of value: when prices keep rising, the money unit no longer measures value consistently, one naira buys less this month than last month. Money becomes an unreliable, shifting measuring rod, so it becomes hard to compare values over time and to plan or keep meaningful accounts.
• On money as a store of value: inflation erodes purchasing power, so money saved today loses value by the time it is spent. Holding wealth in money brings a real loss, which discourages saving in money form and pushes people to hold goods, property or foreign currency instead.

Examination takeaway: the single idea linking both effects is that inflation reduces the purchasing power of money; explain how that instability spoils money both as a yardstick of value and as a way of storing value.

Maelezo ya Majibu

(a) Equilibrium of a consumer. A consumer is in equilibrium when, given his fixed income and the ruling prices of goods, he has spent his income in the way that yields him the maximum total satisfaction (utility), so that he has no incentive to change his pattern of spending.

(b) How a consumer attains equilibrium. There are two standard explanations.

Using marginal utility (the equi-marginal principle). A consumer buying several goods maximises satisfaction by arranging his spending so that the marginal utility of the last unit of money spent on each good is equal. That is, he equalises the marginal utility per naira across all goods:

\[ \frac{MU_x}{P_x} = \frac{MU_y}{P_y} = \cdots = MU_m \]

where \( MU_x, MU_y \) are the marginal utilities of goods \( x \) and \( y \), \( P_x, P_y \) their prices, and \( MU_m \) the marginal utility of money. If a naira spent on one good gave more satisfaction than a naira spent on another, he would transfer spending to the first good; because marginal utility diminishes, this transfer continues until the ratios are equal, at which point total satisfaction is greatest and he is in equilibrium.

Using indifference curves. The consumer is in equilibrium at the point where his budget line is tangent to the highest attainable indifference curve. At that point the slope of the indifference curve (the marginal rate of substitution) equals the slope of the budget line (the price ratio):

\[ MRS_{xy} = \frac{P_x}{P_y} \]

Here he is on the highest indifference curve his income allows, so satisfaction is maximised.

Examination takeaway: state the condition as a formula and explain the adjustment process, the consumer keeps shifting spending until the marginal utility per naira is equal everywhere; that equalising is what "attaining equilibrium" means.

Maelezo ya Majibu

(a) Location versus localisation of industries. Location of industry refers to the particular place or site where a single industry or firm is established, together with the factors (nearness to raw materials, market, labour, power, transport) that decide the choice of that site. Localisation of industry refers to the concentration or clustering of many firms of the same industry in one particular area. In short, location deals with where one industry sites itself, while localisation deals with many similar industries grouping together in the same district.

(b) Locating industries in rural areas.

Three advantages:

• Cheap and available land. Land in rural areas is plentiful and cheaper, so factories can be built and expanded at lower cost.
• Cheap labour and nearness to raw materials. Rural labour is often cheaper, and agro-based industries can be sited close to their farm raw materials, cutting transport costs.
• Reduced congestion and pollution, and more even development. Siting industry in rural areas relieves urban overcrowding and helps spread development, reducing rural-urban migration.

Two disadvantages:

• Poor infrastructure. Rural areas often lack good roads, electricity, water and communication, which raises costs and hampers production.
• Shortage of skilled labour and small local market. Skilled workers prefer towns, and the low rural population and income mean a small local market for the output.

Examination takeaway: keep the distinction sharp, one firm's site (location) against the clustering of many similar firms (localisation), and back each rural advantage or disadvantage with a short reason.

Maelezo ya Majibu

(a) Types of production.

• (i) Primary production. This is the extractive stage, obtaining raw materials directly from nature. Examples: farming, fishing, mining, lumbering and hunting.
• (ii) Secondary production. This is the manufacturing and construction stage, in which raw materials from the primary stage are processed or transformed into finished and semi-finished goods. Examples: baking bread, building houses, assembling cars and refining crude oil.
• (iii) Tertiary production. This is the provision of services (commercial and direct) that help move goods to consumers and satisfy wants. Examples: teaching, banking, transport, trading, nursing and insurance.

(b) Why primary production predominates in developing countries.

• Abundant natural resources and land. Developing countries are richly endowed with fertile land, minerals and forests, which makes extractive activity the easiest and cheapest to undertake.
• Shortage of capital and technology. Manufacturing needs large amounts of capital, machinery and technical know-how, which these countries lack, so they concentrate on the less capital-intensive primary activities.

(Other acceptable reasons include a shortage of skilled manpower, a small domestic market for manufactures, and a ready overseas market for raw materials, a legacy of colonial trade patterns.)

Examination takeaway: for each type give a clear definition and examples, and for part (b) explain why the reason leads to primary dominance rather than just naming resources.

Maelezo ya Majibu

(a) Partnership. A partnership is a business association of between two and twenty persons (two and ten for banking) who agree to pool their capital and skills to carry on a lawful business in common with the aim of making and sharing profit. Their rights and duties are usually set out in a written agreement called the deed of partnership.

(b) Two advantages of a partnership:

• More capital. Because several partners contribute, a partnership can raise more capital than a one-man business, allowing larger operations.
• Combined skills and shared responsibility. Partners bring different talents and share the work, risks and losses, so decisions can be better and the burden on any one person is lighter.

Two disadvantages of a partnership:

• Unlimited liability. General partners are personally liable for the debts of the firm; if the business fails, their private property can be seized to settle debts.
• Disagreement and lack of continuity. Differences of opinion among partners can delay decisions and disrupt the business, and the partnership may be dissolved on the death, insanity or withdrawal of a partner.

Examination takeaway: define a partnership by its numbers (2 to 20), its shared capital and profit motive, and remember that unlimited liability is the disadvantage most often expected in the answer.

Maelezo ya Majibu

(a) Privatisation. Privatisation is the transfer of the ownership, control and management of a public (government-owned) enterprise, wholly or in part, from the government to private individuals or the private sector, usually by selling its shares to the public.

(b) Four reasons for government participation in economic activities:

• To provide essential and social services. Government provides services such as water, electricity, roads, education and health that private firms may neglect because they are not very profitable but are vital to the public.
• To provide public and merit goods. Goods like defence, street lighting and public security will not be supplied adequately by private firms, so the government must provide them.
• To prevent private monopoly and exploitation. By running key utilities itself, the government stops private monopolists from charging excessive prices for essential services.
• To undertake ventures that need huge capital. Some projects (refineries, steel plants, railways) require capital and long payback periods beyond the reach of private investors, so the government steps in.

(Other acceptable reasons: to create employment, to earn revenue, for national security and strategic control, and to promote balanced regional development.)

Examination takeaway: note the contrast between the two parts, privatisation reduces the government's role, while part (b) asks why the government takes on economic roles in the first place; answer each on its own terms.

Maelezo ya Majibu

(a) Incidence of tax. The incidence of a tax is the final resting place of the tax burden, that is, the person or group who ultimately bears and pays the tax and cannot pass it on to anyone else. It should be distinguished from the impact of a tax, which is on the person who first pays it to the government; the impact and incidence fall on the same person only when the tax cannot be shifted.

(b) Four principles (canons) of taxation.

• Equity (ability to pay). A tax should be fair, taking into account the taxpayer's ability to pay, so that those with higher incomes pay more.
• Certainty. The amount, time and manner of payment should be clear and known in advance to the taxpayer, not arbitrary.
• Convenience. A tax should be collected at a time and in a manner most convenient for the taxpayer, for example, deducting income tax when salaries are paid.
• Economy. The cost of collecting the tax should be small relative to the revenue it yields, so that most of what is collected reaches the treasury.

(Other acceptable principles include flexibility, simplicity, neutrality and productivity.)

Examination takeaway: keep impact (first payer) separate from incidence (final bearer), and for each canon give the principle plus a one-line reason for it.

Maelezo ya Majibu

Marginal utility is the change in total utility from one more bottle: \( MU_n = TU_n - TU_{n-1} \). We use this to fill every gap.

(a) Finding the missing figures

• F (MU of the 2nd bottle) \( = 29 - 15 = \mathbf{14} \).
• Check: MU of 3rd \( = 42 - 29 = 13 \) (agrees with the table).
• D (TU of the 4th bottle): MU is 12, so \( D = 42 + 12 = \mathbf{54} \).
• G (MU of the 5th bottle) \( = 65 - 54 = \mathbf{11} \).
• H (MU of the 6th bottle) \( = 75 - 65 = \mathbf{10} \).
• E (TU of the 7th bottle): MU is 0, so \( E = 75 + 0 = \mathbf{75} \).

(b) The demand curve. Since a consumer buys extra units only if the price falls to match the (declining) marginal utility, plot marginal utility on the vertical axis and quantity of bottles on the horizontal axis, and join the points (1, 15), (2, 14), (3, 13), (4, 12), (5, 11), (6, 10), (7, 0). The curve slopes downward from left to right, which is the traveller's demand curve for Coca-Cola.

(c) Law of diminishing marginal utility. The law states that as more units of a good are consumed, the extra satisfaction from each additional unit falls. In the table MU falls steadily (15, 14, 13, 12, 11, 10, 0). Because a rational consumer pays a price equal to the marginal utility of the last unit, this falling MU means the consumer will buy more only at lower prices, which is exactly why the demand curve slopes downward.

Maelezo ya Majibu

When a producer sells more, the extra output can only be sold at a lower price, so he moves down his demand curve. Whether total sales revenue \( (R = P \times Q) \) rises or falls depends on the price elasticity of demand for the product, that is, on how strongly quantity demanded responds to the price change.

(a) When an increase in output decreases sales revenue. This happens when demand is price-inelastic \( (E_d < 1) \). Here a fall in price brings only a smaller proportionate rise in quantity demanded. Because price falls by more (in proportion) than quantity rises, the loss from the lower price outweighs the gain from the extra sales, so total revenue falls. For example, if raising output forces price down by 20% but quantity sold rises by only 5%, revenue drops. This is typical of necessities such as staple foodstuffs.

(b) When an increase in output increases sales revenue. This happens when demand is price-elastic \( (E_d > 1) \). Here a fall in price brings a larger proportionate rise in quantity demanded. The gain from the many extra units more than makes up for the lower price on each unit, so total revenue rises. For example, if price falls by 5% but quantity sold rises by 20%, revenue increases. This is typical of luxuries and goods with close substitutes.

On a diagram, revenue is the rectangle \( P \times Q \) under the demand curve. On a steep (inelastic) demand curve the rectangle shrinks as we move down; on a flat (elastic) demand curve it grows.

Examination takeaway: tie the direction of the revenue change to elasticity, revenue and price move together when demand is inelastic, and revenue and price move in opposite directions (revenue rises as output rises) when demand is elastic.

Maelezo ya Majibu

(a) Fixed cost. Fixed cost is the total cost when output is zero, because it does not vary with output. From the table, at 0 crates total cost is \$50, so fixed cost = \$50.

(b)(i) Marginal cost at each level, \( MC = TC_n - TC_{n-1} \):

(b)(ii) Profit-maximising output. A firm maximises profit where marginal cost equals price (which is the marginal revenue for a price taker). The price of a crate is \$21, and \( MC = \$21 \) at an output of 4 crates. So the profit-maximising output is 4 crates: beyond this, each extra crate costs more to produce (\$29, \$37, ...) than the \$21 it earns.

(c) The demand curve. Because the price stays at \$21 no matter how much the farm sells, the farm is a price taker in a perfectly competitive market. Its demand curve is a horizontal (perfectly elastic) straight line drawn at the price level \$21 on the vertical (price) axis, running parallel to the quantity axis. This same line is the firm's average revenue and marginal revenue curve.

Maelezo ya Majibu

(a) Commercial bank. A commercial bank is a financial institution that accepts deposits from the public, keeps them safe, and lends or invests them, giving loans and advances and creating credit, while operating with the aim of making profit. It also provides services such as the transfer of money and the operation of current, savings and fixed-deposit accounts.

(b) Four ways the Central Bank controls credit given by commercial banks.

• Open market operations (OMO). The Central Bank buys or sells government securities in the money market. Selling securities takes cash out of the banks and reduces their ability to lend (credit contracts); buying securities puts cash into the banks and increases lending (credit expands).
• Bank (discount) rate policy. This is the rate at which the Central Bank lends to commercial banks. Raising the rate makes borrowing dearer, so banks raise their own lending rates and lending falls; lowering it encourages more lending.
• Cash (reserve) ratio requirement. The Central Bank fixes the minimum fraction of deposits banks must keep as reserves. Raising the required ratio leaves banks with less to lend, contracting credit; lowering it frees funds for more lending.
• Special directives and moral suasion. The Central Bank may issue directives or special deposit calls, or appeal to the banks (moral suasion) to restrain or expand lending in particular sectors.

Examination takeaway: for each instrument state the tool and then the direction, how a tightening move (sell securities, raise the bank rate, raise the reserve ratio) reduces the banks' capacity to create credit.

Maelezo ya Majibu

(a) Increase in supply. An increase in supply means that producers are willing and able to offer more of a good at every price, caused by factors other than the good's own price (for example, improved technology, a fall in the cost of inputs, more producers, or good weather). On a diagram it is shown as a rightward shift of the whole supply curve. It must be distinguished from an extension of supply, which is a movement along a fixed supply curve caused only by a rise in the good's own price.

(b) Effect of an increase in the supply of fish on the price of beef. Fish and beef are substitutes, that is, either can be used in place of the other. The effect works in two connected markets.

• In the fish market: the increase in supply shifts the supply curve of fish to the right. With demand unchanged, the equilibrium moves down along the demand curve, so the price of fish falls and the quantity of fish traded rises.
• In the beef market: because fish is now cheaper, consumers switch away from beef towards fish. This reduces the demand for beef, shifting the demand curve for beef to the left. With supply of beef unchanged, the new equilibrium is at a lower price of beef and a smaller quantity of beef traded.

So an increase in the supply of fish, by lowering the price of fish (a substitute), causes the demand for beef to fall and the price of beef to fall.

Examination takeaway: keep the two markets separate, a supply shift in the fish market versus a demand shift in the beef market, and state clearly that fish and beef are substitutes, which is the link that carries the effect across.