INSTITUTE OF CHARTERED SECRETARIES AND

ADMINISTRATORS IN ZIMBABWE

SUGGESTED SOLUTIONS: NOVEMBER 2020

BUSINESS ECONOMICS
QUESTION 1

a)
i) Assuming all workers produce oranges output is 100 x 4 = 400
ii) Assuming all workers make skirts output is: 100 x 3 = 300
iii) Zimbabwe’s PPF

Oranges
400

Unattainable
Inefficient

O 300 Skirts

A PPF defines the set of possible combinations of goods and services an

economy can produce given the available resources. Choices inside the PPF
indicate the inefficient region. They indicate the underutilization of resources.
Choices outside the PPF indicate the unattainable region. Points in this region
can be attained only if technology and/or resources increase and the economy
shifts its PPF to the right.

b)
i) Equate supply to demand: 18 + 2Q = 60 – 4Q, implying 6Q = 42, which is Q = 7.
Hence, P = $32.
ii) At price $24, excess demand is 6 while at price $36 excess supply is 3.

iii) With excess demand the price is bid up, with excess supply the price is pushed
down.

QUESTION 2

a) Reasons why profits are important in a market economy:

 Encourages risk taking: profits are a pre-requisite for undertaking risks.
 Encourages investment: profits encourage investors to invest further in their
businesses
 Provides funds for business expansion: profits provide the needed funds for
business expansion or diversification

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  Source of revenue for governments: governments earn tax revenues for the
benefit of citizens
 Indicates the best use of resources: profits indicate what goods and services
consumers demand.

b)
i) MC is the change in TC that arises when output is incremented by one unit. It is
the cost of producing one more unit of the good. FC refers to the cost that does
not with an increase or decrease in the amount of goods produced. They include
firm costs such as rent that are constant whatever the amount of goods
produced.
ii) The monopolist’s demand curve slopes downwards because the price that the
monopolist gets for each additional unit of output falls as the monopolist
increases output. The new lower price reduces the total revenue that the
monopolist receives from the first N units sold.
iii) Profit maximizing price and quantity for the monopolist:
MR = MC  P* = 14, Q* = 5
iv) Efficient price:
P = MC  P = 4 (at Q = 10)
v) Monopolist’s profits at the profit maximizing price:
TR – TC = 5 (14) – 48 – (5)(4) = 2

QUESTION 3

a)
Product A: -1.5 Product B: -1.0 Product C: -0.3
Type of Elastic: PED > 1Unit elastic: PED Inelastic: PED < 1
elasticity =1
Price Decrease price Leave price Increase price
change unchanged
Comparison Because: Because: Because: %increase
%increase in %change in in price exceeds
demand exceeds demand equals %decrease in
%decrease in %change in demand
price price
Effect on Will increase Will remain Will increase
total unchanged
revenue

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b)
i) Cross elasticity of demand: the percentage/proportionate change in the demand
of one good caused by the percentage/proportionate change in the price of
another good.

ii) Cross elasticity of demand for good

X = ∆QX/∆PY x PY1 + PY2/QX1+ QX2
= 4/1 x 5 + 6/10 + 14 = 44/24 = 1.83

iii) Good X is a substitute good: it has a positive sign. This means that as the price of
good Z increased the consumer switched from good Z to the cheaper good X.

QUESTION 4

a) Economists’ assumptions about consumer behavior:

 Consumer has limited income: income is not large enough to satisfy his/her
needs and wants. Hence, he/she must choose between goods he/she wishes to
buy.
 Consumer aims to get maximum utility given his/her income: he/she spends
limited income in such a way that he/she will achieve the most satisfaction.
 Consumer is rational: h/she acts in a manner that is consistent with his/her
preferences. If he/she sees an identical commodity priced differently in two
adjoining shops he/she will buy it at a lower price.
 Consumer is subject to the law of diminishing marginal utility: as he/she
consumes additional units of a good his/her marginal utility for this good will
eventually decline.

b)
i)
Chicken 1 2 3 4 5 6 7 8 9 10 11
pieces
Maximum 3 5.70 8.10 10.20 12.00 13.50 14.70 15.60 16.20 16.50 16.50
payment ($)
Marginal 3.00 2.70 2.40 2.10 1.80 1.50 1.20 0.90 0.60 0.30 0.00
utility ($)

The MU for the 11th piece of chicken is zero. This indicates that the consumer is not
willing to pay any money to receive the 11th piece of chicken.
ii) The consumer will buy 5 pieces of chicken. He/she will not buy the 6th because it
is worth less to him/her (that is $1.50) than the $1.55 that is charged for it.
iii) If price falls to $1.00, the consumer will buy 7 pieces where the marginal utility
(MU) > price (P). The consumer would not buy the 8th piece because MU < P.

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 iv) The consumer would now consume 8 pieces of chicken. The first four pieces are
worth $10.20 to him/her that is the sum of the MU from 1 to 4. The second four
pieces are worth $5.40 to the consumer that is the sum of MU from 5 to 8.

QUESTION 5

Reasons why an increase in interest rates would decrease investment:

 Higher interest rates increases the opportunity cost of investment:
o A firm can use its profits for investment, placing it in financial institutions to earn
interest or for distributing it to shareholders in the form of dividends. By
choosing to use profit on investment the firm sacrifices money that could have
been gained by placing it in a saving account in a financial institution.
 Higher interest rates make borrowing for investment purposes more expensive
o Although most investment is from retained profits some is financed by
borrowing. Higher interest rates would make borrowing more expensive and so
in turn make investment more expensive.
 Higher interest rates affect the expected return on investment
o Firms will anticipate consumer spending falling because borrowing is more
expensive and saving would give a better return.
 Higher interest rates reduce the demand for shares, which decreases the funds
available for investment.
o This is because some people who may have bought shares may place their
money in an interest-bearing account instead. The lower demand for shares will
reduce the firm’s price level thus decreasing the funds that firms can raise fir
investment.

QUESTION 6

 The circular flow of income shows the movement of spending and income in the
economy or the flow of products and income between producers/firms and
households/consumers. It is a model that explains how the economy works and how
changes in AD occur. As indicated in the diagram below, there are two sectors
households and firms. Between the two sectors are flows: incomes, goods and factor
services.

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 Households

Factors Incomes Spending Goods

Firms

 Households –provide factor services and in return receive income for the factor
services. They use these incomes to goods produced by firms.
 Firms –receive input services from households and pay for the services. They
produce goods and services which they sell to households.

a) The multiplier shows the relationship between the initial injection into the circular
flow of income and the eventual total increase in national income resulting from the
injection. Formula for multiplier: 1/MPS + MPM or 1/1 – (MPC – MPM)

Elements in the formula:

 MPC: -proportion of each additional unit of income which is spent.
 MPM: -proportion of each additional unit of income spent on imports.
 MPS: -proportion of each additional unit of income which is saved.

b) Calculating the value of the multiplier in the Zimbabwean economy:

 MPC = 1 – MPS = 1 – 0.26 = 0.74
 1/1-(MPC–MPM–MPT) = 1/1– (0.74–0.4–0.24) = 1/0.9 = 1.1
 1/MPS + MPM + MPT = 1/0.26 + 00.4 + 0.24 = 1/0.9 = 1.1

QUESTION 7

Possible reasons for limited growth for the Zimbabwean economy include:
 Macroeconomic instability: -Zimbabwe is characterized by macroeconomic
instability, high inflation, high interest rates, lack of foreign currency, etc. All these
contribute to low levels of investment and hence low growth.
 Poor infrastructure: -Zimbabwe has poor road and rail networks. This makes the
conducting of business by firms especially transportation of goods very difficult.
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 Lack of an effective financial system: -financial institutions enable firms to invest.
Zimbabweans are unable to save for a number of reasons including the lack of
confidence in the financial system and the low incomes characterizing the economy.
 Utility problems: -high cost of electricity, water and fuel negatively affects the
performance of Zimbabwean firms. Firms are also negatively affected by shortages
of water, electricity and fuel. This has increased the costs doing business as firms
need to make extra investments such as installation of boreholes at their premises.
 Corruption: -investors usually shun countries with high levels of corruption. Over the
years the level of corruption in Zimbabwe has been on the increase. This makes it
difficult to attract new investors.

“End of Suggested Solutions”

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