COURSE

GUIDE

ECO 121
PRINCIPLES OF ECONOMICS II

Course Team Dr. Ajidani S. Moses (Course Developer) _______ NSUK

NASARAWA STATE UNIVERSITY KEFFI

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Nasarawa State University Keffi
Main Campus
Along Akwanga Road,
Keffi, Nasarawa State

Pyanku Campus
Kilometre 1,
Along Keffi-Nasarawa Road,
Keffi, Nasarawa State

Gudi Campus
Kilometre 1,
Along Gudi-Akwanga Road,
Gudi, Nasarawa State

e-mail:
website:

Printed by
NSUK Press

Printed 2023

ISBN:

All Rights Reserved

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CONTENTS PAGE
Introduction……………………………………………………………………….………….iv
Course Aims……………………………………………………………………...……….….iv
Reading through this Course……………………………………………………………........v
Course Materials………………………………………………………….………………….v
Study Units…………………………………………………………………..……………….vi
Assessment File……………………………………………….………..…..………….……..ix
Tutor-Marked Assignment (TMA)…………………………………………………………...ix
Final Examination and Grading………………………………………….………….………..x
Course Marking Scheme……………………………………………………………………...x
Course Review……………………………………………………………………………......x
Facilitator/Tutors and Tutorials……………………………………………………………....xii
Summary………………………………………………………….…..……………………...xii

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INTRODUCTION

ECO 121: Principle of Economics II, is a three-credit and one-semester undergraduate course for
Economics, other social sciences, and management students. The course is made up of 21 units
spread across fifteen lectures weeks. This course guide tells you what economic problems are
and how they are used to solve households, firm’s, and government economic needs. It tells you
about the course materials and how you can read through these materials. It suggests some
general guidelines for the amount of time required of you on each unit in order to achieve the
course aims and objectives successfully. Answers to your tutor marked assignments (TMAs) are
therein already.

COURSE CONTENT

This course is basically an introductory course on the two broad areas of economics namely;
microeconomics, and macroeconomics. The topics covered includes the subject matter of
economics and basic economics problems; the methodology of economics science; and the
general principles of resource allocation; market mechanism-demand and supply; price
determination and elasticity, theory of consumer behavior; theory of production; market structure
price and output under perfect competition; monopoly; monopolistic competition and oligopoly.
It takes you through meaning of economics and its various definitions. Since economics is
defined based on the two assumptions, the assumptions were elaborated on in relation with some
other concepts that are interwoven. Thereby interdependency and complexity of economics
become obvious through real life scenario given in the units.
COURSE AIMS
The aim of this course is to give you in-depth understanding of the economics as regards:
i) basic concepts and practices of economics
ii) to familiarize students with scarce economics resources which form the basis for rational
decision by households and firms
iii) to stimulate student’s knowledge of decision making within the households and firm
iv) to show the circular relationship between households and firm, input and output and flow of
resources within the economy system
v) to expose the students to economic history and behaviors of households and firms in
allocation of resource and in manipulation of factors of production for profit maximization
COURSE OBJECTIVES
To achieve the aims of this course, there are overall objectives which the course is out to achieve
though, there are set out objectives for each unit. The unit objectives are included at the
beginning of a unit; you should read them before you start working through the unit. You may
want to refer to them during your study of the unit to check on your progress. You should always

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 look at the unit objectives after completing a unit. This is to assist the students in accomplishing
the tasks entailed in this course. In this way, you can be sure you have done what was required
of you by the unit. The objectives serves as study guides, such that student could know if he is
able to grab the knowledge of each unit through the sets of objectives in each one.
At the end of this course, students should be able to:

i) define economics, state its importance and enunciate on assumptions upon which
the definitions are based
ii) state why and how available choices leads to decision making and Relate basic
economic concept and problems
iii) enumerate the importance of basic economics question and know how to apply
rationality to answering the questions in the decision making process
iv) list and explain different methods of solving economic problem which lead to
different types of economies. Differentiate between different types of economies
and know the weaknesses and strength of each method of economy
v) explain how firms transforms resources allocated (input) into product (output) and
understand the circular flow of supply and demand between households and firm
vi) discuss price mechanism, explain demand for a commodity in relation to changes
in price and elucidate on factors that determines quantity demanded and supplied.
Define elasticity in relation to demand and supply
vii) explain why government interfere in the market price
viii) determination and how government interfere in the market
ix) explain the concept of utility, marginal and tot utility
x) describe how input are employed in satisfying human wants, consumer’s
preference and indifferent curve and consumer equilibrium point on the budget line
xi) discuss factors of productions and their specific contribute to process of production
xii) explain Cost concepts and their definitions, different market structures and
behaviour of firms.

READING THROUGH THE COURSE

To successfully complete this course, you are required to read the study units, referenced books
and other materials on the course. Each unit contains Self-Assessment Exercises. At some points
in the course, you will be required to submit assignments for assessment purposes. At the end of
the course there is a final examination. This course should take about 15weeks to complete and
some components of the course are outlined under the course material subsection.
COURSE MATERIALS
The major component of the course, what you have to do and how you should allocate your time
to each unit in order to complete the course successfully on time are listed as follows:

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1. Course Guide
2. Study Unit
3. Textbook
4. Assignment File
5. Presentation Schedule

STUDY UNITS
There are six modules in this course broken into 21 units which should be carefully and
diligently studied.

MODULE 1 INTRODUCTION TO THEORY OF NATIONAL INCOME

Unit 1 Meaning and Accounting of National Income

Unit 2 Reasons for Calculating National Income

Unit 3 Problems and Determinants of national income

MODULE 2 CIRCULAR FLOW OF INCOME

Unit 1 Concept of Circular Flow of Income

MODULE 3 INTRODUCTION TO PUBLIC FINANCE

Unit 1 Concept and Components of Public Finance

MODULE 4 INTRODUCTION TO THE THEORIES Of MONEY

Unit 1 Meaning, Functions and Characteristics of Money

Unit 2 Theories of Demand for Money

MODULE 5 INTRODUCTION TO BUSINESS ORGANIZATION

Unit 1 Meaning and Types of Business Organization

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MODULE 6 INTRODUCTION TO INTERNATIONAL ECONOMICS

Unit 1 Meaning of International Economics

Unit 2 Theories of International Trade
Unit 3 International Trade Restrictions and Balance of Payment

Each study unit will take at least two hours, and it include the introduction, objectives, main
content, conclusion, summary and references. Other areas border on the Tutor-Marked
Assessment (TMA) questions. Some of the self-assessment exercises will necessitate discussion,
brainstorming and argument with some of your colleagues. You are advised to do so in order to
understand and get acquainted with daily economic activities.

There are also textbooks under the references and other (on-line and offline) resources for further
reading. They are meant to give you additional information if you can lay your hands on any of
them. You are required to study the materials; practice the self-assessment exercises and tutor-
marked assignment (TMA) questions for greater and in-depth understanding of the course. By
doing so, the stated learning objectives of the course would have been achieved.

TEXTBOOKS AND REFERENCES

For further reading and more detailed information about the course, the following materials are
recommended:

Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-western Publishing Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. November 30th,
http://homepage.newschool.edu/~foleyd/ratid.pdf.

Marshall, A. (1920). Principles of Economics. Library of Economics and

Liberty. Assessed November 29, 2011
http://www.econlib.org/library/Marshall/marP4.html.

Reynolds, L. R. (2005). Alternative Microeconomics.

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 November 25, 2011, from
http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations.

North, D. C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge:

Cambridge University Press.

Welch, P. J. and Welch, G. F. (2010). Economics: Theory and Practice. (pp.1-560). United State
of America: John Wiley & Sons Inc.

Mahadi, S. Z. (2006). Understanding Economics. Kuala Lumpur: Cosmopoint Sdn. Bhd.

Samuelson, P. A. and Nordhaus, W. D. (2010). Economics. (9th ed.). New York: McGraw Hill
Companies.

O’Sullivian, A. and Sheffrin, S. M. (2003). Microeconomics Principles and Tools. (3rd ed.). New
Jersey: Pearson Education Inc.

Ojo, O. (2002). ‘A’ Level Economics Textbook for West Africa. (5th ed.). Ibadan: Onibonoje
Publishers.

Case, K. E. and Fair, R. C. (1999). Principles of Economics. New Jersey: Prentice Hall.

Hal, R. V. (2002). Intermediate Microeconomics: A Modern Approach. (6th ed.). New York:
Norton.

ASSIGNMENT FILE

This file presents to students with details of the work students must submit to their tutor for
marking. The marks they obtain from these assignments shall form part of their final mark for

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this course. Additional information on assignments will be found in the assignment file and later
in this Course Guide in the section on assessment.
There are four assignments in this course. The four course assignments will cover:

Assignment 1 - All questions in Module 1, Units 1-3, Module 2, unit 1

Assignment 2 - All questions in Module 3, Unit 1, Module 4 Units 1-3
Assignment 3 - All questions in Module 5, Unit 1, Module 6, Units 1-3

PRESENTATION SCHEDULE

The presentation schedule included in this course materials gives you the important dates for the
submission of Tutor-Marked Assignments and attending tutorials. Remember, students are
required to submit all their assignments by due date. The students should guide against falling
behind in their work.

ASSESSMENT

There are two types of assessment in this course. First are the Tutor-Marked Assignments;
second, there is a written examination. In attempting the assignments, students are expected to
apply information, knowledge and techniques gathered during the course. The assignments must
be submitted to their tutor for formal Assessment in accordance with the deadlines stated in the
Presentation Schedule and the Assignments File. The work students submit to their tutor for
assessment will count for 30 % of their total course mark. At the end of the course, you will need
to sit for a final written examination of three hours' duration. This examination will also count
for 70% of your total course mark.

TUTOR-MARKED ASSIGNMENT

There are four Tutor-Marked Assignments in this course. Students will submit all the
assignments. You are encouraged to work all the questions thoroughly. The TMAs constitute
30% of the total score. Assignment questions for the units in this course are contained in the
Assignment File. Students should be able to complete their assignments from the information
and materials contained in their set books, reading and study units. However, it is desirable that
students demonstrate that students have read and researched more widely than the required
minimum. Students should use other references to have a broad viewpoint of the subject and also
to give them a deeper understanding of the subject.

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When you have completed each assignment, send it, together with a TMA form, to your tutor.
Make sure that each assignment reaches your tutor on or before the deadline given in the
Presentation File. If for any reason, you cannot complete your work on time, contact your tutor
before the assignment is due to discuss the possibility of an extension. Extensions will not be
granted after the due date unless there are genuine reason(s).

FINAL EXAMINATION AND GRADING

The final examination will be of three hours' duration and have a value of 70% of the total course
grade. The examination will consist of questions which reflect the types of self-assessment
practice exercises and tutor-marked problems you have previously encountered. All areas of the
course will be covered

Revise the entire course material using the time between finishing the last unit in the Module and
that of sitting for the final examination too. Students might find it useful to review their Self-
Assessment Exercises, Tutor-Marked Assignments and comments on them before the
examination. The final examination covers information from all parts of the course.

COURSE MARKING SCHEME

The table presented below indicates the total marks (100%) allocation.

Assignment Marks
Assignments (Best three assignments out of four 30%
that is marked)
Final Examination 70%
Total 100%

COURSE OVERVIEW

The table below indicates the units, number of weeks and assignments to be taken by students to
successfully complete the course-Principles of Economics (ECO 111).

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Units Title of Work Weeks Assessment
Activities (End of Unit)
Course Guide
Module 1 Introduction to Theory of National Income
1 Meaning of National Income Week 1 Assignment 1
2 National Income Accounting Week 1 Assignment 1

3 Reasons for Calculating Week 2 Assignment 1

National Income
4 Problems faced in calculating Week 2 Assignment 1
national income
5 Determinants of a country's Week 2 Assignment 1
national income
Module 2 Circular Flow of Income
1 Concept of Circular Flow of Week 3 Assignment 1
Income
Module 3 Introduction to Public Finance
1 Concept of Public Finance Week 6 Assignment 2
Module 4 Introduction to the Theories of Money
1 Meaning, Functions and Week 7 Assignment 3
Characteristics of Money
2 Theories of Demand For Week 7
Money
Module 5 Introduction to Business Organization
1 Meaning and Types of Week 8 Assignment 3
Business Organization
Module 6 Introduction to International Economics
1 Meaning of International Week 9 Assignment 4
Economics
2 Theories of International Trade Week 10 Assignment 4
3 International Trade Restrictions Week 10 Assignment 4

4 Balance of Payment Week 11 Assignment 4

Total 11 Weeks

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FACILITATORS/TUTORS AND TUTORIALS

There are some hours of tutorials (2-hour sessions) provided in support of this course. Students
will be notified of the dates, times and location of these tutorials. Together with the name and
phone number of the tutor, as soon as students are allocated tutorial groups.

The tutor will mark and comment on students’ assignments, keep a close watch on their progress
and on any difficulties, they might encounter, and provide assistance to them during the course.
Students must mail your Tutor Marked Assignments to their tutor well before the due date (at
least two working days are required). They will be marked by their tutor and returned to them as
soon as possible.

Students should not hesitate to contact their tutor by telephone, e-mail, or discussion board if
need for help arise. The following might be circumstances in which students may need help.

Contact your tutor if you:

• do not understand any part of the study units or the assigned reading
• have difficulty with the Self-Assessment Exercises
• have a question or problem with an assignment, with your tutor's comments on an
assignment or with the grading of an assignment.

Students should try their best to attend the tutorials. This will provide an opportunity for them to
have face to face contact with their tutor and to ask questions which are answered instantly.
Students can raise any problem encountered in the course of their study. To gain the maximum
benefit from course tutorials, prepare a question list before attending them. You will learn a lot
from participating in discussions actively.

SUMMARY

The course, Principle of Economics (ECO 111), expose students to basic concepts in economics
and production, production process; and factors of production. This course also gives students
insight into price determination by invisible hand of the market through interaction of demand
and supply for output. Thereafter it shall enlighten the students about decision making by
households and firms, theory of firm. Conclusively it explicates on how different behaviours of

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firms lead to different market structures and also make comparison between these different
structures.

On successful completion of the course, students would have developed critical thinking skills
with the material necessary for efficient and effective discussion of economic issues, factors of
production and behaviour of firms and households. However, to gain a lot from the course
students should try and apply all that they learn in the course to term paper writing in other
economic development courses. We wish students success in the course and hope that they will
find it interesting and useful.

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MAIN COURSE

Study Session 1 Meaning and Accounting of National Income…………………………3

Study Session 2 Reasons for Calculating National Income………………………….…10

Study Session 3 Problems and Determinants of national income…………………….13

Study Session 4 Concept of Circular Flow of Income……………….……………….21
Study Session 5 Concept and Components of Public Finance…………….………….27
Study Session 6 Meaning, Functions and Characteristics of Money……….………...48
Study Session 7 Theories of Demand for Money …………………….………………52
Study Session 8 Meaning and Types of Business Organization ………………….….61
Study Session 9 Meaning of International Economics ………………………………83
Study Session 10 Theories of International Trade …………………………………….90
Study Session 11 International Trade Restrictions and Balance of Payment …………94

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 Study Session 1

Meaning and Accounting of National Income

Introduction
This study session starts with meaning of national income. This is followed by other definitions
of national income as propounded by some famous Economists. Since national income is defined
based on the two measures namely; gross domestic product (GDP), and gross national product
(GNP) in relation with some other concepts that are interwoven. Thereby interdependency and
complexity of economics become obvious through real life scenario given in this study session.

Learning Outcomes of Study Session 1

When you have studied this session, you should be able to:
1.1 Provide at least two definitions of national income
1.2 explain at least five Basic Concepts in National Income Accounting
1.3 explain three Methods of Calculating National Income

1.1 Definitions of National Income

National income is the market value of final goods and services produced in an economy over a
period of one year expressed in monetary value. On the other hand, national income accounting
is the summation of the market value of all final goods and services in an economy in monetary
term. The total income earned in an economy is equal to addition of incomes earned by
individual’s business organizations and governments.

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National income means the value of goods and services produced by a country during a financial
year. Thus, it is the net result of all economic activities of any country during a period of one
year and is valued in terms of money. National income is an uncertain term and is often used
interchangeably with the national dividend, national output, and national expenditure. National
Income is the total amount of income accruing to a country from economic activities in a fixed
period of time (i.e., One Year). It includes payments made to all resources either in the form of
wages, interest, rent, and profits. The progress of a country can be determined by the growth of
the national income of the country. There are mainly two types of view to define national
income.
(i)Traditional Definition, and (ii) Modern definition

(i) Traditional Definition

Marshall defined national income as: “the labour and capital of a country acting on its natural
resources produce annually a certain net aggregate of commodities, material and immaterial
including services of all kinds”. This is the true net annual income or revenue of the country or
national dividend.” The definition as laid down by Marshall is being criticized on the following
grounds. Due to the varied category of goods and services, a correct estimation is very difficult.
Because, there is a chance of double counting, hence National Income cannot be estimated
correctly. For example, a product runs in the supply from the producer to distributor to
wholesaler to retailer and then to the ultimate consumer. If on every movement, commodity is
taken into consideration then the value of National Income increases.

Pigou defined national income as “That part of objective income of the community, including of
course income derived from abroad which can be measured in money”. Though Pigou’s
definition avoided the fallacy of double counting and included income from abroad it suffers
from the defect that only goods and services that can be measured in terms of money are
included in national income. According to Pigou, a woman’s services as nurse would be included
in the national income but excluded when she worked in the home to look after the children
because she did not receive any salary for it.

Modern Definition

Simon Kuznets defines national income as “the net output of commodities and services flowing
during the year from the country’s productive system in the hands of the ultimate consumers.”
Whereas, in one of the reports of United Nations, national income has been defined on the basis
of the systems of estimating national income as net national product (NNP). There are various
concepts pertaining to national income are as follows: Gross Domestic Product (GDP) Gross
domestic product relates to the product of the factors of production employed within the
political boundaries i.e., within domestic territory. It is defined as a measure of the total flow of

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goods and services produced by an economy over a specified time period, usually a year. All
value of intermediate products is excluded. So only the market value of final products is included
to define GDP. Gross National Product (GNP) Gross national product is the total measure of the
flow of goods and services at market value resulting from current production during a year in a
country, including net income from abroad.

GNP= GDP + Net income from abroad(X-M), where X= Export, M= Import If the value of (X-
M) is negative then, GDP > GNP Net National Product (NNP). Net national product is
considered a true measure of national product or income. It is defined as GNP minus
depreciation or capital consumption allowance or wear and tear. NNP = GNP – Depreciation.
Unlike GDP, GNP, net national product (NNP) may also be categorized as: NNPmp (Net
national product at market price): Net national product at market prices is net value of final
goods and services evaluated at market prices in the course of one year in a country.

NNPfc (Net national product at factor cost): Net national product at factor cost is the net output
evaluated at factor prices. It includes income earn by factors of production through participation
in the production process such as wages and salaries, rents profits etc. NNP at factor cost is also
called National Income.

NNPmp = NNPfc – S + (IT+ GS) or, NNPmp = NNPfc – subsidies + (indirect tax+ surpluses
from government enterprises) NNPfc = NNPmp + S - (IT+ GS) or, NNPfc = NNPmp + subsidies
(indirect tax+ surpluses from government enterprises).

Normally, NNP at market prices is higher than NNP at factor cost because indirect taxes exceed
government subsidies. However, NNP at market prices can be less than NNP at factor cost when
government subsidies exceed indirect taxes. Some other concepts of national income

Private income: Private income is income obtained by private individuals from any source,
produce or otherwise and retained income of corporations. It can be obtained from NNP at factor
cost by making certain additions and deductions.
Private Income = National income (NNP at factor cost) +Transfer Payments + Interest on Public
Debt – Social Security – Profits and Surpluses of Public Undertakings.

Personal Income: Personal income is the total income received by the individuals of a country
from all sources before direct taxes in one year.
Personal income is never equal to the national income because the former includes the transfer
payments whereas they are not included in national income. Personal income is derived from
national income by deducting undistributed corporate profits, profit taxes, and employee’s
contributions to social security schemes. Personal income differs from private income actually it
is less than private income because it excludes undistributed corporate profits.

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Personal Income = National Income – Undistributed Corporate Profits – Profit Taxes – Social
Security Contributions + Transfer Payments + Interest on Public Debt.

Disposable Income: Disposable income or personal disposable income means the actual income
which can be spent on consumption by individuals and families. Disposable Income = National
Income – Business Savings – Indirect taxes plus Subsidies – Direct Taxes on persons – Direct
Taxes on Business – Social Security Payments + Transfer Payments + Net Income from Abroad
(X-M).

Real Income: Real Income is the income expressed in terms of a general level of prices of a
particular year taken as base year. National income in terms of money at current prices does not
indicate the real state of the economy. So, the concept of real income has been propounded to
rectify such illusions. This is also known as National Income at constant prices. Real NNP =
NNP for the Current Year Multiply with Base Year Index (100) Divided by Current Year Index.

Per Capita Income: The average income of the people of a country in a particular year is called
Per Capita Income for that year. Per Capita Income for 2011 = National Income for 2011 divided
by Population in 2011 This concept enables us to know the average income and the standard of
living of the people. But it is not very reliable due to unequal distribution of national income
exist in every country.

In-Text Question (ITQ) 1.1

Marshall defined national income as-----------------------------------------

In-Text Answer (ITA) 1.1

“The labour and capital of a country acting on its natural resources to produce annually a certain
net aggregate of commodities, material and immaterial including services of all kinds”.

1.2 Basic Concepts in National Income Accounting

Some basic concepts used in national income calculation include the following:
i. Personal income: It is the income received by individuals over a period of time.
ii. Disposable income: It is the amount of money that is left to an individual for
consumption and savings after personal income taxes are deducted.
DI =TI - Taxes
Where;
DI = Disposable in income;
TI = Total income;

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iii. Real income: It is the value of money in terms of goods and
services it can buy. It is calculated as:
RI = TI
P
Where;
RI = Real income
TI= Total income
P = Price
iv. National income accounting: Is the measurement of the monetary value total flow of
output (of goods and services) and of the total flow of inputs (factors of production) that
pass through all markets in the economy during a specified period or time
v. Value added: Is the value of a firm's output minus the value its inputs purchased from
other firm(s).
vi. vi Intermediate products: These are all goods and services used as inputs into a further
stage of production.
vii. Final products: These are the output of the econ0111Y after eliminating all double
counting,
viii. Double Counting: This is the recording of the Value of a single product more than once,
ix. investment: it is expenditure not on immediate consumption but for further production
or goods and services
x. Gross investment: Total investment the economy
xi. capital consumption (depreciation): It is the amount set aside for replacement of worn-
out Capital.
xii. Gross National Income (or GNP): Total income within and outside the economy.
xiii. Gross Domestic Product (or GDP); Total income produced within an economy.
xiv. Net National Income (or NNP): GNP-depreciation.
Net Income from Abroad: GDP
xv. Transfer payments: Any payment for no work done e.g. student bursary awards, sick
benefits, etc.
xvi. Injection: Any activity (or variable) that increase the level of national income e.g.
investment exports, and government expenditure.

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xvii. Withdrawal: Any activity (or variable) that Bases the level of national income e.g.
savings, imports and taxation

In-Text Question (ITQ) 1.2

List any 5 basic concepts in national income accounting.

In-Text Answer (ITA) 1.2

 Personal income
 Disposable income
 Real income
 Gross National Income (or GNI)
 Value added:

1.3 Methods of Calculating National Income

Income Method
Using this method national income is calculated by adding up incomes of individuals, firms and
governments. That is, the income earned as wages, salaries, rents, interest and profits as well as
government revenue. But incomes earned through transfer payment, illegal activities,
unemployment wages, sick benefits and student’s scholarship, which are for no work done are
excluded from the calculation to avoid double counting.

Output Method
This approach computes the total national income in a country in a year. To avoid double
counting, the figures are collected on the basis of value added. But, the value of capital
depreciation is excluded from the calculation.

Expenditure Method
This measures the total expenditures by individuals, firms, and governments on consumption and
investments during the year. Again, transfer payments, such as pension, sick, , etc, are

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excluded from the computation. Any of the methods used give the same result. Thus, total
income equals total value of output which also equals total expenditure.

Where;
NI = National income
TVO = Total value of output
NE = National expenditure

In-Text Question (ITQ) 1.3

Mention any 4 items that should not be included in using income method to calculate national
income.

In-Text Answer (ITA) 1.3

 Incomes earned through transfer payment

 Incomes earned through illegal activities
 unemployment wages
 sick benefits and student’s scholarship

Summary of Study Session 1

In study session 1, you have learned that:
1. National income is the market value of final goods and services produced in an economy
over a period of one year expressed in monetary value.
2. There are some basic concepts in national income accounting, which include; personal
income, disposable income, real income, gross national income (GNI), and Value added.
3. National income can be measured in three different ways, which are: income method,
output method, and expenditure method.

SELF-ASSESSMENT QUESTIONS (SAQs) for Study Session 1

Self-Assessment Question 1.1 (Test Learning Outcome 1.1)

Define national income and state the relationship between GDP and GNP

Self-Assessment Question 1.2 (Test Learning Outcome 1.2)

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Distinguish between Net national product at factor cost (NNPfc) and Net national product at
market prices (NNPmp).

Self-Assessment Question 1.3 (Test Learning Outcome 1.3)

Briefly explain income method of calculating national income

Glossary of Terms
Injection
Any activity (or variable) that increase the level of national income e.g. investment exports, and
government expenditure.

Withdrawal
Any activity (or variable) that Bases the level of national income e.g. savings, imports and
taxation

REFERENCES/FURTHER READING
Ahuja B.N. (1985). Dictionary of Economics. Academic (India) Publishers, New Delhi.
Karunagaran M. & Jeyakumar M (1966). Economics. Macmillan India Limited, New
Delhi.
Jhingan M. L. (1993). Macroeconomic Theory. Konark Publishers Pvt Ltd, New Delhi
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
November 29, 2011 http://www.econlib.org/library/Marshall/marP4.html.

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 Study Session 2
Reasons for Calculating National Income
Introduction
This study session starts with reasons for computing national income. There are several reasons
for computing national income as mentioned in economics literature. These include: i) to know
a country economic performance overtime; ii) to know a country’s per-capital income and
standard of living; iii) to know the structure of production and consumption of goods and
services; iv) to compare the standard of living between countries; etc

Learning Outcomes of Study Session 2

When you have studied this session, you should be able to:
2.1 Explain the reasons for calculating national income

2.1 Reasons for Calculating National Income

There are several reasons for computing national income. These include:
(i) To know a country economic performance overtime: an increase in national income figures
indicate that the country is growing, and vice versa.
(ii) To know a country’s per-capital income and standard of living: This can be achieved by
dividing national income by total population. That is;

PCI = N.I
TP.

Where:

PCI = Per-Capital Income;

N.I = National income; and

T.P. = Total population of the country.

(iii) To know the structure of production and consumption of goods and services. This is done by
comparing the figures of economic sectors and agents.
10
 (iv) compare the standard of living between countries: The country with higher national
income figure is assumed to have higher standard of living, or vice versa.
(v) For economic planning and policies: Since the figures show the performance of the
various sectors of the economy, it can be used for economic planning,
(vi) To aid allocation of resources in the country: Since national income figures show the
contributions from all the regions and states, it assists government in planning how to
redistribute income between them.

In-Text Question (ITQ) 2.1

Mention 3 reasons for calculating national income.

In-Text Answer (ITA) 2.1

 To know a country economic performance overtime: an increase in national income

figures indicate that the country is growing, and vice versa.
 To know a country’s per-capital income and standard of living: This can be achieved by
dividing national income by total population
 To aid allocation of resources in the country: Since national income figures show the
contributions from all the regions and states, it assists government in planning how to
redistribute income between them.

Summary of study session 2

In study session 2, you have learned that:
1. There are many reasons for calculating national income, which include; (i) to know a
country economic performance overtime: an increase in national income figures indicate
that the country is growing, and vice versa; (ii) to know a country’s per-capital income
and standard of living; to assist government in planning how to redistribute income
between the constituent units in the economy

Self-Assessment Questions (SAQs) for Study Session 2

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 2.1 (Test Learning Outcome 2.1)

11
Briefly explain the reasons for calculating national income

Glossary of Terms
Income
Is the sum of money which a business or an individual receives in exchange of sales of goods or
service, or through capital investment.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing Co.
Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,2011
from http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
November 29, 2011 http://www.econlib.org/library/Marshall/marP4.html
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed November 25, 2011 from
http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.
Smith, A. ((1904). An Inquiry into the Nature and Causes of the Wealth of Nations.
Edwin Cannan (Ed). London: Methuen & Co. Ltd.
Chad, B. (2012). What is Economics? Accessed January 29, 2023 from
www.businessnesdaily.com/2639-econ.

Study Session 3

12
 Problems and Determinants of national income
Introduction
In this study session, problems that are likely faced in computing national income will be
explained. These include: i) lack of data; ii) double counting; iii) Inflation; etc. In this unit,
determinants of national income will be explained. These include: i) infrastructure; ii) state of
technology; iii) quantity and quality of factors of production; etc. Also, limitations on the uses of
national income were explained.

Learning Outcomes of Study Session 3

When you have studied this session, you should be able to:
3.1 Explain at least nine problems that are likely faced in computing national income
3.2 Elucidate at least five determinants of a country's national income.

3.1 Problems that are likely faced in calculating national income

There are many problems that are likely faced in calculating national income of a country. They
include:

(i) Lack of data: This problem is due to lack of transportation and communication facilities,
illiteracy fear of taxation on the part of some producers and consumers.
(ii) Double counting: There is the danger of calculating the value of a good twice when
calculating national income, particularly through the output method. For instance, it is
possible to add the values of raw cassava, garri and starch. This may overestimate the
national income figures.
(iii) Lack of statisticians who can collect and analyze data on national income.
(iv) Inflation: During inflation the value of money decreases over time, and this may not
give a correct estimate of the national income.
(v) Transfer payments: It is sometimes difficult to classify some individual's income as
transfer payment or not where as transfer payments are not to be included in the
calculation of national income.

13
(vi) Unpaid services: Since unpaid services such as owner-occupied houses, services of
house wives, etc, are not paid and therefore not included in national income estimates, it
is difficult to arrive at the correct figures.
(vii) Value of depreciation: It is always difficult to know the correct value of capital
depreciation which is be excluded from the gross domestic product before arriving at
national income.
(viii) Difficulties in calculating Net income from Abroad: This is due to instability in
foreign exchange rate and value.
(ix) Illegal Activities: It is difficult to know the value of income earned through illegal
activities, and thus makes the computation of national income difficult.

In-Text Question (ITQ) 3.1

List 4 problems that are likely faced in calculating national income

In-Text Answer (ITA) 3.1

 Illegal Activities
 Transfer payments
 Unpaid services
 Double counting

3.2 Determinants of a country's national income

There are many factors that determine the output and value of goods and service a country.
These include:

(i) The quantity and quality of factors of production: Countries with more of factors of
production and which can make efficient use of them will likely raise their output of
goods and services.
(ii) Infrastructure: Provision of adequate and efficient infrastructural facilities in a country
can increase the out of goods and services in that country.

14
(iii) State of Technology: The techniques of production a country adopts can affect output
and the size of that country's national income,
(iv) Political Stability: This ensures peace and thus people's ability to produce. During wars,
people cannot produce and so output of goods will fall.
(v) External factors such as: terms of trade, foreign direct investment, loans and grants to
and from a country can determine the output of goods and services in that country.
Favorable external factors can raise domestic output, and vice versa.

In-Text Question (ITQ) 3.2

List 3 determinants of a country's national income

In-Text Answer (ITA) 3.2

 The quantity and quality of factors of production

 Infrastructure
 State of Technology.

Summary of study session 3

In study session 3, you have learned:
1. The problems that are likely faced in calculating national income.
2. The determinants of national income include: infrastructure; state of technology; quantity and
quality of factors of production; etc.

Self-Assessment Questions (SAQs) for Study Session 3

Self-Assessment Question 3.1 (Test Learning Outcome 3.1)

Explain the problems that are likely faced in computing national income

Self-Assessment Question 3.2 (Test Learning Outcome 3.2)

Explain how external factors affect national income of a country

15
Glossary of Terms
Expenditure
Expenditure refers to payment or liabilities incurred in exchange for goods or service.
Payment
Is the voluntary transfer of money, equivalent for the exchange of goods an services received to
meet a legal obligation from one person to the other
Output
It is the quantity of goods and services produced in a given time period, by a firm, industry, or
country whether consumed or used for further production

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing
Co.
Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,
2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
November 29, 2011 http://www.econlib.org/library/Marshall/marP4.html
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed November 25, 2011
from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.
Smith, A. ((1904). An Inquiry into the Nature and Causes of the Wealth of Nations.
Edwin Cannan (Ed). London: Methuen & Co. Ltd.
Chad, B. (2012). What is Economics? Accessed January 29, 2023 from
www.businessnesdaily.com/2639-econ.

16
 Study Session 4
Circular Flow of National Income
Introduction
In this study session, determinants of national income were explained. These include: i)
infrastructure; ii) state of technology; iii) quantity and quality of factors of production; etc. Also,
limitations on the uses of national income would be explained.

Learning Outcomes for Study Session 4

When you have studied this session, you should be able to:
4.1 explain circular flow of national income
4.2 circular flow of national income in different types of economies

4.1 Circular flow of national income

The circular flow of national income describes the flow of resources (both money and services)
between productive and consumption agent in a country. Circular flow of income means the
unending flow of production of goods and services, income, and expenditure in an economy. It
shows the redistribution of income in a circular manner between the production unit and
households. These are land, labour, capital, and entrepreneurship. It shows the redistribution of
income in a circular manner between the production unit and households.

These are land, labour, capital, and entrepreneurship.

(i) The payment for the contribution made by fixed natural resources (called land) is known as
rent.
(ii) The payment for the contribution made by a human worker is known as wage/salaries.
(iii) The payment for the contribution made by capital is known as interest.
(iv) The payment for the contribution made by entrepreneurship is known as profit.

In general, it shows how money passes from households (individuals) to firms in return for goods
produced by the firms and money passes from firms to households in return for factor services
provided by households. The flows of money and goods exchanged in a closed circuit
correspond in value, but run in the opposite direction. The circular flow analysis is the basis of
national accounts and hence of macroeconomics.

Basic assumptions: The basic consumptions in circular flow of national income are:

17
 i. National income is constant.
ii. The level of price is constant
iii. There are unemployed supplies of all factors of production.

In-text Question (ITQ) 4.1

1. List 3 Basic assumptions of circular flow of national income.

In-Text Answer (ITA) 4.1

1. The 3 Basic assumptions of circular flow of national income are:

 National income is constant.

 The level of price is constant
 There are unemployed supplies of all factors of production.

4.3 Circular flow of national income in different types of economies

We discussed circular flow of income in three types of economies. They are:

(a)Simple (or spend thrift) economy.

In the simple (or spend thrift) economy, everything produced is consumed. There is no idea of
saving nor investment. Thus, households constitute both productive and consumption agents.
The primitive hunting economy, gathering economy and peasant farming economy are good
examples of spend thrift economy. In the spend thrift economy, the model of national income
determination is given as:

Y = C ……………………………………………………………………………………..…..(4.1)

Where;

Y = national income; and

C = Consumption.
(b) Frugal Economy
In the frugal economy, income flows between households and firms. Thus, it is an economy with
savings and/or investments. Therefore, the model of national income determination is:

18
 Y=C+I ……………………………………………………………...………………….…… (4.2)

Y=C+S ……………………………………………………………………………………… (4.3)

Where:
Y= C = Consumption
I = Investment
S = Savings.
It is shown diagrammatically in figure 2.1.

»avm
i

Figure 4.1: Circular flow of income between Households and firms (in a two-sector closed
economy).

Since this economy assumes savings and investment, financial institutions such as banks are
included:

(i) Flow of resources: Households are endowed with factor which they sell to the firms in the
factor market. The firms used the productive services in certain combinations to produce goods
and sell to the household in the goods market.
(ii) Flow of money: The firms, in return, pay the Households income wages, salaries, rents and
profits, i.e. productive services supplied by the households. The households either use all the
money obtained from the firms to buy goods in the product et or save a portion of it.
The portion saved by households is channeled into financial institutions in the form of savings
and from the firms in form of investment.

Thus, in equilibrium:

19
 C+I=C +S………………………………………………………….…….……….…………… (3)
i.e. I= C……………………………..……………………..………………..………………… (4)
after eliminating C from both sides of equation (3). Hence, in equilibrium„ aggregate demand
must equal aggregate supply or investment must equal savings.

(c) Governed Economy

In this economy government participation through her expenditure and taxation, has been
included. The income, thus, circulate between households, firms and the government. The model
of national income determination is given as:

Y = C + I + G ………………………………………………………………………………… (5)

Where; G = Government activity.

The diagram is present below

Investment (Production)

Fig. 4.2. Circular flow of income between Households, firms and government.

Description
(A) Households: These supply factors of production to the firms through the factor market. In
return, the households received factor payments in the form of wages, rents, interest and
profits.
(B) Firms: These use the factors of production to produce goods which they sell to the
households in the goods market. The firms receive payment from the household for the
goods sold.

20
(C) Governments: Both Households and firms pay taxes to the government (in the form or
personal income taxes and company income taxes) respectively. The tax revenues are used
by government to purchase goods and services in the product market and provide social
services to the households.

In-Text Question (ITQ) 4.2

List 3 types of Circular flow of income

In-Text Answer (ITA) 4.2

 Governed Economy
 Frugal Economy
 Simple (or spend thrift) economy

Summary of Study Session 4

In study session 4, you have learned that:

1. The circular flow of national income is done in many ways. These are: Simple (or spend
thrift) economy; Frugal economy; and governed economy. Circular flow of income is
between households, firms and governments in an economy.
2. Circular flow of income means the unending flow of production of goods and services,
income, and expenditure in different economies. It shows the redistribution of income in
a circular manner between the production unit and consumption units.

Self-Assessment Questions (SAQs) for Study Session 4

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 4.1 (Test Learning Outcome 4.1)

Mention any three factors of production and their respective reward.

The three factors of production are land, labour, and capital.

21
(v) The payment for the contribution made by fixed natural resources (called land) is known as
rent.
(vi) The payment for the contribution made by a human worker is known as wage/salaries.
(vii) The payment for the contribution made by capital is known as interest.

Self-Assessment Question 4.2 (Test Learning Outcome 4.2)

With appropriate diagram, explain the circular flow of income in frugal economy.

Glossary of Terms
Households
Households own all the economic resources in the economy.the economic resources are land,
labpur, capital and enterpreneurial ability.
Firms
A firm is a business organization such as a corporation that produced and sells goods and
services with the aim of generating revenue and making a profit.

References/Further Reading

Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,2011
from http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
November 29, 2011 http://www.econlib.org/library/Marshall/marP4.html
Chad, B. (2012). What is Economics? Accessed January 29, 2023 from
www.businessnesdaily.com/2639-econ.

22
 Study Session 5

Introduction to Public Finance

Introduction
In this study session, concept and sources of public finance were explained. The sources include:
i) taxation; ii) borrowing; iii) aids and grants from other nations; etc. Also, classification of taxes
was discussed.

Learning Outcomes for study session 5

When you have studied this session, you should be able to:
5.1 Explain the meaning of public finance and Sources of Government Revenue
5.2 Explain the meaning of Public Expenditure

5.1 Concept of Public Finance and Sources of Government Revenue

Public finance is the study of ways in which government raise revenue and the items on which it
spends money. In other words, it deals with government revenue and expenditure as well as their
effect on the economy. It can be seen as financial activities that involve borrowing and
lending„ receiving and spending by the federal, state and local governments as well as their
agencies in order to create an effect on households, firms and the governments.

There are six sources of government revenue. They are:

(i) Taxation
(ii) Borrowing
(iii) Privatization n and Commercialization of public enterprises
(iv) Profits from public enterprises
(v) Aids and grants from other nations
(vi) Miscellaneous sources such as Fines, Licenses, etc.

Taxation
Taxation is a compulsory levy imposed by government on individuals and organizations in a
country. It is one of the sources of revenue for government.

23
The characteristics of tax include the following:

i. It is a compulsory levy
ii. It is levied by government only
iii. Its payment involves sacrifice
iv. It is used to 'provide welfare for all

Governments impose taxes for several reasons. These include:

i. To raise revenue: The various types of taxes are good sources of government revenue.
ii. To fight inflation: An increase in tax rate reduces the purchasing power of individuals
thereby leading to a fall in demand for goods and their prices, or vice versa.
iii. To discourage the consumption of harmful goods, the consumption of harmful goods like
tobacco, alcohols, etc, can be discouraged by imposing higher taxes on them, so as to
raise their prices.
iv. To redistribute income: Income can be redistributed and in quality reduced by imposing
progressive or direct taxes. whose payment vary with the level of income. In this case,
higher incomes are charged higher tax rates and vice versa.
v. To protect infant industries new industries: particularly of indigenous ownership can be
protected by imposing higher tax rates on the similar goods imported from their foreign
counterparts.
vi. 'To correct balance of payment problems: Deficit balance of payments can be corrected
by imposing higher taxes on imported commodities and lower taxes on exported goods.
vii. To achieve even development: Taxation can be used to create employment and enhances
development in rural areas. This is done by tax exemption or rebates for industries
located in rural areas.
viii. To Retaliate: A country can retaliate other countries by imposing higher tax rates on
importation of their goods.

There are several principles of a good tax system. These were propounded by Adam Smith in his
book entitled Wealth of Nation". These principles, otherwise called canons of a good tax systern
include:

24
 i. The principle of Economy: The principle states that 1 cost of collecting tax should be
smaller in relation to it amount collected as tax
ii. The Principle of Equity: This principle states that people should be made to pay tax
according to their abilities. This means that payment of tax should not cause undue
hardship to the tax payers.
iii. The principle of convenience: This principle states liven the payment of tax should be
done when the tax payer has money. For example, civil servant personal income tax
should be paid when salaries are being- paid.
iv. The principle of certainty: The principle states that the time of payment of tax. the
manner of payment and amounts to be paid must be known by the tax payer
understanding.
v. The principle of simplicity: This principle states that the manner and rate of payment
should be simple for the tn payer's understanding, vi.The principle of flexibility: This
principle states that the tax system should be flexible to adjust when the need arise.
vi. The principle of Neutrality: the principle states that tax system should not have negative
effect on production. savings, investment and people's willingness to work.

Classification of Taxes
Taxes are classified in two ways namely:
i. Method of payment and
ii. Rate of payment.

Based on method of- payment there are two types of taxes. They are:

Direct taxes:
These are taxes, charged directly on the income or payers. After all taxes have been deducted
from an individual’s gross income what remains is called Disposable income. This is the "take
home” income for an individual. The individual thus spends such an income on any goods and
services he chooses.
(i) Personal income; a very small contribution towards revenue in West Africa since only a few
Nigerians are earners. Moreover, many self-employed persons fail to declare their correct
incomes Col' taxation whilst others evade payment of tax completely.

25
(ii) Corporation or company income tax: this is a tax on the profits of companies. Usually
allowance is made för Capita\ expenditure before calculating profits. Not much revenue is
derived from company tax since only a few industries exist in Nigeria and moreover "tax
holidays” are given to “infant” industries. These tax holidays which exempt companies from
paying tax ranges between four and five years as a way of encouragement and protection.
(iii) Capital Gains Tax: This is a tax on assets held for (Bore than one year. E.g. levies on
owner-occupied houses, cars, etc. Not much revenue is obtained from this since capital in
Nigeria is lacking.
(iv) Death duties: These are taxes on the properties or deceased persons. Such a tax cannot be
levied on land in Nigeria because of the difficulty involved in identifying ownership of land.
(v) Royalties and mining rates, stamp duties and motor-vehicle: Royalties and mining rents
contribute largely to government revenue in Nigeria.

Advantages of Direct Taxes

i. More equitable: The system of Pay-As-You-Earn (P.A. Y.E.) i .e. the progressive tax
system, makes direct taxes more equitable (i.e. fairer) than indirect taxes since the rich pay a
higher rate than the poor.
ii. Re-distribute incomes better: Since more tax is levied on the rich than on the poor, the gap
between the rich and the poor will be reduced.
iii. Tax yield is more certain and easier to calculate: The yield of direct taxes is more certain
and also easier to calculate than that of indirect taxes since the yield of indirect taxes depends
on whether or not people will continue to buy goods and services concerned- i.e. it depends
on the elasticity of demand for the goods and services concerned.
iv. Better for checking inflation: Direct taxes are better for checking inflation than indirect
taxes, with direct taxes, people's purchasing power (i.e. ability to buy) may be reduced by
raising say, income taxes and thus cutting down excess demand and, hence, inflation.
v. Relatively low cost of collection: The cost involved in collecting direct taxes is reasonably
low, especially due to the progressive tax system which takes more from the rich and less
from the poor.

26
 vi. Very convenience to payers: Payers of direct taxes find it more convenient to pay since
they know what they will pay and are thus able to plan how they will spend the rest.
moreover, the incidence of taxation is convenient to the various income groups i.e. the poor
have very little or, at times, nothing to suffer from payment of such taxes and the rich are
more able to pay higher taxes.

Disadvantages of Direct Taxes

i. Disincentive to work: Those who suffer most from the progressive tax system are often
discouraged from working harder especially with overtime workers, since they are conscious
that part of the extra income earned is taken away in the form of higher taxes.
ii. Disincentive to saving: Since higher incon1es are reduced through higher rates or taxation,
people lose (he incentive to save.
iii. Disincentive to investment; The high corporation or company taxes reduce businessmen's
profits and, hence, their ability to re-invest (or plough back).
iv. Easy to evade: Direct taxes can be easily evaded, especially, by self-employed people who
often fail to declare correct incomes.

Indirect taxes

These are taxes levied on goods and services (like health and education). They are paid only
when certain purchases are made. These taxes are paid directly as part of the price of a
commodity or services. Very often, the payer of such a tax does not know how much tax he
pays.
(i) Customs duties: These are taxes levied on levied on goods brought into the country (i.e. Import
duties) and on goods sent to other countries (i.e. export duties). Import and export duties form
the biggest source of government revenue since Nigeria depend very largely on imported capital
goods (for its development projects) and on exports of agricultural, mining and especially in
Nigeria crude petroleum products for its foreign exchange earnings.
(ii) Excise duties: These are taxes levied on home-or locally-produced goods. Not much revenue is
obtained from these since not many goods are locally produced and moreover, many infant

27
 industries are enjoying tax holidays i.e. exemption from payment of tax for the first four or five
year of their establishment,
(iii) Purchase tax: This is a value added tax (i.e. based on the value of commodities)
generally collected at the wholesale stage. It is imposed on a range of selected consumer goods
such as cosmetics; television sets, clothing and furniture at varying rates a high rate on luxury
goods and a low rate on goods in more general demand.
(iv) Sales tax: It is a tax levied and collected either at a wholesale or retail level. E.g. taxes on the
sale of petrol. It is calked value added tax (VAT) in Nigeria since 1994.
(v) Licenses: The use of radio and television sets and the sale of drinks attract taxes in the rot-in of
licenses which have to be obtained.

Advantages of Indirect taxes

i. no exemption or evasion; Indirect taxes are payable by all m unlike direct taxes which are
paid by only a section of the population and which can easily be evaded. Since taxes finally
become part of the price of a commodity all buyers of that commodity are forced to pay the
tax.
ii. No disincentive effects on payers: Since the final payers of indirect taxes are not aware of
how much they pay as tax, they do not become discouraged from working harder, nor from
saving. nor from investing.
iii. Used to protect infant industries: By raising taxes on imports higher than those on exports,
infant industries in the country are protected from undue competition with the well-
established ones in the developed countries.
iv. Easier to collect: Unlike direct taxes. indirect taxes are easier to collect since there are fewer
sources of taxation. For example, imports and exports have to pass through port and are thus
easily taxed.
v. A more important source of government revenue: Indirect taxes yield more revenue to
governments In Nigeria since import and export are very important in the country and also
since indirect taxes are difficult to evade.
vi. Used to correct deficit balance of payment: When a count% s balance of payments is in
deficit owing to unfavorable balance of trade, import duties can be raised to restrict imports
and [or export duties can be reduced to encourage exportation o goods„ vii. Used to check

28
 production and consumption of harmful goods: Goods which are considered harmful to
consumers' health, e.g. tobacco and alcohol, are more heavily taxed to restrict supply or, and
demand for them.

Disadvantages of Indirect Taxes

i. More regressive: One major disadvantage of indirect taxes is that they tend to take equal
amount of money from consumers irrespective of differences in consumers' income. The
poor their rote suffer more than the rich i.e. indirect taxes are regressive.
ii. They are inflationary: Any attempt by government to increase total revenue through
increased taxation on goods can easily lead to higher prices, especially if the demand for
the goods taxed is inelastic. This will result in workers demanding for
iii. higher wages and salaries, thereby worsening the inflationary situation.
iv. Yield is uncertain: The yield from indirect taxation cannot be known and calculated in
advance since it depends very much on the elasticity of demand for the goods taxed,
v. They lead to higher costs of production and a fall in supply: Higher rates of indirect taxes
cause higher costs of production and consequently a decrease in supply of goods and
services.
vi. They restrict free trade: Higher taxes on imports can generate retaliation, i.e, other
countries may do the same and consequently, free trade would be restricted. Using the
rate of payment, taxes are classified as progressive, proportional or regressive.
vii. Do not become discouraged from working harder, nor from saw saving, nor from
investing.
viii. Used to protect infant industries: By raising taxes on imports higher than those on
exports, infant industries in the country are protected from undue competition with the
well-established ones in the developed countries.
ix. Easier to collect: Unlike direct taxes. indirect taxes are easier to collect since there are
fewer sources of taxation. For example, imports and exports have to pass through port
and are thus easily taxed.
x. A more important source of government revenue: Indirect taxes yield more revenue to
governments In Nigeria since import and export are very important in the country and
also since indirect taxes are difficult to evade.
29
xi. Used to correct deficit balance of payment: When a count% s balance of payments is
in deficit owing to unfavorable balance of trade, import duties can be raised to restrict
imports and [or export duties can be reduced to encourage exportation o goods„ vii. Used
to check production and consumption of harmful goods: Goods which are considered
harmful to consumers' health, e.g. tobacco and alcohol, are more heavily taxed to restrict
supply or, and demand for them
xii. Yield is uncertain: The yield from indirect taxation cannot be known and calculated in
advance since it depends very much on the elasticity of demand for the goods taxed.
xiii. They lead to higher costs of production and a fall n supply: Higher rates of indirect
taxes cause higher costs of production and consequently a decrease in supply of goods
and services.
xiv. They restrict free trade: Higher taxes on imports can generate retaliation, i.e, other
countries may do the same and consequently, free trade would be restricted.

Using the rate of payment, taxes are classified as progressive, proportional or regressive

Progressive Tax System

(B) Meaning: Under the progressive taxation the higher the income, the higher the proportion of
income which is taken away as tax and the lower the income, the lower the proportion of
income taken away as tax. In other words, the rate of' taxation increases as income increases
and vice versa, as illustrated in the (Table 1.1) below:

Table 5.1: Progressive Taxation

S/N Income Rate of Taxation Amount paid as Tax

a. N1, 000 2% 2xl 000 =N200
100 1

b. 10% 10x5, 000 =N500

N5, 000
100 1
c. 13% 13x8, 000 =N1,040
N8, 000
100 1
d. 15% 15xl0, 000 =N1, 500
N10, 000
1 1

30
Advantages of progressive taxation
i. It is equitable: Progressive taxation is very equitable, especially where great inequality of
income exists. This is because the rich are taxed more heavily than the poor since the rich
are better able to pay than the poor.
ii. It redistributes income: Being direct taxes, progressive taxation redistributes incomes by
taking more from the rich and less from the poor. This bridges the gap between the l ' h
and the poor.
iii. It is cheap to collect: The cost involved in collecting progressive taxes is very low and
therefore very economical since it takes more from the rich.
iv. Yield is certain: Being direct taxes, the revenue from the progressive. tax system is very
certain, i.e. the government is sure of the yield from such a tax and can therefore base its
estimated expenditure on it.
v. Very convenient: Payers of such taxes find it convenient to pay since they know what they
will pay and are thus able to plan how they will spend the rest of their income. Moreover,
the incidence of progressive taxation is convenient to both the rich and the poor since the
poor have very little, or at times, nothing to suffer from payment of such taxes and the rich
better able to pay higher taxes.

Disadvantages of progressive taxation:

i. Disincentive to work: After a certain point, the Pay-As (P.A.Y.E.) system
involved in progressive taxation dampens workers' incentive to work. Once extra
income is taxed away, workers are discouraged from working harder.
ii. Disincentive to saving: Many of those most hit by this; system is likely to save less
since their incomes are drastically reduced by the tax paid. (iii) Disincentive to
investment: Businessmen have less money to invest since
Their income is very heavily taxed.

Proportional Tax System:

31
Meaning: Proportional taxation is the system whereby the rate of taxation the (i.e. fixed) for all
income-earners. Both the rich and the poor pay the same rate of tax as shown in Table 5.2
below:

Table 5.2: Proportional Taxation

SIN Income Rate of Amount paid as Tax

Taxation
a. ₦1,000 10% ₦100 i.e 10/100 x 1, 000/1

b. ₦ 5, 000 10% ₦500 i.e. 10/100 x 5,000

c. ₦ 8, 000 10% N800 i.e. 10/1 00 x 8,000

₦10, 000 10% N100 i.e. 10/100 x 10,000

Disadvantage: This system is less advantageous than the progressive in that it is less
equitable.
Advantage: However, it does not have as much disincentive effect as the progressive
taxation.

Regressive Tax System:

This is a system in which tax is taken from the poor than the rich or both pay same amount of tax
as illustrated table 5.3 below:

Table 5.3: Regressive Taxation

SIN Income Rate of Taxation Amount paid as Tax

i. ₦1, 000 10% (i.e. 10 x 1 000 N 100

100 1
ii. ₦5, 000 2% (i.e. 2x 5, 000 N100
100 1
iii. ₦10, 000 10% (i.e. 10 x 10, 000 N100
100 1

32
Regressive taxation is where both the rich and the poor have to pay the same amount of
money as tax either directly as poll tax. for example, or indirectly in the form of higher prices of
goods a lid services consumed by both the rich and the poor.

In Nigeria„ most taxes are regressive since people the various communities are usually asked to
pay certain fixed sums of money towards certain development projects, irrespective of incomes.
and since indirect taxes like inn port and export duties form great proportion of government
revenue.
Incidence of Taxation

(a) Meaning: Incidence of a tax refers to the real burden of a tax on people in a country. It
deals with how the burden of a tax is distributed among the people in a country. The
incidence of tax may be bored by the tax payer, shifted to another person or shared persons
depending on the type of tax.
(b) In the case of direct tax like personal income tax the incidence is always on the income
earner. Income tax cannot be shifted on to another person else since the income of the
person who receives it is reduced by the full amount of the tax paid.
(c) But in the case of an indirect tax like sales tax the incidence may fall either on the buyer or
seller of the good on which the tax is charged or shared between them, depending on the
elasticity of demand for the particular good. These are briefly explained below:

Incidence of an Indirect Tax

i. When the Demand is perfectly inelastic: In this case the incidence of tax falls completely
on the buyer of the taxed good. Since the increase in the price of the good, does not affect
the quantity demanded of it.

This is shown in the graph below Price

33
 Price

Fig. 5.1: Incidence of indirect tax when demand is perfectly inelastic

In fig. 5.l, it can be seen that the price of the good rose from P! to P2 as a result of the tax
but quantity demanded remains constant at QI

ii. When demand is fairly inelastic: When demand is fairly inelastic, the incidence of
indirect tax will be shared with the buyer bearing the greater portion of the tax.

This is shown in fig. 5.2 below

Price

Fig. 5.2: Incidence of tax when demand is fairly inelastic

Fig. 5.2: showed that the price of the good increased from P I to P2 as a result of imposition of
tax. It can be seen that the increase in price is greater than the decrease in the quantity
demanded and supplied„

iii. When demand is unitary elastic: When demand is unitary elastic, the incidence of indirect
tax will be shared equally between the buyer and seller.

34
 This is depicted in fig 5.3 below

Fig. 5.3: Showed that the increase in price is equal to the decrease in quantity demanded and
supplied.

iv. When Demand is Fairly Elastic: When demand is fairly elastic the incidence of tax will
be shared between seller and buyer with the seller bearing the greater portion of the tax.
This is shown in fig. 1.4. Below:

Q2 QI Quantity
Fig. 5.4: Incidence of indirect tax when demand is fairly elastic.

Fig. 3.4, Showed that the price rose from PI to as a result of imposition or (or increase in) tax.
This also led to fall in quantity demanded Q 1 to Q2 but the rise in price is smaller than the fall in
quantity demanded.

v. When demand is perfectly elastic

when demand l is perfectly elastic the incidence indirect tax falls completely on the seller the
taxed good. since at an) price above the market price (Pe) buyers will refuse to buy.

35
This is illustrated in fig. 1.5: below:

Fig. 3.5: Incidence of indirect tax when demand is perfectly elastic.

Fig. 1.5: shows that in spite the imposition of (or increase in) tax. the price of the good taxed
remains constant at P0 This means that the tax is completely borned by the seller.

Borrowing
This is another source of government revenue. Government could borrow from internal and/or
external sources.
A. Internal sources of government borrowing include:
i. From individuals through the sales of government securities like treasury bills,
bonds shares, etc.
ii. From financial institutions like banks, insurance companies etc.
Advantages of internal borrowing:
i. It encourages private investment on financial assets.
ii. It is less inflationary since it does not increase the vol of money in circulation.
iii. The so realized can be used to create employment and/or execute development
projects.

Disadvantages of internal borrowing

36
 (i) It can cause inflation and/or unemployment if the amount so realized is mismanaged or
diverted to non-productive activities.
(ii) It is a source of internal debt iii„ It assist in employment creation in the debtor country.
External sources of government borrowing include:
ii. Governments of other countries, and
iii. International financial institutions such as International Monetary Fund (IMF), World
Bank, African Development Bank, etc. Both internal and external borrowing have
advantages and disadvantages and which are briefly explained below:

Advantages of External Borrowing:

i. It augments inadequate domestic funds for Investment since the amount so realized will be
used internally.
ii. It enhances international mobility of capital and technology

Disadvantages of External Borrowing

i. It may cause inflation since it increases the volume money in circulation and particularly if
it is not channeled into direct production.
ii. It is the source of external debt which attracts interest rate and some draconian conditions
like privatization and commercialization, Liberalization, e.t.c which may not do well to
some economies.
iii. It leads to loss of national sovereignty by debtor country as the creditor country may
interfere in economic and political activities in the former. It is also important to mention
that aids and grants from other countries have similar impact on the recipient country as
external borrowing.

In-Text Question (ITQ) 5.1

List 6 sources of government Revenue

In-Text Answer (ITA) 5.1

37
 Taxation
 Borrowing
 Privatization n and Commercialization of public enterprises
 Profits from public enterprises
 Aids and grants from other nations
 Miscellaneous sources such as Fines, Licenses,

5.2 Explain the meaning, and Items of Public Expenditure

Meaning: Public or government expenditure refers to total spending by government of a country
in a. period of time. It is usually composed of capital and recurrent spending of all the tiers of
government, i.e local, state and federal

(i) Capital Expenditure: Capital expenditure is government spending on capital projects such
as building of new schools, hospital* road, dams, stadium etc. Capital expenditure can create
employment and income, but it is more inflationary since the benefits of the capital project
may not be realized immediately.
(ii) Recurrent expenditure: This is government total spending on items that repeat every year.
These include: salaries and wages„ interest on public debts, e.t.c. Recurrent expenditure is
less inflationary as it is only done when outputs have been produced, i.e., it is a payment for
services rendered.

Items of Public Expenditure in Nigeria.

Items of public expenditure in Nigeria are broadly grouped into four, namely:

1. General Administration: The items under general administration include:

i. President
ii. The Legislature
iii. The Judiciary
iv. The civil service

38
 v. The executive
vi. The Police
vii. The Armed Forces
viii. The Paramilitary
ix. The embassies in other countries
x. Political Appointees
xi. Various Governments departments, etc.
2. Social Services: Here, the items include:
i. Education
ii. Health care Delivery
iii. Infrastructural facilities
iv. Environmental Sanitation
v. Market via Recreational Facilities, etc.
3. Economic services: The items here include:
i. Financing of the real sectors such as: agriculture, industry manufacturing, etc.
ii. Power stations

iii. communication, etc.

4. Transfer services: The items here include:
i. Servicing of public debt
ii. Grants aids and loans to other countries
iii.Payments of pensions
iv.Expenses on international organizations and peace keeping activities in other countries.
Causes of Growth in public expenditure in Nigeria:
Public expenditure in Nigeria has continued to rise over the years factors, including the
following.
(i) Increase in population
(ii) Creation of more states
(iii) Inflation
(iv) Grants, aids, and loans to other countries
(v) Increase in insecurity

39
Impact of Public Expenditure on Economy.
The public expenditure has both negative and positive impact on an economy
i. The negative impact of public expenditure is that if government increases its spending
without an immediate corresponding increase in output of goods and services, inflation will
be inevitable in the country,
Positive impact includes:
i. Employment Generation
ii. income generation
iii. Welfare maximization

In-Text Question (ITQ) 5.2

List 2 components of public expenditure

In-Text Answer (ITA) 5.2

 Capital expenditure and

 Recurrent expenditure.

Summary of Study Session 5

In study session 5, you have learned that:

1. Government generate revenue in many ways. These are: taxation; borrowing.
2. Capital Expenditure is government spending on capital projects such as building of new
schools, hospital* road, dams, stadium etc. Capital expenditure can create employment
and income, but it is more inflationary since the benefits of the capital project may not be
realized immediately, and recurrent expenditure is government total spending on items
that repeat every year. These include: salaries and wages„ interest on public debts, e.t.c.
Recurrent expenditure is less inflationary as it is only done when outputs have been
produced, i.e., it is a payment for services rendered.

Self-Assessment Questions (SAQs) for Study Session 5

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

40
Self-Assessment Question 5.1 (Test Learning Outcome 5.1)
Why do governments impose taxes?

Self-Assessment Question 5.2 (Test Learning Outcome 5.2)

Enumerate the various items of government expenditure.

Glossary of Term
Taxation
Taxation is a mechanism through which the government seeks to realize some of its economic
objectives.
Borrowing
Borrowing is a loan taken by the government and falls under capital receipts in the budget
document.

References/Further Reading

Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30, 2011 from
http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed on January 25, 2023.
from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

41
 Study Session 6
Introduction to the Theories of Money

Introduction
This session explains the basic meaning and functions of money. Also, characteristics of money
were explained.

Learning Outcomes for Study Session 6

When you have studied this session, you should be able to:
6.1 Explain the meaning, functions, characteristics of money and
6.2 Explain the Similarities and Differences between Money and other commodities

6.1 Meaning, Functions, and Characteristics of Money

Money is generally denned as any good that has value and is accepted as a medium or exchange
in an economy. This definition, though not conclusive, is in accordance with one of the functions
of money.

Money performs many functions in the economy. They include:

i. Medium of Exchange: Money serves as a means of exchange of goods and services. It is

used to buy goods and services,

42
ii. Store of value: Money is the best mean of storing the values of goods and services. This
is because the value of money is relatively stable.
iii. Means of Deferred Payment: Money can be used to settle debts at a later date.
iv. Unit of account: Money is the most convenient means of nuking computations, assigning
and recording the values of goods and services bought and sold.
v. Measure of Exchange Value: Money is used to measure exchange value of goods and
services. This is done by using the prices of goods.
Characteristics of Money
The characteristics of money include the following:

i. Generally accepted by everybody: Money is generally accepted by everybody.

ii. Divisible: It is capable of being divided into reasonable small units like kobo.
iii. Relatively Durable: Money can be kept for a long time without going bad. It is not a
perishable good.
iv. Relatively Scarce: Money must not be too much so as not to lose its value.
v. Portable: - It is easy to carry from place to place vi. Recognizable It is easily recognized.
vi. Homogeneous: Money must be homogeneous, i.e., it is the same all over an economy in
terms of size, colour and quality.
vii. Stable Value: The value of money is stable so as to encourage lending and borrowing.

In-Text Question (ITQ) 6.1

List 4 functions of money in the economy

In-Text Answer (ITA) 6.1

 Medium of Exchange: Money serves as a means of exchange of goods and services. It is
used to buy goods and services,
 Store of value: Money is the best mean of storing the values of goods and services. This is
because the value of money is relatively stable.
 Means of Deferred Payment: Money can be used to settle debts at a later date.
 Unit of account: Money is the most convenient means of nuking computations, assigning and
recording the values of goods and services bought and sold.

43
6.2 Similarities and Differences between Money and other commodities

 There is fluctuation in the values of money and other commodities.

 Money and other commodities are used for exchange
 Both money and other commodities have their respective markets.
iv. Both are demanded by people.
v. The prices of both ate determined by the forces of 9 demand and supply.
vi. They are all regarded as commodities.

Differences between Money and other commodities

i. Money is generally acceptable while other., commodities are not.
ii. Money is portable while other commodities may not be portable.
iii. Money is relatively scarce while other commodities are not.
iv. Money is homogeneous while other commodities are not.
v. Money is durable while other commodities are not.
vi. Money is stable while other commodities used in trade by barter are not.
vii. Money is divisible into small units while other commodities are not.
viii. Money is easily recognizable by the people, other commodities are not.
ix. Money has no intrinsic values.

x. Money is used as a medium of exchange, other commodities are not.

xi. Money can function as a standard for deferred payment, other commodities cannot
xii. Money serves as a unit of account, other commodities cannot.
xiii. Money can serve as a store of value while other commodities cannot,
xiv. Money can also serve as a measure of value while other commodities cannot

In-Text Question (ITQ) 6.2

List 4 similarities between money and other commodities

44
In-Text Answer (ITA) 6.2
 Both money and other commodities have their respective markets.
 Both are demanded by people.
 The prices of both ate determined by the forces of 9 demand and supply.
 They are all regarded as commodities.

Summary of Study Session 6

In study session 6, you have learned that:

1. Money has some characteristics that makes it valuable and affects our day-to-day activities
and the overall economy, and plays some functions in economy
2. Money has some similarities and differences with other commodities

Self-Assessment Questions (SAQs) for Study Session 6

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 6.1 (Test Learning Outcome 6.1)

Distinguish between money and other commodities.

Self-Assessment Question 6.2 (Test Learning Outcome 6.2)

List 4 differences between money and other commodities

Glossary of Terms
Money
Money is a commodity general accepted as a medium of economic exchange.
Commodity
A commodity is defined as a tangible good that can be bought and sold or exchanged for product
of similar value.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing Co.

45
Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,
2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed on January 25, 2023.
from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

Study Session 7
Theories of Demand for Money
Introduction
In this study session, theories of demand for money were explained. Also, total demand for
money was explained.

Learning Outcomes for Study Session 7

When you have studied this session, you should be able to:
7.1 explain the theories of demand for money;

7.1 Theories of Demand for Money

The demand for money arises from two important function of money, that is, money acts as a
medium of exchange and the second is that it is a store of value. Thus, individuals and businesses
wish to hold money partly in cash and partly in the form of assets. There are three approaches to
the demand for money: the classical; The Keynesian; and the post-Keynesian. We discuss these
approaches one after the other.

Classical Approach

46
The classical economists view on demand for money is inherent in the quantity theory of money.
They emphasized the transactions demand for money in terms of the velocity of circulation of
money. This is because, money acts as a medium of exchange facilitate the exchange of goods
and services.
They used the Fisher's equation of exchange which specifies that:
MV = PT ……………………………………………………………….…………………… (1)
Where M is the total quantity of money V is its velocity of circulation, P is the price level, and T
is the total amount of goods and services changed for money. The right-hand side of the
equation, PT, represents the demand for money which, in fact depends on the volume of the
transactions to be taken in the economy. MV represents the supply of money. Thus, equation
becomes:

Md = PT ……………………………………………………………………………………..(2)

The classical economists believed in say's law whereby supply creates its own demand assuming
the full employment level of income. Thus, the demand for money in classical approach is a
constant proportion of the level of transactions, which in turn, bears a constant relationship to the
level of national income. Furthermore, the demand for money is linked to the volume of trade
going on in an economy at any time. The Cambridge school refined the classical theory on the
demand for money, according to them, the demand for money equation is:
Md = KPY……………………………………………………….……………………………. (3)

Where Md is the demand for money which must equal the supply of money in. equilibrium in
the economy, K is the Fraction of the real money income (P Y) which people wish to hold in
cash and demand deposits P is the price level, and Y is the aggregate real income. They held that
Remand for money in nominal term would be proportional to the nominal level of income for
each individual, and hence for the aggregate economy as well They argued that one should
consider the convenience an individual gets from money holding for transactions which depend
on his wealth A the rate of interest, his expectations about future events, etc, as potentially
important influences upon the land for 1170ney. Criticisms of the Classical Approach to demand
for Money. The classical approach to demand for money has been criticized on many grounds.

A major criticism of the classical approach to the demand for 'money arises from the neglect of
store of function of money. They classical emphasized the of exchange function of money which
Sly acted as a go-between to Facilitate buying and selling. Their view that money performs a
neutral role in the economy, and that it is barren and would not multiply, if stored in the form of
wealth, is erroneous because, money performs the asset function when it is transformed into
other forms of assets like bills, bonds, cars etc.

47
In addition, they say little or nothing about the nature of the relationship that one expects to exist
between such variables as wealth, interest rate etc, and it does hot identify which variable(s)
is/are more important.
The Keynesian Approach

Keynes (1936) in his book entitled "General Theory of interest, income and employment"
remedied the weaknesses in the classical theory of demand for money. In his book, he used a
new term, "Liquidity preferences" to explain demand for money, and he emphasized both the
medium of exchange and store of value functions of money. Keynes" suggested that there are
three motives which lead to the demand for money in an economy, namely.
1. The transitionary demand;
2. The precautionary demand; and
3. The speculative demand.

Transactionary Demand for money

The Transactionary demand for money arises from the medium of exchange function of money
in making regular payments for goods and services. Keynes argues that it relates to the need cash
for daily purchases and business exchange He further divided it into income motive and
business motive.

The income motive is meant to bridge the interval between the receipt of income and its
disbursement. If the •time between receipt of income and its disbursement is small, legs cash
will be held by the people for current transactions, and vice versa.

Similarly, the business motive is meant to bridge the gap between the time of incurring business
cost and that of the receipt of the sale proceeds. That the smaller the gap, the smaller the cash
that will be held by businessmen, and vice versa.
In general, the transactionary demand for money is positively depend on the level of income,
and the interval between receipt of income and its disbursement. It is expressed as:

Mt = ky …………………………………………………………….…………………………. (4)
Where:
Mt is t transactionary demand for money

48
K is the proportion of income which is kept for transaction purposes and
Y is the level of income.
This is illustrated in fig.7.1 below.

This in

Fig. 7.1: Transactionary demand for money (1).

In figure 7.1 above the line KY represents a linear and direct proportional relation between
transactionary demand for money and the level of income. Assuming K = 1/4 and Y
N 1 0009 the transactionary demand for money would be Mt 1/4 (1000) = N250 at point A. If
there is increase in income to N I2009 then Mt = 1/4 x 1200 = N300 at point B on the line Ky.

On the other hand, if income falls due to in institutional and structural conditions of the
economy, and the value of K is reduced to say, /5, then the new transaction demand curve is K 1Y
It shows that for the amounts of NI 000 and N 1,200, transactions demand would be Mt = 1/5
(1000) = N200 and Mt = 1 /5 x 1,200 = N240 at points C and D respectively.
Thus, he concluded that the major determinant of changes in transactionary demand for money is
income. It is the t along movement along the Ky line. But the shift of curve is caused by changes
in the value of K which depend on individual motives. the transactionary demand for money will
also depend upon the length of time period between the receipt of money income and its
disbursement. If the time is short, less amount of income will be held for transactionary
purposes, and vice versa. For instance, a worker who receives his pay after every two weeks will
keep less income than the one who receives his after every four weeks. This is shown in fig.7.2
Below:

49
Fig. 7.2: Transactions demand for money (2).

In fig. 7.2 above, it can be seen that when the total money income of N2000 is paid only once in
a month, the entire amount is needed for transactions during the four weeks. However, if the
same scum is paid in two equal installments„ in two weeks each then N 1000 will be needed for
transactions during the two weeks or N500 for one week, etc.
the transactions demand for money will also depend on the spending habit of the consumer. A
consumer who is in the habit of consuming much will likely keep more income, and vice versa.

Precautionary Demand for Money

The precautionary motive relates to "the desire to provide for contingencies requiring sudden
expenditures and for un foreseen opportunities of advantageous purchases. Both individuals and
businessmen keep cash in reserve to meet unexpected needs.
Individuals hold some cash to provide for accidents, unemployment and other unforeseen
contingencies. Also, businessmen keep cash in reserve to meet unfavorable conditions or to gain
unexpected advantageous deals.
Keynes argues that precautionary demand for money depends upon, the level of income,
business activity, opportunities for unexpected profitable deals, and the cost of holding liquid
assets in bank reserves: etc. He held that the precautionary demand for money, like
transactionary demand, is a function of the level of income. The demand for money for these
two purposes is expressed in the single equation:
Mp = f(Y)………………………………………………………………………………………(5)
Where:
Mp = is the demand for money for transactionary and precautionary purposes and
Y= is the level of income.

Speculative Demand for money

50
The speculative demand for money is the desire to hold money as a store of value. This can
either be stored "in the form of bonds, or other securities q which yield no, interest. He observed
that people deliberately choose to hold wealth in the form of money seeking capital gains if the
rate of interest moves in the direction they speculate.
If people expect that the rate of interest will rise, that implies that there is capital loss because the
price of bond will fall. Therefore, they prefer holding money to holding to bonds. Thus, demand
for money (or money used) for buying bonds will reduce.

On the other hand, if they expect that the rate of interest will fall, that implies capital gain,
because the price of bond will rise. Therefore, they prefer to hold bonds to holding money h
Thus, demand for money (or money used) for buying bonds will increase

For instance, if a bond has a value of N 100 carries 4 percent interest and the market rate of
interest rises to 8 percent, the value of the bond falls to N50 in the market. If the market rate of
interest falls to 2 percent, the value of the bond will rise N200 in the market. This can be worked
out with the help of the equation:

V=R/r
Where:
V is the current value of a bond; R is the annual return on the bond; and r is the rate of return
currently earned or the market rate of interest. So, a bond worth NI 00 (V) and carrying a 4
percent rate of interest (r), gets an annual return (R) ofN4.

When the market rate of interest rises to 8 percent, then V= 4/0.08 = 400/8 = N50
If r fails to 2 percent, then V = 4/0.02 - 400/2, = N200.
Thus, individuals and businessmen can gain by buying bonds worth N 100 each at" the market
price of N50 each when the rate of interest is high (8%) and sell at N200 each when the rate of
interest falls (to 2%).

Keynes states that expectations about changes in bond prices or in the current market rate of
interest determine the speculative demand for money. He argues that if current rate interest (r) is
above the normal rate of interest (rn), businessmen expect it to fall and bond price to rise. Their
demand for money will decrease. They will buy bonds now. Conversely, if the current rate of
interest happens to be below the critical (or normal) rate, businessmen expect it 10 rise bond
prices to fall. They will sell the bonds now, if they have any, and the speculative demand for
money would increase.

Thus, when re >rn an investor holds all his liquid assets in bonds, and when re <r n, his entire
holdings go into money. But, when re = rn, he becomes indifferent to hold bonds cr money.

51
Therefore, the speculative demand for money is a decreasing function of the rate of interest. The
higher the rate of interest, the lower the speculative demand for money, and vice versa. It is
given as;
Ls – f(r) …………………………………………………………………………………………(6)
Where Ms is the speculative demand for money and r is the rate of interest. Graphically, it is
shown in the figure below:
Interest rate

Demand
For Money

Fig: 7.3 Speculative Demand for Money

In the graph above the vertical axis represent interest, while speculative demand for money is
represented by the horizontal axis.

The above graph shows that at a very high rate of interest, r, 2, the speculative demand for money
is zero. As the rate of interest falls to r 10, r8 ..., and to r1 the speculative demand for money
increases to M1 M2... and to M5 respectively

But at a very low rate of interest, such as 1 42, the curve becomes perfectly elastic and the
speculative demand for money is infinitely elastic. This portion of the LS curve is known as the
liquidity trap.

At such a low rate, people prefer to keep money in cash rather than invest in bonds because
purchasing bonds will mean a definite loss. Thus, the lower the interest rate, the smaller the
earnings from bonds. Therefore, the greater the demand for cash holding.

Total Demand for Money

From the foregoing discussion, it can be see that money held for transactions and precaution
purposes is primarily a function of income level, i.e. m (tp)=f(y), and the speculative demand for
money is a function of the interest rate, Ls = f(r).

52
Thus, the demand for money is a function of both income and
Md = Mt + Mp + Ls ………………………………………….…………………………………..
(7)
Md = f(y) + f(r)………………………………………………………………………………….(8)
Md = f (yr) ……………………………………………………………………………………. (9)

In-Text Question (ITQ) 7.1

Transactionary demand for money----------------------------------------
In-Text Answer (ITA) 7.1

Arises from the medium of exchange function of money in making regular payments for goods
and services

Summary of Study Session 7

In study session 7, you have learned that:

:
1. There are three approaches to the demand for money: the classical; The Keynesian; and the
post-Keynesian.
2. There are three motives which lead to the demand for money in an economy, namely.

 The transitionary demand;

 The precautionary demand; and
 The speculative demand.

Self-Assessment Questions (SAQs) for Study Session 7

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 7.1 (Test Learning Outcome 7.1)

Explain classical theory of demand for money.

Glossary of Terms
Demand

53
Demand refers to the consumers desire and willingness to buy a product or service at a given
period or overtime.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,

2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.

Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed

January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.

Reynolds, L. R. (2005). Alternative Microeconomics. Accessed January 25, 2023. From

http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

Study Session 8

Introduction to Business Organization

Introduction
In this session, meaning of business organization will be explained. Also, different types of
business organization as well as public business organizations would be explained.

Learning Outcomes for Study Session 8

When you have studied this session, you should be able to:
8.1 Define business organization and explain different types of business organizations
8.2 Shares

54
8.1 Definition and Types of Business Organizations
Business organization is an enterprise set up by individual(s), government or its agencies for the
purpose of creating employment and making profit as well as providing goods and services for
human consumption. In terms of size, there are three types of business organization, namely:
small, medium and large-scale enterprises. In terms of ownership, there are two types of business
organizations namely: private enterprises and public enterprises.

Types of Private Business Organization

As earlier mentioned, there are two broad types of business organization namely: private
enterprises and public enterprises.

Private Enterprises
Private enterprises arc those enterprises organized, financed, owned controlled and managed by
private individual(s) for profit making. They include: sole proprietorship; partnership; private
limited liability companies„ and cooperative societies, etc.

Sole Proprietorship
Sole proprietorship otherwise called "one-man business" is a private enterprise formed, owned,
financed and managed by one person with the primary aim of maximizing profit. It is the oldest
and perhaps the most popular and common type of business organization in Nigeria. It is
characterized by:

i. Ownership: The business enterprise is owned by one person.

ii. Objective: The main objective of the one-man business is to make profit
iii. Sources of Capital: The capital required to set up and run the business is provided by the
proprietor from his personal savings or loans.
iv. Liability: The sole proprietor has unlimited liability, which is his liability„ can extend to
his personal properties.
v. Legal Entity: It is not a legal entity as the owner is not separated from the business
vi. Management: The business is controlled and managed by the sole proprietor himself.
vii. Life Span: The life span depends on the life span of its owner; the enterprise can fold up at
any time.

55
Source of Capital for Sole Proprietorship in Nigeria
Most sole proprietors in Nigeria usually obtain their capital from the following sources:
(i) Personal Savings: A sole proprietor can obtain capital from his previous savings% or use
his personal income as initial capita14
(ii) from Friends: They can also raise capital by borrowing from friends and relatives
(iii) Tracie Credit: They can obtain capital by buying goods on credit from the suppliers,
producers 014 wholesalers,
(IV) Loan Overdraft from Bank: The sole proprietors can also obtain from financial
institutions in the form of loan or overdraft.
(v) Grant/ Loans from Government: Government can release capital to its agencies in support
of certain programme. Example, the government of Nigeria under its Poverty Alleviation
Programme sometimes release some funds in the form of loans to unemployed graduates,
among others, to set up small businesses.
This constitutes a source of capital for sole proprietors in Nigeria particularly in the recent times.

Advantages of Sole Proprietorship

(i) It requires small capital: The sole proprietorship requires very small capital to set up.

(ii) It is easy to establish: The one-man business is easy to establish because of the small
capital requirement and it may not require much protocol or procedures when setting
up the business.
(iii) Taking of quick decisions: Quick decisions are easily taken by the sole proprietor alone
without the consent of other workers in the organization„

(iii) It is easy manage: The sole proprietor can easily manage the operations of the
enterprise without expert management from outside.
(iv) It requires small operation: The sole proprietorship serves small markets, and as
requires small operations.

56
 (vi) All profits reaped by the owner: All the profits derived from the business belong to
the owner of the business because the capital outlay or provision came from h inn.

(vii) It can thrive in all business environments: The sole proprietor can thrive in almost
all business environments, be it rural or urban environment because of its simplicity in
establishment,

(viii) There is privacy in conducting business affairs: The sole proprietor can keep his
business matters secret. He is not required to publish his account or submit an audited
balance sheet to the government.

(ix) There is easy supervision: In a one-man business the workers are personally known
to the owner. This makes supervision easy and ensures effectiveness of business
operations,

(x) There is a close owner-customer relationship:

The close relationship between the owner and customers allows the former to give
special attention to the later. Also, he easily finds out the special requirements of
customers and satisfy them.
(xi) There is effective planning: The sole proprietor embarks on effective planning and
formulation of policies alone and these will guide him in the smooth running the
enterprise by way of taking prompt business decisions, especially in the area of sales
and purchases.

Disadvantages of Sole Proprietorship

(i) Lack of continuity: In the event of the death of the Owner, the business may also die
with him, especially when there is no successor to take over from him.
(ii) Inadequate capital: The sole proprietor is always faced with inadequate capital because
of the small size of his business and his inability to source funds outside his business and
also general poverty in the case of Nigeria,
(iii) He bears all risks alone: The risk encountered in the course of the business is borne
solely by the owner, If the business is successful, he rejoices but when it fails, he suffers
it all alone.

57
(iv) It has unlimited liability: In the event of business failure, his assets and properties have
to be sold to pay his creditors.
(v) It is not a separate legal entity: In law there is no different between the owner of sole
proprietorship and the business itself. The business cannot sue or be sued in its own
right.
(vi) It lacks specialization: The owner is personally
involved in every section of the business. He works very hard; he may not observe
public holidays, and scarcely has rest. In most cases, when he is absent, the business may
close down temporarily.
(vii) There is limited growth: The sole proprietorship suffers from limited growth both in ideas,
initiation and business, as a result of inadequate capital.

Partnership Business

Definition: A partnership may be defined as a type of business organization in which two to

twenty persons agree legally to set up and manage with sole aim of making profit.

Partnership is usually formed by an association of two to twenty persons, who by an agreement

(usually legal) decide to pool their resources (capital) and/or skills together and establish
business enterprises. The people involved in partnership agreement are called partners and they
share the profit, losses and risks of the business. When partners are involved in banking
enterprises, the number required by law is between two and ten. Some examples of partnership
in Nigeria are Gani Fawehinmi and Coo (law chamber), Diya Fatimilehin and Co. (estate firm).

Characteristics of Partnership

(i) Ownership: The partnership is owned by two to twenty persons but in a banking
enterprise it' is between two and ten.

(ii) Objective: The main objective of the partnership is profit making,

(iii) Sources of capital: The capital to set up the partnership is provided from the contributions
of the partners based on legal agreement.

(iv) Liability: The partners have unlimited liability.

58
(v) Life span: The life span of the partnership depends on the agreement signed by the
partners involved.
(vi) Legal entity: It is not a legal entity as the partners are not separated from the business.

(vii) Management: The business is controlled and managed by the partners

Sources of Capital for Partnership

(i) Personal contributions from partners: The partners jointly contribute their money to form
the business.

(ii) Loans and overdraft: Partnership can also obtain and overdraft from financial institutions,
especially banks.
Advantages of Partnership
(i) Sharing of risks and liabilities: The partners can share risks and liabilities among
themselves and this will reduce individual burden.

(ii) Better chance of continuity: There is better chance for continuity because the death or
exit of a partner may not lead to the death of the business,

(iii) No legal formalities required; In forming a partnership, no major legal procedure of

establishment is required,

(iv) Increase efficiency; The bringing together of special skills and talents help to increase
efficiency in production,

(v) Specialization in management; The principle of lion of labour may be applied in the
managerial and administrative hierarchy of the business. For example, in an accounting
firm, some accountants may be management accountants while others may specialize in
auditing or taxation,
(vi) Greater possibility of profit making: There is greater possibility of making profit by
making use of large capital pooled together by partners.

(vii) Loan facilities: A partnership can easily' obtain loan from creditors since they are jointly
liable. The loan can be used for the expansion of the business.

Disadvantages of Partnership

59
(i) Unlimited liability: The partners are liable for the debts of the partnership business even
up to their persona] properties.

(ii) Business is not a legal entity: Partnership business is not a separate and distinct legal
entity. It cannot sue and be sued in its own name.
(iii) Limited growth: the growth of the partnership will be limited to the managerial
ability of the partners,
(iv) Disagreement between partners can end the business: There is the possibility that a
disagreement between partners can put the business to an end,

(v) Risk of dissolution: Death, insanity and bankruptcy of a partner may bring the business to
an end,
(vi) Slow decision making; since every partner will want to contribute his own quota,
decision-making may be slow and long.
(viü) False records: Some of the partners, especially the active partners„ can use false records to
gain advantage over others.

(viii) Inability to raise sufficient capital: Partner cannot invite the public to raise capital.
Members of the public are always afraid to invest because of it unlimited liability.

(ix) Action of one partner is binding on, others; There is an inherent danger that one partner,
through his recklessness, can put other into problem and this may destroy the business.
All the partners will be held responsible for the action of one another in the course
running the business.

Private Limited Liability Companies

Definition: A private limited liability company is defined as a business formed, financed and
managed by two to fifty persons, and whose name must end with the abbreviation of "Limited",
e.g. Bluebird Nigeria Limited, Godwill Nigeria Limited News watch Nigeria Limited, etc.

Characteristics of Private Limited Liability Companies

(i) Ownership: The business is owned by shareholders who
may be between two and fifty persons in number

60
(ii) Objective: The major aim of private limited company is to make profit.

(iii) Source of Capital: The capital required to set up and run the business is provided by the
shareholders in form of shares However, shares are not sold to the general public, they
are sold privately,
(iv) Liability: The shareholders have limited liability. In the event of liquidation, the amount a
shareholder can lose is limited to the fully paid up value of his share or the capital he has
invested in the business. His personal assets or properties are protected by the law,
(v) Legal entity: The business is a separate legal entity and therefore can sue or be sued in its
own name.
(vi) Continuity: There is continuity of business operations as the withdrawal or death of a
shareholder may not affect the existence of the company,
(vii) Shares are not easily transferable: Shares cannot be resold to other persons except with
the consent of the other shareholders.
(viii) Management: The private limited company is managed by a board of directors appointed
by shareholders.

Sources of Finance Available to Private Limited Company

(i.) Loan and overdraft from banks; Loans and overdrafts can be obtained from
commercial or development banks.
(i) Sale of shares; Shares are usually sold by owners to raise more capital for the company,

(ii) Equipment 'leasing: Equipment can be leased by the company förmoney.

(iii) Profit some part of: The profits made by the company can be set aside or re-invested,
(iv) Credit: Raw materials can be purchased by the company on credit„
(v) Purchase: Facilities can be grated to the company to buy and pay by installments

Advantages of Private Limited Company

(i) Large capital; Private limited liability company can easily raise capital because of the
large number of shareholders the from the business

61
 (ii) It has legal entity: Private limited liability company has legal existence; hence it can sue
and be sued in its own name,

(iii) There it limited liability: In the event of business failure, the shareholder only loses his
shares which he has contributed and his personal properties are not affected.
(iv) Continuity of existence; The chances of continuity of existence is high as the death or
withdrawal (Yl a shareholder may not lead to the death of the company,
(v) Efficient management: The business ii efficiently managed by a board of directors
appointed by the shareholders.
(vi) Large profit: Private limited liability company do enjoy large profits because of their
large

(vii) Possibility of expansion: The business can easily expand because of the large capital
available to set up and run the company.
(viii) It enjoys internal economies of large scale production: As long as the enterprise is large,
production can be carried out on a large scale, leading to economics of production,

Disadvantages of Private Limited Liability Company

(i) Limited capital: As a result of few numbers of shareholders coupled with the fact that
shares cannot be sold to the public, the capital available for use is limited.
(ii) Shares are not sold to public: The private limited company cannot sell its shares directly
to the public. This is one of the limitations to the capital base of the company.
(iii) Shares not easily transferred: A shareholder cannot sell his shares without the consent of
other shareholders.

(iv) Lack of privacy: There is lack of privacy as companies are required to publicize their
accounts.
(v) Payment of corporate tax: Private limited companies are usually required to pay corporate
tax, unlike personal income tax paid by sole proprietorship and partnership.
(vi) Lack of personal contact: There is less personal contact with both the employees and
customers, unlike in the sole proprietorship and partnership.

62
(vii) Delay in decision taking: Before any decision is taken on any crucial matters, the board
of directors or the shareholders must meet and this tends to waste a lot of time.

Public Limited Liability Company (or Joint Stock Company)

Definition: A public limited liability company is a business formed by the public by sale of its
shares, must have a minimum of seven person but no maximum number and the name of the
public limited company must end with the abbreviation "plc",

The word public is used to imply that any member of the public is free to purchase shares in the
business when shares are advertised for sale. Public limited companies are actually owned by
private individual and organizations.
Public limited liability companies or joint stock companies are organizations which have
separate legal entity. It is regarded in law as having an identity of its own. The shareholders are
not personally responsible for anything that is done in the name of the organization. The
shareholders also enjoy limited liability and above all„ it enjoys the advantage of a large number
of people who through the purchase of shares become owners of the company.

Example of public limited liability Companies (or joint stock companies) are: Union Bank Plc.
First Bank Plc. Dunlop Nig. Plc., UTC Nig. Mobil Nig. Etc.
Characteristics of Public Limited Liability Company (or Joint Stock Company)
(i) Ownership: The n umber of shareholders range from seven to infinity i.e. owners must be
at least seven but there is no maximum number.
(ii) It is legal entity: The joint stock company has a distinct personality from that of the
owners. It can sue and be sued in its own name.
(iii) Perpetual existence: The death or withdrawal of some shareholders will not affect the
existence of the company.

(iv)It has limited liability: The liability of shareholders is limited to the amount contributed to
the company. The private properties of the shareholders will not be affected in the event
of liquidation.

63
 (v) Formation: A public limited liability company must follow some special formalities
before registration. They secure incorporation by filling the articles of association and
memorandum of association with the registrar of companies.
(vi) Publication of annual accounts: It is required by law to keep certain prescribed books
of account. The accounts must be audited and published annually.
(vii) Specific line of business: A public limited liability - company is authorized by law to
carry on business specified in the object clause.
(viii) Ownership separated from management: Ownership is separated from management the
shareholders are regarded as the owners of the company while the management is in
the land of board of directors.

Advantages of Public Limited Liability Company (or Joint Stock Company)

i. Legal entity: Public limited liability companies have legal existence„ They *have a
distinct personality from the owners, hence they can sue and be sued in their own flame
ii. Continuous existence: There is continuity in a joint stock company. The death or
withdrawal of a shareholder cannot bring the business to an end.
iii. Limited liability: Their liability is limited to the amount invested as capital in the
business; private properties will not be affected.
iv. large capital: They can raise enough capital by selling more shares or debentures to the
public.
v. Transferability of shares: Share of a public limited liability company can easily be
transferred without having an effect on the business operation.
vi. Loan facilities: Many banks prefer to grant loans to Public limited companies than
other forms of business units because there is no likelihood of default in payment,
vii. Economies of large-scale production: Public limited
liability companies have sufficient capital for expansion, which can lead to mass
production of goods,
vii. Democracy in management: In choosing the of directors, shareholders have the right
to vote or be voted for at the annual general meeting.

64
 viii. ix. Owners are separated from management: In joint stock companies, owners are
separated from management. The shareholders are regarded as the owners of the
company while the management is in the hands of board or directors.
ix. Employees can become Employees could become of the business by
purchasing shares of the company.
x. Recruitment of experts: Joint Stock Company attracts men of ability and skill to
work for it.
xi. Research programmes: In joint stock company, there is greater opportunity to
undertake research programmes.

Disadvantages of Public Limited Company (or Joint Stock Company)

(i) Lack of privacy: Public limited liability companies lack privacy because they are
mandated by law to publish their annual audited accounts to the public; this makes it
impossible for them to maintain secrecy or privacy.
(ii) Conflict of interest: there is the possibility of conflict of interest an-long the
shareholders, directors and staff, which *nay affect the efficiency of operations of the
business.
(iii) Slow decision making: Decision making is slow because of wider \ consultations and
discussions in the no management hierarchy.
(iv) Separation of owners from management the owners of the business (shareholders)
have little or no say in the affairs of the business, while the people at the helm of
affairs who are not the owners may not put in their best.
(v) Hard to establish: The procedures and formalities involved in registration are very hard
and complicated.
(vi) Payment of large corporate tax: The pay heavy t arising from profit declared.

(vii) There is specialization: The Company can only carry on business provided for it in its
objective clause in •the memorandum of association It cannot venture into any other
types of business.
(viii) Decrease in personal interest: The type of interest exhibited in these types of company is
usually very low compared with the sole proprietorship where the zeal and interest are
very high.

65
(ix) large capital requirement the capital required to set up and run a joint stock company is
usually very large.

Sources of Finance Available to Public Limited Company (or Joint Stock Company)

(i) Loans and overdraft: Joint Stock Company can obtain loans and overdraft from
commercial or development banks.

(ii) Sales of shares: A joint stock company can also raise capital by using shares for public
subscription.

(iii) Sale of debentures: These are long term loans obtained from the general public at a fixed
interest.

(iv) Bill of exchange: This is a document duly signed by the debtor's bank to the creditor and
the creditor cashes the money with some discounts.

(v) Equipment leasing: Public limited liability companies can lease out some of their
equipment for money.

(vi) Retained (plough back) profits: The profits made by the company can be set aside for re-
investment.

(vii) Trade credit: Raw materials can be purchased by the joint

stock company on credit.
(viii) Hire purchase: Facilities can be granted to the company to
buy and pay by installments.

Public Business Organizations

Public enterprises are large-scale business organizations set up owned and managed by the
government mainly to provide services to the members of the public. They are usually
established by an act of parliament or decree. Examples of public enterprises include Nigeria
Telecommunication Limited (NITEL), Nigeria Pons Authority (NPA), Power Holding Company
of Nigeria (PHCN), etc.

66
Characteristics of Public Business Organizations

They are characterized by:

Ownership: Public corporations are owned and financed by the government.

Establishment: Public corporations are established either by decree or act of parliament.

Objective: They are established purposely to provide essential services to the generality of the
people.

Legal entity: It is a legal entity as it can sue and be sued in its own right.
Management: Public corporations are managed by board of directors who are appointed by
government.
Not profit oriented: Public corporations are not set up to make profit but to provide good and
services to the people.

Monopolistic in nature: Some corporations are conferred with monopoly power by an act of
parliament or decree. Government and tax payers bear the risks: The risks of the business are
borne by the government and the tax payers, who have provided the capital for financing the
business.

High capital requirement: A public corporation requires large capital to set which cannot be
provided by private individuals

Employees are public servants: Workers in public corporations are public servants and treated as
such.

Accountability: The management of public corporations i.e. (board of directors) are accountable
to the government that set up the corporation. Restriction of services: It is true that public
corporations provide services but each one is restricted to the provision of special services. E.g.
NEPA provides electricity while NITEL is involved in communication.

Advantages of Public Enterprises

Provision of infrastructural facilities: Public corporations provide infrastructural facilities, such
as roads, schools, railways, electricity, to the populace. Availability of large capital: Since public

67
 enterprises are owned by government, there is always availability of sufficient capital to ensure
expansion of the enterprises.
There is continuity: Public corporations can past for a period of time. In other words, there is
continuous existence.

Development of capital projects: Establishment of public corporations can ensure the

development of capital projects, e.g.
Avoidance exploitation of consumers: Public cooperation are consumer conscious as they
ensure that the exploitation of consumers is greatly reduced.

Creation of higher standards: The government enters business in order to ensure higher
standards, e.g. provision of educational facilities.

Accountable to the public: Public enterprises are uncountable to the public because they have
to submit their annual reports to the parliament

Legal entity: A public corporation is a legal entity, i.e. it can sue and be sued on its own.

It caters for the interest of workers: In public enterprisers, the interest of the workers is
catered for, so the employees have a great sense of security.

Provision of employment opportunity: Public corporation provides employment opportunities

for the teeming number of the unemployed.

Enjoyment of large-scale production: As a result of the availability of large capital for

expansion, production can be done on large-scale.

Generation of revenue: Revenue is generated by the government from public corporations, e.g.
water rate or electricity bill, to finance other projects.

Disadvantages of Public Corporation

i. Requires Large Capital: The cost of establishing a public corporation is very high„ i.e. large
capital is involved.

68
 ii. Government interference: Government can interfere in the activities of public enterprises by
influencing the appointment of management board members.
iii. Inefficiency in operation: Lack of competition can bring about inefficiency in business
operation.
iv. Danger of monopoly: Public corporations arc monopolistic in nature, e.g. NEPA, hence it
can abuse the privilege.
v. Bureaucratic tendencies and red tapism: Decision making may be slow because it has to
pass through many people or channels before approval
vi. Corruption and mismanagement: Many public enterprises in Nigeria have become the major
areas for embezzlement and mismanagement of the nation's resources.
vii. Not profitable: Most public enterprises are run at a loss because they are too large and
complex to manage.
viii. Wastage: In public enterprises, waste are not usually discouraged because the belief is that
the losses are borne by the government.
ix. Lack of initiative: Lack of initiative is always exhibited in public enterprises as government
functionaries must endorse the programme and policies of the establishment.
x. Lack of privacy: Since the annual report must be presented to the public, such corporations
have no privacy of their own.

Reasons for the Establishment of Public Corporations

(i) High capital requirement: Public corporations usually required heavy capital outlay, which
may not be affordable by private enterprises.
(ii) Generation of revenue: Public corporations help the government to generate revenue
needed to finance other government projects.
(iii) To prevent foreign dominance of the economy: Government can venture into some
enterprises in order to prevent or reduce foreign control of the economy by foreign
investors.
(iv) To avoid wasteful competition and duplication: Public corporations are established to
avoid wasteful duplication of capital resources.

69
 (v) To provide infrastructural facilities: Government establishes certain enterprises to
provide infrastructural facilities like roads and railways on which returns may not be
forthcoming and which may, therefore, not attract investment by the private sector.
(vi) Prevent monopolistic tendencies: Public corporations are set up to prevent monopolistic
tendencies resulting in very high prices charges if undertaken by private individuals.
(vii) To ensure even distribution of income: Government engages in some enterprises in order
to ensure fair and even hands.
(viii) Provision of essential Services: Government engages itself in economic activities in
order to provide essential services at subsidized rate e.g. water, electricity, etc.
(ix) To ensure higher standard of services provided: Government can participate in
enterprises to ensure higher standard of services provided, such as education, which
requires very expensive facilities that may not be affordable to the private sector.
(x) For strategic and security reasons: Government may engage in business to control certain
key industries such as airports, seaports, defense, the oil industry, etc.
(xi) Employment opportunities: Government may embark on business in order to create
employment opportunities for the people.
(xii) To promote economic development: Government also invest in some enterprises, e.g.
banking, insurance etC9 in order to have firm control over the economy and regulate it
for development purpose.

Ways in which Government Participate in Economic Activities

(i) Establishment of financial institutions. Government participates in economic activities by
establishing; financial institutions to grant overdraft and loans to private and public enterprises,
e.g. Central Bank, Industrial Banks etc.
(ii) Establishment of public corporation. Public corporations are established by government to
provide essential goods and services for the welfare of the people.
(iii) Establishment of joint business venture. Government, in conjunction with some
private enterprises, can established joint business outfit to provide goods arid services for the
people.

70
(iv) Import monopoly. Government can also participate in economic activities by exercising
monopoly over certain items of importation a system in which government is the only agency
that can import certain goods.

In-Text Questions (ITQ) 8.1

List 5 sources of capital for sole proprietorship in Nigeria

In-Text Answer (ITA) 8.1

 Personal Savings: A sole proprietor can obtain capital from his previous savings% or use his
personal income as initial capita14
 from Friends: They can also raise capital by borrowing from friends and relatives
 Tracie Credit: They can obtain capital by buying goods on credit from the suppliers,
producers 014 wholesalers,
 Loan Overdraft from Bank: The sole proprietors can also obtain from financial institutions in
the form of loan or overdraft.
 Grant/ Loans from Government: Government can release capital to its agencies in support of
certain programme. Example, the government of Nigeria under its Poverty Alleviation
Programme sometimes release some funds in the form of loans to unemployed graduates,
among others, to set up small businesses.

8.2 Shares

Definition: A share can be defined as the individual, portion of the company’s capital owned by
shareholders. It is the interest which a shareholder has in a company. In other words, share is a
unit of capital measured by a sum of money. The Company Act defines a share as:

"The interest in a company’s share capital of a member who is entitled to share in the income of
such company" o

Types of Shares

There are two major types of shares. These are Preference shares and Ordinary shares.

71
(i) Preference Shares: A preference share is the type of which has priority in terms of dividend
payment and repayment of capital in the event of winding up. They have a fixed rate of
dividends.

Features of Preference Shares

a. Preference shares have no voting rights.

b. They have fixed rates of interest.
c. Holders receive dividends before others.
d. They are entitled to return of capital first at closing down

Types of Preference Shares

Cumulative preference shares

Cumulative preference shares have priority in the share of dividends over others. Cumulative
preference shareholders receive arrears of dividends not paid before other shares, i.e. when no
profit is declared; their dividends will be carried forward to the following year.

Features of Cumulative Preference Shares

a. No voting rights
b. It has a fixed rate of dividend.
c. They receive arrears of dividends.

Participating preference shares:

Participating preference shares are shares which are entitled to further percentage of dividends
after the ordinary shares have receive a specified percentage of profits. Participating preference
shares have the right to participate equally with the ordinary shareholders in surplus dividends
apart from their fixed dividends.

72
 Features of Participating Preference Shares
(i) They receive fixed rate of dividends like other preference shares.
(ii) They also participate in further dividends after all others have been paid. They do usually
receive dividends before ordinary shares.

Redeemable preference shares

Redeemable preference shares are shares which have prior claims to dividends before - all other
preference shares. The owners of the business can buy back these shares after some time. The
shares are issued to finance a particular project. The redemption of preference shares must not be
regarded as amounting to reduction of capital.

Feature of Redeemable Preference Shares

c. They have prior claims before other preference shares

d. They can be bought back.

e. They are issued out to finance a particular project.

Non-cumulative preference shares

In this type of shares, the dividends do not accumulate from year to another. Where a company
fails to pay dividends in a particular year, it cannot be carried forward.

Non-Participating preference shares

Non-participating preference shares are the opposite of participating preference shares. They are
not entitled to further dividends after the ordinary shares have been paid.

Ordinary Shares

Ordinary shares are also known as equities. The ordinary shareholders are the real owners of the
business. The holders are the risk bearers and they receive their dividends after all other shares
have been paid. They can vote and be voted for. They have no fixed rate of dividend.

73
 Features of Ordinary Shares
(i) There is no fixed rate of dividend
(ii) They have voting rights.
(iii) The holders are the real owners of the business.
(iv)They are the risks bearers.
(v) They receive dividends last, after others have been paid.
Types of Ordinary Shares
Deferred or founder's shares: Deferred shares are hares which are entitled to the remainder of
profit after all other shares (preference and ordinary) have been paid.

i. They can be bought back.

ii. They are issued out to finance a particular project.

Features of Deferred Share

iii. They have more voting rights,
iv. They are issued to the founders of the business.
v. The holders are entitled to the remainder of the dividends after all others have been paid.

Non-cumulative preference shares: In this type of shares, the dividends does not accumulate
from year to another. Where a company fails to pay dividends in a particular year, it cannot be
carried forward.
Non-cumulative preference shares: Non-participating preference shares are the opposite of
participating preference shares. They are not entitled to further dividends after the ordinary
shares have been paid.

In-Text Question (ITQ) 8.2

List 4 features of preference shares
In-Text Answer (ITA) 8.2
ii. Preference shares have no voting rights.
iii. They have fixed rates of interest.
iv. Holders receive dividends before others.
v. They are entitled to return of capital first at closing down

74
Summary of Study Session 8

In study session 8, you have learned that:

1. Business organization is an enterprise set up by individual(s), government or its agencies
for the purpose of creating employment and making profit as well as providing goods and
services for human consumption. In terms of size, there are three types of business
organization, namely: small, medium and large-scale enterprises.
2. The various types of business organizations have distinct characteristics. Understanding
the different characteristics will help students take decisions on whether or not to invest
in any type(s) of the business organization(s).

Self-Assessment Questions (SAQs) for Study Session 8

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 8.1 (Test Learning Outcome 8.1)

What are the advantages of public enterprises?

Self-Assessment Question 8.2 (Test Learning Outcome 8.2)

What are the disadvantages of private enterprises?

Glossary of Terms
Enterprises
Is an organizational unit producing goods or services which has a certain degree of autonomy in
decision making.
Shares
A share is a unit of equity ownership in the capital stock of a corporation which can be bought
and sold in exchange for money.
Liability
A liability is simply a debt or obligation.

75
References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing
Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,

2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.

Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed January 25, 2023.
from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

76
 Study Session 9

Introduction to International Trade

Introduction
There are many theories of international trade. In this study session, meaning and theories of
international trade were explained.

Learning Outcomes for Study Session 9

When you have studied this session, you should be able to:
9.1 define international trade and theories of international trade

9.1 Definition and Theories of International Trade

In its narrow sense, international trade is the trading activities, in tangible goods like cars, cocoa
maize, etc, between peoples and governments of two or more countries. But, buying and selling
of physical goods is accompanied by services. Thus, in its broader sense, international trade
refers to the sale or purchase of' goods and services between governments and peoples of two or
more countries.

International trade exists at three levels, namely:

(i) Bilateral Trade: This is the trading agreement in which two countries exchange goods
and services.

(ii) Multilateral Trade: This is the type of trading arrangement in which there are more
than two countries exchanging goods and services. This would encourage division of
labour and increase the total volume of world output trade.

(iii) Globalization: This is an advanced level of multilateral trade which involves free flow
of goods and services across international boundaries.

77
 Theories of International Trade

There are several theories of international trade. Some of them are explain below.

Absolute Advantage Theory

The absolute advantage theory was propounded by Adam Smith (1723-1790). The theory state
that a country should specialize in the production of goods and services in which it has absolute
advantage over other countries. He believed that the value of a good will be determined by the
amount of labour that was used for production; that is, given two goods A and B absorbing
different labour units, the value of the good with great labour units, will be greater than the value
of the other good which absorbs less unit of labour. To explain the labour theory of value with
regard to the concept of absolute advantage, we shall assume the following:
(i) The two countries in the world, i.e. country A and B, producing two goods X and Y
(ii) Labour is homogenous between the two countries. Each country has 40 unit of labour.
(iii) There is perfect competition in the two countries.
(iv) The exchange ratio in the international market lies between the two domestic exchange ratios.
This is shown in the table below:

Countries
Goods A B
X 30 60
Y 60 30

The relative price is determined by the ratio of the labour used in production of the goods. For
country A, in isolation the relative price is that 30 units X is equal to 60 units of Y.

78
 30X = 60Y. ……………………………………………………………... . . ……………… (l)

X = 2Y………………………………………………………………………...…………… (2)
This implies that with 20 units of labour, country A can either produce 30 units of X or 60 units
of Y. This means that 1 unit of labour is used to produce 1 unit of good X, but that same units
1
of' labour can be used to produce 3 units of Y. Using the labour theory of value /2 units of X is
equal to 3 units of Y in country A.

In country B, with 20 units of labour the country can produce 60 units of X but only 30 units of
goods Y. This means that the value or 3 units of X in country B is equal to 1 unit of Y.

In summary, it is quite clear that country A has an absolute advantage in the production of good
Y while country B has an absolute advantage in the production of good X.

We can now demonstrate that both countries will benefit from the international trade if each
country can concentrate on the production of goods in which it has absolute advantage and
exchange this in the international market, as long as there are differentials in the domestic price
ratios.

The domestic exchange ratios of each country are represented by equations (2) and (3) as:

1X = h Y in country B
1X = 2y in country A

Our (iv) assumption above is that the exchange ratio in the international market lies between the
domestic exchange ratios of the two countries. This means that the international exchange ratio
is represented by equation (l)

It can now be demonstrated that free trade will enhance economic benefits to the two countries if
country A concentrate on the production of Y. In the international Market, country A will obtain
2 units of X by exchanging 2 units of Y in the international market. Compared with domestic
exchange rate, it has gained I unit of X. In the same way, country B specialize in the production
of X and exchange a unit of commodity X with a unit of commodity Y. Compared with her
domestic price ratio, she would gain Ly from every unit of X traded.

79
This means that specialization in the production of different commodities in which each country
had absolute advantage will be beneficial to both countries; An analogy of this is the trade
between Nigeria and Uganda in the production of cocoa and cotton. Both countries will benefit if
Nigeria can concentrate on the production of cocoa and Uganda on the production of cotton.

Comparative Advantage Theory

The concept of comparative advantage has been a step further to the concept of absolute
advantage. The theory has been the contribution of David Richardo to the theory of international
trade.

There is the relevance of the labour theory of value to the concept. Richardo was of the opinion
that the absolute advantage theory might not be sole determined of the international trade for one
of the trading countries might have absolute advantage and yet incur greater cost in the
production of the commodity in question. He emphasized that the real basis of international trade
lies in the ability of each country to produce a unit of commodity under trade at minimum cost
compared to the other country.
Our earlier assumption still holds. We can now demonstrate that free trade will benefit both
countries, even though one country has absolute advantage in the production of the
commodities.

Given the following table:

Countries

Goods A B

X 100 200
Y 200 600

Country B is more efficient in the production of two goods. Do not forget that we are still
discussing labour theory of value with regard to international trade. Going by our assumptions
above especially (ii) both countries will benefit by trade. Though country B has absolute
advantage in the production of both goods, yet it has comparative advantage in the production

80
of country Y. With reference to the table above, the domestic price ratio of both commodities X
and Y in country A is:

100x = 200y
x = 2y ………………………………………………………….…….………... (4)

Also, in country B, the price ratio of the commodities is:

200x = 600y
X = 3y …………………………………..…………………………………….(5)

Using assumption (iv), the exchange rate in the international market that will lie between the two
domestic price ratios i.e. Ix should exchange in the international market, for between 2 and 3ys
and international price of Ix = 2hy will be beneficial to the two countries.
By trading, country A will now gain a half of commodity Y( 1/2 Y) by exchanging a unit or
commodity X(1x) and country A will also gain half a unit of commodity Y on every unit of
commodity X bought. This means that both countries' economic welfare has been enhanced.

Weakness of the Comparative Advantage Theory

There is an implicit assumption in labour theory. The fact is that labour is just a part of all
resources that go into the production of any commodity. The theory therefore is unrealistic. This
in why the classical economics have been criticized on this score.

Modern Theory of International Trade

The modern theory of international trade makes use of the concept of opportunity cost. We can
demonstrate the gain trade through the use of opportunity cost concept and do away with the
ridiculous assumption that only labour cost determines production. The bundle of resources
endowment can be assumed to be labour, land, capital and entrepreneur. The quantity of
commodity X and Y produced will be determined by the bundles of resources endowment
combined in the country:
QA = f(Ld, C.E, Lb) ………………………………………………………………………….(6)

81
There is no way we discuss advantage or cost whether absolutely or comparatively without
reference to the concept of opportunity cost. The domestic price ratios in each country as
demonstrated earlier are the opportunity cost of producing each unit of the commodities in
question. They should be used to determine which good a country should specialize in its
production.

In-Text Question (ITQ) 9.1

International trade is--------------------------------------------------------
In-Text Answer (ITA) 9.1

The trading activities, in tangible goods like cars, cocoa maize, etc, between peoples and
governments of two or more countries.

Summary of Study Session 9

In study session 9, you have learned that:

1. International trade is the trading activities, in tangible goods like cars, cocoa maize, etc,
between peoples and governments of two or more countries. But, buying and selling of
physical goods is accompanied by services. Thus, in its broader sense, international trade
refers to the sale or purchase of' goods and services between governments and peoples of
two or more countries.
2. The theories of international trade include: absolute advantage theory. Comparative
advantage theory, and modern theory.

Self-Assessment Questions (SAQs) for Study Session 9

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 9.1 (Test Learning Outcome 9.1)

What are the three levels of international trade?

Glossary of Term
Trade

82
Trade is the voluntary exchange of goods and services between different economic actors.

Bilateral Trade

This is the trading agreement in which two countries exchange goods and services.

Multilateral Trade

This is the type of trading arrangement in which there are more than two countries exchanging
goods and services. This would encourage division of labour and increase the total volume of
world output trade.

Globalization
This is an advanced level of multilateral trade which involves free flow of goods and services
across international boundaries.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing
Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,

2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed January 25, 2023. From
http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

83
 Study Session 10
Reasons for International Trade, and differences between international trade and internal
trade

Introduction
There are many reasons for international trade. In this session, the reasons for international trade
were explained. Also, the differences between international trade and internal trade were
explained.

Learning Outcomes for Study Session 10

When you have studied this session, you should be able to:
10.1 Explain the reasons for international trade
10.2 Explain the differences between international trade and internal trade

10.1 Reasons for International Trade

There are many reasons why countries trade with one another. These include:

The need to satisfy a required demand

A country may trade with other countries because it wants more of a particular commodity to
satisfy its required demand since what it produces is inadequate. For instance, the USA imports
more crude oil in order to meet its total demand for .

The need to increase market for home commodity

The internal demand for a country's product may not be enough to generate large scale
production and hence full utilization of its domestic resources. Thus, international trade may
84
increase market for home produced commodities. e.g. Kuwaiti's deposit of oil would lie
untapped if not for international trade.

Differences in National Endowment

The differences in climates and soils account for differences in quantity and variety of goods
produced in different parts of the world. E.g., Cocoa and rubber are found in the forest regions of
the tropical countries and cattle, groundnuts and wheat in the tropical and temperate grasslands.

Differences in Mineral Resources

Different types of minerals are found in different areas of the world. E. Diamond in Zaire; Gold
in South Africa and Ghana; Petroleum in Kuwait and Nigeria, etc. Exchange of these resources
necessitate international trade.

Differences in Capital Goods

Some countries have more capital goods and therefore can produce goods in greater and more
varied quantities than countries with less or no capital goods. E.g, Britain, USA and Japan have
more capital goods than less development ones like Nigeria, Ghana, Sierra Leone, etc. By
countries trading with one another these differences in the demand for and supply of' resources
are greatly reduced since each country's needs become satisfied.

In-Text Question (ITQ) 10.1

List 5 resons for International trade
In-Text Answer (ITA) 10.1
 The need to satisfy a required demand
 The need to increase market for home commodity
 Differences in National Endowment
 Differences in Mineral Resources
 Differences in Capital Goods

10.2 Differences Between International Trade and Internal Trade

There are several differences between international trade and internal trade. These include:

85
 i. Foreign trade involves the exchange of goods and services across national frontiers while
internal trade involves the exchange of goods within the border of a country,
ii. In foreign trade, buyers and sellers use different currencies whereas buyers and sellers in
home trade use the same type of currency.
iii. There is possibility of restriction tariffs, import du, les, export duties, quotas, embargoes
when goods are exchange across national boundaries while these do not occur in home
trade,
iv. There are differences in systems of weighing and measuring in one country vis-a-vis
another. A country has only one system or such weighing and measuring.
v. Differences in transport cost due to distance between buyers and sellers, documentation
requirement, need for insurance in respect of foreign trade distinguished foreign trade
from home trade.
vi. There are also differences in legal systems and culture under international trade but the
legal systems are the same in domestic 7dee
vii. Foreign trade requires knowledge of new languages and interpretations while in domestic
trade a common language is used.

In-Text Question (ITQ) 10.2

Internal trade is--------------------------------------------------
In-Text Answer (ITA) 10.2

Trading activities between people within the same economy

Summary of Study Session 10

In study session 10, you have learned that:

1. A country may trade with other countries because it wants more of a particular commodity
to satisfy its required demand since what it produces is inadequate.
2. In foreign trade, buyers and sellers use different currencies whereas buyers and sellers in
home trade use the same type of currency.

Self-Assessment Questions (SAQs) for Study Session 10

86
Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 10.1 (Test Learning Outcome 10.1)

How does differences in Capital Goods affect international trade

Self-Assessment Question 10.2 (Test Learning Outcome 10.2)

What are the differences between international trade and internal trade?

Glossary of Terms
Resources
Resources are the different factors of production used to produce all goods and service in the
economy.
Exchange
Refers to a marketplace where the trade of financial instruments such as commodities and
securities occur.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing
Co.

Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30,

2011 from http://homepage.newschool.edu/~foleyd/ratid.pdf.

Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed

January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.

Reynolds, L. R. (2005). Alternative Microeconomics. Accessed on January 25, 2023.

from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

87
 Study Session 11

International Trade Restrictions and Balance of Payment

Introduction
There are different types of international trade restrictions. In this unit, the meaning of
international trade restrictions, types of international trade restrictions, and reasons for
imposition of international trade restrictions will be explained. Also in this unit, the meaning of
balance of payments, types of balance of payments, and solution to the problems of deficit
balance of payments will be explained.

Learning Outcomes for Study Session 11

When you have studied this session, you should be able to:
11.1 Explain at least five types of international trade restrictions, and reasons for imposition of
international trade restrictions;
11.2 Explain the meaning of balance of payments;

11.1 International Trade Restrictions and reasons for imposition of international trade
restrictions
These are taxes or duties imposed on imports and exports to restrict the volume of trade or
improve the terms of trade. The instruments of trade restriction include:
(i) Import duties or tariffs: This is a tax imposed on imported goods to reduce the amount of
trade,
(ii) Foreign exchange control: trade can be controlled by reducing the foreign exchange available
for trade transactions,
(iii) Devaluation: By lowering the value of a country's currency vis-a-vis the currencies of other
countries importation become costly while export becomes cheaper.
88
(iv) Embargo: This is the prohibition or out-right ban placed on some imported goods.
(v) Import monopoly: This refers to a situation in which the government of a country takes over
the importation of certain goods which are only essential to the country.
(vi) Import quota: import quota restricts imposts by imposing a limit on the quantity (bf goods
can be imported at a particular country.
(vii)Preferential duties: In order to either encourage or discourage the importation of certain
goods from certain countries9 discriminate duties are charge on these goods.
(viii) Exercise duties reduction: This method helps to reduce the prices of locally made goods
so as to enable people to patronize them instead of foreign made goods.
(ix) Import license: Import license is a permit that allows an importer to bring a certain quantity
of foreign goods into a country and allows him to purchaser the foreign currency required to
pay for them.

Reasons for imposition of international trade restrictions

The reasons why nations impose restrictions on international trade include:

(i) To protect infant industries: Tariffs are imposed to protect infant industries from undue
competition with foreign firms.
(ii) Generation of revenue: Tariffs are also imposed to generate revenue for the country. Many
countries derive their revenue from import and export duties.
(iii) To prevent dumping: Tariffs are imposed to prevent dumping of goods from foreign
countries. This is to prevent foreign goods from being sold at prices lower than the home
price.
(iv)To improve balance of payment deficit: By imposing tariffs on imported goods, the
unfavorable
(v) . Retaliatory measure: this can be used in retaliate against countries which impose taxes on
their imports.
(vi)To prevent importation of dangerous goods: dangerous or harmful goods from other
countries re prevented from being imported through restriction.

89
 (vii) Employment generation: countries impose tariff to encourage the establishment of local
industries or enhance the expansion and growth of existing one. This helps to provide job
opportunity.
(viii) Political motives: Tariffs can be introduced as discriminatory measure against unfriendly
countries.
(ix)To promote self-sufficiency: Tariffs are also imposed on imported goods to enable a country
be self-sufficient in production of numerous goods.
(x) To check consumption pattern: if all sorts of goods are allowed to come into the country, the
citizens will develop uncontrolled appetite for foreign goods.
(xi)To protect strategic industries: Tariff may be used in most cases to protect certain strategic
industries.

In-Text Questions (ITQ) 11.1

Trade restriction is-----------------------------------------------------
In-Text Answer (ITA) 11.1

An obstacle impose on international trade.

11.2 Meaning of Balance of Payments

Balance of payment (BOP) is an annual statement of all payment made by a country to other
countries and receipts from them during a period of time usually one year, there are three
accounts in balance of payment, namely:

 Current Account

This is the account which records the value of both tangible and intangible (export and imports)
of goods and service. Thus, items here include: car, cocoa, banking, insurance, etc.

ii Capital Account

This is the account which records the value of capital as investments or loans. The country
transferring the capital to other countries is spending such capital, and so it is recorded on its
debit or expenditure side of its capital account. On the other hand, countries receiving the capital
record it on their credit or income side of the capital account.

90
iii Monetary Movement Account
This is a balancing account, If the country’s receipts are less than its payments, it can draw on its
savings (which is in form of gold) to balance its account, since BOP must always balance. Items
here include; loans, increasing investment abroad, exporting gold, aids, grants, etc.

Causes of the Problems of Deficit Balance of Payments

Deficit balance of payment is a situation when a country's receipt from abroad is less than its
payments to abroad. Some of the causes of deficit BOP include:

(i) Unfavorable terms and balance of trade: If the price of a country’s exports is less than the
price of its import it is likely to face deficit balance of payment, or vice versa. Similarly, if
the value of the country's exports is less than the value of its imports, it will experience
deficit balance of payment.
(ii) Unfavorable exchange rate: If the exchange value of a country’s currency ii less than those
of other country(ies), it will experience deficit balance of payment or vice versa.

Solutions to the Problems of Deficit Balance of Payment

The problem of deficit balance of payment can be resolved by the following policies.
a. Increasing export thereby increasing income (receipts) on the credit side of current account.
b. Boosting domestics production by giving subsidies and tax holidays to producers. This will
reduce imports and payments from the country.
c. Cutting down government expenditure abroad will reduce the debit side of the capital
account, and hence the overall deficit in BOP.
d. Import restrictions by imposing the restriction Insures such as quota, ban$ etc. This will
reduce payments on the current account of BOP.
e. Development of external services by developing shipping companies and tourist industries
will increase invisible earnings over invisible expenditure.
f. Foreign exchange control can limit the outflow of capital account and its deficit.
g. Domestic currency devaluation: this is the last option in solving the BOP deficit.
Devaluation is the deliberate reduction in the value of a national currency in terms of
currencies of other countries. It makes country's goods cheaper for foreigners to buy, this
will stimulate exports and discourage imports.

91
In-Text Question (ITQ) 11.2
Balance of payment is--------------------------------------------
In-Text Answer (ITA) 11.2
An annual statement of all payment made by a country to other countries and receipts from them
during a period of time usually one year.

Summary of Study Session 11

In study session 11, you have learned that:

1. There are many types of international trade restrictions, which include: import duties or
tariffs, embargo, currency devaluation, import quota, import license, etc.
2. There are three accounts in international balance of payments include: current account;
capital account, and monetary movement account.

Self-Assessment Questions (SAQs) for Study Session 11

Now that you have completed this study session, you can assess how well you have achieved its
learning out comes by answering the following question. You can check your answer with the
Notes on Self-Assessment at the end of the sessions.

Self-Assessment Question 11.1 (Test Learning Outcome 11.1)

What are the reasons for imposition of international trade restrictions?

Self-Assessment Question 11.2 (Test Learning Outcome 11.2)

What are the Causes of Deficit Balance of Payments?

Glossary of Terms
Deficit
Deficit occurs when expenses exceed revenue.

References/Further Reading
Friedman, D. D. (1990). Price Theory: An Intermediate Text. South-Western Publishing
Co.

92
Foley, D. K. (2003). Rationality and Ideology in Economics. Accessed November 30, 2011 from
http://homepage.newschool.edu/~foleyd/ratid.pdf.
Marshall, A. (1920). Principles of Economics. Library of Economics and Liberty. Assessed
January 20, 2023 http://www.econlib.org/library/Marshall/marP4.html.
Reynolds, L. R. (2005). Alternative Microeconomics. Accessed on January 25, 2023.
from http://www.boisestate.edu/econ/Ireynol/web/Micro.htm.

NOTES ON ANSWERS TO SELF-ASSESSMENT QUESTIONS

Possible Answers to Self-Assessment Exercise(s) for Study Session 1
1. Define national income and state the relationship between GDP and GNP
2. Distinguish between Net national product at factor cost (NNPfc) and Net national product at
market prices (NNPmp).
3. Briefly explain income method of calculating national income

1. Define national income and state the relationship between GDP and GNP
National income is defined as the net output of commodities and services flowing during the year
from the country’s productive system in the hands of the ultimate consumers.
GNP= GDP + Net income from abroad(X-M), where X= Export, M= Import If the value of (X-
M) is negative then, GDP > GNP Net National Product (NNP). Net national product is
considered a true measure of national product or income. It is defined as GNP minus
depreciation or capital consumption allowance or wear and tear. NNP = GNP – Depreciation.
Unlike GDP, GNP, net national product (NNP) may also be categorized as: NNPmp (Net
national product at market price): Net national product at market prices is net value of final
goods and services evaluated at market prices in the course of one year in a country.
2. Distinguish between Net national product at factor cost (NNPfc) and Net national
product at market prices (NNPmp).
NNPfc (Net national product at factor cost): Net national product at factor cost is the net output
evaluated at factor prices. It includes income earn by factors of production through participation
in the production process such as wages and salaries, rents profits etc. NNP at factor cost is also
called National Income.
NNPmp = NNPfc – S + (IT+ GS) or, NNPmp = NNPfc – subsidies + (indirect tax+ surpluses
from government enterprises) NNPfc = NNPmp + S - (IT+ GS) or, NNPfc = NNPmp + subsidies
(indirect tax+ surpluses from government enterprises).

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Normally, NNP at market prices is higher than NNP at factor cost because indirect taxes exceed
government subsidies. However, NNP at market prices can be less than NNP at factor cost when
government subsidies exceed indirect taxes.

3. Briefly explain income method of calculating national incomeUsing this method national
income is calculated by adding up incomes of individuals, firms and governments. That is, the
income earned as wages, salaries, rents, interest and profits as well as government revenue. But,
incomes earned through transfer payment, illegal activities, unemployment wages, sick benefits
and student’s scholarship, which are for no work done are excluded from the calculation to
avoid double counting.

Possible Answers to Self-Assessment Exercise(s) for Study Session 2

Explain the reasons for calculating national income
Explain the reasons for calculating national income
There are several reasons for computing national income. These include:
i. To know a country economic performance overtime: an increase in national income figures
indicate that the country is growing, and vice versa.
ii. To know a country’s per-capital income and standard of living the people living in the
country.
iii. To know the structure of production and consumption of goods and services. This is done by
comparing the figures of economic sectors and agents.
iv. To compare the standard of living between countries: The country with higher national
income figure is assumed to have higher standard of living, or vice versa.
v. For economic planning and policies: Since the figures show the performance of the various
sectors of the economy, it can be used for economic planning.
vi. To aid allocation of resources in the country: Since national income figures show the
contributions from all the regions and states, it assists government in planning how to
redistribute income between them.

Possible Answers to Self-Assessment Exercise(s) for Study Session 3

1. Explain the problems that are likely faced in computing national income

2. Explain how external factors affect national income of a country

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1. Briefly explain at least nine problems that are likely faced in computing national income.
There are several problems faced in calculating national income of a country. These include:

i. Lack of data: This problem is due to lack of transportation and communication facilities,
illiteracy fear of taxation on the part of some producers and consumers.
ii. Double counting: There is the danger of calculating the value of a good twice when
calculating national income, particularly through the output method. For instance, it is
possible to add the values of raw cassava, garri and starch. This may overestimate the
national income figures.
iii. Lack of statisticians who can collect and analyze data on national income.
iv. Inflation: During inflation the value of money decreases over time, and this may not give
a correct estimate of the national income.
v. Transfer payments: It is sometimes difficult to classify some individual's income as
transfer payment or not where as transfer payments are not to be included in the calculation
of national income.
vi. Unpaid services: Since unpaid services such as owner occupied houses, services of house
wives, etc, are not paid and therefore not included in national income estimates, it is
difficult to arrive at the correct figures.
vii. Value of depreciation: It is always difficult to know the correct value of capital
depreciation which is be excluded from the gross domestic product before arriving at
national income.
viii. Difficulties in calculating Net income from Abroad: This is due to instability in foreign
exchange rate and value.
ix. Illegal Activities: It is difficult to know the value of income earned through illegal
activities, and thus makes the computation of national income difficult.

2.Explain how external factors affect national income of a country

External factors such as: terms of trade, foreign direct investment, loans and grants to and from
a country can determine the output of goods and services in that country. Favorable external
factors can raise domestic output, and vice versa.

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Possible Answers to Self-Assessment Exercise(s) for Study Session 4
1. With appropriate diagram, explain the circular flow of income in frugal economy.

1. With appropriate diagram, explain the circular flow of income in frugal economy.
In the frugal economy, income flows between households and firms. Thus, it is an economy with
savings and/or investments. Therefore, the model of national income determination is:
Y=C+I ……………………………………………………………..……………………..……(2)

Y=C+S ………………………………………………………………………………… (3)

Where
Y= C = Consumption
I = Investment
S = Savings.
It is shown diagrammatically below:

»avm
i

Figure 2.1: Circular flow of income between Households and firms (in a two-sector closed
economy).

Since this economy assumes savings and investment, financial institutions such as banks are
included:

(i) Flow of resources: Households are endowed with factor which they sell to the firms in the
factor market. The firms used the productive services in certain combinations to produce
goods and sell to the household in the goods market.

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(ii) Flow of money: The firms, in return, pay the Households income wages, salaries, rents and
profits, i.e. productive services supplied by the households. The households either use all the
money obtained from the firms to buy goods in the product et or save a portion of it.
The portion saved by households is channeled into financial institutions in the form of savings
and from the firms in form of investment.

Thus, in equilibrium:

C+I=C +S………………………………………………………….……………..…………… (3)

i.e. I= C……………………………..……………………..………………..………………… (4),
after eliminating C from both sides of equation (3). Hence, in equilibrium, aggregate demand
must equal aggregate supply or investment must equal savings.

Possible Answers to Self-Assessment Exercise(s) for Study Session 5

1. Why do governments impose taxes?
2. Enumerate the various items of government expenditure.

1. Why do governments impose taxes?

Governments impose taxes for the following reasons:

i. To raise revenue: The various types of taxes are good sources of government revenue.
ii. To fight inflation: An increase in tax rate reduces the purchasing power of individuals
thereby leading to a fall in demand for goods and their prices, or vice versa.
iii. To discourage the consumption of harmful goods, the consumption of harmful goods like
tobacco, alcohols, etc, can be discouraged by imposing higher taxes on them, so as to
raise their prices.
iv. To redistribute income: Income can be redistributed and in quality reduced by imposing
progressive or direct taxes, whose payment vary with the level of income. In this case,
higher incomes are charged higher tax rates and vice versa.
v. To protect infant industries new industries: particularly of indigenous ownership can be
protected by imposing higher tax rates on the similar goods imported from their foreign
counterparts.

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 vi. 'To correct balance of payment problems: Deficit balance of payments can be corrected
by imposing higher taxes on imported commodities and lower taxes on exported goods.
vii. To achieve even development: Taxation can be used to create employment and enhances
development in rural areas. This is done by tax exemption or rebates for industries
located in rural areas.
viii. To Retaliate: A country can retaliate other countries by imposing higher tax rates on
importation of their goods.

2. Enumerate the various items of government expenditure.

Items of public expenditure in Nigeria are broadly grouped into four, namely:

General Administration: The items under general administration include:

xii. President
xiii. The Legislature
xiv. The Judiciary
xv. The civil service
xvi. The executive
xvii. The Police
xviii. The Armed Forces
xix. The Paramilitary
xx. The embassies in other countries
xxi. Political Appointees
xxii. Various Governments departments, etc.
Social Services: Here, the items include:
vi. Education
vii. Health care Delivery
viii. Infrastructural facilities
ix. Environmental Sanitation
x. Market via Recreational Facilities, etc.
ii. Economic services: The items here include:

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 iii. Financing of the real sectors such as: agriculture, industry manufacturing, etc.
iv. Power stations
iii. Communication, etc.
Transfer services: The items here include:
v. Servicing of public debt
vi.Grants aids and loans to other countries
vii. Payments of pensions
viii. Expenses on international organizations and peace keeping activities in other
countries.

Possible Answers to Self-Assessment Exercise(s) for Study Session 6

1. Distinguish between money and other commodities.
1. Distinguish between money and other commodities.
The differences between money and other commodities are:
i. Money is generally acceptable while other commodities are not.
ii. Money is portable while other commodities may not be portable.
iii. Money is relatively scarce while other commodities are not.
iv. Money is homogeneous while other commodities are not.
v. Money is durable while other commodities are not.
vi. Money is stable while other commodities used in trade by barter are not.
vii. Money is divisible into small units while other commodities are not.
viii. Money is easily recognizable by the people, other commodities are not.
ix. Money has no intrinsic values.

x. Money is used as a medium of exchange, other commodities are not.

xi. Money can function as a standard for deferred payment, other commodities cannot
xii. Money serves as a unit of account, other commodities cannot.
xiii. Money can serve as a store of value while other commodities cannot,
xiv. Money can also serve as a measure of value while other commodities cannot

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2. List 4 differences between money and other commodities

Differences between Money and other commodities

i. Money is generally acceptable while other., commodities are not.
ii. Money is portable while other commodities may not be portable.
iii. Money is relatively scarce while other commodities are not.
iv. Money is homogeneous while other commodities are not.

Possible Answers to Self-Assessment Exercise(s) for Study Session 7

1. Explain classical theory of demand for money.

1. Explain classical theory of demand for money

Classical economists view on demand for money is inherent in the quantity theory of money.
They emphasized the transactions demand for money in terms of the velocity of circulation of
money. This is because, money acts as a medium of exchange facilitate the exchange of goods
and services.
They used the Fisher's equation of exchange which specifies that:
MV = PT ……………………………………………………………….…………………… (1)
Where M is the total quantity of money V is its velocity of circulation, P is the price level, and T
is the total amount of goods and services changed for money. The right-hand side of the
equation, PT, represents the demand for money which, in fact depends on the volume of the
transactions to be taken in the economy. MV represents the supply of money. Thus, equation
becomes:

Md = PT ……………………………………………………………………………………..(2)

The classical economists believed in say's law whereby supply creates its own demand assuming
the full employment level of income. Thus, the demand for money in classical approach is a
constant proportion of the level of transactions, which in turn, bears a constant relationship to the
level of national income. Furthermore, the demand for money is linked to the volume of trade
going on in an economy at any time. The Cambridge school refined the classical theory on the
demand for money, according to them, the demand for money equation is:
KPY………………………………………………………….………………………….. (3)

Where Md is the demand for money which must equal the supply of money in. equilibrium in
the economy, K is the Fraction of the real money income (P Y) which people wish to hold in

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cash and demand deposits P is the price level, and Y is the aggregate real income. They held that
Remand for money in nominal term would be proportional to the nominal level of income for
each individual, and hence for the aggregate economy as well They argued that one should
consider the convenience an individual gets from money holding for transactions which depend
on his wealth A the rate of interest, his expectations about future events, etc, as potentially
important influences upon the land for 1170ney. Criticisms of the Classical Approach to demand
for Money. The classical approach to demand for money has been criticized on many grounds.

A major criticism of the classical approach to the demand for 'money arises from the neglect of
store of function of money. They classical emphasized the of exchange function of money which
Sly acted as a go-between to Facilitate buying and selling. Their view that money performs a
neutral role in the economy, and that it is barren and would not multiply, if stored in the form of
wealth, is erroneous because, money performs the asset function when it is transformed into
other forms of assets like bills, bonds, cars etc.

In addition, they say little or nothing about the nature of the relationship that one expects to exist
between such variables as wealth, interest rate etc, and it does hot identify which variable(s)
is/are more important.

Possible Answers to Self-Assessment Exercise(s) for Study Session 8

1. What are the advantages of public enterprises?
2. What are the disadvantages of private enterprises?

1. What are the advantages of public enterprises?

i. Provision of infrastructural facilities: Public corporations provide infrastructural
facilities, such as roads, schools, railways, electricity, to the populace. Availability of
large capital: Since public enterprises are owned by government, there is always ava i
lability of sufficient capital to ensure expansion of the enterprises.
ii. There is continuity: Public corporations can past for a period of time. In other words,
there is continuous existence.
iii. Development of capital projects: Establishment of public corporations can ensure
the development of capital projects, e.g.
iv. Avoidance exploitation of consumers: Public cooperation are consumer conscious
as they ensure that the exploitation of consumers is greatly reduced.
v. Creation of higher standards: The government enters business in order to ensure
higher standards, e.g. provision of educational facilities.

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 vi. Accountable to the public: Public enterprises are uncountable to the public because
they have to submit their annual reports to the parliament
vii. Legal entity: A public corporation is a legal entity, i.e. it can sue and be sued on its
own.
viii. It caters for the interest of workers: In public enterprisers, the interest of the
workers is catered for, so the employees have a great sense of security.
ix. Provision of employment opportunity: Public corporation provides employment
opportunities for the teeming number of the unemployed.
x. Enjoyment of large-scale production: As a result of the availability of large capital
for expansion, production can be done on large-scale.
xi. Generation of revenue: Revenue is generated by the government from public
corporations, e.g. water rate or electricity bill, to finance other projects.

2. What are the disadvantages of private enterprises?

(i) Limited capital: As a result of few numbers of shareholders coupled with the fact that
shares cannot be sold to the public, the capital available for use is limited.
(ii) Shares are not sold to public: The private limited company cannot sell its shares directly
to the public. This is one of the limitations to the capital base of the company.
(iii) Shares not easily transferred: A shareholder cannot sell his shares without the consent of
other shareholders.

(iv)Lack of privacy: There is lack of privacy as companies are required to publicize their
accounts.
(v) Payment of corporate tax: Private limited companies are usually required to pay corporate
tax, unlike personal income tax paid by sole proprietorship and partnership.
(vi)Lack of personal contact: There is less personal contact with both the employees and
customers, unlike in the sole proprietorship and partnership.
(vii) Delay in decision taking: Before any decision is taken on any crucial matters, the board
of directors or the shareholders must meet and this tends to waste a lot of time.

Possible Answers to Self-Assessment Exercise(s) for Study Session 9

1. What are the three levels of international trade?
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1. What are the three levels of international trade?
International trade exists at three levels, namely:

(i) Bilateral Trade: This is the trading agreement in which two countries exchange goods
and services.

(ii) Multilateral Trade: This is the type of trading arrangement in which there are more than
two countries exchanging goods and services. This would encourage division of labour
and increase the total volume of world output trade.

(iii). Globalization: This is an advanced level of multilateral trade which involves free flow
of goods and services across international boundaries.

Possible Answers to Self-Assessment Exercise(s) for Study Session 10

1. How does differences in Capital Goods affect international trade
Some countries have more capital goods and therefore can produce goods in greater and more
varied quantities than countries with less or no capital goods. E.g, Britain, USA and Japan have
more capital goods than less development ones like Nigeria, Ghana, Sierra Leone, etc. By
countries trading with one another these differences in the demand for and supply of' resources
are greatly reduced since each country's needs become satisfied.

2. What are the differences between international trade and internal trade?

There are several differences between international trade and internal trade. These include:

i. Foreign trade involves the exchange of goods and services across national frontiers while
internal trade involves the exchange of goods within the border of a country,
ii. In foreign trade, buyers and sellers use different currencies whereas buyers and sellers in
home trade use the same type of currency.
iii. There is possibility of restriction tariffs, import du, les, export duties, quotas, embargoes
when goods are exchange across national boundaries while these do not occur in home
trade,

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 iv. There are differences in systems of weighing and measuring in one country vis-a-vis
another. A country has only one system or such weighing and measuring.
v. Differences in transport cost due to distance between buyers and sellers, documentation
requirement, need for insurance in respect of foreign trade distinguished foreign trade
from home trade.
vi. There are also differences in legal systems and culture under international trade but the
legal systems are the same in domestic economy.
vii. Foreign trade requires knowledge of new languages and interpretations while in domestic
trade a common language is used.

Possible Answers to Self-Assessment Exercise(s) for Study Session 11

1. What are the reasons for imposition of international trade restrictions?
2. What are the Causes of Deficit Balance of Payments?

1. What are the reasons for imposition of international trade restrictions?

The reasons why nations impose restrictions on international trade include:

(xii) To protect infant industries: Tariffs are imposed to protect infant industries from undue
competition with foreign firms.
(xiii) Generation of revenue: Tariffs are also imposed to generate revenue for the country.
Many countries derive their revenue from import and export duties.
(xiv) To prevent dumping: Tariffs are imposed to prevent dumping of goods from foreign
countries. This is to prevent foreign goods from being sold at prices lower than the home
price.
(xv) To improve balance of payment deficit: By imposing tariffs on imported goods, the
unfavorable
(xvi) . Retaliatory measure: this can be used in retaliate against countries which impose taxes
on their imports.
(xvii) To prevent importation of dangerous goods: dangerous or harmful goods from other
countries re prevented from being imported through restriction.

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(xviii) Employment generation: countries impose tariff to encourage the establishment of local
industries or enhance the expansion and growth of existing one. This helps to provide job
opportunity.
(xix) Political motives: Tariffs can be introduced as discriminatory measure against unfriendly
countries.
(xx) To promote self-sufficiency: Tariffs are also imposed on imported goods to enable a
country be self-sufficient in production of numerous goods.
(xxi) To check consumption pattern: if all sorts of goods are allowed to come into the country,
the citizens will develop uncontrolled appetite for foreign goods.
To protect strategic industries: Tariff may be used in most cases to protect certain strategic
industries.

2. What are the Causes of Deficit Balance of Payments?

Deficit balance of payment is a situation when a country's receipt from abroad is less than its
payments to abroad. Some of the causes of deficit BOP include:

i. Unfavorable terms and balance of trade: If the price of a country’s exports is less than the
price of its import it is likely to face deficit balance of payment, or vice versa. Similarly, if
the value of the country's exports is less than the value of its imports, it will experience
deficit balance
j. Unfavorable exchange rate: If the exchange value of a country’s currency ii less than those
of other country (ies), it will experience deficit balance of payment or vice versa.
k. Decrease in exports thereby decreasing income (receipts) on the credit side of current
account.
l. Increase in Imports thereby increasing expenditure (payments) on the credit side of current
account.

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