Download ECONOMIC ENVIRO NMENT answers.d oc

INSTITUTE OF BANKERS IN MALAWI
DIPLOMA IN BANKING EXAMINATION
SUBJECT: ECONOMIC ENVIRONMENT (IOBM – D211)
Date: Friday, 9th May 2014
Time Allocated: 3 hours (08:00 – 11:00 am)
INSTRUCTIONS TO CANDIDATES
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This paper consists of TWO Sections, A and B.
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Section A consists of 4 questions, each question carries 15 marks.
Answer ALL questions.
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Section B consists of 4 questions, each question carries 20 marks. Answer ANY
TWO questions.
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You will be allowed 10 minutes to go through the paper before the start of the
examination, you may write on this paper but not in the answer book.
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Begin each answer on a new page.
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Please write your examination number on each answer book used. Answer
books without examination numbers will not be marked.
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All persons writing examinations without payment will risk expulsion from the
Institute
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DO NOT open this question paper until instructed to do so.
SECTION A
(60 MARKS)
Answer ALL questions from this section.
QUESTION 1
a) Explain three interactive parts of economic methodology and how they relate to each
other?
(10 marks)
a. Collecting data whereby the data consists of measurable values of price and
changes in price, for measurable commodities
b. Formulation of models of economic relationships i.e. relationship between the
genera level of prices and the general level of employment.
c. Production of economic statistics; this takes data collected in the first stage
and applies the model in step (b) to produce representation of economic
activity
d. Lastly, reasoning within economic models which sometimes involve advanced
mathematics.
b) Briefly explain any two economic systems?
(2 marks)
a. Traditional or subsistence economies; this
is where there is little
specialisation and trade within the economy and with other countries. People
are to a greater extent self-sufficient.
b. Free market economies; this is where economic decisions are made through
the free market mechanism with minimal government intervention.
c. Command economies; this is where all key economic decisions are made by
the government. Thus the government is involved in a great deal of planning.
d. Mixed economies; mixture of a pure free enterprise market economy and a
command economy. The economy is characterised by the presence of a
public and private sector.
c) Mention any three unique features of the labour market? 3 marks (Total 15 marks)
a. Labour services are embodied in the persons concerned and are not transferable.
b. Labour is always rented rather than sold
c. Considerations other than material advantage enter the relationship between
suppliers and demanders-thus the market is affected by a wide range of noneconomic considerations.
d. Labour is not traded at the best price on daily basis but rather by means of long-term
contracts.
e. Labour is heterogeneous and it cannot be classified or standardised.
f. There are a variety of labour markets, each with its own feature, thus it is a
segmented market.
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g. Remuneration of labour does not consist only of its price, non-wage benefits (such
as housing, medical, pension, travel and holiday benefits)
h. Remuneration of labour is affected by a number of factors which are not directly
related to labour market conditions e.g. taxation and views on what constitutes a
lignin wage or a reasonable standard of living.
QUESTION 2
a) Mention three objectives of macroeconomic policy?
I.
Full employment
II. Price stability
III. A high and sustainable rate of economic growth
IV. Keeping the balance of payments in equilibrium
(3 marks)
b) With the aid of a diagram, illustrate how an increase in the prime lending rate will
affect the consumption function?
(12 marks)
a. Candidates are expected to reproduce a graph on page 131 of the module
which should exclude C2 as it doesn’t apply to this question..
i. An increase in the prime lending rate raises the household’s debt
service and consequently its wealth and thus consumption declines
as well; graphically the Consumption function will shift down from
C1 to C3.
(Total 15 marks)
QUESTION 3
Using the GDP equation under the aggregate demand approach, explain how any three
of these factors have affected Malawi’s GDP growth in the past two years?
GDP= C+I+G+(X-M)
(15 marks)
I.
Consumption; high lending rates have to a greater extent impacted household
wealth negatively with the likely effect of reducing aggregate demand
II. Investments; intermittent power supply and possible lengthy processes that an
investor goes through to register an investment in the country has also affected
the contribution of I to the aggregate demand equation.
III. X-M is in negative for Malawi which creates a BOP imbalance and has a negative
effect of aggregate demand as the country tends to prefer externally produced
goods to local ones.
(Total 15 marks)
QUESTION 4
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a) Explain the term ‘double coincidence of wants?
(4 marks)
a. This relates to the barter economy whereby a supplier of good X wants
good Z and the supplier of good Z wants good X.
b) Why should governments be worried with deflation?
(5 marks)
a. Yes as it slows down economic performance; its more worrisome in cases
where this is not a deliberate government policy.
c) Mention any two major conflicts between macroeconomic objectives? (6 marks)
a. Healthy growth and low inflation-steps taken to keep inflation rate low
such as relatively high interest rates can often restrict growth via reduced
consumer spending and investment-thus it is difficult to achieve both.
b. Healthy growth and a BOP equilibrium-As the economy grows at a
faster pace, consumers prefer to buy more things from abroad which for
countries with narrow export base like money tends to worsen the BOP
position for the country. In cases like this, the exchange rate depreciates,
or government imposes import controls or even deflating the economy
which slows down economic growth.
c. Low unemployment(or full employment) and low inflation-if a
government tries to reduce unemployment trough reflationary measures ,
such as lower interest rates or increased public spending, then the
resulting reduction in unemployment will push wages and then prices
higher. On the other hand when government tries to control high inflation
with high interest rates and reduced spending, the resulting reduced
consumer spending will result in job losses.
(Total 15 marks)
SECTION B
(40 MARKS)
Answer ANY TWO questions from this section
QUESTION 5
Malawi’s inflation rate is currently one of the highest in the Southern Africa Development
Community (SADC) region. Mention any three drivers of this (high inflation rate) and the
effect it is having on the economy.
(20 marks)
Drivers of Malawi’s inflation;
I.
demand pull caused type of inflation; this is mostly captured by food
inflation , where demand of food in particular maize and the available supply
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II.
III.
plays a key role in determining the national inflation rate-this is quite so due
the fact that food has the largest share in the food basket.
Cost push-type of inflation- the size of the economy and the limited
production avenues entails that the country relies heavily on imports for most
of its needs and any change in the importation costs impacts the countries
inflation rate.
Monetarist type of inflation- relates to the effect on inflation due to high
growth in Moneys supply relative to real growth in output.
Effect of inflation rate on the economy;
a. Effect on competitiveness; if Malawi’s inflation rate is higher than that of
the rest of the world, it loses on competitiveness in international markets
assuming a given exchange rate.
b. Reduction in real value of savings especially where real interest rates are
negative.
c. Penalizes consumers and businesses who run on fixed income i.e.
pensioners
d. Inflation leads to a higher nominal interest rate which should have a
deflationary effect on GDP
e. High inflation rate disrupts business planning due to the high degree of
uncertainty that a high inflation rate environment poses.
(Total 20 marks)
QUESTION 6
(a) Explain why the individual labour supply curve is back-ward bending?
(8 marks)
a. There are two explanations for this pattern; substitution and income effects
i. Substitution effect; this is where an increase in the wage rate
encourages workers for more hours by sacrificing leisure to obtain
higher income. Thus increases in wage rate raises the opportunity cost
of leisure and probably entices most workers to sacrifice leisure and to
work longer.
ii. Income effect; this is where an increase in workers expenditure on
goods and services, leads to a decrease in the marginal utility of
consumption and given that leisure is a normal good, the demand for
leisure also increases with the increasing wage rate-backward bending
portion.
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(b) You have been appointed the Minister of Finance in Malawi and your main task is to
see the Malawi economy attaining growth rates of above 6.5% over the next four
years? What initiatives would you put in place to boost aggregate demand for the
country?
(12 marks )
a. Reducing tax rate (could be VAT and PAYE just to mention a few)
b. Encouraging investments by creating a conducing environment for investors
which will create employment thereby translating into more income to spend
for the economy as a whole.
c. Increasing government investment with the same effect as the point above.
(Total 20 marks)
QUESTION 7
(a)
With the aid of a well-labelled diagram, explain the deadweight loss concept in the
context of taxation.
(8 marks )
a. Candidate should reproduce a graph on page 93 of the module.
b. This is a cost to society imposed by marginal taxes and it’s in a form of a loss
in social surplus. It particularly occurs because potential trades are not
executed due to a tax which is levied on a marrow tax base (taxing a
particular good heavily. In other words the tax constricts supply of the
supplied good.
(b) Briefly explain any two types of taxes?
(2 marks)
a. Income tax is levelled on income and it is typically structured to be
progressive tax.
b. Retirement tax; this tax is levied on specific sources of income, generally
wages and salary which is used to fund social security systems.
c. Capital gain tax-which is levied on profit realised upon the sale of an asset
d. Cooperation tax –which is levied on corporate earnings and often includes
capital gains.
e. Poll tax-it levies a set amount per individual
f. Excise tax-these are based on quantity of product purchased
g. Other taxes on pages 89 to 102 of the module.
(c) Explain the Human Poverty and Human Development indices and their
interpretation? (10 marks)
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a. HD I is constructed as an aggregate index of three components; education,
income, and life expectancy at birth scaled to lie within 0 to 1 interval. It
focuses on the escape from poverty which is defined as an HDI of less than
0.5.
b. Human poverty index provides a multidimensional measure of poverty and it
focuses on four basic dimensions of human life-longevity, knowledge,
economic provisioning and social inclusion. A score of 1 signifies a highest
standard of living and moving towards zero implies deterioration in living
conditions.
(Total 20 marks)
QUESTION 8
a) Explain the curvature of the Phillips curve?
(12 marks)
a. Explaining it with a graph is the most ideal (page 162 and 163 of the
module)
i. The curve cuts through zero on the inflation rate axis which
captures the fact that deflation can happen although it will normally
be associated with high unemployment.
ii. The curve rises quite sharply as unemployment gets very low which
means that prices can begin to rise very fast in an overheated
economy.
iii. The curve gets flatter at very high unemployment levels for the
reason that further increases in unemployment, may have little
effect on inflation.
b) Malawi Government recently announced the sale of Malawi Savings Bank.
Provide four concise arguments for OR against this decision?
(8marks) 2 marks for each correct answer
a. Any four Arguments provided for and against privatization on pages 107111 of the module should apply as the sale is a form privatization
QUESTION 9
a) Explain how the Solow’s growth model differs from and the endogenous growth
model?
(10 marks) 5 marks for any of the answers , thus two points are
enough.
I.
Solow’s growth model assumes that countries use their resources
efficiently and that there are diminishing returns to scale whereas the
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endogenous growth model assumes that overall there are constant returns
to scale.
II. It predicts that increasing capital relative to human labor creates economic
growth, since people can be more productive given more capital. The
endogenous model on the other hand, believes that human capital has
increasing rate of return unlike physical capital.
III. The Solow’s growth model further predicts that poor countries with less
capital per person will grow faster because each investment in capital will
produce a higher return than rich countries with ample capital. On the
contrary, the endogenous growth model asserts that growth does not slow
as capital accumulates, but that the rate of growth is dependent on the
types of capital a country invests in.
b) Briefly explain three main methods of privatization? (6 marks)
a. Share issue privatization; involves selling of share on the stock market 2
b. Asset sale privatization-involves selling the entire firm to an investor,
usually by auction 2
c. Voucher auction-shares of ownership are distributed to all citizens, usually
for free or at very low price. 2
c) Mention four ways used by Governments to fund expenditures? (4 marks)
a. Taxation of the population 1
b. Seignorage, the benefit from printing money 1
c. Borrowing money from the population 1
d. Borrowing from other multilateral/bilateral partners 1
(Total 20 marks)
END OF EXAMINATION PAPER
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