THE INSTITUTE OF FINANCE MANAGEMENT

FACULTY OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS AND TAX MANAGEMENT

BACHELOR OF SCIENCE IN TAXATION

YEAR ONE

2022/2023

ASSIGNMENT

NAME REGISTRATION NUMBER

AISHA SAI MOHAMED IMC/BTX/2211347

QUESTIONS

QUESTION ONE

a) Explain the concept of gross domestic product (GDP) and its significance in measuring
economic performance. Discuss the limitations of using GDP as a measure of well-being
in an economy.
b) Analyze the causes and consequences of inflation. How does inflation impact the overall
economy, and what policy measures can be employed to control it?

QUESTION TWO
 a) Differentiate absolute advantage from comparative advantage theories of international
trade.
b) Consider the following table which gives the number of labor required to produce one
barrel of wheat and paddy in Russia and USA

Russia USA
Wheat (1 barrel) 3 2
Paddy (1 barrel) 10 4

Required;
i. Which country has an absolute advantage in the production of both goods?
ii. Calculate the opportunity costs and then, comment which country has a
comparative advantage in the production of wheat and paddy.

QUESTION THREE

a. Use the AD-AS model to explain the effects of an increase in government spending on
the equilibrium price level and real GDP. Illustrate your answer with diagram.
b. Suppose that Tanzania is a country with single commercial bank whose demand deposit
is TZS 20billion. Assume required reserve ratio is 10% and the bank does not hold excess
reserve
A. What is the amount of loan the bank can provide
B. If there is an injection of TZS 10billion in bank’s vault due to
discount loan by central bank, how much more loans is the bank
able to the non bank public?
ANSWERS

QUESTION ONE

a) Explain the concept of gross domestic product (GDP) and its significance in measuring
economic performance. Discuss the limitations of using GDP as a measure of well-being
in an economy.

Gross Domestic Product (GDP) is the total value of goods and services produced within a
country’s borders in a specific period of time, usually a year. measures the monetary value of
final goods and services. Meaning that those that are bought by the final user. Gross Domestic
Product (GDP) can be calculated in three (3) ways, production, expenditure and income
approach. Production can be calculated as the sum of the “value-added” at each stage of
production. Expenditure can be calculated as the sum of purchases made by final users. Income
approach can be calculated as the sum of the incomes generated by production subjects. Gross
Domestic Product (GDP) is the most commonly used measure of economic activity.

The following are the significance of Gross Domestic Product (GDP) in measuring economic
performance.

Gross Domestic Product enables policy makers and central banks to judge whether the economy
is contracting or expanding.

Gross Domestic Product allows policy makers, economists and businesses to analyze the impact
of variables such as monetary and fiscal , economic and tax and spending plans.

The following are the limitations of using Gross Domestic Product (GDP) as a measure of well-
being in an economy .

There is failure to account for or represent the degree of income inequality in society.

There is failure to indicate whether the nations rate of growth is sustainable or not.

There is exclusion of non-market transactions, hence the output and income generated is not
included in the calculation of a nations GDP.
There is failure to account for the costs imposed on human health and the environment of
negative externalities arising from the production or consumption of the nations output.

Treating the replacement of depreciated capital the same as the creation of new capital.

b) Analyze the causes and consequences of inflation. How does inflation impact the overall
economy, and what policy measures can be employed to control it?

The causes of inflation can be mainly grouped into two groups namely, demand-pull inflation
and cost-push inflation. But also inflation expectations is considered as one of the cause of
inflation.

Demand-pull inflation is caused by developments on the demand side of the economy. It

arises when the total demand for goods and services(aggregate demand) increases to exceed
the supply of goods and services(aggregate supply) that can be sustainably produced. This
leads to,

Budget deficit, this is when government expenses exceed revenue. Example when a
government takes in TZS20 billion in revenue in a particular year, and its expenditures for
the same year are TZS25 billion, this means that it runs a deficit of TZS5 billion.

Depreciation of the exchange rate, this means that it is a fall in the value of a currency in
terms of its exchange rate versus other currencies. Government decide to lower the value of
the currency, to export more to become cheaper and imports price to increase.

Direct and indirect taxes, this leads to the increase in their market price and it leads to a rise
in the cost of living as a result of which trade unions demand higher wages to maintain real
income of their workers.

Cost-push inflation is caused by the effect of higher input costs on the supply side of the
economy. It occurs when the total supply of goods and services in the economy which can be
produced (aggregate supply) falls. Which is caused by an increase in the cost of production.
This leads to,

Rising labour costs, this is caused by wage increase which exceed any improvementin
productivity.
 Change in interest rate, this affects firms if they have borrowed significant amounts. The
increase in interest rate lead to raise of the cost of capital.

Higher indirect taxes, this leads to the government to impose higher indirect taxes on raw
materials and final goods.

Rising the cost of imported raw materials, this is caused by inflation in countries that are
heavily dependent on exports of these commodities.

Exchange rate changes particularly if firms import many of their raw materials.

Inflation expectations, are the beliefs that households and firms have about future price
increases.

The following are the impacts of inflation on the overall economy.

Lower purchasing power, when the price increases, this leads to the purchasing power of
consumers to decrease.this means that people are not able to buy as much with the same amount
of money, where this can lead to a decrease in consumer spending.

Higher interest rates, central banks may increase interest rates so as to combat inflation, which
this can make it more expensive for businesses and consumers to borrow money which leads to
the economic growth to slow down.

Redistribution of wealth, inflation can lead to a redistribution of wealth from lenders to

borrowers. This is because the value of the money that is borrowed decreases over time as
inflation increases which can also lead to a decrease in the value of savings.

Increased exports, inflation can make a country’s exports more competitive, this is because the
prices of goods produced in the country will be lower relative to other countries. This can lead to
an increase in exports, which can have positive impacts on the economy.

Uncertainty, inflation can lead to uncertainty in the economy as businesses may be hesitant to
invest in new projects or hire new employees if the y are unsure about future inflation rates,
where this can lead to a slowdown in economic growth.
The following are the policy measures to control inflation

Fiscal policy, is the use of government spending and taxation to influence the economy. Meaning
that, when government increases spending or lowers taxes, it stimulates the economy by
increasing aggregate demand. But also, when the government decrease spending or raises taxes,
it slows down the economy by decreasing aggregate demand.

Exchange rate policy, is the use of government intervention to influence the exchange rate of
their currency. Governments can use various tools such as buying or selling their own currency
in the foreign exchange market, setting interest rates, or imposing trade barriers to influence the
value of their currency.

Monetary policy, is the use of central bank tools to influence the economy. The tools the central
bank can use include, changing the money supply, setting interest rates, and regulating banks to
achieve its goals.

Inflation target, is the monetary policy strategy in which the central bank sets an explicit target
for the rate of inflation and uses monetary policy tools to achieve that target. Typically, the
central bank set an inflation target of around 2% per year, however the exact target can vary
depending on the country’s economic conditions and preferences.

QUESTION TWO

a) Differentiate absolute advantage from comparative advantage theories of international trade.

Absolute advantage suggested on countries should specialize in the production of commodities in

which they have absolute advantage WHILE Comperative advantage suggested on countries
should specialize on the production of low opportunity cost.

Absolute advantage was initiated by Adam Smith WHILE Comperative advantage was initiated
by David Ricardo.
Absolute advantage theory suggests that countries should trade with each other in order to obtain
goods that they cannot produce efficiently WHILE Comperative advantage theory suggests that
countries should trade with each other in order to obtain goods that they cannot produce at a
lower opportunity cost.

Absolute advantage theory assumes that countries have different levels of resources, and that
these resources can be used to produce goods more efficiently WHILE Comperative advantage
theory assumes that countries have the same level of resources, but they have different
opportunity costs for producing goods.

Absolute advantage theory suggests that countries should focus on producing goods that they
have an absolute advantage in, and that they should protect these industries from foreign
competition WHILE Comperative advantage theory suggests that countries should focus on
producing goods that they have a comparative advantage in, and that they should open their
markets to foreign competition in order to obtain goods that they cannot produce efficiently.

b) Consider the following table which gives the number of labor required to produce one
barrel of wheat and paddy in Russia and USA

Russia USA
Wheat (1 barrel) 3 2
Paddy (1 barrel) 10 4

Required;
a. Which country has an absolute advantage in the production of both goods?
b. Calculate the opportunity costs and then, comment which country has a
comparative advantage in the production of wheat and paddy.
a. The country which has absolute advantage in the production of both goods is Russia
because Russia has the advantage of producing more goods than USA.
b.

Russia USA
Wheat 3 2
=0.3 =0.5
10 4
Paddy 10 4
=3.3 =2
3 2

Russia has a comperative advantage of wheat while USA has a comperative

advantage of paddy because the comparative advantage theory states that a
country should specialize in production of good with low opportunity cost.

QUESTION THREE

a) Use the AD-AS model to explain the effects of an increase in government

spending on the equilibrium price level and real GDP. Illustrate your answer
with diagram.

b) Suppose that Tanzania is a country with single commercial bank whose

demand deposit is TZS 20billion. Assume required reserve ratio is 10% and
the bank does not hold excess reserve

A) What is the amount of loan the bank can provide

B) If there is an injection of TZS 10billion in bank’s vault due to

discount loan by central bank, how much more loans is the bank able
to the non bank public?

a. Aggregate demand refers to the total amount of goods and services that consumers and
businesses are willing and able to purchase at a given price level in a specific period of
time. Aggregate supply refers to the total amount of goods and services that producers are
willing and able to supply at a given price level in a specific period of time. When
aggregate demand and aggregate supply are in equilibrium, the economy is said to be in a
state of balance. But when there is a shift in aggregate supply or aggregate demand, it can
 cause changes in the price level and output level of the economy. The diagram below
shows, the initial equilibrium is at point A, where aggregate demand(AD) intersects with
aggregate supply(AS). An increase in government spending shifts the AD curve to the
right, from AD1 to AD2. This cause the equilibrium to shift from point A to point B,
where the new equilibrium output level is higher and the new equilibrium output level is
also higher. This increase in output is represented by the shift in the AS curve.

Price level
AD2
AS
AD1

Real GDP

b.
A. Data given,
Demand deposit=TZS 20billion
Reserve ratio=10%=0.10
Amount of loan the bank can provide=?
Solution
From,
Amount of loans=demand depositx(1-required reserve ratio)
Amounts of loans=TZS 20billionx(1-0.10)
Amounts of loans=20billionx0.90
Amounts of loans=TZS 18billion
Therefore, the bank can provide a loan of TZS 18billion.

B. Data given,
Injection=TZS 10billion
Solution,
Excess reserves=injection-required reserves
Excess reserves=TZS 10billion-(TZS 20 billionx0.10)
Excess reserves=20 billion-2 billion
Excess reserves=TZS 8 billion
Therefore, the bank can provide TZS 8billion more loans.
REFERENCES
“The impact of inflation on the economy”. Investopedia, 2021
https://www.invetopedia.com
“absolute advantage and comparative advantage”. Boundless Economics, 2021
https://courses.lumenlearning.com