ECONOMICS SOLUTIONS – MAY 2012

SECTION A (2 Marks each)

Question / Answer / Question / Answer / Question / Answer
D / 11. / B / 21. / A
A / 12. / C / 22 / D
D / 13. / D / 23. / B
A / 14. / D / 24. / D
A / 15. / D / 25. / D
D / 16. / B / 26. / D
C / 17. / A / 27. / D
A / 18. / D / 28. / D
A / 19. / C / 29. / B
C / 20. / B / 30. / C

SECTION B

Question 1

(a)Price discrimination” states that different prices are set for different customers/consumers/markets even though the cost of supplying these customers is identical. The difference in price does not reflect the differences in cost of supply. Mostly used in Oligopoly and sometimes it can be called “discrimination monopoly”. (4 Marks)

(b)With the aid of a diagram, please describe how supernormal profits can exist in the short run of a perfectly competitive market

Costs

MC

AC MR=AR=D

P

QOutput

MC= Marginal cost, AC= Average Cost, MR= Marginal Revenue, D= Demand, P = Price

Supernormal profits are profits that a firm makes that are more than zero. This occurs when AC is below AR.

Since the market is operating in short term, it is able to enjoy some supernormal profits as indicated by the rectangle box in the graph. In the long run, there is entry of new firms hence not possible to enjoy supernormal profits

The graph is 4 Marks and the explanation is 6 Marks

(c)Compare and contrast between Oligopoly and Monopoly(6 Marks)

Monopoly / Oligopoly
1 / High prices may be charged since there is no competition / Moderate/fair pricing due to competition in market
2 / Can influence the price in the market by virtue of being virtually the only viable seller in the industry. / Can influence the market because of very few firms in the industry. Each firm can therefore significantly influence the market by setting price or production quantity.
3 / Single firm dominating the market / A few firms dominating the market
4 / A monopoly usually exists when barriers to entry are very high - either due to technology, patents, distribution overheads, government regulation or capital-intensive nature of the industry. / Barriers to entry are very high as it is difficult to enter the industry because of economies of scale.

Each point is 2 marks, any other points may be considered

Question 2

National income approaches are:

(a)Output Approach

Output approach measures national income by adding the total value of the final goods and services produced in the year or by adding the value added by each sector of the economy. To avoid double counting, all intermediate output is eliminated when arriving at the final value of output (3 Marks)

Expenditure approach

This is the sum of the final expenditure on goods and services measured at current prices. Mathematically

GDP = C + I + G + (X- M)(3 Marks)

Income Approach

Income approach measures national income by adding the income earned by the factor owners that are residents of the country, undistributed company profits and government income from economic participation. It excludes transfer payments and stock appreciation because transfer payments and stock appreciation are not due to goods and services performed. (3 marks)

(b)Determinants of consumer expenditure

  1. The level of income: Consumption is C=f(Y) hence the higher the income the higher the consumption
  2. The Marginal Propensity to consume (MPC) since MPC = ∆C/ ∆Y
  3. The price expectations, when prices are expected to rise, consumption will increase
  4. Unemployment, when people are unemployed, their disposable income falls hence they may not spend anyhow
  5. Taxation and government expenditure. The higher the taxes, the less people spend whilst when government expenditure rises mostly this will lead to increase in consumer expenditure as well

Other points may be considered. Each explanation will carry 3 marks

(c)Difficulties associated with calculating national income

-Double counting

-It’s not always easy to decide which transactions to include or exclude

-Activities provided by family like farming, cleaning, gardening are not included

-Capturing economic bad like pollution is not easy and usually goes unnoticed

-Inadequate information results in misinformation hence you end up with under or overvalued National Income value.

1.5 Marks each point

(d)National Income is measure of the value of goods and goods produced by the residents of an economy in a given period of time, usually a quarter or a year. 2 Marks

Question 3

a)Types of Indirect tax

i)Vat

ii)Exercise duties

iii)Car tax

iv)Betting tax

Any other forms may be considered and each explanation and correct answer carries 2 Marks

b)Types of Fiscal Policy

  1. Expansionary fiscal policy – an increase in government purchases of goods and services, a decrease in net taxes or some combination of the two for the purpose of decreasing aggregate demand thereby controlling inflation 2 Marks
  2. Contractionary fiscal policy – a decrease in government purchases of goods and services, an increase in net taxes, or some combination of the two for the purpose of decreasing aggregate demand and thus controlling inflation 2 Marks
  3. Neutral fiscal policy – Modest fiscal policy. Generally not commonly used. 2 marks

Any 2 can be considered

c)Why higher taxes;

  1. To prevent undesirable effects like pollution
  2. To prevent damping of cheap goods in an economy
  3. To control markets e.g. Tobacco (to control supply henceforth maintaining the market)
  4. To prevent consumption of bad goods e.g. alcohol, drugs and cigarettes
  5. To protect infant firms from competition

Any other points to be considered and each carries 2 Marks

d)Effects of a subsidy

Once a subsidy is introduced in a sector e.g. fertiliser subsidy, the cost of production of the product will decrease therefore increasing supply of the good X. The increase in supply from SS1 to SS2 will therefore reduce the price of the good from P1 to P2. Thus excess supply leads to reduced prices. Therefore the price will reduce and the quantity supplied will increase.

The graph carries 3 marks and the explanation 3 Marks

Question 4

(a)Unemployment rate is the number of people that are willing to work, are seeking employment but they have not found the employment

(b)Unemployment rate:

UR = total unemployed/total labour force

700,000/ (2,300, 000 + 700,000)

= (700,000/3,000,000) 100

= 23%

1 mark for each step totalling 4 marks

(c)A. W. Phillips’ relationship between inflation and employment in the short run period

A.W Phillips attempted to explain the relationship between inflation and unemployment stating that the two were inversely related. He stated that the higher the existing level of capacity utilization, the greater will be the rate of increase in prices for a given increase in capacity utilization.

This is to say that since the graph crosses the horizontal axis at a positive value, zero inflation will be associated with some form of unemployment. It is not possible therefore to achieve both zero inflation and unemployment at the same time.

4 marks for the graph and 4 marks for the explanation

(a)Demand Pull inflation or Cost Push inflation

Demand pull inflation occurs when there is high aggregate demand that is in excess of the economy’s ability to supply. This then creates a situation where there is too much money chasing too few goods. This may occur when the interests are low and hence increased lending by the banks.

Cost Push inflation occurs when the cost of factors of production rises regardless of whether they are in short supply or not. Usually happens with imported good s and services or wages when there is an anticipation of rise in prices.

Any one of the two for 3 marks

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