UNIVERSITY OF KABIANGA

UNIVERSITY EXAMINATIONS
2019/2020 ACADEMIC YEAR
SECOND YEAR FIRST SEMESTER MAIN EXAMINATIONS
FOR THE DEGREE OF BACHELOR OF SCIENCE
IN
AGRICULTURAL ECONOMICS AND RESOURCE MANAGEMENT

ARE 211: INTERMEDIATE MICROECONOMICS THEORY

MARKING SCHEME
Q1. (a) Sources of Monopoly Power/Barriers to Entry
i. Technical Barriers
 Ownership/control of the entire supply of raw materials required for the production of the
commodity or exclusive knowledge of production techniques.
 The size of the market may be such as not to support more than one plant of optimal size.
 Economies of scale may operate over a sufficiently large range of outputs so as to leave a
single firm supplying the entire market.
 Fusion of competitors’ interest e.g. OPEC
 The existing firm may adopt a limiting pricing policy
 Government monopoly e.g. Parastatals
ii. Legal Barriers
 A Firm may own a patent for exclusive rights to produce a commodity or to use a
particular production process.
 Government franchise/ restrictions through licensing…

(b) Externality is the cost or benefit that affects a party who did not choose to incur that cost or
benefit. Externalities often occur when a product or service's price equilibrium cannot reflect the
true costs and benefits of that product or service.

Externalities can be either positive or negative.

A negative externality is an economic activity that imposes a negative effect on an unrelated

third party. It can arise either during the production or the consumption of a good or service.
Pollution is termed a negative externality because it imposes costs on people who are "external"
to the producer and consumer of the polluting product.

Other examples for negative externalities include:

 Air pollution from burning fossil fuels. This activity causes damages to crops, materials
and (historic) buildings and public health.
 Water pollution by industries that adds effluent, which harms plants, animals, and humans.
Water usage from growing plants could impose a negative externality on citizens of
counties or states who are harmed by decreased water.

Conversely, a positive externality is any difference between the private benefit of an action or
decision to an economic agent and the social benefit. A positive externality is anything that
causes an indirect benefit to individuals.

Examples of positive externalities include:

 Planting trees makes individuals' property look nicer and it also cleans the surrounding
areas.
 A beekeeper who keeps the bees for their honey. A side effect or externality associated
with such activity is the pollination of surrounding crops by the bees. The value
generated by the pollination may be more important than the value of the harvested
honey.
(c) The main factors of production
Factors of production are the economic means (economic resources or inputs) whose
combination makes possible the availability of economic goods and services aimed at
satisfying human material wants.
These factors of production take four different types, that is, Land, Labour, Capital and
entrepreneur.

Land:-
It is a primary natural resource over which people have the power of ownership, control
and disposal, and can be used to yield income or carrying out economic activities.
Land is a gift of nature whose supply is for all practical purposes fixed (no production
cost) and whose reward is rent. It includes soil, mineral deposits and forests.

Labour:
Labour is the human physical and mental effort devoted to the production of goods
and services. It is a primary resource whose factor reward is wages (salaries)
 Capital:
Capital is the stock of wealth or goods which are not required for their own sake but
for further production of other goods.
Capital is either fixed such as machinery, buildings, motor vehicles; or working capital
like stock of raw materials and work-in-progress. The factor reward for capital is
interest.

Entrepreneur:
Is the organizing aspect of resource combination in a production process. It involves
risking of capital and decision-making in anticipation of demand.

(d) (i) Marginal utility is the additional satisfaction derived from the consumption of an extra
unit of a commodity. It is measured by the derivative of the total utility function, that is,
change in total utility per unit change in the quantity (of a commodity) consumed:

MU = dTU/dQ where; MU: Marginal utility

TU: Total utility
Q: Quantity consumed.

This additional satisfaction (marginal utility) decreases as successive units of a

commodity are consumed – thus diminishing marginal utility.
Marginal utility falls under the cardinalist approach of consumer behavior which
assumes that consumer satisfaction (utility) is measurable in terms of money the
consumer is willing and able to pay for a commodity. Marginal utility varies from one
individual to another e.g. a person in North Eastern province of Kenya will find a glass
of cold juice very satisfying relative to a person in a cold area like Limuru or Kericho.

When marginal utility is greater than zero, total utility is rising; total utility is maximum
when marginal utility is zero; when marginal utility is less than zero (-ve) the total utility
falls. Therefore, total utility (TU) increases at a decreasing rate since marginal utility
(mu) decreases at all levels of subsequent consumption of successive units of a
commodity.

(ii) Q TUX1 TUX2 MUX1 MUX2 MUX1 MUX2

P1 P2
1 16 21 16- 0 =16 21- 0 =21 8 7
2 30 40 30-16 =14 40-21=19 7 6.3
3 42 55 42- 30=12 55-40=15 6 5
4 52 67 52- 42=10 67-55=12 5 4
5 60 76 60-52=8 76-67=9 4 3
6 65 82 65-60=5 82-76=6 2.5 2
(i)
At equilibrium,

And

Thus, 2(2) + 3(1) = 7

2(4) +3(3) =17
2(5) +3(4) =22
Thus, the consumer will be in equilibrium when consuming 4 units of X1 and 3 units of
X2.
(ii) TU=TUX1 + TUX2 =52+55 =107
Q2. TC = 1000 + 100Q – 15Q2 + Q3

a) Total and average costs at output levels of 10 and 11 kgs: Total Costs:
i) Total cost At Q = 11
At Q = 10 TC = 1000 +100(11) – 15(11)2 + (11)3
TC = 1000 + 100 (10) – 15(10)2 + (10)3 TC = 1000 + 1100 – 1815 + 1331
TC = 1000 + 1000 – 1500 + 1000 TC = 1616
TC = 1500

ii) Total fixed cost (TFC)

TC = TFC + TVC
TC = 1000 + 100 – 15Q2 + Q3
TFC does not vary with output (same at all levels of output) So when Q = 0
TC = TFC = 1000
When Q = 10 When Q = 11

TF C = 1 0 0 0 TFC = 1000

iii) Total variable cost (TVC)

TC = TFC + TVC
TVC = TC – TFC
 TVC = 1000 + 100Q – 15Q2 + Q3 – 1000
TVC = 100Q – 15Q2 + Q3

When Q = 10 when Q = 11

TVC = 100(10) – 15(10)2 + (10)3 TVC = 100(11) – 15(11)2 + (11)3

TVC = 1000 – 1500 + 1000 TVC = 1100 – 1815 = 1331
TVC = 500 TVC = 616

Average Costs:

i) Average Total Cost (ATC)

Average Total cost is the total cost per unit of output, that is, TC/Q

ATC = 1000 + 100Q – 15Q2 + Q3

Q

ATC = 1000 + 100 – 15Q + Q2

Q
When Q = 10 when Q = 11

ATC = 1000 + 100 – 15(10) + (10)2 ATC = 1000 + 100 – 15(11) +

10 11
ATC = 100 + 100 – 150 + 100 ATC = 90.9 + 100 – 165 + 121
ATC = 150 ATC = 146.9

c) Shape and relationship between AC, AVC, MC and AFC curves.

MC
AC
ATC MC AC

●B AVC

●A

AF C

X1 X2 Output

To illustrate the relationship between AC,AVC, MC and ATC curves

Q3. (a) A public good is a good or service that can be consumed simultaneously by everyone
and from which no one can be excluded. That is, consumption is non-revival and from which it
is impossible to exclude a consumer. A public good has the feature of being non-excludable. A
good is non-excludable if it is impossible, or extremely costly, to prevent someone from
benefitting from a good who has not paid for it. An example of a non-excludable good is
national defense. It would be difficult to exclude a foreign visitor from being defended.

(b) Internal economies of scale

Internal economies of scale are those obtained within the organization as a result of the
growth irrespective of what is happening outside. They take the following forms:

a. Technical Economies
i) Indivisibilities: These may occur when a large firm is able to take advantage of
an industrial process which cannot be reproduced on a small scale, for
example a blast furnace which cannot be reproduced on a small scale while
retaining its efficiency.
ii) Increased Dimension: These occur when it is possible to increase the size of the
firm’s equipment and hence realize a higher volume of output without necessarily
increasing the costs at the same rate.
iii) Economies of Linked Processes: Technical economies are also sometimes
gained by linking processes together eg in the iron and steel industry where iron
and steel production is carried out in the same plant, thus saving on both transport
and fuel costs.
iv) Specialization: Specialisation of labour and machinery can lead to the production
of better quality output and higher volume of output.
v) Research: A large firm will be in a better financial position to devote funds
to research and improvement of its product than a small firm.

b) Marketing Economies
i) The buying advantage: A large-scale organization may buy its materials in
bulk and therefore get preferential treatment and buy at a discount more easily
than a small firm.
ii) The packaging advantage: It is easier to pack in bulk than in small quantities
and although for a large firm the packaging costs will be higher than for small
firms, they will be spread over a large volume of output and the cost per unit will
be lower.
iii) The selling advantage: A large-scale organization may be able to make
fuller use of sales and distribution facilities than a small-scale one.

c) Organizational:
As a firm becomes larger, the day-to–day organizations can be delegated to
office staff, leaving managers free to concentrate on the important tasks. When a
firm is large enough to have a management staff they will be able to specialize in
different functions such as accounting, law and market research.
 d) Financial Economies:
A large firm will have more assets than a small firm. Hence, it will find it cheaper
and easier to borrow money from financial institutions like commercial banks than a
small firm.

e) Risk-bearing Economies
All firms run risks, but risks taken in large numbers become more predictable. In
addition to this, if an organization is so large as to be a monopoly, this considerably
reduces its commercial risks.

f) Overhead Processes
For some products, very large overhead costs or processes must be undertaken to
develop a product, for example an airliner. Clearly, these costs can only be justified if
large numbers of units are subsequently produced.

g) Diversification
As the firm becomes very large it may be able to safeguard its position by
diversifying its products, processes, markets and the location of the production.

External Economies

These are advantages enjoyed by a large size firm when a number of organizations
group together in an area irrespective of what is happening within the firm. They
include:

a) Economies of concentration: When a number of firms in the same industry

band together in an area they can derive a great deal of mutual advantage from
one another. Advantages might include a pool of skilled workers, a better
infrastructure and the stimulation of improvements. The lack of such external
economies is a serious handicap to less developed countries.

b) Economies of information: Under this heading, we could consider the setting

up of specialist research facilities and the publication of specialist journals.
b) Economies of disintegration: This refers to the splitting off or
subcontracting of specialist processes.
 (c)

Output TP
AP
MP
TP

● A
STAGE II STAGE III

●B

STAGE I

AP
●
0 L1 L2 L3 Units of a variable factor of
MP production (eg labour)
The three main stage of diminishing returns
Stage I:
This is the stage of increasing returns which involves varying the units of the variable
factor input upto L2. Both the marginal product and average product are positive.
Average product is increasing

Rising average product does not mean that the variable input becomes more efficient but
with more units of the variable factor, it is possible to utilize the fixed factor more
efficiently for example, through specialization and division of labour in the case of
workers. Thus increasing productivity arises from the overall combination and is
therefore applicable to all workers, particularly since labour units are homogenous.

As long as the average product is rising, efficiency is rising; thus at the employment of L2
units of the variable factor (Labour in this case), the firm is at its most technically efficient
level. This point is also defined by the intersection of the marginal product and average
product curves that is point B.

Marginal product is initially increasing upto a point where it reaches a maximum (i.e.
point A) and then starts to decline. Marginal product rises as the fixed factor is utilized
more efficiently.
Total product increases at an increasing rate as the marginal product is rising and
then starts to increase at a decreasing rate as marginal product starts to fall.
Stage II:-
Stage II begins where the average product starts to fall upto the point where marginal
product becomes zero. This stage is characterized by the following:-
 Both marginal product and average product are declining, with marginal product
falling much faster.
 Declining average product indicates decreasing returns and thus decreasing
efficiency. This comes about because each additional unit of the variable factor
has less and less of the fixed factor to work with.both marginal product and
average product are positive.
 Total product is increasing at a decreasing rate and thus stage II is the stage of
diminishing returns
Stage III:-

Stage III begins where marginal product becomes negative such that the total product
begins to fall as well. AP continues to fall but remains positive. This is the stage of
extreme inefficiency where factors of production are probably getting into each
other’s way, that is, at this stage the use value ( according to the labour theory of
value) is less than the exchange value of labour (i.e. price/wage rate is greater than
the productivity/return)

Q4. (b) Demand function Q=2000-20P

NB: TR = P.Q or TR = AR.Q in perfect competition where AR = P.

Express P in terms of Q in the demand function as follows:

Q – 200 + 20P = 0

20P = 200 – Q

P = 10 – ½ Q

TR = P.Q = Q(10 – ½ Q)
TR = 10Q – ½ Q2 MR = dTR = 10 – Q
dQ
2
TC=0.05Q +10,000

MC = dTC = 0.1Q
dQ

Since the first order condition (FOC) provides that profit maximization is at MR = MC level of
output, then
10 – Q= 0.1Q

10 =1.1Q
Q= 9 units
Q5. (a) According to this criterion, any change that makes at least one individual better off
without making someone else worse off is an improvement in social welfare. Conversely, any
change that makes no one better off and at least one person worse off is a decrease in social
welfare. This criterion can alternatively be stated as follows, a situation in which it’s impossible to make
any one better off without making someone else worse off is said to be Pareto optimal/Pareto efficient.

(b) (i) Movement along the demand curve.

Movement along the demand curve are brought by change own price of the commodity.

Price

Quantity

When price falls from p1 to p2, quantity demanded increases from q1 to q2 and
movement along the demand curve is from A to B. Conversely when price rises from p2
to p1 quantity demanded falls from q2 to q1 and movement along the demand curve is
from B to A.

Shifts in demand curve

Shifts in the demand curve are brought about by the changes in factors like taste, prices of
other related commodities, income etc. other than the price of the commodity. The change
in the demand for the commodity is indicated by a shift to the right or left of the original
demand curve.

In the figure below, DD represents the initial demand before the changes. When the
demand increases, the demand curve shifts to the right from position DD to positions
D2D2. The quantity demanded at price P1 increases from q1 to q'1. Conversely, a fall in
demand is indicated by a shift to the left of the demand curve from D2D2 to DD. The
quantity demanded at price P1 decreases from q1 to q1

Price
(ii) (a) Prices of other related commodities.
Related commodities can be compliments or substitutes.

(i) Compliments: The compliments of a commodity are those used or consumed with
it. Suppose commodities A and B are compliments, and the price of A increased.
This will lead to a fall in the quantity demanded of A, and will in turn lead to a fall in
the demand for B. Example are bread and butter or cars and petrol.

(ii) Substitutes: The substitutes of a commodity are those that can be used or
consumed in the place of the commodity. Suppose commodities X and Y are
substitutes. If the price of X increases, the quantity demanded of X falls, and the
demand for Y increases.

(b) The Aggregate National Income and its distribution among the population. In normal
circumstances as income goes up the quantity demanded goes up. In such a case the good is
called a normal good. However, there are certain goods whose demand shall increase with
income up to a certain point, then remain constant. In such a case the good is called a
necessity e.g. salt. Also there are some goods whose demand shall increase with income
up to a certain point then fall as the income continues to increase. In such a case the good
is called an inferior good.

(c) Taste and preference

There is a direct relationship between quantity demanded and taste. For instance, if
consumers' taste and preferences change in favour of a commodity, demand will increase.
On the other hand, if taste and preferences change against the commodity e.g. due to
changes in fashion, demand will fall. Taste and preferences are influenced by religion,
community background, academic background, environment, etc.

(d) Expectation of future price changes

If it is believed that the price of a commodity is likely to be higher in the future than at
present, then even though the price has already risen, more of the commodity may be
bought at the higher price.

(e) Climatic/seasonal factors

Seasonal variations affect the demand of certain commodities such as cold drinks like
sodas and heavy clothing.

(f) The size and structure of population

Changes in population overtime affect the demand for a commodity. Also as population
increases, the population structure changes in such a way that an increasing proportion of
the population consists of young age group. This will lead to a relatively higher demand
for those goods and services consumed mostly by young age group e.g. fashions, films,

(g) Government influences

 e.g. a legislation requiring the wearing of seatbelts.

(h) Advertising especially the persuasive ones

(c) Marshallian Demand curve
Suppose that in equilibrium, that is when, , quantity of X=X1 and Price of X,
PX=P1 Let the price increase from P1 to P2, thus P1<P2.
Consequently equilibrium will be destabilized such that . To restore
equilibrium, the consumer must increase MUX by reducing the quantity of X consumed say
from X1 to X2 such that X1>X2.