CHARTERED ACCOUNTANTS EXAMINATIONS

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TECHNICIAN LEVEL
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T4: BUSINESS ECONOMICS

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MONDAY 15TH DECEMBER 2014

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TOTAL MARKS 100; TIME ALLOWED: THREE (3) HOURS

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INSTRUCTIONS TO CANDIDATES

1. You have fifteen (15) minutes reading time. Use it to study the examination paper
carefully so that you understand what to do in each question. You will be told when to
start writing.

2. This paper is divided into TWO sections:

Section A: Attempt any TWO (2) Microeconomics questions.
Section B: Attempt any TWO (2) Macroeconomics questions.

3. Enter your student number and your National Registration Card number on the front
of the answer booklet. Your name must NOT appear anywhere on your answer
booklet.

4. Do NOT write in pencil (except for graphs and diagrams).

5. The marks shown against the requirement(s) for each question should be taken as an
indication of the expected length and depth of the answer.

6. All workings must be done in the answer booklet.

7. Present legible and tidy work.

8. Graph paper (if required) is provided at the end of the answer booklet.
SECTION A: MICROECONOMICS

Attempt any two(2) questions in this section.

QUESTION ONE

(a) Some residents in Chilanga have complained about respiratory illnesses attributed to
emissions from cement production activities in the area.

Required:
(i) Name and define the market failure depicted in such a scenario. (2 marks)

(ii) Explain and graphically show how the market failure identified above creates an
inefficient market outcome. (6 marks)

(iii) Highlight any two (2) regulatory instruments that are available to correct the
inefficiency of the market due to pollution. (4 marks)

(b) Briefly analyse the following statements:

(i) Marginal revenue is less than price for a monopoly firm. (3 marks)

(ii) Perfectly competitive firms can make economic profit in the short run but make zero
economic profit in the long run. (4 marks)

(iii) The short run supply curve for a competitive firm is the portion of its marginal cost
curve which lies above average variable cost. (3 marks)

(iv) Cross price elasticity measures the price and quantity responses of related products
such as substitutes. (3 marks)
[Total: 25 marks]

QUESTION TWO

(a) Qd = 40 5P + 0.01Y 2R is the demand for cold drinks during summer months, where
Q is quantity of cold drinks, P is the price in kwacha , Y is income in kwacha, and R is the
number of rainy days during summer.

If the supply curve is represented by Qs = 20P 150,

(i) Find equilibrium price and quantity when Y = K20,000 and R = 20 days.
(3 marks)

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 (ii) What is the new market equilibrium if the number of rainy days is 15 and income
remains unchanged? (3 marks)

(iii) Does the supply curve shift in response to the decline in the number of rainy days?
Using a diagram explain your answer. (5 marks)

(b) Briefly explain any three (3) advantages and two (2) disadvantages of establishing a
corporation. (5 marks)

(c) Antitrust policy is concerned about the abuse of market power and seeks to foster
competition. The three main areas of concern are monopolisation, anticompetitive
behaviour, and mergers and acquisitions.

Describe each of these three practices with emphasis on how they can affect
competition. (9 marks)
[Total: 25 marks]

QUESTION THREE

(a) Consider the following information about the production of computers and copper in
country X:

Possibility Computers (Units) Copper (Tons)

A 0 900

B 40 850

C 110 750

D 140 600

E 165 400

F 185 0

Required:

(i) Plot the production possibilities curve (PPC) for country X with computers on the
vertical axis and copper on the other. (3 marks)

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 (ii) Calculate the opportunity cost of increasing the production of computers from D to E.
(1 mark)
(iii) Suppose a technological advancement makes it possible for the country to produce
twice as many computers as before. Construct the new PPC on the same graph.
(2 marks)

(iv) What does the shape of the PPC tell you about the opportunity cost of producing
more of a good? (2 marks)

(b) A local newspaper employs casual workers to fold and pack newspapers into bags for
delivery. It pays each worker K30 per shift. The capital cost is fixed at K50 per shift. Five
workers can fold and pack 400 newspapers per shift. The fourth worker added 50
newspapers to total output.

Required:

(i) Is the firm operating in the short run or long run? Justify. (1 mark)

(ii) What is the average product of five workers? (1 mark)

(iii) Find the average variable and average fixed costs of folding and packing 400
newspapers. (2 marks)

(iv) What is the marginal cost of one of the 50 newspapers folded and packed by the
fourth worker? (1 mark)

(c) In an oligopoly market, state and explain any three (3) factors that can affect price
cartel. (12 marks)
[Total : 25 marks]

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SECTION B: MACROECONOMICS

Attempt any two (2) questions in this section.

QUESTION FOUR

(a) The Zambian economy can be classified into three broad sectors which contribute to
gross national income (GNI) namely, the primary sector, secondary sector, and tertiary
sector.

Required:

(i) Define each sector and give two (2) examples of industries found in Zambia from
each category. (6 marks)

(ii) Briefly explain the concept of value addition in the secondary sector. Illustrate your
answer by giving two examples. (4 marks)

(iii) Give three reasons why it is important to measure national income. (3 marks)

(b) Explain how wheat can either be an intermediate good or a final good depending on the
buyer and its use. (3 marks)

(c) Suppose tea production in Kawambwa district is considered to be an infant industry

which requires protection from international competition in order to thrive. Give
three (3) arguments in favour of infant industry as it relates to Kawambwa Tea Company.
(9 marks)
[Total: 25 marks]

QUESTION FIVE

(a) Identify and explain any three (3) functions of money. (9 marks)

(b) Discuss the three (3) motives for liquidity preference. (9 marks)

(c) The model for an economy is given to you as follows:

C = 95 + 0.8Yd; I = 85; G = 70; NX = 20; and Tax rate = 25% where, C is consumption
by households, I is investment spending, G is government expenditure, and NX is net
exports.

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 Required:

(i) Calculate the equilibrium income for the economy. (3 marks)

(ii) How much tax does the government collect when the economy is at equilibrium if the
tax function is given as T = 50 + 0.25Y? (2 marks)

(iii) Does the government have a budget deficit or surplus? (2 marks)

[Total: 25 marks]

QUESTION SIX

(a) Improving human capital leads to economic growth and poverty reduction in the long
run. However, many less developed countries face the challenges of brain drain and few
educational opportunities for young women. Explain how the two problems cited above
negatively affect economic growth. (10 marks)

(b) (i) In the overall consumption function C=a+bY, a is a fixed amount and b is a
constant percentage (b%) of the national income Y.

Given that C=100+0.8Y, determine the marginal propensity to consume (MPC) and
the fixed spending. (3 marks)

(ii) Briefly explain any four (4) factors that can influence the amount of consumption.
(12 marks)
[Total: 25 marks]

QUESTION SEVEN

(a) The balance of payments mainly consists of the current account and the financial and
capital account.

(i) Distinguish between direct investment and portfolio investment flows recorded in the
financial account of the balance of payments. (6 marks)

(ii) Why would a positive balance on the financial account of the balance of payments be
beneficial to the Zambian economy? (4 marks)

(b) A rising (appreciating) exchange rate may reflect relatively low inflation and strong trade
and general economic performance in a country. Conversely, poor economic performance
and high inflation will result in currency depreciation (devaluation).

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 (i) Differentiate between currency depreciation and currency devaluation. (3 marks)

(ii) As a result of a fall in the value of the currency, exports would become relatively
cheaper to foreign buyers and so demand for exports would rise.

Briefly explain three (3) factors that affect the increase in export revenue.
(6 marks)

(c) How do demand-pull factors cause inflation? Give any three (3) causes. (6 marks)

[Total: 25 marks]

END OF PAPER

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 T4 SUGGESTED SOLUTIONS
SOLUTION ONE

(a)
(i) This is a negative externality. A negative externality is a cost imposed by the
actions of one party on another party which is not involved in the transaction.

(ii)

Price
Marginal Social Cost

Supply = Marginal Private Cost

External Cost
P1 A
P0 B

Demand = Marginal Social Benefit

Q1 Q0 Output

When external costs exist, the market supply will understate the full social costs.
In the diagram above, an external cost i.e. cost over and above the market
supply exists as shown. Market equilibrium occurs at point B where Demand =
Supply but allocative efficiency occurs at point A where Marginal Social Benefit =
Marginal Social Cost. This means that when external costs exist, resources will be
over-allocated to the production of the good. This is an inefficient outcome.

(iii) One regulatory instrument available is a tax on the output of the firms. If
firms pay a tax per unit of output which is equal to the cost of pollution i.e. the
external cost, this will shift the supply curve so that it equals the marginal social
cost and thereby restoring efficiency.

Another instrument is to introduce an emissions standard for the firm. This

entails setting a maximum level of emissions that the firm will be allowed to
release. The firm meets the standard by installing pollution abatement
equipment.

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 Thirdly, an emissions fee can be charged on each unit of the firms emissions.

Fourthly, when property rights are well defined the individuals who own the
property can exercise the right to be free from pollution. In this case, the firm
emitting pollution and those who suffer from it can negotiate over the tolerable
levels of pollution and how much compensation should be paid for the damage.

(b)
(i) A monopoly firm represents the only supply of goods for the market and will
therefore be a price setter.

Thus, the marginal revenue, that is, the additional revenue from selling an extra
unit of output will be lower for the firm to be able to sell more goods. As long as
each additional unit sells for less, the marginal revenue will be less than the
average revenue (price).

(ii) In a perfectly competitive industry, there is no restriction to entry into the

industry.

Therefore, when firms in an industry are making economic profits new firms will
be attracted to that industry and will join. In the short run, all firms will continue
to enjoy these economic profits.

However, as more firms enter the industry there will be an increase in the supply
of goods which will in turn drive down the prices.

In the long run, all the economic profits will disappear as they would have been
shared amongst the many firms and all will be earning only normal profits.

(iii) Under perfect competition, price is equal to marginal revenue and average
revenue.

The firm will therefore produce the quantity where price equal to marginal cost
to maximise profit as long as the price is equal or greater than the average
variable cost.

The rising part of the firms marginal cost curve above the minimum average
variable cost can be regarded as the firms supply curve because the firm can
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 only operate along that part. If price is below the average variable cost, the firm
should shut down.

(iv) Cross price elasticity is a measure of how much the quantity demanded of one
good will change when the price of a related good changes.

For substitute goods, the response will be positive such that an increase in the
price of one good leads to a reduction in the quantities demanded of that good
but will in turn lead to an increase in the quantity demanded of a substitute
good. An example is butter and margarine.

For complementary goods, the response will be negative such that an increase in
the price of one good leads to a reduction in the quantities demanded of that
good but will in turn lead to a decrease in the quantity demanded of a
complementing good. An example is DVD and DVD players.

SOLUTION TWO
(a)
(i) At equilibrium, Qd = Qs
If Y = 20,000 and R = 20, then Qd = 40 5P + 0.01(20,000) 2(20) or Qd =
200 5P. Qs = 20P 150.

Equating demand and supply,

200 5P = 20P 150
25P = 350
P = K14

Q = 200 5(14)
Q = 200 70
Q = 130 cold drinks

(ii) If R = 15, Qd = 210 5P

Equating demand and supply,

Qd=40-5P+0.01x20,000-2x15
Qd=210-5P
Qs=20P-150
210 5P = 20P 150
25P = 360
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 P = K14.40

Q = 210 5(14.40)
Q = 210 72
Q = 138 cold drinks

Price
d1
s
d0

P1=14.40 B

P0=14 A

No.The supply has remained the same Qs=20P-150. With the increase in
equilibrium price from Po=k14 to P1=K14.40, we see a rightward movement
along the supply curve from A to B.

(b) A corporation is a firm created as a legal entity separate from the persons who
established it. It is usually owned by many individuals whose liability is limited to
their investment in the firm.

Advantages
(i) Some of the advantages of establishing a corporation are:
This form of organisation limits the liability of its owners. If the company goes
bankrupt, the owners can only lose the amount they invested in the
company.
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 A corporation can raise much more money than the other forms of business.
It can do so by issuing shares on the stock market.
A corporation is able to promptly expand in size to take advantage of
economies of scale.
A corporation does not depend on the owner to continue operating. In cases
where an owner dies or an important decision should be made, the big firm
can draw on its wider expertise.

Disadvantages
(ii) Some of the disadvantages of establishing a corporation are:
There can be a conflict of interest resulting from the separation of ownership
and management in which a principal-agent problem arises.
There is the threat of monopoly control which may render the decisions of
many shareholders subservient to those of the majority owners.
Large companies can unduly influence political decisions to an extent where
they compromise efficiency and equity.
When the corporation becomes too big and monopolises the market, the
smooth functioning of the market may cease due to reduced competition.

(c)
Monopolisation refers to the attempt to acquire market power where one firm
is able to control the market for a particular product. Such a dominant
position can injure competition because the monopoly can obtain rebates
from bulk shipments, raise price wars to price out competitors, and coerce
suppliers and customers in order to gain and maintain control over the
market.

Anticompetitive behaviour refers to any action that prevents workable

competition to the extent that it is not possible for firms in all markets to
engage in free and unfettered competition. Behaviour such as when firms
collude to fix prices or price discrimination with the purpose of eliminating
competitors or interlocking directorates where the same people sit on the
board of directors of competing firms, are all violations of antitrust laws.

A merger takes place when two or more companies combine under unified
control. One company may also merge with another by acquiring full control
of the other. However when such combinations have the effect of

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 substantially lessening competition or creating a monopoly, they violate
antitrust laws. Mergers can be conglomerate, vertical or horizontal.

SOLUTION THREE

(a) Computers
units
400
F
350

300
Economic growth where computer production doubles
250

200
F
150

100

50

200 400 600 800 A 1000 tons Copper

Note to marker: The graph above is not drawn to scale but students are
required to use accurate scaling.

(i) As shown above using accurate scale.

(ii) Opportunity cost = 600 400 = 200 tons of copper need to be sacrificed

(iii) As shown above using accurate scale. The student should show that they
calculated the doubling effect on computer production due to improvements
in technology.

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 Possibility Computers Copper (Tons)
(Units)
A 0 900
B 80 850
C 220 750
D 280 600
E 330 400
F 370 0

(iv) The concave shape shows there is an increasing opportunity cost to

producing more of a good. This means that to produce more units of one
good, the country will sacrifice increasing units of the other.

(b) (i) the firm is operating in the short run because its capital cost is fixed.

(ii)Average product = Q/ L = 400/ 5 = 80 newspapers per shift.

(iii)Average variable cost = TVC/ Q = 150/ 400 = K0.38 or 38 ngwee.

Average fixed cost = TFC/ Q = 50/ 400 = K0.13 or 13 ngwee.

(iv) Marginal cost = TC/ Q = 30/ 50 = K0.60 or 60 ngwee.

(c)

The success of a price cartel will depend on several factors :

(i) Whether it consists of most or all the producers of the product.
(ii) Whether or not they are close substitute for the product.
(iii) The ease with which supply can be regulated. In the case of primary
commodities, such as wheat, rice, tea and coffee, total supply is dependant
on weather conditions and even political events in the producing country.
(iv) The price elasticity of demand for the product. Cartels are likely to be
effective for goods which sre inelastic. An attempt to raise prices by cutting
output of an elastic good might result in such a large fall in demand and
such a small rise in price that the total income of produce also falls.
(v) Whether producers can agree on their individual shares of the total
restricted supply to the market. This is often the greatest difficulty of all .

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SOLUTION FOUR
(a)
(i) The primary sector is one in which raw materials are extracted. Examples in
Zambia are mining, fishing, forestry, and agriculture.

The secondary sector is the manufacturing part of the economy in which raw
materials and other inputs are used to produce other products. Examples in
Zambia include electricity production, milling plants, fertilizer production, fruit
cannery, clothing factories, and wooden craft making.

The tertiary sector is the services and trade section of the economy. Examples
are transport, communication, education, and financial services such as banking
and building societies.

(ii) Value addition means transforming the raw materials into a finished product or
transforming a raw material into an intermediate product followed by another
transformation into finally a finished product.
Eg milling maize into mealie meal; transforming copper ore into copper cable .
(iii)It is important to calculate national income because:
It measures the standard of living in a country
It allows for comparisons between the wealth of different countries
It creates a base to measure a countrys economic performance
It assists the central government in its planning for the future

(b) An intermediate good is one that is purchased to be used as an input in

producing other goods. In the case of wheat, it is an intermediate good when it
is processed further to make baking flour which is sold to the end user.

A final good is one that is used or consumed by individuals, households, and

firms. When wheat is bought and then boiled at home for breakfast, it is a final
good.

(c) The infant industry argument follows that:

The existence of fierce foreign competition may make it hard for some
industries to survive in the short run.

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 It may thus be desirable to restrict trade in a particular industry of interest if
allowing it to survive for a short period of time would make it capable of
surviving and competing when the restrictions are lifted.
During the short run period, the infant industry is expected to develop the
expertise to compete.
This argument is valid for as long as the industry identified will be able to
compete in the long run.
Protection may also involve outlays from the State in order to subsidise the
initial loss making period during establishment. This is a stress on the
government funds.
One clear difficulty is to identify an industry that will survive without
protection.
Another problem is the failure to provide for a timeline in which to end the
period of protection. An industry should not be an infant indefinitely.
Generally, such protection may attract retaliation from trading partners.

SOLUTION FIVE

(a) The following are the functions of money :

>A medium of exchange. It serves as a lubricant or intermediary to
smooth the process of exchange and to make it more efficient. In this regard,
money is the generally accepted means of payment and as such people
believe that it will be accepted as payment by other people.

>A unit of account. It is the agreed measure for stating the prices of goods
and services. It then becomes a common measure which allows people to
know the cost of various goods and services to be able to decide how best to
spend their income.

>A store of value. It is the most common form for holding wealth because
it can always be exchanged for other goods and services at a later date.
Since it is usually more convenient and can be immediately exchanged for
other assets, money is the most liquid form of keeping wealth. As money is
used to store value, it can be used as a standard of deferred payment in
which it can measure the value of future payments.
>A standard of deferred payment. Use money makes it possible for
payment to be deferred from the present to some date. Borrowing and
lending are greatly simplified, loans are taken and repaid in the form of
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 money. Credit transactions cannot easily be carried out unless money is used.
Given the assumed stability in its value, future contract are fixed.
(b) The three main motives for holding money (liquidity preference) are:
The transactions motive. In a money economy, all participants have to
hold money as a medium of exchange. It is impossible to transact without
money. The need to hold money arises because payments and receipts do
not always coincide and the participants have to hold money to buy what
they want and need at the time it is available.

The precautionary motive. In this case, the participants also want to

transact but the nature of the transaction is that it involves unforeseen events
where the expenditure is unpredictable. Money is, therefore, held for
transactions which pop up over and above the normal transaction
requirements.

The speculative motive. This motive relates to money as a store of value

in which the participant has to make a choice between holding wealth in the
form of money or as bonds. This depends on the interest rate i.e. the
earnings from holding bonds which invariably creates an opportunity cost to
holding money which has no interest earned. There is an inverse relationship
between the quantity of money demanded for speculative purposes and the
level of the interest rate.

(c)(i)At equilibrium, Y = AD where AD = C + I + G + (X M).

AD = 95 + 0.8(Y T) + 85 + 70 + 20
AD = 95 + 0.8(Y 0.25Y) + 85 + 70 + 20
AD = 270 + 0.8(0.75Y)
AD = 270 + 0.6Y

Therefore, Y = 270 + 0.6Y

0.4Y = 270
Y = 675

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 (ii)At equilibrium, Y = 675 and T = 50 + 0.25Y.

T = 168.75 50
T = 118.75

(iii) Budget balance is achieved when income=government expenditure

Ie T=G but T(118.75)>G(50)

So 118.75-50=48.75 this represent a budget deficit

SOLUTION SIX
(a) Brain drain is the emigration of many of the most highly educated and skilled
people from less developed countries to the more developed countries in search
of higher standards of living. This situation firstly means that the productive
capacity of the country is reduced. Secondly, brain drain leaves the people left
behind poorer because they cannot enjoy the positive externalities that
education confers on society. In both cases, productivity is reduced and
economic growth is adversely affected in the long run. The government can
counter the problem of brain drain by improving the domestic education system
and the incentives to work locally like better pay and working conditions.

With regard to few educational opportunities for young women, it must be

recognised that women also form part of the labour market pool from which a
country draw workers. By limiting the educational opportunities that young
women can get, the country will be limiting the human capital that this group of
people can develop. In turn, the productivity gains from this neglected potential
labour will be forgone. The low labour force participation rate combined with an
poorly educated labour force will negatively affect economic growth in the long
run. The government can step in to remove barriers which hinder the education
of women like early marriages and other detrimental perceptions that women
should not study.

(b)(i) The marginal propensity to consume (MPC) is 0.8 or 80% representing the value
of b; the fixed spending amount is 100 representing the value of a.

(ii)Factors influencing the amount of consumption :

Changes in disposable income, and the marginal propensity to consume:

changes in disposable income are affected by matters such as pay rises and

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 changes in tax rates. An increase in household wealth, or expectations of the
future increase in household wealth, may increase consumption levels.
Changes in the distribution of national income: some sections of the
population will have a higher marginal propensity to consume than others,
and so a redistribution of wealth might affect consumption.(a redistribution of
wealth might be accomplished by taxing the rich and giving to the poor in the
form of more government allowance).
Government policy: government can influence consumption levels through
taxation and/or public spending.
The development of major new products : when such development happen,
they can create a significant increase in spending by consumers who want to
buy the goods or services.
Interest rates: changes in interest rates will influence the amount of income
that households decide to save, and also the amount that they might elect to
borrow for spending. High interest rates will make savings more attractive.
Conversely, low interest rates will reduce the cost of credit and will therefore
increase levels of consumption.
Price expectations: expectations of price increases may increase current
consumption while expectations of price reductions may have the opposite
effect.

SOLUTION SEVEN
(a)
(i) Direct investment flows of the balance of payments include transactions
related to the acquisition of share capital in foreign countries by establishing new
businesses, or through mergers and takeovers. The purpose of the investor must
be to gain control of the management of the enterprise in which the investment
is made. Direct investment comprises not only the initial equity transaction but
also all the subsequent transactions between the affiliated enterprises.

Portfolio investment, on the other hand, refers to the purchase of assets such
as equities or bonds where the investor is only interested in the expected
financial return on the investment. The investor is not aiming to gain control of
the management of the enterprise in which the investment is made. Portfolio
investment includes international equities and debt securities not classified as
direct.

(ii) A positive balance on the financial account of the balance of payments for
Zambia would mean that there are more financial account inflows than outflows.
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 As a result of such a position, the countrys foreign reserves build up and its
ability to pay for imports is increased significantly. In addition, the country will
enjoy a stable currency exchange.

(b)
(i)A currency devaluation occurs when the value of the currency is lowered in a
fixed exchange rate system.
A currency depreciation occurs when an exchange rate is reduced under a
floating exchange rate system.
(ii)Factors affecting an increase in export revenue :
>The price elasticity of demand for the good in export markets.
> the extent to which industry is able to respond to the rexport opportunities by
either producing more goods, or switching from domestic to export markets.
> It may also depend on the price elasticity of supply. With greater demand for
their goods, producers should be able to achieve some increase in prices(
according to the law of supply and demand),and the willingness of suppliers to
produce more would then depend on the price elasticity of supply.

(c) Demand pull inflation occurs when economic activity is high and aggregate
demand for goods and services increases faster than aggregate supply. In this
case, too much money chases too few goods. The causes of demand-pull
inflation are the result of, or accompanied by, an increase in the money supply.
Demand-pull inflation can be caused by any or a combination of the different
components of aggregate demand including:

Increased consumption spending by households. If, for example, there

is more consumer credit or it becomes cheaper due to lower interest rates,
households will have more money and they will spend.
Increased investment spending by firms. This can happen as a result of
lower interest rates or an improvement in business confidence and
profitability.
Increased government spending which may emanate from actions like
the provision of more and/or better public services and greater employment
by the state.
Increased exports earnings. When world economic conditions are
favourable and the prices of export goods rise, the domestic economy gains
more money in the system.
END OF SUGGESTED SOLUTIONS

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