Economics — July 2020

Question 1(a)

Highlight five reasons that may make a controlled economic system undesirable by many countries. (10 marks)

Answer

1. Limited consumer choice where planners determine the available product range.
2. Weak profit incentives for efficiency, innovation and enterprise.
3. Slow decisions caused by central bureaucracy.
4. Difficulty obtaining the information needed to allocate resources accurately.
5. Risk of shortages, surpluses and political influence over production decisions.

Question 1(b)

Explain the reasons that make perfect competition difficult to achieve in an economy. (10 marks)

Answer

1. Products are differentiated: branding, quality and service mean that buyers do not regard every seller’s output as identical.
2. Information is imperfect: consumers and producers do not know every price, quality or opportunity.
3. Entry is restricted: capital requirements, legal conditions or control of resources can limit new firms.
4. Firms differ in size: some sellers can influence the market rather than being pure price takers.
5. Factors are not perfectly mobile: skills, location and adjustment costs prevent resources moving instantly between uses.

Question 2(a)

Outline five functions of an entrepreneur as a factor of production. (10 marks)

Answer

1. Identifying business opportunities and deciding what to produce.
2. Combining land, labour and capital for production.
3. Organising and coordinating business operations.
4. Bearing business risk and uncertainty.
5. Introducing innovations in products, processes or markets.

Question 2(b)

National income statistics have been used to compare standards of living in different countries. Explain five limitations of using such statistics. (10 marks)

Answer

1. Unequal distribution: a high average income may hide poverty among much of the population.
2. Price differences: the same nominal income buys different quantities across countries, requiring purchasing-power adjustment.
3. Unrecorded production: informal and subsistence activity may be measured incompletely.
4. Quality-of-life omissions: leisure, security, health and environmental quality are not fully captured by income totals.
5. Composition and population differences: spending on defence or repairing damage may raise measured output without a matching improvement in household welfare.

Question 3(a)

Explain six measures that the government may take to control unemployment. (12 marks)

Answer

1. Support productive investment: suitable infrastructure and investment conditions encourage firms to create jobs.
2. Develop relevant skills: training and retraining help workers meet available job requirements.
3. Encourage enterprise: access to appropriate support and finance enables viable self-employment and small-business growth.
4. Improve labour-market information: job matching and mobility support reduce the time spent between jobs.
5. Use suitable demand policies: where unemployment reflects weak demand, appropriately designed spending or monetary measures can increase employment.
6. Diversify production: developing additional sectors and seasonal activities reduces dependence on a narrow range of jobs.

Question 3(b)

Explain four differences between commercial banks and non-bank financial institutions. (8 marks)

Answer

These are conventional textbook distinctions. The precise services of a particular institution depend on its authorisation and business type.

1. Commercial banks ordinarily provide general deposit and lending services; non-bank institutions are often specialised in activities such as insurance, pensions, leasing or investment.
2. Commercial banks ordinarily operate demand-deposit accounts used for general payments; many non-bank institutions do not provide such accounts.
3. Bank lending can create bank deposits within the banking system; non-bank lenders generally lend funds obtained through their own financing arrangements.
4. Commercial banks fall within banking supervision; non-bank institutions are regulated according to their particular financial activity and applicable framework.

Question 4(a)

Increasing the size of an individual firm beyond a certain scale can lead to internal diseconomies of scale. Explain four sources of such diseconomies. (8 marks)

Answer

1. Coordination difficulties: more departments and activities require additional management and can create conflicting decisions.
2. Communication delays: information passes through many layers, causing errors and slow responses.
3. Reduced worker motivation: employees may feel less recognised or involved in a very large organisation, reducing productivity.
4. Bureaucratic control costs: extra supervision, rules and administration can raise cost faster than output.

Question 4(b)

Explain six factors that may influence the wages paid to employees in an organization. (12 marks)

Answer

1. Skills and qualifications: scarce expertise can command higher remuneration.
2. Labour demand and supply: shortages of suitable workers strengthen wage pressure.
3. Productivity: workers who contribute more valuable output may receive higher pay.
4. Bargaining power: collective agreements and negotiation affect remuneration.
5. Job conditions: risk, difficulty or inconvenient hours may require compensating pay.
6. Employer capacity and market conditions: the organisation’s resources, competing wage offers and relevant wage requirements constrain its pay decisions.

Question 5(a)

The Kenyan government has in the recent past decontrolled prices of some commodities. Explain the positive effects of such price decontrol. (8 marks)

Answer

The answer explains possible positive effects; it does not establish which products or policies changed at a particular date.

1. Greater production incentive: prices that cover costs and provide returns encourage suppliers to expand output.
2. Better allocation: market prices signal scarcity and guide resources toward goods consumers demand.
3. Reduced shortages: allowing prices to adjust can bring supply and demand closer together where a binding ceiling had created excess demand.
4. Less unofficial trading: removing an unrealistic controlled price can reduce incentives for black-market sales above that ceiling.

Question 5(b)

Explain six monetary measures that may be taken to reduce inflation in a country. (12 marks)

Answer

These are textbook instruments. The instruments available and their effectiveness depend on the monetary framework and the source of inflation.

1. Raise the policy or bank rate: higher financing costs can discourage borrowing and spending.
2. Sell securities in open-market operations: taking funds from buyers can reduce banking-system liquidity.
3. Increase reserve requirements: a larger required reserve share reduces banks’ capacity to expand credit.
4. Apply appropriate selective credit restrictions: limits on particular lending can reduce excessive demand in targeted areas.
5. Require additional special deposits where available: temporarily immobilising bank funds can restrict loan expansion.
6. Use moral suasion: the monetary authority can urge banks to moderate excessive credit growth.

Question 6(a)

Explain five reasons that may account for an outward shift in the demand curve. (10 marks)

Answer

1. Higher income: for a normal good, increased purchasing power raises demand at each price.
2. More buyers: population growth or entry into new markets increases the number of potential customers.
3. Stronger preference: fashion, advertising or changed tastes make the good more desirable.
4. Changes in related prices: a dearer substitute or cheaper complement can increase demand for the good.
5. Expectations: anticipated shortages or future price rises can encourage purchases now.

Question 6(b)

Certain principles should guide public expenditure. Explain five such principles. (10 marks)

Answer

1. Maximum social benefit: spending should generate worthwhile benefits for society relative to its cost.
2. Economy: avoid waste and obtain the required results using resources efficiently.
3. Authorisation and accountability: expenditure should follow approved budgets and be supported by transparent records.
4. Equity: consider how benefits and burdens are distributed across groups and regions.
5. Financial sustainability: commitments should be consistent with available resources and a manageable long-term fiscal position.

Question 7(a)

Explain four grounds on which progressive tax may be justified. (8 marks)

Answer

1. Ability to pay: higher-income individuals can bear a larger proportionate contribution without losing essential consumption.
2. Reduced inequality: collecting proportionately more from high incomes can finance services and transfers benefiting lower-income groups.
3. Diminishing marginal utility of income: an additional unit of income is generally less valuable for essential welfare at a high income than at a low income.
4. Automatic stabilisation: tax receipts rise relatively strongly when incomes grow and fall when incomes weaken, moderating changes in disposable income and demand.

Question 7(b)

Explain six factors that determine the elasticity of supply. (12 marks)

Answer

1. Time available: producers can usually adjust capacity more easily over a longer period.
2. Spare capacity: unused machinery and labour permit a quicker increase in output.
3. Availability of inputs: readily obtainable materials and skilled labour make expansion easier.
4. Storability: existing stock of durable goods can be released quickly when prices rise.
5. Mobility of factors: resources that can be shifted between uses improve supply responsiveness.
6. Production period: goods requiring long growing or manufacturing cycles cannot expand output quickly.