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SUGGESTED SOLUTIONS: INTRODUCTION TO ECONOMICS – NOVEMBER 2014
PAPER
SECTION A
1. A
2. A
3. B
4. D
5. C
6. D
7. B
8. C
9. A
10. A
11. C
12. D
13. D
14. C
15. C
16. A
17. A
18. D
19. A
20. C
SECTION B
21. (a)
The Law of Diminishing Marginal Returns states that as we add more units of
a variable input (e.g labour) to fixed amounts of capital and land the change in
output will first rise then fall. Diminishing returns to labour occurs when
marginal product starts to fall, implying that total output will increase at a
decreasing rate when more workers are employed.
The student must allude to the fact that marginal product first rise then fall
because the behaviour of marginal product is linked directly to the productivity
of each additional worker. At low levels of employment the fixed factors of
production land and capital are said to be under-utilized. This means that
each additional worker will have enough capital to use and as a result,
marginal product will rise. However, beyond a certain point the factors of
production becomes scarcer and new workers will lack capital to work with
causing conflict among workers scrambling for the now fewer capital and
land. As a result, the productivity of each additional worker falls and as the
labour input increases the capital per worker ratio declines causing
diminishing marginal returns.
(12 marks).
22.
(b)
Four factors:
i.
how much satisfaction they get from buying and consuming an extra
unit of a good or service. (2 marks)
ii.
The price of alternatives/ substitute good and services available. (2
marks)
iii.
The price that they have to pay to make this purchase (2 marks)
iv.
The satisfaction/utility derived from consuming alternative products. (2
marks)
(a)
(i)
(ii)
Number of Close Substitutes within the Market
The availability of substitutes is the most important determinant of
price elasticity of demand because how consumers react to a change
in the price of a product depends on what alternatives they have. For
example when the price of fuel rises, consumers have fewer
alternatives so quantity demanded falls only a little. But if PEOPLES
raises the price of its bread, consumers have consumers have many
alternatives and so quantity demanded is likely to fall quite a lot. In
general, if a product has more substitutes available, it will have more
elastic demand and similarly if a product has fewer substitutes
available it will have less elastic demand. (3 marks)
Luxuries
iii.
(b)
Goods that are luxuries will usually have more elastic demand curves
than goods that are necessities. For example the demand for maize is
inelastic because maize is a necessity and the quantity that people
buy is not very much dependent on its price. Tickets for a concert are
a luxury, so the demand for concert tickets is much more elastic than
the demand for maize. (3 marks)
Percentage of Income Spent on a Good
Goods that take only a small fraction of a consumer’s budget tend to
have less elastic demand. For example most people buy salt
infrequently and in relatively small quantities and further the share of
average consumers budget spent on the same is very low in that the
doubling of the price of salt is likely to result in only a small decline in
the quantity of salt demanded. Big ticket items such as cars and
furniture take up a larger share in the average consumer’s budget and
so increases in the prices of these goods are likely to result in
significant declines in the quantity demanded. In general the demand
for a good is less elastic the smaller the share of the good in the
average consumer’s budget.
(3 marks)
iv.
Passage
Demand tends to be more elastic in the long run rather than in the
short run. For example if the price of fuel increases, it would take a
while for consumers to decide to shift towards buying more fuel
efficient cars reducing the quantity of fuel they purchase. The more
time passes, the more elastic the demand for a product becomes. (3
marks)
v.
Habit Formation of Goods
Goods such as cigarettes and drugs tend to be inelastic in demand.
Preferences are such that habitual consumers of certain products
become de-sensitised to price changes. (3 marks)
Price elasticity of supply refers to the responsiveness of the quantity supplied
to a change in price measured by dividing the percentage change in the
quantity supplied of a product by the percentage change in the products price.
Its value is positive because an increase in price is likely to increase the
quantity supplied to the market and vice-versa. (2 marks)
23. (a)
24.
Exchange is the price of domestic currency per unit of foreign currency. It is
basically a price for selling or buying foreign currency and measures the
relative strength of the domestic currency per unit of foreign currency (3
marks)
(b)
(i) Certainty for exporters and importers; (ii) Strong discipline on firms to keep
costs under control; (iii) Less speculations among traders (9 marks)
(c)
(i) Depreciation makes exports cheaper, hence boosts export revenue
(ii) Depreciation makes imports expensive, hence curtails demand for
imported goods (8 marks)
(a) LRR – the amount of cash reserves banks are required to keep at the central
bank for monetary purposes. Increase in LRR, is a contractionary monetary policy;
lowering LRR is expansionary (5 marks)
(b) Inflation Targeting – specifying/prescribing a given inflation rate and manipulating
other policy variables to achieve the pre-determined target rate (5 marks)
(c) Budget deficit – shortfall between government total revenue and expenditures (5
marks)
(d) External debt refers to the debt of a sovereign to foreign creditors (5 marks).
25.
(a) Banks perform the following functions:
(i) Facilitate payments (3 marks)
(ii) Provide credit hence performing intermediation role (3 marks)
(iii) Provide safe custody of public funds (3 months)
(b) Money market – market where short term instruments are traded; Capital market
where long terms instruments are traded (9 marks)
(c) By encouraging securitization of products; or providing capital gains incentives or
providing incentives for issuance of long term bonds (Any one suggestion) (2 marks)