CPA 3 - Economic Environment March 2021

Solution 2
(a) (i) Accounting for the survival of small scale firms in Uganda.
 Fear of losing control of the firm. Some firms remain small in size because the
owners desire to maintain control over them. The owners need to keep control
over the funds, assets and the workers and this is possible when the firm is
small.
 Interdependence of firms. Some small scale firms use inputs produced by bigger
firms. Due to the raw material inter- dependence, the small firms continue to
survive alongside large scale firms.
 Small scale firms allow for flexibility. Small scale firms give room to the owners to
easily change from less profitable business lines to more profitable ones, hence
the continued existence alongside the large scale ones.
 Production calls for simple techniques. In most cases, production in small scale
firms requires simple tools which are cheap and readily available .It therefore
becomes easy to sustain production in a small scale firm than in a large scale
firm.
 Fear of loss or risks. Large-scale firms are associated with heavy capital
investment and as a result, they are likely to suffer heavy losses in case the
business fails due to fall in prices, decline in demand and others. This
encourages small-scale firms to continue operating as per their size.
 Need to maintain close contact with the clients. Owners of small-scale firms
easily keep in touch with their customers/clients in order to know their likes and
dislikes hence remaining small.
 Some of the small-scale firms are still in their infancy. Due to small size they
have a small market and employ few workers which make them to remain small
in operation alongside large scale firms.
 Limited capital for expansion. Some firms cannot expand to become large in size
due to limited capital which makes their scale of production to remain small
making them exist alongside the large scale ones.
 Some of the firms are experimental units. This is because the production is still
on trial in order to avoid making huge losses in case of failure, they remain
small.
 Production according to special order. Owners of firms which receive small but
special orders from the customers prefer to remain small in order to serve the
needs of their customers adequately.
 Government policy of encouraging small scale firms. Small-scale firms get low
interest loans through government programs which encourages many small-scale
firms to operate alongside the large scale ones.
 Fear of heavy taxation associated with large firms. Owners of firms prefer to
keep them small in size to avoid the heavy taxes levied on large scale firms.
 Limited market for the products of some firms. These firms which serve a small
market always operate on small scale for fear of making losses in case of over
production

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  Limited managerial skills. Some people are willing to set up small scale firms that
are easy to manage due to lack of proper management ability.
 Limited managerial skills. These are associated with large scale firms such as
difficulties in supervision of many workers, embezzlement of money by workers
which scare the small scale firms into expanding.
(ii) Measures taken to promote small scale industries in Uganda.
 Improve labor skills through training. This has increased labor efficiency in the
small scale firms for instance programs like harvest money.
 Development of infrastructure. Roads for instance have been improved and new
ones constructed so that movement to markets and raw material sources is easy.
 Development of entrepreneurial skills. This is taking place right from high school
where Entrepreneurship is taught as a subject to students. Programs like
PAKASA are intensified which assist in passing on skills in an informal nature to
interested parties.
 Control of inflation. This has reduced the cost of production thus increasing profit
margins of the investors which is a further attraction for business.
 Reformed land tenure system. This has made it easy for people to access land
for setting up small scale firms.
 Widened markets. More goods can now be sold in the East African Community
where Uganda is a member and also reducing the subsistence sector by
monetizing the economy, plenty can be sold to earn incomes for the small scale
firms.
 Provided affordable credit to investors. Loan funds have been provided to enable
investors buy inputs to sustain production.
 Reduced conservatism. The public has been sensitized to embrace modern
production techniques which have increased output, sales and profits.
 Encouraged savings. People have learned and appreciated the saving culture
which has made available initial investment capital for the small scale firms.
 Maintained political stability and security. The economy is relatively secure and
politically stable which is an inducement for small scale firms to operate in large
numbers.
(b) Negative effects of Economic dependence.
 Promotes laziness. This is because people always expect to receive support from
other countries and for that matter they do not bother to work hard.
 Leads to increased capital outflow. This is as a result of the high expenditure of
foreign exchange on debt servicing where there is a high dependence on foreign
capital.
 Leads to loss of the country’s sovereignty. Other countries especially the donors
make decisions both economic and social which are not good for the country but
benefiting the donors.
 Discourages the exploitation of local resources. Most of the resources are
acquired externally, which makes it very difficult to exploit the country`s own
resources that are available.

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  Leads to unemployment. This arises due to the use of inappropriate technology
which is capital intensive, yet Uganda is a labor surplus economy.
 Leads to cultural erosion. The local people adopt foreign cultures and discard
their own and sometimes the mixture is not good.
 Leads to brain drain. Some people who undertake training in the foreign
countries which provide the technical aid do not come back after training which
increases the skilled labor deficiency in Uganda.
 Distorts planning in the country. This arises from the fact that external resources
are usually inadequate and at times they are withdrawn before project
completion.
 Leads to balance of payments problems as a result of increased capital outflow.
 Leads to fluctuations of incomes of the producers especially in the agricultural
sector where prices keep fluctuating on the world market.
 Leads to poor terms of trade due to low prices of agricultural products which are
the main exports on which Uganda depends.

Solution 3
(a) (i) Causes of structural inflation in Uganda.
 Breakdown in infrastructure or industries. Breakdown in the road network makes
it difficult to transport goods from areas plenty to areas of scarcity in different
seasons leading to constant increase in prices.
 Shortage of raw materials. This leads to production of insufficient quantities that
do not satisfy the prevailing demand hence constant increase in prices.
 Shortages in foreign exchange. The foreign exchange is required to import either
raw materials used in production or finished goods to supplement the domestic
output. The importing of these items cannot take place where there is foreign
exchange shortage. This creates scarcity and rising prices.
 Speculation by businessmen. This creates shortages by hoarding of the available
goods which creates excessive shortage of goods compared to the demand for
them, hence structural inflation.
 Political instability. Wars and insecurity disrupt and destroy the production
capacity of an economy leading to a persistent reduction in the goods and
services produced followed by increase in their prices.
 Unfavorable natural factors. Due to bad weather conditions like drought, pests,
diseases and floods, low output is produced that creates scarcity and persistent
increase in prices.

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 (ii) Solutions to structural inflation in Uganda.
 Agricultural modernization. By introducing better methods of farming for
example using irrigation, introducing better varieties and diversifying
agriculture, prices of food items are kept stable.
 Improving the political climate. This enables the production of goods to go
on without interruptions throughout the year, which increases supply and
lowers the prices.
 Importing of enough raw- materials. This creates a reliable supply of the
raw-materials to sustain ongoing production by firms hence lowering
prices in the long run.
 Adopting better methods of production. This is more needed in the
agricultural sector and industry accompanied with research to bring out
quick maturing breeds and varieties so that output increases to
correspond with demand and the prices reduce.
 Encouraging private local and foreign investors. Through the policy of
Liberalization, private investors come on board and increase supply of
goods and services leading to eventual reduction in prices.
 Establishing new industries and rehabilitating existing ones. This increases
domestic supply of industrial products leading to reduction in their prices.
 Infrastructural development. This helps to expand production in all areas
and sectors which leads to high supply hence lower prices in the long run.
(b) (i) Reasons for Liberalisation of trade in Uganda.
 To increase employment opportunities. As more and more firms and
people engage in trade of a country, more labor is hired in all the different
stages of production and distribution .which generates plenty of employment
opportunities for the people.
 To increase the levels of output. Many people join the production process
with trade liberalization which increases output in the country leading to
higher rates of economic growth.
 To control structural inflation. With many people participating in production
and trade, the aggregate supply of products increase which minimizes
structural inflation.
 To improve balance of payments position. Through trade liberalization
exports are encouraged which earn for the country increased foreign
exchange that eases the balance of payments problem in the country.
 To improve relations with other countries. Donors and trading partners get
more interactions and trade deals which strengthens the international
understanding and co-operation and the volume of goods and benefits from
trade.
 To avail a variety of goods and services. These come from the increased
participation of traders in all types of products which increases the choices of
consumers and improves their standard of living.

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  To reduce income inequality. Since everyone is free to participate in trade,
those regions and people that were previously excluded can now earn income
and reduce the disparity between the rich and the poor.
 To stimulate innovations and inventions. Liberalisation leads to high
competition which compels producers to make inventions and innovations
that lead to technological development and technological transfer which lead
to increased levels of output to be traded by the participants.
 To promote entrepreneurial skills development. The constant economic
interactions between many traders improves the managerial, communication
and computing skills of the people involved.
 To improve the quality of goods and services. The competition among the
producers, this forces firms to be efficient and supply high quality products in
order to remain in business.

(ii) Measures to improve terms of trade in Uganda.

 Processing of primary products to add value. Uganda should add value to her
agricultural products by making them final consumer goods in order to increase
their prices in the world market which improves the terms of trade.
 Strengthening of commodity agreements. This increases the quota allocation of
the commodity that a country is to put on the world market at any one given
time hence improving the income terms of trade.
 Importing from cheaper sources. Uganda should go in for the policy of importing
especially capital goods and intermediate goods from cheaper sources so that
the exchange becomes relatively fair.
 Stabilization of the foreign exchange rate. Foreign exchange authorities should
interfere with foreign exchange markets to stabilize it through selling foreign
currency. As the local currency loses value the government should discourage
importation of non essential goods from abroad.
 Negotiating for removal of barriers in the export market. The unnecessary trade
barriers on exports should be removed to allow for increased gains from
international trade.
 Establish import-substitution industries .Uganda should establish and expand
local industries which produce what has been formerly imported expensively
from other countries. This helps to improve terms of trade.
 Diversify exports. This minimizes fluctuations in prices and incomes from exports
and where there is a fall in price of one type of product, it is compensated by a
rise in price of another.
 Improving quality of exports. This attracts more international buyers and the
exports can then be sold at high prices.
 Diversify markets for exports. Through regional economic co-operation, demand
for the exports increase and more volumes are sold hence improving the terms
of trade in the country.

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Solution 4
(a) (i) Demerits of a free enterprise economy.
 There is consumer exploitation. The stiff competition leads to intensive
advertising which tends to mislead the consumers, robs them of their freedom of
choice and increase the price through raised cost of production.
 Promotes misallocation of resources. Since there is no centralised planning,
resources are allocated to areas where profits exist, which may not be in areas of
goods that benefit society.
 Leads to wasteful competition. Since there are many producers and they all aim
at maximizing profits, this leads to duplication of activities and wastage of
resources.
 The system makes it hard to cope with rapid structural changes. Some changes
may occur in the economy brought about by wars, floods, famine and many
others, but because there is no regulatory body people suffer because of the
forces of demand and supply operated economy
 Leads to income inequality. The private ownership of property makes some
individuals to get a lot of money and wealth while the poor ones without
property grow poorer with time.
 Over exploitation of resources. In an effort to maximize profits, producers tend
to overuse resources at the expense of society. For instance, over fishing by the
private individuals for maximum profits leading to extinction of some fish species.
 Leads to unemployment. This arises where firms choose to reduce output in
order to sell at high prices or use capital intensive techniques to lower the labor
costs. Also inefficient firms are outcompeted rendering their resources including
labor unemployed.
 Leads to price instabilities. Since there is no government interference to stabilize
prices, whenever there is over or under production, prices fluctuate which
disorganizes future production plans of firms.

(ii) Ways of increasing the supply of entrepreneurs.

 Education and training. More people can be trained to acquire entrepreneurial
skills by setting up many institutions that pass on the knowledge and skills of
entrepreneurship. For example entrepreneurship as a subject is now being
taught in secondary schools right from senior one.
 Encouraging the exploitation of the naturally given ability of entrepreneurs. Some
individuals are naturally endowed with enterprising skills but just need slight
motivation to exploit that potential. National and international competitions can
be carried out to increase the supply of entrepreneurs.
 Government extending subsidies and tax exemptions. These policies have the
effect of increasing the supply of entrepreneurs since they offer prospects of
high profit margins to the concerned individuals w take risks to invest in various
ventures.

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  Availing capital and other resources. Capital is regarded as the engine of growth
of virtually everything and some individuals may have the skills and knowledge of
entrepreneurship but lack capital to transform their ideas into business ventures.
 Reducing conservatism. Cultures, traditions and religious beliefs should be
relaxed to accommodate change so that some people especially women are
bailed out of the bondage of conservatism in their societies and they become
empowered to carry out investments. This increases the supply of entrepreneurs.
 Expanding /widening market for products. A big market for products attracts
many individuals to engage in business since there is an assurance that the
products will be sold, to generate income. Therefore creation and sustaining of
more markets for the products increases the supply of entrepreneurs in an
economy.
 Increasing the level of economic development. More economically developed
nations tend to have bigger supply of entrepreneurs. Uganda should intensify the
programs aimed at attaining higher levels of economic development which goes
together with increased supply of entrepreneurs.

(b) When is labor in Uganda paid a low wage?

 When labor is unskilled with no specific training for certain jobs Employers can
take advantage of the unskilled labor to pay low wages since their supply is
elastic and can be obtained at any time even at low wages.
 When the work done by workers is low. Workers may be paid low wages when
the system of payment is according to the piece rate method and a worker has
done small amount of work.
 Where workers offer few hours of work. The wage rate payable to workers who
give in less time is usually low as it has to be line with what the worker has
offered.
 When workers do not possess special talents, skills or gifts. Workers who are
ordinary may be paid low wages since they have nothing special to offer to the
employer.
 When workers have low bargaining skills. Workers who are not assertive to
bargain seriously with the employer may be paid low wages since the employer
pays what he feels the worker deserves
 When employers do not have adequate financial ability. Workers of poor firms
and poor employers may be paid low wages since the employers are either
unable to pay or unwilling to offer high wages.
 Where workers live in areas where the cost of living is low. Workers living in
areas with a low cost of living may be paid low wages since they do not need a
lot of money to maintain a decent standard of living.
 When it is government policy. In the public and civil service, the government
pays workers of certain grades and certain occupations low wages and it is not
questionable.

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  When there is discrimination in the labor market. Some workers may be paid low
wages basing on their sex, religion or social status because they are not favored
by the employer.
 When workers have low levels of experience or expertise. Workers with fewer
years of working experience may be paid low wages compared to their
counterparts who have more years of working experience and have become
experts at what they do.

Solution 5
(i) Multiplier =1/ MPS.
=1/30/100.
=3.33
(ii) New level of income=Initial income + change in income.
=200x3.3= shs666 million+200=866 million.

(b) Dangers of income inequality.

 Results into low demand for goods and services. This is because the low income
earners who are the majority cannot afford to buy large quantities of goods. The
small market fails to support large scale production which discourages large scale
investments.
 High income inequality leads to rural-urban migration and its associated evils.
People especially the youth move from rural areas to towns looking for better
earning opportunities which leaves the rural less developed.
 High income inequality results into exploitation of the poor by the rich. The poor
who tend to be working for the rich have a low bargaining power and employers
take advantage of them to pay low wages since the poor cannot easily get
justice and are subjected to poor working conditions.
 Inequality results into low government revenue. Where a bigger part of the
population is poor, they have low taxable capacity and less ability to pay taxes
imposed on them.
 It results into political friction and tension. This is because the poor blame the
government to be the major cause of their plight.
 It leads to high dependence burden in the country. This is because the poor rely
on limited resources from relatives or the government in order to survive which
strains the budgets respectively.
 High income inequality leads to brain drain. The poor people tend to move to
other countries in search of employment that can pay them high incomes. This
drains the economy of the much needed skilled labor.
 Apathy towards development among the poor emerges instead of hard work.
This is because the low income earners tend to lose hope and the zeal to work
due to their poor conditions of living.
 The rich engage in lavish expenditure especially those goods of snob appeal that
are imported into the country. This leads to balance of payments problems since
there is too much expenditure of the foreign exchange on the expensive imports.

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  The poor are faced with low standards of living since they cannot access the
basic goods and services like safe water, food and good sanitation.
 High income inequality results into social classes in the economy. Creation of
classes made up of the rich and the poor breeds a lot of disharmony and tension
between the two groups.

(ii) Measures to widen the taxable capacity in Uganda.

 Increasing the levels of income of the tax payers. In situations where many
people have high income it leads to a high taxable capacity than when most
people are low income earners.
 Improving the distribution of incomes among the people. Where many peoples’
incomes lie below the taxable bracket, it leads to low taxable capacity .There is
therefore need to bring about a more equitable distribution of income so that
most people can afford to pay the taxes.
 Increasing the employment level in the country. High levels of employment avail
many people with taxable incomes which widens the taxable capacity.
 Improve the attitude of the people towards taxation. The negative attitude of the
people towards taxes needs to change through sensitization of the masses about
the benefits arising from paying taxes by individuals. People should stop
regarding the payment of taxes as a punishment and begin to pay taxes
willingly.
 Reducing the high level of tax evasion and tax avoidance. Taxpayers need to
appreciate the benefits of paying taxes when they see many good roads being
established, good health services and good education This entices them to pay
taxes hence widening the taxable capacity.
 Create a good political will among the people .This makes the public happy with
the government and they eventually declare their incomes and other wealth.
Smuggling also reduces eventually and this increases the country’s taxable
capacity.
 Reduce the size of the subsistence sector. A high level of commercialization
makes it easy to assess the tax liability of individuals and businesses leading to
higher taxable capacity since many products reach the market and get taxed.
 Reduce corruption among the tax officials so that they stop helping tax payers to
falsely reduce their tax liability in exchange for small amounts of bribe money,
which lead to loss of government revenue and narrow the tax base and taxable
capacity.
 Increase the level of industrialization in the country. Creation of many industries
increases the taxable capacity as the industrial sector does not experience high
price fluctuations like the predominant agricultural sector which avails low
incomes to farmers and reduces the taxable capacity.

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Solution 6
(a) The ways in which unemployment affects the economy of Uganda.
 Unemployment causes a reduction in aggregate demand for goods and services.
This is so because the unemployed have no incomes of their own to support
effective demand for the goods and services. The producers therefore cannot
expand their production as the market is small which hinders investments and
economic growth.
 It leads to brain drain. This is where the highly skilled and professional labor that
remains unemployed leave the country for jobs in other nations. This deprives
Uganda of the skilled labor force which is badly needed.
 Increases government expenditure .Government pays a lot of subsidies to
investors and spends on improving infrastructure in order to encourage investors
create more jobs. Not only that but also providing social services equally among
all the people even those who do not pay taxes because they are unemployed.
 Unemployment worsens income inequality. This is because the unemployed who
do not earn any income and cannot invest become poorer while the employed
become richer. This income gap continues widening with time.
 People lose interest in education. Investment in education is discouraged
because people do not see the value or benefits of going to school when they fail
to get jobs thereafter.
 Leads to rural urban migration. The rural dwellers that are unemployed migrate
to urban areas with a hope of getting jobs in the towns only to be disappointed
and end up creating the large number of the urban unemployed instead.
 It causes instabilities in families. The unemployed cannot adequately provide
what is needed in their families and this makes the family members dissatisfied
and unhappy which increases social unrest.
 Unemployment lowers the general standard of living of the people .The
unemployed who do not have money cannot afford the basic requirements of life
such as food, clothing, and medical care. This ends up frustrating many of them,
others are stressed and depressed and the rest may suffer from quick death
because of no incomes and limited means of s of sustenance.
 Leads to decline in skills of individuals. This is because the unemployed are not
practicing and sooner or later their acquired skills and knowledge disappear or
become outdated.
 Leads to high dependence burden. The few individuals employed have to support
many unemployed which lowers their welfare and standard of living. It also
affects the savings of the people on whom the unemployed depend leading to
low investments and output in the country
 It increases the crime rate in the country. The unemployed in a bid to survive
resort to robbery, prostitution and drug thefts as ways of making ends meet.

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(b) Limitations of the quantity theory of money.
 The four variables M, V, P&T are not independent of each other as the theory
assumes. This is because a change in one of the variables is bound to induce or
influence changes in the others.
 The theory ignores other causes of inflation such as costs of production which
may cause inflation .Such causes may be increase in costs, ever rising demand or
even reduction in the supply of goods and services which result into rising prices.
 The theory assumes a general price level which is not realistic. This is because
there are a series of price levels where different commodities have different
prices which increase at different rates.
 The assumption of constant velocity of circulation of money and volume of
transactions are wrong. These two usually change as soon as there is a change
in the volume of money in an economy.
 Theory ignores barter trade. Some transactions in the economy are carried out
using barter system of exchange which does not affect the general price level at
all.
 The theory does not take into account government control over prices. In some
economies as the quantity of money increases, government steps in to control
the increase in price by legislating maximum price controls and this leads to
steady prices despite the changes in money supply.
 Theory does not explain how the value of money is determined, but only
attempts to explain how changes in the value of money are brought about.
 Theory only considers the transactions motive of holding money There are other
reasons for holding money in cash form like for precautionary purposes and for
speculation but not only for day to day purchases.
 Theory ignores the effects of interest rates on loans and the supply and of and
demand for money. The quantity of money may increase but when the interest
rate is high, borrowing is discouraged which keeps prices stable.
 Theory ignores the existence of idle resources. When a country has many
unemployed resources, an increase in money supply can stimulate producers to
use these idle resources and produce goods and services. This increased output
can keep the prices at the same level or prices may even reduce.
 The theory ignores the existence of a high marginal propensity to save. This is
because the quantity of money may be increased but people save a lot of it
making it difficult for prices to increase.
 Theory is not a theory at all but a truism. It simply confirms the relationship
between quantity of money supplied, velocity of circulation, level of transactions
and the general price level, but never explains how these determine the value of
money.

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(c) Features of the informal sector in Uganda.
 It is dominated by small scale firms. Many activities in this sector are mainly of a
small scale nature owned by low income earners.
 Production is mainly for the domestic market. This is because the products are
made for low income earners and are made using low levels of technology
making them unfit for the international market.
 Produces mainly consumer goods ready for the use of the final customers.
 Produce mainly low quality output. This is due to the poor methods of production
employed that are simple and within the reach of many operators.
 Uses mainly unskilled and semi-skilled labor. This arises out of the fact that many
Ugandans have low levels of education and this makes them a cheap source of
labor for the sector.
 Produces mainly low quality products. This is due to using poor methods of
production which are inefficient and the labor which is also lacking some skills.
 They use mainly simple tools and plenty of labor. That is why the output from
this sector is still low and of poor quality.
 They use local resources. These resources are affordable and readily available to
be used by the sector.
 The sector is dominated by sole proprietorships. Many of the activities in the
sector belong to individuals or families from which they draw the labor which in
most cases is not paid.
 There is limited or no book keeping. That is why it is difficult for government to
tax them properly.
 There is shortage of appropriate shelter. Most producers operate from temporary
shelters or in the open which inconvenience their activities.
 There is limited government control over the sector. This is because of lack of
permanent structures for most of them from where to operate making it very
difficult for government to trace their locations and assist them accordingly.

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