STRICTLY CONFIDENTIAL

THE PUBLIC ACCOUNTS EXAMINATION COUNCIL

OF MALAWI

2009 EXAMINATIONS

ACCOUNTING TECHNICIAN PROGRAMME

PAPER TC 5: ECONOMICS

WEDNESDAY 17 JUNE 2009 TIME ALLOWED: 3 HOURS

2:00 PM - 5:00 PM

SUGGESTED SOLUTIONS
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1. (a) The market structure characteristic represented by the graph shown in the
diagram belongs to a firm in a perfect competition.

(b) The firm will be making zero profits.

All firms in the perfectly competitive industry will make zero profits in the
long run. This is due to perfect flow of information and absence of barriers to
entry, therefore, any profits made by a firm in the industry will attract several
new entrants and this will reduce individual firm‟s profits. On the other hand,
any losses will lead to exit of firms until those that remain will just break-even.

(c) As the chief economist, I would not agree with my CEO to increase the price
of the product that we produce in our company.

The demand curve for a perfectly competitive firm is perfectly elastic. This is
so because in the industry there are many producers who offer homogeneous
products, i.e., perfect substitutes. This implies that a small increase in price of
a product will lead to unprecedented decline in demand, to the extent that it
will end up not selling. In perfect competition, it is not the management but
rather the forces of demand and supply that determine the market price.

(d) The following are the four characteristics of a monopoly:

(i) There is a single supplier in the market offering a particular

product.

(ii) The supplier is the price maker.

(iii) There are barriers to entry.
(iv) There is imperfect flow of information.

(e) The following are the two market separation factors that can help a monopolist
to effectively carry out price discrimination:

(i) Geography – This works when there are separate markets in different
geographical areas, in which customers only buy products from the
firm or firms in their area and not from the outside.

(ii) Age – A firm can create a separate price structure for customers
according to their age or special characteristics, where the type of
customer is clearly identifiable.
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2. (a) Production and Costs of a firm:

(i) The law of diminishing returns states that, given the present state of
technology, as more units of a variable input factor are added to input
factors that are fixed in supply in the short run, the resulting increments
to total production will eventually and progressively decline.

(ii) Candidates are expected to state that total cost is the summation of
variable cost plus fixed cost, i.e.,
total cost = variable cost + fixed cost. They are also expected to
know that fixed costs do not vary and that
total cos t
average cos t  With this in mind then:
output

A  50
B  180
C  300
D5

(b) The six factors that may improve the efficiency of labour are:

(i) The attitudes of the individuals.

(ii) The intelligence and skills of the individuals.
(i) The attitudes of the work group to which the individual belongs.

(iv) Established work practices.

(v) The extent to which labour is able to make use of other factors
of production, notably capital.
(vi) The skill of management in getting the best out of a workforce.

(c) Transfer earnings are the reward the factor of production would receive in its
next best employment, i.e., its opportunity cost. This implies that transfer
earnings are the amount needed to keep the factor of production in its present
employment. On the other hand, economic rent describes the difference
between transfer earnings and the actual reward that a factor of production
receives for its present use; i.e., it is the surplus above transfer earnings.

(d) Small firms have certain advantages over large firms that may outweigh
economies of scale. For example:
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(i) Since they are small, they are more likely to operate in competitive
markets, in which prices will tend to be lower, and the most efficient
firms will survive at the expense of the inefficient.

(ii) Management-employee relations are more likely to be co-operative,

with direct personal contacts between managers at the top and all their
employees.

3. (a) The four factors that would determine the supply of bananas in Blantyre
include:

(i) Price of bananas. An increase in the price of bananas, ceteris paribus,

will lead to an increase in the quantity supplied while a reduction in the
price will lead to a decrease in the quantity of bananas supplied.

(ii) Technology. An improvement in technology, such as the use of

machinery, would lead to an increase in the supply of bananas.

(iii) Environmental factors. Environmental factors, such as persistent

drought, may lead to a reduction in the supply of bananas.

(iv) Cost of production. An increase in the cost of producing bananas will

lead to a reduction in the supply of the product.

(b) The following three reasons make the banana industry imperfect to some
degree:

(i) Buyers and sellers usually have incomplete information about prices
ruling in all other parts of the market. For instance, consumers in
Lilongwe may not be aware of the prices of bananas in Blantyre.

(ii) Producers can create an impression that their bananas are better than
those of their competitors, although they are really quite similar.

(iii) Customer loyalty or inertia sometimes prevents rational decisions by

consumers. For instance, some people buy certain types of bananas just
simply because they like the seller or because they are used to such
types.
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(c) The introduction of value added tax on bananas will have the following
effects:
Supply+VAT
Price

Supply
P1

Pe

Demand

Q1 Qe Output

Let us assume that initially the equilibrium price, Pe is determined by the

intersection of the demand and supply curves with Qe being the quantity
supplied. Then the introduction of value added tax will lead to a leftward shift
in the supply curve to „supply+VAT‟ curve. This is so because levying of tax on
supply is similar to increasing production cost, as such suppliers will cut on
production of the product.

From our graph, it shows that after the introduction of VAT, the equilibrium
price increases from Pe to P1 and equilibrium quantity decreases from Qe to Q1.

4. (a) Market failure:

(i) Market failure refers to a situation where a free market mechanism fails
to produce a satisfactory allocation of resources.

(ii) The six key methods that governments can apply to regulate markets
are:

 Control the means of production.

 Provide public goods.
 Provide some goods in greater quantities than there would
be if an entirely free market operated.
 Influence markets through legislation, e.g., banning dangerous
drugs.
 Redistribute wealth through tax.
 Influence market supply and demand, e.g., through price legislation.
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(b) The Malawi Energy Regulatory Authority (MERA) and fuel price regulation:

(i) An announcement by MERA to set a price ceiling of petrol at MK200

will have the following effect on demand and supply:

Price Supply

MK200 Price Ceiling

Demand

Q1 Q0 Q2 Output

Price ceiling is the maximum price that the government allows

suppliers to charge their customers. It is usually used to protect
consumers hence it is set below the equilibrium price. Therefore, from
our graph, given that the equilibrium point is E, then price ceiling
should be below that point as indicated.
The effect of a price ceiling on fuel is that there will be an increase in
the quantity demanded for fuel from Q0 to Q2 due to a reduction in the
price; while on the other hand there will be a reduction in the quantity
supplied from Q0 to Q1. This will lead to an excess demand (shortage of
fuel) given by Q2-Q1.

(ii) I would agree with the student studying economics in Salima that,
Filling Stations in Malawi fall under monopolistic competition.

This is so because in monopolistic competition, firms sell similar

products which have basically been differentiated. This can be done
through different packaging, different geographical locations and
different technical characteristics. This is true with Filling Stations.
They basically sell the same but differentiated products, i.e., petroleum.

SECTION B

5. (a) The four functions of taxation are:

(i) To raise revenue for the government. Mk

(ii) To discourage certain activities regarded as undesirable.
(ii) To distribute wealth.
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(iii) To protect industries from foreign competition.

Note to markers: Other points can be considered

(b) (i) Progressive income tax takes a higher proportion of income in tax
as income rises.

(ii) The three advantages of progressive income tax are:

 The tax is levied according to the ability of an individual to pay.

 Progressive tax enables a government to redistribute wealth from

the rich to the poor.
 It helps to counterbalance regressive tax, such as indirect
taxes, and this makes the tax system as a whole more fair.

Three disadvantages of progressive tax are:

 Higher income taxes on extra earnings will deter individuals
from working harder since the money advantages would not
justify the effort.
 Entrepreneurs may be reluctant to develop new companies since
the after-tax profits would not be worth the risks involved in
undertaking new investments.
 Many skilled workers might leave the country and look for
employment in countries where they can earn more money.

(c) (i) “National debt” is the amount of debt owed by the central
government of a country to its various creditors. These creditors
may be nationals or foreigners.

(ii) Three advantages that may accrue to Malawi if it were to reduce its
outstanding national debt are:

 The government‟s budgetary position would improve due to

reduced costs of debt servicing because of the reduced volume of
national debt.
 If the government reduces or ceases to borrow from the financial
markets, the demand for loanable funds in the economy will
decline and this could lower interest rates. This may encourage
private investment in the economy to the extent that investment is
sensitive to interest rates.
 The government‟s improved financial position would now allow
the government to reduce the burden of taxation in the economy,
and lower taxes might spur initiative, hard work and enterprise in
the economy.
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6. (a) A country is said to have absolute advantage in the production of a good

if it is more efficient than another country in the production of that good,
i.e., it can produce more of a particular good with the same given amount of
resources than another country.

(b)
Cashew nuts Maize
Malawi 6 9
Mozambique 5 8

It is important to note that given products x and y then opportunity cost of x is

equal to resource requirement for x divided by resource requirement for y.
Therefore:

(i) For Malawi, the opportunity cost of producing maize with respect to
9
cashew nuts equals  1.5
6

(ii) For Mozambique, the opportunity cost of producing cashew nuts with
5
respect to maize equals  0.625
8
(iii) We reproduce the table which indicates the opportunity costs in
brackets:

Cashew nuts Maize

Malawi 6 (0.666) 9 (1.5)
Mozambique 5 (0.625) 8 (1.6)

From the table above it can be noted that Malawi has lower opportunity
cost than Mozambique when it comes to maize production, while
Mozambique has a lower opportunity cost than Malawi when it comes
to production of cashew nuts. As such Malawi should produce maize
and trade it with Mozambique.

(c) The four arguments in favour of protectionism are:

(i) Protectionist measures can be taken against imports of cheap goods that
compete with higher-priced domestically produced goods, and so
preserve output and employment in domestic industries.
(iii) Protectionism might be necessary to counter dumping or surplus
production by other countries at an economically low price.
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(iv) Protectionism, especially in the short-run may be necessary to protect a

country‟s infant industries that have not yet developed to the size where
they can compete at international markets.
(iv) Protectionism can be used as a means for a country to reduce its
balance of trade deficit, by imposing tariffs or quotas on imports.

(b) The four disadvantages of barter trade are:

(i) It is cumbersome.
(ii) It might be difficult to find a prospective customer who has a product
for sale that one is looking for and is also interested in the good on sale
(coincidence of wants).
(iii) There might be problems of divisibility.
(iv) There are likely to be problems of transferability.

7. (a) The four functions of the Reserve Bank of Malawi are:

(i) It acts as a banker to the central government and holds the public
deposits.
(ii) It is the central note-issuing authority in Malawi.
(iii) It acts as the manager of national debt.
(iv) It acts as advisor to the government on monetary economic
policy.

(b) The following are the three problems that the government can face
regarding direct control over bank lending:

(i) It is difficult to enforce the controls. Financial institutions might try to

„bend‟ or avoid the rules in order to continue lending.

(ii) Government restrictions on lending may destroy the development of a

strong capital market, given the recent liberalization of the capital
markets around the world.
(iii) Restriction on certain forms of lending, e.g., investment loans to small
companies or mortgage lending to house buyers could have harmful
economic and social consequences.

(c) The following are the four functions of money: Money acts as:

(i) A medium of exchange.

(ii) A unit of account.
(iii) A standard of deferred payment.
(vi) A store of value.
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(d) Three approaches that can be used in controlling the growth of money supply
are:

(i) By reducing or controlling the size of public borrowing.

(ii) By controlling or managing the commercial banks‟ lending.
(iii) By controlling external and foreign currency items. For instance, this
can be achieved by keeping the balance of payment under control.

8. (a) A Free-floating exchange rate is the form of exchange rate left to the free
play of market forces and there is no official financing at all. There is no need
for government to hold any official reserves, because it will not want to use
them. This is however, theoretical.

A rigidly fixed exchange rate system means that the government of every
country in the international monetary system must use its official reserves to
create an exact match between supply and demand for its currency in the
foreign exchange market, in order to keep the exchange rate unchanged. Using
the official reserves will therefore cancel out a surplus or deficit on the current
account and non-official capital transactions in their balance of payment.

(b) The four factors that tend to influence exchange rates include:

(i) Natural resources of the country. A country that is rich in natural

resources should benefit not only from a net surplus on its current
account but also from long term capital investment from overseas
investors. Such a country‟s currency should therefore be strong in
the foreign exchange market.

(ii) The political stability of a country. A country with stable political

or economic status is likely to have strong investment hence strong
currency.

(iv) Government policies. Some government policies such as exchange

controls and import controls tend to weaken a country‟s currency.

(iv) Speculation by traders. When a currency is expected to depreciate,

debtors who owe money in that currency will pay their debts more
slowly while those who owe in a currency that is expected to
appreciate will pay more quickly. These „leads‟ and „lags‟ add to
the speculative pressure on currencies by altering supply and
demand. .

(c) (i) Under the auspices of the central bank, devaluation lowers the
external value of a country‟s currency while revaluation raises
the external value of the currency against all other currencies
that are part of the fixed exchange rate regime.
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(ii) Depreciation lowers the external value of a country‟s currency

while appreciation raises the external value of a country‟s currency
against other currencies under floating exchange rate system.

(d) The two adverse economic effects from depreciation of the Malawi
Kwacha are:

(i) It tends to be inflationary. Depreciation of the Kwacha makes

imports become more expensive (since the price elasticity of
demand for imports is generally inelastic) leading to imported cost-
push inflation.

(ii) It worsens the BOP deficit. Since our price elasticity of demand to
import, particularly of raw materials, is inelastic, while our export
base is negligible, depreciation tends to worsen the BOP deficit as
we continue to import more at higher prices and export less at
lower prices.

9. (a) Inflation is a general and persistent upward movement in the level of

prices. It is the process in which the price level is rising and money is
losing value.
(b) Demand-pull inflation occurs when the economy is buoyant and there is
high aggregate demand that is in excess of the economy‟s ability to
supply. This pulls up prices to a situation where there is too much money
chasing too few goods. One way in which demand-pull inflation occurs is
when there is an increase in credit lending by banks. Borrowers use their
loans to spend more and there is an increase in the money supply as the
money lent by banks finds its way back into the banks as customers‟
deposits.

Import cost-push inflation occurs where the costs of essential imports rise
regardless of whether or not they are in short supply. The most common
example is with the oil price rises of the 1970s and 2008. In addition, a fall
in the value of a country‟s currency will have import cost-posh effects
since a weakening currency increases the price of imports.

(c) If interest rates are high enough, there should eventually be a reduction in
the rate of growth in consumer spending leading to reduction in inflation.
This situation would occur in the following three ways:

(i) People who borrow must pay more in interest out of their income.
This will leave them with less income, after paying the interest, to
spend on other things.
(ii) High interest rates would encourage more saving, with individuals
therefore spending less of their income on consumption.
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(iii) High interest rates will tend to depress the values of non-monetary
assets, such as houses, and the reduction in people‟s perceived
wealth may make people feel „poorer‟ and consequently reduce the
amounts they spend on consumer goods.

(d) The four undesirable consequences of inflation are:

(i) Redistribution effects. Different income groups are likely to be

affected differently; for instance, those on fixed incomes will have
their purchasing power reduced.

(i) The effect on the balance of payments. High inflation may make
exports less competitive and depending upon the price elasticity of
demand, the effect could be a deficit on the balance of payments.

(ii) Uncertainty of the value of money and prices. If the rate of

inflation is imperfectly anticipated, no one has certain knowledge
of the true rate of inflation. As a result no one has certain
knowledge of the value of money or the real meaning of prices.

(iv) Resource costs of changing prices. In times of high inflation,

substantial labour time is spent on planning and implementing
price changes. Customers may also have to spend more time
making price comparisons if they seek to buy from the lowest cost
source.

END