Economics Text Merged

ECONOMICS
What is Economics?
There is no precise definition of economics, in fact there has been a great deal of controversy among
economists about nature and scope of economics.
In general terms, economics may be defined as the study of how man allocates the scarce resources in
order to satisfy his unlimited wants. Therefore, economics centres on the problem of how best man
can make effective use of the available resources and distribute the output amongst different
economic activities.
Various people overtime have tried to define economics although the different consideration, these
definitions include.
1. The early definition. According to this, economics was defined as an art of house hold
management.
2. Definition of the classicals. These may include Adam smith (1723-1790). He defines economics as
the art of managing resources of people and those of government.
3. John Stuart Mill. He defines economics as the practical science of production and distribution of
wealth.
4. Definition of Neo-classicals. These were led by marshal and define economics as the study of
mankind in ordinary business of life.
5. The modern definition of economics (scarcity definition of economics). This is the modern and
generally acceptable definition of economics and was stated by Lord Robin. It states that
“Economics is a science which studies the relationship between ends and the scare means which
have alternative uses” i.e. it is a social science which studies how best man can allocate scare
resources so that he can satisfy his unlimited wants. From Robin‟s definition, the following can be
observed.
1. Ends of human wants to which resources put are various or unlimited.
2. Material means of achieving these ends limited i.e. means of production available (land, labour and
capital) to society for satisfying wants of its people are limited.
Muhinda Richard Economics notes 2018 1

3. Resources are capable of being put alternative uses e.g. labour performs in different
4. All ends of human wants are not equally important. Some wants are more urgent and pressing than
others. This therefore necessitates making choice.
Choice making requires putting various wants in the order of their important ones for their
fulfillment first. This involves making a list of wants called a scale of preference.
WEALTH
What is wealth?
Wealth is a stock of goods existing at given time which is scarce, possesses utility, has an exchange
value and the ownership is transferable.
It therefore has the following features/characteristics(only 4)
1. It must be scarce i.e. It should be limited in supply and not easily got.
2. Should possess utility in that it must be able to satisfy human needs.
3. It must have an exchange value/price
4. Ownership should be transferable from one individual owner to another e.g. cars, T.Vs, personal
houses.
Forms of wealth
1. Personal wealth/private wealth. This consists of personal wealth and other forms of stock that
satisfy the individual owner e.g. TVs, personal horses etc.
2. Business wealth. This consists of the amount owned by a firm(s) basically to make
economic/commercial profit. This consists of premises, plants, business stock etc.
3. Social wealth/Public wealth. This is also referred to as public or collective wealth
It consists of resources that are owned by the state/government and are meant for the good of all
citizens e.g. roads, dams etc.
TO REMEMBER

Think of it this way, when you are trying to make money/become wealthy, you first have your
personal wealth/private wealth, then after as you socialize with people you learn or can even have
social wealth and after all that finally when you interacting with business organizations, you get to
really understand or even have business wealth.
Forms/
classes
/types
Personal wealth
Social wealth
Business wealth
Why do we study economics?
1. To further our academic and professional studies.
2. *To know what takes place in the business world.
3. To encourage effective participation in the process of development of the economy.
4. *To know how scarce resources can be put to better use.
5. *To understand basic economic concepts and principles so as to acquire basic skills that will help
one to be prepared to face challenges.

6. To understand and appreciate economic problems of society and to be able to interpret these
problems and possibly advise government and policy makers on how to go about the problems
and other development issues. (in simple words, to understand and find solutions to economic
problems in society)
ECONOMICS AS POSITIVE AND NORMATIVE

Positive economics is the approach which means statements that are objective and can only be
obtained from unbiased data/facts e.g. a statement like in the 1970s Uganda‟s industry sector
performed poorly. This is a positive statement because there are facts to support it.
Normative economics is the approach which makes statements that include value judgment and
opinion not necessary based on objective facts.
Positive economics involves the study about what the world/economy is/was. Normative economics
describes what the world/economy should be/ought to be. Economists disagree on most normative
statements but agree on most positive statement.
In other words, positive economics has statements which has statements based off from facts to
support those statements while normative economics has statements based off from opinion.
MACROECONOMICS AND MICROECONOMICS

Microeconomics
This is concerned with the study of economics behaviour of individuals/small groups /units which
cover a small section of the economy.
It is concerned with the study of firms, households, wedges determination, distribution of goods and
services, allocation of resources, price determination etc.
Macroeconomics
• This is the study of the economy in aggregate or as a whole i.e. it is concerned with those
variables or aggregates that affect the economy or nation as a whole- The variables include among
others: -

Inflation
• National income
• Economic growth
• International trade
• Unemployment
• Distribution of income.
Which cover the whole economy as one functioning unit?
BASIC CONCEPTS USED IN ECONOMICS
WANTS. These are the desires or needs of man. They are categorized into material and immaterial
wants. Material wants are satisfied by tangible goods i.e. those that can be seen e.g. shoes, cars,
sugar, trousers etc. whereas immaterial wants are those satisfied by intangible goods like
entertainment, professional services e.g. teaching.
Wants are material or immaterial human desires.
Categories of wants
A. Material human desires- are tangible goods/goods an individual requires for direct use
B. Immaterial Human desires-are intangible goods/goods an individual requires for indirect use
C. RESOURCES. These are called factors of production. They include natural man made and human
resources i.e. they involve what is required to produce goods and services to satisfy human needs.
Resources are factors used in the production of goods
They are classified as natural,man made and human resouces
D. COMMODITIES. These refer to things that are produced by factors of production and are
consumed by man to satisfy his needs/wants.
Commodities are goods produced using resources and are consumed by man to satisfy his needs or
wants.
E. Goods. These are tangible things which satisfy human wants.
TYPES OF GOODS
1. Free goods. These are commodities which exist in natural abundance and are enough for
everyone to consume as much as they want at zero cost e.g. Air, sunshine, rainfall.
2. Economic goods: An economic good is that which is scarce in relation to its demand and the
consumption involves cost i.e. consumers pay for it and it commands a price in the market. An
economic good therefore has the following features/characteristics.
1. It is scarce i.e. limited in supply
2. It has value i.e. obtainable by paying a price.
3. It has utility i.e. it must provide satisfaction to the consumer
3. Private goods: A private good is a commodity or service which provides satisfaction or benefit to
an individual who owns/pays for it. It is excludable in that the consumption by one/consumer
prevents consumption by other consumers e.g. cars, clothes.
4. Public goods: A public good is that which when provided for a particular group or individual
becomes available for others to use at zero/no extra cost and the consumption by one person does
not reduce the amount available for others to use e.g. defence, roads, street lights.
They are characterised by the following

1. They are not divisible i.e. the good/service is provided in totality e.g. defence, roads etc.
2. There is no rivalry in consumption i.e. there is no competition in consumption. One can increase
consumption without reducing consumption of others.
3. One cannot be excluded from consumption. It is difficult for the supplier to exclude someone who
does not pay for the commodity or service from enjoying it e.g. defence.
5. Merit goods: They are those goods consumption of which is deemed intrinsically desirable (are of
high social value) and are meant to improve the quality of life of the people e.g. safe water, medical
health care, education.
6. Intermediated goods: These are goods supplied by one firm to another or those available but still
have to go through the production process i.e. they are not ready for human consumption.
7. Final goods: These are goods that have successfully gone through the production process and are
ready for human consumption or use e.g. shoes, bread etc.
8. Demerit goods: These are commodities which when consumed are harmful to the lives of the
consumers.
PRINCIPLES OF ECONOMICS
Principles of Economics explain the fundamental economic problems of man and these are: scarcity,
choice and opportunity cost/real cost.
People are always in need to satisfy their needs but resources to satisfy them are not enough/scarce
and because they are not enough, human beings have to select form the available alternatives in
order to satisfy their unlimited wants. However selecting means foregoing something else or
opportunity cost.
(a) Scarcity. This is the limitation in supply in relation to demand . All things are in short supply
relative to people‟s desires for them, people‟s wants are many but the resources for making all
the things they need themselves are limited in supply, because of scarcity in relation to unlimited
wants, choice becomes essential.
(b) Choice: This is the preferential determination between ends. Or
It is the taking of the right decision/alternative from existing set of possibilities for the best satisfaction
of individuals or social interest. If all things are scarce relative to the desire for them and if people have
many unsatisfied wants and the means exist for satisfying only a few of these wants, it is obvious they
can‟t satisfy all of them. Therefore they must make a choice. The problem of scarcity and choice leads
us to yet another concept i.e. the concept of opportunity cost/real cost.
(c) Opportunity cost/real cost. Opportunity cost is the second best alternative foregone when a
production or consumption decision is made.
It is also referred to as real cost. Since resources are limited, it implies that the production of one
commodity involves not producing, something else and going by the same logic the consumption of
one product means going without others.
SCARCITY, CHOICE AND OPPORTUNITY COST AND THE PRODUCT

POSSIBILITY FRONTIER/CURVE

The three fundamental problems i.e. scarcity, choice and opportunity cost can be illustrated using the
PPF/PPC curve.
The PPF curve is a locus of points showing all possible combinations of two commodities that can be
maximumly produced when all resources are fully and efficiently employed.
Or
It is the curve showing the maximum production possibilities for two commodities given the resources
available to produce them.
It is drawn basing on the following assumptions.
(i) Resources are fixed /constant.
(ii) The level of technology is fixed /constant.
(iii) Each unit of the resources is homogeneous (similar)
(iv) Only two commodities can be produced using the given resources.
e.g. assuming a country like Uganda utilized all its resources to produce food and cloth, the PPF curve
would appear as shown below. Product possibility frontier (PPF)
Food
3
F a D
(kgs) F
2

PPF curve
C
F1 b
0 C1 C2 C3 cloth (m)
The graph above shows that the country can produce OF, kgs of food or OC3 metres of cloth or
various combinations of food and cloth.
The PPF curve may also show the following economic concepts.
1. Scarcity and Choice: Resources are scarce and the country cannot produce beyond its PPF using
fixed resources e.g. In the graph to produce extra cloth, C 1 C2 more metres of cloth you reduce the
production of food by F2 F3, the reverse is true for producing more of food hence, the need to
choose between the choice can be shown where if OF, of food is produced, cloth will not be
produced.
Therefore there is need to make a choice about which amount of food and cloth to produce.
2. Opportunity cost: This is illustrated by the movement along the PPF curve e.g. from a-b, to
produce C1C2 more metres of cloth, you forego F 2 –F1 kgs of food. Therefore the opportunity cost of
producing C1 C2 metres of cloth is F2 F1kgs of food.
3. Efficiency in production: Points F3, a, b and C3 show efficient utilization of resources C shows
inefficiency as there is still room for improvement while point D is not attainable using the
available resources.
SHIFT OF THE PPF CURVE
Food
1 PPF PPF2
Cloth
The shift of the curve from PPF1,-PP2 indicates an increase in output (economic growth). The causes of
the shift outwards are.
1. Increase in size of the labour force.
2. Increased workers efficiency or skills and this could be through training.
3. Improvement in technology.
4. Discovery of new natural resources.
5. Increase in capital inflow. This could be through foreign aid/direct foreign investments/grants etc.
6. Improved entrepreneurial abilities.
Importance of the opportunity cost concept

1. It is used by producers in making production decisions e.g. whether to use labour intensive
techniques or capital intensive techniques or produce consumer goods or capital goods.
2. It is used by consumers in making their consumption decisions.
3. The concept is used in pricing of goods and services.
4. It is a basis of planning by government e.g. whether to construct schools or construct roads,
whether to fund defence or agriculture etc.
5. It is also useful in determination of prices of factors of production.
6. It is used in the principle of comparative advantage in international trade. I.e. countries should
specialise in the production commodities where they have the lowest opportunity cost.
QUESTIONS THAT ECONOMICS SEEKS TO ANSWER
Faced with the problem of scarcity, every society must find ways of rationing the available resources
among the people who want them. In order to do this there are 5 fundamental questions that must be
answered and these are:-
1. What to produce using available resources. Due to scarcity of resources which are regarded to
be at hand at any given period of time, the decision of what to produce induces a lot of sacrifice
i.e. whether to produce consumer good or capital goods etc.
2. How to produce decision: Having decided what to produce, then society must decide how its
resources are to be combined to produce these goods and services i.e. the technique to use in
production. Whether to use labour or capital intensive techniques.
3. When to produce decision. The simplest question societies have to answer is choice of whether
production should be for present consumption or whether to delay production so as to have
more goods and services in future.
4. Where to produce. This involves deciding where to locate production units or firms, whether to
locate them near the market, raw materials, transport routes etc.
5. For whom to produce. Society must make decision about who must consume the goods and
services produced e.g. the rich or poor, urban or rural consumers.
ECONOMIC SYSTEMS
An economic system is defined as a system of ownership and allocation of resources of a country so as
to achieve major developmental goods. In an economic system, the what, how, where, and for whom
to produce as well as choices are made differently in societies in different ways Basing on this the
major economic systems are:-
1. The free enterprise/market/capitalistic economy.
2. The command/centrally planned economy.
3. The mixed economy.
The free enterprise/market economy

This is commonly described as laissez – faire or capitalistic system
This is an economy where productive resources are owned individually and the allocation of all
these productive resources is by the free inter-play of the market forces of demand and supply.
Characteristics/features of the market economy
1. There is private ownership of wealth i.e. resources are owned by private individuals.
2. Existence of competition among producers and consumers in both factor and output markets
respectively.
3. There is limited or no government interference especially in resource allocation and decision
making.
4. Forces of demand and supply are left to correct imbalances in the market i.e. there is great reliance
on the price mechanism in allocation of resources.
5. There is freedom of choice and enterprise.
6. Self-interest is the dominating motive in all undertakings.
7. Productive is for profit i.e. the aim of the producer is to make as much profit as possible.
Advantages of the market system

1. It is a cheap system because of the automatic allocation of resources using the invisible hand and
there is no need to employ an external body to monitor the process of production as production is
determined by the consumers wish.
2. This ensures that consumers sovereignty. Price mechanism indicates wishes of consumers and
allocates the productive resources accordingly.
3. Efficiency in production is achieved through the profit motive.
4. Completion in production encourages creativity and innovativeness.
5. Quality of final goods is high because of increased competition.
6. Consumers may buy goods at lower prices. This is as a result of competition between producers in
the market.
7. There is limited wastage since production is according to demand.
8. Wide variety of goods is availed to consumer. This because of product differentiation.
9. Idle resources are exploited. This results into creation of more employment opportunities.

Disadvantages
1. Vital public goods such as defence, justice, roads etc. and merit goods e.g. Education, safe water
etc. cannot be adequately provided through the market system. This is because they are not very
profitable.
2. Consumers with more money have the greatest pull in the market and as a result resources are
devoted to production of goods of ostentation or the rich to exclusion of the majority poor.
3. Private monopoly tendencies crop up and with such monopolists, consumers are exploited.
4. Competition its self sometimes leads to inefficiency and waste due to duplication of goods and
competitive advertising.
5. Some resources remain idle while others are over exploited leading to their quick exhaustion.
6. Inequality in society worsens due to lack of regulatory bodies.
7. There is failure to cope with rapidly changing situations since there is no any other regulatory body
other than the market forces to moderate the economic variables.
8. Problems of economic stabilities crop up. These instabilities include, price instabilities,
unemployment and under employment, balance of payments instabilities.
The command/planned hand economy

This also referred to as the controlled/centrally dictated economy. It is an economic system where by
the state or centrally appointed body dictates what to produce and directs the factors of production
accordingly.
Characteristics/features
1. There is existence of planning by the central planning authority.
2. There are no private investors since all investments are publically undertaken.
3. Production is for use rather than for profits since emphasis is on welfare and not commercial gains.
4. Decisions pertaining economic activities are handled by the central planning authority.
5. Economic or productive resources are publically owned.
6. There is limited competition.

Advantages
1. It ensures that adequate resources are devoted to production of community or public and merit
goods.
2. It eliminates the deficiencies that tend to result from meaningless competition.
3. Resources are not wasted because of the planned use of those productive inputs.
4. It uses monopoly powers in the interest of the public e.g. by securing the advantages of large scale
production rather than make maximum profits by restricting output.
5. It takes into consideration uneven distribution of wealth and incomes when planning what to
produce and in rewarding producers.
6. More employment opportunities are provided as the government tries to improve welfare.
Disadvantages
1. May officials are required to estimate and to direct factors of production accordingly and this
results into high costs of administration.
2. There is Bureaucracy usually associated with the system that leads to delay in production and
planning
3. There is inefficiency in production due to absence of competition in production.
4. Limited variety of goods is produced as government‟s interest is producing necessities of life.
5. Quality of final goods and services is rather low due to work to lack of competition.
6. The system is disincentive to produce or individual Initiative.
THE MIXED ECONOMY SYSTEM
The mixed Economy system is one where both private individuals and government own resources and
the allocation of these resources is by both the market forces (demand and supply) and central
authority.
It is system that has the features of both free enterprise and planned economy.

Characteristics
1. Ownership is by both private individuals and the state.
2. Economic decisions are made by both the state and private individuals.
3. Production for both profit and welfare maximization or use.
4. Allocation of resources is by both market forces and the central body.
5. There is regulated competition in production and consumption.
6. There is co-existence of private and public sector.
Advantages
1. There are limited social evils such as exploitation and unfair distribution of wealth.
2. There is limited wastage due to regulated competition.
3. Wide variety of goods is produced.
4. High level of employment of resources and labour exists.
5. There is increased rate of efficiency in production due to competition and planning.
PRICE THEORY
This chapter is concerned with the study of prices and is regarded as the basis of Economic theory. In
this chapter we look at different concepts which relate to prices, their determinants and uses of prices
in different fields of economics.
PRICE
This is the exchange value of a commodity in terms of money . It is the amount of money that has to
be paid for a specific quantity of a commodity or,
It is the amount of money that will purchase a definite weight/measure of a commodity. Prices may be
classified as; equilibrium price, market price, normal price/ideal price and reserve price.
1. Normal/ideal price: This is the price that regulates the flow of production and consumption so
that they stand at equilibrium position in the long run.

2. Equilibrium price: This is the price at which the quantity supplied equals to quantity demanded
as illustrated below.
D S
S
D
Price
E
Pe
Qe Quantity
Pe is the equilibrium price and Qe is the equilibrium quantity.
3. Market price: It is the ruling price in the market at a particular time.
4. Reserve price: This is the minimum price below which the seller is not able to offer his
commodity for sale in the market. It is determined by the following factors.

1. Nature of the commodity: Durable commodities have high reserve price than perishable
commodities.
2. Future cost of production: If a seller expects the cost of production to rise in future, he fixes a
higher reserve price than when it is expected to fall.
3. Liquidity reference of the seller: The higher the liquidity preference by the seller, the lower the
reserve price. On the other hand, if the liquidity preference is low, the reserve price is high.
4. Expectation of future demand: If the seller expects demand to rise in future, he fixes a higher
reserve price than if demand is expected to fall.
5. Future price changes: If the seller expects the price to rise in future, he fixes a higher reserve price
than when prices are expected to fall.
Determinants of market price
There are several ways through which the price in a market will be determined.
1. Haggling/Bargaining: This is involves the buyer and a seller negotiating to reach an agreeable
price.
2. Auctioning: This is when a seller offers goods to the market for bids and the highest bidder takes
the commodity (one who offers the highest price). This is very common in sale of vehicles or in
fundraising.
3. Government fixed prices/price legislation: The government can fix the price of some commodities
in form of minimum and maximum prices.
4. Sales through treaties/agreements: The market price may be set say by the formation of the cartel
e.g. (OPEC) or a commodity agreement e.g. the international coffee agreement.
5. Forces of demand and supply: The interaction of the forces of demand and supply sets the price
(equilibrium price).
6. Offers at fixed prices: This is involves the producer or seller setting the price that is not negotiable.
This is mainly by monopolists who unless interrupted by the government have the sole authority to
manipulate market price to the disfavour of the public.

7. Price leadership/oligopolistic price determination: This is where by either the dominant firm or low
cost firm sets the price that guides others in their price determination.
8. Re-sale price maintenance: In this case the producer of the product sets the price at which the item
or product should be sold to final consumers. It is common with goods like Magazines,
Newspapers, soft drinks etc.
TYPES OF MARKETS
1. Product markets: These are markets in which a good or service for the consumers is bought and
sold.
2. Resource markets/factor markets: These are market in which production resources especially
labour and capital are bought and sold.
3. Spot market: This is a market where a commodity/ currency are traded for immediate delivery.
4. Forward/ Future market: This is the market where buyers and sellers make a contract to buy / sell
commodities at a fixed date at the price agreed in the contact.
5. Free market: This is a market where there is no government intervention.
6. Controlled markets: This is a market controlled by the government.
7. Perfect market: This refers to the market where none of the buyers/sellers has the power to
influence price in the market by either influencing demand or supply.
THE THEORY OF DEMAND

Demand refers to the desire to have a commodity for one‟s satisfaction at a given price in a given
period of time. Or
It is the amount of commodities consumers are willing to purchase at given prices per period of time.
Effective demand
This is the actual buying/purchasing of the commodity at a given price.
Or

Effective demand refers to the desire backed by the ability and willing to have the commodity at a
given price in a given period of time.
Or
It is the actual amount of goods and services purchased or bought by the consumer at a given price
and at a given time.
DETERMINANTS OF QUANTITY DEMANDED
When considering the effect of one factor on quantity demanded we assume other factors are
constant (ceteris paribus). The determinants of quantity demanded of a commodity are:
1. The price level of the commodity: The higher the price the lower the demand for a given
commodity(s). This is because the commodity is expensive and people leave them and by
substitutes. A decline in price/lower prices increase the quantity demanded of commodity
because it is cheaper than the substitutes.
2. Price of substitute goods: This is where two commodities are used to satisfy the same demand
e.g. beans and G.nuts. The higher the price of a substitute the higher the demand for a
commodity in question because it is cheaper while a fall in price of a substitute the lower the
demand for the commodity in question since is more affordable.
3. Complements: These are commodities that are jointly demanded e.g. cars and petrol, guns and
bullets, sugar and coffee. The increase in one commodity like guns increases quantity
demanded of other commodities (bullets) because they are jointly while a fall in the demand for
a complement causes an increase in demand.
4. Level of income of a consumer: The rise in income of a consumer leads to an increase in quantity
demanded because of the increase in the purchasing power while low income causes low
demand because of the low purchasing power. This is only in case of normal goods such as cars,
shoes etc.
For inferior goods as the consumer‟s income increases, quantity demanded falls because the
consumer takes the commodity to be cheap for him or her and shifts to expensive ones which
he takes to be of high value such include sweet potatoes, beans.
For necessity goods even if income increases, quantity demanded cannot increase after a
certain level of income e.g. demanded for sugar, soap etc.
5. Expectation of changes in prices in future. When consumers expect prices to rise in future, they
purchase more commodities and stock them which causes high demand for commodities in the
short run. When prices are expected to fall in future, consumers purchase less now and more in
future since the purchasing is high in future.
6. Tastes and preferences of the commodity: favourable tastes cause high demand for
commodities because there are more buyers of a given commodity and when the tastes are
unfavourable there is low demand for a commodity because there are fewer people purchasing
a commodity.
7. Distribution of Income: A fair distribution of income in an economy increases demand for goods
and services in an economy because majority of the population are capable of purchasing
goods and services and unfair distribution of income is concentrated in the hands of few
people.
8. Effect of advertising: A high level of advertising increases people‟s awareness about the
presence and availability of the commodity and when persuasive advertising is used, people are
lured to purchase goods and services hence a high level of demand .Poor advertising therefore
is associated with low demand because of consumers‟ ignorance.
9. Seasonal changes: A favourable change in the season causes a high demand because there are
more consumers while an unfavourable change causes low level of demand because there are
few consumers. e.g. success cards are normally demanded during times of exams, gum boots
and umbrellas during rainy season demand falls when the season comes to an end.
10. Size of the population: A big population size other factors being constant offers a bigger level of
demand because there are more consumers and a small population size causes low demand
because there are few consumers.
11. Government policy on taxation and subsidization: High direct taxes cause a low level of demand
because they reduce disposable income and therefore cause a low purchasing power while low

level of taxation leads to high disposable income and therefore high purchasing power which
leads to a high level of demand.
12. Availability of credit facilities. The more credits facilities are available the higher the demand
because the enable one access goods and services while limited credit facilities cause a low level
of demand because of limited accessibility to credit facilities.
Why people demand for goods
1. Functional demand: This is demand for a commodity for one‟s own use e.g. buying sugar for one‟s
consumption.
2. Impulse buying: Some people buy on impulse or because they have seen a commodity e.g. a
hawker passing around and one gets the idea of buying a commodity.
3. Speculative demand: Some people hope to make capital gains or other benefits by buying a given
commodity and selling it in future at a profit.
4. Snob effect: This is conspicuous consumption i.e. the desire to impress the public by one‟s ability
to consume expensive items.
5. Veblen effect (exclusivity): Some people demand for goods for being exclusive. Quantity
demanded will fall when other people buy that similar good.
6. Band wagon effect: This is demand for a good to look like others. Here people demand for goods
because they have seen others consuming them. It is common in fashions, models etc.
The demand schedule
This is a table showing quantities demanded for a commodity at different alternative prices per period
of time. It is as illustrated below.
Price(shs) Qty (kgs)

5 40

10 25
15 15
20 5
It is drawn basing on the assumption, that the higher the price, the lower the quantity demanded and
vice versa.
THE DEMAND CURVE
It is a locus of points showing quantity demanded of a commodity at various prices per period of time,
it is drawn basing on the assumption (The law of demand) that, “Holding all the other factors
constant, the higher the price, the lower the quantity demanded and the lower the price the higher the
quantity demanded.
The demand curve can be derived from the above demand schedule as shown below.
Price (shs) D
15
10
15 25 40 Quantity (kgs)
Why the demand curve is down ward sloping (Why it has a negative slope)
1. It obeys the law of diminishing marginal utility: The demand curve is down ward sloping
because it obeys the law of diminishing marginal utility which states that as one consumes more
of a commodity at a certain point, the satisfaction derived from additional units diminishes or

reduces. When utility is high the consumer is willing to pay a high price and when utility is low a
consumer buys more of a commodity at low price.
As a consumer purchases more of a commodity, marginal utility reduces (additional units if the
price is reduced.
2. Income effect: A fall in price of a commodity, income remaining constant causes an increase in
real income i.e. the consumers purchasing power increases and therefore more goods and
services can be bought using the fixed income. When the price increases, less will be purchased
because of the fall in the real income.
3. Substitution effect: As the price of a commodity falls assuming the price of a substitute remains
constant, consumers purchase more of it and purchase less of the substitutes. When price of a
commodity increases, consumers leave it and purchase its substitutes which are relatively
cheaper.
4. Price effect: The demand curve obeys the law of demand which states that more of the
commodity is demanded when the price is low because of the increase in the purchasing power
and less is demanded when the price is high because of the fall in the purchasing power.
5. The behaviour of low income groups/earners: Low income earners buy more of the commodity
when the price is low and their demand falls as price increases.
6. Different uses of a commodity: When price of a commodity which has many uses is high,
consumers use that commodity for vital purposes only which leads to a fall in demand. When
prices are low consumers use it for even luxurious purposes and quantity demanded increases
e.g. electricity and water.
Shifts in Demand
These include the change in quantity demanded and charge is demand.
Change in quantity demanded

This refers to increase/decrease in the amount of commodity purchased in the market due to the
decrease or increase in price holding all the other factors that affect demand constant e.g. incomes,
tastes and preferences etc. It is illustrated by the movement along the same demand curve as
illustrated below.
D
Price(shs) a
P1 Decrease in quantity demanded.
P2 b
Increase in quantity demanded
P3 c
Q1 Q2 Q3 Quantity (kgs)
Note: Decrease in price from P1 to P2 brings about increase in quantity demanded from Q1 to Q2.
Change in demand
A change in demand refers to when at constant price more/less of a commodity is purchased brought
about the other factors that affect demand becoming more favourable or unfavourable. It involves the
movement of the entire demand curve to the left or to the right as illustrated below.
D1
Price(shs) Do
D2
P0
D1
D0
D2
Q2 Qo Q1 Quantity (kgs)
From the above illustration, movement from Do to D2 represents a decrease in demand from Qo to
Q2 and movement from Do to D1 represents increase in demand from Qo to Q1
Demand for a commodity may increase or decrease at constant price due to the following:-
Causes of change in demand
1. Changes in the consumer‟s disposable income. An increase in the income of the consumer
increases demand for the commodity because of the rise in the purchasing power of the
consumer while a fall in the consumer‟s income causes a decline in demand because the
purchasing power falls and as such fewer commodities are purchased.
2. Changes in tastes and preferences of the consumer. An improvement in tastes and preferences
causes an increase in demand because of the increase in the number of people who are willing
to purchase the commodity while a decline in the tastes and preferences causes a decrease in
demand because of the fall in the number of people who are willing to purchase the
commodity.
3. Changes in the prices of substitutes of a product. An increase in the price of a substitute for a
given commodity causes an increase in the demand for the commodity in question because
consumers leave the commodity whose price has increased and purchase that commodity
whose price has remained constant since they serve the same purpose. A decline in the price of
a substitute commodity causes a decline in the demand for the commodity in question because
consumers leave this commodity and by the commodity whose price has fallen because it is
now cheaper.

4. Changes in prices of complementary goods. An increase in the price of a complement causes a
decline in demand for the other commodity because they are used together while a decline in
the price of a complement causes an increase in the demand for the other commodity.
5. Expectation of future price changes. When prices are expected to increase in future there is an
increase in demand for the commodity in the current period and less is purchased in future
since the commodities are expensive and when prices are expected to fall in future the demand
for the commodity in the current period falls since the commodity is now expensive and more is
purchased in future since the commodity becomes cheap.
6. Change in the size of the population. An increase in the population size causes an increase in
demand because of the rise in the number of consumers while a fall in the population size
causes a decline in the number of consumers hence a fall in demand.
7. Changes in the taxation/subsidization of consumers. Increase in taxes imposed on consumers
cause a fall in the disposable income hence a fall in purchasing power and this causes a decline
in the demand for a commodity while a reduction in taxation of consumers causes an increase in
demand because of the increase in the disposable income and the increase in purchasing
power.
8. Changes in economic conditions. An improvement in economic conditions causes an increase in
income and hence increases the purchasing power which causes an increase in demand while a
decline in economic conditions causes a fall in income and the purchasing power which leads to
a decline in demand.
9. Changes in seasons. A favourable change in seasons causes an increase in demand because of
the increase in the number of consumers while an unfavourable change in seasons causes a
decline in demand because of the fall in the number of consumers.
10. Changes in advertisement. An increase in advertising causes an increase in demand because of
the increase in the number of consumers due to increase in the awareness of the consumers
about the presence of a commodity while a fall in advertising causes a decline in demand
because of the fall in the number of consumers due to a fall in awareness about the availability
of the commodity.

11. Changes in the availability of credit facilities. An increase in the availability of credit facilities
increases demand for commodities because it enables consumers access goods and service
while a fall in the availability of credit facilities causes a decline in demand because it becomes
difficult for consumers to access goods and services.
12. Change in the distribution of income. An improvement in the distribution of income causes an
increase in the demand for a commodity because of the increase in the number of consumers
who have higher purchasing power while an increase in inequitable distribution of income
causes a decline in demand because of the fall in the number of people who are able to
purchase goods and services.
ABNOMAL/REGRESSIVE DEMAND CURVE
These are demand curves which violet the law of demand i.e. they do not take the shape of a
downward sloping demand curve are:-
1. Demand for goods/articles of ostentation: These are luxuries which are demanded by the rich to
emphasize their status and as such, as their prices increase, the rich buy more of them e.g.
luxurious cars, ear rings, necklaces etc.
The demand curve for articles of Ostentation is abnormal at high price levels as illustrated below.
Price D
P2
P1
P0 x
Q3 Q1 Q2 Quantity

In the illustration above, the demand curve is abnormal at high price levels i.e. increase in price
from P1 to P2 leads to an increase in quantity demanded from Q1 to Q2.
2. Expectation of future price changes: When prices are expected to increase, consumers buy more
commodity even when prices are increasing because they expect further price increase
e.g. during periods of war, the demand curve in this case is similar to that of articles of ostentation.
3. Demand for giffen goods: A giffen good is a basic commodity that takes a large proportion of
one‟s income such that when its price increases, one tends to buy more of it and less when the
price falls. Examples include food stuffs such as posho, beans, potatoes etc. The demand curve is
abnormal at low price levels as illustrated below.
Price D
P3
P2 x
P1
Q3 Q1 Q2 Quantity
In the illustration above the demand curve is abnormal at low price levels, below P 1 as the price
falls, quantity demanded also falls.
4. When the fall in price is associated with the fall in quality of the product. Quantity demanded may
not increase thus giving an abnormal demand curve at low piece levels. It resembles that of a giffen
good.
5. Period of economic depression: In periods of economic depression characterized by low level of
income, low levels of employment, low levels of investment etc., and quantity demanded does not
increase even when the prices are low. The demand curve during this period is similar to that of the
demand curve for giffen goods.
Types of demand (inter-related demand)
Inter-related demand is a situation where demand for one commodity affects demand for another
commodity positively or negatively or not affecting it all. It includes:-
1. Joint or complementary demand: This refers to the demand for commodities which are used
together such that increase in demand for one of them increases the demand for the other e.g. cars
and petrol, guns and bullets, paint and bushes etc.
2. Competitive demand: It refers to the demand for commodities which serve the same purpose such
that increase in demand for one of them reduces the demand for the other e.g. coffee and tea,
G.nuts and peas.
3. Derived demand: This refers to the demand for a commodity/good due to the demand for what it
helps to produce. E.g. demand for factors of production is derived from or depends on demand for
commodities which such factors of production are used to make.
4. Composite demand: This is the total demand for a commodity with many uses e.g. electricity used
for cooking, ironing, lighting etc.
ELASTICITY OF DEMAND
Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to a

change in the factors that affect demand. Elasticity of demand is categorized into three: - i.e. (a) Price
elasticity of demand
(b) Cross elasticity of demand
(c) Income elasticity of demand
PRICE ELASTICITY OF DEMAND (PED)

This is the measure of responsiveness of quantity demanded to a proportionate change in the
commodity‟s own price. It is the ratio of the percentage change in amount demanded to percentage
change in price.
The co-efficient of price elasticity of demand (PED) is got using a formula
Or
PED = DQ X P1
DP Q1
The price of meat change from 3,500/= to 5,000/= and caused a change in quantity demanded from
50kg to 30kg per week. Calculate the price elasticity of demand. Solution
NOTE: The negative sign in the above formula shows the negative slope of the demand curve. The
value of price elasticity of demand co-efficient ranges from O to infinity. The bigger the elasticity co-
efficient, the greater the degree of elasticity.
Price elasticity co-efficient is described according to the answer you get, using the above formula of
calculating it and it ranges from Zero(0) to infinity.
Example
A price of a kg of maize increased from 1000/= to 1200/= per kilo and caused a decline in quantity
demanded from 2700 tons to 1900 tons. Calculate
(i) The price elasticity of demand
(ii) What is the type of elasticity for the above commodity?
TYPES OF ELASTICITY
Perfectly/completely inelastic.
This is when PED is 0. This means that quantity demanded does not respond to changes in price at all
as illustrated below.
Price D
P1
P0
0 Qo Quantity
Change in price from OP 0 to 0P1 leaves quantity demanded or Q 0 unaffected e.g. demand for
cigarettes/alcohol.

Inelastic demand: This is when the price of elasticity of demand co-efficient is greater than O (zero)
but less than one; it means that the percentage change in quantity demanded is smaller than
proportionate change in quantity demanded as illustrated below.
D
P1
P2
0 Q1 Q2 Quantity
Change in price P1 P2 is greater than change in quantity demanded Q1 Q2.
Elastic demand: This is when elasticity of demand is greater than 1(one) but less than infinity i.e.
percentage change in quantity demanded is greater than percentage change in price as illustrated
below.

D
Price P 1
P
D
0 Q1 Q2 Quantity
Change in price from P1 to P2 leads to a proportional greater change in quantity demanded from Q 1 to
Q2.
Unitary demand (PED =1): This is when price elasticity of demand is equal to 1 (one) in other wards
quantity demanded changes exactly by the same percentage as does the price as illustrated below.

Price D
P1
Unitary elastic demand curve

P2
D
0 Q1 Q2 Quantity
Change in price from P1 to P2 is equal to change in quantity demanded from Q1 to Q2.
Perfectly elastic demand: This is when price elasticity of demand is equal to infinity meaning that at
constant price consumers are willing to purchase and none at all even at a slightly higher price as
illustrated below.
Price
P0 D
D Perfectly elastic demand curve

0 Q1 Q2 Qty.
DETERMINANTS OF PRICE ELASTICITY OF DEMAND

1. Availability of substitutes: When substitutes are easily available, the demand for the commodity is
elastic; this is because the consumer has alternatives. Scarcity of substitutes makes the demand for
the commodity inelastic because the consumer has no alternatives e.g. demand for petrol is
inelastic because it has no close substitutes in the running of vehicles.
2. Degree of complementarity: For complementary goods, price elasticity of demand is inelastic
because demand for one item requires demand for another. Increase in price of one of the
commodities leads to reduction in quantity demanded of another commodity.
3. Habit in the use of the commodity: For commodities whose demand follows a continuous habit
makes the demand for the commodity is price inelastic because one cannot do without the
commodity. E.g. demand for cigarettes and alcohol may not be easily affected by changes in price.
4. Level of income of the consumer: Generally the higher the income of the consumer the more
inelastic the demand is for commodities because the rich are not very much affected by price
changes. However for a poor man quantity demanded increases with a fall in price and falls once
prices are slightly higher and this makes his demand elastic.
5. Proportion of the consumer‟s income spent on the commodity: Demand is elastic for commodities
which take a small proportion of the consumer‟s income because they have minimal impact on the
income of an individual e.g. a match box. Commodities which take a big proportion of the
consumer‟s income have elastic demand because a small increase in price causes a significant
reduction in quantity demanded.
6. Number of uses a commodity can be put to: Commodities with several uses have elastic demand
because a change in price has a significant effect on the amount purchased while a commodity
with a single use has its demand inelastic because there are no alternatives to the commodity.
7. Nature of the commodity: Durable commodities like radio. TVs, bicycle etc. have inelastic demand
because they are used for a long period of time- even if the prices of such commodities fall one
may not buy more.
8. Demand for a commodity whose use can be postponed (degree of postponement). A commodity
whose demand can be postponed makes its demand elastic while that commodity of which the use
can‟t be postponed makes the demand inelastic.

9. Level of advertising of a commodity: Commodities that are advertised have their demand inelastic
while those that are not advertised elastic demand.
10. Level of ignorance of the consumers: Consumer ignorance makes the demand for a commodity
inelastic while having knowledge about the market conditions makes the demand for a product
elastic.
11. Time period: In the short run the demand for a product is inelastic because consumers are still
trying to adjust to price changes. In the long run demand is elastic because consumers are able to
find substitutes.
PRACTICAL APPLICATIONS OF THE CONCEPT OF PRICE ELASTICITY OF DEMAND

The concept of elasticity of demand is of great importance in the formulation and understanding of a
number of economic policies and problems. The concept is use to consumers, producers and the
government.
1. To the consumers: To consumers, the concept of elasticity of demand is used in planning
expenditures. Goods with inelastic demand tend to take a high proportion of the consumer‟s
expenditure/income than products with elastic demand.
2. To the producer: The concept of elasticity helps the producer in the following;
a) Pricing of commodities: If the demand for a product is elastic, a producer gains more profit or
revenue by fixing a low price and therefore maximizing sales. In case the demand is inelastic, the
producer gains more by charging a high price.
b) It is used in the determination of price under discriminating monopoly. Under discriminating
monopoly the possibility of pricing the same commodity differently in two or more different
markets depends on the elasticity of demand in each market. In a market with elastic demand the
monopolists fix low price in order to maintain a high level of demand and in the market with
inelastic demand, he changes a high price since demand is not significantly affected.
c) It is used by producers in wage determination: Labour with elastic demand is given a low wage
because trade union pressure and strikes may not convince the producer to pay a higher wage.
Labour whose demand is inelastic is given a higher wage because it is not easy to dismiss the
labourer and replace him immediately.
3. To the government
The concept of elasticity of demand is important to the government in the formulation of the
following policies.
a) It is important in the taxation policy: If the aim is to increase revenue, high taxes are levied or
imposed on commodities with inelastic demand like cigarettes, alcoholic drinks, luxuries etc.
since demand is not significantly affected and low taxes are imposed on commodities with
elastic demand because a small increase in price causes a significant reduction in quantity
demanded.
b) Helps in determining the incidence of a tax: i.e. how much of a tax is to be paid by producer or
consumer. When elasticity of demand is inelastic the consumer pays more of the tax because it
is easy to pass on the burden to consumers in form of high prices and the demand is not
significantly affected, when it is elastic the producer pays more of that tax because a significant
increase in price as a result of the tax would cause great reduction in quantity demanded.
c) Used in devaluation policy: Devaluation refers to the legal or deliberate reduction of a country‟s
currency value in terms of other currencies this is done to increase exports and reduce imports
as a measure of correcting balance of payment problems. It is successful if the demand for the
country‟s imports and exports is elastic.
d) Guides in making foreign trade policies: The concept is used to determine gains from
international trade. A country gains more from international trade, if the demand for imports is
inelastic.
e) Guides in the policy of subsidization: When government subsidies industries producing
commodities with elastic demand there is a big reduction in price but a small increase in
demand while when the demand is elastic there is a small reduction in price but a significant
increase in demand.
f) Helps the government in determination of exchange rates: The exchange rate is high when the
demand for foreign currencies is inelastic and low when the elasticity of demand for foreign
currencies is elastic.
INCOME ELASTICITY OF DEMAND (YED)

Income elasticity of demand is the measure of responsiveness of quantity demanded of a commodity
to a change in the consumer‟s income i.e. it is the ratio of the percentage change in quantity
demanded due to a change in the consumer‟s income. The income elasticity of demand co-efficient is
got using the formula.
YED = Percentage change in quantity demanded
Percentage change in the consumer‟s income
= ∆Q X P1 = ∆P Q1
If the co-efficient of income elasticity of demand for a product is positive, then the commodity is a
normal good. If it negative than the commodity is either inferior or giffen.
If it is zero the commodity is a necessity.
E.g. the income of James increased from 50,000/= to 80,000/= per months and caused a reduction in
quantity demanded of beans from 15kgs to 10kgs per months. Calculate the income elasticity of
demand.
What is the nature of the commodity consumed?
CROSS ELASTICIY OF DEMAND (CED)
This is the measure of the responsiveness of quantity demanded of a commodity to change in the
price of another commodity. I.e. it is the responsiveness in demand for a product to the proportionate
change in the price of another commodity.
It is given by the formula;
Cross elasticity of demand = Percentage change in quantity demanded of a commodity (X)
Percentage change in price of commodity (Y)
= ∆Qx . Py
∆Py Qx

If the co-efficient of cross elasticity of demand for a product is positive, then the two commodities are
substitutes if it is negative, the two are complements and if it is zero the two commodities are not
related at all.
Example:
The price of commodity (A) increased from 20,000/= to 25,000/= and caused a decline in demand for
a commodity (B) from 30 to 15 units a week.
• Calculate the cross of elasticity of demand.
• What is the relationship between the two commodities
Solution = ∆QB . PA ∆PA

QB
= 15 – 30 . 20,000
25,000-20,000 30
= 15 x 20,000
5,000 30
= -1 x 2
= -2
Therefore the commodities are complements Reasons:
(a) The increase in prices of A decreases the demand for commodity B (b) The co-
efficient is negative.
SUPPLY
This refers to the amount of a commodity suppliers or producers are willing to offer to the market at
alternative prices per period of time holding all the other factors constant i.e. supply of a commodity is

how much of a good will be offered for sale at a given price per period of time. This can be illustrated
using a supply schedule.
Supply Schedule
This is a table showing the amounts of a commodity offered for sale at alternative prices per period of
time. It is drawn on the assumption, “The higher the price the higher quantity supplied and the lower
the price, the lower the quantity supplied holding all the other factors constant as illustrated below.
Price (shs) Quantity
(kgs)
100 50
150 100
250 500
From this illustration, it can be seen that as the price increases, quantity supplied also increases.
The supply Curve

It is a locus of points showing quantity supplied of a commodity at various prices per period of time.
The supply curve is a graphical representation of the supply schedule.
It is drawn basing on the law of supply that states that “All factors constant, the higher the price the
higher quantity supplied and the lower the price, the lower the quantity supplied” as illustrated
below.
Price(shs) S
250
0 50 100 500 Quantity (kgs

)
150
100
FACTORS THAT AFFECT SUPPLY
1. The price of the commodity: Other factors being constant, more of a commodity is supplied at a
higher price because the producer realises a high level of profit and less is supplied at a lower price
because it leads to low profits.
2. Cost of production: A high cost of production causes low supply because it becomes expensive to
produce and low profits are realised while a low cost of production cause low supply of goods
because it is cheap to produce and more profits are realised.
3. Availability of inputs/factors of production: The more available and cheaper the inputs are, the
greater the supply of commodities because of a low cost of production since profits are high and
when the inputs are scarce the cost of production is high and this causes low supply and low
profits.
4. Level of technology: Adoption/use of better production methods has an effect of reducing the cost
of production and therefore increasing supply of goods due to an improvement in efficiency in
production. Poor techniques of production cause a high cost of production due to inefficiency in
production and therefore there is low supply.

5. Price of competitive commodities: For competitive commodities supply is low for a given
commodity when the price of other commodity is high and it is high when the price of the other
commodity is low.
6. The price of jointly supplied goods. The increase in the price of one commodity causes an increase
in the supply of the other commodity since they have a common source. The reverse is true.
7. The number of producers in the Market: The greater the number of producers, the higher the
supply of goods and services this is because there are more firms contributing to total output.
Fewer producers in most cases produce low output thus low supply because there are few firms
contributing to total output.
8. Working conditions/terms of service: Favourable terms of service lead to an increase supply
because output is high since workers are motivated and these include; lower risks at work,
favourable working hours etc. On the other hand, poor working conditions result in lower supply
because there is low output since workers are demoralised.
9. Size of the market: The bigger the market size the higher the level of supply because more profits
are realised and when the market size is small supply is low due to low profits earned by the
producers.
10. Climatic conditions (A case with agricultural production). Favourable climatic conditions result into
high supply because the farmers realise high yields while unfavourable climatic conditions cause
low yields and therefore a low supply.
11. Development of means of transport and communication: Well developed means of transport and
communication facilitate easy movement of goods and services to the market and this causes high
supply while poorly developed infrastructure causes low supply because it is difficult to transport
goods to the market.
12. Peace, security and political climate: During times of political stability, peace and security supply is
high because there is more investment since producers are assured of security for life and property
while political instability causes low supply because of low investment since the investors are not
assured of security for their lives and property.

13. Government policy on production: High level of taxation by government causes low supply
because taxation causes high cost of production while low taxation causes a low cost of production
and this causes high supply and profits.
14. Gestation period: Short gestation period causes high supply because it takes a short time to deliver
goods in the market while a long gestation period reduces supply because even if prices increase it
is not possible to increase supply immediately.
15. Objective of the firm. When the objective of the firm is profit maximisation there is low supply
because the producer offers less to charge a high price. When the goal of the firm is sales revenue
– maximisation, the producer supplies more in order to sale more and, earn more revenue.
ELASTICITY OF SUPPLY
Elasticity of supply refers to the measure of responsiveness 0f quantity supplied to a change in the
factors that affect supply.
This refers to the responsiveness of quantity supplied of a commodity to a change in the price of a
commodity. The co-efficient of elasticity of supply is given by the formula:- PES = Percentage change
in quantity supplied
Percentage change in price
= ∆Qs ÷ ∆P
Qs P1
= ∆Qs x P1
Qs ∆P
= ∆Qs . P1
∆P Qs
TYPES OF ELASTICITY OF SUPPLY

Elastic supply
Price
S
P2
P1
S
Q1 Q2 Quantity
This is where the co-efficient is greater than one but less than infinity i.e. percentage change in
quantity supplied is greater than percentage change in price. Quantity supplied changes by a bigger
proportion for a smaller change in price.
Perfectly inelastic supply

Price S
P2
P1
Q1 Quantity
This is where elasticity of supply is zero meaning that quantity supplied does not respond to changes
in price.
Unitary Supply
S
Price
P2
P1
S
Q1 Q2 Quantity
Change in price P1-P2 is equal to change in quantity Q1 – Q2
The elasticity co-efficient is equal one. In this type percentage change in quantity supplied is equal to
percentage change in price.
Inelastic supply
S
Price
P2
P1
Q1 Q2 Quantity
Elasticity co-efficient is greater than zero but less than one. Here the proportionate change in quantity
supplied is less than the proportionate change in price i.e. quantity supplied responds less for a
greater change in price. I.e. change in price P 1 – P2 is greater than change in quantity demanded Q 1 –
Q2.
1. Perfectly elastic Supply
P1 S
0
Q1 Q2 Quantity

The elasticity of supply co-efficient is infinity; Quantity supplied varies for a given price. In the above
illustration, sellers are not ready to sale at any price below P 1 while they are willing to supply all they
can above.
FACTORS THAT INFLUENCE ELASTICITY OF SUPPLY

1. Availability of variable factors of production: The more readily available these factors are the more
elastic the supply because of the low cost involved. While hardships in acquiring variable factors of
production e.g. labour, capital makes supply inelastic because of the high cost of production.
2. Length of the production process: (Gestation period) long gestation periods implies inelastic or
rigid supply e.g. agricultural products because it takes long to deliver commodities in the market
on the other hand supply is elastic for those commodities with short gestation period because it
takes less time is taken to deliver commodities on the market.
3. Ease of entry of new firms into an industry/market: When it is easy for firms to enter the market
following an increase in price makes supply elastic because it becomes easy for firms to deliver
commodities in the market. Difficulty for new firms to enter an industry because of the amount of
capital required or legal barriers limiting entry of the firms makes supply inelastic.
4. Cost of Production: Commodities that involve very high cost of production have inelastic supply
because it is expensive to have them on the market while goods with low cost of production have
elastic supply since it is cheap to produce the goods.
5. Nature of the product: Durable commodities have elastic supply because it is easy to store them
and have them supplied when prices are high. Perishable goods have inelastic supply because it is
difficult to store them and supply them at an appropriate time when prices are high.
6. Method of production/technique used: Commodities produced with the help of simple methods of
production have elastic supply while those that require complicated method of production have
inelastic supply because it takes long to produce such products.
7. Price expectation changes: Expectation of fall in prices makes supply inelastic even if prices
increase in the current period. Expectation of increase in prices makes the supply elastic even if
prices are low in the current period.

8. Number of producers in the market: A bigger number of producers in the market makes supply
elastic since there are more producers contributing to output. The presence of one producer or
supplier in the market as in the case of monopoly makes supply inelastic.
9. Factor mobility: If factors of production are easy to relocate to other lines of production, elasticity
of supply is elastic e.g. if it is easy to expand human labour, it means supply can be increased
resulting in elastic supply. On the other hand immobility of factors makes supply inelastic because
of low production.
10. Political climate. Stable political environment causes elastic supply because investors produce
more because they are assured of security for their lives and property and when the political
situation is unstable supply is inelastic because of a low level of investment production since the
investors are not assured of security for their lives and property.
11. Government policy. An unfavourable policy on production e.g. high taxation cause a high cost of
production and discourages production and therefore supply is inelastic while a favourable policy
on production and investment makes supply elastic because of the low cost of production that
encourages production.
12. Size of the market. A bigger market size makes supply elastic because it encourages production
since high profits are realised and supply is inelastic with a small market size because production is
discouraged due to the low profits.
13. Level of development of infrastructures.
INTERRELATED SUPPLY
The various forms of interrelated supply are the following;
1. Joint/complementary supply: This is the supply of those goods which have common procedure of
production such that an increase in the supply of one automatically leads to an increase in the
supply of the other. The goods originate from the same source and their supply is increased
simultaneously e.g. wool and mutton, meat, hides and skins, cotton and cotton seeds etc.
2. Composite supply: This refers to total quantity or supply of goods that are substitutes to one
another e.g. mutton, beef and chicken or supply of tea, coffee and cocoa.

3. Competitive supply: This refers to the supply of commodities that require the same resource such
that the increase in supply one causes a reduction in the supply of the other commodity. For the
case of agriculture a farmer uses the same piece of land to produce maize and beans. An increase
in production of maize reduces the production of beans.
ABNORMAL SUPPLY CURVES

Normal curves usually slopes upwards from left to right. In this case abnormal or regressive curves do
not obey the law of supply i.e. they don‟t slope upwards from left to right. This is the case with.
1. The back ward bending supply curve of labour.
W3
W2 X
W1
0 L 1 L3 L2 Labour per man hour
In the illustration the supply curve is initially sloping but after point X (wage W 2) labourers work for
less hours i.e. as the wage increases to W3 hours worked reduce to L3. This can be attributed to:
1. Preference for leisure: i.e. for some employees as the wage rate increases after a certain point, they
reduce on the number of hours to work to have some leisure time.
2. The issue of target workers: These are people who work to fulfill targets and once fulfilled they
reduce on the hours of work.
3. Cultural and political factors or discrimination in the labour market.
4. Deterioration in the real wage due to inflation. 5. Old age-when one has reached retirement age
6. Substitutability of labour by machine.
7. The rate of taxation.
2. SUPPLY WITH CAPACITY LIMITATION

Price
D
P3
P2 X
P1
Q1 Q2 Q3 Quantity
This is illustrated with a curve that is normal for the 1 st few units produced up to a given point after
which it becomes perfectly inelastic as illustrated above. After point X an increase in price from P 2 to P3
leaves quantity supplied Q2 the same. This situation may arise due to the following.
3. FIXED SUPPLY
E.g. supply of land, supply of money in an economy, in this situation the supply of goods cannot
increase whatever the price offered e.g. supply of land, the curve is illustrated below.

Price S
P2
P1
0 Q1 Quantity
In the above illustration supply cannot increase due to the inability to change other factors eg land the
same situation applies to the supply of agricultural commodities in the short run because of the long
gestation period.
CHANGE IN SUPPLY
This shows an increase or decrease in the amount offered to the market for sale at constant price
brought about by changes in other factors that affect quantity supplied rather than price. It is
illustrated as follows.

Price S 1 S0
S2
P0
Quantity
Q1 Q0 Q2
An increase in supply is shown by shift in the supply curve from S 0 to S2 where quantity supplied
increases from Q0 to Q2. The decrease in supply is shown by shift of supply curve from S 0 to S1 where
quantity supplied reduces from Q0 to Q1.
CHANGE IN QUANTITY SUPPLIED

This is when there is an increase or decrease in the amount offered to the market for sale brought
about by increase or decrease in price holding other factors that affect supply constant. It is the
movement along the same supply curve as below.
Price
S
P2
P1
0 Q1 Q2 Quantity
Increase in price from P1 to P2 increases quantity supplied from Q1 to Q2. Reduction in price from P2 to
P1 would cause reduction in quantity supplied from Q2to Q1.

PRICE MECHANISM
Price mechanism is a system in a free enterprise economy where prices in the market are determined
by the forces of demand and supply. Prices determine allocation of resources and there is consumer
sovereignty/the consumer is the king.
Or
This is a system of economic organization in which every individual either as a producer or resource
owner or consumer is involved in economic activities with a large measure of freedom due to limited
government interference.
Or
It is a system of economic organization in which resources are privately owned with limited or no
government intervention and resources are allocated by market forces of demand supply due to
consumer sovereignty.
It is a system under which all economic decisions are made in view of prices of commodities and prices
of other factors of production. It works best in a free market economy where the private sector s
dominant and as long as it operates, some assumptions are made.
ASSUMPTIONS OF PRICE MECHANISM

• There is limited/no government intervention in determining prices.
• No wastage of resources cause an individual only buys what he/she needs and there is no force on
him or her, producers also supply only what is required.
• Consumers buy from the cheapest source.
• Some firms are more efficient than others.
• Profits attract new producers into an industry or market and profits are the main objective of the
production.
• There is free movement of factors of production i.e. factors are free to move from where they are
paid less to where they are highly paid.

• Consumers have the freedom to decide e.g. on what to consume i.e. there is consumers
sovereignty.
NB: Consumer sovereignty is a situation where by the consumer is taken to be a king who influences
producers on what, when and how much to produce.
Question: Examine the role of price mechanism in an economy?
THE ROLE OF PRICE MECHANISM IN THE ECONOMY

POSITIVE ROLES
1. It ensures efficiency of firms: Price Mechanism ensures efficiency of firms when allocating resources
by ensuring that resources are properly used in producing what is demanded and this is achieved
through use of better technology.
2. It ensures better quality products because of the competition it creates between firms, this lowers
the prices of goods and services.
3. It distributes incomes. Under price mechanism incomes go to resource owners e.g. land receives
rent capital receives interest etc.
4. It promotes or encourages inventions and innovations. Under the system, firms and individual
engage in research as a result, they come up with improved and new methods of production, new
commodities etc. therefore it encourages creativity.
5. It helps to determine for whom to produce: Under the system producers supply commodities that
are demanded by consumers who are able to pay a higher price i.e. it promotes consumer
sovereignty.
6. It helps in resource allocation e.g. labour moves to where it is highly paid.
7. It helps to determine the type of technology to use (how to produce). This involves choice of
production technique i.e. whether to use labour/capital intensive technique). Producers prefer a
production technique that is cost effective and efficient.
8. It helps in determining what to produce. Producers in the market supply commodities that are
highly demanded and where higher profits are generated.

9. It determines where to produce i.e. location of production units. This involves choice of location of
firms i.e. whether to locate them near the market, source of raw materials etc. Firms are located
where location costs are minimal.
10. It helps to determine when to produce. Producers supply commodities when demand is high and
consumers have incomes to pay.
11. It helps to provide a variety of goods since firms are free to enter the market and make profits. This
avails consumer a wide variety of goods and services.
12. Determines how much to produce, under price mechanism, producers only supply what is
demanded and therefore it helps to provide an automatic adjustment between supply and demand
i.e. it eliminates wastage.
Question:
(a) What is the role of price mechanism in an economy?
(b) Discuss the Merits and Demerits of price mechanism in an economy.
ADVANTAGES/MERITS OF PRICE MECHANISM

1. It encourages competition leading to improvement in the quality and quantity of goods as well as
lowering prices because of use of improved methods of production.
2. It enables efficient allocation of resources i.e. producers produce in response to consumers
demand. This means there is no over production and under production.
3. It encourages inventions and innovation. The desire to make profits leads to increased investment
in research encouraging hard work. Inventions and innovation and therefore increased productivity
and economic growth.
4. It avails a wide of goods and services. This means consumers can make better choice and thus
maximise satisfaction or utility.
5. It involves low or no administrative costs because government control is not necessary i.e. the
system is automatic.
6. It decentralises economic power i.e. individual households and producers make their own
decisions.
7. It encourages flexibility in production. This enables producers to adjust to changes in market
conditions being guided by price and profit signal.
8. It encourages speculation. Business may buy commodities in periods of plenty and at cheaper
prices and sale them in times of scarcity in order to earn more profits.
9. It encourages arbitrage (distribution of goods). This involves the transfer of commodities from
areas of plenty where prices are low to areas of scarcity where prices are high.
10. It helps to learners of productive enterprises in making critical economic decisions e.g. where to
produce, when to produce etc.
11. It increases employment opportunities. The presence of a large number of producers in the market
increases employment opportunities.
DISADVANTAGES/DEMERITS OF PRICE MECHANISM

1. There is uneven distribution of income. (Income inequality). Price mechanism encourages
inequality in society as some people own more productive factors out of which they derive their
income, such people tend to have more incomes to spend the rich becomes richer and the poor
becomes poorer.
2. Existence /emergency of monopolists. These arise when some firms are driven out of the market
and those that remain become monopolists. It becomes difficult for new firms to enter the market
as they are out competed by the monopolists.
3. Consumer exploitation exists as a result of ignorance. Price mechanism assumes that consumers
know the prices being charged everywhere in the market which is not the case because of
ignorance, advertisement that distorts the consumers‟ decision.
4. It does not consider the effect of private benefit over public benefit. There is over exploitation of
resources which causes exhaustion and the negative effects e.g. over fishing, lumbering that result
into deforestation and hence soil erosion etc. both of which are bad to society, individuals gain at
the expense of the society.

5. Price mechanism fails to adjust in situations of rapid structural changes e.g. inability to provide
infrastructure when it is needed, solving income inequalities. This calls for government intervention
in the economy.
6. It encourages resource wastage. Price mechanism is responsible for resource wastage because it
encourages production at excess capacity resulting from selecting use of resources. It therefore
encourages underutilization of resources in some cases.
7. Cheap commodities tend to disappear from the market. This is because it directs resources to the
production of commodities desired by the rich who have more purchasing power and necessities
demanded by the poor are not given emphasis.
8. It causes economic instability as it is associated with instability in prices, balance of payment
income unemployment etc.
9. There is emergence of unemployment. This is because when some inefficient firms are driven out
of the market, the former employees become unemployed. Also in an Endeavour to make more
profits, firm owners employ machines which replace human labour causing technological
unemployment.
10. There is lack of incentive to provide public goods. Vital goods (public) are not provided for;
therefore price mechanism fails to produce goods collectively demanded. Services like fire services
medical health, roads etc. might not be available to society since they might not be profitable. This
calls for government interference.
11. There is wastage of resources due to duplication of goods and services. This due to the presence of
many firms in the same industry and this leads to resource wastage.
SUGGESTED SOLUTIONS TO THE DEFECTS OF PRICE MECHANISM

The defects of price mechanism call for government intervention to correct them and
government can:
1. Use price controls/ price legislation: Price controls are taken to reduce greater fluctuations in prices
because of the short comings and the state may fix price above/below the one ruling in the market.

2. Use subsidization Policy: This is under taken when government wants to help producers to reduce
the production cost as this helps lower the prices of goods increasing their demand and supply.
Government may also subsidise consumers so as to reduce expenditure on goods.
3. Use taxation: The government can use progressive taxes so that the rich pay a higher part of their
income and the revenue obtained used to subside the poor on essential services like education,
health etc., it may also tax profits earned by monopolists so as to reduce their economic power.
4. Use a quota system: Here an individual economic entity is allowed to produce or consume a
definite quantity of commodity in a given period of time. This system limits possible pressure that
may arise due to excessive demand or supply.
5. Nationalise production: Government may interfere with the free inter play of market forces (price
mechanism) by taking over production (firms) and the eventual distribution of commodities.
6. Ration scarce commodities: This involves direct action by public authorities of apportioning or
dividing scarce supplies to all households on a regular basis. It helps to check fluctuation due to
acute shortages most especially for goods that are necessities.
7. Encourage formation of consumer organizations: This policy is undertaken when it is realised that
private producers over charge consumers therefore consumers protect themselves against
exploitation.
8. Use anti-monopoly legislations: Parliament may be used to put in place laws to fight against
merging of firms that result into monopoly.
9. Government can also provide public goods e.g. education, health, etc. from funds obtained
through taxation.
Question: What measures have been used to regulate demerits of price mechanism in your country?
1. Used taxation: Firms are haven been taxed e.g. use of corporate taxes on profits of companies to
reduce their capacity to expand and influence the market.
2. Government has Subsidised firms and Consumers: this has enable low income earners afford some
goods.
3. Licensed producers or exploiters of certain resources to minimize the rate of exploitation.
4. Banned production and consumption of some demerit goods.
5. Encouraged formation of consumers association or educating consumers. This has helped
consumers fight exploitation by consumers.
6. Government has set up institutions to regulate economic activities or bureau of standards.
7. Enacted laws bodies to protect the environment e.g. [NEMA].
8. Provided emergence relief or provided for disasters. This has helped those in needed get goods
and services for their survival.
9. Government has provided merit and public goods.
LIMITATIONS OF PRICE MECHANISM
1. Government interference: This may be in form of price controls, nationalization etc.

2. Ignorance: Ignorant consumers demand for good whose prices are high when they can be
obtained cheaply elsewhere.
3. Immobility of factors of production: When factors of production are not mobile e.g. labour, even
when there is demand for goods and services, production may not take place thus creating
shortages.
4. Existence of monopolies: In a bid to make higher profits, monopolists tend to produce less output
creating artificial shortages and charging consumers high prices.
5. Irrationality of consumers. Irrational consumers purchase expensive commodities even when they
can obtain them from cheaper sources, some do this to emphasize their status.
6. Limited capital: Inadequacy of capital limits the establishment of productive enterprises and this
creates shortages in the market.
7. Limited skilled labour: Insufficient supply of skilled labour results into less production of goods and
services and thus demand may exceed supply.
8. Limited entrepreneurship. This causes the inability to mobilise resources to establish enterprises
and this causes scarcity of goods.
9. Poor infrastructure. It causes low level of production because the cost of production is high.

PRICE FLACTUATION
AGRICULTURE IN RELATION TO SUPPLY AND DEMAND AND THE CAUSES OF GREATER
FLUCTUATION IN PRICES OF AGRICULTURAL PRODUCTS
Price fluctuation refers to the inconsistent upward and downward movement of prices due to periodic
shortages and surpluses in the uncontrolled markets of agricultural products due to changes in
demand and supply.
Agricultural output/primary products are faced with price instabilities. The greater oscillation of prices
of goods as compared to the prices of manufactured goods is as a result of a number of factors as
below.
CAUSES OF AGRIC PRICE FLUCTUATION (UGANDA)
1. Divergence between planned and actual output: For the case of agriculture, planned output is
never equal to actual output. When actual output is greater than planned output, there is excess
supply and this causes fall in prices. When output is less than planned output, there is shortage and
hence increase in prices. Manufactured commodities are not affected by natural factors and
therefore output is stable as well as the prices.
2. Long gestation period: Agricultural products take long to produce such that during periods when
prices are high, producers plan to produce more and when this output is supplied it exceeds
demand and therefore there is a reduction in prices. Manufactured goods are easier to store and
therefore when there is an increase in demand producers simply draw from stores and supply and
hence stable prices.
3. Perishability of agriculture products: Agricultural products cannot be kept for long so even though
the product is the good one. One has to dispose it quickly even or sometimes at a much lower
price. Industrial output can be kept until favourable prices are offered.
4. The demand for agricultural products is price Inelastic: Demand for food stuff is inelastic so that
whether prices increase or decrease consumers demand almost the same quantities. This is

applicable to other agricultural products implying change in demand is not followed by change in
supply thus resulting into continuous change in price levels. Manufactured goods have elastic
demand and fall in price leads to greater quantity demanded.
5. Low income elasticity of demand for primary products: This mean that as people‟s income
increase, less of agricultural products are demanded leading to the fall in prices. Manufactured
goods on the other hand are income elastic and as income increases, quantity demanded also
increases.
6. Agricultural production form a small portion of the manufactured goods: They do form a small part
as inputs so the excess supply cannot be absorbed in the manufacturing sector e.g. Rubber as an
input in case of manufactured goods forms a small portion.
7. Discovering of raw material saving techniques: Raw material saving innovations have tended to
interfere with planning output in the primary sector and as a result fewer raw materials are
demanded to produce a given volume of goods. This causes instability in supply as well as prices of
primary products.
8. The ever growing competition from synthetic materials: This brings about decline in demand/slow
growth in demand for unprocessed products. The fall in demand coupled with rigidities in supply
results into price instability e.g. the competition between cotton and Nylon.
9. The poor disposal machinery: Developing countries are faced with the problem of poor
infrastructure such as under developed transport facilities, poor storage etc. This makes it difficult
for producers to sale their surplus output in time hence fall in prices. Developed infra on other
hand makes it possible to regulate supply and hence higher output.
10. The weak bargaining power in the world market: The developed countries are more/less price
makers in foreign markets making it difficult for agriculture producers in developing countries to
have control over their primary goods. When supply is high they are offered low prices and when it
is low prices are increased. Because of such unequal bargaining strength, developing countries
can‟t secure table prices for their products.
11. Fluctuations in the cost of production: The prices of farm inputs such as pesticides, machinery etc.
are ever fluctuating. Low prices for farm inputs lead to low prices of agriculture products and high
prices of farm inputs cause an increase in prices for the agriculture products.
12. The bulkiness of the products: Agricultural commodities are bulky and this makes their
transportation from areas of security. Difficulty therefore prices are low in areas of pretty and high
in areas of scarcity.
13. Agriculture is carried out by many producers who are not coordinated and as a result they are not
able to regulate output so as to have fair prices. And when there is a lot of supply on the market,
prices are low and vice versa.
EFFECTS OF AGRIC PRICE FLUCTUATIONS IN AN ECONOMY
a. Discuss the causes of agriculture, price fluctuation in your country.

b. Examine the effects of agricultural price fluctuations in your country.
Effects of price fluctuations of agriculture commodities in your country
1. Fluctuations in terms of trade; as prices go up, the terms of trade improve and as the prices fall,
the terms of trade worsen.
2. Price fluctuations lead to fluctuations in the level of employment. As prices of agriculture

commodities increase there is an increase in employment in the agriculture sector because
people are attracted by the high incomes while fall in prices leads to fall in employment as
farmers are discouraged by the returns from the sector and therefore abandon farming.
3. They cause fluctuations in the incomes of farmers. Increase in prices leads to increase in income
of the farmers and when prices fall there is an increase in the income of the farmers.

4. Lead to fluctuations in balance of payment position. The increase in prices of agriculture exports
leads to increased export earnings while fall in prices of agriculture exports leads to the fall in
export earnings.
5. Price fluctuations result into fluctuations in government revenue. Government receives most of
the revenue from tax income earned and therefore fall in prices leads to fall in income earned by
farmers thus a fall in tax revenue. On the other hand, increase in prices leads to increase in tax
revenue of the government since farmers realise an increase in income which government taxes.
6. Government planning based on expected earnings from the primary sector becomes difficult.
This is because as prices change, government can never be sure of the revenue to be earned in
any one given period. This distorts the planning process.
7. There is unstable inflow of foreign exchange from export commodities.
Fluctuations of prices of major export crops lead to instability in export earnings i.e., they rise
with increase in prices and fall with a decline in prices.
8. It breeds/causes speculations and irrational use of land i.e. farmers increase the use of land in
periods of high prices since they earn higher incomes and use less of it during periods of low
prices because they earn less income. This results into irrational allocation of resources and
production without planning thus wastage.
9. Government planning based on expected earnings from the primary sector becomes difficult.
This is because as prices change, government can never be sure of the revenue to be earned in
any one given product. This destroys the planning process.

10. They encourage rural-urban migration and the negative effects; this is because as the prices fall,
some farmers abandon agriculture and run to urban centers with the hope of greeting better
earnings or unemployment. This results into high crime rates.
11. Price fluctuations cause instabilities in exchange rates.
12. It worsens income inequality. As prices of agriculture products decline in some seasons, farmers
earn less from the activities compared to other people engaged in other sectors e.g. industries.
This creates more income inequality between the farmers and those engaged in other sectors.
13. Investment in agriculture is discouraged since farmers cannot predict earnings from the sector.
QN: Suggest measures that should be taken to minimize fluctuation of prices of agriculture
products in developing countries.
Measures of reducing fluctuation of price of agricultural commodities
1. Use of price control. This is in form of minimum price legislation where the government fixes
the prices for agriculture commodities above the equilibrium price making it illegal for any
buyer to purchase the commodities from the farmers at any price below that set.
2. Improving upon infrastructure. There is need to develop quick and efficient transport systems.
Better transport systems help to dispose surplus hence a reduction in instability of prices.
3. Use of buffer stock arrangement. This is where the government through marketing boards buys
surplus or excess produce from farmers during harvesting or in periods of plenty, stores it and

releases it in periods of scarcity. This helps to even out prices during periods of scarcity and
period of plenty.
4. Use of stabilization fund. Here the government/marketing board compensates farmers in

products when the prices fall below a certain level and makes profits in other products when
prices are high in the market. This aims at ensuring that farmers get stable prices and thus
stabilizes.
5. Modernization of agriculture. This is done to produce better quality products and reduce its
dependence on nature. This can be achieved through use of irrigation, introducing better
varieties etc.
6. Undertaking intensive industrialization programs within agriculture. In order to add value to
agriculture products, a simple industrial plant should be set up or fully processed agriculture
products before selling them off. Such commodities fetch higher pieces and are durable.
7. Adoption of strict quota systems. In this case, different producers are assigned to the amount
of the commodity that they should put on the market to avoid market flooding and falling of
prices.
8. Undertaking market expansion and diversification to reduce dependence on few traditional
markets. This helps to dispose-off the surplus output.
9. Strengthening or joining international commodity agreements. With the aim of ascertaining

markets and earnings for all member producers through control of supply.

10. Stability costs of production. Government can achieve this by subsidizing farmers on the
purchase of some in puts.
11. Encouraging proper planning of production.

12. Encouraging cooperatives to regulate supply. These solve problems which cause fluctuations
e.g. ignorance, absence of storage and transport facilities etc.
13. Encouraging diversification within agric. To reduce the effect of few crops, there is need to
diversify the crops so that the failure of one can be compensated by the successful harvest of
other crops.
Question: Discuss the measures being taken to stabilize prices of agriculture products in your
country.
- Encouraging diversification of the agriculture sector. This is reducing reliance on few products
and thus enabling farmers have alternative sources of income. - Strengthening agro-commodity
agreements.
- Finding new markets for the agricultural products or diversification of the market.
- Undertaking proper planning of agriculture sector. This is reducing reliance on nature that
causes poor harvest in some cases.
- Encouraging contract farming. This is helping to assure the farmers of market for their produce
and fair prices for their produce.
- Improving on transport system or infrastructure improving storage facilities. This making
accessibility to the market easy and thus helping farmers to dispose-off their produce.

- Reducing dependency on nature by encouraging use of irrigation farming. This ensuring steady
supply of products hence stable prices.
- Encouraging/strengthening cooperative societies. These help the farmers access market and to
negotiate for better prices.
- Establishing agro-based industries. These help process the produce and thus increase the price
and shelf life of the products.
NB: The tense to use is „IS‟

PRICE CONTROLS/LEGISLATION
Price legislation involves interfering with the forces of demand and supply by the government
to set prices of goods and services.
This may be in form of minimum and maximum prices. Therefor price controls are of two major
forms;
1. Minimum price legislation

2. Maximum price legislation.
MINIMUM PRICE LEGISLATION/PRICE FLOOR
Minimum price legislation is the process where the government fixes the price of a commodity
above the equilibrium price below which it is illegal to buy or sell a product/commodity.
It is illegal to buy or sell a product or commodity and it mainly protects producers.

NB: Minimum price is the price fixed by the government above the equilibrium price below
which it is illegal to sell or buy a product or commodity.
Minimum price is usually for agriculture commodities for the benefit of firms or producers of
those commodities. It is as illustrated below.
P1 is the minimum price set by the government above equilibrium price.
Question: Outline any four reasons for government fixing minimum price.
Reasons for setting minimum price (price floor)
1. To protect weak producers or farmers from exploitation by strong buyers.

2. To encourage mass production (production in large quantities) because a high price induces
farmers to supply more.

3. To encourage potential investors to invest in production of primary products i.e. it helps to
attract new investors.
4. To control price fluctuations and therefore make an economy attain price stability.
5. To offset economic depression/recession. Minimum prices tend to activate investment or
production in an economy.
6. To discourage consumption of certain commodities i.e. those that are considered to be harmful
to people‟s health.
7. To minimize exploitation of labour as in the case of a minimum wage.

8. To encourage creativity and innovativeness in production.
9. Minimum prices more especially on foreign products are set to reduce the importation of
products so as to reduce balances of payment problems.
Question: Discuss the effect of fixing a minimum price in an economy.
Effects of minimum price legislation
Positive effects/advantages
1. It reduces the fluctuation in prices of agriculture commodities. Since the buyers are supposed to
pay the price fixed by government irrespective of any changes in demand.
2. It reduces exploitation of producers or firms by the buyers who usually pay them lower prices.
3. It leads to an increase in production of agriculture commodities since farmers are encouraged
by high profits realized.
4. It reduces income inequality between producers of agriculture products, people employed in
other sectors of the economy e.g. industrial sector as the farmers are able to get stable incomes
due to the stable price fixed.
5. It increases aggregate demand or purchasing power of the producers and discourages
investment in production to satisfy the demands of the producers.
6. Earnings of primary producers increase and this results into increase in investment in the
agriculture sector i.e. the incomes of the producers are established due to the fact that
fluctuations in prices of agricultural commodities are reduced.
7. It leads an economy out of depression or recession. As the demand increases, investment
increases, profits increase, employment increases etc.
8. Labour strikes or unrests are reduced. This is the case with minimum wage. This is because a
fairly satisfactory wage is given.
9. Effort and initiative (handwork) at work are encouraged hence increased participation in
productive activities.
10. Excess capacity is reduced as some resources are put to use.

Negative effects
1. It results into surplus output because of excess production and this may result into unnecessary
waste of commodities.
2. It is very expensive for the government. The government has to purchase the surplus output
from the market so that the price does not fall because of the surplus output (price support).
Price support is where the government buys surplus output on the market arising from the
fixing of the minimum price. This policy is used with an aim of supporting or holding the
minimum price legislated by the government.
3. Problems of storage arise more especially in developed countries where there are forced
storage facilities.
4. It encourages price increase and hence inflation tendencies arise. This causes high cost of living
in the economy.
5. Consumption reduces as many people find it difficult to afford goods whose prices have been
legislated.
6. It leads to an increase in the cost of production where the commodities for which the minimum
prices have been fixed are inputs in the production of other goods.

7. It results into inefficient allocation of resources. Many of the producers may channel resources
to the production of commodities whose prices have been legislated at an expense of other
commodities and this distorts the working of price mechanism.
MAXIMUM PRICE LEGISLATION (price ceiling)
This is a process whereby the government fixes the price of a commodity below the equilibrium price
and it is illegal to sell or buy above this price. It is basically meant to protect consumers. It is also called
price ceiling.
NB: A maximum price is the price set by the government below equilibrium price above which it
is illegal to sell or buy a commodity.
Maximum price is set for consumer commodities and it is usually set when the government
finds out that the equilibrium price in the market is too high to enable some people purchase
the commodity.
Illustration

P2 is the maximum price.
Question: outline any four reasons why the maximum price may be fixed in an economy.
Reasons for maximum price
1. To protect consumers from exploitation by profit minded traders and some producers.
2. To maintain price stability /minimize unnecessary price increases.
3. To encourage consumption of some selected goods most especially merit goods.
4. To check or regulate monopoly tendencies as monopolists to a greater extent are price makers.
5. To discourage production of some commodities that are undesirable to peoples‟ health and
morals e.g. demerit goods and public bads.
6. To ensure equitable distribution of income in an economy. This is done by reducing profits by

producers and expenditure by consumers.

7. To discourage exportation of expensive items so as to encourage exports in order to increase
government revenue.
Question: Examine the effects of maximum price legislation.
Positive effects (Advantages)
1. It protects the consumers from exploitation by sellers who usually charge them very high prices.
2. It reduces price fluctuation since the prices are fixed by the government and cannot change due
to forces of demand and supply.
3. It makes essential; goods available and affordable to all people in the country since the
maximum price is relatively low.
4. Maximum prices discourage production of some commodities especially those which are
undesirable to people‟s health and morals. The price is low and therefore low profits
discourage.
5. Maximum price controls monopoly power. This is by setting a price which makes a monopolist
make low profits which reduces the capacity of the monopolist to expand and influence the
market.
6. Maximum price ensures equitable distribution of income. It is because it reduces profits of
producers and expenditure by consumers.

7. It helps to bring about industrial peace where prices of products and factors of production are
fixed by the government in form of maximum prices.
Negative effects (Disadvantages)
1. It results into shortages of commodities in an economy. This is because the legislated prices
tend to be less attractive to producers.
2. It is expensive for the government to enforce as it involves high administrative costs to make
sure that sellers sell at the price fixed by the government.
3. Malpractices develop in the market and these include; hoarding, black marketing, smuggling
etc.
NB: Black marketing is where the commodity is sold illegally at prices higher than those set by
the government.
4. It results into inefficient allocation of resources as producers divert resources away from
production of other commodities hence leading to distortion of price mechanism.
5. It discourages investment in the production of the commodities whose prices have been
legislated and this retards economic growth.
6. Unemployment and underemployment result as firms try to reduce their costs and lay-off some
workers. Questions
1. a) Differentiate between maximum price legislative and minimum price legislation.

b) Examine the merits and demerits of price control in an economy.

c) Distinguish between price control and price support.
2. a) Examine the merits and demerits of price control in an economy.
b) Distinguish between price ceiling and price control.
c) Explain the effects of price control in an economy.
Effects of price control
Positive effects
1. Consumers are protected from exploitation by producers.

2. Monopoly powers are controlled.
3. Price stability is maintained /inflation is controlled.
4. It protects producers from being exploited.
5. It leads to increase in output.
6. It helps to make commodities available to all groups of people in the economy.
7. It helps to establish industrial peace where prices with products and factors of production are
controlled.
8. Producers realize stable income.

9. It may discourage the consumption of undesirable commodities.
10. It reduces income inequalities.
11. It helps an economy to offset an economic depression/recession in case of minimum price.
Negative effects

1. It can lead to unmanageable surpluses leading to storage problems.
2. Reduction in social welfare because of high cost of living in the case of minimum price.
3. It leads to production of excess capacity /underutilization of resources.
4. Unemployment may occur due to reduced investment.
5. It reduces incentives for private entrepreneurs/investment and this slows down economic
growth.
6. It leads to shortages of supply of goods due to increased demand in case of maximum price.
7. It leads to inefficient allocation with resources due to distortion of price mechanism i.e.
allocation of resources to those areas of goods where there are price controls.
8. It encourages malpractices e.g. smuggling, black markets, hoarding in the case of maximum
price.
9. It is expensive for government to enforce price controls i.e. high administration costs are
involved.
10. It may lead to excess production that calls for dumping in case of minimum price.
Question: Explain why price controls may be avoided in an economy
They may be avoided due to the following.
1. For fear of causing malpractices e.g. black markets, smuggling.

2. For fear of raising cost of production which arise out of high cost of raw materials because of
minimum price legislation.
3. To avoid unemployment e.g. maximum prices are less attractive to producers and therefore
results into less employment of resources/some firms lay-off employees to cut the cost of
production.
4. To avoid unmanageable surpluses and storage problems (minimum prices). Minimum price
encourages firms to produce in large quantities at times beyond the market demand.
5. To avoid discouraging entrepreneurs through tempering with their profit margins for the sake
of maximum price.
6. To avoid higher administrative costs on those price controls i.e. those monitoring compliance
with the legislated prices.
7. To avoid unnecessary distortion of price mechanism, this may lead to misallocation of
resources.
8. For fear of reducing the social welfare of the people e.g. minimum price which causes inflation
which reduces the purchasing power and demand.
9. To reduce production of excess capacity or underutilization of resources. Minimum price
increases the profit margin which encourages production.
10. For fear of causing shortages by discouraging production.
THE CONCEPT OF UTILITY

Utility means the amount of satisfaction derived from the consumption of a given unit of
commodity.
OR
It is the want satisfying power of the commodity. Utility can be divided into two i.e. i.
Total utility
ii. Marginal utility.

Total utility. This refers to the total satisfaction derived from the consumption of given units of
the commodity.
Marginal utility. This refers to the extra satisfaction derived from consuming an additional unit of the
commodity. e.g.
If one consumes 5 bottles of sodas and then consumes the 6 th one, total utility will be the satisfaction
derived from all the 6 bottles of soda.
The marginal utility of a god depends on the amount of the commodity already consumed. The 1 st unit
of a commodity gives higher satisfaction than the subsequent units. This is because the need for a
commodity is gradually satisfied.

The quantity of goods consumed and marginal utility vary inversely as illustrated below.
Quantit Total utility (TU) Marginal

y utility(MU)
0 0 0
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
The above information in the table is repeated graphically as shown above.

The relationship between quantity consumed, total utility and marginal utility
1. Marginal utility is equal to total utility for the 1st unit consumed.
2. As long as the total utility is increasing, marginal utility is decreasing up to a given point.
3. When the total utility is at maximum (the 6 th unit), marginal utility is zero. The point where total
utility is at maximum is the point of satiety commonly known as the bliss point.
4. The total utility is decreasing, marginal utility is negative.
The law of diminishing marginal utility
This is derived from the utility concept.
According to this law, as the consumer buys more units of the commodity, the satisfaction derived
from additional units reduces.

CONSUMER’S SURPLUS AND PRODUCER’S SURPLUS
Consumer’s surplus
This is defined as the difference between what a consumer is willing to pay for a commodity and what
he actually pays for the commodity.
OR; it is the extra utility enjoyed by the consumer without paying for it.
Consumer‟s surplus is =Expected expenditure - Actual expenditure
Consumer‟s surplus
Units of Price willing actual Consumer
commodity to pay price ‟s surplus
1 1000 250 750
2 750 250 500
3 500 250 250
4 400 250 150
5 300 250 50
6 250 250 0
Total 3200 1500
Consumer‟s surplus = Total expected expenditure-Actual expenditure
= (1000 + 750 + 500 + 400 + 300 + 250) – (250 X 5)

= 3200 – 1500
= 1700 shillings
Producer’s surplus; this is the difference between the amount of money a producer is willing to
accept for the sale of a commodity and what he actually receives. It can be illustrated as below.
Producer‟s surplus=Actual earnings – Expected earnings.
THE COB WEB THEORY
This explains the continuous fluctuations in prices of agriculture commodities in developing countries.
For it to operate the following assumptions are made.
1. Land output can never be equal to actual output e.g. farmers plan to produce more but in most
cases, they actually realize less.
2. Demand depends on current price.
3. Supply of the commodity depends on price in the previous production period.
4. Agriculture products have a long gestation period implying they take a long time to mature and
supply.
5. Agriculture products have inelastic supply meaning that what is supplied is not necessarily what is
demanded.
6. Farmers can‟t accurately predict the future market needs so plans are not always appropriate.
7. There are possibilities of storing the produce for so long therefore there is no speculation.
Once supplied on the market, it continues until the available stock is exhausted. The cob
web can either be regular, convergent or divergent.
REGULAR/PERFECT COB WEB

1. Regular cob web: The cob web is regular when the slopes of both the demand and supply curves are
the same i.e. both supply and demand curves have identical slopes. The angle would be regular
and prices and quantities will go on alternating on either side of equilibrium price by the same
magnitude as shown below.
In the illustration above, it can be seen that equilibrium quantity is Qe and price Pe. A high price P1 will
attract farmers who will produce a higher output Q2 in time period t2 causing an excess in supply and
in order to sell that is produced in that period. Farmers sale at low prices P2 which discourages them
to reduce output to Q1 in time period t3. This output is sold at price P1. In this case prices rotate
between two points and equilibrium is never attained.
CONVERGENT COB WEB
Here the supply curve is sleeper that the demand curve meaning that a small price fluctuation leads to
attainment of equilibrium. In other words, price fluctuations can be seen to steadily approach the
equilibrium point as illustrated below.

As seen above price fluctuations converge towards equilibrium.
2. Divergent/Elusive Cob Web
In the diagram above, under this cycle, price fluctuations tend to develop far away from equilibrium
over time. Demand is more inelastic than supply as illustrated above.
In the illustration above, it can be seen that prices are moving away from the equilibrium position i.e.
as the prices rise and fall; there is no hope that they will rich the equilibrium levels.

PRODUCTION
It refers to the transformation of raw materials or inputs into finished goods.
Or
It refers to creation of utility.
NB: Utility is the ability to satisfy a need.
Production involves a wide range of activities which include transportation, entertainment,
manufacturing, extraction of raw materials etc.
LEVELS/STAGES /CATEGORIES OF PRODUCTION
Primary production
This refers to the extraction and exploitation of natural resources. Therefore it involves the exploitation
of gifts of nature which provide raw materials. It involves activities like farming, fishing, mining,
lumbering, etc.
Secondary production
This involves transforming raw materials into finished goods that are ready for consumption by the
final consumer.

It involves activities like manufacturing, processing, construction, etc.
Tertiary production
This refers to the provision of services such as teaching, transportation, banking, insurance, etc. The
services that are produced under tertiary production are divided to two namely; (a) Direct/personal
services e.g. these of lawyers, teachers, etc.
(b) Indirect/commercial services such as advertising transport. Etc.
TYPES OF PRODUCTION
There are two types of production namely;
a) Direct/subsistence production
b) Indirect/commercial production.
Direct/subsistence production
This refers to the production of goods and services by an individual for own consumption.
Characteristics of direct production

1. Production is aimed at satisfying immediate needs of the producer.
2. If there is any form of exchange it is mainly by barter.
3. Poor quality products are mainly produced due to use of poor tools and absence of
competition.
4. Family labour is mainly used in doing the work.
5. Use of mainly poor tools e.g. pangas, hoes, etc. due to low levels of innovation and invention.
6. Limited invention and innovations due to limited research
7. Terms of service or conditions of work are either poor or non-existent
8. There is no specialising because the producer tries to produce almost everything he wants.
Merits of direct production

1. There is limited resource wastage because whatever is produced is consumed.

2. It is cheap because it mainly uses family labour which is abundant.
3. It is easy to manage because it uses mainly family labour and production is normally on a small
scale.
4. It uses simple and affordable tools which even peasant farmers can manage to purchase.
5. It is the main source of food to the modern sector.
6. It is the major source of employment for the majority of the illiterate peasant farmers.
7. No distribution costs are incurred because the producers are the consumers.
Demerits of direct production

1. It encourages excess capacity/under utilisation of the resources.
2. Poor quality output is produced because of limited competition.
3. Low productivity/low incomes hence low savings implying low capital accumulation.
4. There is limited specialisation and trade.
5. There is underemployment of labour.
6. Causes low tax revenue. This is due to the low output and the limited marketing of produce.
7. Limited inventions and innovations due to limited competition.
8. Worsens the problem of income inequality.
Reasons for reducing the direct production/subsistence sector

1. To increase production because producers producing in excess of what they need.
2. To move towards monetisation of the economy. There is focus on the market to earn incomes.
3. To promote inventions and innovations in production. Production becomes competitive.
4. To discourage rural-urban migration with its associated disadvantages
5. To widen the tax base so as to increase the government revenue inform of taxes. As output
increases capacity to pay taxes also increases.
6. To improve on the quality of final output. This is because production becomes competitive.
7. To encourage specialisation in production. Producers aim at earning more and therefore
concentrate of few crops.

8. To improve incomes/reduce income inequality. As output increases farmers‟ incomes increase.
9. To improve employment opportunities.
INDIRECT/COMMERCIAL PRODUCTIONAL
This is where producers are profit motivated and therefore produce surplus with an aim of selling.
Characteristics of commercial production
1. There is production of high quality goods due to competition.
2. There is specialisation in production since the aim is sale.
3. There is mechanization of farming activities.
4. Production is mainly on a large scale.
5. Exchange mainly involves monetary terms.
6. Production is mainly market and profit oriented.
7. The mainly the use of hired labour.
8. There is a high level of research in production.
Merits of commercial production

1. High quality products are produced due competition in production.
2. There is specialisation. This is because production is on large scale and producers aim at
exchange.
3. There is use of modern technology due to investment in research, inventions and innovations
thus there is higher productivity.
4. There is use of skilled labour hence a high level of output.
5. There is diversification in production and this reduces risks.
6. Encourages the development of infrastructure to reduce the cost of production.
7. Improves the BOP position of the country due to increased production for export which
increases foreign exchange earnings.
8. Generates more employment opportunities due to operation on a large scale.

9. Improves linkages with other sectors of the economy e.g. the industrial sector as it provides raw
materials for the agro-based industries and market for other industries.
10. Firms enjoy economies of scale due to operation on a large scale.
DEMERITS
1. High costs of production are incurred especially when distributing and transporting the final
products to distant markets.
2. In case of change of demand and tastes of consumers against the product, large scale
producers suffer great losses.
3. There is danger of technological unemployment as a result of mechanisation in production i.e.
machines displace workers
4. There may be high expenditure on inputs of raw materials as producers compete for raw
materials in the market.
5. Because of profit motive in the long run, there may be over exploitation of some resources.
6. It promotes dependence on other countries to get what is not being produced.
7. It leads to pollution and environmental degradation. This is due to mechanisation
FACTORS OF PRODUCTION
Factors of production refer to the inputs used in the production of goods and services to satisfy
human wants. Sometimes factors of production are referred to as agents of production
They are necessary and must be present before production takes place. They include the following
with their respective rewards/factor prices;
Factor payments refer to the monetary payments to factors of production for the services rendered
in the production process.
a) Land - Rent
b) Labour - Wages/Salaries
c) Capital - Interest
d) Entrepreneurship - Profit/loss.
LAND AS A FACTOR OF PRODUCTION

Land refers to anything provided by nature that is found above the earth's surface on the earth's
surface and beneath land. I.e. all free gifts of nature. Examples include minerals, forests, lakes and
rivers, climate. Etc.
Characteristics of land
1. The supply of land is fixed i.e. the supply of land cannot be increased
2. Land is a free gift provided by nature (God given gift) and cannot be created by man.
3. Is geographically in mobile but occupationally mobile i.e. cannot be transferred from one place
to another.
4. The productivity of land can be varied.
5. Land is supplied at a zero price
NB. The factor price/monetary reward for using land is called rent
TYPES OF RENT
Commercial rent. This refers to the payment made for the hire/use of a durable asset e.g. renting a
house, machines, land, etc.
Location/site rent. This is rent made to land due to its strategic location site e.g. land in Kampala has a
higher payment made to it than in rural areas due to location Quasi rent.
This is payment to a factor of production which is over and above the transfer earnings, due to its
inelastic supply in the short run but elastic supply in the long run e.g. payment made to doctors,
aircraft engineers, pilots etc.
Economic rent. This refers to the payment to a factor of production which is over and above its supply
price/transfer earnings.

Or
Payment to a factor of production over and above what it would have earned in its next best
occupation.
The determinants of economic rent are:

1. The elasticity of supply of the factor.
2. The supply price of the factor.
3. The elasticity of demand for the factor.
4. The degree of substitutability of the factor.
5. The demand for the factor.
6. The supply of the factor.
7. Time period.
8. Specificity of the factor.
9. The productivity of the factor.
Transfer earnings is a minimum payment to a factor of production necessary to retain or keep it in its
present employment (without transferring to the next best alternative job.
Thus the factors total earnings = Economic rent + transfer earnings.
Question: Assuming that a factor of production has transfer earnings of shs. 250000= and its
economic rent is 1/2 (half) times the transfer earning, calculate the factors actual earning. Factor‟s
actual earning = Economic rent + Transfer earning
= 1/2 X 25000 + 25000
= 37,500 shillings
Activity
Given that a factor of production receives transfer earnings of 350,000 shillings and its economic rent
is 2 ½ times the transfer earnings. Calculate the factors actual earnings.
LABOUR

This is the physical and/or mental human effort which is used in the production of good and services
to satisfy human wants. Labour can be skilled, semi-skilled or unskilled.
Characteristics of labour
1. Labour is mobile i.e. both geographically and occupationally.
2. Labour cannot be stored.
3. Labour cannot be separated from the labourer.
4. Its productivity can be varied.
PRODUCTIVITY AND EFFICIENCY OF LABOUR

Productivity of labour refers to the amount produced per unit of labour employed during a given
period of time e.g. if ten (10) tailors can produce 70(seventy) skirts, then;
The productivity of labour = Total of skirts
Total number of workers
= 70/10
= 7 shirts per worker
Marginal productivity of labour. This refers to the additional output that results from employing an
external unit of labour.
Average product of labour. This refers to the output per unit of labour employed.
Efficiency of labour. This refers to measure of quality and quantity of output that a unit of labour can
produce within a given period of time.
Or
The ability to achieve greater output in a short time without any decline in the quality of output.
Factors that affect (influence) productivity and efficiency of labour

1. Mental ability and the physical strength. A mentally sound and physically fit labour is more
productive because they have what it takes to engage in production while a mentally disabled
person has low efficiency and productivity because they lack what it takes to ably engage in
production.
2. Working conditions. Good working conditions increase labour productivity and efficiency
because they motivate employees while poor ones reduce productivity and efficiency of labour
because workers are demoralized.
3. Wage levels and incentives offered to a worker. Better incentives and pay increase labour
productivity and efficiency because they motivate employees while limited incentives reduce
productivity of labour because workers are demoralised.
4. Level of education and training attained. A highly trained worker is more productive and
efficiency because he/she is equipped with what it takes to engage in production while low level
of education is associated with low level of productivity and efficiency of labour because he/she
lacks what it takes to engage in production.
5. Working hours for the labourers. The longer the working hours the lower the productivity of
labour because the workers are over worked and become less motivated over time while
reasonable working hours result into higher efficiency and productivity because workers are
alert and motivated.
6. Quality of management. The higher the quality of management the greater the productivity and
efficiency because there is better supervision of workers while poor management leads to low
productivity and inefficiency because of poor supervision of employees.
7. The quality of co-operant factors. The higher the quality of co-operant factors the higher the
productivity efficiency of labour because the employees have what to use e.g. machines and
poor quality of co-operant factors causes low productivity because employees do not have
sufficient supply of what to use.
8. Attitude towards work. Positive attitude causes high productivity because employees have high
motivation to produce while poor attitudes to work lead to low level of output because there is
less motivation to perform.

9. Political climate. Political stability increases production and efficiency because employees are
assured of security for the property and lives while political instability reduces labour efficiency
because of the threat to life and property.
10. Level of specialisation of labour. Highly specialized labour has a high level of productivity
because it is very knowledgably about the tasks while less specialized labour has low
productivity and efficiency because of being less knowledgeable about the tasks.
11. Degree of expertise/experience. Highly experienced labour is more productive and efficient
because of being knowledgeable due to performing tasks for a long period of time while labour
with low experience has low efficiency because it is less knowledgeable due to limited time
spent doing a task.
12. Workers health conditions. Workers who are healthy have higher productivity because they are
energetic to engage in production while unhealthy workers have less energy to engage in
production.
13. Sociological factors. A good social environment leads to high productivity because of high
motivation while a poor social environment causes low productivity because of low level of
motivation.
Factors which may increase average product of labour.

1. Increases training/education
2. Improved working conditions
3. Improved nature of co-operant factors e.g. capital, quality land, etc.
4. Increased specialisation/division of labour.
5. Increased wages
6. Improved level of technology 7. Positive attitude towards work.
8. Political stability.
MOBILITY OF LABOUR

It refers to the ease with which labour can move from occupation to another or from one geographical
location to another.
Mobility of labour can be either geographical or occupation.
1. Geographical mobility. This refers to the ease with which labour can be moved from one
geographical area to another. E.g. house maid moving from Bushenyi to Kampala.
2. Occupation mobility. This refers to the ease (ability or labour to more from one occupation
to another e.g. labour charging from being a teacher to be an accountant in a bank.
IMMOBILITY OF LABOUR
This refers to the inability of labour to move from one occupation to another or from one
geographical area to another.
Therefore geographical immobility of labour refers to the inability of labour to easily move from one
geographical area to another.
Occupational immobility of labour refers to the inability of labour to easily change from one
occupation to another.
N.B Occupational mobility of labour can also be vertical or horizontal

(a) Vertical mobility of labour: This refers to the ease with which labour can move from one job to
another. E.g. movement of labour from a job of a lower rank or grade to another job of a higher rank
or grade but in the same organisation or company e.g. from being a class room teacher to being the
Deputy Head teacher
(b) Horizontal mobility of labour: This refers to the movement of labour from one job to another
while maintaining the same status or rank e.g. from being an accountant in a hospital to being an
accountant in the bank.
FACTORS DETERMINING MOBILITY OF LABOUR

1. The level of specialisation. Highly specialized labour is less mobile because there are limited
employment opportunities elsewhere while a low level of specialisation causes high level of
mobility because one can take up take up different jobs.
2. The level of wages offered to the worker. High level of wages at the current job makes labour to
stay in such an occupation/place because of the high level of motivation while low wages at the
current job makes labour to look for highly paying jobs and therefore a higher level of labour
mobility.
3. The age of worker. Old workers tend to be less mobile because of the commitments they have
while young people are more mobile because they are energetic and have less commitments.
4. The marital status. Married people find it difficult to move from one job to another or
geographical area to another because they do not want to stay far away from their families
while singles find it easy to move from one job to another or from one area to another due to
the absence of family attachments.
5. The working conditions of a given place or job. Favourable working conditions of a given job
tend to make labour immobile since they motivate the worker as there is less threat to life while
unfavourable working conditions tend to make labour more mobile as labour tends to move
from one geographical area to another of from one occupation to another due to the threat
they pose the lives of individuals.
6. Government policy. If labour is restricted from one occupation to another e.g. under the army,
then labour becomes immobile but where the government doesn‟t restrict the movement of
labour from one job/region to another labour is mobile.
7. Political climate. Labour tends to be mobile in places where there is political instability due to
the fear of losing life and tends to be immobile in places where there is political stability since
there is no serious threat to life.
8. Prospect of promotion. Where there is high possibility of promotion labour is less mobile and
more mobile when the chances of promotion are limited.
9. Level of advertisement of existing job opportunities/the knowledge about existing job
opportunities. Where there is awareness of existing job opportunities labour is mobile since the

jobs can be easily located but where there is ignorance of existence of job opportunities labour
is immobile since the jobs are not known.
10. Transport costs. Where the transport costs are high, labour mobility is low (immobile) because it
is expensive to move and when the transport costs are low mobility is high because it is cheap
to move.
11. Professional and institutional barriers. Presence of such barriers in some professions e.g.
doctors, lawyers where entry into such profession is restricted the mobility of labour is low but
where entry is not restricted, labour is highly mobile since accessing the jobs is easy.
12. Social ties. The higher the social ties the less mobile labour is because individuals are not willing
to leave family members and friends to establish new ones and when the social ties are lose
labour mobility is high since individuals are willing to make new friends.
13. The cost of living. A high cost of living in an area encourages labour mobility as workers seek
where expenditure is low and low cost of living makes labour less mobile since expenditure on
goods is low.
CAUSES OF MOBILITY OF LABOUR

1. Poor working conditions at the job place. Labour tends to move from where conditions of
work are poor to where they are good e.g. where transport allowances, housing allowances
are given.
2. Political instability. Labour tends to move from areas which are politically unstable to
working places that are politically stable to protect themselves form the possibility of losing
life.
3. Government policy of transferring workers from one place/job to another.
4. Low wages at the current job/place. Labour tends to move from low paying jobs/places to
where wages are high since high wages enable the employee be in a better position to
afford necessities of life.
5. High costs of living at the current place. This makes workers to move to other places where
the cost of living is lower so as to spend less on goods and services.
6. High degree of discrimination at places of work basing on tribe, sex, age, race.
7. Lack of possibility of promotion at the current job.
8. Natural calamities such as earth quakes, landslides etc. at current places of work.
9. Poor working relations at the current job. This makes labour to move for alternative jobs
where he or she qualifies for promotion.
Barriers to occupational mobility of labour factors limiting occupation of labour/Causes of

occupational immobility of labour
1. Inadequate skills for the alternative job. This implies that one is inadequate for the job available.
2. Better working conditions at the current job. There is less threat to one‟s life and therefore there
is no need for one to move.
3. High discrimination in the labour market that is labour will not move from one job to another
because of fear of being discriminated against in other alternative occupations.
4. The lower status of the alternative job. This will make a worker to stay on his/her current job
where the status is high.
5. Better wages at the current job. High wages at the current jobs are able to afford one more
goods and services.
6. High prospects of promotion on the current job. This makes the employee or worker to
continue working on his current occupation with the hope of being promoted in the near future.
7. High costs of obtaining the alternative job. This discourages people from taking on such jobs
because they require additional expenses of training.
8. Long period of training for the alternative job. Professionals that require long period of training
such as architecture, surveying etc. require a lot of time to sacrifice which may discourage many
people.
9. Old age workers who are quite old find it difficult to change from one occupation to another.
10. Cultural beliefs/social; restrictions. In some cultures women are not allowed to carry out certain
occupation like becoming a butcher. This makes some workers to stay at their current jobs.

11. Barriers by professional bodies/ entry restrictions into some professional bodies. Some bodies
such as ULS (Uganda Law society) Medical Workers Association limit the entry of members into
their bodies unless somebody certain skills.
12. Limited natural ability (lack of talent) People without certain talents (natural ability) including
high levels of intelligence cannot join some occupation.
Barriers/limitations to geographical mobility of labour/causes of geographical immobility of labour

1. Political instability in certain places. Workers are reluctant to move from current places of
work where there is peace and stability to places of insecurity for fear of losing their lives.
2. Family ties/social ties and attachments at the current place of work. Some workers do not
leave their homelands especially where they have family members who require their
attention and support such as the aged parents, blind people etc.
3. High costs of living in alternative places of work. Places of high cost of living require
individuals to spend more and therefore some individuals are not willing to move to such
places.
4. Shortage of housing facilities in the places where alternative jobs are found that is workers
who do not like areas without decent accommodation.
5. Poor transport and communication in the alternative areas.
Workers do not want to go to areas which poor infrastructure where transport costs are high
e.g. highlands.
6. Limited knowledge about the existence of job opportunity in other places workers which are
not move to other places because they are not aware that jobs are there.
7. Permanent investment one possesses in an area. Some people are not willing to leave those
places where they have long term investments.
Ways of increasing geographical mobility of labour

1. Advertising the employment opportunities. This increases the awareness about the
availability of jobs.

2. Developing infrastructure. This increases the movement of jobs to different areas.
3. Improve the political climate. This makes the areas attractive to labour.
4. Increasing wages in areas with low wages.
5. Improving the health of the workers.
6. Improving working conditions in other areas.
7. Fight social prejudices/bias/discrimination.
Advantages of labour mobility

1. It reduces the level of unemployment and under employment in the economy since labour
can move from one place to another or from one occupation to another.
2. It promotes equitable distribution or income in an economy since labour tends to change to
higher paying jobs.
3. It creates competition in the labour market which leads to increase in labour productivity and
efficiency.
4. It helps to fill manpower shortages in some areas or fields in the country that is the country is
in position to overcome labour shortage.
5. It enables labour to acquire new skills because as labour changes from one job to another,
they are able to develop then acquire new skills
6. It offers higher wages to workers. This is because labour moves from areas of low pay to
areas of high pay.
Disadvantages of labour mobility

1. It may create shortages of man power in some occupations especially those of low pay.
2. It may affect the level of output in the economy due to shortage of labour in some areas of
the country.
3. It causes transitional unemployment due to changes of jobs
4. It may lead to loss of craftsmanship
5. It encourages brain drain with all its associated disadvantages

N.B Brain drain refers to the movement of labour to other countries (one country to another) in search
of green pasture.
Ways of encouraging labour mobility.

1. By providing on job training such that labour acquires more skills.
2. Improving on transport and communication network so as to make it easy for labour to move
from one area to another.
3. Ensuring political stability in all parts of the country.
4. Increasing the level of advertisement such that people are aware of existence of jobs else where
5. Minimising restrictions by trade union on movement especially one country to another.
6. Ensuring uniformity in wage payments that is increasing the level of wages in different regions
especially where labour does not want to go.
SPECIALISATION AND DIVISION OF LABOUR

Division of labour is the practice of performing one particular function in the production process e.g.
in the process of manufacturing a car, one can concentrate on the engine, another in fixing tyres,
another in windscreens etc.
Or
It refers to splitting of production work into different stages or activities each being undertaken by
special group of people usually according to their talents and ability.
In other words, refers to the allocation of tasks among workers in production so that everyone
engages in tasks that they or she can do most efficiently.
Specialisation of labour
Is the concentration of an individual on one or a few occupations or in production of one commodity
where he is most efficient. Or refers to the concentration of labour in production of what one can do
best and gets the rest through exchange.
Advantages/merits of specialisation and division of labour
1. Time saving. It takes little time to learn the job that is no time wasted in moving from one job
to another.
2. Enable workers gain experience and skills that is they become efficient as a result of
repeating the same task.
3. Duplication of tools and tasks is avoided.
4. Enables workers to exploit their natural talents by concentrating on their jobs which they can
do better e.g. doctors, lawyers, teachers, etc.
5. Encourages and makes possible the use of machines at various stages of production because
of producing in bulk and this increases the output.
6. Regional specialisation and International division of labour enable regions or countries to
exploit their natural resources and to get what they cannot produce from other regions to
countries.
7. Involves production in bulk/large quantities. This enables firms to reap economies of large
scale production.
8. Specialisation encourages firms to employ specialists at different stages of production which
leads to efficiency and increased output.
9. Less fatigue since an employee is one place using a given machine.
10. There is improvement in the quality of final products. This is because the process is
standardized.
Demerits of specialisation
1. Creates boredom. As one repeats the same task, time after time work becomes
monotonous which dulls intelligence.
2. Leads to unemployment. E.g. for instance in case of change in fashion, demand,
specialists who are laid off cannot easily change to other jobs.

3. Specialisation may cause temporary shortages in case of absence of one of the few
specialists at a particular stage of production. More to that the whole production process
may come to a standstill in case one worker misses or if there is breakdown at a particular
stage of production.
4. International specialisation leads to overdependence on other countries and discourages
diversification.
5. May result into over exploitation of resources which leads to resource depletion
especially these that cannot be replaced such as minerals.
6. Leads to loss of skills and craftsmanship in other occupations since one concentrates on
one or a few tasks
7. Limits occupational mobility of labour in a country. People who are highly specialised
tend to become less mobile occupationally.
8. Specialisation may lead to over production creating surpluses that may be difficult to
market.
9. Specialisation exposes workers together risks like occupational diseases e.g. these who
specialise in welding, fumigation etc. normally develop health complications if not well
protected.
10. Encourages use of machines which are specific and hence may not serve more than one
purpose.
CAPITAL
This refers to man-made resources used to further the production process. Thus capital includes
machinery, money, buildings, tools and equipment used in production, roads, schools etc.
The reward for capital is interest
Capital therefore consists of producer goods and stock of consumer goods not yet in the hands of
consumers.
All in all capital is wealth which helps in the production of more wealth.
Forms of capital
1. Normal /money/ liquid capital. This refers to capital inform of monetary units and can be
inform of currency (Coins and notes (or near cash e.g. a cheque.
2. Real physical capital. This refers to a capital in terms of physical assets such as machinery,
vehicles, and building
3. Fixed capital refers to the capital or machinery or buildings, factory equipment, cars etc.
that are used in production process. It is durable in nature and can be used over and over
again.
4. Private individual capital. Refers to capital owned exclusively by an individual and it yields
income to the individual owner e.g. the business assets, buildings, etc.
5. Public/social overhead capital. This refers to capital which is collectively owned by the
society as a whole. It is usually provided by the state e.g. public roads, hospitals, etc.
6. Operational/working/circulating capital. Capital that consists of raw materials that are
required for the day to day running of the firm e.g. fuel, farm seeds, allowances etc.
7. Sunk capital. This is specialised capital that cannot easily be adapted to alternative uses
e.g. popcorn machines concentrate mixer or plough.
8. Floating capital. Refers to capital that can be used for a number of purposes in various
ways. It is also referred to as non-specific capital e.g. buildings, money etc.
ROLE OF CAPITAL IN THE PROCESS OF DEVELOPMENT

1. Capital increases productivity and efficiency of other factors of production. The use of
machines increases the output of labour since machines are more efficient.
2. Facilitates optimum use of idle resources. The use of machines increases hence leading to
full employment of such resources e.g. raw materials, fertile lands, forests, water resources.
3. Promotes technological development and technological transformation in the country that is
improvement of the methods of production.

4. Capital inform of money promotes exchange of goods and service (trade of commerce) and
thus commercial production is encouraged.
5. Promotes specialisation in the production process through the use of machines thus leading
to increase in production.
6. Capital is an engine to economic reforms that where capital economic transformation can
take place e.g. the economy can move from being agro based to being an industrial
economy to use of capital.
7. Encourages development of infrastructural such as transport and communication
development network like roads, electricity etc. using machines.
8. Facilitates industrialisation process. Nominal capital encourages establishment of industries
since it is used to purchase machines, hire labour, etc.
9. Simplifies and quickens work thereby increasing output.
10. Leads to production of quality products that is with the use of machines there is
improvement in the quality of final output due to higher efficiency.
11. Facilitates research. Nominal capital helps to finance research which leads to improvement in
technology.
12. Creates employment opportunities. The establishment of industries using liquid capital
increases employment opportunities.
13. Reduces economic dependence. Capital in form of machinery increases the capacity to
produce goods and services which reduces the importation of goods.
14. Increases output hence economic growth. Use of machinery increases the productive
capacity of enterprises hence a high rate of economic growth.
15. It is an engine for economic reforms.
CAPITAL ACCUMULATION/FORMATION
This refers to the process of increasing a country's stock of producer goods/capital goods.
Or

Accumulation is the process of creating a country‟s stock of capital (mainly through
investment).
FACTORS AFFECTING /INFLUENCING CAPITAL ACCUMULATION

1. Level of income. High level of income leads to high level of accumulation because it enables
individuals to purchase inputs while when the level of income is low the capacity to purchase
inputs is hence low production and low capital accumulation.
2. Population growth rate. High population growth rate leads to high expenditure on
consumption leading to low savings, low investment and low capital accumulation while low
population growth rate leads to low expenditure on consumption which leads to high savings,
investments and high capital accumulation.
3. Level of capital inflow and capital outflow. High level of capital inflow inform of donations,
foreign investors and income earned by citizens working abroad leads to high capital
accumulation because it avails funds for purchase of inputs for production.
4. Size of the market. Ready market promotes production which causes an increase in profits and
thus high capital accumulation. When there is limited market for goods there is low capital
formation due low profits.
5. Level of infrastructure development. Developed infrastructure aids production by reducing the
cost of production and therefore higher profits which leads to high level of capital accumulation
and poorly developed infrastructure leads to a high cost of production and therefore low profits
which causes a low level of capital accumulation.
6. Level of savings in an economy. High level of savings leads to high level of investment hence
high capital accumulation because individuals have funds to purchase the required inputs and
the low level of savings implies limited funds for purchase of inputs hence a low level of
investment.
7. Level of inflation. High inflation rates discourage savings and investments because it reduces
the purchasing power and cause increase in the cost of production thus low profits and low
capital accumulation on the other hand a low rate of inflation encourages savings and

investment due the low cost of production thus high profits and a low rate of capital
accumulation.
8. Political climate in the country. Peace and stability encourages investment because there is
certainty about security for life and property and this leads to high capital accumulation while
political instability discourages investment and production because of the uncertainty about the
security for life and property thus low capital accumulation.
9. Level of entrepreneurial abilities in the country. Poor entrepreneurial skills cause poor resource
mobilization and therefore low level of investment and thus low level of capital accumulation on
the other hand good entrepreneurial skills lead to better resource mobilization and co-
ordination and therefore high level of investment and production causing a high level of capital
accumulation.
10. Government policy on investment. Where there is a favourable government policy like giving
subsidies to producers encourages investment because of the low cost of production and an
increase in profits is encouraged thus high capital accumulation but an unfavourable
government policy like high taxation discourages investment because it increases the cost of
production and reduces profits hence low capital accumulation.
11. Existing stock or capital. A high capital stock leads to more capital accumulation because it
increases efficiency in production while limited capital stock causes low efficiency in production
hence low capital accumulation.
12. Degree of accountability/corruption. A high rate of corruption reduces the amount of money
available for investment in production and this causes a low level of profits and thus low capital
accumulation on the other hand a low rate of corruption causes a high level of investment
because funds for investment become adequate and this leads to a high level of profits and
capital accumulation.
13. The techniques of production/state of technology. Poor techniques of production cause a low
level of efficiency in production and therefore low profits and capital accumulation while good
techniques of production cause a high level of efficiency in production which leads to high
profits and capital accumulation.

14. Cultural factors/degree of conservatism. A high degree of conservatism cause limited ability to
adopt better techniques of production and this causes a low level of output and profits thus a
low level of capital accumulation while low level of conservatism leads to easy adoption of
better techniques of production and this cause a n increase in production and profits and thus
high level of capital accumulation.
15. Level of interest rate on loans. A high rate of interest on loans causes a low rate of capital
accumulation because it discourages borrowing for investment and this causes a low level of
capital accumulation while a low rate of interest on borrowed funds cause a high rate of
investment because it encourages borrowing and this causes a high rate of capital
accumulation.
Students’ activity: Explain the factors limiting capital accumulation in your country.
FACTORS LIMITING CAPITAL ACCUMULATION IN LDCS

1. Low levels of income.
2. High population growth rate. This discourages savings investments hence low capital
accumulation.
3. Low level of savings.
4. High degree of conservatism.
5. Poor techniques of production.
6. Political instability.
7. Small market size (both domestic and foreign)
8. Low levels of development of infrastructure.
9. High rates of corruption/ embezzlement.
10. Limited domestic and foreign markets.
11. Low levels of capital inflow which high levels of outflow
12. Low levels of entrepreneur skills.
13. High rates of inflation.

14. Unfavourable government policy on investment.
15. High level of interest on loans.
MEASURES BEING TAKEN /THAT SHOULD BE TAKEN TO INCREASE CAPITAL

ACCUMULATION IN LDCS.
1. Improving infrastructure e.g. roads, power dams etc. this is reducing the cost of production
and thus increasing the level of profits and capital accumulation.
2. Widening of the market. This is through economic integration and this is increasing the
demand for goods produced locally and therefore more profits are being realized thus
increasing capital accumulation.
3. Fighting and Minimising corruption and embezzlement of public funds, especially in the
public investments this is making funds sufficient and thus more output thereby leading to
high capital accumulation.
4. Checking the population growth rate. This is through under taking population control
measures that is use of family planning methods so as to reduce on the dependence ratio
thereby increasing savings, investments and capital accumulation.
5. Extending credit facilities to the small scale businesses. This is encouraging investment and
production which is leading to high capital accumulation.
6. Encouraging macroeconomic stability/reducing inflation this is encouraging production
because of the low cost of production eventually encouraging investments and finally
increasing capital accumulation.
7. Stabilizing the political climate. This assuring the investors security for life and property and
therefore more investment and capital accumulation.
8. Improving entrepreneurship skills. This is increasing the ability of individuals to mobilise and
coordinate resources and thus high level of production and capital accumulation.
9. Providing investment incentives. These are reducing the cost of production and thus
encouraging investment which is increasing profits and capital accumulation.

10. Improving techniques of production. This is increasing efficiency in production as well as the
profits and thus increasing capital accumulation
11. Encouraging people to save.
ENTREPRENEURSHIP
This refers to the under taking of risks of initiating and financing of business with the
intention of making profits, An entrepreneur, undertakes risks by introducing both new
products and new ways of making the product The reward for entrepreneurship is
profit/loss
FUNCTIONS OF AN ENTREPRENUER
1. He starts the business or firm.
2. He employs other factors of production and coordinates their activities therefore he is
coordinator.
3. He bears risks of initiating and financing the business.
4. He monitors the entire business or production process.
5. He takes major decisions and makes sure that they are carried on i.e. takes decisions about how
and what to produce; therefore he is a decision maker.
6. He organises the other factors of production into new kinds of enterprises associated with new
projects
7. He takes responsibility of losses and profits of the firm.
8. He makes arrangements for rewarding other factors of production.
Factors that determine the supply of entrepreneurship
1. Level of education and training. The higher the level of education the greater the supply of
entrepreneurs and the lower the level of education the lower the supply of entrepreneurship.
2. Natural and acquired abilities People with natural abilities are better than those with limited
abilities and therefore their supply is higher.
3. Government policy in relation to investment. Conducive policies inform of low taxes,
subsidisation leads to high supply of entrepreneurship because of the low cost of production
while unfavourable policies such as high taxation leads to low supply of entrepreneurs
because of the high cost of production and the low profits.
4. Level of economic development. The higher the level of economic development the greater
the supply of entrepreneur and vice versa.
5. Social economic factors e.g. religion, traditions and cultures affect will power of individuals in
undertaking risks in business ventures in a society since a lot of valuables are attached on
such socio-economic factors leading to low supply of entrepreneurship.
6. Size of the market. A large market leads to high supply of entrepreneurship since more
profits are realized where as a small market leads to low supply of entrepreneurship because
the profits are low.
7. Political climate. Political instabilities lead to low supply of entrepreneurship because they
threaten the lives and property of the entrepreneurs while political stability and security
leads to high supply of entrepreneurship because entrepreneurs are assured of security for
their lives and property.
8. Level of development of infrastructural facilities e.g. roads, development banking sectors
leads to high supply of entrepreneurship because they lead to low cost of prodution and
while poorly developed infrastructure leads to low supply of entrepreneurs because it cause
a high cost of production.
9. Land tenure system. A good land tenure system makes acquisition of land easy and this
encourages expansion of enterprises hence high supply of entrepreneurship while a poor
land tenure system causes low supply of entrepreneurship because it makes acquisition of
land difficult.
10. Availability of raw materials. Presence of raw materials increases supply of entrepreneurship
because of the cost of production and when they are scarce the supply of entrepreneurs is
low because it becomes costly to produce.

11. The rate of inflation. A low rate of inflation causes a high supply of entrepreneurship because
the cost of production is low and profits are high while a rate of inflation causes a low level of
entrepreneurship because cost of production is high and profits are low.
12. Degree of accountability/corruption. A high level of corruption causes a low level of
entrepreneurship because it makes starting enterprises costly and therefore a low supply of
entrepreneurs while a low level of corruption makes starting enterprises less costly and
therefore a high supply of entrepreneurs.
Measures that can be taken by the government to increase entrepreneurship in Uganda
1. Encouraging economic integration. This increases the market for goods and therefore more
profits are realised
2. Building strong and sound infrastructural facilities e.g. roads telecommunication etc.
to support investments facilities. These reduce the cost of production and therefore make it
easy to establish enterprises.
3. Further privatising state enterprises. This increases competition in production and
encourages individuals to engage in production by starting enterprises.
4. Further liberalising the economy. This makes it easy for individuals to start enterprises since
some unnecessary restrictions are removed.
5. Ensuring a stable political atmosphere. This assures the investors of security for life and
property and therefore more enterprises are established.
6. Providing incentives to investors e.g. free land, tax holidays etc. These reduce the cost of
production and therefore more enterprises are established.
7. Establishment of specialised institutions e.g. Uganda Investment Authority (UIA). These
provide assistance to entrepreneurs by providing the required information on possible
investment opportunities.
8. Ensuring price stability. This reduces the cost of production and increases the profit levels.
9. Providing affordable loans. This is enabling people start production enterprises as they are
provided with the needed funds to purchase inputs for production.
10. Improving the land tenure system. This is making acquisition of land for investment and
mechanisation easier and therefore more output is produced.
11. Fighting corruption. Funds set aside are used for their intended purpose and therefore
projects to support production are put in place.
12. Encouraging savings. This enables individuals to accumulate capital for investment.
13. Providing affordable loans. This enables potential investor access the capital to purchase the
required inputs.
Specific factors of production

There are inputs designed and used for a particular purpose and little used for anything else. E.g.
water pipes commonly used for transporting water e.g. specialised labour e.g. dentists are trained to
treat only the teeth.
Non-specific factors of production

Inputs that can be used four various purposes e.g. agricultural land is used for growing various crops
and rearing animals. Non skilled labour which has no training e.g. managing directors who are not
employed because of their knowledge but their ability in decision making.
DEMAND FOR THE FACTORS OF PRODUCTION.

This is refers to demand derived from the demand of products produced by a factor of production.
Demand for the factors of production depend on;
Factors determining/ affecting the demand for factors of production

1. Demand for the product that the factors of production produce. Where the demand for the
product is high, the demand for the factors of production is also be high and vice versa.
2. Price/cost of the factors of production if the cost of the factors of production is high, its demand
is low and vice versa.

3. Proportion/fraction of the cost of the factor to a total cost of production. If the proportion of the
cost of factor to the total cost is high the demand is low and vice versa.
4. Degree of the substitution of the factor of production. If it is easy to replace labour with capital
the demand for labour is low and if it is not easy the demand for labour is high.
5. Complementarity of the factors of production. The higher the degree of complementarity the
higher the demand for a factor and vice versa.
6. Marginal productivity of a factor of production labour. The higher the marginal productivity of
the factor, the higher the demand and vice versa.
Mobility of factors of production
Factor mobility refers to the ease with which a factor of production can move from one geographical
area to another or from one occupation to another.
Geographical mobility of a factor of production refers to the movement of the factor of production
from one area to another in the process of production. Occupational mobility of a factor of production
refers to the ease with which a factor can move from one occupation to another.
Barriers to factor mobility in Uganda
1. High degree of specificity of a factor of production.

2. Low payment in alternative uses on high payment in the current job.
3. Some factors of production are impossible to move because of their fixed nature e.g.
land, buildings. etc.
4. Poor conditions of work in alternative places/occupations
5. Ignorance of other job opportunities
6. Cultural of social ties. Same people find it difficult to work far away from their homes.
7. Social status. That is high in the current job and low in the alternative job.
8. Political instability in area of alternative jobs.
9. Lack of appropriate job specifications.
10. Fear of the unknown.
11. Barriers by trade unions.
12. Poor health.
13. Old age that is reluctance to move due to old age.
Question 1. Distinguish between capital accumulation and capital appreciation (b)

Examine the factors that influence capital accumulation in Uganda
2. Why is capital taken to be important in the development of Uganda's economy? (b)

Describe the obstacles of capital accumulation in Uganda
3. Distinguish between occupation mobility of labour and geographic.

(b) Discuss the factors that determine LM in LDCs
4. Define the term labour mobility
(b) Explain the causes of labour mobility in the economy.
5(a) Distinguish between specialisation and division of labour.

(b) Examine the merits and demerits of specialisation and division of labour.
6(a) Define factor mobility

(b) State any three barriers of factor mobility in Uganda
9c) Distinguish between transfer earns and economic rent.
Given that the market supply price is 130,000 and its economic rent is half the supply price. Determine
the factors actual earnings.
PROFIT
It is the reward for an entrepreneur for undertaking a risk for starting the business or firm. It is
the difference between the total revenue and total cost of the firm. (Total revenue - total cost).

Types of profits
1. Abnormal/pure/super normal profits. This refers to the returns an entrepreneur earns when
average revenue is greater than average cost.
Or
The returns an entrepreneur earns that is enough to keep him in production and induces new
firms to join the industry.
2. Normal /zero profits. It is the profit level earned where average revenue is equal to average cost
(AR = AC) Or
3. Economic profits. These are earnings measured or derived by getting the difference between
revenue and opportunity cost of factors used in the production of output sold by the firm. Or
It refers to the difference between revenue got by a firm and what it would have got in the
second best alternative use/employment.
4. Normal profits are earnings or rewards to an entrepreneur or a firm (s) that is just
sufficient/enough to cover total cost or keep him/it in production without inducing other firms
to join the industry.
Functions of profits
1. They serve as an incentive that encourages an entrepreneur to take risks of investment because
without profit the entrepreneur cannot take risks.
2. Profits are a source of finance to the investor who will re-invest or plough back the profits and
thus encourage expansion.
3. They stimulate innovation - that is profits provide incentive to innovate and improve
productivity and efficiency.
4. They guide government in taxation. An increase in profits increases the capacity of firms to pay
taxes.

5. They help ensure efficiency in firms. It is the most efficient firms that are better placed to
continue in business.
6. Used for financing research and development to achieve better efficiency.
7. They are used by creditors in advancing loans or credit facilities; they are an indicator of ability
of debtors.
8. Trade unions are helped by profit levels in negotiations are likely to succeed when the employer
is earning huge profits.
Determinants of profits in Uganda

1. Price levels. High prices result into high profits while low prices result into low profits
2. Cost of production e.g. level of taxation, prices of raw materials. Higher level of taxation leads to
high production cost hence leading to low profits while low level of taxation leads to high
profits because they reduce the costs of production.
3. Entrepreneurial skills or organisation ability. High degree of entrepreneur skills on the part of
investors enables them to organise other F.O.P well hence leading to high profits and the
reverse is true.
4. Degree of risks the higher the risk, the more profits while the lower the risk, the less the profits.
5. Level of output/supply High output leads to high profits while low output leads to low profits.
6. Size of the market demand. High demand for a given product leads to high profits because the
seller can even increase the price and people continue buying the commodity while low
demand for a product leads to low profits.
7. Ease of entry in an economy/number of firms/producers in the economy. Presence of more
firms in an industry increases supply of output hence reducing the profit margin while presence
of few firms in an industry leads to high profits because of presence of few firms in an industry
leads to low supply in the market.
8. Goal of the producer. Different producers have different goals e.g. a producer whose goal is to
maximise profits sells at a high price in order to earn more profits.

QUESTION: (a) Distinguish between normal and super normal profits. (c) Mention
any two determinants of profits in Uganda.
BUSINESS UNITS
Sole proprietorship:
This is the business under the control and management of one person. He provides all the capital and
labour (although he sometimes uses family labour) makes all decisions, suffers any risks that may arise
and enjoys all the profits.
It is very common in retail trade
The major sources of finance earning are his savings and borrowing.
Advantages of sole proprietorship

1. Decision making is easy and quick. This is because the owner has full control over the
business i.e. there is no need for consultations.
2. Enjoys top secrecy in running the business as the secrets concerning the day to day running
of the business are kept to one person.
3. There is a lot of flexibility in this business that is he can make necessary changes in a short
period that is he responds quickly to changes in demand.
4. It is easy to start since there are no formal procedures required such as registration and
documentation.
5. He has direct personal contacts with his customers and knows them personally. This means
that he can extend credit facilities to trust worthy customers which increases sales and hence
more profits.
6. He enjoys all the profits alone, this enables him to work very hard.
7. When the owner dies inheritance is easier than in a partnership business.
8. The business is small and he can supervise it properly as compared to joint stock that is at
times faced with special problems like strikes.

Disadvantages of sole proprietorship
1. The owner has unlimited liability that is if the business collapses the owner is responsible for
all debts of the business he can even lead to the sale of his own property.
2. There is lack of continuity in case the owner dies.
3. It is very difficult for the owner to get loans from financial institution. This is because the
owner cannot be trusted.
4. Has little working capital therefore his purchases are relatively small and the discount he
receives from purchases is quite small hence low profits.
5. Low output in the business which implies low turnover hence low income.
6. He suffers all risks and losses alone.
PARTNERSHIP
It is a type of business unit formed by a group of people between two and twenty who contribute
capital to start a business with an aim of making profits.
The minimum of the number of people is 2 (two) and the maximum is 20.
A partnership begins operation after the partners have signed a partnership deed.
Types of partnership
1. Ordinary (unlimited) partnership. This is one in which all the members have unlimited liability i.e.
they are answerable to the firm‟s debts up to the extent of selling off their personal property.
2. Limited partnership. This is one in which the liability of the members is restricted to the nominal
amount of capital they have put in the business.
Types of partners
1. Active partners

A partner who is directly involved in the day to day running of the business in addition to his
capital contribution when starting the business.
2. Dormant partners
These are partners who are not actively involved in the running of the business but contribute
capital to the business
3. Quasi partners
These are partners who allow their names to be used in the business because of their good
conduct but don't involve in the running of the business and contribute no capital.
Advantages of partnership
1. More capital can be raised compared to sole proprietorship business.
2. It is easier to form and run as compared to joint stock companies.
3. It is capable of attracting different talents as compared to sole trading
4. Specialisation is possible unlike sole proprietorship where work is done by one man
5. Enjoys privacy (in accounts unlike public limited companies.
6. The business benefits from a variety of skills by different members as compared to sole trade
7. Can easily access loans from financial institutes to sole trade.
8. Continuity of the business is assured incase a member dies
Disadvantages
1. Decision making is slow since consultations have to be made.
2. There is unlimited liability in case of ordinary partnership.
3. Disagreement between partners may lead to the collapse of the business of sometimes greatly
affect operations of the business.
4. Profits have to be shared among members in the business. This discourages them to work hard.
5. The business may collapse in case of death, resignation of an active partner
6. Sometimes it results into laziness or incompetence among some members as everyone tries to
escape from work after all profits are shared among all members.

7. Any partner can legally bind all the other members of partnership. All partners may be held
liable for the acts or misconduct of one their fellow members.
JOINTSTOCK COMPANIES
These are business units comprising or between 2(two) to 50 members or 7 (seven) to a maximum of
indefinite number of individuals organized for the purpose of carrying on some business with the aim
of making profits. These members are referred to as shareholders who a supposed to take a share of
the profits of the business at the end of each year. Shareholders have got limited liability.
Features of joint stock companies

1. The minimum number of members is 7 and no maximum for public limited companies and 2 to
50 for private limited companies.
2. Shares are freely transferrable in the stock exchange market.
3. The company has a legal entity.
4. The members have limited liability.
5. Are free to raise capital by selling shares to the public.
Advantages of public limited company

1. Members have got limited liability. Collapse of the company does not affect financial
standard of an individual as is the case under sole proprietorship.
2. More capital can be raised compared to sole proprietorship and partnership 3. Shares are
freely transferrable specifically in a public limited Company
4. Specialisation is possible in the firm.
5. It is not affected by death or bankruptcy by any one member.
6. Employees may be allowed to buy shares in the company which improves their motivation.
Disadvantages of public limited companies

1. The shareholders do not have direct control over the business because they employ experts.
2. The procedure of forming a public limited liability company is quite long that it has to obtain
the following; Memorandum of association, articles of association and a prospectus.
3. Decision making is quite slow because all members must be consulted for before taking a
decision
4. Some public limited companies become too large to attain maximum efficiency.
5. Decision making may be slow because some decisions are taken by directors while some are
taken by shareholders.
N.B: Public limited Liability Company is a business unit comprising of a minimum number seven and
no maximum number of shareholders who have contributed capital through buying shares from the
company with an aim of making profits.
Private Limited Liability Company

This is a business unit comprising of a minimum number of two and a maximum of 50 shareholders
who have contributed capital through buying shares from the company with an aim of making profits.
A private limited liability company is usually small in size the members are usually a group of friends
and family members.
Characteristics of public limited liability company
1. The minimum number of members is two and the maximum is 50

2. Shares are not freely transferrable
3. They are not allowed to sale their shares publically
4. They are not required to publicise their accounts to the general public. Advantages of
private limited companies
1. Members have got limited liability

2. More capital can be raised compared to sale and partnership
3. Specialisation is possible in the firm
4. It is not affected by death and bankruptcy
5. They enjoy a lot of dependency
6. They are direct control over the business.
Disadvantages
1. Shares are not freely transferrable
2. Membership is restricted to a maximum of 50 people hence expected capital is limited.
3. Shares cannot be sold publicly
SOURCES OF BUSINESS FINANCE

The firm‟s main financial sources include the following.
1. Personal savings. An individual or family business may be started on the basis of the
proprietor‟s accumulated savings.
2. Bank loans and advances. Besides requiring capital to finance materials, firms also require
capital for building, buying machinery and vehicles. These require long term loans from
banks.
3. Shares and debentures. In its early days, a firm will rely on the original shares of capital
subscribed by members or debentures. A debenture refers to a unit of a long term loan of a
company or firm by the members of the public.
4. Retained profit/accumulated reserves. Once a firm is established, the most common
method of raising long term capital is from retained profits. Within a year, a firm may pay
some of its profits to shareholders but will retain or reserve some profits for future use.
5. Borrowing from friends and relatives. I.e. the proprietor may get capital from friends and
relatives.
6. Selling of fixed assets. The business may get finance from mortgaging fixed assets such as
land, permanent buildings durable items like cars permanent buildings etc.

7. Trade credit. Under this the producer receives a delivery or raw materials and other supplies
without immediate payment i.e. the manufacturer pays for the supplies at a future date.
8. Issuing new shares. That is if the firm wishes to expand more rapidly than the retained
profits. It can issue new shares to the public such that when they a brought, the firm gets
more capital and profits.
COOPERATIVE SOCITIES
Is a voluntary association of people who have got common interest/objectives.
It is a voluntary association formed by the group of people for the purpose of benefiting its members.
PRINCIPLES OF CO-OPERATIVE SOCIETIES

Open and voluntary membership. The principle emphasises that no one is forced to become a
member of cooperative society. IN other words it should be voluntary interest of the person.
2. Democratic administration that is
The affairs of the co-operative society must be collectively administered that the principle is one man
one vote.
2. The dividends depend on each member‟s contribution to the cooperative society. A member who
contributes more will get more dividends compared to the one who contributes less. 4 Cooperation
with other co-operative societies that is at the local level, national level and international level.
Because co-operative societies have a lot in common. This makes them learn a lot from each other.
TYPES OF CO-OPERATIVE SOCIETIES
1 Consumer co-operative society. This is a retail business owned and operated by a group of final
consumers with a major aim of trading purposely to enable members buy their requirement
collectively and at a relatively cheaper price.
2. Producer co-operative society. This is a co-operative society owned and operated by producers
especially in the agricultural sector to collectively produce, process, transport and market their
products.

3. Savings and credit societies. These are societies that are set up to encourage savings by
members. Members can also get loans from these societies for buying basic needs, construction or
storage facilities etc.
4 Transport co-operative societies. These are basically to assist consumer and producer societies with
transportation of their commodities e.g. the former Uganda Co-operative Transport Union. (UCTU)
ROLE OF CO-OPERATVES TO THE DEVELOPMENT OF LDCS

They provide credit to individuals especially the credit co-operative society such credit is used to
improve productivity especially in the agricultural sector in the small scale industries.
2. They increase production since they increase on the number of small scale producers thereby
promoting economic growth.
3. Development of infrastructure especially; transport and storage facilities to members at reduced
costs. This leads to development of various infrastructures e.g. roads.
4 They develop the skills to producers that is they help to educate farmers or producers better
methods of production which in turn leads to an increase in the level of production.
5. They carry out market research and provide important information on the type of crops demanded
and how to improve on the quality of the produce.
6 They provide employment opportunities to people in the country in various capacities e.g.
drivers, manager, accountants.
7 Saving and credit societies encourage, provider the culture of savings in the country which can
promote investment.
8. Help in the transformation of the economy from being predominantly subsistent to becoming a
monetised economy through encouraging large scale production instead of small production. They
help in stabilization of prices. This is normally done with the marketing boards through buffer stocks
and stabilization funds.
Problems of co-operative societies in Ldcs

Poor organisation
Unfavourable climatic conditions
Limited managerial skills
Conservativeness hence low levels of out put
Financial difficulties
Political instabilities in some areas of the country.
Distinguish between a private and a public limited company. Examine the advantages and
disadvantages of public limited companies.
THE PRODUCTION FUNCTION /INPUT - OUTPUT RELATIONSHIP

This refers to the relationship between factors of production (inputs) and the commodities (output)
produced. The relationship shows the extent to which inputs are combined to produce the amount of
output i.e. turning raw materials into finished products. There two types of factors of production
considered in the process.
These are:
(a) Fixed factors. These are factors of production that cannot be changed or varied in the short run
e.g. land.
(b) Variable factors. These are factors of production which can be changed so as to increase output
e.g. labour and capital.
The input-output relationship depends on the planning periods also called the „runs‟. These are
production periods or simply the length of production period a firm may take to have a given level of
output in case of change in demand and price. The four runs in economics are:
Planning or production periods
1. Very short run/market period. This is a production period when the factors of production are
fixed and the firm can only supply more by withdrawing some of its output that was kept in
store. It is that period immediately after the change in price when the firm is unable to change
output.
2. Short run period: This is a period in production when the time is short that the firm cannot vary
all its factors of production but can alter its variable factor inputs e.g. labour, raw materials, etc.

to increase or reduce output if price has increased or reduced. In other wards in the short run,
some of the factors of production must be fixed.
3. Long run period. This is a production period that is long enough for the firm to alter all its
factors of production except technology so as to supply what is necessary/demanded at the
new price.
In other words in the long run, all factor of production become variable except technology.
4. Very long run period. This is a production period where all factors of production including
technology. This is when the firm is able to employ better technology in production in addition
to employing more of the fixed and variable factors of production increasing its level of output.
Production in the short run

A product also known as output is simply the net return of any production process. It is the final
return of any production process. It is the final return a firm realises after using a given
combination of inputs. Production in the short run can be looked at in the respect of total
product, average product and marginal product.
In order to understand the input-output relationship the following must be used.
1. Total product (T.P). This refers to the total amount of output produced in a given period of time
when all the factors of production are employed.
Output
TP

Units of variable (labour)
2. Average product (A.P). This is the output produced per unit of variable factor/the output per
unit input.
AP = Total product
Units of the variable factor (labour)
Output
AP

3. Marginal product (M.P).This is the change in the total output resulting from employing an
additional unit of a factor input e.g. labour or it refers to the additional output produced by an
additional unit of a factor employed e.g. Labour.
Marginal product = Change in total product

Change in units of the variable factor (labour)
Output
MP

The table showing total product, average product and marginal production in the short run.
Land Labour Total Average Marginal

product(AP) product(AP product (MP)
)
1 ha 0 0 O
1 ha 1 3 3 3
1 ha 2 8 4 5
1 ha 3 12 4 4
1 ha 4 15 3.5 3
1 ha 5 17 3.4 2
1 ha 6 17 2.6 0
1 ha 7 16 2.3 -1
1 ha 8 13 1.6 -3
Graphical relationship between total product, marginal product and average product.

From the graph and the table above the following can be concluded:
a) Initially as inputs increase, the TP, AP, and MP increase.
b) MP reaches the maximum earlier than the TP and AP.
c) AP is equal is equal to MP when AP is at its maximum (point Z) but after this AP begins to
fall.
d) MP is above AP when increasing but below AP when falling.
e) At point X TP is at its maximum while at point A MP is at its maximum.
f) AP, MP, TP start falling after reaching maximum because of the law of diminishing
returns.
Factors that may lead to increase in marginal product of labour are:

1. Increase in the wage rate 2. Improvement in
technology.
3. Increase in education level training skills
4. Improvement in the quality of management and supervision 5. Improvement in the
working conditions.
6. Improvement in the attitude towards work (positive attitude)
The law of variable factor proportions or the law of diminishing returns
It states that as more and more units of a variable factor are applied to a given quantity of a fixed
factor, the marginal product first rises reaches maximum point and then falls.
Assumptions of the law of diminishing returns

1. Existence of a variable factor
2. Existence of a fixed factor e.g. land
3. Technology used is constant.
4. All units of a variable factor are homogenous or equally efficient or easily divisible in to small
units
5. Constant factor prices e.g. wages, salary.
6. It assumes the short run period of production.
Questions
(a) State the law of variable factor proportions
(b) Outline the assumptions of the law of diminishing returns
(c) Distinguish between marginal product and average product
(d) State two factors that may lead to an increase in marginal product of labour.
RETURNS TO SCALE
This refers to relationship between the change in the scale or output and the resulting change
of output in the long run when all the inputs have changed in the same proportion. Returns to
scale takes place in three (3) forms.
1. Increasing returns to scale. This is when the firms output increases at decreasing per unit cost
as a result of increased combination of factor inputs. This is where by a given increase in the
scale of inputs by a given percentage leads to a bigger percentage increase in the level of
output. With increasing returns to scale, the marginal product rises which leads to a fall in the
average costs, therefore increasing returns to scale due to enjoyment of the economies of scale
enjoyed by large scale firms.
2. Constant returns to scale.
This is when an increase in the existing factor combination increases output at constant per unit
cost. This is where by a given increase in the scale of inputs by a given percentage leads to an
equal percentage increase in the level of outputs e.g. doubling of inputs leading to the
doubling of the output.
3. Decreasing returns to scale.
This is where by a given increase in the scale of inputs by a given percentage leads to a smaller
large increase in the level of output.
With decreasing returns to scale, the, marginal product happens to be falling leading to
increasing average cost.
The decreasing returns to scale are due to the disadvantages of large scale production.
Output x
Qo
MP
O L0 Variable
factor (labour)
From the above illustration, the, marginal product of labour first rises up to point x because the
fixed factor is still more than the variable factor.

At point x we have maximum marginal product because the fixed factor (Land) is fully utilised by
the variable factor (Labour)
After point X, marginal product of any additional unit of variable factor (labour) decreases
because the fixed factor is over utilised by the variable factor.
THE THEORY OF A FIRM

A firm is a production unit under a unified control and management that is involved in
production of either homogeneous or differentiated goods.
It may be a sole trading business, a partnership or a joint stock company.
A firm may be a sole trade business or partnership or joint stock company. The
examples of firms include; schools, hospitals, shops
An industry is a combination of a firm that produce similar or related products e.g. beer
industry, mattresses industry.
Firms in an industry may produce in competition with each other or they may combine and
produce together
The industry is also ways known or by the name of the product, foot ware industry.
Factors that determine the size of the firm (growth)

1. Size of the market. A small size of the market limits the growth of firms due to the low level of
output and profits while a big market encourages more production due to high output and
profits, making a firm to grow big in size.
2. Availability of capital. Large sums of capital make a firm produce much more because it is able to
purchase inputs while limited capital causes a small size because there are limited funds to
purchase inputs and therefore there is a low level of production and growth.
3. Objectives of the firm. A firm may expand or remain small depending on the choice of the
enterprise. If the aim of the firm is sales-revenue maximisation the firm is likely to grow bigger
because it has to produce on a large scale and if the aim of the firm is profit maximisation, the

firm produces less output in order to sell it at high prices to get high profit hence making the
firm remain small.
4. Level of technology. A firm with modern technology produces more output and expands in size
to become large because of better efficiency in production while use of poor technology limits
the expansion of the firm due to low levels of productivity and efficiency in production.
5. Government policy on investment. Favourable government policy such as low taxes,
subsidization, tax holidays etc. enable expansion of firms to large scale because of the low cost
of production and high profits while unfavourable government policies such as high taxes limit
the expansion of a firm because they increase the cost of production and reduce profits.
6. The political climate. Political instability leads to small size of the firms because of the limited
investment due the fear to lose lives and property while when there is political stability firms
grow into large scale enterprises because of security for life and property that encourages
investment in production.
7. Level of entrepreneurship. Poor entrepreneurial skills cause limited ability to mobilise resources
for production and expansion of enterprises which leads to small scale firms while better
entrepreneurial skills result into better resource mobilization and therefore expansion of firms
into large enterprises.
8. The rate of price stability/inflation. A high rate of inflation causes firms to remain small because it
leads to a high cost of production and low profits while a low rate of inflation causes expansion
of enterprises because of the low cost of production and high profits that are realised.
9. The land tenure system. A poor land tenure system makes enterprises remain small because it is
expensive/difficult to purchase land for expansion while a good land tenure system makes
acquisition of land cheap and this encourages expansion of firms into big enterprises.
10. The degree of accountability. Poor accountability in enterprises causes slow growth of
enterprises because the funds for investment reduce and better accountability in enterprises
causes expansion of firms into large scale firms because the funds for investment are sufficient.
11. Period of operation. In the short run, the firm may not expand because it has just jobs been
established while the long run the firm expands because of adequate time to expand the scale of
production.
12. The level of infrastructure development. Well-developed infrastructure encourages large scale
expansion of the firms because of the low cost of production and easy access to the market
while poor infrastructure leads to high cost of production and limited accessibility to the market.
13. Nature of business. There are some firms which by their nature have to remain small e.g. watch
repair, shoe mending unless the allocation of the firm.
14. Availability of raw materials. Limited supply of raw materials limits production and expansion of a
firms since it increases the cost of production and when raw materials are readily available the
cost of production is low which causes large scale production
15. Availability of skilled labour. Presence of skilled labour leads to large scale production due the
higher level of efficiency while limited supply of skilled labour leads to small scale production
because of the low level of efficiency in production.
16. Possibility of merging. Where firms merge the firm becomes large since more assets are
available and the scale of operation increases.
17. Level of research carried out by the firm. A firm that undertakes research extensively is likely to
expand and grow bigger because research involves discoveries in technology, competent labour,
market expansion all of which increase the size of the firm. Limited research leads to firms
remaining small because there is use of poor technology and there is a low level of output.
(a) Distinguish between a firm and the industry.

(b) Explain the factors that influence the size and growth of the firm.
Objectives of the firm

1. For profit maximization. Under this objective, many firms aim at earning the highest profit
possible from the output produced and sold, such firms charge high prices and produce at
excess capacity.
2. For sales/revenue maximization. Some firms aim at increasing output by selling more at
relatively lower prices in order to earn more revenue
3. To have a good image. Some firms aim at attracting the public through offering or sponsoring
the services e.g. MTN sponsoring world cup, coca cola sponsoring the national championship.
4. For national and public interest, some firms especially government owned aim at improving the
welfare of the citizens.
5. For long run survival. Management of some firms makes decisions which are aimed at
increasing their market share.
6. For entry limitation/to limit the entry of new firms in business. Some firms aim at limiting other
firms from joining the market as a way of reducing competition for the market this can be best
achieved by charging a very lower price that makes it unattractive to join the market.
7. To maximise output i.e. production of commodities. Some firms are established to produce
goods and services for the people.
8. To enjoy the economies of scale. Some firms aim at enjoying advantages of operating on a large
scale.
9. To offer employment opportunities to the citizens some firms aim at providing jobs to the
people.
10. Welfare maximisation. Some firms aim at keeping their workers contented by paying them high
wages, providing good accommodation, providing medical and other necessary services in
order to promote their productivity and efficiency.
GROWRTH OF A FIRM
Methods to achieve growth

The growth of a firm refers to the ability of a firm to increase in size and its scale of production.
1. Natural or internal growth.
This is achieved through investing of profits realised by expanding the scale of production a concept
known as ploughing back of profits. By investing in a wide range of products a firm creates many
sources of income. A firm attains specialisation which improves the efficiency in the output produced
hence earning a lot of income for itself.
2. Merging (external /Artificial) Growth. This type of growth is realised through integration or merging.

Merging/integration is the joining of two or more firms to form one firm so as to enjoy greater
economies of scale.
The reasons for merging of firms are:
1. To encourage efficiency/improve quality of output.
2. To reduce average cost of production/ profits.
3. To attain monopoly power/to control the market.
4. To effectively exploitation available resources.
5. To minimise unnecessary duplication and waste.
6. To enjoy economies of scale/to increase output.
Mergers are also referred to as amalgamations/combinations

Various forms of mergers/merging
(a) Horizontal/merging
This is the coming together of two or more firms at a same stage of production and in the same
industry.
(b) Vertical merging
This is where two or more firms at different stages of production in an industry join together e.g. a
cotton ginning firm and cotton weaving firm merging. Vertical integration may be forward or
backward;
(c) Lateral merging
This is bringing together assets of two or more firms producing commodities that are related but not
the same and can be conveniently marketed together e.g. airtime, simcards and phones, shoes and
shoes polish and socks firms joining.
(d) Conglomerate merging/integration/diversifying
This is where firms dealing in unrelated products combine for the purpose of achieving diversification
of their activities with an aim of making profits e.g. timber processing and salt mining, a restaurant
and a bookshop.
(a) Absorption merging. This is when the firm completely takes over/buys another firm.

(d) Consortium merging
This is when two or more firms join their effort to perform as one or more big firm where the activity to
perform is complex for one firm e.g. construction of a tarmac road. In such situation when the activity
is completed, the merger is dissolved.
(e) Holding company merging.
This is when one company buys a big number of shares in another company by taking up at least 51%
of the shares of the company issued.
(f) Cartel merging.
This is when firms producing similar commodities came together to determine the price at which to
sell their commodities. This is done to avoid unhealthy competition in market. This is common with
OPEC (Organisation of petroleum Exporting countries) A cartel has the following objective once
formed.
1. To reduce uncertainties in production 2. To
increase/control a bigger market share.
3 To reduce fluctuation of prices (achieve price stability) 4. To
increase the efficiency of the cartel members.
Advantages/importance of merging
1. It widens the market. Integration enables firms to enjoy a large market because of reduced
competition in the market.
2. It increases the profit margin. More profits are attained than when firms are operated on
individual basis due to economies of scale. This encourages further production.
3. Increases production. Integration expands the level of output due to use of better technology.
This leads to reduced costs per unit output.
4. Economies of scale are enjoyed. This is because integration encourages expansion of firms
leading to reduced costs of production.
5. It encourages diversification. The integration of firms can offer a wide variety of products hence
increasing consumer's choice and welfare.

6. It leads to better management of firms. This increases production and improves efficiency due
to access to skilled labour.
7. It minimises costs of duplication. This is due to reduced competition among firms hence
minimising wastage of resources
8. Reduces competition for the market among firms. This further reduces the costs of production
since firms spend little money on persuasive advertisement.
9. It makes it easy to secure loans from financial institutions. This is because of the presence of
more assets to use as collateral security to get loans.
10. Risks are shared. Risks are shared between firms which reduces the burden felt by each firm.
11. Leads to better utilisation of resources. There is use of better technology which causes better
utilisation due to efficiency in production.
12. It becomes easier to access better technology. This is because firms can pool resources together
and purchase better quality machinery.
13. There is easy access to skilled labour. This is because one firm can use skilled labour from
another firm and this improves efficiency in production
Disadvantages of merging
1. Results into unemployment. When firms merge some workers are laid off in order to reduce
costs. This reduces their incomes and welfare.
2. Result into the production of poor quality products. Merging of forms minimises
competition hence production of poor quality goods and service.
3. Results into over production. Merging of firms enables access to better technology which
leads to high output beyond market demand. This causes wastage of resources.
4. Managerial problems arise. This is because of the complexity of many departments and a
large number of employees and these make supervision of the new enterprise difficult.
5. Results into diseconomies of scale. These are the disadvantages arising from large scale
production such as failure to get adequate market for the produced output or shortage of
skilled labour for the big firm/industry.
6. Leads to development of monopoly powers. There is exploitation of consumers in form of
high prices due to reduced competition.
7. Profits are shared. This results into low profits per firm
8. High taxes are charged on the big firm. This is because the firm is operating on large scale
and this reduces on the profit margin.
9. A firm may make a lot of losses in case of errors by management. This makes the firm close
down its operations.
10. Results into loss of independence by individual firms. Integrated firms work together and
there is need for consultation before a final decision is made. This delays decision making
and implementation.
Factors that limit the merging of firms (obstacles) 1. Difference in

economic objectives of the firms.
2. Small market for the products that are being produced by the firm. This makes it unnecessary
for firms to merge and produce on a large scale.
3. The government anti-monopoly legislation. In some cases there are laws which prohibit
merging of firms.
4. Fear of diseconomies of scale. The firms fear challenges of high risks, fear of complexity of
management, increased cost of production. Firms fear to incur high cost of production
associated with large scale production which they may not be in position to handle.
5. Fear of loss of independence by individual firms. When firms merge they tend to change names
and decisions making also changes since consultations have to be made.
6. Fear of paying high taxes which may be imposed on one big firm. The government usually taxes
heavily large scale firms since they make bigger profit margins.
7. When firms are dealing in unrelated products requiring different kinds of specialisation.
Merging becomes difficult due to differences in labour requirements, machinery etc.
8. Fear of unemployment of some of the members of management and workers which may result
after merging. Some workers are laid off after merging in order to cut costs.

9. Fear of losing direct contact with consumers. Merging makes the firms bigger and this causes
loss of contact with customers.
10. Reluctance to share profits/fear to share losses. Some firms fear to merge because when profits
made they are shared by all firms including those that did not make a significant contribution.
11. Fear of bureaucratic delays. When firms merge there is a lot of consultation which causes delays
in decision making and implementation
12. Shortages of skilled labour. Merging may necessitate hiring skilled labour that may not be
readily available.
13. Differences in the technics of production.
Advantages of horizontal merging of firms

1. Improved efficiency in management.
2. Reduced competition for raw materials.
1. Reduced costs of advertising.
2. Reduced duplication of goods and service.
4. Improves the optimal level of production because of minimal wastage.
5. Research is possible or easy.
6. Sharing of risks is possible.
7. Increased output/sales/profits.
8. There is access to better technology.
9. Reduces competition in the market.
10. Increased access to capital/loans.
11. Reduced prices due to low costs of production.
14. Increased access to skilled labour.
Disadvantages of horizontal merging

1. The new firm may suffer diseconomies of scale which leads to increased costs of output
produced.

2. Monopoly of new firms may lead to inefficiency thus leading to production of substandard
products
3. It may lead to unemployment. There is laying-off of some workers.
4. Artificial shortages may result in an attempt for new firms to earn more profits.
Advantages of vertical merging

1. A reliable source of raw materials is enjoyed e.g. in backward vertical merging
2. Monopoly power over the supply of raw materials is enjoyed e.g. in backward vertical merging
3. Economies of large scale are enjoyed e.g. marketing economies, managerial economies, etc.
4. It increases on the firm‟s profits.
5. Competition is reduced in the market.
Disadvantages of vertical merging

1. Inability to buy raw materials cheaply from other firms e.g. backward vertical merging 2. Lack of
a variety of products produced by the firm.
LOCATION AND LOCALISATION OF AN INDUSTRY
An industry
It is a collection of firms producing similar/related commodities
1. Rooted industries
These are industries which must be located in a particular area due to the pull factors.
2. Foot loose industries
These are industries which can be located anywhere without considering location factors.
3. Tied industries
These are located near the market of the finished products e.g. furniture workshop.
4. Bulk increasing/weight gaining industries

These are industries located near the market because of finished products becoming bulky e.g. ship
building industry
5 Bulk decreasing/weight reducing industry
These are industries located at the source of the bulky raw materials to reduce the cost of
transportation of raw materials e.g. sugar processing industry are located near sugar cane plantations.
Location of industry
It refers to a geographical site where a firm or an industry is established Or
It refers to the establishment of a firm or an industry in a particular area irrespective of whether there
are other firms or not.
Factors that influence location of an industry

There are both economic and non-economic factors economic factors which influence the
establishment of enterprises in a given area.
Economic factors
1. Availability of raw materials. Producers prefer to locate industries near the source of raw
materials especially when they a bulky to reduce the costs of production e.g. most sugar cane
plantation are near sugarcane processing industry.
2. Availability of market. Industries are located where there is adequate market for the final
products especially when they are perishable and hence difficult to transport e.g. milk
processing industry.
3. Availability of labour. Labour intensive industries are always located near the cheap source of
labour to reduce the cost of transporting labour and the production costs e.g. the sugar and tea
industries are found in highly populated areas.
4. Availability of electricity/power supply. Industries are established where there is steady power
supply for smooth running of machines e.g. Jinja is highly indistrialised because of being near
hydroelectric power.

5. Availability of water, Industries which normally use water as a raw material and for dumping
waste are usually located near the source of water e.g. Nile breweries is located near Victoria.
6. Availability of land for expansion. Firms are usually located outside city centres where there is
adequate room for expansion and where the land is relatively cheap.
7. Availability of well-developed transport and communication network. Industries are located
near transport routes to facilitate easy movement of raw materials and finished goods to and fro
the market or to reduce production cost.
8. Availability of auxiliary services. Industries are attracted near or in areas where services that
support production are found. These services include insurance banking, ware housing etc.
9. The political atmosphere. A stable political atmosphere encourages the establishment of
industries since the entrepreneurs are assured of security for life and property. Areas that are
politically unstable discourage establishment Industries because there is fear to lose life and
property.
10. Government policy. The government may locate an industry in a place regardless of whether
there exist location factors or not, this may be due to the following reasons.
(a) To provide employment opportunities to a particular area
(b) To create balance regional development e.g. distributing infrastructural facilities
(c) To change people's attitude from subsistence to monetised production. (Independent
production) based on raw materials found in the area.
(d) For strategic reasons e.g. security purposes e.g. the location of an army industry in Nkasongola.
(e) For political reasons that is to gain popularity and political votes
(f) To encourage delocalisation of industry that is redistribute industries so as to reduce costs of
industries such as pollution.
11. Entrepreneur‟s choice. An entrepreneur may decide to locate his business in a place of his
choice regardless of other factors.
12. Industrial inertia is the tendency of industry to remain located in an area or even new ones
being attracted to an area when the original advantages for their location are no longer
significant. This is because of the already existing infrastructure, presence of skilled labour etc.

Questions
(a) What is meant by the term industrial inertia?
(b) Explain the factors that influence the location of industries in an area or our country.
(c) Distinguish between location and localisation of industries
(d) Why may the government influence the location of industries in an area?
LOCALISATION OF INDUSTRY
This refers to the concentration of many firms in a particular area or place which may be producing
similar or differentiated products.
N.B: The factors that determine the localisation of industries are the very factors that may lead to the
location of industries.
Advantages of localisation
1. It leads to the expansion of employment opportunities. This is due to many
activities/enterprises in an area in which people get jobs.
2. Better quality products are produced. This is due to competition among firms which results
into the production of high quality products hence improving people's welfare.
3. It increases market for goods and services. Localisation increases market for raw materials as
well as finished products leading to optimum utilisation of resources.
4. Development of Infrastructure is stimulated. It encourages the construction and
rehabilitation of infrastructure which eases transportation of goods and services from the
firms.
5. It attracts high skilled and specialised labour. This implies that the localised area enjoys a
pool of skilled personnel at low costs hence efficiency in production.
6. It is easy for localised areas to get government support. It becomes cheap for the
government to provide service such as schools, electricity, and security because of the
significance of the area to the country.
7. It results into the development of forward and backward linkages lead to increased
industrialisation. Industries support each other by providing market for output from other
firms.
8. Leads to cooperation of industries in solving common problems. The firms try to solve
common problems since they able to share costs which reduces the burden faced by each
firm.
9. Wide variety of products is produced in the area. This is because of product differentiation
by the different firms.
10. Promotes the development of auxiliary services in the area. There is emergence of other
services to support production e.g. insurance companies, banks, etc.
11. Leads to increased utilisation of would-be idle resources. The increase in the number of firms
increases the demand for raw materials which increases there exploitation.
12. Promotes specialisation and its advantages. Firms specialise in the production of certain
products to avail inputs to other firms.
13. Leads to low prices of final products. The competition between firms creates competition
between which causes prices to fall.
14. Increased government revenue. The firms form an important tax base which increases
government revenue through taxation.
15. Increased reputation/popularity of the area. The products from the area become popular
because there are many firms involved in production.
16. Increased security of the area.
17. Increased output hence economic growth. The increase in the number of firms involved in
production causes high production hence a high rate of economic growth.
N.B: A forward linkage is where the established industry leads to development of another industry that
uses its products as inputs or raw materials.
Or
It is where one industry's output goes as inputs for another industry e.g. sugar industry prompting the
establishment of sweet or bread industries
Backward linkage is where an industry creates demand (Market) for other industries products which it
uses as its inputs e.g. sugar industry, creating demand for sugarcanes or sacks for packing sugar.
Demerits of localisation in industries

1. It promotes regional imbalance in development. Some areas develop at the expense of
others since better infrastructure and facilities are provided.
2. It promotes rural urban migration and its negative consequences, some people move to
urban areas in search for job opportunities which they do not get and therefore resort to
crimes.
3. Overstrains infrastructure in the area. Localisation of industries overstrains infrastructure
like water, sanitation and power. This is because of the large number of people to serve.
4. It increases social costs such as pollution and environmental degradation. The presence
of many firms causes environmental degradation due to poor waste management.
5. It increases costs of living. Localisation attracts many people and this forces prices of
goods and service to increase because of scarcity of goods.
6. Heavy losses are experienced in localised areas in case of disasters like wars, earthquakes
etc. This is because such areas are usually targeted in case of war leading to big losses.
7. It may lead to displacement to people as more and more industries are established in
area. This is because of the need for more land for expansion.
8. Leads to problem of income inequality. Those working in the area are paid higher wages
than those in other areas.
9. There is quick depletion of resources. The large number of firms in the area causes an
increase in the demand for raw materials which causes over exploitation of resources
hence depletion.
10. Increases cost of land/high rent. This is because of the competition for land in the area.
11. Increases cost of labour. This is due to the competition for labour by the firms.
12. Rising costs of inputs in the area. This is due to the competition for raw materials in the
area.

DELOCALISATION OF INDUSTRIES
This is a deliberate government act of distributing industries throughout the country to avoid
concentration of industrial establishments in one particular area. It is done by the government directly
by establishing industries where there are no or a few industries or where they have been lacking e.g.
through use of tax holidays, providing efficiently infrastructure and giving subsides.
Advantages
1. It reduces rural urban migration with its associated problems such as drug abuse, prostitution,
etc.
2. It promotes balanced development in different regions that is it promotes regional economic
balance.
3. It reduces the problem of unemployment in certain areas by utilising labour force in such areas
4. It minimise pollution in certain areas and congestion which is common in localisation areas.
5. It leads to fair distribution of infrastructure in the economy since industrialisation stimulates
infrastructure development.
6. It encourages utilisation of resources in different part of the country.
7. It encourages commercial production especially by those who produce to supply inputs to the
agro-based industries.
Demerits
1. It increases government expenditure to provide infrastructure in certain areas to enable
production take place.
2. It may lead to increased production which may lack market especially in low developed
countries
3. It requires highly skilled manpower which is not readily available hence production difficulties
arise and increase the cost of production.
4. It increases the debt burden of the country when it borrows to finance agriculture in the
country.

1(a) Distinguish between location and localisation of industries. (b) Examine
demerits the delocalisation of industries.
ECONOMIES OF SCALE
These are advantages of large scale production that a firm enjoys by way of reduced per unit costs due
to its good internal organisation or as a result of operation of other firms in a given locality. Or
They are advantages enjoyed by the firm inform of reduced average cost as a result of increasing the
scale of production. Under large scale production, output increases at a decreasing cost per unit of
production.
Under large scale production, output increases at a decreasing cost per unit of output.
In the short run, output can be increased by using more of the variable factors of production while the
fixed factor remains constant. In the long run however, the firm can vary all factors of production to
increase output. It will at first experience a fall in the average costs of production to low point
(optimum point) as output increases because of economies of scale.
However beyond its optimum, output is increased at increasing costs per unit thus it experiencing
diseconomies of scale leading to high average costs.

cost LAC
Q0 Output
P0 A
From the above illustration, point A is the optimum point of the firm where it incurs the lowest
average costs.
Before point A costs are declining as output increases. This is termed as economies of scale.
After point A, average costs are increasing hence the firm is suffering/experiencing diseconomies of
scale.
Economies of scale are represented by downward sloping portion of the long run average sloping cost
curve while diseconomies of scale are represented by the upward sloping portion of the long run
average cost curve.
Economies of scale are divided into the following

1. Pecuniary economies
2. Real economies
3. Internal economies 4. External economies.
1. Pecuniary economies

These are advantages of large scale production enjoyed by the firm inform of less payments for
the inputs used in production because it purchases these inputs in bulk e.g. cash discount on
purchases is considered pecuniary. Or
They are advantages of large scale production that are enjoyed as a result of paying low prices
for factors of production e.g. land, labour, capital and distribution of good and service.
2. Real economics
These are advantages enjoyed inform of reduced average costs due to reduction in the physical
quantity of inputs used in the production process. Or
These are ones enjoyed by the firm operating on a large scale in form of using less factor inputs
to produce a particular level of output e.g. saving on cement used in the making blocks.
3. Internal economies of scale.
These are advantages of large scale production inform of reduced average costs that are
enjoyed by the firm due to good internal organisation.
TYPES OF INTERNAL ECONOMIES OF SCALE

1. Marketing economies of scale. Large firms usually buy then sell in bulk and as such, they get
discounts when buying in large quantities and they are also able to advertise at low rates. All
this results into red reduced average cost.
2. Transport economies of scale. Large firms are able to pay lower transport costs to transport in
good quantities thus reducing average cost per unit or output.
3. Technical economies of scale. Large firms are capable of using better techniques of production
which are modern and efficient hence increased output at a reduced average costs.
4. Financial economies of scale. Large firms are able to obtain loans from financial institutions at
favourable interest rates to finance their operations because they have collateral security.
5. Social /welfare economies of scale. A large firm can easily provide better working conditions
that motivate employees to produce more at reduced cost e.g. medical, transport, housing
allowances etc.

6. Storage economies of scale. Large firms store their goods and raw materials in bulk therefore
they incur less storage cost per unit.
7. Risk bearing economies of scale. A big firm can easily minimise risks unlike a small firm through
diversification of output, market or insuring the business.
8. Managerial economies of scale. These arise out of specialisation of labour and better
organisation with in the firm as it expands which improves efficiency and therefore there is high
output at reduced cost.
External economies of scale

These are the advantages of large scale production which are realised as the industry rather than
individual firm grows in size. Firms may enjoy these economies due to activities of other production
units in that particular industry or as a result of an advantaged location.
Types of external economies of scale.
1. Economies of concentration/localisation. This comes as a result of concentration of a large
number of firms in a particular area, all firms enjoy common services. Such as pool of skilled
labour, transport facilities, etc. which lower per unit cost. Enjoyment of scale services such as
insurance, banking, transport, etc.
2. Economies of specialisation. Due to expansion of firms in an industry, different firms specialise
in different activities and this increases the level of output and efficiency leading to reduced
average cost.
3. Economies of information. An industry can easily establish a research station at a low cost
compared to a single firm the information gathered is shared. This raises the productive
efficiency of the industry.
4. Economies of welfare. An industry provides better welfare facilities to the workers than a single
firm e.g. recreational facilities. These motivate employees and therefore raise their efficiency
and thus a reduction in cost.
5. External financial economies of scale. Concentration of firms in an area can attract financial
institutions like banks and insurance companies which provide financial assistance at low costs.

6. Transport economies. An industry can share transport costs in case the different firms use the
same means of transport. This reduces average costs.
7. External technical economies. Firm in area can share facilities like technology experts, garages
etc. therefore the costs are shared by the firm leading to reduced average costs of production.
8. Security economies. Various firms in an area have an advantage of mobilising themselves to
provide security personnel to safeguard their property.
DISECONOMIES OF SCALE
These are disadvantages of large scale production that a firm experiences in form of rising per unit
cost of production as output increases, either due to internal factors or as a result of behaviours of
other firms.
Types of diseconomies of scale

1. Internal economies of scale 2. External
economies of scale.
Internal diseconomies of scale.

These are the disadvantages accruing to a firm operating on large scale mainly due to the existing
conditions within the firm.
Types of internal diseconomies of scale

1. Technical diseconomies of scale. As the firm expands, it gets more machinery but depreciation
increases which increases the cost of production.
2. The marketing diseconomies of scale. As the firm expands, it becomes difficult for it to get
enough raw materials and a wider market for its products. This leads to extensive advertising
and distribution costs hence leading to high average costs.
3. Managerial. As the firm expands it becomes very difficult to manage or supervise because of
many departments and workers. Inefficient management results into inefficient production
hence increased cost per unit of output.
4. Financial diseconomies. As the firm expands it becomes very difficult to get adequate funds to
maintain its capacity. High costs are incurred when servicing high interest loans that were
acquired which results into rising average costs.
5. Risk bearing diseconomies. As the scale of production expands risks also increase e.g. a mistake
in judgement made by the sales manager before the production manager may negatively affect
the sales which results into a big loss to the firm.
6. Welfare diseconomies. When a firm expands in size, it becomes difficult to provide appropriate
welfare facilities to its workers. This may result into inefficiency, reduced output and increased
costs of production.
7. Storage diseconomies. It becomes difficult for a large firm to store large amounts of output due
to shortage of storage facilities. This may necessitate renting or ware houses leading to
increased costs per unit of output.
External diseconomies of scale.

This refers to the disadvantages that accrue to a firm because of the activities of other firms in
the same industry or activities of other production units in the same locality.
Types of external diseconomies of scale

1. Labour diseconomies. It becomes difficult to retain skilled labour when the entire industry
expands hence firms increase wages to attract labour leading increased costs of production.
2. Social diseconomies. The concentration of many firms in an area results into high social costs
such as pollution environmental degradation. These costs are expensive to be controlled thus
increasing the cost of production.
3. Shortage of land for expansion. The expansion of industries increases demand for land as many
firms compete for it leading to increased rent hence high costs of production.
4. High costs of living. The concentration of firms in an area results into Increase in the population
size leading to the shortage of accommodation facilities, food staffs hence forcing the workers
to demand for higher wages hence increased costs of production.
5. Transport diseconomies. Transport costs increase because of many firms in an area which
compete for similar transport services, it also results into traffic congestion and hence high
transport costs of raw materials, Final products and workers.
6. Marketing diseconomies. As a result of localisation there is competition for market which
increases marketing costs the demand for raw materials increases leading to increase in their
prices hence increase in average costs.
7. Rural urban migration. The concentration of firms in an area encourages rural urban migration
with its associated problems. E.g. High crime rate unemployment etc., these are expensive to
control leading to increase in average costs.
Distinguish between internal and external diseconomies of scale (b) Discuss

the different types of external diseconomies of scale.
SMALL SCALE FIRMS

Qn. Why do small firms continue to exist despite the advantages of large scale firms?
Despite the advantages enjoyed by the large firms, small firms have continuously existed because of
the number of reasons.
1. Limited capital for expansion. The owners of some of the small scale firms have limited capital to
purchase inputs to expand the enterprises.
2. Limited market size. Firms in a small market remain small to avoid wastage of resources i.e. large
scale production would be waste of resources due to limited demand for the products.
3. Limited skilled labour. Limited skilled labour results into inefficiency in the enterprise thus
limited output and growth.
4. Fear of diseconomies of scale. Owners of some of the small scale firms fear the high cost of
production associated with diseconomies of scale i.e. marketing, financial, diseconomies, etc.
5. Small scale firms are easy to manage and control as compared to large scale firms. Decision
making is easy and there is prompt decision making and implementation since there is no need
for consultation in most cases.
6. Limited supply of raw materials. This limits expansion of the firm because scarcity leads to a high
cost of production/it is difficult to supply raw materials to large enterprises.
7. Choice of the entrepreneur. The small nature of the enterprise could be because of the choice of
the owner who is comfortable.
8. Poor techniques of production. Poor techniques of production cause low level of output and
thus low level of sales and profit which limits the expansion.
9. Fear of increased taxes. Expansion of the enterprises results into bigger profits which attract the
attention of government hence high taxes.
10. Poor infrastructure. Poor infrastructure makes it difficult to access the market which leads to low
sales, low profits and thus limited expansion
11. Limited entrepreneurial ability. This limits the ability to mobilise resources and therefore there is
limited production and expansion of the enterprise.
12. Poor land tenure system. This makes acquisition of land for investment expensive and therefore
there is limited room for expansion.
13. They are flexible in in nature. In case of change in tastes and preferences the owner can easily
change to a new line of business with minimal loses.
14. They are used to pilot projects/research purposes. Such enterprises remain small to maintain a
high level of effectiveness
15. Market requiring personal touch or personal service. Some firms remain small to maintain
personal contact with clients because when the firm becomes bigger production on a large
scale causes inability to reach out to all the customers.
16. 15 They are beginners of new firms. Some firms are still in their infancy and therefore in the early
stages of development but with time as more profits are reinvested there is hope of the firm
becoming bigger.
17. Fear to loose independence.
ADVANTAGES OF SMALL SCALE INDUSTRY

1. They are less costly/easy to start. They are cheaper to set up as they do not require a lot of
capital and other forms of resources.
2. They are flexible thus there is less wastage. A change in tastes and preferences causes minimal
loses and it is easy to change from one line of production to another.
3. They are easy to control and manage. That is easily affordable since they do not require more
skills and employ limited labour.
4. They promote use of local technology and therefore are a means of technological development.
The firms in the long run are able to acquire better technology.
5. They encourage fair distribution of income. This is because they are easier to start and do
employ a large number of the population.
6. They provide cheap or affordable goods to the population and therefore improve people's
welfare. The firms enable low income earners get goods at fairly low prices.
7. They promote innovation and creativity and therefore contribute to the growth and
development of the economy. The owners engage in research which leads to better production
technics.
8. They are appropriate for small markets and thus limited wastage. They produce in fairly small
quantities which minimises wastage.
9. Personal/services are easily offered. This is due to personal contacts with customers.
10. They provide employment opportunities and therefore improve welfare of the employees. This
is because they are many in number and are widely spread.
11. They are training grounds for labour. They help in skills acquisition and development because
there is on job training.
12. They help in saving foreign exchange. They help to reduce on the demand for imports by
making goods locally available which save foreign exchange expenditure abroad.
13. Promote entrepreneurial development. They are training grounds for local entrepreneurs
because individuals start small and graduate to big enterprises.
14. Encourage use of local resources. They many in number and use the available resources as raw
materials.

15. They are a source of government revenue. Some of the enterprises pay taxes to the
government.
16. They help to increase the national income. Since they are many they increase the national
output.
Disadvantages of small scale firms

1. Higher per unit cost is incurred in production since total costs are spread over smaller output.
2. They are unable to face emergences and as such they are vulnerable (exposed). This is because
of poor risk management and limited diversification.
3. They do not enjoy economies of scale and this makes it difficult for the firms to expand. This is
because of small scale production.
4. Small firms provide limited employment opportunities to the population. Each firm employees a
limited number of people.
5. They cause under utilisation of resources. There is excess capacity in the firms and this causes
wastage of resources.
6. There is limited specialisation in the enterprises. This makes production costly and wasteful.
THE OPTIMUM CONCEPT OF A FIRM
The optimum point refers to a point where firm incurs the minimum average costs.
An optimum firm is the one which operates at the minimum average cost and it is the most efficient.

AC Price
a
0 Q0 Quantity
Point a is the optimum point of the firm when firm is producing output less than 0 then it is operating
at excess capacity.
Excess capacity is a situation where by the firm or industry is producing at less than the installed
capacity O it is a state of underutilisation of available resources.
Causes of excess of capacity

1. Inadequacy of co-operant factors
2. Poor technology
3. Small or limited market
4. Poor infrastructure
5. Desire for higher profits by enterprise
6. High costs due to high corporate taxes, inflation.
N.B Over production is a situation of producing commodities in excess of demand or a situation of

putting on the market more commodities than what is required.
A marginal firm refers to the least efficient firm in the industry that cannot exist if the price is reduced.
i.e. it is the first firm to pullout of the industry. 1(a) Distinguish between excess capacity and over
production (b) Mention the causes of excess capacity in a country.

THE THEORY OF COSTS
Costs of production are monetary expenses of the firm. That is they are total payments incurred to
produce a given level of output. Costs can be categorized as follows;
Social costs
A social cost of production is the opportunity cost foregone in production of one commodity instead
of another e.g. if a firm puts its inputs in production of say maize instead of using the same resources
in production of the beans. Then the social cost of producing maize is the beans foregone by the firm.
Private costs
These are monetary expenses incurred by the firm in production of a given level of output. These may
include costs of labour, raw materials, capital etc. Private costs can be distinguished into; a) Implicit
costs
b) Explicit costs Implicit costs
These are monetary expenses incurred in production that are over looked when calculating costs of
the firm. They are costs which are self-owned e.g. salary of the sole proprietor, house rent, family
labour etc. Explicit costs
These are monetary expenses of the firm that are taken to be as the true spending of the business
enterprise in the course of production of the good. They include; salaries and wages, costs of raw
materials, transport and distribution costs, insurance premium etc.
Explicit costs can further be classified as

a) Fixed costs and
b) Variable costs
Fixed costs/supplementary costs/overhead costs/indirect costs

These are expenses incurred by the firm irrespective of the level of output. They are incurred by the
firm regardless of the level of output e.g. rent or business promises, salaries of top management,
interest on capital borrowed, insurance premiums etc. Fixed cost are constant at all levels the output
as illustrated below;
From the illustration, total fixed costs remain fixed at cost C 0 as output increases from Q1 – Q2
Variable costs/prime costs/direct costs

These are expenses of the firm that change with the level of output. As output increases the total
variable costs also increase e.g. wages, transport costs, cots of raw materials etc. Illustration

From the diagram above as output increases, total variable cost also increases. Total costs
These are total expenses of the firm incurred in production of a given level of output. It is the sum of
total fixed costs and total variable costs. The total cost and variable cost curve have the same shape
and the difference between total cost and total variable cost is the total fixed cost the total cost curve
starts with the total fixed curve starts and zero output. Illustration showing relationship between total
costs and total variable cost.
Total fixed costs start above zero because even when there is no output the fixed cost must be
incurred.

Total cost curve lies above the total fixed curve and the total variable curve. This is because total costs
are the sum of total fixed costs and total variable costs
When output is Zero, total cost = total fixed costs since there are no variable costs incurred.
VARIATION COSTS IN THE SHORT RUN

In the short run we have one fixed cost while other costs are variable. We therefore have both fixed
costs and variable costs in the short run where as in the long we have no fixed costs.
In short run the following costs are considered
(I) Average Variable Cost (AVC)
(ii) Average Fixed Costs (AFC)
(iii) Average Total Cost (ATC)
(iv) Marginal cost (MC)
Average variable costs (AVC)

These are total expenses incurred by the firm on the variable factors per unit of output. Therefore AVC
is derived by dividing total variable costs by total output.
AVC = Total variable cost

Total output
Average variable cost curve is u -shaped in that it begins by falling reaches minimum and rises as
shown below.

Average fixed cost (AFC)
These are the total fixed expenses incurred per unit of output produced.
Average fixed costs are derived by dividing the total fixed costs by total output.
AFC = Total fixed costs
Total output
Since the total fixed costs are constant, it means that as output increases, the average fixed cost keeps
on reducing.
This is why average fixed costs curve slopes down wards from left to right.
Cost
AFC
Output
Average total cost /Average cost (ATC/A.C)
This refers to the total cost per unit output produced. It is the cost incurred in production of each unit
of output and is given the formular.

ATC/AC = Total cost
Out put ATC = AFC +
AVC
The average total cost curve is U-shaped as shown below.
The AC curve is U-shaped due to the law of diminishing returns

The Law applies in the short run because as output increases initially the cost per unit reduces up to
the point where the firm produces the highest level of output at the least possible cost as illustrated
above.
Output Q 0 is the optimum output of the firm
The optimum point of the firm is the most efficient size of the firm where the cost of production per
unit output is at its minimum
Marginal cost (MC)

These are additional costs incurred by a firm in the production of an extra unit of output. It is the
change in the firms total cost per unit change in its output.

Marginal cost = Change in total costs
Change in output.
The marginal cost curve is U-shaped as shown below.
As output increases, marginal cost falls reaches a minimum and starts increasing continuously.
Below is a table showing the variation of costs of the firm in the short run.
Output TC (shs) AVC (shs) AFC (shs) MC (shs) ATC (shs)

0 1100
1 1400
2 1620
3 1750
4 1800
5 1850
6 1940
7 2190
8 2600
9 3250
Complete the table above by calculating AVC, AFC, MC and ATC
FIRMS REVENUE AND PROFITS
The revenue of the firm means the returns or proceeds to the firm after selling a given level of output
Or
It refers to the firms earnings received from the sale of goods and services.
Revenue of a firm can be looked at 3 ways;
a) Total revenue
b) Marginal revenue
c) Average revenue
Total revenue (TR)
This is the total amount of money received by the firm as a result of selling its total output produced in
a given period.
Total revenue = Price (P) X Quantity (Q).
TR = P XQ
Average revenue (AR)

Refers to the total revenue per unit output sold i.e. it is the average price or is the total revenue
received from each unit of output sold.
Average revenue = Total revenue
Total output
AR = T.R
Q

N.B Average revenue is the same as price
TR = P XQ
A.R = TR (P X Q)
Q
A.R = P
Marginal revenue (MR)

This is the additional revenue resulting from the sale of an extra unit of output.
Marginal revenue = change in total Revenue

Change in total output
MR = ∆TR
∆Q
N.B The shape of the average revenue and marginal revenue curve depends on the market structure
conditions.
MARKET STRUCTURES
A market is an arrangement or an organisation in which buyers and sellers come together to negotiate
the exchange of a given commodity.
ESSENTIALS OF THE MARKET

1. Existence of a commodity.
2. Presence of buyers.
3. Presence of sellers.
4. Existence of a medium of exchange.
Market structures are the characteristics of a particular market organisation that are likely to affect the
firms‟ behaviour and performance in terms of output and price

It refers to the categorisation of markets basing on number of buyers and sellers, degree of freedom
and entry of firms and nature of products produced.
Because of their characteristics market structures can be divided into four major structures
1. Perfect competition
2. Monopolistic competition
3. Monopoly
4. Oligopoly
PERFECT COMPETITION
Is a market structure where there are many buyers and many sellers of homogenous products. In
reality this market does not exist because conditions in which it operates are quite ideal i.e. unrealistic.
Characteristics of perfect competition

1. Existence of many buyers and many sellers. This means that the firms cannot influence price in
the market and therefore produce much as possible at the existing price.
2. Homogenous products are produced. Each firm produces and sells homogenous products so
that no consumer has preference to the products of any individual firm over other firms. There is
no way a consumer can differentiate the product of one firm and products of other firms. This
means that the firms charge the same price.
3. There is freedom of entry and exit into the industry. When a firm earns abnormal profits in the
short run, other firms are free to join the industry and enjoy profits. In the long run when there
are no profits, firms are free to leave the industry.
4. There is no government intervention in the market. The government does not interfere in price
and output determination. Forces of demand and supply are left to determine price and output.
Therefore in this market, there are no maximum and minimum prices.
5. There is no persuasive adverting by firms. This is because of product homogeneity and this
reduces the cost of production.

6. There are no transport costs. Raw materials, firms and consumers are in one place and therefore
firms charge the same price.
7. There is perfect mobility of factors of production in the market. This is especially capital and
labour. Therefore no firm has monopoly over the factors of production in the market.
8. There is perfect knowledge about the market conditions. Buyers and sellers have perfect
information regarding, price, output and places where transaction takes place. This means that
firm charges the same price and any firm that tries to increase price will not sell to anything.
9. Firms under perfect competition aim at profit maximisation. Therefore each firm produces at the
level of output where M.C = MR
10. The demand curve is perfectly elastic due to competition. If the firm reduces the price other
firms may do the same. If the firm increases price buyers will purchase from other sellers since
goods are homogenous.
11. There is no collusion. There is no collusion between buyers or sellers of goods. They do not
group to manipulate price and output.
Pure competition: This is the market situation where there are many buyers and sellers of a
homogenous commodity but without perfect flow of knowledge and perfect mobility of factors of
production.
Equilibrium position of a firm under perfect competition in the short run or output, price profit
determination of a firm under perfect competition
In the short run period a firm maximises profits at a point where marginal cost = marginal revenue
(MC = MR), this is the necessary condition.

The equilibrium output of a firm (OQ0) is determined at the point where marginal cost is equal
marginal revenue (MC =MR) at point x
Equilibrium price of a firm (OP0) is determined at a point where the output line meets the demand
curve (AR) that is Point x
Cost are determined where the output line meets the average cost curve (A.C) i.e. at point y
At the equilibrium level of output average revenue is greater than average cost. (AR > AC)
A firm earns abnormal profits represented by the shade part (rectangle C 0P0XY)
Equilibrium position of a firm under perfect competition in the long run

Under perfect competition market in the long run profits are maximised at a point where
MC = MR

- In the long run, price is determined at a point where the output line meets the long run average
revenue/demand curve.
- Output is determined at a point where the long run average cost curve = long run average
revenue curve (LAC = LAR)
- Costs are determined at a Point where the output line meets the long run average cost curve i.e.
point A
- Normal profits are earned since the long run average cost = long run average revenue. This is
because of the freedom of entry and exit to firms into and out of the industry which competes away
the abnormal profits earned in the short run.
Advantages of perfect competition

1. It ensures efficient allocation of resources in the economy. In the long run a firm produces
optimum output which indicates the countries resources are fully utilised.
2. It ensures fair and stable price in the market. This is due to the fact that firms are price takers
and therefore no individual firm can increase prices.
3. There is no wastage of resource in persuasive advertising that would increase prices. This is
because commodities are homogeneous.

4. It ensures increased output. This is because of the large number of firms in the industry.
5. It ensures equitable distribution of income because of the many firms in and individual to due
to freedom of entry of new firms into the industry.
6. It provides on efficient standard or convenient measuring rod for comparison of price
determination in other markets.
Disadvantages of perfect competition

1 It assumes certain ideal market situations that do not exist in real life like perfect flow of knowledge
and perfect mobility of factors of production were unrealistic in the real world.
2. It cannot eliminate natural monopolists and business ownership or capital.
3. Low profit levels in the long run because normal profits limit research and innovations 4. Lack of
economies of large scale due to limited expansion in the long run.
5. Unemployment may result in the long run since inefficient firms are pushed out of production due
to competition.
6. It limits choice of consumers that is consumers are denied a variety of choice,
7. It leads to wastage of resources due to duplication of services or economic activities because there
are many firms producing the same product therefore a perfectly competitive structure is not
suitable for producing public utilities.
The breakeven point and shut down point of a firm

The break-even point of a firm is a point where a firm earns normal profits (AR= AC). i.e. a firm neither
makes supernormal profits nor losses.
This means that at break-even point, the revenue that is got from selling the output can only pay for
the fixed and variable costs N.B At breakeven point, AR = AC = MC.

The breakeven point is at point A where MC = AR and the breakeven output is 0Q 1
Shut down point or a firm refers to the point below which a firm cannot cover its average variable
costs. (AR =A.V.C)
Or
It is a point where the firm covers only its Average Variable costs. At shut down point AR = AVC = MC
Point B is the shutdown point at which the firm is in position to cover only the average variable costs
corresponding output 0Q2 which is the shutdown output.
Reasons why a firm continues to operate even if its Average costs is greater than average revenue
(AC>AR) (Even if its revenue does not cover the fixed costs)/when it is making losses
1. It may he hoping to merge such that the average costs will reduce when the firm have merged
2. Sometimes the losses may be seasonal in nature in that after a certain seasons, the firm may
recover from the seasonal high costs.
3. Fear of incurring high costs of depreciation especially in situations where the firm has fixed
assets that cannot be sold off when the firm closes down.
4. The firm may be having hopes of changing the management especially if the losses are due to
inefficient management

5. The firm may be owned by the state because it is offering essential services and closure would
lead to suffering of the people and some firms are subsidized by the government
6. It may be the choice of the investor or owner more especially, if it was started to create good
image of the owner e.g. by providing employment to family members as long as he can pay the
members, he will be able to continue.
7. The firm may be a branch or an industry that is making profits. The loss by the branch is offset
by the profits earned by the entire industry.
8. Fear of losing skilled labour. A firm may continue operating if it suspects that it may lose its
skilled labour that it may have trained at a high cost.
9. If it is research firm. Research firms are not normally established to make profits and may not
close down when producing the below the break-even point.
10. If it fears to lose contract. If a firm is operating on contract it may continue to produce for fear of
losing contact and also for fear of being sued.
11. When the firm hopes to get a loan. If a firm hopes to get a loan from a financial institution so
that it improves the production process, it may continue to operate even when making losses.
MONOPOLY
This is a market structure where there are many buyers and one seller /producer of a commodity with
limited or no close substitutes.
Pure/absolute/perfect monopoly
This is a market situation in which there are many buyers and one seller of a commodity that has no
substitutes at all.
Imperfect monopoly
This is a market situation in which there are many buyers and one seller of a commodity that has
limited close substitutes.
Types of monopoly
Bilateral monopoly
This is a situation where there is only one producer /seller and one buyer of a single commodity e.g. a
trade union and the employees association.
Natural monopoly
This is a type of monopoly which arises from exclusive ownership of a strategic raw material or natural
resource.
Spatial monopoly
This is a type of monopoly that arises from long distance between two producers or a similar product.
Partial monopoly
This is monopoly which exists when a firm is a sole distributor of a particular brand of a product. It is a
type of monopoly which is brought about by product differentiation.
Statutory monopoly
This is monopoly that results from the government statutes or from acts of parliament that stops other
firms from entering into the industry e.g. UNEB and National social security Fund (NNSF).
Collusive /Collective monopoly
This is the type of monopoly that comes as a result or merging of firms
Demand curve /Revenue curve under monopoly

The demand curve under monopoly is represented by average revenue curve and is fairly inelastic in
nature because of the absence of close substitutes
The demand curve is down ward sloping from left to right indicating that each extra unity of output
produced by a monopolist is sold at a lower price than the previous one
The marginal revenue curve (MR) of a monopolist lies below average revenue implying that for any
given output, MR < AR
Diagrammatically the demand curve and average revenue are illustrated below.

Price
D
Output
Profit maximisation under monopoly in the short run.
Under monopoly, the firm maximises profits when it is in equilibrium at a point where marginal cost is
equal to marginal revenue. (MC = MR.)
1. A monopolist fixes price at a point where the output line meets the AR/demand curve and the
price is P0.

2. At equilibrium output, profits are maximised when average revenue is greater than average cost
(AR >AC)
3. A monopolist earns super normal profits represented by the shaded area C 0P0XY in the diagram.
N.B: The demand curve for a monopolist is the same both in the long and short run because of the
restricted entry of new firms in the industry that enables it to earn abnormal profits both in the short
run and in the long run.
Features of monopoly
1. There is only one producer or one firm in the industry due to some limitations that keep other
firms from entering.
2. The commodity produced by the monopoly firm has limited or no close substitutes
3. Entry of new firms into the industry is blocked that is no new or other firms are allowed to enter
the industry both in the long run and the short run
4. A monopolist is a price maker of his commodity. This means that the monopolist determines the
price at which to sell the commodity but cannot determine both the output and price therefore
he can either determine the output or price
5. A monopolists produces at excess capacity i.e. he underutilises resources with an aim of
producing less output to create shortage so as to sell at high prices
6. Under monopoly the firm is the industry and the industry is the firm because there is only firm in
the industry
7. The demand curve for a monopolist is fairly inelastic that is it is down ward sloping from left to
right.
8. There is no persuasive advertisement under monopoly but can have informative advertisement.
This is because there are no competing firms and no close substitutes.
9. The main aim of the firm is maximising profits even in the long run because there are no new
firms that are allowed to enter compete away the abnormal profits.
10. A monopolist is able to carry out price discrimination i.e. in position to sell a similar product to
different buyers at different prices.
Causes/basis/origin/factors give rise to monopoly
1. Ownership of a strategic raw material. This is where a firm controls the source of a raw material
used in the production of a given commodity. Therefore no any other firm can access the
strategic raw material leading to natural monopoly.
2. Protectionism. This is when there is use of foreign trade restrictions like tariffs, quotas, total ban
etc. to protect a home industry from outside competition which results into monopoly.
3. Long distance between producers. Monopoly arises due to long distance between producers
such that each producer becomes a monopolist in his/her own locality/area. This is because
buyers in each locality find it difficult to cross to another producer to buy commodities because
of high transport costs.
4. Patent and copy rights. This is where the government gives legal rights to an individual to
produce of a given product e.g. text books and films. And therefore they become the only
produces of those products for a given period of time.
5. High initial capital requirement. There are some investments which require large sums of money
and are expensive to undertake and therefore it is impossible for new firms to set up and
compete with the existing firm.
6. Through acts of parliament. The government establishes and controls certain enterprise to
avoid duplication of service and resource wastage. The provision of such service is not open to
competition hence monopoly.
7. Merging of firms. This is where firms producing similar/related products or related goods come
together to form one big firm
8. Possession of special talents. People who have special talents become monopolist in the supply
of certain services e.g. Musicians, footballers and comedians.
9. Long period in training. A long period of training in a specific field leads to monopoly because it
takes a long time before a competitor emerges. This is more especially with consultants like
doctors, engineers etc.
10. Possession of exclusive technology. When a firm attains excusive technology to produce a given
product; it becomes a monopolist because other firms are not able to produce a product to
compete.
11. Through product differentiation. This is leads to monopoly when a producer is in position to
produce certain products and brands, which limit other firms entering the market.
12. Small size of the market. The market may be too small to support more than one firm and
therefore only one firm is left into the industry.
Advantages of Monopoly
1. A monopolist is able to enjoy economies of scale which results into reduced average costs of
production. This is because a monopolist is able to expand the size of the firm since he is the
only seller.
2. Abnormal profits are enjoyed both in the short or long run. These encourage large scale
production and easy expansion of the business
3. There is limited duplication of goods and service. Resources are not wasted since there is only
one firm producing a given commodity
4. Public utilities provide cheaper service. State monopolies are established to serve the public at
relatively cheaper prices because the aim is not to maximise profits like others e.g. the provision
of Water when there is no competition
5. Enables growth and development of infant industries because of patent accorded to
monopolists or through foreign trade restrictions. The infant industries enjoy the local market
since they are not exposed to competition from abroad.
6. Price discrimination that is practiced under monopoly enables the poor to access certain
commodities which maximises there welfare and reduces income inequality.
7. A monopoly has low operational costs. There is no competition and therefore there is no
pervasive advertisement costs and products differentiation.

8. Provision of employment. There is creation of employment opportunities for labour and other
factors of production since monopolists operate on a large scale and therefore employs many
people. This is especially so for state monopolies
9. Source of revenue to government through taxation. Under monopoly super normal profits are
sources of revenue to the government through taxation.
10. Research and innovations are encouraged. This is through patent and copyright to producers
and innovators of products which leads to better production technics
Disadvantages of monopoly
1. There is excess capacity i.e. underutilisation of resources. Monopolists underutilize resources
such that they produce less than their full capacity in order to maximise profits by charging
high prices.
2. Leads to problems of income inequality. This is because of the o abnormal profits that made by
a monopoly firms both in the short run and long run hence they earn excessive profits at the
expense of the society which leads to income inequality.
3. Limited variety/Lack for choice for consumers. There is absence of variety of products because
there is no product differentiation thus limited choice and therefore a low standard of living.
4. Shortages especially in time of break down or in case of any calamity or war. If the firm breaks
down, the entire community faces shortages of output one market since there is no alternative
supplier.
5. Low quality commodities are provided. The quality of final products under monopoly tends to
be low due to absence of competition in production.
6. There is exploitation of workers by way of under paying them since the employer is aware that
the worker may not alternative employers.
7. High pressure is exerted on government especially in decision making. The huge economic
power of monopolists is transformed into political power as monopoly firms exert pressure on
the government to influence decision making so that favourable policies are put in place.

8. Underemployment and unemployment of labour exists. A monopolist doesn't have capacity to
provide wider employment opportunities to members of the society.
9. Results into exploitation of consumers by charging high prices of the commodity. This reduces
welfare since few commodities are consumed.
10. Results into limited innovation since there is no drive to improve on the quality. This is due to
lack of competition.
Price discrimination/parallel pricing under monopoly
Price discrimination refers to the act by a producer/monopolist/ a seller charging different prices for a
similar product to different groups of consumers.
E.g. the firms using price discrimination include hotels, UMEME, Saloons, National water and Sewerage
Corporation.
Conditions necessary for the success of price discrimination

1. The producer must be a monopolist. There must be one seller or the commodity in the market
such that this monopolist can charge any price that he feels like charging.
2. The market should be divided into sub markets e.g. basing on age, income, geographical
location, etc. low price should be charged in a market with elastic demand and in a market with
elastic demand a low price is charged.
3. There should be different price elasticities of demand in the market. Such that in the market
where demand is inelastic, a monopolist charges high prices and where demand is elastic, he
charges low prices.
4. The cost of transferring the commodity from one market to another should be high/no
arbitrage.
N.B: Arbitrage refers to the transfer of goods from a place where they are in abundance and
cheap to places where they are scarce and expensive.
5. The cost of separating the markets should be low such that the producer will benefit from the
practice,
6. The consumer must be ignorant about the existence of other cheaper markets.
7. There should be no government interference in the fixing of prices in the markets.
8. It is possible where goods are sold on special orders or contract. One byer does not know what
is being charged on other buyers.
9. It can succeed where consumers are buying on special orders or contract and one buyer will not
be aware of the price charged on the other buyers.
8. It is possible where personal services which cannot be transferred from one person to another
are involved e.g. medical services.
9. The marginal revenue in the market should be the same
10. The commodity produced by a monopolist should not have close substitutes i.e. for price
discrimination to succeed the consumers should not have alternatives
Forms of price discrimination

1. Discrimination based on age. Here different prices are charged according to the age of the
consumer e.g. shows where they charge low prices on the young and high prices for the mature
people.
2. Discrimination based on sex. Here women are sometimes charged low prices compared to men
e.g. in discotheques where some days are referred to ladies night where they do not pay.
3. Discrimination based on geographical distance. This enables the selling of goods abroad at
cheaper prices than at home.
4. Based on the use of the product. E.g. electricity charges are different from domestic and industry
use. Also transport costs
5. Discrimination based on the level of income. People are charged different prices depending on
their level of income. The rich are charged highly compared to the poor. This is common with
direct services.
6. Discrimination based on nature of the commodity. E.g. hard covered books are more expensive
than those with simple covers even when produced by the same producer.

7. Discrimination based on time of service. E.g. during the weekend shows are usually expensive
compared to the week days or transport fares are at times low during the day and high at night.
Advantages of price discrimination

1. It enables low income earners to get essential services or goods at affordable prices which they
would not manage for price discrimination was not in existence e.g. doctors charge low prices
on poor patients.
2. It brings about equitable distribution of income because the high income earners are made to
pay high prices than the low income earners.
3. It increases sales and total revenue or a monopolist who charges different prices even in foreign
markets.
4. Price discrimination in form of dumping enables the country to acquire foreign exchange.
5. N.B Dumping is the sale of the commodity to a foreign country at prices that are lower than the
domestic prices.
6. It leads to an increase in profits made by a monopolist due to increased sales.
7. A monopolist can use profits to finance research and come up with production techniques to
improve the quality of the products.
8. There is an increase in the level of output which in the end improves on the welfare of the
consumers.
9. It helps producers to dispose of their surplus commodities thereby minimising wastage of
resources.
10. The government earns revenue from the taxes charged or paid by the monopolist.
Disadvantages of price discrimination

1. There is over exploitation of consumers by overcharging certain groups of people that is the
high income earners or rich buyers are exploited.
2. In the markets where low prices are charged the producer may sell poor quality product since
he is guarding against losses. This causes a reduction in consumer welfare.

3. It may lead to quick resource depletion /exhaustion because of the desire to maximize total
revenue. This is because there is over exploitation.
4. International price discrimination involves dumping commodities that are relatively cheaper.
This kills local infant industries that are not able to compete with dumped goods.
5. It encourages income inequalities. People who practice it earn abnormal profits that cannot be
made by producers in other market structures.
Measures of controlling monopoly power in an economy

1. Using price control. The government normally fixes prices (maximum) on products produced by
monopolists; this reduces consumers exploitation in form of high prices. The price may be fixed
where it is equal to MC or AC.
(a) Average cost pricing. This is where the government fixes maximum price for a monopolist at
a point where AC = AR.
Effects of average the cost pricing

a) Output increases.
b) Profit reduces.
c) Price reduces.
(b) Marginal cost pricing: This is a situation where the government fixes a minimum price for the
monopolist that is equal to the marginal cost. This one causes the monopolist to increase his
output however he may make losses which may be covered by subsides from the government
that is MC = AR
Effects of Marginal Cost pricing

a) Output increases
b) Profit reduces
c) Price reduces
2. Taxing the producers. The government may /can impose high taxes on the products sold by
monopolists to reduce their profits. Taxes which can be imposed on the monopolist are lump
sum tax and specific tax.
(a) Lump sum tax: This is a tax imposed on a monopolist regardless of the level of output
produced. It is regarded as a fixed cost to a monopolist.
Effects of Lump sum
a) Average cost increases
b) Monopolists profits reduce
c) Marginal cost remains unchanged
d) Price remains unchanged
e) Output remains constant.
(b) Specific tax. Tax imposed on each unit of output produced. It is therefore variable cost to a
monopolist.
Effects of a specific tax
a) Average cost increases
b) Marginal cost increases
c) Price increases.
d) There is a reduction in output.
e) Profits reduce.
3. Setting up of rival firms. The government can set up or encourage the setting of rival /firms to
produce the same products or close substitutes so as to create competition which will make a
monopolist to improve the quality of his products.
4. Nationalising private firms, that is taking over of ownership, control and management of private
monopoly firm such that they are owned by the government. This enables government provide
goods at fair prices.
5. Removal of foreign trade restrictions. That is the government may reduce or remove trade
restrictions such as total ban import quotas, reducing tariffs. This makes it possible for local
firms to compete with international firms which improve efficiency in production and the quality
of goods.
6. Privatisation of public enterprises. This reduces the monopoly power of state owned enterprises
which means that more firms are able to enter into the industry/business and compete for the
local market hence improving quality and quantity.
7. Establishing a bureau of standards. Such institutions help in setting standards that producers
must follow especially concerning the quality of products.
8. Discouraging the merging of firms which may bring up monopoly. This can be done by putting
in place anti-monopoly laws which discourage merging of firms which is collusive monopoly.
9. Encourage foreign investors using investment incentives. Foreign investors should be
encouraged in the country using investment incentives to compete with the private monopolist
and produce goods that are produced by monopolists.
10. Liberalisation. Liberalisation such that other producers are allowed to enter the industry as this
reduces the dominance of statutory monopolies. This increases the availability of goods and
services.
11. Restriction on the period of patent rights. Government should give limited patent period to a
producer such that his firm does not become a monopoly.
MONOPOLISTIC COMPETITITON
This is a market structure where there are many buyers and sellers dealing in differentiated
commodities.
Monopolistic competition lies between monopoly and perfect competition and therefore combines
elements of both. E.g. those that deal in soft drinks, bread industry, soap industry etc.
N.B Production differentiation is a practice of creating artificial differences between products so that
to the consumers they appear not similar.
Production differentiation is the practice by producers in an imperfect market to creating artificial
differences.
Features of production differentiation
1. Differentiated packaging
2. Different branding
3. Different colour
4. Persuasive advertising
5. Different designs
6. Different shapes 7. Different scent. Etc.
Features of monopolistic competition

1. There are many buyers. There is a large number of firms in the market or industry however
each controls a small portion of the total market because of brand loyalty.
2. Many sellers in the market however none of them influences the market conditions.
3. There is wide spread persuasive advertising. Competitive advertising contributes a big
proportion to the total cost of production.
4. The firms produce/sell differentiated products. Products are differentiated from others by use
of different scents, trademarks, colours etc.
5. Firms under monopolistic competition operate at excess capacity that is they under utilise
resources such that they produce the level of output which is below optimum.
6. Firms are price makers to a certain extent because of having monopoly over a brand while
buyers are price takers.
7. There is existence of brand loyalty among consumers some consumers tend to attracted to buy
a certain brand of a product.
8. Firms under monopolistic competition aim at maximising profits and they produce at the level
of output where MC =MR.
9. There is limited interdependency between firms.
10. There is existence of free entry and exit of firms into and out of the industry.
11. The demand curve of a firm under monopolistic competition is fairly elastic. This is because of
the presence of the close substitutes.

12. Firms operating under monopolistic competition buy their resources from competitive
markets. i.e. compete with firms from other industries.
Equilibrium position of a firm making abnormal profits under monopolistic competition in the short
run
In the short run a firm under monopolistic competition maximises profits at the point where
MC = MR
Price is determined where the output line meets the AR/DD curve that is at point X Costs are
determined where the output line meets the AC curve at point Y.
At equilibrium output profits are maximised when AR > AC
The firm earns abnormal /Super normal profits as shown by the shaded rectangle C 0P0XY.
Long run equilibrium position of the firm under monopolistic competition making normal products
In the long run, a firm in a monopolistic competitive market maximises profits at point determines
where LMC =LMR
This can be illustrated as below.

Price is determined where the output line meets the AR/DD curve where the AR is tangential to AC i.e.
at point x.
In the long run the firm earns normal profits this when AR=AC because other firms enter and compete
way the abnormal profits. Advantages of monopolistic competition
1. There is production of high quality products. This is because there is competition between
firms that are producing goods and services.
2. Consumers are able to enjoy a variety of products. This because of product differentiation
which widens their choice.
3. Abnormal profits are earned in the short run. These are used for expansion of firms in the
country/industry.
4. Low prices are charges compared to the prices that are charged under monopoly. This is due
to the competition in the industry.
5. High output is produced. This is due to the presence of many firms in the long run.
6. Persuasive advertisement enables firms expand market for their products.
7. It is a source of government revenue through taxation.
8. Provide employment opportunities. This is because there are many firms in the industry.
9. Monopolistic competition promotes innovations and inventions. The competition in the
industry makes firms engage in research in order to have better techniques of production
Disadvantages of monopolistic competition

1. There is underutilisation of resources. This is because of producing of at excess capacity.
2. There is limited research. This is because firms earn normal profits in the long run.
3. There is duplication of goods and services hence wastage of resources.
4. High costs of production. This is due to persuasive advertising and product differentiation
carried out by the firms.
5. Limited market share. This is because of the many firms in the market.
6. Leads to unemployment. This is when there is exit of some firms in the long run.
7. Persuasive advertisement distorts consumer choices. Some adverts are misleading.
8. Prices charged are higher compared to perfect competition. Therefore there is consumer
exploitation
Difference and similarities between pure monopoly and monopolistic competitive markets
Differences
1. In pure monopoly, there is only one firm/seller while in monopolistic competitive markets there
are many producers. i.e. there is no competition in pure monopoly while competition exists in
monopolistic competition.
2. In pure monopoly market, entry is blocked while in monopolistic competitive markets there is
freedom of entry in the industry.
3. In pure monopoly market, there is no persuasive advertisement while in monopolistic
competition it is there.

4. The demand or average revenue curve in pure monopoly is inelastic while that of monopolistic
competition is fairly elastic (Elastic).
5. In pure monopoly market one product without substitutes is produced while in monopolistic
competitive markets firms produce differentiated products.
6. In the long run, pure monopoly firms earn abnormal profits while in monopolistic competitive
markets; firms earn normal profits in the long run.
7. In pure monopoly, a firm practices price discrimination which is not the case with firms under
monopolistic competition.
Similarities
1. Existence of excess capacity in both markets
2. The producers/sellers/firms in both market situations are price makers.
3. The demand or average revenue curves are down sloping in both markets from left to right.
4. The firms in both market situations earn abnormal profits in the short run.
5. Both markets attain equilibrium output at point where price equals average revenue but greater
than MR = MC.
6. In both market situations there are many buyers/consumers.
Question: How does existence of monopolistic competitive markets affect producers

in Uganda?
1. It leads to wastage of resources due to duplication of services or economic activities.

2. They carry out competitive advertisement which leads to high operational costs.
3. They produce at excess capacity thus under utilisation of resources.
4. The firms or producers earn normal profits in the long run limiting expansion of operations.
5. Existence of stiff competition leads to collapse of small or inefficient firms.
6. Firms earn abnormal profits in the short run which can be ploughed back or used for expansion.
7. Existence of competition leads to production of high quality products i.e. improved innovations
and invention.
8. The firms are price makers because of having monopoly over their brands.
9. Persuasive advertisement enable firms expand market for their products.
OLIGOPOLY
This is a market structure where there are few firms of different sizes with many buyers dealing in
either differentiated or homogenous products.
Types of oligopoly
1. Perfect oligopoly. This is a market situation where there are few producers and many buyers of
homogenous products.
2. Imperfect differentiated oligopoly. This is a market structure where there are few large firms
with many buyers dealing in differentiated products.
3. Duopoly. This is a market situation where there are two producers/sellers and many buyers of
commodities which are close substitutes. e.g. the cement industry, soda industry (Century
bottling company, and crown bottling).
4. Duopsony. This is a market structure where there are only two buyers but with many producers
of a commodity.
6. Oligopsony. This is a market situation where there are many producers with few buyers of closely
related commodities.
Characteristic firms under Oligopoly

1. There are few large firms. Oligopoly is a market situation where the number of sellers dealing in
homogenous or differentiated products is small. Each firm contributes a considerable fraction to
the total output and can have noticeable effect on the market.
2. There is production of homogenous products for perfect oligopoly and differentiated products
for imperfect oligopoly i.e. products have substitutes.

3. There is restricted entry and exit of firms into the industry. This is because the firms existing in
the industry are large and strong and resist upcoming firms and the cost of establishment is also
high.
4. There is high degree of uncertainty in the market. An oligopolistic firm cannot predict accurately
the reactions and actions of its rivals to its price changes e.g. If one firm reduces its prices it is
not sure whether other firms will follow suit.
5. There is existence of price rigidity. Firms tend to stick to the established price because a change
has negative consequences.
6. There is existence of firms of different sizes. Though large the firms under oligopoly are of
different sizes and influence the market differently.
7. There is no unique pattern of pricing in the industry. Firms under oligopoly have no unique way
of determining price mainly due to interdependence between firms as well as the uncertainty.
8. The major aim of firms under oligopoly is to maximise profits. Just like in any market situation
profit maximisation is main goal of the oligopolistic market. Profits are maximised at a point of
equilibrium where MC = MR.
9. There is existence of a lot of non -price competition which tends to win as many customers as
possible. This is seen through forms such as persuasive advertisements, sales promotions etc.
10. There is existence of close interdependency of firms. Each firm in the oligopoly market situation
keeps watch over the activities or reactions of other firms. In this industry the decision taken by
any firm influences price and output decisions of other firms.
11. The demand curve is kinked it is not easy to trace the demand curve for oligopolistic. This is due
to the high degree of uncertainty and high level of interdependence existing in the market. It is
illustrated as below.

Price
P0
0 Q0 Quantity
The demand curve of an oligopolist is kinked because of the differences in the elasticities of demand
at different price levels i.e. the demand curve has got two portions; the upper portion being elastic
and the lower portion is inelastic.
This is because if one firm charges a higher price above the administered price (0P 0), other firms will
not follow suit and therefore, its demand will fall by relatively a bigger percentage (elastic), but if a firm
fixes the price below the administered price other firms will fear to lose customers and therefore will
reduce on prices even at a lower level to form cut throat competition or they may divert to non-price
competition making demand change by a small percentage (inelastic).
The short run and long run equilibrium position and profit maximisation of a firm under oligopoly
The firm under oligopoly maximises profits at the point of equilibrium where MC = MR.

Price is determined by extending the output line to meet the AR/DD curve at point X and price is
P0.
In the short run firms under oligopoly make abnormal profits and this is when AR>AC
The firm makes abnormal shown by the shaded are or rectangle C0P0XY
Price determination under oligopoly
1. Independent price. This involves each firm or seller within the oligopoly industry setting its own
profit maximising price for its output. However this practice causes price wars. NB: price wars
refer to when price cut by one seller leads to retaliatory price cutting by other sellers.
2. Collusion between firms. This involves firms producing similar commodities coming together to
agree on how to share market/the price to charge for their commodities so as to reduce
competition in the market.
3. Price leadership. This is where one firm decides on the price for other firms to follow. The
dominant firm or low cost firm can either determine the price.
Advantages of oligopoly markets

1. There is production of quality products. This is because of the competition in the industry.
2. There is production of a wide variety of goods which widens consumer‟s choice. This is brought
about by product differentiation by the firms in order to win customers.
3. Low prices are charged from consumers compared to monopoly. The competition between the
firms in the industry.
4. The firms provide employment opportunities. The firms operate on a large scale and therefore
provide more employment opportunities.
5. The oligopolistic firms contribute to government revenue. Taxes are imposed on the abnormal
profits realized by the firms.
6. There are high levels of innovations and inventions. The competition in the industry encourages
investment in research hence a high level of technological development.
7. Consumers benefit from non-price competition by the way of giving gifts, free samples, and
promotional offers and after sales services etc.
8. There is development of infrastructure. There is construction and improvement of
infrastructures which ease movement of goods and services and reduce the cost of production.
9. The firms contribute to economic growth. The produce on a large scale which increases the
volume of output and hence a high rate of economic growth.
10. Firms enjoy abnormal profits in the short run and long run. This is because there is restricted
entry into the industry and these profits enable expansion of the firms as well as research.
11. It eases consumer budgeting. There is because under oligopoly there is price stability/price
rigidity.
Disadvantages of oligopoly firms
1. There is distortion of consumer‟s choice. This because of persuasive advertisement.
2. There is exploitation of consumers by over charging them. This due to the existence of collusion
between firms in price determination.
3. Firms incur high costs of production. This because firms engage in intensive sales promotion
activities/Prices of final goods are high because of the high cost of competition.

4. There is duplication of goods and services hence wastage of resources. This is because of the
stiff competition between firms.
5. It worsens income inequality in the economy. This is due to the fact that firms in oligopolistic
markets realise high profits.
6. Leads to collapse of small firms. This is because the small firms are out competed by the large
oligopolistic firms.
7. There are limited employment opportunities. There are limited employment opportunities
because the firms use machines and the firms are small in number.
8. There is limited entrepreneurial development. This because establishing a firm is very costly and
therefore there are few individuals who can afford the high cost.
9. Industries with large firms exert pressure of government. The firms want government to come
up with favorable policies.
10. There is under utilisation of resources. This is due to operation at excess capacity.

NATIONAL INCOME
National income is the measure in terms of money the value of all goods and services produced with
in a country over a given period of time/year.
NB. National income is also called National output/National product.
TYPES OF NATIONAL INCOME
In national income accounting there four types of national income figures that an economy may
compile depending on the data/information that is used in compiling the figures. The forms that
national income may take include:
GROSS DOMESTIC PRODUCT (GDP)
This the money value of all goods and services produced within the territorial boundaries of a country
during a specific period of time usually one year.
It is the national income produced within the territorial boundaries by both the nationals and
foreigners living in that country in a year. It includes the sum total of money value of all goods and
services resulting from productive activities within the economy irrespective whether production is by
nationals or foreigners living in a country.
Sectors that produce within an economy include households (C), business sector (I), the government
sector (G), plus the depreciation incurred in production of goods and services. Therefore GDP= C+ I +
G + depreciation.
NET DOMESTIC PRODUCT (NDP)
This is the money measure of goods and services produced within the territorial boundaries of a
country during a given period of time usually a year excluding the value of depreciation. It is the
country‟s GDP less the depreciation
Therefore NDP = GDP – depreciation.
GROSS NATIONAL PRODUCT (GNP)
This is the money value of all goods and services produced by the nationals over a given period of
time excluding the value of what is produced by foreigners living in that country. It is the money value
of goods and services produced by the nationals of a country living with in a country and those
abroad during a given year.
It excludes the value produced by foreigners living within the country and does also not take into
account the depreciation of capital equipment.
In this case GNP = C + I + G + (X-M) where (X-M) represents net earnings from abroad, X is exports
and M imports.
Net income from abroad/net property income from abroad
This refers to the difference between income earned by the nationals of a country abroad and income
earned by the foreigners in a country in a given period of time usually a year.
NET NATIONAL PRODUCT (NNP)
This is the money measure of goods and services produced by nationals living within and outside the
country during a year excluding the value of depreciation.
i.e. NNP = GNP- Depreciation
Depreciation/capital consumption
This refers to the wear and tear of capital goods during the production process i.e. it is the loss of
value of capital goods.
Causes of depreciation
1. Wear and tear due to disuse.

2. Passage of time.
3. Physical factors e.g. accidents, rusting.
4. Economic factors e.g. inflation.
5. Assets becoming outdated.
Capital consumption allowance. This is the amount of money put aside by firms to carter for
depreciation of capital goods.
CONCEPTS USED IN NATIONAL INCOME
1. Per capita income: This means the average income of an individual of a given country in a
particular year. It can also be defined as income per head.
Income per capita = Total national income in a year
Total population of a country
2. Nominal income: This is the national income of a country in monetary terms.
3. Real income: This is the value of goods produced with in a period of time when valued at
constant prices.
Real income = Money/nominal income X 100
Price index of the year

4. Personal income: This refers to earnings received by individuals from all sources in a year
before direct taxes and other compulsory payments are deducted. i.e. It includes income from
transfer payments, pensions, grants, etc.
5. Disposable income: This refers to the income of an individual that remains after direct taxes and
other compulsory payments have been deducted that can be consumed or saved.
6. Real income per capita – Is the average income valued at base year price.
Or
Average income of the people in terms of quantity of goods and services it can purchase.
While
7. Nominal income per capita – Is the average income of population in monetary terms. /The
average income valued at current price.
8. Nominal gross domestic product – Refers to GDP/one/national output valued at current year
price. or
The total monetary value of all final goods and services produced within a country in a given period
of time valued at current year prices.
While
9. Real gross domestic product – is one valued at base year prices
What is the importance of measuring national income in an economy?
Importance of measuring income in an economy

1. National income figures are useful for economic analysis and planning/research purpose. Planners
use the national income figures to allocate resources according to areas of need.
2. The figures show the level of standard of living by way of per capita GNP. A high national figure
indicates the country is experiencing a higher standard of living and vice versa.
3. It indicates the rate of economic growth and development. An increase in the national income
figures indicates increase in the rate of economic growth rate and vice versa.
4. International agencies giving aid may require information about national income to see which
sector they can aid. The performance of the different sectors helps to show those that are in serious
need of foreign funding.
5. The figures are used for comparison purposes within the country over time. The figures of one year
can be compared with those of another year to identify whether there was an improvement or not.
6. The figures are used for international comparison between countries. The figures of one country
can be compared with those of another country to identify whether there has been an
improvement in one or not.
7. It shows the structure of the economy and identifies weaknesses of the structure for future
action/identifies leading sectors. The contribution of each sector to national income helps to
identify those that contribute more and those with less contribution and therefore help to come up
with appropriate actions.
8. It shows income distribution/resource distribution and helps on appropriate action to be taken.
9. It shows the expenditure patterns within a country.
Discuss the factors that affect the size of national income in your country.
FACTORS THAT DETERMINE THE SIZE OF NATIONAL INCOME
1. Availability and utilisation of resources: These include land, capital stock and organisation of
factors of production in the right proportions. When the available natural resources are well
utilised there is high level of output because firms have inputs/raw materials to use in

production and this leads to a high level of national income while when the available resources
are not well utilised national is low because of limited availability of inputs/raw materials.
2. Policy of government on production and investment: A favourable government policy in form
provision of investment incentives encourages production because low costs of production are
realised hence there is high national income while a unfavourable government policy such as
high taxation leads to high cost of production and therefore a low level of national income .
3. State and level of technology: Use of modern technology results in high efficiency and
therefore high level of national income, poor technology is a hindrance to the growth of a
country‟s national income because of low efficiency.
4. The political situation or extent of peace and security: A stable political atmosphere attracts
both local and foreign people to invest because there is less threat to property and lives hence
more production and national income, and unstable environment is a threat to local and foreign
investors, destroys property and hence low output and low national income.
5. Level of infrastructure development both social and physical. Well-developed infrastructure
such as roads, railways, etc. leads to high national income because it lead to a low cost of
production which encourages production while poor infrastructure leads to low level of national
income because of the high cost of production that discourages production.
6. Population growth rate. A high population growth rate causes low level of national income
because it leads to low level of savings and investment since much of the income is consumed
and leads to level of production and national income. On the other hand a low population
growth rate leads to high level of savings and investment which results into a high level of
production and high national income.
7. Level of skills. When majority of the population in the country are well educated and trained
higher national income figures are realised because there is high efficiency in production which
results into a high level of national income. While when the majority are less educated there is a
low level of national income because of low efficiency in production.
8. Degree of monetisation. A high degree of monetisation (where much of what is produced is for
the market) leads to high national income because there is great incentive to produce since
there is desire for higher profits while a high level of subsistence (where much of what is
produced is for own consumption rather than for the market) causes a low level of national
because there is less produced for immediate family needs.
9. Entrepreneurial ability. Better entrepreneurial ability leads to high level of national income
because of the higher level of resource mobilisation and production while poor entrepreneurial
abilities lead to low level of investment in enterprises because of poor resource mobilisation
and this causes low level of production and national income.
10. Availability of capital stock. The availability of physical capital encourages production because of
high efficiency, high level of output and national income. Low level of capital stock implies low level
of national output because of low levels of efficiency hence low level of national income.
11. Size of the market. Availability of big markets for the goods being produced encourages
producers to produce more because of the higher profits thus high level of national income.
Limited market internally and externally limits production because of the low level of profits and
hence low national income.
12. Nature of the land tenure system. A poor land tenure system makes acquisition of land for
investment very difficult and expensive and this limits investment and mechanisation hence a low
level of output and national income. On the other hand a good land tenure system makes
acquisition of land for investment and production easy hence high level of national income.
13. Degree of conservatism. A high level of conservatism leads to inability of people to easily adopt
better production techniques and this leads to low level of production hence low level of national
income while low level of conservatism leads to adoption of better production techniques which
lead to high level of production and national income.
14. The level of price stability. When prices are stable low production costs are experienced and this
results into high level of production since producers realise high profits which leads to high level of
national income while unstable prices increase cost of production and this discourages production
hence a low level of national income
15. The level of savings. A high level of savings leads to high level of investment and Production
because there are funds to acquire inputs and this leads to high level of national income while low

level of savings leads to low level of investment and production because there are limited funds to
purchase inputs and this leads to low level of national income.
16. Degree of accountability. High level of accountability leads to a higher level of national income
because resources are used for their intended purposes to raise production while low level of
accountability causes low level of national income because funds are diverted to other uses which
reduce funds for investment in production.
17. Attitude towards work.
Methods of measuring national income
There are three approaches or methods of measuring national income. These are:
• The income approach

• Expenditure approach and
• The product/output/valued added approach
These three approaches denote the three ways of deriving identical result.
Identity of the three approaches
If we wish to calculate the total money value of goods and services produced and sold during a year, it
can be done in any of the three ways.
1. We can add up market expenditure by final consumers including purchase of final goods by
firms.
2. We can add up all incomes received by individuals who have contributed to output but
excluding incomes from un productive activities and all forms of transfer payments.
3. We can find out the value of each of the firms contribution to total output i.e. value added or
net output of all the firms. This gives the valued added approach.
The above three approaches are the three ways of deriving the same total. Algebraically we can
express the above relationship as O = Y= E
Where O represents the output approach Y the income approach and E the expenditure approach. To
understand the relationship between the three approaches we use the circular flow of income and
expenditure in a two sector model/simple economic system (closed economy).
Circular flow of income in a closed economy
This is the movement of income and expenditure among the sectors of the economy and these are:
a) Household sector: these are consumers and owners of factors of production to whom payments
are made.
b) The business sector. These are productive firms which use the factors of production to produce
goods and services.
The two sector model assumes the following:
1. It assumes a closed economy (autarky) i.e. an economy that does not engage in international
trade.
2. It assumes that all factors of production are owned and provided by the house hold sector.
3. The house hold sector comprises a consuming class i.e. all consumption takes place in the
house hold sector and no production takes place in this sector.
4. That all production takes place in the business sector and that no consumption takes place in
this sector.

5. There is no saving by the households and business sector i.e. all income earned is automatically
spent.
Following the assumptions above the circular flow of income is as illustrated below:
Household sector Business sector
From the above diagram;

• Arrow 4 shows that what is received by the firms from the sale of final goods equals house
hold expenditure on them.
• Arrow 3 indicates household consumption of output produced by firms.
• Arrow two shows that households supply factors of production to the firms.
• Arrow 1 indicates firms spending on factors of production.
The amount spent by firms goes to the owners in terms wages for labour, interest for capital, rent for
land and profits for entrepreneurs. This income payment is denoted as Y. The whole income received
by firms must go out again as factor income payments since whatever is not paid as wages, interest or
rent must be profits. Therefore O = Y (output = Income).
Finally we assume that households do not save out of their incomes. Therefore expenditure by
households = what is obtained as factor payments i.e. Y = E. Therefore O = Y. it therefore follows that
O = Y = E (the three methods of getting National income).
The Output or Product /value added method
This method involves adding up the total values added to the output at each stage of the production
process in a year. Or it involves summing up of the money value of final goods and services from all
productive activities of the economy in a given year. e.g. agriculture, industry etc.
Problems faced when using the output method

1. Inadequate data. There is difficulty in knowing the contribution of the value added by the
enterprises within a year. This problem is worsened by the limited qualified personnel to
collect the information from productive units.
2. The problem of inventories. These are goods that are produced during a certain year but
sold in the following year. It is not easy to value such goods and the prices at which the
goods should be valued are not clear.
3. It is not easy to distinguish between final and intermediate goods and this may result into
double counting.
4. Problem of subsistence output. These are goods that are produced not sold.
Attaching values to goods is a problem since they are not taken to the market.
5. Statistical errors of over valuing or undervaluing the output.
6. Defining the boundary of production is difficult i.e. what include or exclude, e.g.
whether to include subsistence output or not.
INCOME APPROACH OR METHOD
This method involves adding up the total final money value of all the incomes received by the factors of
production or persons and enterprises for rendering services in an economy in a year. These include rent,
wages/salaries, interest and profits that go to factors of production. Therefore National income = W + I + R +
P.
NOTE: In this method the following are not included; transfer payments/transfer incomes
(unemployment benefits, grants, gifts, pensions etc.) because they are non-quid-pro-quo and illegal
activities such as robbery, smuggling etc.
Problems faced when calculating national income using the income approach
1. Double counting i.e. considering income more than once.
2. Lack of adequate information or data, since some individuals are not willing to reveal all their
sources of income.
3. Problem of transfer payments. These are not supposed to be included because they are not
derived from current production.
4. Problem of income from abroad. Sometimes this income is not included because it is difficult to
estimate income from abroad.
5. Problems of capital gains. Assets tend to gain value with time as a result of changes in prices;
owners of these assets do make profits which gains should not be included when calculating
national income because they do not involve increase in output.
6. Problem of depreciation allowance. Different firms use different methods of determining
depreciation and therefore a standard figure is difficult to get.
7. Subsistence sector. Income from this sector is difficult to determine and therefore an imaginary
value is used.
8. Unpaid for services. Some services are not paid for e.g. work done by house wives and therefore
an imaginary figure is used.
Using this method national income is obtained by adding up public and private expenditure on final goods
and services during any given year. Therefore total national expenditure = Household expenditure (C) +
Investment expenditure (I) + Government expenditure on goods and services (G) and overseas buyers (X-M).
Therefore National income = C + I + G + (X- M)
EXPENDITURE METHOD
Problems faced when using expenditure method

1. Problem of distinguishing final from intermediate expenditure. This results into double
counting.
2. Lack of appropriate information/statistics about expenditure. This results from people‟s
failure to reveal information about their expenditure.
3. Problem of government expenditure on transfer payments. Only expenditure on currently
produced goods should be included however it is not easy to identify the transfer payments.
4. The problem of double counting.
Problems encountered when compiling national income figures
In theory it is a relatively straight forward matter to measure the national income of a country. In
practice however, many problems are encountered when compiling national income statistics and
below are those that deserve mention:
1. Inadequate information/data. Statistical services are poor and some people give false
information to escape taxation, in addition the high levels of illiteracy and insufficient funds
make compilation of good information difficult. This leads to underestimation of national
income.
2. Difficulty in valuing subsistence output. This results into using an imputed value/estimated
that either exaggerates or under-estimates the national income.
3. Unpaid for services/work done oneself. It is difficult to determine the value of unpaid for
services and as result they are ignored which leads to low level of national income.
4. Errors of omission and commission. Errors of omission result into underestimation of
national income because some information is not included while errors of commission result
into exaggerated national income because some information is included when it should not.
5. Problem /difficulty in valuing depreciation. Valuing of depreciation is difficult because
different firms use different methods and this makes it difficult to determine the net output.
6. Shortage of trained personnel/equipment. This makes gathering of data difficult as it results
into inaccurate information being gathered

7. Danger of double counting e.g. transfer payments. This results from the failure to distinguish
between final and intermediate goods which exaggerate the national income.
8. Problem of estimating net income from abroad. Obtaining the figures of income from
abroad is difficult because some of the nationals are not willing to reveal their incomes and a
number of those working abroad is sometimes not known.
9. Problem of defining the boundary of production. This involves the difficult of determining
what to include or not to include and therefore when a lot is included national income is
exaggerated and when some items are left out national income is under estimated.
10. Difficulty in valuing inventories/work in progress. At times production of some commodities
starts in one year and extends into another year and there is therefore difficulty in
determining in which year it should be considered.
11. Difficulty in valuing government expenditure. Figures of government expenditure are
difficult to get since some of the information is not released to the public and this causes
under estimation of national income.
12. Problem of illegal activities e.g. smuggling, drug trafficking, prostitution etc. It is very hard to
know incomes from such activities yet they should not be included. This results into
exaggerated national income.
13. Price changes inflation. Inflation exaggerates national income figures yet in actual sense
there is no increase in output and fall in prices leads low national income even when there
might have been an increase in output.
1. Discuss the factor responsible for the low level of national income in your country.
2. Suggest measures that should be taken to increase national income in your country.
Home work: Explain the points below
The causes of low level of national income in Uganda are:

1. Low level of technology.
2. Limited natural resources and low level of their exploitation.
3. Limited domestic and foreign market.
4. Poor political climate.
5. Low level of existing capital stock.
6. Low level of entrepreneurial ability.
7. Existence of a large subsistence sector.
8. High level of conservatism.
9. Limited skilled labour.
10. Low level of saving.
11. High rate of inflation.
12. Unfavourable government policy on investment and production.
13. Poor land tenure system.
14. Low level of industrialisation.
15. Poorly developed infrastructure.
Measures being taken to increase national income in Uganda
1. Ensuring political stability. This is attracting local and foreign investors because they are
assured of security for life and property which increases the level of investment and
production.
2. Improving technology. This is realised through increased research and therefore better
technology is used which increases efficiency in production.
3. Equipping labour with skills. This involves equipping labour with practical skills through
vocational education and thus increasing labour efficiency which increases investment and
production.
4. Encouraging capital accumulation. This is realised by encouraging saving so that people
accumulate capital to purchase inputs for use in the production.
5. Expanding the market. This is achieved through economic integration so that there is an
increase in the out let for the goods and services which increases profits.
6. Encouraging infrastructural development. This is through construction and rehabilitation so
that production costs are reduced and production is increased.
7. Offering investment incentives. These are in the form of tax incentives, subsidisation etc.
these are reducing the production cost and increase production.
8. Privatising public enterprises. Privatising enterprises is increasing efficiency in production
and therefore causing a high level of national income due to a higher level of production.
9. Liberalising the economy. Liberalisation is increasing the number of enterprises involved in
production and this is resulting into increased production of goods and services.
10. Ensuring economic stability/price stability. This involves using fiscal and monetary policies to
stabilise prices which reduces the cost of production and increases business confidence and
therefore increased production of goods and services.
11. Controlling the population growth rate. This is done by encouraging family planning and as
result savings increase which increases the rate of investment and production.
12. Modernising agriculture. This involves providing farmers with better varieties of crops and
animals which increases production due to a reduction in the reliance on nature.
13. Providing affordable loans. This is enabling people start production enterprises as they are
provided with the needed funds to purchase inputs for production.
14. Improving the land tenure system. This is making acquisition of land for investment and
mechanisation easier and therefore more output is produced.
15. Fighting corruption. Funds set aside are used for their intended purpose and therefore
projects to support production are put in place.
STANDARD OF LIVING
Standard of living refers to the conditions of life in which people live or aspire to live. Or it is the
measure of the level of human or social and economic welfare of an individual or society as

represented by the basket of goods consumed. Or it is the minimum of necessities or luxuries of life
which a person or group of people may be accustomed to.
Cost of living refers to the amount of money required by an individual to sustain life style accustomed
to.
The factors that influence people’s standard of living

1. The general price level in the economy /rate of inflation. A high rate of inflation leads to a
low standard of living because it increases the cost of living/reduces the purchasing power
while stable prices lead to high standard of living because of the low cost of living which
results into a high standard of living.
2. Nature of income distribution. A fair income distribution implies that majority of the people
are able to purchase goods and services and therefore a high standard of living while unfair
distribution of income leads to low standard of living because majority of the people have
low purchasing power.
3. Level of income of an individual. The higher the income of an individual the high the
standard of living because of a high purchasing power while low levels of income lead to low
purchasing and therefore low standard of living.
4. Level of education and skills. The higher the education level the higher the standard of living
because one is able to get employment and earn income that is used to purchase goods
services while low level of education leads to low standard of living because of limited
chances of employment.
5. Nature of goods produced i.e. whether capital goods or consumer goods. Production of
capital goods leads to low standard of living because they do not improve welfare directly
while production of consumer goods leads to high standard of living because they improve
welfare directly.

6. The quality of social amenities/level of development of infrastructure /nature of government
expenditure. Availability of well developed infrastructure leads to high standard of living
because it is easy for individuals to access social services while poor infrastructure leads to
low standard of living because of limited accessibility to social services
7. The political climate. Political instability leads to fear and terror hence a low standard of
living while when there is stability people live free from fear and therefore there is a high
standard of living.
8. The quality and quantity of goods produced. High quality and low quantity lead to a high
standard of living because they have sufficient quantities to consume and when there is less
to consume the standard of ling is low.
9. The level of employment in the country. High level of employment leads to high standard of
living because people earn and have what to spend on goods while unemployment leads to
standard of living because of low incomes and purchasing power.
10. Degree of political freedom. Presence of freedom of expression leads to high standard of
living while when there is limited freedom of expression leads to low standard of living.
11. Levels of environmental pollution. High level of pollution leads to low standard of living
because it causes ill health while low level of pollution leads to high standard of living
because people enjoy good health.
12. Availability of time for leisure. When people have limited leisure time their standard of living
is low because they are over strained by work while presence of ample time for leisure leads
to high standard of living because it relieves stress.
PER CAPITA INCOME AND STANDARD OF LIVING
This is the average income per head in the country. It is the money value of goods and services
available per person in a country in a year. Dividing the national income figure by the population gives
the per capita income. The concept of per capita income enables us to know the average income and

standard of living in a particular country. Per capita income can be computed over years in a given
country or used to compare standards of living between two or more countries. When per capita
income rises over time it may be an indicator of improvement in economic growth as well as
improvement in the standards of living.
Why is per capita income not a good measure of standard of living?
Problems of using per capita income as a measure of standard of living
1. It does not take into account the type of goods produced in the country. Per capita income
may be high in a country which is producing capital goods yet these do not improve peoples ‟
lives directly.
2. It does not consider leisure fore gone/long hours of work. Per capita income may be high in a
country where leisure is foregone, people over work themselves and as a result they do not
enjoy a high standard of living.
3. It does not take into account the distribution of income. Per capita income may be high when
income is concentrated in the hands of few individuals implying that majority of the people
have a low standard of living since there purchasing power is low.
4. It does not take into account the political situation in the country. Per capita income may be
high because of heavy government expenditure to stabilise the country and yet people are
living in fear for their lives which implies that people are having a low standard of living.
5. It does not consider the quality of goods produced. Per capital income may be high because
of production and consumption of poor quality goods means that the people are
experiencing a low standard of living.
6. It does not take into account price levels. Per capita income may be high because of high level
of inflation in the country that exaggerates implying that in actual sense people have a low
standard of because of the high cost of living/low purchasing power.

7. It does not consider the level of subsistence sector. Per capita income may be low when
people produce at subsistence level but this does not mean that people are experiencing a
low standard of living because they have what to consume.
8. It does not consider social costs. Per capita income may be high because of high level of
industrialisation yet it causes a high level of pollution which negatively affects peoples‟ health.
9. Does not consider working conditions. Per capita income may be high when workers are
working under harsh conditions which negatively affect peoples‟ lives.
10. It does not take into account the pattern of government expenditure. Per capita income may
be high when much of government spending is on non-productive ventures which do not
improve peoples‟ welfare directly.
11. It does not consider the level of unemployment. Per capita income may be high when there is
high unemployment in the country implying that people have low purchasing power hence a
low standard of living.
12. It does not take into account the level of taxation on incomes of individuals. Per capita income
may be high when high taxes are being imposed on peoples‟ incomes meaning that they
experience a low standard of living because the taxes reduce the disposable income of
individuals.
13. It does not take into account inaccuracy in statistical data. Per capita income may be high
because of under estimating the population of the country. There per capita income is high
because of the total national income being divided by a small population.
(a) What are the limitations of using per capita income to compare welfare/standard of living of
people in a country over time?
(b) Limitations of using per capita income to compare standard of living of people in a country
over time
1. It does not take into account changes in income distribution over time. Per capita income
may be high in one period but when there is high income inequality meaning that majority are
not able to purchase goods and services and low in another period when but there is
equitable distribution of income implying that there are many people who can afford goods
and therefore a high standard of living.
2. It does not consider changes in nature of goods over time. Per capita income may be high
when capital goods that do not improve peoples‟ welfare directly are produced implying a
low standard of living but low in another period when consumer goods that improve peoples‟
welfare are produced implying a high standard of living.
3. It does not consider changes in the amount of leisure foregone over time. Per capita income
may be high in one period when people are over worked and do not have time for leisure
meaning that they have poor health and low in another period when people are enjoying
leisure and therefore having a high standard of living.
4. It does not take into account changes of working conditions over time. Per capita income
may be high in one period but when employees are subjected to poor working conditions and
thus a low standard of living and per capita income may be low in another period but when
employees are experiencing good working conditions thus a better standard of living.
5. It does not consider changes in expenditure pattern of government over time. Per capita
income may be high in one period when government expenditure is on nonessential goods
implying a low standard of living but low in another period yet government expenditure is on
essential goods that improve peoples‟ welfare hence a high standard of living.
6. It does not consider the changes in the quality of goods produced over time. In one period
per capita income may be high when there is mass production of poor quality goods hence a
low standard of living but low in another period when good quality goods are produced
implying a better standard of living.
7. It does not consider changes in accuracy of statistical data over time. In one period per
capita income may be high because of under estimating population figures but low in another
when there were accurate population figures.
8. It does not put into account the changes of taxation level over time. Per capita income may
be high in one period when high taxes are imposed on people implying low disposable
income and low standard of living and in other period per capita income is low when low taxes

are imposed on people leaving them with sufficient disposable income hence a high standard
of living.
9. It does not take into account the changes in employment over time. Per capita income may
be high in one period when there is a high rate of unemployment implying that many people
have low purchasing power hence a low standard of living but per capita income may be low
in another period when there is a low rate of unemployment implying that majority have high
purchasing power and hence a high standard of living.
10. It does not take into changes in the political climate of a country over time. Per capita
income may be high when there is political instability and people are living in fear hence a low
standard of living and low in another period when there is peace implying a high standard of
living.
11. It does not take into account the changes in social costs over time. Per capita income may be
high in one period when there is a high rate of pollution that cause illnesses hence a low
standard of living and low in another period when there is low rate of pollution and people are
living in good health implying a high standard of living.
Explain the problems of using per capita income to compare standard of living between countries
Problems of using national income and per capita income figures for comparison between
countries
Both national income and per capita figures are not definite indicators of economic welfare of the
people of a country. National income figures are aggregates while per capita figures are averages and
so problems that may arise in using these figures for comparison are:
1. It does not take into account differences in inaccurate estimates of population. A large national
income figure does not necessarily imply a high standard of living because population figures of

various countries are taken into consideration. In developing countries population figures are
not accurate thus per capita income obtained is not accurate and therefore is not a good
measure of welfare.
2. It ignores differences in price structures between countries. Countries value their productive
activities differently and this makes it difficult to compare living conditions between countries
e.g. servants in developing countries are cheap while in the developed countries they are
expensive and rarely used. This implies that a country with high price structures may end up
with high per capita income when the standard of living is low.
3. It ignores differences in boundary of production and methods of compiling national income
between countries. The definition of what to include or not to include varies from one country
to another. What one country includes another may exclude making comparison using per
capita income difficult.*
4. It does not consider differences in tastes and preferences between countries. People in different
countries have different consumption habits. Some countries have expensive and others cheap
tastes due to differences in tastes different goods and services are produced e.g. in Britain
higher incomes are spent on processed goods which most Africans do not want.
5. It does not consider differences in requirements between countries. Countries have different
requirements e.g. in temperate regions the climate is so cold and therefore per capita income
figures may be high because of heating expenses. This does not mean people in those countries
are well off than those who live in hot countries where it is not necessary to heat homes.*
6. It ignores differences in transport and distribution costs between countries. Different countries
experience different cost structures. A country experiencing high costs will have its income
figures inflated and therefore it makes no sense comparing national income figures with that of
another country experiencing low costs.
7. It ignores differences in currencies and the problem of exchange rates between countries.
Countries use different currencies to compute their national incomes in terms of their respective
currencies e.g. Uganda uses shillings, USA the dollar, etc. the problem with this is that these
values may not be equivalent in terms of goods and services they buy in these countries. This is
because different currencies have different purchasing powers in these countries.
8. It ignores the differences in the level of subsistence sector between countries. The subsistence
sector is not the same in all countries. In most developed countries this problem does not exist
but in developing countries or economies the problem of subsistence sector is wide spread and
so it is illogical to compare such distinct economies.
9. It does not take into account differences in the nature of distribution of income between
countries. Per capita income does not show how incomes are distributed among citizens. It may
be high in an economy where there is income inequality i.e. the resources are concentrated in
the hands of few people while the majority are suffering in poverty, hunger and other economic
hardships. In another country however per capita income may be lower but when resources are
evenly distributed and people are enjoying a better welfare.
10. It ignores differences in types of goods produced between countries. It does not consider the
types of goods produced. Per capita income may be high in country which produces capital
goods which do not improve people‟s welfare directly unlike in a country that produces
consumer goods that improve welfare directly.
11. It does not consider differences in leisure foregone between countries. Per capita income does
not take in account leisure which contributes to welfare. It may be high in a country where
people work hard and forego leisure hence over working themselves leading to deterioration in
standard of living.
12. Does not consider the differences in the quality of products produced. In one country per capita
income may be high when the quality of the products is poor negatively affecting people‟s
welfare while in other the per capita income may be low but when the products produced are of
high quality meaning a better standard of living.
13. Does not consider the difference in government expenditure. Per capita income may be high in
one country when government is spending on non-essential goods that do not improve welfare
directly yet in another per capita income may be low but when government is spending on
essential goods that improve welfare and therefore enjoying a high standard of living.
14. Differences in the social costs e.g. pollution. Per capita income may be high in a country where
there is high pollution that causes illnesses to people implying a low standard of ling but low in

another country that has low level of pollution implying that people have a high standard of
living.
15. Differences in the levels of taxation. Per capita income may be high in a country that has high
direct taxes implying that people have low disposable and therefore a low standard of living yet
in another country per capita income may be low but with low direct taxes implying that people
have high disposable income and high standard of living.
16. Differences in the working conditions. Per capita may be high in a country when workers are
subjected to poor working conditions implying that they have low standard of living and low in
other where the workers have good working conditions which means that they a better
standard of living.
17. Differences in the level of employment
INCOME DISTRIBUTION
This refers to the distribution of income among the various social groups or between citizens within a
country. The resources may be equally distributed or inequitably distributed (income inequality).
Income equality
This is a state of imbalance in resource allocation and or ownership. It is a situation where there is
inequitable distribution of wealth such that there exist the very rich and the very poor in society.
The nature of inequality is such that it may exist between individuals, regions, sectors r with in a given
sector of the economy.
Types of inequalities

1. Individual inequality. This is a situation where there those who are educated leaving a
long the illiterate ones, some people are poor co-existing with the rich.
The difference is due to differences in income, education attainment, sex, age etc.
2. Regional or geographical inequality. This one is brought about by the differences in
resource endowment, un even distribution of population and among other things non-
uniform distribution of socio-economic and physical infrastructure.
3. Sectoral inequality. This exists between agriculture and industry, rural and urban and the
formal and informal sectors of government.
4. Intra-sectoral inequality. This is due to the difference in the levels of development within
a particular sector e.g. in agriculture sector there is imbalance in development of
commercial agriculture and subsistence agriculture.
Measuring inequality
To measure inequality in country and measure this phenomenon among countries more accurately,
economists use the Lorenz curves and Gini indices.
The Lorenz curve
This is a graph which shows overall distribution of income among the population. It shows the
percentage of GNP allocated to any percentage of the population as illustrated below:

Per of
GNP
50
10
A 50 Percentage of population
The gini index is more convenient when the task is to compare income inequality between many
countries. The index is calculated as the area between the Lorenz curve and line of perfect
equality expressed as a percentage of the triangle under line OA. The gini index of 0 (zero)
represents perfect equality while that f 100% implies perfect inequality.
Causes of income inequality
1. Differences in resource endowment. Areas that are endowed with resources e.g. land,
climate have higher and fairer distribution of income than those areas with limited natural
resources because people tap them and get income.

2. Differences in talent/natural abilities. Highly talented individuals e.g. footballers, athletes,
etc. have higher incomes than those people with limited natural gifts. This because the
highly talented contribute more to output than the less talented
3. Differences in levels of education and training. People with higher education attainments
secure better paying jobs and therefore better payments because they have high efficiency
while those with low levels of education are paid less because of low levels of efficiency.
4. Differences in accessibility to developed infrastructure. Areas with better infrastructure e.g.
schools, hospitals, etc. have high incomes because of high levels of production while those
with poorly developed infrastructure have low incomes because of low levels of production
since production costs are higher.
5. Differences in the degree of political climate/state of security. Areas which are politically
stable have higher production levels and therefore higher incomes because people are
assured of security for life and property while areas with political instability have low levels of
investment and production and therefore low levels of income because investors are
uncertain about the future.
6. Political influence in the allocation of resources in favour of certain regions/sectors. Areas
that are favoured in terms of allocation of resources experience higher levels of output and
incomes because more resources are availed than those that are less favoured.
7. Discrimination in the labour market on the basis of gender, age etc. those who are favoured
get higher pay while those that are disfavoured do not get jobs and therefore do not earn.
8. Non-matching wage policy by the employers. Some employers are given more than others.
Those in a higher scale get higher wages than those in a low scale.
9. Differences in family or social background. People from rich family background continue
being rich because of inheriting property/income yet those born in humble situations
usually remain poor because there is no wealth to inherit.
10. Differences in seniority or experience. Senior members of staff get higher pay than the
juniors because senior employees have high productivity/efficiency than junior employees.

11. Differences in the quantity of output produced a case with piece rate. Employee who are
more productivity earn more income because of their greater contribution to revenue while
those who are less productive get low incomes because of their low contribution to revenue
of the enterprise.
12. Differences in the elasticity of labour supply. Labour whose elasticity of supply is inelastic is
paid higher wages because it is hard to get and labour whose supply is elastic is paid a low
wage because it is easy to get.
13. Differences in the trade unions ability to bargain. Trade unions that have strong bargaining
power are able to convince the employers and therefore get high wages for their members
on the other hand weak unions are not able to adequately convince the employer and
therefore get low wages for the members.
14. Variation in the employers‟ ability to pay. Employers with higher ability give their employees
higher wages while those with low ability to pay offer their employees low wages.
15. Differences in the nature of occupations and risks. Risky occupations are given high wages to
compensate the employees for exposure to risks while those in less risky jobs are paid low
wages.
16. Differences in the individuals‟ ability to bargain for incomes. Employees with high
bargaining power are able to convince employers and therefore get high wages while those
with weak bargaining skills are not able to convince employers and therefore get low wages.
17. Differences in the number of hours worked. Employees who spend more time at work get
higher wages than employees who spend less time at work.
18. Differences in the cost of living. Employees in areas of high cost of living are given higher
wages to enable them off set the high cost of goods while those in areas of low cost of living
are paid low wages since they spend less on goods and services.
19. Differences in accessibility to contracts
Advantages of income inequality

1. It encourages hard work. The poor are encouraged to work hard so as to catch up with the rich
and the rich try to distance themselves in terms of wealth.
2. It encourages investment by the rich. The rich have a high marginal propensity to save and
therefore there are high levels of investment because they have the funds to purchase
production inputs.
3. It broadens the tax base because government axes the poor and the rich at different rates.
4. It stimulates government efforts to adopt policy programmes to alleviate poverty in society and
therefore the government makes appropriate income policies.
5. It encourages mobility of labour (geographically and occupationally). Labour mobility enables
people to acquire employment.
6. It improves labour relations i.e. it creates harmony between the employees and employers i.e.
the poor respect the rich.
7. Income inequality is a source of cheap labour and as a result the production cost is reduced.
8. It results in to social balance and stability among individuals since naturally people‟s incomes
can never be the same.
9. Uneven distribution of income encourages inventions and innovations as the poor try to imitate
the rich and the rich try to maintain their lead.
Disadvantages of income inequality
1. It leads to under development. This is because the poor have limited capital to invest in the
productive activities.
2. It leads to small market. With the poor dominating there is low aggregate demand and thus the
low levels of investment and development.
3. It encourages brain drain. The poor people are encouraged to live the country to find the better
opportunities elsewhere as a result the economy loses a lot of human capital for development.
4. It creates and encourages rural and urban migration resulting into social economic problems
such as decline in agricultural production in rural areas neglect of families etc.

5. Social unrest and political strikes develop as a result of disparity that exists between the poor
and the rich i.e. the poor become hostile to the rich.
6. Social evils are promoted and these include theft, robbery, and prostitution. And the result is
high cost of eliminating these evils.
7. Misallocating of resources these exist as most productive resources may be channelled to
production of luxuries that the rich demand at the expense of the poor masses going without
the basic cheap essentials.
8. Government planning becomes difficult since inequality in society creates a number of
economic and social classes with diverse needs i.e. education medical health care which the
government maybe not in position to provide adequately.
9. Low revenue to the government is generated i.e. low tax revenue is generated because the poor
have low capacity to pay taxes and the government is unable to provide adequate basic
necessities e.g. roads, education etc.
10. Leads to dependency burden i.e. dependency of the poor on the rich. This perpetuates poverty
in society because savings and investments are low.
11. Leads to exploitation of the poor by the rich. The rich enjoy the services of the poor at un
reasonably cheap rates by taking the advantage of the poor who are rather desperate and in
need of basics for the survival.
Measures that have been adopted to minimise uneven distribution of income in Uganda
1. Introduced Education reforms. There has been improvement in the education system through
expansion of facilities that allow many have access to education and this has improved skills of
individuals enabling get jobs.
2. Reformed the land tenure system. This has made it easy for individuals and investors to access
land for production purposes thus increasing earnings.
3. Progressive taxation. Progressive taxes such as P.A.Y.E have been used with the rich paying
more than the poor and money obtained used to subsidise the poor.

4. Improved infrastructure. Efforts have been made to construct and rehabilitate infrastructure in
different parts of the country and therefore reducing the cost of production and also increased
accessibility to market enabling individuals earn income.
5. Liberalised the economy. The government has liberalised the economy making it possible for
more people to participate in production without unnecessary restrictions and thus increasing
employment opportunities.
6. Decentralised government. The decentralisation of political and economic power has brought
services and resources closer to the people therefore increasing their productive capacity and
incomes.
7. Controlled population growth rate. This has gone a long way to reduce consumption,
unemployment etc. and hence improve people‟s savings and promoted investment.
8. Modernised agriculture. Modern methods of farming such as using improved seed varieties,
controlling pests, accessing better markets etc. These have reduced the reliance on nature and
enabled farmers carry out activities continuously and thus improving their earnings.
9. Diversified the economy. There has been promotion of various sectors e.g. industry, mining,
tourism, etc. and also diversification within sectors for example promoting the traditional and
non-traditional crops in agriculture. These enable many people earn income.
10. Raised the incomes of low income earners/groups. Some low income groups have been given
support by the government in form of increasing their salaries and wages.
11. Improvement of the investment climate. Incentives have been given to investors such as tax
holidays, tax exemptions and these have helped to reduce the cost of production and
encourage production causing employment of more people.
12. Empowerment of disadvantaged groups
13. Increased government expenditure to develop the disadvantaged regions or
groups/subsidisation of the poor. This enabled the areas have more resources to engage in
production.
14. Improved political climate. This has assured the investors of security for life and property and as
such encouraged more people to engage in production with confidence.

15. Encouraged the development of small scale enterprises.
INCOME DETERIMINATION AND EQUILIBRIUM
In this sub topic attention is given to the factors that determine the level of income in an economy and
how equilibrium income level is attained in an economy. In order to understand this better, the factors
that determine income and possibly the factors that influence the equilibrium level of income shall be
considered.
Income determination in a closed economy
A closed economy is one that is not involved in international trade. It is one that is self-reliant and has
no foreign interference. In a closed economy without government participation the main factors that
determine the country‟s income level are Consumption (C), Savings (S), and Investment (I). This means
that the country‟s income can be used for consumption or savings.
Savings are leakages. Leakages are elements that reduce the circular flow of national income.
Leakages reduce aggregate demand and reduce equilibrium level of income.

Investment is an injection in to the circular flow of income. Injections are elements that add to the
circular flow of national income.
Injections increase the level of national income.
An open economy
This is one in which there exists government intervention and an economy participates in international
trade. The country‟s income level can be determined by consumption spending by all households (C),
savings (S), taxation (T), import expenditure (M), and capital outflow, government expenditure (G),
investment (I), and export earnings (X).

In this case the leakages are; savings, taxes, import expenditure and capital outflow. To maintain the
same level of income there must be injections and these are; government
expenditure, investment, export earnings and capital inflows. This is as
illustrated bel
Injections
Leakages injections
Taxes Investment
Investment
National Export earnings

Savings income
Import expenditure
Government expenditure
Capital outflow
Capital inflow

THE KEYNESIAN EQUILIBRIUM LEVEL OF INCOME
According to the classical economists, equilibrium income is attained at the level where Aggregate
demand (AD) is equal to Aggregate supply. i.e. at this point of equilibrium the economy is at full
employment. The classical economists believed that at equilibrium income level leakages are equal to
injections and since resources are automatically fully employed there is no need for government
intervention.
However Keynes disagrees with the classical economists. He says that full employment level of income
may not necessarily be equal to equilibrium income level. He says that:
1. Full employment level of income may be equal to equilibrium income level (Y f=Ye).
2. Full employment level may be greater than equilibrium income level thus giving rise to a
deflationary gap.
3. Full employment level of resources may be less than the equilibrium level of income thus
giving rise to an inflationary gap.
The above two possibilities (ii and iii) indicates the need for government intervention to bring the
economy to general equilibrium. Disequilibrium in an economy is expressed by inflationary and
deflationary gaps.
DEFLATIONARY GAP OR POSITIVE OUTPUT GAP
This is a situation in an economy where aggregate supply exceeds aggregate demand at full
employment level of national income. In other words aggregate demand is not sufficient to generate
full employment level of production. I.e. realised investment is greater than demand and this leads to
unconsumed goods/inventory accumulation
A diagram showing a deflationary gap
Aggregate supply & AS
Aggregate d demand E AD = C + I +
G + (x – m
0 ye yf National income
Point E is at equilibrium level of income but since it is less than full employment level of income it
means that some resources are idle (unemployed). This point can also be called the unemployment
equilibrium. The deflationary gap can be reduced by increasing aggregate demand. The policies that
government can be used to close the deflationary gap include:
1. Reducing direct taxes

2. Increasing government expenditure
3. Encouraging exportation of goods. This increases earnings and spending power.
4. Using an expansionary monetary. This increases purchasing power due to increased supply of
money in circulation.
5. Restricting imports. This is meant to increase the demand for locally manufactured goods.
6. Subsidising consumers. This reduces their expenditure and increases demand.
INFLATIONARY GAP/NEGATIVE OUTPUT GAP
This is a situation in an economy where aggregate demand is exceeds aggregate supply at full
employment of income. It means that realized investment is less than actual demand implying that
what is supplied is not enough. This will result into inflation. The inflationary is as illustrated below:
Aggregate supply AS
&
Aggregate demand AD = C + I +
G + (x – m

a - b is the inflationary gap.
To close this gap the following policies may be used:
1. Increasing direct taxes so as to reduce people‟s purchasing power.

2. Reducing government expenditure, this reduces consumer spending because of less money in
the hands of the public.
3. Restricting exports so that there is sufficient output for the local population.
4. Encouraging imports from cheap sources.
5. Use of a restrictive monopoly as a way of reducing the amount of money in circulation.
6. Government subsidizing output so that they are able to increase output.
7. Infrastructural development to facilitate production to much local demand for goods and
services.
SAVING
Saving refers to the act of abstaining from current consumption to create funds for future use.
Whereas
Savings refer to the proportion of income which is not spent on current consumption but set
aside for future use.

Factors that influence savings (Uganda)
1. Level of income. The higher the income the higher the savings and the lower the income the
lower the savings.
2. The rate of inflation/The price level. A high rate of inflation leads to low savings because
individuals spend more of their income on goods and services while low rate of inflation leads
to low spending hence higher savings.
3. The government policy on savings. A favourable policy leads to high savings such as
encouraging saving and cooperative organizations while an unfavorable policy leads to low
savings
4. The interest rate. A low rate of interest on savings leads to low savings because people are not
attracted by financial institutions while a high interest attracts people to save hence high
savings.
5. The people‟s spending habits. The high the spending the lower the savings because there is less
money left while a low level of spending leaves one with more money to save.
6. The level of development of commercial banks and other infrastructure or institutions.
7. The population growth rate. A high population growth leads to low savings since much of the
income is used to purchase goods while low population growth rate leads to high savings since
there is less spent on goods and services.
8. The degree of monetisation/Commercialisation of the economy.
9. The degree accountability in the financial sector. Low level of accountability discourages people
from saving thus low savings and vice versa.
10. The level of taxation and subsidization. High taxation leaves one with low income hence low
savings while low taxes lead to high incomes of individuals hence high savings
11. The existing stock of wealth.
12. The marginal propensity to save/The marginal propensity to consume.
CONSUMPTION
Consumption refers to the act of using a commodity or resource to satisfy ones needs.
The determinants of consumption of goods and services (Uganda)
1. Level of disposable income. High level of income means a higher purchasing power hence high
level of consumption and when the income level is low the purchasing power is low hence low
level of consumption.
2. Availability of goods and services. Scarcity of goods and services brings about low consumption
levels and vice versa.
3. Price level/inflation. High prices cause low levels of consumption because of reduced disposable
income which causes low demand while low price lead to high disposable income hence high
consumption.
4. Government policy/taxation and subsidization. High taxes lead to low levels of consumption
because they reduce the purchasing power while subsidization leads to high consumption since
it increases the purchasing power.
5. Tastes and preference. Favourable tastes and preferences lead to high consumption since there
are more consumers while unfavourable tastes lead to low consumption.
6. Demonstration effect. Positive demonstration effect leads to high consumption while negative
demonstration effect leads to low consumption.
7. Population size/size of the market. The bigger the market size the higher the consumption since
there are more consumers and the smaller the size of the market the lower the consumption as
it avails few consumers.

8. The existing stock of capital. The high the capital stock the higher the consumption since there
is higher capacity to produce goods and services and vice versa.
9. The distribution of income. High inequality in income leads to low consumption as there are
people able to purchase goods while a more equitable distribution of income leads to high
consumption because of the large number of people with high purchasing power.
10. The rate of interest charged on borrowed funds. The high the rate the lower the consumption
because of low borrowing and vice versa.
The consumption schedule
This is a table showing amounts of consumption corresponding to different levels of income.

These are shown below:
Income Consumption Savings
0 200 -200
600 700 -100
1200 1200 0
1800 1700 100
2400 2200 200
3000 2700 300 3600
3200 400

The table above shows that there can be consumption at zero income. This is called dis-saving. It
should be noted that one‟s income can be used for consumption or saving. (Y = C+ S)
Average propensity to consume (APC)
This refers to the proportion of total income that is consumed rather than saved. It is given by the
formula:
APC = Total Consumption
Total income
Average propensity to save (APS)
This refers to the proportion of total income that is saved rather than consumed. It is given by the
formula:
APS = Total savings
Total income
Note: As income increases APC declines because the proportion of income spent on consumption
reduces. APS increases with an increase in income.
APC + APS = 1
Marginal propensity to consume (MPC)
This refers to the proportion of change in total income that is saved rather than being saved. It is the
change in consumption due to change in income. It is given by the formula:

MPC = Change in consumption expenditure
Change in total income
Marginal propensity to save (MPS)
This refers to the proportion of change in total income that is saved rather than being saved. It is given
by the formula:
MPS = Change in savings
Change in total income
Note: MPC + MPS = 1
INVESTMENT
Investment refers to the process of increasing capital stock.
OR
Investment refers to the process of devoting a person‟s or nation‟s income to creation of capital
stock/capital goods.
Factors that influence/affect investment in Ldcs/Uganda

1. The rate of interest on capital. A low rate of interest on borrowed capital leads to a high level of
investment because individuals have funds to finance the purchase of inputs while a high
interest rate on borrowed capital causes a low level of investment because individuals are
discouraged to borrow to finance the purchase of inputs.
2. Changes in technology/level of technology. A high level of technology leads to high level of
investment because high level of efficiency in production and profits realised while when the
technology is poor there is low efficiency and hence a low level of investment.
3. Political situation in the country. Political instability leads to low level of investment because it
scares investors because they fear for their lives and property while a peaceful environment
attracts investors since there is limited threat to life and property.
4. Level of development of infrastructure. Well-developed infrastructures lead to high level of
investment because they make it easy to access input and product markets easily and reduce
production cost etc. while poorly developed infrastructures make accessibility to markets
difficult, increase production costs hence low level of investment.
5. Level of income. Low level of income causes a low level of investment because one has limited
funds to purchase raw materials, pay labour etc. while a high level of income leads to high
investment because of the availability of funds to purchase inputs, tec.
6. Size of the market/population size/consumption level. A big population size encourages
investment because it provides more profits while a small population size leads to low
investment because there less profits realised by the investors.
7. The supply of raw materials. Limited supply of raw materials causes a low level of investment
because of the high cost of production while presence of raw materials causes a high level of
investment because of the low cost involved in acquiring them.
8. The quality of labour force. Of Presence of a high supply skilled labour encourages investment
because there is high efficiency in production and limited supply of skilled labour causes a low
level of investment because of the low level of efficiency.
9. Level of entrepreneurship. Poor entrepreneurship skills lead to low level of investment because
the low ability to mobilise resources for investment while good entrepreneurship skills result in
to better resource mobilization and business management hence a high level of investment.
10. Government investment policies. A favourable policy in form of low taxes, subsidisation of
producers, etc. leads to high level of investment because they lead to low production costs on
the other hand an unfavourable policy in form of high taxes, limited subsidisation leads to high
production cost hence low level of investment.
11. Level of savings. A low level of savings causes a low of investment because there is low capital
accumulation to hire factors of production while a high level of savings causes a high level of

capital accumulation leading to high ability to hire factors of production hence higher level of
investment.
12. Existing stock of capital. The higher the stock of capital the higher the level of investment since
the higher efficiency in production and when the stock of capital is low there is low efficiency in
production hence low level of investment.
13. Prevailing economic conditions e.g. inflation, unemployment, etc. A high level of inflation leads
to low level of investment because it leads to high production costs while a low level of inflation
leads to leads to a high level of investment because it is associated with low production costs.
14. Degree of conservatism. A high level of conservatism causes a low of investment because
individuals are reluctant to commit resources to into the production process while a low level of
conservatism causes a high level of investment because individuals are willing to commit
resources into the production process.
15. The population growth rate. A high population growth rate cause low level of savings since
much of the income is spent on purchasing goods and services hence a low level of investment
and when the population growth rate is low there is a higher level of savings and therefore
more funds for investment since there is a low level of consumption.
16. Degree of liquidity preference. A high level of liquidity preference causes a low level of
investment because individuals are not willing to commit resources into the production process
while a low level of liquidity preference cause a high level of investment because individuals are
will to commit funds to into the production process.
17. Marginal propensity to import. A high marginal propensity to import causes a low level of
investment to since there is low demand for locally produced goods and therefore low profits
and a low level of liquidity preference causes a high level of investment because there is high
demand for goods locally and investors are assured of high profits.
18. Capital inflows/outflows. A high rate of capital inflow leads to a high level of investment
because it because it avails capital to purchase inputs and other requirements for investment on
the other hand a low rate of capital inflow leads to a low investment because there is less capital
to purchase inputs and other equipment.

19. Nature of land tenure system. A poor land tenure system makes acquisition of land for
investment difficult/expensive and therefore causes a low level of investment while a favourable
land tenure system leads to high level of investment because it makes acquisition of land for
investment easy.
20. Existing natural resources. The presence of more natural resources results into a high level of
investment because of increased availability of inputs for firms while when the natural resources
are not resources are few there is a low level of investment because of limited availability of
inputs for the firms.
Steps being taken to increase investment in Uganda
1. Offering of investment incentives e.g. tax holidays. These are reducing the cost of production
and therefore attract more investors.
2. Building of strong and sound infrastructural facilities. These make it easy to access markets of
inputs and final goods and reduce the cost of production.
3. Ensuring peace and political stability in the country. The use of democracy in governance is
assuring investors of security for life and property and thus attracting more investment.
4. Privatising government enterprises. This is ensuring a competitive atmosphere with in the
business community and thus attracting more investors.
5. Encouraging savings. The government is encouraging individuals to save so that they
accumulate capital to purchase inputs for investment purposes
6. Reducing conservatism through sensitization. People are being sensitized to adopt new
techniques of production so that they realise more output, earn and invest more.
7. Encouraging technological development. Technological development is being encouraged so
that there is an improvement in efficiency in production so more output causes an increase in
profits and thus more investment.

8. Improving the skills of labour. The skills of labour are being improved through training so that
there is improvement in the efficiency in production and therefore increasing earnings and
investment.
9. Liberalising trade. The liberalisation of the trade is making it easy for investors to participate in
business undertaking since government is reducing unnecessary restrictions.
10. Ensuring sound macro-economic policies focused on the attainment or maintenance of
economic stability/checking inflation. These increase certainty and predictability in business
undertakings as well as reducing the cost of production hence attracting more investors.
11. Widening of markets through economic integration. This is increasing the outlets for output,
increasing profits and therefore making it easy for investors to increase production.
12. Establishing specialised institutions to promote investment e.g. UIA (Uganda Investment
Authority). These are providing the necessary information and assistance to the investors.
13. Availing affordable credit to investors. Government is availing affordable loans to investors so
that they can expand their enterprises and make more investments.
14. Reforming the land tenure. This is increasing accessibility to land by making acquisition of land
easier.
15. Fighting corruption. This speeding the process of clearing investors and enabling them access
services faster.
16. Encouraging the training of entrepreneurs. This is equipping the entrepreneurs with better skills
to mobilise resources and manage their enterprises better.
17. Diversifying the economy.
18. Publicising the potentials for investment. This is making the foreign investors aware of the
investment potentials of the country.
MULTIPLIERS
The multiplier refers to the number of times an initial change in expenditure multiplies itself to give a
final change in (national) income.

It is the co-efficient which measures the number of times the initial change in an element of aggregate
demand multiplies itself to bring about a final change in income.
The multiplier is obtained using the formula:
Multiplier = 1/1-MPC or 1/MPS
Example: Given the MPC is 4/5 and the initial expenditure is shs 10,000 shillings.
Calculate the:
i. The multiplier,
ii. The final income.
Solution
a. Multiplier = 1/1-MPC
= 1/1-4/5
= 5 times
b. Final income = multiplier X initial expenditure

= 5 X 10,000
= 50,000 shillings
Types of multipliers
There are various types of multipliers namely:
1. The income/consumption multiplier. This refers to the number of times the initial change in
consumption expenditure multiplies itself to generate a final change in national income.
Income multiplier = change in income
Change in consumption expenditure
2. Government expenditure multiplier. This refers to the number of times by which initial change in
government expenditure multiplies itself to generate a final change in national income.
Government expenditure multiplier = change in income
Change in government expenditure
3. Tax multiplier. This refers to the number of times the change in taxation multiplies itself to give a
final change in national income. Tax multiplier = change in income
Change in taxation
4. Export multiplier. This refers to the number of times change in export earnings multiplies itself
to give a final change national income.
Export multiplier = change in income
Change in exports (earnings)
Marginal propensity to export. This refers to the proportion of the additional income realised
from exports.
Marginal propensity to export = change in exports

Change in (national) income
5. Import multiplier. This refers to the number of times the initial change in import expenditure
multiplies itself to bring about a final change in national income. Import multiplier = change in
income
Change in import expenditure
Marginal propensity to import. This refers to the proportion of additional income that is spent
on imports.
Marginal propensity to import = change in imports
Change in import expenditure
6. Investment multiplier. This refers to the number of times by which a given change in investment
expenditure multiplies itself to generate a final change in national income. Investment multiplier
= change in income
Change in investment expenditure
Factors that affect the effective operation of the investment multiplier in LDCs/Uganda
1. The rate of interest on capital. A low rate of interest on borrowed capital leads to a high level of
investment because individuals have funds to finance the purchase of inputs while a high
interest rate on borrowed capital causes a low level of investment because individuals are
discouraged to borrow to finance the purchase of inputs.
2. Changes in technology/level of technology. A high level of technology leads to high level of
investment because high level of efficiency in production and profits realised while when the
technology is poor there is low efficiency and hence a low level of investment.
3. Political situation in the country. Political instability leads to low level of investment because it
scares investors because they fear for their lives and property while a peaceful environment
attracts investors since there is limited threat to life and property.
4. Level of development of infrastructure. Well developed infrastructures lead to high level of
investment because they make it easy to access input and product markets easily and reduce
production cost etc. while poorly developed infrastructures make accessibility to markets
difficult, increase production costs hence low level of investment.
5. Level of income. Low level of income causes a low level of investment because one has limited
funds to purchase raw materials, pay labour etc. while a high level of income leads to high
investment because of the availability of funds to purchase inputs, tec.
6. Size of the market/population size/consumption level. A big population size encourages
investment because it provides more profits while a small population size leads to low
investment because there less profits realised by the investors.
7. The supply of raw materials. Limited supply of raw materials causes a low level of investment
because of the high cost of production while presence of raw materials causes a high level of
investment because of the low cost involved in acquiring them.
8. The quality of labour force. Of Presence of a high supply skilled labour encourages investment
because there is high efficiency in production and limited supply of skilled labour causes a low
level of investment because of the low level of efficiency.
9. Level of entrepreneurship. Poor entrepreneurship skills lead to low level of investment because
the low ability to mobilise resources for investment while good entrepreneurship skills result in
to better resource mobilization and business management hence a high level of investment.
10. Government investment policies. A favourable policy in form of low taxes, subsidisation of
producers, etc. leads to high level of investment because they lead to low production costs on
the other hand an unfavourable policy in form of high taxes, limited subsidisation leads to high
production cost hence low level of investment.
11. Level of savings. A low level of savings causes a low of investment because there is low capital
accumulation to hire factors of production while a high level of savings causes a high level of
capital accumulation leading to high ability to hire factors of production hence higher level of
investment.
12. Existing stock of capital. The higher the stock of capital the higher the level of investment since
the higher efficiency in production and when the stock of capital is low there is low efficiency in
production hence low level of investment.
13. Prevailing economic conditions e.g. inflation, unemployment, etc. A high level of inflation leads
to low level of investment because it leads to high production costs while a low level of inflation
leads to leads to a high level of investment because it is associated with low production costs.
14. Degree of conservatism. A high level of conservatism causes a low of investment because
individuals are reluctant to commit resources to into the production process while a low level of
conservatism causes a high level of investment because individuals are willing to commit
resources into the production process.
15. The population growth rate. A high population growth rate cause low level of savings since
much of the income is spent on purchasing goods and services hence a low level of investment
and when the population growth rate is low there is a higher level of savings and therefore
more funds for investment since there is a low level of consumption.
16. Degree of liquidity preference. A high level of liquidity preference causes a low level of
investment because individuals are not willing to commit resources into the production process
while a low level of liquidity preference cause a high level of investment because individuals are
will to commit funds to into the production process.
17. Marginal propensity to import. A high marginal propensity to import causes a low level of
investment to since there is low demand for locally produced goods and therefore low profits
and a low level of liquidity preference causes a high level of investment because there is high
demand for goods locally and investors are assured of high profits.
18. Capital inflows/outflows. A high rate of capital inflow leads to a high level of investment
because it because it avails capital to purchase inputs and other requirements for investment on
the other hand a low rate of capital inflow leads to a low investment because there is less capital
to purchase inputs and other equipment.
19. Nature of land tenure system. A poor land tenure system makes acquisition of land for
investment difficult/expensive and therefore causes a low level of investment while a favourable
land tenure system leads to high level of investment because it makes acquisition of land for
investment easy.
20. Existing natural resources. The presence of more natural resources results into a high level of
investment because of increased availability of inputs for firms while when the natural resources
are not resources are few there is a low level of investment because of limited availability of
inputs for the firms.

THE ACCELERATOR PRINCIPLE
This refers to the number of times the initial change in consumption expenditure multiplies itself to
bring about a change in investment.
Accelerator principle = change in investment
Change in consumption
Example: The increase in consumption of sugar from 500kgs to 800kgs caused an increase in
investment from shs. 50,000 to shs. 90,000: calculate the accelerator principle.
Accelerator principle = change in investment
Change in consumption
= 90,000 – 50,000
800 – 500
= 133.33 times
Worked examples
Example 1
a) Differentiate between investment multiplier and government multiplier.

b) Given that the MPC in an economy is 0.7 and there is a change in investment of shs 50m.
calculate the;
i. Investment multiplier,

ii. Final change in income in the economy. Investment multiplier = 1
1-MPC
=1
1-0.7
= 3.33 times
Final level of income = Multiplier X Change in investment
= 3.33 X 50m
= 166.5m shillings
Example 2
a. Define the term marginal propensity to save (MPS).

b. Given that the current level of GDP is 300m shillings, the increase in investment expenditure is
50m shillings and MPS is 0.2. Calculate the final level of income. Multiplier = 1
MPS
=1
0.2
= 5 times
Change in income = Multiplier X increase in investment
= 5 X 50
= 250m shillings
Final level of income = current level of GDP + change in income

= 300m + 250m
= 550m shillings
Example 3
a. What is meant by marginal propensity to save?

b. Given that the initial national income is shs 22bn and MPS is 40%. Calculate the final income in
that country.
Final income = Initial income X (1/MPS)
= 22bn X 1/40%
= 55bn shillings
BUSINESS TRADE CYCLE
This refers to the fluctuations in the general economic level in an economy e.g. aggregate demand,
income, output, the price level etc. as shown below
It has the following phases:

1. The peak/boom. This is the upper point in the level of economic activities and it is characterized
by high of income, high level of employment, high level of investment, high business
confidence.
2. Recession. This is a period of declining economic activities in the economy e.g. production is
falling, wages fall, profits fall, prices decline, investment falls, etc.
3. The trough/economic depression. This is a period of severe down turn in the level of economic
activities (lowest level of economic activities). It is characterized by; very low purchasing power,
very low profits, fall in prices, closure of some businesses etc.
4. Recovery/expansion. During this period, output increases, profits, wages, employment levels
rise, prices of goods generally rise.
PRICE INDICES
Index numbers measure changes in certain variables from one period to another e.g. wholesale prices,
GDP etc.
Price index refers to a figure which measures relative changes in prices of some selected goods from
one period to another.
The consumer price index/cost of living index
This measures the relative changes in prices of consumer goods from one period to another.
Procedures/steps of compiling price indices/cost of living index/consumer price index
a) Choosing a base year. This must be a year when prices were relatively stable.
b) Selecting a representative basket of goods and services. These are goods commonly consumed
in the area.

c) Collection of prices of goods and services in the basket both in the current (year) and in the
base year.
d) Calculation of price relative/simple (price) index for each commodity (in the basket) using the
formula:
Simple price index = current year price X 100
Base year price
e) Computing the average simple (price) index/price relative using the formula Average simple
index = Ʃ (sum) simple price index for each commodity
Number of commodities
f) Attaching weights to the commodities in the basket. Weights show which commodities are
more important to the consumers than others.
g) Calculating the weighted index for each commodity using the formula: Weighted index = price
relative/simple price index X weight.
h) Calculating the average weighted index:
Average weighted index = Ʃ (sum) weighted index/simple index X weight
Ʃ (sum) of weight
The figure obtained helps in determining the cost of living which influences the standard of
living. Therefore when the figure obtained is greater than 100, subtract 100 from it e.g. 155.5 –
100 = 55.5 this means generally prices increased by 55.5%.
This means that there was an increase in the cost of living (inflation) and a decline in the
standard of living.
When the figure obtained is less than 100 e.g. 80, subtract it from100 e.g. 100 – 80 = 20. This
implies that there was a fall in the cost of living (deflation) and therefore an improvement in the
standard of living.

Example:
Study the table below and answer the questions that follow:
Commodity Average price Simple index Average weight
kg/litres 1995 (Ugx) 1995 price
1998 (Ugx)
Sugar 800 100 1000 3
Soap 450 100 600 4
Maize 2200 100 4000 5
Meat 700 100 1200 2
Fuel 550 100 950 1
Calculate the following:
i. The simple price index for each commodity in 1998,

ii. The average simple index for 1998, iii. The weighted index for each commodity
in 1998, iv. The average weighted index for 1998.
Importance of compiling price indices/the cost of living
1. They help in measuring changes in the value of money/determining the level of

inflation/deflation. When the figure obtained is greater than 100 that is an indicator of
inflation/fall in the value of money while a figure below 100 implies increase in the value of
money/deflation.

2. They help/assist in wage determination. When the cost of living index is high then there is need
to adjust the wages upwards to enable employees meet the high cost of living.
3. They help in the deflation/adjustment of nominal income figures to give the real national
income
Real national income = nominal national income X 100
Price index of the year
4. They help in the comparison of the cost of living within a country over time
5. They help in the comparison of the cost of living between countries at a time. The figure of one
country is compared with that of another to establish which one is performing better.
6. They help in determining tax rates/levels. When the cost of living is high government may have
to reduce indirect taxes to enable producers charge low prices so as to reduce the cost of living.
7. They are used to measure the terms of trade of a country.
Problems/challenges/difficulties faced when compiling price indices
1. Difficulty of getting a suitable base year. It is not easy to get a year when prices were stable
because of fluctuations in prices brought about by natural factors, political instabilities etc.
2. There is difficulty in selecting a representative basket of goods and services. This is because
different people have different tastes and preferences.
3. Difficulty in attaching weights to goods and services. This is because of the differences in tastes
and preferences, income levels, etc. therefore weights do not reflect the importance attached to
commodities by all consumers.
4. Changes in the level of prices over time/price instability. Price instabilities make it difficult to
have standard prices for the commodities in the computing and base year.
5. Limited data/information. Some individuals do not have proper records of quantities sold and
their prices which make it difficult to determine the quantities consumed and their respective
prices.
6. Changes in tastes and preferences. This is because of differences in income, culture etc and this
complicates the process of selecting a reliable basket of goods and services.
7. Emergence of new products and exist of old ones from this the market. This complicates the
selection of a suitable basket of goods and services.
8. Absence of standard weights and measures e.g. some commodities are sold in tin, baskets,
heaps, etc. This makes it difficult to determine the quantity consumed and expenditure on such
commodities.
9. There is absence of standard prices in the same area. This is due to bargaining, breakdown of
infrastructure, etc.
10. Limited skilled labour. This makes the computation, analysis and interpretation difficult.
11. Limited facilities. This makes the collection, processing and storage of data difficult.
12. Quality improvements usually affect prices of goods. This therefore gives the impression that
prices have gone up/inflation which may not be the case.

MONEY AND BANKING
MONEY
Money refers to anything which is generally acceptable for the settlement of debts and obligations.
Money is legal tender and everyone in the country concerned is bound to accept it in the settlement
of debts.
QUALITIES OF GOOD MONEY

1. Acceptability. Money should be acceptable so that it can be used in trade. People accept money
because they know that others will accept it.
2. Stability. Money should be stable in value for a long time so that it can be used for a relatively
long period.
3. Durability. Money should not wear out easily. It should stand constant handling during
transactions if it is to function properly.
4. Portability. Money should be easy to carry from one place to another and the cost of carrying
money should not exceed its value.
5. Homogeneity. Money should be uniform throughout the country. There should be no variation
in shape, texture, etc.
6. Divisibility. Money should easily be divided into smaller denominations to facilitate smaller
transactions.
7. Money should be difficult to imitate or forge.
8. Scarcity. Money should be limited in supply if it is to maintain its value and for people to have
confidence in it.
9. Money should be easily identified, recognised and distinguished from other objects.
FUNCTIONS OF MONEY
1. Medium of exchange. Money makes it possible to determine the value of goods to be
exchanged.
2. Money is a unit of account. Money helps in effecting business calculations especially
accounting and auditing.
3. Measure of value. Money is a measuring unit to assess the relative value of different
commodities. A high money price attach to a commodity may reflect its value.
4. Store of wealth. Money can be used as a store of wealth because it is not bulky and it is not
perishable.
5. Means of differed payment. Money facilitates payment of debts and transactions to some
future date.
6. It is a means of transferring immovable assets e.g. land
Types of money
1. Commodity money. These are articles or goods used as medium of exchange because of their
intrinsic value or their ability to satisfy human wants e.g. travellers‟ cheques.
2. Metallic money. This refers to money in form of coins and it is divided into two:
a) Standard/fully branded money. These are coins where the intrinsic value is equal to face
value.
b) Coins whose value is less than the face value – token money.
3. Paper money. This includes the following:
a) Currency. It is the money stock of a country which includes foreign currencies.
b) Fiduciary issue. This is money issued by the central bank at its discretion and is not
backed by gold or foreign reserves but by government securities.
c) Quasi money. This refers to (financial) assets which can easily be converted into money
but they are not money themselves. E.g. treasury bills, bonds, cheques etc.
d) Managed currency. This is the currency which is used only within the territorial boundary
of the country. E.g. Ugandan shillings.
e) Fiat money. Money printed by the central bank on government orders and is not backed
by government securities, gold reserves or foreign reserves.
f) Representative paper money. This refers to money which is fully backed by gold or hard
currencies.
g) Convertible paper money. This refers to money can readily be changed into the other
currencies e.g. US dollar, pound sterling, etc.
h) Inconvertible paper money. This is the type of paper money which cannot be readily
converted or exchanged for other currencies.

i) Legal tender. This is money which according to law must be accepted in the settlement of
any obligation.
MONEY SUPPLY
Money supply refers to the quantity or volume of money in circulation in the whole economy at
a particular time.
1. Broad money supply refers to the sum of that amount of money in the hands of the public plus
all the deposits within commercial banks and other saving institutions or schemes.
2. Narrow money supply is the sum of money in the hands of the public plus the amount in
current accounts in commercial banks.
3. Exogenous money supply is the sum of money which is fixed and determined by the printing
authority e.g. the Central Bank. It is also called discretionary money supply.
4. Endogenous money supply is one determined by the level of economic activity in the country. It
is also called automatic money supply.
Determinants of money supply in an economy
1. Government monetary policy. A restrictive monetary policy leads to low supply of money in
circulation while an expansionary monetary policy leads to high supply of money.
2. Level of liquidity preference. High level of liquidity preference leads to low supply of money
since it is not in circulation while when liquidity preference is low more money is in circulation
hence high supply of money.
3. Interest rates. High rates of interest lead to low supply of money because they discourage
borrowing from financial institutions while a low rate of interest encourages borrowing hence
high supply of money.

4. Level of economic activity/level of investment. The higher the level of economic activity the high
supply of money because it is needed to effect transactions while when the level of economic
activity is low the supply of money is low because there is less money needed to effect
transactions.
5. Inflow of funds from abroad. A high inflow of money/funds leads to high supply of money in an
economy because it is converted into the local currency while low inflow of funds leads to low
supply of money.
6. Government borrowing/government expenditure. High government expenditure leads to a
high supply of money in an economy and the supply of money in an economy is low when there
is low government expenditure.
7. Level of monetisation of the economy. A high level of monetisation of the economy leads to a
high supply of money because most transactions are effected using money while a low level of
monetisation leads to low supply of money because there are few transactions using money.
8. Level of total output of goods and services. A high level of output leads to high supply of
money because it initiates a high level of transactions and vice versa.
9. The Bop position of the country. A BOP surplus leads to an increase in supply of money because
the foreign exchange is converted into local currency while a deficit leads to low supply of
money.
10. The type of fiscal policy employed by government. High taxation leads to low supply of money
because it withdraws money from the public while low taxation leads to high supply of money.
THE QUANTITY THEORY OF MONEY
The quantity theory of money was put forward Professor Irving Fisher. The theory states that, an
increase in money supply will lead to appropriate change in general price level provided the
velocity of circulation and the level of transactions are held constant.
This leads to the equation of exchange which is MV=PT or P=MV
T
Where M= money supply/quantity of money

V=velocity of circulation
P=General Price level
T=Level of transactions
Or
The general price level and the quantity of money vary in direct proportion to each other.
PαM
Or
P=κM
ASSUMPTIONS OF THE QUATITY THEORY OF MONEY
1. Demand and supply of money is equal and proportional

2. Supply of money is exogenously determined
3. Level of transactions and velocity of circulation do not change
4. Price is only affected by changes in money supply
5. Level of investment in an economy is constant
6. There is full employment and the economy is constant
7. Money is only demanded for transactions motive 8. All business transactions are effected
by use of money
9. It is only operational in the long run.

LIMITATIONS OR CRITICISMS OF QUANTITY THEORY OF MONEY
1. It assumes that prices are constant and that they change when there is an increase in money
supply. This is not true for the case of Africa as inflation is rampant and caused by a number of
factors e.g. cost push, poor infrastructure etc.
2. It only recognises the transactions motive of holding money and neglects other motives like,
precautionary and speculative motives.
3. It assumes general price level yet there is no general price level but rather a series of prices.
4. The theory tries to explain changes in the value of money but not how the value is determined.
5. The theory is not regard as an adequate theory of demand for money because it does not take
into account the influence of the rate of interest. It is therefore incomplete without reference to
the rate of interest.
6. The variables in the equation MV=PT are not independent of one another because a change in
one induces a change in others.
7. It assumes that all business transactions are carried out with the use of money and ignores the
possibilities of barter trade.
8. The theory emphasises the supply of money and ignores the demand for money.
9. It assumes that the velocity of circulation and level of transactions are constant which is not the
case in real life situation as some people hold cash either in savings or in their homes etc. and
this reduces the velocity of circulation.
10. Haggling between buyers and sellers to reach an agreeable price is not taken into
consideration.
11. When output increases and employment expands, money supply may increase without
affecting price levels.
12. The theory assumes full employment of resources in an economy yet there may be rampant
unemployment. I.e. it is very difficult to attain full employment.

13. Increase in money supply could lead to increased production of goods and services which
causes prices to instead reduce e.g. during a depression, an increase in money supply increases
production.
14. Government control of prices is not covered by the theory. Governments at times set minimum
and maximum prices.
15. It is a truism which merely shows that M, V, P and T are related.
16. An increase in money supply may result into saving, more so if the marginal to propensity to
save (MPS) is high, this reduces the velocity of circulation and price may fall.
NB: The term value for money refers to the amount of goods and services a unit of money can
buy.
Or
Value of money refers to the purchasing power of a unit of money.
The factors that influence the value of money are:
1. The quantity of money in circulation/monetary policy.

2. The velocity of circulation of money.
3. Availability of goods and services/transactions.
4. The price levels/rate of inflation.
5. Government policy of devaluation/revaluation.
DEMAND FOR MONEY/ LIQUIDITY PREFERENCE
Liquidity preference or demand for money refers to the desire or willingness of people or the
public to hold assets or wealth in form of cash or near cash.
The reasons why people demand / hold money are explained by the Keynesian theory known as
Liquidity Preference Theory.

The Keynesian theory of demand for money
Lord Maynard Keynes identified the following motives for holding money:
1. The transactions motive. This refers to the holding of money to meet the day to day business
obligations such as buying food, clothes etc. This motive is influenced by:
a) The price level
b) The income level
c) The rate of interest
d) The need to fulfil other motives
e) Availability of goods and services
2. The precautionary motive. Money in this case is held to meet or solve unforeseen or
unexpected events that may require unforeseen expenditure e.g. illness, visitors etc. Money held
for this motive depends on:
a) The level of income
b) The possibility of borrowing at short notice
c) The ability to anticipate unforeseen events
d) The rate at which income is received
3. The speculative motive. According to this motive, money is held to make profits through
speculation. The major determinant of this motive is the rate of interest on securities (bonds
and treasury bills). a) The level of income.
b) The possibility of borrowing at short notice.
c) The ability to anticipate unforeseen events.
d) The rate at which income is received.
FACTORS THAT INFLUENCE LIQUIDITY PREFERENCE IN UGANDA

1. Price level. The higher the price level the higher the liquidity preference because more money is
needed is to effect transactions and the lower the price level the lower the liquidity preference
because there is less money needed to effect transactions to effect.
2. Degree of uncertainty. The higher the degree of uncertainty the higher the demand for money
because it is needed to meet unforeseen expenditure and when the uncertainty is low the
demand for money is low.
3. The rate of interest on financial assets. A high rate leads to low demand for money since people
invest in financial assets and when the rate is low people prefers to hold money because it is not
beneficial to invest in these assets.
4. The level of transactions. Low level of transactions leads to low demand for money since there
are few transactions and when there more transactions the demand for money is high since
money is needed to effect the transactions.
5. Level of income. High level of income leads to high demand for money and vice versa
6. Knowledge of banking facilities. Ignorance of banking facilities leads to high demand for money
while having more knowledge leads to low demand for money because it is kept in the banks.
7. The degree of speculation. A high degree of speculation leads to high demand for money and
vice versa.
8. Level of development of commercial banks and other financial institutions.
9. Requirements for opening and operating bank accounts.
10. Level of illiteracy.
BANKING
Financial intermediaries
These are financial institutions that bring together borrowers and lenders. They are of two types:
banking and non-banking financial intermediaries.

Non-banking financial intermediaries are financial institutions that receive deposits, give loans, but do
not create credit e.g. co-operative banks, insurance companies, post office savings bank etc.
While
Banking financial institutions receive deposits, give loans and create credit e.g. Stanbic, Centenary,
NBC banks.
Functions of non-banking financial institutions

1. Giving loans to clients
2. They accept deposits from clients to keep them safely and thus encourage savings 3. They
encourage investments by giving loans to potential investors
4. They ensure social security e.g. through life assurance.
5. They encourage trade
6. They indemnify in the case of insurance
COMMERCIAL BANKING
Commercial banks are institutions that deal in credit or borrowed funds. The main aim of
commercial banks is to maximise profits.
FUNCTIONS OF COMMERCIAL BANKS

1. Commercial banks keep safely monies of their clients in the different accounts
2. They give/advance loans and over drafts to customers who wish to undertake different
investment ventures.
3. Act as custodians of their customers valuables (by providing strong rooms).
4. Act as trustees and executors of property and wills of their customers i.e. they sometimes look
after the property of the deceased customers and also distribute the assets as specified in the
will.
5. They provide advice to investors on possible investment choices.
6. Under-write shares and debentures of companies as well as discount bills of exchange.

7. Exchange of currencies of different countries.
8. They facilitate international trade through issuing of travellers cheques to those who travel to
other countries to carry out business/issuance of various forms credit instruments.
9. They issue letters of credit and act as referees (to their clients).
10. They help the central bank to implement monetary policy hence controlling inflation/deflation
and the level of economic activities.
11. They create more deposits through the process of credit creation.
The role of commercial banks in development
1. They assist the government in executing monetary policy designed to control supply of money in
order to bring about economic stability.
2. They facilitate the process of capital formation through mobilisation of savings which are
important for investment and economic development.
3. They advance loans and over drafts to credit worthy customers who use this money to start
production enterprises hence increasing the rate of economic growth.
4. Commercial banks participate in direct investment activities and this increases the rate of economic
growth.
5. They generate employment opportunities through their various branches and business ventures
and as a result people are able to earn a living.
6. They act as a source of government revenue because they pay taxes.
7. They offer diversified and specialised services that are highly necessary for people‟s welfare
e.g. acting as trustees, providing safe custody for valuable items, etc.
8. They facilitate development of infrastructure such as transport and communication etc. and these
support other economic activities in the country.
9. Commercial banks promote development of international trade through money transfer providing
foreign exchange through their bureaus.

10. They are channel through which government programmes are implemented.
11. They strengthen or promote international relations between the countries where the commercial
banks are foreign owned.
Foreign commercial banks
Positive roles of commercial banks

1. They ensure efficiency. They ensure efficiency in the banking sector because they encourage
competition which improves service delivery.
2. They promote the development of local skills. This is through training the local manpower in
modern banking.
3. They increase employment opportunities. The presence of several banks in the country increases
employment opportunities since there are many people who work at different levels.
4. They facilitate the inflow of capital. The banks help in the remittance of foreign currencies into the
country by nationals living abroad as well as the foreigners since they are highly trusted.
5. They help to monetise the economy. This is because they facilitate commercial transactions as well
as being used by foreign investors to have funds into the country.
6. They contribute to government revenue. The banks pay taxes(corporate taxes)
7. They encourage foreign investors. This is because they help to transfer funds into the country.
8. They encourage savings. By securing peoples‟ money they encourage them to save.
9. The promote international relations. The banks originate from several countries which strengthens
bi-lateral relations.
10. They encourage international trade. They facilitate financial transactions between businessmen of
different countries.
11. They promote technological advancement. They help introduce modern banking technology
through technology transfer.
12. They help individuals to establish ventures. This is because they provide loan facilities for
investment purposes.

13. They encourage entrepreneurship. This is because they facilitate the individuals in the
establishment of business ventures.
The negative roles of foreign commercial banks

1. They encourage capital outflow. There is profit repatriation by the banks and therefore they
contribute to the BOP problem.
2. There is discrimination in employment. Some top jobs are preserved for foreign works which
undermines the capacity of local manpower to improve their management skills.
3. There is limited control over them by the central bank. This is because they have strong attachment
with the central banks of the countries of origin and therefore some of their policies are at times
not in line with local policies thus undermining the authority of the local central bank.
4. They out compete the local banks. They have better management skills which discourages the
development of local financial institution.
5. They tend to discriminate in their lending policies. They finance limited range of activities.
6. They promote regional imbalance in development. This is because they are mainly urban based.
7. They discourage savings for some people. This is because of the high minimum balance
requirement.
8. Their dominance in the banking sector causes loss of economic independence.
Problems faced by commercial banks in Uganda
1. The low level of income among the masses and as a result many of the people do not have
sufficient incomes to save with the banks and thus low bank deposits.
2. The high level of illiteracy/ignorance results in to limited use of bank services/most people do not
take advantage of banking services.
3. Poor distribution of banks with most of them being urban based leaving the rural areas unattended
to. Furthermore the banks concentrated in urban areas compete for the few customers.
4. Unfavourable government policy of high taxation. This causes a high cost of operation and
therefore low profits.
5. Uncalled for government interference in the advance of loans, appointment of managers. This
makes running and recovery of loans difficult.
6. Political instability in some parts of the country minimises the smooth running of the banks as the
level of economic activities is low.
7. High liquidity preference makes. This results into limited savings in the banks.
8. Political instability. This limits operations of banks in some areas as there is fear of losing life and
property.
9. High rate of inflation. This raises the cost of operations of banks and reduces the profits.
10. Poor infrastructure. This makes accessibility to some areas difficult and also raises the cost of
operation hence low profits.
11. High degree of corruption. This reduces funds available ending in commercial banks.
12. There is high liquidity preference. This results into a small number of people making deposits
hence limited funds for lending by commercial banks.
13. Limited skilled manpower. This causes inefficiency in the banking sector.
14. High rate of inflation. This causes a high cost of operation and also makes lending expensive
because it causes an increase in the rate of interest.
15. Poorly developed infrastructure.
Measures that be taken to improve performance of the banking sector

1. Ensuring equitable distribution of commercial banks. This ensures that most parts of the country
are catered for.
2. Giving investment incentives to potential investors. This helps to reduce the cost of operation and
therefore more profits.
3. Maintaining a stable political atmosphere. This assures the investors of security for life and
property enabling them to operate continuously.
4. Ensuring mass education and sensitisation of the people about the importance of saving. This
increases savings
5. Encouraging local ownership of banks. This increases peoples‟ confidence in the banking sector.

6. Fighting corruption in the banking sector. This save guards customers‟ deposits and therefore
increases their confidence in the banking sector.
7. Improving infrastructures. This makes accessibility to commercial banks easier and also reduces the
cost of production.
8. Further training of the local manpower. This increases efficiency in the banking sector.
NATIONALISATION OF COMMERCIAL BANKS

Nationalisation of commercial banks refers to the transfer of ownership and control of
commercial banks from the private sector to the public sector/government.
Reasons for nationalisation of commercial banks

1. To direct allocation of resources/funds into desired economic activities and projects that satisfy the
interests of the nationals.
2. To control profit repatriation which characterises foreign commercial banks.
3. To enable easy implementation of the monetary policy since government is in control.
4. To expand or provide employment opportunities to nationals.
5. To ensure balanced regional development since private banks have a tendency of mainly being
urban based.
6. To strengthen national independence/sovereignty.
7. To allow easy access to loans by the poor since private commercial banks are discriminative in
lending.
8. To mobilise more savings from both rural and urban population.
9. To control the economy and their entire financial system.
10. To win political support of the nationals and consolidating political power.
11. To ensure proper control of money supply and regulation of mismanagement of public funds.
Problems of nationalisation of commercial banks

1. It limits the citizens‟ choice as far as banking services are concerned.
2. Inefficiency in banking sector results due to lack of competition.
3. It creates friction between the government and the former owners and this results into political
tension.
4. Nationalisation leads to loss of experts from foreign commercial banks that have managerial and
technical skills in banking as the go elsewhere for better paying jobs.
5. Nationalised banks tend to favour the public sector and this limits private initiative and creativity.
This is because they heavily controlled by the state.
6. Financial confidence is lost when foreign commercial banks are nationalised and this discourages
foreign investment.
7. It is incompatible with current modern thinking which is towards economic liberalisation and free
market economies.
8. Nationalised banks are subject to government manipulation where decisions are made on political
rather than economic grounds.
9. Nationalisation of foreign owned banks under mines international co-operation and this results in
to loss of support from other countries.
CREDIT
Credit refers to the facility which enables individuals to acquire goods and services without
immediate cash payment but with a promise to pay at a later date.
Or
It refers to any borrowed facilities or funds/money by deficit spending units.
Instruments of credit
These are written document which guarantee payment in the near future and give holders
rights over money. They are documents which promise future payment and the holders can
receive value out of them e.g. cheques/post-dated cheques, promissory notes, bills of
exchange, bank drafts, credit cards, debentures, letters of credit etc.

Importance of credit
a) Credit facilitates production since it helps in the purchase of factors of production and other goods
and services.
b) It enables the public to access loans for investment and consumption.
c) It promotes a fast pace of capital accumulation.
d) It encourages the development of large scale business enterprises.
e) It increases the level of consumption as it increases peoples‟ purchasing power.
f) It promotes differed payment which increases consumption of goods and services.
CREDIT CREATION
This is the process by which money lent out by commercial banks using the cheque facility
expands to result into greater volume of credit than the original amount deposited.
Assumptions for the process of credit creation

1. There is a fixed cash ratio e.g. 20%.
2. There is an initial deposit that is fixed at say 10, 0000/=.
3. There are many banks involved in the system i.e. B1, B2, B3.
4. There are many individuals who are able and willing to borrow money from commercial banks.
5. The banks are willing to lend to their clients.
6. Transactions are carried out by cheques and are deposited in the very banks that give them.
7. Adjustments are made in the ledger book without transferring cash since people get loans in
cheque form.
Bank New deposits Cash ratio/reserve Loan advances (shs)

(shs) (shs)
B1 100,000 20,000 80,000
B2 80,000 16,000 64,000
B3 64,000 12,800 52,000
B4 52,000 10,240 40,960
Total 500,000
The total credit created is given by the formula:-

Total income/credit = Initial deposit X 1 or Initial deposit X credit multiplier
r
Where r is the cash ratio
Note: Credit multiplier is = 1
r Total deposit = 100,000 X1/20%
= 100,000 X 5
= 500,000/=
Total deposit = B1 + B2 + B3 + B4 + ………… Question: How do
commercial banks create credit?
Commercial banks create credit by:

1. Commercial banks create credit by receiving deposits and lending part of it.
2. Receiving of the initial deposit by the first bank (bank A) from a client/customer.
3. Keeping a percentage of the deposit as a cash ratio/reserve by the first bank (bank A).
4. Lending the balance to a credit worthy customer by bank A.
5. Receiving the money lent out as new deposit in another bank/second bank (by bank B).
6. Keeping a percentage of the deposit in bank B as cash ratio/reserve.
7. Lending the balance to credit worthy customer by bank B.
8. The process continues until the initial deposit dissolves in the banking system.
9. At the end of the process the total credit created is:
Total credit created = initial deposit X 1/cash ratio.
BANK DEPOSIT MULTIPLIER/CREDIT MULTIPLIER

It is the number of times an initial deposit in the bank multiplies itself to result into a greater
final credit. It is given by the formula,
1
Cash ratio
Or Change in the final deposits
Change in the initial deposits
Determinants of the bank deposit multiplier
1. Amount of cash held

2. Policy of the Central bank / Central bank interference
3. Size of the initial deposit injected into the banking system
4. Degree of liquidity preference
5. Availability of credit worthy customers
6. Degree of uncertainties
7. Possession of collateral security
8. Distribution of commercial banks
9. Level of investment
10. Level of interest on loans
11. Level of cash ratio/reserves.
12. Peoples‟ knowledge and popularity of loans.
13. Degree of accountability.
14. Level of income of the population.
15. Political atmosphere.
16. Size of the subsistence sector.

Factors that limit the process of credit creation
1. Interference by the central bank through monetary policy. This limits the powers of commercial
banks to avail credit by using tools of monetary policy and therefore there is limited lending and
less credit is created.
2. Existence of few credit worthy customers. Some people do not pay loans advanced to them
therefore banks are reluctant to lend to them hence few loans are given.
3. High rate of interest charged on borrowers. This discourages borrowers and as a result loans are
given to few people.
4. High liquidity preference. A large number of people prefer to keep their own money rather than
depositing it in the banks hence limiting the amount of funds available for lending thus less credit
is created.
5. Existence of few banks which are poorly distributed. This results into low bank deposits and
therefore limited lending by commercial banks.
6. Ignorance of banking facilities because of low levels of education. This causes limited effective use
of commercial banks and therefore limited bank deposits for lending.
7. Political instabilities. Theses hinder the smooth running of commercial banks as people are scared
to save with banks out of fear for their lives and also increased demand for cash to meet the
unforeseen circumstances this causes a low amount of loanable funds because of limited savings.
8. Presence of a large subsistence sector. There is a lower amount of money in circulation because of
a large subsistence sector and therefore commercial banks have less credit created due to limited
savings by individuals.
9. High cash ratio. In some cases the central bank raises the cash ratio which limits the amount
available for lending.
10. Low income level of the population. There are low bank deposits because of the high levels of
poverty. This results into low savings and limited funds for lending.
11. Corruption and embezzlement of funds. In some cases loans are given out basing on political lines,
religious affiliation etc. and at times the money is embezzled leading to less money for lending.

12. Low savings/low deposits. Low savings in commercial banks cause a low amount of loanable funds
and therefore limited lending.
13. Low level of investment. Low level of investment causes a low demand for loans hence a low
amount of credit is created due to limited borrowing.
14. Lack of collateral security. Limited collateral security results into limited lending and therefore a low
amount of credit is created.
15. Unpopularity of loans. There is limited borrowing since people are not interested in loans and this
causes a low amount of credit creation.
16. High degree of uncertainty.
Sample question:
How do commercial banks create credit in your country (illustrate your answer)
1. Banks create credit by receiving deposits and lending part of it.

2. An initial deposit is received by one commercial bank.
3. A given cash ratio is retained by the bank e.g. 20%
4. A table showing lending and borrowing
Bank New deposits Cash ratio/reserve Loan advances (shs)
(shs) (shs)
B1 100,000 20,000 80,000
B2 80,000 16,000 64,000
B3 64,000 12,800 52,000
B4 52,000 10,240 40,960
Total 500,000
5. The process continues until the whole amount dissolves in the banking system.
6. Total amount created = initial deposit X bank multiplier (1/cash ratio
= 100,000 X 1/20%
= 100,000 X 5
= 500,000shillings
ASSETS OF COMMERCIAL BANK

These are possessions of the bank plus claims on its deposits.
They include the following:
1. Cash at hand.
2. Reserves with the central bank.
3. Deposits in other banks.
4. Loans and over drafts to clients
5. Fixed and moveable items e.g. premises, vehicles, etc.
6. Medium and long term investments e.g. investing in bonds and treasury bills.
7. Cheques drawn in other banks.
8. Bills discounted for customers.
9. Retained profits.
LIABILITIES OF COMMERCIAL BANKS

These are the claims against the assets of the bank by creditors and depositors. They
include:
1. Money in the accounts of the accounts of the clients.
2. Deposits of other banks and non-banks.
3. Dividends to be paid.
4. Reserve funds payable to the central bank.
5. Share capital/equity.
6. Creditors to the bank.
7. Bills discounted with the central bank.
The dilemma facing commercial banks in their lending policies

Commercial banks are always faced with a problem of achieving various objectives and these are;
security, liquidity, and profitability.
1. Liquidity as an objective of commercial banks implies that commercial banks have got to keep
funds to meet the cash demands of their clients.
2. Security as an objective of commercial banks requires that commercial banks reduce losses and
risks in order to maximise profit.
3. Profitability is achieved by lending customers deposits at an interest rate and also investing in short
term and long term ventures.
How banks achieve the security objective

1. The banks require borrowers to present collateral security.
2. The banks leave lending where there is a great risk for loss.
3. The borrowers have to present sureties so that in case of default the banks can recover the amount
lent to the client.
4. The physical address of the borrowers is established so that they can be traced when need arises.
5. Division of loans into short term, medium and long term.
6. Maintaining reserves with the central bank.
7. Employing security guards at the banks.
8. Having strong rooms in which the customers deposits are kept.
How commercial banks achieve the liquidity objective 1. Maintaining

cash ratio.
2. Commercial banks keep accounts with other banks and use them to for borrowing when there is
need for more cash.
3. Lending on short term basis.
4. Avoiding lending all the customers deposits.
5. Keeping assets and property that can easily be converted into cash.
6. Receiving more cash deposits from clients.

7. Borrowing from other financial institutions and the central bank.
8. Discounting bills of exchange.
9. Demanding for highly marketable collateral security from borrowers.
10. Requiring customers to maintain a reasonable minimum balance.
How commercial banks achieve the profitability objective
1. Lending money/loans with interest payable.

2. Investing some of the customers deposits in profitable ventures.
3. Charging customers for certain services rendered e.g. banking charges on school fees deposits.
4. Discounting bills of exchange.
5. Investing in government securities.
THE CENTRAL BANK

A central bank is a financial institution whose aim is to control the quantity and use of money in such a
way as to facilitate the implementation of monetary policy in the economy to influence the level of
economic activities.
Functions of the central bank

1. It is a bank to the government. It advances money to the government and maintains cash balances
for the government.
2. It prints bank notes and mints coins. It therefore controls the supply of money in the economy.
3. It manages the country‟s public debt and also helps to raise funds through the ministry of finance
to repay the public debt.
4. It supervises and regulates commercial banks and other financial institutions in the country to
make sure they are sound in their performance.

5. It acts as a banker to commercial banks. By law commercial banks are supposed to keep a certain
percentage of their deposits with the central bank.
6. It is the controller of credit as it regulates the amount and availability of credit in the economy
using the various monetary policy tools.
7. It manages the country‟s foreign reserves.
8. It advises the government on financial and economic issues.
9. It is a lender of last resort. When commercial banks run out of cash, they borrow from the central
bank.
10. It controls foreign exchange into the country monitoring its inflow and outflow.
11. It is a clearing house for commercial banks as it is a place where they settle their indebtedness and
any matters relating to inter-banking business.
MONETARY POLICY
This refers to the deliberate attempt by the government through the central bank to regulate the
amount of money in circulation so as to attain objectives of development. These include; balance of
payment, price stability, full employment etc.
Objectives of monetary policy
1. To influence the rate of economic growth. Increasing the bank rate causes an increase in the rate of
interest charged by commercial banks on borrowers and this discourages borrowing for
investment purposes hence a low rate of economic growth as it increases the cost of production. A
low bank rate causes commercial banks to charge low rate of interest on client
and this encourages borrowing for investment since the cost of production is and this results into a
high rate of economic growth.
2. To maintain domestic price stability. Selling of securities to the public by government reduces the
amount of money in circulation which in turn leaves the pubic with less money to spend on goods
and services and this brings down the prices. To increase prices the government buys securities
from the public which increases the amount of money in circulation and therefore increases
aggregate demand and prices increase.
3. To achieve full employment. When the government lowers the bank rate commercial banks charge
a low rate of interest on borrowers and this reduces the cost of production and encourages more
investment and therefore more employment opportunities. While increasing the bank rate
increases the cost of borrowing by commercial banks which in turn charge a high rate of interest
on borrowers and this causes a low rate of investment because it increases the cost of production
and there is low level of employment.
4. To influence the balance of payment position (BOP). The central may call for selective credit control
which makes it hard for imports to get credit and this reduces importation of commodities into the
country which improves the BOP position due to reduced foreign exchange expenditure.
5. To ensure a stable foreign exchange rate. The government achieves this by selling and buying
foreign currencies. Selling foreign currencies reduces the exchange rate and buying the foreign
currencies increases the exchange rate.
6. To encourage the growth of the financial sector. In this case the central bank supervises and
regulates commercial banks to ensure that there is sound performance.
7. To influence the level and nature of investment. Raising the bank rate reduces borrowing by
commercial banks from the central and this in turn causes commercial banks to charge a high rate
of interest which results into a low level of investment because it increases the cost of production.
Reducing the bank rate causes commercial banks to increase borrowing from the central bank and
they in turn charge a low rate of interest on borrows which increases investment because it reduces
the cost of borrowing.
8. To influence the interest rates. When the central bank raises the bank rate commercial banks
charge a high rate of interest on borrows since they have borrowed expensively and when the bank
rate is reduced the commercial banks charge a low rate of interest since they have borrowed
cheaply.
The tool of monetary policy

1. The bank rate policy. This is the rate of interest charged by the central bank on commercial banks
when they borrow from it. A high bank rate discourages borrowing by the commercial banks from
the central bank and they in turn charge a high interest rate on their clients which discourages
borrowing as loans become expensive and causes a low supply of money. A low bank rate makes
borrowing cheap and commercial banks in turn charge a low rate of interest on clients which
encourages borrowing as loans become cheap and this results in to a high amount of money in
circulation
2. Open market operation. This involves the buying and selling of government securities. Selling of
government securities to the public reduces the amount of money in circulation because
individuals investment their money in these financial assets while buying government securities
increases the amount of money in circulation because individuals are paid the amounts due and
the interest.
3. (Minimum)Legal reserve requirement. This refers to the fraction or proportion of the commercial
banks deposits that are by law supposed to be kept with the central bank. To reduce the amount of
money in circulation the legal reserve requirement is raised and this reduces loanable funds and
therefore clients are given less loans and when the legal reserve requirement is reduced the
amount of money in circulation increases because commercial banks have more money to lend.
4. Rationing of credit. This involves the central bank setting a limit on the amount commercial banks
may borrow form it. To reduce the amount of money in circulation the central bank lowers how
much the commercial banks can borrow form it which results into commercial banks having less
loanable funds and when the limit is raised commercial banks have more loanable funds and this
increases the amount of money in circulation.
5. Selective credit control. This involves the central bank directing commercial banks to discriminate
in their lending. Tightening on lending results into few sectors getting loans and this causes a low
amount of money in circulation. When it is relaxed more sectors get loans which increases the
amount of money in circulation.
6. Moral suasion. This involves the central bank appealing and persuading commercial banks to
adopt either expansionary or restrictive monetary policy. To reduce the amount of money in

circulation commercial banks are persuaded reduce lending and to increase the amount of money
in circulation commercial banks are persuaded to increase lending.
7. Margin requirement. This refers to the difference between the value of the security and the loan to
be advanced. To increase the amount of money in circulation the margin requirement is reduced
which encourages borrowing by individuals since the conditions are not tight while increasing the
margin requirement makes it difficult for individuals to borrow and therefore there is a low amount
of money in circulation.
8. Special deposit/supplementary legal reserve requirements. This is where the central bank requires
commercial banks to make more deposits over and above the legal reserve requirement. When the
commercial banks are requested to make more deposits they are left with less loanable funds
which reduce the amount of money in circulation and when the special deposits are reduced
commercial banks have more loanable funds and this increases the amount of money in
circulation.
9. Variable reserve requirement (cash ratio, liquidity ratio). This refers to the proportion of the total
commercial bank deposits which commercial banks must keep in cash or near cash form to meet
the cash demands of their clients. Raising cash ratio reduces the amount available for lending and
this reduces the amount of money in circulation. When the cash ratio is increased the commercial
banks have more money to lend and this increases the amount of money in circulation.
10. Currency reform. This involves replacing the current currency with a new currency.
When the current currency is in excess, the government withdraws it and replaces it with a new one
whose supply is regulated.
Factors limiting the smooth operation of monetary policy in LDCs/Uganda
1. The presence of under developed money markets. This limits the buying and selling of government
securities.
2. Ignorance of the public of open market operations. Many members of the public are not aware of
how the money markets operate and therefore this limits the buying of government securities.

3. Poor distribution of commercial banks. Most of the banks are concentrated in urban areas, this
leaves a lot of money in the hands of the people in rural making it hard for the central bank to
control money which is outside the banking system.
4. Presence of a large subsistence sector. This implies limited use of banking facilities and thus tools
like bank rate, selective credit control do not apply.
5. Existence of excess liquidity in commercial banks. This results into some commercial banks
continuing to give loans.
6. There is high liquidity preference by the population. This makes it difficult to regulate money that is
outside the banking system.
7. Corruption in the central bank and commercial bank. This makes monitoring of some tools difficult
for example selective credit control.
8. Dominance of the foreign commercial banks. Some of them defy the guidelines issued by the
central bank because they are answerable to the overseas commercial banks and as a result some
tools are not effective e.g. open market operations.
9. Political interference. The decisions taken by the central bank are interfered with by the politicians
who aim at political gains, these compromise the efficiency of some tools as some guidelines are
not followed.
10. Conflicting government objectives. The central banks objectives are contradicted by some policies
of the government for example government raising wages when the central bank is trying to
reduce amount of money in circulation.
11. There is limited effective use of commercial banks. There are few transactions with commercial
banks which makes some tools weak in regulating amount of money in circulation e.g. the bank
rate, selective credit control, etc.

INFLATION
Inflation refers to the persistent increase in the general price level in an economy. It is a situation
where there is a continuous decline in the value of money as measured by the price index.
Inflation rate = Current price – previous price x 100
Previous price
Inflation can be classified according to its degree of intensity or according to causes.
Inflation according to intensity

1. Mild/creeping/gradual inflation. This is where the persistent increase in the general price level
proceeds at slow rate, usually not exceeding 10%. This type of inflation is good for an economy
as it promotes production, employment, investment, etc.
2. Hyper/runaway/galloping inflation. This is where the persistent increase in the general price
level proceeds at a very high rate, the rise taking place within hours, days or weeks. The
percentage increase per annum is over 10%. This kind of inflation makes people lose confidence
in money and it is disastrous to an economy.
Inflation according to causes
1. Demand pull/excessive demand inflation. This is where the persistent increase in the general
price level is as result of aggregate demand exceeding aggregate supply in and economy. It is
usually associated with conditions of full employment when an economy is operating at full
capacity with no further increase in output and supply cannot increase to satisfy the available
demand.
Causes of demand pull inflation
1. Increased demand for exports which increase export earnings increase the supply of money in
an economy as well as the purchasing power of individuals.
2. Decrease in direct taxation which increases peoples‟ purchasing power.
3. Excessive capital inflow e.g. grants, aid etc. which when exchanged into the local currency
increases the supply of money.
4. Excessive supply of money due to printing of money.
5. Excessive spending by the government for example on wages, subsidies, etc.
6. An expansionary monetary policy in form of reduced interest rate, etc.

Policies to reduce demand pull inflation
1. Using a restrictive monetary policy so that there is less money in circulation.

2. Decreasing government expenditure for example reducing wages, subsidies etc.
3. Increasing direct taxation to reduce peoples‟ disposable income.
4. Wage control by the government so that employees‟ disposable incomes are reduced.
2. Cost push inflation. This is when the persistent increase in the general price level is as a result of
persistent increase in the cost of production e.g. wages, rent, cost of raw materials.
Causes of cost push inflation are:
• Rising costs of fuel/power.

• Depreciation of the local currency against foreign currencies.
• Rising costs/prices of imported inputs/raw materials.
• Rising wages/salaries.
• Rising tax levels.
• Increasing transport costs.
• Rising costs of advertising/sales promotion.  Increasing costs of borrowing/interest
rates.
• Rising costs of rent/storage facilities.
Cost push inflation may be in form of:

i. Wage price inflation. This occurs when workers demand for higher wages through their
trade unions or demand for an increased share of output and the increase in wages leads
to increase in cost of production and hence increase in prices.
ii. Price wage inflation/inflation spiral. This is when increase in commodity prices leads to
workers demanding for higher wages which initiates further price increases.
iii. Comparison by workers in one firm/sector with other sectors/firms. A rise in one
sector/firm causes demand for higher wages in other firms/sectors which is shifted to
consumers in form of high prices.
Policies to reduce cost push inflation
1.Subsidisation of producers which goes a long way to reduce the cost of production.
2.Reducing taxes on producers.
3.Encouraging importation of scarce commodities from cheaper sources.
4.Wage legislation by the government.
5.Controlling production units by government-nationalisation of enterprises producing essential
commodities.
Imported inflation
This is where the persistent increase in the general price level results from importing commodities
from inflation prone countries; resulting into price increment in the domestic economy. Such goods
imported may include machinery, fuel products, raw materials, etc.
Causes of imported inflation
1. Importation of highly priced intermediate goods.

2. High costs of transport on imported goods.
3. Inflation in a trading partner.
4. Foreign assistance at high rate of interest.
5. Devaluation of the domestic currency makes imports expensive.
6. Depreciation of the local currency.
Policies that may be used to fight imported inflation
1. Encouraging import substitution strategy i.e. encouraging establishment of industries to

produce goods which formerly imported.
2. Using a restrictive monetary policy to reduce the amount of money in circulation which reduces
the demand for imported commodities.
3. Restricting imports using qualitative /quantitative means e.g. a total ban.
4. Subsidisation of importers so that commodities are cheap in the domestic market.
5. Encouraging the use of the domestic raw materials where necessary. This reduces the cost of
production especially for those goods with a high imported content.
6. Economic integration can be under taken so that countries purchase from each other at lower
prices.
Bottleneck/structural inflation
Structural inflation is that which occurs as a result of supply rigidities.
Sources of bottleneck inflation
1. Political instability. It scars away potential investors due to the fear to lose life and property and
destroys production units thus causing shortage of goods.
2. Infrastructural breakdown. This increases the cost of production due high level of wear and
tear/depreciation.
3. Break down of key industry. There is decline in production which causes shortage of goods and
services.
4. Natural hazards. These destroy crops in the agriculture sector which cause scarcity and thus
increase in prices.
5. Hoarding of goods by traders. This causes artificial shortage of goods and thus increases prices.
6. Scarcity of inputs/scarcity of raw materials/natural resources. This causes an increase in the cost
of production due to shortage.
7. Foreign exchange shortages. This causes the depreciation of the local currency and results into
increase in prices for those goods with a high imported raw material component.
Policies to reduce bottleneck inflation
1. Improving/rehabilitating infrastructure to facilitate easy movement of goods and services from

area to another/ to reduce the cost of production.
2. Improving political climate so as to assure the investors of security for life and property. This
increases investment and production of goods.
3. Encouraging private local and foreign investors who have the capital to invest using incentives
such as subsidisation. This reduces the cost of production.
4. Modernising agriculture/diversification. This reduces the reliance on nature and ensures
continued supply of goods.
5. Importation of raw materials from cheaper sources.
6. Rehabilitation and establishment of industries.
Expectation inflation
This is where the persistent increase in the general price level results from speculation by the
businessmen. This is caused by announcements in the media about say increase in the salaries of civil
servants.

Monetary inflation
This is where the persistent increase in general price level is caused by the excessive issuance of
currency/ excessive government borrowing from the central bank/.
EFFECTS OF INFLATION
Positive effects of inflation
1. Mild inflation stimulates effort/hard work. People have to cope with the increasing cost of living
or maintain their standard of living by putting in extra hours of work.
2. It stimulates investment/entrepreneurship. The gradual increase of prices increases profits and
this increases the level of entrepreneurship.
3. More employment opportunities are created. This is because of increased
investment/establishment of firms that provide jobs.
4. Increased government revenue is realised. This is due to the increase in economic activities that
are taxed.
5. It encourages innovativeness and creativity. As the cost of living increases people try out
different businesses to get means of survival.
6. Borrowers gain in real terms. This is because at the time of borrowing the purchasing power of
money is higher than at the time of paying back.
7. It promotes forced savings. The inflation causes individuals to save so that they are able to
accumulate income and be in position to buy goods at later stage.
8. It encourages labour mobility especially by the young who are looking for means of survival and
these avail labour to different parts of the economy.
9. Leads to increased resource utilisation. The gradual increase in prices causes an increase in
profits which encourage establishment of more firms that utilise the available resources.
10. Mild inflation increases the level of output and thus stimulates growth.
11. It leads to higher profits/business gains. A slight increase in the price of the commodity greatly
increases the gains of the producer.
12. It encourages the establishment of import substitution industries which promotes selfreliance.
As prices rise government encourages establishment of industries to reduce imported inflation.
Negative effects of inflation (hyperinflation)
1. Savings are discouraged. This is because individuals do not see the benefits of saving yet the
money loses value over time.
2. It causes loss of confidence in the local currency. Some people prefer to use other currencies
like the dollars because of their steady value and purchasing power.
3. Fixed income earners suffer. This is because the increase in prices is not matched by an increase
in wages therefore the real wage reduces.
4. Inflation worsens the balance of payment problem. It encourages the importation of cheaper
commodities while exports are expensive.
5. The problem of income inequality worsens. During inflation production is manageable by few
individuals who earn higher profits at the expense of the majority.
6. Lending is discouraged. This is because creditors get less in real terms.
7. It leads to brain drain. Employees who are hard pressed find employment in other countries
which leads to loss of human capital.
8. Unemployment results. Some firms lay off some employees to reduce the cost of production. It
is also as result of some firms closing down due to the manageable/high cost of production.
9. High inflation rates make planning difficult. Plans have to be revised from time to time which
causes unnecessary delays in implementation.
10. It leads to production and consumption of low quality/inferior goods. To reduce the cost of
production some firms reduce ingredients or use cheaper alternatives hence production of low
quality products.
11. Inflation encourages malpractices such as smuggling, corruption, black market, etc. since
people try to survive by any means.

12. People are strained. In attempts to cope up with the rising cost of living some people over work
themselves which results into low quality of life as they are not able to afford majority of goods.
13. It makes government unpopular. This is because many people are not able to afford majority of
the goods and services and blame it on the government.
14. High inflation rates lead to industrial unrest. Employees demand for wage increments which at
times are not met by the employers causing violence, destruction of property and loss of lives.
15. It leads to capital outflow. Some people prefer to invest their capital in other countries where
prices are relatively stable which leads to loss of capital to other countries.
16. It reduces production. It results into high cost production that reduce profits which discourages
production and worse still some firms are pushed out of business.
17. Discourages local and foreign investors. This is because it increases the cost of production and
reduces profit margins.
The causes of inflation in Uganda
1. Rising cost of production e.g. rising wages, interest rates, fuel prices. The producers raise prices
of goods to off-set the cost of producing goods and services.
2. Importation of commodities from inflation prone countries. Commodities get into the country
at high prices since other costs are added such as transport costs, insurance etc. These cause
increase in prices.
3. Unfavourable natural factors. Theses destroy crops and as a result there is scarcity of agricultural
products thus bottleneck inflation.
4. High degree of speculation by the business community e.g. by hoarding goods, speculators
cause artificial scarcity of goods and prices increase.
5. Greed for excess profits by the business community. The profit greedy entrepreneurs increase
prices to gain more profits.

6. Political instability. It causes a low level of investment since the investors fear for their lives and
property and there is therefore low production of goods and services which causes shortages
and this causes prices to increase.
7. Breakdown of infrastructure. This makes it difficult to transport raw materials to the firms and
finished goods to the market. This causes shortage of goods and services since demand
exceeds supply and also increases the production cost.
8. Excessive issuance of currency. It increases the supply of money in circulation which raises the
aggregate demand for goods and services forcing prices upwards.
9. Increased/excessive inflow of incomes from abroad. This increases the amount of money in
circulation and therefore raises the aggregate demand above the supply of goods hence
increasing prices.
10. Depreciation of the local currency. It leads to increase in prices of local products especially those
that have imported components because they increase the cost of production.
11. Excessive government expenditure. This increases the amount of money in circulation which
raises the purchasing power of individuals and therefore an increase in the aggregate demand
for goods causing increase in prices.
12. Excessive exportation of essential goods that causes shortages at home. This increases prices of
such goods since there is shortage.
13. Excessive/uncontrolled credit creation. This causes an increase in the amount of money in
circulation which increases the purchasing power and therefore increases the demand for
goods and services over the supply thus increase in price.
14. Excessive borrowing from the central bank by the government. It causes an increase in the
amount of money in circulation, an increase in the purchasing power and therefore increase in
the aggregate demand.
Measures being taken to reduce inflation in Uganda
1. Increasing direct taxation. This is reducing peoples‟ disposable income and therefore reducing
the demand for goods and services causing a fall in prices.
2. Reducing government expenditure on provision of non-essential goods. This is reducing the
amount of money in circulation which is reducing the purchasing power and thus a reducing the
aggregate demand for goods and services.
3. Liberalising economy to increase production. This is encouraging increased participation of
individuals in production of goods and services due to the competition and is therefore
reducing shortage of goods and services/increasing the aggregate supply of goods.
4. Privatising public enterprises. This increases efficiency in production causing an increase in the
supply of goods and services thus solving bottleneck inflation.
5. Providing tax incentives to investors. These encourage investment since they reduce the cost of
production which enables producers increase output on the market thus solving scarcity of
goods and services.
6. Developing infrastructure. This is reducing the cost of production and therefore enabling
producers to increase output and therefore overcoming scarcity of goods.
7. Controlling issuance of currency. This reduces the amount of money in circulation checks
peoples spending power and therefore reduces demand for goods and this helps to bring down
the prices.
8. Encouraging importation of commodities from cheaper sources. This is enabling the country get
goods at fair prices and therefore checking imported inflation.
9. Modernising agriculture. This is reducing reliance on natural factors ensuring continuous supply
of food and enabling the economy to eliminate scarcity thus resulting into a reduction in the
food prices.
10. Tightening monetary policy e.g. sale of government securities. This is reducing the amount of
money in circulation causing a reduction in the purchasing power and aggregate demand for
goods and services
11. Improving the political climate. This is increasing the level of investment and increases
production of goods and services because the investors have security for their lives and
property.
12. Encouraging import substitution industries. These check the importation of goods from abroad
and therefore reduce imported inflation.
13. Regulating the exportation of essential goods. This is reducing the scarcity of such goods in the
country and therefore stabilising prices.
14. Reducing government borrowing from the central bank. This is checking the amount of money
in circulation which reduces the purchasing power and reduces the demand for goods and
services.
Circumstances when inflation is desirable

1. When it is used by government as a method to increase forced savings instead of introducing
new taxes which may prove unproductive.
2. When there is a recession or depression so that high prices revive the economy i.e. it catalyses
other variables like investment, employment, etc.
3. Gradual/mild inflation may stimulate investment because as prices increase, the profit level also
increases.
4. When excess capacity or underutilisation of resources exists, inflation is necessary so that it
stimulates increased output.
5. When there is need to stimulate or increase employment since it increases investment hence
generating employment.
6. When there is need to stimulate or expand the market/demand.
7. Inflation is desirable when there is need to redistribute incomes from wage earners with low
marginal propensity to save to profit earners with high MPS.
8. When there is need to stimulate economic growth through the effect of excessive demand or
profits and investment.
9. When the marginal efficiency of capital is low it spurs increased investment.
• Stagflation is a situation where high rates of inflation co-exist with high levels of
unemployment and stagnant output.
• Deflation refers to persistent decrease in price of goods and services in a country.

• Reflation refers to a deliberate government policy to force prices upwards to recover
from a depression. Instruments of reflation include; tax reduction, increase in government
expenditure, encouraging exports, use of expansionary monetary policy and increase in
wages. The instruments/policies of reflation are:
1. Tax reduction to increase disposable income.

2. Increase in government expenditure/subsidisation.
3. Encouraging exports.
4. Use of expansionary monetary policy.
5. Increase in wages.
UNEMPLOYMENT
This is a situation where some members of the labour force/working age 16-64 years fail to obtain
jobs at the ruling market wage rate despite their willingness to work. Unemployment can either be
voluntary or involuntary.
Distinguish between voluntary involuntary unemployment

Voluntary unemployment
This is a situation where jobs are available but some members of the labour force are not willing to
take up jobs at the ruling market wage rate.
Explain the causes of voluntary unemployment in your country
The causes of voluntary unemployment are:
1. A low wage rate that is unacceptable to the employee and therefore one would rather remain
unemployed.
2. Good economic background or where one has a wealthy background. Some people are born in
rich families where everything needed for their survival is available and therefore they see no need
as to why they should work.
3. Expectation of a better job in future. One remains unemployed in the short term as he/she awaits
the promised job that is better than the current one.
4. The preference for leisure. Some people cannot afford to miss out on leisure and therefore forego
work.
5. Poor working conditions at the available job/occupation. Poor working conditions discourage
some individuals from taking up some jobs because they consider them harmful to their
health/unacceptable and therefore one prefers to remain unemployed e.g. long hours of work,
harsh treatment, etc.
6. Laziness for some people. Some individuals are reluctant to take up jobs because of their inner
weaknesses.
7. Preference to live on other peoples‟ incomes. Some people are comfortable living on incomes of
other people since there is no effort of own to get such money and it enables them purchase some
necessities.

8. The Low status associated with some jobs. Some people refuse to take up certain jobs because
society under rates them and considers such occupations socially unacceptable.
9. Being too qualified for the available job. Some members of the labour force have higher skills and
qualifications compared to the jobs on offer and are therefore not interested in taking up jobs
below their qualifications.
10. Desire to live on past savings. Some people accumulate money which they consider sufficient for
their survival and therefore opt not to take up any jobs.
11. Unfavourable geographical location of the jobs. Some people remain unemployed because of the
fear to move to places where the geographical conditions are considered harsh e.g. very cold or
very hot conditions and therefore not conducive for their health.
12. High risks involved in the available jobs. Some people forego certain jobs because they fear the
risks involved that may cost them their lives/cause some injuries to them.
13. Social restrictions. Some people remain unemployed because of some norms and cultures held by
some people in certain societies that discriminate some people from taking up certain jobs e.g.
discrimination against women in places of work.
14. Social ties. Some people are so much attached to their families and friends that they are not willing
to move to other places but would rather remain unemployed and stay close to their relatives and
friends.
Involuntary unemployment
This is where some members of the labour force are not able to get jobs at current market wage rate
despite their willingness to work.
The causes of unemployment/involuntary unemployment in Uganda
1. The high population growth rate. In this case the rate of population increase exceeds the rate of
job formation and therefore there is excess supply of labour compared to the available jobs
hence unemployment.

2. A defective education system. Emphasis is on theoretical knowledge rather than practical skills
and it therefore generates job seekers rather than job creators yet there are few jobs on offer.
3. High rate of rural urban migration hence open urban unemployment. There is an increase in the
number of people moving to urban areas expecting better paying jobs which they fail to get
because of the limited skills, use of advanced technology in enterprises and as a result and there
is open urban unemployment.
4. Changes in technology/technological advancement substituting manpower. Advancements in
technology result into machines replacing human labour thus technological unemployment.
5. Seasonal variations in economic activities mostly agriculture or unfavourable change in climate.
In some cases, people are employed when a given season is favourable e.g. agriculture, tourism
and after the season is over the people become unemployed.
6. Discrimination in the labour market on the basis of gender, religion, etc. This is on the basis of
gender, race, religion, etc. and therefore those who are favoured are given jobs while those that
are not favoured remain unemployed.
7. Political instability and its effects on employment where by investors both local and foreign are
discouraged for fear of lives and industries destroyed which discourages investment limiting
employment opportunities.
8. Deficiency of co-operating factors especially capital to set up industries, projects etc.
9. Ignorance about the availability of jobs else. Labour force remains unemployed even when jobs
are available elsewhere because of the mismatch between those who have the jobs and those
who have the skills.
10. Physical and mental incapacitation resulting into residual unemployment. In this case people
are not employed because they cannot contribute anything to production because of some
limitations or their low efficiency.
11. Poor land tenure system. There is limited accessibility to land by some individuals which limits
investment and therefore there are limited employment opportunities generated.

12. Decline/unfavourable change in demand for products of some firms. When there is a decline in
demand for some products, there is a decline in the demand for factors of production especially
labour, because the demand for labour is derived from the demand for goods and services.
13. Retrenchment (in order to cut costs). This involves laying-off workers in order to cut costs as
way of increasing profits this however leaves many people unemployed.
14. Breakdown of industrial firms/breakdown in production process. This involves breakdown of
some machinery or lack of spare parts and this labour remains unemployed for some time until
the firms have been repaired.
15. Under – developed infrastructure. This limits the level of production and also limits the
establishment of firms because of the high cost of production and therefore results into
unemployment because of limited use of factors of production especially labour.
16. High degree of specialisation. Labour that is highly specialised finds it difficult to get jobs
because there are limited opportunities for them.
Explain the measures being taken to solve unemployment in Uganda.
Measures being taken to reduce unemployment in Uganda
1. Educational reforms. Practical subjects are being encouraged at higher levels of learning so as
to encourage self-employment/reduce the number of job seekers and have more job creators.
2. Ensuring stable political climate. This is being done by ensuring democratic governance,
negotiating with political rivals. This is encouraging investment and increased production since
the investors are assured of security for life and property which leads to creation of jobs
especially in the private sector.
3. Increased advertisement of jobs in the media especially newspapers. This is increasing
awareness about jobs and making it possible for members of the labour force to locate the jobs.
4. Checking the population growth rate. Government is controlling the population growth rate by
encouraging family planning methods so that the number of job seekers matches the available
jobs
5. Modernisation of agriculture sector. This is through improving techniques in production,
providing extension services. These lead to increase in output in the sector therefore making it
more attractive to a wide number of people in the sector.
6. Widening the market. This involves encouraging regional co-operation so as to expand market
for goods and services thus increasing the demand for labour hence more employment
opportunities.
7. Development of infrastructure. There is construction and rehabilitation of infrastructure to ease
mobility of labour and increase production to generate more employment opportunities since
there is a lower production cost.
8. There is provision of incentives to investors. These are encouraging foreign investors to
establish industries or business ventures that provide employment because they reduce the
cost of production and investment increases more job opportunities are generated.
9. Encouraging diversification of economic activities. There is diversification of the economy where
a number of activities are being promoted so that these activities/sectors absorb many of the
unemployed people.
10. Liberalisation of the economy. The liberalisation of the economy is making it easy for individuals
to start and manage enterprises and in so doing create self employment and also employ
others.
11. Privatisation of former state owned enterprises. Privatisation leads to efficiency in management
of firms since the owners are profit oriented and the expansion of enterprises results into more
job opportunities being generated.
12. The government is reforming the land tenure system so that individuals have greater right on
their land and are able to use it to acquire loans to start income generating activities. It also
makes acquisition of land easy and this encourages investment and production hence
generating more employment opportunities.
13. By providing affordable credit for investment. The government is providing low interest loans so
that people are able to start income generating activities/self employment.

14. Exporting surplus labour to other countries. There are agencies that are involved in the
exportation of labour to other countries so as to reduce the number of the unemployed.
15. Undertaking special programmes for persons with special needs/persons with disabilities.
16. Further industrialisation.
Discus the effects of unemployment in an economy
The effects of unemployment in Uganda
1. It leads to decline in the level of acquired skills. There is a decline in the level of acquired skills
because the failure to put into practice what one studied results into a decline in efficiency and
effectiveness.
2. It increases the dependency burden and therefore worsens the problem of vicious circle of
poverty. This is because the few people who are employed have to support those who are not
employed which increases poverty since there is less money set aside for investment.
3. It results into low production/low GDP hence low economic growth. There is low level of
effective utilisation of resources since there are few people involved in production and therefore
a low rate of economic growth is experienced.
4. Leads to low government revenue. This is because the unemployed do not have the capacity to
pay taxes and since they are few people paying taxes government realises less revenue.
5. It worsens income and wealth inequalities. The unemployed do not have the capacity to start
their own ventures so as to increase their earnings and therefore those who are employed
become rich and the unemployed become poorer.
6. Leads to low aggregate demand for goods and services. Those who are not employed have low
disposable income
7. It leads to brain drain. As some members of the labour force fail to get jobs the move to other
countries and this leads to loss of the skilled manpower which retards economic growth.
8. It increases levels of immorality (crime rate). Those who do not have jobs engage in illegal
activities to earn a living.
9. Leads to increased or high government expenditure as it tries to cater for the population by
providing services when it should be used on productive activities such supporting industries.
10. Leads to social unrest. It creates hatred between the rich or employed and those who are not
employed.
11. Under exploitation of productive resources hence waste. Those who are not employed do not
have the capacity to establish ventures to utilise the available resources.
12. There is misery and low level of living due to low or no incomes. The unemployed have limited
capacity to purchase some of basic necessities.
13. It creates political tension/unrest. Those who do not get jobs blame it on the government and
engage in demonstrations that destabilise the country.
14. It discourages investment in education. When some members of the labour force fail to get jobs
they discourage those in education from continuing since they will not get jobs.
15. It increases rural urban migration and its adverse effects. People move to urban areas expecting
to get better paying jobs and when they fail they resort to acts like theft, robbery, etc.
Types of involuntary unemployment
1. Underemployment. This is a situation where an employee‟s capacity to work is underutilised.

Underemployment may be in the following forms:
i. People working for few hours than they should. ii.
Working full time on socially unacceptable jobs.
iii. Working on a job whose requirements are below one‟s qualifications.
iv. Working full time in unproductive activities e.g. farming in infertile soils.
v. People working full time but getting incomes below the statutory incomes.
Underemployment may be caused by:
1. Shortage of co-operant factors. Lack of sufficient capital to expand production so that more
members of the labour force are absorbed.
2. Poor land tenure system for example in areas where land is highly fragmented to uneconomic
levels. This makes use of such land difficult because it is small.
3. Limited market. This causes low demand and since the demand for labour is derived from the
demand for goods and services unemployment is experienced.
4. Political instability. It hinders smooth operation of economic activities and therefore people
have no jobs because of low levels of production that lead to low demand for labour.
5. Ignorance of people about availability of jobs elsewhere. This due to low publicity of the jobs
and it causes occupational and geographical mobility of labour.
6. Poor attitudes of people towards work in form of laziness.
7. Limited skills of labour force. There is inability to increase output because of low productivity.
8. Seasonal changes in this case labour is employed when the season is favourable and
unemployed in another when the season becomes unfavourable as in the case of agriculture
e.g. during the dry season/after harvesting people become unemployed.
9. Rural urban migration. This leads to unemployment in urban areas as some people fail to get
jobs of their choice due to limited skills, use of capital intensive techniques, etc.
10. Poor manpower planning. In this case the supply of labour exceeds the demand.
11. Discrimination in the labour market on the basis of race, gender etc. those who are not
favoured are not able to get jobs.
12. High population growth rate. It causes the population in an area to exceed the available
resources such as land/causes surplus labour compared to the available jobs.
Disguised unemployment
This is a situation where by labour appears to be actively involved at work but the marginal
productivity is either zero, negligible or negative. This can be illustrated as below:
Output (kgs)
6
4 MP
0 1 2 3 4 5 6 Labour
In the illustration above, an increase in labour from 1-2 employees‟ increases output from 4-6 units,
there after additional workers 3-5 leaves output the same.
Causes of disguised unemployment
1. Limited capital to have more co-operant factors e.g. capital to buy more land.
2. Poor land tenure system e.g. land fragmentation in densely populated areas causing land
shortages.
3. High population growth rate which makes resources insufficient e.g. land for cultivation being
limited by fragmentation.
4. Limited skills and therefore inability to increase production in a meaningful way.
5. Lack of information about existing jobs elsewhere due to poor publicity.
6. Poor manpower planning e.g. excess supply of manpower in a given field visa-viz the demand.
7. Nepotism in some sectors which results into over enrolment/recruitment.
8. The employers desire to retain work force for future use.
Solutions to disguised unemployment
1. Availing cheap capital or credit so that people can borrow and start income generating
activities.

2. Reform the land tenure system so that those with large pieces of land can make it available to
those who do not have it.
3. Checking the population growth rate through family planning so that job seekers match the
available jobs.
4. Equipping labour with multiple skills.
5. Advertising the available jobs in the media to make members of the labour force aware of the
available job opportunities.
6. Reforming the education system so that the training of labour is line with the demands of the
market.
Structural unemployment
This is unemployment that results from immobility of labour both occupationally/geographically. It is

brought about by long term changes in the structure of industry of the economy. It is caused mainly
by:
1. Changes in demand away from output of certain industries due to changes in tastes and
preferences.
2. Use of inappropriate technology (capital intensive) where machines replace human beings.
3. Exhaustion of deposits of raw materials or inputs e.g. mining which makes miners unemployed.
4. Imbalance between rural and urban areas which leads to open urban unemployment.
5. Political instability which causes displacement of people and as such some of them lose their
jobs.
Solutions to structural unemployment
1. Ensuring flexibility in production which enables industries to change with changes in tastes and
preferences.
2. Diversification of production so that there is no reliance one commodity.
3. Using appropriate so as to reduce technological unemployment.
4. Ensuring that there are facilities for retraining of workers whose skills are no longer in demand.
5. Ensuring serious manpower planning to forecast future trends in the economy so as to make
the necessary adjustment in time.
6. Retraining workers to equip them with skills that are needed in the job market.
7. Equipping workers with multiple skills so that they are able to do several jobs.
8. Ensuring political stability through good governance.
9. Widening markets through regional integration so that the demand for goods and services
increases causing an increase in demand for labour.
Seasonal unemployment
This is unemployment which occurs as a result of climate or seasonal variations.

Causes
1. Climatic changes e.g. in agriculture.

2. Periodical changes or variations in demand.
3. Failure to tame/harness nature.
Solutions
1. Diversification of production activities e.g. production of many crops including the drought
resistant ones.
2. Introduction of small scale industries since these are not so much affected by weather
conditions.
3. Training labour to do so many jobs/multiple skilling.
4. Taming nature e.g. introducing irrigation farming so that activities go on throughout the year.
Frictional/Normal/Transitional/Search unemployment
This is a type of unemployment which occurs when labour is changing jobs in the short run.
OR
It occurs where there are unemployed workers of a particular occupation in one part of the country
but there are jobs in other parts.
Causes
1. Ignorance about existence of job opportunities elsewhere.

2. The immobility of labour geographically this could be because of poor infrastructure, political
instability, etc.
3. Specialised training in a given job/lack of skills on the part of the employees.
4. Structural break down in some sectors e.g. the breakdown of machinery and this causes labour
to be unemployed until the repair of the machines.
5. Change in demand and supply conditions in the market.
6. Technological development/use of machinery which results into machines replacing labour
force.
7. Temporary shortage of raw materials and such enterprises do not run for some time.
8. Political instability some parts of the country.
Solutions
1. Advertisement of jobs by employers in newspapers, radio, etc.

2. Providing fast and efficient transport means to ease mobility of labour.
3. Encouraging use of appropriate technology.
4. Retraining of workers so that they have up to-date skills.
5. Ensuring stable political climate so that there is no disruption of economic activities.

Residual unemployment
This is unemployment due to physical or mental disability which renders such people unemployed
due to their low standard of efficiency.
Solution
Provide work suitable for their dependence.
Casual/erratic unemployment
This is unemployment felt after one has accomplished an assignment or task as he/she waits for
another one.
Technological unemployment
This is unemployment caused by changes in production techniques so that machines replace human
beings e.g. use of capital intensive techniques which reduce the demand for labour in the concerned
industries.
Full employment
This refers to a situation in which everyone who wants to work at the prevailing wage rate is able to get
a job. Or
A situation in which an economy has succeeded in solving her unemployment problems and
unemployment is less than 5% of the work force, equivalent to workers switching jobs.
Reasons for failure to achieve full employment in Uganda

1. The presence of rural urban migration. Some of the people who go to urban centres for jobs
cannot get them because they do not have the relevant skills.
2. High population growth rate. High population growth rate results into the labour force
exceeding the available jobs hence unemployment.
3. Unfavourable change in seasons. During the unfavourable season some members of the labour
cannot be employed because of the instability in their basis employment.
4. Persistent retrenchment of workers. The retrenchment of workers leaves many people without
jobs.
5. Poor political climate. Political instability scares away investors and destroys enterprises which
render people unemployed.
6. Poor education system/difficulty in fully vocationalising the education system. There are more
job seekers than job creators.
7. Decline in demand for products produced by some firms. This leads to low demand for the
factors of production hence unemployment.
8. Poor land tenure system. Land is not readily available to some individuals so that they engage in
production
9. Difficulty in raising sufficient capital for lending/lack of sufficient capital. This limits
establishment of enterprises to provide jobs.
10. Poor entrepreneurial skills.
11. Continuous substitution of labour by machines.
12. Lack of knowledge of existing jobs.
13. Employment of foreigners.
THE KEYNESIAN/CYCLICAL THEORY OF UNEMPLOYMENT

The Keynesian theory of unemployment states that unemployment arises due to deficiency in
aggregate demand for final goods and services especially in times of economic recession/depression.
That is to say, due to low demand for final products firms reduce their output, income levels fall,
investment is discouraged and thus less capital and labour are employed.
AD AS
AS dg AD = C+I+G+X -M
45
The level of unemployment ye – yf is due to deficiency in aggregate demand dg.
The major remedy according to Keynes is increasing aggregate demand. This can be increased
through (solutions according to Keynes):

1. Reducing direct taxation which increases peoples‟ disposable incomes hence increasing the
demand for commodities.
2. Increasing government expenditure which increases money in circulation and therefore
increasing demand for goods.
3. Use expansionary monetary policy. This increases the supply of money in the hands of the
public and causes increase in demand for goods and services hence increasing demand for
labour.
4. Subsidisation of consumers so as to enhance their capacity to consume goods.
5. Creation of a favourable investment climate through provision of investment incentives such as
tax holidays, exemptions, etc. These increase investment and more jobs opportunities are
generated.
To a greater extent the Keynesian theory of unemployment is irrelevant to developing countries

because of the following reasons:
1. It is mainly concerned with demand deficiency yet unemployment in developing countries is

basically from the supply side. i.e. short supply of co-operant factors e.g. capital,
entrepreneurship. This makes it difficult to set up enterprises to absorb labour force.
2. It mainly affects industrialised economies yet developing countries are basically agrobased
economies.
3. The theory is applicable under conditions of full employment which conditions are not found in
developing countries because unemployment is the order of the day.
4. As a solution to unemployment, Keynes prescribes policies which increase levels of aggregate
demand but these policies may be inflationary in developing countries.
5. The theory is based on assumption of a highly monetised industrial economy yet developing
countries economies are basically subsistence.
6. Keynesian theory is based on a big and strong private sector yet in developing countries the
private sector is small and weak.
7. Product, factor and money markets in developing countries are not as functional as in more
developed countries which make policy implementation of the theory irrelevant.
8. Firms in developing countries because of structural difficulties tend to not respond quickly and
effectively to changes in demand. As a result few employment opportunities are generated.
9. The theory emphasises investment multiplier as a contributor to employment yet in most
developing countries it is the export multiplier i.e. increase in demand for exports increases
employment at home.
10. Keynes based his theory on a closed economy yet most economies of the world including
developing countries are open. Therefore there are chances of labour force getting jobs abroad.
11. The high marginal propensity to import reduces the multiplier effect which in turn reduces
employment domestically.
To a small extent, the Keynesian theory of unemployment is relevant to developing countries
1. At times unemployment in developing countries results due to fall in demand both domestic
and abroad.
2. In developing countries, there is an element of industrialisation hence the theory may be
applicable to the industrial sector.
3. In the long run as supply of co-operating for labour increases (increasing capital, supply of
labour) the theory becomes relevant.
4. The investment climate affects employment level and therefore promotion of investment in
Ldcs has potential to expand development as stated by Keynes.
5. Use of expansionary monetary policies to increase purchasing power in most developing
countries have tended to increase employment levels, this is a policy that was put forward by
Keynes.

POPULATION
Population refers to the number of people living in a given area a particular time such as a town, city
or country. The number of people in an area is arrived at by carrying out a population census.
Population census refers to the physical counting of people in a given area so as to discover the social
and economic implications which must be planned for accordingly.
Importance of carrying out a population census
1. To know the population distribution and hence determine the demarcation of constituencies for
electoral purposes.
2. It is necessary for calculation of per capita income which is an indicator for standard of living in a
country.
3. To establish the quality of the population e.g. literacy levels.
4. To determine the size of the labour force for purposes of policy formulation regarding
employment.
5. It helps to determine the birth and death rates hence helps to determine the natural population
growth rate.
6. It helps to determine the levels of migration so as to establish the artificial population growth
rates.
7. It helps a country seek foreign aid.
8. It helps to identify variables like divorce, fertility rates, access to health facilities, etc. that are
necessary when planning.
Population growth rate

This refers to the rate at which the population of a given country changes over time in a given area.
The population growth is determined by mainly the birth rate, death rate and net migrations.
Birth rate. This refers to the number of people born alive in a year per 1000 of the total population.
Example. The population of Uganda in 2002 was 24 million people with 900,000 live births and
165,000 deaths. Calculate the:
(i) Birth rate.

(ii) Death rate.
= 37.5 approximately 38 people per 1000 OR
= 3.8%
Factors that affect birth rate

1. The rate at which birth control measures are used.
2. The average age of marriage. In the case of developing countries it is low and that is why the
birth rate is high.
3. The proportion of women getting married, in Ldcs it is high,
4. The willingness to get married, it is still high in developing countries.
5. The willingness to bear children. Many people are willing to have children
6. The status of women in society. In developing countries the primary work of woman is to bear
children.
7. The level of education, it is low in developing countries and this explains the high birth rate.
8. The rate of urbanisation. The rising rate of urbanisation is reducing the birth rate.
9. The sex ratio.
10. The fertility of women, it is high in developing countries. This is responsible for the high rate of
population growth.
Death rate. This refers to the total number of deaths per 1000 of the total population.
= 6.9/7 per 1000 people
Factors that affect death rate
1. Improvement in medical health care.

2. Improvement in nutrition.
3. Improvement in housing facilities.
4. Better management of natural disasters e.g. famine, floods, etc.
5. Improvement in security.
Artificial population growth
This is due to migrations; it depends on the number of people coming to settle in the country
(immigrations) and those moving out to settle in other countries (emigrations).
Revision question: Examine the effects of a high population growth rate in an economy.
Effects of a high population growth rate
Positive implications or effects
1. It widens the market for goods and services. This because it provides a large number of people
who must be provided with goods and services.
2. Leads to high supply of labour force. There is a high supply of labour force because there more
people who graduate in to the labour force.
3. It provides an incentive for massive investment. The increase in the population causes an
increase demand for goods and services and therefore producers invest more since more profits
are realised.
4. It increases government revenue. As the number of people increases those who qualify to pay
taxes also increases which increases government revenue.
5. An increasing population initiates effort to work harder to sustain the predominantly dependent
population. The working population works harder to provide for young who are yet working.

6. It awakens government to it responsibility of providing the necessary infrastructure such as
schools, hospital, etc. Government constructs infrastructure to improve the welfare of the
people.
7. Such population provides the young who are innovative and this provides room for inventions.
The young are willing to try out new things.
8. It increases resource utilisation. The need to provide goods to the increasing population results
into more resources being put to use which promotes economic growth.
9. It reduces the per capita social overhead costs i.e. the cost of providing infrastructure such as
schools, roads is low with a large population concentrated in an area.
Negative implications/effects of a high population growth rate
1. Leads to high dependence burden/low savings since much of the income is spent on providing
basics to the young this perpetuates the vicious cycle of poverty.
2. It increases unemployment and unemployment. The population growth rate provides a labour
force which is higher than the rate of job formation.
3. Causes low labour productivity. The rapid increase in population causes because low levels of
education/skills development which results into low productivity.
4. It leads to limited domestic market. There are many young people who are unable to purchase
goods because of low/no earnings as some of them not employed.
5. Leads to external resource dependence e.g. on foreign manpower. This is due low levels of
education which necessities using expatriates who are expensive.
6. It causes BOP problems. This is because of high importation of goods to supplement
domestically produced commodities.
7. The available infrastructure is over strained. This is because there are more people per service
and this seen in the congestion in schools, hospitals etc. which causes poor service delivery.
8. Effective planning for the population becomes difficult. This is because of the diverse social
needs which the government is not able to meet adequately.
9. Leads to high government expenditure on provision of social service which strains the
government budget causing poor service delivery.
10. There high social costs in form of pollution, congestion, etc. and the government may have to
spend heavily to clean the environment. This is because there are more people to provide for
which causes over exploitation of resources.
11. Results into brain drain especially for those who are not able to get jobs. This causes loss of the
skilled manpower which causes under development.
12. It leads to high rates of rural-urban migration and the associated negative effects such as high
crime rate, poor accommodation etc. This is because there those who do not have jobs in rural
areas migrate to urban areas.
13. It exerts pressure on the available resources such as forests, swamps, etc. which leads to over
exploitation. This is because there are more people to cater for which causes excessive
exploitation of resources.
14. Leads to income inequality because production is dominated by few rich who can afford to set
production units.
15. It exerts pressure on land hence land fragmentation. There is more land needed for
16. It increases the debt burden. The government borrows to provide services to the population
which worsens the debt burden.
Suggest measures that should be taken to check the high population growth rate.
Measures that can be used to control high population growth rate
1. Adopt family planning programmes which involves changing people‟s attitudes, perceptions
and use of contraception.
2. Encourage small families using the media e.g. radio, TV, etc.

3. Set up appropriate marriage laws e.g. the age of consent above 18 years.
4. Encourage education for all as people get enlightened about the dangers of large families.
5. Manipulate economic incentives and disincentives e.g. reducing maternity leaves, imposing
financial penalties etc.
6. Resettle of people from densely populated areas to reduce pressure on land.
7. Distribute of land to the landless this can be done by confiscating land from the rich to the poor.
8. Encourage emigrations and discouraging immigrations.
9. Government can use force on some people so that they have smaller families.
Explain the measures that have been taken to check the high population growth rate in your
country.
Measures that have been taken to control population growth rates in Uganda
1. Government has promoted family planning campaigns and methods.

2. The government has educated/sensitised the masses/public about the dangers of large
families/high population growth rates.
3. The government has instituted a minimum legal age of consent to marriage being eighteen
years. This has reduced the number of those getting married at a young age.
4. Government has manipulated the social and economic incentives and disincentives.
5. The government has encouraged people to migrate from populated areas to less populated
areas.
6. Government has increased the role of women in economic and political activities through
affirmative action/emancipation of women. This has enabled women make important decisions
including giving birth.
7. The government has encouraged girl child education. This is reducing the number of those
getting married at an early age.

8. Government has encouraged urbanisation. Urbanisation has reduced the need for bigger
families.
9. Government has embarked on eliminating economic imbalances.
10. Government has embarked on improving the health/medical facilities.
Describe the structure of population in your country.
The structure of Uganda’s population
1. It is dominated by the young.

2. Females are more than the males.
3. The population is mainly rural based.
4. Majority of the population are semi-skilled and or unskilled.
5. There are high illiteracy rates.
6. The productive force of the population is mainly engaged in primary production.
7. The population growth rate is high.
8. There is uneven spatial distribution with Kampala having the highest density.
9. A big population live below the international poverty line.
Implications of Uganda’s population structure
Positive implications
1. High market potential. This is because of the high population growth rate that increases the
number of consumers
2. High potential for labour force. The population is dominated by the young who grow up to
constitute the labour force.
3. Provides an incentive/potential for massive future investment. The high population growth rate
increases the number of consumers who increase demand and therefore encouraging
investment since there is possibility of high profits.
4. High tax potential. This is because of high population growth rate which increases the number
of tax payers.
5. Initiates efforts to work harder to sustain the predominantly dependent population. This is
because the population is dominated by the young, therefore working population must work
must put in extra effort to support it.
6. Government is awakened to its responsibility of providing necessary infrastructure. This is
because of the high level of poverty and population being dominated by the young.
7. Encourages labour mobility. This is because the population is dominated by the young.
8. High potential for increased resource utilisation. The high population growth rate increases the
demand for goods and services which causes the increase in the utilisation of resources to
satisfy their demands.
9. They young are innovative.
10. Reduces per capita social overhead costs. This is because of the high population growth rate
which makes number of people to serve bigger.
Negative implications of the population structure
1. Leads to high dependence burden/low savings. This is because it is dominated by the young
who have to be supported by the working population.
2. It increases unemployment and unemployment. This is because of the high population growth
rate which causes labour supply to surpass demand for labour.
3. Causes low labour productivity. This is because majority of the people are unskilled or semi-
skilled.
4. It leads to limited domestic market. This because of the high level of poverty in the country.
5. Leads to external resource dependence e.g. on foreign manpower. This because majority of the
people are semi-skilled and unskilled which necessitates use of expatriates.
6. It causes BOP problems. This is because of the high population rate which necessitates
importation of goods to supplement domestically produced commodities.
7. The available infrastructure is over strained. This is because there is a high population growth
rate and therefore there are more people per service and this seen in the congestion in schools,
hospitals etc. which causes poor service delivery.
8. Effective planning for the population becomes difficult. This is because of the high levels of
poverty and the population being mainly rural based.
9. Leads to high government expenditure on provision of social service which strains the
government budget. This is because of the high levels of poverty where many people have to be
catered.
10. There high social costs in form of pollution, congestion, etc. The high population growth rate
causes poor waste management.
11. Results into brain drain. This is because of the high rate of unemployment and under
employment. This causes loss of the skilled manpower which leads to under development.
12. It leads to high rates of rural-urban migration and the associated negative effects such as high
crime rate, poor accommodation etc. This is because of the high rate of unemployment in the
country.
13. It causes quick depletion of resources/exerts pressure on the available resources. This is because
of the high population growth rate and therefore there are more people to cater for which
causes excessive exploitation of resources.
14. Leads to income inequality. This is because of the high level of poverty in the country and
therefore production is dominated by few rich who can afford to set production units.

15. It exerts pressure on land hence land fragmentation. This is because of the high population
growth rate in the rural areas where majority of the people are based.
16. It increases the debt burden. This is because of the high levels of poverty and the high
population growth rate causes government to borrow heavily to provide services which worsens
the debt burden.
Under population, optimum population and over population
Under population refers to that population size that provides insufficient labour force which when
combined with the existing co-operant factors leads to low output/income per capita.
In this case as the population increases the additional population leads to increasing output per
person.
Optimum population refers to a population size that provides labour force that is sufficient to
combine with existing co-operant factors leading to maximum output per worker/highest per capita
income/average product.
Over population refers to a population size that supplies labour force which when combine with the
existing co-operant factors leads to declining output/income per capita.
Hence a certain number of people is required to optimally utilise the available resources, below it
(under population) there is under-utilisation of resources; while above it (over population) resources
are over utilised. As illustrated below

Income/product
Per capita
Under Over average product
Pop‟n Pop‟n
0 Po population
P0 is the optimum population
Advantages of under population
1. There is limited unemployment. Unemployment problems are reduced as the number of people
competing for jobs is low.
2. It improves the balance of payments position of the country. This is because under population
reduces the volume of imports and the volume of exports may also increase due to low
domestic consumption.
3. There is effective planning for the population. This is because the population is because the
small number of means limited needs.
4. There is less stain on the infrastructure of the country because it caters for a limited number of
people.
5. There is less government expenditure on provision of social services since there few people to
carter for.
6. It reduces brain drain since unemployment problems are minimal
Disadvantages of under population

1. Limited/small market size. This results into low aggregate demand for goods and services.
2. Limited labour supply. This leads to high cost of production because of scarcity of labour.
3. Low output hence low economic growth rate.
4. Low tax revenue. This is because there are few people to contribute to tax revenue.
5. Low level of innovations and inventions. This results into poor techniques of production and a
low level of national output.
6. Underutilisation of natural resources. There are a lot of resources that remain unutilised.
7. High cost of social-capital. This is because there are few people to serve
8. Low level of investment//discourages investment. This because of the low demand for goods
and services.
Advantages and disadvantages of overpopulation refer to the effects of high population growth
rate
Population distribution according to age structure
This considers the age groups namely; the young, the working and old. In this case consideration can
be for the developing and developed countries.
Population pyramid of a developing country
65+ years (the old)

16-64 years(working age population/labour 0 – 15 years (the young)
The age pyramid above is characterised by:
1. There are many dependents in the age bracket 0-14 compared to other age brackets. This is due
to the high birth rate and falling death rate. This is characteristic of developing countries.
2. There few people in the working age bracket.
3. There is a very small number of 64 years and above due to low life expectancy.
The above structure is dominated by the young, the effects of a young population are:
Positive effects
a) High demand for goods and services.

b) Awakens government to its responsibility of providing necessary infrastructure which leads to
increase in output.
c) Initiates effort to work harder to sustain the predominately dependent population.
d) Promotes increased resources utilisation.
e) Encourages investment.
Negative effects
a) It causes a high dependency burden/low savings/ low investment.

b) Leads to low effective demand.
c) Results into high government expenditure on social services.
d) Low labour supply/small size of labour force.

e) Causes low labour productivity/low output.
f) The available infrastructure is overstrained.
g) Causes BOP problems due to high import requirements to supplement domestic supply. h)
Increases the debt burden.
i) Causes low tax revenue
The population pyramid of a developed country
65+
16 - 64
0 – 15 years
The age pyramid above is characterised by:
1. There are many old dependants (65+) due to high life expectancy.
2. There are few people in the working age bracket.
3. There are very few young dependants. This is due to low birth rates and low death rates, high
life expectancy, high rates of urbanisation which are characteristic of developed countries. The
above pyramid shows an ageing population.
AN AGEING POPULATION
An ageing population is a situation where the number of the old people (65+) is higher than other age
groups. An ageing population has the following negative consequences.
Effects of an ageing population
1. It is associated with a low supply of labour in new and expanding industries.

2. It strains the working age group who have to care for the young and the old in form of pensions,
social security, etc.
3. It causes changes in tastes and preferences e.g. increased demand for commodities of the old.
4. Structural unemployment is likely to set in especially when the demand changes.
5. Immobility of labour occurs since majority of the population are old and this denies some areas
labour force.
6. The old are generally conservative and this retards the pace of development.
(a) Explain the Malthusian theory of population
(b) To what extent is the Malthusian theory of population relevant in LDCs/your country?
THE MALTHUSIAN THEORY OF POPULATION
The Malthusian population theory states that, whereas population grows at a geometrical rate; food
production tended to grow at an arithmetic rate. Malthus said that due to the above trend, population
growth after a time would outstrip food production (population trap) and after such a time there was
need to control the population through negative checks like moral restraint, celibacy etc. otherwise
the positive checks like pestilence, wars, diseases etc. would serve to reduce population growth and
then population would equal food supply
Population growth
Food supply
Food and population

Growth
0 t Time period
A is the population trap at this point food production is equal to population growth beyond which
there is starvation and death.
Limitation of the theory
1. Assumed that technology and science are constant but technological progress occurs and is
causing increased food production.
2. It ignored the possibility of international trade and foreign aid to overcome food shortages yet
countries engage in international trade and get food. I.e. LDCs are open economies.
3. Malthus did not foresee great improvement in transport which enables countries get food from
near and far countries.
4. Malthus did not realise that rising living standards can cause a fall in birth rates and population.
5. He was influenced by the law of diminishing returns which is not wholly true. There are cases of
increasing returns when land is used.
6. Agriculture modernisation is not foreseen by the theory yet this is taking place in most LDCs
and is causing increase in food production that supports the increasing population.
7. He assumed a subsistence economy yet economies are growing out of subsistence/get
monetised. There are some people who produce food for sale to those who do not produce
food.
8. The theory ignored the deliberate and scientific methods of birth control or modern methods of
family planning. These are now in use in many developing countries.
9. Population growth does not depend on food alone. It is influenced by several factors such as
birth rate, death rate etc.

10. Did not foresee labour mobility to ease pressure on land. As labour moves from rural areas
more land is availed for the production of food.
11. Ignored the possibility of emigrations to reduce population pressure on land.
12. There is no mathematical relation as regards population growth and food production.
13. The theory did not foresee the possibility of getting foreign aid and resources from other
countries to support the population yet several countries get aid.
Applicability of the theory in Uganda
1. Land is fixed in supply and subject to the law of diminishing returns a situation experienced as
anticipated by Malthus.
2. Natural family planning methods/control measures like celibacy being used are his initiation.
3. Positive checks (wars, diseases) on population exist in LDCs.
4. Land problems or disputes are common in LDCs today.
5. Some areas in Low developed countries face food shortages/famine.
6. Existence of a subsistence sector which is still large in LDCs.
LABOUR
Labour refers to the human resource (physical/mental) available to society for use in the production
process. This labour can be unskilled, semi-skilled or skilled. It is one of the most important factors of
production.
Labour force. This is the proportion of the population that is made up of the working age group,
excluding full time students and housewives.
Or
It is the total number of people of the working age group that is available for employment at a given
time.

Determinants of the size of labour force in Uganda are:
1. Size of the population.

2. Number of full time students/length of the training period.
3. Health status of the population.
4. Government policy in terms of employment age/age structure.
5. Social customs/No of full time housewives.
Features of Uganda’s labour force are:
1. Mainly unskilled.
2. Mainly youthful.
3. Mainly employed in agriculture sector/primary production.
4. The majority are in rural areas.
5. Mostly concentrated in urban areas/geographical concentration per unit area.
6. The majority are highly mobile.
7. There are slightly more females than males.
Labour supply refers to the total number of people available for employment in a country in a given
period of time at an on-going wage rate.
OR
The total time labour is willing to offer for work at the on-going wage rate.
Factors that influence labour supply
1. Size of the population. The bigger the size of the population in the country, the higher the
labour supply this is because there are more people available for employment and a small

population size causes a low supply of labour force because there are few people for
employment.
2. The age structure of the population. The bigger the population in the age bracket of 16-64
years, the larger the supply of labour this is because the working population is big while a small
working population leads to a low supply of labour.
3. Level of wages and other non-monetary factors. High wages paid to workers cause high supply
of labour because they motivate employees while low wages cause low supply of labour
because there is less motivation.
4. Government policy. Heavy government restrictions on workers reduce supply of labour in the
country this is because they make it difficult for individuals to get jobs while limited restrictions
cause an inflow of foreign workers which causes a high supply.
5. Working conditions. Good and favourable working conditions lead to high supply of labour
because they there is less threat to their lives while poor working conditions make workers
uncomfortable and this causes low supply of labour.
6. Influence of trade unions. A strong trade union restricts labour supply if workers are being
under paid and where there is no trade union, labour supply increases because there no
restrictions.
7. Level of education. Education increases the supply of skilled labour because it avails those who
are employable while low level of education causes low supply of labour because there are few
people who are employable.
8. The health conditions of the worker/mental/physical ability. Workers who are healthy lead to
high supply of labour because they have the effort to engage in production while those who are
sickly cause low supply of labour because there is less effort for them to engage in production.
9. Nature of the jobs i.e. risky or not risky. Risky jobs attract low supply of labour because
employees are not willing to expose themselves to danger while jobs associated with low risks
lead to high supply of labour because there is less exposure to danger.
10. Attitude of the worker towards work. Favourable attitude towards work leads to causes a high
supply of labour as works have the willing to work while poor attitudes towards work lead to a
low supply of labour as there is less willingness to work.
11. Political climate. Political instability causes a low supply of labour because workers fear for their
lives and therefore unwilling to work while politically unstable environment leads to high supply
of labour because there is no threat to their lives.
12. The level of mobility, both geographically and occupationally. Immobility of labour causes low
supply of labour because it is not available where it is required while higher mobility of labour
causes high supply of labour because it is available where it is needed
13. Legal working age. A low legal working age leads to a high supply of labour because it attracts
those in the lower age groups while a high legal working age group leaves out some people
hence a low supply of labour.
14. The sex composition of the population.
15. The number of hours worked
DEMAND FOR LABOUR
Demand for labour is defined as the quantity of labour desired by an employer at a particular time and
wage rate. The demand for labour is derived from what it can produce i.e. it is demanded not for its
own sake but to produce goods that have been demand.
Determinants of demand for labour
1. The demand for commodities that are produced by labour. The high the demand for
commodities the higher the demand for labour needed to produce them holding other factors
constant.
2. The price of labour/wage rate. The higher the wage rate the lower the demand for labour and
the lower the wage rate the higher demand for labour.
3. The proportion of labour cost to the total cost of production. The high the ratio of labour cost to
total cost of production the lower the demand for labour and vice versa.
4. The cost of labour relative to that of capital. If labour is cheaper than capital more labour is
demanded and vice versa when capital is cheaper.

5. Degree of substitutability of labour. The demand for labour is high if it is not easily
substitutable.
6. Degree of complementarity. The demand for labour is high when it is seriously needed in
conjunction with other factors of production.
7. The marginal productivity of labour. The more productive labour is the higher the demand and
vice versa.
WAGES
A wage is a reward to labour as a factor of production for the services it renders in the production
process. A wage can be expressed as nominal or real wage.
Nominal wage refers to that expressed or received in monetary terms e.g. a worker receiving 100,000
Shs per month.
Real wage is a wage expressed in terms of goods and services it can purchase.
Or
Real wage is the purchasing power of the nominal wage.
Factors that influence the size of the real wage
1. Size of the nominal wage. Holding other factors constant, the higher the nominal wage the
higher the real wage and vice versa.
2. Level of taxation. High taxes reduce one‟s income and consequently the real wage reduces.
3. Price level of goods/cost of living/rate of inflation. High prices reduce the real wage while low
prices increase it.

4. Amount/quantity of goods available. Availability of goods increases the real wage because it
makes commodities cheaper while scarcity reduces the real wage because it makes
commodities expensive.
5. Money supply. A high supply of money increases the real wage while low supply reduces the
real wage.
6. Size of the monetary sector.
A salary is a fixed reward to labour and it may not change because of time or piece worked.
THEORIES OF WAGE DETERMINATION
These try to:
a) Explain the average level of wages in the short run and long run.
b) To explain the differences in payment of wages.
A number of theories have been formulated to explain the general level of wages prevailing in an
economy. These are:
1. The bargaining theory of wages.

2. The market theory of wages.
3. Wage fund theory.
4. Surplus value theory.
5. The residual theory.
6. The subsistence theory.
7. The marginal productivity theory and,
8. State legislation.
1. The bargaining theory of wages.

It states that wages in an organisation are determined by negotiation between management
(employers) and the trade union representatives. A strong trade union may succeed in securing
high wages for its members.
2. The wage fund theory.
This theory was advanced by Stuart Mill. According to him, there is a wage pool (wage fund) set
aside out of which the wages are paid. They wage paid is usually determined by the size of
employees and pool set aside. The bigger the pool the greater the wage and vice versa.
Criticism of the theory
i. It does not show the source of the fund and how it is determined.
ii. There is no fund set aside for wages.
iii. It does not explain wage differentials in different occupations.
3. The market theory of wages.
This theory puts it that since wages are prices for labour, wages are determined by the
interaction of forces of demand and supply so that if there exists excessive demand for labour,
wages rise and vice versa. It is also called the modern theory of wages.

4. The surplus value/Marxian.
According to Karl Marx, labour creates all values. The value of the commodity produced is
equivalent to the price of labour. Labour is always paid less because the capitalists take the
profits which should also be earned by labour. i.e. the workers are given a wage that is below
the price of the commodities they produce and are thus exploited.
5. Subsistence theory/Iron law of wages
The theory states that workers should paid wages to enable them meet their bare subsistence
needs (so that they work harder after experiencing hardships like hunger).
If wages rise above this level, there is an increase in population, increasing competition for
employment among workers which causes wages to fall.
If wages fall below this level, there is decrease in population increasing competition for
employment among workers which causes wages to increase.
This means that a worker should be given a wage that is just enough to enable him/her meet
the basic needs e.g. clothing, food etc.
Note: A living wage is payment to a worker sufficient to provide his basic needs.
Or
A living wage is a reward that is adequate for a worker and his family to subsist comfortably.
a) To what extent is the subsistence theory of wages used in the determination of wages in
Uganda?
b) To a larger extent the subsistence theory of wages is not applicable in determination of
wages due to:
1. The theory approaches the problem of wage determination entirely from the supply side, it
ignores the demand for labour entirely thus difficulty in using it.
2. The theory relates wage rates to birth rates/population growth which is not the case in
Uganda‟s labour.
3. According to the theory all workers should receive the same wage rate which is not the case in
Uganda i.e. wages differ.
4. Theory does not consider the fact that the bare minimum needs vary from time to time
depending on price levels, economic conditions, etc.
5. The theory is only applicable to the subsistence sector/in subsistence level of living but not to
the commercialised sectors of Uganda‟s economy which use other considerations in wage
determination.
6. Trade union influence in wage determination is not taken into account by the theory.
7. Contrary to the law employees work harder when paid higher wages and do not work hard
when paid low wages.
To small extent the iron law of wages is applicable in Uganda in determination of wages because:

1. Casual workers/unskilled labourers are paid basing on the level of their subsistence needs.
2. In the subsistence sector of Uganda rewards to workers is based on basic needs.
3. Employers in a bid to retain cheap labour tend to pay workers wages which are just enough to
cater for their subsistence needs.
4. Entrepreneurs due to profits maximisation goal pay workers wages which are just enough to
meet their subsistence needs.
5. Employees due to high level of unemployment are willing to accept low wage rates as long as it
covers their subsistence needs.
6. The residual theory.
According to this theory, wages are the left over after other factors of production have been
rewarded. The more the left-overs, the higher the wage and vice versa.
Criticisms of the theory
ii. The theory does not explain how trade unions attempt to raise wages. iii.
The theory ignores the influence of labour in wage determination.
7. State legislation/government determined wages.
This is where the government sets the wage which is to be paid by employers to employees and
it is illegal to pay any employee a wage below or above that set by the government. This may be
in form of minimum and maximum wages.
Minimum wage legislation

A minimum wage is one set by the government above equilibrium wage below which it is illegal for an
employer to pay an employee.
W1 D S
We
W 1 is the minimum wage
0 L1 Le Labour
Reasons for fixing minimum wage
i. To raise workers‟ incomes as a way of increasing their purchasing power.

ii. To raise and maintain the efficiency of labour.
iii. To minimise industrial unrest (possibility of strikes) iv. To fight corruption, embezzlement
and bribery among workers.
v. To reduce income inequalities between the highly paid and least paid workers.
vi. To protect workers from exploitation by employers.
vii. To increase the taxable capacity of government as a way of raising revenue.
Effects of minimum wage
Positive effects
1. It increases the efficiency of workers because it improves motivation.

2. It reduces voluntary unemployment or it increases the supply of labour because a high wage
attracts more people into the production process.
3. It minimises industrial strikes or industrial unrest since a fairly satisfactory wage is given.
4. It reduces brain drain and therefore a country‟s trained labour force is not lost to other
countries and this promotes economic growth and development.

5. It increases savings and investment. This is because out of the earned income employees are
able to save part of it and accumulate funds for investment.
6. Increases government revenue through taxation because as the wage of the employee
increases the capacity to pay taxes also increases.
7. It ensures equitable distribution of income especially when it is widely employed in the
economy.
8. It helps employees meet the increasing cost of living as it improves their purchasing power.
9. It helps to fight malpractices e.g. corruption and embezzlement among workers in certain
occupation.
10. It helps to motivate mobility of idle labour and this makes labour available in different parts of
the county.
11. It increases the popularity of the sitting government and this makes management of the
population relatively easy.
12. It increases the demand for goods and services due to increased incomes this encourages
investment in production of goods and services.
Negative effects
1. It leads to excess supply of labour in relation to demand and therefore results into
unemployment because some workers are laid off/dismissed to in order to minimise
production.
2. It increases the production cost due to high labour costs.
3. It may result into technological unemployment because some employers may find it cheaper
it cheaper to use machines.
4. It worsens income inequality if not evenly implemented.
5. It discourages investment especially when investors fear high costs associated with high
wages.

6. It leads to rural urban migration because it is mainly established in the industrial sector yet
most of the dwellers are in agriculture therefore would like to take up jobs in the industrial
sector that are found in urban areas. This causes problems like congestion, high crime rate.
7. It is inflationary. High minimum wage causes cost push inflation since the increase in wages
increases cost of production subsequently the producer increases the price of the goods and
services.
8. Low profit levels are realised and these discourage entrepreneurship due to increased cost
of production.
Maximum wage legislation
Maximum wage is the wage set by the government below wage equilibrium and it is illegal for
an employer to pay any worker above it. It is otherwise called wage sealing or wage freezing.
D S
We W1 is the maximum w1
0 Le L2 Labour
Reasons for fixing a maximum wage
i. To decrease aggregate demand in the economy in order to control demand pull inflation.
ii. To decrease cost of production in order to control cost push inflation.
iii. To encourage employers to use labour intensive techniques of production and to provide
employment to more employees.

iv. To discourage labour mobility especially from rural to urban areas.
v. To decrease government expenditure in form of wages. vi. To decrease wage differentials by
ensuring that no employees are paid more than the maximum wage. vii. To reduce rural urban
migration with its consequences such as development of slums, congestion, etc.
Demerits of maximum wage legislation
1. It encourages voluntary unemployment since low wages cannot motivate employees.

2. Maximum wage legislation discourages work effort given that high efficiency is not rewarded.
3. It creates income inequality between employers and employees.
4. It increases the rate of strikes or creates industrial unrest as the employees pressurise employers
for better pay.
5. The employees‟ purchasing power falls and this worsens their standard of living.
6. It encourages brain drain where the country loses the skilled manpower to other countries
where higher wages are paid.
7. It discourages investment and low output is produced this leads to low rate of economic
growth.
8. Employees are exploited since they are not allowed to share on the abnormal profits they
contribute to the employer.
9. There is a fall in aggregate demand because of the low level of income/wages.
THE MARGINALPRODUCTIVITY THEORY OF WAGES
The marginal productivity theory of wages states that under perfect conditions, the reward to each
unit of labour should be equal to the value of its marginal product. Thus, wage = value of marginal
product of labour (VmPL) or wage = marginal Revenue Product of Labour (MRPL)
This is shown in the illustration below.
MuhindaWage
Richard Economics notes 2018 352
Marginal Revenue Product (MRPL = VmPL)/
0 Le Labour
From the above illustration, a rational employer stops recruiting labour at point E where the marginal
factor cost (MFC) of labour is equal to the marginal product of labour.
NB: The supply of labour is perfectly elastic because all labour units are homogenous. The demand
curve for labour is downward slopping due diminishing marginal productivity of labour.
Assumptions of the theory
a) It assumes a perfectly competitive market (without government intervention, perfect mobility of

labour, homogeneous labour units).
b) Labours and employers can calculate the marginal product.
c) All factors of production can be substituted.
d) The output can be quantified in measurable units.
e) The law of diminishing returns applies.
f) Equal bargaining power of workers and employers.
g) Free competition among employers for workers.
h) It assumes a long run period.
i) Assumes there is no government intervention in wage determination.
Criticisms/limitations of the theory
a) Government usually intervenes in fixing wages. This through fixing minimum and maximum
wages.
b) It ignores the role of trade unions in bargaining for high wages/individual bargaining power of
workers. Trade unions in some cases influence the wage given to employees through collective
bargaining.
c) Labour is not homogeneous and workers productivity varies. The productivity of skilled labour is
different from that which is unskilled.

d) Factors of production cannot wholly be substituted. There limitations to how this can be done
especially with specialisation.
e) Labour tends to be immobile occupationally and geographically.
f) The law of diminishing returns may not hold there may be increasing returns.
g) Employers at times use subsistence level as a measure of wages, which may be above or below
the value of the marginal product.
h) It is difficult to measure the marginal product of labour in some occupations/sectors e.g.
services.
i) It ignores historical factors in wage determination e.g. inherited salary structures.
j) It does not consider exploitation of workers by capitalists. Capitalists pay employees wages low
than their marginal productivity.
k) It does not consider the level of education and training, which may differ. Employees with
higher education have higher productivity than employees with lower levels of education
l) It ignores supply of labour e.g. unskilled labour.
m) Labour and employers cannot determine the exact value of the marginal product since output is
produced by many factors.
Methods /modes of wage payment
To avoid conflicts between workers and their employers brought about how much wages to pay
and to be paid, a standard method of wage payment is necessary. The various methods of wage
payment are:
1. Time rate
2. Piece rate
3. Bonus method
4. Sliding scale
5. Payment in kind
6. Profit sharing

PIECE RATE PAYMENT
This is a method of wage payment where a worker is paid according to the amount of work done. A
work receives payment for a definite and measurable amount of work e.g. number of bricks made,
loaves of bread etc.
Advantages of piece rate payment
1. High output levels are obtained at lower average cost.

2. It is associated with low supervision costs since self- initiative is the driving force.
3. The system favours hard workers who are able to increase their earnings more than the slow
workers.
4. Under this system it is possible for employers to estimate the labour cost since they know the
number of employees.
5. It is easy for employers to estimate output basing on the number of employees.
6. The system favours casual workers whose output can be measured as it makes it easy to
determine a workers output.
7. The dull and lazy workers are also encouraged to work harder in order to raise their earnings.
8. It limits or reduces disagreements/conflicts over payments and thus minimises strikes.
9. It protects employers from falsified payments since wages are directly related to output.
10. It helps to identify suitable employees i.e. those who are fit for retaining, promoting, etc.
11. It helps fast workers get more pay. The higher the output the higher the wage
12. It promotes team work and thus simplifying work done by each individual in the group.
13. Workers accomplish tasks at their own pace and this limits the rate at which exhaustion is
experienced.
14. Tasks are completed faster. Employees work to finish a task and take on another one.

Disadvantages
1. Health conditions of workers may worsen because labours tend to over work themselves in
order to earn more.
2. Quality may decline since workers are more interested in quantity rather than quality.
3. When a worker genuinely falls sick or misses work he or she is not paid for the days missed.
4. There are possibilities of high risks or accidents as people try to produce more and earn more.
5. The worker is not assured of regular pay and therefore he/she cannot plan effectively.
6. There may be over production due to high output consequently resulting into wastage.
7. Slow but careful workers are discouraged since higher earnings are the driving force.
8. Hard working people are resented.
TIME RATE PAYMENT
This is where a fixed sum of money is paid to a worker or employee for a given amount of time spent
at work. This could be hourly, daily, weekly or monthly etc.
Advantages of time rate payment
1. The worker is assured of regular income even during the time of illness/sickness.
2. It is easy to calculate where work done is hard to measure e.g. for professionals like doctors,
lawyers, teachers etc.
3. The worker can easily plan for his/her income i.e. how to spend it when and where.
4. The quality of work is high since workers do not rush to complete tasks given to them.
5. It minimises risks of damages and accidents since workers take their time.
6. The employer is given sufficient time to mobilise funds to pay the employees.
7. Employees and employers can easily agree on working conditions
8. It has an element of discipline, a spirit of personal responsibility and efficiency among workers.
9. Hard workers are encouraged through overtime which also increases earning.
10. It facilitates taxation of income earners by the government and is therefore associated with
lower taxation costs.
11. There is job security for efficient workers because should necessity to dismiss some workers
arise the lazy ones are dismissed first.
Disadvantages
1. It involves a lot of supervision costs since one has to see how is being done.
2. It may lead to inefficiency as the hard working persons are discouraged by those who are lazy
but earn the same amount.
3. There is a tendency of workers absenting themselves or dodging or doing less work since wages
will not be affect.
4. Low quality work may be realised since it does not consider how work is accomplished but
rather the period.
5. Output tends to be low because the system encourages slow work.
6. It is difficult for the employer to determine the contribution of each worker to the total output.
7. It is not easy for the employee to get the amount due him before the end of time in case of
urgent need.
BONUS SYSTEM OF PAYMENT
This is a method of payment where by a worker who produces above what is expected of him/her in
terms of output or work done in a given period of time is paid an extra amount for each excess output
produce or task accomplished.
SLIDING SCALE/WAGE INDEX

This is method of wage payment which is related to the cost of living. Workers are paid more if the
cost of living increases and are paid less if reduces.
Disadvantages
1. It is hard to calculate the cost of living at different intervals.

2. Workers are not assured of regular income.
3. Workers always resist wage reductions.
PROFIT SHARING
This is a system where employees take share of the profits with their employers. Workers are
promoted to hold certain number of shares as long as they remain in employment of the firm and so
receive a share of the profits.
How are wages determined in Uganda?
In Uganda wages are determined through:
1. Through forces of demand and supply. In situations of excess demand labour for labour
employees receive higher wages and high supply of labour in relation to demand leads to
payment of low wages.
2. Using the piece rate. Employees are paid basing on output produced.
3. Using the time rate. Employees are paid basing on time spent at work.
4. Through collective bargaining. This involves negotiation between employees representatives
and the employer.
5. By employers setting the salaries/wages. The employer offers wage which the employee takes
or leaves.
6. Individual bargaining. This involves negotiation between an individual employee and the
employer.
Factors that influence the level of wages in Uganda
1. Demand and supply of labour. When the demand for labour is low and supply of labour is high
a low wage is paid because the stiff competition for jobs while when the demand for labour is
high and supply of labour is low a high wage is offered since there is competition for
employees.
2. Bargaining strength of an individual worker. A worker who has strong bargaining power
receives a higher wage because he is able to convince the employer while a worker who is weak
at bargaining receives a low wage because he is not able to convince the employer to pay more.
3. Amount of work done by the worker. A worker with high productivity is paid a higher wage than
a worker with low productivity.
4. Bargaining strength of trade unions. Employees who belong to strong trade unions receive
higher wages because they are able to convince the employer to pay higher wages while
employees who belong to weak trade unions get low wages because they are not able to
convince the employer to pay more.
5. Number of hours worked. The more the time spent at work the higher the pay because more
output and revenue is realised while when less time is spent at work less output is realised and
therefore a low wage is paid.
6. Cost of living. High cost of living leads to a low wage being paid because employees spend less
on goods and services while when the cost of living is high employees are paid a high wage to
enable them be in position to buy goods and services.
7. Level of education and skills. Educated employees are paid a high wage because of their high
efficiency while those employees with low level of education are paid low wages because of the
low efficiency.
8. Nature of jobs/type of work done. Risky jobs attract high wages to compensate the employees
for exposure to risk while less risky jobs are paid low wages since there is less exposure to harm.

9. Employers‟ ability and/or willingness to pay. Employers with high profits pay higher wages
while employers with low profits pay low wages since their ability is low.
10. Talents and natural gifts. Employees with better talents are paid higher wages because they
contribute more to output while less gifted get low wages because they contribute less to
output.
11. Experience, expertise or responsibility. High experienced employees get higher wages because
of the higher level of efficiency while the less experienced employees get low wages because of
low efficiency.
Causes of wage differentials in Uganda
1. Differences in bargaining strength of individual workers. Workers with stronger bargaining

powers get higher wages because they are able to convince the employer while those with poor
bargaining skills get low wages because they are not able to convince the employer.
2. Differences in levels of skills/education/training. Highly educated employees get higher wages
because of higher efficiency in production while employees with low education get low wages
because of their low efficiency.
3. Government policy on incomes and wages which is non-matching. Government employees are
paid differently depending on the salary scale therefore those in a higher scale get more than
those in a low scale.
4. Differences in the cost of living. Employees in areas of high cost of living (urban areas) are given
higher wages because they spend more on goods and services while those in areas of low cost
of living get low pay because they spend less on goods.
5. Differences in employer‟s ability and willingness to pay based on aspects like profits earned by
the firm, number of employees etc. firms that generate high profits have higher ability to pay
their employees than those with lower profits.
6. Differences in the nature of jobs. Risky jobs are paid higher to compensate them for exposure to
harm while less risky jobs are paid less because of less exposure to harm.

7. Differences in the number of hours worked. E.g. the case with time rate. Employees who work
for longer hours in some cases more than those who work for fewer hours.
8. Differences in talents and natural gifts. Talent employees get higher wages because they
contribute more to output while the less talented get low wages because they contribute less.
9. Discrimination in the labour market on the basis of gender, age, religion, race etc. E.g. those
who are favoured get higher wages than those who are less favoured.
10. Differences in elasticity of supply of labour. Labour whose elasticity of supply is inelastic is given
higher wages because they are limited in supply while that whose supply is elastic is given a low
wage because there is higher supply of compared to the demand.
11. Differences in people‟s ability to do work, a case with piece rate. Employees who do a lot of
work get higher wages because they contribute more to output while those who contribute less
get a low wage.
12. Differences in strength of trade unions. Employees who belong to strong trade unions earn
more because they are able to convince the employer while weak trade unions get low wages
for their members because they are not able to convince the employer.
13. The differences in experience/responsibility. Senior workers earn more than because of the
higher efficiency in production while the junior workers get low wages because of their low
efficiency.
TRADE UNIONS
Trade unions are associations/organisation of employees formed by workers to collectively bargain

for increased wages, improved conditions of work, improved skills of members, etc. They are
associations of workers in a particular firm or industry formed with a purpose of maintaining and
improving the conditions of their working lives.
Note: Collective bargaining is the peaceful roundtable negotiation between representatives of
trade unions/workers and employers on issues pertaining to wages, conditions of work and welfare
of workers.
Objectives of trade unions
1. To protect members against unfair treatment.

2. To improve the working conditions for the workers.
3. To improve the skills of the members.
4. To maintain unity among workers.
5. To advise government on policies concerning workers, investment etc.
6. To help in fighting for human rights e.g. freedom of association, freedom of speech etc.
TYPES OF TRADE UNIONS
1. General union. These are unions that accommodate different types of workers without regard
to any particular skills.
2. Industrial unions. These are unions which organise all workers in a particular industry regardless
of the type of job done by the workers. E.g. medical workers union etc.
3. Craft unions. These bring together workers with a particular skill e.g. lawyers, teachers, etc.
4. Closed shop union. This is the type of union or agreement that particular employees have to
join particular unions in order to obtain and retain employment.
5. Open shop union. This is the type of union where all types of workers irrespective of their skills
and occupation are free to join. Industrial and general unions are examples of open shop
unions.
6. White collar union.
Features of trade unions in LDCS
1. They lack permanent membership.

2. Financially weak.
3. Attract small membership.
4. Mainly urban based.
5. Have weak leadership/corruption.
6. Tend to be politically motivated.
7. Characterised by disunity e.g. on religious/tribal basis.
Factors that determine the strength/success of trade unions
1. The amount of strike fund and financial strength. Unions that are financially strong are in a
better position to agitate for better wages and improved working conditions because they are
able to mobilise their members while financially weak unions are not able to mobilise their
members and therefore are not able to convince the employers to pay more.
2. The degree of government interference in trade union activities. Too much interference by the
government erodes the strength of trade unions as it cracks down demonstrations, gatherings
etc. and as a result getting better wages is difficult, while limited interference enables trade
unions to mobilise their members for agitate for better wages.
3. Size of membership/degree of unionisation and bargaining skills. Unions with large
membership are more successful because they have impact on the employer if they withdraw
their labour while limited membership causes low success because their impact on the
employer (s) is low since they do not cause a significant loss to the employer.
4. Prevailing economic conditions. It is much easier to raise wages during a boom because
entrepreneurs are getting higher profits while during a depression success of trade unions is
limited because there low profits and some businesses are closing.
5. Number of employers in the market. In monopoly situations, raising wages is difficult because
workers have no alternative in case they are dismissed, while in perfect competition situation
wages are raised because of fear of losing employees to other employers.
6. The elasticity of supply of labour. Labour whose elasticity of supply is elastic has limited chances
of success because of large numbers; on the other hand labour whose elasticity of supply is
inelastic has high chances of success because of their limited supply.

7. Possibility of substituting labour. When it is easy to substitute labour for machines the success
of trade unions is limited while if it is not easy to substitute labour for machines success is much
easier as the employer finds it hard to dismiss workers.
8. Level of leadership skills. Trade unions that have good and efficient leaders are more successful
because they are able to convince employers to pay while those trade unions that have weak
leaders are less successful because they cannot easily negotiate for better wages.
9. Elasticity of demand for products that workers of a given trade union produce. Employees who
produce commodities that have elastic demand do not find it easy to have their wages raised
because that leads to significant decline in the demand for the goods following a raise in the
prices while when the demand is inelastic the trade unions have higher chances of succeeding
because a rise in the wages would not result into a significant reduction in the demand for the
commodities when the price rises.
10. Level of unemployment. A high level of unemployment leads to limited success of the trade
unions because employees fear being replaced in case they demand for wage increase while
when the level of unemployment is low the trade unions are successful because it is not easy for
employers to dismiss the employees.
11. Level of productivity of members. When the productivity of the employees is high trade unions
are successful since the employer realises higher revenue while when the productivity is low the
unions may not be able to be successful since the revenue is low.
12. Nature of the market, i.e. demand for labour versus co-operant factors.
Tools/methods used by trade unions to achieve their objectives
1. Round table negotiations. This method involves collective bargaining. Collective bargaining
refers to the round table negotiations between employers and trade union representatives
regarding wages and working conditions.
2. Go slow. In this case workers report to their work but put in less effort or few hours of work so
that the employer realises a decline in output.

3. Sabotage. In this method, the employees try to disrupt normal business by way of discouraging
members of the public from consuming the products or services of the business or tampering
with production lines.
4. Sit down strike. Here workers report to their places of work only to nothing. They may also
refuse to leave their places of work.
5. Go on strike. This is when the employees become violent and in some cases cause great
damage or loss to the employers‟ property and the workers themselves may lose lives.
6. Picketing. This is where those who want to work or sabotage the strike are prevented from
doing so and it is done by deploying members of the union to punish those who want to work
or closing down the industry.
7. Industrial court/Court action. These involve a situation of one of the aggrieved parties going to
court for redress in this case the judgment arrived at is binding.
8. Third party mediation. Here an independent and impartial party is requested to help in coming
up with a solution i.e. he examines the arguments of both sides and makes the
recommendations of resolving the disputes.
9. Demonstrations. This involves the employees taking their cause to members of the public to
express their dissatisfaction and anger in order to win public support.
10. Press wars.
Under what circumstances are trade unions justified to
Demand for high wages.
1. When there‟s a rise in the cost of living. This is because high cost of living reduces the real wage of
the worker, therefore employees demand for wage increment to enable them purchase goods and
services.

2. When workers in a similar or related industry have had their wages increased, workers of another
similar sector or different sector may also demand increase in their wages so as to be at the same
footing with their colleagues.
3. When the profit level of the employer increases. The possibility of trade union increasing wages of
their members is high when the profits of the employer increase because they increase the ability
to pay.
4. If the productivity of the workers has increased, productivity may increase as a result of use of the
machines acquiring more skills etc. the trade unions demand for wage increment because the
contribution of the employees to revenue has increased.
5. When the current wage is lower than government minimum wage. In this case unions should
demand that the wage be raised to match the legislated wage.
6. When the employer fails to effect agreed upon periodical wage increases e.g. when the employer
defaults on earlier agreed upon position. The trade unions demand that the employer fulfils the
promised wage.
7. If the worker has high skills to offer, e.g. when the employees have gone for further studies they
deserve wage increment. The increase in skills increases productivity.
8. If political situation in the country favours wage demand. If the government encourages
employees to demand for high wages the trade unions would be successful because of the
support given by the politicians.
9. When the cost of production has reduced, maybe because of the reduction in factor prices or
otherwise, the employees deserve to be rewarded since the employer is realising high profits.
10. Where risky work is involved so that a high wage is given to compensate the employee for any
danger/harm that maybe experienced.
11. When the wage bill makes only a small percentage of the total production cost. The employer can
afford to pay a higher wage.
To what extent have trade unions failed to achieve their objectives?

1. Failure to improve wages and fringe benefits to desirable levels.
2. Failed to improve working conditions.
3. Failure to protect all members against unfair treatment e.g. unfair dismissal of workers.
4. Failure to improve skills of members through training because of high costs, corruption, etc.
5. Negligence of unions to advise government on development process e.g. employment policy,
manpower planning.
6. Failed to maintain consistent membership.
7. Failure to forge unity among workers/unite for a common cause.
To lesser extent trade unions in Uganda have managed to achieve the following:
1. Improvement in wages e.g. medical workers union.

2. Some improvement in working conditions.
3. Advising government on wage policy, manpower planning.
4. Improvement of skills of members through training.
5. Tried to create unity among workers.
6. Tried to seek, promote and maintain human rights.
The Effects of trade unions in an economy Positive effects:
1. They increase the efficiency of employees as a result of improved wages and working conditions.
2. They reduce income inequality especially between the highly paid and least paid in the industry.
3. The purchasing power of the employees is improved through wage increments.
4. The presence of trade unions encourages the employer to use capital intensive techniques
resulting into high output.
5. Improve the skills of labour through training.
6. Help in reducing discrimination in the labour market.
7. Help improve job security for the workers.
Negative effects
1. They lead to wage push inflation since demand for the higher wages result into the employer
increasing the price of goods.
2. They have a negative effect on economic growth since withdrawing of labour through strikes
results into low production.
3. They discourage investment since high wage demands increase the wage bill which scares away
investors due to the high cost of production.
4. They lead to increased level of unemployment since the increase in wages makes the employer
use capital intensive techniques.
5. They create BOP problems since high wages make domestically produced goods expensive than
the imported ones.
6. They create political instability and sometimes lead to over throw of government.
7. They promote income inequality between members of the trade union and non-members.
8. They may create artificial scarcity of labour by demanding that only members should be
employed.
Problems faced by trade unions in Low developed countries (LDCS)
1. Poor leadership skills or limited commitment by leaders. They therefore do not ably convince the
employers to meet workers‟ demands.
2. Poor organisation or discrimination among members on the basis of tribe, religion etc. This
results from lack of unity among workers when demanding for wage increment.
3. Lack of sufficient funds. Members are reluctant to pay their membership and subscription fees
that are required for union activities and these result into limited activities and mobilisation of the
members.

4. Limited skills of members. Most members of the unions have low skills and this attributed to low
levels of education which makes it easy for employers to manipulate them or threaten to dismiss
the employees and they finally accept low wages.
5. Existence of high levels of unemployment. This makes it difficult for the members to go on strike
because they fear being replaced.
6. Low levels of unionisation/limited membership. Few workers belong to trade unions and for this
reason they do not have significant impact on their employers.
7. Poor economic performance/inflation. Developing countries‟ economies are not doing well
especially in terms of price stability as result employers are reluctant to raise wages as this
worsens the problem of inflation.
8. Political/government interference. The governments of Ldcs tend meddle in the election of
leaders, dispersing meetings making strikes illegal etc., in some cases the leaders are given posts
in government hence weakening the unions capacity to demand for better terms of service.
9. Low demand for goods and services hence few employment opportunities are generated limiting
membership in trade unions. More still the employers are reluctant to raise wages because they
generate low profits.
10. Poor communication/infrastructure. Poor communication makes it difficult for trade unions to
conduct activities in some areas and to easily coordinate and mobilise the members on union
matters.
11. Corruption. Trade union leaders swindle union funds for personal benefit and this leads to low
ability of trade unions to conduct union activities such as seminars, workshops, etc.
12. High proportion of wage bill to total cost. The proportion of labour cost to total cost is high and
therefore employers are reluctant to meet the demands of the employees for fear of raising the
cost of production significantly.
13. Apathy i.e. indifference of trade union members. Some employees do not take seriously union
activities and therefore do not join or engage in union activities.

14. Existence of transitory incomes/availability of alternative sources of income/limited commitment
of the members/target workers. Some members therefore do not engage in union activities such
as strikes to demand for better terms of service.

ECONOMIC GROWTH AND DEVELOPMENT
Economic growth refers to the persistent increase in the quantity of goods and services produced in
an economy during a given time/year.
OR
It refers to the steady process by which the productive capacity of the economy is increased to bring
about rising levels of national output and national income.
It is the sustained increase in the country‟s real output of goods and services measured by the GNP.
Growth is a long term process and the increase in the volume of goods and services should be
persistent.
Determinants of Economic Growth
18. Availability and utilisation of resources: When the available natural resources are well utilised
there is high level of output because firms have inputs/raw materials to use in production and
this leads to a high level of economic while when the available resources are not well utilised
there is low rate of economic growth because of limited availability of inputs/raw materials.
19. Policy of government on production and investment: A favourable government policy in form
provision of investment incentives encourages production because low costs of production are
experienced hence there is high rate of economic growth while a unfavourable government
policy such as high taxation leads to high cost of production and therefore a low level of
production and economic growth.

20. State and level of technology: Use of modern technology results in high productivity and
efficiency and therefore high level of economic growth, poor technology is a hindrance to
economic growth because of low efficiency in production.
21. The political situation or extent of peace and security: A stable political atmosphere attracts
both local and foreign people to invest because there is no threat to property and lives hence
high output and economic growth and an unstable environment is a threat to local and foreign
investors, destroys property and hence low output and low rate of economic growth.
22. Level of infrastructure development both social and physical. Well-developed infrastructure
such as roads, railways, etc. leads to high level of economic growth because it lead to a low cost
of production which encourages production while poor infrastructure leads to low level of
economic growth because of the high cost of production that discourages production.
23. Population growth rate. A high population growth rate causes low level of economic growth
because it leads to low level of savings and investment since much of the income is consumed
and leads to level of production and national income. On the other hand a
low population growth rate leads to high level of savings and investment which results into a
high level of production and high rate of economic growth.
24. Level of skills. When majority of the population in the country are well educated and trained
higher level of economic growth is realised because there is high efficiency in production which
results into a high level of output. While when the majority are less educated there is a low level
of output and economic growth because of low efficiency in production.
25. Degree of monetisation. A high degree of monetisation (where much of what is produced is for
the market) leads to high level of economic growth because there is great incentive to produce
than a country that is subsistence oriented (where much of what is produced is for own
consumption rather than for the market).
26. Entrepreneurial ability. Better entrepreneurial ability leads to high level of economic growth
because several enterprises are established that contribute to national output while poor
entrepreneurial abilities lead to low level of investment in enterprises and this causes low level
of production and economic growth.

27. Availability of capital stock. The availability of physical capital encourages production because
of high efficiency, high level of output and national income. Low level of capital stock implies
low level of national output because of low levels of efficiency hence low level of economic
growth.
28. Size of the market. Availability of big markets for the goods being produced encourages
producers to produce more since high profits are realised. Limited market internally and
externally limits production because low profits are generated and hence a low rate of
economic growth.
29. Nature of the land tenure system. A poor land tenure system makes acquisition of land for
investment very difficult and expensive and this limits investment and mechanisation hence a
low level of output. On the other hand a good land tenure system makes acquisition of land for
investment and production easy hence high level of output and economic growth.
30. Degree of conservatism. A high level of conservatism leads to inability of people to easily adopt
better production techniques since they are reluctant to invest funds and this leads to low level
of production hence low level of economic growth while low level of conservatism leads to
adoption of better production techniques since they invest funds which lead to high level of
production and economic growth.
31. The level of price stability. When prices are stable low production costs are experienced and
this results into high level of production since producers realise high profits which leads to high
level of economic growth while unstable prices increase cost of production and this discourages
production hence a low level of economic growth.
32. The level of savings. A high level of savings leads to high level of investment and Production
because there are funds to acquire inputs and this leads to high level of economic growth while
low level of savings leads to low level of investment and production because there are limited
funds to purchase inputs and this leads to low level of economic growth.
33. Degree of corruption. High level of corruption causes low level of production and economic
growth because it reduces funds for implementation of projects and increases cost of

production while a low level of corruption makes implementation of programmes possible since
funds are available and results into a high level of production and economic growth.
BENEFITS OF ECONOMIC GROWTH
These are the advantages enjoyed by individuals and society as whole as GNP increases and different
commodities are produced in an economy. These include the following;
i. Increased production of goods and services leading to improved welfare. This is because there
are several enterprises established to provide various commodities and there is a higher rate of
resource utilisation.
ii. Increases government revenue by increasing the tax base.
iii. Leads to greater utilisation of resources. More resources are employed in the industries and
other production units that are set up since they are used as inputs.
iv. Wide variety of goods is produced increasing consumer choice. This is because there are
several firms involved in production of differentiated goods.
v. Employment opportunities are increased. This is because various industries are established.
vi. Leads to development of infrastructure. There is construction and rehabilitation of
infrastructure to ease movement of goods labour as well as to reduce production costs. vii.
Leads production of exports. Firms produce not only for the local market but also foreign
market since they have better technology and this improves the BOP position of the country.
viii. There is a reduction in income inequality. This is due to increased participation of individuals in
production and the availability of more employment opportunities.
ix. Leads to technological development. This because of invention, innovations and research to
enable firms provide quality goods and services.
x. Improvement in the skills of labour. This is through training and this improves the productivity
of labour. xi. Increased enjoyment of leisure / improved sol / income. The increase in income
enables individuals to enjoy leisure.

xii. Increased humanitarian activities with rich societies reaching out to poor societies. The increase
in incomes improves concern of individuals for other people since they have the capacity to
provide.
xiii. Improved political stability. The population becomes contented since there are more people
employed and a fair distribution of income.
xiv. Removal of obstacles to growth e.g. conservation, backward cultures etc. There is a change in
peoples‟ attitudes as there is improvement in education, urbanisation, etc.
xv. It leads to industrialisation / increased urbanisation. It involves establishment of industries to
produce for the population.
xvi. Price stability due to increased output. There is an increase in production of goods and services
which reduces scarcity.
xvii. Reduced external dependence/self-reliant economy. There is a reduction in the importation of
goods due to the increased production of goods and services.
COSTS OF GROWTH
These are the disadvantages which individuals and society as whole suffer as a result of
economic growth that has been achieved. I.e. it is the opportunity cost of economic growth or
the side effects of economic growth.
i. Causes to quick exhaustion of resources due to over exploitation. This is because there are
several firms involved in production and trying to maximise profits.
ii. Environmental degradation/pollution. This is brought about by poor waste management and
the fumes from industries that pollute the environment.
iii. It requires hard work therefore people forego their leisure time. People strain themselves trying
to increase their incomes through increased output and this causes poor health. iv. It causes
income inequalities. This is because production is undertaken by few who have the required
capital and therefore the rich become richer and the poor become poorer.

v. It causes technological unemployment when capital intensive techniques of production are
used. Machines are used in the place of human beings.
vi. It involves foregoing present consumption and investing most of the incomes in order to
increase output in the future. This results in a decline the welfare of individuals.
vii. It causes rural-urban migration and its associated disadvantages because most economic
activities are urban based. Those who cannot find jobs in rural areas move to urban centres
expecting better jobs which are not readily available hence high crime rate.
viii. It causes foreign domination and profit repatriation. This is because of foreign ownership of
some business undertakings.
ix. Deterioration of cultural values. This is due to urbanisation and foreign influence.
x. Occupational hazards which affects the lives of the workers. The profit driven entrepreneurs
mind less about the safety of employs as they try to reduce cost of production.
xi. It increases the debt burden due to increased borrowing / it increases external dependence.
The need to expand enterprises results into borrowing to finance businesses.
xii. It involves displacement of people in some cases. The need for land for expansion of
enterprises causes displacement of people.
xiii. Leads to imbalance in regional development. There is imbalance in development due
concentration of most enterprises in urban centres.
xiv. Low quality of output. This as a result of using poor technology since production emphasises
quantity rather than quality.
ROWSTOW’S THEORY OF ECONOMIC GROTH
Rostow explained growth from a historical perspective. Using capital accumulation as the origin of
growth. Rostow identified five stages through which all economies must pass in order to achieve
economic development.
THE TRADITIONAL STAGE

This is the lowest stage in economic growth and is characterised by the following
i. There is a large subsistence sector
ii. There is low productivity due to use of poor tools and scientific methods
iii. Surplus is exchanged by barter system
iv. There is a high level of illiteracy
v. The economy is closed i.e. there is no international trade
vi. There is no saving i.e. rate of saving is around 0% due subsistence production. vii. There is
conservatism i.e. chiefs dominate the social structure
Pre-condition for take-off/transitional stage
This is a transitional stage in which the traditional systems are over come so that the economy can
start developing. It characterised by the following;
i. Adoption of better and efficient methods of production/improvement in technology.

ii. Reduction of illiteracy.
iii. The economy becomes dualistic in nature. iv. Foreign trade emerges.
v. There is a breakthrough in conservatism/cultural barriers begin to reduce.
vi. There is improvement of socio- economic infrastructure. vii. Industrialisation
begins to take root.
viii. An entrepreneurial class emerges. ix. Savings rise to
about 5% of GNP.
x. Investment increases to 5% of GDP/GNP.
xi. Emergence of foreign trade/the economy becomes open. xii. Agriculture is the leading
sector. xiii. Presence of investors who are willing to give financial support to new ideas
xiv. Removal of obstacles to economic growth.
TAKE-OFF STAG
This is an important stage where an economy attains self sufficient i.e. there is a
Reduction in foreign dependence. The stage is characterised by the following;
1. High investment 10-15% of GDP/national income.

2. High savings 10-15% of GDP/national income.
3. High level of industrialisation/a leading sector emerges.
4. Emergence of new economic and political institutions.
5. High level of employment.
6. Emergence of new markets- domestic and abroad.
7. Self sustaining growth as seen in the reduction of foreign goods and promotion of import
substitution industries
8. High levels of infrastructure development
9. The economy becomes technically advanced and highly productive (technological progress).
10. There is change in the social, political institutional and structural framework of the economy to
aid development.
11. High level of urbanisation.
DRIVE TO MATURITY
Rostow defines this stage as period when society has effectively applied the range of modern
technology to its resources. It is a period of long sustained economic growth. It is characterised by the
following:
1. High levels of investment 10-20% of the national income

2. High levels of industrialisation i .e. development of heavy industries
3. Use of professional / highly skilled labour
4. Increased employment opportunities
5. High levels of urbanisation with a high proportion of the population living in urban areas 6.
High levels of infrastructural development
7. High levels of savings 10-20% of GNP.
8. Existence of bureaucracy.
9. High level of monetisation.
10. Improvement in technology.
AGE OF HIGH MASS CONSUMPTION
According to Rostow this is the highest stage of economic growth. There is a very high standard of
living. It is characterised by the following:
1. There is heavy industrialisation

2. Presence of highly skilled labour force
3. There is mass production of sophisticated consumer goods and services
4. High level of technology
5. There is high income per capita leading to high standard of living.
NB: Uganda is in the pre-conditions for take-off stage because of the following reasons:
1. The manufacturing sector is beginning to develop as a leading sector.

2. Savings and investment are coming up
3. Bottlenecks to development are slowly being over come
4. The Ugandan economy is experiencing a steady growth rate
5. Agricultural modernisation is taking place
6. Infrastructure is being developed slowly but steadily
7. There is a general improvement in the living standards
8. Technological advancement is taking place
9. Illiteracy rates are greatly reducing through UPE and USE
10. There is an increase in the entrepreneurial class.

Limitations of the theory
1. It assumes that capital accumulation is the only engine of economic growth, which is not true
since there are other factors such as markets, skills, technology etc.
2. It is difficult to demarcate one stage of growth from the other e.g. 4 th and 5th stages.
3. He assumed continuity in the road to development yet there could be
discontinuity/delays/decline in economic growth.
4. It does not consider the nature of distribution of income emphasis is on the leading sector.
5. It does not consider external factors which affect economic performance especially foreign aid.
6. High level of savings may not necessarily lead to economic growth.
7. Some stages may not be necessary – some economies skip some stages in their development
process.
8. Resources are not homogeneous in all countries/societies.
THE BALANCED GROWTH STRATEGY
The theory of balanced growth by Ragnar Nurkes emphasises harmonious and simultaneous
investment in the all sectors of the economy so that they complement each other and grow more
or less at the same pace. In this strategy balance should be achieved in sectors like industry and
agriculture consumer goods and capital goods, domestic and foreign sectors investment in human
capital and physical capital etc.
ARGUMENTS FOR BALANCED GROWTH STRATEGY
1. There is promotion of inter sectoral linkages in the economy resulting in to an integrated and
self-sustaining economy. The linkages are forward and backward.
2. There is skills development. It encourages training in various labour skills which improves the
efficiency of labour thus increased productivity in the long run.
3. It improves the BOP position of a country. It eases the problem of unfavourable bop through
diversification of production and increasing export earnings.
4. It helps widen the tax base through industrialisation and diversification of economic activities.
This increases government revenue
5. It widens employment opportunities. More employment opportunities are created in the
various sectors of the economy hence improved earnings.
6. It leads to increased output. This is because several firms are established thus accelerates
economic growth.
7. The strategy ensures better utilisation of resources by the different sectors. This is due the large
number firms involved in production and the increased demand for goods and services.
8. It leads production of a variety of good. This is because there are several firms producing
differentiated goods hence widening consumer choice.
9. It widens the market. The simultaneous development of sectors creates market inn each sector
since the sectors are interdependent / because of increased activities.
10. There is reduced dependence on other economies or one sector. This is because there are more
goods available locally which reduces the demand for imports.
11. It reduces income inequalities in the economy as most people are employed in various sectors
where they earn incomes
12. The strategy promotes balanced regional development. The various sectors of the economy are
catered for, this is because of investment in most sectors so that they grow at the same time.
13. It promotes the development of infrastructure. There is construction of infrastructure to ease
movement of goods and services.
14. The strategy promotes technological development. This is because there is technology transfer
and increased innovations and investments.
NB: Forward linkages exist when setting of an industry results into emergence of other industries with
the newly established plats forming markets for products (and by-products) of the already existing
industry.
While

Backward linkages is where existence of an industry leads to setting of new industries to supply
existing industry with inputs.
DISADVANTAGES OF BALANCED GROWTH STRATEGY
1. It is an expensive or costly strategy as it requires a lot of capital which developing countries do

not have to sustain investment in all sectors of the economy. This causes shortage of inputs.
2. It involves wastage of resources because of limited markets in developing countries as the
purchasing power is low due poverty.
3. The strategy leads to quick depletion of resources because it makes extra ordinary demands on
the available resources.
4. It necessitates borrowing since a country may not have sufficient capital to invest in all sectors
resulting into a debt burden.
5. The strategy encourages dependence on other countries for resources since the local resources
may not be enough to support all the sectors of the economy.
6. It may lead to heavy losses because of project failure brought about by incidents like war, lack of
sufficient capital etc.
7. It is inflationary in the short run because of too much spending by the different sectors of the
economy
8. The strategy strains government planning machinery because of the limited skilled manpower
in developing countries hence poor planning that does not achieve high rates of growth.
9. Limited control of government over the economy i.e. failure by the government to oversee all
the sectors due to limited manpower.
Factors which limit the operation of balance growth strategy

1. Limited capital. This limits the ability to purchase the required inputs hence limited production.
2. Limited entrepreneurship. There is limited establishment of enterprises.
3. Limited skilled labour. There is inefficiency in production hence wastage of resources.

4. Inadequate market. This limits the capacity to produce goods since there are low profits and
causes wastage of resources.
5. Poor infrastructure. Limits movement of factors of production and finished goods hence high
cost of production.
6. Poor/uncoordinated planning/weak planning machinery.
7. Conservatism. This causes the inability to finance business undertakings and improve the
technology.
8. Weak inter-sectoral linkages.
9. Unfavourable government policy on investment.
10. Limited government control over the economy. Some sectors are neglected hence imbalance in
development.
11. Limited technology. There is production of poor quality goods and services.
12. Political instability. This destroys projects hence wastage of resources.
13. Corruption. It reduces the funds for projects hence causing unfinished projects.
14. Poor land tenure system. Acquisition of land for expansion is difficult hence limiting production
THE UNBALANCED GROWTH STRATGY
This strategy was advanced by Professor Albert Hirschman. It states that leading sector(s) with
strategic importance should be selected and expanded first so that it pulls up or develops other
sectors through linkages. The leading sectors are the key sectors of the economy with backward and
forward linkages e.g. developing agriculture first it would later lead to industrialisation as the
agriculture sector provides raw materials to the industrial sector.
Advantages of unbalanced growth strategy

1. It requires less capital and therefore can be pursued using few resources hence it is suitable for
developing countries with limited capital
2. It has sectoral linkages as it makes use of the forward and backward linkages and thus is able to
result into a self-sustaining and integrated economy in the long run
3. The strategy makes use of the locally available resources therefore foreign exchange
expenditure abroad on imported inputs is limited
4. It suits countries with limited markets because what is produced locally by the leading sector
will easily find market
5. The strategy recognises the crucial role played by international trade in the development of
countries. Thus resources should be concentrated in areas where countries have comparative
advantage to maximise gains
6. The strategy is appropriate for developing countries because it maximises shortage of skilled
manpower rampant in these countries
7. There is less wastage since the country produces according to demand
8. Presence of poor socio- economic infrastructure cannot sustain balanced growth means this
strategy is appropriate for developing countries that have poor infrastructure in form of roads,
railways, etc.
9. It is appropriate for developing countries with poor planning machinery so that the little
manpower is committed to the leading sector with the balanced growth strategy since one
sector is involved.
DISADVANTANGES OF UN BALANCED GROWTH STRATEGY
1. It encourages economics dualism as one sector is developed at the expense of other sector. This
delays the rate of development.
2. The collapse of the priority sector will bring severe hardship and stagnation in the economy.
3. It emphasises specialisation producing according to comparative advantages which has
disadvantages like lack of sufficient market fluctuation of price that lead to the instability in the
economy
4. It promotes unemployment because the leading sector cannot fully absorb most of the
resources most especially labour.
5. It may lead to shortages as one sector may not be enough to provide what is demanded before
other sectors have been developed. This creates scarcity in the economy resulting in inflation.
6. It perpetuates dependency syndrome since the country cannot meet all her needs it has to
depend on imports making the economy valuable to domination by other economics
7. In most cases priority is given to industrial development with the industries being urban based
hence leading to rural migration.
8. The strategy promotes income inequity because those engaged in the leading sector will
receive more income while those engaged in non-priority sectors will receive less earnings
hence income inequality.
9. Increased output in the key sector may fail to get market resulting in sever losses for the
producers in the economy.
10. The strategy worsens BOP position of the country as it has to depend on other countries for
survival i.e. importing commodities from other countries.
11. It promotes regional imbalance as it emphases industries that are mainly urban based with well
developed infrastructure at the expense of rural areas.
THE BIG PUSH STRATEGY
The strategy advocates for massive investment of capital and other resources into the economy on
large scale necessary for the promotion of rapid industrialisation and expansion of economic
infrastructure. I.e. a large comprehensive programme is needed in the form of a high minimum
amount of investment to overcome the obstacles to development in developing countries. The
massive investment which is required is called critical minimum effort.
Critical minimum effort is the minimum investment or sacrifice required to attain massive capital
stock necessary for a country to take- off.

Arguments for the Big Push Strategy
1. Economic growth is faster and rapid and an economy develops in a short time.
2. It generates employment opportunities on wider scale. This is because several industries and
infrastructure provided jobs hence improvement in people‟s welfare.
3. It promotes quick industrialisation of the economy. This is achieved through massive investment
in industry and infrastructure.
4. It widens market for goods and services. As many firms are set up many people are employed
increasing their purchasing power.
5. There is establishment of infrastructure through construction which leads to the overall
development of the economy. This because it eases transportation of goods and services.
6. It increases the volume of exports and reduces the volume of imports hence solving the bop
problems of a country.
7. The strategy reduces income inequalities since many people are able to get employment.
8. It encourages massive use of the locally available resources reducing dependence on external
resources or borrowing.
9. It widens the tax base enabling the government earn revenue.
10. The strategy helps in skills acquisition since labour is trained in various skills to manage the
different sectors. This improves the efficiency of labour.
Disadvantages of Big Push Strategy
1. It assumes abundance of capital to invest in all sectors of the economy which is not the case for
developing countries where capital is not adequate. This results into incomplete projects.
2. Lack of sufficient market to absorb all that is produced because of the low purchasing power of
individuals leads to wastage of resources.

3. The strategy underrates the structural and institutional problems evident in developing
countries e.g. poor land tenure system, negative attitudes to work, etc. These limit the capacity
to produce goods and services.
4. The strategy emphasises the industrial sector at the expense of the agricultural sector thus it
promotes dualism.
5. In developing countries there is shortage of entrepreneurs who can undertake risks invest due
to poor investment climate.
6. Limited capital in Ldcs necessitates borrowing which has some strings attached that may not be
in line with the countries development programmes.
7. Inefficient administration, corruption and embezzlement are common in developing may not
permit proper use of resources
8. There is limited control of the economy by government which may leave some sectors and parts
of the country unattended to.
9. Existence of poor infrastructure limits the smooth operation of the sectors. It limits the
movement of factors of production and finished goods which increases the cost of production.
10. Poor technology.
Factors that limit application of big push strategy
1. Limited capital. This causes inability to purchase the required in puts hence a low level of
production.
2. Limited skills. There is inefficiency in production hence wastage of resources 3. Small
market. This causes low level of production since there are low profits.
4. Limited entrepreneurial skills. There is limited establishment of enterprises hence a low level of
production.
5. Limited basic infrastructure. This causes inability to access inputs markets and markets of final
goods hence high cost of production.
6. Political instability. It destroys projects and causes wastage of resources.

7. Conservatism.
8. Poor land tenure system. This makes acquisition of land expensive and this limits production
9. Corruption. It reduces the funds for establishment of projects and thus collapse of projects.
10. Weak policy implementation machinery.
ECONOMIC DEVELOPMENT
Economic development refers to the persistent qualitative and quantitative increase in the volume of
goods and services produced in a country over a given time.
Or
The persistent quantitative and qualitative increase in GDP over a long period of time; it includes
qualitative changes in variables that improve life of citizens such as increased freedoms of choice; self-
esteem etc.
Whereas economic growth may be achieved in a short time economic development is achieved after a
considerably long time. Therefore a country may achieve economic growth and not economic
development.
Why a country may achieve economic growth without development:
1. Growth may be achieved with an increase in output when there is no increase in quality
2. It may be attained when there is un even distribution of income
3. Economic growth may be achieved when society is over strained by work or when there is
hardly any leisure enjoyed
4. Growth may be achieved amidst high levels of unemployment
5. It may be achieved when there are high levels of inflation
6. Economic growth may achieved when there is high population growth rate
7. It may be achieved amidst political instability
8. Economic growth may be achieved with increasing public debt
UNDERDEVELOPMENT
Under development refers to state of underutilisation of a country‟s resources.
The world is mainly divide into developed and under developed countries.
Characteristics of under developed countries:
1. There is predominance of the subsistence agriculture.

2. Countries experience high rates of unemployment.
3. Underutilisation of productive resources.
4. There are high rates of illiteracy or presence of un skilled labour force because of low levels of
education
5. There is a vicious circle of poverty- low levels of income, savings, investment and capital
accumulation
6. Countries experience high population growth rates- exceeding the growth in GNP
7. There low levels of infrastructure development e.g. roads, power supply, communication
facilities
8. There exists dualism in the economies e.g. technological, sect oral, etc.
9. Political immaturity that leads to wide spread political instabilities dictatorship etc. are common
in Ldcs
10. Limited entrepreneurship because of the poor investments climate limited invasions and
intensions etc.
11. Use of poor/inappropriate technology.
12. Prevalence of economic dependence.
13. Weak industrial sector.

DEVELOPMENT GOALS
A development goal is a pre-set target/objective of development that is to be achieved by an

economy during a given period of time.
Or
It refers to targets relating to improvements in citizens‟ socio-economic welfare that an economy

aspires to achieve during a given time.
Government in east Africa and the word over have put in place development goals as a way of
achieving economic development. Goals or objectives of development are broad policy guidance
designed to achieve an improvement in people welfare .the goals of development include:
1. To achieve high economic growth rates and development.

2. To achieve fair income distribution i.e. narrow the gap between the rich and the poor so that sol
of the people can be raised by increasing demand for commodities and eradicating poverty
3. To achieve full employment of resources/to reduce the level of unemployment.
4. To ensure political stability i.e. ensure a peaceful atmosphere conducive for growth which gives
confidence to investors/ to ensure security for life and property.
5. To ensure domestic stability i.e. reducing the rate of inflation which is macroeconomic problem
6. To achieve stable/favourable BOP position.
7. To eliminate illiteracy/to attain large pool of highly skilled labour.
8. To control population growth rates.
9. To reduce economic dependence/attain self-sufficiency.
DEVELOPING AGRICULTURE AS DEVELOPMENT STRATEGY
Arguments for agriculture development

Advocates of the agriculture developments strategy have the view that developing countries can
achieve economic growth through the agricultural development strategy and they raise the following
arguments:
1. Agriculture requires less capital investment than industrialisation and therefore it is the most
appropriate for the developing countries since they do not have insufficient capital.
2. Agriculture has quick returns because of the less capital requirements and the quick maturity of
the agricultural produce farmers are able to realise returns in a very short time
3. It is a source of raw materials. Agriculture is a major source of raw material for the agro based
material and therefore it brings about rapid industrialisation.
4. It provides employment to both the skilled unskilled. Majority of the people in developing
countries depend on agriculture and are more employed in the sector. Therefore its
development would provide employment to many people.
5. It provides an important source of revenue to the government by taxing farmers, cooperatives
etc.
6. It reduces rural-urban migration as developing agriculture leads to the development of rural
areas reducing the need to move to urban areas for employment.
7. Ensures balanced regional development, if well-developed it would lead to balanced regional
development as it is the activity in the developing countries.
8. It contributes to the GDP through the substantial amount of output.
9. It is source of food to the population- both the urban and rural population thus developing it
leads to quality quantity and cheap produce.
10. It provides market for manufactured goods like fertilizers, hoes etc. thus promoting
industrialisation.
11. Encourages the development of infrastructure. There is development of infrastructure through
construction to support the sector e.g. roads which promote the development of the entire
economy.
12. It is an important foreign exchange earner as it is an important source of exports e.g. tea, cotton,
etc.
13. The development of the agriculture releases labour force to the industrial sector in the long run.
The development of the sector leads to less labour requirements.
14. It reduces income inequalities because majority of the population are able to earn through
employment, selling produce etc.
ARGUMENTS AGAINST AGRICULTURE DEVELOPMENT
1. Less revenue is realised by the government because of the low earnings by those in the sector.
Government imposes low taxes.
2. It leads to unfavourable terms of trade as the prices of agricultural products are generally low
compared to those of manufactured goods.
3. It causes un favourable BOP because revenue obtained from agricultural exports is low
compared to high expenditure on imported goods
4. Price fluctuations are common in the sector due to the changes brought about by the changes
in weather, costs of production, etc.
5. Agricultural development may not solve the mass unemployment that is rampant in Ldcs since
there is seasonal and disguised unemployment.
6. Agriculture is subject to the law of diminishing returns and therefore output reduces over time
reducing people‟s earnings / incomes of those employed in the sector.
7. It increases external dependence as emphasising it would lead to the supply of agricultural
products at the expense of manufactured goods causing trade dependence.
STRATEGIES FOR AGRICULTURAL DEVELOPMENT
Strategies for agricultural development aim at improving the methods used in agriculture, changing
or transforming the methods used in agriculture in order to increase output.
The improvement approach

This refers to ways of increasing the agricultural output within the same framework/structure by using
modern methods of farming.
This approach aims at encouraging agricultural development within the existing peasant production
units by changing the existing production techniques without changing the basic organisation of
farming. It requires provision of inputs, extension services, credit facilities, infrastructure, etc.
Advantages of the improvement approach
1. It does not require a lot of capital compared to other strategies e.g. mechanisation.
2. It creates employment for the unemployed as it improves „their skills.
3. It improves the quality of labour in rural areas leading to better quality products.
4. Fundamental changes not needed by the farmers.
Demerits of the improvement approach
1. It requires some capital which Ldcs do not have in sufficient amounts.

2. Due to ignorance and cultural taboos some farmers not ready to adopt new techniques of
production.
3. Farm in are inadequate because they are scarce and expensive.
4. Infrastructure connecting to the farmers is poor.
5. Limited extension services / staff.
THE TRANSFORMATION APPROACH
This refers to changing from the existing method which is traditional and out dated to one which is
modern to meet the current demand for agricultural output. It depends on large scale mechanisation.
It involves the following:
1. It requires the use of capital intensive techniques.

2. It requires large scale agricultural production.
3. It involves mechanisation both on small and large scale.
4. Requires extensive research on animal and plant breeds
5. It requires collective farming e.g. ujaama villages in Tanzania.
Disadvantages
1. It requires a lot of capital which Ldcs do not have in sufficient amounts.

2. It advocates for capital intensive techniques which create unemployment in developing
countries.
3. It requires transformation of cultural and traditional values which is hard to achieve in a short
time.
4. People may resist working in groups as it may be misinterpreted to mean communism.
MECHINISATION OF AGRICULTURE
Mechanisation involves use of machines like tractors, ploughs, sprayers, etc. in order to increase
quality and quantity of output.
Advantages
1. It improves the quality of agricultural output through irrigation schemes, spraying against
diseases etc.
2. It results into high levels of output.
3. It results into greater amount of work arising from using machines to prepare land, seed beds,
etc.
4. Mechanisation reduces the production cost since the use of machines reduces the amount of
labour required to plant, spray, etc.

5. Mechanisation simplifies work and reduces the time required to accomplish activities.
6. It encourages specialisation and its associated advantages. This is because it permits production
on a large scale.
7. It provides the opportunity to use large tracts of land.
8. It leads to acquisition of skills by labour. This is through on job training.
9. Promotes the development of infrastructure. Infrastructure is constructed enable movement of
machinery.
10. Promotes research. There is investment in research to improve the techniques of production
11. Undertakes activities that cannot be performed man.
12. Allows labour to enjoy leisure since work is undertaken in a short time.
Disadvantages
1. Requires large pieces of land and yet there is a poor land tenure system in developing countries
due land fragmentation.
2. Increases the rate of land exhaustion and thus reduction in the productivity of land.
3. Promotes over production and hence wastage of resources.
4. Causes environmental degradation. There is because machines release fumes into the
atmosphere.
5. Promotes specialisation and its associated problems.
6. There is lack of sufficient funds to invest in mechanisation for the case of developing countries.
7. Mechanisation causes unemployment. This is because few people are employed where
machines are used.
8. Rural–urban migration is promoted. Those who cannot get jobs in rural areas go to urban
centres since machines are preferred.
9. It promotes income inequality because it is mainly affordable by the rich.
10. It may create a landless class as it requires large tracts of land. Factors which limit
mechanisation of agriculture

1. Limited skilled manpower. There few people to run the machines due to limited education and
this causes high cost to train the labourers.
2. Poor land tenure system. Pieces of land are small in some cases and this limits the ability to
move the machines.
3. Small market for our agricultural produce. There is production since there is not sufficient
market for the goods.
4. Limited capital stock. This limits the ability to purchase spare parts and this reduces the
efficiency of the machines.
5. Limited entrepreneurial skills. There are few people who are willing to invest in the purchase of
the machines since they fear to take risks.
6. Under developed technology.
7. Conservatism of some farmers. Some farmers are not willing to invest in the purchase of
machines.
8. Unstable/low agricultural prices. These cause low earnings and therefore limit the ability of
individuals to invest in machines
9. Inapplicability where human judgement is necessary.
10. Unfavourable topography. This limits the construction of infrastructure to facilitate the
movement of machinery.
11. Political instability. This cause the fear to invest in machinery for fear of destruction by the wars.
12. Corruption.
WAYS OF IMPROVING AGRICULTURE OUTPUT IN DEVELOPING COUNTRIES
• Changing the land tenure system e.g. land consolidation.

• Availing credit to farmers to enable them purchase the necessary in puts. Improvement of
technology / use of better tools/mechanisation.
• Carrying out research in all fields/encouraging new farming methods.

• Ensuring extension services so as to educate the farmers on better methods of production.
• Use of irrigation to overcome unfavourable environmental conditions e.g. drought.
• Improving transport and marketing facilities/improvement of infrastructure.
• Market expansion through regional integration.
• Improving pricing policies e.g. through strengthening commodity agreements.
• Training of labour.
• Industrialisation within agriculture.
• Encouraging cooperative movements.
• Agricultural diversification.
• Ensuring political stability.
INDUSTRIALISATION AS A DEVELOPMENT STRATEGY
Industrialisation is the process of manufacturing consumer and capital goods.
Developing countries in the past have tried the agricultural strategy but have not registered significant
economic progress. There is an argument that for developing countries to achieve high rates of
growth and development they should industrialise and the following are given as arguments in favour
of industrialisation:
1. It creates more employment opportunities in the long run.

2. Prices of industrial products are stable this encourages stability of incomes tax revenue and
good planning.
3. It improves terms of trade because prices of industrial products are higher than those of
agricultural products and thus yield higher incomes.
4. It improves the bop position Ldcs that are faced with deficits because they depend on few
primary exports that fetch low prices yet they spend a lot on imports.

5. It leads to improvement in labour skills because of improvement in training facilities that result
into improved efficiency.
6. It provides wide market for agricultural output because there is ready market for agricultural
commodities like cotton, coffee, etc. as it has forward backward linkages.
7. It encourages the development of social economic infrastructure in form of roads, banks, power
dams, etc. that lead to the overall development of the nation.
8. Production in the industrial sector is achieved under increasing returns thus investments lead to
results into more output.
9. It encourages technological development as new and better methods of production are
introduced through technological transfer to increase the level of output.
10. It involves transformation of the society e.g. bringing about social equity, more equitable
distribution of income, balanced regional development, etc.
11. It reduces external dependence by reducing importation of goods and services.
ARGUMENTS AGAINST INDUSTRIALISATION
1. It requires a lot of capital which Ldcs do not have in sufficient amounts thus Ldcs cannot afford
this strategy i.e. it is expensive.
2. The strategy is associated with low levels of employment in the short run and therefore cannot
solve the mass unemployment that is rampant in developing countries.
3. It worsens the problem of income inequality especially in the short run because few people are
employed or those employed in the industrial sector earn higher incomes than those in other
sectors e.g. agriculture.
4. It leads to rural urban migration because most industries are concentrated in urban areas.
5. It encourages external agriculture dependency since some industries require imported raw
materials. This worsens the problem of dependency.
6. It leads to over exploitation of resources as there is high rate of resource exploitation because of
use of better methods thus quick resource exhaustion.

7. It causes regional imbalance because for the case of LDCs the industries are mainly urban based
8. Industrialisation involves high social costs e.g. pollution this negatively affects peoples‟ lives by
causing diseases
9. Returns from the industrial sectors are not immediate yet the developing countries need to
develop urgently.
IMPORT SUBSTITUTION INDUSTRIALISATION STRATEGY
This is a deliberate policy by the government to encourage the establishment of industries in an

economy to produce commodities formerly imported. It is an inward looking development strategy
which is aimed at production of a wide range of the consumer goods by replacing them with products
produced locally. For this strategy to be successful the following has to be done:
1. A well developed infrastructure

2. A well trained labour force
3. Fiscal incentives to investors e.g. tax holidays subsidies
4. The infant industries should be protected(protectionism)
5. An expanded market
6. Availability of raw materials
Arguments for import substitution
1. There is provision of more employment opportunities. This is because there are several
industries established that require labour force and the use of labour intensive techniques of
production.
2. It reduces the extent of foreign dependency. It leads to self sufficiency in basic consumer goods
and other requirements since they are locally provided.
3. It facilitates the development of local skills. This through the training of the labour force and this
improves the efficiency of labour.

4. It helps save the scarce foreign exchange. This by producing formerly imported goods i.e. it
reduces capital flight
5. It improves on the bop position of the country. This is because the expenditure on imports is
reduced by producing goods locally.
6. It facilitates more exploitation of domestic resources. The industries that are established this
reduces excess capacity.
7. Imports substitution results into increased government revenue. This is through taxes on
industries and commodities produced by the industries
8. It facilitates transfer of technology from developed to developing countries. This is because
most of the industries are foreign owned and this increases the productive capacity of the
country
9. It facilitates the development of infrastructure. This is through construction e.g. roads, banks to
ease movement of goods and services.
10. In the long run it helps to earn foreign exchange through the exportation of goods.
11. It leads to the expansion of the manufacturing sector as more industries are established
12. It helps in controlling imported inflation. This is because some goods will no longer be imported
but produced at home.
13. The strategy facilities capital in flow through attraction of foreign investors.
14. It promotes economic growth through increased volume of goods and services produced.
There are several industries involved in production of goods and services.
Arguments against import substitution
1. It is associated with profit repatriation because most of the industries are foreign owned.
2. It encourages use of capital intensive techniques of production which results into
unemployment.
3. It leads to capital outflow through importation of intermediate inputs and labour / expatriates.
This leads to bop problems.

4. Most firms are high cost firms due shortage of manpower, importation of manpower.
This results into production of priced goods.
5. Poor quality goods are produced due to limited competition.
6. It worsens balance of payments position in LDCS due to importation highly priced inputs.
7. The strategy tends to concentrate on the production of consumer goods at the expense of
capital goods that are necessary. This retards growth.
8. There is limited variety of goods in the market that leads to limited consumer choice and a
decline in welfare.
9. The protection of home infant industries during import substitution may give rise to monopoly
with all its negatives since there is limited competition.
10. It leads to production at excess capacity due limited domestic market i.e. there is wastage of
resources.
11. Over protection of the domestic firms‟ leads to retaliation by the other countries limiting the
countries capacity to export and earn foreign exchange.
12. The strategy reduces government revenue from custom duties as there is limited importation of
goods and services. This affects planning.
13. It leads to rural- urban migrations and its associated disadvantages as most industries are urban
based.
14. Increases government expenditure to support such industries by way of subsidies and other
concessions.
15. It is associated with social costs e.g. pollution. There is poor waste management.
16. Management contracts are usually expensive to maintain due to use of foreign manpower.
THE EXPORT PROMOTION STRATEGY
This is a deliberate strategy by the government to encourage the establishment of domestic

manufacturing industries to produce commodities specifically for the markets abroad.

It is a deliberate policy by the government to expand the volume of the country‟s exports through
incentives and other means in order to generate foreign exchange and to improve its Bop position. It
is an outward looking development strategy. For it to be successful the following must be in place:
• Availability of skilled labour

• Well developed infrastructure e.g. roads, energy, etc.  Trade agreements and cooperation
• Availing fiscal and credit incentives to producers
• Availability of raw materials
• Finding market for the produced goods
Arguments for export promotion strategy
1. It leads to the expansion of the market for goods and services which increases the country ‟s
foreign exchange through exports
2. There is considerable development of infrastructure through construction and
rehabilitation in form of roads, railways, etc. to ensure smooth operation of the industries.
3. It helps in the improvement of quality as the firms are subjected to international
competition/add value to gods.
4. There is increased resource utilisation by the industries especially those that use locally available
resources
5. It encourages inventions and innovations as research is promoted to ensure efficiency in the
firms.
6. Causes the diversification of foreign markets. It avails a country opportunity to sell to various
countries.
7. The strategy improves relations between countries through trade.
8. It encourages the development of labour skills as employees are trained in modern skills of
production so as to increase efficiency in production.

9. The strategy encourages the development of the industrial sector. Several industries are
established to produce for markets abroad.
10. Stimulates the growth of entrepreneurial ability. Profit oriented individuals are encouraged to
establish industries.
11. It reduces geographical concentration of trade. There is diversification of markets since the
country is able to trade with several countries.
12. It improves the country‟s balance of payment position. This because it increases export
earnings.
13. Helps to diversify the economy.
14. It widens the country‟s tax base. The various industries established are taxed by government to
generate revenue.
15. Increases the rate of economic growth as the level of output increases since there are various
industries involved in production.
16. Promotes specialisation.
Limitations of the export promotion strategy
1. Presence of protectionism, the demand for commodities from developing countries is law
because of protectionist policies imposed by developed countries e.g. tariffs on goods from
developing countries
2. Products from Ldcs are of low quality and therefore out competed by commodities from the
developed countries
3. Developing countries find it hard to trade with each other since they produce the same
commodities
4. Most developing countries incur high cost of production because of poor infrastructure which
makes the commodities expensive.
5. Developing countries do not have sufficient skilled man power to run the industries
necessitating expatriates who are expensive to maintain
6. High cost market research and sales promotion is involved yet developing countries are not in
position to meet the cost
7. The strategy may lead to quick depletion of domestic resources*
8. The strategy requires fiscal incentives e.g. subsidisation of both local and foreign investors, this
makes the strategy expensive for developing countries.
9. Inadequate capital to set up industries.
10. Limited local natural resources/Limited raw materials. This causes an increase in the cost of
production.
11. Poor infrastructure. This makes transportation of inputs and finished products difficult and
therefore increases the cost of production.
12. Political instabilities. These scare investors as they fear for their lives and property and as a result
there is limited investment.
13. Corruption and embezzlement/low level of accountability.
15. Limited export promotion facilities/institution.
SMALL SCALE INDUSTRIES
These are industries that employ less than 100 employees and the capital invested is less than 300,000
US dollars. Examples include dairy farms, poultry farms etc.
Role of small scale industries in development
Positive role
1. Provision of employment opportunities. There several of them established and therefore many
people are able to get jobs.
2. Training grounds for entrepreneurs. They enable some entrepreneurs start small and over time
learn how to manage bigger enterprises.
3. Promote economic diversification/industrialisation.
4. Encourage development of infrastructure. There is construction of infrastructure to facilitate
movement of raw materials and finished products.
5. Increased incomes/GDP. The several firms produce and contribute the nation‟s output.
6. Reduced income disparities. They are easier to start and are therefore enable many people to
engage in production and earn income.
7. Grounds for technological development. There is innovation and invention as people try
produce better quality goods.
8. Production of affordable goods and services.
9. Improved BOP position. They reduce the demand for imported goods and therefore reduce
foreign exchange expenditure.
10. Source of government revenue. Some of the firms are taxed and contribute to government
revenue
11. Promotion of self sufficiency. They reduce the reliance on imported goods.
12. Acquisition of skills. There is on-job training which improves the efficiency of labour.
13. Creation of forward and backward linkages/provision of markets.
14. Utilisation of would be idle resources. The local resources are used as inputs.
15. Variety of goods and services are locally produced. There is product differentiation by the many
producers.
Negative role
1. Congestion in peri-urban areas. This is because of poor planning in their establishment.

2. Increased administration costs. This because they produce a low level of output.
3. Wastage because of unnecessary competition and duplication.
4. Limited contribution to employment. They employee few people.
5. Under utilisation of resources. They produce less and therefore use fewer resources.
6. Pollution. There is poor waste management.
7. Low output/growth rate of the economy.
8. Growth of slums.
9. Low revenue to government. They earn low profits and therefore pay low taxes.
10. Production of poor quality goods. They use poor technology and therefore there is low
efficiency.
Advantages of small scale industries
1. They have less capital requirement they are therefore appropriate for developing countries that
do not have sufficient capital.
2. The small scale industries provide employment to a wide range of skilled and semi- skilled
labour force. This is because they are mainly labour intensive.
3. They promote rural transformation because they can easily be located anywhere including rural
areas.
4. Small scale industries are flexible and therefore can easily respond and adapt themselves to
changing economic conditions e.g. changes in demand.
5. They are suitable for the small size of market in developing countries therefore minimise
wastage of resources
6. The industries do not require highly skilled labour force and therefore appropriate for
developing countries that do not have sufficient skilled manpower
7. They act as training grounds for the indigenous entrepreneurs who are in short supply and
therefore help developing countries to establish large scale industries
8. They produce a wide range of consumer goods for the low income earners. This reduces foreign
exchange expenditure on imported commodities
9. They mainly use local raw materials and therefore encourage better utilisation of the locally
available resources
10. They help to reduce income inequalities because they are easy to establish in many parts of the
country and employ many people.
11. They increase the tax base and thus increased government revenue

12. They help to promote self sufficiency since the mainly produce for the local market and use
locally available resources
13. Small scale industries can be used to solve Bop problems since there establishment reduces the
need to import goods
Arguments against small scale industries
1. They produce less for export and therefore bop problems continue to be experienced
2. Small scale industries do not enjoy economies of scale because they are high cost firms they
charge consumers high prices- exploit consumers
3. They are not appropriate in some sectors e.g. in the mining sector where heavy machinery is
required
4. They tend to use poor technology and therefore produce poor quality products that are not
marketable locally and internationally
5. They concentrate on the production of consumer goods neglect capital goods that are
necessary for development
6. They yield less revenue to the government because the profits to tax are small
7. They may not solve the mass unemployment in developing countries because they do not
absorb many people are they are small in size.
LARGE SCALE INDUSTRIES
A large scale firm is one which employs more than 100 employs; capital invested is big and has a high
level of output.
Arguments for large scale industries
1. They are associated with high levels of output and therefore lead to high rates of economic
growth
2. Firms enjoy economies of scale hence a low cost of production is experienced
3. The government earns high revenue from the taxes imposed on the big profits earned by the
owners
4. There is use of advanced technology which results in the production of quality goods
5. They create more employment opportunities in the long run thus help in solving the mass
unemployment in Ldcs
6. They improve the export capacity of the nation because of mass and quality production hence
increased foreign exchange earning
7. Large scale industries encourage acquisition of skills through training of labour
8. Encourage development of infrastructure to support the industries
9. Lead to more equitable distribution of income in the long run as more people are to get
employment
10. They promote technological development since they invest in research.
11. More resources are put to use. This promotes economic growth.
Arguments against large scale industries
1. They lead to unemployment because the use labour intensive technology

2. They require heavy capital investment which is not readily available in Ldcs
3. The small domestic markets in Ldcs may not be in position to support the large scale industries
4. They are associated with high social costs e.g. pollution resource exhaustion etc.
5. Large scale industries enhance income inequalities because they employ few people who earn
high than those in other sectors
6. They encourage rural urban migration because they are mainly urban based
7. They encourage profit repatriation because of foreign ownership of firms
CHOICE OF PRODUCTION TECHNIQUE

Another important aspect of the development strategy is the choice of the production technique.
There are two techniques of production i.e. labour intensive and capital intensive technique.
Labour intensive technique
This is a form of production technique which uses a big proportion of labour in relation to other
factors of production such as capital. It is also called a capital saving technique of production because
it uses less capital.
Arguments for labour intensive technique
1. Labour is a cheap and abundant resource in developing countries.

2. It provides employment opportunities thus helping to solve the mass unemployment in Ldcs.
3. It reduces income inequality because it leads to employment of many people who earn a living.
4. It is more appropriate in Ldcs since it does not require highly skilled labour force to operate
machines as seen in the agricultural sector.
5. It facilitates exploitation of the vast resources since most of the labourers are found in rural
areas.
6. There is no need to import expatriates since the technique can be operated by the labour which
is locally available.
7. It encourages investment, as more people are employed incomes and aggregate demand rise
encouraging investment.
8. It does not lead to over exploitation of resources as labourers are not as efficient as machines.
9. It is needed in agriculture where human judgement is paramount
10. The technique can easily be spread all over and hence increasing output in the economy
11. The technique is not associated with social cost in form of pollution.
12. It widens the tax base as the technique improves the earnings of labour. The wages of
employees are taxed and government gets revenue.
13. It uses locally available resources. The techniques do not require importation of spare parts, etc.

Arguments against labour intensive techniques
1. The productivity per unit of labour is very low and this retards economic growth
2. The technique tends to produce low quality products which makes it difficult to market the
products
3. It is associated with management problems like strikes by the workers, demanding for high
wages which disrupt production
4. It does not encourage high level of skills development
5. The technique is costly in the long run in terms of feeding, providing accommodation, medical
health care etc.
6. It results into under utilisation of resources because of low efficiency
7. The technique does not encourage technological development because limited inventions and
innovations
8. Labour intensive techniques are slow and time consuming. Less output is realised in a given
period of time.
9. It is hard to standardise output using the techniques. This is because the efficiency of labour is
low.
CAPITAL INTENSIVE TECHNIQUE
This is a production technique that uses a big proportion of capital in relation to other factors of
production such as labour. It is also called a labour saving technique of production.
Arguments against capital intensive technique
1. It increases the productivity of labour as a result high output is realised

2. The technique leads to production of better quality product which makes the selling of goods
easy and fetching high prices

3. There are limited managerial problems because machines are easy to manage as there are
limited incidents of strikes, etc.
4. The wage bill is reduced since few people are employed and this minimises the cost of
production, accommodation, etc.
5. There is development of labour skills as it involves the training of labour in various skills
6. It enhances better utilisation of the available resources and is used where labour may not be
used e.g. in heavy mining operations.
7. The technique increases employment opportunities in the long run because as output increases
the demand for labour also increases thus creating employment opportunities
8. It facilitates technological transfer and development i.e. from the developed to the developing
countries which increases the productive capacity of the nation
9. The technique is faster and time saving since machines are more efficient.
10. It is easy to standardise output. This is because machines are more efficient than human labour
11. It facilitates infrastructural development. There is construction of infrastructure to ease
movement of machinery.
12. It is associated with mass production therefore high output levels and high rates of economic
growth.
Arguments against capital intensive technique
1. Use of machinery leads to technological un employment

2. It is not readily available in developing countries as the economies do not have sufficient capital
to purchase machinery
3. It requires complex skills that may not available as it requires highly skilled labour force
4. There is repatriation of profits / capital as it is associated with foreign ownership or it leads to
capital out flow as there is importation of expatriates and spare parts
5. It leads to income inequalities as few people who earn highly are employed

6. It promotes rural – urban migration as most industries employing the techniques are mainly
urban based
7. The technique is associated with bop problems because of high importation of spare parts
8. It is associated with high social costs e.g. pollution
9. The techniques lead to quick resource depletion because of over exploitation.
10. It is associated with mass production which is not suitable for small internal markets leading to
wastage of resources.
11. Machines are less flexible and less adjustable compared to labour intensive techniques.
12. It is inapplicable in areas where human judgement is paramount.
13. Leads to production of expensive commodities thus neglecting low income earners‟ demands.
Factors that limit adoption of capital intensive techniques of production
1. Limited funds/stock of capital. There is a low level finance to facilitate the purchase the inputs.
2. Limited skilled labour. There is low efficiency in the running of the techniques of production
3. Limited entrepreneurial ability. There few people willing to inject funds in the purchase of
machinery.
4. Low level of innovations and inventions/research. There is limited funding of research to come
up with new technologies hence continuous use of outdated technology.
5. Cultural rigidities/conservatism. Some people are not willing to invest funds in new
technologies.
6. Poor topography. It is difficult to move machines from one place to another since there is poor
infrastructure.
7. Small/limited market for technology and products. There are few people with the capacity to
purchase better technologies due poor.
8. Underdeveloped/poor conditions of infrastructure. There difficulty in moving machines from
one place to another.

9. Poor land tenure system. There are small pieces of land which make use of machines un
economically viable.
10. Poor accountability/corruption.
INTERMEDIATE TECHNOLOGY
This refers to a method of production which lies between capital intensive and labour intensive
methods of production.
Qualities of intermediate technology
1. It basically uses locally available resources/materials.

2. Production is basically for the local market.
3. Mainly rural oriented.
4. It is fairly cheap and affordable by large number of producers.
5. It employs the abundant labour force since it does not require highly skilled personnel.
Advantages of intermediate technology
1. Creates employment opportunities. This because many people easily adopt it.
2. It increases productivity of labour. This is because it is more efficient.
3. It saves the scarce foreign exchange. This is due to the limited importation of spare parts.
4. It promotes linkages and hence limited wastage of resources.
5. Promotes exploitation of local resources. This increases the level of resource utilisation.
6. It promotes acquisition of skills by labour force as there is on job training and this increases
productivity of labour.
7. It helps to improve the distribution of income. This because many people are able to use in the
production process which improves their income.
8. It reduces foreign dependence. This is because it reduces importation of spare parts.
9. It produces according to local needs of the people so it reduces wastage.
10. It provides market for the country‟s resources.
Disadvantages of intermediate technology
1. It is not appropriate inn large scale industries. This is because of its low productivity.
2. It results into production of poor quality products because it is associated with a low level of
efficiency.
3. It does not improve skills of labour. This is because labour does not handle completed and
modern machines.
Limitations of intermediate technology
1. Poor topography. This limits the movement of machines.

2. Low level of innovations and inventions.
3. Limited capital.
4. Limited market for goods.
5. Conservatism and cultural rigidities.
6. Limited skilled labour which is required to operate the technology.
APPROPRIATE TECHNOLOGY
This is a production method which is socially and economically suitable for a given economy/society.
Or
A production method which is in line with development objectives and suits the development level of
an economy.

Factors that affect the development of appropriate technology
1. Availability of funds/capital.
2. Level of entrepreneurship.
3. Level of innovations/inventions.
4. External/foreign influence.
5. Government influence on technological development.
6. Market for the technology and products.
7. Cultural factors.
8. Natural factors e.g. topography, soils, etc.
9. Political climate.
10. Degree of corruption.
EDUCATION
Education is the process of acquiring knowledge and skills. This is mainly through formal and informal
education.
1. It is an intangible commodity.
2. Education as an investment
1. Like investment, education involves costs e. g. payment of school fees
2. Education has future returns inform of improved standard of living, wages, etc.
3. Education involves risks and uncertainties e.g. failing exams, unemployment etc.
4. It involves opportunity cost e.g. foregoing leisure, foregoing work etc.
Education as consumption good
1. It is desired as an end in itself since people enjoy learning

2. It permits an individual to enjoy a wide range of goods more fully e.g. newspapers, magazines,
etc.
3. It increases ones prestige
4. It raises life expectancy.
5. The recipient derives satisfaction.
The role of education in development
Positive roles
1. Education involves the development of the skills of labour through training and this increases
the productivity of labour
2. It provides direct and indirect employment in fields like teaching, drivers, etc. which improves
their standard of living
3. Education reduces government expenditure on expatriates and therefore saves the country‟s
foreign exchange
4. It encourages inventions and innovations which leads to technological development and
increased industrialisation
5. It leads to increased aggregate demand especially if majority of the population are educated,
this promotes increased investment
6. It breaks cultural ties which retard development since people drop their anti-development ideas
and attitudes
7. Education helps to reduce income inequalities more so when majority of the population are
educated and employed
8. It helps to check the population growth rate as the educated have preference for smaller
families, this increases savings and investment
9. It makes it easy for government to implement policies because the educated are more receptive
to new ideas

10. It is used national unity and development-a spirit of nationalism leading to economic growth
and development.
11. It encourages industrial development as trained labour force is generated. This reduces the cost
that would have been used to train labour force to acquire skills.
12. It widens the tax base as the employed are able to pay taxes leading to increased government
revenue.
Negative roles of education
1. It leads to rural urban migration since the educated in developing countries prefer to live in
urban areas where better amenities of life are found
2. Education results into income inequalities in developing countries because there few educated
who earn high incomes while the majority are not educated
3. It involves high opportunity cost e.g. long time spent at school and not enjoying leisure
4. Education contributes to Bop problems because of the demonstration effect where the
educated prefer imported luxurious goods increasing foreign exchange expenditure
5. It promotes brain drain as the educated leave their countries for the developed world where
better wages are paid
6. It leads to neglect of agriculture since it prepares the youth for white collar jobs and the
educated prefer leaving in urban centres.
7. Education in developing countries is expensive and affordable by few people leading to few
leading to few elites and the majority illiterate creating dualism in education.
8. When education is provided to the majority of the people gradually it leads to unemployment
especially where there is poor man power planning.
PRIVATE FOREIGN INVESTMENT/ FOREIGN CAPITAL INVESTMENT
Foreign capital investment refers to the transfer of resources mainly funds from one country to
another either by multinational corporations or from one government to another.
Foreign direct investment refers to the transfer of productive resources or capital by foreign
individuals, companies and multinational corporations in the form of business operations.
Multinational corporations are multinational or transnational companies which have headquarters in

country but with a variety of branch offices and areas of operation in a number of countries both
developed and developing. E.g. Shell, Total Coca cola etc.
Question: Assess the role of foreign capital investment in the development of your country.
Positive role
1. They help in closing the savings-investment gap because local savings are not sufficient to
make meaningful investment, therefore foreign capital investment helps in providing funds for
investment.
2. It helps in closing the foreign exchange gap because foreign exchange generated from exports
is low. It provides the needed foreign exchange for development purposes.
3. It promotes technological development and transfer because the foreign investors come along
with advanced technology which is used to increase production in the country.
4. It enhances creation of more employment opportunities especially where labour intensive
techniques of production are used.
5. It helps in skills development since local manpower is trained in new skills and how to use
modern technology. This increases the productivity of labour.
6. It promotes development of infrastructure e.g. roads, telecommunication etc., which facilities
more investment and production.
7. It facilitates production of a wide variety of goods and services which widen consumer‟s choice
and welfare.
8. Encourages competition which leads to improved efficiency in locally owned firms i.e. the
competition between foreign firms and local firms improves efficiency in the local firms.

9. It promotes international co-operation between countries and this encourages trade between
the host country and the country of origin of the investors.
10. It encourages improved resource utilization because of using better technology leading to
increase in growth.
11. It fills the manpower gap since the locally trained manpower is not enough and this through the
use of expatriates in some sectors.
12. It accelerates industrial growth because a number of industries are established to provide wide
variety of goods and services.
13. It encourages inventions and innovations because the desire to make more profits makes the
entrepreneurs invest in research and this results into better techniques of production.
14. It promotes development of local entrepreneurial skills because the local entrepreneurs are able
to learn from the managerial skills of those who own the private foreign firms.
15. Leads to increased output hence economic growth.
Negative role
1. It leads to capital flight by way of profit repatriation which drains the country‟s foreign
exchange.
2. It worsens income inequalities in the country because the few people who are employed are
paid highly compared to those in other sectors.
3. The use of capital intensive techniques results into technological unemployment.
4. Causes BOP problems
5. The excess concessions given to investors in form of tax holidays, tax exemptions reduce the net
befit from private foreign investment.
6. It leads to sectoral or regional imbalance in development due to preference for urban
concentration leading to rural-urban migration and its associated negative effects.
7. There is over exploitation of resources due to use of better technology leading to quick
resource exhaustion.
8. Local firms are outcompeted by the developed and this discourages local investors.
9. There is interference in the political or economic decisions and therefore policies generated are
at times not in favour of the local citizens.
10. There is erosion of cultural or moral values where expatriates staff are used.
11. Worsens economic dependency problem.
12. Promotes rural urban migration and the related problems. Enterprises are mainly established in
urban centres.
13. Contributes to social costs.
Question. (a) What is meant by the term Multinational corporations?
(b) Examine the role of multinational corporations in the development of your country.
1. Closing the savings – investment gap.

2. Close the foreign exchange gap.
3. Source of government revenue.
4. Promote technological transfer/fills the technological gap.
5. Create employment opportunities.
6. Help in skills development.
7. Encourage infrastructural development.
8. Widen consumer choices due to production of variety of goods.
9. Efficiency of firms is encouraged due to competition with local firms.
10. Promote international co-operation hence increased trade, aid, etc.
11. Fill the manpower gap.
12. Improved utilization of natural resources.
13. Encourage inventions and innovations.
14. Produce quality goods.
15. Increased output hence economic growth.

16. Facilitate industrialization.
Negative effects/impact of multinational corporations
1. Capital flight.
2. Bop problem.
3. Worsening of economic dependency problem.
4. Unemployment due to use of capital intensive technology.
5. Excessive concessions given sometimes exceed real or net gain.
6. Over exploitation of natural resources.
7. Sectoral/regional imbalance in development.
8. Promote rural – urban migration and related problems/disadvantages.
9. Interference in government decisions.
10. Erosion of cultural and moral values.
11. Worsen income inequality.
12. Contribute to social costs.
Question. (a) Distinguish between technological development and technological
transfer.
(b) Examine the merits and demerits of technological transfer.
Technological transfer refers to the shifting or movement of new and efficient techniques of
production from one country to another. Mainly from developed to developing countries.
While

Technological development is the process of initiating, innovating and improving the existing
techniques of production within an economy.
Merits of technology transfer
1. It promotes efficiency in resource utilization thus limiting wastage.

2. Leads to increased output hence leading to economic growth.
3. Leads to the development of infrastructure. It facilitates the construction and rehabilitation of
infrastructure.
4. There is production of quality goods and services because of using better technology and skills.
5. Promotes the growth of the industrial sector.
6. There is production of standardize output which makes marketing the products easy thus
increasing sales.
7. The prices of final output are due to the economies of scale
8. Reduces the wage bill since it is capital intensive/requires few workers.
9. There are improved labor skills since labour force is trained in modern skills of managing the
enterprises.
10. Improves international relations between countries which promote trade between the countries.
Demerits of technology transfer
1. It promotes technological dependence because it kills local initiative to develop indigenous

technology.
2. There is a high cost of employing expatriates who demand for very high wages.
3. Leads to over exploitation of resources hence quick resource exhaustion.
4. Leads to production of surplus output as local markets are not sufficient to consume the
commodities which results into waste of resources.
5. It creates technological unemployment because of using capital intensive techniques of
production
6. Leads to outflow of foreign exchange in form of profit repatriation, purchase of spare parts,
payment of expatriates which worsen the BOP problems.
7. It leads to income inequality because those employed in enterprises using better technology
pay high wages.
8. Leads to regional imbalance because of mainly locating in urban areas leading to rural urban
migration and its negative effects.
9. Leads to misuse of scarce resources due to transfer of out dated or inappropriate technology.
Foreign aid and development
Foreign aid is the international transfer of resources/funds in the form of loans or grants or technical
assistance etc, either directly from one government to another (that is bilateral aid) or indirectly
through the vehicle of a multi – lateral assistance agency like World Bank and the International
Monetary Fund (multi – lateral aid).
Or
Foreign aid is the transfer of resources from one country to another; either directly or through
international agencies. It could be bi-lateral aid or multilateral aid.
Forms of aid
1. Physical capital e.g. machines.

2. Technical assistance (skilled man power)
3. Education facilities in form of scholastic materials, man power/teachers
4. Aid in form of consumer goods.
5. Grants which require no repayment.
6. Military hardware.
7. Loans and these may be commercial or concessional loans Motives of giving foreign aid

1. For humanitarian reasons.
2. To create market for the donor country.
3. To create employment for the nationals of a donor country.
4. To achieve military goals/strategic military objectives.
5. For political reasons.
6. For prestige.
7. To extend social/cultural ideology.
8. For development motive.
The role of foreign aid in development
Positive roles:-
1. It fills the savings- investment the gap because the investment requirements exceed the
domestic savings. The funds received are used to finance establishment of enterprises.
2. It fills foreign exchange gap. The foreign exchange requirements for development exceed the
locally available foreign exchange from exports. The foreign exchange received is used to
finance importation of goods.
3. It helps to fill the manpower gap because the skilled manpower requirements in Ldcs exceed
the locally available supply of trained manpower. The aid in form of skilled labour force provides
the needed manpower.
4. It helps to close the technological gap i.e. aid in form of technology enables Ldcs to have access
to better technology and also overcome technological shortages.
5. It helps to close the government-revenue-expenditure gap. Aid in form of funds provides the
needed money to finance budget deficits thus supplementing local revenue.
6. Foreign aid helps in alleviating the effects of catastrophes e.g. famine, floods, etc. The funds
received are used to provide goods and services to those affected by disasters.
7. Foreign aid facilitates the development of infrastructure of a country. Aid in form of equipment
helps in the construction of infrastructure.

8. It strengthens international relations between the aid giving and the recipient country.
9. It helps in the provision of employment opportunities especially the aid that is invested in
productive projects.
10. Foreign aid in form of capital investment accelerates industrialisation. This is because it avails
funds for establishing industries and this promotes economic growth.
11. Foreign aid increases local skills. This is through funding local training and the scholarships
given and this improves the efficiency of labour.
12. Promotes economic growth. Foreign aid invested in productive ventures increases production
of goods and services and this promotes economic growth.
13. Exploitation of idle resources hence avoidance of resource wastage.
14. Promotes political stability. Aid in form of military hardware reduces incidences of war.
Problems associated with foreign aid
1. It creates a burden of debt servicing which denies nationals essential goods and services.
2. Aid to Ldcs has strings attached (tied aid) which are usually not desirable and at times cause
suffering e.g. liberalization of trade, privatization, etc.
3. Undermines capital formation due to debt servicing and payment.
4. It promotes a dependence syndrome. The recipient countries become lazy and always expect
assistance from the international community and as result it reduces the initiative of developing
countries as they are expecting more aid.
5. Aid worsens economic dominance by the donor country over the recipient countries. The donor
countries dictate policies to the disadvantage of the recipient countries.
6. It leads to BOP problems due to the repayment obligations especially for aid that is tied.
7. It causes unemployment. Sometimes technological aid is inappropriate causing unemployment
e.g. aid in form of machinery causes unemployment as workers are laid off.
8. Aid at erodes the socio-cultural values of the recipient country. This is especially the expatriate
staff who interact with local people and introduce negative behaviors.

9. Political strings attached to aid undermine political sovereignty.
10. It causes distortion in planning because it is inconsistent, inadequate, tied, etc. some projects
are abandoned due to insufficient funding hence wastage of resources.
11. High cost of borrowing due to aid being tied to source/purchase tied aid. Some loans carry a
high rate of interest which causes loss of funds to donors.
12. Leads to brain drain. Some students who are given scholarships to study abroad do not return
and this causes loss of skilled labour.
13. Under utilisation of local resources/reduced domestic production of some goods/hinders
growth of some consumer goods industries. This due to reliance on aid in form of consumer
goods which discourages establishment of industries.
NB: Tied aid is one which requires the recipient to abide by conditions set by the donor e.g.
i. The recipient country is required to purchase goods from the donor country using the
grant/funds.
ii. Aid given to finance a specific project named by the donor.
iii. The recipient country is required to implement socio-economic and political conditions
dictated by the donor before aid can be given.
Factors which determine the amount of aid given for economic development
1. Availability of funds. The more funds the donor country has the more funds the recipient is likely
to get and vice-versa.
2. The absorptive capacity. A country is given aid which it can use fully and usefully. Absorptive
capacity means the ability of the country to utilise efficiently the aid given to it.

3. Availability of resources. A country with more resources is likely to get more aid than that
country with very limited resources.
4. The capacity of the country to pay. This determined by the capacity to export as well as
argument the foreign exchange earnings.
5. The will and effort to develop.
6. The ideology i.e. whether the donor and the recipient countries share the same ideology
politically and economically.
7. The political climate.
Causes of under development in Uganda/LDCs
1. Low level of technology.

2. Limited capital stock/low savings/low incomes.
3. Limited labour skills/Brain drain/High illiteracy rates.
4. Unfavourable terms of trade.
5. Corruption/Low level of accountability.
6. High rates of capital outflow (profit repatriation).
7. Political unrest.
8. Poor attitude towards work/conservatism.
9. Limited market (both at home and abroad).
10. Poor infrastructure.
11. Dominance of subsistence sector.
12. Dependence on agriculture.
13. High debt burden and problem of debt servicing
14. Limited strategic natural resources.
15. Low entrepreneurial skills.
16. Dependence on foreign aid.
17. Price and exchange rate instabilities.
18. High population growth rates.
20. Poor investment climate/poor government policy of investment.
21. Unfortunate structural adjustment programmes INTERNATIONAL TRADE
International trade is the exchange of goods and services between countries. This exchange of goods
and services can be between individuals/companies from different countries or between governments
of different countries. If the exchange of goods and services is between two countries then it is called
bi-lateral trade, if the exchange is between many countries it is called multi-lateral trade.
International trade which involves goods only is called visible trade and trade in services is called
invisible trade. International trade involves two forms i.e. import and export trade.
Why do countries trade together? (The need or basis of international trade)
1. Existence of differences in resource endowments and therefore countries trade together in

order to get what they are not able to produce.
2. The lack of self-sufficiency implies that no country can satisfy all her needs, therefore countries
need to trade together in order to get what they do not have or what they lack.
3. The need for specialisation necessitates that countries concentrate on production of commodity
(s) that they best at so that exchange can take place.
4. The need for foreign exchange requires that countries produce and sell to other countries so
that they are able to earn foreign exchange to use in the purchase of what they do not produce.
5. There is need to dispose of surplus because some countries produce more than they need or
can consume so as to minimise wastage of resources. International trade is therefore a vent-for-
surplus. Vent for surplus theory as used in international trade- states that international trade
provides opportunity for countries to utilise formerly idle resources to produce output for the
export markets.
6. The need for capital acquisition. Some countries have natural resources but lack the necessary
capital to exploit them therefore international trade helps countries acquire the needed capital.
7. The need to use international trade to initiate or improve international relations as well as
political and economic ideologies.
Advantages of international trade
1. High output is realised. It allows international specialisation in that countries are able to
produce the commodity in which they have the greatest advantage.
2. It enables a country to import from other countries the goods and services it cannot produce
locally due to lack of resources.
3. It is a source of government revenue. Taxes are imposed on imports and exports.
4. It expands employment opportunities. The expansion of production enterprises and increased
resource utilisation increases employment opportunities.
5. There is production of quality goods. International trade creates a competitive atmosphere
between countries in the production of goods in order to attract market hence leading to
production of quality goods.
6. It makes dumping possible. This provides countries an opportunity to dispose of-surplus output
which minimises resource wastage.
7. It enhances international relations and understanding. This enables countries help one another
in case of disasters, war, etc. and also further trade in goods and services.
8. Provides variety of goods. This is because are many countries involved in production of goods
and this widens consumer choice.
9. Improves efficiency of local firms. Efficiency of domestic firms is due to exposure to competition
from international firms.
10. Promotes specialisation and its benefits. The need to produce for the wider market results into
use of machines and this causes a large amount of goods to be produced.
11. Enables the country to acquire new ideas and values. As people of different countries interact
there is exchange of ideas and this enables people adopt new ways of doing business.

12. Leads to utilisation of resources hence avoiding wastage. The wider market results into
increased consumption of goods and services and this limits wastage of resources.
13. Promotes technological transfer. The competition between countries to deliver better quality
products causes countries to acquire from developed countries improved technology.
14. Enables my country to acquire skilled labour from other countries. The reduction in the trade
barriers between countries enables greater movement of labour from one country to another
and this makes it possible for some countries to acquire skilled labour.
15. Promotes capital inflow. International trade encourages countries to get foreign investors who
invest in industries and securities.
16. Promotes infrastructural development. To ease movement of goods and services countries
construct and rehabilitate infrastructure such roads, railways etc.
17. Supplements domestic production. International trade makes it possible for the country to
access commodities from other countries in case what is produced domestically is not sufficient
to meet local demand.
Disadvantages of international trade
1. Importation of technology and capital reduces the indigenous spirit of inventiveness and
innovativeness which reduces the rate of growth.
2. Causes imported inflation. It may lead to imported inflation which results in local population
consuming commodities expensively.
3. It can lead to balance of payment problems in situations where poor terms of trade are
experienced.
4. It can lead to importation of harmful commodities which can easily worsen the health
conditions of individuals in a country.
5. Exhaustion of non-renewable resources due to over exploitation. This is the case where there is
high demand for a given commodity.

6. Leads to cultural erosion. This is the case when the local people copy foreign cultures that
negatively affect the peoples of living.
7. Collapse of domestic firms due to being outcompeted by foreign firms.
8. Leads to dumping. Dumping causes collapse of local industries since they are cheap.
9. Causes unemployment. Local firms are outcompeted by the more developed industries from
abroad.
10. Promotes dependence/ reduces self-reliance. This is the case where a country imports heavily.
11. Leads to poor terms of trade. This is the case where the country exports cheap commodities
while importing expensive commodities.
PROTECTIONISM
Protectionism refers to the commercial policy of safe guarding the national interest through
restrictions on international trade. It involves government interference with the free movement of
goods and services across a nation‟s boundary. Protectionism involves restrictions on imports and
exports through tariff and non-tariff barriers.
Tariffs. These are taxes imposed on imports and exports. They are therefore import or export duties.
Non-tariff barriers. These are qualitative and quantitative restrictions on the amount of goods that
may enter or live a country. They include:
1. Quotas. These are quantitative restrictions on imported and exported goods. In this case the
amount that may enter or leave country is laid down.
2. Total ban/Embargo. In this case the country stops the importation or exportation of certain
commodities. In this case there is a law prohibiting the flow of such goods to and from the
country.

3. Foreign exchange control. Foreign exchange is restricted to some importers while others are
favoured. It may be given out to priority sectors or importers.
4. Issuing of import licences. Some importers are given licences at lower prices while others at
high prices or they denied completely.
5. Devaluation. This makes foreign exchange more expensive and therefore will make imports
expensive leading to reduction in their demand.
6. Special deposits. Some importers are instructed to make a special deposit before being allowed
to import. The deposit can be fixed highly and those who cannot manage the high deposits are
not allowed to import.
7. Deflation policy. This involves the reduction of liquidity in public hands. This can be achieved by
use of monetary and fiscal policies.
8. Administrative measures. This involves regulations and non-monetary obstacles that include
among others bureaucracy, delays in clearing and forwarding, etc.
9. Subsidisation to priority producers/importers. This is done to enable them charge low prices for
commodities and be able to out compete foreign firms.
Protectionist tools used by Uganda

1. Use of administrative controls.
2. Tariffs
3. Total ban/trade embargo.
4. Manipulation of exchange rates.
5. Offering subsidies to local industries.
6. Quality control measures.
7. Use of quota system.
Commercial policy

Commercial policy refers to government policy meant to influence and direct the volume, value
and direction of trade in the economy.
Objectives of commercial policy
1. To encourage exports and discourage imports to achieve a favourable BOP position.

2. To maintain foreign exchange rate at a desirable level.
3. To expand the volume of international trade.
4. To achieve increased employment.
5. To increase government revenue.
6. To encourage foreign investors by protecting them.
7. To encourage industrialisation by protecting foreign industries
Instruments of commercial policy in Uganda
1. Use of administrative controls.

2. Total ban/trade embargo.
3. Manipulation of exchange rates.
4. Offering subsidies to local industries.
5. Quality control measures.
6. Use of quota system.
ARGUMENTS FOR PROTECTIONISM

1. It helps to protect infant industries. It helps to protect infant industries from competition of the
already established firms that are more efficient and sell goods cheaply which makes it possible
for infant industries to grow.
2. It helps discourage dumping. It helps discourage dumping since the dumped goods limit the
consumption of locally manufactured goods which limits the growth of infant industries.
3. It helps to create employment. Helps to create more employment opportunities at home as
result of the growth of domestic industries that offer job opportunities.
4. It encourages attainment of self sufficiency. It encourages self sufficiency as it encourages the
growth of industries to produce commodities formally imported.
5. It helps to reduce BOP problems. It helps to reduce Balance of payment problem as restricting
imports leads to reduced foreign exchange expenditure.
6. It helps to prevent importation of harmful products. It helps to prevent importation of goods
that are harmful to peoples health e.g. drugs, alcoholic drinks, etc.
7. It checks imported inflation. It checks imported inflation by restricting entry of goods from
those countries affected by inflation.
8. It is source of government revenue. It is a source of government revenue since taxes/tariffs are
imposed on imports and exports.
9. It helps to improve terms of trade. It helps to improve the terms of trade of a country by
restricting the amount of imported commodities while encouraging exports.
10. It is vital for national security. It is vital for national security as it restricts trade in certain
commodities that are considered strategically important for the countries existence e.g. guns
and ammunitions.
11. It helps avoid political and economic domination by reducing on the volume of trade with
certain countries.
12. It encourages use of the locally available resources since the domestic industries are promoted
to produce for the local market using the locally available resources.
Disadvantages of protectionism
1. It subjects nationals to highly priced goods. It subjects nationals to highly priced goods because
levying taxes increases prices of goods and services which reduce their consumption.
2. Encourages inefficiency in protected firms. It encourages inefficiency in protected firms since
the firms that are shielded from competition become high cost firms and there is inefficient
utilisation of resources.
3. It subjects nationals to poor quality goods. It subjects nationals to poor quality goods as there is
limited/no competition in production as well as use of poor technology.
4. It encourages monopoly tendencies in the local market. It encourages monopoly tendencies
because the protected firms monopolise the local and supply less output to the market at high
prices.
5. It limits variety of goods. It subjects nationals to limited range of products thus limiting choice.
6. Protected firms have a tendency of remaining infant so as to continue benefiting from
government protection and therefore remain inefficient.
7. It is an expensive exercise since it calls for subsidisation. It is an expensive exercise since it calls
for subsidisation of firms yet some countries do not have sufficient revenue to sustain this.
8. Protected firms hold government at ransom to continue reaping high profits. I.e. they continue
to benefit from the protection even when they are getting high profits.
9. Results into reduced government revenue. It results into reduced government revenue in case
protectionism is carried out over a wide range of commodities as revenue obtained is no longer
realised (taxes on imported goods).
10. It encourages retaliation from other countries. It encourages retaliation from other countries as
they also seek to minimise on the benefits of the practising country (beggarmy-neighbour
policy) a move that reduces benefits from international trade.
11. It encourages trade mal-practices. It encourages trade mal-practices such as black marketing,
smuggling etc. as sellers try to take advantage of price differences which leads to loss of
revenue on the side of government.

12. Unemployment may be generated because protectionism reduces employment in the import
sector.
13. It discourages specialisation and its associated advantages. This is because it limits on the
volume of trade.
14. It reduces foreign exchange earnings especially when exports are restricted.
FREE TRADE
Free trade refers to unrestricted trade in goods and services between countries. The policy of free
trade implies non-intervention of government in international trade. It is a situation in which there are
no artificial barriers in form of quotas and tariffs to the movement of goods and services between
countries and government allows trade to take its own course.
Arguments for free trade
1. It leads to maximisation of output. Free trade leads to maximisation of output by the

participating countries because of the international division of labour and specialisation.
2. It encourages optimum utilisation of resources. It encourages optimum utilisation of resources
as a country only produces what it can cheaply and leaves that which it is disadvantaged.
3. Wide variety of goods is availed to consumers. Wide variety of goods is availed to consumers
because there are many suppliers of goods from different countries and this leads to increased
consumer choice and welfare.
4. There is improvement in quality of goods. There is improvement in quality of goods because
free trade encourages research and development, improvement in technology and competition
between firms.

5. Countries enjoy wider markets for their goods and services. Countries enjoy wider markets for
their goods and services this is because there is an increase in the number of consumers in the
different countries.
6. It promotes economic growth. It promotes economic growth of the country because it
stimulates specialisation and division of labour, expands market size, and improves skills etc.
which lead to increase in production of goods.
7. It widens the tax base. It widens the tax base because of the numerous industries in the
economy that form an important tax base.
8. There is generation of more employment opportunities. There is generation of more
employment opportunities in the various industries are established to produce for the market as
well as the import sector.
9. There is increased earning of foreign exchange. There is increased earning of foreign exchange
as a result of export of goods and services.
10. It increases efficiency in firms. It increases efficiency in firms because of the international
competition which forces firms to use better technology that leads to reduction in production
costs and this leads to production of quality goods.
11. It encourages faster expansion of infant industries. It encourages faster expansion of infant
industries because they are subject to international competition and increased investment in
research.
12. It discourages trade mal-practices because activities like smuggling and black market are not
beneficial.
13. Discourages monopoly tendencies in the economy. Enterprises are open to international
competition which increases availability of goods and services.
14. Helps to avoid expenditure on implementing protectionist policy. i.e. there is no expenditure on
providing subsidies.
Arguments against free trade

1. It encourages external economic dependency. It encourages external economic dependency
and the dangers associated with it like limited innovations and inventions.
2. It encourages dumping and its negative consequence. It encourages dumping and its negative
consequence of suffocating infant industries.
3. It leads to importation of undesirable commodities. It leads to importation of undesirable
commodities which are harmful to peoples‟ health.
4. Worsens a country‟s terms of trade. It is harmful to less developed countries because of the
unequal share in the gains from international trade as terms of trade are not in favour of
developing countries since they mainly export agricultural products which fetch low prices.
5. Imported inflation may result. This because it is not easy to stop goods from inflation affected
countries.
6. Balance of payment problems worsen. This is because developing countries are likely to import
more than they export leading to high foreign exchange expenditure.
7. Local industries are out competed. This is because they are exposed to industries from the
developed countries that offer better goods and services.
8. It may lead to unemployment. It may lead to unemployment especially when the local firms are
driven out of the market by the more developed industries the employees lose their jobs.
9. Low tax revenue from imports. This is because free trade involves elimination of tariff and non-
tariff barriers.
10. May result into political domination. This happens when a country becomes reliant on other
countries and this undermines the sovereignty of a country.
11. Low level of exploitation of local resources. This results from reliance on imported commodities
that limits local production and therefore limited exploitation of the locally available resources.
THEORIES OF INTERNATIONAL TRADE
The theory of absolute advantage

The theory states that given two countries and two commodities using the same amount of
resources a country should specialise in the production of that commodity (s) it can produce more
cheaply or at a lower cost than the other country . I.e. when two countries are involved in the
production of two commodities e.g. Uganda and Kenya producing say wheat and bananas, each
country should specialise in one all both provided it does so at a lowest cost so that exchange can
take place.
The above can be explained using the illustration below.
Country Unit of resources Wheat (tonnes) Bananas (tonnes)
Uganda 1 8 20
Kenya 1 10 40
In the illustration above Kenya has absolute advantage in over Uganda in the production of both
wheat and bananas.
The comparative advantage theory
According to the comparative advantage principle given two countries and two commodities using
the same amount of resources a country should specialise in the production of a commodity where
it has the least opportunity cost than the other . Even if a country has absolute advantage in the
production of two or more commodities, it should concentrate on the production of the commodity in
which it has least opportunity/real cost.
This can further be explained using the illustration below.

Country Unit of resources Wheat (tonnes) Bananas (tonnes)
Uganda 1 8 20
Kenya 1 10 40
For the countries to benefit from international trade, each country should specialise in the production
of a commodity where it incurs less opportunity cost i.e. where a country loses less by producing the
other commodity. Using the illustration above, whereas Kenya has absolute advantage in the
production of both commodities it may not have comparative advantage in the two commodities
hence the need to specialise in one of the commodities so that exchange can take place between
Uganda and Kenya.
Uganda
The opportunity cost of producing wheat in Uganda
20/8 = 2.5
For every 1 tonne of wheat produced 2.5 tons of bananas are foregone.
Opportunity cost of producing bananas:
8/20 = 0.4
For every 1 tonne of bananas produced, 0.4 tons of wheat are foregone.

Kenya
Opportunity cost of producing wheat
40/10 = 4
For every 1 ton of wheat produced, 4 tons of bananas are foregone.
Opportunity cost of producing bananas is:
10/40 = 0.25
For every 1 tonne of bananas produced, 0.25 tons of wheat are foregone.
Country Wheat Bananas
Uganda 2.5 0.4
Kenya 4 0.25
From the illustration above, Kenya has comparative advantage over Uganda in the production of
bananas while Uganda has comparative advantage over Kenya in the production of wheat.
Assumptions of the comparative advantage theory The theory of
comparative advantage assumes that:
1. It assumes there are only two countries in the world involved in international trade i.e. Uganda
and Kenya.

2. It assumes that only two commodities are produced in between the two countries i.e.
wheat and bananas.
3. That tastes are similar in the two countries.
4. That all factors of production are homogeneous.
5. It assumes that commodities are produced under the law of constant returns to scale.
6. That trade between the two countries takes place without any barriers.
7. It assumes that technology is fixed or constant.
8. It assumes that no transport costs are involved in carrying out trade between the two countries.
9. That all factors of production are fully employed between the two countries.
10. Perfect mobility of factors internally/immobility of factors externally.
11. Demand is elastic.
12. Barter trade system exists.
13. Constant comparative advantage in both countries.
Criticisms of the comparative advantage theory
The theory of comparative advantage makes unrealistic assumptions and has been criticised basing
on the following:
1. The basis that the world is composed of two countries only is unrealistic. There are more than
two countries involved in international trade.
2. Producing two commodities only is unrealistic because countries produce a wide range of
goods and services and trade is therefore multilateral rather than bilateral.
3. Similar tastes do not exist between countries because tastes differ with different groups in a
country and between countries. As a country grows tastes and preferences also change.
4. It ignores transport costs yet they form a significant part in determining the pattern of world
trade.
5. The theory assumes that factors of production are perfectly mobile internally and immobile
externally which is unrealistic because even within the same country factors of production do
not move freely from industry to another or from region to another. The greater the degree of
specialisation of a factor the more immobile it becomes.
6. The basis of free trade is unrealistic because countries apply restrictions on the free movement
of goods and services in form of tariff and non-tariff barriers.
7. The assumption of full employment is unrealistic because in the case of developing countries
unemployment exists in various forms e.g. disguised, seasonal unemployment etc.
8. It neglects the role of technological advancements yet they help increase the supply of goods
not only for the domestic market but also for international markets. As technology improves it
may cause a change in comparative advantage between the two countries.
9. Specialisation according to comparative advantage means that developing countries should
specialise in primary products. This would subject developing countries to eternal poverty due
to unfavourable terms of trade.
10. The assumption that all factors of production are homogeneous is unrealistic because some
labour is skilled the other semi-skilled and unskilled labour. They therefore have different
efficiencies.
11. It ignores the existence of different currencies used in international trade yet some currencies
have more value than others and therefore countries cannot benefit in the same way.
12. It ignores the possibility of absolute cost advantage.
13. It ignores the need for self-reliance by countries. This means a country has to depend on other
countries for what it does not produce.
14. It assumes that demand is elastic yet demand for agricultural products is inelastic.
15. It ignores the existence of diminishing returns/assumes constant returns to scale. Production on
land involves diminishing returns and this minimises the benefits of international trade.
16. It ignores the possibility of change in comparative advantage. When there is a change in
comparative advantage it becomes difficult to for country to change to the production of a new
commodity.
Applicability of the theory

1. Developing countries have tended to specialise in agriculture where they have lowest
comparative advantage.
2. There are barter trade arrangements in Ldcs.
3. There is use of labour intensive techniques which is abundant.
4. There are some cases of free trade.
5. There is some degree of mobility of factors of production within individual countries.
6. Developing countries import manufactured goods where they have lesser comparative
advantages.
TERMS OF TRADE (TOT)

Terms of trade is the ratio of the price index of exports to the price index of imports.
Or
Terms of trade refers to the rate at which a country‟s exports exchange against its imports.
Or
It is the relationship between the price index of exports and the price index of imports.
It represents the units of domestically produced goods foregone to secure one unit of imported
goods.
When prices of imports are greater than prices of exports the terms of trade are said to be
unfavourable.
When prices of exports continuously exceed the prices of imports for a long time the terms of trade
are said to be improving and when prices of imports continuously exceed the prices of exports for a
long period of time the terms of trade are said to be deteriorating. This means that terms of trade are
unfavourable year after year.
Types of terms of trade
There are two types namely:
1. Net barter terms of trade. This refers to the ratio of price index of exports to the price index of
imports.
It is given by the formula: Price index of exports
Price index of imports
Using the above formula when the figure obtained is less than 1 the country is faced with
unfavourable terms of trade and when greater than 1 the terms of trade is favourable.
2. Income or monetary terms of trade. This refers to the ratio of the value of exports to the price
index of imports. It shows how much a country can import using incomes from exports.
Why Ldcs face unfavourable terms of trade
1. The low income elasticity of demand for primary products. It is low because primary products
especially food stuff are required in fixed quantities and an increase in income of the people in
developed countries does not lead to an equal increase in their demand. There the output on
the market is sold at low prices.

2. Existence of protectionist policies of developed countries. Existence of protectionist policies of
developed countries in form of quotas quality controls limit the amount developing countries
are able to sell in such countries and therefore sell at low prices.
3. There is increasing substitution of exports for synthetics produced by developed countries. This
implies that the demand for artificial fibres and commodities produced has reduced
significantly which lowers the prices of the primary products.
4. The invention of raw material saving techniques has greatly reduce the demand for primary
products because developed countries are able to produce large quantities using less output
hence low prices are offered for the large output from Ldcs.
5. The prices of exports have continuously fallen due poor quality and as a result low prices are
offered for the commodities.
6. There is exportation of semi-processed agricultural and mineral products. These fetch low prices
in world market because of low valued added.
7. The weak bargaining power in the international market due stiff competition among the
producing countries. This means that the developing countries accept the low prices offered to
them by the developed countries so as to have their products bought.
8. There is market flooding with agricultural products. This leads to low prices being offered
because developing countries tend to produce in large quantities similar products without
controlling output.
9. The low quality of exports due to use of poor technology, poor skills results into producers
getting low prices for their commodities since the products cannot easily compete with those
from the developed world.

10. The importation of expensive manufactured capital and consumer goods.
11. Prices of imports have continued to rise because among other things high fuel costs,
technological advancements etc. and for this reason the importing countries pay higher prices.
12. The existence of unfavourable exchange rates between the developing and developed
countries. The currencies of developing countries are weaker than those of the developed
countries which is to the disadvantage of the developing countries. Because they make exports
cheap and imports become expensive.
Measures that should be taken to improve terms of trade developing countries
1. Diversify primary exports. There should be introduction of industrial exports in order to reduce
dependence on few traditional exports whose terms of trade keep on fluctuating.
2. Process primary exports to add value, this can be achieved through industrialisation so that
producers fetch higher prices.
3. Diversify markets/join/strengthen regional cooperation. This should be done to widen market
for commodities.
4. Strengthening commodity agreements. This should be done especially for those countries
producing similar goods in order to increase their bargaining power.
5. Encourage importation from cheaper sources so that developing countries purchase
commodities at fair prices.
6. Encourage import substitution. This should done by using investment incentives to encourage
establishment of industries in the country so as to make it possible for developing countries to
reduce importation of highly priced goods since theses goods are domestically available.
7. Improve quality of exports. This should be through establishment of industries in which better
technology and skills are used. This results into better prices being paid for the commodities.
8. Negotiating for removal of trade barriers in export markets. This should be done so that
developing countries are able to access wider markets in the developed world.
9. Stabilise the foreign exchange rates through central bank interventions in the foreign exchange
markets.
BALANCE OF PAYMENTS (BOP)
Balance of payments refers to the difference between country‟s receipts/income from abroad and
expenditure/payments abroad during a given time.
Or
It is a systematic record of a country‟s receipts and payments in international transactions in a given

year.
Or
Balance of payments is defined as the financial record of a country‟s transactions with the rest of the
world during a given period.
OR
It the difference between receipts from both visible and invisible exports and payments for both
visible and invisible imports of a country during a given period and it includes capital inflows and
outflows.
It shows the relationship between the countries total expenditure abroad and total income from
abroad in a given year. When the county‟s receipts from abroad exceed expenditure/payments
abroad then a favourable BOP is realised i.e. a country enjoys a BOP surplus. On the other hand if a
country‟s payments abroad exceed earnings from abroad then an unfavourable BOP is realised (BOP
surplus).
Components/structure of the BOP account

The BOP account has four components namely:
1. The current account

2. The capital account
3. The monetary account and,
4. Errors and omissions
The current account
This is the part of the BOP account which in records of the total exports and imports (both visible
and invisible) of a country is found.
It has two components namely:
1. Visible trade account.

2. Invisible trade account.
The visible trade account records all income from sell of tangible/physical exports and payments for
the purchase of tangible imports.
The difference between the value of the country‟s exports and visible imports is called the balance of
trade or the visible trade account.
The invisible trade account records all earnings from exports of intangible commodities or services
and payments for import of services. The difference is called invisible balance of trade.
The capital account

In this account, the records of all transactions involving capital movements are recorded.
These are in terms of capital inflows and outflows, borrowing from foreign countries and lending to
foreign countries. It also includes direct investment in foreign countries and indirect invest (portfolio
investment) in other countries bonds and treasury bills. The difference between inflow and outflow of
capital gives the BOP on capital account.
The monetary/cash account
This account shows the records of the official foreign exchange reserves in response to the current
and capital accounts. It is a statement that shows a deficit or surplus in the BOP account and how
each can be off set to attain BOP equilibrium.
The errors and omissions account
It records all the total errors and omissions during the compilation of the BOP account . This is the
balancing part of the BOP account
NB: The BOP account should always balance but this is not always the case especially in developing
countries. Ldcs normally experience BOP deficits/problems/disequilibrium. Therefore the errors and
omissions account is used to make the necessary adjustments.
The causes of BOP problems/deficits in Ldcs (Uganda)
1. The low volume of exports. Ldcs export few products to developed world /external markets and
worse still dominated by primary products these fetch low prices and therefore low foreign
exchange is earned.
2. There is exportation of low quality products because of using poor technology and less skilled
manpower as result the products cannot compete favourably internationally and earn less
foreign exchange since low prices are charged.

3. There is high marginal propensity to import. This is as a result of the low productive capacity
and high demonstration effect this leads to high foreign exchange expenditure abroad on the
purchase of imports.
4. There is political instability which leads to high military expenditure mainly through high
importation of fire arms to reduce incidences of war thus high foreign exchange expenditure.
5. There is importation of highly priced commodities and therefore there is high foreign exchange
expenditure.
6. There is exportation of low value commodities because most of them are either not processed
or semi processed these fetch low prices and thus low foreign exchange earnings/Low prices of
exports as they are dominated by agricultural products results into low foreign exchange
earnings because these fetch low prices.
7. High rate of capital outflow due to debt servicing since most countries generate less revenue
from taxes. This causes high foreign exchange expenditure abroad when paying the interest and
principle sum.
8. The presence of protectionist and discriminatory policies of developed countries limits the
amount of commodities that developing countries are able to export and as a result less foreign
exchange is earned from the limited exports.
9. There is excessive expenditure by government on bureaucrats, foreign travels; foreign missions
etc. yet these are not directly productive this results into high foreign exchange expenditure
abroad.
10. Prices of some exports are dictated by major buyers because of weak bargaining power in the
international markets therefore low prices are offered which results into low foreign exchange
earnings.
11. High level of profits and wages repatriation due to use of expatriate staff. This causes excessive
foreign exchange expenditure abroad on payment of wages to the expatriate staff.
12. Market flooding/limited market for similar products abroad. The production and exportation of
similar products by developing countries results into stiff competition in the international
market and as result low prices are charge which leads to low foreign exchange earnings.

13. Limited variety of exports. There is a narrow range of exports due to limited diversification of
production and this causes low amount of foreign exchange being earned.
14. Poor and or the ever fluctuating exchange rate due low export capacity, unfavourable
international monetary policies etc. this leads to unfavourable exchange between the
developed and developing countries.
Effects of balance of payments problems
1. Reduction in volume of imports. As spending on imports increases over time the capacity to
import decreases because the country earns less from exports to support importation.
2. Limited employment opportunities. Spending heavily on imports results into less employment
at home since there is low demand for local products and hence firms employ few people.
3. Disinvestment may arise. Firms prefer to relocate their investments elsewhere where there
better possibilities of exporting more.
4. Leads to inflation. This occurs when the country imports from inflation hit countries.
5. Encourages currency depreciation. Too much importation leads to high foreign exchange
expenditure abroad and scarcity of foreign exchange in the local economy and this causes
depreciation of the local currency.
6. Retards economic growth and development. The increase in demand for imports results into
low level of production by the local firms since there is low demand for their products this leads
to a low level of economic growth.
7. Increases external borrowing/dependency. External borrowing in order to finance importation
of goods since the country has low foreign exchange from exports.
8. Limits savings and investment. The high level of expenditure on imports leaves individuals with
low incomes for savings and investment.
9. Leads to shortage of foreign exchange. There is shortage of foreign exchange in the country
because a lot of it is spent on purchasing imports yet less is earned from exports.

10. Government in power becomes unpopular. Government becomes unpopular because imported
commodities are expensive and therefore there is a high cost of living.
11. May lead to high taxation.
Measures that should be taken to improve the BOP position of developing countries.
1. Use trade restrictions. These check the amount imported into the country and reduce foreign
exchange expenditure abroad.
2. Promote import substitution industrialisation using investment incentives to encourage
establishment of industries in the economy. This should be done to reduce the foreign
exchange expenditure abroad/saves the scarce foreign exchange.
3. Diversify export markets through joining regional integration. This reduces reliance on few
export markets and therefore increases foreign exchange earnings from the various markets as
there is an increase in the bargaining poor for higher prices.
4. Increase volume of exports by encouraging industries using investment incentives. This should
be done to increase foreign exchange earnings from abroad as the quantity for sale increases.
5. Diversify exports. This should be done to reduce reliance on few export commodities and help
to increase the foreign exchange earnings.
6. Stabilise political atmosphere. This should be done to reduce huge expenditure on importation
of military hardware.
7. Manpower development to reduce expenditure on experts.
8. Restructure foreign mission and reduce foreign travels by government officials. This has the
benefit of reducing foreign exchange expenditure abroad.
9. Strengthen/join commodity agreements to increase bargaining power in export markets. This
results into fair prices and high foreign exchange earnings.
10. Appeal for debt relief/debt conversion. This should be done to reduce government spending on
paying debts.

11. Process exports to increase value and prices. This increases export earnings because of increase
in prices.
12. Improve quality of exports. This should be done through encouraging industrialisation and to
improve prices of exports and export earnings.
13. Encourage depreciation of the local currency. Depreciation of the local currency makes exports
cheap and this increases export earnings.
14. Devaluing the local currency which makes exports cheap and imports expensive which increases
foreign exchange earnings.
DEVALUATION
Devaluation refers to the legal reduction of the country‟s currency value in terms of other currencies.
OR
It is the deliberate measure taken by government to reduce the value of her local currency in terms of
other currencies. The local currency becomes cheaper or of less value while foreign currencies
become expensive or of high value.
Reasons for devaluation

1. To discourage imports as devaluation makes imports expensive.
2. To encourage exports because after devaluation exports become cheap and those with foreign
currencies are able to purchase more.
3. To solve the problem of BOP resulting from combined effect of reduced imports and increased
exports.
4. To check the problem of imported inflation. This is because devaluation makes imports
expensive and there is a reduction in demand.
5. To attract more investment. Foreign investors find it cheap to invest in a country that has
devalued because they are able to accomplish more using less foreign exchange.
6. To increase employment as result of increased investment and production for export.
7. To increase the tax base. With devaluation there is an increase in productive enterprises and it is
these that form an important tax base.
8. To increase resource utilisation. The increase in the number of enterprises producing for the
local market and foreign market leads increased resource utilisation.
9. To encourage self reliance. This is because it reduces imports and increases exports.
10. To protect the local infant industries against foreign competition. Conditions necessary for
devaluation to be successful
1. The domestic demand for imports should be elastic since devaluation makes imports expensive
so that their demand reduces.
2. The demand for exports in the foreign markets should be elastic so that there is increased
demand for exports.
3. The supply of exports in the devaluing country should be elastic as devaluation reduces the
prices of exports which increase their demand in the foreign markets.
4. Other countries should not retaliate as this neutralises the benefits of devaluation.
5. The rate of inflation should be low so that the prices of exports are kept low so as to increase
their demand in the international market.
6. There should be political stability so that there is continued production for exports and reduced
expenditure abroad.
7. There should be limited/no restrictions on trade by the developed or trading partners. This
increases accessibility to foreign markets.
8. There should be a fixed exchange rate system so that producers and exporters can predict
earnings from exports.
9. There should not be smuggling of commodities out of the country. Once there is smuggling of
goods out of the country less foreign exchange is earned.

Why devaluation may fail to solve BOP problems
1. The demand for exports is price inelastic it means that even when the prices of exports reduce
there is no significant increase in demand and therefore there is less foreign exchange earned.
2. Existence of inelastic demand for imports. When the demand for imports is inelastic there is no
significant reduction in the demand for imports and foreign exchange expenditure remains
high.
3. Presence of inelastic supply of exports. This results from insufficient supply of factors of
production such as capital to exploit the country‟s resources so as meet international demand.
The country therefore exports less despite the increase in the demand for exports
4. Existence of political instability which disrupts production and also contributes to increased
government expenditure on non-productive fire arms.
5. There is a high marginal propensity to import by the devaluing countries since productive
capacity is low and there is high demonstration effect. This means the country continues to
import large volume of commodities.
6. Presence of high inflation. This results into high export prices and hence low demand for the
products.
7. Most countries do not operate a fixed exchange rate system that is a precondition for the
success of devaluation i.e. they operate floating/multiple exchange rate systems. Therefore
there is high uncertainty in the economy which discourages investment.
8. There are trade restrictions such as quotas, quality controls, etc. which limits the amount of
commodities that developing countries are able to sell in the foreign markets.
9. The presence of weak administrative machinery to implement the policy due to absence of
sufficient skilled manpower.
10. There is inability to produce cheaper commodities that are able to compete at the international
level. This is because of the poor technology used.
11. The fear of the possibility of other countries retaliating which makes it impossible for
developing countries to benefit substantially.

12. Insufficient import substitution facilities/low level of industrialisation in devaluing countries
which implies that even when they devalue they continue to import heavily.
13. The poor quality of exports. This results into low capacity to export.
14. Existence of trade malpractices e.g. smuggling. Malpractices reduce the capacity of the country
to export.
ECONOMIC INTEGRATION
This refers to the coming together of two or more countries in a given region for the sake of mutual
benefit of all member states.
Or
Economic integration refers to the merging to various degrees the economies and economic policies
of two or more countries in a given region for the mutual benefit of member countries.
Examples of economic integration include COMESA, ECOWAS, North America free Trade Area,
European Union, etc.
Forms of economic integration
The various forms of economic integration include:
1. Preferential Trade Area (PTA)

2. Free trade Area (FTA)
3. Customs Union
4. Common market
5. Economic Union
1. Preferential Trade Area. This is the initial stage of economic integration.

The stage involves reduction of tariff and non-tariff barriers among member countries on
selected commodities; however each country continues to impose its own tariff structure on
non-member countries. E.g. the former PTA.
2. Free Trade Area. This stage involves abolition of trade barriers which enables free movement of
goods among member countries however each member country retains its own tariff structure
on non-member countries.
3. Customs Union. This stage involves free movement of goods and services into member
countries and adoption of a common external tariff structure against non-member countries.
4. Common Market. It involves free movement of goods and services, a common external tariff
structure and free movement of factors of production e.g. labour, capital and entrepreneurship.
5. Economic Union. This stage involves elimination of all tariffs among member countries,
adoption of uniform tariff structure on commodities for non-member countries, free mobility of
factors of production, adoption of harmonious economic policy, etc.
Conditions necessary for the success of economic integration
1. The countries/intending members must be relatively at the same level of development or else
resources will move from a less developed country to which is more developed.
2. Countries should be in the same region or share common borders to maximise gains. This
reduces the cost of transport between the trading partners.
3. The members or intending countries should have similar political and economic ideology e.g.
multi-party system/market economy etc. This makes the harmonisation of political and
economic policies easy.
4. The members or intending countries should be of approximately the same population size or
market size. This makes it possible for countries to equitably benefit from the integration.
5. The countries should be ready to maintain good political ties or relations among themselves.
This eases trade between the countries.

6. Comparative advantage must differ among the countries i.e. there should be specialisation in
different products to avoid duplication of products so as to widen market.
7. Presence of well-developed infrastructure to enable the free movement of factors of production
and commodities.
8. Intending member countries should have a common language/similar social customers. This
eases communication in trade.
9. Member countries need to have uniform currencies. It makes exchange easy and reduces the
cost of transaction since there is no need to convert from one currency to another.
10. The administration of member states must devise means of distributing the benefits and costs
which arise as a resulted of economic integration equally among member countries.
11. Member countries/intending countries should be politically stable. Political stability enables
countries to attract investment and allows easy movement of goods.
12. There should be laxed/relaxed boarder restrictions. This reduces unnecessary delays in the
delivery of goods and services
Benefits of economic integration
1. There is trade creation. This is when after economic integration member countries shift from
high cost goods of non-member states to low cost goods produced by member states. This
reduces foreign exchange expenditure.
2. There is an expansion of market for goods and services. This because of the rise in the number
of consumers which increases profits.
3. There is a reduction in duplication of resources/goods. This is because production is according
to comparative advantage.
4. It encourages specialisation among member countries and the associated advantages, such
increased production quality improvement since production is according to comparative
advantage.

5. Attracts foreign resources. Financial bodies can easily lend to such integration other than
individual countries because of the security guarantees by the different countries.
6. More employment opportunities are availed. This is because there is free movement of factors
of production especially labour force/the expansion of enterprises increases job opportunities.
7. It improves on the bargaining power of member countries in the international market which
increases the regions capacity to export and earn foreign exchange. This is because the
countries negotiate as a block.
8. There is production of quality goods. It encourages competition between member countries
and the result is production of quality goods and services.
9. There is promotion of economic and political stability. This is because of the greater
cooperation and mutual understanding between member countries.
10. The cost of undertaking some projects or programmes is lower. This is because they are in some
cases undertaken as joint ventures/encourages joint research.
11. It encourages increased production of goods and services. This is because of a bigger market or
consumers to serve.
12. There is greater utilisation of the available resources. This is because the wider market results
into establishment of more enterprises which increase resource exploitation and this increases
the GDP of the country.
13. It enables citizens in the member countries have access to a wider variety of goods. This is
because there many producers which increases consumer choice and welfare.
14. Trade can be eased by the use of one currency since it eliminates the need to convert from one
currency to another that leads to losses.
15. It leads to transfer of knowledge and skills among member states. This is because there is
movement of labour from one country to another.
16. Economies of scale are enjoyed by firms/efficiency is promoted. This is because of the wider
market served.
17. Stimulates industrial development. There is greater development of industries because of the
wider market available.

Disadvantages of economic integration
1. It leads to trade diversion. This is a situation where after economic integration member states
shit from low cost produced goods of non-member states to high cost goods produced by
member states.
The results among others include
• Consumption of poor quality commodities,  Commodities become expensive.

• There is high capital outflow.
• Low consumption level.
• Smuggling in of cheaper commodities from non-member states.
• Limited variety of commodities.
• Loss of government revenue.
• Discourages unity of member countries.
2. There is reduction/loss of customs revenue. This is because of elimination of taxes on imports.
3. There is unequal distribution of benefits i.e. some countries have more infrastructure, more
industries and as a result some countries benefit more than others.
4. Limited degree of self-reliance among individual member countries. This is because of
increased reliance on one another.
5. The movement of labour among member countries may encourage brain drain. This leads to
loss of skilled manpower to other countries.
6. Surplus output may be the outcome. This is due to production of similar products by member
states hence waste of resources.
7. The differences in member states cultures may not expand the market potential as thought. This
is because there are differences in tastes and preferences.
8. National interests are sometimes foregone at the expense of integration e.g. language, currency
etc. To harmonise trade some cherished aspects are forgone in the interest of the interest of the
integration.

Factors which limit economic integration among developing countries
1. Developing countries tend to produce similar goods and this reduces the incentive for countries
to integrate. This is because there is limited exchange of goods.
2. The failure to share benefits equally or the fear of unequal distribution of benefits. This results in
the reluctance of the-would-be members to join the integration.
3. There is fear to lose customs revenue since the countries heavily depend on tax revenue.
4. The existence of political instability in some countries or regions makes it difficult to carry out
trade.
5. Differences in economic policies make the harmonisation of the partnership difficult.
6. Differences in the levels of development make the less developed countries reluctant to join for
fear of being exploited.
7. Differences in social factors e.g. culture, region etc. which make communication and trade in
certain items difficult.
8. In some cases there are conflicts among leaders. Some of the leaders are therefore reluctant to
adopt agreed upon aspects.
9. Different currencies have different strengths which make exchange difficult.
10. There are external influences/interferences especially from the developed countries which try to
sabotage efforts of the intending countries for personal reasons.
11. Lack of political will/support because some leaders are reluctant to commit themselves basing
on nationalistic grounds or the fear to lose sovereignty.
12. Poor infrastructure among countries. This limits the ability of countries to conduct trade among
them because accessibility to markets is difficult.
13. Limited geographical proximity between countries. The long distance between some countries
makes trade difficult because it leads to high transport costs.
14. Differences in the market/population size. Some countries have bigger market and this makes
them earn more than other countries.
15. Differences in political ideology.

THE THEORY OF EXCHANGE RATES
Exchange rate refers to the rate at which the domestic currency is exchanged for other currencies.
OR
It is the price of the domestic currency in terms of other foreign currencies.
Types of exchange rates
1. The fixed/pegged exchange rate.

2. The floating/flexible exchange rate.
3. The mixed/managed exchange rate.
The fixed exchange rate
This is on in which the rate at which the local currency exchanges for other currencies is determined
and maintained by the central monetary authority (in relation to a particular foreign currency). The
rate can either be fixed below or above the equilibrium exchange rate as illustrated below:
When the exchange rate is fixed above equilibrium it is called devaluation (R 1) while if it is fixed below
equilibrium it is called revaluation (R2).
Advantages of the fixed exchange rate
1. It encourages capital inflow since it limits uncertainties in the foreign exchange market.
2. It encourages discipline among monetary authorities i.e. there is controlled issuing of the
foreign currencies.
3. Helps to stabilise value of the domestic and foreign currencies.

4. It discourages speculation in the foreign exchange market due to restricted or limited
depreciation/appreciation of currencies.
5. It encourages regional economic integration.
6. It makes prices of commodities more realistic in the international market.
7. Induces production and promotes economic growth.
8. Encourages investment.
9. Encourages long term planning/contract trade.
10. Stabilises prices in the economy/checks inflationary tendencies.
Disadvantages of the fixed exchange rate
1. It is associated with high administrative costs in that government has to employ people to
oversee the compliance with exchange rate set.
2. It is not appropriate in terms as it may cause inflation especially when there is high capital
inflow.
The floating/flexible exchange rate
This is one in which the rate at which the local currency exchanges for other currencies is determined
by market forces of demand and supply in the foreign exchange market. It is as illustrated below:
Re is the equilibrium exchange rate at which the demand and supply of foreign currency are equal. The
exchange rate is flexible because it can rise all fall depending upon the supply and demand for foreign
currency.
If the demand exceeds supply the exchange rate increases and if the supply exceeds the demand the
exchange rate falls.

NB: Under the floating exchange rate there can be currency appreciation or depreciation.
Currency appreciation refers to the increase in the country‟s currency value in terms of other
currencies as influenced by the forces of demand and supply in the foreign exchange market.
Whereas
Currency depreciation refers to the decrease in the country‟s currency value in terms of other
currencies caused by the forces of demand and supply in the foreign exchange market.
Effects of currency depreciation in an economy
1. It discourages investment.
2. Leads to unfavourable terms of trade/makes imports expensive.
3. Projected planning is made difficult.
4. Leads to loss of confidence in the local currency/Loss of government popularity.
5. Increases the volume of exports/reduces BOP problem.
6. Increases foreign capital inflow.
7. It encourages speculation.
8. Worsens the external debt burden.
9. Leads to inflation.
10. Exporters gain high local currency revenue.
Advantages of the floating exchange rate
1. It provides an automatic mechanism for correcting the balance of payment disequilibrium.

2. It preserves the autonomy of the domestic monetary policy.
3. It saves the country the burden of holding large official reserves.
4. It is cheap to administer.
5. It shows the most realistic value of the local currency in terms of other currencies.
6. It discourages the operation of parallel foreign exchange markets (black markets).
7. It encourages investment.
Disadvantages of the floating exchange rate
1. It encourages speculation in the foreign exchange market which is not good for business i.e.
anticipating gains is difficult.
2. It is inflationary in nature.
3. It creates uncertainty among the businessmen which negatively affects international trade.
4. It makes planning difficult since prices change from time to time.
The mixed/multiple/dual/managed floating exchange rate
This is one in which the forces of demand and supply determine the rate at which the local currency
exchanges for the other currencies but within limits set by the monetary authority/central bank.
Advantages of the mixed exchange rate
1. It ensures a favourable exchange rate in the foreign exchange market.

2. It checks speculation in the foreign exchange market.
3. The monetary authorities have some control over the exchange rate.
4. The importers and exporters are safe guarded from frequent fluctuations in their earnings which
causes losses.
5. Under valuation or overvaluation of local currency is possible.
6. It regulates the flow of funds in to and out of the country.

7. It allows the country to pursue its own domestic policies e.g. can easily stabilise price levels,
control income and expenditure.
8. It promotes international trade due to easy access to foreign exchange.
9. It provides an automatic mechanism of correcting trade imbalance or balance of payment
problems/deficits.
10. It reveals the strength/ the purchasing power of the local currency in international monetary
system.
Disadvantages of a managed floating exchange rate
1. It reduces the volume and value of international trade.

2. It is expensive for the government to administer.
3. It requires maintenance of large reserves.
4. It worsens the external debt burden of the country and instability in foreign exchange earnings.
5. It encourages speculation in the foreign exchange market.
6. It leads to depreciation of the local currency.
7. It causes economic instability/inflation/imported inflation.
8. It leads to balance of payment problems due to increased importation and reduced exportation.
Factors which determine the exchange rate in an economy
1. The volume of the domestic output. The higher the output the stronger the local currency
and vice versa.
2. The rate of domestic money supply. The higher the rate of domestic supply of money supply
the weaker the local currency and vice versa.
3. Volume of exports. The higher the volume of exports the stronger the local currency and vice
versa.
4. Volume of imports. The higher the volume of imports the weaker the local currency and vice
versa.

5. The level of foreign exchange reserves. The higher the volume of foreign exchange reserves
the stronger the local currency and vice versa.
6. The demand and supply of foreign exchange.
7. Government policy on exchange rate in case of a fixed exchange rate system.
8. The level of capital inflow. A high level of capital inflow causes appreciation of the local
currency while a high level of capital outflow causes depreciation of the local currency.
9. The rate of inflation in the economy. A high rate of inflation makes the domestic currency
strong and vice versa.
10. The political climate. Political instability weakens the domestic weaker and vice versa.
Foreign exchange control
Foreign exchange rate control refers to where the state/monetary authority regulates the rate at
which the local currency exchanges for foreign currencies.
Reasons for foreign exchange control
1. To stabilise exchange rates. This is achieved by the government intervening in the foreign
exchange market through buying and selling the foreign currencies.
2. To achieve price stability/control inflation. By stabilising the foreign exchange prices in the local
market are stabilised.
3. To encourage investment. With stable exchange rate investment is encouraged since
uncertainty is minimised.
4. To control the importation and consumption of undesirable goods. In this case the government
makes it difficult for importers to access foreign exchange.
5. To discourage speculation in the foreign exchange market. This is achieved by the government
using a fixed exchange rate system.
6. To encourage long term planning. By stabilising the exchange rate planning by government
becomes easy since prices are stable and there is no need to revise plans from time to time.
7. To protect domestic industries. This involves government making it difficult for importers to
access foreign exchange which limits importation of commodities into the country.
8. To check capital flight/control capital outflow. This involves government setting a rate that
makes it less attractive to transfer funds to other countries.
9. To ensure availability of foreign exchange so as to enable government and private individuals
access essential commodities/facilitate trade.
10. To acquire foreign exchange to service debts.
11. To improve on the country‟s BOP position by controlling imports and encouraging exports.
12. To earn revenue to the government under a multiple exchange rate system due to price
discrimination.
Advantages of foreign exchange control
1. It helps in preventing unstable capital outflow. This is because of the stability of exchange rates.
2. It helps to improve the BOP position of a country by restricting imports.
3. It ensures stability in the value of the domestic currency.
4. It encourages investment. A stable foreign exchange rate makes it easy to predict profits and
this encourages investment.
5. It discourages speculation in the foreign exchange markets and this promotes trade.
6. It encourages long term planning because of the elimination of speculation and improved
stability in the foreign exchange market.
7. It checks importation of undesirable goods. This is achieved when government limits
accessibility to foreign exchange by the importers.
8. It ensures stability in the foreign exchange market. This makes it easy to carry out international
trade Disadvantages

1. It reduces the volume as well as the value of international trade by restricting imports and
export.
2. It checks black markets in the foreign exchange market.
3. It is expensive as a number of people have to be employed for its smooth operation.
4. It discourages foreign investment especially when the exchange rate is too low.
5. It promotes retaliation in foreign trade.
6. It promotes corruption especially by those in authority.
Factors that influence/determine the demand and supply of foreign currency in Uganda
1. Price of imports. The higher the price of imports the lower the demand and supply for foreign
currency because few people are involved in import trade and vice versa when the price for
imports is high.
2. Volume of imports. The higher the volume of imports the higher the demand and supply of
foreign currency since more foreign exchange is needed to effect transaction.
3. Debt servicing requirements. The higher the need to service debts the higher the demand for
foreign exchange
4. Government‟s external obligations. The more external obligations the higher the demand for
foreign exchange and vice versa.
5. Corporate repatriation needs. The higher the level of corporate repatriation the higher demand
for demand for foreign currencies and vice versa.
6. Central bank intervention. The central bank intervenes in the foreign exchange market by
buying and selling foreign currencies. When the central bank buys foreign currencies there is a
decrease in supply of foreign currencies since there is withdraw of foreign currencies while when
the government sells foreign currencies there is an increase in supply of foreign currencies.
7. Government‟s external borrowing for consumption. A low level of borrowing for consumption
leads to low supply of foreign exchange while when there is high level of borrowing there is an
increase in supply of foreign currencies.
8. Price of exports. The higher the price of exports the higher the supply of foreign currencies since
there is an increase in foreign exchange earnings while low prices lead to
9. Volume of exports. The bigger the volume of exports the higher the supply of foreign exchange
because of the increased foreign exchange earnings while a small volume of exports results
into low supply of foreign exchange because of low foreign exchange earnings.
10. Need to accumulate reserves. The higher the need to accumulate reserves the lower the supply
of foreign exchange and vice versa.
11. Capital inflow. The higher the rate of capital inflow the higher the supply of foreign exchange
and vice versa.
12. Level of inflow of grants/donations.
Causes of foreign exchange shortages in Ldcs
1. Exportation of mainly primary products which fetch low prices.

2. High rate of capital outflow due to debt servicing.
3. Mismanagement of foreign exchange through corruption and bribery.
4. Rampant political instabilities hence high expenditure on military hardware.
5. Repatriation of capital by foreign firms/investors.
6. High marginal propensity to save.
7. Limited volume of exports.
How to conserve foreign exchange
1. Encourage import substitution.

2. Diversify exports.
3. Promote export oriented industries.
4. Improve the tax system to increase domestic earnings hence reducing borrowing.
5. Adopting devaluation.
6. Encourage foreign investors.
7. Encourage use of locally available resources.
Structural Adjustment programmes of International Monetary Fund (IMF)
1. Retrenchment/demobilisation/cost sharing.
2. Liberalisation.
3. Privatisation.
4. Devaluation.
5. Improvement of tax collection/introducing new taxes.
6. Promotion of export diversification.
7. Agricultural modernisation.
TRADE LIBERALISATION
Trade liberalisation refers to the removal of unnecessary controls on trade hence giving people the
liberty to trade without undue government controls.
Or
It is the removal of unnecessary restrictions to trade (by relaxing the use of instruments such as quota,
total ban, tariffs and administrative control) in order to give people opportunity for increased
participation in trade/to increase value, volume and benefits of trade.
Merits of trade liberalisation
1. Increased employment opportunities. The increase in the number of business enterprises results
into more employment opportunities.
2. Increased level of output hence increased growth rates.
3. Encourages resource(s) utilisation. The increase in the number of enterprises results into a
higher level of resource use.
4. Encourages inventions and innovations/technological transfer/technological development.
Investors improve technology through research and this causes improvement in the quality of
output.
5. Competition forces firms to be efficient in order to remain in business.
6. Improves quality of goods. This results from competition between firms and better technology
used in production.
7. Increases revenue to government. This is through taxation and this enables government to fulfil
its budget obligation.
8. Fights corruption. Private individuals are profit oriented and therefore ensure good
accountability in business undertakings.
9. Tends to control (structural) inflation. The large number firms involved in production provide a
large volume goods and this minimises shortage of goods.
10. Improved BOP position. The increase in the number of producers increases availability of
commodities and reduces expenditure on imports and exports are encouraged which increases
foreign exchange earnings.
11. Reduces income and wealth inequalities among people and regions. This is because it accords
many people the opportunity to engage in production improving their earnings.
12. Encourages foreign investment/inflow of capital/resources. The reduced participation of
government in business encourages investors to do business as this promotes fair competition
in business.
13. Upholds consumer sovereignty. Private individuals produce what is demanded by the
consumers.
14. Increased infrastructural development. This makes accessibility to inputs and markets easy.
15. Improves relations with other countries especially donors. This promotes trade between
countries.
16. Promotes economic diversification. This results from the many business enterprises started and
this brings about economic stability.
17. Promotes entrepreneurship skills. The people who start their businesses acquire skills to
manage the businesses.
18. Helps to develop labour skills. Demerits of trade liberalisation
1. Makes the economy susceptible to instabilities especially price fluctuations. This is because
individual producers set their own prices in order to maximise profits.
2. Leads to collapse of local firms since some of them are outcompeted by the more established
foreign firms that produce better quality products.
3. It leads to unemployment. When some businesses are pushed out of production the employees
lose jobs.
4. There is a danger of resource misallocation. Production mainly targets the production of
commodities demanded by the rich at the expense of the poor.
5. There is wastage of resources due to duplication.
6. Depletion of some resources due to over exploitation. Some businesses are profit oriented and
over exploit resources in a bid to maximise profits.
7. Flooding of markets sometimes force prices to go very low to unacceptable levels.
8. Distortion of consumer choice due to persuasive advertisement/intensive sales promotional
activities.
9. Consumer exploitation due to ignorance.
10. Encourages capital outflows. This is mainly by the foreign investors who repatriate profits.
11. May give rise to monopoly and its associated evils. When some firms are pushed out of business
those that remain monopolise the market and exploit consumers.
12. Leads to increased exposure of consumers to harmful products. This because of limited
regulation of production of some commodities by the government.
13. Leads to income and wealth inequalities. Production is mainly undertaken by the rich who
accumulate wealth and become richer.
14. Environmental degradation is accelerated. This is mainly by the profit hungry producers who
over exploit the resources.
15. Leads to foreign economic dominance.
PUBLIC FINANCE AND FISCAL POLICY
PUBLIC FINANCE
This deals with financial activities of the government and public authorities. It is the study of how the
government raises money and how it spends. The study of public revenue is divided into the
following:
1. Public revenue. This involves studying the methods of raising public revenue and the principles
of taxation.
2. Public expenditure. This involves studying the principles and effects of public expenditure on
the economy.
3. Public debt management. This involves studying the causes and methods of public borrowing
as well as public debt management.
4. Financial administration. This involves studying the preparation and execution of the budget.
5. Fiscal policy. This involves government use of taxation, borrowing and government expenditure
to regulate the level of economic activities in the country.
PUBLIC REVENUE
This refers to the funds received by the government from different sources. Government undertakes
various activities and therefore needs income to fund these activities. The main sources of
government can be categorized into two. (a) Tax revenue and (b) Non-tax revenue.
Tax revenue
This is derived from various sources i.e. direct and indirect taxes.
Non- tax revenue

These include several sources;
(i) Fines and penalties. These are not imposed as collected revenue but to punish the people for
the infringement/breaking of state laws.
(ii) Fees. These are payments made by the individuals to the government for personal services
rendered to them by the state e.g. education.
(iii) License dues. This refers to payments to government to secure permission to carry out any
profitable activity e.g. trade.
(iv) Profits from government profit enterprises. Government at times owns
companies/shares in public companies.
(v) Income from lotteries. A means of raising money by selling numbered tickets and giving
prizes to the holders of numbers drawn at random.
(vi) Foreign aid

(vii) Gifts and grants from within and outside the country. Financial donations given to
government to cater for the cost of specific projects or help a country out of a financial
problem.
(viii) Special assessments. A special assessment is a compulsory contribution levied in proportion
to the special benefits derived to cover the cost of a specific improvement made to property
undertaken in public interest.
(ix) Loans from both internal and external.
(x) Sales of government property/ disinvestment.
(xi) Rents from government owned property.
(xii) Deficit financing/printing more money to finance expenditure.
(xiii) Market dues charged on those who sell goods in the market.
(xiv) Rates. These are charges imposed on owners of specific types of property especially in urban
areas. E.g. rates charged on private property like houses or land.
(xv) Fundraising.
(xvi) Tolls e.g. road and bridge tolls.
(xvii) Forced savings.
TAXATION
A tax is a compulsory non-quid-pro-quo payment made to the government for the purpose of
administering certain services to the public as a whole.
OR
A tax is a compulsory transfer of money from private individuals, institutions or groups to the
government.
A tax is a compulsory contribution to the states revenue assessed and imposed by a government on
individuals and business enterprises.
Reasons for imposing taxes

1. To generate revenue. Taxes are imposed to raise revenue to enable government provide
essential goods and services. This is by imposing direct and indirect taxes.
2. To redistribute income/wealth. Taxes help to reduce income inequalities especially progressive
taxes since the rich pay more than the poor.
3. To protect domestic infant industries. High taxes help to protect infant industries against the
cheap dumped commodities from abroad. This enables them to grow and compete
internationally.
4. To correct BOP problems. This is achieved by taxing imports highly which reduces their demand
since they become expensive and imposing low taxes on exports making them cheap. This
reduces import expenditure and increases foreign exchange from exports.
5. To check consumption of harmful commodities. Taxes imposed on some commodities
discourage their consumption because they become expensive which reduces their demand
thus protecting people‟s health.
6. To control the emergence of monopolists. High taxes reduce the profits realised by the
monopolists and this reduces their economic power and influence in the market.
7. To influence resource allocation. The taxation of some commodities highly and imposing low
taxes on others results into the channeling of resources from production of the highly taxed to
low taxed commodities.
8. To check inflation in the economy. Imposing taxes in on imported commodities checks
imported inflation because taxes make the commodities expensive, while taxes on income
check demand pull inflation since direct taxes reduce disposable income.
9. To reduce the dumping of commodities so as to reduce the competition between local products
and those that are from other countries.
10. To influence the level of economic growth. High taxes on enterprises cause low level of
investment and production because they lead to high production costs while low taxes cause
low production costs and this encourages investment and production hence high rate of
economic growth.

11. To encourage hard work and initiatives/effort. When high taxes are imposed people are
discouraged from working since the taxes reduce their incomes and vice versa when taxes are
low.
Canons/principles of taxation
1. Canon of equity. Every person should be taxed according to his ability to pay i.e. the rich should
pay more and the poor less and for this reason taxes should be progressive in nature. Equity is
either horizontal or vertical. Vertical equity means treating people differently so that high
income earners pay high taxes than low income earners.
2. Canon of certainty. The time of payment, the manner of payment and the amount to be paid
should all be clear to the tax payer and collector. The amount of tax to pay should be known and
not arbitrarily determined.
3. Canon of convenience. The time and mode of payment of the tax should be so fixed that it
makes it easy for the tax payer to pay. E.g. a tax should be collected when one has income e.g. at
the end of the month.
4. Cheapness/economy. The cost of collecting or administering tax collection should be as low as
possible. I.e. the cost of collecting taxes should be smaller/low in proportion to the amount to
be collected.
5. Simplicity. The nature of the tax, its assessment and collection should be straight forward and
understood by both the tax payer and collector. This helps avoid hostility between the tax
payers and the collectors.
6. Elasticity/buoyancy. A good tax should be flexible, i.e. it should be capable of easily being
altered to meet the changing financial requirements of government.
7. Productivity. A good tax should be able to encourage effort and initiatives and should not
discourage investment.
8. Neutrality. There should be no discrimination in taxation on the basis of tribe, race, religion, etc.
The tax should treat different categories according to their income.

9. Optimality. Taxation should maintain a balance between revenue collected and services
rendered.
10. Comprehensive. A good tax system is one which touches as many sources/bases as possible so
that a lot of revenue is generated.
11. Consistency. Should be in line with national economic objectives, especially in allocation of
resources.
12. Should avoid double taxation. A tax payer should not use the same source/base to pay a tax.
Classification of taxes
1. Proportional tax. This is where whatever the income the same rate or percentage is paid from
ones income. Or where the rate of tax is constant for all tax payers regardless of the level of
income. E.g. 10% of one‟s monthly income.
Tax rate
R0
0 y1 y2 Income
In the illustration the same rate of tax is paid irrespective of the changes in income from y 1 – y2.
2. Progressive tax. This is a tax whose percentage rate increases as the income of an individual
increases. I.e. as the income increases the tax also increases gradually and vice versa. It has the
following effects: - yields high revenue to government, ensures equitable distribution of
income, favours the low income earners and helps to fight demand pull inflation.

Tax rate
R1
R2
Y2 y1 Income
In the illustration above as income increases from y 1 – y2 the
rate also increases from R1 –
R2
3. Regressive tax. This is one whose percentage rate decreases as the income increases. i.e.
as the income of a person increases the tax rate reduces.
Tax rate
R1
R2
y1 y2 Income
4. Digressive tax. This is where the percentage rate increases with increases with income, however
it tends to be uniform after a certain income level has been reached.
Types of taxes
Direct taxes

These are taxes levied on incomes and property of individuals and enterprises such that the incidence
of the tax rests on the tax payer concerned and cannot be shifted to another person e.g. personal
income tax, property tax etc.
OR it is a tax imposed on one‟s income/property and the burden of the tax cannot be shifted to
another party. It is paid by the one intended to bear it. The examples under this type are:
1. Personal income tax. This is a tax levied on the income of an individual.

2. Corporation tax. This is a tax levied on the profits of a company.
3. Death duty. This is a tax levied on the property of the deceased person before transfer to
another person.
4. Capital gains tax. This is a tax imposed on financial assets whose values have
increased/appreciated from time of their purchase to the time of their sale.
5. Inheritance duty. This is the tax applied to transfer of wealth made on death.
6. Gift tax this is one levied on gifts received by an individual.
7. Capital levy. A special tax levied on the rich to finance emergencies.
8. Surtax. A tax on people with exceedingly high incomes.
9. Graduated tax this is one levied on an individual basing on his income and property holdings.
Advantages of direct taxes
1. They ensure equitable distribution of income. This is because they are progressive in nature
since the rich pay more than the poor e.g. pay as you earn.
2. They have an element of certainty. They are more predictable by both the tax payer and tax
collectors. Tax payers know the amount and the time to pay the taxes.
3. They are flexible. This is because they can easily be increased or reduced depending on the
financial requirements of the country.
4. They are productive. They help government generate revenue and therefore a small increase in
tax yields a lot of revenue.
5. They influence resource allocation e.g. corporate taxes.

6. They promote hard work/initiative by individuals and companies. This because firms and
individuals put in extra effort as they Endeavour to pay.
7. They are convenient because the burden is spread over sometime i.e. it is not paid in lump sum.
8. They promote consciousness and awareness among tax payers/civic responsibility.
9. Help to reduce/control inflation. This is because they reduce the disposable income which
reduces aggregate demand.
10. They help to regulate/control monopoly powers. High corporate taxes reduce the capacity of
the monopoly firms to expand and influence the market.
11. Encourage economic growth/production. Low taxes encourage the establishment of firms
because of the low cost of production which increases the level of output hence high rate of
economic growth while high taxes discourage production and investment because they
increase the cost of production causing low levels of economic growth.
12. They redistribute income in an economy. The rich pay more while the poor pay less. e.g.
progressive taxes.
13. Direct taxes do not directly affect commodity prices and therefore cause less resent towards the
government.
Disadvantages of direct taxes
1. They are discriminative because they are not paid by all; some groups are exempted from
paying. Hence less revenue is realised.
2. High direct taxes discourage effort and hard work e.g. high corporate taxes discourage
industrialists since their profits significantly reduced.
3. They are associated with high incidents of evasion and avoidance as a result they lead to low
revenue on the part of government.
4. They are arbitrarily determined/are unfair. The assessment and collection are harsh and cruel.
This creates resentment among the people hence low revenue is generated.
5. High direct taxes reduce aggregate demand. This is because they reduce disposable income
and this discourages investment.
6. They are uneconomical. The cost of collecting them is very high/high cost of
administration/high government expenditure on collection.
7. Lead to inflation e.g. cost push inflation. As the government imposes taxes on employees they
request for wage increment and this causes wage push inflation.
8. They lead to resource diversion from highly taxed activities to sometimes non-productive
ventures which are not taxed e.g. high corporate taxes.
9. Direct taxes are easily noticeable by the public and therefore can cause political and social
unrest.
10. They hinder the expansion of firms since profits are taxed that would have been ploughed back.
Indirect taxes
These are taxes imposed on commodities and the burden can be shifted by the tax payer on to
another party wholly or partially in form of high prices e.g. import tax, export tax, etc. They
include:
1. Excise duty. This is a tax imposed on the production of commodities whether they are meant for
local consumption or export.
2. Customs duty. This is the tax imposed on the import and export of commodities. They are of
two types;
(i) Export duty. This is a tax on those commodities that are leaving the country for
countries abroad.
(ii) Import duty. This is a tax imposed on those commodities entering a country e.g.
cars, cosmetics.
3. Sales tax. This is a tax levied on the level of transactions which take place between the seller and
the buyer of a particular commodity in a country weather produced locally or imported.
4. Value added tax. This is a tax which is imposed on the improvement made on product at
different stages of production.
5. Sumptuary tax. It is a tax which is imposed on the consumption of goods in the country usually
to discourage the consumption of certain commodities.
6. Octori tax. This is a tax levied on the goods in transit from one state through the territory of
another state.
Advantages of indirect taxes
1. They are productive. A small increase in the tax rate results into high government revenue and
therefore contributes more to government revenue.
2. They are economic because the cost of collecting them is small since the producers and sellers
deposit them with the government.
3. They are comprehensive in nature because they can be levied on a wide variety of goods and
they do not discriminate.
4. Indirect taxes are associated with low evasion. This is because they are imbedded in the price.
5. They are flexible. They are therefore easy to adjust depending on the financial needs and
economic conditions of the country.
6. They are instrumental in checking the production and consumption of harmful products. Once
imposed on commodities they become expensive which reduces their demand.
7. They help to protect infant industries byway of using high import duties to discourage imports
since the commodities become expensive.
8. They help to improve the BOP position of the country. High import duties discourage imports
and low export duties encourage exports.
9. They are less felt and resented because they are imbedded in the price.
10. They lead to easy redistribution of income. This is when they are selectively imposed for
example high taxes on luxuries and low taxes on essentials.
11. They are convenient to the tax payer because they are paid only when one purchases a
commodity.
12. They influence resource allocation heavy indirect taxes can be used to discourage production of
commodities and channels resources to productive resources.
Disadvantages of indirect taxes

1. There is uncertainty in the revenue from the taxes. This is because it is not possible to accurately
estimate their effect on production and consumption and as such a small increase can
significantly lead to decline in revenue.
2. They are regressive in nature. The poor and the rich pay the same amount for goods consumed,
they therefore cause income inequality.
3. High indirect taxes have a bad effect on production and employment because they increase the
cost of production and employers take on few workers to reduce cost of production.
4. They are inflationary in nature. This is because their imposition increases the cost of production
and subsequently producers increase prices of commodities.
5. They cause planning difficulties. This is due to the uncertainties in the revenue generated and
the effects they have on imports and exports.
6. They promote inefficiency in the infant industries. When indirect taxes are used to protect
domestic infant industries they are shielded from competition and this leads inefficiency in the
local firms.
7. Lead to diversion of resources from more taxed commodities to the production of nontaxed
commodities leading to misallocation of resources.
8. They lead to trade malpractices such as smuggling. Some traders try to avoid and evade taxes
and therefore engage in malpractices to maximize gains.
9. Reduce people‟s welfare because they reduce the disposable income of the consumers.
10. Discourage international trade i.e. custom duties reduce imports and exports.
Advantages of VAT
1. It widens the tax base hence causes an increase in government revenue.
2. It encourages efficiency in business since there is record keeping.
3. It minimises tax avoidance.
4. It minimises tax evasion.
5. It minimises the informal sector.

6. It reduces trade malpractices e.g. smuggling.
7. It minimises double taxation. Disadvantages
1. It is complex to understand thus it lacks the quality of simplicity.
2. It causes resentment and makes government unpopular.
3. It is discriminative as some goods are not included.
4. Discourages savings and investment because it makes people spend more on goods and
services.
5. It reduces consumer welfare as it increases prices of goods and services.
CONCEPTS USED IN TAXATION
Taxable capacity. This is the ability of the tax payer to pay a tax imposed on him/her and
remains with sufficient disposable income to enable him/her live a decent life to which he/her
family is accustomed.
OR
It is the ability of a nation to raise expected revenue from taxes without causing socially harmful
results or effects.
Or
It is the extent to which government can levy taxes without causing adverse effects on tax
payers.
Causes of low taxable capacity in developing countries
1. High poverty levels which cause inability to start income generating activities/low incomes.
2. Presence of income inequalities which result in few people being taxed thus low revenue is
generated.
3. Low level of economic activity e.g. industrialisation, services, etc.
4. Low levels of commercialization and as a result there are few activities to tax.
5. Poor consumption habits.
6. Limited tax bases due to high tax concessions
Tax base. This refers to an entity, income or property items on which a tax is levied.
The causes of narrow tax base in Uganda are:
1. Poorly developed infrastructure. This makes accessibility to potential tax bases difficult.
2. Large subsistence sector/limited commercialisation of the economy. This results into few taxes
as the activities of the sector are not taxed.
3. Limited employment opportunities. There are few people who are formally employed and this
results into fewer people being taxed.
4. Tax exemptions/provision of tax incentives to potential tax payers by government.
5. Poor identification of sources/limited skills of the tax officials. Some activities are left out due to
poor skills hence low tax revenue.
6. Small formal sector/large informal sector. Some businesses are not known to government
because they are not registered and therefore not taxed.
7. Political instability making it difficult to assess certain possible tax avenues
8. Limited diversification of economic activities. There are few activities upon which to impose
taxes.
9. Low level of income.
10. Low level of accountability/corruption. Some people who should be taxed are left out or taxed
less than they should.
Tax yield. This refers to the amount of money that results when the rate of tax is applied to
money value of the tax base, minus the cost of collecting the tax.
OR

This means the net revenue from taxation after the cost of tax administration has been
deducted from the total collection.
Tax avoidance. This is a situation where the tax payer exploits loopholes in the tax laws not to
pay part or the whole tax levied on him/her.
Tax evasion/tax default. This is when a tax payer deliberately refuses to pay the tax
assessed on him or her. It is illegal and punishable by the law.
Causes of tax evasion are:

1. The desire by the tax payer to keep all income.
2. Ignorance of the tax payer of the advantages of paying taxes
3. Imposing high taxes on the public.
4. High level of corruption in tax administration.
5. Limited benefit realised by the tax payers.
6. Unfair tax assessment.
7. Weak tax administration/ineffective enforcement of tax laws.
8. Unpopularity of the government to some tax payers/political sabotage.
Tax burden. This is the immediate strain felt by the tax payer as soon as payment of the tax has
been effected. This may be in the following forms:
(a) Direct money burden. This refers to the loss of money in form of paying the tax.
(b) Indirect money burden. This refers to a situation when an individual, company/economic
entity loses money that would have been used somewhere else.
(c) Direct real burden. This refers to the loss of economic welfare as a result of paying the tax. Or
the reduction of the ability of an individual to purchase goods and services as a result of the
tax.
(d) Indirect real burden. This is where and when the tax on a commodity increases its price
leading to a reduction in the consumption of that commodity.

Taxable income. This is the amount of income which is subjected to taxation.
Impact of a tax. This refers to the person or firm on whom a tax is officially/initially levied.
OR
It refers to the first resting place of a tax.
OR
The immediate effect of a tax on a person on whom it is levied.
One may however shift forward or backward onto another party. Shifting of the tax may take
the following forms:
(a) Forward shifting of the tax. This is where the tax payer passes the tax revenue to the next
party in the distribution chain e.g. a retailer passing on the tax burden to the consumer in
form of increased price.
(b) Backward shifting of the tax. This where the tax payer passes the tax revenue to the
previous stage in the production process e.g. when the producer shifts the tax burden to the
raw materials supplier in form of reduced prices of the raw materials.
Incidence of a tax. This refers to the final resting place of a tax imposed or the person who
ultimately bears the money burden of the tax imposed.
Incidence of a tax depends on the type of tax.
(a) For direct taxes, the incidence and impact are on the same person i.e. the incidence
cannot be shifted onto another party.
(b) For indirect taxes, the incidence falls on either the producer, consumer or shared by both
depending on the elasticity of demand and supply for the commodity.
Factors that influence incidence of a tax
1. Elasticity of demand for the commodity.

2. Price of the commodity.
3. The type of tax.
4. Nature of the market
Elasticity of demand and supply and incidence of a tax
1. When demand is inelastic and supply is elastic
Price D S
P0 S
P1
P2
0 Q 0 Q1 Quantity
Tax
The consumer pays tax equal to P0 P1 while the producer pays P1 P2 the consumer pays more.
2. When demand is elastic and supply inelastic

Price
Tax D S
P1
P0
P2
0 Q0 Q1 Quantity
The consumer pays P0 P1 while the produce pays P0 P2 the producer pays more.
Specific tax. This is a tax that is levied as a fixed amount per unit of a commodity. Also called
per unit tax e.g. a tax on each bottle of beer.
Advalorem tax. This is the tax levied as a percentage of the value of the commodity.
Deadweight tax. This is one which when imposed causes the tax payer to abandon the
activity which forms the tax base on which the tax is levied.
Tax rebate. This refers to the reduction of a tax mainly used to encourage investment.
THE EFFECTS OF TAXATION
Positive effects

1. Taxes are a source of government revenue.
2. It helps to protect domestic infant industries. It helps to protect domestic infant industries from
competition of cheap/dumped commodities which enables them to grow and become
competitive. This is by way of imposing high taxes on dumped goods which makes them
expensive and people prefer locally produced goods.
3. Helps to influence resource allocation. Helps to influence resource allocation from nonessential
products to essential product. This by imposing high taxes on the non-essential products and
low taxes on essential products.
4. Helps to reduce consumption of harmful products. The imposition of high taxes on harmful
goods reduces their demand. This is because they become expensive after taxation.
5. Helps to redistribute incomes in society and this achieved by imposing high taxes on the rich
and low taxes on the poor.
6. Helps to check inflation in an economy. High taxes on people‟s incomes reduce the disposable
income and thus a fall in the purchasing power and as demand falls prices also fall.
7. Helps to improve the balance of payments position. By imposing high taxes on imports and low
taxes on exports, this causes reduction in foreign exchange expenditure and increased earnings
from exports.
8. Helps to influence the level of economic growth. Low taxes increase investment and production
because they reduce cost of production hence a high rate of economic growth while high taxes
cause a low level of investment and production leading to low rate of economic growth.
9. Helps in regulating or controlling monopoly power. High taxes on monopolists reduce their
profits and this limits capacity to expand and influence the market.
Negative effects
1. Taxation reduces consumer‟s welfare. This is because taxes reduce the disposable income of
people reducing their consumption.

2. High taxes discourage investment. This is because they increase the cost of production and
reduce profits e.g. high indirect taxes
3. High taxes lead to trade malpractices such as smuggling of goods from neighboring countries.
Government loses revenue as they try to evade and dodge taxes.
4. It creates resentment that erodes popularity of the government especially high direct taxes. An
increase in taxation reduces welfare because it reduces disposable income.
5. Taxes lead to diversion of resources from highly taxed commodities that are essential to
production of low taxed commodities that are non-essential.
6. High taxes discourage saving because income available for saving is reduced.
7. Discourage effort and initiative since working hard means more income and high taxes.
8. Indirect taxes are inflation since imposing them on producers‟ results into a high cost of
production.
9. Reduces the volume and benefits of trade i.e. it reduces the income of the producer.
10. Breeds inefficiency in the protected firms/protected firms tend to remain infants. This is because
once taxes are imposed on imports the local firms are not exposed to competition.
Problems faced by tax authorities in low developed countries
1. Narrow tax base. This is attributed to low incomes of the people and the few economic
activities on which to levy taxes therefore less revenue is realised.
2. Low taxable capacity. Most people are poor and businesses are weak which result into limited
capacity to pay taxes.
3. There are high incidents of tax evasion. This is because of poverty, unfair assessment,
harassment in collection etc. and as a result many people are not willing to pay.
4. High levels of tax avoidance. This is because of loopholes and the lack of strictness of the tax
laws and as a result many people are not willing to pay.
5. Political instabilities in some areas. These negatively affect economic activities and make
collection of revenue difficult.

6. There is corruption in the collection of taxes. The tax officials swindle money and as such less
revenue is realised by governments.
7. Frequent changes in employment make it difficult to truck the tax payers for assessment and
collection of taxes/there is a large informal sector which means it is difficult to assess those who
should pay and therefore there are many people who do not pay taxes.
8. The conflicting government objectives/policies e.g. tax exemptions to encourage investment.
These are policies that on one hand give exemptions on the other hand government imposes
high taxes to generate.
9. Political interference in assessment and collection of taxes. Some potential taxes are left out
because of their connections to politicians.
10. Resistance from the public against tax payment/ignorance of the public about the importance
of paying taxes and therefore most people view payment of taxes as a punishment rather than
an obligation and contribution towards nation building.
11. Difficulty in identifying taxable sources because of using unskilled labour. Some tax sources are
left out by the assessor as a result less revenue is generated.
12. Shortage of skilled manpower to help in the collection and assessment of taxes. Less revenue is
generated because some sources/bases are not tapped and therefore government loses
revenue.
13. Poor infrastructure and this makes accessibility to potential tax payers very difficult and
therefore less revenue is generated.
Methods or ways to improve the tax collection/system in Uganda
1. Reduce/eliminate corruption which can be done by penalizing or imprisoning the culprits.

2. Sensitise the masses on the importance of taxation so that people do not look at taxes as a
punishment but as something necessary for better services delivery.

3. Develop a tax payer friendly system of collection by making the time of payment, place, etc.
known to the tax payer. This encourages the tax payers pay promptly.
4. Adopt the principle of equity/fair assessment. This helps to minimize the incidents of evasion
and avoidance.
5. Build up infrastructure. This makes it easy to access potential tax payers in different parts of the
country.
6. Train or use trained personnel to assess and collect taxes. This minimizes the loss of revenue as
a result of poor assessment and collection.
7. Ensure proper and effective use of taxes. It reduces the resentment towards tax collectors.
8. Improve implementation of the tax laws. This minimizes embezzlement, avoidance and tax
default.
9. Ensure political stability. This increases range of economic activities for taxation and also makes
tax assessment and collection possible since the employees are assured of security for their lives
10. Reward tax collectors properly. By giving them fair wages it minimizes swindling of funds.
11. Develop a comprehensive tax system by tapping into many bases. This increases the tax base as
well as tax revenue.
Suggest measures of increasing tax revenue in Uganda
1. Reducing/eliminating corruption which can be done by penalizing or imprisoning the culprits.

2. Sensitising the masses on the importance of taxation so that people do not look at taxes as a
punishment but as something necessary for better services delivery.
3. Develop a tax payer friendly system of collection by making the time of payment, place, etc.
known to the tax payer. This encourages the tax payers pay promptly.
4. Ensuring fair assessment. This helps to minimise the incidents of evasion and avoidance.
5. Improving infrastructure. This makes it easy to access potential tax payers in different parts of
the country.
6. Training or using trained personnel to assess and collect taxes. This minimises the loss of
revenue as a result of poor assessment and collection.
7. Ensuring proper and effective use of taxes. It reduces the resentment towards tax collectors.
8. Improving implementation of the tax laws. This minimizes embezzlement, avoidance and tax
default.
9. Ensuring political stability. This increases range of economic activities for taxation and also
makes tax assessment and collection possible since the employees are assured of security for
their lives
10. Rewarding tax collectors properly. By giving them fair wages it minimizes swindling of funds.
11. Identifying new tax bases. This increases tax revenue because there more entities contributing
to government revenue.
12. Diversifying economic activities. This increases entities on which to impose taxes.
13. Encouraging registration of firms. This helps to easily identify businesses on which to impose
taxes.
14. Encouraging proper record keeping. This helps the tax authorities to ensure fair tax assessment.
15. Minimising incentives given to investors. This helps government to collect more revenue.
PUBLIC/ GOVERNMENT EXPENDITURE
This refers to the using of money/revenue in the provision of public services and influencing economic
activities so as to improve welfare of the people and achieve economic growth.
Public expenditure takes different forms and these are: (a)
Recurrent expenditure and (b) Development expenditure.
1. Recurrent expenditure. This refers to the day to day spending of government aimed at
maintaining the existing capacities e.g. payment of wages for civil servants, rates, rents etc.
2. Development/capital expenditure. This is the expenditure by the government on the
establishment of projects for purposes of both expanding existing capacities and creating new
ones to generate more goods and services. e.g. expenditure on setting up medical centres,
schools, roads etc.

Causes of high government expenditure in LDCs/Uganda
1. Rapid population growth rate. This causes high government expenditure to support the
increasing population in terms of providing services e.g. medical care, education etc.
2. Debt servicing. Here government spends money paying the principal and interest thus high
expenditure abroad.
3. Alleviating the effects of natural calamities. The government spends money providing
assistance to those who have been hit by disasters so there welfare improves in case of drought,
floods, famine etc.
4. Political instabilities in some parts of the country this increases military expenditure purchasing
fire arms etc.
5. Development and rehabilitation of infrastructures. These require heavy spending yet funds are
not readily available through taxation, such as roads, power dams that require heavy
expenditure.
6. Poverty alleviation programmes. The government spends a lot of money financing poverty
reduction programmes so that people can start income generating activities e.g. NAADS,
prosperity for all etc.
7. Big size of civil and public servants. The government spends a lot of money in paying salaries
and allowances for civil servants who are very many in different departments.
8. Corruption and embezzlement of funds. This forces the government to make supplementary
budget to replace the money stolen government officials in different departments.
9. Frequent state visits to foreign countries by president, MPs, ministers these spend a lot of
money abroad.
10. Increased number of administrative units e.g. districts. Government spends a lot of money on
employees.
11. High rate of inflation. This off sets the budget plans because money loses value and this calls for
supplementary budget.

12. Continuous over ambitious planning. This necessitates government to spend heavily to finance
the budget.
Measures undertaken to reduce government expenditure
1. Ensuring political stability by democratic governance and hold peace talks with rivals thus
reducing military expenditure.
2. Privatization of public enterprises. This reduces expenditure on financing and maintaining
public enterprises.
3. Retrenchment of civil servants thus reducing the high wage bill.
4. Debt rescheduling this reduces government expenditure in the short run.
5. Strengthening management of public funds. The government has set up institutions to fight
corruption such as IGG, Auditor General, etc.
6. Cost sharing in public institutions like hospitals, schools to reduce government expenditure on
provision of social services.
7. Population control measures to reduce government expenditure on provision of social services.
PUBLIC DEBT MANAGEMENT
Public debt refers to the total borrowing (both internal the central external) by the central
government, local authorities and public corporations. It is a debt incurred by the state as a result of
borrowing from within a country and foreign sources.
National debt is money owed by the state (central government) to people and institutions within its
borders or to foreigners, excluding the debts of local authorities and public corporations.
Public debt management refers to the process of acquiring, utilizing, servicing and repayment of
debts by the central authority or local authority or public corporations.

Objectives of public debt management
1. To maintain price stability. Borrowing from the public reduces money in circulation hence
stabilising prices.
2. To influence income distribution/to control income inequality. Government achieves fair
distribution by using progressive taxes.
3. To ensure proper utilization of funds/minimize or control corruption.
4. To influence the rate of interest. A low rate of borrowing causes a low rate of interest while a
high rate of borrowing causes an increase in the interest rate.
5. To reduce the debt burden/minimize the cost of the public debt. This is through debt
conversion.
6. To mobilize financial resources. The central bank identifies and mobilises funds by selling bonds
and treasury bills.
Reasons for borrowing
1. To fill the savings- investment gap because the savings in developing countries are not
sufficient to generate investment.
2. To ease the burden of taxation on citizens in the short run. By borrowing the government does
not need to impose high taxes to raise revenue.
3. To raise funds needed for recurrent public expenditure.
4. To finance BOP deficits in the short run/filling the foreign exchange gap. Borrowing avails the
needed foreign exchange to use in purchasing imports.
5. To control inflation by reducing amount of money in the hands of the public e.g. through selling
securities to the public.
6. To help repay interest and even the principal sums borrowed. The borrowed funds enable
government to pay the earlier acquired debts.
7. To help the country borrowing achieve and maintain a given level of employment. Funds
borrowed are used to establish projects which offer employment opportunities.
8. To sustain market by leaving citizens with adequate disposable incomes.
9. To handle the effects of calamities/disasters. Borrowed funds enable government give aid to
those affected by calamities and thus enabling them to have a fairly decent life.
Types of debts
1. Internal debt. This is one raised from within the country. This is in form of selling bonds and
treasury bills to the public.
2. External debt. This involves borrowing from abroad from external sources like international
financial institutions such as IMF, World Bank, etc.
3. Funded debt is a long term debt for which there is no redemption date/date of repayment but
the borrower keeps on paying annual interest on the principal.
4. Unfunded debt. This is a long term debt for usually less than a year for which the government
does not create a special fund for paying it. Or a debt with no stated future date/time for
repayment.
5. Redeemable debt. This is the debt which is repayable by the government after a specific period
of time.
6. Irredeemable debt. This is one whose principal amount is not refunded by the government
however interest rate is paid.
7. Reproductive debt. This is one where money is obtained and invested in productive activity that
generates income for the debt liquidation.
8. Unproductive debt/deadweight debt. This one which is acquired and used/spent on projects
which are not self-liquidating. Or debt acquired to finance non-productive activities.
Differences between debt financing and taxation financing
Debt financing is where government borrows to finance its expenditure that may not be
covered by tax revenue.
Whereas
Taxation financing is where government uses revenue from taxes to finance its expenditure.
The advantages of debt financing over taxation financing are:
1. Borrowing does not have negative political effects compared to taxes that may cost that may
cost the government political popularity.
2. It is sometimes easier to borrow than to tax.
3. Borrowing helps to realise a lump sum of money compared to taxes where revenue comes in
slowly/it is a quicker way of raising money.
4. Borrowing arguments tax revenue that tends to be slow because of the narrow tax base, low
taxable capacity, etc.
5. Through borrowing government makes use of both external and internal sources compared to
taxation that is only internal.
6. Borrowing does not have adverse effects on consumption compared to taxation that reduces
disposable income.
7. Debt financing does not involve costly methods of collection compared to taxation.
8. Borrowing does not raise costs of production compared to taxation that leads to inflation as a
result of indirect taxes.
9. Borrowing does discourage savings and investment as is the case with taxation.
10. The debt burden of borrowing can be shifted to future generation something which cannot be
done with taxation.
Effects of borrowing in an economy
1. It supplements government revenue/fills the government revenue expenditure gap.

Borrowed funds supplement government revenue from taxes which is at times not enough.
2. Reduces negative effects of taxation on work effort and consumption/easen the burden of
taxation on citizens. By borrowing the government does not impose heavy taxes to raise
revenue and this encourages effort and leaves citizens with sufficient disposable income.
3. Fills the manpower gap/increases labour skills. Funds that are borrowed are used to finance
the training of manpower which improves the skills of labour.
4. Helps to fill the savings-investment gap/raises funds for investment. The money borrowed
government avails funds needed to purchase the required inputs and this encourages
investment.
5. It narrows the technological gap/facilitates importation of modern technology. Borrowed
funds are used to finance the purchase of modern technology or to finance research which
leads to better production techniques.
6. Helps to fight demand pull inflation-the case with internal borrowing. Government
borrowing from the public using bonds and treasury bills reduces the amount of money in
circulation and this causes a fall in aggregate demand and therefore a fall in prices.
7. Increases employment opportunities. Borrowed funds are used to finance the setting up of
projects that provide employment opportunities to the citizens.
8. Fills the foreign exchange gap/finances BOP deficits in the short run. External borrowing
avails to government the needed foreign exchange and thus over-coming the foreign
exchange shortages.
9. Sustains market by leaving consumers with adequate disposable incomes. Borrowing by the
government enables government to levy low taxes on the citizens and this leaves them with
sufficient disposable income.
10. Helps to settle debts. Government borrowing enables it to pay debts acquired earlier/debt
conversion.
11. Promotes industrial development. It promotes industrial development because the borrowed
money is used to finance the setting up of industries as it is used to purchase the required
inputs.
12. Increased utilisation of idle resources. Borrowing helps to acquire modern technology which
helps to utilize the available resources because of the higher level of efficiency.
13. Leads to economic growth. Borrowed funds help to set up industries which increase the level of
output and thus a higher level of economic growth.

14. Alleviates effects of natural calamities. The borrowed funds are used to purchase items that are
given to those who are affected by calamities so that they are able to have better conditions of
living.
15. Improves relationship/friendship between Uganda and donors.
16. Leads to infrastructure development. The borrowed funds are used to purchase machinery
which is used to construct infrastructure.
Positive effects of borrowing

1. Encourages dependence/laziness. It causes reliance on other economies for money which
limits the capacity of the country to come up with its own solutions.
2. Undermines capital formation due to debt burden. The payment of debts reduces the
amount of money available for saving.
3. It is inflationary (the case with external borrowing). External borrowing causes an increase in
the supply of money which causes increase in demand and therefore increase in prices.
4. Worsens the BOP position. Payment of external debts causes high foreign exchange
expenditure abroad.
5. Shifts the burden of debt payment to the future generations who may not have benefited
from the debt but pay it.
6. Worsens income inequality. Internal borrowing causes income inequality because those who
lend to government earn interest and therefore become richer.
7. Leads to manipulation of the country by foreigners. The lenders dictate to the country
policies which are at times not favourable.
8. Leads to misallocation of resources/extravagance/corruption. There is misuse of funds since
they are assured of getting more funds from other sources.
9. Citizens are being burdened by taxes to raise revenue for debt payment. The government
imposes high taxes on citizens to raise money to pay of debts.
10. Undermines private investment due to public borrowing outcompeting private investment in
both the money and capital markets.

11. External debt payment limits import capacity.
12. Nationals are denied essential goods due to debt repayment. This is because the
government spends heavily on payment of debts which reduces the expenditure on essential
goods and services.
Ways of managing a public debt
1. Raising revenue by levying taxes

2. Use of accumulated profits from state enterprises
3. Sale of government securities e.g. treasury bills, bonds etc.
4. Borrowing from both internal and external sources
5. Use of a sinking fund. In this case there is budget allocation for specifically paying debt.
6. Disinvestment. This involves the sale of government owned assets and the money realised is
used to pay the debt.
7. Operation of surplus budget. The surplus funds are used to pay the debt.
8. Debt repudiation. This is when the government refuses to pay its creditors.
9. Debt rescheduling. The government agrees with the creditors‟ fresh terms and conditions of
payment.
10. Debt conversion. This involves borrowing from a low interest sources and paying off a high
interest loan.
11. Negotiation for debt cancellation/Relief/Waiver. The government and the creditors agree that
the debtor be relieved of any responsibility to pay.
12. Financial accommodation- printing more money and using it to pay off debts.
13. Use of accumulated foreign reserves.
14. Use of grants donations/gifts etc.
Payment of public debts/methods used to reduce the burden of public debt

1. Debt conversion where the government acquires a low interest loan to pay off a high interest
loan.
2. Internal borrowing through sale of treasury bills and bond using the central bank.
3. Selling state investments/privatization and the money obtained used to pay debts.
4. Using foreign exchange reserves.
5. Negotiation for cancellation of debts.
6. Controlled government expenditure.
7. Sale of gold reserves. The funds are used to settle debts.
8. Debt rescheduling. This involves agreeing fresh terms with the creditors.
9. Using grants.
10. Debt repudiation. This is the refusal by the government to meet its obligations.
11. Ensuring proper planning. This ensures that the government draws plans in accordance with the
available resources.
12. Maintaining price stability. By maintaining price stability the government is able to check the
cost of implementing projects and this reduces the need for borrowing.
13. Import substitution to avoid borrowing to imports.
14. Fighting corruption to avoid domestic loss of funds.
15. Settling differences peacefully. This reduces the need to borrow to finance purchasing of fire
arms.
Methods of settling national debts
1. Payment of interest on loans

2. Payment of the principle
3. Debt repudiation
4. Debt swap
5. Appealing for debt relief

NATIONAL BUDGET
BUDGETING
A national budget is an estimate of a country‟s expected revenue and expenditure for a given
financial year.
Components of a budget
1. Review of the previous year.

2. How government is going to raise revenue.
3. Current GNP/GDP.
4. Economic growth.
5. Desired economic growth.
6. BOP position
7. Monetary and fiscal strategies for the year.
8. Contribution to the national economy per sector in the previous year.
9. Total estimated revenue and expenditure for the year.
Objectives of a budget in Uganda
1. To attain and maintain price stability/controlling inflation. Taxes imposed on incomes reduce
disposable income, demand falls and this brings down the prices.
2. Creating employment opportunities/Reducing unemployment. Low taxes cause an increase in
investment which results into more people getting jobs.
3. To improve the BOP position/correcting the BOP deficit. This by increasing taxes on imports
which causes a fall in their demand hence fall in foreign exchange expenditure.
4. To reduce income inequality/promotion of equitable income distribution. This is by use of
progressive taxes where the rich pay more than the poor.
5. To protect domestic infant industries. This is achieved by imposing high taxes on imports which
make them expensive and this increases the demand for locally manufactured goods.
6. To discourage consumption of harmful/undesirable products. This involves imposing high taxes
on those commodities considered undesirable which reduces their demand because they
become expensive.
7. Reducing regional imbalance in development. The areas that are not doing well are given more
funds to enable them march the level of other areas.
8. Accelerating rate of economic growth. This is by varying taxes on investors e.g. low taxes on
investors causes a high level of investment because of the low cost of production and vice versa.
9. To raise revenue for the government. This by imposing direct and indirect taxes.
10. To influence investment. High taxes reduce the rate of investment because they raise the cost of
production while low taxes lead to low cost of production and therefore a higher level of
investment.
11. Influencing resource allocation. High taxes on some commodities and low taxes on others
causes diversion of resources from highly taxed to low taxed commodities.
12. Regulating government expenditure.
13. To mobilise/solicit foreign resources. The budget is used as a borrowing tool since it is used by
government to show which areas need funding.
14. To mobilise masses to participate in national development.
15. To reduce economic dependence/to ensure self-reliance. Low taxes on investors encourage
investment and therefore increased production which reduces the demand for imports.
A budget is divided into major parts:
(a) Recurrent budget

(b) Development budget
Recurrent budget
This is where estimated government revenue and expenditure is meant to maintain the existing
capacities or day to day programs e.g. payment of wages to civil servants.
Development budget
This is where estimated government revenue and expenditure is to be allocated for long term
projects which lead to increase in production directly or indirectly e.g. expenditure on financing
industries, roads, etc.
The budget can also be expressed as a balanced, surplus or deficit budget.

1. Balanced budget. This is one in which planned/anticipated government revenue is equal to
government planned expenditure in a given financial year.
2. Unbalanced budget. This is one in which estimated government revenue is less than or greater
than estimated government expenditure in a given year.
3. Surplus budget. This is one in which planned /anticipated government revenue is greater than
planned expenditure in a given financial year.
Reasons for planning a surplus budget
1. To decrease money in circulation so as to fight inflation.

2. To increase investment especially in productive activities.
3. To improve on the BOP position of a country.
4. To use the surplus funds to advance grants and loans to other countries.
5. To increase people‟s confidence in the sitting government as it indicates a brighter future.
6. To enable the government accumulate foreign reserves thus making the economy more sound.
7. To avail funds for paying off her debts.
8. To reduce external dependence because a surplus budget promotes self-reliance by
encouraging us of internal resources.

Deficit budget
This one in which government planned expenditure is greater than the government planned
revenue in a given financial year.
Reasons for planning a deficit budget
1. To close/cure a deflationary gap/slump/recession.

2. To avoid negative effects associated with high taxation.
3. To increase consumption by raising disposable incomes of the people/improve welfare.
4. To encourage investment.
5. To win political support.
6. To encourage borrowing (it is cheaper to raise revenue).
7. To solicit for foreign aid.
Advantages of a deficit budget
1. It increases aggregate demand since it increases money in circulation.

2. It reduces the negative effects of taxation.
3. It stimulates invests which are encouraged by increase in aggregate demand.
4. It increases saving among the people since they are charged less tax.
5. It is easier to borrow than imposing taxes so as to raise government revenue.
Disadvantages of a deficit budget
1. It leads to inflation since low taxes are imposed and people have high purchasing power.
2. It leads to BOP deficit as there is increased borrowing to finance the deficit in the budget.
3. It encourages economic dependence because of increased reliance on external resources by
way of borrowing.
4. It increases capital outflow as the government pays the debts.

5. Leads to economic instability and uncertainty since loans from abroad may be withdrawn before
completion of projects.
The causes of budget deficits in Ldcs/Uganda
1. There is low taxable capacity because of the low level of economic activities, poor tax
administration etc.
2. Few tax bases because of poverty, poor assessment, etc. Less revenue is generated.
3. High administrative expenditure on civil servants and politicians in terms of paying wages and
salaries.
4. Political instability leading to high military expenditure/high cost of improving political climate.
5. High cost of maintaining and developing infrastructure. Development of infrastructure requires
large sums of money.
6. Ambitious planning. The government plans to spend more yet realises less revenue 7. Heavy
debt servicing and repayment of principle.
8. Weak tax administration. This is the case with when there is poor collection and poor use of the
funds realised.
9. Few and low non tax sources of revenue.
10. High levels of corruption/low levels of accountability. Money realised by the government is
swindled by some officials and this reduces the money available for use by the government.
11. Frequency of natural disasters/hazards that require heavy emergence funding.
12. Heavy expenditure on external commitments e.g. contributions to international organizations,
peace keeping mission, etc. These cause excessive foreign exchange expenditure abroad.
How governments finance deficits in the budget
1. Borrowing from the central bank/printing of more money/deficit financing.

2. Borrowing from external sources.
3. Use donations/grants.
4. Sale of government securities/borrowing from the public.
5. Use of foreign reserves.
6. Sale of government enterprises to raise revenue/disinvestment.
7. Use of profits from government commercial ventures.
8. Compulsory savings.
9. Levying special taxes e.g. capital levy on the very rich people.
10. Use of national lottery/by gambling.
Measures used by government of Uganda to reduce persistent budget deficits
1. The retrenchment of civil servants and demobilization of soldiers.

2. Introduction of cost sharing in the provision of certain services e.g. in education, hospitals.
3. Population control by encouraging family planning.
4. Improving the political climate through peaceful means.
5. Rationalization of foreign missions (embassies). This reduces foreign exchange expenditure
abroad
6. Rationalization of government departments and public administration. This minimises foreign
exchange expenditure abroad.
7. Proper planning.
8. Appealing for debt relief.
9. Improving accountability.
10. Widening the tax base by identifying new sources of tax revenue.
11. Strengthening tax administration to reduce evasion of taxes.
12. Increasing non tax sources of government revenue.
13. Avoiding giving unnecessary tax concessions.
14. Further privatization to reduce financing non performing public enterprises.
The significance of the budget as a tool of economic policy

1. Raising revenue to finance development through taxation/forced savings.
2. It is used as a correcting tool during both the inflationary period and during a slump for
example high taxes during inflation reduce disposable incomes and therefore demand pull
inflation is done away with.
3. Improving the BOP position through reducing the amount of imports using import taxes.
4. Creating a conducive investment climate to promote employment.
5. Raising the level of economic activity in the private sector to promote economic
growth/accelerates the rate of economic growth.
6. For equitable distribution of income through taxation for example using progressive taxes.
7. It influences resource allocation to priority sectors/areas/influences investment.
8. Protecting infant industries, this is done by imposing high import taxes on foreign commodities
which leads to low demand in the local market.
9. To mobilise foreign resources, a well-drawn budget when presented to donors helps a country
get resources in form of loans and grants.
10. Helping to discourage the consumption of harmful products by imposing high taxes on
undesired products.
11. Helps to rally the masses behind a sitting a government/win votes/mobilization of the masses.
12. Management of the public debt.
13. Regulation of government expenditure.
14. Reduction of economic dependence.
FISCAL POLICY
Fiscal policy is a deliberate policy under which government uses its expenditure and revenue
(taxation) programmes to regulate the level of economic activities.

OR This is a deliberate policy of government to regulate, influence and direct economic activities in
the economy through regulating government expenditure, borrowing, public finance and debt
management in order to achieve economic development.
Instruments of fiscal policy
1. Taxation
2. Subsidisation
3. Government expenditure
4. Public borrowing
5. Licensing
6. Fees
7. Fines 8. Debt repayment
9.
Objectives of fiscal policy
To achieve desirable price levels/price stability through increased taxation and reduced government
expenditure.
1. To achieve desirable consumption level through discouraging consumption of demerit goods

through high taxation.
2. To raise employment level through promotion of investment and subsidization of producers.
3. To maintain or achieve fair distribution of income by taxing the rich and subsidizing the poor.
4. To increase the rate of economic growth through influencing production levels e.g. low taxes
lead to high rate of invest and production.
5. To achieve a fair BOP position by discouraging imports and promoting exports.
6. To protect infant industries by use of import duties.
7. To improve incomes and quality of life of the population by increasing government expenditure
on social services.
8. To influence resource allocation through tax holidays/relief.
9. To influence investment levels through tax relief.
10. To achieve balanced regional development by taxing already developed areas and increasing
government expenditure in underdeveloped areas.
11. To achieve desirable political objectives e.g. through tax reliefs etc.
12. To raise government revenue through taxation.
13. To control monopoly through taxation/subsidization of other firms.

DEVELOPMENT PLANNING
Development planning is a deliberate and continuous effort by government to systematically

influence economic variables so as to achieve certain targets or objectives over a given period of time.
Economic development planning is the conscious government‟s effort to influence, direct and in
some cases control changes in a nation‟s principle economic variables to achieve perdetermined
objectives/objectives of development over a given period of time.
OR
It is a deliberate government‟s effort to formulate decisions on how productive resources shall be

allocated among different uses in order to attain targeted economic objectives over a given period of
time.
Rationale/reasons for formulating an economic development plan

1. For proper allocation of resources. Planning ensures that resources are allocated to areas that
ensure maximum social welfare.
2. For equitable redistribution of income or wealth/balanced regional development. Planning
ensures that resource allocation is done in such a way that
3. To correct deficiencies of price mechanism, especially during times of rapid structural changes.
The market does not solve some challenges such as rapid population growth, income inequality
and therefore planning helps government to minimise these challenges.
4. To solve/control unemployment problem. Through planning government is able support
income generating activities that provide jobs by giving individuals affordable loans.
5. For resource mobilisation e.g. borrowing. It helps government identify the finance gap and
therefore uses it to mobilise funds through borrowing.
6. To identify areas suitable for public and private investment. Government takes up the less
profitable projects that require large some sums of money and are very crucial for national
development leaving the profitable projects to the private sector.
7. To relate the present to future trends and targets. Planning helps government to make
projections for future development basing on current state of affairs.
8. For harmonious and consistent use of resources. Planning helps government to ensure that
targets and objectives put in place march the available resources.

9. To encourage public participation in the development process/solicit for political support.
Planning shows the role to be played by the public and the benefits to be realised so that the
plans are not sabotaged.
10. To attain price stability by influencing production levels. Planning enables government to
ensure price stability by encouraging production through incentives to producers that help
reduce the production costs.
11. To correct balance of payment problems. Through planning government supports local
producers using investment incentives that help to reduce the cost of production which
increases local production and reduces the need to import.
12. To solicit for foreign aid/assistance from development partners. Government uses the plans to
seek for aid by showing the funding gap and the areas that need support.
13. To determine the rate of economic growth and development. Through planning government is
able to support producers using tax incentives, improving infrastructure, etc. which help to
reduce the cost of production and thus increased production of goods and services.
14. To reduce economic dependence/promote self-sufficiency. Planning enables the country to

support local producers using tax incentives, improving infrastructure and this causes an
increase in local production of goods which reduces the need to import.
The role of economic development planning in an economy

The positive roles of planning
1. It helps in improving and strengthening the market mechanism in an economy especially when
it fails to cope with rapid structural changes e.g. high population growth rate, availing
infrastructure. It helps government to minimise the failures of the market so that the public is
safe guarded.
2. Planning ensures equitable distribution of wealth. Through planning government supports the
low income groups start income generating by way of giving them low interest loans.
3. Planning helps to increase the rate of economic growth and development. This is by way
encouraging production in a country through encouraging establishment of private firms using
tax concession.
4. It ensures stability of prices and so is a powerful tool to maintain economic stability of a country
e.g. stability of foreign exchange etc. Planning enables government support local production
through investment incentives, liberalising the economy, etc. this increases supply of goods
which stabilises prices.
5. It helps in correcting BOP position. Planning enables the government to ensure local production
by way of supporting import substitution industries which reduces foreign exchange
expenditure on imported goods.
6. Planning enables the government to reduce unemployment. It helps encourage the
establishment of industries, sconstruction of infrastructure, etc. which help provide jobs to the
nationals.
7. It ensures proper resource allocation. Planning helps to make sure that resources are allocated
in those areas that make sure that improve peoples‟ welfare at the lowest possible cost.
8. It helps in soliciting for foreign aid or encourages attraction of more foreign resources. Plans
when presented to donor countries or institutions help them to identify areas that need
funding.
9. Planning harmonises or ensures constant use of resources. It reduces competition which is
wasteful and unfair that is harmful to the economy.
10. Planning helps in identifying areas suitable for public and private investment. Planning enables
government take up some large risky ventures where individuals may not invest leaving the less
risky projects but profitable ones to the private sector.
11. It ensures self sufficiency or reduces economic dependence. Through planning productive
ventures are encouraged using investment incentives that reduce the cost of production and
encourage production which reduces the demand for imported goods.
12. It relates present to future trends and targets thus consistence in growth and development.
Planning helps the government to make projections from the current state of affairs in the
country.
13. Encourages public participation in the development of the economy. Planning helps to show
the public the role they are to play in implementation and the benefits to be realised to avoid
sabotaging the implementation of projects.

14. Promotes resource mobilisation. Planning helps government identify the shortage in funds for
implementation of projects which enables it to mobilise resources through borrowing to bridge
the gap.
Negative role of planning are:
1. It distorts the working of price mechanism. Interference by the government limits the operation
of forces of demand and supply in influencing resource allocation.
2. There is wastage of resources. This occurs when planning encourages the production of
commodities that are not so much required by consumers.
3. Planning kills individual/private initiative. This happens when planning is in the hands of few
individuals who dictate what should be produced and the result is reduced invention and
innovation.
4. It encourages bureaucracy. This causes delay in decision making which delays implementation
of projects.
5. It is costly in terms of formulation, implementation and monitoring. This is because many
employees are required who have to be paid wages which is costly to the government.
6. It promotes inefficiency in production. This is because it discourages competition, innovation
and inventions.
7. Poor quality products are produced. This is because of lack of competition in production

8. Corruption becomes rampant. Some individuals take advantage their positions to divert public
funds for personal benefit and therefore some government projects are not implemented due
to shortage of funds.
9. It promotes political dictatorship. Few individuals in authority use their powers to supress others
the case with the command economy where to much power is invested in the hands of the
central government.
10. It limits consumer sovereignty. Production is not guided by the forces of demand and supply
but what the central authority deems necessary which is at times not in line with the demands of
the people.
Conditions necessary for successful planning
1. Availability of technical personnel (skilled labour). These are the people who are responsible for
the implementation, monitoring, etc. skilled causes efficiency in implementation of projects
2. Availability of quality statistical information or which is reliable and accurate. Accurate
information ensures that all areas are taken into account making the available resources
sufficient.
3. Mobilisation of resources/funds from internal as well as external sources so that plan

implementation, monitoring etc. can be under taken. Sufficient funds are necessary so that
projects are implemented
4. There is need for public cooperation/support from the different political/social groups in the
country. Public support makes implementation easy and reduces incidences of sabotage.
5. Presence of an efficient and incorruptible administration to maximise resource utilisation. A low
level of corruption makes the funds sufficient for the implementation of projects.
6. Mobilisation of popular support using institutions to make sure that the public is behind the
plans. Planning is successful when it has the support of the different social groups since it
reduces sabotage of projects.
7. Political stability. A stable political environment assures the formulators and implementors of
security for life and property.
8. Setting specific and clear objectives. This makes it possible for the government to achieve what
it sets to achieve.
9. Balancing of the plan. This makes it possible for the government to realise balanced
development in the country.
10. Fixing of targets and priorities.
Principles of a good development plan
1. Comprehensiveness. A good plan is one that covers the entire economy or all sectors of the
economy.
2. Consistency. The aims of the plan should match with the available resources and in line the
country‟s economic development objectives.

3. Compatibility. Good planning is one that promotes linkages/co-existence/contradictions
between the different sectors of the economy. e.g. linkage between agriculture and industry.
4. Good sequencing. The implementation of project should be done in an orderly way one step
after another.
5. Political acceptability. It should have blessing of the different political groups within the
economy to avoid sabotage.
6. Socially relevant. A good development plan should tackle problems and issues/needs pertinent
to the local areas.
7. Have an element of continuity.

8. Economically feasible. The objectives set should be those that can be achieved within a specific
period of time using the available resources.
9. Proportionality. The different sectors/regions of the country should be given due consideration
when distributing resources to ensure balance regional development.
10. Participation of society. The public should take up an active role in the formulation,
implementation, monitoring and evaluation so that there is no sabotage of government
projects.
11. Optimality in use of resources so that improved welfare of the citizens is realised at the lowest
cost possible.
12. Simplicity. It should be easily understood by both the technical and non-technical people.
Characteristics of a good development plan

1. It should be comprehensive i.e. covering the entire economy or all sectors of the economy.
2. It should ensure consistence so that the aims of the plan match with the available resources
and in line the country‟s economic development.
3. Should ensure compatibility so that there is promotion of linkages/co-existence between the

different sectors of the economy e.g. linkage between agriculture and industry.
4. Good sequencing so that the implementation of project is done in an orderly way one step
after another.
5. It should be politically acceptable/have blessing of the different political groups within the
economy.
6. It should be socially relevant by tackling problems and issues/needs pertinent to the local
areas.
7. Have an element of continuity.

8. It should be economically feasible so that the objectives set should be those that can be
achieved within a specific period of time using the available resources.
9. The plan should ensure proportionality in allocating resources so that the different
sectors/regions of the country are given due consideration to ensure equitable distribution
of resources.
10. It should involve participation of society so that people take up an active role in the
formulation, implementation, monitoring and evaluation.

11. The plan should ensure optimality in use of resources so that improved welfare of the
citizens is realised at the lowest cost possible.
12. It should be simple and easy to understand by both the technical and non-technical people.
13. It should be internationally relevant- in line with foreign policies.

Types of planning
2. Comprehensive planning. Is one where targets are set to cover all/most sectors of the
economy.
3. Partial planning/sectoral planning. Is one which covers part/section of the economy e.g.
agriculture, industry.
4. Annual planning. This is short term planning in which targets are to cover one year are drawn
e.g. the national budget.
5. Long term planning/perspective planning. Is long term planning in which long term are set in
advance for a period of ten or more years.
6. Centralised planning. This is one where the central authority plans for the whole economy and
it directs implementation of plans in line with the set targets/objective. The rationale for
centralised planning in an economy
1. To minimise wastage of resources/Efficient allocation of resources.

2. To ensure proper co-ordination in sect oral development since the private sector is still weak.

3. To ensure equitable distribution of resources/To fight income inequality/Balanced regional
development.
4. For proper sequencing of operations in the economy.

5. To solve the problem of shortage of manpower at local/low levels.
6. To protect national interests.
7. To ensure consistency of plans since centralised planning is done in line with the available
resources.
8. To ensure proportionality and compatibility of plans
9. For easy mobilisation of resources.
10. To allow regional specialisation and thus avoid duplication of development projects.
11. For political support.
12. To ensure economic stability e.g. price stability.
13. To solve unemployment problem.
14. To promote self reliance.
15. To achieve a pre-determined rate of economic growth.
16. To identify areas suitable for public and private investment.
17. To relate present and future trends and targets.
18. To correct deficiencies of price mechanism especially during situations of rapid structural
changes.
19. To minimise divergence between social costs and benefits.

7. Decentralised planning. Is one where by decision making and the implementation of plans in
line with set targets are undertaken by local government/local authority instead
of the central authority. This is one where planning is done at regional/sectoral level and plans
are incorporated into the central government plan.
Merits of decentralised economic planning
a) Promotes use of local resources

b) Ensures balanced regional development
c) Ensures that each area/region takes full advantage of its priorities
d) Efficiency in resource allocation is attained
e) Fair distribution of employment opportunities
f) Equity in income distribution is easily attained
g) Fair distribution of employment opportunities
h) Reduced bureaucratic chain/easy decision making
i) Promotes a sense of belonging and commitment
j) Controls rural urban migration
k) Encourages participation of the local people in development
Negative effects of decentralised planning
a) It leads to sustenance of regional inequality

b) It maintains income inequality
c) High costs of administration
d) Duplication of services/projects
e) Difficulty in coordinating sectoral development
f) Leads to inconsistence of plans
g) Leads to incompatibility/disharmony in plan objectives by the different regions
h) Does not enhance national integration
8. Capitalistic planning. This is where planning is done by the private sector without direct control
of the government but rather the government influences the planning process indirectly
through monetary and fiscal policies.
9. Indicative planning. This is the type of planning where government identifies appropriate
investment areas and provides incentives and required information to individual economic units
to achieve pre-determined, forecast targets.
Factors that affect the implementation of development plans in Uganda are as follows:-
1. The availability of funds. The more available the funds are the high the success of plan
formulation and implementation because funds enable the purchase of inputs to implement
projects while limited availability of funds causes poor planning because there not enough
funds to purchase inputs for plan formulation and implementation.

2. The availability of data/information. Limited information results into some areas being given
little attention or left out altogether since funds not set aside and when information is readily
available different areas are catered for and therefore the funds set aside are sufficient for plan
formulation and implementation.
3. The degree of responsiveness of the private sector. The higher the level of the private sector
response the better the planning because it plays its part by investing in the areas of interest
while a low level of response causes results into limited success because the private sector
does not do what is supposed to do.
4. The level of government commitment/the level of conservatism/the will of the people. A high
level of commitment of the government results into adequate resources/funds being set aside
for plan formulation and implementation while low level of government commitment results
into limited success because there is low funding from government.
5. The degree of political interference. Too much interference from politicians undermines the
work of the technicians and causes diversion of projects on the other hand limited interference
from politicians‟ enables plans go on according to designs and implementation of projects.
6. The efficiency of the implementation machinery/the labour skills. The lower the skills of labour
the lower the success of planning since there is low efficiency in implementation while
presence of sufficient supply of skilled labour causes a higher level of efficiency in planning and
thus higher success.

7. The political atmosphere/climate. Political instability leads to low success of the planning
process because the planners are not able to go to some places for fear for their lives and
property while a stable political environment assures the planners the security for their lives
and property and therefore higher success.
8. The level of accountability. A higher level of accountability causes higher success in planning
because the funds are used in projects as planned and are therefore adequate when the level
of accountability is low funds are diverted for personal use which results into funds being
inadequate for formulation and implementation of projects low level of success.
9. The rate of inflation/the price level. A high rate of inflation causes limited success of plans
because it increase the cost of formulating and implementing projects. A low rate of inflation
causes a low cost of implementing projects and therefore a high success of the planning
process.
10. The ambition of planning relative to means/the degree of ambitiousness of planning.

Ambitious planning causes limited success because resources are not enough on the hand a
less ambitious plan implies that resources become sufficient a therefore a higher level of
success.
11. The degree of dependence on external resources/aid for planning. A high level of reliance on
foreign aid causes limited success because the funds are inconsistent, insufficient and
therefore some projects are never completed on the other hand less reliance on foreign aid
causes higher success because local sources of funds that are more reliable are utilised.

12. The level of dependence on nature/the conduciveness of natural factors. Unfavourable natural
factors increase the cost of implementing projects because they cause emergence funding on
the other hand limited occurrence of unfavourable natural factors leads to higher success
because the funds set aside become sufficient.
13. The level of infrastructural development. Well-developed infrastructure makes planning more
successful because it makes accessibility to project areas easy and the cost of implementing
projects is low while poorly developed infrastructure causes difficulty in accessing project areas
and increases the cost of implementing projects. Home work: Explain the points below
Factors limiting effective planning in developing countries (Uganda)
1. There is lack of sufficient accurate and reliable information/data.

2. There is lack of enough trained personnel.
3. Presence of high rates of inflation.
4. There is limited government will or support
5. There is dependence on foreign aid which is inadequate, inconsistent and uncertain.
6. Existence of political instabilities.
7. Lack of sufficient capital/funds.
8. Existence of unforeseen circumstances/Natural calamities/disasters.
9. Some plans drawn are over ambitious.
10. The high rates of corruption and embezzlement.
11. There is limited will by the people.
12. Presence of poor infrastructure.
13. Non-responsive growing private sector.
14. Interference by politicians/government.
Measures that should be taken to improve economic development planning in Uganda
1. Reduce dependence on natural factors. This makes it possible for the available funds to be
adequate since there is limited emergence funding.
2. Develop infrastructure. Infrastructure should be improved to increase accessibility to project

areas and also to reduce the cost of implementing projects
3. Train statisticians/planners/labour. Employees should be trained to improve efficiency in

implementation of plans.
4. Improve data collection and management. There should be an improvement in data collection
so that the funds set aside are sufficient for the projects since all areas are captured by the
information.
5. Raise sufficient funds for planning. Government should raise sufficient funds for planning so
that all the areas are catered for without shortages
6. Improving accountability. Accountability should be ensured so that funds set aside are not
diverted but are used for their intended purposes, this ensures that funds for projects are
sufficient.

7. Minimise dependence on foreign aid/Reducing dependence on other countries. There should
be increased generation of revenue locally to reduce dependence on aid which is not reliable as
this ensures that funds are adequate.
8. Improve the political climate. The political climate should be improved to assure the planners of
security for their lives and property.
9. Attaining/maintaining price stability. This should be realised so that the cost of implementing
projects is reduced.
10. Avoiding ambitious planning. This should be done so that the funds set aside become sufficient
to meet the targets.
11. Improve mobilisation of the masses to participate in planning. Mobilising the masses reduces
incidences of sabotage of government projects.
12. Reduce the role of politicians in planning. The reduced role of politicians results into technicians
doing their work according design and there is no diversion of projects.
13. Ensure government commitment in planning. This results in to sufficient funds for projects
being set aside.
14. Sensitising the private sector on her role in planning. The private sector is able to come up with
projects that support government effort.

THE STRUCTURE OF UGANDAS ECONOMY
The structure of the economy refers to the main basic features or the outstanding characteristics of a
given economy.
THE STUCTURE OF UGANDAS ECONOMY BASIC FEATURES OF UGANDAS ECONOMY
(a) Describe the structure of the economy of your country.

(b) Examine the factors responsible for under development in your country.
1. There is dominance of agriculture sector. It is predominantly an agricultural economy. There is

heavy dependency on agriculture for food, foreign exchange earnings and is a major employer
of the labour force and major source of raw materials.
2. Small but growing industrial sector. It has small but growing industrial sector which
contributes significantly to GDP
3. Mixed economy system. Both the government and private sectors participate in the economic
activities therefore there is both public and private sector

4. Dual economy. It is characterised by some elements of dualism e.g. there is social dualism
technology dualism regional dualism sector dualism and intra sector dualism
5. It is an open economy. Uganda participates in the international trade; foreign trade is
dominated by the visible traditional agricultural exports. A few invisible exports like tourism,
power are also exported. The visible imports are mainly the manufactured goods few vehicles
and consumer goods, the invisible imports include banking insurance, transport, expatriates
services etc.
6. There is wide spread unemployment and under employment. Most of Uganda‟s factors of
production such as labour, land, capital are under employed. There is resource under-utilisation,
hence high levels of unemployment.
7. High population growth rate. Uganda has a high population growth rate.
8. High dependence. There is heavy trade dependence/external resource dependence (relying on
foreign aid and foreign capital, direct economic dependence (depending on external decision
and foreign manpower)
9. Poorly developed infrastructure. The economy is characterised by poorly developed
infrastructure both economic and social infrastructure like schools, hospitals, etc.
10. Excess capacity exists in many sectors. There is excess capacity existing in many sectors for
example there is presence of abundant and underutilised resources of land and labour. This is
because of limited capital, poor skills etc.
11. Uganda’s manpower is of low quality. The quality of labour force is poor because of a poor
education system; the graduates possess mainly theoretical knowledge.
THE STRUCTURE OF AGRICULTURE IN UGANDA

Agriculture is the dominant sector of the economy and forms the backbone of the country.
(a) Describe the structure of agriculture in your country.

(b) Explain the factors limiting modernisation of agriculture in your country.
Features of the agricultural sector in Uganda are:-
1. Dependent on family labour. This is because it is cheap and readily available.

2. Mainly carried out on small scale. Due to the small nature of the plots of land and limited
capital to invest in agriculture.
3. Mainly rural based. This is where majority of the people live and land is relatively cheap.
4. Uses mainly unskilled and semi-skilled labour. This is due to the low levels of education and
poor education system.
5. Mainly labour intensive/mainly uses simple tools or rudimentary technology. This is because
of the limited capital to invest in research or to purchase improved technology.
6. Mainly dependent on nature. This is due to the low levels of technology/research.
7. Dominated by subsistence production. This is due to the low levels of income, high levels of
illiteracy etc.
8. Mainly low quality output is realised. This is due to the poor skills used in production and the
poor technology.
9. Quantity of output is generally low. There is low level of technology used in the country.
10. Production is mainly for the local market. There is poor quality and thus low demand in the
international market.
11. Mainly food stuffs/narrow range of cash crops. Food crops are mainly grown to meet the
immediate family food requirements.
12. Narrow range of exports. Few crops are grown to export in the international markets.
Examine the implications of the agricultural sector in your country.

The positive implications of the structure of agriculture sector
1. It is a source of raw materials. The agriculture sector is a major source of raw material for the
agro based material and therefore it brings about rapid industrialisation.
2. It provides employment to both the skilled unskilled. Majority of the people in the country
depend on agriculture and are more employed in the sector.
3. It provides an important source of revenue to the government by taxing farmers, cooperatives
etc.
4. It reduces rural-urban migration. It employs many people in the rural areas and therefore
reduces the need to move to urban areas.
5. Ensures balanced regional development, it is spread throughout the country.
6. It contributes to the GDP through the substantial amount of output.
7. It is source of food to the population- both the urban and rural population thus developing it
leads to quality quantity and cheap produce.
8. It provides market for manufactured goods like fertilizers, hoes etc. thus promoting
industrialisation.
9. Encourages the development of infrastructure. There is development of infrastructure through
construction to support the sector e.g. roads which promote the development of the entire
economy.
10. It is an important foreign exchange earner as it is an important source of exports e.g. tea, cotton,
etc.
11. It reduces income inequalities because majority of the population are able to earn through
employment, selling produce etc.
12. Encourages the utilisation of the local resources because it is mainly rural based. This increases
the rate of economic growth.
Implications / consequences of the structure of agriculture in Uganda

1. Since agriculture is mainly subsistence and the output level is low the income from the sector is
low.
2. Government revenue base is low since the major sector agriculture is basically subsistence.
3. Due to use of poor tools/ technology the quality of output is low. This makes marketing the
products very difficult, especially in international markets.
4. There is limited exploitation of the available land because of limited mechanisation.
5. Heavy fluctuation in prices and incomes to farmers leads to fluctuation in export earnings which
makes government planning difficult.
6. The mainly low level of output in the agricultural sector leads to unstable supply of raw materials
which hinders industrial production.
7. Existence of large subsistence sector hinders capital accumulation process in Uganda because this
sector produces mainly for one‟s own consumption.
8. The reliance on nature causes production of low quality and quantity.
9. Poor quality products mainly produced in the sector lead to problems of marketing on the
10. Dependence on natural factors e.g. increases risks and uncertainties in the sector and this
discourages investment.
(a) What is meant by modernisation of agriculture?

(b) Explain the factors limiting modernisation of agriculture in your country.
Agricultural modernisation
This refers to the changing of agriculture sector from subsistence production to commercialised
high yielding sector.
OR

It is a policy of increasing the output and incomes of the agriculture sector through measures such as
mechanisation/use of better production techniques, use of improved breeds etc.
Factors limiting agricultural modernisation/productivity in Uganda
1. Limited supply of capital/low incomes/low savings. This makes purchase of inputs, machinery, etc.
very difficult.
2. Limited supply of skilled labour/illiteracy of the farmers. There is low level of output due low
efficiency and productivity.
3. Poor techniques of production. There is low output because of low efficiency.
4. Limited market both at home and abroad. Farmers produce less since they are not assured of
market and low profits are generated.
5. Conservatism of farmers. They do not easily receive new techniques of production and are
resistant to change. This causes a low level of investment in new techniques of production.
6. Natural hazards/unfavourable natural factors. These destroy crops and so lead to low output, they
also affect the quality of final output.
7. Unfavourable political climate. This disrupts production activities, makes accessibility to markets
difficult. This limits investment because of the fear to lose life and property.
8. Corruption or low levels of accountability. Finances meant for use in the sector are used for
personal and this reduces the amount of funds available for investment in the sector.
9. Low prices of the products/fluctuations in prices of agricultural products. These cause fluctuation
of income and also cause high cost of production.
10. Poor infrastructures. These make accessibility to markets difficult thus there is waste of produce.
11. Poor land tenure system. Makes acquisition of land by some people difficult and expensive and
also results into low levels of mechanisation.
12. Poor entrepreneurship. There is a low level of creativity and innovation as well as a low level of
resource mobilisation and this causes a low level of productivity in the sector.
13. Unfavourable topography. It makes mechanisation difficult and therefore there is less output
realised
(a) Explain the measures being taken to improve performance of the agricultural sector in your
country.
(b) Suggest measures that should be taken the improve performance of the agriculture sector in
your country.
Measures that should be taken to improve the agriculture sector
1. Introduce land reforms. This makes acquisition of land easier.

2. Provide affordable credit. Cheap credit facilities should be provided farmers to enable them
purchase inputs.
3. Carry out research in all fields/ introduce new farming methods. To introduce fast maturing
varieties.
4. Put emphasis on agricultural diversification. This should been done to reduce reliance on few
crops that are affected by fluctuation of prices and this stabilises revenue of the farmers.
5. Improve technology. Technology should be improved so as to increase productivity.
6. Improve infrastructure. This should be done to make accessibility to markets easy.
7. Industrialise within agriculture. There is processing of agricultural produce which improves
quality and shelf life of the products thus enabling the farmers to get high prices.
8. Develop and/or revive co-operatives. These should be done to organise the farmers make it
possible for them to buy inputs at fair prices and market final products easily- increase
bargaining power of the farmers.
9. Provide subsidised inputs to farmers/provide inputs. This reduces the costs of production
and helps to stabilise the prices and revenue of the farmers.
10. Improve the skills of labour. This should be done to increase their productivity.
11. Ensure political stability. This ensures farmers work on their farms without fear of losing their
lives and property and makes accessibility to markets easy.
12. Market expansion through regional integration. This increases the demand for agricultural
products, helps to reduce wastage and stabilises prices and revenue of the farmers.

13. Improve pricing through strengthening commodity agreements. This should be done to
improve farmers bargaining power.
(a) Describe the structure of industry in your country.

(b) Examine the factors affecting the development of the industrial sector in your country.
STRUCTURE OF INDUSTRY IN UGANDA
1. Industries are mainly involved in the production of consumer goods due to import
substitution strategy of the government.
2. Mainly large scale industries are concentred in urban areas because of the good
infrastructure and market for the goods and services.
3. The industrial sector is mainly dominated by small scale industries because most of the
people do not have sufficient capital to expand their industries.
4. Most of the large scale industries are foreign owned while the small scale ones are
dominated by the local people. The limited capital by local entrepreneurs does not permit
them to expand their industries.
5. Firms mainly use simple labour intensive technology. It is only few industries owned by the
foreigners that use capital intensive technology. This is because many of the local
entrepreneurs do not have sufficient capital to purchase modern technology.
6. Mainly import substituting industries /produce mainly for the local market with little left for
export.
7. High imported raw materials and intermediate product content.
8. Industries produce mainly at excess capacity due to limited capital, limited market, poor
technology, etc.
9. Many industries are agro-based, processing raw materials.
10. Many industries use mainly semi-skilled and unskilled labour force. This is because of the
low levels of education and a poor education system i.e. theoretical in nature.
11. The sector has limited linkages with other sectors of the economy.
12. Durable consumer goods industries are mostly assembling plants. This is because of poor
technology.
13. There is production of mainly poor quality manufactured goods. This is because of use of
poor technology and skills.
14. Mainly comprise of processing industries.
Assess the implications of the structure of industry in your country.
IMPLICATIONS OF UGANDA’S INDUSTRIAL SECTOR
Positive implications
1. Provides employment. Small scale industries mainly labour intensive and therefore
provide employment.
2. Uses locally available resources. Small scale industries use the locally available resource
inputs.
3. Helps to reduce income inequality. Small industries are widely spread and therefore help
to redistribute income.
4. They help to improve entrepreneurial and managerial skills which are inadequate in the
country. The small scale industries are training grounds for local entrepreneurs.
5. The industrial sector is an important source of revenue to the government through
taxation.
6. Contributes to the development of infrastructure. There is construction of infrastructure
to improve accessibility to markets for inputs and outputs.
7. Improve the balance of payment position. The industries produce goods and services for
export and reduce import expenditure and thus improve the BOP position.
8. Provides variety of goods. This is because there is product differentiation which increases
consumers‟ choice and welfare.
9. Reduces dependence. Reduces dependence since there is increased availability of goods
locally and reduced importation of goods.
10. Improves the skills of labour. There is training of the local labour force which improves
efficiency and productivity.
11. Provides quality goods. There is provision of quality goods and services due to
competition in the sector.
12. It attracts local and foreign investment. The desire to maximise profits attracts investors
into the sector.
13. Increases output. It contributes to national output since there are several industries and
this increases the rate of economic growth.
14. Encourages technological development. This technological development because firms
invest in research and this results into production of good quality products.
Negative implications
1. The industrial sector offers low employment opportunities because it is dominated by

small scale industries
2. There is the problem of profit repatriation because of foreign ownership of most of the
large scale industries.
3. There is over exploitation of some resources which causes exhaustion. This is especially by
the large scale industries.
4. It causes income inequality. Those employed in the sector earn high than those in other
sectors.
5. Concentration of industries in urban areas leads to regional imbalance in development and
rural urban migration. This is because there are better employment opportunities and
infrastructure.
6. Causes environmental degradation/pollution. This is due to poor waste management by
the many firms.
7. There are high operational costs. This is due to dominance of small industries since they do
not enjoy economies of scale.
8. There is limited supply of inputs. The industrial sector faces low supply of inputs since the
agriculture sector is affected by unfavourable natural factors and this causes high cost of
production and therefore low profits.
9. Predominance of consumer goods industries leads to heavy reliance on imports for
intermediate and capital goods.
10. Limited economic indigenisation due to existence of foreign ownership of most large scale
industries.
11. Increased unemployment because of use of capital intensive techniques of production in
most large scale industries.
12. Little tax revenue contribution from the industrial sector in form of corporate tax. This is
because the sector is dominated by small scale industries that pay low taxes.
13. Poor quality products. This is due most industries using poor techniques of production.
14. Little contribution to GDP. This is because the sector is dominated by small scale industries
which contribute less output.
15. Many industries depend on imported raw materials. This is because of limited availability of
some of the inputs. This causes BOP problems.
16. Bop problems due to dependence on imported raw materials.
Discuss the problems limiting the development of the industrial sector in your country.
PROBLEMS OF THE INDUSTRIAL SECTOR IN UGANDA
1. Low level of technology. This leads to low efficiency in production.

2. Limited skilled labour. This causes inefficiency in production.
3. Weak entrepreneurial skills. This low level of innovation and invention.
4. Underdeveloped capital market. Makes raising capital for expansion difficult.

5. Poor infrastructure and hence transport problem. Accessing inputs and markets for final
products is difficult and costly.
6. Limited markets both domestic and foreign markets. The domestic market is narrow due to
poverty, while the foreign market is limited due to poor products. This causes low level of
profits and investment.
7. Political instability in some parts of the country. This causes low level of investment because
of fear for loss of life and property.
8. Limited capital. Raising capital for establishment and expansion of industries is
difficult
9. Limited supply of raw materials. Poor performance of the agricultural sector causes limited
supply of inputs hence high cost of production.
10. There is corruption and political interference into management. This causes high cost of
production of production/ reduces funds available for investment.
11. There is high taxation/unfavourable government policy on industrialisation. This acts as a
disincentive to investment since it increases the costs of production.
12. Poor land tenure system in some areas. This makes acquisition of land difficult as it is
expensive.
13. Unstable prices. This raises the cost of production which discourages farming as low profits
are realised.
Explain the measures being taken to improve performance of the industrial sector.
Measures being taken to improve performance of the industrial sector in Uganda
1. Developing infrastructure. This is making it easy for industrialists to access inputs and markets.
2. Widening markets through integration. This increasing the demand for commodities,
increases profits and investment.

3. Providing affordable capital for investment/industrialisation. This is enabling the industrialists
to purchase machinery, hire labour and expand their enterprises.
4. Stabilising the political atmosphere/climate. This is encouraging investment in the industrial
sector since there is limited threat to life and property.
5. Vocationalising education/improving the skills. This is reducing dependence on expatriates
and improving efficiency of labour
6. Encouraging saving. This is enabling individuals accumulate capital to purchase requirements
for establishing industries.
7. Liberalising the economy. This is encouraging many people to engage in establishment of
industries.
8. Improving the land tenure. This improving accessibility to land/making purchase of land easy.
9. Fighting corruption. This is making funds set aside for investment in the sector adequate.
10. Stabilising prices. This is reducing cost of production and stabilising earnings of industrialists
and making planning easy.
11. Modernising agriculture. This makes availability of raw materials to industrialists easy thus
helping to keep the cost of production low.
12. Improving entrepreneurship skills. This is improving innovations and inventions and creativity
and also helping in resource mobilisation.
13. Providing tax incentives. This is reducing costs of production and increases profits
14. International campaigns to attract industrial investors.
15. Strengthening specialised institutions to improve performance of the sector. These are
providing the required information regarding investment in the different sectors of the
economy.
16. Further privatisation of public assets/enterprises. This is improving performance of the
enterprises due better management by the profit oriented owners.
17. Improving techniques of production/technological development/transfer. This is improving
efficiency in production.

THE INFORMAL SECTOR
(a) What is an informal sector?

(b) Describe the structure of the informal sector in your country.
This is an intermediate sector between the traditional and modern sector. OR It is a sector which lies
between the subsistence traditional sector and the monetary sector. It is mainly found in urban areas
and it comprises the, drivers, automobile and bicycle repairs, banking, bread selling etc. These
activities have been developed from the traditional and later they are modernised.
Features/characteristics of informal sector
1. Production is mainly on small scale because of limited use of capital.

2. It is mainly urban or semi-urban based. This is because of the presence of market for the goods.
3. Mainly produces poor quality output because of use of poor technology.
4. It is mainly dominated by unskilled and semi-skilled labour.
5. Firms in the sector basically/mainly use locally available resources. This is because they are
readily available.
6. The sector basically produces for the local market. There is production at excess capacity and
therefore unable to adequately supply foreign markets.
7. It is characterised by limited (formal) record keeping or book keeping.
8. It is dominated by sole proprietorship.
9. Mainly there is use of poor and simple techniques of production- labour intensive. This is
because the owners have limited capital to purchase better techniques of production.
10. There is simple entry into business i.e. licensing is cheap or non- existent.
11. Mainly low quantity of output is produced by firms.
12. It produces mainly consumer goods and simple producer goods.
(a) Examine the contribution of the informal sector in the development of your country.

ROLE /CONTRIBUTION OF THE INFORMAL SECTOR
Positive:
a. Provides employment opportunities. It is labour intensive and therefore provides employment

opportunities
b. It provides affordable goods. This enables low income earners purchase goods and services.
c. Improves the skills of labour. This through on job training which improves the efficiency of
labour.
d. It facilitates use of idle local resources. The resources are used as inputs in the production of
goods and services.
e. Helps in reduction of capital out flow that would have used to import goods and services. The
sector provides goods and services that would have been imported.
f. Helps in the development of entrepreneurial skills. The sector acts as a training ground for
entrepreneurs. This improves creativity and innovation.
g. It contributes to increase in GDP through increasing production of goods and services
therefore, it contributes to economic growth.
h. It contributes to government revenue. The activities of the sector are taxed.
i. It promotes technological development since some enterprises are able to acquire fairly
advanced technology for the production of commodities.
j. Ensures fair distribution of income. This is because it employs a wide range of people and it is
wide in coverage.
k. The sector promotes commercialisation of the economy. Goods and services produced in the
sector are basically for sale /it reduces the subsistence sector.
l. It widens consumer choice by providing a variety of cheap and affordable goods.

Negative:
1. It leads to congestion in sub-urban or peri-urban areas as the activities of the sector are not
properly planned or started haphazardly to have a competitive advantage over others.
2. It causes pollution of the environment because of poor waste disposal which affects
development.
3. There is duplication of goods and services and therefore it promotes wasteful competition.
4. It causes public revenue instabilities because of the temporary nature of the businesses.
5. It has given rise to unemployment and under employment because of limited capital to make
investments to absorb many employees.
6. There are high administrative costs because of operating mainly on small scale producing a
low level of output.
Discuss the problems faced by the informal sector in your country.
Problems faced by the informal sector
1. Lack of adequate capital to expand the businesses due lack of collateral security to access
credits. This makes it difficult to purchase inputs and expand enterprises.
2. Unfavourable government policy e.g. high taxation. This demoralises the informal sector
operators as it increases the cost of production and reduces the profit margin.
3. Inadequate skilled manpower since most of the labour force in the sector is either unskilled or
semi-skilled. This results in to efficiency in production.
4. The markets of informal sector operators are not protected due to absence or ineffective laws
hence exposing the sector to stiff competition from abroad.

5. There is insufficient supply of inputs and this limits production because of high production costs
/poor quality goods.
6. The existence of political instability in some parts of the country. This discourages investment in
the sector as well as limiting accessibility to markets and threatens destroys life and property.
7. Poor infrastructure. This limits accessibility to inputs and markets for goods and also increases
the cost of production.
8. Poor technology. Poor technology causes low efficiency in production.
9. Limited entrepreneurship skills. This causes low level of innovation, creativity and investment.
10. Political instability. Discourages investment in the sector because of fearing to lose life and
Property.
11. Poor land tenure system. This makes acquisition of land difficult and expensive.
12. Price instability. Unstable prices cause an increase in the cost of production.
13. High level of corruption. This causes high cost of production and delays implementation of
projects.
Suggest measures that should be taken to improve the performance of the informal sector in your
country.
MEASURES THAT MAY BE TAKEN TO IMPROVE PERFORMANCE OF THE INFORMAL SECTOR
1. Ensure favourable fiscal policies e.g. reduced taxation, subsidisation of producers etc. This
reduces cost of production and increases profits.
2. Encourage savings. Encourage co-operative societies among the informal sector members to
enable them save and mobilise funds for investment.
3. Provide affordable loans. Banks and other financial institutions should be encouraged to provide
loans at favourable interest rates/terms. This enables entrepreneurs get funds to purchase inputs.

4. Government should endeavour to encourage establishment of training centres to equip
employees with appropriate skills. This should be done to increase the productivity of labour.
5. Provide adequate infrastructure like electricity, water, roads, etc. to minimise production costs.
6. Ensure political stability as a way of attracting investment in the sector. This is because it assures
the investors of security for their lives and property.
7. Fight corruption. This should be done to ensure that the available funds in the sector are
adequate for investment.
8. Stabilise prices. This should be ensured so that the cost of production is reduced.
9. Improve the land tenures system. This should be undertaken so that acquisition of land for
investment and expansion of enterprises is easy to acquire.
10. Modernise agriculture. This makes it possible for enterprises to acquire inputs at fair prices and
reduce the cost of production.
11. Improve the skills of labour. This should be done to improve the efficiency of labour.
12. Improve technology/ finance research. Government should finance research to improve efficiency
in production.
The formal sector
It involves businesses that are registered, have proper record keeping and are governed by laws.
Characteristics of the formal sector
1.Made of predominately registered businesses.

2.Mainly provides wage employment.

3.Has proper record keeping.
4.Businesses are mainly governed by laws/acts of parliament.
5.Dominated by corporate ownership of resources.
6.Has employees and employers unions.
7.Uses mainly modern technology/improved technology/capital intensive techniques of
production.
8.Mainly produces better quality products.
9.Mainly urban or sub-urban based.
10. Mainly uses skilled labour.
11. Production is mainly for the market.
THE PRIVATE SECTOR
It is that part of the economy where economic and social activities are under the control of private
individual investors operating side by side with the government or public sector. OR it refers to
that part of the economy where economic activities are under the control of non-governmental
economic units such as households, or firms.
Each economic unit owns its resources and uses them for the maximisation of its own welfare.
Describe the structure of the private sector in your country.
FEATURES / CHARACTERISTICS OF THE PRIVATE SECTOR
1. It is mainly profit driven.

2. It is dominated by small scale businesses or enterprises. This is because of limited capital to
invest in expansion of enterprises.
3. Mainly labour intensive techniques are used. There is limited capital to purchase modern
techniques of production.
4. Uses mainly unskilled and semi-skilled labour force. This is due to low levels of education and the
theoretical education system.
5. Produces mainly consumer goods. This is due to the import substitution strategy of
industrialisation.
6. It is mainly under sole proprietorship.
7. Widely spread or dispersed in location.
8. Production is mainly for the local market.
9. Entry is largely free / there is limited government control
10. Uses mainly local raw materials. These are readily available.
11. Production of variety of goods / differentiated goods. This is due to competition in the market.
12. The sector is characterised by price instability. The profit minded entrepreneurs set their own
prices.
13. Control over price varies from industry to industry.
Assess the role of the private sector in the development of your country.
THE ROLE OF THE PRIVATE SECTOR IN THE DEVELOPMENT OF UGANDA

1. Provision of employment opportunities. This is because there are several enterprises established
which provide job opportunities.
2. It attracts capital- both from within and foreign private investment. This is because of the
competitive atmosphere in the sector which attracts private investors.
3. It promotes industrialisation process in Uganda hence promoting economic growth and

development.
4. It provides revenue to the government. This is through taxation of private enterprises e.g.
corporation tax on profits of companies.
5. The sector promotes entrepreneurial skills. As individuals undertake investment there

entrepreneurial skills improve due innovations and inventions.
6. promotes technological improvement. It encourages inventions and innovations and therefore

promotes technological development.
7. It helps to improve infrastructure. This is through construction and rehabilitation which makes
movement of goods and services easier.
8. Encourages efficiency in production. It encourages competition and thus promotes efficiency in

production as the firms are profit driven.
9. The sector provides a variety of goods and services to the population. This is because of product
differentiation which increases choice and welfare.
10. There is production of quality goods. Competition in the sector leads to the production of quality
goods and services.

11. It promotes exploitation of idle resources. The establishment of industries causes an increase in
the demand for raw materials hence increased exploitation of resources and a high rate of
economic growth.
12. Helps to improve the skills of labour. The private sector is a training ground of labour and
therefore helps in acquisition of skills and thus improves efficiency in production.
13. Increases foreign exchange earnings. It provides commodities for exports and as such is a source
of foreign exchange.
14. Promotes commercialisation of the economy. The sector encourages production for the market.
15. Helps improve the country‟s BOP position. This is because there reduction in the importation of
goods.
16. Diversifies the economy/reduces dependence since it increases the country‟s capacity to
produce goods and services.
Disadvantages of the private sector / Negative role
a. There monopolistic tendencies characterised by restriction of out, charging of high prices

and hence consumer exploitation.
b. It promotes uneven distribution of income since most of them are urban based leading to
regional imbalance.
c. It is associated with capital repatriation because of foreign ownership of some of the
firms.
d. The existence of foreign ownership of some of the firms is leading to the loose of
indigenisation of the economy/ danger of foreign control of the economy.
e. Due to profit motive there is failure by the private sector to allocate resources in vital
infrastructure e.g. roads, etc. which are necessary for development.

f. There is concentration on the production of consumer goods at the expense of capital
goods and this retards the development process. This causes heavy expenditure on
importation of capital goods.
g. Some of the medium and heavy industries mainly use capital intensive techniques that
cause unemployment.
h. There is wastage of resources because of duplication of goods and services.
i. There is distortion of consumer choice due to persuasive advertisement.
Discuss the problems faced by the private sector in your country.
PROBLEMS FACED BY THE PRIVATE SECTOR
1. Inadequate capital in the sector. This limits the expansion of the sector because of limited funds
to purchase inputs.
2. Insecurity in some parts of the country. This scares away potential investors in the sector for fear
of losing life and property.
3. Limited skilled manpower. This causes inefficiency in production
4. Limited market for the products due to the low purchasing power. This results in to low profits
and thus discouraging production.
5. Low levels of technology. This results into low levels of efficiency in production.
6. Limited entrepreneurial skills. This limits innovation, invention and creativity and therefore there
is limited ability to mobilise resources.

7. Poor infrastructure such as roads. It affects the activities of the private sector and contributes to
the high cost of production.
8. Unfair taxation of the sector. It discourages investment as taxes raise production costs.
9. Low or unstable prices. This leads to unstable earnings in the sector and causes high cost of
production.
10. Ineffective patent / copy rights discourage personal initiative.
11. Poor land tenure system. It makes acquisition of land difficult and expensive.
12. High level of corruption. Corruption makes the cost of production high and reduces funds for
investment.
13. Unfavourable natural factors/limited supply of inputs. These make production in the agricultural
sector difficult causing limited supply of inputs for the agro-based industries which increases the
cost of production.
Explain the measures being taken to improve performance of the private in your country.
MEASURES BEING TAKEN TO IMPROVE PREFORMANCE OF THE PRIVATE SECTOR
1. Developing capital markets. This is being done to avail capital for investment and expansion.
2. Maintaining a stable political environment. This is assuring the investors of security life and
property and thus encouraging investment.
3. Ensuring economic stability/ensure price stability/fight inflation/ promote stable foreign

exchange rate, etc. This is being done to reduce the cost of production and increasing profits.

4. Improving on infrastructure so as to attract both local and foreign investors. This is being done to
reduce the cost of production.
5. Further Liberalisation of the economy / trade. This is encouraging individuals to establish
enterprises.
6. Offering investment incentives to investors e.g. tax holidays, subsidises etc. This is encouraging
establishment of enterprises since it is lowering the cost of production.
7. Privatising public enterprises. This enhancing efficiency and quick expansion of enterprises since
private individuals are profit oriented.
8. Improving skills of labour. This is being done through Vocationalising education and is improving
the efficiency in production.
9. Widening markets through integration. This is increasing outlets for output thus increasing
profits.
10. Strengthening the Uganda Bureau of standards to provide technical and quality standards. This is
reducing on marketing problems due to poor quality.
11. Encouraging technological development/transfer. This is improving efficiency in production.
12. Provided land for development/changed land tenure system. This is making acquisition of land
easier and cheaper.
13. Improving entrepreneurship skills. This is being done through workshops and seminars and is
improving innovation, inventions and creativity.
14. Encouraging proper accountability. This is enabling firms have sufficient funds for investment.
15. Enacting copy right and patent right law. These are encouraging innovations and inventions.

16. Undertaking international campaigns and publicity. This is attracting foreign investors.
17. Establishing specialised institutions to promote investment. The institutions are providing
information on areas for investment.
THE PUBLIC SECTOR
What is a public sector?
The public sector of an economy consists of business establishments that are owned by the
government and are engaged in commercial activities.
OR
The public sector is that part of the economy consisting of enterprises that are owned by the
government or state.
Such business establishments called the state enterprises may take the form of local authority, or
public corporation or parastatal body.
Account for the need of government to participate in business undertakings.
Reasons for government participation in ownership of industries and other commercial activities.
The reasons for government participation in business undertaking establishment of public

enterprises/e are:
1. To provide goods and services which have low commercial profitability but having high socio-
economic benefits.
2.To avoid duplication and wastage. It is not economically viable to have many firms produce
public utilities.
3.To create employment opportunities. Government owned enterprises operate on large scale and
therefore provide more employment opportunities.
4.To produce goods of strategic importance. Production of some commodities cannot be left to
private individuals because of the sensitivity of such products.
5.To provide essentials of life at fair prices. Some commodities if left to private producers leads to
exploitation of consumers yet they are vital to society.
6.Promoting investment. Government investment in enterprises encourages investment by private
individuals especially when the very investors are bought by individuals.
7. To raise revenue. The established enterprises earn revenue to the government through profits
earned and the taxes they pay to the government.
8.To ensure social security.
9.Promoting economic independence. By establishing firms to produce goods locally there is
reduction in the importation of commodities.
10. To protect nationals from exploitation. The establishment of government owned enterprises
minimises exploitation of nationals because government is profit oriented but welfare orient
and therefore charges low prices.
11. Because of heavy capital requirement. Some business undertakings require large sums of capital
which individuals may not be able to raise hence government steps in to establish such
enterprises.
12. To mobilise savings. Funds/ raised from the public enterprises enable government to
accumulate savings for investment purposes.
13. Complementing the private sector to avoid monopoly. The establishment of public enterprises
helps the government break the monopoly of private enterprises.
14. To protect primary producers from exploitation. The establishment of public enterprises enables
producers of primary products get fair prices since government is not profit oriented.
15. To stabilise prices and incomes. Firms that buy from producers of primary regulate output on
the market and this helps to stabilise prices and incomes of the producers since the surplus in
the market is reduced.

16. To promote resource utilisation. Establishing enterprises by the government helps to increase
the rate of resource utilisation since they are used as inputs hence increasing the rate of
economic growth.
17. To promote balanced regional development. Government distributes industries in different
parts of the country and this helps to bring about balanced regional development.
18. To promote equity in the distribution of income and wealth.
19. To develop infrastructure.
Shortcomings of government participation in commercial activities are:
1.Delays in policy implementation due to bureaucracy and red tape.

2.Interference from government officials and politicians usually overrides the decision of technical
experts and this delays decision making.
3.There is emergency of absolute monopolies since they do not face any competition and this may
lead to inefficiency and production of low quality goods.
4.Many such enterprises usually face diseconomies of scale because of their enormous sizes.
5.Existence of state interest in business may be disincentives to private initiative in the private
sector.
Problems faced by public enterprises are:
1. Inadequate capital. There is inadequate capital for expansion of the business units and
purchasing inputs.
2. Poorly developed infrastructures. The poor developed infrastructure makes it difficult to access
input markets and markets for final products and also increases the cost of production.
3. Bureaucratic red tape/bureaucracy. There is a problem of bureaucracy that causes delay in
decision making and implementation.

4. Political interference. The interference by politicians in the affairs of public enterprises results
into poor management.
5. Political instability. Political instability leads to destruction of enterprises and also causes
inability to get to potential markets.
9. Foreign interference.
10.Limited commitment and interest on part of management. This results into mismanagement of
the enterprises
12. Poor management/limited skilled manpower. The use of poor skilled manpower results into
production of poor quality products.
13. Low level of accountability/corruption/embezzlement. Funds are swindled for personal benefit
and this leaves the enterprises with fewer funds to run the enterprises.
14. Limited supply of raw materials. Limited supply of raw materials results into a high cost of
production and low level of output.
15. Limited market size. Limited market for final products is due poor quality of some of the
products and poverty among the people this results into wastage of resources/low profits.
16. Poor techniques of production. The poor techniques of production lead to production of poor
quality products that are less marketable.
17. Competition from the private sector. The competition results into limited market for the final
products.
18. Price instability. Instability in prices of products result into instability the revenue of the
enterprises and this discourages production.
Public corporations
What is a public corporation?

A public corporation is a joint stock company in which a government holds either all the shares
or a majority of its share capital and is created by an act of parliament which clearly defines the
aims and objectives.
Examine the role of public corporations in the development of your country.
The role of public corporation in development
Positive role
1.Creation of employment opportunities to the people. They usually employ many nationals due to
operation on large scale.
2.Development of infrastructure. They participate in the construction of roads, schools, and
hospitals etc. which support other economic activities.
3.They raise large sums of capital and thus undertake large scale operations. The private sector is
unable to undertake large scale projects like power dams due inadequate funds, technical skills
etc., through public corporations government raises funds to establish the projects.
4.Provision of essential goods and services at affordable prices. These commodities are usually of
low commercial profitability yet they are so vital for the welfare of the nationals e.g. safe water,
garbage collection etc.
5.Help in avoiding foreign domination of the economy. Their existence in one way or another is a
step towards economic indigenisation.
6.They undertake strategic or sensitive investment projects of national importance. Some projects
are so sensitive that they cannot be left in the hands of the private sector e.g. manufacture of
fire arms, as this would threaten the security of the state.
7.They are a source of revenue to the government. They generate profits which supplement
government revenue. They also pay taxes.

8.They protect consumers against undesirable goods e.g. UNBS. They protect the consumers by
ensuring that certain quality standards are adhered to.
9.They help check private monopoly. They complement and regulate the activities of the private
sector by providing competition hence raising efficiency.
10. They promote economic growth. They are development oriented in resource allocation and
investment which leads to increased output.
11. They promote fair distribution of resources incomes and balanced regional development, they
are usually set up with many branches in many parts of the country.
Negative roles
1.They overstrain the government budget. This is by way of spending on managing public
corporations.
2.Provision of poor quality goods and services. This is due to lack of competition.
3.Bureaucracy in decision making and implementation. The lowers the efficiency and ability to
adjust to rapid structural changes.
4.The public is highly taxed to cover the losses made by those public corporations. This reduces
peoples‟ disposable incomes and welfare.
5.Poor accountability by public officials which results into more losses.
6.Limited flexibility in operation. They are slow in adaption to changes due to bureaucracy in
decision making.
7.Limited consumer sovereignty. Production is not driven market forces of demand and supply but
rather depends on government policy on social welfare this leads to limited choice.
8.They are interfered with by politicians e.g. through political appointments, employment of
relatives, etc. this results into mismanagement.
9.They tend to discourage private investors by outcompeting them. They have large capital and
produce on large scale and at subsidised cost. There by selling at relatively cheaper price.
10. Large scale operation results into diseconomies of scale. This is due to gross management.

11. They limit innovativeness and initiative due to disinterested officials. Most public officials do not
have self drive to initiate new and better methods of production.
PARASTATAL ORGANISATIONS
What is a parastatal organisation?
A parastatal organisation is a state owned enterprise/firm set up by the act of parliament/government

decree to carry out specific functions/activities without putting much emphasis on profit.
Assess the role of parastatal organisations in the development of your country.
The role of parastatal organisation in an economy
1.Creation of employment opportunities to the people.

2.Development of infrastructure.
3.Raising large capital and thus undertaking large scale operations.
4.Promoting economic growth and development i.e. they are development oriented.
5.Provision of essential services to the public at affordable rates/prices e.g. NWSC.
6.Avoiding foreign domination of the economy. By producing the required commodities they
reduce external dependence.
7.Undertaking strategic investments/projects of national interest/importance. This is because some
firms cannot be left to private individuals because of their sensitivity.
8.Provision of non-profitable but essential goods and services to the public e.g. garbage collection.
9.Raising revenue for the government through selling goods and services.
10. Ensuring consumer protection against undesirable products.
11. Controlling private monopoly. The establishment of such firms reduces the monopoly of private
enterprises that at times exploit consumers.
12. Ensuring fair distribution of resources for balanced economic growth development.

13. Mobilisation of savings from the public.
14. Ensuring price and income stability.
15. Promotion of investment. The established enterprises can later be sold to private individuals
who may not have the initial capital to start large scale enterprises.
16. Facilitate development of skills through training.
17. State monopoly enterprises avoid wastage of resources by eliminating/controlling duplication
of activities/services.
PRIVATISATION
(a) Distinguish between privatisation and nationalisation.

(b) Account for the privatisation of public enterprises in your country.
Privatisation is the process of changing /transferring ownership and control of public enterprises from
government to private individuals. It is a denationalisation move that aims at expanding the
private sector of the economy.
Forms of privatisation
1. Complete privatisation or divestiture

This is when the government sells off 100% of its shares to private individuals either local or foreign
or it involves liquidation/sale of all public shares or assets to the private sector.
1. Partial sale/privatisation
This involves selling a portion of government ownership in a given business. It is common with
businesses that have diversified activities such that a line of activity is retained by the state while
the other is relinquished to the private sector.
2. Joint venture

This is where the government runs business units together with the private entrepreneurs only that
she holds at most 49% shares in the business with at least 51% shareholding belonging to private
individuals.
3. Mortgaging/Leasing
This is the temporary sale of public enterprise to private sector with the aim of repossession by
the state. It is also referred to as sales and lease back privatisation.
4. Contracting
This is the form of privatisation that involves selling of business management to private
entrepreneurs for a specific period of time as per agreement after which control of the business
may be returned to the government when deemed necessary.
REASONS FOR PRIVATISATION OF PUBLIC ENTERPRISES
1. To enable firms operate more efficiently. Private individuals have a personal interest and
therefore ensure strict supervision and accountability since they are profit oriented.
2. To reduce corruption and embezzlement. Strict supervision and accountability reduces misuse
of funds.
3. To attract foreign investors. It attracts foreign investors since it gives them opportunity to
finance enterprises with limited or no competition.
4. To reduce government expenditure. Privatising enterprises reduces government expenditure

since the government no longer finances operations of such enterprises.
5. To meet IMF conditionality of creating a private sector led economy. Some countries privatised
to be able to get loans to finance several sectors of the economy.
6. Need for more employment creation in the long run.

Privatisation increases employment in the long run because the profit driven entrepreneurs expand
the enterprises creating more job opportunities.
7. Need to increase government revenue. Privatisation increases government revenue through

selling of the public enterprises and also taxing private industries and companies.
8. To increase on the levels of resource utilisation. Privatisation attracts foreign investors with big
capital which can be invested in large scale undertakings this increases productivity leading to
increased resource utilisation sine they are required as inputs
9. To reduce bureaucratic tendencies in public enterprises. By transferring ownership to private

individuals there is quick decision making because there are few consultations to make and they
are profit oriented.
10. To control structural inflation. It increases productivity and wipes out structural inflation because
the profit oriented individuals use better production techniques which results into large of goods
and services.
11 To attract private initiative and thus encourage innovation, creativity and entrepreneurship in the
private sector. This because it allows competition in production.
12. To encourage competition in business by eliminating monopolistic tendencies so that better

quality commodities are produced.
13. To allow government concentrate on the provision of social services since there is reduced
government expenditure on subsidising government enterprises the funds saved are used to
provide more social services.
14. To increase output and thus ensure economic growth. Privatisation increases investment because
there is an increase in efficiency and therefore more output is realised.

15. To improve the BOP position. Privatisation improves efficiency in production hence there is mass
production of goods which reduces importation of goods while encouraging exportation of
goods.
Examine the benefits of privatisation in your country.
Effects/benefits of privatisation
1. In the long run more employment opportunities are provided to the citizens. The expansion of
enterprises and better management generates more employment opportunities.
2. It reduces bureaucracy in the running of enterprises and this promotes quick decision making
and production.
3. Competition between firms encourages efficiency/cost effectiveness in resources allocation. This
because there is strict supervision.
4. Increased output is realised which leads to economic growth. This is because of an improvement
techniques of production.
5. Quality of final goods and services is high. This is because there is competition between firms.
6. Exploitation of idle resources is possible which promotes economic growth.
7. Foreign investment and capital are attracted to the economy which accelerates the process of
growth and development.
8. Innovativeness and creativity (research) are promoted. The desire to maximise profits results into
better production techniques.
9. Ensures variety. It widens consumer choice due to production of variety of commodities.
10. It reduces dependence on imports. It increases local production/availability of goods and thus
reduces dependence on other economies.
11. It reduces corruption in the running of enterprises since private investors are profit oriented and
ensure efficiency in running the enterprises.
12. Leads to improvement in labour skills. Employees are trained in various skills to improve their
efficiency.

13. Privatisation reduces structural inflation. This is because there is increased production of goods
and services.
14. It improves international relations between the country and the international community
especially the donors because of the increase inflow of foreign investors.
15. It widens the tax base and hence increased tax revenue to the government.
16. As a form of retrenchment it results into reduced government enabling government to
concentrate on the provision essential services such as education and medical health care.
Negative benefits of privatisation
1. Increased consumer exploitation. This is because high prices are charged by the profit oriented
individuals.
2. It leads to unemployment in the short run. Some workers are retrenched and others substituted
with machines in order to reduce costs of production.
3. It leads to increased foreign control of the economy. This is because most of the privatised
enterprises are bought by foreign investors who have the financial muscles.
4. It leads to irrational exploitation of resources causing environmental degradation. The profit
oriented producers over utilise the resources
5. There is a reduction in provision of essential vital goods. Private sector is more interested in
enterprises that bring in more profits.
6. It leads to income inequality. This is because the privatised enterprises are bought by few wealthy
individuals earn more profits.
7. There is an increase in price fluctuations. Individuals set their own profit maximising prices.
8. There is profit repatriation. There is profit repatriation due to investments being mainly in the
hands of foreign investors.
9. Losses are incurred due to under valuation and high cost of advertising the enterprise etc.
10. There is wasteful competition among producers and this makes the economy lose some of the
productive resources due to meaningless duplication within the private sector.

11. Resentment of government by the public. This is especially by those opposed to the sitting
government
(a) What problems have been faced in the privatisation of public enterprises in your country?
(b) Problems encountered in the privatisation of public enterprises
1. Opposition from the public who think that privatisation leads to loss of economic control to
foreigners while others are opposed to the process on political grounds as they are not in favour of
the sitting government.
2. Corruption in the privatisation unit because of lack of transparency in the sell of some of the
parastatals where some of them are sold to those who do not qualify.
3. There is poor valuation/undervaluation of the public enterprises that are on sell leading to loss of
revenue.
4. The presence of unscrupulous buyers- these are the successful bidders who fail to pay in time while
others are no serious buyers.
5. The poor state of some of the enterprises because they have been run down makes it hard for the
government to sell them yet government does not have sufficient funds to rehabilitate them.
6. The small domestic market resulting from poverty scares away some potential investors. This
because low profits are realised.
7. The lack of well developed capital and money markets makes the selling and raising of capital
difficult.
8. The poverty among the nationals results into most of the privatised enterprises being bought
mainly by foreigners.
9. Political instability that scares away the-would-be potential investors to purchase the public
enterprises for fear of losing life and property.
10. The cost of privatisation is high as it involves advertising locally and internationally, hiring experts
to value the enterprises, etc.
11. There is political sabotage from some politicians who de-campaign the process for political gains
and this frustrates government effort.
NATIONALISATION
Nationalisation of enterprises is where the government deliberately takes over control and
ownership of privately owned enterprises with or without compensation.
Discuss the merits and demerits of nationalisation of enterprises in an economy.
Merits of nationalisation of enterprises
1. Reduces wasteful competition/duplication of activities.

2. Encourages large scale production/increased output/economies of scale/economic growth. This
because nationalised enterprises enjoy monopoly.
3. Reduces consumer exploitation by charging affordable prices/provision of public utilities.
4. Makes it easy to respond to structural changes when need arises.
5. Nationalisation of private enterprises enables the country get rid of foreign domination with all
its associated evils.
6. It promotes economic stability e.g. price control. This because government is in control of the
prices.
7. Promotes equitable distribution of resources/wealth and income/balanced regional
development. This because government endeavours to equitably distribute the enterprises.
8. It minimises profit and income repatriation by foreign investors.
9. It encourages government to manage vital investment/strategic enterprises.
10. Reduces social costs. By operating on large scale few enterprises are established and this reduces
the rate of environmental degradation.
11. It controls private monopoly and its negative effects.
12. It generates revenue for the government i.e. nationalised industries generate revenue for the
government through the profits realised.
13. Protects consumers against consumption of undesirable products.
14. It increases employment opportunities. Nationalised enterprises operate on a large scale and
therefore have high capacity to employ many people.
Demerits of nationalisation of enterprises
1.It leads to low efficiency and therefore production of low quality output.
2.Encourages corruption and thus misuse of funds.
3.Consumer choice is restricted due to limited variety of goods and services/Reduced consumer
sovereignty.
4.It is associated with bureaucracy and thus slows decision making and implementation.
5.There is high government expenditure on running nationalised enterprises/May subject nationals
to high taxation.
6.There is political interference in running of nationalised enterprises e.g. political appointment of
managers.
7.Leads to low tax revenue. Some of the nationalised enterprises are exempted from paying taxes.
8.Leads to resource misallocation since it interferes with price mechanism.
9.Discourages private investment. This is because the nationalised enterprises are favoured by the
government.
DUALISM
This refers to the co-existence of two contrasting phenomena that are mutually exclusive, existing
side by side one is desirable and modern the other is undesirable and under developed. This
where one sector is superior, modern and desirable while the other sector is inferior, backward
and undesirable.
Features/examples of dualism
1.The extremely rich and very poor people

2.Rudimentary and modern advanced technology
3.Formal and informal sector
4.Rural and urban sectors
5.Traditional sector and the modern sector
6.Subsistence and commercial production
7.Small scale and large scale production
Forms of dualism
State the forms of dualism in your country
1.Social dualism. This is the co-existence of two contrasting social systems in the economy
i.e. traditional sector and modern sector.
2.Economic dualism. This is the co-existence of two contrasting economic sectors in an economy
e.g. commercial and subsistence sector, barter and monetary economy etc.
3.Technological dualism. This refers to co-existence of two contrasting sectors/techniques of
production e.g. capital intensive and labour intensive technology.
4.International dualism. It is the co-existence of developed counties and less developed countries.
5.Sectoral dualism. It‟s the co-existence of two contrasting sectors with different levels of
production e.g. urban sector and rural sector, formal and informal sector.
6.Exchange dualism. This is where barter trade co-exists with monetary exchange.
7.International dualism. This is the co-existence of Ldcs alongside MDGs in the world.
Causes of dualism in Uganda
1.Unfair distribution income in Uganda. This gives rise to the co-existence of the very rich and the
very poor.
2.Uneven distribution of resource. This makes some regions to develop at faster rate than others.
3.Inappropriate education system giving rise to the co-existence of the skilled alongside the semi-
skilled or unskilled labour.

4.Unequal distribution of infrastructure like roads, communication lines etc.
5.Concentration of investment in urban areas giving rise sect oral dualism.
6.The demonstration effect where the rich purchase luxuries yet the poor cannot afford the basic
necessities of life.
7.Production influenced by comparative advantage theory which ties developing countries to
primary products and developed countries to manufactured goods.
8.Cultural rigidities that hinder people from adopting modern practices.
Measures to minimise dualism in the country
1.Modernising agriculture.
2.Development of infrastructure.
3.Delocalisation of industry.
4.Improving the education system.
5.Ensuring increased monetisation of the economy.
Advantages of a dualism
1. Government raises a lot of revenue through progressive taxation of the modern sector.
2. The government is awakened to its responsibility of providing utilities for the less developed
regions.
3. It provides impetus for research and planning to identify ways and means of developing the
economy.
4. It fosters factor mobility from traditional sector to modern sector.
5. It promotes diversification in the economy due to existence of firms in both the formal and
informal sectors of the economy.
6. It increases employment both in the formal and informal sectors
EXTERNAL SECTOR
Uganda is an open economy which trades with Ldcs and MDCs.
STRUCTURE OF UGANDA’S EXPORTS AND IMPORTS
Describe the structure of imports-exports in your country.
Features of Uganda’s export sector.
1. Uganda‟s exports are mainly agricultural/ primary products e.g. coffee, tobacco, vanilla etc.
2. There is limited variety for export / there is commodity concentration of trade i.e. a biggest
percentage of trade is with developed countries.
3. Most of the exports are basically semi-processed or unprocessed or low value is added e.g.
exportation of lint.
4. The export sector experiences limited range of markets as much of the trade is with developed
countries.
5. Few manufactured consumer goods are exported
6. Few services are exported and these include invisible exports like tourism, banking services etc.
7. They are mainly of poor quality.
8. Prices of exports are low and are always fluctuating because most of them are primary products.
9. Low volume of exports.
Implications / consequences of the structure
1. Foreign exchange earnings. Exportation of agricultural products earns the country foreign.

2. Leads to economic growth. The increase in the production of commodities for export leads to
a high rate of economic growth
3. Promotes international friendship and trade/cooperation.
4. Leads to utilisation of idle resources. Production for exports results into utilisation of the
locally available resources.
5. Provision of revenue to the government. There is provision of government revenue through
taxes.
6. Provides employment opportunities. There is provision of employment opportunity in the
import and export sector.
7. Promotes innovations and inventions in order to compete in the global market.
8. Widens consume choices due to importation of variety of goods.
9. Fills the technological gap/manpower gap/resource gap. This is due technology transfer.
10. Improved quality of output due to competition with high quality imports.
11. Increased efficiency of local firms this due the competition between locally produced goods
and the imports.
Negative implications of the features of foreign trade in Uganda:
1. Leads to poor terms of trade. This is because there is of importing expensive commodities and
exportation of low priced exports.
2. Leads to unfavourable BOP position. The importation of expensive commodities while
exporting low priced exports leads to high expenditure abroad and low foreign exchange
earnings.
3. There is vulnerability of foreign domination due to geographical concentration of trade.
4. Under utilisation of some resources due to narrow range of exports.
5. High level of unemployment. Unemployment is due to high importation of goods and services
that results into less employment of labour.
6. Dependence on other countries e.g. for markets, supplies, etc.
7. High level of capital/income outflow due to importation of intermediate goods.
8. Low foreign exchange earnings. This due exportation of mainly primary products which fetch
low prices.
9. Collapse of local firms because they are out competed by the superior imported goods.
10. Regional imbalance in development.
11. Fluctuations in foreign exchange earnings due to fluctuations in prices of exports since they
are mainly primary products.
12. Fluctuations in exchange rate. This is due to reliance on agricultural exports whose prices are
not stable.
Structure of Uganda’s imports
1. Imports are mainly industrial products.

2. Imports are of wide variety.
3. Imports are mainly of high value/mainly processed.
4. Imports are mainly from few countries/geographical concentration of trade.
5. Imports are mainly manufactured consumer and intermediate goods.
6. Imports are mainly of high quality.
7. Many services are imported.
8. Prices of imports are mainly high and stable 9. Imports are mainly of high volume/quantity.
STEPS TO CHANGE THE STRUCTURE OF EXPORTS AND IMPORTS IN UGANDA
1. Diversification of agriculture exports to reduce reliance on few agricultural crops

2. Establishment of imports substitution industries with sizable domestic market to minimise
foreign exchange expenditure
3. Processing of agricultural products to add valve on them so as to fetch high price
4. Establishment exports promotion industries to reduce pre dominance of export sector with
agricultural products

5. Need to expand invisible export e.g. tourism banking insurance electricity
6. Train our man power to reduce dependence on expatriates
7. Prospects on our mineral resources of oil around l. Albert should be pursed to reduce importation
of petroleum products
8. Widening of market for Uganda through joining regional groupings this will increase trade
among Ldcs e.g. COMESA
b) Outline any four features of Uganda‟s export sector
c) Define the term invisible exports
d) What are the components of your country‟s sectors export- import trade
Explain the measures that may be undertaken to increase export earnings in your country.
Measures that may be used to increase export earning
1.Diversification of exports products. This increases foreign exchange earnings since there are a
number of products sold abroad.
2.Diversification of export markets. Reduces reliance on few markets which provides alternative
sources of foreign exchange
3.By joining regional integration. This expands market for goods.
4.Increasing volume of exports/producing more for export.
5.Strengthening commodity agreements. This increases bargaining for fair prices in the
6.Allowing the local currency to depreciate. It makes exports cheap and imports expensive which
reduces foreign exchange earnings while reducing expenditure abroad.
7.Processing primary products to add value. This results into exports fetching higher prices and
thus more foreign exchange earnings.
8.Lowering costs of production. This increases the demand for locally manufactured goods because
they are cheap and this increases foreign exchange earnings.
9.Intensifying publicity of Uganda‟s products in the foreign markets.
10. Campaign for removal of trade barriers in export markets. This enables the country export more
due to increased access to markets.
11. Improve quality of the exports. This causes an increase in the prices which improves earnings
N.B: Invisible exports are services/intangible goods sold by a country to other countries e.g. Insurance
banking and tourism
ECONOMIC DEPEDENCE
(a) Distinguish between economic dependence and economic interdependence. (b)

Explain the forms of economic dependence in your country.
Economic dependence refers to the reliance of an economy on other economies or sector for her
survival/development.
OR
Economic dependence is the reliance of an economy on other resources and decision or on specific
economic activities sectors for her development.
While
Economic interdependence refers to a situation in which two or more economies rely on each other
for mutual benefit of all.
Uganda is an open and dependent economy and economic dependence can be seen under
the following aspects:-
Forms of economic dependence
1. Trade dependence
This is the reliance on international trade/foreign markets for export and imports. Trade dependence
in Uganda is characterised by the following
• Dependence on export of few primary products in order to get foreign exchange needed
for development purpose with little output from the industrial sector commodity
concentration of trade.
• Dependence on the imported/foreign manufactured goods e.g capital equipment, fuel,
drugs chemicals, machinery to satisfy local requirements
• Dependence on few exports markets e.g. Uganda exports to the same region/ few
countries (geographical concentration of trade).
2. External resources dependence
This is the reliance on foreign economies foreign aid, skilled labour and technology. This is in
form of:
• Dependence on foreign skills.

• Dependence on foreign aid.
• Dependence on the technology.
3. Direct economic dependence
This is reliance on external/foreign decision making. Uganda depends on external decision

makers who have influenced economic policies in the country e.g. economic policies of
liberalisation, retrenchment, and privatisation all which are conditions of IMF for aid.
Uganda also relies on foreign manpower in form of expatriates.
1. Sectoral dependence.
This is the reliance on one sector e.g. agriculture. Uganda mainly depends on agriculture which is the
backbone of the economy as an important source of food, source of industrial raw materials etc.
Discuss the causes of economic dependence in developing countries.

Causes of economic dependence
1. Ldcs need foreign finances / resources for promoting development in order to break the vicious
cycle of poverty.
2. Shortage of skilled manpower has led to economic dependence in order to get manpower for
development of Ldcs economies e.g. expatriates.
3 Ldcs have weak under developed manufacturing sector leading to dependence on foreign
economies.
4. Poor technology in Ldcs has led to economic dependence in order to get technology to develop
their sectors like agriculture, industry, transport etc.
5. Inadequate domestic markets hence dependence on foreign markets.
6. High population growth rates which increase government expenditure reduce savings and limit
investment.
7. Natural calamities of earthquakes, droughts etc. These cause excessive need for funds to for
humanitarian assistance and yet government has less revenue.
8. Large agricultural sector hence dependence on agriculture.
9. It helps in availing resources for infrastructural development.
10. Shortage of foreign exchange. This is due to the low export capacity of the nation.
Examine the effects of economic dependence in developing countries.
DEMERITS OF ECONOMIC DEPENDENCE

1. It is responsible for the persistent balance of payment problem as a result of importation of high
priced manufactured goods which lead to high import expenditure.
2. It encourages capital outflow due to over dependence on foreign private investment and foreign
manpower in form of expatriates leading to repatriation of their profits and wages.
3. It stagnates the development of local technology. External resource dependence especially in the
field of technology has been an obstacle to the development of appropriate technology in Ldcs
because of transfer of inappropriate technology.
4. It has contributed to the unemployment and underemployment problem in Ldcs due to foreign
manpower dependence and use of capital intensive techniques in firms.
5. It leads to external economic dominance of Uganda by foreigners. Some policies are dictated on
Uganda yet some of them are not conducive for the country.
7. Heavy reliance on foreign capital discourages local savings and investment as citizens are always
hoping for aid.
8. Overdependence on external resources leads to under -utilisation of the local resources and
skills.
9. Over reliance on foreign resources such as foreign aid has contributed to heavy debt burden in
Ldcs.
10. Worsens political domination of my country by foreigners. Some political decision are dictated on
Uganda which undermines the political sovereignty of the country.
11. Poor terms of trade. Poor terms of trade result from exporting low priced products while
importing expensive commodities

12. Fluctuation of prices. Dependence on one sector such as agriculture results in to fluctuation of
prices because it is affected by several factors beyond the producers‟ control.
13. Fluctuation of incomes. Fluctuation of prices results into fluctuation of income of the producers.
14. It distorts the planning process. This is because aid is inconsistent, insufficient and therefore
some projects are abandoned.
15. Leads to social cultural domination/cultural erosion. This results from the citizens copying
the behaviours of the foreigners.
17. It worsens the debt burden. This because of continuous borrowing to finance the budget.
Positive effects
1. Promotes economic growth. It avails capital is invested in enterprises thus increasing national
output.
2. Helps to acquire financial resources. Dependence on capital from abroad avails finance to the
country.
3. Helps to cover technological gap. This is through technology transfer.
4. Helps to cover manpower gap. This is achieved by use of expatriates.
Suggest measures that may be taken to reduce economic dependence in your country.
MEASURES OF REDUCING ECONOMIC DEPENDENCE IN UGANDA/PROMOTING ECONOMIC

INDPENDENCE
1 Diversification of the agricultural production to reduce dependence on few exports and widen
income from agriculture.

2. Training of labour force to reduce dependence on expatriates by emphasizing practically
oriented education.
3. Promoting import substitution strategy of industrialisation to minimise dependence on foreign

manufactured goods.
4. Export promotion strategy to earn foreign exchange and reduce dependence on foreign aid.
5. Efforts should be put in the development of local technology and this can be achieved by
encouraging research and development.
6. Encouraging local investment through giving the local investors incentives e.g. subsidising them,
tax exemptions etc. to minimise on the dependence on foreign investors.
7. Diversifying markets to reduce dependence on few export markets by encouraging economic

integration.
8. Pursuing an industrialisation strategy that utilises more of our local resources and address
domestic demands to reduce dependence on foreign raw materials.
9. Improvement in political and investment climate to increase productivity and promote local
investment.
10. Liberalisation of foreign exchange markets to increase supply of foreign exchange.
11. Improving infrastructure. This reduces the cost of production and enables the producers supply
more goods and services reducing the demand for imports.

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ECONOMICS

Muhinda Richard Economics notes 2018 1

Muhinda Richard Economics notes 2018 2

Muhinda Richard Economics notes 2018 3

ECONOMICS AS POSITIVE AND NORMATIVE

MACROECONOMICS AND MICROECONOMICS

Muhinda Richard Economics notes 2018 4

BASIC CONCEPTS USED IN ECONOMICS

They are characterised by the following

SCARCITY, CHOICE AND OPPORTUNITY COST AND THE PRODUCT

Muhinda Richard Economics notes 2018 7

Muhinda Richard Economics notes 2018 8

Importance of the opportunity cost concept

QUESTIONS THAT ECONOMICS SEEKS TO ANSWER

The free enterprise/market economy

Advantages of the market system

Muhinda Richard Economics notes 2018 12

The command/planned hand economy

Muhinda Richard Economics notes 2018 13

THE MIXED ECONOMY SYSTEM

Muhinda Richard Economics notes 2018 14

Muhinda Richard Economics notes 2018 15

3. Market price: It is the ruling price in the market at a particular time.

Muhinda Richard Economics notes 2018 16

Determinants of market price

Muhinda Richard Economics notes 2018 17

THE THEORY OF DEMAND

Muhinda Richard Economics notes 2018 18

DETERMINANTS OF QUANTITY DEMANDED

Muhinda Richard Economics notes 2018 20

Why people demand for goods

The demand schedule

Price(shs) Qty (kgs)

Muhinda Richard Economics notes 2018 21

THE DEMAND CURVE

Muhinda Richard Economics notes 2018 22

These include the change in quantity demanded and charge is demand.

Change in quantity demanded

Muhinda Richard Economics notes 2018 23

Muhinda Richard Economics notes 2018 25

Muhinda Richard Economics notes 2018 26

ABNOMAL/REGRESSIVE DEMAND CURVE

Muhinda Richard Economics notes 2018 27

Types of demand (inter-related demand)

Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to a

PRICE ELASTICITY OF DEMAND (PED)

Muhinda Richard Economics notes 2018 29

Muhinda Richard Economics notes 2018 31

Muhinda Richard Economics notes 2018 32

Muhinda Richard Economics notes 2018 33

Unitary elastic demand curve

Change in price from P1 to P2 is equal to change in quantity demanded from Q1 to Q2.

D Perfectly elastic demand curve

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

Muhinda Richard Economics notes 2018 34

Muhinda Richard Economics notes 2018 35

PRACTICAL APPLICATIONS OF THE CONCEPT OF PRICE ELASTICITY OF DEMAND

INCOME ELASTICITY OF DEMAND (YED)

CROSS ELASTICIY OF DEMAND (CED)

Muhinda Richard Economics notes 2018 38

Solution = ∆QB . PA ∆PA

Muhinda Richard Economics notes 2018 39

The supply Curve

Muhinda Richard Economics notes 2018 40