Free Economics Revision questions and answers-CPA Foundation

A socialist economy is a system in which the means of production, distribution, and exchange are owned or regulated by the community as a whole, usually through the state.
The key features of a socialist economic system:
i.Collective Ownership: Unlike capitalism, where private individuals or corporations own the means of production (factories, land, etc.), in socialism, the state, communities, or cooperatives typically own these resources. This means the profits generated from industries benefit society as a whole, rather than private owners.
ii. Central Planning or Regulation: In many forms of socialism, a central authority (often the government) plays a significant role in planning the economy, deciding what goods and services are produced, and how resources are distributed. This contrasts with market-based economies, where supply and demand largely determine these factors.
iii. Wealth Redistribution: Socialist economies aim to reduce income inequality by redistributing wealth through taxation, public services (like healthcare, education, and housing), and social welfare programs. The idea is to ensure that everyone has access to necessities, regardless of their economic position.
iv. Emphasis on Public Welfare: The focus is on meeting the basic needs of all citizens, such as healthcare, education, and housing. The goal is to eliminate poverty, improve living standards, and provide universal access to services.
v. Worker Control: In some socialist systems, there is an emphasis on worker control of industries and decision-making. This can take the form of worker cooperatives, where employees collectively manage the enterprise, or workers have a significant say in how businesses are run.
vi. No or Limited Private Property: Private ownership of land, factories, or major industries is either limited or nonexistent in a purely socialist system. This is intended to ensure that economic power is not concentrated in the hands of a few individuals or corporations.

According to the law of demand, buyers will demand less of an economic good at higher prices and more at lower prices, all else being equal.
According to the law of supply, suppliers will supply more of an economic good at higher prices and less at lower prices, all else being equal.

In economics, demand refers to the quantity of a good or service that consumers are willing and able to purchase at various prices over a given period. There are several types of demand that economists use to analyze different situations:

i. Individual Demand: This refers to the demand for a good or service by an individual consumer. It shows how much of a good or service an individual is willing to buy at different prices.
ii. Market Demand: This is the total demand for a good or service in a market, which is the sum of all individual demands at different price levels.
iii. Elastic Demand: When the quantity demanded of a good changes significantly in response to a price change, it is said to have elastic demand. A small change in price leads to a large change in quantity demanded( e.g., Luxury goods).
iv. Inelastic Demand: In this case, the quantity demanded does not change significantly when the price changes (e.g., basic food items or medications).
v. Perfectly Elastic Demand: This occurs when the demand for a good is extremely responsive to price changes. If the price increases even slightly, the demand drops to zero. This is a theoretical concept.
vi. Perfectly Inelastic Demand: This refers to a situation where the quantity demanded remains constant, no matter the price. Essential goods, like life-saving medication, can sometimes have perfectly inelastic demand.
vii. Joint Demand: Joint demand refers to products that are used together, where the demand for one product is directly linked to the demand for another. For example, printers and ink cartridges, or cars and fuel.
viii. Composite Demand: This occurs when a good is demanded for more than one purpose. For example, oil may be demanded for fuel, as a raw material for chemicals, and for heating.
ix. Derived Demand: This is demand for a factor of production or a good that arises from the demand for another good or service. For instance, the demand for labor in a factory is derived from the demand for the products that the factory produces.
x. Seasonal Demand: Some goods or services experience changes in demand depending on the season, such as holiday decorations, winter clothing, or summer vacations.
xi. Latent Demand: This refers to demand that exists but has not yet been realized or expressed in the market. It represents potential demand that could occur if certain conditions change (e.g., technological advances, changes in consumer preferences).

a) = Price= KES 200
b) = Quantity =6000 liters

A Giffen good is a type of inferior good for which an increase in price leads to an increase in demand, contrary to typical demand curves. This happens because the income effect outweighs the substitution effect. When the price of a Giffen good rises, it reduces the consumer's real income, and they end up buying more of the Giffen good because they can no longer afford to buy more expensive alternatives.
So, the demand for a Giffen good increases even as its price rises. This is a rare and counterintuitive phenomenon in economics.

If the price of one product rises, consumers may switch to a similar, cheaper alternative (the substitute good). This leads to an increase in demand for the substitute when the price of the original product goes up.

The marginal cost (MC) curve intersects the average cost (AC) curve at the lowest point of the average cost curve because of the way costs behave as output changes. This is because:
i. Average Cost (AC) is the total cost divided by the quantity of output. It reflects the per-unit cost of producing each item, on average.
ii. Marginal Cost (MC) is the additional cost of producing one more unit of output. It reflects the change in total cost when output increases by one unit.
Therefore:
• When MC is less than AC, the cost of producing one more unit is less than the average cost of the previous units. This causes the average cost to fall because the cost of the additional unit is pulling the average down.
• When MC is greater than AC, the cost of producing one more unit is greater than the average cost of previous units. This causes the average cost to rise because the additional unit is more expensive than the average of earlier units, thus pushing the average up.
• When MC equals AC, the average cost is at its minimum. This is because the marginal cost has just enough influence to stop either decreasing or increasing the average. At this point, the cost per unit is at its lowest.
Thus, the MC curve intersects the AC curve at the lowest point of the AC curve, because that's the point where MC exactly matches AC, neither pulling it up nor pushing it down anymore.

In an oligopoly market, there are a few dominant firms, and they are interdependent. If one firm increases its prices, the other firms may follow suit to avoid losing market share or profits. This is because each firm is highly aware of the actions of its competitors, and the decisions made by one firm can affect the entire market. However, this behavior can vary depending on the specific market and the nature of competition.

i. Less inequality: The government controls the means of production and determines who works where and for how much pay.

ii. Low unemployment levels: Command economy can set wages and job openings to create unemployment rate and wage distribution that it sees fit.

iii. Common good: A command economy government tailors the products for the benefit of the common good without regard for profits and losses.

iv. It is more efficient.

When actual output is greater than potential output, the economy is "overheating," meaning resources (like labor and capital) are being used beyond their optimal capacity, creating excess demand. This often leads to inflation because businesses struggle to meet demand, driving up prices. So, the inflationary gap occurs when:
• Actual Output > Potential Output
• There is too much demand in the economy compared to its capacity to produce goods and services.

Several factors can contribute to the high cost of living in developing countries. These causes often interact and compound each other, making it more challenging for people to afford basic goods and services. Some key causes include:
i. Inflation: A general rise in prices for goods and services, often driven by inflationary pressures, can increase the cost of living. Inflation in developing countries may be caused by factors such as an increase in demand for goods and services, currency devaluation, or supply chain disruptions.
ii. Currency Depreciation: When a country's currency loses value relative to other currencies, the cost of importing goods rises. Since many developing countries rely on imports for essential goods (such as fuel, food, and raw materials), currency depreciation can make these goods more expensive, thereby driving up the cost of living.
iii. Dependence on Imports: Developing countries often depend on imported goods, including food, fuel, machinery, and consumer goods. When global prices for these imports rise, developing countries experience higher costs. In particular, a lack of domestic production capacity or infrastructure can make a country highly vulnerable to external price fluctuations.
iv. Limited Production Capacity: Many developing countries face challenges in scaling up domestic production, which can lead to a reliance on imports. Limited industrialization or insufficient agricultural capacity can result in higher prices for locally-produced goods due to scarcity, driving up living costs.
v. High Transportation Costs: Poor infrastructure, inadequate roads, and an inefficient transportation network can drive up the cost of moving goods from one place to another. Transportation inefficiencies increase the cost of getting goods to consumers, which ultimately contributes to higher prices in the market.
vi. Energy Costs: Energy costs, particularly for electricity and fuel, can be a significant part of the cost of living. In many developing countries, energy production and distribution are inefficient, or the country may rely heavily on imported energy sources like oil. As energy prices rise globally, developing countries face higher utility bills, affecting both businesses and consumers.
vii. Market Monopolies and Cartels: In some developing countries, a few large companies or cartels may dominate key industries such as food, transportation, or telecommunications. These monopolies can manipulate prices, reduce competition, and create artificially high costs for consumers.
viii. Urbanization and Housing Shortages: Rapid urbanization without corresponding infrastructure development can lead to housing shortages, which push up rent and property prices. As more people move to urban areas in search of better employment opportunities, demand for housing rises, leading to higher living costs.
ix. Political Instability and Conflict: Political instability, corruption, or ongoing conflicts can disrupt markets, discourage investment, and create supply shortages. This can result in higher costs for goods and services, especially for basic needs like food, water, and healthcare.
x. High Taxes and Import Tariffs: Some developing countries impose high taxes or import duties on essential goods, which raises the price of these items. Tariffs on imports, particularly on food and fuel, can directly affect the affordability of daily necessities.
xi. Inadequate Social Services: When governments fail to provide adequate public services like healthcare, education, and transportation, citizens must pay out-of-pocket for these services, increasing their overall cost of living. Private alternatives to these services may be expensive or of poor quality, forcing families to spend more.
xii. Income Inequality: In many developing countries, income inequality is significant. A large gap between the rich and poor means that those in lower-income brackets may struggle with the rising costs of goods and services. Inequality can also drive inflationary pressures as the wealthy demand more luxury goods, driving up prices for everyone.
xiii. Debt and Economic Policies: High levels of national debt can lead to austerity measures and reductions in government spending, which can result in higher costs for public services or an increase in indirect taxes. Furthermore, economic policies like tight monetary policies aimed at controlling inflation can sometimes have unintended effects on living costs.
xiv. Lack of Competition and Inefficiencies: In many developing countries, the private sector may be underdeveloped or lack competition. This leads to inefficiency and higher prices in sectors such as retail, healthcare, and transportation.

An inflationary gap occurs when the actual (current) GDP exceeds the potential GDP of an economy. This means the economy is producing beyond its sustainable capacity, often leading to upward pressure on prices (inflation).

Increasing marginal revenue typically does not indicate that the company is producing too little relative to consumer demand. In fact, marginal revenue generally decreases as production increases in a monopolistic market, due to the price reduction needed to sell additional units.
If marginal revenue is increasing, this is unusual in typical monopoly behavior and might suggest that the firm is experiencing some form of pricing or output inefficiency. Usually, a firm producing too little relative to demand would see decreasing marginal revenue, not increasing. Hence, if marginal revenue is increasing, it's not necessarily a sign of profit opportunities by expanding production.

A currency’s value is primarily determined by the market forces of demand and supply in the foreign exchange market. Factors influencing this include interest rates, inflation, economic stability, and investor sentiment.

Thus, KCB will provide loans and advances to its customers worth kes 285,714/=. When the bank lends kes 284,714/= to a borrower, she/he might take this amount and deposit in another bank, with the result that this amount becomes demand deposit for that bank and liable to LRR changes again.

A free market system is characterized by several key features that define how goods and services are exchanged with minimal government intervention. These characteristics include:
i. Private Property: Individuals and businesses have the right to own and control property and resources. They can buy, sell, or use their property as they see fit.
ii. Voluntary Exchange: Transactions are made freely between buyers and sellers based on mutual agreement. Both parties enter into exchanges because they believe it benefits them.
iii. Competition: Multiple businesses and individuals compete with each other to provide goods and services. This encourages innovation, efficiency, and lower prices.
iv. Profit Motive: Individuals and businesses are driven by the desire to make a profit. The pursuit of profit incentivizes them to produce goods and services that are in demand.
v. Consumer Sovereignty: Consumers have the power to influence what is produced in the market based on their purchasing choices. The demand for goods and services dictates what businesses produce.
vi. Minimal Government Intervention: The government plays a limited role, mainly enforcing laws and contracts. There are no significant regulations on prices, production, or distribution, allowing market forces (supply and demand) to dictate outcomes.
vii. Supply and Demand: Prices and the quantity of goods and services are determined by the forces of supply and demand. When demand increases, prices tend to rise, and when supply exceeds demand, prices may fall.
viii. Flexibility and Innovation: The free market encourages new ideas and innovations. Businesses are free to enter new markets, adapt to changing consumer preferences, and develop new products.

The cardinal approach in the theory of consumer behavior, which assumes that utility can be measured in absolute terms, has several limitations.
i. Assumption of measurable utility: The cardinal approach assumes that utility can be quantified and expressed in numerical terms (e.g., utils). However, in reality, utility is a subjective and psychological concept, making it difficult, if not impossible, to measure it in precise units. Consumer satisfaction is not something that can be easily quantified.
ii. Interpersonal comparison of utility: Cardinal utility assumes that the utility of one individual can be compared to that of another in a meaningful way (e.g., if one person gets 10 calories from an apple, and another person gets 8, the first person is better off). In practice, comparing the utility levels between different individuals is problematic because each person has a different scale of preferences and experiences.
iii. Constant marginal utility of money: The cardinal approach typically assumes a constant marginal utility of money, implying that each additional unit of income provides the same increase in utility. However, in reality, the marginal utility of money tends to decrease as income increases (law of diminishing marginal utility of money), and this is not always captured accurately in the cardinal utility framework.
iv. Utility is not always consistent or additive: The assumption that total utility is simply the sum of individual utilities from different goods or services may not always hold true in real life. Utility can be affected by factors like consumer preferences, the context of consumption, and psychological factors that may not be easily additive.
v. Simplification of consumer behavior: The cardinal approach simplifies consumer behavior by assuming that individuals make decisions purely based on maximizing utility in measurable terms. However, in practice, consumer choices are influenced by many other factors, such as emotions, social influences, or behavioral biases, which the cardinal approach fails to account for.
vi. Does not consider time and changing preferences: The cardinal utility model tends to focus on static consumption choices and does not adequately incorporate the fact that consumer preferences and utility can change over time due to various factors like experience, income, or changing circumstances.

The marginal cost (MC) curve always intersects the average total cost (ATC) curve at its lowest point. This is because when marginal cost is less than average total cost, the average total cost decreases. When marginal cost is greater than average total cost, the average total cost is increasing. Therefore, the point where the MC curve intersects the ATC curve is the point where ATC is at its lowest. This happens because marginal cost directly influences the average total cost as production increases.

No, this market is not in equilibrium because market equilibrium happens when the quantity demanded equals the quantity supplied at a given price (i.e., everyone who wants to buy a ticket at the current price can get one, and there are no leftover tickets or unmet demand).

In this case:
• The movie tickets sold out (supply is gone).
• There are still teenagers waiting outside who want to buy tickets (unmet demand).
• The current price isn't balancing supply and demand — demand is greater than supply.
Therefore, there is an excess demand (shortage), which signals the market is not in equilibrium.

• Avoidable costs are costs that can be eliminated if a particular decision is made, such as discontinuing a product or operation. These costs can be both direct and indirect and can be affected by the level of output.
• Unavoidable costs are costs that cannot be eliminated, regardless of the decision made. They are often fixed costs that remain the same regardless of the level of output. These can be both direct and indirect, but they are typically not affected by the level of output.

In a perfectly competitive market, economic profits are driven to zero in the long run due to the characteristics of the market and the behavior of firms within it. This can be explained by the following:
i. Perfect Competition Assumptions: Under perfect competition, there are many firms in the market that no single firm can influence the price.
• All firms sell identical products, meaning consumers can switch easily from one seller to another.
• Firms can enter or exit the market without barriers, such as high start-up costs or government regulations.
• Both buyers and sellers have complete information about prices and products.
• Firms are price takers, meaning they must accept the market price as given because they are too small to influence it.
ii. Short-Run Economic Profit: In the short run, a firm may earn positive economic profits if it can sell its product at a price higher than its average total cost (ATC). This can happen if the firm’s product is in demand and it can charge a price above its cost of production. Firms will respond to the positive profits by attracting new firms to the market. As new firms enter, the supply of the good increases, which causes the market price to fall (since more firms are offering the same product).
iii. Entry of New Firms: Because there are no barriers to entry in a perfectly competitive market, other firms are incentivized to enter when they observe existing firms making positive profits. As these new firms enter the market, the total supply of the product increases, and this leads to a decrease in the market price.
iv. Zero Economic Profit in the Long Run: As long as firms are making economic profits, the incentive for new firms to enter the market remains strong. The entry of new firms drives the market price down, and the economic profit that existing firms are earning begins to diminish. Eventually, the market price will fall to the point where price equals the average total cost (P = ATC) for every firm.
• When P = ATC, firms are making zero economic profit (they are covering their costs, but they are not making excess profits beyond what they would expect to earn in an alternative use of their resources).
• If P > ATC, firms will make positive profits, leading to entry by more firms.
• If P < ATC, firms will incur losses, leading to exit from the market.
v. Dynamic Adjustment Process: In the short run, firms can experience profits or losses. But in the long run, the ease of entry and exit ensures that economic profits will be driven to zero as the market adjusts to the point where supply and demand balance and firms only earn normal profits.

At zero economic profit, firms are still making a return, but it's just equal to the opportunity cost of their resources. This means that the firm is earning a return that is sufficient to cover all its explicit costs (e.g., wages, rent, etc.) and implicit costs (e.g., the return the owner could have earned elsewhere).
In other words, the firm isn't losing money, but it's also not earning any extra profit beyond what it could get by using its resources in the next best alternative. This is considered the normal profit level, which is the minimum profit necessary for a firm to continue its operations in the long run.

i. Nominal National Output: This refers to the total value of goods and services produced in an economy in a given period, measured using current prices (the prices at the time of measurement).Since it uses current prices, nominal national output is affected by inflation or deflation. If prices are rising, nominal output can increase even if the actual quantity of goods and services hasn't changed (e.g., if the value of goods produced in an economy increases but prices rise due to inflation, nominal GDP will show an increase even if the production level remains the same.

ii. Real National Output: This refers to the total value of goods and services produced in an economy, adjusted for changes in the price level (inflation or deflation). It reflects the actual volume of production in an economy, using constant prices from a base year. Since it adjusts for inflation, real output gives a more accurate measure of economic growth or contraction, as it shows the actual changes in the quantity of goods and services produced, not just changes in price (e.g., Real GDP would show the growth or shrinkage of the economy based on actual production, not influenced by price changes).

Climate change can contribute to a high cost of living in a developing country.
The impacts of climate change, such as extreme weather events, rising sea levels, and droughts, can disrupt agriculture, reduce food production, damage infrastructure, and lead to health crises. These disruptions often result in higher costs for basic goods, services, and rebuilding efforts, which disproportionately affect developing countries that may have fewer resources to cope with these challenges. Additionally, climate change can lead to increased migration, resource scarcity, and conflicts, which can further strain local economies and drive up living costs.

The industrial sector plays a crucial role in the economic development of developing countries. It contributes to economic growth, creates jobs, and helps reduce poverty.
i. Job Creation and Poverty Reduction
• Industrialization leads to the creation of both skilled and unskilled jobs. It provides employment opportunities in manufacturing, construction, and other industrial services, which helps reduce unemployment and poverty.
• Industrial jobs typically offer higher wages compared to jobs in agriculture, contributing to better standards of living for workers and their families.
ii. Economic Growth and Diversification
• Industrialization contributes significantly to the GDP of developing countries. The sector often has high productivity levels, leading to increased output and higher national income.
• Moving away from an over-reliance on agriculture, industrialization helps diversify the economy, making it more resilient to economic shocks such as fluctuations in commodity prices.
iii. Improved Infrastructure
• Industrialization requires infrastructure such as roads, electricity, water supply, and telecommunications. Investments in the industrial sector often lead to improvements in public infrastructure that benefit the wider economy.
• Industrial growth encourages technological advancements, innovation, and the development of new industries, fostering long-term economic sustainability.
iv. Export Promotion and Foreign Exchange Earnings
• Industries, especially in manufacturing, often produce goods for export, helping the country earn foreign exchange. This is critical for balancing trade deficits and boosting the nation's international trade position.
• Industrialization allows developing countries to become competitive in global markets by providing cheaper, quality products compared to more developed countries.
v. Technology Transfer and Skill Development
• The industrial sector facilitates the transfer of modern technologies and know-how from developed nations or multinational corporations, enhancing productivity and efficiency in the local economy.
• As industries grow, there is a demand for skilled labor. This can lead to significant improvements in education, vocational training, and the overall skill level of the workforce.
vi. Development of Local Supply Chains and Linkages
• The industrial sector has strong backward and forward linkages with other sectors, such as agriculture, services, and trade. For example, industries need raw materials (agriculture and mining) and provide products (such as machinery, fertilizers, etc.) that help boost productivity in other sectors.
• Small and medium enterprises (SMEs) often emerge to support larger industries. This creates a vibrant local business ecosystem, contributing to further economic expansion.
vii. Urbanization and Regional Development
• Industrialization often leads to urbanization as workers move from rural areas to cities in search of employment. This process can lead to the development of new urban areas, better access to public services, and improved quality of life.
• The growth of industrial hubs can spur regional development by attracting investments in infrastructure, education, and healthcare, improving living standards across the country.
viii. Improvement in Standard of Living
• As industries produce more goods, there is a higher supply of consumer products, making them more affordable and accessible to the population. This contributes to improving the standard of living for the average citizen.
• Industrialization can lead to better healthcare and social services as a consequence of increased tax revenues and better infrastructure.
ix. Environmental and Social Challenges: While the industrial sector plays an essential role in economic development, it also poses environmental challenges, such as pollution, resource depletion, and deforestation. Developing countries must balance industrialization with sustainable practices and environmental protection.

The concept of the "double coincidence of wants" refers to the situation where two parties each have something the other wants, and they can trade it directly without needing a medium of exchange (like money). In this case, Alice wants her car repaired, and Michael wants computer software upgrades. Since both individuals have what the other wants, their double coincidence of wants is satisfied.