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CAPE Economics, June 2006, Unit 1, Paper 2 suggested answer by Edward Bahaw

CAPE Economics, June 2006, Unit 1, Paper 2 suggested answer by Edward Bahaw

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CAPE Economics, June 2006, Unit 1, Paper 2 suggested answer by Edward Bahaw CAPE Economics, June 2006, Unit 1, Paper 2 suggested answer by Edward Bahaw Document Transcript

  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS CAPE ECONOMICS th May 25 2006 Unit 1 Paper 2 EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS June 2006 – Unit 1 – Paper 2 1 a i) Equilibrium Price - This represents the price at which the quantity of a good or service which consumers wish to purchase is equal to the quantity which producers are willing to offer for sale. This occurs where the demand and supply curves intersect. 1 a ii) Pareto Efficiency represents the conditions in a free market economy where social welfare is maximized. The two necessary conditions are: • Production eefficiency which is achieved when the average cost of producing goods and service are minimized. This occurs at the point where the marginal cost curve intersects the average cost curve. • Allocative efficiency means that allocation of resource among the production of goods and services is done in such a way that no good or service is under produced or over produced. In other words the socially optimal quantities are produced which results in the maximization of net benefits as a result of the production and consumption of each good or service. In the absence of externalities this occurs where the price is equal to marginal cost. 1 a iii) A price ceiling is an artificially or “fiat” price imposed by the government. In this case the government authorities stipulate a maximum price for a good or service. Any seller can legally sell the good at this price or any price below it. The objective is to promote affordability so that all consumers are able to purchase the item. 1 b i) Four factors which influence the Demand for Beef 1) Changes in the price of beef – the demand for the majority of goods including beef follows the first law of demand. This means that as the price of beef increases, the quantity of beef consumed would fall. Conversely if the price of beef falls an increased quantity would be purchased. These changes are shown by movements along the demand curve. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Demand Curve for Beef P ($) D $10 $5 D O 6 12 Quantity of Beef Consumed per Month in kg In figure as the price of beef is lowered from $10 to $5, the quantity demanded by the consumer increases from 6kg to 12kg. 2) Increase in income. Beef can be regarded as a normal good and as such increases in consumers’ income lead to an increase in demand and vice versa. 3) More Advertising. This is an important marketing tool by suppliers which can increase the demand for beef. 4) Increase in population of the country. The demand for beef would increase as the population of a country grows. All factors covered above with the exception of the price of beef would lead to a rightward shift of the demand curve for beef. This is shown in the figure by the shift from D1 to D2. This implies that an increased quantity is purchased at an unchanged price level. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Increase in Demand for Beef P ($) D2 D1 $10 D2 D1 O 6 14 Quantity of Beef Consumed per Month in kg 1 b ii) Four factors which influence the Supply of Beef 1) Changes in the price of beef – as the price of beef increases, the quantity which supplier would be willing to supply to the market will increase. This is shown by an extension of supply as the figure illustrates. Supply Curve of Beef P ($) S $10 $5 S 100 220 Quantity of Beef Consumed per Month in kg 2) Changes in the Price of factors of production – as the payments made to factors of production decreases, cost of production falls and producers would be able to produce a greater output. That is supply would increase. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS 3) Improvements in Technology. As technology improves, firms would be able to increase the amount of output they produce. 4) Exogenous factors – these are factors such as weather conditions of the outbreak of disease which can affect the supply of beef by farmers. If favourable weather is experienced and dcattle diseases are avoided then beef production would increase. All factors covered above with the exception of the price of beef would lead to a rightward shift of the supply curve for beef. This is shown in the figure by the shift from S1 to S2. This implies that an increased quantity is supplied at an unchanged price level. Increase in Supply of Beef S1 P ($) S2 $5 S1 S2 100 240 Quantity of Beef Consumed per Month in kg c i) Although ceiling or maximum prices usually enable greater affordability to low income consumers, they tend to result in a situation where a shortage exists, which means that consumers may be unable to obtain the desired quantity of the good in question. In the figure the market equilibrium price is PE and the price ceiling price is PC. This creates a shortage in the market given by the horizontal distance QS to QD. This shortage means that not all low income families would be able to increase the consumption of milk. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Ceiling or Maximum Prices P($) D S E PE PC Price Ceiling S D QS QD Quantity Shortage of milk 1c ii) As a result of shortage created by the price ceiling, there would be upward pressure on prices as the excess demand on the market would encourage consumers who can afford to offer higher prices for the item. Since the price ceiling prevents consumers and producers from legally buying or selling the good at a higher price, they might choose to do so secretly in black markets. 1 c iii) One option available to government to maintain the price ceiling amidst the shortage in the market is to encourage an increase supply. For instance if a subsidy on milk production is introduced then this would lead to a rightward shift of the supply curve which can help to eliminate the shortage at the price ceiling. 1 c iv) To ensure that low income families benefit from the pricing policy a rationing system can be introduced where although consumers don’t get the full quantities they desire they all still get an allocation which ensures that all families would be able to consumer some quantity of the good. For instance is the supply in the market is 100 units while there are 50 consumers in the market with a total demand of 150 units at the price ceiling then an allocation of 2 units per consumer can me implemented by the government. This might require an administrative mechanism such as coupons given to families which must be presented to the retailers in order to purchase the allocated quantities. 1 d) One Advantage of Free Markets - there is consumer sovereignty, as consumers determine what is to be produced. Democracy is also promoted through decentralized decision making via market signals 1 d) One Disadvantage of Market Economies – An unequal distribution of income. In many near free market economies, some people may become very successful from hard EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS work or pure luck or a combination of both which enhances their income and personal wealth. In other cases, some people remain quite unsuccessful in economic terms due to poor decision making or even bad luck. As a result, economic divisions emerge in society where exceptionally rich individuals coexist with the poverty stricken. This is particularly the case in free market economies where individuals are free to make choices with the motive of pursuing their own self interest. 2 a i) The production function refers to the relationship between the quantity of inputs and quantity of output in a production process. Inputs can be divided into four sub groups: 1. Land 2. Labour 3. Capital 4. Enterprise 2 a ii) There are three stages of production. Primary stage – the extraction of raw materials and natural resources. This stage begins with the mobilisation of factors of production to areas where there are natural resources and ends with the extraction or harnessing of such free gifts of nature and distributing to factories and other production facilities which utilise these primary products as inputs. Secondary stage. The manufacturing of goods can be carried out in factories or in the case of self-employed people like a snow cone vendor the output can be produced at home. It begins with the procurement of primary products inputs and ends with the production of output of manufactured goods for use by either consumer of service providers. Tertiary stage The producers can also provide services to meet the needs and wants of people. Some examples of services are; medical, educational, transportation, consultancy, banking and other services. This stage begins with the procurement of manufactures goods and ends with the use of these products to render services to final consumers. 2 a iii) The figure shows the relationship between inputs used in production and the output produced. Essentially this is the type of relationship or conversion process which is involved in the secondary stage of production. In stage one, there isn’t any process of converting inputs to output, instead inputs are simply collected. The third stage involves the use of finished goods to provide services without any production process taking place. 2 b) In the short run, when one factor is fixed in supply and successive units of a variable factor are added to it, then after some time, the extra output derived from the employment of each successive unit of the variable factor must diminish. The law of diminishing returns therefore implies that if more units of labour are employed along with a fixed amount of capital say, the marginal output will, after some time, decrease. The reason why diminishing return is experienced is linked directly to the capital to labour ratio and hence the productivity of each additional worker. If a small amount of labour is employed, the fixed factors of production, capital is under-utilized. Here each additional worker will have plenty capital to use and, as a result, productivity will be high. Beyond a certain point however, the fixed factors of production become scarcer and new workers EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS will not have much capital to work with. In other words, as the labour input increases, the capital to labour ratio declines. As a result, the productivity of each additional unit of labour falls and this leads to a decline in marginal physical product. 2 c i) Constant returns to scale – if in the long run if as the firm employs more of all factors of production and output increases proportionately to the increase in inputs. 2 c ii) Increasing returns to scale – if in the long run if as the firm employs more of all factors of production and output increases more than proportionately to the increase in inputs. 2 c iii) Decreasing returns to scale – if in the long run if as the firm employs more of all factors of production and output increases less than proportionately to the increase in inputs. 2 c iv) Economies of scale are the cost savings or cost economies that a firm can exploit by expanding its scale of production in the long run.. These cost advantages enjoyed by the firm enables it to produce its output at a lower unit cost. 2 d i) Reasons fore economies and diseconomies of scale Indivisibilities is one reason for economies of scale – this refers to the ability of large- scale businesses to make use of technology which is not available to businesses which operate on a smaller firm. For instance, a supermarket chain which handles thousands of retail transactions may make use of computer technology in its operations which results in cost savings. The small corner shop which transacts a few daily sales may not be able to use such technology for just a handful of transactions. If, however, it were possible to adapt the technology in order to make it suitable for a small number of transactions, then small firms would be able to benefit from it. Technology however, may be indivisible in this way and thus only large firms may be able to take advantage of the cost savings it enables Management and Administrative problems is one reason for economies of scale – Large firms may experience difficulties in managing and administering production across several plants in different locations and different countries. These difficulties results in reduced efficiency and hence higher costs 2 d ii) The long run average cost curve is U shaped, but this occurs because of the influence of economies of scale and diseconomies of scale at different levels of output. This is shown in the figure. As the firm’s output grows from 0 to Q”, long run average $ cost declines as a result economies of scale. The output level Q” is referred to as the minimum efficient scale (MES) of output. As output increase beyond the MES level of LAC output, long run average cost increases due to diseconomies of scale. Economies of Diseconomies Long Run Average Cost (LAC) and Economies and Diseconomies of Scale Scale of Scale EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Q” Quantity
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS 3 a) Market structure refers to the type of competition which exists among firms in a particular industry. The type of competition is distinguished by the characteristics of the industry which gives an indication of how firms would operate in terms of price and output. 3 b) Four assumptions of perfect competition: 1. The market is large, meaning that there are a large number of consumers and there are a large number of suppliers where each individual firm contributes a small proportion of the overall market supply. 2. The market is liberal in the sense that any buyer and seller could freely conduct business in the market. 3. The output supplied by each firm in the market is identical. That is, there is product homogeneity throughout the market. 4. Buyers and sellers have perfect knowledge of all market variables. As such, market participants are able to make well informed decisions and thus rational individuals are able to take full advantage of all opportunities in the market. 3 ci) Market Structure Examples Mobile phone services in Trinidad and Tobago Monopoly provided by TSTT prior to 2005. The Banking Industry in Trinidad and Tobago Oligopoly Monopolistic Competition The Fast Food Industry in Trinidad and Tobago 3 cii) Different characteristics of perfect competition relative to other types of market structure Profit Efficiency Barriers Number to Entry Type of of and Short Long Other Competition Sellers Exit Run Run Production Allocative Characteristic EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Larger Only a theoretical Perfect number No Any level Normal Yes Yes possibility Economies of scale might be Monopoly One Yes Abnormal Abnormal No No achieved None price competition Oligopoly Few Yes Abnormal Abnormal No No through branding Increased variety to cater for Monopolistic diverse consumer Competition Many No Any level Normal No No needs 3 d) An industry with a long run average total cost (ATC) which is still falling even after the entire market demand is met is known as a natural monopoly. Such industries are characterized by the existence of very high fixed cost. As such if one firm supplies the entire market average cost of production would be lower compared to if more than one firm supplied the market. In other words, there is a natural reason for this industry being a monopoly as more than one smaller scale firms would encounter higher unit cost of production than the natural monopolists. This is illustrated in figure 9-1, where the LRAC curve is U shaped reflecting the common tendency for average costs to first fall, due to cost savings arising from economies of scale, only to rise as output continues to increase due to inefficiencies that result from diseconomies of scale. Figure 9-1 : Long Run Average Costs of a Natural Monopoly EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS $ $28 $18 LRAC $8 25 50 100 120 Quantity In the figure, average cost is at a minimum when output is 120. If the market demand is 100 units, then average cost of production from a monopoly producer would be $8. If instead, two firms supplied the market evenly, then each firm would produce 50 units. The average cost of producing this level of output would be $18 which much higher than the average cost from the monopoly producer. As more and more firms supply the market average cost of production rises higher and higher. Interestingly, the telecommunications industry has in the past been considered a natural monopoly. This is because it was thought that if several firms provided this service, then each provider would have to set up its own network infrastructure consisting of cables and transmitters. As such, each firm would be faced with high fixed cost which combined with a small market share would make it unfeasible. Recent improvements in technology have significantly reduced the cost of providing this service and as such the industry is no longer featured by monopolies. 3 e i) If a firm earns abnormal profits in the short run then at the profit maximising point (MC = MR), AR > AC. This is shown in the figure where abnormal profits represented by the shaded area are earned by the firm. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS $ Abnormal profit MC AC E MR=AR Q 3 e ii) At a price of P1 firms earn abnormal profits since the point where marginal revenue is matched with marginal costs (MR1 = MC), occurs where average revenue is greater than average costs (AR>AC). Such abnormal profit, however, attract firms to the industry which causes the supply curve to shift to the right from S1 to S1. As a result, the market price falls to P2 which presents firms with a new demand curve and marginal revenue curve as shown by MR2= AR2. In this case, at the point where marginal revenue is equated to marginal costs, the firm’s average revenue coincides with its average costs. This implies that just normal profit is earned, in which case stability or long run equilibrium is achieved throughout the industry. That is to say, the number of firms in the industry is constant as there would be no new firms entering or any firms leaving the industry. Long run Equilibrium under Perfect Competition EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS Panel A: Market Price Panel B: The Individual Firm $ $ AC S1 MC D S2 P1 MR1= AR1 P2 MR2= AR2 S1 Productive S1 D Optimum Q Q 4 a i) Public goods have two main characteristics: • Non-rivalry in consumption • Non-excludability in consumption Non-rivalry in consumption means the good or service can be consumed by a group of consumers at the same time. Non-excludability in consumption means that consumers can make use of the good or service even though they do not pay it. Examples of public goods are roads are street lighting. These are provided by the government since if left to the market private producers will not provide them. This is because the non-excludability feature of public goods means that people who use public goods and services do not pay for them. 4 a ii) Externalities occur when there are third parties (those who are neither consumers nor producers of a good or service in a particular market) who enjoy spill over benefits or face spill over costs as a result of production and consumption of a particular good or service. The word spill over is used to denote the fact that the benefits and cost which affect third parties were not intended for them in the first place. An example of a spill over benefit or positive externality can be demonstrated by a consumer who buys a large exterior lighting arrangement and installs it, the house next door would benefit as it gets free lighting at night. These benefits were not really intended for the house next door but are received anyway. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS To exemplify spill over cost or negative externalities consider a household situated close to a factory which emits a lot of smoke may be faced with carbon monoxide emissions and other pollutants in and around their home. This would lead to additional cleaning and some residents may even be faced with health problems as result of the smoke which require expensive medical treatment. These costs brought on by production at the factory were not really intended for the residents but they face it anyway. 4 a iii) Asymmetric information is defined as a difference in access to relevant information by different participants of a transaction. Asymmetric information distorts decision making and causes markets to become allocatively inefficient. Take the case of an individual who offers a very old for sale at an extremely low price. If the interested buyer is aware that the car is a limited edition antique while the seller does not know this then this is an example of asymmetric information. 4b) Market Failure with Public Goods If left to the market, no private producer would be willing to supply goods and services which are non-excludability. This is because no consumer would pay them and the producer would not get any revenue. As such, the government is responsible for providing public goods. It therefore uses the money that it collects from taxes to cover the cost of providing public goods and services. 4b) Market Failure due to Externalities Market do not take into consideration the spill over cost and benefits received by third parties. This is because externalities impact third parties who are neither producers or consumers of the good in question. When there are positive externalities the market would ignore this and output would be below the allocative efficient level of output. As a result these goods are under produced. This cases a loss in welfare which means allocative efficiency is not achieved. When negative externalities exist, the market would ignore this and output would be above the allocative efficient level.Such over production causes a loss in welfare as too many resources are being used in the production of the good or service. 4b) Market Failure due to Information Asymmetry As certain participants in a transaction may have all the relevant information, while other participants may not be fully aware of all the relevant details decision making would be distorted. This especially applies to the party who has imperfect information and the end result is market failure. The two kinds of market failure due to asymmetric information are moral hazard and adverse selection. Moral harzard occurs when an individual makes a suboptimal decision or undertakes a hidden action if the other party in the transaction cannot monitor his or her behaviour all the time. Adverse selection refers to a suboptimal decision by one party in a transaction when there is a hidden attribute about a good or service which the other party is aware off. 4 c) Methods of Correcting Market Failure EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS i) Indirect Taxation. Indirect taxation can be used when there are negative externalities and the good or service is over produced. Indirect taxes cause the supply curve to shift to the left. This results in a decrease in output of the good or service. ii) Subsidization Goods and services that generate positive externalities can be subsidized. This results in an increase in production of the good or service. iii) Regulation – this can be implemented by the following measures. 1. Nationalization - under this approach the government takes ownership of the production facilities and takes charge of production. As such the government chooses to produce the quantity of output which achieves allocative efficiency. 2. A Ban on the product - with this method the government would simply put a ban on the production of the good or service which causes significant negative externalities. Examples of such goods are guns and illegal drugs. 3. A ban on the negative externality – the government can introduce regulations which outlaw negative externalities. This would force firms to find a methods to eliminate spill over cost from the production of goods and services. 5a) Definition of the four factors of Production 1. Land accounts for all the natural resources on the planet which can be used in the production process. It includes agricultural land, forestry, oceans, mineral deposits such as diamonds and petroleum and of course the geographical site where production is located. The payments made for the use of land is called rent. 2. Labour is the contribution made by workers in the production process. Labour is not homogenous though, as different labourers have different skills or physical abilities. As compensation for this effort in production, labour receives income in the form of wages. 3. Capital accounts for all man made goods used to produce other goods and services. This includes; machines, computers, tools, factories and roads. Notably, capital can be used over several years which make it distinct from intermediate goods or raw materials which are used up immediately in the process of production. Increases in the stock of capital are called investment. The return to this factor is called interest. 4. Enterprise is the factor of production which is responsible for organizing the other three factors of production. This is the role of the entrepreneur who decides how the other three factors of land, labour and capital are to be combined to produce output. The entrepreneur also undertakes risk in producing output and anticipating that it would be sold. In return for these responsibilities, the entrepreneur is compensated by profit earned by the firm. 5 b i) Marginal Marginal Factor or Units of Output per Marginal Marginal Revenue Resource Labour Week Product Revenue Product Cost 0 0 na na na na 1 14 14 3 42 18 2 26 12 3 36 18 3 36 10 3 30 18 EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS 4 44 8 3 24 18 5 50 6 3 18 18 6 54 4 3 12 18 5 b ii) AURO INC would employ 5 workers as this is where profit from the employment of labour is maximized. Under perfect competition this occurs where marginal revenue product is equal to the wage rate of labour. 5 c i) In the figure at any wage rate above $15 per hour per worker, the income effect of an increase in wages exceeds the substitution effect. A Regressive or Backward Bending Supply Curve of Labour Wage S $20 $15 S O 10 11 Quantity of Labour (hours) 5 c ii) Reasons for negative slope of supply curve - As the wage rate increases there is a substitution and income effect. As the wage rate increases this induces the individual worker to devote more time towards working and less time towards leisure. This is the substitution effect. Furthermore, an increase in the wage rate enables more income to be earned from every hour spent working and this encourages the individual to consume more leisure which is a normal good and therefore less time is devoted to working. This is the income effect. The substitution and income effect of an increase in wages work in opposite directions on the amount of hours an individual allocates to work. Over the segment of the curve with the negative slope the income effect outweighs the substitution effect which means that as the wage rate increases, less hours would be spent working, as the individual would consume more leisure. 5 c iii) Reasons for Wage Differentials. 1. Non-homogeneity of labour - The productivity of labour varies among different units of labour and as such labour compensation would differ accordingly. The differences could be intrinsic, as some individuals may naturally possess unique EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS characteristics such as physical strength or good mental abilities. As such individuals put these labour qualities to use they would be commensurately rewarded. In addition, labour may vary as a result of acquired attributes through training and education which also enhances labour productivity and results in higher wages to such workers. 2. Relative Demand and Supply of Labour - Differences in the relative demand and supply of labour in different labour markets would result in different wage rates. For instance, if the demand for labour is relatively high compared to its supply, then wages are likely to be low, whilst in the converse situation, if the demand for labour is low relative to supply, then wages would be high. 3. Non-monetary rewards. The compensation to labour could be decomposed into monetary rewards and non-monetary rewards. Monetary rewards are the contracted wage payments in money terms which are made to workers periodically. Non monetary rewards refer to non-wage compensation received by workers from a particular job. These non-monetary facets include perquisites such as housing, company cars and other benefits which are provided courtesy the employer. In addition, other factors such as the work environment, health and safety factors and job satisfaction would also form part of the non-monetary rewards obtained from working. If non-monetary rewards are relatively high, then workers may be willing to accept a lower monetary wage. Conversely, workers who receive high monetary rewards may receive relatively lower non-monetary wages. In such cases, wage differentials may appear to exist, however, in terms of the total compensation, there may be no disparity. 4. Labour Market Structure - Wage differential can also arise from differences in labour market structures. The table shows that the differences in the structure of labour markets depend on whether or not there is a monopsony or a trade union. This gives different levels of market power to the employers or workers respectively which grants greater negotiating positions in terms of determining the wages rate. Labour Market Labour Demand Labour Supply - Structure - Employers Workers Market Power Wage Rate Neither Competitive - Employers or MRP Theory Competitive Competitive Workers Market Rate Below Market Monopsony Non-Competitive Competitive Employer Rate Higher than Trade Union Competitive Non-Competitive Trade Union Market Rate Monopsony and Employer and Higher or Below Trade Union Non-Competitive Non-Competitive Trade Union Market Rate 6 a i) The poverty line, is the minimum level of income deemed necessary to achieve an adequate standard of living. In practice, like the definition of poverty, the official or common understanding of the poverty line is significantly higher in developed countries than in developing countries. Determining the poverty line is usually done by finding the total cost of all the essential resources that an average human adult consumes in one year. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS This approach is based on an assessment of the minimum expenditure needed to maintain a basically acceptable standard of living. 6 a ii) In general, poverty refers to a state of deprivation by individuals. There are two ways of measuring such deprivation. These are:  Absolute poverty - Absolute poverty measures the actual number of people within an economy who are unable to afford certain basic goods and services such as food and shelter. This occurs simply because there income is below the poverty threshold, or poverty line. According to the United Nations development program, the poverty line is US$2 per day and all individuals with an income below this threshold are absolutely poor.  Relative Poverty - Relative poverty measures the extent to which a household's financial resources falls below the average income level of the economy. For instance, if the average level of income in a country is US$10,000 per annum then an individual who earns $US6,000 per annum would be classified as relatively poor as he falls below this relative power line. Clearly a person, who is classified as relatively poor, may not be absolutely poor. 6 b) Factors which contribute to Poverty i.) Non ownership of resources – whether a person is employed or not, ownership of other factors of production such as land or capital may provide sufficient income to afford a high standard of living. Individuals who do not own these productive resources would therefore not benefit from additional income sources in the form of rent and interest. ii.) Unemployment - unemployment is a key cause of poverty, as those individuals who are not engaged in any paid form of employment have no source of income. To purchase goods and services for consumption, such individuals would have to use up whatever savings they may posses or they would be forced to depend on the generosity of relatives or friends for sustenance. Either way, the lack of income would seriously deprive them of money to buy basic goods and services and thus expose them to a life of poverty.1 iii.)Large family size – the distribution of income among a family household can also result in poverty. In large nuclear families, household income would have to be shared among a large number of children or dependents which results in each member of the family having a small amount of money for spending. iv.) Single parent, female headed family – in addition to large family sizes, poverty can be even more pronounced where the household is headed by a single female parent who has to allocate time between being bread winner and mother. This is extremely difficult challenge face by some mothers which exposes the family to a live of poverty. v.) Discrimination – this refers a most relevant issue where workers may be discriminated against in terms of employment opportunities or even promotions. This can take place on the basis of many factors such as: gender, race, religion or 1 There are many different causes of unemployment as chapter 33 highlights. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS even marital status.2 As individuals are discriminated against they are unable to maximise their full potential as a result may be faced with a life of poverty. 6 c i) A welfare programme refers to any government initiative which seeks to provide a minimum level of income or financial aid as well as other support such as access to free services for underprivileged or deprived peoples such as the poor, elderly and the disabled. Such programs are financed by government taxation revenue. 6 c ii) Government Welfare Programmes Aimed at Poverty Reduction The government can directly intervene by using its resources to alleviate poverty. This can be done by undertaking measures which tackles different aspects of poverty such as: 1. Health - the state can also reduce the burden on the poor by providing cheaper or even free access to health care. This may be either through providing free medication or free medical attention. This may also require infrastructural improvements to existing health care units and the construction of new facilities. In Jamaica the Program for Advancement through Health and Education (PATH) tackles both health and education as reasons for poverty. In Trinidad and Tobago there is the Chronic Disease Assistance Programme (CDAP) which provides free prescription drugs and other pharmaceutical items for a number of health conditions such as diabetes and asthma etc. 2. Education - This policy overcomes poverty at the source by improving the skills and hence employability of workers. Education also improves labour productivity and this result in increased wages to workers. Poverty reducing measures with respect to the provision of education include: free education, book grants, public school transportation and even school meals. In Trinidad and Tobago for instance, there is universal free provision of primary and secondary education by the state. Tertiary education is also fully subsidized to those who need financial aid. In Barbados, Tertiary education is also provided free to all persons who undertake such academic training. 3. Housing - Another measure which the government can implement to lessen poverty is the use of housing subsidies to enable low income earners to afford a home. The state can also implement housing construction projects which make use of state. In Trinidad and Tobago for instance, the Housing Development Corporation (HDC) is in charge of providing housing solutions to the citizens of that country. 4. Employment – the government can ease poverty by either creating employment or provide assistance to the unemployed. Unemployment Relief – The state can reduce unemployment by undertaking state projects which directly create jobs for the poor and underprivileged in society. In Trinidad and Tobago for instance, the government has instituted the Unemployment Relief Program (URP) and the Community Environment Protection and Enhancement Programme (CEPEP) as methods of creating employment opportunities for the unemployed. Unemployment or Welfare benefits – these are any program or initiatives undertaken by the government to provide assistance to the poor. This includes monetary grants or 2 Even person living with HIV-AIDS may be discriminated against. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS
  • EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS assistance provided to the unemployed to ensure that those without jobs are able to afford basic necessities. This would also include disability payments to those who are disabled and unable to work and must therefore rely on financial support from the state. In addition, other forms of assistance such as grocery handouts could also be offered to the most destitute in society. EDWARD BAHAW CAPE ECONOMICS PAST PAPER SOLUTIONS