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CHARTERED ACCOUNTANTS EXAMINATIONS

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TECHNICIAN LEVEL
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T4: BUSINESS ECONOMICS
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MONDAY 14 DECEMBER 2015
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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.

Cell Phones are NOT allowed in the Examination Room.

6.

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.

7.

All workings must be done in the answer booklet.

8.

Present legible and tidy work.

9.

Graph paper (if required) is provided at the end of the answer booklet.

SECTION A: MICRO ECONOMICS


Answer any TWO (2) questions from this section
QUESTION ONE
(a)

Explain any four (4) factors that affect elasticity of demand for a good.

(8 marks)

(b)

Outline any four (4) problems associated with state ownership of the means of
production in an economy like Zambia
(8 marks)

(c)

State any three (3) advantages and any three (3) disadvantages of a limited
company as a legal form of a business organisation.
(6 marks)

(d)

Define the term Production Possibilities Frontier/Curve

(3 marks)
[Total: 25 Marks]

QUESTION TWO
(a)

Describe any five (5) main features of monopolistic competition.

(10 marks)

(b)

Explain whether the government regulation is required under a monopolistic


competition.
(5 marks)

(c)

Explain whether a monopolistic firm can make above normal profits or economic
profits in the long run?
(6 marks)

(b)

Under what situation will a monopoly be of better service to society than a perfectly
competitive firm? Give two situations.
(4 marks)
[Total: 25 Marks]

QUESTION THREE
(a)

A manufacturing firm in Lusaka has the following price and cost structure:
Number of Units (Output)

Price (K)

Total cost (K)

0
1
2
3
4
5
6
7

120
120
120
120
120
120
120
120

80
100
140
210
280
400
600
840

(i)

Calculate for each output: (Present your answer in a tabular format)


1.
2.

Fixed cost
Marginal cost

(1 mark)
(3 marks)
2

3.
4.
5.

Total revenue
Marginal revenue
Profit

(3 marks)
(1 mark)
(3 marks)

(ii)

Under what market structure is the firm operating in? Explain.

(4 marks)

(iii)

How many units should the firm sell in order to maximise profits and what is
the maximum achievable profit?
(4 marks)

(b)

Define the Law of Diminishing Marginal Returns.

(2 marks)

(c)

Using a clear example, explain why this Law is important in economics.

(4 marks)

[Total: 25 Marks]
SECTION B: MACRO ECONOMICS
Answer any TWO (2) questions from this section
QUESTION FOUR
(a)

Explain the term Gross National Product.

(b)

Describe three (3) weaknesses of using Gross National Product as a measure of


economic welfare in a country.
(6 marks)

(c)

The following figures (in Thousands of Kwacha) represent national income accounts
for country X.
Consumer Expenditure
Taxes on Expenditure
Import and property income paid abroad
Public authorities expenditure
Exports and property income from abroad
Capital consumption
Gross domestic fixed capital formation
Value of physical increase in stocks
Subsidies

(3 marks)

K 000
140
40
60
40
40
50
40
30
30

Required:
Compute the following:
(i)

Gross Domestic Expenditure at market price

(4 marks)

(ii)

Gross National Product at factor cost

(4 marks)

(iii)

Net National Income

(4 marks)

(d)

Outline four (4) uses of National Income Statistics

(4 marks)
[Total: 25 marks]

QUESTION FIVE
(a)

The Kwacha has for the first time been not stable. Holding other things constant,
explain the effects of a strong kwacha on:
(i)
(ii)

Zambian Second-hand car importers from Japan


Zambian copper exports to China

(5 marks)
(5 marks)

(i)
(ii)

State four (4) causes of demand-pull inflation


(4 marks)
Define the consumer price index and explain how it is used to measure
inflation.
(5 marks)

(b)

(c)

Briefly explain any three (3) functions of the Bank of Zambia.

(6 marks)

QUESTION SIX
(a)

Define the term financial intermediation.

(2 marks)

(b)

Give at least five (5) examples of financial intermediaries in Zambia.

(5 marks)

(c)

Distinguish between managed flexibility and freely floating exchange rate systems.
(5 marks)

(d)

State and explain any four (4) functions of taxation in Zambia.

(e)

Distinguish between injections and withdrawals in the circular flow of income


model.
(5 marks)

(8 marks)

[Total: 25 marks]
QUESTION SEVEN
(a)

The following table gives data for two countries namely China and Nigeria with
regard to the production of two products clothing and oil.
Country

Clothing (Tonnes)

China
Nigeria

500
250

(i)

Oil (Barrels)
50
20

What is meant by absolute advantage?

(2 marks)

(ii)

(iii)

(b)

According to the data in the above table, in which product does each country
(that is, China and Nigeria) have an absolute advantage. Justify your answer.
(2 marks)
What is meant by comparative advantage?
(2 marks)

(iv)

According to the data in the table given above, in which product does each
country have a comparative advantage? Show your calculations. (4 marks)

(v)

Would trade between China and Nigeria be beneficial to both countries?


Explain.
(3 marks)

(vi)

If one of the two countries had a continuous balance of payments deficit,


state any three (3) measures it could take to correct and finance the deficit.
(6 marks)

Explain the three (3) key objectives of commercial banks

(6 marks)
[Total: 25 Marks]

END OF PAPER

T4: BUSINESS ECONOMICS


SUGGESTED SOLUTIONS
DECEMBER 2015 EXAMINATIONS
SOLUTION ONE
a) The concept of elasticity of demand, which measures how responsive buyers are to a
change in price.
Formula: |PED| = Percentage change in quantity demanded/Percentage change in
price
The factors that affect elasticity of demand for any product are:
Substitutability: A product with close substitutes has high elasticity
compared to a product without close substitute.
Necessities versus Luxuries: A necessity is a good consumed to
sustain life while a luxury is a good which makes life easier and
enjoyable.
Percentage of income: Small items in expenditure such as a box of
matches tend to have inelastic demand compared to large items.
Time Horizon: In the short run demand is inelastic while in the long
run it is elastic as buyers can have many options to choose from.
Habit: goods which are habit-forming tend to be inelastic, because the
consumer needs the goods despite their increase in price. This pattern
can be seen with addictive products such as cigarettes
Competitor Pricing: if the response of competitors to a price increase
by one firm is to keep their prices unchanged, the firm raising its prices
is likely to face elastic demand for its goods at higher prices. If the
response of competitors to a reduction in price by one firm is to march
the price reduction themselves, the firm is likely to face inelastic
demand at lower prices.
b) The following are the problems of state ownership of means of production:
Less competition for consumers: Less consumer choice due to existence of
monopolies.
Political interference: Appointments are made on partisan lines rather than
professionalism
Inefficiencies and ineffectiveness: Parastatals are too bureaucratic and
wasteful.
Pricing problems: Monopolies find it easy to increase prices continually to
cover inefficiency and over-manning.
Economic viability: Many nationalised industries fail to even breakeven.

c) i) The advantages of companies are:


Limited liability: In an event of liquidation, shareholders cannot lose what
they have invested in the company.
Continuity is unaffected by death of a shareholder
More able to raise funds for expansion
ii) The disadvantages of companies are:

A lot of documentation is required to form a company


Management may be complicated giving rise to agency conflict
Dividends are taxed twice ; one as corporation tax and the other as personal income
of shareholders
For very large companies decision making is slow due to bureaucracy.
d) PPF is a curve showing the different combinations of two goods or services that can
be produced by an economy if its resources are fully utilised using current
technology.
SOLUTION TWO
a)
The features of monopolistic competition which distinguish it from other market
structures are:
There are a large number of sellers for a product, though not as large as
under perfect competition
The sellers are have a small influence on the price of the product
There is freedom of entry and exit into the industry i.e. no barriers to entry
The product is differentiated, mainly owing to location differences
The firms cannot make economic profits in the long run
The firms face a downward sloping demand curve
b) Yes, government intervention may be required. This is because there is freedom of entry
and exit in the long run, this will eliminate abnormal profits as more and more firm enter the
industry.
c)No, because monopolistic competition firm cannot make profit above normal profit or
economic profit because of the freedom of entry and exit which ensures that firms in this
market structure make only normal profits in the long run.
d)The benefits of monopoly over perfect competition include:

If monopoly is caused by economies of scale, then a society will be better


served by one firm than many.
Monopolies have huge financial resources at their disposal to engage in
research and development.

SOLUTION THREE
a) i)
Q
0
1
2
3
4
5
6
7

P
120
120
120
120
120
120
120
120

TC
80
100
140
210
280
400
600
840

FC
80
80
80
80
80
80
80
80

MC
20
40
70
70
120
200
240

TR
0
120
240
360
480
600
720
840

MR
120
120
120
120
120
120
120

PROFIT(LOSS)
(80)
20
100
150
200
200
120
0

NOTE: Fixed cost is K80 as when nothing is produced FC = TC. TR = PQ


ii) Perfect competition. This is because the price is fixed at K120 hence given and the
firm is a price taker.
iii) To maximise profits, the condition MC = MR must be satisfied. This occurs when
5 units are sold and the maximum achievable profit is K200.
b) The Law of Diminishing marginal Returns states that as more and more of a variable
factor is added to the fixed factor, the marginal product of the variable factor must
eventually decline or diminish.
c) This law is important because it helps to locate a limit to a variable factor.
Productivity cannot increase indefinitely by adding a variable factor. This is clearly
seen in agriculture. If this was not the case, then the whole world would be fed
from someones backyard garden (Paul Samuelson).
SECTION B: MACROECONOMICS
SOLUTION FOUR
a. Gross National Product (GNP) is a measure of economic activity. It consists of the
value of all the economic transactions in a country aggregated together. It may be
measured as the sum of all incomes derived from the production of goods and
services in the economy of a country, or the sum of all outputs, or the sum of all
expenditure on final products during a specific period of time (usually a year).
To this value add net property income from abroad to obtain the Gross National
income (GNP)
b. Weaknesses of GNP as a measure of economic welfare include:
i. Effect of population: unless the value of GNP are related to the population to give
us the Gross National Product per capita, it does not tell us much about the
economic welfare. The per capita income gives us what each citizen would receive
as income if the GNP was divided equally among all citizens.
ii. Income distribution: GNP does not tell us how equally or otherwise income is
distributed among the citizens.

iii. Externalities: GNP takes no account of externalities. Some important costs and
benefits never enter the GNP calculations, such as environmental pollution.
iv. Non-market products and services: products which are produced and consumed by
the producers i.e., not sold on the market are not included in the calculation of
GNP. Thus payment in kind is also left out(barter).
c.
K 000
Consumer Expenditure
140
Public authorities expenditure
40
Gross domestic fixed capital formation
40
Value of physical increase in stocks
30
GROSS DOMESTIC EXPENDITURE AT MARKET PRICES
250
Net property income paid abroad
(20)
Taxes on Expenditure
(40)
Plus: Subsidies
30
GROSS NATIONAL PRODUCT AT FACTORS COSTS
220
Less: Capital consumption
50
NET NATIONAL INCOME
170
Therefore
i.
ii.
iii.

Gross Domestic Expenditure at market prices is = K250 000


Gross National Product at factor Costs = K220 000
Net National Income is = K170 000

d. Four uses of National Income statistics:


i.
To indicate the general standards of living of the people within a country
ii. To compare the standards of living of different countries
iii. To calculate the rate at which the nations income is growing(i.e. measure rate of
growth)
iv. To assist the government in planning the economy.
SOLUTION FIVE
a) A strong kwacha will change the terms of trade. The price of imports will fall in
kwacha terms and the price of exports will rise in foreign currency terms.
i)
Demand for second-hand cars by Zambian importers will increase. This is
because the cars will become cheap in kwacha terms. For example, at an
exchange rate of $/K =7.00 an imported car costing $10 000 will cost the
Zambian importer K70 000. However, if the kwacha strengthens to K5.00 the
same car will cost the Zambian importer K50 000, representing a decrease of
K20 000. Thus, a strong kwacha encourages imports of cars and other goods
and services.
ii)
Supply of copper by Zambian exporters will fall when the kwacha
strengthens. For Zambian exporters, the Zambian copper will become less
competitive in the global market as foreigners will find our copper very

expensive in terms of their home currencies. This will reduce demand for
copper.
b)
(i)

Demand pull inflation is caused by the following:


Increase in Consumption expenditure of the household
Increase in Investment expenditure of the private firms
Increase in Government expenditure
Increase in Export revenue

(ii) The consumer price index (CPI) is an index which reflects the cost of a
representative basket of a consumer goods and services.
The basket consists of basic goods and services consumed in households and
each of them is assigned a weight according to the average spending on the
item.
The CPI is estimated by comparing the cost of one basket to that of the next
basket. It is calculated for each month and the annual figure is an average of
the 12 monthly indexes for a year.
To compute the inflation rate from year to year, the change in annual CPI
between the respective years is calculated as a percentage.
c) The following are the functions of the Bank of Zambia as provided by the two Acts of
Parliament:
Banker to the banking system
Banker to the government
Implementation of monetary policy
Fiscal agent of the government
Prudential supervision of banking and financial system
Foreign exchange supervision
SOLUTION SIX
a) Financial intermediation is the process through which funds are channelled from
surplus units to deficit units.
b) Examples of financial intermediaries include commercial banks, building Societies,
Pension Funds, Insurance Companies, Unit Trusts, Investment trusts.
c) Managed flexibility: Under this system the government will intervene in the
market to buy or sell currently in order to achieve an exchange rate target ; free
floating or flexibility is not allowed to avoid non achievement of the exchange rate
target.

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A freely floating rate system, on the other hand, is a system where the exchange
rate is determined by the market forces of demand of and supply for foreign
currencies, without any systematic government intervention.
d) The functions of taxation are (any three):
To raise revenue for the government to finance public and merit goods.
To redistribute income and wealth
To protect domestic industries from foreign competition
To put into effect automatic stabilisers in national income.
e) Injections are those activities which increase the size of the circular flow of income.
Examples are exports, investment and government expenditure. Withdrawals are
those activities which reduce the size of the circular flow of income. Examples are
imports, savings and taxation.
SOLUTION SEVEN
a)
i)

Absolute advantage occurs when a country can produce a good using fewer
resources than its trading partner.

ii)

In the above table, China has an absolute advantage in producing both goods.

iii)

A country has a comparative advantage in the good it can produce at lower


opportunity cost than its trading partner.

iv)

Thus the key to comparative advantage is the difference in opportunity costs.


Opportunity cost of Clothing in China =50/500 =0.10
Opportunity cost of Clothing in Nigeria =20/250 = 0.08
Opportunity cost of oil in China = 500/50 = 10
Opportunity cost of oil in Nigeria = 250/20 = 12.5
From the above calculations, China has a comparative advantage in oil
production as the opportunity cost of 10 is lower than 12.5 for Nigeria. Nigeria,
on the other hand, has a comparative advantage in clothing production as the
opportunity cost of 0.08 is lower than 0.10 for China.

v)

Trade would be beneficial because each country has a comparative advantage in


one product. Each country will specialise in one product and engage in a
beneficial trade with the other country.

vi)

A balance of payment deficit can be corrected by (any two):


Allowing domestic currency to depreciate which encourages exports and
discourages imports.
Restricting imports using barriers to trade
Using deflationary measures aimed at reducing aggregate demand
Raising interest rates to attract foreign exchange
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A balance of payment deficit can be financed by (any two):

Borrowing from official sources such IMF


Using the countrys reserves
Sale of overseas investments
Buying on credit
Accepting gifts

b) The objectives of a commercial bank are:


Profitability: A commercial banks profit is normally obtained from interest
charged on assets minus interest paid on liabilities. Commercial banks have to
lend for long periods and to high risk customers in order to earn high interest
rates. This entails that a bank has to hold less liquid assets.
Liquidity: This means being able to settle daily cash withdrawals from
customers and to settle accounts with other commercial banks in the clearing
system, but balances for these purposes earn no interest and are
unprofitable. This entails that a bank should hold more liquid assets.
Supplementary liquid could be raised in times of exceptional demand upon a
bank by borrowing from the inter-bank market or the central bank.
Safety or security: Commercial banks are expected to act prudently to
safeguard the interests of depositors and shareholders. This reduces
opportunities for profit lending. Banks help to make themselves secure by
ensuring formal security or collateral, in respect of most loans advanced by
them. The security of banks also requires the maintenance of a sizeable base
of capital reserves as protection against bad debts and operating losses
(capital adequacy).

END OF SOLUTIONS

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