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Economics Text Merged
Economics Text Merged
What is Economics?
There is no precise definition of economics, in fact there has been a great deal of controversy
among economists about nature and scope of economics.
In general terms, economics may be defined as the study of how man allocates the scarce
resources in order to satisfy his unlimited wants. Therefore economics centres on the problem of
how best man can make effective use of the available resources and distribute the output
amongst different economic activities.
Various people overtime have tried to define economics although the different consideration,
These definitions include.
1. The early definition. According to this, economics was defined as an art of house hold
management.
2. Definition of the classicals. These may include Adam smith (1723-1790). He defines
economics as the art of managing resources of people and those of government.
3. John Stuart Mill. He defines economics as the practical science of production and distribution
of wealth.
4. Definition of Neo-classicals. These were led by marshal and define economics as the study of
mankind in ordinary business of life.
5. The modern definition of economics (scarcity definition of economics). This is the modern
and generally acceptable definition of economics and was stated by Lord Robin. It states that
“Economics is a science which studies the relationship between ends and the scare means
which have alternative uses” i.e. it is a social science which studies how best man can
allocate scare resources so that he can satisfy his unlimited wants. From Robin‟s definition,
the following can be observed.
1. Ends of human wants to which resources put are various or unlimited.
2. Material means of achieving these ends limited i.e. means of production available (land,
labour and capital) to society for satisfying wants of its people are limited.
3. Resources are capable of being put alternative uses e.g. labour performs in different
4. All ends of human wants are not equally important. Some wants are more urgent and
pressing than others. This therefore necessitates making choice.
Choice making requires putting various wants in the order of their important ones for their
fulfillment first. This involves making a list of wants called a scale of preference.
WEALTH
What is wealth?
Wealth is a stock of goods existing at given time which is scare, possesses utility, has an
exchange value and the ownership is transferable.
It therefore has the following features.
1. It must be scarce i.e. It should be limited in supply and not easily got.
2. Should possess utility in that it must be able to satisfy human needs.
3. It must have an exchange value/price
4. Ownership should be transferable from one individual owner to another e.g. cars, T.Vs,
personal houses.
Macroeconomics
This is the study of the economy in aggregate or as a whole i.e. it is concerned with those
variables or aggregates that affect the economy or nation as a whole- The variables include
among others:-
Inflation
National income
Economic growth
International trade
Unemployment
1. WANTS. These are the desires or needs of man. They are categorized into material and
immaterial wants. Material wants are satisfied by tangible goods i.e. those that can be seen
e.g. shoes, cars, sugar, trousers etc. whereas immaterial wants are those satisfied by
intangible goods like entertainment, professional services e.g. teaching.
2. RESOURCES. These are called factors of production. They include natural man made and
human resources i.e. they involve what is required to produce goods and services to satisfy
human needs.
3. COMMODITIES. These refer to things that are produced by factors of production and are
consumed by man to satisfy his needs/wants.
4. Goods. These are tangible things which satisfy human wants.
TYPES OF GOODS
1. Free goods. These are commodities which exist in natural abundance and are enough for
everyone to consume as much as they want at zero cost e.g. Air, sunshine, rainfall.
2. Economic goods: An economic good is that which is scarce in relation to its demand and
the consumption involves cost i.e. consumers pay for it and it commands a price in the
market. An economic good therefore has the following features/characteristics.
1. It is scarce i.e. limited in supply
2. It has value i.e. obtainable by paying a price.
3. It has utility i.e. it must provide satisfaction to the consumer
3. Private goods: A private good is a commodity or service which provides satisfaction or
benefit to an individual who owns/pays for it. It is excludable in that the consumption by
one/consumer prevents consumption by other consumers e.g. cars, clothes.
4. Public goods: A public good is that which when provided for a particular group or individual
becomes available for others to use at zero/no extra cost and the consumption by one person
does not reduce the amount available for others to use e.g. defence, roads, street lights.
5. Merit goods: They are those goods consumption of which is deemed intrinsically desirable
(are of high social value) and are meant to improve the quality of life of the people e.g. safe
water, medical health care, education.
6. Intermediated goods: These are goods supplied by one firm to another or those available but
still have to go through the production process i.e. they are not ready for human
consumption.
7. Final goods: These are goods that have successfully gone through the production process
and are ready for human consumption or use e.g. shoes, bread etc.
Muhinda Richard Economics notes 2018 3
8. Demerit goods: These are commodities which when consumed are harmful to the lives of the
consumers.
PRINCIPLES OF ECONOMICS
Principles of Economics explain the fundamental economic problems of man and these are:
scarcity, choice and opportunity cost/real cost.
People are always in need to satisfy their needs but resources to satisfy them are not
enough/scarce and because they are not enough, human beings have to select form the available
alternatives in order to satisfy their unlimited wants. However selecting means foregoing
something else or opportunity cost.
(a) Scarcity. This is the limitation in supply in relation to demand. All things are in short
supply relative to people‟s desires for them, people‟s wants are many but the resources for
making all the things they need themselves are limited in supply, because of scarcity in
relation to unlimited wants, choice becomes essential.
(b) Choice: This is the preferential determination between ends.
Or
It is the taking of the right decision/alternative from existing set of possibilities for the best
satisfaction of individuals or social interest. If all things are scarce relative to the desire for them
and if people have many unsatisfied wants and the means exist for satisfying only a few of these
wants, it is obvious they can‟t satisfy all of them. Therefore they must make a choice. The
problem of scarcity and choice leads us to yet another concept i.e. the concept of opportunity
cost/real cost.
(c) Opportunity cost/real cost. Opportunity cost is the second best alternative foregone when
a production or consumption decision is made.
It is also referred to as real cost. Since resources are limited, it implies that the production of one
commodity involves not producing, something else and going by the same logic the consumption
of one product means going without others.
The three fundamental problems i.e. scarcity, choice and opportunity cost can be illustrated using
the PPF/PPC curve.
The PPF curve is a locus of points showing all possible combinations of two commodities that
can be maximumly produced when all resources are fully and efficiently employed.
Or
It is the curve showing the maximum production possibilities for two commodities given the
resources available to produce them.
It is drawn basing on the following assumptions.
(i) Resources are fixed /constant.
(ii) The level of technology is fixed /constant.
(iii) Each unit of the resources is homogeneous (similar)
(iv) Only two commodities can be produced using the given resources.
e.g. assuming a country like Uganda utilized all its resources to produce food and cloth, the PPF
curve would appear as shown below.
Product possibility frontier (PPF)
PPF curve
0
C
F1 b
0 C1 C2 C3 cloth (m)
The graph above shows that the country can produce OF, kgs of food or OC3 metres of cloth or
various combinations of food and cloth.
The PPF curve may also show the following economic concepts.
1. Scarcity and Choice: Resources are scarce and the country cannot produce beyond its PPF
using fixed resources e.g. In the graph to produce extra cloth, C1 C2 more metres of cloth you
reduce the production of food by F2 F3, the reverse is true for producing more of food hence,
the need to choose between the choice can be shown where if OF, of food is produced, cloth
will not be produced.
Therefore there is need to make a choice about which amount of food and cloth to produce.
2. Opportunity cost: This is illustrated by the movement along the PPF curve e.g. from a-b, to
produce C1C2 more metres of cloth, you forego F2 –F1 kgs of food. Therefore the opportunity
cost of producing C1 C2 metres of cloth is F2 F1kgs of food.
3. Efficiency in production: Points F3, a, b and C3 show efficient utilization of resources C
shows inefficiency as there is still room for improvement while point D is not attainable
using the available resources.
SHIFT OF THE PPF CURVE
Food
PPF1 PPF2
Cloth
The shift of the curve from PPF1,-PP2 indicates an increase in output (economic growth). The
causes of the shift outwards are.
1. Increase in size of the labour force.
2. Increased workers efficiency or skills and this could be through training.
3. Improvement in technology.
Faced with the problem of scarcity, every society must find ways of rationing the available
resources among the people who want them. In order to do this there are 5 fundamental questions
that must be answered and these are:-
1. What to produce using available resources. Due to scarcity of resources which are
regarded to be at hand at any given period of time, the decision of what to produce
induces a lot of sacrifice i.e. whether to produce consumer good or capital goods etc.
2. How to produce decision: Having decided what to produce, then society must decide how
its resources are to be combined to produce these goods and services i.e. the technique to
use in production. Whether to use labour or capital intensive techniques.
3. When to produce decision. The simplest question societies have to answer is choice of
whether production should be for present consumption or whether to delay production so
as to have more goods and services in future.
4. Where to produce. This involves deciding where to locate production units or firms,
whether to locate them near the market, raw materials, transport routes etc.
5. For whom to produce. Society must make decision about who must consume the goods
and services produced e.g. the rich or poor, urban or rural consumers.
ECONOMIC SYSTEMS
An economic system is defined as a system of ownership and allocation of resources of a country
so as to achieve major developmental goods. In an economic system, the what, how, where, and
for whom to produce as well as choices are made differently in societies in different ways Basing
on this the major economic systems are:-
1. The free enterprise/market/capitalistic economy.
2. The command/centrally planned economy.
3. The mixed economy.
Disadvantages
1. Vital public goods such as defence, justice, roads etc. and merit goods e.g. Education, safe
water etc. cannot be adequately provided through the market system. This is because they are
not very profitable.
2. Consumers with more money have the greatest pull in the market and as a result resources
are devoted to production of goods of ostentation or the rich to exclusion of the majority
poor.
3. Private monopoly tendencies crop up and with such monopolists, consumers are exploited.
4. Competition its self sometimes leads to inefficiency and waste due to duplication of goods
and competitive advertising.
5. Some resources remain idle while others are over exploited leading to their quick exhaustion.
6. Inequality in society worsens due to lack of regulatory bodies.
Characteristics/features
1. There is existence of planning by the central planning authority.
2. There are no private investors since all investments are publically undertaken.
3. Production is for use rather than for profits since emphasis is on welfare and not commercial
gains.
4. Decisions pertaining economic activities are handled by the central planning authority.
5. Economic or productive resources are publically owned.
6. There is limited competition.
Advantages
1. It ensures that adequate resources are devoted to production of community or public and
merit goods.
2. It eliminates the deficiencies that tend to result from meaningless competition.
3. Resources are not wasted because of the planned use of those productive inputs.
4. It uses monopoly powers in the interest of the public e.g. by securing the advantages of large
scale production rather than make maximum profits by restricting output.
5. It takes into consideration uneven distribution of wealth and incomes when planning what to
produce and in rewarding producers.
6. More employment opportunities are provided as the government tries to improve welfare.
Disadvantages
1. May officials are required to estimate and to direct factors of production accordingly and this
results into high costs of administration.
2. There is Bureaucracy usually associated with the system that leads to delay in production and
planning
3. There is inefficiency in production due to absence of competition in production.
4. Limited variety of goods is produced as government‟s interest is producing necessities of life.
5. Quality of final goods and services is rather low due to work to lack of competition.
6. The system is disincentive to produce or individual Initiative.
The mixed Economy system is one where both private individuals and government own
resources and the allocation of these resources is by both the market forces (demand and supply)
and central authority.
It is system that has the features of both free enterprise and planned economy.
Advantages
1. There are limited social evils such as exploitation and unfair distribution of wealth.
2. There is limited wastage due to regulated competition.
3. Wide variety of goods is produced.
4. High level of employment of resources and labour exists.
5. There is increased rate of efficiency in production due to competition and planning.
PRICE THEORY
This chapter is concerned with the study of prices and is regarded as the basis of Economic
theory. In this chapter we look at different concepts which relate to prices, their determinants and
uses of prices in different fields of economics.
PRICE
This is the exchange value of a commodity in terms of money. It is the amount of money that
has to be paid for a specific quantity of a commodity or,
It is the amount of money that will purchase a definite weight/measure of a commodity. Prices
may be classified as; equilibrium price, market price, normal price/ideal price and reserve price.
1. Normal/ideal price: This is the price that regulates the flow of production and
consumption so that they stand at equilibrium position in the long run.
2. Equilibrium price: This is the price at which the quantity supplied equals to quantity
demanded as illustrated below.
D S
Price
E
Pe
S
D
Qe Quantity
Pe is the equilibrium price and Qe is the equilibrium quantity.
4. Reserve price: This is the minimum price below which the seller is not able to offer his
commodity for sale in the market. It is determined by the following factors.
1. Nature of the commodity: Durable commodities have high reserve price than perishable
commodities.
2. Future cost of production: If a seller expects the cost of production to rise in future, he fixes a
higher reserve price than when it is expected to fall.
3. Liquidity reference of the seller: The higher the liquidity preference by the seller, the lower
the reserve price. On the other hand, if the liquidity preference is low, the reserve price is
high.
4. Expectation of future demand: If the seller expects demand to rise in future, he fixes a higher
reserve price than if demand is expected to fall.
5. Future price changes: If the seller expects the price to rise in future, he fixes a higher reserve
price than when prices are expected to fall.
There are several ways through which the price in a market will be determined.
1. Haggling/Bargaining: This is involves the buyer and a seller negotiating to reach an
agreeable price.
2. Auctioning: This is when a seller offers goods to the market for bids and the highest bidder
takes the commodity (one who offers the highest price). This is very common in sale of
vehicles or in fundraising.
3. Government fixed prices/price legislation: The government can fix the price of some
commodities in form of minimum and maximum prices.
4. Sales through treaties/agreements: The market price may be set say by the formation of the
cartel e.g. (OPEC) or a commodity agreement e.g. the international coffee agreement.
5. Forces of demand and supply: The interaction of the forces of demand and supply sets the
price (equilibrium price).
6. Offers at fixed prices: This is involves the producer or seller setting the price that is not
negotiable. This is mainly by monopolists who unless interrupted by the government have the
sole authority to manipulate market price to the disfavour of the public.
7. Price leadership/oligopolistic price determination: This is where by either the dominant firm
or low cost firm sets the price that guides others in their price determination.
8. Re-sale price maintenance: In this case the producer of the product sets the price at which the
item or product should be sold to final consumers. It is common with goods like Magazines,
Newspapers, soft drinks etc.
TYPES OF MARKETS
1. Product markets: These are markets in which a good or service for the consumers is bought
and sold.
2. Resource markets/factor markets: These are market in which production resources especially
labour and capital are bought and sold.
Effective demand
This is the actual buying/purchasing of the commodity at a given price.
Or
Effective demand refers to the desire backed by the ability and willing to have the commodity at
a given price in a given period of time.
Or
It is the actual amount of goods and services purchased or bought by the consumer at a given
price and at a given time.
When considering the effect of one factor on quantity demanded we assume other factors
are constant (ceteris paribus). The determinants of quantity demanded of a commodity
are:
1. The price level of the commodity: The higher the price the lower the demand for a given
commodity(s). This is because the commodity is expensive and people leave them and by
substitutes. A decline in price/lower prices increase the quantity demanded of commodity
because it is cheaper than the substitutes.
2. Price of substitute goods: This is where two commodities are used to satisfy the same
demand e.g. beans and G.nuts. The higher the price of a substitute the higher the demand
for a commodity in question because it is cheaper while a fall in price of a substitute the
lower the demand for the commodity in question since is more affordable.
3. Complements: These are commodities that are jointly demanded e.g. cars and petrol,
guns and bullets, sugar and coffee. The increase in one commodity like guns increases
quantity demanded of other commodities (bullets) because they are jointly while a fall in
the demand for a complement causes an increase in demand.
4. Level of income of a consumer: The rise in income of a consumer leads to an increase in
quantity demanded because of the increase in the purchasing power while low income
causes low demand because of the low purchasing power. This is only in case of normal
goods such as cars, shoes etc.
1. Functional demand: This is demand for a commodity for one‟s own use e.g. buying sugar for
one‟s consumption.
2. Impulse buying: Some people buy on impulse or because they have seen a commodity e.g. a
hawker passing around and one gets the idea of buying a commodity.
3. Speculative demand: Some people hope to make capital gains or other benefits by buying a
given commodity and selling it in future at a profit.
This is a table showing quantities demanded for a commodity at different alternative prices per
period of time. It is as illustrated below.
It is a locus of points showing quantity demanded of a commodity at various prices per period of
time, it is drawn basing on the assumption (The law of demand) that, “Holding all the other
factors constant, the higher the price, the lower the quantity demanded and the lower the price
the higher the quantity demanded.
The demand curve can be derived from the above demand schedule as shown below.
Price (shs) D
15
10
15 25 40 Quantity (kgs)
Why the demand curve is down ward sloping (Why it has a negative slope)
1. It obeys the law of diminishing marginal utility: The demand curve is down ward sloping
because it obeys the law of diminishing marginal utility which states that as one
consumes more of a commodity at a certain point, the satisfaction derived from additional
units diminishes or reduces. When utility is high the consumer is willing to pay a high
price and when utility is low a consumer buys more of a commodity at low price.
Shifts in Demand
This refers to increase/decrease in the amount of commodity purchased in the market due to the
decrease or increase in price holding all the other factors that affect demand constant e.g.
incomes, tastes and preferences etc. It is illustrated by the movement along the same demand
curve as illustrated below.
D
Price(shs) a
P1 Decrease in quantity demanded.
P2 b
Increase in quantity demanded
P3 c
Q1 Q2 Q3 Quantity (kgs)
Change in demand
A change in demand refers to when at constant price more/less of a commodity is purchased
brought about the other factors that affect demand becoming more favourable or unfavourable. It
involves the movement of the entire demand curve to the left or to the right as illustrated below.
D1
Price(shs) Do
D2
P0
D1
D0
D2
Q2 Qo Q1 Quantity (kgs)
From the above illustration, movement from Do to D2 represents a decrease in demand from Qo to
Q2 and movement from Do to D1 represents increase in demand from Qo to Q1
Demand for a commodity may increase or decrease at constant price due to the following:-
Causes of change in demand
These are demand curves which violet the law of demand i.e. they do not take the shape of a
downward sloping demand curve are:-
Price D
P2
P1
P0 x
Q3 Q1 Q2 Quantity
In the illustration above, the demand curve is abnormal at high price levels i.e. increase in
price from P1 to P2 leads to an increase in quantity demanded from Q1 to Q2.
2. Expectation of future price changes: When prices are expected to increase, consumers buy
more commodity even when prices are increasing because they expect further price increase
e.g. during periods of war, the demand curve in this case is similar to that of articles of
ostentation.
3. Demand for giffen goods: A giffen good is a basic commodity that takes a large proportion of
one‟s income such that when its price increases, one tends to buy more of it and less when
the price falls. Examples include food stuffs such as posho, beans, potatoes etc. The demand
curve is abnormal at low price levels as illustrated below.
Price D
P3
P2 x
P1
Q3 Q1 Q2 Quantity
In the illustration above the demand curve is abnormal at low price levels, below P 1 as the
price falls, quantity demanded also falls.
Inter-related demand is a situation where demand for one commodity affects demand for
another commodity positively or negatively or not affecting it all. It includes:-
1. Joint or complementary demand: This refers to the demand for commodities which are used
together such that increase in demand for one of them increases the demand for the other e.g.
cars and petrol, guns and bullets, paint and bushes etc.
2. Competitive demand: It refers to the demand for commodities which serve the same purpose
such that increase in demand for one of them reduces the demand for the other e.g. coffee
and tea, G.nuts and peas.
3. Derived demand: This refers to the demand for a commodity/good due to the demand for
what it helps to produce. E.g. demand for factors of production is derived from or depends on
demand for commodities which such factors of production are used to make.
4. Composite demand: This is the total demand for a commodity with many uses e.g. electricity
used for cooking, ironing, lighting etc.
ELASTICITY OF DEMAND
Or
The price of meat change from 3,500/= to 5,000/= and caused a change in quantity demanded
from 50kg to 30kg per week. Calculate the price elasticity of demand.
Solution
NOTE: The negative sign in the above formula shows the negative slope of the demand curve.
The value of price elasticity of demand co-efficient ranges from O to infinity. The bigger the
elasticity co-efficient, the greater the degree of elasticity.
Price elasticity co-efficient is described according to the answer you get, using the above formula
of calculating it and it ranges from Zero(0) to infinity.
Example
A price of a kg of maize increased from 1000/= to 1200/= per kilo and caused a decline in
quantity demanded from 2700 tons to 1900 tons. Calculate
(i) The price elasticity of demand
(ii) What is the type of elasticity for the above commodity?
TYPES OF ELASTICITY
Perfectly/completely inelastic.
This is when PED is 0. This means that quantity demanded does not respond to changes in price
at all as illustrated below.
Price D
P1
P0 D
0 Qo Quantity
Change in price from OP0 to 0P1 leaves quantity demanded or Q0 unaffected e.g. demand for
cigarettes/alcohol.
Inelastic demand: This is when the price of elasticity of demand co-efficient is greater than O
(zero) but less than one; it means that the percentage change in quantity demanded is smaller
than proportionate change in quantity demanded as illustrated below.
P2
0 Q1 Q2 Quantity
Change in price P1 P2 is greater than change in quantity demanded Q1 Q2.
Elastic demand: This is when elasticity of demand is greater than 1(one) but less than infinity
i.e. percentage change in quantity demanded is greater than percentage change in price as
illustrated below.
D
Price P1
P
D
0 Q1 Q2 Quantity
Change in price from P1 to P2 leads to a proportional greater change in quantity demanded from
Q1 to Q2.
Unitary demand (PED =1): This is when price elasticity of demand is equal to 1 (one) in other
wards quantity demanded changes exactly by the same percentage as does the price as illustrated
below.
0 Q1 Q2 Quantity
Perfectly elastic demand: This is when price elasticity of demand is equal to infinity meaning
that at constant price consumers are willing to purchase and none at all even at a slightly higher
price as illustrated below.
Price
P0 D D Perfectly elastic demand curve
0 Q1 Q2 Qty.
1. Availability of substitutes: When substitutes are easily available, the demand for the
commodity is elastic; this is because the consumer has alternatives. Scarcity of substitutes
makes the demand for the commodity inelastic because the consumer has no alternatives e.g.
demand for petrol is inelastic because it has no close substitutes in the running of vehicles.
2. Degree of complementarity: For complementary goods, price elasticity of demand is inelastic
because demand for one item requires demand for another. Increase in price of one of the
commodities leads to reduction in quantity demanded of another commodity.
3. Habit in the use of the commodity: For commodities whose demand follows a continuous
habit makes the demand for the commodity is price inelastic because one cannot do without
the commodity. E.g. demand for cigarettes and alcohol may not be easily affected by changes
in price.
4. Level of income of the consumer: Generally the higher the income of the consumer the more
inelastic the demand is for commodities because the rich are not very much affected by price
This is the measure of the responsiveness of quantity demanded of a commodity to change in the
price of another commodity. I.e. it is the responsiveness in demand for a product to the
proportionate change in the price of another commodity.
It is given by the formula;
Cross elasticity of demand = Percentage change in quantity demanded of a commodity (X)
Percentage change in price of commodity (Y)
= ∆Qx . Py
∆Py Qx
If the co-efficient of cross elasticity of demand for a product is positive, then the two
commodities are substitutes if it is negative, the two are complements and if it is zero the two
commodities are not related at all.
Example:
The price of commodity (A) increased from 20,000/= to 25,000/= and caused a decline in
demand for a commodity (B) from 30 to 15 units a week.
Calculate the cross of elasticity of demand.
What is the relationship between the two commodities
Solution
= ∆QB . PA
∆PA QB
= 15 – 30 . 20,000
25,000-20,000 30
= 15 x 20,000
5,000 30
= -1 x 2
= -2
Therefore the commodities are complements
Reasons:
(a) The increase in prices of A decreases the demand for commodity B
(b) The co-efficient is negative.
SUPPLY
This refers to the amount of a commodity suppliers or producers are willing to offer to the
market at alternative prices per period of time holding all the other factors constant i.e. supply of
Supply Schedule
This is a table showing the amounts of a commodity offered for sale at alternative prices per
period of time. It is drawn on the assumption, “The higher the price the higher quantity supplied
and the lower the price, the lower the quantity supplied holding all the other factors constant as
illustrated below.
Price (shs) Quantity (kgs)
100 50
150 100
250 500
From this illustration, it can be seen that as the price increases, quantity supplied also increases.
Price(shs) S
250
150
100
1. The price of the commodity: Other factors being constant, more of a commodity is supplied
at a higher price because the producer realises a high level of profit and less is supplied at a
lower price because it leads to low profits.
2. Cost of production: A high cost of production causes low supply because it becomes
expensive to produce and low profits are realised while a low cost of production cause low
supply of goods because it is cheap to produce and more profits are realised.
Elastic supply
Price
S
P2
P1
S
Q1 Q2 Quantity
This is where the co-efficient is greater than one but less than infinity i.e. percentage change in
quantity supplied is greater than percentage change in price. Quantity supplied changes by a
bigger proportion for a smaller change in price.
Price S
P2
P1 S
Q1 Quantity
This is where elasticity of supply is zero meaning that quantity supplied does not respond to
changes in price.
Unitary Supply
S
Price
P2
P1
S
Q1 Q2 Quantity
Change in price P1-P2 is equal to change in quantity Q1 – Q2
The elasticity co-efficient is equal one. In this type percentage change in quantity supplied is
equal to percentage change in price.
Inelastic supply
S
Price
P2
P1
Q1 Q2 Quantity
Elasticity co-efficient is greater than zero but less than one. Here the proportionate change in
quantity supplied is less than the proportionate change in price i.e. quantity supplied responds
less for a greater change in price. I.e. change in price P1 – P2 is greater than change in quantity
demanded Q1 – Q2.
P1 S
0
Q1 Q2 Quantity
The elasticity of supply co-efficient is infinity; Quantity supplied varies for a given price. In the
above illustration, sellers are not ready to sale at any price below P1 while they are willing to
supply all they can above.
INTERRELATED SUPPLY
The various forms of interrelated supply are the following;
1. Joint/complementary supply: This is the supply of those goods which have common
procedure of production such that an increase in the supply of one automatically leads to an
increase in the supply of the other. The goods originate from the same source and their
supply is increased simultaneously e.g. wool and mutton, meat, hides and skins, cotton and
cotton seeds etc.
2. Composite supply: This refers to total quantity or supply of goods that are substitutes to one
another e.g. mutton, beef and chicken or supply of tea, coffee and cocoa.
3. Competitive supply: This refers to the supply of commodities that require the same resource
such that the increase in supply one causes a reduction in the supply of the other commodity.
For the case of agriculture a farmer uses the same piece of land to produce maize and beans.
An increase in production of maize reduces the production of beans.
W3
W2 X
W1
In the illustration the supply curve is initially sloping but after point X (wage W2) labourers work
for less hours i.e. as the wage increases to W3 hours worked reduce to L3. This can be attributed
to:
1. Preference for leisure: i.e. for some employees as the wage rate increases after a certain
point, they reduce on the number of hours to work to have some leisure time.
2. The issue of target workers: These are people who work to fulfill targets and once fulfilled
they reduce on the hours of work.
3. Cultural and political factors or discrimination in the labour market.
4. Deterioration in the real wage due to inflation.
5. Old age-when one has reached retirement age
6. Substitutability of labour by machine.
7. The rate of taxation.
P2 X
P1
Q1 Q2 Q3 Quantity
This is illustrated with a curve that is normal for the 1st few units produced up to a given point
after which it becomes perfectly inelastic as illustrated above. After point X an increase in price
from P2 to P3 leaves quantity supplied Q2 the same. This situation may arise due to the following.
3. FIXED SUPPLY
E.g. supply of land, supply of money in an economy, in this situation the supply of goods cannot
increase whatever the price offered e.g. supply of land, the curve is illustrated below.
Price S
P2
P1
0 Q1 Quantity
CHANGE IN SUPPLY
This shows an increase or decrease in the amount offered to the market for sale at constant price
brought about by changes in other factors that affect quantity supplied rather than price. It is
illustrated as follows.
Price S1 S0
S2
P0
Quantity
Q1 Q0 Q2
An increase in supply is shown by shift in the supply curve from S0 to S2 where quantity supplied
increases from Q0 to Q2. The decrease in supply is shown by shift of supply curve from S 0 to S1
where quantity supplied reduces from Q0 to Q1.
Price
S
P2
P1
0 Q1 Q2 Quantity
Increase in price from P1 to P2 increases quantity supplied from Q1 to Q2. Reduction in price
from P2 to P1 would cause reduction in quantity supplied from Q2to Q1.
PRICE MECHANISM
It is a system under which all economic decisions are made in view of prices of commodities and
prices of other factors of production. It works best in a free market economy where the private
sector s dominant and as long as it operates, some assumptions are made.
Question:
(a) What is the role of price mechanism in an economy?
(b) Discuss the Merits and Demerits of price mechanism in an economy.
Question: What measures have been used to regulate demerits of price mechanism in your
country?
1. Used taxation: Firms are haven been taxed e.g. use of corporate taxes on profits of companies
to reduce their capacity to expand and influence the market.
2. Government has Subsidised firms and Consumers: this has enable low income earners afford
some goods.
3. Licensed producers or exploiters of certain resources to minimize the rate of exploitation.
4. Banned production and consumption of some demerit goods.
5. Encouraged formation of consumers association or educating consumers. This has helped
consumers fight exploitation by consumers.
6. Government has set up institutions to regulate economic activities or bureau of standards.
7. Enacted laws bodies to protect the environment e.g. [NEMA].
8. Provided emergence relief or provided for disasters. This has helped those in needed get
goods and services for their survival.
9. Government has provided merit and public goods.
PRICE FLACTUATION
AGRICULTURE IN RELATION TO SUPPLY AND DEMAND AND THE CAUSES OF
GREATER FLUCTUATION IN PRICES OF AGRICULTURAL PRODUCTS
Price fluctuation refers to the inconsistent upward and downward movement of prices due to
periodic shortages and surpluses in the uncontrolled markets of agricultural products due to
changes in demand and supply.
Agricultural output/primary products are faced with price instabilities. The greater oscillation of
prices of goods as compared to the prices of manufactured goods is as a result of a number of
factors as below.
1. Divergence between planned and actual output: For the case of agriculture, planned output is
never equal to actual output. When actual output is greater than planned output, there is
excess supply and this causes fall in prices. When output is less than planned output, there is
shortage and hence increase in prices. Manufactured commodities are not affected by natural
factors and therefore output is stable as well as the prices.
2. Long gestation period: Agricultural products take long to produce such that during periods
when prices are high, producers plan to produce more and when this output is supplied it
exceeds demand and therefore there is a reduction in prices. Manufactured goods are easier
to store and therefore when there is an increase in demand producers simply draw from stores
and supply and hence stable prices.
3. Perishability of agriculture products: Agricultural products cannot be kept for long so even
though the product is the good one. One has to dispose it quickly even or sometimes at a
much lower price. Industrial output can be kept until favourable prices are offered.
4. The demand for agricultural products is price Inelastic: Demand for food stuff is inelastic so
that whether prices increase or decrease consumers demand almost the same quantities. This
is applicable to other agricultural products implying change in demand is not followed by
change in supply thus resulting into continuous change in price levels. Manufactured goods
have elastic demand and fall in price leads to greater quantity demanded.
1. Fluctuations in terms of trade; as prices go up, the terms of trade improve and as the
prices fall, the terms of trade worsen.
1. Use of price control. This is in form of minimum price legislation where the government
fixes the prices for agriculture commodities above the equilibrium price making it illegal
for any buyer to purchase the commodities from the farmers at any price below that set.
2. Improving upon infrastructure. There is need to develop quick and efficient transport
systems. Better transport systems help to dispose surplus hence a reduction in instability
of prices.
3. Use of buffer stock arrangement. This is where the government through marketing boards
buys surplus or excess produce from farmers during harvesting or in periods of plenty,
stores it and releases it in periods of scarcity. This helps to even out prices during periods
of scarcity and period of plenty.
4. Use of stabilization fund. Here the government/marketing board compensates farmers in
products when the prices fall below a certain level and makes profits in other products
when prices are high in the market. This aims at ensuring that farmers get stable prices
and thus stabilizes.
5. Modernization of agriculture. This is done to produce better quality products and reduce
its dependence on nature. This can be achieved through use of irrigation, introducing
better varieties etc.
6. Undertaking intensive industrialization programs within agriculture. In order to add value
to agriculture products, a simple industrial plant should be set up or fully processed
Price legislation involves interfering with the forces of demand and supply by the
government to set prices of goods and services.
This may be in form of minimum and maximum prices. Therefor price controls are of two
major forms;
Minimum price legislation is the process where the government fixes the price of a
commodity above the equilibrium price below which it is illegal to buy or sell a
product/commodity.
NB: Minimum price is the price fixed by the government above the equilibrium price
below
Minimum price is usually for agriculture commodities for the benefit of firms or
producers of those commodities. It is as illustrated below.
Question: Outline any four reasons for government fixing minimum price.
Positive effects/advantages
1. It reduces the fluctuation in prices of agriculture commodities. Since the buyers are
supposed to pay the price fixed by government irrespective of any changes in demand.
2. It reduces exploitation of producers or firms by the buyers who usually pay them lower
prices.
3. It leads to an increase in production of agriculture commodities since farmers are
encouraged by high profits realized.
4. It reduces income inequality between producers of agriculture products, people employed
in other sectors of the economy e.g. industrial sector as the farmers are able to get stable
incomes due to the stable price fixed.
5. It increases aggregate demand or purchasing power of the producers and discourages
investment in production to satisfy the demands of the producers.
6. Earnings of primary producers increase and this results into increase in investment in the
agriculture sector i.e. the incomes of the producers are established due to the fact that
fluctuations in prices of agricultural commodities are reduced.
7. It leads an economy out of depression or recession. As the demand increases, investment
increases, profits increase, employment increases etc.
8. Labour strikes or unrests are reduced. This is the case with minimum wage. This is
because a fairly satisfactory wage is given.
9. Effort and initiative (handwork) at work are encouraged hence increased participation in
productive activities.
10. Excess capacity is reduced as some resources are put to use.
1. It results into surplus output because of excess production and this may result into
unnecessary waste of commodities.
2. It is very expensive for the government. The government has to purchase the surplus
output from the market so that the price does not fall because of the surplus output (price
support).
Price support is where the government buys surplus output on the market arising from
the fixing of the minimum price. This policy is used with an aim of supporting or holding
the minimum price legislated by the government.
3. Problems of storage arise more especially in developed countries where there are forced
storage facilities.
4. It encourages price increase and hence inflation tendencies arise. This causes high cost of
living in the economy.
5. Consumption reduces as many people find it difficult to afford goods whose prices have
been legislated.
6. It leads to an increase in the cost of production where the commodities for which the
minimum prices have been fixed are inputs in the production of other goods.
7. It results into inefficient allocation of resources. Many of the producers may channel
resources to the production of commodities whose prices have been legislated at an
expense of other commodities and this distorts the working of price mechanism.
MAXIMUM PRICE LEGISLATION (price ceiling)
This is a process whereby the government fixes the price of a commodity below the equilibrium
price and it is illegal to sell or buy above this price. It is basically meant to protect consumers. It
is also called price ceiling.
NB: A maximum price is the price set by the government below equilibrium price above
which it is illegal to sell or buy a commodity.
Maximum price is set for consumer commodities and it is usually set when the
government finds out that the equilibrium price in the market is too high to enable some
people purchase the commodity.
Question: outline any four reasons why the maximum price may be fixed in an
economy.
1. To protect consumers from exploitation by profit minded traders and some producers.
2. To maintain price stability /minimize unnecessary price increases.
3. To encourage consumption of some selected goods most especially merit goods.
4. To check or regulate monopoly tendencies as monopolists to a greater extent are price
makers.
5. To discourage production of some commodities that are undesirable to peoples‟ health
and morals e.g. demerit goods and public bads.
6. To ensure equitable distribution of income in an economy. This is done by reducing
profits by producers and expenditure by consumers.
7. To discourage exportation of expensive items so as to encourage exports in order to
increase government revenue.
Question: Examine the effects of maximum price legislation.
1. It protects the consumers from exploitation by sellers who usually charge them very high
prices.
2. It reduces price fluctuation since the prices are fixed by the government and cannot
change due to forces of demand and supply.
3. It makes essential; goods available and affordable to all people in the country since the
maximum price is relatively low.
4. Maximum prices discourage production of some commodities especially those which are
undesirable to people‟s health and morals. The price is low and therefore low profits
discourage.
5. Maximum price controls monopoly power. This is by setting a price which makes a
monopolist make low profits which reduces the capacity of the monopolist to expand and
influence the market.
6. Maximum price ensures equitable distribution of income. It is because it reduces profits
of producers and expenditure by consumers.
7. It helps to bring about industrial peace where prices of products and factors of production
are fixed by the government in form of maximum prices.
Negative effects (Disadvantages)
Positive effects
OR
It is the want satisfying power of the commodity. Utility can be divided into two i.e.
i. Total utility
ii. Marginal utility.
Total utility. This refers to the total satisfaction derived from the consumption of given
units of the commodity.
Marginal utility. This refers to the extra satisfaction derived from consuming an additional unit
of the commodity. e.g.
If one consumes 5 bottles of sodas and then consumes the 6th one, total utility will be the
satisfaction derived from all the 6 bottles of soda.
The marginal utility of a god depends on the amount of the commodity already consumed. The
1st unit of a commodity gives higher satisfaction than the subsequent units. This is because the
need for a commodity is gradually satisfied.
The quantity of goods consumed and marginal utility vary inversely as illustrated below.
The relationship between quantity consumed, total utility and marginal utility
1. Marginal utility is equal to total utility for the 1st unit consumed.
2. As long as the total utility is increasing, marginal utility is decreasing up to a given point.
3. When the total utility is at maximum (the 6th unit), marginal utility is zero. The point
where total utility is at maximum is the point of satiety commonly known as the bliss
point.
4. The total utility is decreasing, marginal utility is negative.
According to this law, as the consumer buys more units of the commodity, the satisfaction
derived from additional units reduces.
Consumer’s surplus
This is defined as the difference between what a consumer is willing to pay for a commodity and
what he actually pays for the commodity.
OR; it is the extra utility enjoyed by the consumer without paying for it.
Consumer‟s surplus
= 3200 – 1500
= 1700 shillings
In the diagram above, under this cycle, price fluctuations tend to develop far away from
equilibrium over time. Demand is more inelastic than supply as illustrated above.
In the illustration above, it can be seen that prices are moving away from the equilibrium
position i.e. as the prices rise and fall; there is no hope that they will rich the equilibrium levels.
Primary production
This refers to the extraction and exploitation of natural resources. Therefore it involves the
exploitation of gifts of nature which provide raw materials. It involves activities like farming,
fishing, mining, lumbering, etc.
Secondary production
This involves transforming raw materials into finished goods that are ready for consumption by
the final consumer.
It involves activities like manufacturing, processing, construction, etc.
Tertiary production
This refers to the provision of services such as teaching, transportation, banking, insurance, etc.
The services that are produced under tertiary production are divided to two namely;
(a) Direct/personal services e.g. these of lawyers, teachers, etc.
(b) Indirect/commercial services such as advertising transport. Etc.
TYPES OF PRODUCTION
There are two types of production namely;
a) Direct/subsistence production
b) Indirect/commercial production.
Direct/subsistence production
This refers to the production of goods and services by an individual for own consumption.
INDIRECT/COMMERCIAL PRODUCTIONAL
DEMERITS
1. High costs of production are incurred especially when distributing and transporting the
final products to distant markets.
2. In case of change of demand and tastes of consumers against the product, large scale
producers suffer great losses.
3. There is danger of technological unemployment as a result of mechanisation in
production i.e. machines displace workers
4. There may be high expenditure on inputs of raw materials as producers compete for raw
materials in the market.
5. Because of profit motive in the long run, there may be over exploitation of some
resources.
6. It promotes dependence on other countries to get what is not being produced.
7. It leads to pollution and environmental degradation. This is due to mechanisation
FACTORS OF PRODUCTION
a) Land - Rent
b) Labour - Wages/Salaries
c) Capital - Interest
d) Entrepreneurship - Profit/loss.
Characteristics of land
1. The supply of land is fixed i.e. the supply of land cannot be increased
2. Land is a free gift provided by nature (God given gift) and cannot be created by man.
3. Is geographically in mobile but occupationally mobile i.e. cannot be transferred from one
place to another.
4. The productivity of land can be varied.
5. Land is supplied at a zero price
NB. The factor price/monetary reward for using land is called rent
TYPES OF RENT
Commercial rent. This refers to the payment made for the hire/use of a durable asset e.g.
renting a house, machines, land, etc.
Location/site rent. This is rent made to land due to its strategic location site e.g. land in Kampala
has a higher payment made to it than in rural areas due to location
Quasi rent.
This is payment to a factor of production which is over and above the transfer earnings, due to its
inelastic supply in the short run but elastic supply in the long run e.g. payment made to doctors,
aircraft engineers, pilots etc.
Economic rent. This refers to the payment to a factor of production which is over and above its
supply price/transfer earnings.
Or
Payment to a factor of production over and above what it would have earned in its next best
occupation.
LABOUR
This is the physical and/or mental human effort which is used in the production of good and
services to satisfy human wants. Labour can be skilled, semi-skilled or unskilled.
Characteristics of labour
1. Labour is mobile i.e. both geographically and occupationally.
2. Labour cannot be stored.
3. Labour cannot be separated from the labourer.
4. Its productivity can be varied.
Efficiency of labour. This refers to measure of quality and quantity of output that a unit of
labour can produce within a given period of time.
Or
The ability to achieve greater output in a short time without any decline in the quality of output.
MOBILITY OF LABOUR
It refers to the ease with which labour can move from occupation to another or from one
geographical location to another.
Mobility of labour can be either geographical or occupation.
1. Geographical mobility. This refers to the ease with which labour can be moved from
one geographical area to another. E.g. house maid moving from Bushenyi to
Kampala.
2. Occupation mobility. This refers to the ease (ability or labour to more from one
occupation to another e.g. labour charging from being a teacher to be an accountant in
a bank.
IMMOBILITY OF LABOUR
This refers to the inability of labour to move from one occupation to another or from one
geographical area to another.
Therefore geographical immobility of labour refers to the inability of labour to easily move from
one geographical area to another.
Occupational immobility of labour refers to the inability of labour to easily change from one
occupation to another.
N.B Brain drain refers to the movement of labour to other countries (one country to another) in
search of green pasture.
Specialisation of labour
Is the concentration of an individual on one or a few occupations or in production of one
commodity where he is most efficient. Or refers to the concentration of labour in production of
what one can do best and gets the rest through exchange.
Demerits of specialisation
1. Creates boredom. As one repeats the same task, time after time work becomes
monotonous which dulls intelligence.
2. Leads to unemployment. E.g. for instance in case of change in fashion, demand,
specialists who are laid off cannot easily change to other jobs.
3. Specialisation may cause temporary shortages in case of absence of one of the
few specialists at a particular stage of production. More to that the whole
production process may come to a standstill in case one worker misses or if there
is breakdown at a particular stage of production.
4. International specialisation leads to overdependence on other countries and
discourages diversification.
5. May result into over exploitation of resources which leads to resource depletion
especially these that cannot be replaced such as minerals.
6. Leads to loss of skills and craftsmanship in other occupations since one
concentrates on one or a few tasks
7. Limits occupational mobility of labour in a country. People who are highly
specialised tend to become less mobile occupationally.
8. Specialisation may lead to over production creating surpluses that may be difficult
to market.
9. Specialisation exposes workers together risks like occupational diseases e.g. these
who specialise in welding, fumigation etc. normally develop health complications
if not well protected.
10. Encourages use of machines which are specific and hence may not serve more
than one purpose.
This refers to man-made resources used to further the production process. Thus capital includes
machinery, money, buildings, tools and equipment used in production, roads, schools etc.
The reward for capital is interest
Capital therefore consists of producer goods and stock of consumer goods not yet in the hands of
consumers.
All in all capital is wealth which helps in the production of more wealth.
Forms of capital
1. Normal /money/ liquid capital. This refers to capital inform of monetary units and
can be inform of currency (Coins and notes (or near cash e.g. a cheque.
2. Real physical capital. This refers to a capital in terms of physical assets such as
machinery, vehicles, and building
3. Fixed capital refers to the capital or machinery or buildings, factory equipment,
cars etc. that are used in production process. It is durable in nature and can be
used over and over again.
4. Private individual capital. Refers to capital owned exclusively by an individual
and it yields income to the individual owner e.g. the business assets, buildings,
etc.
5. Public/social overhead capital. This refers to capital which is collectively owned
by the society as a whole. It is usually provided by the state e.g. public roads,
hospitals, etc.
6. Operational/working/circulating capital. Capital that consists of raw materials that
are required for the day to day running of the firm e.g. fuel, farm seeds,
allowances etc.
7. Sunk capital. This is specialised capital that cannot easily be adapted to
alternative uses e.g. popcorn machines concentrate mixer or plough.
8. Floating capital. Refers to capital that can be used for a number of purposes in
various ways. It is also referred to as non-specific capital e.g. buildings, money
etc.
CAPITAL ACCUMULATION/FORMATION
This refers to the process of increasing a country's stock of producer goods/capital goods.
Or
Accumulation is the process of creating a country‟s stock of capital (mainly through
investment).
ENTREPRENEURSHIP
This refers to the under taking of risks of initiating and financing of business with the
intention of making profits, An entrepreneur, undertakes risks by introducing both
new products and new ways of making the product
The reward for entrepreneurship is profit/loss
FUNCTIONS OF AN ENTREPRENUER
1. He starts the business or firm.
2. He employs other factors of production and coordinates their activities therefore he is
coordinator.
3. He bears risks of initiating and financing the business.
4. He monitors the entire business or production process.
5. He takes major decisions and makes sure that they are carried on i.e. takes decisions
about how and what to produce; therefore he is a decision maker.
6. He organises the other factors of production into new kinds of enterprises associated with
new projects
7. He takes responsibility of losses and profits of the firm.
8. He makes arrangements for rewarding other factors of production.
1. Level of education and training. The higher the level of education the greater the
supply of entrepreneurs and the lower the level of education the lower the supply of
entrepreneurship.
2. Natural and acquired abilities People with natural abilities are better than those with
limited abilities and therefore their supply is higher.
3. Government policy in relation to investment. Conducive policies inform of low taxes,
subsidisation leads to high supply of entrepreneurship because of the low cost of
production while unfavourable policies such as high taxation leads to low supply of
entrepreneurs because of the high cost of production and the low profits.
4. Level of economic development. The higher the level of economic development the
greater the supply of entrepreneur and vice versa.
5. Social economic factors e.g. religion, traditions and cultures affect will power of
individuals in undertaking risks in business ventures in a society since a lot of
valuables are attached on such socio-economic factors leading to low supply of
entrepreneurship.
6. Size of the market. A large market leads to high supply of entrepreneurship since
more profits are realized where as a small market leads to low supply of
entrepreneurship because the profits are low.
7. Political climate. Political instabilities lead to low supply of entrepreneurship because
they threaten the lives and property of the entrepreneurs while political stability and
security leads to high supply of entrepreneurship because entrepreneurs are assured of
security for their lives and property.
1. Encouraging economic integration. This increases the market for goods and therefore
more profits are realised
2. Building strong and sound infrastructural facilities e.g. roads telecommunication etc.
to support investments facilities. These reduce the cost of production and therefore
make it easy to establish enterprises.
3. Further privatising state enterprises. This increases competition in production and
encourages individuals to engage in production by starting enterprises.
4. Further liberalising the economy. This makes it easy for individuals to start
enterprises since some unnecessary restrictions are removed.
5. Ensuring a stable political atmosphere. This assures the investors of security for life
and property and therefore more enterprises are established.
6. Providing incentives to investors e.g. free land, tax holidays etc. These reduce the
cost of production and therefore more enterprises are established.
7. Establishment of specialised institutions e.g. Uganda Investment Authority (UIA).
These provide assistance to entrepreneurs by providing the required information on
possible investment opportunities.
8. Ensuring price stability. This reduces the cost of production and increases the profit
levels.
9. Providing affordable loans. This is enabling people start production enterprises as
they are provided with the needed funds to purchase inputs for production.
10. Improving the land tenure system. This is making acquisition of land for investment
and mechanisation easier and therefore more output is produced.
11. Fighting corruption. Funds set aside are used for their intended purpose and therefore
projects to support production are put in place.
Factor mobility refers to the ease with which a factor of production can move from one
geographical area to another or from one occupation to another.
Geographical mobility of a factor of production refers to the movement of the factor of
production from one area to another in the process of production. Occupational mobility of a
factor of production refers to the ease with which a factor can move from one occupation to
another.
PROFIT
It is the reward for an entrepreneur for undertaking a risk for starting the business or firm.
It is the difference between the total revenue and total cost of the firm.
(Total revenue - total cost).
Types of profits
1. Abnormal/pure/super normal profits. This refers to the returns an entrepreneur earns
when average revenue is greater than average cost.
Or
The returns an entrepreneur earns that is enough to keep him in production and induces
new firms to join the industry.
4. Normal profits are earnings or rewards to an entrepreneur or a firm (s) that is just
sufficient/enough to cover total cost or keep him/it in production without inducing other
firms to join the industry.
Functions of profits
BUSINESS UNITS
Sole proprietorship:
This is the business under the control and management of one person. He provides all the capital
and labour (although he sometimes uses family labour) makes all decisions, suffers any risks that
may arise and enjoys all the profits.
It is very common in retail trade
The major sources of finance earning are his savings and borrowing.
PARTNERSHIP
It is a type of business unit formed by a group of people between two and twenty who contribute
capital to start a business with an aim of making profits.
The minimum of the number of people is 2 (two) and the maximum is 20.
A partnership begins operation after the partners have signed a partnership deed.
Types of partnership
1. Ordinary (unlimited) partnership. This is one in which all the members have unlimited
liability i.e. they are answerable to the firm‟s debts up to the extent of selling off their
personal property.
2. Limited partnership. This is one in which the liability of the members is restricted to the
nominal amount of capital they have put in the business.
Types of partners
1. Active partners
A partner who is directly involved in the day to day running of the business in addition to
his capital contribution when starting the business.
2. Dormant partners
These are partners who are not actively involved in the running of the business but
contribute capital to the business
3. Quasi partners
These are partners who allow their names to be used in the business because of their good
conduct but don't involve in the running of the business and contribute no capital.
Advantages of partnership
1. More capital can be raised compared to sole proprietorship business.
2. It is easier to form and run as compared to joint stock companies.
3. It is capable of attracting different talents as compared to sole trading
4. Specialisation is possible unlike sole proprietorship where work is done by one man
5. Enjoys privacy (in accounts unlike public limited companies.
6. The business benefits from a variety of skills by different members as compared to sole
trade
7. Can easily access loans from financial institutes to sole trade.
8. Continuity of the business is assured incase a member dies
Disadvantages
1. Decision making is slow since consultations have to be made.
2. There is unlimited liability in case of ordinary partnership.
JOINTSTOCK COMPANIES
N.B: Public limited Liability Company is a business unit comprising of a minimum number
seven and no maximum number of shareholders who have contributed capital through buying
shares from the company with an aim of making profits.
Disadvantages
1. Shares are not freely transferrable
2. Membership is restricted to a maximum of 50 people hence expected capital is
limited.
3. Shares cannot be sold publicly
1. Personal savings. An individual or family business may be started on the basis of the
proprietor‟s accumulated savings.
2. Bank loans and advances. Besides requiring capital to finance materials, firms also
require capital for building, buying machinery and vehicles. These require long term
loans from banks.
COOPERATIVE SOCITIES
Is a voluntary association of people who have got common interest/objectives.
It is a voluntary association formed by the group of people for the purpose of benefiting its
members.
Output
TP
AP
Output
MP
The table showing total product, average product and marginal production in the short run.
Graphical relationship between total product, marginal product and average product.
It states that as more and more units of a variable factor are applied to a given quantity of a
fixed factor, the marginal product first rises reaches maximum point and then falls.
Questions
(a) State the law of variable factor proportions
(b) Outline the assumptions of the law of diminishing returns
(c) Distinguish between marginal product and average product
(d) State two factors that may lead to an increase in marginal product of labour.
RETURNS TO SCALE
This refers to relationship between the change in the scale or output and the resulting
change of output in the long run when all the inputs have changed in the same proportion.
Returns to scale takes place in three (3) forms.
1. Increasing returns to scale. This is when the firms output increases at decreasing per
unit cost as a result of increased combination of factor inputs. This is where by a given
increase in the scale of inputs by a given percentage leads to a bigger percentage increase
in the level of output. With increasing returns to scale, the marginal product rises which
leads to a fall in the average costs, therefore increasing returns to scale due to enjoyment
of the economies of scale enjoyed by large scale firms.
2. Constant returns to scale.
This is when an increase in the existing factor combination increases output at constant
per unit cost. This is where by a given increase in the scale of inputs by a given
percentage leads to an equal percentage increase in the level of outputs e.g. doubling of
inputs leading to the doubling of the output.
3. Decreasing returns to scale.
This is where by a given increase in the scale of inputs by a given percentage leads to a
smaller large increase in the level of output.
With decreasing returns to scale, the, marginal product happens to be falling leading to
increasing average cost.
The decreasing returns to scale are due to the disadvantages of large scale production.
Output x
Qo
MP
From the above illustration, the, marginal product of labour first rises up to point x
because the fixed factor is still more than the variable factor.
An industry is a combination of a firm that produce similar or related products e.g. beer
industry, mattresses industry.
Firms in an industry may produce in competition with each other or they may combine
and produce together
The industry is also ways known or by the name of the product, foot ware industry.
GROWRTH OF A FIRM
Advantages/importance of merging
1. It widens the market. Integration enables firms to enjoy a large market because of
reduced competition in the market.
2. It increases the profit margin. More profits are attained than when firms are operated on
individual basis due to economies of scale. This encourages further production.
3. Increases production. Integration expands the level of output due to use of better
technology. This leads to reduced costs per unit output.
4. Economies of scale are enjoyed. This is because integration encourages expansion of
firms leading to reduced costs of production.
5. It encourages diversification. The integration of firms can offer a wide variety of products
hence increasing consumer's choice and welfare.
6. It leads to better management of firms. This increases production and improves efficiency
due to access to skilled labour.
Disadvantages of merging
1. Results into unemployment. When firms merge some workers are laid off in order to
reduce costs. This reduces their incomes and welfare.
2. Result into the production of poor quality products. Merging of forms minimises
competition hence production of poor quality goods and service.
3. Results into over production. Merging of firms enables access to better technology
which leads to high output beyond market demand. This causes wastage of resources.
4. Managerial problems arise. This is because of the complexity of many departments
and a large number of employees and these make supervision of the new enterprise
difficult.
5. Results into diseconomies of scale. These are the disadvantages arising from large
scale production such as failure to get adequate market for the produced output or
shortage of skilled labour for the big firm/industry.
6. Leads to development of monopoly powers. There is exploitation of consumers in
form of high prices due to reduced competition.
7. Profits are shared. This results into low profits per firm
8. High taxes are charged on the big firm. This is because the firm is operating on large
scale and this reduces on the profit margin.
9. A firm may make a lot of losses in case of errors by management. This makes the
firm close down its operations.
10. Results into loss of independence by individual firms. Integrated firms work together
and there is need for consultation before a final decision is made. This delays decision
making and implementation.
An industry
It is a collection of firms producing similar/related commodities
1. Rooted industries
These are industries which must be located in a particular area due to the pull factors.
2. Foot loose industries
These are industries which can be located anywhere without considering location factors.
3. Tied industries
These are located near the market of the finished products e.g. furniture workshop.
4. Bulk increasing/weight gaining industries
These are industries located near the market because of finished products becoming bulky e.g.
ship building industry
5 Bulk decreasing/weight reducing industry
These are industries located at the source of the bulky raw materials to reduce the cost of
transportation of raw materials e.g. sugar processing industry are located near sugar cane
plantations.
Location of industry
It refers to a geographical site where a firm or an industry is established
Or
It refers to the establishment of a firm or an industry in a particular area irrespective of whether
there are other firms or not.
Questions
(a) What is meant by the term industrial inertia?
(b) Explain the factors that influence the location of industries in an area or our country.
LOCALISATION OF INDUSTRY
This refers to the concentration of many firms in a particular area or place which may be
producing similar or differentiated products.
N.B: The factors that determine the localisation of industries are the very factors that may lead to
the location of industries.
Advantages of localisation
1. It leads to the expansion of employment opportunities. This is due to many
activities/enterprises in an area in which people get jobs.
2. Better quality products are produced. This is due to competition among firms which
results into the production of high quality products hence improving people's welfare.
3. It increases market for goods and services. Localisation increases market for raw
materials as well as finished products leading to optimum utilisation of resources.
4. Development of Infrastructure is stimulated. It encourages the construction and
rehabilitation of infrastructure which eases transportation of goods and services from
the firms.
5. It attracts high skilled and specialised labour. This implies that the localised area
enjoys a pool of skilled personnel at low costs hence efficiency in production.
6. It is easy for localised areas to get government support. It becomes cheap for the
government to provide service such as schools, electricity, and security because of the
significance of the area to the country.
7. It results into the development of forward and backward linkages lead to increased
industrialisation. Industries support each other by providing market for output from
other firms.
8. Leads to cooperation of industries in solving common problems. The firms try to
solve common problems since they able to share costs which reduces the burden
faced by each firm.
9. Wide variety of products is produced in the area. This is because of product
differentiation by the different firms.
10. Promotes the development of auxiliary services in the area. There is emergence of
other services to support production e.g. insurance companies, banks, etc.
11. Leads to increased utilisation of would-be idle resources. The increase in the number
of firms increases the demand for raw materials which increases there exploitation.
12. Promotes specialisation and its advantages. Firms specialise in the production of
certain products to avail inputs to other firms.
13. Leads to low prices of final products. The competition between firms creates
competition between which causes prices to fall.
14. Increased government revenue. The firms form an important tax base which increases
government revenue through taxation.
15. Increased reputation/popularity of the area. The products from the area become
popular because there are many firms involved in production.
16. Increased security of the area.
N.B: A forward linkage is where the established industry leads to development of another
industry that uses its products as inputs or raw materials.
Or
It is where one industry's output goes as inputs for another industry e.g. sugar industry prompting
the establishment of sweet or bread industries
Backward linkage is where an industry creates demand (Market) for other industries products
which it uses as its inputs e.g. sugar industry, creating demand for sugarcanes or sacks for
packing sugar.
DELOCALISATION OF INDUSTRIES
This is a deliberate government act of distributing industries throughout the country to avoid
concentration of industrial establishments in one particular area. It is done by the government
ECONOMIES OF SCALE
These are advantages of large scale production that a firm enjoys by way of reduced per unit
costs due to its good internal organisation or as a result of operation of other firms in a given
locality.
Or
They are advantages enjoyed by the firm inform of reduced average cost as a result of increasing
the scale of production. Under large scale production, output increases at a decreasing cost per
unit of production.
Under large scale production, output increases at a decreasing cost per unit of output.
In the short run, output can be increased by using more of the variable factors of production
while the fixed factor remains constant. In the long run however, the firm can vary all factors of
production to increase output. It will at first experience a fall in the average costs of production
to low point (optimum point) as output increases because of economies of scale.
However beyond its optimum, output is increased at increasing costs per unit thus it experiencing
diseconomies of scale leading to high average costs.
P0 A
Q0 Output
From the above illustration, point A is the optimum point of the firm where it incurs the lowest
average costs.
Before point A costs are declining as output increases. This is termed as economies of scale.
After point A, average costs are increasing hence the firm is suffering/experiencing
diseconomies of scale.
Economies of scale are represented by downward sloping portion of the long run average sloping
cost curve while diseconomies of scale are represented by the upward sloping portion of the long
run average cost curve.
1. Pecuniary economies
These are advantages of large scale production enjoyed by the firm inform of less
payments for the inputs used in production because it purchases these inputs in bulk e.g.
cash discount on purchases is considered pecuniary.
Or
They are advantages of large scale production that are enjoyed as a result of paying low
prices for factors of production e.g. land, labour, capital and distribution of good and
service.
2. Real economics
These are advantages enjoyed inform of reduced average costs due to reduction in the
physical quantity of inputs used in the production process. Or
These are ones enjoyed by the firm operating on a large scale in form of using less factor
inputs to produce a particular level of output e.g. saving on cement used in the making
blocks.
3. Internal economies of scale.
DISECONOMIES OF SCALE
These are disadvantages of large scale production that a firm experiences in form of rising per
unit cost of production as output increases, either due to internal factors or as a result of
behaviours of other firms.
5. Transport diseconomies. Transport costs increase because of many firms in an area which
compete for similar transport services, it also results into traffic congestion and hence
high transport costs of raw materials, Final products and workers.
6. Marketing diseconomies. As a result of localisation there is competition for market which
increases marketing costs the demand for raw materials increases leading to increase in
their prices hence increase in average costs.
7. Rural urban migration. The concentration of firms in an area encourages rural urban
migration with its associated problems. E.g. High crime rate unemployment etc., these
are expensive to control leading to increase in average costs.
1. They are less costly/easy to start. They are cheaper to set up as they do not require a lot of
capital and other forms of resources.
2. They are flexible thus there is less wastage. A change in tastes and preferences causes
minimal loses and it is easy to change from one line of production to another.
3. They are easy to control and manage. That is easily affordable since they do not require
more skills and employ limited labour.
4. They promote use of local technology and therefore are a means of technological
development. The firms in the long run are able to acquire better technology.
5. They encourage fair distribution of income. This is because they are easier to start and do
employ a large number of the population.
6. They provide cheap or affordable goods to the population and therefore improve people's
welfare. The firms enable low income earners get goods at fairly low prices.
7. They promote innovation and creativity and therefore contribute to the growth and
development of the economy. The owners engage in research which leads to better
production technics.
The optimum point refers to a point where firm incurs the minimum average costs.
An optimum firm is the one which operates at the minimum average cost and it is the most
efficient.
0 Q0 Quantity
Point a is the optimum point of the firm when firm is producing output less than 0 then it is
operating at excess capacity.
Excess capacity is a situation where by the firm or industry is producing at less than the installed
capacity O it is a state of underutilisation of available resources.
Costs of production are monetary expenses of the firm. That is they are total payments incurred
to produce a given level of output. Costs can be categorized as follows;
Social costs
A social cost of production is the opportunity cost foregone in production of one commodity
instead of another e.g. if a firm puts its inputs in production of say maize instead of using the
same resources in production of the beans. Then the social cost of producing maize is the beans
foregone by the firm.
From the illustration, total fixed costs remain fixed at cost C0 as output increases from Q1 – Q2
Total fixed costs start above zero because even when there is no output the fixed cost must be
incurred.
Total cost curve lies above the total fixed curve and the total variable curve. This is because total
costs are the sum of total fixed costs and total variable costs
When output is Zero, total cost = total fixed costs since there are no variable costs incurred.
Average variable cost curve is u -shaped in that it begins by falling reaches minimum and rises
as shown below.
AFC
Output
Average total cost /Average cost (ATC/A.C)
This refers to the total cost per unit output produced. It is the cost incurred in production of each
unit of output and is given the formular.
As output increases, marginal cost falls reaches a minimum and starts increasing continuously.
The revenue of the firm means the returns or proceeds to the firm after selling a given level of
output
Or
It refers to the firms earnings received from the sale of goods and services.
Revenue of a firm can be looked at 3 ways;
a) Total revenue
b) Marginal revenue
c) Average revenue
Total revenue (TR)
This is the total amount of money received by the firm as a result of selling its total output
produced in a given period.
Total revenue = Price (P) X Quantity (Q).
TR = P XQ
MARKET STRUCTURES
A market is an arrangement or an organisation in which buyers and sellers come together to
negotiate the exchange of a given commodity.
PERFECT COMPETITION
Is a market structure where there are many buyers and many sellers of homogenous products.
In reality this market does not exist because conditions in which it operates are quite ideal i.e.
unrealistic.
Pure competition: This is the market situation where there are many buyers and sellers of a
homogenous commodity but without perfect flow of knowledge and perfect mobility of factors
of production.
Equilibrium position of a firm under perfect competition in the short run or output, price
profit determination of a firm under perfect competition
In the short run period a firm maximises profits at a point where marginal cost = marginal
revenue (MC = MR), this is the necessary condition.
- In the long run, price is determined at a point where the output line meets the long run average
revenue/demand curve.
- Output is determined at a point where the long run average cost curve = long run average
revenue curve (LAC = LAR)
- Costs are determined at a Point where the output line meets the long run average cost curve i.e.
point A
- Normal profits are earned since the long run average cost = long run average revenue. This is
because of the freedom of entry and exit to firms into and out of the industry which competes
away the abnormal profits earned in the short run.
The breakeven point is at point A where MC = AR and the breakeven output is 0Q1
Shut down point or a firm refers to the point below which a firm cannot cover its average
variable costs. (AR =A.V.C)
Or
It is a point where the firm covers only its Average Variable costs. At shut down point AR =
AVC = MC
Point B is the shutdown point at which the firm is in position to cover only the average variable
costs corresponding output 0Q2 which is the shutdown output.
Reasons why a firm continues to operate even if its Average costs is greater than average
revenue (AC>AR) (Even if its revenue does not cover the fixed costs)/when it is making
losses
1. It may he hoping to merge such that the average costs will reduce when the firm have
merged
MONOPOLY
This is a market structure where there are many buyers and one seller /producer of a commodity
with limited or no close substitutes.
Pure/absolute/perfect monopoly
This is a market situation in which there are many buyers and one seller of a commodity that has
no substitutes at all.
Imperfect monopoly
This is a market situation in which there are many buyers and one seller of a commodity that has
limited close substitutes.
Types of monopoly
Bilateral monopoly
This is a situation where there is only one producer /seller and one buyer of a single commodity
e.g. a trade union and the employees association.
Natural monopoly
This is a type of monopoly which arises from exclusive ownership of a strategic raw material or
natural resource.
Spatial monopoly
Partial monopoly
This is monopoly which exists when a firm is a sole distributor of a particular brand of a product.
It is a type of monopoly which is brought about by product differentiation.
Statutory monopoly
This is monopoly that results from the government statutes or from acts of parliament that stops
other firms from entering into the industry e.g. UNEB and National social security Fund
(NNSF).
Collusive /Collective monopoly
This is the type of monopoly that comes as a result or merging of firms
Price
Output
Profit maximisation under monopoly in the short run.
Under monopoly, the firm maximises profits when it is in equilibrium at a point where marginal
cost is equal to marginal revenue. (MC = MR.)
N.B: The demand curve for a monopolist is the same both in the long and short run because of
the restricted entry of new firms in the industry that enables it to earn abnormal profits both in
the short run and in the long run.
Features of monopoly
1. There is only one producer or one firm in the industry due to some limitations that keep
other firms from entering.
2. The commodity produced by the monopoly firm has limited or no close substitutes
3. Entry of new firms into the industry is blocked that is no new or other firms are allowed
to enter the industry both in the long run and the short run
4. A monopolist is a price maker of his commodity. This means that the monopolist
determines the price at which to sell the commodity but cannot determine both the output
and price therefore he can either determine the output or price
5. A monopolists produces at excess capacity i.e. he underutilises resources with an aim of
producing less output to create shortage so as to sell at high prices
6. Under monopoly the firm is the industry and the industry is the firm because there is only
firm in the industry
7. The demand curve for a monopolist is fairly inelastic that is it is down ward sloping from
left to right.
8. There is no persuasive advertisement under monopoly but can have informative
advertisement. This is because there are no competing firms and no close substitutes.
1. Ownership of a strategic raw material. This is where a firm controls the source of a raw
material used in the production of a given commodity. Therefore no any other firm can
access the strategic raw material leading to natural monopoly.
2. Protectionism. This is when there is use of foreign trade restrictions like tariffs, quotas,
total ban etc. to protect a home industry from outside competition which results into
monopoly.
3. Long distance between producers. Monopoly arises due to long distance between
producers such that each producer becomes a monopolist in his/her own locality/area.
This is because buyers in each locality find it difficult to cross to another producer to buy
commodities because of high transport costs.
4. Patent and copy rights. This is where the government gives legal rights to an individual to
produce of a given product e.g. text books and films. And therefore they become the only
produces of those products for a given period of time.
5. High initial capital requirement. There are some investments which require large sums of
money and are expensive to undertake and therefore it is impossible for new firms to set
up and compete with the existing firm.
6. Through acts of parliament. The government establishes and controls certain enterprise to
avoid duplication of service and resource wastage. The provision of such service is not
open to competition hence monopoly.
7. Merging of firms. This is where firms producing similar/related products or related goods
come together to form one big firm
8. Possession of special talents. People who have special talents become monopolist in the
supply of certain services e.g. Musicians, footballers and comedians.
9. Long period in training. A long period of training in a specific field leads to monopoly
because it takes a long time before a competitor emerges. This is more especially with
consultants like doctors, engineers etc.
10. Possession of exclusive technology. When a firm attains excusive technology to produce
a given product; it becomes a monopolist because other firms are not able to produce a
product to compete.
11. Through product differentiation. This is leads to monopoly when a producer is in position
to produce certain products and brands, which limit other firms entering the market.
12. Small size of the market. The market may be too small to support more than one firm and
therefore only one firm is left into the industry.
Advantages of Monopoly
1. A monopolist is able to enjoy economies of scale which results into reduced average
costs of production. This is because a monopolist is able to expand the size of the firm
since he is the only seller.
Disadvantages of monopoly
1. There is excess capacity i.e. underutilisation of resources. Monopolists underutilize
resources such that they produce less than their full capacity in order to maximise profits
by charging high prices.
2. Leads to problems of income inequality. This is because of the o abnormal profits that
made by a monopoly firms both in the short run and long run hence they earn excessive
profits at the expense of the society which leads to income inequality.
3. Limited variety/Lack for choice for consumers. There is absence of variety of products
because there is no product differentiation thus limited choice and therefore a low
standard of living.
4. Shortages especially in time of break down or in case of any calamity or war. If the firm
breaks down, the entire community faces shortages of output one market since there is
no alternative supplier.
5. Low quality commodities are provided. The quality of final products under monopoly
tends to be low due to absence of competition in production.
6. There is exploitation of workers by way of under paying them since the employer is
aware that the worker may not alternative employers.
7. High pressure is exerted on government especially in decision making. The huge
economic power of monopolists is transformed into political power as monopoly firms
exert pressure on the government to influence decision making so that favourable
policies are put in place.
8. Underemployment and unemployment of labour exists. A monopolist doesn't have
capacity to provide wider employment opportunities to members of the society.
Price discrimination refers to the act by a producer/monopolist/ a seller charging different prices
for a similar product to different groups of consumers.
E.g. the firms using price discrimination include hotels, UMEME, Saloons, National water and
Sewerage Corporation.
(b) Marginal cost pricing: This is a situation where the government fixes a minimum
price for the monopolist that is equal to the marginal cost. This one causes the monopolist
to increase his output however he may make losses which may be covered by subsides
from the government that is MC = AR
2. Taxing the producers. The government may /can impose high taxes on the products sold
by monopolists to reduce their profits. Taxes which can be imposed on the monopolist
are lump sum tax and specific tax.
(a) Lump sum tax: This is a tax imposed on a monopolist regardless of the level of output
produced. It is regarded as a fixed cost to a monopolist.
Effects of Lump sum
a) Average cost increases
b) Monopolists profits reduce
c) Marginal cost remains unchanged
d) Price remains unchanged
e) Output remains constant.
(b) Specific tax. Tax imposed on each unit of output produced. It is therefore variable
cost to a monopolist.
Effects of a specific tax
a) Average cost increases
b) Marginal cost increases
c) Price increases.
d) There is a reduction in output.
e) Profits reduce.
3. Setting up of rival firms. The government can set up or encourage the setting of rival
/firms to produce the same products or close substitutes so as to create competition which
will make a monopolist to improve the quality of his products.
MONOPOLISTIC COMPETITITON
This is a market structure where there are many buyers and sellers dealing in differentiated
commodities.
Monopolistic competition lies between monopoly and perfect competition and therefore
combines elements of both. E.g. those that deal in soft drinks, bread industry, soap industry etc.
N.B Production differentiation is a practice of creating artificial differences between products so
that to the consumers they appear not similar.
Production differentiation is the practice by producers in an imperfect market to creating
artificial differences.
Features of production differentiation
1. Differentiated packaging
2. Different branding
3. Different colour
4. Persuasive advertising
5. Different designs
6. Different shapes
7. Different scent. Etc.
Price is determined where the output line meets the AR/DD curve that is at point X
Costs are determined where the output line meets the AC curve at point Y.
At equilibrium output profits are maximised when AR > AC
The firm earns abnormal /Super normal profits as shown by the shaded rectangle C0P0XY.
Long run equilibrium position of the firm under monopolistic competition making normal
products
Price is determined where the output line meets the AR/DD curve where the AR is tangential to
AC i.e. at point x.
In the long run the firm earns normal profits this when AR=AC because other firms enter and
compete way the abnormal profits.
Advantages of monopolistic competition
1. There is production of high quality products. This is because there is competition
between firms that are producing goods and services.
2. Consumers are able to enjoy a variety of products. This because of product
differentiation which widens their choice.
3. Abnormal profits are earned in the short run. These are used for expansion of firms in
the country/industry.
4. Low prices are charges compared to the prices that are charged under monopoly. This is
due to the competition in the industry.
5. High output is produced. This is due to the presence of many firms in the long run.
6. Persuasive advertisement enables firms expand market for their products.
7. It is a source of government revenue through taxation.
8. Provide employment opportunities. This is because there are many firms in the industry.
9. Monopolistic competition promotes innovations and inventions. The competition in the
industry makes firms engage in research in order to have better techniques of production
Difference and similarities between pure monopoly and monopolistic competitive markets
Differences
1. In pure monopoly, there is only one firm/seller while in monopolistic competitive
markets there are many producers. i.e. there is no competition in pure monopoly while
competition exists in monopolistic competition.
2. In pure monopoly market, entry is blocked while in monopolistic competitive markets
there is freedom of entry in the industry.
3. In pure monopoly market, there is no persuasive advertisement while in monopolistic
competition it is there.
4. The demand or average revenue curve in pure monopoly is inelastic while that of
monopolistic competition is fairly elastic (Elastic).
5. In pure monopoly market one product without substitutes is produced while in
monopolistic competitive markets firms produce differentiated products.
6. In the long run, pure monopoly firms earn abnormal profits while in monopolistic
competitive markets; firms earn normal profits in the long run.
7. In pure monopoly, a firm practices price discrimination which is not the case with firms
under monopolistic competition.
Similarities
1. Existence of excess capacity in both markets
2. The producers/sellers/firms in both market situations are price makers.
3. The demand or average revenue curves are down sloping in both markets from left to
right.
4. The firms in both market situations earn abnormal profits in the short run.
5. Both markets attain equilibrium output at point where price equals average revenue but
greater than MR = MC.
6. In both market situations there are many buyers/consumers.
OLIGOPOLY
This is a market structure where there are few firms of different sizes with many buyers dealing
in either differentiated or homogenous products.
Types of oligopoly
1. Perfect oligopoly. This is a market situation where there are few producers and many
buyers of homogenous products.
2. Imperfect differentiated oligopoly. This is a market structure where there are few large
firms with many buyers dealing in differentiated products.
3. Duopoly. This is a market situation where there are two producers/sellers and many
buyers of commodities which are close substitutes. e.g. the cement industry, soda
industry (Century bottling company, and crown bottling).
4. Duopsony. This is a market structure where there are only two buyers but with many
producers of a commodity.
6. Oligopsony. This is a market situation where there are many producers with few buyers
of closely related commodities.
Price
P0
0 Q0 Quantity
The demand curve of an oligopolist is kinked because of the differences in the elasticities of
demand at different price levels i.e. the demand curve has got two portions; the upper portion
being elastic and the lower portion is inelastic.
This is because if one firm charges a higher price above the administered price (0P0), other firms
will not follow suit and therefore, its demand will fall by relatively a bigger percentage (elastic),
but if a firm fixes the price below the administered price other firms will fear to lose customers
and therefore will reduce on prices even at a lower level to form cut throat competition or they
may divert to non-price competition making demand change by a small percentage (inelastic).
The short run and long run equilibrium position and profit maximisation of a firm under
oligopoly
The firm under oligopoly maximises profits at the point of equilibrium where MC = MR.
National income is the measure in terms of money the value of all goods and services produced
with in a country over a given period of time/year.
In national income accounting there four types of national income figures that an economy may
compile depending on the data/information that is used in compiling the figures. The forms that
national income may take include:
This the money value of all goods and services produced within the territorial boundaries of a
country during a specific period of time usually one year.
It is the national income produced within the territorial boundaries by both the nationals and
foreigners living in that country in a year. It includes the sum total of money value of all goods
and services resulting from productive activities within the economy irrespective whether
production is by nationals or foreigners living in a country.
Sectors that produce within an economy include households (C), business sector (I), the
government sector (G), plus the depreciation incurred in production of goods and services.
Therefore GDP= C+ I + G + depreciation.
This is the money measure of goods and services produced within the territorial boundaries of a
country during a given period of time usually a year excluding the value of depreciation. It is the
country‟s GDP less the depreciation
This is the money value of all goods and services produced by the nationals over a given period
of time excluding the value of what is produced by foreigners living in that country. It is the
money value of goods and services produced by the nationals of a country living with in a
country and those abroad during a given year.
It excludes the value produced by foreigners living within the country and does also not take into
account the depreciation of capital equipment.
This refers to the difference between income earned by the nationals of a country abroad and
income earned by the foreigners in a country in a given period of time usually a year.
This is the money measure of goods and services produced by nationals living within and outside
the country during a year excluding the value of depreciation.
Depreciation/capital consumption
This refers to the wear and tear of capital goods during the production process i.e. it is the loss of
value of capital goods.
Causes of depreciation
1. Per capita income: This means the average income of an individual of a given country in a
particular year. It can also be defined as income per head.
3. Real income: This is the value of goods produced with in a period of time when valued at
4. Personal income: This refers to earnings received by individuals from all sources in a year
before direct taxes and other compulsory payments are deducted. i.e. It includes income from
transfer payments, pensions, grants, etc.
5. Disposable income: This refers to the income of an individual that remains after direct taxes
and other compulsory payments have been deducted that can be consumed or saved.
6. Real income per capita – Is the average income valued at base year price.
Or
Average income of the people in terms of quantity of goods and services it can purchase.
While
7. Nominal income per capita – Is the average income of population in monetary terms. /The
average income valued at current price.
8. Nominal gross domestic product – Refers to GDP/one/national output valued at current
year price. or
The total monetary value of all final goods and services produced within a country in a given
period of time valued at current year prices.
While
1. National income figures are useful for economic analysis and planning/research purpose.
Planners use the national income figures to allocate resources according to areas of need.
2. The figures show the level of standard of living by way of per capita GNP. A high national
figure indicates the country is experiencing a higher standard of living and vice versa.
3. It indicates the rate of economic growth and development. An increase in the national income
figures indicates increase in the rate of economic growth rate and vice versa.
Discuss the factors that affect the size of national income in your country.
1. Availability and utilisation of resources: These include land, capital stock and
organisation of factors of production in the right proportions. When the available natural
resources are well utilised there is high level of output because firms have inputs/raw
materials to use in production and this leads to a high level of national income while
when the available resources are not well utilised national is low because of limited
availability of inputs/raw materials.
2. Policy of government on production and investment: A favourable government policy
in form provision of investment incentives encourages production because low costs of
production are realised hence there is high national income while a unfavourable
government policy such as high taxation leads to high cost of production and therefore a
low level of national income .
3. State and level of technology: Use of modern technology results in high efficiency and
therefore high level of national income, poor technology is a hindrance to the growth of a
country‟s national income because of low efficiency.
4. The political situation or extent of peace and security: A stable political atmosphere
attracts both local and foreign people to invest because there is less threat to property and
lives hence more production and national income, and unstable environment is a threat to
local and foreign investors, destroys property and hence low output and low national
income.
5. Level of infrastructure development both social and physical. Well-developed
infrastructure such as roads, railways, etc. leads to high national income because it lead
to a low cost of production which encourages production while poor infrastructure leads
to low level of national income because of the high cost of production that discourages
production.
There are three approaches or methods of measuring national income. These are:
If we wish to calculate the total money value of goods and services produced and sold during a
year, it can be done in any of the three ways.
1. We can add up market expenditure by final consumers including purchase of final goods
by firms.
2. We can add up all incomes received by individuals who have contributed to output but
excluding incomes from un productive activities and all forms of transfer payments.
3. We can find out the value of each of the firms contribution to total output i.e. value added
or net output of all the firms. This gives the valued added approach.
The above three approaches are the three ways of deriving the same total. Algebraically we can
express the above relationship as O = Y= E
Where O represents the output approach Y the income approach and E the expenditure approach.
To understand the relationship between the three approaches we use the circular flow of income
and expenditure in a two sector model/simple economic system (closed economy).
This is the movement of income and expenditure among the sectors of the economy and these
are:
b) The business sector. These are productive firms which use the factors of production to
produce goods and services.
1. It assumes a closed economy (autarky) i.e. an economy that does not engage in
international trade.
2. It assumes that all factors of production are owned and provided by the house hold sector.
3. The house hold sector comprises a consuming class i.e. all consumption takes place in the
house hold sector and no production takes place in this sector.
4. That all production takes place in the business sector and that no consumption takes place
in this sector.
5. There is no saving by the households and business sector i.e. all income earned is
automatically spent.
Following the assumptions above the circular flow of income is as illustrated below:
Arrow 4 shows that what is received by the firms from the sale of final goods equals
house hold expenditure on them.
Arrow 3 indicates household consumption of output produced by firms.
Arrow two shows that households supply factors of production to the firms.
Arrow 1 indicates firms spending on factors of production.
The amount spent by firms goes to the owners in terms wages for labour, interest for capital, rent
for land and profits for entrepreneurs. This income payment is denoted as Y. The whole income
received by firms must go out again as factor income payments since whatever is not paid as
wages, interest or rent must be profits. Therefore O = Y (output = Income).
Finally we assume that households do not save out of their incomes. Therefore expenditure by
households = what is obtained as factor payments i.e. Y = E. Therefore O = Y. it therefore
follows that O = Y = E (the three methods of getting National income).
This method involves adding up the total values added to the output at each stage of the production
process in a year. Or it involves summing up of the money value of final goods and services from all
productive activities of the economy in a given year. e.g. agriculture, industry etc.
1. Inadequate data. There is difficulty in knowing the contribution of the value added
by the enterprises within a year. This problem is worsened by the limited qualified
personnel to collect the information from productive units.
2. The problem of inventories. These are goods that are produced during a certain year
but sold in the following year. It is not easy to value such goods and the prices at
which the goods should be valued are not clear.
3. It is not easy to distinguish between final and intermediate goods and this may result
into double counting.
4. Problem of subsistence output. These are goods that are produced not sold.
Attaching values to goods is a problem since they are not taken to the market.
5. Statistical errors of over valuing or undervaluing the output.
6. Defining the boundary of production is difficult i.e. what include or exclude, e.g.
whether to include subsistence output or not.
This method involves adding up the total final money value of all the incomes received by the factors
of production or persons and enterprises for rendering services in an economy in a year. These
include rent, wages/salaries, interest and profits that go to factors of production. Therefore National
income = W + I + R + P.
NOTE: In this method the following are not included; transfer payments/transfer incomes
(unemployment benefits, grants, gifts, pensions etc.) because they are non-quid-pro-quo and
illegal activities such as robbery, smuggling etc.
Problems faced when calculating national income using the income approach
Using this method national income is obtained by adding up public and private expenditure on final
goods and services during any given year. Therefore total national expenditure = Household
expenditure (C) + Investment expenditure (I) + Government expenditure on goods and services (G)
and overseas buyers (X-M). Therefore National income = C + I + G + (X- M)
EXPENDITURE METHOD
In theory it is a relatively straight forward matter to measure the national income of a country. In
practice however, many problems are encountered when compiling national income statistics and
below are those that deserve mention:
1. Inadequate information/data. Statistical services are poor and some people give false
information to escape taxation, in addition the high levels of illiteracy and insufficient
funds make compilation of good information difficult. This leads to underestimation
of national income.
2. Difficulty in valuing subsistence output. This results into using an imputed
value/estimated that either exaggerates or under-estimates the national income.
3. Unpaid for services/work done oneself. It is difficult to determine the value of unpaid
for services and as result they are ignored which leads to low level of national
income.
4. Errors of omission and commission. Errors of omission result into underestimation of
national income because some information is not included while errors of
commission result into exaggerated national income because some information is
included when it should not.
5. Problem /difficulty in valuing depreciation. Valuing of depreciation is difficult
because different firms use different methods and this makes it difficult to determine
the net output.
6. Shortage of trained personnel/equipment. This makes gathering of data difficult as it
results into inaccurate information being gathered
7. Danger of double counting e.g. transfer payments. This results from the failure to
distinguish between final and intermediate goods which exaggerate the national
income.
8. Problem of estimating net income from abroad. Obtaining the figures of income from
abroad is difficult because some of the nationals are not willing to reveal their
incomes and a number of those working abroad is sometimes not known.
9. Problem of defining the boundary of production. This involves the difficult of
determining what to include or not to include and therefore when a lot is included
national income is exaggerated and when some items are left out national income is
under estimated.
10. Difficulty in valuing inventories/work in progress. At times production of some
commodities starts in one year and extends into another year and there is therefore
difficulty in determining in which year it should be considered.
1. Discuss the factor responsible for the low level of national income in your
country.
2. Suggest measures that should be taken to increase national income in your
country.
1. Ensuring political stability. This is attracting local and foreign investors because they
are assured of security for life and property which increases the level of investment
and production.
2. Improving technology. This is realised through increased research and therefore
better technology is used which increases efficiency in production.
STANDARD OF LIVING
Standard of living refers to the conditions of life in which people live or aspire to live. Or it is
the measure of the level of human or social and economic welfare of an individual or society as
represented by the basket of goods consumed. Or it is the minimum of necessities or luxuries of
life which a person or group of people may be accustomed to.
Cost of living refers to the amount of money required by an individual to sustain life style
accustomed to.
This is the average income per head in the country. It is the money value of goods and services
available per person in a country in a year. Dividing the national income figure by the population
gives the per capita income. The concept of per capita income enables us to know the average
income and standard of living in a particular country. Per capita income can be computed over
years in a given country or used to compare standards of living between two or more countries.
When per capita income rises over time it may be an indicator of improvement in economic
growth as well as improvement in the standards of living.
1. It does not take into account the type of goods produced in the country. Per capita
income may be high in a country which is producing capital goods yet these do not
improve peoples‟ lives directly.
2. It does not consider leisure fore gone/long hours of work. Per capita income may be
high in a country where leisure is foregone, people over work themselves and as a
result they do not enjoy a high standard of living.
3. It does not take into account the distribution of income. Per capita income may be high
when income is concentrated in the hands of few individuals implying that majority of
the people have a low standard of living since there purchasing power is low.
4. It does not take into account the political situation in the country. Per capita income
may be high because of heavy government expenditure to stabilise the country and yet
people are living in fear for their lives which implies that people are having a low
standard of living.
5. It does not consider the quality of goods produced. Per capital income may be high
because of production and consumption of poor quality goods means that the people are
experiencing a low standard of living.
6. It does not take into account price levels. Per capita income may be high because of
high level of inflation in the country that exaggerates implying that in actual sense
people have a low standard of because of the high cost of living/low purchasing power.
7. It does not consider the level of subsistence sector. Per capita income may be low when
people produce at subsistence level but this does not mean that people are experiencing
a low standard of living because they have what to consume.
8. It does not consider social costs. Per capita income may be high because of high level
of industrialisation yet it causes a high level of pollution which negatively affects
peoples‟ health.
9. Does not consider working conditions. Per capita income may be high when workers
are working under harsh conditions which negatively affect peoples‟ lives.
10. It does not take into account the pattern of government expenditure. Per capita income
may be high when much of government spending is on non-productive ventures which
do not improve peoples‟ welfare directly.
(a) What are the limitations of using per capita income to compare welfare/standard of
living of people in a country over time?
(b) Limitations of using per capita income to compare standard of living of people in a
country over time
1. It does not take into account changes in income distribution over time. Per capita
income may be high in one period but when there is high income inequality meaning
that majority are not able to purchase goods and services and low in another period
when but there is equitable distribution of income implying that there are many people
who can afford goods and therefore a high standard of living.
2. It does not consider changes in nature of goods over time. Per capita income may be
high when capital goods that do not improve peoples‟ welfare directly are produced
implying a low standard of living but low in another period when consumer goods that
improve peoples‟ welfare are produced implying a high standard of living.
3. It does not consider changes in the amount of leisure foregone over time. Per capita
income may be high in one period when people are over worked and do not have time
for leisure meaning that they have poor health and low in another period when people
are enjoying leisure and therefore having a high standard of living.
4. It does not take into account changes of working conditions over time. Per capita
income may be high in one period but when employees are subjected to poor working
conditions and thus a low standard of living and per capita income may be low in
another period but when employees are experiencing good working conditions thus a
better standard of living.
5. It does not consider changes in expenditure pattern of government over time. Per
capita income may be high in one period when government expenditure is on non-
essential goods implying a low standard of living but low in another period yet
government expenditure is on essential goods that improve peoples‟ welfare hence a
high standard of living.
6. It does not consider the changes in the quality of goods produced over time. In one
period per capita income may be high when there is mass production of poor quality
goods hence a low standard of living but low in another period when good quality
goods are produced implying a better standard of living.
Explain the problems of using per capita income to compare standard of living between
countries
Problems of using national income and per capita income figures for comparison between
countries
Both national income and per capita figures are not definite indicators of economic welfare of
the people of a country. National income figures are aggregates while per capita figures are
averages and so problems that may arise in using these figures for comparison are:
1. It does not take into account differences in inaccurate estimates of population. A large
national income figure does not necessarily imply a high standard of living because
population figures of various countries are taken into consideration. In developing
countries population figures are not accurate thus per capita income obtained is not
accurate and therefore is not a good measure of welfare.
2. It ignores differences in price structures between countries. Countries value their
productive activities differently and this makes it difficult to compare living conditions
between countries e.g. servants in developing countries are cheap while in the developed
countries they are expensive and rarely used. This implies that a country with high price
structures may end up with high per capita income when the standard of living is low.
INCOME DISTRIBUTION
This refers to the distribution of income among the various social groups or between citizens
within a country. The resources may be equally distributed or inequitably distributed (income
inequality).
Income equality
This is a state of imbalance in resource allocation and or ownership. It is a situation where there
is inequitable distribution of wealth such that there exist the very rich and the very poor in
society.
The nature of inequality is such that it may exist between individuals, regions, sectors r with in a
given sector of the economy.
Types of inequalities
1. Individual inequality. This is a situation where there those who are educated
leaving a long the illiterate ones, some people are poor co-existing with the rich.
The difference is due to differences in income, education attainment, sex, age etc.
Measuring inequality
To measure inequality in country and measure this phenomenon among countries more
accurately, economists use the Lorenz curves and Gini indices.
This is a graph which shows overall distribution of income among the population. It shows the
percentage of GNP allocated to any percentage of the population as illustrated below:
Per of
GNP
50
10
A 50 Percentage of population
1. Differences in resource endowment. Areas that are endowed with resources e.g. land,
climate have higher and fairer distribution of income than those areas with limited
natural resources because people tap them and get income.
2. Differences in talent/natural abilities. Highly talented individuals e.g. footballers,
athletes, etc. have higher incomes than those people with limited natural gifts. This
because the highly talented contribute more to output than the less talented
3. Differences in levels of education and training. People with higher education
attainments secure better paying jobs and therefore better payments because they
have high efficiency while those with low levels of education are paid less because of
low levels of efficiency.
4. Differences in accessibility to developed infrastructure. Areas with better
infrastructure e.g. schools, hospitals, etc. have high incomes because of high levels of
production while those with poorly developed infrastructure have low incomes
because of low levels of production since production costs are higher.
5. Differences in the degree of political climate/state of security. Areas which are
politically stable have higher production levels and therefore higher incomes because
people are assured of security for life and property while areas with political
instability have low levels of investment and production and therefore low levels of
income because investors are uncertain about the future.
6. Political influence in the allocation of resources in favour of certain regions/sectors.
Areas that are favoured in terms of allocation of resources experience higher levels of
output and incomes because more resources are availed than those that are less
favoured.
7. Discrimination in the labour market on the basis of gender, age etc. those who are
favoured get higher pay while those that are disfavoured do not get jobs and therefore
do not earn.
8. Non-matching wage policy by the employers. Some employers are given more than
others. Those in a higher scale get higher wages than those in a low scale.
9. Differences in family or social background. People from rich family background
continue being rich because of inheriting property/income yet those born in humble
situations usually remain poor because there is no wealth to inherit.
10. Differences in seniority or experience. Senior members of staff get higher pay than
the juniors because senior employees have high productivity/efficiency than junior
employees.
11. Differences in the quantity of output produced a case with piece rate. Employee who
are more productivity earn more income because of their greater contribution to
1. It encourages hard work. The poor are encouraged to work hard so as to catch up with the
rich and the rich try to distance themselves in terms of wealth.
2. It encourages investment by the rich. The rich have a high marginal propensity to save
and therefore there are high levels of investment because they have the funds to purchase
production inputs.
3. It broadens the tax base because government axes the poor and the rich at different rates.
4. It stimulates government efforts to adopt policy programmes to alleviate poverty in
society and therefore the government makes appropriate income policies.
5. It encourages mobility of labour (geographically and occupationally). Labour mobility
enables people to acquire employment.
6. It improves labour relations i.e. it creates harmony between the employees and employers
i.e. the poor respect the rich.
7. Income inequality is a source of cheap labour and as a result the production cost is
reduced.
8. It results in to social balance and stability among individuals since naturally people‟s
incomes can never be the same.
9. Uneven distribution of income encourages inventions and innovations as the poor try to
imitate the rich and the rich try to maintain their lead.
1. It leads to under development. This is because the poor have limited capital to invest in
the productive activities.
2. It leads to small market. With the poor dominating there is low aggregate demand and
thus the low levels of investment and development.
3. It encourages brain drain. The poor people are encouraged to live the country to find the
better opportunities elsewhere as a result the economy loses a lot of human capital for
development.
4. It creates and encourages rural and urban migration resulting into social economic
problems such as decline in agricultural production in rural areas neglect of families etc.
5. Social unrest and political strikes develop as a result of disparity that exists between the
poor and the rich i.e. the poor become hostile to the rich.
6. Social evils are promoted and these include theft, robbery, and prostitution. And the
result is high cost of eliminating these evils.
7. Misallocating of resources these exist as most productive resources may be channelled to
production of luxuries that the rich demand at the expense of the poor masses going
without the basic cheap essentials.
8. Government planning becomes difficult since inequality in society creates a number of
economic and social classes with diverse needs i.e. education medical health care which
the government maybe not in position to provide adequately.
9. Low revenue to the government is generated i.e. low tax revenue is generated because the
poor have low capacity to pay taxes and the government is unable to provide adequate
basic necessities e.g. roads, education etc.
10. Leads to dependency burden i.e. dependency of the poor on the rich. This perpetuates
poverty in society because savings and investments are low.
11. Leads to exploitation of the poor by the rich. The rich enjoy the services of the poor at un
reasonably cheap rates by taking the advantage of the poor who are rather desperate and
in need of basics for the survival.
Measures that have been adopted to minimise uneven distribution of income in Uganda
1. Introduced Education reforms. There has been improvement in the education system
through expansion of facilities that allow many have access to education and this has
improved skills of individuals enabling get jobs.
2. Reformed the land tenure system. This has made it easy for individuals and investors to
access land for production purposes thus increasing earnings.
3. Progressive taxation. Progressive taxes such as P.A.Y.E have been used with the rich
paying more than the poor and money obtained used to subsidise the poor.
4. Improved infrastructure. Efforts have been made to construct and rehabilitate
infrastructure in different parts of the country and therefore reducing the cost of
production and also increased accessibility to market enabling individuals earn income.
5. Liberalised the economy. The government has liberalised the economy making it possible
for more people to participate in production without unnecessary restrictions and thus
increasing employment opportunities.
In this sub topic attention is given to the factors that determine the level of income in an
economy and how equilibrium income level is attained in an economy. In order to understand
this better, the factors that determine income and possibly the factors that influence the
equilibrium level of income shall be considered.
A closed economy is one that is not involved in international trade. It is one that is self-reliant
and has no foreign interference. In a closed economy without government participation the main
factors that determine the country‟s income level are Consumption (C), Savings (S), and
Investment (I). This means that the country‟s income can be used for consumption or savings.
Savings are leakages. Leakages are elements that reduce the circular flow of national
income.
An open economy
This is one in which there exists government intervention and an economy participates in
international trade. The country‟s income level can be determined by consumption spending by
all households (C), savings (S), taxation (T), import expenditure (M), and capital outflow,
government expenditure (G), investment (I), and export earnings (X).
In this case the leakages are; savings, taxes, import expenditure and capital outflow. To maintain
the same level of income there must be injections and these are; government expenditure,
investment, export earnings and capital inflows. This is as illustrated bel
Injections
Leakages injections
Taxes Investment
Investment
Import expenditure
Government expenditure
Capital outflow
Capital inflow
According to the classical economists, equilibrium income is attained at the level where
Aggregate demand (AD) is equal to Aggregate supply. i.e. at this point of equilibrium the
economy is at full employment. The classical economists believed that at equilibrium income
level leakages are equal to injections and since resources are automatically fully employed there
is no need for government intervention.
However Keynes disagrees with the classical economists. He says that full employment level of
income may not necessarily be equal to equilibrium income level. He says that:
1. Full employment level of income may be equal to equilibrium income level (Yf=Ye).
2. Full employment level may be greater than equilibrium income level thus giving rise to
a deflationary gap.
3. Full employment level of resources may be less than the equilibrium level of income
thus giving rise to an inflationary gap.
The above two possibilities (ii and iii) indicates the need for government intervention to bring
the economy to general equilibrium. Disequilibrium in an economy is expressed by inflationary
and deflationary gaps.
This is a situation in an economy where aggregate supply exceeds aggregate demand at full
employment level of national income. In other words aggregate demand is not sufficient to
generate full employment level of production. I.e. realised investment is greater than demand and
this leads to unconsumed goods/inventory accumulation
Aggregate demand E d AD = C + I + G + (x – m
0 ye yf National income
Point E is at equilibrium level of income but since it is less than full employment level of income
it means that some resources are idle (unemployed). This point can also be called the
unemployment equilibrium. The deflationary gap can be reduced by increasing aggregate
demand. The policies that government can be used to close the deflationary gap include:
This is a situation in an economy where aggregate demand is exceeds aggregate supply at full
employment of income. It means that realized investment is less than actual demand implying
that what is supplied is not enough. This will result into inflation. The inflationary is as
illustrated below:
&
Aggregate demand AD = C + I + G + (x – m
0 ye yf National income
Saving refers to the act of abstaining from current consumption to create funds for future
use.
Whereas
Savings refer to the proportion of income which is not spent on current consumption but
set aside for future use.
1. Level of income. The higher the income the higher the savings and the lower the income
the lower the savings.
2. The rate of inflation/The price level. A high rate of inflation leads to low savings because
individuals spend more of their income on goods and services while low rate of inflation
leads to low spending hence higher savings.
3. The government policy on savings. A favourable policy leads to high savings such as
encouraging saving and cooperative organizations while an unfavorable policy leads to
low savings
4. The interest rate. A low rate of interest on savings leads to low savings because people
are not attracted by financial institutions while a high interest attracts people to save
hence high savings.
5. The people‟s spending habits. The high the spending the lower the savings because there
is less money left while a low level of spending leaves one with more money to save.
6. The level of development of commercial banks and other infrastructure or institutions.
7. The population growth rate. A high population growth leads to low savings since much of
the income is used to purchase goods while low population growth rate leads to high
savings since there is less spent on goods and services.
8. The degree of monetisation/Commercialisation of the economy.
9. The degree accountability in the financial sector. Low level of accountability discourages
people from saving thus low savings and vice versa.
10. The level of taxation and subsidization. High taxation leaves one with low income hence
low savings while low taxes lead to high incomes of individuals hence high savings
11. The existing stock of wealth.
12. The marginal propensity to save/The marginal propensity to consume.
CONSUMPTION
Consumption refers to the act of using a commodity or resource to satisfy ones needs.
1. Level of disposable income. High level of income means a higher purchasing power
hence high level of consumption and when the income level is low the purchasing power
is low hence low level of consumption.
2. Availability of goods and services. Scarcity of goods and services brings about low
consumption levels and vice versa.
3. Price level/inflation. High prices cause low levels of consumption because of reduced
disposable income which causes low demand while low price lead to high disposable
income hence high consumption.
4. Government policy/taxation and subsidization. High taxes lead to low levels of
consumption because they reduce the purchasing power while subsidization leads to high
consumption since it increases the purchasing power.
0 200 -200
1200 1200 0
The table above shows that there can be consumption at zero income. This is called dis-saving. It
should be noted that one‟s income can be used for consumption or saving. (Y = C+ S)
This refers to the proportion of total income that is consumed rather than saved. It is given by the
formula:
Total income
This refers to the proportion of total income that is saved rather than consumed. It is given by the
formula:
Total income
Note: As income increases APC declines because the proportion of income spent on
consumption reduces. APS increases with an increase in income.
APC + APS = 1
This refers to the proportion of change in total income that is saved rather than being saved. It is
the change in consumption due to change in income. It is given by the formula:
This refers to the proportion of change in total income that is saved rather than being saved. It is
given by the formula:
INVESTMENT
OR
Investment refers to the process of devoting a person‟s or nation‟s income to creation of capital
stock/capital goods.
1. Offering of investment incentives e.g. tax holidays. These are reducing the cost of
production and therefore attract more investors.
2. Building of strong and sound infrastructural facilities. These make it easy to access
markets of inputs and final goods and reduce the cost of production.
3. Ensuring peace and political stability in the country. The use of democracy in governance
is assuring investors of security for life and property and thus attracting more investment.
4. Privatising government enterprises. This is ensuring a competitive atmosphere with in the
business community and thus attracting more investors.
5. Encouraging savings. The government is encouraging individuals to save so that they
accumulate capital to purchase inputs for investment purposes
6. Reducing conservatism through sensitization. People are being sensitized to adopt new
techniques of production so that they realise more output, earn and invest more.
7. Encouraging technological development. Technological development is being
encouraged so that there is an improvement in efficiency in production so more output
causes an increase in profits and thus more investment.
MULTIPLIERS
The multiplier refers to the number of times an initial change in expenditure multiplies itself to
give a final change in (national) income.
It is the co-efficient which measures the number of times the initial change in an element of
aggregate demand multiplies itself to bring about a final change in income.
Example: Given the MPC is 4/5 and the initial expenditure is shs 10,000 shillings.
Calculate the:
Solution
a. Multiplier = 1/1-MPC
= 1/1-4/5
= 5 times
= 50,000 shillings
Types of multipliers
1. The income/consumption multiplier. This refers to the number of times the initial change
in consumption expenditure multiplies itself to generate a final change in national
income.
Income multiplier = change in income
2. Government expenditure multiplier. This refers to the number of times by which initial
change in government expenditure multiplies itself to generate a final change in national
income.
Government expenditure multiplier = change in income
Change in government expenditure
3. Tax multiplier. This refers to the number of times the change in taxation multiplies itself
to give a final change in national income.
Tax multiplier = change in income
Change in taxation
4. Export multiplier. This refers to the number of times change in export earnings multiplies
itself to give a final change national income.
Export multiplier = change in income
Change in exports (earnings)
Marginal propensity to export. This refers to the proportion of the additional income
realised from exports.
5. Import multiplier. This refers to the number of times the initial change in import
expenditure multiplies itself to bring about a final change in national income.
Import multiplier = change in income
Marginal propensity to import. This refers to the proportion of additional income that
is spent on imports.
Marginal propensity to import = change in imports
Change in import expenditure
6. Investment multiplier. This refers to the number of times by which a given change in
investment expenditure multiplies itself to generate a final change in national income.
Investment multiplier = change in income
1. The rate of interest on capital. A low rate of interest on borrowed capital leads to a high
level of investment because individuals have funds to finance the purchase of inputs
while a high interest rate on borrowed capital causes a low level of investment because
individuals are discouraged to borrow to finance the purchase of inputs.
2. Changes in technology/level of technology. A high level of technology leads to high level
of investment because high level of efficiency in production and profits realised while
when the technology is poor there is low efficiency and hence a low level of investment.
3. Political situation in the country. Political instability leads to low level of investment
because it scares investors because they fear for their lives and property while a peaceful
environment attracts investors since there is limited threat to life and property.
4. Level of development of infrastructure. Well developed infrastructures lead to high level
of investment because they make it easy to access input and product markets easily and
reduce production cost etc. while poorly developed infrastructures make accessibility to
markets difficult, increase production costs hence low level of investment.
5. Level of income. Low level of income causes a low level of investment because one has
limited funds to purchase raw materials, pay labour etc. while a high level of income
leads to high investment because of the availability of funds to purchase inputs, tec.
6. Size of the market/population size/consumption level. A big population size encourages
investment because it provides more profits while a small population size leads to low
investment because there less profits realised by the investors.
This refers to the number of times the initial change in consumption expenditure multiplies itself
to bring about a change in investment.
Change in consumption
Example: The increase in consumption of sugar from 500kgs to 800kgs caused an increase in
investment from shs. 50,000 to shs. 90,000: calculate the accelerator principle.
Change in consumption
= 90,000 – 50,000
800 – 500
= 133.33 times
Worked examples
Example 1
1-0.7
= 3.33 times
= 3.33 X 50m
= 166.5m shillings
Example 2
MPS
=1
0.2
= 5 times
Change in income = Multiplier X increase in investment
= 5 X 50
= 250m shillings
Example 3
This refers to the fluctuations in the general economic level in an economy e.g. aggregate
demand, income, output, the price level etc. as shown below
1. The peak/boom. This is the upper point in the level of economic activities and it is
characterized by high of income, high level of employment, high level of investment,
high business confidence.
2. Recession. This is a period of declining economic activities in the economy e.g.
production is falling, wages fall, profits fall, prices decline, investment falls, etc.
3. The trough/economic depression. This is a period of severe down turn in the level of
economic activities (lowest level of economic activities). It is characterized by; very low
purchasing power, very low profits, fall in prices, closure of some businesses etc.
4. Recovery/expansion. During this period, output increases, profits, wages, employment
levels rise, prices of goods generally rise.
PRICE INDICES
Index numbers measure changes in certain variables from one period to another e.g. wholesale
prices, GDP etc.
Price index refers to a figure which measures relative changes in prices of some selected goods
from one period to another.
This measures the relative changes in prices of consumer goods from one period to another.
a) Choosing a base year. This must be a year when prices were relatively stable.
b) Selecting a representative basket of goods and services. These are goods commonly
consumed in the area.
c) Collection of prices of goods and services in the basket both in the current (year) and in
the base year.
e) Computing the average simple (price) index/price relative using the formula
Average simple index = Ʃ (sum) simple price index for each commodity
Number of commodities
f) Attaching weights to the commodities in the basket. Weights show which commodities
are more important to the consumers than others.
g) Calculating the weighted index for each commodity using the formula:
Weighted index = price relative/simple price index X weight.
h) Calculating the average weighted index:
Average weighted index = Ʃ (sum) weighted index/simple index X weight
Ʃ (sum) of weight
The figure obtained helps in determining the cost of living which influences the standard
of living. Therefore when the figure obtained is greater than 100, subtract 100 from it e.g.
155.5 – 100 = 55.5 this means generally prices increased by 55.5%.
This means that there was an increase in the cost of living (inflation) and a decline in the
standard of living.
When the figure obtained is less than 100 e.g. 80, subtract it from100 e.g. 100 – 80 = 20.
This implies that there was a fall in the cost of living (deflation) and therefore an
improvement in the standard of living.
Example:
Study the table below and answer the questions that follow:
4. They help in the comparison of the cost of living within a country over time
5. They help in the comparison of the cost of living between countries at a time. The figure
of one country is compared with that of another to establish which one is performing
better.
6. They help in determining tax rates/levels. When the cost of living is high government
may have to reduce indirect taxes to enable producers charge low prices so as to reduce
the cost of living.
7. They are used to measure the terms of trade of a country.
1. Difficulty of getting a suitable base year. It is not easy to get a year when prices were
stable because of fluctuations in prices brought about by natural factors, political
instabilities etc.
2. There is difficulty in selecting a representative basket of goods and services.
This is because different people have different tastes and preferences.
3. Difficulty in attaching weights to goods and services. This is because of the differences in
tastes and preferences, income levels, etc. therefore weights do not reflect the importance
attached to commodities by all consumers.
4. Changes in the level of prices over time/price instability. Price instabilities make it
difficult to have standard prices for the commodities in the computing and base year.
5. Limited data/information. Some individuals do not have proper records of quantities sold
and their prices which make it difficult to determine the quantities consumed and their
respective prices.
6. Changes in tastes and preferences. This is because of differences in income, culture etc
and this complicates the process of selecting a reliable basket of goods and services.
7. Emergence of new products and exist of old ones from this the market. This complicates
the selection of a suitable basket of goods and services.
MONEY
Money refers to anything which is generally acceptable for the settlement of debts and
obligations. Money is legal tender and everyone in the country concerned is bound to accept it in
the settlement of debts.
1. Acceptability. Money should be acceptable so that it can be used in trade. People accept
money because they know that others will accept it.
2. Stability. Money should be stable in value for a long time so that it can be used for a
relatively long period.
3. Durability. Money should not wear out easily. It should stand constant handling during
transactions if it is to function properly.
4. Portability. Money should be easy to carry from one place to another and the cost of
carrying money should not exceed its value.
5. Homogeneity. Money should be uniform throughout the country. There should be no
variation in shape, texture, etc.
6. Divisibility. Money should easily be divided into smaller denominations to facilitate
smaller transactions.
7. Money should be difficult to imitate or forge.
8. Scarcity. Money should be limited in supply if it is to maintain its value and for people to
have confidence in it.
9. Money should be easily identified, recognised and distinguished from other objects.
FUNCTIONS OF MONEY
1. Medium of exchange. Money makes it possible to determine the value of goods to be
exchanged.
2. Money is a unit of account. Money helps in effecting business calculations especially
accounting and auditing.
3. Measure of value. Money is a measuring unit to assess the relative value of different
commodities. A high money price attach to a commodity may reflect its value.
4. Store of wealth. Money can be used as a store of wealth because it is not bulky and it is
not perishable.
5. Means of differed payment. Money facilitates payment of debts and transactions to
some future date.
6. It is a means of transferring immovable assets e.g. land
Types of money
1. Commodity money. These are articles or goods used as medium of exchange because of their
intrinsic value or their ability to satisfy human wants e.g. travellers‟ cheques.
MONEY SUPPLY
Money supply refers to the quantity or volume of money in circulation in the whole
economy at a particular time.
1. Broad money supply refers to the sum of that amount of money in the hands of the public
plus all the deposits within commercial banks and other saving institutions or schemes.
2. Narrow money supply is the sum of money in the hands of the public plus the amount in
current accounts in commercial banks.
3. Exogenous money supply is the sum of money which is fixed and determined by the
printing authority e.g. the Central Bank. It is also called discretionary money supply.
4. Endogenous money supply is one determined by the level of economic activity in the
country. It is also called automatic money supply.
The quantity theory of money was put forward Professor Irving Fisher. The theory states
that, an increase in money supply will lead to appropriate change in general price level
provided the velocity of circulation and the level of transactions are held constant.
This leads to the equation of exchange which is MV=PT or P=MV
T
1. It assumes that prices are constant and that they change when there is an increase in
money supply. This is not true for the case of Africa as inflation is rampant and caused by
a number of factors e.g. cost push, poor infrastructure etc.
2. It only recognises the transactions motive of holding money and neglects other motives
like, precautionary and speculative motives.
3. It assumes general price level yet there is no general price level but rather a series of
prices.
4. The theory tries to explain changes in the value of money but not how the value is
determined.
5. The theory is not regard as an adequate theory of demand for money because it does not
take into account the influence of the rate of interest. It is therefore incomplete without
reference to the rate of interest.
6. The variables in the equation MV=PT are not independent of one another because a
change in one induces a change in others.
7. It assumes that all business transactions are carried out with the use of money and ignores
the possibilities of barter trade.
8. The theory emphasises the supply of money and ignores the demand for money.
9. It assumes that the velocity of circulation and level of transactions are constant which is
not the case in real life situation as some people hold cash either in savings or in their
homes etc. and this reduces the velocity of circulation.
10. Haggling between buyers and sellers to reach an agreeable price is not taken into
consideration.
11. When output increases and employment expands, money supply may increase without
affecting price levels.
12. The theory assumes full employment of resources in an economy yet there may be
rampant unemployment. I.e. it is very difficult to attain full employment.
NB: The term value for money refers to the amount of goods and services a unit of
money can buy.
Or
Value of money refers to the purchasing power of a unit of money.
Liquidity preference or demand for money refers to the desire or willingness of people or
the public to hold assets or wealth in form of cash or near cash.
The reasons why people demand / hold money are explained by the Keynesian theory
known as Liquidity Preference Theory.
Lord Maynard Keynes identified the following motives for holding money:
1. The transactions motive. This refers to the holding of money to meet the day to day
business obligations such as buying food, clothes etc. This motive is influenced by:
a) The price level
b) The income level
c) The rate of interest
d) The need to fulfil other motives
e) Availability of goods and services
2. The precautionary motive. Money in this case is held to meet or solve unforeseen or
unexpected events that may require unforeseen expenditure e.g. illness, visitors etc.
Money held for this motive depends on:
a) The level of income
b) The possibility of borrowing at short notice
c) The ability to anticipate unforeseen events
1. Price level. The higher the price level the higher the liquidity preference because more
money is needed is to effect transactions and the lower the price level the lower the
liquidity preference because there is less money needed to effect transactions to effect.
2. Degree of uncertainty. The higher the degree of uncertainty the higher the demand for
money because it is needed to meet unforeseen expenditure and when the uncertainty is
low the demand for money is low.
3. The rate of interest on financial assets. A high rate leads to low demand for money since
people invest in financial assets and when the rate is low people prefers to hold money
because it is not beneficial to invest in these assets.
4. The level of transactions. Low level of transactions leads to low demand for money since
there are few transactions and when there more transactions the demand for money is
high since money is needed to effect the transactions.
5. Level of income. High level of income leads to high demand for money and vice versa
6. Knowledge of banking facilities. Ignorance of banking facilities leads to high demand for
money while having more knowledge leads to low demand for money because it is kept
in the banks.
7. The degree of speculation. A high degree of speculation leads to high demand for money
and vice versa.
8. Level of development of commercial banks and other financial institutions.
9. Requirements for opening and operating bank accounts.
10. Level of illiteracy.
BANKING
Financial intermediaries
These are financial institutions that bring together borrowers and lenders. They are of two types:
banking and non-banking financial intermediaries.
Non-banking financial intermediaries are financial institutions that receive deposits, give loans,
but do not create credit e.g. co-operative banks, insurance companies, post office savings bank
etc.
While
COMMERCIAL BANKING
Commercial banks are institutions that deal in credit or borrowed funds. The main aim of
commercial banks is to maximise profits.
1. They assist the government in executing monetary policy designed to control supply of
money in order to bring about economic stability.
2. They facilitate the process of capital formation through mobilisation of savings which are
important for investment and economic development.
3. They advance loans and over drafts to credit worthy customers who use this money to start
production enterprises hence increasing the rate of economic growth.
4. Commercial banks participate in direct investment activities and this increases the rate of
economic growth.
1. The low level of income among the masses and as a result many of the people do not have
sufficient incomes to save with the banks and thus low bank deposits.
2. The high level of illiteracy/ignorance results in to limited use of bank services/most people
do not take advantage of banking services.
3. Poor distribution of banks with most of them being urban based leaving the rural areas
unattended to. Furthermore the banks concentrated in urban areas compete for the few
customers.
4. Unfavourable government policy of high taxation. This causes a high cost of operation and
therefore low profits.
5. Uncalled for government interference in the advance of loans, appointment of managers. This
makes running and recovery of loans difficult.
6. Political instability in some parts of the country minimises the smooth running of the banks
as the level of economic activities is low.
7. High liquidity preference makes. This results into limited savings in the banks.
8. Political instability. This limits operations of banks in some areas as there is fear of losing
life and property.
9. High rate of inflation. This raises the cost of operations of banks and reduces the profits.
10. Poor infrastructure. This makes accessibility to some areas difficult and also raises the cost of
operation hence low profits.
11. High degree of corruption. This reduces funds available ending in commercial banks.
12. There is high liquidity preference. This results into a small number of people making
deposits hence limited funds for lending by commercial banks.
13. Limited skilled manpower. This causes inefficiency in the banking sector.
14. High rate of inflation. This causes a high cost of operation and also makes lending expensive
because it causes an increase in the rate of interest.
15. Poorly developed infrastructure.
CREDIT
Credit refers to the facility which enables individuals to acquire goods and services
without immediate cash payment but with a promise to pay at a later date.
Or
It refers to any borrowed facilities or funds/money by deficit spending units.
Instruments of credit
These are written document which guarantee payment in the near future and give holders
rights over money. They are documents which promise future payment and the holders
can receive value out of them e.g. cheques/post-dated cheques, promissory notes, bills of
exchange, bank drafts, credit cards, debentures, letters of credit etc.
Importance of credit
a) Credit facilitates production since it helps in the purchase of factors of production and other
goods and services.
b) It enables the public to access loans for investment and consumption.
c) It promotes a fast pace of capital accumulation.
d) It encourages the development of large scale business enterprises.
e) It increases the level of consumption as it increases peoples‟ purchasing power.
f) It promotes differed payment which increases consumption of goods and services.
CREDIT CREATION
This is the process by which money lent out by commercial banks using the cheque
facility expands to result into greater volume of credit than the original amount deposited.
Bank New deposits (shs) Cash ratio/reserve (shs) Loan advances (shs)
B1 100,000 20,000 80,000
B2 80,000 16,000 64,000
B3 64,000 12,800 52,000
B4 52,000 10,240 40,960
Total 500,000
= 100,000 X 5
= 500,000/=
Total deposit = B1 + B2 + B3 + B4 + …………
Question: How do commercial banks create credit?
Sample question:
How do commercial banks create credit in your country (illustrate your answer)
Commercial banks are always faced with a problem of achieving various objectives and these
are; security, liquidity, and profitability.
1. Liquidity as an objective of commercial banks implies that commercial banks have got to
keep funds to meet the cash demands of their clients.
2. Security as an objective of commercial banks requires that commercial banks reduce losses
and risks in order to maximise profit.
3. Profitability is achieved by lending customers deposits at an interest rate and also investing in
short term and long term ventures.
MONETARY POLICY
This refers to the deliberate attempt by the government through the central bank to regulate the
amount of money in circulation so as to attain objectives of development. These include; balance
of payment, price stability, full employment etc.
1. To influence the rate of economic growth. Increasing the bank rate causes an increase in the
rate of interest charged by commercial banks on borrowers and this discourages borrowing
for investment purposes hence a low rate of economic growth as it increases the cost of
production. A low bank rate causes commercial banks to charge low rate of interest on client
1. The bank rate policy. This is the rate of interest charged by the central bank on commercial
banks when they borrow from it. A high bank rate discourages borrowing by the commercial
banks from the central bank and they in turn charge a high interest rate on their clients which
discourages borrowing as loans become expensive and causes a low supply of money. A low
bank rate makes borrowing cheap and commercial banks in turn charge a low rate of interest
on clients which encourages borrowing as loans become cheap and this results in to a high
amount of money in circulation
2. Open market operation. This involves the buying and selling of government securities.
Selling of government securities to the public reduces the amount of money in circulation
because individuals investment their money in these financial assets while buying
1. The presence of under developed money markets. This limits the buying and selling of
government securities.
Inflation refers to the persistent increase in the general price level in an economy. It is a situation
where there is a continuous decline in the value of money as measured by the price index.
Previous price
1. Mild/creeping/gradual inflation. This is where the persistent increase in the general price
level proceeds at slow rate, usually not exceeding 10%. This type of inflation is good for
an economy as it promotes production, employment, investment, etc.
2. Hyper/runaway/galloping inflation. This is where the persistent increase in the general
price level proceeds at a very high rate, the rise taking place within hours, days or weeks.
The percentage increase per annum is over 10%. This kind of inflation makes people lose
confidence in money and it is disastrous to an economy.
1. Demand pull/excessive demand inflation. This is where the persistent increase in the
general price level is as result of aggregate demand exceeding aggregate supply in and
economy. It is usually associated with conditions of full employment when an economy
is operating at full capacity with no further increase in output and supply cannot increase
to satisfy the available demand.
Causes of demand pull inflation
1. Increased demand for exports which increase export earnings increase the supply of
money in an economy as well as the purchasing power of individuals.
2. Decrease in direct taxation which increases peoples‟ purchasing power.
3. Excessive capital inflow e.g. grants, aid etc. which when exchanged into the local
currency increases the supply of money.
4. Excessive supply of money due to printing of money.
5. Excessive spending by the government for example on wages, subsidies, etc.
6. An expansionary monetary policy in form of reduced interest rate, etc.
2. Cost push inflation. This is when the persistent increase in the general price level is as a
result of persistent increase in the cost of production e.g. wages, rent, cost of raw
materials.
Causes of cost push inflation are:
i. Wage price inflation. This occurs when workers demand for higher wages through
their trade unions or demand for an increased share of output and the increase in
wages leads to increase in cost of production and hence increase in prices.
ii. Price wage inflation/inflation spiral. This is when increase in commodity prices
leads to workers demanding for higher wages which initiates further price
increases.
iii. Comparison by workers in one firm/sector with other sectors/firms. A rise in one
sector/firm causes demand for higher wages in other firms/sectors which is shifted
to consumers in form of high prices.
1. Subsidisation of producers which goes a long way to reduce the cost of production.
2. Reducing taxes on producers.
3. Encouraging importation of scarce commodities from cheaper sources.
4. Wage legislation by the government.
This is where the persistent increase in the general price level results from importing
commodities from inflation prone countries; resulting into price increment in the domestic
economy. Such goods imported may include machinery, fuel products, raw materials, etc.
Bottleneck/structural inflation
1. Political instability. It scars away potential investors due to the fear to lose life and
property and destroys production units thus causing shortage of goods.
2. Infrastructural breakdown. This increases the cost of production due high level of wear
and tear/depreciation.
3. Break down of key industry. There is decline in production which causes shortage of
goods and services.
Expectation inflation
This is where the persistent increase in the general price level results from speculation by the
businessmen. This is caused by announcements in the media about say increase in the salaries of
civil servants.
Monetary inflation
This is where the persistent increase in general price level is caused by the excessive issuance of
currency/ excessive government borrowing from the central bank/.
EFFECTS OF INFLATION
1. Mild inflation stimulates effort/hard work. People have to cope with the increasing cost
of living or maintain their standard of living by putting in extra hours of work.
2. It stimulates investment/entrepreneurship. The gradual increase of prices increases profits
and this increases the level of entrepreneurship.
3. More employment opportunities are created. This is because of increased
investment/establishment of firms that provide jobs.
4. Increased government revenue is realised. This is due to the increase in economic
activities that are taxed.
1. Savings are discouraged. This is because individuals do not see the benefits of saving yet
the money loses value over time.
2. It causes loss of confidence in the local currency. Some people prefer to use other
currencies like the dollars because of their steady value and purchasing power.
3. Fixed income earners suffer. This is because the increase in prices is not matched by an
increase in wages therefore the real wage reduces.
4. Inflation worsens the balance of payment problem. It encourages the importation of
cheaper commodities while exports are expensive.
5. The problem of income inequality worsens. During inflation production is manageable by
few individuals who earn higher profits at the expense of the majority.
6. Lending is discouraged. This is because creditors get less in real terms.
7. It leads to brain drain. Employees who are hard pressed find employment in other
countries which leads to loss of human capital.
8. Unemployment results. Some firms lay off some employees to reduce the cost of
production. It is also as result of some firms closing down due to the manageable/high
cost of production.
9. High inflation rates make planning difficult. Plans have to be revised from time to time
which causes unnecessary delays in implementation.
10. It leads to production and consumption of low quality/inferior goods. To reduce the cost
of production some firms reduce ingredients or use cheaper alternatives hence production
of low quality products.
11. Inflation encourages malpractices such as smuggling, corruption, black market, etc. since
people try to survive by any means.
12. People are strained. In attempts to cope up with the rising cost of living some people over
work themselves which results into low quality of life as they are not able to afford
majority of goods.
1. Rising cost of production e.g. rising wages, interest rates, fuel prices. The producers raise
prices of goods to off-set the cost of producing goods and services.
2. Importation of commodities from inflation prone countries. Commodities get into the
country at high prices since other costs are added such as transport costs, insurance etc.
These cause increase in prices.
3. Unfavourable natural factors. Theses destroy crops and as a result there is scarcity of
agricultural products thus bottleneck inflation.
4. High degree of speculation by the business community e.g. by hoarding goods,
speculators cause artificial scarcity of goods and prices increase.
5. Greed for excess profits by the business community. The profit greedy entrepreneurs
increase prices to gain more profits.
6. Political instability. It causes a low level of investment since the investors fear for their
lives and property and there is therefore low production of goods and services which
causes shortages and this causes prices to increase.
7. Breakdown of infrastructure. This makes it difficult to transport raw materials to the
firms and finished goods to the market. This causes shortage of goods and services since
demand exceeds supply and also increases the production cost.
8. Excessive issuance of currency. It increases the supply of money in circulation which
raises the aggregate demand for goods and services forcing prices upwards.
9. Increased/excessive inflow of incomes from abroad. This increases the amount of money
in circulation and therefore raises the aggregate demand above the supply of goods hence
increasing prices.
10. Depreciation of the local currency. It leads to increase in prices of local products
especially those that have imported components because they increase the cost of
production.
11. Excessive government expenditure. This increases the amount of money in circulation
which raises the purchasing power of individuals and therefore an increase in the
aggregate demand for goods causing increase in prices.
12. Excessive exportation of essential goods that causes shortages at home. This increases
prices of such goods since there is shortage.
1. Increasing direct taxation. This is reducing peoples‟ disposable income and therefore
reducing the demand for goods and services causing a fall in prices.
2. Reducing government expenditure on provision of non-essential goods. This is reducing
the amount of money in circulation which is reducing the purchasing power and thus a
reducing the aggregate demand for goods and services.
3. Liberalising economy to increase production. This is encouraging increased participation
of individuals in production of goods and services due to the competition and is therefore
reducing shortage of goods and services/increasing the aggregate supply of goods.
4. Privatising public enterprises. This increases efficiency in production causing an increase
in the supply of goods and services thus solving bottleneck inflation.
5. Providing tax incentives to investors. These encourage investment since they reduce the
cost of production which enables producers increase output on the market thus solving
scarcity of goods and services.
6. Developing infrastructure. This is reducing the cost of production and therefore enabling
producers to increase output and therefore overcoming scarcity of goods.
7. Controlling issuance of currency. This reduces the amount of money in circulation checks
peoples spending power and therefore reduces demand for goods and this helps to bring
down the prices.
8. Encouraging importation of commodities from cheaper sources. This is enabling the
country get goods at fair prices and therefore checking imported inflation.
9. Modernising agriculture. This is reducing reliance on natural factors ensuring continuous
supply of food and enabling the economy to eliminate scarcity thus resulting into a
reduction in the food prices.
10. Tightening monetary policy e.g. sale of government securities. This is reducing the
amount of money in circulation causing a reduction in the purchasing power and
aggregate demand for goods and services
11. Improving the political climate. This is increasing the level of investment and increases
production of goods and services because the investors have security for their lives and
property.
12. Encouraging import substitution industries. These check the importation of goods from
abroad and therefore reduce imported inflation.
13. Regulating the exportation of essential goods. This is reducing the scarcity of such goods
in the country and therefore stabilising prices.
14. Reducing government borrowing from the central bank. This is checking the amount of
money in circulation which reduces the purchasing power and reduces the demand for
goods and services.
Stagflation is a situation where high rates of inflation co-exist with high levels of
unemployment and stagnant output.
Deflation refers to persistent decrease in price of goods and services in a country.
Reflation refers to a deliberate government policy to force prices upwards to
recover from a depression. Instruments of reflation include; tax reduction,
increase in government expenditure, encouraging exports, use of expansionary
monetary policy and increase in wages.
The instruments/policies of reflation are:
This is a situation where some members of the labour force/working age 16-64 years fail to
obtain jobs at the ruling market wage rate despite their willingness to work. Unemployment can
either be voluntary or involuntary.
Voluntary unemployment
This is a situation where jobs are available but some members of the labour force are not willing
to take up jobs at the ruling market wage rate.
1. A low wage rate that is unacceptable to the employee and therefore one would rather remain
unemployed.
2. Good economic background or where one has a wealthy background. Some people are born
in rich families where everything needed for their survival is available and therefore they see
no need as to why they should work.
3. Expectation of a better job in future. One remains unemployed in the short term as he/she
awaits the promised job that is better than the current one.
4. The preference for leisure. Some people cannot afford to miss out on leisure and therefore
forego work.
5. Poor working conditions at the available job/occupation. Poor working conditions
discourage some individuals from taking up some jobs because they consider them harmful
to their health/unacceptable and therefore one prefers to remain unemployed e.g. long hours
of work, harsh treatment, etc.
6. Laziness for some people. Some individuals are reluctant to take up jobs because of their
inner weaknesses.
7. Preference to live on other peoples‟ incomes. Some people are comfortable living on
incomes of other people since there is no effort of own to get such money and it enables
them purchase some necessities.
8. The Low status associated with some jobs. Some people refuse to take up certain jobs
because society under rates them and considers such occupations socially unacceptable.
9. Being too qualified for the available job. Some members of the labour force have higher
skills and qualifications compared to the jobs on offer and are therefore not interested in
taking up jobs below their qualifications.
10. Desire to live on past savings. Some people accumulate money which they consider
sufficient for their survival and therefore opt not to take up any jobs.
11. Unfavourable geographical location of the jobs. Some people remain unemployed because
of the fear to move to places where the geographical conditions are considered harsh e.g.
very cold or very hot conditions and therefore not conducive for their health.
Involuntary unemployment
This is where some members of the labour force are not able to get jobs at current market wage
rate despite their willingness to work.
The causes of unemployment/involuntary unemployment in Uganda
1. The high population growth rate. In this case the rate of population increase exceeds the
rate of job formation and therefore there is excess supply of labour compared to the
available jobs hence unemployment.
2. A defective education system. Emphasis is on theoretical knowledge rather than practical
skills and it therefore generates job seekers rather than job creators yet there are few jobs
on offer.
3. High rate of rural urban migration hence open urban unemployment. There is an increase
in the number of people moving to urban areas expecting better paying jobs which they
fail to get because of the limited skills, use of advanced technology in enterprises and as a
result and there is open urban unemployment.
4. Changes in technology/technological advancement substituting manpower.
Advancements in technology result into machines replacing human labour thus
technological unemployment.
5. Seasonal variations in economic activities mostly agriculture or unfavourable change in
climate. In some cases, people are employed when a given season is favourable e.g.
agriculture, tourism and after the season is over the people become unemployed.
6. Discrimination in the labour market on the basis of gender, religion, etc. This is on the
basis of gender, race, religion, etc. and therefore those who are favoured are given jobs
while those that are not favoured remain unemployed.
7. Political instability and its effects on employment where by investors both local and
foreign are discouraged for fear of lives and industries destroyed which discourages
investment limiting employment opportunities.
8. Deficiency of co-operating factors especially capital to set up industries, projects etc.
9. Ignorance about the availability of jobs else. Labour force remains unemployed even
when jobs are available elsewhere because of the mismatch between those who have the
jobs and those who have the skills.
10. Physical and mental incapacitation resulting into residual unemployment. In this case
people are not employed because they cannot contribute anything to production because
of some limitations or their low efficiency.
11. Poor land tenure system. There is limited accessibility to land by some individuals which
limits investment and therefore there are limited employment opportunities generated.
1. Educational reforms. Practical subjects are being encouraged at higher levels of learning
so as to encourage self-employment/reduce the number of job seekers and have more job
creators.
2. Ensuring stable political climate. This is being done by ensuring democratic governance,
negotiating with political rivals. This is encouraging investment and increased production
since the investors are assured of security for life and property which leads to creation of
jobs especially in the private sector.
3. Increased advertisement of jobs in the media especially newspapers. This is increasing
awareness about jobs and making it possible for members of the labour force to locate the
jobs.
4. Checking the population growth rate. Government is controlling the population growth
rate by encouraging family planning methods so that the number of job seekers matches
the available jobs
5. Modernisation of agriculture sector. This is through improving techniques in production,
providing extension services. These lead to increase in output in the sector therefore
making it more attractive to a wide number of people in the sector.
6. Widening the market. This involves encouraging regional co-operation so as to expand
market for goods and services thus increasing the demand for labour hence more
employment opportunities.
7. Development of infrastructure. There is construction and rehabilitation of infrastructure
to ease mobility of labour and increase production to generate more employment
opportunities since there is a lower production cost.
8. There is provision of incentives to investors. These are encouraging foreign investors to
establish industries or business ventures that provide employment because they reduce
the cost of production and investment increases more job opportunities are generated.
1. It leads to decline in the level of acquired skills. There is a decline in the level of acquired
skills because the failure to put into practice what one studied results into a decline in
efficiency and effectiveness.
2. It increases the dependency burden and therefore worsens the problem of vicious circle of
poverty. This is because the few people who are employed have to support those who are
not employed which increases poverty since there is less money set aside for investment.
3. It results into low production/low GDP hence low economic growth. There is low level of
effective utilisation of resources since there are few people involved in production and
therefore a low rate of economic growth is experienced.
4. Leads to low government revenue. This is because the unemployed do not have the
capacity to pay taxes and since they are few people paying taxes government realises less
revenue.
5. It worsens income and wealth inequalities. The unemployed do not have the capacity to
start their own ventures so as to increase their earnings and therefore those who are
employed become rich and the unemployed become poorer.
6. Leads to low aggregate demand for goods and services. Those who are not employed
have low disposable income
7. It leads to brain drain. As some members of the labour force fail to get jobs the move to
other countries and this leads to loss of the skilled manpower which retards economic
growth.
8. It increases levels of immorality (crime rate). Those who do not have jobs engage in
illegal activities to earn a living.
Disguised unemployment
This is a situation where by labour appears to be actively involved at work but the marginal
productivity is either zero, negligible or negative.
This can be illustrated as below:
Output (kgs)
6
4 MP
0 1 2 3 4 5 6 Labour
In the illustration above, an increase in labour from 1-2 employees‟ increases output from 4-6
units, there after additional workers 3-5 leaves output the same.
1. Limited capital to have more co-operant factors e.g. capital to buy more land.
2. Poor land tenure system e.g. land fragmentation in densely populated areas causing land
shortages.
3. High population growth rate which makes resources insufficient e.g. land for cultivation
being limited by fragmentation.
4. Limited skills and therefore inability to increase production in a meaningful way.
5. Lack of information about existing jobs elsewhere due to poor publicity.
6. Poor manpower planning e.g. excess supply of manpower in a given field visa-viz the
demand.
7. Nepotism in some sectors which results into over enrolment/recruitment.
8. The employers desire to retain work force for future use.
1. Availing cheap capital or credit so that people can borrow and start income generating
activities.
Structural unemployment
1. Changes in demand away from output of certain industries due to changes in tastes and
preferences.
2. Use of inappropriate technology (capital intensive) where machines replace human
beings.
3. Exhaustion of deposits of raw materials or inputs e.g. mining which makes miners
unemployed.
4. Imbalance between rural and urban areas which leads to open urban unemployment.
5. Political instability which causes displacement of people and as such some of them lose
their jobs.
Seasonal unemployment
Solutions
Frictional/Normal/Transitional/Search unemployment
This is a type of unemployment which occurs when labour is changing jobs in the short run.
OR
It occurs where there are unemployed workers of a particular occupation in one part of the
country but there are jobs in other parts.
Causes
Solutions
Solution
Provide work suitable for their dependence.
Casual/erratic unemployment
This is unemployment felt after one has accomplished an assignment or task as he/she waits for
another one.
Technological unemployment
Full employment
This refers to a situation in which everyone who wants to work at the prevailing wage rate is able
to get a job.
Or
A situation in which an economy has succeeded in solving her unemployment problems and
unemployment is less than 5% of the work force, equivalent to workers switching jobs.
1. The presence of rural urban migration. Some of the people who go to urban centres for
jobs cannot get them because they do not have the relevant skills.
2. High population growth rate. High population growth rate results into the labour force
exceeding the available jobs hence unemployment.
3. Unfavourable change in seasons. During the unfavourable season some members of the
labour cannot be employed because of the instability in their basis employment.
4. Persistent retrenchment of workers. The retrenchment of workers leaves many people
without jobs.
5. Poor political climate. Political instability scares away investors and destroys enterprises
which render people unemployed.
6. Poor education system/difficulty in fully vocationalising the education system. There are
more job seekers than job creators.
7. Decline in demand for products produced by some firms. This leads to low demand for
the factors of production hence unemployment.
8. Poor land tenure system. Land is not readily available to some individuals so that they
engage in production
The Keynesian theory of unemployment states that unemployment arises due to deficiency in
aggregate demand for final goods and services especially in times of economic
recession/depression.
That is to say, due to low demand for final products firms reduce their output, income levels fall,
investment is discouraged and thus less capital and labour are employed.
AD AS
AS dg AD = C+I+G+X-M
450
0 ye yf National income
The major remedy according to Keynes is increasing aggregate demand. This can be increased
through (solutions according to Keynes):
1. Reducing direct taxation which increases peoples‟ disposable incomes hence increasing
the demand for commodities.
2. Increasing government expenditure which increases money in circulation and therefore
increasing demand for goods.
3. Use expansionary monetary policy. This increases the supply of money in the hands of
the public and causes increase in demand for goods and services hence increasing
demand for labour.
4. Subsidisation of consumers so as to enhance their capacity to consume goods.
Population refers to the number of people living in a given area a particular time such as a town,
city or country. The number of people in an area is arrived at by carrying out a population
census.
Population census refers to the physical counting of people in a given area so as to discover the
social and economic implications which must be planned for accordingly.
This refers to the rate at which the population of a given country changes over time in a given
area. The population growth is determined by mainly the birth rate, death rate and net migrations.
Birth rate. This refers to the number of people born alive in a year per 1000 of the total
population.
Example. The population of Uganda in 2002 was 24 million people with 900,000 live births and
OR
= 3.8%
Death rate. This refers to the total number of deaths per 1000 of the total population.
This is due to migrations; it depends on the number of people coming to settle in the country
(immigrations) and those moving out to settle in other countries (emigrations).
Revision question: Examine the effects of a high population growth rate in an economy.
1. It widens the market for goods and services. This because it provides a large number of
people who must be provided with goods and services.
2. Leads to high supply of labour force. There is a high supply of labour force because there
more people who graduate in to the labour force.
3. It provides an incentive for massive investment. The increase in the population causes an
increase demand for goods and services and therefore producers invest more since more
profits are realised.
4. It increases government revenue. As the number of people increases those who qualify to
pay taxes also increases which increases government revenue.
5. An increasing population initiates effort to work harder to sustain the predominantly
dependent population. The working population works harder to provide for young who
are yet working.
6. It awakens government to it responsibility of providing the necessary infrastructure such
as schools, hospital, etc. Government constructs infrastructure to improve the welfare of
the people.
7. Such population provides the young who are innovative and this provides room for
inventions. The young are willing to try out new things.
8. It increases resource utilisation. The need to provide goods to the increasing population
results into more resources being put to use which promotes economic growth.
9. It reduces the per capita social overhead costs i.e. the cost of providing infrastructure
such as schools, roads is low with a large population concentrated in an area.
1. Leads to high dependence burden/low savings since much of the income is spent on
providing basics to the young this perpetuates the vicious cycle of poverty.
Suggest measures that should be taken to check the high population growth rate.
Explain the measures that have been taken to check the high population growth rate in
your country.
Measures that have been taken to control population growth rates in Uganda
Positive implications
1. High market potential. This is because of the high population growth rate that increases
the number of consumers
2. High potential for labour force. The population is dominated by the young who grow up
to constitute the labour force.
3. Provides an incentive/potential for massive future investment. The high population
growth rate increases the number of consumers who increase demand and therefore
encouraging investment since there is possibility of high profits.
4. High tax potential. This is because of high population growth rate which increases the
number of tax payers.
5. Initiates efforts to work harder to sustain the predominantly dependent population. This is
because the population is dominated by the young, therefore working population must
work must put in extra effort to support it.
6. Government is awakened to its responsibility of providing necessary infrastructure. This
is because of the high level of poverty and population being dominated by the young.
7. Encourages labour mobility. This is because the population is dominated by the young.
8. High potential for increased resource utilisation. The high population growth rate
increases the demand for goods and services which causes the increase in the utilisation
of resources to satisfy their demands.
9. They young are innovative.
10. Reduces per capita social over- head costs. This is because of the high population growth
rate which makes number of people to serve bigger.
Under population refers to that population size that provides insufficient labour force which
when combined with the existing co-operant factors leads to low output/income per capita.
In this case as the population increases the additional population leads to increasing output per
person.
Optimum population refers to a population size that provides labour force that is sufficient to
combine with existing co-operant factors leading to maximum output per worker/highest per
capita income/average product.
Hence a certain number of people is required to optimally utilise the available resources, below it
(under population) there is under-utilisation of resources; while above it (over population)
resources are over utilised. As illustrated below
Income/product
Per capita
Pop‟n Pop‟n
0 Po population
1. Limited/small market size. This results into low aggregate demand for goods and
services.
This considers the age groups namely; the young, the working and old. In this case consideration
can be for the developing and developed countries.
1. There are many dependents in the age bracket 0-14 compared to other age brackets. This
is due to the high birth rate and falling death rate. This is characteristic of developing
countries.
2. There few people in the working age bracket.
3. There is a very small number of 64 years and above due to low life expectancy.
The above structure is dominated by the young, the effects of a young population
are:
Negative effects
65+
16 - 64
0 – 15 years
1. There are many old dependants (65+) due to high life expectancy.
2. There are few people in the working age bracket.
3. There are very few young dependants. This is due to low birth rates and low death rates,
high life expectancy, high rates of urbanisation which are characteristic of developed
countries. The above pyramid shows an ageing population.
AN AGEING POPULATION
An ageing population is a situation where the number of the old people (65+) is higher than other
age groups. An ageing population has the following negative consequences.
The Malthusian population theory states that, whereas population grows at a geometrical rate;
food production tended to grow at an arithmetic rate. Malthus said that due to the above trend,
population growth after a time would outstrip food production (population trap) and after such a
time there was need to control the population through negative checks like moral restraint,
celibacy etc. otherwise the positive checks like pestilence, wars, diseases etc. would serve to
reduce population growth and then population would equal food supply
Population growth
Food supply
Growth
0 t Time period
A is the population trap at this point food production is equal to population growth beyond which
there is starvation and death.
1. Assumed that technology and science are constant but technological progress occurs and
is causing increased food production.
1. Land is fixed in supply and subject to the law of diminishing returns a situation
experienced as anticipated by Malthus.
2. Natural family planning methods/control measures like celibacy being used are his
initiation.
3. Positive checks (wars, diseases) on population exist in LDCs.
4. Land problems or disputes are common in LDCs today.
5. Some areas in Low developed countries face food shortages/famine.
6. Existence of a subsistence sector which is still large in LDCs.
LABOUR
Labour refers to the human resource (physical/mental) available to society for use in the
production process. This labour can be unskilled, semi-skilled or skilled. It is one of the most
important factors of production.
Labour force. This is the proportion of the population that is made up of the working age group,
excluding full time students and housewives.
Or
1. Mainly unskilled.
2. Mainly youthful.
3. Mainly employed in agriculture sector/primary production.
4. The majority are in rural areas.
5. Mostly concentrated in urban areas/geographical concentration per unit area.
6. The majority are highly mobile.
7. There are slightly more females than males.
Labour supply refers to the total number of people available for employment in a country in a
given period of time at an on-going wage rate.
OR
The total time labour is willing to offer for work at the on-going wage rate.
1. Size of the population. The bigger the size of the population in the country, the higher the
labour supply this is because there are more people available for employment and a small
population size causes a low supply of labour force because there are few people for
employment.
2. The age structure of the population. The bigger the population in the age bracket of 16-64
years, the larger the supply of labour this is because the working population is big while a
small working population leads to a low supply of labour.
3. Level of wages and other non-monetary factors. High wages paid to workers cause high
supply of labour because they motivate employees while low wages cause low supply of
labour because there is less motivation.
4. Government policy. Heavy government restrictions on workers reduce supply of labour
in the country this is because they make it difficult for individuals to get jobs while
limited restrictions cause an inflow of foreign workers which causes a high supply.
5. Working conditions. Good and favourable working conditions lead to high supply of
labour because they there is less threat to their lives while poor working conditions make
workers uncomfortable and this causes low supply of labour.
Demand for labour is defined as the quantity of labour desired by an employer at a particular
time and wage rate. The demand for labour is derived from what it can produce i.e. it is
demanded not for its own sake but to produce goods that have been demand.
1. The demand for commodities that are produced by labour. The high the demand for
commodities the higher the demand for labour needed to produce them holding other
factors constant.
2. The price of labour/wage rate. The higher the wage rate the lower the demand for labour
and the lower the wage rate the higher demand for labour.
3. The proportion of labour cost to the total cost of production. The high the ratio of labour
cost to total cost of production the lower the demand for labour and vice versa.
4. The cost of labour relative to that of capital. If labour is cheaper than capital more labour
is demanded and vice versa when capital is cheaper.
5. Degree of substitutability of labour. The demand for labour is high if it is not easily
substitutable.
Muhinda Richard Economics notes 2018 223
6. Degree of complementarity. The demand for labour is high when it is seriously needed in
conjunction with other factors of production.
7. The marginal productivity of labour. The more productive labour is the higher the
demand and vice versa.
WAGES
A wage is a reward to labour as a factor of production for the services it renders in the
production process. A wage can be expressed as nominal or real wage.
Nominal wage refers to that expressed or received in monetary terms e.g. a worker receiving
100,000 Shs per month.
Real wage is a wage expressed in terms of goods and services it can purchase.
Or
1. Size of the nominal wage. Holding other factors constant, the higher the nominal wage
the higher the real wage and vice versa.
2. Level of taxation. High taxes reduce one‟s income and consequently the real wage
reduces.
3. Price level of goods/cost of living/rate of inflation. High prices reduce the real wage
while low prices increase it.
4. Amount/quantity of goods available. Availability of goods increases the real wage
because it makes commodities cheaper while scarcity reduces the real wage because it
makes commodities expensive.
5. Money supply. A high supply of money increases the real wage while low supply reduces
the real wage.
6. Size of the monetary sector.
A salary is a fixed reward to labour and it may not change because of time or piece worked.
a) Explain the average level of wages in the short run and long run.
b) To explain the differences in payment of wages.
A number of theories have been formulated to explain the general level of wages prevailing in an
economy. These are:
This theory was advanced by Stuart Mill. According to him, there is a wage pool (wage
fund) set aside out of which the wages are paid. They wage paid is usually determined by
the size of employees and pool set aside. The bigger the pool the greater the wage and
vice versa.
i. It does not show the source of the fund and how it is determined.
ii. There is no fund set aside for wages.
iii. It does not explain wage differentials in different occupations.
This theory puts it that since wages are prices for labour, wages are determined by the
interaction of forces of demand and supply so that if there exists excessive demand for
labour, wages rise and vice versa. It is also called the modern theory of wages.
According to Karl Marx, labour creates all values. The value of the commodity produced
is equivalent to the price of labour. Labour is always paid less because the capitalists take
the profits which should also be earned by labour. i.e. the workers are given a wage that
is below the price of the commodities they produce and are thus exploited.
The theory states that workers should paid wages to enable them meet their bare
subsistence needs (so that they work harder after experiencing hardships like hunger).
If wages rise above this level, there is an increase in population, increasing competition
for employment among workers which causes wages to fall.
If wages fall below this level, there is decrease in population increasing competition for
employment among workers which causes wages to increase.
This means that a worker should be given a wage that is just enough to enable him/her
meet the basic needs e.g. clothing, food etc.
Note: A living wage is payment to a worker sufficient to provide his basic needs.
Or
A living wage is a reward that is adequate for a worker and his family to subsist
comfortably.
a) To what extent is the subsistence theory of wages used in the determination of wages
in Uganda?
b) To a larger extent the subsistence theory of wages is not applicable in determination
of wages due to:
1. The theory approaches the problem of wage determination entirely from the supply side,
it ignores the demand for labour entirely thus difficulty in using it.
To small extent the iron law of wages is applicable in Uganda in determination of wages
because:
1. Casual workers/unskilled labourers are paid basing on the level of their subsistence
needs.
2. In the subsistence sector of Uganda rewards to workers is based on basic needs.
3. Employers in a bid to retain cheap labour tend to pay workers wages which are just
enough to cater for their subsistence needs.
4. Entrepreneurs due to profits maximisation goal pay workers wages which are just enough
to meet their subsistence needs.
5. Employees due to high level of unemployment are willing to accept low wage rates as
long as it covers their subsistence needs.
According to this theory, wages are the left over after other factors of production have
been rewarded. The more the left-overs, the higher the wage and vice versa.
ii. The theory does not explain how trade unions attempt to raise wages.
iii. The theory ignores the influence of labour in wage determination.
This is where the government sets the wage which is to be paid by employers to
employees and it is illegal to pay any employee a wage below or above that set by the
government. This may be in form of minimum and maximum wages.
W1 D S
We
0 L1 Le Labour
Positive effects
Negative effects
1. It leads to excess supply of labour in relation to demand and therefore results into
unemployment because some workers are laid off/dismissed to in order to minimise
production.
2. It increases the production cost due to high labour costs.
3. It may result into technological unemployment because some employers may find it
cheaper it cheaper to use machines.
4. It worsens income inequality if not evenly implemented.
5. It discourages investment especially when investors fear high costs associated with
high wages.
6. It leads to rural urban migration because it is mainly established in the industrial
sector yet most of the dwellers are in agriculture therefore would like to take up jobs
in the industrial sector that are found in urban areas. This causes problems like
congestion, high crime rate.
7. It is inflationary. High minimum wage causes cost push inflation since the increase in
wages increases cost of production subsequently the producer increases the price of
the goods and services.
8. Low profit levels are realised and these discourage entrepreneurship due to increased
cost of production.
Maximum wage is the wage set by the government below wage equilibrium and it is
illegal for an employer to pay any worker above it. It is otherwise called wage sealing or
wage freezing.
D S
We W1 is the maximum
w1
0 Le L2 Labour
i. To decrease aggregate demand in the economy in order to control demand pull inflation.
ii. To decrease cost of production in order to control cost push inflation.
The marginal productivity theory of wages states that under perfect conditions, the reward to
each unit of labour should be equal to the value of its marginal product. Thus, wage = value of
marginal product of labour (VmPL) or wage = marginal Revenue Product of Labour (MRPL)
Wage
0 Le Labour
NB: The supply of labour is perfectly elastic because all labour units are homogenous. The
demand curve for labour is downward slopping due diminishing marginal productivity of labour.
a) Government usually intervenes in fixing wages. This through fixing minimum and
maximum wages.
b) It ignores the role of trade unions in bargaining for high wages/individual bargaining
power of workers. Trade unions in some cases influence the wage given to employees
through collective bargaining.
c) Labour is not homogeneous and workers productivity varies. The productivity of skilled
labour is different from that which is unskilled.
d) Factors of production cannot wholly be substituted. There limitations to how this can be
done especially with specialisation.
e) Labour tends to be immobile occupationally and geographically.
f) The law of diminishing returns may not hold there may be increasing returns.
g) Employers at times use subsistence level as a measure of wages, which may be above or
below the value of the marginal product.
h) It is difficult to measure the marginal product of labour in some occupations/sectors e.g.
services.
i) It ignores historical factors in wage determination e.g. inherited salary structures.
j) It does not consider exploitation of workers by capitalists. Capitalists pay employees
wages low than their marginal productivity.
k) It does not consider the level of education and training, which may differ. Employees
with higher education have higher productivity than employees with lower levels of
education
l) It ignores supply of labour e.g. unskilled labour.
m) Labour and employers cannot determine the exact value of the marginal product since
output is produced by many factors.
To avoid conflicts between workers and their employers brought about how much wages to
pay and to be paid, a standard method of wage payment is necessary. The various methods of
wage payment are:
1. Time rate
2. Piece rate
3. Bonus method
4. Sliding scale
5. Payment in kind
6. Profit sharing
This is a method of wage payment where a worker is paid according to the amount of work done.
A work receives payment for a definite and measurable amount of work e.g. number of bricks
made, loaves of bread etc.
1. Health conditions of workers may worsen because labours tend to over work themselves
in order to earn more.
2. Quality may decline since workers are more interested in quantity rather than quality.
3. When a worker genuinely falls sick or misses work he or she is not paid for the days
missed.
4. There are possibilities of high risks or accidents as people try to produce more and earn
more.
5. The worker is not assured of regular pay and therefore he/she cannot plan effectively.
6. There may be over production due to high output consequently resulting into wastage.
7. Slow but careful workers are discouraged since higher earnings are the driving force.
8. Hard working people are resented.
This is where a fixed sum of money is paid to a worker or employee for a given amount of time
spent at work. This could be hourly, daily, weekly or monthly etc.
1. The worker is assured of regular income even during the time of illness/sickness.
2. It is easy to calculate where work done is hard to measure e.g. for professionals like
doctors, lawyers, teachers etc.
3. The worker can easily plan for his/her income i.e. how to spend it when and where.
4. The quality of work is high since workers do not rush to complete tasks given to them.
5. It minimises risks of damages and accidents since workers take their time.
6. The employer is given sufficient time to mobilise funds to pay the employees.
7. Employees and employers can easily agree on working conditions
8. It has an element of discipline, a spirit of personal responsibility and efficiency among
workers.
9. Hard workers are encouraged through overtime which also increases earning.
10. It facilitates taxation of income earners by the government and is therefore associated
with lower taxation costs.
11. There is job security for efficient workers because should necessity to dismiss some
workers arise the lazy ones are dismissed first.
Disadvantages
1. It involves a lot of supervision costs since one has to see how is being done.
2. It may lead to inefficiency as the hard working persons are discouraged by those who are
lazy but earn the same amount.
3. There is a tendency of workers absenting themselves or dodging or doing less work since
wages will not be affect.
This is a method of payment where by a worker who produces above what is expected of him/her
in terms of output or work done in a given period of time is paid an extra amount for each excess
output produce or task accomplished.
This is method of wage payment which is related to the cost of living. Workers are paid more if
the cost of living increases and are paid less if reduces.
Disadvantages
PROFIT SHARING
This is a system where employees take share of the profits with their employers. Workers are
promoted to hold certain number of shares as long as they remain in employment of the firm and
so receive a share of the profits.
1. Through forces of demand and supply. In situations of excess demand labour for labour
employees receive higher wages and high supply of labour in relation to demand leads to
payment of low wages.
2. Using the piece rate. Employees are paid basing on output produced.
3. Using the time rate. Employees are paid basing on time spent at work.
4. Through collective bargaining. This involves negotiation between employees
representatives and the employer.
5. By employers setting the salaries/wages. The employer offers wage which the employee
takes or leaves.
1. Demand and supply of labour. When the demand for labour is low and supply of labour is
high a low wage is paid because the stiff competition for jobs while when the demand for
labour is high and supply of labour is low a high wage is offered since there is
competition for employees.
2. Bargaining strength of an individual worker. A worker who has strong bargaining power
receives a higher wage because he is able to convince the employer while a worker who
is weak at bargaining receives a low wage because he is not able to convince the
employer to pay more.
3. Amount of work done by the worker. A worker with high productivity is paid a higher
wage than a worker with low productivity.
4. Bargaining strength of trade unions. Employees who belong to strong trade unions
receive higher wages because they are able to convince the employer to pay higher wages
while employees who belong to weak trade unions get low wages because they are not
able to convince the employer to pay more.
5. Number of hours worked. The more the time spent at work the higher the pay because
more output and revenue is realised while when less time is spent at work less output is
realised and therefore a low wage is paid.
6. Cost of living. High cost of living leads to a low wage being paid because employees
spend less on goods and services while when the cost of living is high employees are paid
a high wage to enable them be in position to buy goods and services.
7. Level of education and skills. Educated employees are paid a high wage because of their
high efficiency while those employees with low level of education are paid low wages
because of the low efficiency.
8. Nature of jobs/type of work done. Risky jobs attract high wages to compensate the
employees for exposure to risk while less risky jobs are paid low wages since there is less
exposure to harm.
9. Employers‟ ability and/or willingness to pay. Employers with high profits pay higher
wages while employers with low profits pay low wages since their ability is low.
10. Talents and natural gifts. Employees with better talents are paid higher wages because
they contribute more to output while less gifted get low wages because they contribute
less to output.
11. Experience, expertise or responsibility. High experienced employees get higher wages
because of the higher level of efficiency while the less experienced employees get low
wages because of low efficiency.
TRADE UNIONS
1. General union. These are unions that accommodate different types of workers without
regard to any particular skills.
2. Industrial unions. These are unions which organise all workers in a particular industry
regardless of the type of job done by the workers. E.g. medical workers union etc.
3. Craft unions. These bring together workers with a particular skill e.g. lawyers, teachers,
etc.
4. Closed shop union. This is the type of union or agreement that particular employees
have to join particular unions in order to obtain and retain employment.
5. Open shop union. This is the type of union where all types of workers irrespective of
their skills and occupation are free to join. Industrial and general unions are examples of
open shop unions.
6. White collar union.
1. The amount of strike fund and financial strength. Unions that are financially strong are in
a better position to agitate for better wages and improved working conditions because
they are able to mobilise their members while financially weak unions are not able to
mobilise their members and therefore are not able to convince the employers to pay more.
1. When there‟s a rise in the cost of living. This is because high cost of living reduces the real
wage of the worker, therefore employees demand for wage increment to enable them
purchase goods and services.
2. When workers in a similar or related industry have had their wages increased, workers of
another similar sector or different sector may also demand increase in their wages so as to be
at the same footing with their colleagues.
3. When the profit level of the employer increases. The possibility of trade union increasing
wages of their members is high when the profits of the employer increase because they
increase the ability to pay.
4. If the productivity of the workers has increased, productivity may increase as a result of use
of the machines acquiring more skills etc. the trade unions demand for wage increment
because the contribution of the employees to revenue has increased.
5. When the current wage is lower than government minimum wage. In this case unions should
demand that the wage be raised to match the legislated wage.
6. When the employer fails to effect agreed upon periodical wage increases e.g. when the
employer defaults on earlier agreed upon position. The trade unions demand that the
employer fulfils the promised wage.
7. If the worker has high skills to offer, e.g. when the employees have gone for further studies
they deserve wage increment. The increase in skills increases productivity.
To lesser extent trade unions in Uganda have managed to achieve the following:
Positive effects:
1. They increase the efficiency of employees as a result of improved wages and working
conditions.
2. They reduce income inequality especially between the highly paid and least paid in the
industry.
3. The purchasing power of the employees is improved through wage increments.
4. The presence of trade unions encourages the employer to use capital intensive techniques
resulting into high output.
5. Improve the skills of labour through training.
6. Help in reducing discrimination in the labour market.
Negative effects
1. They lead to wage push inflation since demand for the higher wages result into the
employer increasing the price of goods.
2. They have a negative effect on economic growth since withdrawing of labour through
strikes results into low production.
3. They discourage investment since high wage demands increase the wage bill which scares
away investors due to the high cost of production.
4. They lead to increased level of unemployment since the increase in wages makes the
employer use capital intensive techniques.
5. They create BOP problems since high wages make domestically produced goods expensive
than the imported ones.
6. They create political instability and sometimes lead to over throw of government.
7. They promote income inequality between members of the trade union and non-members.
8. They may create artificial scarcity of labour by demanding that only members should be
employed.
1. Poor leadership skills or limited commitment by leaders. They therefore do not ably
convince the employers to meet workers‟ demands.
2. Poor organisation or discrimination among members on the basis of tribe, religion etc. This
results from lack of unity among workers when demanding for wage increment.
3. Lack of sufficient funds. Members are reluctant to pay their membership and subscription
fees that are required for union activities and these result into limited activities and
mobilisation of the members.
4. Limited skills of members. Most members of the unions have low skills and this attributed
to low levels of education which makes it easy for employers to manipulate them or
threaten to dismiss the employees and they finally accept low wages.
5. Existence of high levels of unemployment. This makes it difficult for the members to go on
strike because they fear being replaced.
6. Low levels of unionisation/limited membership. Few workers belong to trade unions and
for this reason they do not have significant impact on their employers.
7. Poor economic performance/inflation. Developing countries‟ economies are not doing well
especially in terms of price stability as result employers are reluctant to raise wages as this
worsens the problem of inflation.
8. Political/government interference. The governments of Ldcs tend meddle in the election of
leaders, dispersing meetings making strikes illegal etc., in some cases the leaders are given
posts in government hence weakening the unions capacity to demand for better terms of
service.
9. Low demand for goods and services hence few employment opportunities are generated
limiting membership in trade unions. More still the employers are reluctant to raise wages
because they generate low profits.
Economic growth refers to the persistent increase in the quantity of goods and services produced
in an economy during a given time/year.
OR
It refers to the steady process by which the productive capacity of the economy is increased to
bring about rising levels of national output and national income.
It is the sustained increase in the country‟s real output of goods and services measured by the
GNP. Growth is a long term process and the increase in the volume of goods and services should
be persistent.
18. Availability and utilisation of resources: When the available natural resources are well
utilised there is high level of output because firms have inputs/raw materials to use in
production and this leads to a high level of economic while when the available resources
are not well utilised there is low rate of economic growth because of limited availability
of inputs/raw materials.
19. Policy of government on production and investment: A favourable government policy
in form provision of investment incentives encourages production because low costs of
production are experienced hence there is high rate of economic growth while a
unfavourable government policy such as high taxation leads to high cost of production
and therefore a low level of production and economic growth.
20. State and level of technology: Use of modern technology results in high productivity
and efficiency and therefore high level of economic growth, poor technology is a
hindrance to economic growth because of low efficiency in production.
21. The political situation or extent of peace and security: A stable political atmosphere
attracts both local and foreign people to invest because there is no threat to property and
lives hence high output and economic growth and an unstable environment is a threat to
local and foreign investors, destroys property and hence low output and low rate of
economic growth.
22. Level of infrastructure development both social and physical. Well-developed
infrastructure such as roads, railways, etc. leads to high level of economic growth
because it lead to a low cost of production which encourages production while poor
infrastructure leads to low level of economic growth because of the high cost of
production that discourages production.
23. Population growth rate. A high population growth rate causes low level of economic
growth because it leads to low level of savings and investment since much of the income
is consumed and leads to level of production and national income. On the other hand a
These are the advantages enjoyed by individuals and society as whole as GNP increases and
different commodities are produced in an economy. These include the following;
i. Increased production of goods and services leading to improved welfare. This is because
there are several enterprises established to provide various commodities and there is a
higher rate of resource utilisation.
ii. Increases government revenue by increasing the tax base.
iii. Leads to greater utilisation of resources. More resources are employed in the industries
and other production units that are set up since they are used as inputs.
iv. Wide variety of goods is produced increasing consumer choice. This is because there are
several firms involved in production of differentiated goods.
v. Employment opportunities are increased. This is because various industries are
established.
vi. Leads to development of infrastructure. There is construction and rehabilitation of
infrastructure to ease movement of goods labour as well as to reduce production costs.
vii. Leads production of exports. Firms produce not only for the local market but also foreign
market since they have better technology and this improves the BOP position of the
country.
viii. There is a reduction in income inequality. This is due to increased participation of
individuals in production and the availability of more employment opportunities.
ix. Leads to technological development. This because of invention, innovations and research
to enable firms provide quality goods and services.
x. Improvement in the skills of labour. This is through training and this improves the
productivity of labour.
xi. Increased enjoyment of leisure / improved sol / income. The increase in income enables
individuals to enjoy leisure.
xii. Increased humanitarian activities with rich societies reaching out to poor societies. The
increase in incomes improves concern of individuals for other people since they have the
capacity to provide.
xiii. Improved political stability. The population becomes contented since there are more
people employed and a fair distribution of income.
xiv. Removal of obstacles to growth e.g. conservation, backward cultures etc. There is a
change in peoples‟ attitudes as there is improvement in education, urbanisation, etc.
xv. It leads to industrialisation / increased urbanisation. It involves establishment of
industries to produce for the population.
xvi. Price stability due to increased output. There is an increase in production of goods and
services which reduces scarcity.
xvii. Reduced external dependence/self-reliant economy. There is a reduction in the
importation of goods due to the increased production of goods and services.
These are the disadvantages which individuals and society as whole suffer as a result of
economic growth that has been achieved. I.e. it is the opportunity cost of economic
growth or the side effects of economic growth.
i. Causes to quick exhaustion of resources due to over exploitation. This is because there
are several firms involved in production and trying to maximise profits.
ii. Environmental degradation/pollution. This is brought about by poor waste management
and the fumes from industries that pollute the environment.
iii. It requires hard work therefore people forego their leisure time. People strain themselves
trying to increase their incomes through increased output and this causes poor health.
iv. It causes income inequalities. This is because production is undertaken by few who have
the required capital and therefore the rich become richer and the poor become poorer.
v. It causes technological unemployment when capital intensive techniques of production
are used. Machines are used in the place of human beings.
vi. It involves foregoing present consumption and investing most of the incomes in order to
increase output in the future. This results in a decline the welfare of individuals.
vii. It causes rural-urban migration and its associated disadvantages because most economic
activities are urban based. Those who cannot find jobs in rural areas move to urban
centres expecting better jobs which are not readily available hence high crime rate.
viii. It causes foreign domination and profit repatriation. This is because of foreign ownership
of some business undertakings.
ix. Deterioration of cultural values. This is due to urbanisation and foreign influence.
x. Occupational hazards which affects the lives of the workers. The profit driven
entrepreneurs mind less about the safety of employs as they try to reduce cost of
production.
xi. It increases the debt burden due to increased borrowing / it increases external
dependence. The need to expand enterprises results into borrowing to finance businesses.
xii. It involves displacement of people in some cases. The need for land for expansion of
enterprises causes displacement of people.
xiii. Leads to imbalance in regional development. There is imbalance in development due
concentration of most enterprises in urban centres.
xiv. Low quality of output. This as a result of using poor technology since production
emphasises quantity rather than quality.
Rostow explained growth from a historical perspective. Using capital accumulation as the
origin of growth. Rostow identified five stages through which all economies must pass in
order to achieve economic development.
This is the lowest stage in economic growth and is characterised by the following
This is a transitional stage in which the traditional systems are over come so that the economy
can start developing. It characterised by the following;
TAKE-OFF STAG
This is an important stage where an economy attains self sufficient i.e. there is a
Rostow defines this stage as period when society has effectively applied the range of modern
technology to its resources. It is a period of long sustained economic growth. It is characterised
by the following:
According to Rostow this is the highest stage of economic growth. There is a very high standard
of living. It is characterised by the following:
NB: Uganda is in the pre-conditions for take-off stage because of the following reasons:
The theory of balanced growth by Ragnar Nurkes emphasises harmonious and simultaneous
investment in the all sectors of the economy so that they complement each other and grow
more or less at the same pace. In this strategy balance should be achieved in sectors like
industry and agriculture consumer goods and capital goods, domestic and foreign sectors
investment in human capital and physical capital etc.
NB: Forward linkages exist when setting of an industry results into emergence of other industries
with the newly established plats forming markets for products (and by-products) of the already
existing industry.
While
Backward linkages is where existence of an industry leads to setting of new industries to supply
existing industry with inputs.
This strategy was advanced by Professor Albert Hirschman. It states that leading sector(s) with
strategic importance should be selected and expanded first so that it pulls up or develops other
sectors through linkages. The leading sectors are the key sectors of the economy with backward
and forward linkages e.g. developing agriculture first it would later lead to industrialisation as
the agriculture sector provides raw materials to the industrial sector.
1. It requires less capital and therefore can be pursued using few resources hence it is
suitable for developing countries with limited capital
2. It has sectoral linkages as it makes use of the forward and backward linkages and thus is
able to result into a self-sustaining and integrated economy in the long run
3. The strategy makes use of the locally available resources therefore foreign exchange
expenditure abroad on imported inputs is limited
4. It suits countries with limited markets because what is produced locally by the leading
sector will easily find market
5. The strategy recognises the crucial role played by international trade in the development
of countries. Thus resources should be concentrated in areas where countries have
comparative advantage to maximise gains
The strategy advocates for massive investment of capital and other resources into the economy
on large scale necessary for the promotion of rapid industrialisation and expansion of
economic infrastructure. I.e. a large comprehensive programme is needed in the form of a high
minimum amount of investment to overcome the obstacles to development in developing
countries. The massive investment which is required is called critical minimum effort.
1. Economic growth is faster and rapid and an economy develops in a short time.
2. It generates employment opportunities on wider scale. This is because several industries
and infrastructure provided jobs hence improvement in people‟s welfare.
3. It promotes quick industrialisation of the economy. This is achieved through massive
investment in industry and infrastructure.
4. It widens market for goods and services. As many firms are set up many people are
employed increasing their purchasing power.
5. There is establishment of infrastructure through construction which leads to the overall
development of the economy. This because it eases transportation of goods and services.
6. It increases the volume of exports and reduces the volume of imports hence solving the
bop problems of a country.
7. The strategy reduces income inequalities since many people are able to get employment.
8. It encourages massive use of the locally available resources reducing dependence on
external resources or borrowing.
9. It widens the tax base enabling the government earn revenue.
10. The strategy helps in skills acquisition since labour is trained in various skills to manage
the different sectors. This improves the efficiency of labour.
1. It assumes abundance of capital to invest in all sectors of the economy which is not the
case for developing countries where capital is not adequate. This results into incomplete
projects.
2. Lack of sufficient market to absorb all that is produced because of the low purchasing
power of individuals leads to wastage of resources.
3. The strategy underrates the structural and institutional problems evident in developing
countries e.g. poor land tenure system, negative attitudes to work, etc. These limit the
capacity to produce goods and services.
4. The strategy emphasises the industrial sector at the expense of the agricultural sector thus
it promotes dualism.
5. In developing countries there is shortage of entrepreneurs who can undertake risks invest
due to poor investment climate.
6. Limited capital in Ldcs necessitates borrowing which has some strings attached that may
not be in line with the countries development programmes.
7. Inefficient administration, corruption and embezzlement are common in developing may
not permit proper use of resources
8. There is limited control of the economy by government which may leave some sectors
and parts of the country unattended to.
9. Existence of poor infrastructure limits the smooth operation of the sectors. It limits the
movement of factors of production and finished goods which increases the cost of
production.
1. Limited capital. This causes inability to purchase the required in puts hence a low level of
production.
2. Limited skills. There is inefficiency in production hence wastage of resources
3. Small market. This causes low level of production since there are low profits.
4. Limited entrepreneurial skills. There is limited establishment of enterprises hence a low
level of production.
5. Limited basic infrastructure. This causes inability to access inputs markets and markets of
final goods hence high cost of production.
6. Political instability. It destroys projects and causes wastage of resources.
7. Conservatism.
8. Poor land tenure system. This makes acquisition of land expensive and this limits
production
9. Corruption. It reduces the funds for establishment of projects and thus collapse of
projects.
10. Weak policy implementation machinery.
ECONOMIC DEVELOPMENT
Economic development refers to the persistent qualitative and quantitative increase in the volume
of goods and services produced in a country over a given time.
Or
The persistent quantitative and qualitative increase in GDP over a long period of time; it includes
qualitative changes in variables that improve life of citizens such as increased freedoms of
choice; self-esteem etc.
Whereas economic growth may be achieved in a short time economic development is achieved
after a considerably long time. Therefore a country may achieve economic growth and not
economic development.
1. Growth may be achieved with an increase in output when there is no increase in quality
2. It may be attained when there is un even distribution of income
3. Economic growth may be achieved when society is over strained by work or when there
is hardly any leisure enjoyed
4. Growth may be achieved amidst high levels of unemployment
5. It may be achieved when there are high levels of inflation
6. Economic growth may achieved when there is high population growth rate
7. It may be achieved amidst political instability
UNDERDEVELOPMENT
The world is mainly divide into developed and under developed countries.
DEVELOPMENT GOALS
Or
Government in east Africa and the word over have put in place development goals as a way of
achieving economic development. Goals or objectives of development are broad policy guidance
designed to achieve an improvement in people welfare .the goals of development include:
Advocates of the agriculture developments strategy have the view that developing countries can
achieve economic growth through the agricultural development strategy and they raise the
following arguments:
1. Agriculture requires less capital investment than industrialisation and therefore it is the
most appropriate for the developing countries since they do not have insufficient capital.
2. Agriculture has quick returns because of the less capital requirements and the quick
maturity of the agricultural produce farmers are able to realise returns in a very short
time
3. It is a source of raw materials. Agriculture is a major source of raw material for the agro
based material and therefore it brings about rapid industrialisation.
4. It provides employment to both the skilled unskilled. Majority of the people in
developing countries depend on agriculture and are more employed in the sector.
Therefore its development would provide employment to many people.
5. It provides an important source of revenue to the government by taxing farmers,
cooperatives etc.
6. It reduces rural-urban migration as developing agriculture leads to the development of
rural areas reducing the need to move to urban areas for employment.
7. Ensures balanced regional development, if well-developed it would lead to balanced
regional development as it is the activity in the developing countries.
8. It contributes to the GDP through the substantial amount of output.
9. It is source of food to the population- both the urban and rural population thus
developing it leads to quality quantity and cheap produce.
10. It provides market for manufactured goods like fertilizers, hoes etc. thus promoting
industrialisation.
11. Encourages the development of infrastructure. There is development of infrastructure
through construction to support the sector e.g. roads which promote the development of
the entire economy.
1. Less revenue is realised by the government because of the low earnings by those in the
sector. Government imposes low taxes.
2. It leads to unfavourable terms of trade as the prices of agricultural products are generally
low compared to those of manufactured goods.
3. It causes un favourable BOP because revenue obtained from agricultural exports is low
compared to high expenditure on imported goods
4. Price fluctuations are common in the sector due to the changes brought about by the
changes in weather, costs of production, etc.
5. Agricultural development may not solve the mass unemployment that is rampant in Ldcs
since there is seasonal and disguised unemployment.
6. Agriculture is subject to the law of diminishing returns and therefore output reduces over
time reducing people‟s earnings / incomes of those employed in the sector.
7. It increases external dependence as emphasising it would lead to the supply of
agricultural products at the expense of manufactured goods causing trade dependence.
Strategies for agricultural development aim at improving the methods used in agriculture,
changing or transforming the methods used in agriculture in order to increase output.
This refers to ways of increasing the agricultural output within the same framework/structure by
using modern methods of farming.
This approach aims at encouraging agricultural development within the existing peasant
production units by changing the existing production techniques without changing the basic
organisation of farming. It requires provision of inputs, extension services, credit facilities,
infrastructure, etc.
1. It does not require a lot of capital compared to other strategies e.g. mechanisation.
2. It creates employment for the unemployed as it improves „their skills.
3. It improves the quality of labour in rural areas leading to better quality products.
4. Fundamental changes not needed by the farmers.
This refers to changing from the existing method which is traditional and out dated to one which
is modern to meet the current demand for agricultural output. It depends on large scale
mechanisation. It involves the following:
Disadvantages
MECHINISATION OF AGRICULTURE
Mechanisation involves use of machines like tractors, ploughs, sprayers, etc. in order to increase
quality and quantity of output.
Advantages
1. It improves the quality of agricultural output through irrigation schemes, spraying against
diseases etc.
2. It results into high levels of output.
3. It results into greater amount of work arising from using machines to prepare land, seed
beds, etc.
4. Mechanisation reduces the production cost since the use of machines reduces the amount
of labour required to plant, spray, etc.
Disadvantages
1. Requires large pieces of land and yet there is a poor land tenure system in developing
countries due land fragmentation.
2. Increases the rate of land exhaustion and thus reduction in the productivity of land.
3. Promotes over production and hence wastage of resources.
4. Causes environmental degradation. There is because machines release fumes into the
atmosphere.
5. Promotes specialisation and its associated problems.
6. There is lack of sufficient funds to invest in mechanisation for the case of developing
countries.
7. Mechanisation causes unemployment. This is because few people are employed where
machines are used.
8. Rural–urban migration is promoted. Those who cannot get jobs in rural areas go to urban
centres since machines are preferred.
9. It promotes income inequality because it is mainly affordable by the rich.
10. It may create a landless class as it requires large tracts of land.
Factors which limit mechanisation of agriculture
1. Limited skilled manpower. There few people to run the machines due to limited
education and this causes high cost to train the labourers.
2. Poor land tenure system. Pieces of land are small in some cases and this limits the ability
to move the machines.
3. Small market for our agricultural produce. There is production since there is not
sufficient market for the goods.
4. Limited capital stock. This limits the ability to purchase spare parts and this reduces the
efficiency of the machines.
5. Limited entrepreneurial skills. There are few people who are willing to invest in the
purchase of the machines since they fear to take risks.
6. Under developed technology.
7. Conservatism of some farmers. Some farmers are not willing to invest in the purchase of
machines.
8. Unstable/low agricultural prices. These cause low earnings and therefore limit the ability
of individuals to invest in machines
Developing countries in the past have tried the agricultural strategy but have not registered
significant economic progress. There is an argument that for developing countries to achieve
high rates of growth and development they should industrialise and the following are given as
arguments in favour of industrialisation:
1. It requires a lot of capital which Ldcs do not have in sufficient amounts thus Ldcs cannot
afford this strategy i.e. it is expensive.
2. The strategy is associated with low levels of employment in the short run and therefore
cannot solve the mass unemployment that is rampant in developing countries.
3. It worsens the problem of income inequality especially in the short run because few
people are employed or those employed in the industrial sector earn higher incomes than
those in other sectors e.g. agriculture.
4. It leads to rural urban migration because most industries are concentrated in urban areas.
5. It encourages external agriculture dependency since some industries require imported raw
materials. This worsens the problem of dependency.
6. It leads to over exploitation of resources as there is high rate of resource exploitation
because of use of better methods thus quick resource exhaustion.
7. It causes regional imbalance because for the case of LDCs the industries are mainly urban
based
8. Industrialisation involves high social costs e.g. pollution this negatively affects peoples‟
lives by causing diseases
9. Returns from the industrial sectors are not immediate yet the developing countries need
to develop urgently.
1. There is provision of more employment opportunities. This is because there are several
industries established that require labour force and the use of labour intensive techniques
of production.
2. It reduces the extent of foreign dependency. It leads to self sufficiency in basic consumer
goods and other requirements since they are locally provided.
3. It facilitates the development of local skills. This through the training of the labour force
and this improves the efficiency of labour.
4. It helps save the scarce foreign exchange. This by producing formerly imported goods i.e.
it reduces capital flight
5. It improves on the bop position of the country. This is because the expenditure on imports
is reduced by producing goods locally.
6. It facilitates more exploitation of domestic resources. The industries that are established
this reduces excess capacity.
7. Imports substitution results into increased government revenue. This is through taxes on
industries and commodities produced by the industries
8. It facilitates transfer of technology from developed to developing countries. This is
because most of the industries are foreign owned and this increases the productive
capacity of the country
9. It facilitates the development of infrastructure. This is through construction e.g. roads,
banks to ease movement of goods and services.
10. In the long run it helps to earn foreign exchange through the exportation of goods.
11. It leads to the expansion of the manufacturing sector as more industries are established
12. It helps in controlling imported inflation. This is because some goods will no longer be
imported but produced at home.
13. The strategy facilities capital in flow through attraction of foreign investors.
14. It promotes economic growth through increased volume of goods and services produced.
There are several industries involved in production of goods and services.
1. It is associated with profit repatriation because most of the industries are foreign owned.
2. It encourages use of capital intensive techniques of production which results into
unemployment.
3. It leads to capital outflow through importation of intermediate inputs and labour /
expatriates. This leads to bop problems.
4. Most firms are high cost firms due shortage of manpower, importation of manpower.
This results into production of priced goods.
5. Poor quality goods are produced due to limited competition.
6. It worsens balance of payments position in LDCS due to importation highly priced
inputs.
It is a deliberate policy by the government to expand the volume of the country‟s exports through
incentives and other means in order to generate foreign exchange and to improve its Bop
position. It is an outward looking development strategy. For it to be successful the following
must be in place:
1. It leads to the expansion of the market for goods and services which increases the
country‟s foreign exchange through exports
2. There is considerable development of infrastructure through construction and
rehabilitation in form of roads, railways, etc. to ensure smooth operation of the industries.
3. It helps in the improvement of quality as the firms are subjected to international
competition/add value to gods.
These are industries that employ less than 100 employees and the capital invested is less than
300,000 US dollars. Examples include dairy farms, poultry farms etc.
Positive role
1. They have less capital requirement they are therefore appropriate for developing
countries that do not have sufficient capital.
2. The small scale industries provide employment to a wide range of skilled and semi-
skilled labour force. This is because they are mainly labour intensive.
3. They promote rural transformation because they can easily be located anywhere
including rural areas.
4. Small scale industries are flexible and therefore can easily respond and adapt themselves
to changing economic conditions e.g. changes in demand.
5. They are suitable for the small size of market in developing countries therefore minimise
wastage of resources
6. The industries do not require highly skilled labour force and therefore appropriate for
developing countries that do not have sufficient skilled manpower
7. They act as training grounds for the indigenous entrepreneurs who are in short supply and
therefore help developing countries to establish large scale industries
8. They produce a wide range of consumer goods for the low income earners. This reduces
foreign exchange expenditure on imported commodities
9. They mainly use local raw materials and therefore encourage better utilisation of the
locally available resources
10. They help to reduce income inequalities because they are easy to establish in many parts
of the country and employ many people.
11. They increase the tax base and thus increased government revenue
12. They help to promote self sufficiency since the mainly produce for the local market and
use locally available resources
13. Small scale industries can be used to solve Bop problems since there establishment
reduces the need to import goods
1. They produce less for export and therefore bop problems continue to be experienced
2. Small scale industries do not enjoy economies of scale because they are high cost firms
they charge consumers high prices- exploit consumers
3. They are not appropriate in some sectors e.g. in the mining sector where heavy machinery
is required
4. They tend to use poor technology and therefore produce poor quality products that are not
marketable locally and internationally
A large scale firm is one which employs more than 100 employs; capital invested is big and has a
high level of output.
1. They are associated with high levels of output and therefore lead to high rates of
economic growth
2. Firms enjoy economies of scale hence a low cost of production is experienced
3. The government earns high revenue from the taxes imposed on the big profits earned by
the owners
4. There is use of advanced technology which results in the production of quality goods
5. They create more employment opportunities in the long run thus help in solving the mass
unemployment in Ldcs
6. They improve the export capacity of the nation because of mass and quality production
hence increased foreign exchange earning
7. Large scale industries encourage acquisition of skills through training of labour
8. Encourage development of infrastructure to support the industries
9. Lead to more equitable distribution of income in the long run as more people are to get
employment
10. They promote technological development since they invest in research.
11. More resources are put to use. This promotes economic growth.
This is a form of production technique which uses a big proportion of labour in relation to other
factors of production such as capital. It is also called a capital saving technique of production
because it uses less capital.
1. The productivity per unit of labour is very low and this retards economic growth
2. The technique tends to produce low quality products which makes it difficult to market
the products
3. It is associated with management problems like strikes by the workers, demanding for
high wages which disrupt production
4. It does not encourage high level of skills development
5. The technique is costly in the long run in terms of feeding, providing accommodation,
medical health care etc.
6. It results into under utilisation of resources because of low efficiency
This is a production technique that uses a big proportion of capital in relation to other factors of
production such as labour. It is also called a labour saving technique of production.
1. Limited funds/stock of capital. There is a low level finance to facilitate the purchase the
inputs.
2. Limited skilled labour. There is low efficiency in the running of the techniques of
production
3. Limited entrepreneurial ability. There few people willing to inject funds in the purchase
of machinery.
4. Low level of innovations and inventions/research. There is limited funding of research to
come up with new technologies hence continuous use of outdated technology.
5. Cultural rigidities/conservatism. Some people are not willing to invest funds in new
technologies.
6. Poor topography. It is difficult to move machines from one place to another since there is
poor infrastructure.
7. Small/limited market for technology and products. There are few people with the
capacity to purchase better technologies due poor.
8. Underdeveloped/poor conditions of infrastructure. There difficulty in moving machines
from one place to another.
9. Poor land tenure system. There are small pieces of land which make use of machines un
economically viable.
10. Poor accountability/corruption.
11. Political instability.
INTERMEDIATE TECHNOLOGY
This refers to a method of production which lies between capital intensive and labour intensive
methods of production.
1. Creates employment opportunities. This because many people easily adopt it.
2. It increases productivity of labour. This is because it is more efficient.
3. It saves the scarce foreign exchange. This is due to the limited importation of spare parts.
4. It promotes linkages and hence limited wastage of resources.
5. Promotes exploitation of local resources. This increases the level of resource utilisation.
6. It promotes acquisition of skills by labour force as there is on job training and this
increases productivity of labour.
7. It helps to improve the distribution of income. This because many people are able to use
in the production process which improves their income.
8. It reduces foreign dependence. This is because it reduces importation of spare parts.
9. It produces according to local needs of the people so it reduces wastage.
10. It provides market for the country‟s resources.
1. It is not appropriate inn large scale industries. This is because of its low productivity.
2. It results into production of poor quality products because it is associated with a low level
of efficiency.
3. It does not improve skills of labour. This is because labour does not handle completed
and modern machines.
APPROPRIATE TECHNOLOGY
This is a production method which is socially and economically suitable for a given
economy/society.
Or
A production method which is in line with development objectives and suits the development
level of an economy.
1. Availability of funds/capital.
2. Level of entrepreneurship.
3. Level of innovations/inventions.
4. External/foreign influence.
5. Government influence on technological development.
6. Market for the technology and products.
7. Cultural factors.
8. Natural factors e.g. topography, soils, etc.
9. Political climate.
10. Degree of corruption.
EDUCATION
Education is the process of acquiring knowledge and skills. This is mainly through formal and
informal education.
1. It is an intangible commodity.
2. Education as an investment
1. Like investment, education involves costs e. g. payment of school fees
2. Education has future returns inform of improved standard of living, wages, etc.
3. Education involves risks and uncertainties e.g. failing exams, unemployment etc.
4. It involves opportunity cost e.g. foregoing leisure, foregoing work etc.
Positive roles
1. Education involves the development of the skills of labour through training and this
increases the productivity of labour
2. It provides direct and indirect employment in fields like teaching, drivers, etc. which
improves their standard of living
3. Education reduces government expenditure on expatriates and therefore saves the
country‟s foreign exchange
1. It leads to rural urban migration since the educated in developing countries prefer to live
in urban areas where better amenities of life are found
2. Education results into income inequalities in developing countries because there few
educated who earn high incomes while the majority are not educated
3. It involves high opportunity cost e.g. long time spent at school and not enjoying leisure
4. Education contributes to Bop problems because of the demonstration effect where the
educated prefer imported luxurious goods increasing foreign exchange expenditure
5. It promotes brain drain as the educated leave their countries for the developed world
where better wages are paid
6. It leads to neglect of agriculture since it prepares the youth for white collar jobs and the
educated prefer leaving in urban centres.
7. Education in developing countries is expensive and affordable by few people leading to
few leading to few elites and the majority illiterate creating dualism in education.
8. When education is provided to the majority of the people gradually it leads to
unemployment especially where there is poor man power planning.
Foreign capital investment refers to the transfer of resources mainly funds from one country to
another either by multinational corporations or from one government to another.
Foreign direct investment refers to the transfer of productive resources or capital by foreign
individuals, companies and multinational corporations in the form of business operations.
Question: Assess the role of foreign capital investment in the development of your country.
Positive role
1. They help in closing the savings-investment gap because local savings are not sufficient
to make meaningful investment, therefore foreign capital investment helps in providing
funds for investment.
2. It helps in closing the foreign exchange gap because foreign exchange generated from
exports is low. It provides the needed foreign exchange for development purposes.
3. It promotes technological development and transfer because the foreign investors come
along with advanced technology which is used to increase production in the country.
4. It enhances creation of more employment opportunities especially where labour intensive
techniques of production are used.
5. It helps in skills development since local manpower is trained in new skills and how to
use modern technology. This increases the productivity of labour.
6. It promotes development of infrastructure e.g. roads, telecommunication etc., which
facilities more investment and production.
7. It facilitates production of a wide variety of goods and services which widen consumer‟s
choice and welfare.
8. Encourages competition which leads to improved efficiency in locally owned firms i.e.
the competition between foreign firms and local firms improves efficiency in the local
firms.
9. It promotes international co-operation between countries and this encourages trade
between the host country and the country of origin of the investors.
10. It encourages improved resource utilization because of using better technology leading to
increase in growth.
11. It fills the manpower gap since the locally trained manpower is not enough and this
through the use of expatriates in some sectors.
12. It accelerates industrial growth because a number of industries are established to provide
wide variety of goods and services.
13. It encourages inventions and innovations because the desire to make more profits makes
the entrepreneurs invest in research and this results into better techniques of production.
14. It promotes development of local entrepreneurial skills because the local entrepreneurs
are able to learn from the managerial skills of those who own the private foreign firms.
15. Leads to increased output hence economic growth.
Negative role
1. It leads to capital flight by way of profit repatriation which drains the country‟s foreign
exchange.
2. It worsens income inequalities in the country because the few people who are employed
are paid highly compared to those in other sectors.
(b) Examine the role of multinational corporations in the development of your country.
1. Capital flight.
2. Bop problem.
3. Worsening of economic dependency problem.
4. Unemployment due to use of capital intensive technology.
5. Excessive concessions given sometimes exceed real or net gain.
transfer.
Technological transfer refers to the shifting or movement of new and efficient techniques of
production from one country to another. Mainly from developed to developing countries.
While
Technological development is the process of initiating, innovating and improving the existing
techniques of production within an economy.
Foreign aid is the international transfer of resources/funds in the form of loans or grants or
technical assistance etc, either directly from one government to another (that is bilateral aid) or
indirectly through the vehicle of a multi – lateral assistance agency like World Bank and the
International Monetary Fund (multi – lateral aid).
Or
Foreign aid is the transfer of resources from one country to another; either directly or through
international agencies. It could be bi-lateral aid or multilateral aid.
Forms of aid
Positive roles:-
1. It fills the savings- investment the gap because the investment requirements exceed the
domestic savings. The funds received are used to finance establishment of enterprises.
2. It fills foreign exchange gap. The foreign exchange requirements for development exceed
the locally available foreign exchange from exports. The foreign exchange received is
used to finance importation of goods.
3. It helps to fill the manpower gap because the skilled manpower requirements in Ldcs
exceed the locally available supply of trained manpower. The aid in form of skilled
labour force provides the needed manpower.
4. It helps to close the technological gap i.e. aid in form of technology enables Ldcs to have
access to better technology and also overcome technological shortages.
5. It helps to close the government-revenue-expenditure gap. Aid in form of funds provides
the needed money to finance budget deficits thus supplementing local revenue.
6. Foreign aid helps in alleviating the effects of catastrophes e.g. famine, floods, etc. The
funds received are used to provide goods and services to those affected by disasters.
7. Foreign aid facilitates the development of infrastructure of a country. Aid in form of
equipment helps in the construction of infrastructure.
8. It strengthens international relations between the aid giving and the recipient country.
9. It helps in the provision of employment opportunities especially the aid that is invested in
productive projects.
10. Foreign aid in form of capital investment accelerates industrialisation. This is because it
avails funds for establishing industries and this promotes economic growth.
11. Foreign aid increases local skills. This is through funding local training and the
scholarships given and this improves the efficiency of labour.
12. Promotes economic growth. Foreign aid invested in productive ventures increases
production of goods and services and this promotes economic growth.
13. Exploitation of idle resources hence avoidance of resource wastage.
14. Promotes political stability. Aid in form of military hardware reduces incidences of war.
1. It creates a burden of debt servicing which denies nationals essential goods and services.
2. Aid to Ldcs has strings attached (tied aid) which are usually not desirable and at times
cause suffering e.g. liberalization of trade, privatization, etc.
3. Undermines capital formation due to debt servicing and payment.
4. It promotes a dependence syndrome. The recipient countries become lazy and always
expect assistance from the international community and as result it reduces the initiative
of developing countries as they are expecting more aid.
5. Aid worsens economic dominance by the donor country over the recipient countries. The
donor countries dictate policies to the disadvantage of the recipient countries.
6. It leads to BOP problems due to the repayment obligations especially for aid that is tied.
NB: Tied aid is one which requires the recipient to abide by conditions set by the donor e.g.
i. The recipient country is required to purchase goods from the donor country using the
grant/funds.
ii. Aid given to finance a specific project named by the donor.
iii. The recipient country is required to implement socio-economic and political conditions
dictated by the donor before aid can be given.
Factors which determine the amount of aid given for economic development
1. Availability of funds. The more funds the donor country has the more funds the recipient is
likely to get and vice-versa.
2. The absorptive capacity. A country is given aid which it can use fully and usefully.
Absorptive capacity means the ability of the country to utilise efficiently the aid given to it.
3. Availability of resources. A country with more resources is likely to get more aid than that
country with very limited resources.
4. The capacity of the country to pay. This determined by the capacity to export as well as
argument the foreign exchange earnings.
5. The will and effort to develop.
6. The ideology i.e. whether the donor and the recipient countries share the same ideology
politically and economically.
7. The political climate.
International trade is the exchange of goods and services between countries. This exchange of
goods and services can be between individuals/companies from different countries or between
governments of different countries. If the exchange of goods and services is between two
countries then it is called bi-lateral trade, if the exchange is between many countries it is called
multi-lateral trade.
International trade which involves goods only is called visible trade and trade in services is
called invisible trade. International trade involves two forms i.e. import and export trade.
1. High output is realised. It allows international specialisation in that countries are able to
produce the commodity in which they have the greatest advantage.
2. It enables a country to import from other countries the goods and services it cannot
produce locally due to lack of resources.
3. It is a source of government revenue. Taxes are imposed on imports and exports.
4. It expands employment opportunities. The expansion of production enterprises and
increased resource utilisation increases employment opportunities.
5. There is production of quality goods. International trade creates a competitive atmosphere
between countries in the production of goods in order to attract market hence leading to
production of quality goods.
1. Importation of technology and capital reduces the indigenous spirit of inventiveness and
innovativeness which reduces the rate of growth.
2. Causes imported inflation. It may lead to imported inflation which results in local
population consuming commodities expensively.
3. It can lead to balance of payment problems in situations where poor terms of trade are
experienced.
4. It can lead to importation of harmful commodities which can easily worsen the health
conditions of individuals in a country.
5. Exhaustion of non-renewable resources due to over exploitation. This is the case where
there is high demand for a given commodity.
6. Leads to cultural erosion. This is the case when the local people copy foreign cultures
that negatively affect the peoples of living.
7. Collapse of domestic firms due to being outcompeted by foreign firms.
8. Leads to dumping. Dumping causes collapse of local industries since they are cheap.
PROTECTIONISM
Protectionism refers to the commercial policy of safe guarding the national interest through
restrictions on international trade. It involves government interference with the free movement of
goods and services across a nation‟s boundary. Protectionism involves restrictions on imports
and exports through tariff and non-tariff barriers.
Tariffs. These are taxes imposed on imports and exports. They are therefore import or export
duties.
Non-tariff barriers. These are qualitative and quantitative restrictions on the amount of goods
that may enter or live a country. They include:
1. Quotas. These are quantitative restrictions on imported and exported goods. In this case
the amount that may enter or leave country is laid down.
2. Total ban/Embargo. In this case the country stops the importation or exportation of
certain commodities. In this case there is a law prohibiting the flow of such goods to and
from the country.
3. Foreign exchange control. Foreign exchange is restricted to some importers while others
are favoured. It may be given out to priority sectors or importers.
4. Issuing of import licences. Some importers are given licences at lower prices while others
at high prices or they denied completely.
5. Devaluation. This makes foreign exchange more expensive and therefore will make
imports expensive leading to reduction in their demand.
6. Special deposits. Some importers are instructed to make a special deposit before being
allowed to import. The deposit can be fixed highly and those who cannot manage the
high deposits are not allowed to import.
7. Deflation policy. This involves the reduction of liquidity in public hands. This can be
achieved by use of monetary and fiscal policies.
8. Administrative measures. This involves regulations and non-monetary obstacles that
include among others bureaucracy, delays in clearing and forwarding, etc.
9. Subsidisation to priority producers/importers. This is done to enable them charge low
prices for commodities and be able to out compete foreign firms.
Commercial policy
Commercial policy refers to government policy meant to influence and direct the volume,
value and direction of trade in the economy.
Disadvantages of protectionism
1. It subjects nationals to highly priced goods. It subjects nationals to highly priced goods
because levying taxes increases prices of goods and services which reduce their
consumption.
2. Encourages inefficiency in protected firms. It encourages inefficiency in protected firms
since the firms that are shielded from competition become high cost firms and there is
inefficient utilisation of resources.
3. It subjects nationals to poor quality goods. It subjects nationals to poor quality goods as
there is limited/no competition in production as well as use of poor technology.
4. It encourages monopoly tendencies in the local market. It encourages monopoly
tendencies because the protected firms monopolise the local and supply less output to the
market at high prices.
5. It limits variety of goods. It subjects nationals to limited range of products thus limiting
choice.
6. Protected firms have a tendency of remaining infant so as to continue benefiting from
government protection and therefore remain inefficient.
FREE TRADE
Free trade refers to unrestricted trade in goods and services between countries. The policy of free
trade implies non-intervention of government in international trade. It is a situation in which
there are no artificial barriers in form of quotas and tariffs to the movement of goods and
services between countries and government allows trade to take its own course.
The theory states that given two countries and two commodities using the same amount of
resources a country should specialise in the production of that commodity (s) it can produce
more cheaply or at a lower cost than the other country. I.e. when two countries are involved in
the production of two commodities e.g. Uganda and Kenya producing say wheat and bananas,
each country should specialise in one all both provided it does so at a lowest cost so that
exchange can take place.
Uganda 1 8 20
Kenya 1 10 40
In the illustration above Kenya has absolute advantage in over Uganda in the production of both
wheat and bananas.
According to the comparative advantage principle given two countries and two commodities
using the same amount of resources a country should specialise in the production of a
commodity where it has the least opportunity cost than the other. Even if a country has absolute
advantage in the production of two or more commodities, it should concentrate on the production
of the commodity in which it has least opportunity/real cost.
Kenya 1 10 40
For the countries to benefit from international trade, each country should specialise in the
production of a commodity where it incurs less opportunity cost i.e. where a country loses less
by producing the other commodity. Using the illustration above, whereas Kenya has absolute
advantage in the production of both commodities it may not have comparative advantage in the
two commodities hence the need to specialise in one of the commodities so that exchange can
take place between Uganda and Kenya.
Uganda
20/8 = 2.5
For every 1 tonne of wheat produced 2.5 tons of bananas are foregone.
8/20 = 0.4
For every 1 tonne of bananas produced, 0.4 tons of wheat are foregone.
Kenya
40/10 = 4
10/40 = 0.25
For every 1 tonne of bananas produced, 0.25 tons of wheat are foregone.
Kenya 4 0.25
From the illustration above, Kenya has comparative advantage over Uganda in the production of
bananas while Uganda has comparative advantage over Kenya in the production of wheat.
1. It assumes there are only two countries in the world involved in international trade i.e.
Uganda and Kenya.
2. It assumes that only two commodities are produced in between the two countries i.e.
wheat and bananas.
3. That tastes are similar in the two countries.
4. That all factors of production are homogeneous.
5. It assumes that commodities are produced under the law of constant returns to scale.
6. That trade between the two countries takes place without any barriers.
7. It assumes that technology is fixed or constant.
8. It assumes that no transport costs are involved in carrying out trade between the two
countries.
9. That all factors of production are fully employed between the two countries.
10. Perfect mobility of factors internally/immobility of factors externally.
11. Demand is elastic.
12. Barter trade system exists.
13. Constant comparative advantage in both countries.
The theory of comparative advantage makes unrealistic assumptions and has been criticised
basing on the following:
1. The basis that the world is composed of two countries only is unrealistic. There are more
than two countries involved in international trade.
2. Producing two commodities only is unrealistic because countries produce a wide range
of goods and services and trade is therefore multilateral rather than bilateral.
3. Similar tastes do not exist between countries because tastes differ with different groups in
a country and between countries. As a country grows tastes and preferences also change.
4. It ignores transport costs yet they form a significant part in determining the pattern of
world trade.
1. Developing countries have tended to specialise in agriculture where they have lowest
comparative advantage.
2. There are barter trade arrangements in Ldcs.
3. There is use of labour intensive techniques which is abundant.
4. There are some cases of free trade.
5. There is some degree of mobility of factors of production within individual countries.
6. Developing countries import manufactured goods where they have lesser comparative
advantages.
Or
Terms of trade refers to the rate at which a country‟s exports exchange against its imports.
Or
It is the relationship between the price index of exports and the price index of imports.
It represents the units of domestically produced goods foregone to secure one unit of imported
goods.
When prices of imports are greater than prices of exports the terms of trade are said to be
unfavourable.
When prices of exports continuously exceed the prices of imports for a long time the terms of
trade are said to be improving and when prices of imports continuously exceed the prices of
exports for a long period of time the terms of trade are said to be deteriorating. This means that
terms of trade are unfavourable year after year.
1. Net barter terms of trade. This refers to the ratio of price index of exports to the price
index of imports.
It is given by the formula: Price index of exports
Using the above formula when the figure obtained is less than 1 the country is faced with
unfavourable terms of trade and when greater than 1 the terms of trade is favourable.
2. Income or monetary terms of trade. This refers to the ratio of the value of exports to
the price index of imports. It shows how much a country can import using incomes from
exports.
1. The low income elasticity of demand for primary products. It is low because primary
products especially food stuff are required in fixed quantities and an increase in income
of the people in developed countries does not lead to an equal increase in their demand.
There the output on the market is sold at low prices.
2. Existence of protectionist policies of developed countries. Existence of protectionist
policies of developed countries in form of quotas quality controls limit the amount
developing countries are able to sell in such countries and therefore sell at low prices.
3. There is increasing substitution of exports for synthetics produced by developed
countries. This implies that the demand for artificial fibres and commodities produced
has reduced significantly which lowers the prices of the primary products.
4. The invention of raw material saving techniques has greatly reduce the demand for
primary products because developed countries are able to produce large quantities using
less output hence low prices are offered for the large output from Ldcs.
5. The prices of exports have continuously fallen due poor quality and as a result low prices
are offered for the commodities.
6. There is exportation of semi-processed agricultural and mineral products. These fetch low
prices in world market because of low valued added.
7. The weak bargaining power in the international market due stiff competition among the
producing countries. This means that the developing countries accept the low prices
offered to them by the developed countries so as to have their products bought.
8. There is market flooding with agricultural products. This leads to low prices being
offered because developing countries tend to produce in large quantities similar products
without controlling output.
9. The low quality of exports due to use of poor technology, poor skills results into
producers getting low prices for their commodities since the products cannot easily
compete with those from the developed world.
11. Prices of imports have continued to rise because among other things high fuel costs,
technological advancements etc. and for this reason the importing countries pay higher
prices.
12. The existence of unfavourable exchange rates between the developing and developed
countries. The currencies of developing countries are weaker than those of the developed
Balance of payments refers to the difference between country‟s receipts/income from abroad and
expenditure/payments abroad during a given time.
Or
Or
Balance of payments is defined as the financial record of a country‟s transactions with the rest of
the world during a given period.
OR
It the difference between receipts from both visible and invisible exports and payments for both
visible and invisible imports of a country during a given period and it includes capital inflows
and outflows.
This is the part of the BOP account which in records of the total exports and imports (both
visible and invisible) of a country is found.
The difference between the value of the country‟s exports and visible imports is called the
balance of trade or the visible trade account.
The invisible trade account records all earnings from exports of intangible commodities or
services and payments for import of services. The difference is called invisible balance of trade.
In this account, the records of all transactions involving capital movements are recorded.
These are in terms of capital inflows and outflows, borrowing from foreign countries and lending
to foreign countries. It also includes direct investment in foreign countries and indirect invest
(portfolio investment) in other countries bonds and treasury bills. The difference between inflow
and outflow of capital gives the BOP on capital account.
This account shows the records of the official foreign exchange reserves in response to the
current and capital accounts. It is a statement that shows a deficit or surplus in the BOP account
and how each can be off set to attain BOP equilibrium.
It records all the total errors and omissions during the compilation of the BOP account. This is
the balancing part of the BOP account
NB: The BOP account should always balance but this is not always the case especially in
developing countries. Ldcs normally experience BOP deficits/problems/disequilibrium.
Therefore the errors and omissions account is used to make the necessary adjustments.
1. The low volume of exports. Ldcs export few products to developed world /external
markets and worse still dominated by primary products these fetch low prices and
therefore low foreign exchange is earned.
2. There is exportation of low quality products because of using poor technology and less
skilled manpower as result the products cannot compete favourably internationally and
earn less foreign exchange since low prices are charged.
3. There is high marginal propensity to import. This is as a result of the low productive
capacity and high demonstration effect this leads to high foreign exchange expenditure
abroad on the purchase of imports.
4. There is political instability which leads to high military expenditure mainly through high
importation of fire arms to reduce incidences of war thus high foreign exchange
expenditure.
5. There is importation of highly priced commodities and therefore there is high foreign
exchange expenditure.
6. There is exportation of low value commodities because most of them are either not
processed or semi processed these fetch low prices and thus low foreign exchange
earnings/Low prices of exports as they are dominated by agricultural products results into
low foreign exchange earnings because these fetch low prices.
7. High rate of capital outflow due to debt servicing since most countries generate less
revenue from taxes. This causes high foreign exchange expenditure abroad when paying
the interest and principle sum.
8. The presence of protectionist and discriminatory policies of developed countries limits
the amount of commodities that developing countries are able to export and as a result
less foreign exchange is earned from the limited exports.
9. There is excessive expenditure by government on bureaucrats, foreign travels; foreign
missions etc. yet these are not directly productive this results into high foreign exchange
expenditure abroad.
1. Reduction in volume of imports. As spending on imports increases over time the capacity
to import decreases because the country earns less from exports to support importation.
2. Limited employment opportunities. Spending heavily on imports results into less
employment at home since there is low demand for local products and hence firms
employ few people.
3. Disinvestment may arise. Firms prefer to relocate their investments elsewhere where
there better possibilities of exporting more.
4. Leads to inflation. This occurs when the country imports from inflation hit countries.
5. Encourages currency depreciation. Too much importation leads to high foreign exchange
expenditure abroad and scarcity of foreign exchange in the local economy and this causes
depreciation of the local currency.
6. Retards economic growth and development. The increase in demand for imports results
into low level of production by the local firms since there is low demand for their
products this leads to a low level of economic growth.
7. Increases external borrowing/dependency. External borrowing in order to finance
importation of goods since the country has low foreign exchange from exports.
8. Limits savings and investment. The high level of expenditure on imports leaves
individuals with low incomes for savings and investment.
9. Leads to shortage of foreign exchange. There is shortage of foreign exchange in the
country because a lot of it is spent on purchasing imports yet less is earned from exports.
10. Government in power becomes unpopular. Government becomes unpopular because
imported commodities are expensive and therefore there is a high cost of living.
11. May lead to high taxation.
1. Use trade restrictions. These check the amount imported into the country and reduce
foreign exchange expenditure abroad.
2. Promote import substitution industrialisation using investment incentives to encourage
establishment of industries in the economy. This should be done to reduce the foreign
exchange expenditure abroad/saves the scarce foreign exchange.
3. Diversify export markets through joining regional integration. This reduces reliance on
few export markets and therefore increases foreign exchange earnings from the various
markets as there is an increase in the bargaining poor for higher prices.
4. Increase volume of exports by encouraging industries using investment incentives. This
should be done to increase foreign exchange earnings from abroad as the quantity for sale
increases.
5. Diversify exports. This should be done to reduce reliance on few export commodities and
help to increase the foreign exchange earnings.
6. Stabilise political atmosphere. This should be done to reduce huge expenditure on
importation of military hardware.
7. Manpower development to reduce expenditure on experts.
8. Restructure foreign mission and reduce foreign travels by government officials. This has
the benefit of reducing foreign exchange expenditure abroad.
9. Strengthen/join commodity agreements to increase bargaining power in export markets.
This results into fair prices and high foreign exchange earnings.
10. Appeal for debt relief/debt conversion. This should be done to reduce government
spending on paying debts.
11. Process exports to increase value and prices. This increases export earnings because of
increase in prices.
12. Improve quality of exports. This should be done through encouraging industrialisation
and to improve prices of exports and export earnings.
13. Encourage depreciation of the local currency. Depreciation of the local currency makes
exports cheap and this increases export earnings.
14. Devaluing the local currency which makes exports cheap and imports expensive which
increases foreign exchange earnings.
DEVALUATION
Devaluation refers to the legal reduction of the country‟s currency value in terms of other
currencies.
OR
It is the deliberate measure taken by government to reduce the value of her local currency in
terms of other currencies. The local currency becomes cheaper or of less value while foreign
currencies become expensive or of high value.
1. The domestic demand for imports should be elastic since devaluation makes imports
expensive so that their demand reduces.
2. The demand for exports in the foreign markets should be elastic so that there is increased
demand for exports.
3. The supply of exports in the devaluing country should be elastic as devaluation reduces
the prices of exports which increase their demand in the foreign markets.
4. Other countries should not retaliate as this neutralises the benefits of devaluation.
5. The rate of inflation should be low so that the prices of exports are kept low so as to
increase their demand in the international market.
6. There should be political stability so that there is continued production for exports and
reduced expenditure abroad.
7. There should be limited/no restrictions on trade by the developed or trading partners. This
increases accessibility to foreign markets.
8. There should be a fixed exchange rate system so that producers and exporters can predict
earnings from exports.
9. There should not be smuggling of commodities out of the country. Once there is
smuggling of goods out of the country less foreign exchange is earned.
1. The demand for exports is price inelastic it means that even when the prices of exports
reduce there is no significant increase in demand and therefore there is less foreign
exchange earned.
2. Existence of inelastic demand for imports. When the demand for imports is inelastic there
is no significant reduction in the demand for imports and foreign exchange expenditure
remains high.
ECONOMIC INTEGRATION
This refers to the coming together of two or more countries in a given region for the sake of
mutual benefit of all member states.
Or
Economic integration refers to the merging to various degrees the economies and economic
policies of two or more countries in a given region for the mutual benefit of member countries.
Examples of economic integration include COMESA, ECOWAS, North America free Trade
Area, European Union, etc.
2. Free Trade Area. This stage involves abolition of trade barriers which enables free
movement of goods among member countries however each member country retains its
own tariff structure on non-member countries.
3. Customs Union. This stage involves free movement of goods and services into member
countries and adoption of a common external tariff structure against non-member
countries.
4. Common Market. It involves free movement of goods and services, a common external
tariff structure and free movement of factors of production e.g. labour, capital and
entrepreneurship.
5. Economic Union. This stage involves elimination of all tariffs among member countries,
adoption of uniform tariff structure on commodities for non-member countries, free
mobility of factors of production, adoption of harmonious economic policy, etc.
1. There is trade creation. This is when after economic integration member countries shift
from high cost goods of non-member states to low cost goods produced by member
states. This reduces foreign exchange expenditure.
2. There is an expansion of market for goods and services. This because of the rise in the
number of consumers which increases profits.
3. There is a reduction in duplication of resources/goods. This is because production is
according to comparative advantage.
4. It encourages specialisation among member countries and the associated advantages,
such increased production quality improvement since production is according to
comparative advantage.
5. Attracts foreign resources. Financial bodies can easily lend to such integration other than
individual countries because of the security guarantees by the different countries.
6. More employment opportunities are availed. This is because there is free movement of
factors of production especially labour force/the expansion of enterprises increases job
opportunities.
7. It improves on the bargaining power of member countries in the international market
which increases the regions capacity to export and earn foreign exchange. This is because
the countries negotiate as a block.
8. There is production of quality goods. It encourages competition between member
countries and the result is production of quality goods and services.
9. There is promotion of economic and political stability. This is because of the greater co-
operation and mutual understanding between member countries.
10. The cost of undertaking some projects or programmes is lower. This is because they are
in some cases undertaken as joint ventures/encourages joint research.
11. It encourages increased production of goods and services. This is because of a bigger
market or consumers to serve.
12. There is greater utilisation of the available resources. This is because the wider market
results into establishment of more enterprises which increase resource exploitation and
this increases the GDP of the country.
13. It enables citizens in the member countries have access to a wider variety of goods. This
is because there many producers which increases consumer choice and welfare.
14. Trade can be eased by the use of one currency since it eliminates the need to convert
from one currency to another that leads to losses.
15. It leads to transfer of knowledge and skills among member states. This is because there is
movement of labour from one country to another.
16. Economies of scale are enjoyed by firms/efficiency is promoted. This is because of the
wider market served.
1. It leads to trade diversion. This is a situation where after economic integration member
states shit from low cost produced goods of non-member states to high cost goods
produced by member states.
The results among others include
1. Developing countries tend to produce similar goods and this reduces the incentive for
countries to integrate. This is because there is limited exchange of goods.
2. The failure to share benefits equally or the fear of unequal distribution of benefits. This
results in the reluctance of the-would-be members to join the integration.
3. There is fear to lose customs revenue since the countries heavily depend on tax revenue.
4. The existence of political instability in some countries or regions makes it difficult to
carry out trade.
5. Differences in economic policies make the harmonisation of the partnership difficult.
6. Differences in the levels of development make the less developed countries reluctant to
join for fear of being exploited.
Exchange rate refers to the rate at which the domestic currency is exchanged for other currencies.
OR
This is on in which the rate at which the local currency exchanges for other currencies is
determined and maintained by the central monetary authority (in relation to a particular foreign
currency). The rate can either be fixed below or above the equilibrium exchange rate as
illustrated below:
When the exchange rate is fixed above equilibrium it is called devaluation (R1) while if it is fixed
below equilibrium it is called revaluation (R2).
1. It encourages capital inflow since it limits uncertainties in the foreign exchange market.
1. It is associated with high administrative costs in that government has to employ people to
oversee the compliance with exchange rate set.
2. It is not appropriate in terms as it may cause inflation especially when there is high
capital inflow.
This is one in which the rate at which the local currency exchanges for other currencies is
determined by market forces of demand and supply in the foreign exchange market. It is as
illustrated below:
Re is the equilibrium exchange rate at which the demand and supply of foreign currency are
equal. The exchange rate is flexible because it can rise all fall depending upon the supply and
demand for foreign currency.
If the demand exceeds supply the exchange rate increases and if the supply exceeds the demand
the exchange rate falls.
NB: Under the floating exchange rate there can be currency appreciation or depreciation.
Currency appreciation refers to the increase in the country‟s currency value in terms of other
currencies as influenced by the forces of demand and supply in the foreign exchange market.
Whereas
Currency depreciation refers to the decrease in the country‟s currency value in terms of other
currencies caused by the forces of demand and supply in the foreign exchange market.
1. It discourages investment.
2. Leads to unfavourable terms of trade/makes imports expensive.
3. Projected planning is made difficult.
4. Leads to loss of confidence in the local currency/Loss of government popularity.
5. Increases the volume of exports/reduces BOP problem.
6. Increases foreign capital inflow.
7. It encourages speculation.
8. Worsens the external debt burden.
9. Leads to inflation.
10. Exporters gain high local currency revenue.
1. It encourages speculation in the foreign exchange market which is not good for business
i.e. anticipating gains is difficult.
2. It is inflationary in nature.
3. It creates uncertainty among the businessmen which negatively affects international
trade.
4. It makes planning difficult since prices change from time to time.
This is one in which the forces of demand and supply determine the rate at which the local
currency exchanges for the other currencies but within limits set by the monetary
authority/central bank.
1. The volume of the domestic output. The higher the output the stronger the local
currency and vice versa.
2. The rate of domestic money supply. The higher the rate of domestic supply of money
supply the weaker the local currency and vice versa.
3. Volume of exports. The higher the volume of exports the stronger the local currency
and vice versa.
4. Volume of imports. The higher the volume of imports the weaker the local currency
and vice versa.
5. The level of foreign exchange reserves. The higher the volume of foreign exchange
reserves the stronger the local currency and vice versa.
6. The demand and supply of foreign exchange.
7. Government policy on exchange rate in case of a fixed exchange rate system.
8. The level of capital inflow. A high level of capital inflow causes appreciation of the
local currency while a high level of capital outflow causes depreciation of the local
currency.
9. The rate of inflation in the economy. A high rate of inflation makes the domestic
currency strong and vice versa.
Foreign exchange rate control refers to where the state/monetary authority regulates the rate
at which the local currency exchanges for foreign currencies.
1. To stabilise exchange rates. This is achieved by the government intervening in the foreign
exchange market through buying and selling the foreign currencies.
2. To achieve price stability/control inflation. By stabilising the foreign exchange prices in
the local market are stabilised.
3. To encourage investment. With stable exchange rate investment is encouraged since
uncertainty is minimised.
4. To control the importation and consumption of undesirable goods. In this case the
government makes it difficult for importers to access foreign exchange.
5. To discourage speculation in the foreign exchange market. This is achieved by the
government using a fixed exchange rate system.
6. To encourage long term planning. By stabilising the exchange rate planning by
government becomes easy since prices are stable and there is no need to revise plans
from time to time.
7. To protect domestic industries. This involves government making it difficult for
importers to access foreign exchange which limits importation of commodities into the
country.
8. To check capital flight/control capital outflow. This involves government setting a rate
that makes it less attractive to transfer funds to other countries.
9. To ensure availability of foreign exchange so as to enable government and private
individuals access essential commodities/facilitate trade.
10. To acquire foreign exchange to service debts.
11. To improve on the country‟s BOP position by controlling imports and encouraging
exports.
12. To earn revenue to the government under a multiple exchange rate system due to price
discrimination.
1. It reduces the volume as well as the value of international trade by restricting imports and
export.
2. It checks black markets in the foreign exchange market.
3. It is expensive as a number of people have to be employed for its smooth operation.
4. It discourages foreign investment especially when the exchange rate is too low.
5. It promotes retaliation in foreign trade.
6. It promotes corruption especially by those in authority.
Factors that influence/determine the demand and supply of foreign currency in Uganda
1. Price of imports. The higher the price of imports the lower the demand and supply for
foreign currency because few people are involved in import trade and vice versa when the
price for imports is high.
2. Volume of imports. The higher the volume of imports the higher the demand and supply
of foreign currency since more foreign exchange is needed to effect transaction.
3. Debt servicing requirements. The higher the need to service debts the higher the demand
for foreign exchange
4. Government‟s external obligations. The more external obligations the higher the demand
for foreign exchange and vice versa.
5. Corporate repatriation needs. The higher the level of corporate repatriation the higher
demand for demand for foreign currencies and vice versa.
6. Central bank intervention. The central bank intervenes in the foreign exchange market by
buying and selling foreign currencies. When the central bank buys foreign currencies
there is a decrease in supply of foreign currencies since there is withdraw of foreign
currencies while when the government sells foreign currencies there is an increase in
supply of foreign currencies.
7. Government‟s external borrowing for consumption. A low level of borrowing for
consumption leads to low supply of foreign exchange while when there is high level of
borrowing there is an increase in supply of foreign currencies.
8. Price of exports. The higher the price of exports the higher the supply of foreign
currencies since there is an increase in foreign exchange earnings while low prices lead to
9. Volume of exports. The bigger the volume of exports the higher the supply of foreign
exchange because of the increased foreign exchange earnings while a small volume of
exports results into low supply of foreign exchange because of low foreign exchange
earnings.
1. Retrenchment/demobilisation/cost sharing.
2. Liberalisation.
3. Privatisation.
4. Devaluation.
5. Improvement of tax collection/introducing new taxes.
6. Promotion of export diversification.
7. Agricultural modernisation.
Trade liberalisation refers to the removal of unnecessary controls on trade hence giving people
the liberty to trade without undue government controls.
Or
It is the removal of unnecessary restrictions to trade (by relaxing the use of instruments such as
quota, total ban, tariffs and administrative control) in order to give people opportunity for
increased participation in trade/to increase value, volume and benefits of trade.
PUBLIC FINANCE
This deals with financial activities of the government and public authorities. It is the study of
how the government raises money and how it spends. The study of public revenue is divided into
the following:
1. Public revenue. This involves studying the methods of raising public revenue and the
principles of taxation.
2. Public expenditure. This involves studying the principles and effects of public
expenditure on the economy.
3. Public debt management. This involves studying the causes and methods of public
borrowing as well as public debt management.
4. Financial administration. This involves studying the preparation and execution of the
budget.
5. Fiscal policy. This involves government use of taxation, borrowing and government
expenditure to regulate the level of economic activities in the country.
PUBLIC REVENUE
This refers to the funds received by the government from different sources. Government
undertakes various activities and therefore needs income to fund these activities. The main
sources of government can be categorized into two.
(a) Tax revenue and
(b) Non-tax revenue.
Tax revenue
This is derived from various sources i.e. direct and indirect taxes.
TAXATION
A tax is a compulsory non-quid-pro-quo payment made to the government for the purpose of
administering certain services to the public as a whole.
OR
A tax is a compulsory transfer of money from private individuals, institutions or groups to the
government.
A tax is a compulsory contribution to the states revenue assessed and imposed by a government
on individuals and business enterprises.
1. To generate revenue. Taxes are imposed to raise revenue to enable government provide
essential goods and services. This is by imposing direct and indirect taxes.
2. To redistribute income/wealth. Taxes help to reduce income inequalities especially
progressive taxes since the rich pay more than the poor.
3. To protect domestic infant industries. High taxes help to protect infant industries against
the cheap dumped commodities from abroad. This enables them to grow and compete
internationally.
4. To correct BOP problems. This is achieved by taxing imports highly which reduces their
demand since they become expensive and imposing low taxes on exports making them
cheap. This reduces import expenditure and increases foreign exchange from exports.
5. To check consumption of harmful commodities. Taxes imposed on some commodities
discourage their consumption because they become expensive which reduces their
demand thus protecting people‟s health.
6. To control the emergence of monopolists. High taxes reduce the profits realised by the
monopolists and this reduces their economic power and influence in the market.
7. To influence resource allocation. The taxation of some commodities highly and imposing
low taxes on others results into the channeling of resources from production of the highly
taxed to low taxed commodities.
Canons/principles of taxation
1. Canon of equity. Every person should be taxed according to his ability to pay i.e. the rich
should pay more and the poor less and for this reason taxes should be progressive in
nature. Equity is either horizontal or vertical. Vertical equity means treating people
differently so that high income earners pay high taxes than low income earners.
2. Canon of certainty. The time of payment, the manner of payment and the amount to be
paid should all be clear to the tax payer and collector. The amount of tax to pay should be
known and not arbitrarily determined.
3. Canon of convenience. The time and mode of payment of the tax should be so fixed that
it makes it easy for the tax payer to pay. E.g. a tax should be collected when one has
income e.g. at the end of the month.
4. Cheapness/economy. The cost of collecting or administering tax collection should be as
low as possible. I.e. the cost of collecting taxes should be smaller/low in proportion to the
amount to be collected.
5. Simplicity. The nature of the tax, its assessment and collection should be straight forward
and understood by both the tax payer and collector. This helps avoid hostility between the
tax payers and the collectors.
6. Elasticity/buoyancy. A good tax should be flexible, i.e. it should be capable of easily
being altered to meet the changing financial requirements of government.
7. Productivity. A good tax should be able to encourage effort and initiatives and should not
discourage investment.
8. Neutrality. There should be no discrimination in taxation on the basis of tribe, race,
religion, etc. The tax should treat different categories according to their income.
9. Optimality. Taxation should maintain a balance between revenue collected and services
rendered.
10. Comprehensive. A good tax system is one which touches as many sources/bases as
possible so that a lot of revenue is generated.
11. Consistency. Should be in line with national economic objectives, especially in allocation
of resources.
12. Should avoid double taxation. A tax payer should not use the same source/base to pay a
tax.
1. Proportional tax. This is where whatever the income the same rate or percentage is paid
from ones income. Or where the rate of tax is constant for all tax payers regardless of the
level of income. E.g. 10% of one‟s monthly income.
Tax rate
R0
0 y1 y2 Income
In the illustration the same rate of tax is paid irrespective of the changes in income from
y1 – y2.
2. Progressive tax. This is a tax whose percentage rate increases as the income of an
individual increases. I.e. as the income increases the tax also increases gradually and vice
versa. It has the following effects: - yields high revenue to government, ensures equitable
distribution of income, favours the low income earners and helps to fight demand pull
inflation.
Tax rate
R1
R2
Y2 y1 Income
In the illustration above as income increases from y1 – y2 the rate also increases from R1 –
R2
3. Regressive tax. This is one whose percentage rate decreases as the income increases. i.e.
as the income of a person increases the tax rate reduces.
Tax rate
R1
R2
y1 y2 Income
Types of taxes
Direct taxes
These are taxes levied on incomes and property of individuals and enterprises such that the
incidence of the tax rests on the tax payer concerned and cannot be shifted to another person e.g.
personal income tax, property tax etc.
OR it is a tax imposed on one‟s income/property and the burden of the tax cannot be shifted to
another party. It is paid by the one intended to bear it. The examples under this type are:
1. They ensure equitable distribution of income. This is because they are progressive in
nature since the rich pay more than the poor e.g. pay as you earn.
2. They have an element of certainty. They are more predictable by both the tax payer and
tax collectors. Tax payers know the amount and the time to pay the taxes.
3. They are flexible. This is because they can easily be increased or reduced depending on
the financial requirements of the country.
4. They are productive. They help government generate revenue and therefore a small
increase in tax yields a lot of revenue.
5. They influence resource allocation e.g. corporate taxes.
6. They promote hard work/initiative by individuals and companies. This because firms and
individuals put in extra effort as they Endeavour to pay.
7. They are convenient because the burden is spread over sometime i.e. it is not paid in
lump sum.
8. They promote consciousness and awareness among tax payers/civic responsibility.
9. Help to reduce/control inflation. This is because they reduce the disposable income which
reduces aggregate demand.
10. They help to regulate/control monopoly powers. High corporate taxes reduce the capacity
of the monopoly firms to expand and influence the market.
1. They are discriminative because they are not paid by all; some groups are exempted from
paying. Hence less revenue is realised.
2. High direct taxes discourage effort and hard work e.g. high corporate taxes discourage
industrialists since their profits significantly reduced.
3. They are associated with high incidents of evasion and avoidance as a result they lead to
low revenue on the part of government.
4. They are arbitrarily determined/are unfair. The assessment and collection are harsh and
cruel. This creates resentment among the people hence low revenue is generated.
5. High direct taxes reduce aggregate demand. This is because they reduce disposable
income and this discourages investment.
6. They are uneconomical. The cost of collecting them is very high/high cost of
administration/high government expenditure on collection.
7. Lead to inflation e.g. cost push inflation. As the government imposes taxes on employees
they request for wage increment and this causes wage push inflation.
8. They lead to resource diversion from highly taxed activities to sometimes non-productive
ventures which are not taxed e.g. high corporate taxes.
9. Direct taxes are easily noticeable by the public and therefore can cause political and
social unrest.
10. They hinder the expansion of firms since profits are taxed that would have been ploughed
back.
Indirect taxes
These are taxes imposed on commodities and the burden can be shifted by the tax payer
on to another party wholly or partially in form of high prices e.g. import tax, export tax,
etc. They include:
1. Excise duty. This is a tax imposed on the production of commodities whether they are
meant for local consumption or export.
2. Customs duty. This is the tax imposed on the import and export of commodities. They
are of two types;
(i) Export duty. This is a tax on those commodities that are leaving the country for
countries abroad.
(ii) Import duty. This is a tax imposed on those commodities entering a country e.g.
cars, cosmetics.
1. They are productive. A small increase in the tax rate results into high government
revenue and therefore contributes more to government revenue.
2. They are economic because the cost of collecting them is small since the producers and
sellers deposit them with the government.
3. They are comprehensive in nature because they can be levied on a wide variety of goods
and they do not discriminate.
4. Indirect taxes are associated with low evasion. This is because they are imbedded in the
price.
5. They are flexible. They are therefore easy to adjust depending on the financial needs and
economic conditions of the country.
6. They are instrumental in checking the production and consumption of harmful products.
Once imposed on commodities they become expensive which reduces their demand.
7. They help to protect infant industries byway of using high import duties to discourage
imports since the commodities become expensive.
8. They help to improve the BOP position of the country. High import duties discourage
imports and low export duties encourage exports.
9. They are less felt and resented because they are imbedded in the price.
10. They lead to easy redistribution of income. This is when they are selectively imposed for
example high taxes on luxuries and low taxes on essentials.
11. They are convenient to the tax payer because they are paid only when one purchases a
commodity.
12. They influence resource allocation heavy indirect taxes can be used to discourage
production of commodities and channels resources to productive resources.
1. There is uncertainty in the revenue from the taxes. This is because it is not possible to
accurately estimate their effect on production and consumption and as such a small
increase can significantly lead to decline in revenue.
2. They are regressive in nature. The poor and the rich pay the same amount for goods
consumed, they therefore cause income inequality.
3. High indirect taxes have a bad effect on production and employment because they
increase the cost of production and employers take on few workers to reduce cost of
production.
Advantages of VAT
1. It widens the tax base hence causes an increase in government revenue.
2. It encourages efficiency in business since there is record keeping.
3. It minimises tax avoidance.
4. It minimises tax evasion.
5. It minimises the informal sector.
6. It reduces trade malpractices e.g. smuggling.
7. It minimises double taxation.
Disadvantages
1. It is complex to understand thus it lacks the quality of simplicity.
2. It causes resentment and makes government unpopular.
3. It is discriminative as some goods are not included.
4. Discourages savings and investment because it makes people spend more on goods and
services.
5. It reduces consumer welfare as it increases prices of goods and services.
Taxable capacity. This is the ability of the tax payer to pay a tax imposed on him/her
and remains with sufficient disposable income to enable him/her live a decent life to
which he/her family is accustomed.
OR
It is the ability of a nation to raise expected revenue from taxes without causing socially
harmful results or effects.
Or
It is the extent to which government can levy taxes without causing adverse effects on tax
payers.
1. High poverty levels which cause inability to start income generating activities/low
incomes.
Tax base. This refers to an entity, income or property items on which a tax is levied.
1. Poorly developed infrastructure. This makes accessibility to potential tax bases difficult.
2. Large subsistence sector/limited commercialisation of the economy. This results into few
taxes as the activities of the sector are not taxed.
3. Limited employment opportunities. There are few people who are formally employed and
this results into fewer people being taxed.
4. Tax exemptions/provision of tax incentives to potential tax payers by government.
5. Poor identification of sources/limited skills of the tax officials. Some activities are left
out due to poor skills hence low tax revenue.
6. Small formal sector/large informal sector. Some businesses are not known to government
because they are not registered and therefore not taxed.
7. Political instability making it difficult to assess certain possible tax avenues
8. Limited diversification of economic activities. There are few activities upon which to
impose taxes.
9. Low level of income.
10. Low level of accountability/corruption. Some people who should be taxed are left out or
taxed less than they should.
Tax yield. This refers to the amount of money that results when the rate of tax is applied
to money value of the tax base, minus the cost of collecting the tax.
OR
This means the net revenue from taxation after the cost of tax administration has been
deducted from the total collection.
Tax avoidance. This is a situation where the tax payer exploits loopholes in the tax laws
not to pay part or the whole tax levied on him/her.
Tax evasion/tax default. This is when a tax payer deliberately refuses to pay the
tax assessed on him or her. It is illegal and punishable by the law.
Tax burden. This is the immediate strain felt by the tax payer as soon as payment of the
tax has been effected. This may be in the following forms:
(a) Direct money burden. This refers to the loss of money in form of paying the tax.
(b) Indirect money burden. This refers to a situation when an individual,
company/economic entity loses money that would have been used somewhere else.
(c) Direct real burden. This refers to the loss of economic welfare as a result of paying
the tax. Or the reduction of the ability of an individual to purchase goods and services
as a result of the tax.
(d) Indirect real burden. This is where and when the tax on a commodity increases its
price leading to a reduction in the consumption of that commodity.
Impact of a tax. This refers to the person or firm on whom a tax is officially/initially
levied.
OR
It refers to the first resting place of a tax.
OR
The immediate effect of a tax on a person on whom it is levied.
One may however shift forward or backward onto another party. Shifting of the tax may
take the following forms:
(a) Forward shifting of the tax. This is where the tax payer passes the tax revenue to the
next party in the distribution chain e.g. a retailer passing on the tax burden to the
consumer in form of increased price.
(b) Backward shifting of the tax. This where the tax payer passes the tax revenue to the
previous stage in the production process e.g. when the producer shifts the tax burden
to the raw materials supplier in form of reduced prices of the raw materials.
Incidence of a tax. This refers to the final resting place of a tax imposed or the
person who ultimately bears the money burden of the tax imposed.
Incidence of a tax depends on the type of tax.
(a) For direct taxes, the incidence and impact are on the same person i.e. the
incidence cannot be shifted onto another party.
(b) For indirect taxes, the incidence falls on either the producer, consumer or shared
by both depending on the elasticity of demand and supply for the commodity.
Price D S
Tax
P0 S
P1
P2
0 Q0 Q1 Quantity
The consumer pays tax equal to P0 P1 while the producer pays P1 P2 the consumer pays
more.
Price
Tax D S
P1
P0
P2
0 Q0 Q1 Quantity
The consumer pays P0 P1 while the produce pays P0 P2 the producer pays more.
Specific tax. This is a tax that is levied as a fixed amount per unit of a commodity.
Also called per unit tax e.g. a tax on each bottle of beer.
Advalorem tax. This is the tax levied as a percentage of the value of the commodity.
Deadweight tax. This is one which when imposed causes the tax payer to abandon
the activity which forms the tax base on which the tax is levied.
Positive effects
Negative effects
1. Taxation reduces consumer‟s welfare. This is because taxes reduce the disposable income
of people reducing their consumption.
2. High taxes discourage investment. This is because they increase the cost of production
and reduce profits e.g. high indirect taxes
3. High taxes lead to trade malpractices such as smuggling of goods from neighboring
countries. Government loses revenue as they try to evade and dodge taxes.
4. It creates resentment that erodes popularity of the government especially high direct
taxes. An increase in taxation reduces welfare because it reduces disposable income.
1. Narrow tax base. This is attributed to low incomes of the people and the few economic
activities on which to levy taxes therefore less revenue is realised.
2. Low taxable capacity. Most people are poor and businesses are weak which result into
limited capacity to pay taxes.
3. There are high incidents of tax evasion. This is because of poverty, unfair assessment,
harassment in collection etc. and as a result many people are not willing to pay.
4. High levels of tax avoidance. This is because of loopholes and the lack of strictness of the
tax laws and as a result many people are not willing to pay.
5. Political instabilities in some areas. These negatively affect economic activities and make
collection of revenue difficult.
6. There is corruption in the collection of taxes. The tax officials swindle money and as such
less revenue is realised by governments.
7. Frequent changes in employment make it difficult to truck the tax payers for assessment
and collection of taxes/there is a large informal sector which means it is difficult to assess
those who should pay and therefore there are many people who do not pay taxes.
8. The conflicting government objectives/policies e.g. tax exemptions to encourage
investment. These are policies that on one hand give exemptions on the other hand
government imposes high taxes to generate.
9. Political interference in assessment and collection of taxes. Some potential taxes are left
out because of their connections to politicians.
10. Resistance from the public against tax payment/ignorance of the public about the
importance of paying taxes and therefore most people view payment of taxes as a
punishment rather than an obligation and contribution towards nation building.
11. Difficulty in identifying taxable sources because of using unskilled labour. Some tax
sources are left out by the assessor as a result less revenue is generated.
12. Shortage of skilled manpower to help in the collection and assessment of taxes. Less
revenue is generated because some sources/bases are not tapped and therefore
government loses revenue.
13. Poor infrastructure and this makes accessibility to potential tax payers very difficult and
therefore less revenue is generated.
This refers to the using of money/revenue in the provision of public services and influencing
economic activities so as to improve welfare of the people and achieve economic growth.
Public expenditure takes different forms and these are:
(a) Recurrent expenditure and
(b) Development expenditure.
1. Recurrent expenditure. This refers to the day to day spending of government aimed at
maintaining the existing capacities e.g. payment of wages for civil servants, rates, rents
etc.
2. Development/capital expenditure. This is the expenditure by the government on the
establishment of projects for purposes of both expanding existing capacities and creating
new ones to generate more goods and services. e.g. expenditure on setting up medical
centres, schools, roads etc.
1. Rapid population growth rate. This causes high government expenditure to support the
increasing population in terms of providing services e.g. medical care, education etc.
2. Debt servicing. Here government spends money paying the principal and interest thus
high expenditure abroad.
3. Alleviating the effects of natural calamities. The government spends money providing
assistance to those who have been hit by disasters so there welfare improves in case of
drought, floods, famine etc.
4. Political instabilities in some parts of the country this increases military expenditure
purchasing fire arms etc.
5. Development and rehabilitation of infrastructures. These require heavy spending yet
funds are not readily available through taxation, such as roads, power dams that require
heavy expenditure.
6. Poverty alleviation programmes. The government spends a lot of money financing
poverty reduction programmes so that people can start income generating activities e.g.
NAADS, prosperity for all etc.
7. Big size of civil and public servants. The government spends a lot of money in paying
salaries and allowances for civil servants who are very many in different departments.
1. Ensuring political stability by democratic governance and hold peace talks with rivals
thus reducing military expenditure.
2. Privatization of public enterprises. This reduces expenditure on financing and
maintaining public enterprises.
3. Retrenchment of civil servants thus reducing the high wage bill.
4. Debt rescheduling this reduces government expenditure in the short run.
5. Strengthening management of public funds. The government has set up institutions to
fight corruption such as IGG, Auditor General, etc.
6. Cost sharing in public institutions like hospitals, schools to reduce government
expenditure on provision of social services.
7. Population control measures to reduce government expenditure on provision of social
services.
Public debt refers to the total borrowing (both internal the central external) by the central
government, local authorities and public corporations. It is a debt incurred by the state as a result
of borrowing from within a country and foreign sources.
National debt is money owed by the state (central government) to people and institutions within
its borders or to foreigners, excluding the debts of local authorities and public corporations.
Public debt management refers to the process of acquiring, utilizing, servicing and repayment
of debts by the central authority or local authority or public corporations.
1. To maintain price stability. Borrowing from the public reduces money in circulation
hence stabilising prices.
2. To influence income distribution/to control income inequality. Government achieves fair
distribution by using progressive taxes.
3. To ensure proper utilization of funds/minimize or control corruption.
1. To fill the savings- investment gap because the savings in developing countries are not
sufficient to generate investment.
2. To ease the burden of taxation on citizens in the short run. By borrowing the government
does not need to impose high taxes to raise revenue.
3. To raise funds needed for recurrent public expenditure.
4. To finance BOP deficits in the short run/filling the foreign exchange gap. Borrowing
avails the needed foreign exchange to use in purchasing imports.
5. To control inflation by reducing amount of money in the hands of the public e.g. through
selling securities to the public.
6. To help repay interest and even the principal sums borrowed. The borrowed funds enable
government to pay the earlier acquired debts.
7. To help the country borrowing achieve and maintain a given level of employment. Funds
borrowed are used to establish projects which offer employment opportunities.
8. To sustain market by leaving citizens with adequate disposable incomes.
9. To handle the effects of calamities/disasters. Borrowed funds enable government give aid
to those affected by calamities and thus enabling them to have a fairly decent life.
Types of debts
1. Internal debt. This is one raised from within the country. This is in form of selling bonds
and treasury bills to the public.
2. External debt. This involves borrowing from abroad from external sources like
international financial institutions such as IMF, World Bank, etc.
3. Funded debt is a long term debt for which there is no redemption date/date of repayment
but the borrower keeps on paying annual interest on the principal.
4. Unfunded debt. This is a long term debt for usually less than a year for which the
government does not create a special fund for paying it. Or a debt with no stated future
date/time for repayment.
5. Redeemable debt. This is the debt which is repayable by the government after a specific
period of time.
6. Irredeemable debt. This is one whose principal amount is not refunded by the
government however interest rate is paid.
7. Reproductive debt. This is one where money is obtained and invested in productive
activity that generates income for the debt liquidation.
8. Unproductive debt/deadweight debt. This one which is acquired and used/spent on
projects which are not self-liquidating. Or debt acquired to finance non-productive
activities.
Debt financing is where government borrows to finance its expenditure that may not be
covered by tax revenue.
Whereas
Taxation financing is where government uses revenue from taxes to finance its
expenditure.
1. Borrowing does not have negative political effects compared to taxes that may cost that
may cost the government political popularity.
2. It is sometimes easier to borrow than to tax.
3. Borrowing helps to realise a lump sum of money compared to taxes where revenue comes
in slowly/it is a quicker way of raising money.
4. Borrowing arguments tax revenue that tends to be slow because of the narrow tax base,
low taxable capacity, etc.
5. Through borrowing government makes use of both external and internal sources
compared to taxation that is only internal.
6. Borrowing does not have adverse effects on consumption compared to taxation that
reduces disposable income.
7. Debt financing does not involve costly methods of collection compared to taxation.
8. Borrowing does not raise costs of production compared to taxation that leads to inflation
as a result of indirect taxes.
9. Borrowing does discourage savings and investment as is the case with taxation.
10. The debt burden of borrowing can be shifted to future generation something which
cannot be done with taxation.
1. Debt conversion where the government acquires a low interest loan to pay off a high
interest loan.
2. Internal borrowing through sale of treasury bills and bond using the central bank.
3. Selling state investments/privatization and the money obtained used to pay debts.
4. Using foreign exchange reserves.
5. Negotiation for cancellation of debts.
6. Controlled government expenditure.
7. Sale of gold reserves. The funds are used to settle debts.
8. Debt rescheduling. This involves agreeing fresh terms with the creditors.
9. Using grants.
10. Debt repudiation. This is the refusal by the government to meet its obligations.
11. Ensuring proper planning. This ensures that the government draws plans in accordance
with the available resources.
NATIONAL BUDGET
BUDGETING
Components of a budget
Recurrent budget
This is where estimated government revenue and expenditure is meant to maintain the
existing capacities or day to day programs e.g. payment of wages to civil servants.
Development budget
This is where estimated government revenue and expenditure is to be allocated for long
term projects which lead to increase in production directly or indirectly e.g. expenditure
on financing industries, roads, etc.
Deficit budget
This one in which government planned expenditure is greater than the government
planned revenue in a given financial year.
1. It leads to inflation since low taxes are imposed and people have high purchasing power.
2. It leads to BOP deficit as there is increased borrowing to finance the deficit in the budget.
3. It encourages economic dependence because of increased reliance on external resources
by way of borrowing.
4. It increases capital outflow as the government pays the debts.
5. Leads to economic instability and uncertainty since loans from abroad may be withdrawn
before completion of projects.
1. There is low taxable capacity because of the low level of economic activities, poor tax
administration etc.
2. Few tax bases because of poverty, poor assessment, etc. Less revenue is generated.
3. High administrative expenditure on civil servants and politicians in terms of paying
wages and salaries.
4. Political instability leading to high military expenditure/high cost of improving political
climate.
5. High cost of maintaining and developing infrastructure. Development of infrastructure
requires large sums of money.
6. Ambitious planning. The government plans to spend more yet realises less revenue
7. Heavy debt servicing and repayment of principle.
8. Weak tax administration. This is the case with when there is poor collection and poor use
of the funds realised.
9. Few and low non tax sources of revenue.
10. High levels of corruption/low levels of accountability. Money realised by the government
is swindled by some officials and this reduces the money available for use by the
government.
11. Frequency of natural disasters/hazards that require heavy emergence funding.
12. Heavy expenditure on external commitments e.g. contributions to international
organizations, peace keeping mission, etc. These cause excessive foreign exchange
expenditure abroad.
FISCAL POLICY
Fiscal policy is a deliberate policy under which government uses its expenditure and
revenue (taxation) programmes to regulate the level of economic activities.
1. Taxation
2. Subsidisation
3. Government expenditure
4. Public borrowing
5. Licensing
6. Fees
7. Fines
8. Debt repayment
9.
Objectives of fiscal policy
To achieve desirable price levels/price stability through increased taxation and reduced
government expenditure.
Economic development planning is the conscious government‟s effort to influence, direct and
in some cases control changes in a nation‟s principle economic variables to achieve per-
determined objectives/objectives of development over a given period of time.
OR
1. For proper allocation of resources. Planning ensures that resources are allocated to areas
that ensure maximum social welfare.
2. For equitable redistribution of income or wealth/balanced regional development.
Planning ensures that resource allocation is done in such a way that
3. To correct deficiencies of price mechanism, especially during times of rapid structural
changes. The market does not solve some challenges such as rapid population growth,
income inequality and therefore planning helps government to minimise these challenges.
4. To solve/control unemployment problem. Through planning government is able support
income generating activities that provide jobs by giving individuals affordable loans.
5. For resource mobilisation e.g. borrowing. It helps government identify the finance gap
and therefore uses it to mobilise funds through borrowing.
6. To identify areas suitable for public and private investment. Government takes up the less
profitable projects that require large some sums of money and are very crucial for
national development leaving the profitable projects to the private sector.
8. For harmonious and consistent use of resources. Planning helps government to ensure
that targets and objectives put in place march the available resources.
9. To encourage public participation in the development process/solicit for political support.
Planning shows the role to be played by the public and the benefits to be realised so that
the plans are not sabotaged.
10. To attain price stability by influencing production levels. Planning enables government to
ensure price stability by encouraging production through incentives to producers that help
reduce the production costs.
11. To correct balance of payment problems. Through planning government supports local
producers using investment incentives that help to reduce the cost of production which
increases local production and reduces the need to import.
12. To solicit for foreign aid/assistance from development partners. Government uses the
plans to seek for aid by showing the funding gap and the areas that need support.
13. To determine the rate of economic growth and development. Through planning
government is able to support producers using tax incentives, improving infrastructure,
etc. which help to reduce the cost of production and thus increased production of goods
and services.
14. To reduce economic dependence/promote self-sufficiency. Planning enables the country
to support local producers using tax incentives, improving infrastructure and this causes
an increase in local production of goods which reduces the need to import.
1. It distorts the working of price mechanism. Interference by the government limits the
operation of forces of demand and supply in influencing resource allocation.
2. There is wastage of resources. This occurs when planning encourages the production of
commodities that are not so much required by consumers.
3. Planning kills individual/private initiative. This happens when planning is in the hands of
few individuals who dictate what should be produced and the result is reduced invention
and innovation.
4. It encourages bureaucracy. This causes delay in decision making which delays
implementation of projects.
5. It is costly in terms of formulation, implementation and monitoring. This is because many
employees are required who have to be paid wages which is costly to the government.
6. It promotes inefficiency in production. This is because it discourages competition,
innovation and inventions.
7. Poor quality products are produced. This is because of lack of competition in production
8. Corruption becomes rampant. Some individuals take advantage their positions to divert
public funds for personal benefit and therefore some government projects are not
implemented due to shortage of funds.
9. It promotes political dictatorship. Few individuals in authority use their powers to supress
others the case with the command economy where to much power is invested in the
hands of the central government.
1. Availability of technical personnel (skilled labour). These are the people who are
responsible for the implementation, monitoring, etc. skilled causes efficiency in
implementation of projects
2. Availability of quality statistical information or which is reliable and accurate. Accurate
information ensures that all areas are taken into account making the available resources
sufficient.
3. Mobilisation of resources/funds from internal as well as external sources so that plan
implementation, monitoring etc. can be under taken. Sufficient funds are necessary so
that projects are implemented
4. There is need for public cooperation/support from the different political/social groups in
the country. Public support makes implementation easy and reduces incidences of
sabotage.
5. Presence of an efficient and incorruptible administration to maximise resource utilisation.
A low level of corruption makes the funds sufficient for the implementation of projects.
6. Mobilisation of popular support using institutions to make sure that the public is behind
the plans. Planning is successful when it has the support of the different social groups
since it reduces sabotage of projects.
7. Political stability. A stable political environment assures the formulators and
implementors of security for life and property.
8. Setting specific and clear objectives. This makes it possible for the government to
achieve what it sets to achieve.
9. Balancing of the plan. This makes it possible for the government to realise balanced
development in the country.
10. Fixing of targets and priorities.
1. Comprehensiveness. A good plan is one that covers the entire economy or all sectors of
the economy.
2. Consistency. The aims of the plan should match with the available resources and in line
the country‟s economic development objectives.
3. Compatibility. Good planning is one that promotes linkages/co-existence/contradictions
between the different sectors of the economy. e.g. linkage between agriculture and
industry.
4. Good sequencing. The implementation of project should be done in an orderly way one
step after another.
5. Political acceptability. It should have blessing of the different political groups within the
economy to avoid sabotage.
6. Socially relevant. A good development plan should tackle problems and issues/needs
pertinent to the local areas.
7. Have an element of continuity.
8. Economically feasible. The objectives set should be those that can be achieved within a
specific period of time using the available resources.
9. Proportionality. The different sectors/regions of the country should be given due
consideration when distributing resources to ensure balance regional development.
10. Participation of society. The public should take up an active role in the formulation,
implementation, monitoring and evaluation so that there is no sabotage of government
projects.
11. Optimality in use of resources so that improved welfare of the citizens is realised at the
lowest cost possible.
12. Simplicity. It should be easily understood by both the technical and non-technical people.
Characteristics of a good development plan
1. It should be comprehensive i.e. covering the entire economy or all sectors of the
economy.
2. It should ensure consistence so that the aims of the plan match with the available
resources and in line the country‟s economic development.
1. Comprehensive planning. Is one where targets are set to cover all/most sectors of the
economy.
2. Partial planning/sectoral planning. Is one which covers part/section of the economy
e.g. agriculture, industry.
3. Annual planning. This is short term planning in which targets are to cover one year are
drawn e.g. the national budget.
4. Long term planning/perspective planning. Is long term planning in which long term
are set in advance for a period of ten or more years.
7. Capitalistic planning. This is where planning is done by the private sector without direct
control of the government but rather the government influences the planning process
indirectly through monetary and fiscal policies.
1. The availability of funds. The more available the funds are the high the success of plan
formulation and implementation because funds enable the purchase of inputs to
implement projects while limited availability of funds causes poor planning because
there not enough funds to purchase inputs for plan formulation and implementation.
2. The availability of data/information. Limited information results into some areas being
given little attention or left out altogether since funds not set aside and when information
is readily available different areas are catered for and therefore the funds set aside are
sufficient for plan formulation and implementation.
3. The degree of responsiveness of the private sector. The higher the level of the private
sector response the better the planning because it plays its part by investing in the areas
of interest while a low level of response causes results into limited success because the
private sector does not do what is supposed to do.
4. The level of government commitment/the level of conservatism/the will of the people. A
high level of commitment of the government results into adequate resources/funds being
set aside for plan formulation and implementation while low level of government
commitment results into limited success because there is low funding from government.
5. The degree of political interference. Too much interference from politicians undermines
the work of the technicians and causes diversion of projects on the other hand limited
interference from politicians‟ enables plans go on according to designs and
implementation of projects.
6. The efficiency of the implementation machinery/the labour skills. The lower the skills of
labour the lower the success of planning since there is low efficiency in implementation
while presence of sufficient supply of skilled labour causes a higher level of efficiency
in planning and thus higher success.
7. The political atmosphere/climate. Political instability leads to low success of the
planning process because the planners are not able to go to some places for fear for their
1. Reduce dependence on natural factors. This makes it possible for the available funds to
be adequate since there is limited emergence funding.
2. Develop infrastructure. Infrastructure should be improved to increase accessibility to
project areas and also to reduce the cost of implementing projects
3. Train statisticians/planners/labour. Employees should be trained to improve efficiency in
implementation of plans.
4. Improve data collection and management. There should be an improvement in data
collection so that the funds set aside are sufficient for the projects since all areas are
captured by the information.
5. Raise sufficient funds for planning. Government should raise sufficient funds for
planning so that all the areas are catered for without shortages
6. Improving accountability. Accountability should be ensured so that funds set aside are
not diverted but are used for their intended purposes, this ensures that funds for projects
are sufficient.
The structure of the economy refers to the main basic features or the outstanding characteristics
of a given economy.
Agriculture is the dominant sector of the economy and forms the backbone of the
country.
1. It is a source of raw materials. The agriculture sector is a major source of raw material
for the agro based material and therefore it brings about rapid industrialisation.
2. It provides employment to both the skilled unskilled. Majority of the people in the
country depend on agriculture and are more employed in the sector.
3. It provides an important source of revenue to the government by taxing farmers,
cooperatives etc.
4. It reduces rural-urban migration. It employs many people in the rural areas and therefore
reduces the need to move to urban areas.
5. Ensures balanced regional development, it is spread throughout the country.
6. It contributes to the GDP through the substantial amount of output.
1. Since agriculture is mainly subsistence and the output level is low the income from the sector
is low.
2. Government revenue base is low since the major sector agriculture is basically subsistence.
3. Due to use of poor tools/ technology the quality of output is low. This makes marketing the
products very difficult, especially in international markets.
4. There is limited exploitation of the available land because of limited mechanisation.
5. Heavy fluctuation in prices and incomes to farmers leads to fluctuation in export earnings
which makes government planning difficult.
6. The mainly low level of output in the agricultural sector leads to unstable supply of raw
materials which hinders industrial production.
7. Existence of large subsistence sector hinders capital accumulation process in Uganda because
this sector produces mainly for one‟s own consumption.
8. The reliance on nature causes production of low quality and quantity.
9. Poor quality products mainly produced in the sector lead to problems of marketing on the
international market.
10. Dependence on natural factors e.g. increases risks and uncertainties in the sector and this
discourages investment.
Agricultural modernisation
It is a policy of increasing the output and incomes of the agriculture sector through measures
such as mechanisation/use of better production techniques, use of improved breeds etc.
(a) Explain the measures being taken to improve performance of the agricultural sector in
your country.
(b) Suggest measures that should be taken the improve performance of the agriculture
sector in your country.
Measures that should be taken to improve the agriculture sector
1. Industries are mainly involved in the production of consumer goods due to import
substitution strategy of the government.
2. Mainly large scale industries are concentred in urban areas because of the good
infrastructure and market for the goods and services.
3. The industrial sector is mainly dominated by small scale industries because most of
the people do not have sufficient capital to expand their industries.
4. Most of the large scale industries are foreign owned while the small scale ones are
dominated by the local people. The limited capital by local entrepreneurs does not
permit them to expand their industries.
5. Firms mainly use simple labour intensive technology. It is only few industries
owned by the foreigners that use capital intensive technology. This is because many
of the local entrepreneurs do not have sufficient capital to purchase modern
technology.
6. Mainly import substituting industries /produce mainly for the local market with
little left for export.
7. High imported raw materials and intermediate product content.
8. Industries produce mainly at excess capacity due to limited capital, limited market,
poor technology, etc.
Positive implications
Discuss the problems limiting the development of the industrial sector in your country.
Explain the measures being taken to improve performance of the industrial sector.
1. Developing infrastructure. This is making it easy for industrialists to access inputs and
markets.
2. Widening markets through integration. This increasing the demand for commodities,
increases profits and investment.
3. Providing affordable capital for investment/industrialisation. This is enabling the
industrialists to purchase machinery, hire labour and expand their enterprises.
4. Stabilising the political atmosphere/climate. This is encouraging investment in the
industrial sector since there is limited threat to life and property.
5. Vocationalising education/improving the skills. This is reducing dependence on
expatriates and improving efficiency of labour
6. Encouraging saving. This is enabling individuals accumulate capital to purchase
requirements for establishing industries.
7. Liberalising the economy. This is encouraging many people to engage in establishment
of industries.
8. Improving the land tenure. This improving accessibility to land/making purchase of
land easy.
9. Fighting corruption. This is making funds set aside for investment in the sector
adequate.
10. Stabilising prices. This is reducing cost of production and stabilising earnings of
industrialists and making planning easy.
11. Modernising agriculture. This makes availability of raw materials to industrialists easy
thus helping to keep the cost of production low.
This is an intermediate sector between the traditional and modern sector. OR It is a sector which
lies between the subsistence traditional sector and the monetary sector. It is mainly found in
urban areas and it comprises the, drivers, automobile and bicycle repairs, banking, bread selling
etc. These activities have been developed from the traditional and later they are modernised.
Positive:
Negative:
1. It leads to congestion in sub-urban or peri-urban areas as the activities of the sector are
not properly planned or started haphazardly to have a competitive advantage over
others.
2. It causes pollution of the environment because of poor waste disposal which affects
development.
3. There is duplication of goods and services and therefore it promotes wasteful
competition.
4. It causes public revenue instabilities because of the temporary nature of the businesses.
5. It has given rise to unemployment and under employment because of limited capital to
make investments to absorb many employees.
6. There are high administrative costs because of operating mainly on small scale
producing a low level of output.
1. Lack of adequate capital to expand the businesses due lack of collateral security to access
credits. This makes it difficult to purchase inputs and expand enterprises.
2. Unfavourable government policy e.g. high taxation. This demoralises the informal sector
operators as it increases the cost of production and reduces the profit margin.
3. Inadequate skilled manpower since most of the labour force in the sector is either
unskilled or semi-skilled. This results in to efficiency in production.
4. The markets of informal sector operators are not protected due to absence or ineffective
laws hence exposing the sector to stiff competition from abroad.
5. There is insufficient supply of inputs and this limits production because of high
production costs /poor quality goods.
6. The existence of political instability in some parts of the country. This discourages
investment in the sector as well as limiting accessibility to markets and threatens destroys
life and property.
7. Poor infrastructure. This limits accessibility to inputs and markets for goods and also
increases the cost of production.
8. Poor technology. Poor technology causes low efficiency in production.
9. Limited entrepreneurship skills. This causes low level of innovation, creativity and
investment.
10. Political instability. Discourages investment in the sector because of fearing to lose life
and Property.
11. Poor land tenure system. This makes acquisition of land difficult and expensive.
12. Price instability. Unstable prices cause an increase in the cost of production.
13. High level of corruption. This causes high cost of production and delays implementation
of projects.
Suggest measures that should be taken to improve the performance of the informal sector in
your country.
1. Ensure favourable fiscal policies e.g. reduced taxation, subsidisation of producers etc. This
reduces cost of production and increases profits.
2. Encourage savings. Encourage co-operative societies among the informal sector members
to enable them save and mobilise funds for investment.
3. Provide affordable loans. Banks and other financial institutions should be encouraged to
provide loans at favourable interest rates/terms. This enables entrepreneurs get funds to
purchase inputs.
Muhinda Richard Economics notes 2018 363
4. Government should endeavour to encourage establishment of training centres to equip
employees with appropriate skills. This should be done to increase the productivity of
labour.
5. Provide adequate infrastructure like electricity, water, roads, etc. to minimise production
costs.
6. Ensure political stability as a way of attracting investment in the sector. This is because it
assures the investors of security for their lives and property.
7. Fight corruption. This should be done to ensure that the available funds in the sector are
adequate for investment.
8. Stabilise prices. This should be ensured so that the cost of production is reduced.
9. Improve the land tenures system. This should be undertaken so that acquisition of land for
investment and expansion of enterprises is easy to acquire.
10. Modernise agriculture. This makes it possible for enterprises to acquire inputs at fair prices
and reduce the cost of production.
11. Improve the skills of labour. This should be done to improve the efficiency of labour.
12. Improve technology/ finance research. Government should finance research to improve
efficiency in production.
It involves businesses that are registered, have proper record keeping and are governed by
laws.
It is that part of the economy where economic and social activities are under the control of
private individual investors operating side by side with the government or public sector.
OR it refers to that part of the economy where economic activities are under the control of
non-governmental economic units such as households, or firms.
Each economic unit owns its resources and uses them for the maximisation of its own
welfare.
3. Mainly labour intensive techniques are used. There is limited capital to purchase modern
techniques of production.
4. Uses mainly unskilled and semi-skilled labour force. This is due to low levels of education
and the theoretical education system.
5. Produces mainly consumer goods. This is due to the import substitution strategy of
industrialisation.
10. Uses mainly local raw materials. These are readily available.
11. Production of variety of goods / differentiated goods. This is due to competition in the
market.
12. The sector is characterised by price instability. The profit minded entrepreneurs set their
own prices.
Assess the role of the private sector in the development of your country.
2. It attracts capital- both from within and foreign private investment. This is because of the
competitive atmosphere in the sector which attracts private investors.
4. It provides revenue to the government. This is through taxation of private enterprises e.g.
corporation tax on profits of companies.
9. The sector provides a variety of goods and services to the population. This is because of
product differentiation which increases choice and welfare.
10. There is production of quality goods. Competition in the sector leads to the production of
quality goods and services.
12. Helps to improve the skills of labour. The private sector is a training ground of labour and
therefore helps in acquisition of skills and thus improves efficiency in production.
14. Promotes commercialisation of the economy. The sector encourages production for the
market.
15. Helps improve the country‟s BOP position. This is because there reduction in the
importation of goods.
16. Diversifies the economy/reduces dependence since it increases the country‟s capacity to
produce goods and services.
1. Inadequate capital in the sector. This limits the expansion of the sector because of limited
funds to purchase inputs.
2. Insecurity in some parts of the country. This scares away potential investors in the sector
for fear of losing life and property.
4. Limited market for the products due to the low purchasing power. This results in to low
profits and thus discouraging production.
5. Low levels of technology. This results into low levels of efficiency in production.
6. Limited entrepreneurial skills. This limits innovation, invention and creativity and therefore
there is limited ability to mobilise resources.
7. Poor infrastructure such as roads. It affects the activities of the private sector and
contributes to the high cost of production.
8. Unfair taxation of the sector. It discourages investment as taxes raise production costs.
9. Low or unstable prices. This leads to unstable earnings in the sector and causes high cost of
production.
11. Poor land tenure system. It makes acquisition of land difficult and expensive.
12. High level of corruption. Corruption makes the cost of production high and reduces funds
for investment.
13. Unfavourable natural factors/limited supply of inputs. These make production in the
agricultural sector difficult causing limited supply of inputs for the agro-based industries
which increases the cost of production.
Explain the measures being taken to improve performance of the private in your country.
1. Developing capital markets. This is being done to avail capital for investment and
expansion.
2. Maintaining a stable political environment. This is assuring the investors of security life
and property and thus encouraging investment.
4. Improving on infrastructure so as to attract both local and foreign investors. This is being
done to reduce the cost of production.
6. Offering investment incentives to investors e.g. tax holidays, subsidises etc. This is
encouraging establishment of enterprises since it is lowering the cost of production.
7. Privatising public enterprises. This enhancing efficiency and quick expansion of enterprises
since private individuals are profit oriented.
8. Improving skills of labour. This is being done through Vocationalising education and is
improving the efficiency in production.
9. Widening markets through integration. This is increasing outlets for output thus increasing
profits.
10. Strengthening the Uganda Bureau of standards to provide technical and quality standards.
This is reducing on marketing problems due to poor quality.
12. Provided land for development/changed land tenure system. This is making acquisition of
land easier and cheaper.
13. Improving entrepreneurship skills. This is being done through workshops and seminars and
is improving innovation, inventions and creativity.
14. Encouraging proper accountability. This is enabling firms have sufficient funds for
investment.
15. Enacting copy right and patent right law. These are encouraging innovations and
inventions.
16. Undertaking international campaigns and publicity. This is attracting foreign investors.
17. Establishing specialised institutions to promote investment. The institutions are providing
information on areas for investment.
The public sector of an economy consists of business establishments that are owned by the
government and are engaged in commercial activities.
OR
Such business establishments called the state enterprises may take the form of local
authority, or public corporation or parastatal body.
1. To provide goods and services which have low commercial profitability but having high
socio-economic benefits.
2.To avoid duplication and wastage. It is not economically viable to have many firms
produce public utilities.
3.To create employment opportunities. Government owned enterprises operate on large scale
and therefore provide more employment opportunities.
4.To produce goods of strategic importance. Production of some commodities cannot be left
to private individuals because of the sensitivity of such products.
5.To provide essentials of life at fair prices. Some commodities if left to private producers
leads to exploitation of consumers yet they are vital to society.
6.Promoting investment. Government investment in enterprises encourages investment by
private individuals especially when the very investors are bought by individuals.
7. To raise revenue. The established enterprises earn revenue to the government through
profits earned and the taxes they pay to the government.
8.To ensure social security.
9.Promoting economic independence. By establishing firms to produce goods locally there is
reduction in the importation of commodities.
10. To protect nationals from exploitation. The establishment of government owned
enterprises minimises exploitation of nationals because government is profit oriented but
welfare orient and therefore charges low prices.
11. Because of heavy capital requirement. Some business undertakings require large sums of
capital which individuals may not be able to raise hence government steps in to establish
such enterprises.
12. To mobilise savings. Funds/ raised from the public enterprises enable government to
accumulate savings for investment purposes.
13. Complementing the private sector to avoid monopoly. The establishment of public
enterprises helps the government break the monopoly of private enterprises.
14. To protect primary producers from exploitation. The establishment of public enterprises
enables producers of primary products get fair prices since government is not profit
oriented.
1. Inadequate capital. There is inadequate capital for expansion of the business units and
purchasing inputs.
2. Poorly developed infrastructures. The poor developed infrastructure makes it difficult to
access input markets and markets for final products and also increases the cost of
production.
3. Bureaucratic red tape/bureaucracy. There is a problem of bureaucracy that causes delay in
decision making and implementation.
4. Political interference. The interference by politicians in the affairs of public enterprises
results into poor management.
5. Political instability. Political instability leads to destruction of enterprises and also causes
inability to get to potential markets.
9. Foreign interference.
10. Limited commitment and interest on part of management. This results into
mismanagement of the enterprises
12. Poor management/limited skilled manpower. The use of poor skilled manpower results
into production of poor quality products.
13. Low level of accountability/corruption/embezzlement. Funds are swindled for personal
benefit and this leaves the enterprises with fewer funds to run the enterprises.
Public corporations
What is a public corporation?
A public corporation is a joint stock company in which a government holds either all the
shares or a majority of its share capital and is created by an act of parliament which clearly
defines the aims and objectives.
Positive role
1.Creation of employment opportunities to the people. They usually employ many nationals
due to operation on large scale.
2.Development of infrastructure. They participate in the construction of roads, schools, and
hospitals etc. which support other economic activities.
3.They raise large sums of capital and thus undertake large scale operations. The private
sector is unable to undertake large scale projects like power dams due inadequate funds,
technical skills etc., through public corporations government raises funds to establish the
projects.
4.Provision of essential goods and services at affordable prices. These commodities are
usually of low commercial profitability yet they are so vital for the welfare of the
nationals e.g. safe water, garbage collection etc.
5.Help in avoiding foreign domination of the economy. Their existence in one way or another
is a step towards economic indigenisation.
6.They undertake strategic or sensitive investment projects of national importance. Some
projects are so sensitive that they cannot be left in the hands of the private sector e.g.
manufacture of fire arms, as this would threaten the security of the state.
7.They are a source of revenue to the government. They generate profits which supplement
government revenue. They also pay taxes.
8.They protect consumers against undesirable goods e.g. UNBS. They protect the consumers
by ensuring that certain quality standards are adhered to.
Negative roles
1.They overstrain the government budget. This is by way of spending on managing public
corporations.
2.Provision of poor quality goods and services. This is due to lack of competition.
3.Bureaucracy in decision making and implementation. The lowers the efficiency and ability
to adjust to rapid structural changes.
4.The public is highly taxed to cover the losses made by those public corporations. This
reduces peoples‟ disposable incomes and welfare.
5.Poor accountability by public officials which results into more losses.
6.Limited flexibility in operation. They are slow in adaption to changes due to bureaucracy in
decision making.
7.Limited consumer sovereignty. Production is not driven market forces of demand and
supply but rather depends on government policy on social welfare this leads to limited
choice.
8.They are interfered with by politicians e.g. through political appointments, employment of
relatives, etc. this results into mismanagement.
9.They tend to discourage private investors by outcompeting them. They have large capital
and produce on large scale and at subsidised cost. There by selling at relatively cheaper
price.
10. Large scale operation results into diseconomies of scale. This is due to gross
management.
11. They limit innovativeness and initiative due to disinterested officials. Most public
officials do not have self drive to initiate new and better methods of production.
PARASTATAL ORGANISATIONS
PRIVATISATION
Forms of privatisation
2. Joint venture
This is where the government runs business units together with the private entrepreneurs only
that she holds at most 49% shares in the business with at least 51% shareholding belonging to
private individuals.
4. Contracting
This is the form of privatisation that involves selling of business management to private
entrepreneurs for a specific period of time as per agreement after which control of the
business may be returned to the government when deemed necessary.
1. To enable firms operate more efficiently. Private individuals have a personal interest and
therefore ensure strict supervision and accountability since they are profit oriented.
3. To attract foreign investors. It attracts foreign investors since it gives them opportunity to
finance enterprises with limited or no competition.
5. To meet IMF conditionality of creating a private sector led economy. Some countries
privatised to be able to get loans to finance several sectors of the economy.
Privatisation increases employment in the long run because the profit driven entrepreneurs
expand the enterprises creating more job opportunities.
10. To control structural inflation. It increases productivity and wipes out structural inflation
because the profit oriented individuals use better production techniques which results into
large of goods and services.
13. To allow government concentrate on the provision of social services since there is
reduced government expenditure on subsidising government enterprises the funds saved are
used to provide more social services.
14. To increase output and thus ensure economic growth. Privatisation increases investment
because there is an increase in efficiency and therefore more output is realised.
15. To improve the BOP position. Privatisation improves efficiency in production hence there
is mass production of goods which reduces importation of goods while encouraging
exportation of goods.
Effects/benefits of privatisation
1. In the long run more employment opportunities are provided to the citizens. The expansion
of enterprises and better management generates more employment opportunities.
2. It reduces bureaucracy in the running of enterprises and this promotes quick decision
making and production.
3. Competition between firms encourages efficiency/cost effectiveness in resources
allocation. This because there is strict supervision.
4. Increased output is realised which leads to economic growth. This is because of an
improvement techniques of production.
5. Quality of final goods and services is high. This is because there is competition between
firms.
6. Exploitation of idle resources is possible which promotes economic growth.
7. Foreign investment and capital are attracted to the economy which accelerates the process
of growth and development.
8. Innovativeness and creativity (research) are promoted. The desire to maximise profits
results into better production techniques.
9. Ensures variety. It widens consumer choice due to production of variety of commodities.
10. It reduces dependence on imports. It increases local production/availability of goods and
thus reduces dependence on other economies.
11. It reduces corruption in the running of enterprises since private investors are profit oriented
and ensure efficiency in running the enterprises.
12. Leads to improvement in labour skills. Employees are trained in various skills to improve
their efficiency.
13. Privatisation reduces structural inflation. This is because there is increased production of
goods and services.
1. Increased consumer exploitation. This is because high prices are charged by the profit
oriented individuals.
2. It leads to unemployment in the short run. Some workers are retrenched and others
substituted with machines in order to reduce costs of production.
3. It leads to increased foreign control of the economy. This is because most of the privatised
enterprises are bought by foreign investors who have the financial muscles.
4. It leads to irrational exploitation of resources causing environmental degradation. The profit
oriented producers over utilise the resources
5. There is a reduction in provision of essential vital goods. Private sector is more interested in
enterprises that bring in more profits.
6. It leads to income inequality. This is because the privatised enterprises are bought by few
wealthy individuals earn more profits.
7. There is an increase in price fluctuations. Individuals set their own profit maximising prices.
8. There is profit repatriation. There is profit repatriation due to investments being mainly in
the hands of foreign investors.
9. Losses are incurred due to under valuation and high cost of advertising the enterprise etc.
10. There is wasteful competition among producers and this makes the economy lose some of
the productive resources due to meaningless duplication within the private sector.
11. Resentment of government by the public. This is especially by those opposed to the sitting
government
(a) What problems have been faced in the privatisation of public enterprises in your
country?
(b) Problems encountered in the privatisation of public enterprises
1. Opposition from the public who think that privatisation leads to loss of economic control to
foreigners while others are opposed to the process on political grounds as they are not in
favour of the sitting government.
2. Corruption in the privatisation unit because of lack of transparency in the sell of some of the
parastatals where some of them are sold to those who do not qualify.
3. There is poor valuation/undervaluation of the public enterprises that are on sell leading to
loss of revenue.
4. The presence of unscrupulous buyers- these are the successful bidders who fail to pay in time
while others are no serious buyers.
NATIONALISATION
Nationalisation of enterprises is where the government deliberately takes over control and
ownership of privately owned enterprises with or without compensation.
1.It leads to low efficiency and therefore production of low quality output.
2.Encourages corruption and thus misuse of funds.
3.Consumer choice is restricted due to limited variety of goods and services/Reduced
consumer sovereignty.
4.It is associated with bureaucracy and thus slows decision making and implementation.
5.There is high government expenditure on running nationalised enterprises/May subject
nationals to high taxation.
6.There is political interference in running of nationalised enterprises e.g. political
appointment of managers.
7.Leads to low tax revenue. Some of the nationalised enterprises are exempted from paying
taxes.
8.Leads to resource misallocation since it interferes with price mechanism.
9.Discourages private investment. This is because the nationalised enterprises are favoured
by the government.
DUALISM
This refers to the co-existence of two contrasting phenomena that are mutually exclusive,
existing side by side one is desirable and modern the other is undesirable and under
developed. This where one sector is superior, modern and desirable while the other sector
is inferior, backward and undesirable.
Features/examples of dualism
1.Social dualism. This is the co-existence of two contrasting social systems in the economy
i.e. traditional sector and modern sector.
2.Economic dualism. This is the co-existence of two contrasting economic sectors in an
economy e.g. commercial and subsistence sector, barter and monetary economy etc.
3.Technological dualism. This refers to co-existence of two contrasting sectors/techniques of
production e.g. capital intensive and labour intensive technology.
4.International dualism. It is the co-existence of developed counties and less developed
countries.
5.Sectoral dualism. It‟s the co-existence of two contrasting sectors with different levels of
production e.g. urban sector and rural sector, formal and informal sector.
1.Unfair distribution income in Uganda. This gives rise to the co-existence of the very rich
and the very poor.
2.Uneven distribution of resource. This makes some regions to develop at faster rate than
others.
3.Inappropriate education system giving rise to the co-existence of the skilled alongside the
semi-skilled or unskilled labour.
4.Unequal distribution of infrastructure like roads, communication lines etc.
5.Concentration of investment in urban areas giving rise sect oral dualism.
6.The demonstration effect where the rich purchase luxuries yet the poor cannot afford the
basic necessities of life.
7.Production influenced by comparative advantage theory which ties developing countries to
primary products and developed countries to manufactured goods.
8.Cultural rigidities that hinder people from adopting modern practices.
1.Modernising agriculture.
2.Development of infrastructure.
3.Delocalisation of industry.
4.Improving the education system.
5.Ensuring increased monetisation of the economy.
Advantages of a dualism
1. Government raises a lot of revenue through progressive taxation of the modern sector.
2. The government is awakened to its responsibility of providing utilities for the less
developed regions.
3. It provides impetus for research and planning to identify ways and means of developing
the economy.
4. It fosters factor mobility from traditional sector to modern sector.
5. It promotes diversification in the economy due to existence of firms in both the formal
and informal sectors of the economy.
6. It increases employment both in the formal and informal sectors
EXTERNAL SECTOR
1. Uganda‟s exports are mainly agricultural/ primary products e.g. coffee, tobacco, vanilla
etc.
2. There is limited variety for export / there is commodity concentration of trade i.e. a biggest
percentage of trade is with developed countries.
3. Most of the exports are basically semi-processed or unprocessed or low value is added e.g.
exportation of lint.
4. The export sector experiences limited range of markets as much of the trade is with
developed countries.
6. Few services are exported and these include invisible exports like tourism, banking
services etc.
8. Prices of exports are low and are always fluctuating because most of them are primary
products.
Explain the measures that may be undertaken to increase export earnings in your country.
1.Diversification of exports products. This increases foreign exchange earnings since there
are a number of products sold abroad.
2.Diversification of export markets. Reduces reliance on few markets which provides
alternative sources of foreign exchange
3.By joining regional integration. This expands market for goods.
4.Increasing volume of exports/producing more for export.
5.Strengthening commodity agreements. This increases bargaining for fair prices in the
international market.
6.Allowing the local currency to depreciate. It makes exports cheap and imports expensive
which reduces foreign exchange earnings while reducing expenditure abroad.
7.Processing primary products to add value. This results into exports fetching higher prices
and thus more foreign exchange earnings.
8.Lowering costs of production. This increases the demand for locally manufactured goods
because they are cheap and this increases foreign exchange earnings.
9.Intensifying publicity of Uganda‟s products in the foreign markets.
10. Campaign for removal of trade barriers in export markets. This enables the country
export more due to increased access to markets.
11. Improve quality of the exports. This causes an increase in the prices which improves
earnings
N.B: Invisible exports are services/intangible goods sold by a country to other countries e.g.
Insurance banking and tourism
ECONOMIC DEPEDENCE
OR
Uganda is an open and dependent economy and economic dependence can be seen under
the following aspects:-
1. Trade dependence
This is the reliance on international trade/foreign markets for export and imports. Trade
dependence in Uganda is characterised by the following
Dependence on export of few primary products in order to get foreign exchange needed for
development purpose with little output from the industrial sector commodity
concentration of trade.
Dependence on the imported/foreign manufactured goods e.g capital equipment, fuel, drugs
chemicals, machinery to satisfy local requirements
Dependence on few exports markets e.g. Uganda exports to the same region/ few countries
(geographical concentration of trade).
2. External resources dependence
This is the reliance on foreign economies foreign aid, skilled labour and technology. This is
in form of:
1. Sectoral dependence.
This is the reliance on one sector e.g. agriculture. Uganda mainly depends on agriculture
which is the backbone of the economy as an important source of food, source of industrial
raw materials etc.
2. Shortage of skilled manpower has led to economic dependence in order to get manpower
for development of Ldcs economies e.g. expatriates.
3 Ldcs have weak under developed manufacturing sector leading to dependence on foreign
economies.
4. Poor technology in Ldcs has led to economic dependence in order to get technology to
develop their sectors like agriculture, industry, transport etc.
6. High population growth rates which increase government expenditure reduce savings and
limit investment.
7. Natural calamities of earthquakes, droughts etc. These cause excessive need for funds to for
humanitarian assistance and yet government has less revenue.
10. Shortage of foreign exchange. This is due to the low export capacity of the nation.
2. It encourages capital outflow due to over dependence on foreign private investment and
foreign manpower in form of expatriates leading to repatriation of their profits and wages.
8. Overdependence on external resources leads to under -utilisation of the local resources and
skills.
9. Over reliance on foreign resources such as foreign aid has contributed to heavy debt burden
in Ldcs.
10. Worsens political domination of my country by foreigners. Some political decision are
dictated on Uganda which undermines the political sovereignty of the country.
11. Poor terms of trade. Poor terms of trade result from exporting low priced products while
importing expensive commodities
12. Fluctuation of prices. Dependence on one sector such as agriculture results in to fluctuation
of prices because it is affected by several factors beyond the producers‟ control.
13. Fluctuation of incomes. Fluctuation of prices results into fluctuation of income of the
producers.
14. It distorts the planning process. This is because aid is inconsistent, insufficient and
therefore some projects are abandoned.
15. Leads to social cultural domination/cultural erosion. This results from the citizens copying
17. It worsens the debt burden. This because of continuous borrowing to finance the budget.
Positive effects
1. Promotes economic growth. It avails capital is invested in enterprises thus increasing national
output.
2. Helps to acquire financial resources. Dependence on capital from abroad avails finance to the
country.
3. Helps to cover technological gap. This is through technology transfer.
4. Helps to cover manpower gap. This is achieved by use of expatriates.
Suggest measures that may be taken to reduce economic dependence in your country.
4. Export promotion strategy to earn foreign exchange and reduce dependence on foreign aid.
5. Efforts should be put in the development of local technology and this can be achieved by
encouraging research and development.
6. Encouraging local investment through giving the local investors incentives e.g. subsidising
them, tax exemptions etc. to minimise on the dependence on foreign investors.
8. Pursuing an industrialisation strategy that utilises more of our local resources and address
domestic demands to reduce dependence on foreign raw materials.
9. Improvement in political and investment climate to increase productivity and promote local
investment.
11. Improving infrastructure. This reduces the cost of production and enables the producers
supply more goods and services reducing the demand for imports.