Course Outline

1. Introduction to Economics
2. Demand and Supply Analysis
3. Price Determination
4. Theory of Production
5. Theory of the Firm
6. Market Structures
7. National Income
8. Money
9. Inflation
10. Banking
11. Public Finance
12. International Trade
13. Population Theories
14. Unemployment
15. Economic Growth
16. Emerging Issues & Trends
TOPIC ONE: INTRODUCTION TO ECONOMICS
Economics is the study of production and distribution of goods and services. It is the human
effort to satisfy unlimited wants. It is the study of how man tries to utilize his limited (finite)
resources to meet his unlimited (infinite) needs. Economics is classified as a social science
because it deals with the study of human's life and how he lives with other humans.
Economics is subdivided into two broad subjects;
· Microeconomics
· Macroeconomics
I. Microeconomics-
This is the study of individual decisions made by people and businesses regarding the allocation
of resources, prices of goods and services. Microeconomics is concerned with supply, demand
and equilibrium, production theory &labour economics (taxes).
II. Macroeconomics-
It studies the behavior of a country and how their policy affects the economy as a whole. It
analyses entire industries and economies as opposed to individuals and specific conglomerates. It
is concerned with inflation, economic growth and international trade.

Definition of Economic Terms

Wants- These are desires of life. They are those items, goods or services that are necessary but
someone can do without.eg big car, palatial home and
Needs – These are the basic requirements for human survival. They are goods or services that
one can’t do without.eg food, shelter, and education.
Scarcity- It’s a situation in which goods and services are in limited supply.
Choices – Decisions that one makes when faced with scarcity.
Customer Sovereignty- It’s a situation where the preferences of a customer are dominant over 7
above what is produced in the market.
Opportunity Cost- Referred as the alternative that is foregone when you make the choice to
consume a specific good/choice. It is the opportunity lost by consuming a specific good instead
of another.
The Fundamental Economic Problem.
The economic problem, sometimes called the basic, central or fundamental economic problem, is
one of the fundamental economic theories in the operation of any economy. It asserts that there is
scarcity, or that the finite resources available are insufficient to satisfy all human wants and
needs. The problem then becomes how to determine what is to be produced and how the factors
of production (such as capital and labor) are to be allocated. Economics revolves around methods
and possibilities of solving the economic problem.
Because of limited resources and infinite demands, society needs to determine how to produce
and distribute these relatively scarce resources. It is possible humans could limit their demands
and be satisfied with the basic necessities of life. Society is mostly dominated by people wishing
to consume more goods and services than are available. Because there is a shortage of resources,
economics considers the best possible combination to produce the best satisfaction.
Economic Systems
Refers to the limited number of ways in which people around the world have set to answer the
central economic problems. In economics producers have three fundamental questions;
1. What commodities shall be produced e.g. food, cars and in What quantities,(WHAT?)
2. How the goods shall be produced (HOW?) Labour intensive or Capital Intensive?
3. For whom shall the goods be produced?(WHOM)
The Economics Systems try to answer these questions. Economic Systems include;
· Free Enterprise Economy/Price System
· Centrally Controlled System
· Mixed Economic System
A. Free Enterprise Economy/Price System
It is a system where decisions about what is produced is the outcome of millions of separate
individual decisions made by consumers, producers & owners of productive services.
Features of a free market
1. Ownership of means of production is by the public i.e. Individuals are free to own the
factors of production i.e. land, labour, entrepreneurship, capital and enjoys income from
them in form of rent, salaries/wages, profit and interest respectively.
2. Freedom of choice and enterprise- Entrepreneurs are free to invest in businesses of their
choice and produce any product of their choice.
 3. Self Interest and dominating motive- Firms aim at maximizing their profits, workers aim
at maximizing their wages/salaries, land owners aim at maximizing their returns and
consumers aim at maximizing their satisfaction/utility.
4. Competition- In a free market economy there are large numbers of buyers and sellers and
this aids competition in the market.
5. Reliance on Price Mechanism- A price mechanism is where the prices are determined in
the market by supply and demand and consumers base their expenditure plans on market
prices.
6. Limited Role of the Government- The government plays a very limited role in a free
market economy.
Advantages of a Free Market Economy
i. Incentive – People are encouraged to work hard because opportunities exist for
individuals to accumulate high levels of wealth.
ii. Choice – People are spending their money how they want. They can choose to set up
their own firms or they can choose whom they want to work for.
iii. Competition – Through this less efficient producers are pushed out of the market, more
efficient producers supply their own products at lower prices for customers.
iv. Flexible – A free market responds to wealth and changes in consumer wishes.
Disadvantages of the price system
i. The free market gives rise to certain inefficiencies called Market Failures. i.e. where the
market system fails to provide an optimal allocation of resources.
ii. Unequal distribution of wealth- Wealthy members of the society tends to hold most of
the resources, economic and political power while the poorer members have much less
influence.
iii. Public goods- These are the goods which provide benefits which are not confined to
individual households i.e. possess the characteristics of non-rival consumption and non-
exclusion.
iv. Externalities – Since the profit motive is all important to producers, they may ignore
social cost production e.g. pollution.
 v. Hardships – Although in theory factors of production such as labour are mobile and can
be switched from one market to another, in practice, there is the major problem of
unemployment.
B. Centrally Planned Economies
It is a system where all major economic decisions are made by a government ministry or
planning organization. Here all questions about allocation of resources are determined by the
government.
Features of Centrally Controlled Economy
i. It relies exclusively on state.
ii. The government decides what is made, how much is made, how it is made and how
distribution takes place.
iii. The resources (factors of production) are controlled by the government.
iv. Price levels are not determined by the forces of demand and supply but they are fixed by
the government.
Advantages of Centrally Planned Economy
i. Use of resources – central planning can lead to the full use of all factors of production so
reducing or ending unemployment.
ii. Large Scale production – Economies of scale become possible due to much production
taking place.
iii. Public Services – Natural monopolies e.g. Supply of domestic power or defense can be
provided efficiently through central planning.
iv. Basic Services- Emphasis is placed on providing a range of goods and services for all
population.
v. There are less dramatic differences in wealth and income distribution done in a free
market economy.
Disadvantages of a Centrally Planned Economy
i. Lack of choice – Consumers have little influence over what is produced and people may
have little to say in what they do as a career.
ii. Little incentive – Since competition between different producers is not as important as in
the free market, there is no incentive to improve the system.
 iii. Centralized control – because the state makes all decisions, there must be large
influential government departments.
C. Mixed Economies
In reality, there is no economy in the world which is entirely market or planned but all will
contain elements of both systems.
Features of Mixed Economies
i. It includes elements of both market & planned economies.
ii. The government operates and controls the public sector.
iii. The private sector is largely governed by market forces.
iv. The private sector is regulated.
Advantages of Mixed Economies
i. Necessary services are provided in a true market economy.
ii. Incentive – since there is a private sector where individuals can make a lot of money,
incentives still exist in the market.
iii. Competition – Prices of goods and services are kept down by competition.
Disadvantages of Mixed Economies
i. Large monopolies can still exist in the private sector and so competition does not really
take place.
ii. There is likely to be a lot of bureaucracy (many lines of authority – channels to be
followed) due to the existence of a public sector.
Summary Questions
1. Differentiate Macroeconomics from Microeconomics.
2. What are the features of a Mixed Economy?
3. Is Kenya a free market economy or a central economy, explain your answer?
DEMAND ANALYSIS
Demand is the quantity of a commodity which consumers are able to buy at a given price at a
given period of time. Demand refers to the quantity of goods or services bought during a time.
Factors Affecting Demand
i. Price of the commodity- the price of a commodity affects demand in that demand for the
product will be high when the prices are low while the demand will be low when prices
are high.
ii. Tastes and preferences- when a change in the flavour of a in demand is high more people
will prefer to buy the products.
iii. Level of income- when the level of income is high the demand of goods and services is
also high and when the level of income is low the demand for goods and services is also
low.
iv. Prices of substitute commodities- the demand of a commodity may change due to
changes in price of any substitute commodity for example the price of coffee increasing
increases the demand for tea.
v. Government policy. The government may restrict the demand of a given product by
increasing its taxation rates and subsidizing substitute commodity.
vi. Economic conditions- demand of a given product will be high during the periods of
economic prosperity done during inflation
vii. Seasonal and climatic changes. During rainy Seasons demand for umbrellas is high.
viii. Changes of population. Increase in population increases the demand of products.
ix. Future expectations of price changes. Consumers buy more of a commodity when they
expect its shortage when did expect it increase in price for example fuel prices.
x. Advertisement- a successful advertising campaign for a certain good will increase the
demand for it.
Types of Demand
1 Derived demand - Type of demand which arises from the demand of another product.
2. Joint demand refers to a situation where two or more goods are needed are used or consumed
together.
3. Composite demand, is the demand of commodities used for two or more purposes.
4. Competitive demand, this is the type of demand of commodities serving the same purpose.
LAW OF DEMAND
The law of demand states that " the quantity demanded for a good or service is inversely
proportional to the price of that good or service ceteris paribus(All factors held constant)"
Assumptions of the law of demand
i. There are no change incomes of consumers.
ii. There is no change in taste and preferences of a consumer.
iii. There is no change in price of a substitute commodity.
iv. New goods are not invented.
Exemptions to the law of demand
i. The law does not apply to giffen goods because in such a case a fall in price level
demand increases.
ii. The marginal utility of any commodity tends to increase when more and more units of
that commodity are consumed in this case the law of demand won't apply.
iii. Due to ignorance about the condition off the market less is purchased at lower prices is
purchased at higher prices.
Demand Schedule and the Demand Curve
Demand schedule is a set of data which relates to the quantity of goods demanded two different
prices of the same commodity. Demand Curve is a graphical representation of the data shown in
the demand schedule
Demand Schedule
Price Quantity Demanded
20 140
40 100
60 70
80 50
100 35
120 25
Demand Curve
The Demand Curve above slopes from the left to the right downwards ; this is because of the law
of diminishing utility, one consumer will be prepared to buy more at a lower price because utility
of every excessive unit decreases as consumption proceeds.
Shifts and Movements of the Demand Curve
Movements in the Demand Curve
The movement along a demand curve occurs due to a change in price upwards or downwards as
shown below:
Check Video Graph 2.1

At price Po the quantity demanded is Qo and the demand Curve is at point A. At a higher price
P1, the quantity demanded is Q1 and therefore the resultant effect is the movement along the
demand Curve from point a to b . Suppose the price falls to P2, the quantity demanded will be
Q2 and this move the demand from point b to c.
Shift in the Demand Curve
A Shift is caused by all other determinants of demand except price. It can either be to the left or
to the right as illustrated below
Check Video Graph 2.2
A rise in the demand shifts demand curve to the right to D2D2. A fall if the demand, shifts the
demand curves from DoDo to D1D1 which is a shift to the left.
Types of elasticity of demand
Elasticity is the measure of the degree of responsiveness of the changes in quantity demanded to
a change in price. They include;
1. Price elasticity into (Ep )
Refers to the responsiveness to changes of the demand of a good or service to changes in price.
EP= proportionate change in demand
proportionate change in price
EP= Di-Do / Pi-Po Where Di-New demand Do-Old Demand
Do Po Pi- New Price Po- Old Price
Example
The price of a commodity is 500 shillings a unit and the demand for that product is 10 units . the
price of that commodity decreases to 400 shillings and demand increases to 12 units. Calculate
the price elasticity of demand.
(Note that price elasticity is always negative)
2. Income elasticity (Ei)
This is the responsiveness of the demand to a change in the income of the consumer
Ei= proportionate change in demand
proportionate change in income
EP= Di-Do / Ii-Io where Di-New demand Do-Old Demand
Do Io Ii- New Income Io- Initial Income
Example
A consumer earns $1000 and his demand for sugar is 5 units. His income increases to $1200 and
demand increases to 7 units. Calculate the income elasticity.
(Note that income elasticity is always positive)
3. Cross elasticity (Ec)
It is the ratio at which demand for any commodity changes due to a change in price of any
substitute commodity.
Ec= proportionate change in demand for commodity 1
proportionate change in price of commodity 2
Example
The price of coffee is 10 shillings per unit for tea at its own price is 10 units, price of coffee rises
from 10 shillings to 12 shillings and as a result demand for tea rises from 10 units to 15 units.
Calculate the Cross elasticity.
4. Complementary elasticity
When consumers purchase more of one product due to a fall in its price, they may purchase a
greater quantity of this commodity and of another complementary commodity. For example
when price of cars fall, the demand for cars will increase and therefore demand for petrol will
also increase. The ratio at which the demand for petrol increases due a fall in price of cars is
known as complementary elasticity.
5. Arc elasticity
This is elasticity of a specific part of a demand Curve at 2 prices and 2 levels of demand.
See "Image 2.3".

Arc Elasticity= proportionate change in quantity demanded / proportionate change in price

6. Point elasticity
This is elasticity at a specific point of a demand Curve. It is used when the demand curve is not a
straight line or when the distance between the two in the demand Curve is very small. Point
elasticity is measured by the slope of the tangent to the demand Curve at that point .
See "Image 2.3".

From Image 2.3, the point elasticity is

Point elasticity = RT/Rt
Supply Analysis
This refers to the quantity of commodity which producers are willing to produce at a given a
given period of time
Factors affecting Supply
i. Production cost- if the production cost of a product increases, its supply will decrease.
ii. Prices of substitute commodities- the price of substitute commodities when high will
result in an increased supply and when the price of substitute is low it will result in
decreased supply.
iii. Price of the product- when prices are high the producer increases the supply.
iv. Climatic situation- during rainy seasons, agricultural production will increase and as a
result of this, the supply of potatoes will increase.
v. Improvement in methods of production- better technology will increase supply of a given
commodity and vice versa.
vi. Availability of Transport and communication network- a well-developed infrastructure
facility increases the supply of a particular product.
vii. Number of producers in the market- when the producers of a similar product are many
the higher the product supply.
viii. Government policy- when restrictions are imposed by the government on the movement
of commodities the supply will fall and when the restrictions are removed by the
government the supply will increase.
ix. Rate of taxes - when taxes are high, supply is low and when taxes are low supplies is
high.

Shifts and Movements of the Supply Curve

Movement along the Supply Curve
(Check Graph 3.1)
Movement along the supply Curve is caused by changes in price alone. Initially the supply Curve
(SS) is at point a, price being at Po and quantity supplied Qo. An increase in price from Po to P1
causes movement along the supply Curve from point a to b and quantity supplied from Qo to Q1.
At a lower price P2 the quantity supplied is Q2 and the supply Curve moves from point b to c.
The movement from point B to C is called a contraction of supply and the movement from point
a to point b is called an expansion of supply.
Contraction of supply refers to the movement downwards of the supply Curve where are
expansion of supply is movement upwards the supply Curve.

Shifts of the Supply Curve

(Check Graph 3.1)
Shifts in the supply Curve are caused by all factors except price that is price remains constant
According to the Law of Supply shifts in the supply Curve can either be to the left or right as a
result of changes in any determinant of supply except price. A producer using a superior
technology may produce more efficiently and cost-effectively therefore supply more from point
Qo to Q1 and this shifts thee supply Curve from SoSo to S1S1 .
Suppose the demand for a specific commodity goes down and the producer is forced to produce
less of that commodity to avoid wastage therefore the quantity supplied of that commodity drops
from Qo to Q2 and this shift the curve to the left that is SoSo to S2S2.
A shift to the right is called a rise in supply and a shift to the left is called a fall in supply.
Elasticity of Supply
This is the responsiveness of a change in supply to change in price level of a given commodity .
It is denoted by the formula;
PES = proportionate change in supply / proportionate change in price

Supply has a direct relationship with price, when supply rises a great deal in response to an
increase in price and when due to a little change in price, supply changes a great extent we will
say that supply is more elastic .
When due to a big change in supply level, supply changes to a small extent we will say the
supply is less elastic.
Notice how the less elastic supply curve is steeper than the more elastic supply curve.
Illustration
Elasticity of supply is equal to proportionate change in supply divided by proportionate change
in price that is,
change in supply/ original supply divided by change in price/ original price i.e.
Q1-Qo divided by P1-Po
Qo Po
Where
Q1 is the new supply
Qo is the original supply
Po is the original price
P1 is the new price
Example:
The price of a textbook is 300 shillings per unit; the supply is 10 units, when the price rises to
400 shillings supply increases to 15 units. Calculate elasticity of supply.

NB: Elasticity of supply is always positive. The supply is said to be elastic when it has units
which are more than one. Supply is said to be inelastic when it has less than one unit.
Factors Affecting Elasticity of Supply
i. Nature of commodity - food commodities that can be kept for a long time without going
bad have a lesser elasticity of supply e.g. clothes, wheat.
ii. Cost of production - commodities with too high cost of production have a less elastic
supply and vice versa.
 iii. Time - goods which are produced in a short period have a greater elasticity.
iv. Method of production - commodities which can be produced with simple methods is
more elastic and vice versa.

Law of Returns
Commodities which are produced under the condition of increasing returns have a greater
elasticity of supply and commodities produced under conditions of diminishing returns have a
lesser elasticity of supply.
Importance of Elasticity of Supply
To consumers;
1. Facilitates the planning of commodity on deciding when to buy.
2. Goods which have no elastic supply need to be stocked in plenty due to price changes. ( a
decrease in price will result in a great shortage)
To suppliers;
1. Facilities in planning of production level. Goods with an elastic price of supply need to
be produced in a large-scale since a slight increase in price will result in a great increase
in quantity to be supplied.
To government;
1. Helps the government to control and regulate prices whenever supply is elastic.
2. Facilitate the decision on tax rate applicable to different commodities.

TOPIC 4: THEORY OF PRODUCTION

By the end of the topic the learner should be able to:

Specific Objectives
a) Explain the meaning of production;
b) Distinguish between the different types of utility;
c) Distinguish between direct and indirect production;
d) Describe the levels of production and occupations relating to each;
e) Discuss the factors of production and the rewards for each;
f) Explain the role of division of labour and specialization in the production process;
g) Classify goods and services produced in an economy.
Introduction
Production is the creation of goods and services or increasing their usefulness to became more
satisfying.
Utility - The ability of a good or service to satisfy human wants.
Types of utility
i.) Form utility
This is changing the form of a commodity by converting raw materials to finished goods. For
example it can be done though processing.
ii.) Time utility
This is created by storing the goods until the appropriate time to use it. For example storing food
for later use.
iii.) Place utility
This is the bridging of geographical gap between the producers and consumers through
transportation. For example transporting goods from one area to another.
iv.) Possessive utility
This is the transfer of ownership of goods from one person to another through trade.
Direct and indirect production
There are two types of production:
ü Direct production.
ü Indirect production.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Direct production/subsistence
This is production of goods and services for personal use and the products are not marketed.
Characteristics of Direct Production
ü Productivity usually on small scale
ü Usually for own consumption
ü Production is not for the market
ü Use simple method of production
ü Goods and Services are of low quantity and quality
ü Encourages individualism.
ü Leads to low standards of living.
ü Can be very tiring.
Indirect production
This is the production of goods and services with the aim of selling excess in order to acquire
what one does not produce.
Characteristics of Indirect Production
ü Production with a view of exchange.
ü The producer specializes in one or a few areas of production.
ü It results in surplus production of goods and services.
ü Goods produced are of high quality.
Level of production and Related Occupation
There are three levels of production.
a.) Primary level/extractive
This level involves extraction of goods from their natural setting.
b.) Secondary level
In this level raw materials are transformed into finished product or into more useful forms.
c.) Tertiary level
This level of production deals with provision of services and it is divided into three categories as
follows:
 Communal Service
 Direct personal services.
Level Nature Examples
Primary Extractive Lumbering , Mining , Farming

Secondary Processing, Manufacturing, Maize Milling, Coffee

Constructive processing,Oil refinery
Road&railway building

Tertiary Commercial Services Banking, Insurance, Wholesaler

Direct Personal Services Hairdressing, teaching

Factors of production
These are resources that are necessary in the production process. They are resources or agents
required in the production, without which production is not possible. They are discussed as
follows:
a.) Land
Land refers to all the natural resources. For example. Soil, mineral, rivers, lakes and climate.
Rewards for land are:
 Royalty
 Rent
 Rates
 Commission
Characteristics of land as a factor of production
 Basic factor of production.
 Supply is fixed.
 It lacks geographical mobility.
 Quality is not homogeneous.
 Productivity of land can be increased by increasing quantity and quality of capital.
 It is subjected to the law of diminishing returns.
 It is a natural resource.
b.) Labor
This is human physical or mental effort applied in production. Rewards for labor are:
 Wages.
 Salaries.
Characteristic of labor as a factor of production
 Basic factor of production.
 Cannot be stored.
 Labour cannot be separated from the laborer.
 Laborers sell their labour and themselves.
 Labour is mobile.
c.) Capital
This refers to all man – made resources used in production of goods and services. Rewards for
labour:
 Interest
Characteristic of labour as a factor of production
 Man – made hence supply is under man‟s control.
 Basic factor of production.
 It is subjected to depreciation.
 Can be improved through technology.
d.) Entrepreneurship
This is the ability to organize other factors of production in appropriate proportions for effective
production.The rewards are:
 Profit
 .Satisfaction and Meaning to life

Function of entrepreneurship
 Identifies viable business opportunity.
 Combine the other factors of production.
 Provides capital required to carry out production.
 Employs and rewards other factors of production.
 He bears all the risks and losses.
 He makes all the decisions on the business.
 He controls and manages the business.
Division of labour and specialization
Division of labour
This is where a production process is broken down into stages and each stage is assigned
to an individual OR group of individuals.
Specialization
This refers to where one concentrates in the production of what he/she can produce best leaving
other people to produce other commodities.
Advantages of division of labour and specialization
 Output per worker is greatly increased.
 Production of high quality goods and service.
 A worker can engage in a trade which she/he is best talented.
 Specialization encourages invention and innovation.
 Makes production faster and efficient.
 Enable a worker to acquire skills in a particular field.
 Division of labour saves time.
Disadvantages of division labour and specialization
 Specialization leads to monotony of work resulting to boredom.
 Hinders creativity since people work mechanically just like machines.
 Specialization make a worker depends on one trade.
 Use of machines is encouraged which creates unemployment.
 Specialization may make a country dependent on other countries.
 Many people are brought together leading to social problems such as crimes and prostitution.
Classification of goods and services produced in an economy.
Consumer goods are produced for final or direct use by the buyer. E.g. food and clothing.
Producer goods produced to be used in production of other goods. E.g. Machines.

Free Goods they are available in abundant as gifts of nature. E.g. Air.
Economic goods they are goods which are scares in supply and have money value. E.g. human
resource.
Perishable goods are those that go bad very easily unless stored in special facilities. E.g. flowers
and fruits.
Durable goods are those that will continue giving services for a long time. E.g. vehicles and
television.
Public goods are those goods that belong to no one in particular but are owned by the
government or by all collectively. E.g. roads, airports and rivers.
Private goods are owned by individuals. E.g. personal cars and private schools.
Intermediate goods are goods that are not ready for use before they are further
processed. E.g. sisal, Sugar- cane and wheat.
Finished goods are final products that come out of production in the required form. E.g.
Furniture from Timber.
Material goods are commodities that are tangible like books, chairs and vehicle.
Non –material goods are services such as teaching, nursing, entertaining.
Ways in which production activities affect environment.
i. Depletion of productive resources e.g. forests, fish in lakes, exhaustion of minerals.
ii. Degradation of environment which may lead to climate changes that may have adverse
consequences on the lives of the people.
iii. Pollution of air and water which is detrimental to both human and animal life.
iv. Problem of disposal of solid and plastic waste which may result in spread of diseases.
v. Adverse effects on the ozone layer posing a threat to the future of mankind.
For example continues depletion of ozone would lead to increased cases of skin cancer.
vi. Pollution of human habitat making it unhealthy and prone to diseases.

TOPIC FOUR: THEORY OF THE FIRM

A firm is an economic unit or business organization that combines inputs to sell or offer at a
profit.
An industry is a combination of many firms which are engaged in production of similar goods or
similar services.
Examples
KCB- Banking Industry
KIPS Technical – Education Industry
KCC, Brookside – ?
Safaricom LLC - ?
The Cost Concept
These are decisions on the cost incurred in production. Factors to be considered;
· Level of Production
· Level of technology to use
· Nature of Products
· Intended use
· Financial Stability
Decisions made by firms
1. Level of Production.
2. How production is to take place
3. How production can be improved and controlled
4. The source of funds
5. Where production is meant to be located
6. Decision on goods to produce and services to offer
TYPES OF COSTS
(i) Direct Cost
(ii) Indirect Cost
Direct Cost – These are costs that are traceable to creating or production of goods and services
within a particular production period.
Indirect Cost- Costs that cannot be traced at the end of a production period.
In order to understand the cost concept the above costs need to be broken down further to;
a. Fixed Cost
b. Variable Cost
c. Total Cost
d. Marginal Cost
e. Average Cost
Fixed Costs – These are costs that don’t vary with output i.e. always fixed. They are associated
with fixed factors of production such as rent, electricity, administrative expenses e.g. wages,
interest and loan repayment. Fixed costs are also referred to as prime/direct costs.
Variable Costs – These are costs that are directly related to the output i.e. they vary with varying
output. They include wages of labour, costs of raw materials, electricity bills, transport cost.
They are also referred to as overhead/indirect costs.
Total Costs – Represents the total sum of all costs involved in production of a given commodity.
It is the sum of fixed cost and variable cost.
TC = FC + VC
Average Costs – It is the total cost of producing any given output divided by the number of units
produced i.e. Average Cost = Total Cost/Output (No. of units produced)
AC = TC / Q
But TC = FC + VC
Therefore AC = (FC + VC) / Q
AC = FC/ Q + VC / Q
Where FC / Q is the average fixed cost and VC / Q is the average variable cost
Thus AC = AFC + AVC
i.e. AC = FC/Q + VC/Q
Marginal Cost – This is the change in total cost due to a unit change in the output.
MC = Change in Total Cost / Change in Output
MC = TC / Q

Determining the Size of a Firm

1. Volume/Level of output.
2. Size of labour force- number of employees.
3. Level of capitalization - amount of capital investment.
4. Market Share - size of output services.
5. Volume of sales.
6. Methods of production used.
7. Size of building - in terms of floor area.
Factors Limiting Growth of a Firm
1. Lack of business skills.
2. Limited market.
3. Inadequate capital.
4. Competition.
5. Willingness to take risks.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Factors considered when locating a firm

1. Source of raw material.
2. Location of market.
3. Transport links.
4. Level of security
5. Availability of auxillliary services e.g. Banking, Insurance
6. Government Policy.
7. Space for expansion.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Localization of Industries
This refers to the concentration of a particular industry in one particular area. In this case, all
factories of one type are established in one particular area, town or county e.g. most textile
factories are located in Eldoret(Kenya) and Jinja(Uganda). Main reason for localization of
industries is the availability of raw materials, labour, water, power transport and communication
facilities.
Decentralization of industries means the spreading of a particular type of industry i.e. one type of
factory ends up being established in different parts of the country e.g. if sugar factories , textile
mills are established in different parts of Kenya.
Advantages of Localization
1. Encourages the establishment of other related businesses in the area.
2. If an industry is located in an area the people specialized in that field will prefer to settle in
that area.
3. Products of some factories may be used as raw material by other factories thus reducing
production cost and transport cost.
4. The government becomes more concerned about the success of those industries.
Disadvantages of Localization
1. Congestion of people in one town.
2. Migration to a certain town will cost underdevelopment in some towns.
3. During times of war this situation may be very dangerous.
NB: The advantages of localization are the disadvantages of de-localization whereas the
disadvantages of localization are the advantages of delocalization.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Economies of Scale
These are the benefits that are derived by a firm from its increase in size and scale of operation.
It can be subdivided into 2;
i) Internal Economies
ii) External Economies

i. Internal economies of scale

These are advantages that accrue to a single firm as its production increases, independent of what
happens in the other firms in the industry. They include the following:
a.) Marketing economies - A firm that buys in large quantities is likely to get benefits such as
large trade discounts and they also incur less cost per unit in transporting the goods bought.
b.) Financial economies - A firm with strong financial base can obtain loans at a low interest
rates against their assets.
c.) Risk bearing economies - Large firms can reduce the risks involved in market failure through
diversification of products or markets. This can be done so that failure of one product is offset by
the success of the other products.
d.) Managerial economies - Large firms are able to practices division of labour which leads to
specialization hence an overall increase in the firm‟s outputs.
e.) Technical economies - These refers to benefits which accrue to a firm due to specialization of
both labour and machinery. This is because large scale firms are able to hire specialized
labour and machinery more economically than small scale firms.
f.) Research economies - Research is very important in production but it‟s always very
expensive and only firms large firms can afford to raise the needed finance to carry it out.
g.) Welfare economies - A firm is able to motivate its workers through proper recreation
facilities e.g. housing, health or education for its employees.
h.)Transport and Storage economies - the firm is able to acquire its own means of transport and
build its own storage facilities e.g. warehouses and this reduces the cost of transport.
ii) External economies of scale
These are those benefits that accrue to a firm as a result of the growth of the whole industry.
They include the following:
 Skilled labour force
 Ready market may be available from the surrounding industry.
 Easy disposal of waste products
 Improved infrastructure.
 Ready market for organizations products.
 Better government policy
 Improved research and development facilities.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Diseconomies of scale
These are problems which a firm experience due to expansion.
a.) Internal diseconomies of scale.
These are problems a firm experiences as a result of large – scale production arising from its
persistent growth. They include:
 Managerial diseconomies.- this will lead to limited interactions between managers and
workers leading to delays in decision making.
 High overhead costs. - intensity in promotional campaigns, heavy transport costs,
generous discounts lead to an increase in overhead costs of production.
b.) External diseconomies of scale

These are the demerits that a firm experience as a result of growth of the entire industry.
 Scramble for raw materials.
 Non-availability of land for expansion.
 Scramble for available labour.
 Competition for available markets.
 Easy target especially in times of war.
Reasons for the continued existence of small firms in an economy
a.) Flexibility - It is easier for small scale retailers to change from one form of business to
another location compared to large scale firms.
b.) Size of the market - If the demand for a product is not high, large scale production may not be
necessary and it's only appropriate for such a market to be served by small firms.
c.) Nature of the product - Nature of the product may make it very difficult to be produced in
large quantities, such as personalized services as painting which can only be provided by one
individual.
d.) Need to retain control - The owners of the firm may wish to keep it small in order to retain
control and independence.
e.) Simplicity of organization - Where the firm intends to take advantage of simplicity to avoid
the bureaucracy, wastage and management complexity associated with large scale organizations,
it may chose to remain small.
f.) Quick decision making - In a situation where the founders want to avoid delay in decision
making they may opt to maintain a small business as this would involve less consultations.
g.) Rising cost of production - In situations where production costs rise so fast, such that
diseconomies of scale set in very early, the firm has to remain small.
h.) Legal constraints -The law may restrict the growth of a firm hence the existing firms has to
remain small.
Implication of production activities on environmental and community health
 Air and water pollution from factories.
 Destruction of environment.
 Solid waste pollution.
 Noise pollution

TOPIC SIX: NATIONAL INCOME

By the end of the topic the learner should be able to:
a) Explain the meaning of national income;
b) Describe the circular flow of income;
c) Explain the methods of measuring national income;
d) Explain the problems encountered in measuring national income;
e) Discuss the uses of national income statistics;
f) Discuss the factors which influence the level of national income.

Introduction
National Income is the total income received by the owners of the factors of production in a
given country over a given period of time usually one year. It is the same as National output or
national product.
Terms used in national income
1. Gross Domestic product (GDP) and Net Domestic product (NDP)
GDP refers to the total monetary value of all goods and services produced in a country over a
period of one year.
Net Domestic Product is equal to gross domestic product less depreciation.
2. Gross National Product (GNP) and Net National Product (NNP)
Gross National Product measures the total monetary value of all goods and services
produced by the individuals of a given country irrespective of whether they are producing it in
their country or outside the country.
GNP = GDP + Net factor income from aboard (export less imports).
Net national product is the gross national product less value of capital used in the
production process (depreciation)
NNP = GNP - Depreciation.
3. Per capita income.
The average income per head per year in a given country.
Per capita income = National income/total population.
The Circular Flow of Income.
The movement of income from households to the firm and then back to the households is known
as the circular flow of income.
The flow money (income) round the economy is shown by the dotted lines while the flow of
goods and factor services is shown by continuous (inside) line.
Assumptions made for the circular flow of income to hold.
 There are only two sectors in the economy that is households and firms.
 Households spend all their income on goods and services produced by the firms.
 Firms spend all their revenues on factors of production provided by the household.
 There is no government intervention.
 The economy is closed, that is no foreign trade.

The assumptions do not hold because of the following

 No country can exist without dealing with other countries.
 It is difficult to have an economy where all incomes are spent on only acquisition of goods
and services without savings and investments.
 It is not possible to have an economy where the government does not take part
Injections
They are factors that increase income and expenditure in the circular flow are referred to as
injections.
 Government Spending:
When the government spends money on infrastructure projects, public services, or other
initiatives, it introduces new income into the economy. This spending stimulates demand for
goods and services, boosting economic activity.
 Investment:
Businesses invest in capital goods, such as machinery or equipment, to expand production or
improve efficiency. This investment introduces new money into the economy, stimulating
demand and increasing overall output.
 Exports:
When a country exports goods or services to other countries, it earns income in the form of
foreign currency. This income is then used to purchase goods and services within the domestic
economy, injecting money back into the circular flow.

In contrast to injections, leakages represent economic activities that remove money from the
circular flow of income. Examples of leakages include savings, taxes, and imports. These
activities reduce the amount of money available for spending within the economy, potentially
leading to a slowdown in economic activity.

Withdrawals/leakages
The factors that reduce the volume of flow are referred to as withdrawals/leakages.
Factors that affect the circular flow of income
a.) Savings
Savings by households reduce income received by firms since they have been withdrawn from
the circular flow.
b.) Government
The government affects the circular flow by either taxation which reduce the amount of income
available for spending or through government expenditure.
c.) Investment
Firms borrow money that households have saved in financial institutions such as banks and use it
to invest. The investments leads to higher income to households since the capital goods are either
hired or bought from households.
d.) Foreign trade
Through exports a country is able to earn income from other countries. The income earned from
the foreigners is an addition to the circular flow of income and hence an injection.

Equilibrium National Income

The national income equilibrium is achieved when total injections are equal to total
withdrawals (leakages).
For national income to be in equilibrium the following equation must
Savings + Taxes + Imports = Investments + Exports + Government expenditure.
S +T + M = I + X + G

Measurement of national income

National income may be measured using the following methods.
1.) Expenditure approach
The national income is arrived at by adding together the expenditure on all final goods and
services in the economy. The total expenditure is broken into the following stages:

a.) Expenditure on consumer goods by the general public (C).

b.) Expenditure on capital goods. Capital goods are also called investments denoted by letter (l).
c.) Government expenditure which may be divided into expenditure on goods and services
from firms and expenditure on factor services from households. Government is denoted by (G)
d.) Expenditure on net exports.Net exports are atotal exports less total imports.Its denoted by the
expression ( X – M ).
National income = C + I + G + ( X – M)
NOTE
Only expenditure on new goods is added in the calculation while expenditure on second hand
goods is not added as no production has taken place.
The national income arrived at using the expenditure approach is at market price because it
involves expenditure on final goods and services thereby including indirect taxes and subsidies
in order to get the national income at factor cost, subsidies are added while indirect taxes are
subtracted.

G.N.E at factor cost = C + I + G + (x – m) + (subsidies – Indirect taxes)

To get net national expenditure/national income capital consumption (depreciation) is
subtracted from Gross National Expenditure.

Thus: National income = Gross National Expenditure – Depreciation

Problems associated with the expenditure approach
i.) No accurate records of expenditure are kept especially in the private sector.
ii.) Expenditures for the subsistence sectors are only approximations due to lack of records in
the sector.
iii.) Differentiating between final expenditure and intermediate expenditure may be difficult.
iv.) Suffers from the problem of double counting.
v.) Fluctuating exchange rates may pose challenges especially in valuation of exports
and imports.
2.) Income approach
Income approach takes into account the sum of money that is received as income by different
individuals who contribute to the production of goods and services. The incomes include rent,
interest, wages and profit.
In addition public income and retained profits are included, it should be noted that transfer
payments are excluded from the final calculations of national income because they represent a
redistribution of incomes from those who have earned them to the recipients.
Such income include, national insurance and social security benefits to individuals,
student‟s grants and pocket money.
National income may be calculated as:
G.N.I = personal income + retained profit – (transfer payments + stock appreciation).
The national income arrived at using this method is at factor cost because it represents the actual
payments to the factors of production. In order to get national income at market price,indirect
taxes are added and subsidies subtracted.
Gross National income is got by adding the net income from abroad to gross Domestic product.
Thus .G.N.I = GDP + ( x – m )
To arrive at the net National income or simply National income, capital consumption
(Depreciation) is subtracted from Gross National income. Thus, N.I = G.N.I – depreciation.
Problems associated with the income approach
i.) Problem of inaccurate data
ii.) Price fluctuations make it difficult to calculate national income.
iii.) Problem of handling illegal and unrecorded yield income to recipients.
iv.) Transfer payments pose a problem
v.) Income disclosures aren‟t true because people and firms like evading tax
3.) Output approach( value added )
The national income is arrived at by adding up the values of all final goods and services
produced by firms during the year or it may be calculated by adding up the values to the product
at each stage of production.
Government contribution to the national output is also taken into an account. Such services
include education, health care and security. To find their value we get what it cost the
government to provide them.
The GDP aimed at using this method is a factor cost as it excludes subsidies and indirect taxes.
To arrive at the Gross National Product, Net Income from abroad is added to the Gross Domestic
Product
Thus, GNP = GDP + (x-m)
To get the Net National Product/National Income depreciation is subtracted from the gross
National product.
National Income = GNP – Depreciation
Problems with the output approach
I.) Problems of valuation due to unavailability/inaccuracy of output figure especially in the
private section.
II.) Problem of deciding on the goods/services to include eg. Whether the output of a house
wife should be included or not.
III.) The problem of valuing output in the subsistence sector.
IV.) Problem of frequent changing process.
V.) Problem of valuing government output since many of its services are not sold in the
market.
VI.) Problems of differentiating primary inputs from intermediate inputs.
VII.) Valuing illegal activities like drug trafficking.

National Income statistics

National income statistics refers to all the data collected or computed from various sources that
gives information about national income.
Uses of National Income Statistics
i. Use to measure rate of economic growth of a country. When output figures are high it means
productivity has improved.
ii. Helps the government to plan its economy since it provides useful information required by
planners.
iii. Used to compare the standards of living of people in a country. By comparing the per capita
figures.
iv. Help the country to know the size and contribution of various sectors to natural income hence
can take appropriate measures to improve them.
v. Shows the progress of the economy over a given period by comparing national income
statistics over given period.
Disadvantages of using National income to compare standards of living in different
countries.
a.) Different currencies
Conversation of currencies may be tedious.
b.) Different goods and services
The type of goods and services that are used to compute national income may differ from
country to country.
c.) Disparity in distribution of income
Although income per capita may be similar in both countries, standards of living may differ
considerably because of disparity in income distribution.
d.) Different needs and tastes
National income statistics may not give a true and a fair picture of standard of living due to
different in taste and needs of the people.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Factors that influence the level of national income

a.) Labour supply
A country with more labour produces more than a country with less labour and also a country
with more skilled labour force would produce high quality goods and services than a country
with less skilled labour force.
b.) Capital
A country which uses modern equipment such as tractors in ploughing, would be able to produce
more than a country using simple tools like jembes. This is because capital varies from simple
tools to modern equipment‟s.
c.) Entrepreneurship
Availability of Entrepreneurs who have the ability to organize the factors of production in correct
proportions, make their output to increase thereby increasing the national income.
d.) Availability of natural resources
The size of national income of a country depends on the natural resources endowment of that
country. Therefore a country with abundant resources is likely to have a higher national income
relative to a country without.
e.) Level of technology
If advance technology and latest equipment used in the process of production, then more goods
can lie produced, which increase the volume or size of national income.
f.) Political stability.
If there is political stability in the country, the production can be sustained at the highest level
and the size of national income will be large. In case of political condition is not good the
production will be adversely affected and so the size of national income will be small.
g.) Attitude of citizens towards work.
A country whose labour force has negative attitude towards work may register low level of
national income compared to another country where citizens are hard working.
MARKET STRUCTURE
The market is the interaction of buyers and sellers to transact business pertaining to a
particular commodity.
Types and features of a Markets.
1.) Perfect competition
A perfect competition is very rare and it has the following characterizes
a.) Large number of buyers and sellers
Buyers and sellers are so many that the separate actions of each person of them has no effect on
the market. This implies that no single buyer or seller can influence the price of the commodity.
b.) Homogeneity (uniformity) of the product.
Commodities from different producers are identical in all aspects such that one cannot
distinguish them hence there would be no advantage or disadvantage of buying from a particular
producer.
c.) Perfect knowledge of the market
Each buyer and seller has perfect knowledge about the market and therefore no one would affect
business at any price other than the equilibrium price.
d.) Freedom of entry or exit
The buyers and sellers have the freedom to enter and leave the market at will.
e.) Uniformity of buyers and sellers
All buyers and sellers are identical so there is no benefit of selling to a particular buyer or buying
from a particular seller.
f.) No government interference
The price prevailing in the market is determined strictly by the interplay of demand and supply
and there should not be any form of government intervention.
g.) No excess supply or demand
The sellers are able to sell all that they supply into the market and the buyers are able to buy all
what they require hence there are no excess supply and demand.
h.) No transport costs
In a perfect competition market, it is assumed that the buyers and sellers are located in one area
hence there is no need for transportation.

2.) Monopoly
This is a market situation where there are many buyers but only one seller called a monopolist.
Characteristics
a.) Only one supplier
There is only one supplier for the entire market hence the firm is the industry.
b.) No close substitute
The commodity supplied does not have close substitutes which may bring competition.
c.) Difficulty to enter
It is difficulty for other firms to enter into the market
d.) Fixed prices
Prices are fixed by the supplier
e.) Possibility of price discrimination
Price discrimination may be possible. This is charging different prices for the same
commodity in different markets.
Conditions necessary for price discrimination
 Consumers are in different markets making it difficult for one to go to another market.
 The cost of maintaining the separate market is not very high.
 The production of the commodity is in the hands of monopolist hence they are able to control
production.
Basis of Market separation
a.) Geographical
Goods may be sold differently in different market. The price charged in local market may be
cheaper than foreign market.
b.) Income
Consumers may be charged differently according to their income level
c.) Time
A firm may sell the same commodity at a high price during the peak period and lower the price
during the off peak period.
Sources of monopoly power
a.) Control of an important input in production.
A firm may draw its monopoly from having control of an important factor of production such as
raw material.
b.) Ownership of production rights
Monopoly can be created if a firm has the right to production or ownership of a commodity such
as patents rights, copyrights and royalties belonging only to the firm.
c.) Internal economies of scale
The existence of internal economies of scale that enables a firm to reduce its production costs to
the level that other firms cannot. This will force these firms out of business leaving creating a
monopoly
d.) Size of the market
The size of a market may be best served by one person or a firm. Addition of more than one firm
may lead to all of them incurring losses.
e.) Addition costs by other firms
If other firms have to incur additional cost to enter into the market then their products may be
less attractive due to increased price. This make the local firm to be monopolist.
f.) Where a group of firms combines to act as one
Some firms may combine/amalgamate or work together for the purpose of controlling the market
of their product. They therefore create monopoly.
g.) Restrictive practices
A firm may include price limit where a firm sells its product at a very low price to drive away
competitors, then raising the price after putting the other firms out of business creating
monopoly.
h.) Financial factors
If huge capital is required to enter into the market, it may make it very difficult for other firms to
enter into the market making the existing firm to operate as a monopoly.
3.) Monopolistic competition
A market structure that combines the aspects of perfect competition and those of a monopoly.
Characteristics
a.) Many buyers and sellers
Many buyers and sellers acting independently
b.) Variation in quality
The products vary in quality or are a close substitutes of each other.
c.) No barriers to entry or exit exists.
New firms wishing to supply the same commodity are free to do so and existing firms wishing to
leave are also free.
d.) Perfect knowledge of the market
There is perfect knowledge of the market for both sellers and buyers.
4.) Oligopoly
A market structure with few firms
Types
i.) Duopoly
Where the industry is made up of two firms.
ii.) Perfect /pure oligopoly
Where the products are identical
iii.) Imperfect/differentiated oligopoly
Where the markets have products which are close substitutes or are the same but made to appear
different.
Characteristics
 There are few firms in the market.
 Interdependence among the firms.
The Kinked Demand Curve
Once a price has been arrived at in an oligopolistic market it tends to remain stable. It follows
that a firm in oligopolistic market faces two sets of demand curves. One curve, for prices above
the determined one. Which is fairly gentle. The other curve, for prices below the determined one
which is fairly steep. This is illustrated below.

It can be noted from the above diagram that:

i.) The price that is generally charged in the industry is P. This is the point at which the price
is rigid.
ii.) The demand curve (kinked) is .
iii.) At prices above P the curve is fairly gradual and as such, an increase in price will lead to
a big loss in quantities demanded as consumers will shift to suppliers who have not raised their
prices.
iv.) At prices below P the curve is fairly steep. A reduction in price will therefore create little
additional sales as other firms are likely to reduce their prices to the same level or even lower.
It can be noted from the above diagram that:

i.) The price that is generally charged in the industry is P. This is the point at which the price
is rigid.
ii.) The demand curve (kinked) is .
iii.) At prices above P the curve is fairly gradual and as such, an increase in price will lead to
a big loss in quantities demanded as consumers will shift to suppliers who have not raised their
prices.
iv.) At prices below P the curve is fairly steep. A reduction in price will therefore create little
additional sales as other firms are likely to reduce their prices to the same level or even lower.
TOPIC 11: INTERNATIONAL TRADE
Specific Objectives
By the end of the topic the learner should be able to:
a) Explain the meaning of international trade;
b) Explain the advantages and disadvantages of international trade;
c) Discuss the terms of trade, balance of trade and balance of payments;
d) Discuss the causes of balance of payment disequilibrium;
e) Discuss the measures that may be taken to correct balance of payment disequilibrium;
f) Explain the terms of sale in international trade;
g) Describe the documents used in international trade;
h) Discuss the role of international financial institutions in international trade;
i) Describe the various forms of economic integration;
j ) Explain the importance of economic integration to a country;
k) Explain the advantages and disadvantages of free trade;
l) Explain the reasons for trade restriction;
m) Discuss the methods of trade restriction;
n) Discuss the advantages and disadvantages of trade restriction;

Introduction
A trade between two or more countries is referred to as international trade.
Classification of international trade
 Multilateral trade - A trade among many countries
 Bilateral trade - A trade between two countries
Exports - Goods and services sold by one country to another country.
Imports - Goods and services bought by a country from another country.
Advantages of international trade
a.) Exchange of goods and services
It enables a country to obtain what she does not produce through imports and exports
b.) Promotes peace
Helps in promoting peace among the trading countries
c.) Availability of cheaper goods
Enables a country to obtain goods more cheaply than it can produce them
d.) Encourages specialization
Enables a country to specialize in production of goods and services for which they have
comparative advantage in terms of resources endowment.
e.) Promotes competition
Promotes competition between imports and locally produced goods which in effect
improves the quality of goods produced.
f.) Transfers of technology
Facilitates transfers of technology from more developed countries to less developed ones thereby
accelerating development.
g.) Exploitation of resources
The wide market created by the trade enables a country to fully exploit her resources due to
wider market
h.) Morbidity of factors of production
Facilitates the mobility of factors of production such as labour and capital from one country to
another.
Disadvantages
a.) Collapse of local industries
May cause collapse of local industries as people tend to buy imported goods.
b.) Harmful and unwanted products
Can result into unwanted and harmful products such as hard drugs entering into the country.
c.) Over dependency
Results into over dependency on imported commodities especially the essential ones could lead
to a country becoming a slave of the other and this could compromise its sovereignty.
d.) Problems of supply
A country that relies on imported products may face problems of supply during times of
emergency.
e.) Imported inflation
May lead to a country experiencing imported inflation
f.) Negative effects of interaction
Through interaction, people of a given country may end up acquiring bad cultural values from
their trading partners
Play
Mute
Stream Type LIVE
Picture-in-Picture

Terms of trade
This is a relationship between what a country exports and what she imports. It is the rate at
which a country‟s export exchange against imports.
Reason for Differences in the terms of trade between countries.
a.) Nature of the commodity being exported
A country whose main export is raw materials is likely to experience unfavorable terms of trade.
While a country that exports finished products like manufactured goods is likely to experience
favorable terms of trade as the prices of manufactured goods are higher compared to unprocessed
goods.
b.) Nature of the commodity being imported
A Country that imports expensive goods such as manufactured goods may experience adverse
terms of trade while one that imports cheap raw materials may experience favorable terms of
trade.
c.) Demands for a country‟s exports
A country with increased demands for its exports is likely to experience favorable terms of trade
while if the demands reduces she may experience unfavorable terms of trade.
d.) Existing world economic order
Due to their bargain powers industrialized countries tend to dominate decision making in the
international market. International markets tends to favor products from these two countries
hence having a favorable terms of trade as a result.
e.) Total quantity supplied
If a commodity is being supplied by many countries into the world market, its supply becomes
very high reducing its price. A country relying on such products may experience unfavorable
terms of trade. While a country that relies on exportation of commodities that are in short supply
experience favorable terms of trade
Balance of Payment Accounts
It is a summary statements showing all the transactions that have taken place between a
particular country and the rest of the world over a given period of time.
Transaction may arise from
 Trade in tangible or visible goods
 Trade in invisible goods (services)
 Flow of capital into and out of the country.
Components of balance of payments accounts
It has three major components
a.) The balance of payments of current account
This is the difference between the total value of exports and imports for both invisible and visible
goods
In summary
(Visible exports -visible imports) + (Invisible exports - invisible imports) = balance of
payments on current account.
Note
The receipts are credited and payments debited in the current account. The balance of payments
on current account may be:
a) In equilibrium
The receipts are to the payments for visible and invisible goods
b) Unfavorable
The receipts are less than the payments for invisible and visible goods
c) Favorable
The receipts are more than the payments for invisible and visible goods
b.) Balance of payment on capital account
The difference between the value of capital receipts and the value of capital payments.
c.) The official settlement Account
This is the account that summarizes the financial transitions between a country‟s central bank
and other countries through the international Monetary Fund ( IMF)
Balance of Payment Disequilibrium
This occurs when there is either a credit (surplus) or a debit(deficit) balance in the balance of
payments.
Causes of Balance of payments Disequilibrium
a.) Fall of volume of export
A decline in the volume of exports may reduce export earnings causing a deficit.
b.) Deterioration in the countries terms of trade
If the value of a countries exports reduce relative to that of imports, the country may experience
disequilibrium in the balance of payments as the exports would be earning less compared to
what‟s being paid for the imports
c.) Increase in the volume of imports
When a country‟s exports remain constant but the volume of imports increases a disequilibrium
is likely to occur.
d.) Restriction by trading partners
If a trading partner decides to reduce importation, the other country may be importing more from
such partner country compared to what it is exporting to the partner.
e.) Less capital inflow compared to outflow
Where capital inflow is less than capital outflow a country may experience a deficit in capital
account and this may be reflected in the balance of payment.
f.) Over valuation of a domestic currency
An overvalued domestic currency makes the country‟s exports becomes more expensive
compared to imports and this may discourage exportation leading to disequilibrium in the
balance of payment.
g.) Devaluation by a trading partner
Devaluation encourages exports while discouraging imports. A country trading with a
country that has devalued her currency may end up importing more from and exporting less to
such a country
Correcting balance of payments Disequilibrium
The measures to be taken are as follows:
I.) Measures that would control the volume of imports
a.) Imposing or increasing import duty
By increasing or imposing import duty, imported goods becomes more expensive than locally
produced goods. This would discourage importation of goods.
b.) Quotas

By reducing the maximum amount of goods that can be imported will reduce the amount of
imports.

c.) Foreign exchange control

Importers pay for imports through foreign exchange, the amount of imports can be limited by
limiting the foreign exchange that is located to the importation of goods.

d.) Administration of bottlenecks

Government may restrict the importation of commodities by putting in place cumbersome and
complicated procedures to be followed by those who wish to import.

II.) Measures that would increase volume of Exports

a.) Export compensation scheme
Under this scheme, the exporter is allowed to claim from the government a certain percentage
of the value of the products exported. This will enable the exporter to charge less hence
increasing the demand for the product in the world market.

b.) Help given to exporters by the government departments

The government departments such as the departments of foreign affairs or trade and industry
may give useful information about the world market and also negotiate with other countries to
secure preferential treatment for their country‟s exports.

c.) Customer drawbacks

The government may refund either in full or in part the custom duty paid when importing raw
materials for the manufacture of finished products if they are exported. The refund is called draw
backs.

III.) Encouraging foreign Investment into the country.

A country may correct disequilibrium in the balance of payments by encouraging foreigners to
invest in the country. The foreigners would bring in capital to build and run factories.

IV.) Devaluation
Devaluation promotes exports while restricting imports thereby correcting disequilibrium
in the balance of payments.

Terms of sale in international trade

This is the price quotation that states the expenses that are paid for by the exporter and those that
are to be paid for by the importer.
The following are some of the common terms of sale in international trade:
Ex- works or Ex-warehouse or LOCO
Price quoted covers the goods as they are in the exporter‟s premises. The importer has to meet
the costs of moving the goods from the exporter‟s premises to their destination.
F.O.R (Free on Rail)
Price quoted includes the expenses for transporting the goods from the seller‟s warehouse up
to the nearest railway station.
D.D (Delivered Docks)
Price quoted includes expenses up to the docks. A dock is a place where ship awaits for cargo.
F.A.S (Free Alongside ship)
Price quoted includes transport expenses up to the docks as well as dock charges.
F.O.B (free on Board)
The price quoted includes the movement of goods up to when they are in the ship.
Play
Mute
Stream Type LIVE
Picture-in-Picture

C & F (Cost and Freight)

The price quoted includes the cost as well as shipping charges.
C.I.F.(Cost insurance and Freight)
The price quoted includes the cost of goods, cost of transport and insurance cover against
marine risks up to importers port of entry.
Loaded
Price quoted includes all expenses up to the port of destination as well as unloading charges.
In bond
The price quoted includes the expenses of handling the goods in the bonded warehouse.
However, storage charges and customers duties are met by the buyer
Franco (free of Expenses)
This includes the cost of goods and any other expense up to the importers premises. This means
that the importer does not incur any other expense other than the quoted price.
O.N.O (or nearest offer the quoted one.)
This means that the exporter is willing to accept the quoted price or any other nearest to the
quoted one.

Documents Used in International Trade

a.) Letter of credit
This is a document that enables an importer to get goods on credit to assure the exporter that the
amount due would be paid.
Importance
The letter signifies that the issuing bank would pay to the corresponding bank the amount stated
therein provided that the exporter meets certain conditions such as submitting the necessary
exporting documents
b.) Import license
A document that enables a person to import goods.
Importance
It shows that the importer has a permission to deal with the goods.
c.) Indent
This is an order sent by an importer to an agent in the exporting country.
Importance
 Contains the details of the goods required.
 The method of packing.
 The transporting company.
 The terms of payments.
Play
Mute
Stream Type LIVE
Picture-in-Picture

d.) Bill of lading

A document prepared when goods ordered are loaded into the ship,
Importance/purpose
 It is evidence that goods have been received by the owner.
 It is evidence of the terms of contract between the ship owner and the shipper
 It is a document of title in that it enables the person named therein or his agent to claim the
goods when they arrive at the port of destination.
e.) Policy or certificate of insurance
A document to show that goods are insured before being dispatched
f.) Certificate of origin
A document prepared by an exporter giving details of the goods exported and the name of the
country of origin.
Importance
Enables the importer to get preferential treatment on the goods imported especially if they
originated from a country that is a member of trading bloc.
g.) Airway Bill
A document prepared when goods are transported by air.
Importance/purpose
It shows the charges that the importer is supposed to pay to the airline company.
h.) Commercial invoice
This is a document that is prepared by the seller to demand payments
Contents include
 Name and address of the exporter
 Name and address of the importer
 Price
 Terms of sale
 Description of the consignment
 Name of the ship transporting the consignment.
Importance/purpose
To demand payments
i.) Consular invoice
A document that shows that the prices charged on the goods are fair as certified by the importing
country‟s officials or consul with the embassy in the exporting country.
Importance/purpose
Helps in speeding up delivery of goods to the importer.
j.) Proforma invoice
It resembles an invoice apart from being marked proforma. It does not hold the buyer liable for
payment of the amount marked in it.
Circumstances under which it is issued.
 To serve as a formal quotation.
 To serve as a polite request for payment in advance for the goods ordered especially
if the customer is new.
 Where the importer would like to initiate clearing of customs duty early enough to avoid
delays.
k.) Freight Note
A document prepared by the shipping company to indicate the charges for shipping the goods.
Importance
It is sent to the exporter who upon payment of the charges gets a receipts
l.) Letter of hypothecation
This is a letter written by the exporter to his or her bank authorizing it to resell the goods being
exported.
m.) Weight Note
A document that states the weight and measurements of the goods delivered at the docks
n.) Shipping Note
This is a document that is issued by the ship owner giving details of the goods shipped.

Play
Mute
Stream Type LIVE
Picture-in-Picture

International Financial Institutions

a.) International Money Fund (IMF)
Created in a conference held in Bretton Woods in 1944.The objectives of IMF includes
 Maintenance of stable exchange rates
The fund requires member countries to intervene in the foreign exchange market to ensure that
exchange rates are within the required limits
 promotion of consultation and co-operation amount member countries
Consultation and cooperation among member countries is necessary in order to maintain stable
exchange rates and a smooth international trade.
 Provision of sufficient international liquidity
IMF holds gold and a pool of member countries currencies' which are used to facilitate
international transactions,
b.) African Development Banks (ADB)
The Africa Development Bank Group is a multinational development bank supported by 77
nations and established in 1964.The Bank Groups consist of Three institutions:
 The African Development Bank (ADB).
 The African Development Fund (ADF).
 The Nigeria Trust Fund (NTF).
c.) International Bank for Reconstruction and Development (IBRD)
Also referred as World Bank was created in Bretton Woods Conference 1944
MONEY AND BANKING
Specific Objectives
By the end of the topic the learner should be able to:

a) Explain the meaning and limitations of barter trade;

b) Explain the meaning and characteristics of money;
c) Explain the functions of money;
d) Discuss demand for and supply of money;
e) Explain the meaning of banking;
f) Describe the development of banking;
g) Explain the functions of commercial banks;
h) Explain the main types of accounts offered by commercial banks;
i) explain the functions of non-bank financial institutions;
j ) Distinguish between commercial banks and non-bank financial institutions;
k) Discuss the role of a Central Bank in an economy;
1) Discuss trends in banking.

Introduction
Money is anything that is generally accepted as a medium of exchange for goods and services.
Banking refers to all the activities carried out by financial institutions involving money
Financial institutions includes
- Central bank
- Commercial banks
- Non-financial institutions
Barter trade
Exchange of goods and services for other goods and services
Play
Mute
Stream Type LIVE
Picture-in-Picture

Merits/Advantages /Benefits of barter trade.

Buyer and sellers are able to get the goods and services they require immediately.
a.) A country or person is able to dispose of the surplus
b.) Promote social relations among the trading communities
c.) Promote specialization in production of goods and services.
d.) Promotes the standard of living of people involved in it.
Limitations/draw backs of Barter trade
a.) Lacks standard measure of value.
It is very difficult to determine how much of a commodity can be exchanged for another
b.) Perish ability of commodities
Some commodities cannot be stored for a long period to be used in future for exchange purposes
c.) Requires double coincidence of wants
There must be somebody who wants exactly what you have for you want he has for barter trade
to take place.
d.) Indivisibility of commodities
Some commodities cannot be divided into smaller units without loss of value.
e.) Inconvenience in Transporting some Goods
Heavy and bulky goods are difficult to carry as you look for a trading partner.
f.) Lacks units of Account
Where barter trade is used, it is difficult to calculate and hence keep a record of the values of
different commodities.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Money system
Characteristics of Money
a.) Acceptability
It must be accepted by everyone to be used as a medium of exchange
b.) Divisibility
It should be divided into smaller units without loss of value.
c.) Portability
Should be light and not bulky to carry around
d.) Durability
It should be able to last for long without getting defaced torn or losing its shape and texture
e.) Stability
Money should be able to last for a long time without changing in value so that it maintains
credibility and acceptability.
f.) Homogeneity
Money of the same denomination should be uniform in quality and therefore identical.
g.) Scarcity
Money should be relatively scarce in supply. If it‟s abundant in supply then it would loss value
Functions of money
a.) Medium of exchange
Money is generally accepted by everybody in exchange for goods and services
b.) Measure of value
Money provides a common denominator in which the value of various goods and services are
expressed
c.) Unit of account
The values of different commodities are calculated and records kept in terms of money
d.) Store of value
Money is the most convenient means of storing wealth.This is because money is easily
convertible into other forms of assets
e.) Standard Deferred payments
A debt incurred today can be paid later using money .This is because money is acceptable by
everyone at all times.
Play
Mute
Stream Type LIVE
Picture-in-Picture

Demand for Money / Liquidity Preference

It refers to the tendency of an individual or general public to hold onto money instead of
speeding it.
a.) The transaction motive
This is a situation where one holds money with a motive of meeting daily expenses such as
buying food, paying for transport costs and entertainment. It is divided into two: Business motive
and income motive
b.) The precautionary Motive
This is where people tend to hold money to meet expenses that might occur unexpectedly such as
sickness accidents.
c.) The speculative Motive
Money can held to be used in the future especially when people anticipate that the prices of
goods and services will be lower than they are presently.
Supply of Money
Supply of money therefore refers to the stock of monetary items that are in circulation in an
economy at a particular time. It includes Total currency and Total demand deposits

Banking
The banking system of Kenya consists of four elements
a.) Central bank at the top
b.) Commercial banks follows
c.) Specialized development banks is next
d.) The fourth category are non-bank financial institutions
Commercial banks
Formed with the main aim of making profit through financial intermediation. There profits are
usually generated through
a.) Interests earned on loans and overdrafts extended to customers
b.) Investments in medium term government securities
c.) Income from operations
Services Offered by Commercial Banks
a.) Accepting deposits
Commercial banks play an important role in the economy by mobilizing domestic savings and
enabling efficiency and convenience in transactions by accepting deposits.
It has three main accounts
Current accounts
Money is withdraw able on demand by means of cheque. Characteristics
 A cheque is used to withdraw money from the account
 Money is withdraw able on demand
 No minimum balance is required to be maintained
 Does not earn interest but instead the bank charges ledger fees for services rendered
 Have overdrafts that is bank allows customers to withdraw more money than they have in
their current accounts.
Savings account
Characteristics
 Balance on the account above a certain minimum earn interest

 Funds are not withdrawn by use of cheques

 Overdrafts not allowed
 Most cases one is required to maintain a certain amount in the account
 Withdrawable of money exceeding certain maximum amount may require a notice to be given
by the customer.
 Ordinarily withdrawals can only be made by the account holders themselves.
Time deposits
They are called fixed deposit account because they do not allow withdrawal or addition of
money before the end of a fixed pre-determined period.
Characteristics
 Earns interests at an agreed rate
 There is minimum account that can be allowed for this type of account
 On expiry of the deposits period the account holder can withdraw all the money together with
interests.
 If money is withdrawn before the agreed period the customer losses accrued interest, but can
be charged for breach of contract
b.) Lending money
They may lend money to individuals, private businesses, the government and other public
authorities in form of loans and overdrafts
c.) Safekeeping of valuable items
They accept valuable items such as title deeds, share certificates, jewellery and wills for safe
keeping for their customers.
d.) Provision of foreign Exchange
A person with foreign currency can convert it into local currency at the prevailing
exchange rates
e.) Giving Advice on investments and Management of Funds
Commercial banks can give advice to their clients on available investment opportunities and the
best ways of managing their funds.
f.) Acting as a Guarantor or Referee
Commercial banks may act as guarantors to customers who would want to either get goods on
credit from new supplies or secure loans from a financial institution.
g.) Acting as intermediaries Between savers and borrowers
By accepting money from people who have excess to save and give loans to investors,
commercial banks act as intermediaries between the two parties.
h.) Money transfer Facilities
Commercial banks provide convenient methods of transferring money through facilities such as;
 Standing order
Instruction to the bank by the customer to be paying a certain amount of money to a named
person or institution after a given interval until a specified date.
 Credit transfers
A method of paying many people using one cheque. Its main advantages are saving time,
stationary and bank handling costs
 Telegraphic transfers
Method of remitting money offered by commercial banks to anybody who wants to send money
to another,
It must have the following information:
i.) Name of the person
ii.) Name of payee
iii.) The amount of money being remitted
iv.) The bank where the money would be paid
 Cheque
A cheque is a written order by the drawer to a bank to pay on demand a specified amount of
money to the person named as the payee or to the bearer.
Non- banking financial Institutions (NBFI)
They address themselves to the financial needs of particular sectors of the economy which
commercial banks have not been able to cater for adequately.
Examples
a.) Development Finance Institutions (DFI)
Provide medium and long term finances especially to the manufacturing sector. They
include:
- Kenya Industrial Estate KIE

- Development Finance Company of Kenya DFCCK\

- Industrial Development Bank IDB
- Small Enterprise Finance Company SEFC
b.) Housing Finance Companies
They are mainly involved in financing housing activities. Examples
- Houses Finance Company of Kenya HFCK
- East Africa Building Society EABS
c.) Savings and credit co-operation Societies (SACCOS)
These are co-operative societies formed to mainly enable the members save and also obtain loans
most conveniently and at a favorable conditions.
d.) Insurance companies
These companies provides finance to commercial organizations as well as to individuals.
Difference between commercial banks and Non-banking Financial Institutions.
i.) Commercial banks provides current account facilities to their customers while NBFIs do
not.
ii.) Commercial banks normally provide short –term and medium –term finance while NBFIs
provide medium and long term finance.
iii.) Commercial banks provides finance that is not restricted to any particular activity
while NBFIs provide finance for specified purpose.
iv.) Commercial banks can provide foreign exchange transactions to their customers while
NBFIs do not.
v.) Commercial banks provide finance mainly for working capital while NBFIs
provides finance for capital development
vi.) Commercial banks do not participate in capital market trade while NBFIs can participate
vii.) Commercial banks participate in clearing houses while non-bank institutions do not.
The Central Bank
An institution that control and manage the supply of and demand for money in a particular
country.
The objective of monetary control by the central bank
a.) Facilitate rapid and steady economic growth
b.) Create employment
c.) Stabilize prices of commodities
d.) Ensure balance development
e.) Enhance equilibrium in the balance of payment
Function of central bank
a.) Issue of currency
The responsibility of issuing new currency that is notes and coins is solely in the hands of the
central bank
b.) Acts as a bank banker
The central bank acts as a banker to commercial banks and other financial institutions in that it
accepts deposits from these organizations. It also acts as a lender of last resort
c.) Acts as the government bank
The government operates its account with the central bank. The central bank is also the
government financial adviser
d.) Controlling commercial Banks
The central bank controls commercial banks and other financial institutions by giving
instructions to them on lending procedures and proper banking practices.
e.) Acts as a link bank to external financial institutions
The central bank acts as a link to central bank and monetary authorities of the other countries
thereby facilitating international financial relationships.
f.) Maintaining stability in Exchange Rates
The central bank is responsible for maintaining a suitable exchange rate between the local
currency and foreign currencies.it does this through setting off specific foreign exchange rates or
intervening in the foreign exchange market through revaluation or devaluation of domestic
currency.
g.) Administering Public Debt
Public debt is the amount money the government has borrowed both internally and externally
that is outstanding. The central bank is responsible for management and repayment of the debt
when it matures.
h.) Lender of last resort
The central bank plays the role of lender of last resort to the commercial bank. This means that
commercial banks can obtain loans to meet their day to day financial obligations.
i.) Control of Monetary system
The central bank is responsible for controlling the monetary system in order to regulate the
economy.
Ways in which the central bank regulate money in the economy
a.) Bank rates.
This is the rate at which the central bank lends to commercial banks. It can be varied to
encourage or discourage credit/ raising/ lowering bank rate
b.) Open market operation
The central bank may sell or buy securities in the market. Selling securities reduces the money
supply (For lending)
c.) Special deposits/ compulsory deposits/ minimum reserve requirements
The central bank require other financial institutions to have a certain percentage of deposits
deposited in the central bank which can be varied to encourage / discourage credits
d.) Cash ratio/ liquidity ratio
The ration of cash/ deposits may be carried to control money supply credit which can be
increased to reduce money supply/ can be decreased to increase money supply.
e.) Moral persuasion/ Liquid assets persuasion
The central bank may appeal/ request/ persuade/ restrain leading/ credit rationing. The
commercial banks may be required by the central bank to approve loans only for special types of
projects e.g. agriculture, manufacturing etc.
f.) Direct action/ directive/ instructions
Central banks can use its authority to direct/instruct the financial Institutions to lend more/ less/
apply credits squeeze/ credit expansions margins requirements.
Trends in banking
a.) Use of computers
b.) Automated Teller Machine ( A.T.M)
c.) Credit facilities are now easier to get due to competition
d.) Mobile banks to give access to people who are in remote areas
e.) Customer care services being set up by banks
f.) M-banking to allow an account holder to access his or her bank account anywhere any time

PUBLIC FINANCE
Specific Objectives
By the end of the topic the learner should be able to:
a) Explain the meaning and purpose of public finance;
b) Describe the various sources of public finance;
c) Categorize government expenditure;
d) Explain the principles of government expenditure;
e) Explain the meaning and purpose of taxation;
f) Explain the principles of taxation;
g) Classify taxes;
h) Explain the merits and demerits of each type of tax;

Introduction
These refers to the activities carried out by the government associated with raising revenue.
Sources of finance
i.) Fines imposed by courts on offenders
ii.) Rent and rates paid for the use of government properties
iii.) License fees paid by those who want to operate businesses
iv.) Dividends and profits earned from government direct investments
v.) Investments earned on loans advanced by government to firms
vi.) Taxes
vii.) Government borrowing
viii.) Proceeds from sale of government property
ix.) Government Borrowing
Government borrowing
a.) Internal borrowing
Borrowing by government from firms and individuals within the country.
b.) External borrowing
Government borrows money externally through bilateral or multilateral basis.
Factors to consider before the government can decide whether to borrow internally or
externally
 Conditions laid by external financiers
 The crowding out effect
 The relative cost of internal borrowing as compared to external borrowing.
Government expenditure
Spending by the government on the finances it has raised
Categories of Government Expenditure
Recurrent Expenditure
Government expenditure that takes place on regular basis e.g payments of salaries to civil
servants, provision of drugs in public hospitals and fuelling of government vehicles
Development Expenditure
This refers to government spending that goes into financing specific projects such as
construction of railway lines, roads airports industries and administration offices
Principles of public Expenditures
These are the considerations made by government before any expenditure is incurred
a.) Sanctions
Public expenditure must be sanctioned or approved by relevant authority before it is incurred
b.) Maximum social Benefits
Majority of people should be able to reap maximum benefit out of it
c.) Flexibility
The policy on public expenditure should be flexible enough to meet the prevailing economic
situations
d.) Economy
Public expenditure must be incurred in the most economical way by avoiding any possible waste
e.) Proper Financial Management
Public finance should be well managed by proper accounting records which should also be
audited as required
Tax
Tax is a compulsory payments by either individuals or organizations to the government
Taxation
This refers to the process through which the government raises its revenue by collecting taxes
Reasons for taxation
a.) Raising revenue
Government raises revenue which is used in providing goods and services
b.) Discouraging consumption
Discouraging consumption of certain products such as beer or cigarettes
c.) Discouraging importation
Discouraging importation of certain products in order to protect local industries such as high tax
on imported products
d.) Reducing inequality in income distribution
This is done by taxing the rich and using the money on development projects that benefits the
poor
e.) Controlling inflation
Taxation reduces money supply through reduction of people‟s disposal income thereby
controlling inflation
f.) Helping locates businesses
High tax on businesses located on urban areas would make entrepreneurs locate their business in
rural areas where tax is less
g.) Correcting balance of payments
High tax on imported products would discourage importation, thereby increasing the
balance of payments
The amount of revenue to collected through taxation depends on
 Distribution of incomes
 Social and political factors
 Honesty and efficiency of tax authorities
 Citizens level of real incomes
 Economic structure of the country
Principle of taxation
These are characteristics or cannons of a good taxation system
a.) Equitable
A good tax system should ensure that there is fairness in payments of taxes i.e tax burden should
be distributed to the community as equitable as possible.
b.) Certain
The tax that an individual is supposed to pay should be clear in terms of the amount, time and
manner in which it should be paid.
c.) Convenient
Tax should be levied at a time when the payee has money and it should be paid in a way that is
most convenient to the payees
d.) Economical
The cost of administering tax should be lower than revenue to be collected
e.) Elastic
A good tax system should allow the government to increase revenue as need arises under the
current tax system.
f.) Flexible
A good tax system should be capable of changing in accordance with changes in national
income. Tax should therefore rise when incomes increases and reduce when income
reduces
g.) Diversified
A good tax system should be diversified so that it meets revenue requirements of the country and
also be in line with the principle of equity.
Impact and incidence of tax
The burden of tax on initial person is the impact of tax and the final resting place of the tax
burden is the incidence of tax.
Classification of taxes
According to structure
Taxes are classified according to the relationship between the amount paid as tax and the income
of the tax payers as follows.
a.) Regressive
This is a type of tax which takes a higher proportion of low income earners as compared to high
income earners.eg sales tax
b.) Proportional Tax
Tax payers pay a fixed percentage of their income as tax.eg corporate tax
c.) Progressive tax
Amount paid increases proportionately with increase in income.
Disadvantages of progressive tax
 May discourage people from working more as additional income goes to tax
 Investors may be discouraged from taking risks because if the venture is successful
than average then the government takes high proportion of the extra profit
 It is based on the assumption that people earning the same amount of income have similar
needs and ability to pay tax.

Classification according to impact on the tax.

We get the following taxes;
Direct tax
The impact and the incidence of the tax are on the same person and the person is unable to shift
any part of the tax to anybody else. The tax includes the following;
Personal income tax
Imposed on income earned by individuals. The tax is always progressive in nature as the tax rate
increases with increase in income.
Corporation tax
Levied on profits of companies. The tax paid is always proportional in nature as the tax rate
remains the same.
Stamp duty
Tax paid in areas such as conveyancing of land or securities from one person to another.
Estate (death)duty
Tax imposed on properties transfers after the owner‟s death. This helps in generating revenue
and also in redistributing income since the inheritor has not worked for it.
Wealth tax
This tax is levied on personal wealth that goes beyond a certain limit. The main
disadvantage is that it may discourage people from accumulating wealth
Capital transfer/ Gifts tax
This is tax imposed on the value of property transferred from one person to another as gifts.
Merits of Direct tax
a.) Economical in collection
Direct taxes are mostly collected at the source and the cost of collecting them is fairly low.
b.) Tax revenue is certain
Yields from direct tax such as income tax is fairly certain and maybe calculated accurately in
advance
c.) Equitable
Direct tax ensures that there is fairness in contribution of tax. This because contributors pay
according's to the size of their income
d.) Does not affect the price of goods and services
It affects consumer‟s disposable income and not the price of goods and services.
e.) Brings redistribution of wealth
The wealthier members of the society are taxed more than the poorer in the case of progressive
tax systems. Finance obtained from the wealthier members are used to finance services
that benefits the poor.
d.) Simple to understand
Direct tax is both simple and easier to understand by both the contributors and the tax collector.
e.) Desirable
The tax is desirable as it only affects people who fall within the jurisdiction of income tax and
corporation tax.
f.) Flexible
The tax is flexible in that it can be expanded to cover as many areas as desirable
g.) Elastic
The tax is elastic in that it may be raised or reduced according to the needs of the economy.
Demerits of Direct tax
a.) Possible tax evasion
It can easily be evaded by tax payers by either ignoring the payments or falsifying their income
information
b.) Deterrent to savings
High taxation on people would reduce their ability to save as it leaves them with less disposable
income.
c.) Deterrent to work
High tax on personal income may discourage people from working harder. This is because the
extra amount of money would be taxed more.
d.) Deterrent to investment
Heavy tax on profits may discourage entrepreneurs from investing in highly risky but profitable
areas this is because such profits are highly eroded by tax
e.) Inconvenient
Taxation inconveniences the tax-payer who has to comply with complicated formalities relating
to sources of income as well as expenses incurred while generating it. This complication
may force the tax payer to engage services of tax experts who has to be paid.
f.) Not imposed on all citizens.
The tax is not imposed on all citizens as low income earners who do not fall within the tax
brackets are exempted.
Indirect tax.
In this type of tax the person on whom it is initially imposed may not shoulder the whole tax
burden but may shift either the whole or part of it to someone else. The impact and the incidence
of tax maybe on different individuals.
This tax is based on consumption of goods and services that involves the following:
Sales tax
Sales tax is based on the sales made by the seller, it may be assessed on either as a percentage
such as20% of the sales or fixed amount
Value added tax (VAT)
The tax levied on the value that a business adds to a product. Export duty
A type of tax that is levied on exports the purpose being to discourage exportation of certain
commodity or to raise revenue. Import duty
Import duty is a tax that is charged on goods entering into a country. The purpose may include:
 Raising revenue for the government.
 Reducing incidences of dumping
 Discouraging consumption of imported goods
Merits of indirect tax
a.) Can be used selectively
It can be used selectively to achieve a specific objective for example if the government want to
discourage consumption of beer it imposes a high tax on it.
b.) Tax payment is voluntary
It is only paid by those who consume the taxed commodity. If one does not want to pay the tax
he or she would only need to avoid the consumption of taxed commodity.
c.) Not possible to evade
It is not possible to evade because all those who buy the taxed commodity have to pay the tax.
d.) Stimulate effort
Increase in indirect tax is likely to stimulate efforts as people struggles to maintain their current
standards of living
e.) More revenue can be raised(broad based)
Indirect tax is likely to yield more revenue. This is because all people are likely to consume the
taxed commodities thereby making the tax have a broader base.
f.) Convenient
Indirect tax is convenient because it is not paid in lump sum but in small bits as one buys the
commodity. The tax is also hidden in the price of commodity and therefore the payer may not be
aware of it.
g.) Elastic.
The tax is flexible which enables the government to either raise or reduce the tax rate to suite the
prevailing economic situations in the country.
Demerits of indirect tax.
a.) May fuel inflation
Continued increase in indirect tax may fuel inflation as it directly increases prices of goods and
services.
b.) Less equitable
The burden of indirect tax falls heavily on consumers with low income compared to those with
high income with high income. This is because all consumers pay the same amount of tax per
unit consumed irrespective of the levels of their incomes.
c.) Can be avoided
Indirect tax can be avoided by people who do not consume the taxed commodity.
d.) Might interfere with resource allocation
Indirect tax increases the price of the taxed commodities relative to others. This might
discourage consumers from buying them shifting consumption and production resource towards
commodities that are not being taxed.
e.) Uncertainty in revenue yield
One cannot predict the amount of revenue yield in indirect tax due to difficulty in forcasing
sales as they may be affected by other factors.
f.) Lack of contributor‟s awareness.
Many of the contributors of indirect tax are not aware that they are contribution anything
to the state inform of tax.

Budget.

A budget is a statement of estimates or proposals of the way the government plans to raise
finances and how such finances are to be spent in a given financial year.
Types of budgets
I.) Balanced budget
A balanced budget is where budgeted expenditure is equal to budgeted revenue
II.) Deficit budget
A budget having a deficit is where budgeted revenue is less than budgeted expenditure
III.) Surplus budget
A budget having a surplus is where budgeted revenue is less than budgeted expenditure
The raising of government revenue and the expenditure of the revenue raised in order to achieve
the desired objectives is referred to as the fiscal policy.
Budget as a tool for planning
The government uses the budget to achieve the following;
 Checking inflation by collecting more revenue and spending less.
 Stimulating economic growth by collecting less revenue and spending more
 The budget may point out specific objectives expected of a particular sectors of the economy
 Spelling out the measures that the government, intends to take in order to achieve the said
objects.
POPULATION THEORIES AND EMPLOYMENT
Specific Objectives
By the end of the topic the learner should be able to:
a) Explain the basic concepts in population
b) Explain the implications of population size and structure on the development of a country
c) Explain the meaning of employment and unemployment
d) Discuss the various types and causes of unemployment
e) Discuss the measures that may be taken to solve unemployment problems
Content
a.) Basic concepts in population: Fertility, Mortality, Growth rate, Optimum population, Under-
population, Over-population, Young population, ageing population, Declining Population.
b.) Implication of population size and structure on development.
c.) Employment and Unemployment.
d.) Types and causes of unemployment.
e.) Solving unemployment problems
Definition
Population refers to the number of people living in a particular region at a particular time.
Basic concepts in population
1.) Population growth rate
Rate at which the size of a population changes over a given period of time usually one year.
Factors associated with growth rate
 Mortality rate-the rate of death in every 1000 people.
 Birth rate-the number of live births in a year per 1000 people.
 Migration –population movement from one region to another. it can either be:
 Immigration-migration into an area.
  Emigration-migration out of an area.
Factors leading to high birth rate
 Cultural practices like believing that many children act as a source of security.
 Early marriages prolonging the woman reproductive life.
 Children being seen as a source of cheap labour.
 Many births as a family searches for a male child.
 Religious beliefs which encourage large families.
 Ignorance leading to opposition of family planning.
Factors that leads to decline in birth rates
 Delayed marriages due to such things as staying in school for too long.
 Craving for a higher standard of living leading to people having few children.
 Desire to give children better lives than the parents.
 Where a small family is considered fashionable.
 Due to reduced infant mortality rates, most people have confident that all the children will
survive hence no need of having many children.
 Availability of viable retirement benefits schemes which made people to stop viewing
children as a source of security in old age.
2.) Optimum population
The population level which is equal to the availability resources.
What optimum population depicts
 It is the population that can generate the highest living standards at the available resources
and the state of technology.
 It is the population size that can lead to the most efficient use of resources while maximizing
output per capita.
 Population below optimum level implies that resources are under-utilized and standards of
living are low.
 An increase in population beyond optimum population level leads to
overutilization of resources and hence standard of living.
3.) Under population
This is a situation where available resources in a country are greater than the size of population
in the country.
Factors leading to under population
a.) An increase in Death Rate
Natural Catastrophes such as earthquakes, flood etc. will lead to an increase in death rate
therefore the country witnesses a reduction of population
b.) A fall in Birth Rate:
When a country decides to reduce the number of children for fear of eventual overpopulation or
any socio-political factor which does not favor children, the country becomes under populated
c.) High Level of Emigration
A persistent increase in emigration over immigration will leads to a reduction in a country
d.) Low birth rates
If the birth rate is low, the total population may remain small to the extent that it does not get to
the optimum.
Positive effects of under population
a.) No Congestion:
A country with less population experiences little or no congestion
b.) Employment Opportunities:
As a result of small size of the population, there will be enough job opportunity for the people
c.) Increased in Social and Infrastructural Facilities:
An under Populated Country experiences a higher per capita in terms of social and
infrastructural facilities available to the people in the country.
d.) Availability of Idle Resources:
The fact that a country is less populated means that the resource available in that country is
higher than the number of people; hence, many idle resources would abound everywhere.
Negative Effects of under population

a.) Lower Standard of Living:

Under Population engender lower standard of living as a result of inadequate labor force that
would have conveniently boost output and production of goods and services.
b.) Lack of Adequate Manpower:
Under population results to shortage of labor with that attendant effect of low
investments and income
c.) Underutilization of Resources:
Resources are highly underutilized in a country with low population
d.) Lack of People to Defend the Country:
At times of war and emergency, a country might find it difficult to mobilize enough people to
defend it.
e.) Equilibrium at Less than Full Employment:
Under population leads to reaching of equilibrium at less than full employment as a result of idle
resources.
4.) Over population
Occurs when a country‟s population is large compared to its resources such that the
resources are overstretched.
Advantages of over population
a.) Widening Market
Large population provides a wide market for goods and services.
b.) Better utilization of resources
Large population creates increased demand for goods and services and in an attempt to meet the
increased demand, there is better utilization of the available resources.
c.) Creates a pool of labour
A pool of labour force is created where producers can satisfy their labour force needs.
d.) Stimulates investments
Due to large population, entrepreneurs may expand their business to meet the growing demand
for goods and services due to over population while at the same time new investments are made.
e.) Promotes labour mobility
Overpopulation increases labour mobility as jobless people tend to move from one area to
another in search of employment.
Disadvantages of overpopulation
a.) Strain on the available social amenities
Excess demand of the available social amenities such school and health facilities may put
pressure on the them resulting to poor services delivery.
b.) Low standard of living
As the population increases while income remain constant, the income per head reduces.
Reduced income reducesindividual‟s ability to acquire basic needs such as food and health care.
c.) Encourages rural to urban migration
Many people move from rural to urban areas where they think they can get employment. As a
result the urban areas get more people than the available jobs.
d.) High dependency level
In overpopulation areas, there are many people who are not employed. Such people tend to
depend on the employed ones for their upkeep and this may strain those who are employed
e.) Imbalance in demand and supply
Overpopulation creates excess demand in population to the supply of goods and services, where
the supply of goods and services is not able to keep pace with the increase in demand for them,
prices may keep on increasing.
f.) Food shortage
Overpopulation may result in shortage of foods due to increased population in which the amount
of food is not enough to feed the whole population.
g.) Increased crime rates
When many people are unemployed because of overpopulation it may make it hard to acquire
even the basic necessities and they may engaged in crimes such as stealing to survive.
h.) Environmental degradation
Overpopulation may cause over exploitation of natural resources leading to environmental
degradation.
5.) Young population
This a population where there are more young people than old people.
Causes of young population
 High birth rate and low infant mortality rate.
 Low life expectancy.
 High mortality rate be among aging adult.
Problems associated with young population
a.) High dependency ratio
There is high dependency ratio on working population as it may be forced to cater for a large
number of young population who are unemployment.
b.) High rate of unemployment
The demand for jobs by many young people entering the labour market is higher than the
available jobs creating unemployment.
c.) Increased social evils/crimes
Young population may have a large number of youth idle. They may engage in cries in order to
survive.
d.) Low labour supply
Young population may experience low labour supply as many of the youths may have not
attained the working age
e.) Pressure on goods and services
Increased demand for goods and services required by the youths may put pressure on them as the
demand overtake supply.
f.) Reduced savings and investments
Due to high rate of consumptions by the young people savings is reduced and in turn results in
low investments.
g.) Diversion of government expenditure
The government may be forced to divert its expenditure from other needy sectors as it caters for
the welfare of the youth.
6.) Ageing population
This is a population with higher proportion of older people. These people are above 65 years old.
Problems associated with ageing population
 Old people tend to provide a less mobile labour force.
 Low labour supply is likely as old people tend to be less productive.
 High dependence of old people on working populations.
 Society becomes less progressive as it lacks the input of the energetic youth.
 May led to unemployment due to fall in demand for goods and services required by the youth.
7.) Declining population
This is a population that has been reducing over time.
Effects of declining population
a.) Reduces government expenditure
The government may spend less in provision of resources such as infrastructure and social
services making them to improve on the quality of their services to the citizens.
b.) Attainment of optimum population
Declining population may enable a country that has been overpopulated to attain optimum
population.
c.) Proper utilization of land and other resources
For a country that is overpopulated, declining population may reduce pressure created on land
and other resources and this may lead to improved productivity while declining population may
lead to underutilization land and other resources.
d.) Discouraging investments
As the population declines, the market for goods and services also declines. This may force the
existing business to close down while new investors may be scared away.
e.) Reducing dependency of the unemployed on the employed
For over populated country, decline in population may reduce the dependency of the unemployed
because they will now get employment due to reduced population.
8.) Population structure
This is the composition of population according to age, sex, income distribution and levels of
literacy. Below is a hypothetical population structure of a country that assumes equal number of
male and female.
Implication of Population size and structure on Development
The population structure may have both negative and positive implications.
Positive implications
a.) Increase in market demand
When population increases a wide market for goods and services is created depending on the
structure of the population.
b.) Enough labour supply
Rapid population growth leads to increased labour supply which would in turn lead to payment
of low wages.
c.) Technological advancement
Competition and pressure of resources may lead to increased labour supply which would lead to
higher efficiency and also insipire people to look for new methods of improving productivity.
d.) Diverse talents
In a rapid growing population the number of talents are likely to be many.
Negative implications of a rapid population growth.
a.) Decrease in per capita income
When the growing population depends on a fixed factor of production, output may increase up to
a certain point and beyond this point, output per head which also determines per capita income
declines.
b.) Increased dependency ratio
In a rapid growing population most the people depend on the available work force for survival.
c.) Reduction in savings and investments
In a large population most of the earnings is spend leaving nothing or very little to save. This
will in turn lead to low investment.
d.) Unemployment
The number of people in the labour force exceeds the number of jobs available leading to
unemployment.
e.) Strain on social amenities
Due to overpopulation, the government may find it difficult to provide adequate essential social
services such as health, education and housing.
f.) Uneven distribution of income
In over populated countries there are very few rich people and very many poor people leading to
unequal distribution of income.
g.) Environmental degradation
Over population usually leads to over exploitation of the natural resources leading to
environmental degradation
Employment and Unemployment.
Employment
The term refers to engagement in any type of income generating activity.
Unemployment
The term refers to inability of people who are capable and willing to work to get
meaningful employment opportunities
Types of unemployment
Cyclical unemployment – occurs due to relatively low general demand for goods and
services.
Structural unemployment – caused by changes in production methods, change in technology and
changes in demand for goods and services.
Frictional unemployment – occurs when people are unable to secure jobs due to barriers which
hinder them from getting jobs such as ignorance. Or when people lose jobs and go looking for
new ones
Seasonal unemployment – occurs due to relatively low demand for labour at certain times of the
year.
Involuntary unemployment/open unemployment - results from lack of jobs. For example people
willing to work at the prevailing wages but work is not available.

Real wage/Voluntary unemployment – occurs when job seekers are not willing take up jobs at
the prevailing wage rates
Disguised/Hidden unemployment – Occurs when the number of people employed exceeds the
number which is required for the job.
Residual unemployment – Affects people who are physically & mentally challenged.
Erratic /Casual unemployment - Affects certain sectors of the economy like construction where
demands for labour is erratic and not regular.
Causes of unemployment
a.) Poor education system
The education structure used in developing countries is not beneficial to the students as it does
not directly correspond to the prevailing economic activities outside the school system. Rather
than providing useful skills to students and molding professionals, theory is what is being taught
instead of practical. This mismatch between the school levers and jobs requirements creates
unemployment‟
b.) Bad leadership
Lack of employment in developing countries is also linked to the bad leadership and corrupt
attitude of individuals in power. Moreover, there is a lot of money embezzlement and power
retention exhibited by policy makers in the education sector in Africa. This means funds required
for improvement of education are diverted for selfish personal use. Hence, the education sector
remains largely undeveloped.
c.) Rural to urban migration
When people move from rural areas to urban areas in search of employment, they put
tremendous pressure on the available resource and expanding work force that cannot be
absorbed.
d.) Rapid population growth
If the population is growing at a faster rate than the economy is expanding, it leads to more
workforce entering a labour market which causes unemployment.
e.) Lack of product market
If the demand for goods and services is less due to low income producers will be discouraged to
produce more leading to unemployment.
f.) Seasonality in production
Seasonal variations cause unemployment such that during the peak season, employment is high
and during off peak seasons employment is low.
g.) Use of inappropriate technology

If a country uses labour intensive methods of production it will limit the growth of employment
opportunities.
Methods to solve unemployment
a.) Population control
Advocating for reduction in the population growth rates in the country through various ways
such as family planning.
b.) Adaption of appropriate education systems
Introducing the appropriate forms of education and training people for the jobs that are available.
c.) Use of labour intensive methods
Use of labour intensive techniques in government institutions and projects.
d.) Proper planning
By proper planning and management of natural resources and fighting corruption so that
resources can be used well to create jobs.
e.) Entrepreneur culture
Through encouraging the entrepreneurship culture in the country by providing a conducive
environment for investment.
f.) Delocalization of firms/Rural development
Delocalization of firms by the government to create jobs in rural areas hence reducing rural to
urban migration of people in search of employment.
g.) Encouraging direct foreign investments.
Encouraging foreign investment enough various policies such as tax holidays and enabling
repatriation of profits from the businesses of foreigners.
h.) Increase government spending or expenditure.
Expenditure on infrastructure such as roads railways and electricity supply creates jobs and
releases money in circulation creating demand for goods and services.
i.) Encouraging the use of local resources
Government can increase its expenditure on projects that will create more jobs
opportunities.
j.) Encouraging the use of local resources
Government can encourage investment on economic activities that use locally available raw
materials or inputs which will intern create more jobs opportunities.
k.) Encouraging the use of local resources
Government can encourage investment on economic activities that use locally available raw
materials or inputs which will in turn create employment for those involved in provision.