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BUSINESS STUDIES FORM 3

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TOPIC 1: DEMAND

CONTENTS

• Introduction

• Factors influencing demand

• Types of demand

• Demand schedule and demand curve

INTRODUCTION

Demand refers to the quantity of a good or service which is purchased at a specific

price within a given period of time.

Demand therefore exists only when there is willingness and ability to pay for the

product.

THE LAW OF DEMAND

The law of demand states that, “with all other factors held constant, the higher the

market price, the lower the market demand and vice versa”

Assumptions of the law of demand

a) The demand for a product is normal and not habit forming

b) Demand and price in the market are constant for a specific period of time

c) Consumers’ tastes and preferences do not change

d) There are no anticipated future changes in market price

e) There is no change in the income levels of the consumers

f) There are no changes in the prices of related products

FACTORS INFLUENCING DEMAND

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• Price of the product

• Price and availability of related products

• Income of consumers

• Tastes and preferences

• Consumer expectations

• Size of the population

• Income distribution

• Government policies

• Sociological factors

• Seasonal changes

• Terms of sale

PRICE OF THE PRODUCT

For a normal product, the higher the market price, the lower the market demand and

vice versa.

PRICE AND AVAILABILITY OF RELATED PRODUCTS

Related products are classified into two:

• Substitutes

• Compliments

Substitutes: These are products that can be used in place of one another e.g. tea and

coffee. If the price for one substitute product goes up, it’s demand fall as consumers

switch to the other product.

Complements: Compliments are those products which are used together e.g. car and

petrol. If the price for one product increases, its demand will fall and so will be the

demand for its compliment

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INCOME OF CONSUMERS

Income determines the ability of consumers to buy. The higher the income, the

higher the demand and vice versa.

TASTES AND PREFERENCES

Taste is the desire of the product by the consumer due to the satisfaction he derives

from using the product. When consumer tastes and preferences change in favor of

the product, its demand will increase and vice versa

CONSUMER EXPECTATIONS

Expectations refer to future anticipated changes. These changes may relate to price

and supply. When consumers expect price to fall in future, they will buy less now

and more in future. On the other hand, if consumers expect a future shortage, they

will buy more now and less later

SIZE OF POPULATION

An increase in population means more products are demanded to satisfy the needs of

the growing population. The opposite will happen if the population decreases.

INCOME DISTRIBUTION

When income is evenly distributed, more consumers will have the ability to buy

hence demand will increase. On the other hand, when income is in the hands of a

few, ability to buy is reduced hence demand decreases.

GOVERNMENT POLICIES

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Government influences demand through the following methods:

• Taxation

• Subsidies

• Legislations

• Price control

Taxation: Imposing a tax increases the price of the product hence reducing its

demand. On the other hand a reduction in tax will reduce price leading to price

reduction.

Subsidies: Subsidies reduce the production costs enabling producers reduce their

selling prices hence increasing demand.

Legislations: The government may pass laws that encourage or discourage

consumption of certain products e.g. cigarettes. This will increase or decrease

demand for such product.

Price control: The government may control the price of certain products by ensuring

that they don’t exceed certain limits. This move will increase the demand for such

products. SOCIALOGICAL FACTORS

Refers to factors such as age, education, marital status, culture etc. All these factors

may dictate the kind and amount of product consumers’ demand. For instance, young

people are likely to buy more movies than the aged.

SEASONAL CHANGES

Demand for some products depends on the season. For example, umbrellas are

demanded more during the rainy season.

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TERMS OF SALE

Terms of sale refers to credit, cash sales or discounts. When terms of sale are

favorable, demand will be high unlike when they are unfavorable.

TYPES OF DEMAND

There are FOUR types of demand:

• Joint demand

• Derived demand

• Competitive demand

• Composite demand

JOINT DEMAND

This is demand that arises from complementary goods. It is the demand that exists

between goods that are used together e.g. tea and sugar such that as demand for

one product increases, demand for the other product also increases.

DERIVED DEMAND

This is where the demand for one product is triggered by the demand for the other

product. For example, demand for hens is derived from the demand for eggs.

COMPETITIVE DEMAND

This is demand existing between close substitutes e.g. tea and coffee. An increase

in demand for one product reduces the demand for the other product.

COMPOSITE DEMAND

This is the demand that arises where the product is used for more than one

purpose e.g. demand for timber which is required for building, making furniture

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etc. Therefore a rise in need for one of the purposes, will increase the demand for

timber.

DEMAND SCHEDULE AND DEMAND CURVE

DEMAND SCHEDULE

A demand schedule is a table that shows the quantities of goods demanded at a

particular time

TYPES OF DEMAND SCHEDULE

Demand schedule can be classified into two:

• Individual demand schedule

• Market demand schedule

Individual demand schedule: This is a table showing the quantities demanded

by a single consumer at a particular time.

Illustration: The table below shows the demand schedule of consumer A

PRICE(Ksh) QUANTITIES

DEMANDED(Kgs)

10 40

20 30

30 20

40 10

Market demand schedule: This is a table showing the sum of all the quantities

demanded by all consumers at a particular time.

Illustration: The table below shows the demand schedules for consumers A, B

and C

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PRICE(Ksh) QUANTITY

DEMANDED

BY A(Kgs)

QUANTITY

DEMANDED

BY B

QUANTITY

DEMANDED

BY C(Kgs)

TOTAL

MARKET

DEMAND(Kgs)

10 40 40 40 120

20 30 30 30 90

30 20 20 20 60

40 10 10 10 30

DEMAND CURVE: A demand curve is a graphical representation of the

information contained in a demand schedule.

NOTE: Mention the law of demand

TYPES OF DEMAND CURVES

Individual demand curve

This is a graphical representation of an individual demand schedule.

Assign: Draw the demand curve for the individual demand schedule above

Market demand curve

This is a graphical representation of a market demand schedule.

Assign: Draw the demand curve for the market demand schedule above

ABNORMAL DEMAND

Refers to a situation where a decrease in the price of the commodity may not

result in an increase in the quantity demanded for the commodity and vice versa

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(Illustrate)

Reasons for abnormal demand

a) Goods of ostentation (prestigious goods)

b) Inferior goods

c) Giffen goods

d) Necessities

e) Habitual goods and services

f) Expectations of future shortages

g) Expectations of future increase in price

MOVEMENTS ALONG THE DEMAND CURVE

The demand curve may either contract or extend due to changes in market price.

An extension in demand refers to an increase in quantity demanded while a

contraction refers to a decrease in quantity demanded. (Illustrate)

SHIFTS IN DEMAND CURVE

Refers to the dislocation of the entire demand curve either to the right or to the

left. A shift to the right indicates an increase in demand where as a shift to the left

indicates a decrease in demand. (Illustrate)

A shift in demand curve is caused by changes in any other factor affecting

demand other than market price.

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Causes of a shift to the right (increase in demand)

• A rise in the incomes of consumers

• A rise in the price of the substitute product

• A fall in the price of the complement product

• A positive change in consumers’ tastes towards the product

• Favorable government policies e.g. lower taxes

• Increase in consumer in incomes

• Increase in population

• Even distribution of income

Causes of a shift to the left (decrease in demand)

• A fall in consumer income

• A fall in price of the substitute product

• A rise in the price of the complement product

• Negative change in consumer preferences

• Uneven income distribution

• Decrease in population

• Decrease in consumer income

• Unfavorable government policies e.g. increase in taxes

TOPIC 2: SUPPLY

CONTENTS

• Introduction

• Factors influencing supply

• Types of supply

• Supply schedule and curve

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INTRODUCTION

Supply refers to the quantity of a product that sellers are able and willing to bring

to the market at a particular price over a given period of time

THE LAW OF SUPPLY

The law of supply states that, “with other factors held constant, the higher the

market price, the higher the market supply and vice versa”

Assumptions of the law of supply

a) Suppliers have perfect knowledge of price changes in the market

b) Suppliers have the ability to offer any quantity of a commodity in the at any

given price

c) Consumers are rational in their consumption behavior

d) There are no abnormal price fluctuations in the market

FACTORS INFLUENCING SUPPLY

• Price of the product

• Prices of other related products

• Prices of factors of production

• State of technology

• Goals of the firm

• Time

• Government policies

• Natural factors

• Industrial unrest

• Entry of new firms

• Future expectation of changes in price

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PRICE OF THE PRODUCT

The higher the market price of a product the higher the market supply. This is due

to the fact that sellers will be motivated to make more profits from increased

prices.

PRICES OF RELATED PRODUCTS

Related products can be classified into two:

• Substitutes

• Complements

Substitutes: These are products which compete for the same piece of land e.g.

maize and wheat. An increase in the supply of one product causes a decrease in

the supply of the other product.

Complements: These are products which undergo the same production process

e.g. hide and beef. An increase in supply for one product leads to an increase in

supply for the other product.

PRICES OF FACTORS OF PRODUCTION

Factors of production refer to the inputs to the production process. If these inputs

are expensive to acquire, the cost of production will increase hence reducing the

quantity supplied in the market.

STATE OF TECHNOLOGY

With improved technology, production of commodities may increase. Therefore,

producers will produce more and market supply will increase.

GOALS OF THE FIRM

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Goals set by a firm may also influence what they produce and how much they

produce. For instance, a firm may decide to continue producing a particular

product irrespective of the risks incurred. In this case supply for the product will

increase. On the other hand, if a firm fears taking risks, its production of certain

products may reduce.

TIME

Supply for some products is seasonal e.g. agricultural products. In this case, their

supply will be high during harvesting season. Some products are also supplied

more during specific seasons e.g. umbrellas are demanded more during the rainy

season.

GOVERNMENT POLICIES

Government can influence supply through the following methods:

• Subsidies

• Taxation

• Quotas

• Price control

Subsidies: Subsidies are incentives given to producers e.g. free seeds for farmers.

Subsidies have the effect of lowering production cost hence increasing supply

Taxation: Taxes have the effect of increasing the cost of production therefore

discouraging producers leading to lower market supply.

Quotas: A quota is a restriction on the amount of a product that can be produced.

Quotas therefore control the amount of a product thereby reducing its market

supply.

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Price control: If the government sets a low price for the product, its supply will

be lower.

NATURAL FACTORS

Refers to factors related to weather and climate. Such factors affect the production

of agricultural products. When these factors are favorable, supply will increase

and vice versa.

INDUSTRIAL UNREST

Industrial unrest refers to disagreements between the employers and the

employees which in most cases lead to strikes. Industrial unrests hinders

production therefore reducing market supply.

ENTRY OF NEW FIRMS

Entry of new firms in the industry will increase market supply. On the other hand,

withdrawal of firms from an industry will lead to a reduction in market supply.

FUTURE EXPECTATIONS OF CHANGES IN PRICE

If producers expect a future increase in market price, they will hoard their

products and sell them later. This will reduce the current supply for the product.

But if producers expect a future decrease in price, they will sell more products

hence increasing its supply.

TYPES OF SUPPLY

There are two major types of supply:

• Joint supply

• Competitive supply

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JOINT SUPPLY

This is supply which exists between products which undergo the same production

process e.g. hide and beef. An increase in the supply of one product will cause an

increase in supply for the other product and vice versa.

COMPETITIVE SUPPLY

This is a kind of supply which occurs when a factor of production is used to

produce two or more products e.g. maize and wheat.an increase in the supply of

one product leads in a decrease in supply for the other product.

SUPPLY SCHEDULE AND CURVE

SUPPLY SCHEDULE

A supply schedule is a table which shows the quantities of a commodity that

sellers are willing and able to offer for sale at a specific price at a given period of

time.

The supply schedule

PRICE(Ksh) QUANTITY(Kgs)

10 10

20 20

30 30

40 40

SUPPLY CURVE

A supply curve is a graphical representation of the information contained in the

supply schedule. (Illustrate)

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MOVEMENT ALONG THE SUPPLY CURVE

Refers to extension or contraction of supply due to changes in market price. When

price increases, quantity supplied increases (extension).On the other hand, when

price decreases, quantity supplied will decrease (contraction) (Illustrate)

SHIFT IN SUPPLY CURVE

Refers to the dislocation of the entire demand curve either to the left or to the

right. A shift to the right indicates an increase in supply whereas a shift to the left

indicates a decrease in supply (Illustrate)

Causes of a shift to the right (increase in supply)

• A fall in price of factors of production

• Improvement in technology

• Favorable government policies

• Entry of new firms in the industry

• Favorable weather conditions

• Industrial peace

Causes of a shift to the left (decrease in supply)

• An increase in the price of competing products

• An increase in the price of relevant factors of production

• Improved technology in the production of a competing product

• Unfavorable weather conditions

• Industrial unrest

TOPIC 3: EQUILIBRIUM PRICE AND QUANTITY

CONTENTS

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• Introduction

• Excess demand and excess supply

• Effects of shifts in demand and supply curves on equilibrium price and

quantity(Illustrate)

• Other methods of determining market price other than price mechanism

INTRODUCTION

The term equilibrium means equal or balanced. Equilibrium price is the price that

equates quantity demanded and quantity supplied. Equilibrium quantity is that

quantity that is bought and sold at the equilibrium price. The point at which

demand and supply are equal is the equilibrium point. (Illustrate)

EXCESS DEMAND AND EXCESS SUPPLY

Excess demand is the amount by which the quantity demanded exceeds the

quantity supplied at a given price. On the other hand, excess supply is the amount

by which the quantity supplied exceeds the quantity demanded.

Excess demand or excess supply will cause disequilibrium in the market

(illustrate)

EFFECTS OF SHIFTS IN BDEMAND AND SUPPLY ON EQUILIBRIUM

PRICE AND QUANTITY

(Illustrate)

OTHER METHODS OF DETERMINING MARKET PRICE

Apart from price mechanism, other methods of determining market price include

• Haggling

• Government intervention

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• Auction

• Tendering

Haggling: Refers to bargaining

Government intervention: Refers to a system where prices are influenced by the

government through:

• Price control

• Taxation

• subsidies

Auction: A method of selling where buyers are given the opportunity to compete

for the product by quoting different prices. The one who quotes the highest price

becomes the buyer.

Tendering: A method of selling where buyers are given an opportunity to suggest

the selling price independently. The highest bidder becomes the buyer.

TOPIC 4: THEORY OF A FIRM

CONTENTS

• Introduction

• Factors influencing what to produce

• Determining the size of a firm

• Location of a firm

• Localization and delocalization of firms

• Economies and diseconomies of scale

• Existence of small firms in an economy

• Effects of production activities on the environment and community health

• Ensuring a health environment

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A FIRM: The term firm refers to a single unit of business organization that

brings together factors of production in order to produce a given product e.g.

Bata shoe company

AN INDUSTRY: An industry refers to all those firms producing a particular

product for a given market.

Types of production decisions made a firm

a) What to produce

b) How production is to take place

c) Where the production plant is to be located

d) When to produce

e) What the scale of production will be

f) When and where to invest

g) How to improve and control production

h) What type of business activity to engage in

Factors influencing the decisions made by the firm

a) Whether the firm is product oriented or market oriented

b) Level of market competition

c) Level of technology

d) Financial viability of the firm

e) Socio-cultural factors

f) The level of the country’s economy

g) Government policy

h) Profitability of the business

i) Environmental issues

j) Costs of production

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FACTORS INFLUENCING WHAT TO PRODUCE

These are factors considered by a firm before it makes a decision on the kind of

goods and services to produce. These factors may include:

PROFITABILITY

Businesses tend to produce those goods and services that yield more profit

LEVEL OF COMPETITION

Firms tend to produce those products whose market competition is minimum i.e.

those that are scarce in the market

AVAILABILITY OF RESOURCES

A firm will produce those products whose required resources it has. These resources

may include labor, raw materials, equipment etc.

GOVERNMENT POLICY

A firm will produce those products which are favored by the government i.e. those

which are lowly taxed and legal

MARKET DEMAND

Firms will produce products whose demand is high in order to ensure high sales

volume

COST OF PRODUCTION

A firm will produce those products whose production cost is low.

DETERMINING THE SIZE OF A FIRM

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INDICATORS OF THE SIZE OF A FIRM

NUMBER OF EMPLOYEES

Large firms employ more staff since there several functions to be executed unlike

small firms which only require fewer staff

VOLUME OF OUTPUT

Large firms unlike small firms produce more goods and services

AREA COVERED BY PREMISES

Large firms have several building which covers a lot of space unlike small firms

AMOUNT OF CAPITAL INVESTED

Firms with high invested capital are considered large firms whereas firms with little

capital investment are small firms.

TYPE OF PRODUCTION METHODS USED

Large firms have the financial capability to afford advanced production methods

such as division of labor and specialization unlike small firms

SIZE OF MARKET SERVED

Large firms unlike small firms control a large market

SALES VOLUME

If a firm presents many goods and services to the market, then it is considered to be

a large firm unlike when it presents fewer goods and services to the market

LOCATION OF A FIRM

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Location of a firm refers to selection of a place where the proposed firm is to be

established

FACTORS TO CONSIDER WHEN LOCATING A FIRM

AVAILABILITY OF RAW MATERIALS

Most firms are located near a source of raw materials. This is because of the need to:

• Lower the cost of transporting raw materials to the firm

• Prevent raw materials from going bad especially when they are perishable

• Minimize the handling costs of raw materials

• Ensure constant supply of raw materials in order to facilitate continuous

production

• Counter competition especially when competition for raw materials is high

• Comply with the government policy e.g. when the government requires firms

to be located near a source of raw materials

AVAILABILITY OF MARKET

It is advisable to locate a firm near a market. This is because of the need to:

• Lower cost of transportation to the market

• Avoid breakages especially where fragile goods are produced

• Prevent perishable goods from going bad

AVAILABILITY OF LABOUR

Labour intensive firms are located near an abundant labour source e.g. in urban

areas

AVAILABILITY OF APPROPRIATE TRANSPORT AND

COMMUNICATION NETWORK

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Firms are located in area with a good transport network in order to:

• Ensure constant supply of raw materials

• Facilitate easy transportation of finished goods to the market

• Facilitate information flow

• Facilitate easy movement of labour to and from work

• Save on transport cost and frequent repair of vehicles

AVAILABILITY OF ADEQUATE POWER AND WATER SUPPLY

Water and power are very essential to a firm’s operations. Power is required to run

the machines whereas water is used as a machine coolant, for cleaning or even as a

raw material. Firms should therefore be located in places with adequate supply of

water and power.

GOVERNMENT POLICIES

Government may also influence the location of firms using the following methods:

• Offering free or cheap land

• Reduction of taxes

• Offering subsidies

• Offering financial assistance

• Improving infrastructure

• Providing credit facilities to investors

OTHER FACTORS

1. Availability of auxiliary services such as banking and insurance

2. Availability of room for expansion

3. Effects of a firm’s operation on the environment

4. Availability of security

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5. Nature of terrain

6. Climatic conditions

LOCALISATION AND DELOCALISATION OF FIRMS

LOCALISATION OF FIRMS

Localization refers to concentration of similar firms in one particular region.

REASONS FOR LOCALISATION

• A well-developed infrastructure

• Availability of a large population to provide labour and market

• Need for interdependence among firms in areas such as training of personnel

• Government policy requiring firms to be located in a given area

• Availability of raw materials in a given area

• Availability of support industries such as banks

ADVANTAGES OF LOCALISATION

a) It encourages the establishment of support industries e.g. banking, insurance,

warehousing etc.

b) Encourages the creation of a pool of labour due to rural urban migration

c) Establishment of firms that use finished goods as raw materials are encouraged

d) Disposal of waste products is made easier since it can be sold to other firms or

recycled

e) Creation of employment opportunities is encouraged

f) Encourages the development of infrastructure such as roads, communication,

health and education facilities

DISADVANTAGES OF LOCALISATION

a) May cause environmental pollution from industry emissions

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b) Results in regional imbalance in development

c) Encourages rural-urban migration leading to overcrowding in towns

d) Emergency of social problems such crimes, diseases, immorality etc.

e) May attract terrorist attacks since terrorists mostly target congested areas

f) A fall in the of the product produced by a localized firm may spark widespread

unemployment

DELOCALISATION OF FIRMS

Refers to establishment of firms in different parts of the country. It is highly

encouraged by the government

ADVANTAGES OF DELOCALISATION

a) Reduces effects of terrorist attacks

b) Provides employment opportunities to every part of the country

c) Reduces rural-urban migration

d) Ensures balanced regional development

e) Widens market for local produce

f) Makes products easily available to local consumers

DISADVANTAGES OF DELOCALISATION

a) Spreads pollution all over the country

b) Lack of skilled manpower in the rural areas

c) There may be insecurity in some areas

d) Service industries may not be available in the rural areas

e) Incentives offered by the government to encourage delocalization may burden

the taxpayer

f) Continued protection of local firms from competition from foreign firms by the

government may make local firms produce poor quality goods.

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Disadvantages of locating a business away from other businesses

a) Difficulty in acquiring relevant labour

b) Exchange of ideas is not easy

c) Difficulty in acquiring raw materials

d) The firm may produce poor quality goods due to lack of competition

e) Exchange of technology is not possible

Objectives of delocalization

a) To promote a balance regional development

b) To redistribute income by ensuring that there is a widespread location of

industries

c) To ensure better use of resources in different parts of the country

d) To create employment in various regions

e) To reduce congestion in urban centres

Methods used to delocalize industries

a) Offering cheap land

b) Offering tax concessions

c) Provision of infrastructure

d) Establishment of rules and regulations

e) Development of training institutions in different regions

f) Government directives

ECONOMIES AND DISECONOMIES OF SCALE

ECONOMIES OF SCALE

Refers to advantages a firm enjoys as a result of expansion.

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There are two economies of scale:

• Internal economies of scale

• External economies of scale

INTERNAL ECONOMIES OF SCALE

These are advantages accruing to a single firm as a result of it’s expansion

irrespective of what happens in other firms. These economies may include:

• Marketing economies

As the firm expands, it buys and sells goods in large quantities thus enjoying the

following:

• Trade discounts

• Lower transport cost

• Lower cost of advertising

• Lower distribution cost

• Financial economies

As a firm expands its scale of operations, it is in a position of accessing loans

easily and in large amount from financial institutions.

• Risk bearing economies

Large firms are able to reduce risks though selling many products in several

markets such if one product fails or demand in one market declines, the firm

can still make profit.

• Managerial economies

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As the firm expands, it is in a position of employing qualified staff. These staff

can go a long way in increasing the efficiency and productivity of the firm.

• Technical economies

Technical economies are those benefits associated with specialization of both

labour and machinery. A large scale firm is able to hire qualified staff and buy

modern machines to improve its productivity.

• Research economies

Research is a very expensive exercise and it can only be afforded by large firms

• Welfare economies

Welfare facilities are those things which motivate workers. Such things may

include: recreation, health, education etc. These facilities are expensive and can

only be afforded by large firms.

EXTERNAL ECONOMIES OF SCALE

These are those benefits which accrue to a firm as a result of growth in the

entire industry. These benefits include:

• Availability of ready skilled labour

• Ready market

• Easy disposal mechanisms

• Improved infrastructure

Ways in which large-scale businesses reduce their cost of operations

a) Buying goods in bulk from suppliers hence enjoying quantity discounts

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b) Promoting their products hence increasing sales

c) Bargaining for lower interest rates on loans

d) Diversifying products and markets hence spreading risks

e) Attracting skilled manpower hence lowering supervisory costs, wastes and

losses so as to improve efficiency

f) Using modern technology hence ensuring efficient production

g) Producing and selling in large quantities thereby reducing average costs

h) Carrying out research hence improving methods of production

DISECONOMIES OF SCALE

These are those problems a firm experiences as a result of expansion. They may be

classified into two.

• Internal diseconomies of scale

• External diseconomies of scale

INTERNAL DISECONOMIES OF SCALE

Refers to those problems which arise from within the firm as it expands. They

include:

• Managerial diseconomies

Continued expansion of a firm may pose problems associated with poor control

and coordination, long decision making and poor relations between staff and

management

• High operational costs

As the firm expands, money required for the day to day running of the firm will

increase. This is likely to lower the profits of the firm.

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EXTERNAL DISECONOMIES OF SCALE

These are problems a firm experiences as a result of growth in the entire industry.

They include:

• Struggle for raw materials

• Lack of land for expansion

• Scramble for qualified labour

• Market competition

• Easy target for terrorist activities

Ways of expanding a business

a) Entering into a suitable merger or amalgamation

b) Diversifying operations/ dealing in a variety of products so as to capture a

wider market

c) Buying/acquiring other similar businesses so as to widen the scope of

operations

d) Securing loans to expand the capital base

e) Arranging for franchising by acquiring rights to produce/sell goods under the

name of another firm

f) Expanding market to increase the volume of sales

g) Adopting appropriate technology to increase the quantity and quality of output

h) Ploughing back profits to finance its operations

i) Forming cartels with similar businesses

EXISTENCE OF SMALL FIRMS IN AN ECONOMY

Despite the benefits enjoyed by large firms, small firms still exist alongside large

firms. Some of the reasons for this existence may include:

• Size and nature of market

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In cases where the market size is small, small firms will prevail since it will be

uneconomical for large firms to operate in such markets. Consumers in some markets

may demand goods in small quantities, in such cases small firms will be preferred.

• Nature of the product

Some products cannot be provided in large quantities e.g. personal services such as

nursing or painting. These products can only be provided by a small firm.

• Simplicity in organization and operation

Small firms may also exist due to the fact that they are easy to operate as compared

with big firms

• Flexibility

Compared with large firms, small firms are easily adaptable to changes in the

environment. For example it is easy for a small scale firm to switch from one line of

trade to another unlike a large. Small firms will therefore exist in an economy due to

the fact that they highly flexible.

• Quick decision making

Most people go for small firms because it is easier to make decisions in these firms

given that few people are to be consulted when making a decision

• Simplicity in management

Most businessmen may opt for small firms due to the belief that they are easy to run

as compared to big firms

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• Lower costs of production

Small firms unlike large firms enjoy lower operational costs

• Desire to retain control

The need to exercise control and be the own boss may drive business people towards

operating in small scale

• Legal constraints

Measures put in place by the government may also hinder the growth of firms e.g.

the government may impose a higher tax if sales exceed a given limit, in this case,

the firm will rather remain small.

Disadvantages of small firms

a) High overhead costs due to low output

b) It is difficulty for small firms to diversify

c) Low profits due to limited capital

d) Overworking due to lack of division of labour

Role of small firms in developing countries

a) They create employment since they mostly use labour intensive techniques

b) They allow more low income earners to participate in economic activities

c) They promote delocalization of industries

d) They lend valuable support to large industries

IMPLICATION OF PRODUCTION ACTIVITIES ON ENVIRONMENTAL

AND COMMUNITY HEALTH

As production activities take place in a given area, environment and the health of

people around may be adversely affected. Some these effects may include:

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a) Affects the health of the people and animals due to pollution of water, air and

soil

b) Disrupts the ecosystem of the area as animals and plants may have to be moved

or destroyed

c) Leads to excessive use of resources resulting in land degradation and reduction

in the productivity of land

d) Depletion of the environment especially the ozone layer through toxic

emissions from industries

e) Causes negative social effects such as crimes in areas where production

activities take place due to high population in those areas

MAINTAINING A HEALTHY ENVIRONMENT

A healthy business environment can be promoted using the following methods

• Preventing pollution

• Providing security

• Ensuring availability of necessary resources such as labour, finance, machines

etc.

• Maintaining a healthy relationship

TOPIC 5: PRODUCT MARKETS

CONTENTS

• Introduction

• Types and features of product markets

INTRODUCTION

A product refers to goods or services sold in the market. A product is also known as

a commodity.

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A market refers to the mechanism through which the buyer and the seller interact to

transact

Essentials of a market

a) There must be willing buyers and sellers

b) There must be commodities to be bought or sold

c) There must be an acceptable medium of exchange e.g. money

d) There must be a market price

TYPES AND FEATURES OF PRODUCT MARKETS

Markets are classified based on the nature of the buyer, seller, and the product. These

classifications include:

• Perfect competition market

• Monopoly market

• Monopolistic competition market

• Oligopoly markets

PERFECT COMPETITION MARKET

This is a market with very many buyers and sellers dealing in an identical product.

Its features

• Large number of buyers and sellers

Buyers and sellers are very many such that any decision by any of them won’t affect

the market. Hence no single buyer or seller may influence market price.

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• Uniformity of the product

Commodities dealt in are similar in all respects such that they cannot be

distinguished. Therefore there is no advantage or disadvantage by buying from a

specific seller

• Perfect knowledge of the market

All sellers and buyers have a perfect knowledge about the market hence no seller can

sell above the market price

• Freedom of entry or exit

Buyers and sellers are free to enter and leave the market at will

• Uniformity of buyers and sellers

All buyers are identical in the eyes of the seller. All sellers are also identical before

the eyes of the buyer hence there is no advantage gained by selling to a specific

buyer or buying from a specific seller

• No government interference

Government does not interfere with the operations in this market. Therefore there are

no taxes, subsidies. Quotas, price control etc. Price is determined by the forces of

demand and supply

• No excess supply or demand

In this market, sellers sell everything they supply whereas buyers are able to buy

everything they need

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• Perfect mobility of factors of production

Land, labour, capital and entrepreneurship are assumed to move from one supplier to

another or from one occupation to another with easy

• No transport costs

It is assumed that buyers and seller live in one region. Firms therefore do not incur

carriage costs

• Common prevailing price

The selling price in a perfect competition market tends to be uniform

• No preferential treatment of buyers and sellers

All sellers are seen to be equal by buyers. Similarly, all buyers are seen to be equal

by sellers

MONOPOLY MARKET

This is a market situation where there are many buyers with only one seller known as

a monopolist.

Its features

• There only one supplier for the entire market. The supplier is therefore the

industry

• The product sold has no close substitutes hence there is no competition

• No freedom of entry

• The supplier sets the market price

• Price discrimination may be possible

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Price discrimination

Price discrimination refers to charging different prices for the same product in

different markets

Conditions necessary for price discrimination

• There must be no close substitutes for the product

• The different markets must be separated and the cost of separating should not

be too high

• Consumers should not be able to buy the product at a lower price in one market

and sell it at a higher price in another market where its price is higher

• Communication should not be possible between/among the markets

• Elasticity of demand must be different between/among the markets

Basis of market separation

Refers to what firms use to separate market. Includes:

a) Geographical

Goods are sold in different prices in different markets

b) Income

Different prices can be charged to different class of consumers depending on their

level of income e.g. in hospitals

c) Time

A seller may charge different prices during peak and off-peak periods e.g. in

matatus.

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Sources of monopoly power

• Control of an important input in production

Firms may become monopolies by controlling an important raw material, factor of

production or technical knowhow of producing a particular product

• Ownership of production rights

If production rights such as patents rights, copyrights and patents belong to one

supplier, this supplier may grow to become a monopoly. The government may also

encourage a monopoly by giving production license to a specific firm

• Existence of internal economies of scale

Existence of Internal economies may enable a firm lower its cost of production to

earn more profits and keep expanding to a point where other firms cannot compete

with it.

• Size and nature of the market

The market may be such that it can only be served by a single seller to avoid running

at losses

• High costs of entering the market

It may be expensive for other firms to enter a certain market due to high costs of

transportation and advertising incurred. This will eliminate competition resulting in a

monopoly

• Business combinations

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Some businesses may merge their operations in order tom operate as one. This will

result in the formation of a very big firm that is able to eliminate competition and

control the entire market

• Application of restrictive practices

A firm may employ unfair practices that will eliminate other firms from the market

e.g. lowering price to eliminate competition and later increasing price once the

competition has been eliminated.

• High capital requirement

Sometimes amount of capital required to start a particular business may be too much

for many firms to afford. A firm that can afford this start-up capital will therefore

become a monopoly.

Advantages of monopolies

a) It provides standard goods hence gives equal benefits to consumers

b) It provides price and output stability

c) The firm is able to produce in large scale thus enjoying economies of scale

d) Provides revenue to the government by taxing the huge profits made by

monopolies

e) The firm can use its huge profits to carry out research

f) There is no wastage of resources either in product differentiation or in

advertising because there is no competition

g) The firm can distribute its products to all parts of the country

h) The firm is able to spend its surplus funds on research and development hence

introducing new production techniques

Disadvantages of monopolies

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a) Monopolies may charge high prices hence exploiting consumers

b) Due to lack of competition, monopolies can produce substandard/inferior

quality goods

c) Causes unequal distribution of income

d) Too much monopoly power may influence the government to adopt

unfavorable policies

e) Denies consumers a variety of goods and services

f) Monopolists may overlook some markets which are less profitable hence

denying consumers in those markets access to goods and services

g) Monopolists may cause artificial shortages so as to manipulate prices

Differences between monopolies and perfect competition markets

Monopoly Perfect competition

There is government interference There is no government interference

There is only one seller There are many sellers

Products are differentiated Products are identical

There is price discrimination Common price prevailing

Entry into the market is restricted There is freedom of entry into the

market

Abnormal profits are made in the long run

Normal profits are made in the long run

Control of monopolies

The government can control monopolies by using the following methods

a) Using price controls to control their selling prices

b) Taxing monopoly’s profits and redistributing the money to citizens in the form

of service provision

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c) Reducing barriers to entry into monopoly markets so as to introduce

competition

d) Breaking large monopoly firms into smaller business units under different

management

e) Forming monopoly commissions to oversee and control the operations of

monopolies

f) Nationalization of the firm i.e. the government can take over the firm and start

supplying products at reasonable prices

g) Refusing to license monopolies

MONOPOLISTIC COMPETITION MARKET

This is a market that combines features of a perfect competition and a monopoly. In

this market, there is a large number of buyers and sellers dealing in a similar product

which is differentiated e.g. toothpastes, bread etc. Methods used in differentiating

products may include:

• Branding

• Wrapping

• Packaging

• coloring

Its features

• There are many buyers and sellers who act independently of one another

• Products are differentiated making each firm enjoy some level of monopoly

• There is freedom of entry and exit

• Sellers and buyers have a perfect knowledge about the market

• The firm is a price maker i.e. it is able to determine its selling prices

Advantages of monopolistic competition

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a) It provides a variety of consumer goods from the many brands

b) It provides information to consumers through aggressive advertising

c) It encourages innovation among the competing firms

Disadvantages of monopolistic competition

a) There is a duplication of resources in producing similar goods

b) There is wasteful advertising

c) Firms operate at excessive capacity in the long run

d) Expenditure on advertising increases the cost of production

e) Inefficient firms may survive in business due to differentiation

f) Competition prevents standardization

Differences between monopolistic competition and perfect competition markets

Monopolistic competition Perfect competition

Products are differentiated Products are homogeneous

Demand curve is downward sloping

Demand curve is horizontal

The firm is a price maker No single firm decides the price

Differences between monopoly and monopolistic competition markets

Monopoly Monopolistic competition

Has one seller Has many sellers

Products sold have no close

substitutes

Products sold have close

substitutes

Firms make abnormal profits in the long run

Firms make normal profits in the long run

Entry into the market is restricted There is freedom of entry into the

market

There is no competition for market Firms compete for market

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Similarities between monopoly and monopolistic competition

a) Both have downward sloping demand curves

b) Both are price makers

OLIGOPOLY MARKET

This is a market with very few firms which are very big to control a large percentage

of the market e.g. nation and standard newspapers.

Types of oligopoly

1) Duopoly

This is an oligopoly with only two firms e.g. BAT and mastermind tobacco Kenya

2) Perfect or pure oligopoly

This is an oligopoly that is made up of firms dealing in identical products e.g. firms

selling petroleum products

3) Imperfect or differentiated oligopoly

This is an oligopoly that is made up of firms dealing in close substitutes i.e. similar

products that are made to appear different e.g. bread

4) Collusive or cooperative oligopoly

This is an oligopoly where firms cooperate with each other in determining price or

output or both

5) Non-collusive or non-cooperative oligopoly

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This is an oligopoly market where firms compete with each other.

Price leadership

This is a situation where one or two of the firms in an oligopolistic market greatly

influences the market price. They set the price first and the other firms become price

takers

ASSUMPTIONS OF OLIGOPOLY

a) firms are profit maximizers

b) if one firm increases its selling price, the other firms won’t follow suit

c) if one firm decreases its selling price, the other firms are likely to follow suit

because they don’t want to lose their market

FEATURES OF OLIGOPOLY MARKETS

a) Products can be identical or differentiated

b) There is rivalry among firms

c) Composed of few but large firms

d) There is interdependence among firms i.e. actions of one firm affects the

actions of other firms

e) There is non-price competition i.e. firms tend to follow the fixed price for a

long period of time

f) No freedom of entry of new firms into the market. This is achieved through the

use of barriers such as patents and high capital requirements

g) High advertising and selling costs due to need for a lot of product promotion

h) Firms tend to work as a group in decision making so as to protect the interest of

all firms.

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The kinked demand curve

The price charged by the firm is at point P. If price increases beyond P, there will a

big loss in amount of quantities demanded since customers will shift to buying from

competitors

Lowering the price below P may lead to a very small increase in sale since

competing firms are also likely to lower their prices

This explains why prices in oligopoly markets are always stable

NOTE: one of the major limitations of the kinked demand curve is the fact that it

doesn't explain how price was arrived

Differences between oligopoly and perfect competition

Oligopoly Perfect competition

Composed of few but large sellers Composed of very many sellers

There is inter-dependency among

firms in decision making

Firms make decisions

independently

Products have close substitutes Products are homogeneous

(identical)

There is no freedom of entry into

the market

There is freedom of entry into the

market

There is government interference There is no government

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interference

Firms have a kinked demand curve Firms have a perfectly elastic demand curve

TOPIC 6: CHAIN OF DISTRIBUTION

CONTENTS

• Introduction

• Channels of distribution.

• Roles played by intermediaries in the distribution chain

• Factors influencing the choice of a distribution channel

INTRODUCTION

Distribution refers to the movement of goods and services from the production point

to the consumption point

CHANNELS OF DISTRIBUTION

Channels of distribution are the paths that products follow from the producers to the

consumers.

Traders and organizations which play a role in delivering goods to the consumer are

known as middlemen or intermediaries

The more the middlemen in a distribution chain the more the expenses and hence the

higher the market price

Types of middlemen

a) Merchant traders

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These are traders who buy goods and services for resell e.g. whole salers and

retailers

Their features include:

• They buy and sell goods on their own behalf

• They earn profit as a reward for their services

• They take business risks. They can also suffer losses in case their

business fails

• They work independent of producers whose goods they deal in

b) Mercantile traders

These are traders who represent other traders in the exchange of goods and services

e.g. agents, brokers, factors etc.

Their features include

• They do not buy or sell goods on their own behalf

• They act on behalf of producers and other traders

• They earn a commission for their services

• They do not take business risks

• They do not work independently i.e. their activities are controlled by those who

hire them (principals)

TYPES OF CHANNELS OF DISTRIBUTION

The following are the most common distribution channels:

a) Channels for distributing local agricultural produce

b) Channels for distributing locally manufactured goods

c) Channels for distributing imported goods

1) Channels for distributing local agricultural produce

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There are six channels which can be used to distribute local agricultural produce.

They include

Channel 1: FARMER----cooperative----marketing board----wholesaler----

retailer----CONSUMER

The farmer sells the product through a producer cooperative society. The cooperative

society will sell the product to the marketing board. The marketing board will sell to

the wholesaler who will sell to the retailer. The retailer sells the product to the final

consumer

Channel 2: FARMER----retailer----CONSUMER

The retailer can buy directly from the farmer and sell to the final consumer

Channel 3: FARMER----wholesaler----retailer----CONSUMER

Large scale wholesalers can buy goods directly from farmers and later sell to

retailers who will finally sell to consumers

Channel 4: FARMER----CONSUMER

Farmers may take the product to the market and sell directly to the consumer.

products sold through this channel are relatively cheap

Channel 5: FARMER----marketing board----wholesaler----retailer----

CONSUMER

Farmers can sell to the marketing board who sells the product to the wholesaler. The

wholesaler sells to the retailer who in turn sells to the consumer

Channel 6: FARMER----marketing board----retailer----CONSUMER

Farmers can sell to marketing boards from which retailers can buy the product and

sell it to the consumer

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2) Channels for distributing locally manufactured goods

The following seven channels can be used to distribute locally manufactured goods

Channel 1: LOCAL MANUFACTURER----wholesaler----retailer----

CONSUMER

Wholesalers can buy in large quantities from the manufacturer and later sell in small

quantities to retailers who later sell the product to the consumer

Channel 2: LOCAL MANUFACTURER----CONSUMER

The consumer can buy directly from the manufacturer

Channel 3: LOCAL MANUFACTURER----wholesaler----CONSUMER

The manufacturer can sell in large quantities to wholesalers who later sell the

product to consumers

Channel 4: LOCAL MANUFACTURER----retailer----CONSUMER

Large scale retailers can buy directly the from manufacturer and sell to consumers

Channel 5: LOCAL MANUFACTURER---government agent---wholesaler---

retailer---CONSUMER

The government may appoint an agent who buys goods from manufacturers and sells

them to wholesalers. The wholesaler sells to retailers who later sell goods to

consumers. The role of the government agent is to ensure that goods are equally

distributed to all consumers and that consumers are not exploited through high

prices.

Channel 6: LOCAL MANUFACTURER----government agent----wholesaler----

CONSUMER

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The government agent may sell the product to the wholesaler who later sells to the

consumer

Channel 7: LOCAL MANUFACTURER----government agent----retailer----

CONSUMER

The government agent may buy from the manufacturer and sell to the retailer who

finally sells to the consumer

3) Channels for distributing imported products

There are six channels that can be used to distribute imported goods. They include:

Channel 1: FOREIGN PRODUCER----agent----wholesaler----retailer----

LOCAL CONSUMER

A foreign producer may appoint an agent in the importing country whose main

responsibility is to look for market. The agent then sells to the local wholesaler who

later sells to the local retailer. The local retailer finally sells to the local consumer.

Channel 2: FOREGN PRODUCER----wholesaler----retailer----LOCAL

CONSUMER

The local wholesaler may buy directly from the foreign producer and sell to the local

retailer who later sells to the local consumer

Channel 3: FOREIGN PRODUCER----LOCAL CONSUMER

The foreign producer can sell directly to the local consumer

Channel 4: FOREIGN PRODUCER----foreign producer’s representative----

wholesaler----retailer----LOCAL CONSUMER

The foreign producer may appoint his own representative in the importing country

who sells goods on his behalf. This representative may sell goods to the local

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wholesaler who later sells to the local retailer. The local retailer finally sells to the

local consumer

Channel 5: FOREIGN PRODUCER----wholesaler---- LOCAL CONSUMER

The foreign producer may sell goods to the local wholesaler who in turn sells to the

local consumer

Channel 6: FOREIGN PRODUCER----retailer----LOCAL CONSUMER

Foreign producer may sell to the local retailer who will in turn sell to the local

consumer

Activities carried out during distribution of goods and services

a) Handling

b) Storage

c) Packing/packaging

d) Transportation

e) Grading

f) Blending

g) Sorting

h) Breaking the bulk

Expenses incurred during distribution

a) Storage costs

b) Transport costs

c) Advertising costs

d) Salaries and wages

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e) Packing and blending costs

f) Insurance costs

CHANNEL LENGTH

Channel length refers to the number of intermediaries involved in the distribution or

movement of goods from the producer to the final consumer’

The more the number of intermediaries in the channel, the longer the channel.

The length of the channel affects the final price of the product. Therefore the longer

the channel, the higher the selling price and vice versa.

Advantages of a short channel

a) The price of the goods is lower

b) Goods reach the consumer faster

c) The producer is able to have direct contact with his/her customers

d) Goods reach the consumer while still fresh

e) Producers are able to get feedback from consumers

Disadvantages of a short channel

a) Distribution of goods is limited to a small area

b) Producers bear all the risks involved in distribution

c) Limited profits since goods don’t reach a wider market

d) Limited market raises the cost of production

Advantages of a long channel

a) Goods reach wider markets

b) Enables the producer to pass some risks tom middlemen

c) It is convenient to producers

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Disadvantages of a long channel

a) Prices of goods are higher

b) It causes delays

c) The producer has no direct contact with the customers.

d) Perishable goods will go bad before reaching the consumer

e) There are increased chances of damage to the goods due to handling

Advantages of buying directly from the producer

a) Goods may be bought at relatively lower prices

b) The buyer may be provided with transport by the seller

c) The buyer may be allowed cash discount

d) The buyer may be allowed to buy on credit

e) The buyer has the opportunity of selecting best quality items

FACTORS INFLUENCING THE LENGTH OF A DISTRIBUTION

CHANNEL (Number of intermediaries in the channel of distribution)

a) Producer’s marketing skills

A producer with good marketing skill will prefer selling directly to consumers

resulting in a shorter channel of distribution. On the other hand, a producer with poor

marketing skills will prefer selling through intermediaries resulting in a longer

channel of distribution.

b) Financial capability of the producer

A producer with adequate finances in invest in transport will sell directly to

consumers resulting in a shorter channel of distribution. On the other hand, a

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producer with inadequate finances will involve intermediaries in order to distribute

his/her products to consumers resulting in a longer channel of distribution

c) Nature of the product

Low valued goods with lower profit margins require high sales volume compared to

high valued goods. As such these goods require to be distributed to wider markets

hence a longer channel is used.

Perishable goods unlike durable goods require shorter channels in order to reach the

consumer when still fresh

d) Availability and geographical size of market

A wider distribution of consumers require a longer channel unlike when consumers

are concentrated near the producer

e) Availability of middlemen

Where there are enough middlemen, a longer channel may be used unlike when there

are few middlemen.

ROLES PLAYED BY INTERMEDIARIES IN THE CHAIN OF

DISTRIBUTION

a) Reducing the number of transactions between producers and consumers

Intermediaries help in reaching potential consumers on behalf of the producer

thereby conducting transactions on behalf of the producer

b) Breaking the bulk

Intermediaries play an important role in buying goods in large quantities from

producers and selling in small quantities to consumers

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c) Accumulating bulk

Some intermediaries may accumulate bulk by buying goods in small quantities

from several producers which they later sell to consumers who demand goods in

large quantities. Such intermediaries are known as assemblers

d) Risk taking

Intermediaries relieve the producer of any risks associated with the movement of

goods to the consumer. This may include the risk of damage to the goods.

e) Providing finance

Intermediaries provide finances which facilitate the movement of goods to the

consumer

f) Passing information

Intermediaries link consumers and producers. As such they gather important

information concerning market demand to producers as they also inform consumers

on the type of goods available

g) Product promotion

Intermediaries advertise goods on behalf of producers thereby promoting sales

h) Transport and storage

Intermediaries may store goods in their warehouses before taking them to the market.

When demand increases they transport these goods to the market.

i) Providing varieties

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Intermediaries may buy different varieties of goods from various producers which

they sell to consumers

j) Availing goods to consumers

Intermediaries make goods accessible to consumers apart from ensuring steady

supply of goods

Reasons for eliminating intermediaries (selling directly to consumers)

a) When the market is localized/a small market such that the producer is able to

sell directly to consumers

b) When products require long period of negotiation before they are sold

c) When products require specialized after-sale-services

d) When market competition is high hence the producer sells directly to consumer

so as to counter market competition by selling at lower prices

e) When products are perishable

f) When the producer is producing in small scale

g) When customers order products directly from the producer

h) When the producer is financially capable of opening his/her own retail outlets

i) When the government requires certain products to be sold directly to

consumers

j) When products are designed to specific customers’ specifications

k) When there is need to make the product affordable to the consumer

l) When the producer wants to have personal contact with consumers.

m) When the producer wants to take charge of the marketing of his/her products

Circumstances under which the wholesaler becomes essential in the channel of

distribution

a) When the market is spread out for the producer to reach the consumers

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b) When the producer does not have enough finances to set up his/her own

distribution points

c) Where the infrastructure is poor hence hindering the distribution of goods

d) Government policy

e) Where the producers requires finances which will be provided by the

wholesaler

f) Where the producer lacks transport facilities which can be provided by the

wholesaler

g) Where the producer wants to promote sales hence uses the wholesaler to

advertise

h) Where the producer wants to get information about the market

Effects of eliminating wholesalers from the distribution chain

a) Producers/manufacturers will be forced to set up their own distribution centres,

depots or warehouses which are an additional cost to the producer

b) The cost of distribution may be increased and the effects passed over to the

consumer in form of high selling prices

c) The retailer will have to go to the producer for the goods which will be an

additional cost to the retailer

d) The producers will have to break the bulk because the retailers may not be able

to buy in large quantities

e) Retailers may be forced to pay for the goods in cash requiring them to have

more working capital

f) Producers may be forced to extend credit facilities to retailers which requires

more capital

g) Results in reduction in specialization due to increased functions

h) Market prices may fluctuate due to unsteady flow of goods

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FACTORS INFLUENCING THE CHOICE OF A DISTRIBUTION

CHANNEL

Before deciding on the channel of distribution, the following factors need to be

considered:

a) Nature of the product

Before deciding on the distribution channel, one has to consider whether the products

are perishable, durable or bulk. Perishable goods unlike durable goods require a

shorter channel in order to reach the consumer as soon as possible. Bulky goods

require a shorter channel to reduce transportation and handling costs

b) Nature of the market

When consumers are closer to the producer, a shorter channel can be used but when

they are spread out a longer channel involving many intermediaries is used in order

to reach these consumers

c) Role of intermediaries

The role played to be played by intermediaries may determine the distribution

channel. For example if the producer requires branding to be done on the goods, he

will go for that intermediary who can do brand the goods to his requirement.

d) Resources and the size of a firm

Smaller firms unlike large firms produce goods in small scale. Such goods can only

serve a small market hence a shorter channel is required to distribute those goods. On

the other hand small firms unlike large firms have fewer resources that can only

enable them produce in small scale which can only serve smaller markets hence they

require a shorter channel of distribution. Alternatively bigger firms have enough

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finances to enable them set up their own retail outlets from where they sell directly to

consumers.

e) Level of market competition

When a firm wants to avoid direct market competition with the competing firm, it

will use a channel different from the one used by the competitor. On the other hand

when the firm wants to compete directly with the competitor, it will choose a channel

similar to that of the competitor

f) Government policy

The government may abolish the use of certain channels in order to protect

consumers from exploitation. This means a firm will have to use those channels

which are approved by the government.

g) Marketing risks

To avoid risks involved in distribution, a firm will sell its goods through middlemen.

Therefore the more the risks, the more the middlemen

h) Scale of production

A firm that producers in large scale will require the services of middlemen to

distribute its products to consumers. Such a firm will use longer channels of

distribution for its products.

TRENDS IN DISTRIBUTION

a) The development of e-commerce has reduced the length of distribution

channels

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b) The development of the concept of one-stop shopping e.g. shopping from the

supermarkets and hypermarkets have reduced channel lengths

c) The increasing developments of modern forms of hawking which bring

products closer to consumers hence reducing channel length

d) The development of mail order services for selling products have reduce the

length of the distribution channel

e) Orders are made over the internet

f) Conversion of premises into large shopping malls.

TOPIC 7: NATIONAL INCOME

CONTENTS

• Introduction

• Terms used in national income

• The circular flow of income

• Injections and withdrawals

• Equilibrium national income

• Measures of national income

• Uses of national income statistics

• Factors which influence the level of national income

INTRODUCTION

National income refers to the total income earned by owners of factors of production.

Incomes earned by factors of production may constitute:

• Rent

• Salaries/wages

• Interest

• Profit

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National income is measured by the government after a given period of time usually

one year

TERMS USED IN NATIONAL INCOME

a) Gross domestic product (G.D.P)

G.D.P refers to the total money value of all goods and services produced within a

country over a given period of time. Note that G.D.P excludes incomes from abroad

b) Net domestic product (N.D.P)

N.D.P refers is equal to G.D.P less depreciation on capital goods used to produce

goods and services

N.D.P=G.D.P-Depreciation

c) Gross national product (G.N.P)

G.N.P refers to the monetary value of all goods and services produced by citizens of

the country both from within the country and from overseas countries

G.N.P=G.D.P-Net income from abroad

Net income from abroad=Exports-Imports

d) Net national product (N.N.P)

N.N.P refers G.N.P less depreciation on capital equipment used in production

N.N.P=G.N.P-Depreciation

e) Per capita income

Per capita income refers to the average income per head per year in a country. It is

calculated as follows:

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Per capita income=National income ÷ Total population

Limitations of per-capita income (National income) as a measure of the

standard of living

a) Per- capita income may be computed using inaccurate population data

b) Per-capita income may be computed from inaccurate national income data

c) There are inequalities in income distribution i.e. few people with high incomes

and very many people with low incomes

d) Improper government expenditure i.e. spending most income on matters which

do not directly improve the living standards of citizens

e) National income may have been earned through strain and hard work.

Therefore even if Per-capita income is high, it does not show better living

standards

f) High per-capita income may be obtained at the expense of leisure

Circumstances when per-capita income may be used as a good indicator of the

standard of living

a) When income is evenly distributed

b) When actual statistics on population are available

c) When output per year is based on essential and final goods and services

consumed by the masses

d) When national income is in real terms

f) Personal income (P.I)

This is the sum of all incomes received by the residents of a country during a year

g) Disposable personal income (D.P.I)

This is the income that an individual or a resident of a country receives after paying

direct taxes to the government

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THE CIRCULAR FLOW OF INCOME

Refers to the movement of money in an economy. (Illustrate)

Households spend their money by buying goods and services produced by firms.

Firms on the other hand spend their money on paying for factors of production

provided by households

Note that for the circular flow of income to exist, the following conditions should be

met:

• There are only two players in the economy i.e. firms and households

• There is no foreign trade

• There is no government interference

• Firms spend all their incomes on factors of production

• Households spend all their incomes on goods and services

• All goods and services produced are bought

• A person or a firm cannot be a producer and a consumer at the same time

FACTORS AFFECTING THE FLOW OF NATIONAL INCOME

In the circular flow of income illustrated above, we are assuming that consumers

spend all their money on buying goods and services whereas firms spend all their

money on paying for factors of production. In reality this may not be the case since

consumers save part of their income while firms pay part of their income as tax. The

following factors will therefore affect the amount money flowing between firms and

households

a) Savings

Savings refers to that part of income that is kept for future use. Savings by

households reduces the amount of money reaching firms hence reducing amount of

money in the circular flow

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b) Government

The government may also influence the amount of money changing hands between

firms and households in two ways

• Taxation: taxation reduces amount of money available for spending by firms

therefore reducing amount of money in the circular flow

• Government expenditure: government expenditure introduces more money to

the economy. This may be through giving subsidies, buying products from

firms or paying salaries to consumers. Government expenditure will therefore

increase the amount of money in the circular flow.

c) Investment

Investments refer to amount spent by firms on buying capital goods such as

machines from households. Investments therefore ensures additional incomes for

households hence increasing money in the circular flow

d) Foreign trade

Foreign trade constitutes exports and imports. Exports earn income to the country;

they therefore increase money in the circular flow. On the other hand imports

withdraw money from the economy therefore reducing money in the circular

INJECTIONS AND WITHDRAWALS

• Injections: Refers to factors that introduce additional moneys in the circular

flow of income. They constitute:

a) Investments

b) Government expenditure

c) Exports

• Withdrawals: Refers to those factors which reduce the amount of money in

the circular flow of income. Also known as leakages. They constitute:

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a) Savings

b) Taxes

c) Imports

NATIONAL INCOME EQUILIBRIUM

Equilibrium in national income is achieved when total injections equal total

withdrawals.

At this point, the economy is at balance

National income equilibrium equation can therefore be given as:

S+T+M=I+X+G

Where:

S=savings

T=taxes

M=imports

I=investments

X=exports

G=government expenditure

MEASURTEMENT OF NATIONAL INCOME

National income can be measured using either of the following methods

• Expenditure approach

• Income approach

• Output approach

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1. Expenditure approach

Using this approach, national income is arrived at by adding all expenditures

incurred in the economy on final goods and services

NOTE: Final goods and services refer to those goods and services which are meant

for final consumption i.e. not for use as raw materials

Using this approach therefore, the following expenditures are added to arrive at

national income:

• Consumption expenditure: Refers to expenditure by consumers. Denoted

using letter C

• Investment expenditure: Refers to expenditure by firms. Denoted using

letter I

• Government expenditure: refers to expenditure by the government.

Denoted using letter G

• Net expenditure on exports: refers to total expenditure incurred when

exporting goods. Represented by (x-m)

(x-m) means exports – imports

This approach gives national income at market prices

NOTE:

Expenditure approach calculates national income by adding the market prices at

which different goods are bought; these market prices can be influenced by subsidies

and taxes. The market price of products may also be influenced by depreciation.

When calculating national income using expenditure approach, taxes, subsidies and

depreciation has to be taken into consideration

Therefore national income using expenditure approach is given as follows:

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National income=C+I+G+(x-m) +subsidies-taxes-depreciation

Problems associated with expenditure approach

a) Lack of expenditure records especially in the private sector

b) Expenditure in the subsistence sector can only be estimated since no accurate

records are available

c) Difficulty in distinguishing between final and intermediate expenditures

d) Double counting of expenditures may result

e) Changes in foreign exchange rates may affect valuation of imports and exports

f) Incorrect values of government expenditure

2. Income approach

This approach sums up all incomes received by those individuals who take part in

the production of goods and services (personal income) and the income received by

the government on its investments (public income).It gives national income at factor

prices.

Incomes received by individuals constitute:

• Rent

• Interest

• Wages

• Profit

Incomes received without working are excluded from the calculation of national

income. These incomes are known as transfer payments are may include:

• Insurance compensations

• Pension payments

• School fees

• Bursary allocations and grants to needy students

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• Grants from friends

• Students’ pocket money

Transfer payments if included may constitute double counting

Therefore national income using income approach is given as follows:

National income=Personal income + public income + retained profit + appreciation -

transfer payments – depreciation

Problems associated with income approach

• Difficulty in identifying and value amount constituting transfer payments so as

to exclude them from the calculation of national income

• Lack of accurate data on incomes since businesses will state lower incomes in

order to pay less taxes

• Changes in prices of commodities affects profits earned by firms

• Difficulty in identifying incomes from illegal activities such smuggling which

is to be excluded from national income

• It is difficulty to obtained statistics on the total earned by the government

3. Output (value added) approach

Using this approach, national income is arrived at by adding the values of all final

goods and services produced by firms in a given year

National income may also be arrived at by adding the value added on different

products for example if A sells a product to B at Ksh 40,B sells it to be at Ksh65, and

C sell it to D at Ksh 90,then value added Is calculated as follows:

Value added by A = Ksh40

Value added by B = Ksh (65-40) = Ksh 25

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Value added by C = Ksh (90-65) = Ksh 25

Total value added (national income) = Ksh 90

Note: Ksh 90 equals total output

The value of goods and services produced from abroad is also included in the

calculation of national income. Therefore using this approach, national income is

given as follows:

National income=GDP+(x-m)-depreciation

Problems associated with the output approach

• Lack of accurate output figures especially in the private sector

• Difficulty in identifying value of illegal activities to be excluded

• Difficulty in valuing government output which does not reach the market

• Changes in market prices making valuation difficult

• Problems in differentiating between final and intermediate products

• Difficulty in valuing output from the subsistence sector

Reasons why high national income may not lead to high living standards

a) Income distribution may be uneven with so much of it in the hands of very few

citizens and the little being shared by very many citizens

b) Incorrect statistics might have been used to compute national income resulting

in wrong national income figures

c) Higher national income may have cost the labour force their leisure time

d) Higher national income may have been obtained after working under

unfavourable working conditions

e) Higher national income might have been realized from activities that were

detrimental to the environment or health of the worker

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f) Higher national income might have been obtained from illegal activities

g) Rising levels of inflation may limit the purchasing power of the citizens despite

increase in national income

Reasons for disparities in income distribution among citizens in a country

a) Disparity in natural resource endowment where some parts of the country have

more natural resources than others

b) Corruption which results in outright stealing of a country’s resources that are

meant to benefit everyone

c) Disparity in access to education i.e. some people have limited access to

education than others. Such people are not able to access employment

opportunities

d) Differences in individual and personal talents

e) Rampant use of nepotism to secure good job opportunities

f) Some people are mare politically advantaged than others

g) Some get their wealth through illegal means e.g. robbery

USES OF NATIONAL INCOME STATISTICS

National income statistics refers to the information gathered from different sources

of national income. This information has the following uses:

a) Indicates the standard of living

Standard of living refers the quality of life of people in an economy. Standard of

living is influenced by the levels of income. The level of national income therefore

has a direct impact on standards of living in the sense that the higher the national

income, the better the standard of living and vice versa.

b) Enables comparison of living standards in different countries

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Levels of national income are used to compare which country is more developed and

therefore has better living standards than the other .A country with high national

income level is assumed to enjoy better living standards. Sometimes however high

national income levels may not reflect improved standards of living due to the

following factors:

• Differences in currency rates

• Differences in goods and services used to compute national income in different

countries

• Differences in equality in income distribution

• Differences in needs, tastes and preferences

c) Facilitates the assessment of economic performance over time

By comparing national income levels at different periods, information is provided on

the period of the year the economy was doing well

d) Facilitates economic planning

The government will use information on national income to come up with plans on

how grow the economy

e) Enables entrepreneurs make investment decisions

Investors will use information on national income level to make decisions on which

markets and sectors to invest in. This is because a higher national income means

more per capita incomes hence high market demand and vice versa. Information on

national income also enables investors know which sectors in the economy are doing

better than others

FACTORS INFLUENCING THE LEVEL OF NATIONAL INCOME

a) Supply of labour

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Labour supply refers to the quantity and quality of a country’s workforce. The higher

the number of workers, the higher the output hence more national income. On other

hand, with skilled labour, high quality goods and services which generate higher

national incomes will be produced

b) Amount and quality of capital

Capital refers to tools and equipment used in production. When capital is of high

quality, output will be high hence more national income is earned unlike when poor

quality goods are used

c) Level of entrepreneurship

Availability of entrepreneurs who have the ability to organize the factors of

production in the right proportions to produce goods and services will influence the

level of national income .A country with efficient entrepreneurs is likely to produce

more and increase its level of national income as compared to a country with

inefficient entrepreneurs.

d) Availability of land

Land contains all the natural resources required in production, therefore a country

with enough land will produce more and increase its level of national income

e) Level of technology

Technology refers to the techniques used in the production of goods and services.

The higher the level of appropriate technology, the higher the output and hence

higher national incomes

f) Political stability

A country with peace and stability is likely to encourage investors who will

contribute greatly in increasing the level of national income

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g) Attitude of citizens towards work

A country with hardworking citizens will have high levels of national income

compared to a country with lazy citizens

h) Size of the subsistence sector

Subsistence sector refers to those who produce goods for consumption purposes.

When the subsistence sector is large, amount of goods and services produced for sale

will be low hence reducing the level of national income

i) Level of foreign investment

Level of foreign investment refers to the number of foreign investors in a country.

Increase in foreign investment therefore increases production thereby raising the

level of national income

REASONS WHY COUNTRIES WITH EQUAL NATIONAL INCOME

LEVELS HAVE DIFFERENT LEVELS OF DEVELOPMENT

a) Inequality in the distribution of income

A country where national income is equally distributed among its citizens will have

better standards of living than a country where incomes are unequally distributed

b) Differences in tastes

Some tastes and preferences are costly than others. A country whose citizens desire

expensive items which they don’t produce will spend a lot of its income importing

such income resulting in poor living standard compared to a country whose citizens

desire cheaper items

c) Differences in money values

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A country with a devalued currency is likely to encourage exports which in turn

increases the level of national income resulting in higher living standards. On the

other hand, a country whose currency is highly valued is likely to encourage imports

which in turn drains its national income resulting in poor living standards

d) Different patterns of expenditure

A wasteful country will experience poor living standards as compared to a country

whose expenditure is not wasteful

e) Population size

Highly populated countries experience poor living standards due to low per-capita

incomes as compared to countries with low population

TOPIC 9: POPULATION AND EMPLOYMENT

CONTENTS

• Introduction to population

• Basic concepts in population

• Introduction to Employment and unemployment

• Types of unemployment

• Causes of unemployment

• Solutions to unemployment problem

POPULATION

Population refers to the number of people living in a particular place at a given time.

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Details on population are obtained through a census. A census is an exercise which

is carried out to determine the number of people living in a particular place

Population is very important in business because it is the source of market for goods

and services produced. Population also provides factors of production such as labour,

entrepreneurship etc.

BASIC CONCEPTS IN POPULATION

Most common concepts in population are:

• Population growth rate

• Optimum population

• Under population

• Overpopulation

• Ageing population

• Young population

• Declining population

• Population structure

1. POPULATION GROWTH RATE

Population growth refers to the rate of change in population with time. This time is

usually one year. Population growth rate may be influenced by three factors, namely;

• Birth rate

• Mortality rate

• Migration

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a) Birth rate

Birth rate is the number of live births per year per 1000 of the population

It is also known as crude birth rate and calculated using the formula

Crude birth rate = (number of live births ÷ total population) × 1000

Birth rate is greatly influenced by fertility rate. Fertility rate refers to rate at which

women in the child bearing age give birth in a given region. Fertility rate is

influenced by the following factors:

• The age and sex structure of the population

• Level of barrenness

• Social and cultural attitudes towards child bearing

• Social significance of children to parents

• The rate of marriages in the population

• Ignorance on demerits of large families

• Government policies which may encourage or discourage large families e.g.

free primary education may encourage large families whereas family planning

discourages large families

Factors leading to high birth rates

• Cultural practices which regard children as a source of labour and financial

security in old age

• Early marriages which may prolong a woman’s productive life

• Desire to have many children as a precaution in case some of the children die

• Ignorance on family planning methods

• Religious beliefs which may encourage large families

• Desire to have a male child in the family

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Factors leading to lower birthrates

• Delayed marriages due to prolonged school life

• Desire for a good living standard for the family will make go smaller families

which they can provide for

• Consideration of a small family as being fashionable

• Declining mortality rates which increases chances of child survival

• Introduction pension schemes has removed the concept of having to regard

children as financial security in old age

b) Mortality/death rates

Mortality refers to the number of deaths in a given region at a given time

Mortality rate is therefore the rate of death per 1000 of the population. It is also

known as the attrition rate and is given by the formula

Mortality rate= (number of deaths ÷ total population) × 1000

Mortality rates are influenced by two major factors:

• Level of health standards

• Level of nutrition

c) Migration

Refers to the movement of people from one place to another. It has two components:

• Immigration: refers to the movement of people into an area

• Emigration: refers movement of people from an area

The difference between immigration and emigration is the net immigration.

Therefore

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Net immigration rate = immigration rate – emigration rate

NOTE: Population growth rate = crude birth rate – death rate + net immigration rate

2. OPTIMUM POPULATION

Refers to that level of population where the number of people is in balance with

available resources (illustrate)

At optimum population resources are well utilized hence living standards are high

NOTE:

• Optimum population is the population that achieves highest living standards

using the available resources

• It is a population which enables efficient utilization of resources

• Population below optimum population means resources are under-utilized

leading to low living standards

• Population above optimum population means resources are over-utilized

leading to low living standards

3. UNDER-POPULATION

This the population which is below the available resources such that the available

resources are under-utilized (illustrate)

NOTE: a country can have a higher population but as long as the resources in the

country are under-utilized; the country is considered under populated

Resources in this case refers to factors of production such as land, labour, capital and

entrepreneurship

Factors that may lead to under population may include:

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• Low birth rate

• High rate of emigration

• Emergence of natural calamities such as war and diseases

Disadvantages of under-population

a) Limited supply of labour

A small population may not make available adequate number of workers required to

facilitate production activities.

b) Limited market

With a small population, demand for goods and services will decline. This will

discourage investments

c) Under-utilization of resources

Due to limited labour supply, most resources in under populated countries are under-

utilized. This will hinder the economic growth of the country

d) High transport costs

People in under populated regions are scattered all over. This increases the cost of

travelling from one place to another, it therefore becomes expensive to transport

goods and services to the people in some regions.

e) Lack of specialization

Limited labour supply in under populated countries makes specialization and

division of labour impossible. This leads to production of poor quality goods and

services

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f) Slow rate of economic growth and development

Underutilization of resources in under populated countries will lead to less national

income and per capita incomes which will result in poor standards of living

4. OVERPOPULATION

Refers to the population which is higher than the available resources such that

resources are overstretched.

Over population is a problem since it may lead to:

• Unemployment

• High dependency ratios

• Poor and insufficient housing

• Insufficient medical and educational facilities

(Illustrate)

Advantages of overpopulation

a) Widens the market

With a large population demand for goods and services increases encouraging

investments

b) Adequate labour supply

The number of people willing to work in regions with large population is high,

therefore firms are able to hire qualified staff that will help in increasing productivity

c) Better utilization of resources

Available resources are optimally utilized. This will increase productivity

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d) Encourages creativity

Competition among individuals to earn a living makes them very creative. This

creativity will finally lead to introduction of new production methods

e) Encourages investments

Large population creates high demand for products. To meet this demand, new

businesses will be created while existing businesses will expand

f) Promotes mobility of labour

Overpopulation increases geographical mobility of labour as the unemployed people

are forced to move to different regions in such of jobs

Disadvantages of overpopulation

a) Strains social amenities

Excess demand on social amenities such as schools and hospitals may lead to

congestion and poor service delivery

b) Lowers standard of living

An increase in population with constant national income may lead to lower per capita

incomes results in a decline in the standards of living

c) Encourages rural-urban migration

Overpopulation forces people to move to urban centres to look for jobs. This results

in congestion in urban centres leading to social problems such as high crime rates,

poor sanitation etc.

d) Results in high dependency level

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With over population there is a high number of people who will be unemployed. The

unemployed will depend on few who are employed for their upkeep. This will strain

the employed making it difficult for them to save and invest

e) Creates excess demand

Overpopulation may lead to a situation where demand for goods and services

exceeds supply. This may trigger a rise in market prices resulting in inflation

f) Results in food shortages

Overpopulation may lead to a situation where available is not enough to feed the

available number of people. This will increase cases of malnutrition

g) Increases crime rates

Overpopulation is always associated with unemployment. The unemployed people in

their struggle to survive may engage in crimes

h) Leads to environmental degradation

Overpopulation may force people to over exploit the environment in order to survive.

For example pressure on housing may force people to clear forests in order to create

homesteads. This may lead to desertification

5. YOUNG POPULATION

This is where a bigger proportion of the population is composed of young people. It

may be as result of:

• High birth rate with low infant mortality rate

• High mortality rate among the aged

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• Low life expectancy

Young population is composed of majority of aged below 18 years

Challenges (Disadvantages) of a young population

a) High dependency level

Many of the young people are not working; as such they depend entirely on those

who are working for upkeep. This will hinder savings and investments

b) High unemployment rate

With many young people looking for jobs, the country may find it difficult to meet

increasing demand for employment leading to unemployment

c) High level of social evils and crimes

Young people who are unemployed may engage in crimes and other vices such as

prostitution in order to survive

d) Low supply of labour

Many young people may not have skills required in the job market or they may be

too young to work. The country will therefore lack adequate supply of labour

e) Increase in demand

Demand on goods and services required by young people may lead to excess demand

that may result in increase in prices

f) Reduction in savings and investment

High dependency level results in low savings leading in lack of investments

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g) Changes government expenditure structure

Increase in number of the youth may force the government to divert its expenditure

to youth welfare programs

Advantages of a young population

a) Provides a large market for goods and services

b) It may result in technological advancement since most young people are

innovative

6. AGEING POPULATION

This is a population which is composed of more old people. Old people are those

aged above 65 years

May result from a decrease in fertility rates and increase in a decrease in adult

mortality rates

Disadvantages of ageing population

• Lack of labour mobility since old people will rarely move

• Low labour supply

• High dependence level leading to low productivity

• Slow economic growth rates due to poor productivity

• Low demand for goods and services required by the youth resulting in closure

of firms and unemployment

7. DECLINING POPULATION

This is a population that keeps reducing over time. This may be as a result of:

• Low birth rate with high mortality rate

• Low immigration rate with high emigration rate

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Declining population may have both negative and positive implications

Effects of declining population

a) Reduction in government expenditure

Amount of money spent by the government on providing essential services will

reduce. This will enable the government the government improve the quality of

services it offers to existing citizens

b) Attainment of optimum population

With declining population an overpopulated country is able to attain an optimum

population

c) Proper utilization of resources

In cases of overpopulation, a declining population will reduce pressure on existing

resources making the fully utilized to increase productivity

d) Discourages investments

Declining population reduces demand for goods and services leading to closure of

firms and discouraging opening of new firms

e) Reduces dependency level

Declining population may result in reduction of unemployment rate since most

people in the population will be employed. This reduces the dependency level

8. POPULATION STRUCTURE

Refer to the composition of the population in terms of age, gender, levels of

education, income distribution etc.

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Age structure is important since it enables the government determine its labour

supply and dependency level. Sex, education levels and income distribution enables

the assessment of demand for different goods and services.

IMPLICATION OF POPULATION SIZE AND STRUCTURE ON

DEVELOPMENT

Refers to the effects of high population. These effects can be positive or negative.

Positive implications

a) Increase in market

High population increases general demand for goods and services. This encourages

investments

b) High labour supply

High population increases labour supply since there will many skilled people in the

population willing to work. This enables firms hire qualified staff at a relatively

lower cost.

c) Advancement in technology

Competition for survival makes people creative. This will introduce new production

methods that will improve productivity

d) Diversity in talents

In high populated regions, there are varieties of talents available. This enables

maximum usage of technology to improve productivity

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Negative implications

a) Decrease in per capita income

When population increases with constant national income, income per person

decreases leading to poor quality lives

b) Increase in dependency ratio

In high population, many people will be unemployed therefore depending on the few

who are employed. This reduces savings and investments

c) Reduction in savings and investments

In high populations, the number of consumers exceeds the number of those who

work, as such more incomes are consumed and very little is saved. This results fewer

investment.

d) High rate of unemployment

In overpopulated regions, number of people willing to work exceeds available jobs,

this leads to many people being unemployed

e) Strain on social amenities

Overpopulation strains the available social amenities such as schools, hospitals,

housing etc. this makes them insufficient.

f) Unequal distribution of income

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Overpopulated countries are always characterized by very few rich people and very

many poor people. This is due to the fact that many people have large families which

they struggle to provide for

g) Environmental degradation

With overpopulation, natural resources will be over exploited as people look for

means of survival. Forests may be cleared to provide homesteads and farmlands

leading to desertification

THE VICIOUS CYCLE OF RAPID POPULATION GROWTH

(Illustrate)

EMPLOYMENT AND UNEMPLOYMENT

Employment

Refers to engagement in any income generating activities

Unemployment

Refers to a situation where people are willing and able to work at the prevailing

wage rates but cannot find jobs

People who are disabled, those not willing to work or those who are on strike are not

considered unemployed

Unemployment rate = (total unemployment ÷ labour force) × 100

TYPES OF UNEMPLOYMENT

a) Seasonal unemployment

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This is a type of employment that is characterized by changes in demand for labour

during different seasons. For example in agriculture demand for labour is high during

harvesting and planting seasons

b) Structural unemployment

This is a type of employment which is caused by the mismatch in the skills of the job

seeker and the skills required in the job market due to changes in production methods

e.g. Use of ATMs which have reduced staff in the banks. It may also be caused by

differences in the locations of the employer and the job seeker

c) Frictional unemployment

This is unemployment which occurs when workers are unemployed after losing jobs

and are actively looking for new jobs.

d) Cyclical unemployment

It is also known as mass unemployment, demand deficit unemployment or general

unemployment.

It is a type of unemployment which is caused by changes in economic performance

such that when the economy is doing well, employment level is high than when the

economy is doing poorly

Economic performance can assume four cycles

• Peak/boom

• Recession

• Depression

• Recovery

(Illustrate)

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e) Voluntary unemployment

It is also known as real wage unemployment.

This is unemployment which is caused by a mismatch in wages demanded by job

seekers and those offered by firms. Firms may be offering lower wages than what job

seekers want to be paid; as such many job seekers will remain unemployment

voluntarily

f) Involuntary unemployment

It is also known as open unemployment

This unemployment occurs when people are looking for jobs at the prevailing wage

rates but cannot find jobs

g) Disguised unemployment

It is also known as hidden unemployment

It occurs when the number of people employed exceeds those who are required to the

extent that some of them remain idle and therefore are laid off thereby becoming

unemployed

h) Residual unemployment

This is a type of unemployment that affects the mentally and physically disabled

such that they cannot be employed to do certain jobs thereby remaining unemployed

i) Erratic(casual) unemployment

This occurs when workers are hired for a short period of time after which they again

become unemployed. For example a school can hire teachers per school term when

students are in school.

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CAUSES OF UNEMPLOYMENT

a) Rapid population growth

When population is high, number of workers entering the job market is quite high for

the available jobs. Therefore many people will remain unemployed

b) Inadequate co-operant factors of production

Co-operant factors of production are those that need to be combined with labour for

production to take place. These factors may include land and capital. When these

factors are inadequate, firms cannot expand hence additional jobs cannot be created

c) Use of inappropriate technology

Inappropriate technology refers to that technology that does not favour use of human

labour in production e.g. use of machines instead of human labour

When firms opt to use capital intensive techniques in production, many people will

remain unemployed as their work is now done by machines

Some of the reasons for using capital intensive techniques may include:

• They are efficient

• They are cheap

• Avoid high wage rates

d) Rural-urban migration

Refers to the movement of people from rural areas to urban areas. With rural-urban

migration many skilled people move to towns in search of jobs. Since available jobs

in urban centres cannot accommodate them, many remain unemployed

e) Inappropriate education system

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An education system that trains the youth to be job seekers but not job creators

makes the youth unable to become self-employed but focusing on looking for

employed. Since available job opportunities cannot accommodate the rising number

of trained youth, many of them become unemployed

f) Seasonality in production

Seasonal production leads to seasonal unemployment in the sense that

unemployment is high during off-peak than peak periods

g) Low market demand

A lower market demand reduces profits made by firms. This discourages investments

and expansion of firms thereby reducing employment opportunities

MEASURES TO SOLVE UNEMPLOYMENT PROBLEM

a) Encouraging the private sector to create employment opportunities

Through measures such as lower taxes and subsidies, firms will be encouraged to

expand their operations and even invest more. This will go a long way in creating

employment opportunities.

b) Encouraging labour intensive techniques

These are those techniques which require the use of more labourers in production.

The government may encourage the use of labour intensive techniques in production

through reducing the minimum wage rate in order to make labour cheaper. The

government may also increase taxes on machines to discourage the use of capital

intensive techniques.

c) Adopting a relevant education system

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An education system that trains the youth to be job creators and not job seekers

should be adopted in order to enable majority of the youth self employed

d) Diversifying economic activities

This refers to putting in place measures that will ensure that economic activities

continue throughout the year without interruptions. This will help in reducing

seasonal unemployment. For example in agriculture, irrigation programmes can

assist in ensuring that agricultural activities continue throughout the year.

e) Increasing government expenditure

The government can solve unemployment problems by increasing its expenditure on

economic activities that create employment e.g. kazi Kwa vijana project.

f) Developing rural areas

Developing rural areas will encourage investors to relocate their firms to those areas

hence creating employment opportunities. Development of rural areas also helps in

reducing rural-urban migration thereby reducing unemployment in urban areas.

g) Encouraging direct foreign investment

Foreign investors can be encouraged to open businesses in a country in order to

provide employment opportunities to the local people. This can be done through

reduction in taxes, provision of security and ensuring that there is political stability

h) Encouraging utilization of local resources

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Local resources can be utilized to create employment opportunities. For example

using locally produced cotton in textile industries in order to encourage more local

farmers to plant more cotton in order to earn a living.

i) Controlling population

Reducing the population size will help in reducing the number of people entering the

labour market thereby reducing unemployment rate. This can be done by

encouraging people to adopt family planning methods

Effects of unemployment

a) It leads to wastage of human resources

b) Creates inequality in income distribution as the unemployed people become

poorer

c) It makes people lose their self-worth

d) It is expensive to the government to provide essential services such as health to

unemployed people

e) May result in high crime rates due to idleness

f) Results into loss of revenue to the government in form of income taxes

g) Results in low standards of living among the unemployed

h) Results in low rate of investments

i) Results in high dependency levels as the unemployed depend on the employed

for upkeep

TRENDS IN POPULATION AND EMPLOYMENT

a) Increased rates of HIV/Aids

b) Increase in population growth rates

c) Provision of free basic health services to all

d) Ensuring the country has food security

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e) Checking illegal immigration from war ton countries

TOPIC 10: DETERMINING THE NETWORTH OF A BUSINESS

CONTENTS

• Introduction

• Some basic terms in business

• Book keeping equation

• The balance sheet

• Net worth of a business

INTRODUCTION

Transactions taking place in the business have to be recorded in the books of account

in order to aid in determining whether the business is making profit. The act of

recording transactions in the books of account is known as book keeping.

BASIC TERMS USED IN BUSINESS

a) Debtor

A debtor is a person or an organisation who owes money to another. For example if

Musa bought goods on credit from Kimani, then Musa is Kimani’s debtor.

b) Creditor

A creditor is a person or organisation to whom money is owed. For example if Musa

bought goods on credit from Kimani, then Kimani is Musa’s creditor

c) Goods

In trade, goods refer to items bought by the business for resale

d) Assets

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Refers to property that a business owns to which monetary value can be attached e.g.

vehicles, stock, tables, cash etc.

There are two types of assets:

• Fixed assets

• Current assets

i. Fixed assets

These are those assets which are expected to stay in the business for more than one

year. They include; buildings, land, vehicles, furniture etc.

ii. Current assets

These are assets which are expected to stay in the business for a period which is less

than one year. They include cash or items easily convertible to cash. Examples

include; stock, debtors, cash in hand, cash at bank etc.

Characteristics of assets

• They are owned and controlled by the business

• They can be measured in monetary terms

• Its benefits are enjoyed by the business

• May either be fixed or current

• Must have been acquired in the past

e) Liabilities

Refers to what is owed to others. Includes borrowed money and goods bought on

credit. Examples includes loans, creditors etc.

There are two types of liabilities:

• Long term liabilities

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• Current liabilities

I. Long term liabilities

These are those debts that are not intended to be settled within a year e.g. a three year

loan

II. Current(short term) liabilities

These are those debts that are payable within a year e.g. bank overdrafts, creditors

etc.

Characteristics of liabilities

• It is a present obligation resulting from past commitment

• Its resettlement may reduce business assets

• Amount involved can be measured reliably in monetary terms

• They are owned by outsiders

• May be classified as long term or short term

f) Capital

Refers to money or items contributed by the owner in order to start or sustain a

business

Capital is what the owner owns in the business

It is also referred to as owner’s claims or owner’s equity

g) Net worth

Refers to the actual value of the business at a particular date. It is used to refer to

capital and is given by

Net worth= assets - liabilities

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THE BOOK-KEEPING EQUATION

This equation is also referred to as the balance sheet equation or the accounting

equation

The book-keeping equation relates assets, liabilities and capital

According to this equation,

Assets = capital + liabilities

(Illustrations)

BALANCE SHEET

This is a statement that shows the financial position of the business at a particular

date. It shows the total assets, capital and liabilities of a business at a particular date

A balance sheet is prepared after a given period of time known as a trading period

or an accounting period

A trading period is a fixed period of time after which a business determines its

financial performance.

Its format

HEADING

ASSETS LIABILITIES+CAPITAL

Heading

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Contains

• Name of the business

• Name of statement

• Date at which it is prepared

Assets, capital and liabilities

Assets are recorded on one side while capital and liabilities are recorded on the other

side

Total assets must equal total liabilities

Totals on each side are double underlined

Items in a balance sheet are either prepared according to the order of permanency

or order of liquidity

(Illustrations)

Uses of a balance sheet

• Enable financiers such as banks determine whether the business is in a position

to pay them

• Enables shareholders determine their money is well invested

• Enables the government in determining whether the business is paying the right

amount of tax

• Enables potential investors decide whether to buy shares in the business or not

• Determines the types of capital invested in the business

• Determines the capital structure of the business

• Determines the financial position of the business

• Helps management in:

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✓ Comparing performance with the previous year

✓ Comparing their performance with other business

✓ Identifying areas in the business requiring improvement

TOPIC 11: BUSINESS TRANSACTIONS

CONTENTS

• Introduction

• Effects of transactions on the balance sheet

• Changes in capital

• Initial and final capital

INTRODUCTION

Business transactions refers to exchange of goods and services for money

There are two types of business transactions:

• Cash transactions

• Credit transactions

a) Cash transactions

This is a transaction where payment is made immediately goods are delivered

Payment may either be in cash or through other forms of payment such as cheques,

money orders etc.

b) Credit transactions

This is where payment for goods and services delivered at a later date. It is also

known as deferred payment

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EFFECTS OF TRANSACTIONS ON THE BALANCE SHEET

A transaction taking place in a business will have the effect of increasing or

decreasing some items in the balance sheet as illustrated below

(Give examples)

CHANGES IN CAPITAL

Capital in a business does not remain static, it keeps on changing. These changes in

capital may be caused by the following;

• Drawings

• Additional investments

• Profits

• Losses

a) Drawings

Refers to cash or items taken from the business by the owner for personal use.

Drawings reduce the amount of capital. (Illustrate)

b) Additional investment

Refers to additional cash or additional assets brought to the business by the owner.

An additional investment increases business capital. (Illustrate)

c) Profit

Refers to excess of selling price over cost price. Profit increases capital. (Illustrate)

d) Loss

Refers to excess of cost price over selling price. Loss reduces capital. (Illustrate)

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INITIAL AND FINAL CAPITAL OF A BUSINESS

Initial capital is the amount of capital available at the start of the trading period

whereas final capital is the Amount of capital available at the end of the trading

period

Final capital is calculated as follows:

Final capital = initial capital + profit + additional investments – drawings

NOTE: where a loss is made, it is subtracted

(Illustrate)

TOPIC 11: THE LEDGER

CONTENTS

• Introduction

• Rules of recording transactions in the ledger

• The concept of double entry

• Recording of stock in the ledger accounts

• Recording of expenses in the ledger accounts

• Recording revenues in the ledger accounts

• Recording drawings in the ledger accounts

• Balancing ledger accounts

• Uses of ledger accounts

• The trial balance

• Purpose of the trial balance

• Limitations of the trial balance

• Classification of accounts

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INTRODUCTION

A ledger is a book of account where transactions are recorded. It contains all

transactions pertaining to a particular item e.g. all cash transactions are recorded in

the cash ledger account

Its format

A ledger is T-shaped with three basic features

a) Title: contains the name of the account, usually centred at the top of the

account

b) Debit side: this is the name given to the left hand side of the ledger account

and is usually abbreviated “Dr”

c) Credit side: this is the name given to the right hand side of the ledger account

and is abbreviated “Cr”

Each side of the ledger has four columns

• Date column where the date of the transaction is recorded

• Particulars(details) column where a short description of the transaction is

recorded

• Folio column which is a cross reference

• Amount columns in which the figures in monetary terms are recorded

Dr Title (Name of account)

Cr

Date Particulars Folio Amount (sh)

Date Particulars Folio Amount (sh)

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RULES OF RECORDING TRANSACTIONS IN LEDGER ACCOUNTS

Transactions resulting in increases in a particular item are recorded on one side of

the account while those resulting in decreases are recorded on the other side as

explained below

a) Assets

An increase in an asset is recorded on the debit side (debited) while a decrease is

recorded on the credit side (credited)

b) Liability

An increase in a liability is credited while a decrease is debited

c) Capital

An increase in capital credited in the capital account while a decrease is debited

d) Expenses

Expenses are those costs incurred in running the business such electricity, storage,

insurance etc.

An increase in an expense is debited in the respective expense account while a

decrease is credited

e) Revenues

Revenues refer to incomes earned from non-business activities. They may include;

discount received, commission received, rent received etc.

An increase in revenue is credited in the respective revenue account while a decrease

is debited

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NOTE: assets and expenses are recorded the same way while liabilities, capital and

revenue are recorded the same way.

Summary of the rules

a) An increase in the value of an asset is debited in the respective asset account

whereas a decrease in the value of the asset is credited in the respective asset

account

b) An increase in the value of a liability is credited in the respective liability

account whereas a decrease in the value of a liability is debited in the

respective liability account

c) An increase in the value of capital is credited in the capital account whereas a

decrease in the value of capital is debited in the capital account

d) An increase in the value of revenue/income is credited in the respective

revenue/income account whereas a decrease in the value of revenue/income is

debited in the respective revenue/income account

e) An increase in the value of expenses is debited in the respective expense

account whereas a decrease in the value of expenses is credited in the

respective expense account

THE DOUBLE ENTRY CONCEPT

The double entry concept states that, for every debit entry, there is a corresponding

credit entry. This means that for any transaction made, there is an account to be

debited and another account to be credited

The double entry concept must be adhered to whenever recording transactions in the

ledger

RECORDING TRANSACTIONS IN THE LEDGER ACCOUNT

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(Illustrations)

RECORDING OF STOCK IN LEDGER ACCOUNTS

Stock refers to those goods bought to the business for resale purposes. Stock may

increase or decrease.

Causes of increase in stock are:

• Purchase of more goods

• Customers returning goods previously sold to them (sales returns or returns

inwards)

Causes of decrease in stock may include:

• Sale of goods

• Goods previously bought being returned by the business to the suppliers

(purchase returns or returns outwards)

a) Purchase of goods (stock)

When goods are purchased to the business they increase stock. The value of such

goods should be debited in the purchases account.

Note that only those goods purchased for resale are to be recorded in the purchases

account

Purchases can be in cash or on credit

1) Purchases in cash

When goods are bought in cash, purchases account is debited with the value of the

goods while the cash account is credited (Illustrate)

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2) Purchases on credited

When goods are bought on credit, purchases account is debited while the respective

creditor’s account is credited. (Illustrate)

b) Sale of goods (stock)

Sale of goods reduces stock. The value of goods sold is credited in the sales account.

Note that only those goods bought for resale are to be recorded in the sales account.

Sales can be in cash or on credit.

1) Sales in cash

When goods are sold in cash, sales account is credited with the value of goods sold

while the cash account is debited. (Illustrate)

2) Sales on credit

When goods are sold on credit, sales account is credited with the value of the goods

while the respective debtor’s account is debited. (Illustrate)

c) Purchase returns

These are part of goods bought previously now returned to the suppliers because of

reasons such as; poor quality, being defective or being excess.

The value of purchase returns is credited in the purchases returns account while the

respective supplier account is debited (Illustrate)

d) Sales returns

These are part of goods that were previously sold now being returned to the business

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The value of sales returns is debited in the sales returns account while the respective

customer is credited (Illustrate)

RECORDING OF EXPENSES IN THE LEDGER ACCOUNTS

Expenses are those costs incurred in running the business effectively. They may

include; stationery, wages, insurance, advertising, discount allowed etc.

Payment of an expense is debited in the respective expense account while cash/bank

account is credited with the amount paid (Illustration)

RECORDING OF REVENUES IN THE LEDGER ACCOUNTS

Revenues are those incomes obtained from non-trading activities. They may include;

rent received, commission received, discount received etc.

Receipt of revenue is credited in the respective revenue account while cash/bank

account is debited (Illustrate)

RECORDING OF DRAWINGS IN THE LEDGER ACCOUNTS

Drawings refer to assets taken from the business for private use. Such assets may be

in form of goods or cash.

When drawings are made in cash or from the bank, the drawings account is debited

with the amount withdrawn while the cash/bank account is credited

When drawings are in the form of goods (stock), drawings account is debited with

the value of goods withdrawn while the purchases account is credited

SUMMARY OF THE RULES OF RECORDING IN THE LEDGER

Items with debit balances include the following; assets, expenses, purchases, sales

returns and drawings.

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Items with credit balances include; liabilities, revenues, sales and purchase returns

BALANCING LEDGER ACCOUNTS

An account balance is an accounting term meaning the mathematical difference

between the totals of the credit and debit sides of an account.

If the debit side is more than the credit side, the difference is known as a debit

balance but when the credit side is more than the debit side, the difference is known

as credit balance

To balance accounts therefore;

• Find totals of each side

• Find the difference in these totals

• Insert the difference on the side with a smaller total as a balance carried down

(c/d) or balance carried forward (c/f) to make the totals equal

• Write the totals of each side on the same level and double underline them

• Record the account balance on the opposite side below the totals as balance

carried down (b/d) or balance brought forward (b/f)

(Illustrate)

USES OF LEDGER ACCOUNTS

a) Shows the amount by which a particular item increases or decreases

b) Enables the calculation of the value (balance) of an item at any time

c) Can be used for future reference

THE TRIAL BALANCE

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This is a document that is used to check the accuracy of ledgers. It shows all the

debit balances of ledgers on one side and credit balances of ledgers on the side.

The totals of the two sides should be equal.

Its format

details Dr Cr

Failure of the trial balance to balance

When the trial balance fails to balance, it means there is an error either in the

accounts or in the trial balance, these errors may include;

• Failure to observe the concept of double entry

• Transferring (posting) wrong balances to the trial balance

• Arithmetical errors in totaling trial balance totals

• Arithmetical errors when balancing ledger accounts

• Failure to transfer a balance from the ledger to the trial balance

• Transferring a balance to the wrong side of the trial balance

• Transposition of figures i.e. recording 791 as 971

• Failure to transfer all balances from the ledger to the trial balance

PURPOSE OF A TRIAL BALANCE

a) Checking the accuracy of ledger accounts by determining whether

• The double entry concept has been observed

• Accounts are free of arithmetical errors

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b) It gives a summary of the information contains in ledgers

c) Facilitates the preparation of final accounts

d) Provides information to stakeholders in the business such as banks, investors,

customers etc.

LIMITATIONS OF A TRIAL BALANCE

The trial balance has a limitation in the sense that it may feel to identify some errors

made in the ledger account. Such errors include:

a) Error of total omission

This error occurs when a transaction which has taken place is not recorded in the

books of account

b) Error of original entry

This error occurs when a transaction takes place but wrong amount is recorded in the

accounts e.g. a transaction involving Ksh 2000 is recorded as involving Ksh 3000

c) Error of commission

This error is made when a transaction is recorded in a different account of the same

class but with the correct amount e.g. when Ksh 2000 is debited in Onyango’s

account instead of Anyango’s account

d) Compensating errors

These are errors which have an effect of canceling out e.g. debiting stock with Ksh

2000 and crediting cash with the same amount

e) Complete reversal of entries

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This error occurs when a transaction is recorded on the wrong side of the ledger

accounts e.g. cash sales to Kamau are recorded by crediting the cash account and

debiting sales account instead of doing the opposite

f) Error of principle

This occurs when a transaction is a wrong account of different class e.g. rent income

is debited to rent expense account instead of being credited to rent income account.

Rent income is revenue while rent expense is an expense hence they belong to

different classes.

CLASSIFICATION OF LEDGER ACCOUNTS

a) Sales (debtors) ledger

This is a ledger where accounts of debtors are recorded

b) Purchases (creditors) ledger

This is a ledger where accounts of creditors are recorded

c) The cash book

This is a form of ledger account where cash in hand and cash at bank is recorded

d) Nominal ledger

This is a ledger account where transactions relating to sales, expenses, revenues and

purchases are recorded.

e) Private ledger

This is a ledger where confidential transactions are recorded. Such confidential

information may be relating to drawings, capital and trading profit and loss account.

This information is only accessible to owners and management of the business.

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f) The general ledger

This is a ledger where all transactions relating to fixed assets and some current assets

e.g. stock are recorded. Debtors and creditors arising from dealings in fixed assets

are also recorded in this ledger.

CLASSIFICATION OF ACCOUNTS

All accounts operated by a business can be classified into two categories:

• Personal accounts

• Impersonal accounts

a) Personal accounts

These are accounts of persons. They are mainly accounts of creditors and debtors.

Therefore purchases ledger and sales ledger are classified as personal accounts

b) Impersonal accounts

These are accounts that are not for persons. They can further be sub-divided into

real, nominal and private accounts

Real accounts are accounts of tangible assets such as buildings and furniture.

Nominal accounts are accounts of items whose balances are transferred to the profit

and loss account. Such items include expenses, revenues, sales and purchases.

Private accounts are accounts of items the firm considers to be highly confidential

such as capital, drawings and T P & L account

TOPIC 12: THE CASH BOOK

CONTENTS

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• Introduction

• Basic types of cashbooks

INTRODUCTION

The cash book is a ledger that contains cash and bank accounts only

Cash and bank accounts are kept are kept in a separate ledger due to the following

reasons:

• To reduce the bulkiness of the general ledger since most of the transactions

taking place in the business involve cash and bank accounts

• Cash and bank accounts are more sensitive as they record liquid cash hence

have to monitored separately

• Cash and bank accounts are recorded on the same page in the cash book,

therefore making tracing of records easier

BASIC TYPES OF CASHBOOKS

There are five types of cashbooks, these include:

• Single-column cash book

• Two-column cash book

• Three-column cash book

• Petty cash book

• Analysis cash book

The first three types are covered in form three and the remaining two in form four

a) Single-column cash book

This is a cash book with only one amount column. This amount column is used to

record cash in hand or cash at bank.

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It is normally kept by small businesses which either operates only cash accounts or

bank accounts.

The cash and bank accounts are separated

Date Details L.F Amount Date Details L.F Amount

N/B: In the ledger folio column is recorded the name of the ledger and the page

where the account named in the details column is to be found

(Illustrations)

b) The two-column cash book

This is a cash book with two amount columns, i.e. cash and bank amount columns on

the debit and credit sides.

The cash column records cash in hand whereas the bank column records cash at bank

Date Details L.F Cash

(Sh)

Bank

(Sh)

Date Details L.F Cash

(Sh)

Bank

(Sh)

(Illustrations)

Balancing off the two-column cash book

At the end of the trading period, the cash book is balanced to obtain both cash and

bank balances (Illustrate)

The cash account cannot end up with a credit balance but the bank account can. Such

credit balance in the cash book is known as a bank overdraft.

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Uses of a 2-column cashbook

a) It is used to record cash payments

b) It is used to record cash receipts

c) It is used to determine cash balances

d) It reduces the number of transactions in the main ledger

e) It is used to prepare bank reconciliation statements

c) The three-column cash book

This is a cash book with three columns both on the debit and credit side. These

columns are for discount, cash and bank

Dat

e

Detail

s

L.

F

Disc.al

l

Cas

h

Ban

k

Dat

e

Detail

s

L.

F

Dis

c

rec

Cas

h

Ban

k

Discount

Discount is an allowance by a seller of goods to a buyer of goods so that the buyer

pays less than the quoted price.

(Illustrations).

Uses of a 3-column cashbook

a) It reduces entries in the general ledger

b) It shows the total expenditure

c) It shows the sources of money that was spent

d) It is used by management to control all transactions since all business

transactions must end in the cashbook

e) It facilitates the preparation of cash budgets

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f) It allows easy monitoring of cash flows in the business.

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.

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