MONETARY ECONOMICS (HND)

MONETARY
ECONOMICS
(Lecture notes for Hnd)

cOurse instructor:
Hyacinth chebangang
Bsc, DIPET II, MSc, PhD

INTRODUCTION
This course guide tells you the nature of the course the materials you are going to use and how
you are expected to use them for meaningful benefits. It is expected that at least two hours
should be devoted to the study of every unit. For each course units there are exercises. You are

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encouraged to do them. They serve as points of reflections, which are necessary for proper
understanding of the facts. At the end of each unit, there are tutor-marked assignments, which
you are expected to answer. They serve as revision and continuous assessment. Tutorial lectures
will be provided. This is the opportunity you have for a face-to-face contact with your facilitator.
Any area you did not understand will be explained during the tutorial classes.

COURSE AIMS
The course aims at exposing you (students) to the necessary information that will add to the
student’s knowledge on Monetary Economics. The aim of the course shall be achieved by:

 Introducing you to the concept of Monetary Economics.

 Examining the meaning, scope and nature of Monetary Economics.
 Dilating copiously the roles of Monetary Economics .. ..
 Assessing Monetary Economics architecture and design.

COURSE OBJECTIVES

Upon successful completion of this course, you should be able to: Discuss succinctly the concept
of Monetary Economics.

UNIT 1: MONEY
UNIT 2: DEMAND FOR MONEY
UNIT 3: SUPPLY OF MONEY
UNIT 4: TYPES OF FINANCIAL INSTITUTIONS
UNIT 5: FUNCTIONS OF FINANCIAL INSTITUTIONS
UNIT 6: INFLATION
UNIT 7: DEFLATION
UNIT 8: TOOLS OF MONETARY POLICIES
UNIT 9: INTERNATIONAL TRADE
UNIT 10: THE BALANCE OF PAYMENTS
UNIT 12: SCOPE OF PUBLIC FINANCE
UNIT 13: TAXATION AND FISCAL POLICIES
UNIT 14: PUBLIC DEBT
UNIT 15: NATIONAL INCOME
UNIT 16: ECONOMIC GROWTH AND DEVELOPMENT

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UNIT 17: DEVELOPMENT PLANNING

UNIT 18: UNEMPLOYMENT
UNIT 19: MANAGEMENT OF FOREIGN OPERATION AND INTERNATIONAL
TRADE

For each study unit, which you are expected to spend at least three hours, there are specific
objectives. At the end of each unit, measure what you have learnt against the objectives. If there
is any deviation go back to the contents of the unit. There are textbooks, which you may go for
additional information. The exercise in each unit have to be attempted to ensure that you are
following the ideas being presented. In addition, there are tutor-marked assignments. You are
entreated to attempt them, as some of them will form part of the continuous assessment.
READING SECTION
Remember that your tutor’s job is to help you. When you need help, don’t hesitate to call and ask
your tutor to provide it.
1. Read this course guide thoroughly.
2. Organize a study schedule. Refer to the “Course overview” for more details. Note the time you
are expected to spend on each unit and how the assignments relate to the units. Whatever method
you choose to use, you should decide on and write in your own dates for working on each unit.
3. Once you have created your own study schedule, do every thing you can to stick to it. The
major reason that students fail is that they get behind with their course work. If you get into
difficulties with your schedule, please let your tutor know before it is too late for help.

CHAPTER ONE
MONEY
CONTENTS

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1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Definitions of Money?
3.2 Barter System
3.3 Types of Money
3.4 Qualities of Money
3.5 Functions of Money
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignments
7.0 References/Further Reading

1.0 INTRODUCTION
In this unit, you will learn that the wealth of a community exists in the goods and services it
produces and that money is merely a convenient way of measuring wealth. We must now
investigate money more closely and determine what it does, and what problems it creates.
Market economy or Money economy should be compared with the subsistence economy.
Subsistence economy means that people consume what they have themselves produced and
exchange nothing. In a market economy, exchange may take two forms: direct exchange (barter)
or indirect exchange using money as a “means of payment” or “medium of exchange”. It should
be noted that barter involves such inconveniences at a comparatively early stage. In the
development of an economy, we should expect a medium of exchange; money comes into use.
In every economic system, whether dominated by private interest as in capitalism or government
interest as in communism and socialism, or mixed economy having a blend of capitalism and
communism, money has very crucial roles to play. Its roles in the economy is pervasive,
touching every aspect of the economy.
A special attention is given to money because the use of monetary policy as a stabilization tool
by the government is based on the role of money in the economy. We cannot have a proper grasp
of monetary theories and policies without first of all understanding money.
2.0 OBJECTIVES
It is hoped that by the end of this unit, you will be able to:
 Understand the meaning of money and its evolution.
 Show the various types of money and the functions that money performs in every
economy.

3.0 MAIN CONTENT

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3.1 Definition of Money?

Everybody who has reached the age of Kindergarten knows what money is. You possibly have
touched money today. However, the term ‘money’ means different things to the ordinary man in
the street. It is often used to describe wealth and financial resources, credit and income. When
we say “the man has money or the man is in money”, we are referring to money as wealth or
financial resources. It differs from the way an economist uses the term ‘money’.
Economists see money as anything that serves as a medium of exchange in a given society.
Chandler and Goldfield (1997) defined money as “anything that is generally acceptable as a
medium of exchange”. Amacher and Ulbrich (1986) defined it as “an item that people accept as
payment for goods or services.” Cox (1983) defined it as “anything which passes freely from
hand to hand and is generally acceptable in settlement of debt and other financial obligation is
money. “Traditional view or view of the currency school and Keynes defined money as ''
currency and demand deposits’’ (M = C + D where M - Money supply, C - Currency and D -
Demand deposits). Friedman's empirical definition of money means ''literally the number of cash
people are carrying around in their pockets, the number of cash they have to their credit at banks
in the form of demand deposits and commercial bank time deposits''. Friedman's theoretical
definition of money defines money as ''any asset capable of serving as a temporary abode of
purchasing power''. His broader definition of money includes bank deposits, non - bank deposits
and any other type of assets through which the monetary authority influences the future level of
income, prices, employment or any other important macro variable (Here, money is expressed as
M2 = C + D + S + T). The Radcliffe committee defined money as '' note plus bank deposits''.
Gurley - Shaw definition regard a substantial volume of liquid assets held by financial
intermediaries and the liabilities of non - bank intermediaries as close substitutes for money.
Intermediaries provide substitute for money as a store of value. Money proper which is defined
as equal to currency plus demand deposits is only one liquid asset. They have thus formulated a
wider definition of money based upon liquidity which includes bonds, insurance reserves,
pension funds, savings and loan shares. From these definitions, we have two things to note. The
first is that whatever serves as money has to be generally acceptable in settling financial
obligations. The second thing is that anything whatsoever can serve as money provided it is
acceptable as money within a given community. The legal tender approach to defining money
brings to fore the point that the law can help a commodity to achieve general acceptability.
3.2 Barter System
Trade by barter is the direct system and practice of exchanging goods and services for goods or
services. The best way to understand the importance of money in any economy is to look at an
economy that does not use money. When there is no generally accepted medium of exchange,
individuals engage in barter. A barter economy is a moneyless economy. It is also a simple
economy where people produce goods either for self - consumption or for exchange with other
goods which they want. The problem or difficulties of Trade by Barter includes:

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 The difficulty of double co-incidence of wants;

 It wastes time and energy, i.e. labourious and time-consuming;
 Lack of a common measure of value, i.e. ,difficulty in assessing the value of
commodities using this model, R = n (n - 1)/2 where R and n denote respectively the
total number of separate exchange ratios and the total number of commodities exchanged
in the economy.
 The exchange always becomes uninteresting;
 It does not encourage deferred payments;
 It does not encourage the system of division of labour and specialization;
 There is no lending and borrowing;
 It discourages large-scale production.
 Difficulty in storing value;
 Indivisibility of certain goods;
STUDENTS ASSESSMENT EXERCISE
How did Trade by Barter encourage the introduction of money?
3.3 Types of Money
(i) Coins: They are metal money with definite amount.
(ii) Paper Money: It is in form of paper notes which originated from the receipts that the
Goldsmiths issued to people.
(iii) Bank Money: It is deposit in both Savings Account, Current Account and Fixed Deposit
Account.
(iv) Foreign Money: It is the money of other countries and it serves as money in the foreign
exchange market.
(v) Legal Tender: It is money backed by the force of law in a country which is generally
acceptable as a medium of exchange.
(vi) Gold Backed Money: It is money that can easily be converted or changed into gold by the
central authority that issues money.
(vii) Commodity Money: It is commodity used as money in the olden days, e.g. cowries, shart
teeth manilla etc.
(viii) Token Money: This is money whose intrinsic worth is less than its normal or face value.
(ix) Representative Money: It is a document or lieu of legal tender but not fully and freely
acceptable e.g. cheques, postal and money order bills, etc.
(x) Fiduciary Note Issue: This is the type of money that are not backed by either gold or any
foreign currency.

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(xi) Standard money: is money whose value as a commodity for non-monetary purposes is as
great as its value as money.
(xii) Subsidiary Money: This type of money is to assist token money (coins) and are limited
legal tender.
(xiii) Credit money: Credit money or bank money is money transferred by a commercial bank
in the form of a cheque or draft.
(xiv) Optional money or Non - Legal Tender: This type of money does not possess any legal
authority of the state or central bank. Such optional monies are time deposits, bonds, securities,
debentures, bills of exchange, treasury bills, postal certificates, insurance policies, cheques and
drafts.
3.4 Qualities of Money
This is also known as the characteristics of money.
(a) Homogeneity: Each unit of money must be homogenous, that is, each unit held by different
individuals must be identical;
(b) General Acceptability: Each unit of money must be generally acceptable in exchange for
goods and services purchased;
(c) Portability: Each money unit must be easily carried about. In other words, it must be easily
transmissible;
(d) Divisibility: Money must be capable of being divided into small units;
(e) Recognisibility: Money must be easily recognizable by all and sundry in order to detect any
counterfeit;
(f) Relative Scarcity: Money must be relatively scarce in order to maintain its value;
(g) Stability in Value: There should be absence of inflation and deflation to make money stable
in value as well as enable it serve some useful functions such as the store of value and means of
deferred payment;
(h) Durability: Money must possess durability quality. It should be storable and last long without
losing its value over a period of time. i.e., money must be capable of staying long without
spoiling or going bad.

3.5 Functions of Money

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Money performs a number of primary, secondary, contingent and other functions which
eliminate the difficulties of barter.
Primary functions:
(a) Money serves as a medium of exchange. With the introduction of money, goods and
services are exchanged with money and thus exchange is facilitated. With money as a mean of
exchange, the problems of barter are bye-passed.
(b) Money serves as a unit of account. All business transactions are accounted in money units.
Whether it is payments, debts or costs, it is made in money units. This facilitates exchange or
transactions.
(c) Money serves as a measure of value. With money, one can measure the quality or value of
goods, services or different occupations.
Thus money is used to measure and compare the value of goods and services.
Secondary functions:
(a) Money serves as a standard for deferred payments - With the use of money, one can
postpone or defer the payment for goods and services purchased. This function is important these
days when business transactions are carried out mostly on credit basis.
(b) Money serves as a store of value. In-so-far as there is no inflation and deflation in the
economy, money serves as a store of value since money would not lose its value any period it is
kept.
(c) Money serve as a transfer of value: since money is a generally acceptable means of
payment and acts as a store of value.
Contingent functions:
Money also performs certain contingent or incidental functions such as
(a) Money as the most liquid of all liquid assets - Money as the most liquid of all liquid assets in
which wealth is held. Individuals and firms may hold wealth in infinitely varied forms.
(b) Basis for the credit system - Money is the basis of credit system. Business transactions are
either in cash or on credit.
(c) Equalizer of marginal Utilities and productivities: Money acts as an equalizer of marginal
utilities for the consumer. The main aim of a consumer is to maximize his satisfaction by
spending a given sum of money on various goods. This happens when the ratios of the marginal
utilities and prices of the various goods are equal.

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(d) Measurement of National Income: It was not possible to measure the national income under
the barter system. Money helps in measuring national income. This is done when the various
goods and services produced in a country are assessed in money terms.
(e) Distribution of National Income: Money also helps in the distribution of national income.
Rewards of factors of production in the form of wages, rent, interest and profit are determined
and paid in terms of money.
Other functions:
(a) Helpful in making Decisions: Money is a means of store of value and the consumer meets his
daily requirements on the basis of money held by him. If the consumer has a scooter and in the
near future he needs a car, he can buy a car by selling his scooter and money accumulated by
him. In this way, money helps in taking decisions.
(b) Money as a basis of adjustment: to carry on trade in a proper manner, the adjustment between
money market and capital market is done through money. Similarly, adjustments in foreign
exchange are also made through money. Further, international payments of various types are also
adjusted and made through money.
4.0 CONCLUSION
Money has a very crucial role to play in every economy. One good way to understand the
importance of money to any society is to imagine a situation where there is no money in an
economy. All the problems associated with the barter system will become very prominent in
such economy.
In every economy, money performs four major functions. The first two can be classified as
primary or basic function while the last two are secondary functions. They are said to be
secondary because they are derived from the first two. Any commodity that can perform the
primary function can automatically perform the secondary functions, but not all commodities
that perform the secondary functions can perform the primary functions.
The primary functions of money are: (a) Money as a medium of exchange. (b) Money as a
unit of value.
The secondary functions are:
(a) Money as a standard for deferred payment. (b) Money as a store of value.

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CHAPTER TWO
DEMAND FOR MONEY

CONTENTS
1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Demands for Money
3.2 The Liquidity Preference Theory
3.3 Motives for Holding Money (DD for Money)
3.4 Determinants of Money Demand
3.5 Quantity Theory of Money
3.6 Criticisms of Quantity Theory of Money
4.0 Conclusion
5.0 Summary
6.0 Tutor-Marked Assignments
7.0 References/Further Reading

1.0 INTRODUCTION
Money just like every other commodity has its own demand and supply. However, money has
certain qualities, or characteristics, or attributes, which distinguishes it from other commodities.
Money does not need to be converted to any other thing before it is used to pay for other goods
and services. It is the most liquid of all commodities. Money confers to the holder a general
purchasing power. Once you hold money, you can get other commodities. The most
distinguishing feature of money is that it is a medium of exchange. It is generally accepted in
settlement of financial obligations. Now, we know that money serves as a medium of exchange
and a store of value. People, therefore, demand to hold money in order to utilise these services.
Broadly speaking, there are three motives or reasons why people prefer to hold money instead of
other assets. They are the Transactionary Motive, the Precautionary Motive and the Speculative
Motive. This unit, therefore, presents a detailed discussion of the demand for money.
2.0 OBJECTIVES
At the end of this unit, you should be able to:
 define the ''Demand for Money''.
 understand the meaning of liquidity preference and the various reasons why people
demand for money to hold as idle cash balances.
 comprehend what is Quantity Theory of Money and the criticisms associated with it.

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3.0 MAIN CONTENT

3.1 Demand for Money
Each individual or person tries to hold his wealth in any of two broad forms. It is either held as
idle cash balances which yield no income or held as non-cash assets such as securities, houses,
bags of rice, vehicles and other commodities. These other commodities yield some income,
appreciate or depreciate in value over time. Wealth held as idle cash balances guarantees no
income, instead it reduces in value during inflation. The decision to hold money as cash balances
instead of spending it immediately in buying other assets is called the demand for money.
Demand for money, therefore, refers to the total amount of money balances that people want to
hold for certain purposes.
SELF ASSESSMENT EXERCISE
(i) Explain the term “Demand for Money”
Solution ; Demand for money means the demand to hold money, that is, to keep one’s resources
in liquid form instead of in some form of investment. OR it means the desire to hold money in
liquid cash as against spending the money.
3.2 The Liquidity Preference Theory
If an individual decides to hold all his wealth in the form of other wealth-creating or financial
assets, he faces the danger of illiquidity (that is, having no cash to settle his immediate illiquidity
obligations). To avoid the danger of illiquidity, he may prefer to hold money instead of other
assets. This is what Lord J. M. Keynes called Liquidity Preference. Liquidity Preference is the
extent to which a person prefers to hold cash balances instead of parting with it or keeping his
wealth as other assets. Keynes propounded the Liquidity Preference theory, which states that
“the stock of money held by the public will vary inversely with the rate of interest (price of
money).” The higher the return on income-yielding assets, the less likely it is that cash will be
held (Leiter, 1968:55). There is a level to which interest rate will reach and people will no longer
be willing to invest at all. This level is called the Liquidity trap level.
Apart from the level of income and rate of interest generated by other assets, there are other
determinants of how much a person will be willing to hold as cash. These other factors include
interval between pay days, general price level, level of expenditure, and availability of credit.
These factors are, however, influenced by the level of income. Other factors such as a person’s
attitude towards risks and expectations are equally influenced by the rate of return (or Interest
Rate). When interest rates are high, more people will be willing to take risk.
3.3 Motives for Holding Money (DD for money) Whoever is holding money is holding it to
enable him get something else. Each person has his own reasons for holding money, and not

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because he wants to chew the paper called money. The demand for money is, therefore, said to
be a derived demand.

Lord John Maynard Keynes who propounded the Keynesian theory identified three reasons that
prompt people to hold money. These reasons are transactions, precautionary and speculative.
I. Transactions Motive
The first reason people hold money balances is to enable them pay for their normal day to-day
transactions. People hold money as a medium of exchange. It is generally accepted by
individuals and firms in payment for goods and services.
Keynes observed that the level of transaction undertaken by individuals and society as a whole
has a stable relationship with the level of income. Keynes, therefore, confirmed that “the demand
for money for transactionary purposes was proportional to the level of income”. This means that
the higher the income level, the larger the amount held for transaction purpose. The Monetarists
led by Milton Friedman also agreed that “the demand for money will be proportional to the level
of income for each individual and hence for the aggregate economy. Therefore, money is held
for the purchase of goods and services because of the non-synchronisation of the periods of
income receipts and their disbursements. This is determined directly by the level of income.
Given these factors, the transactions demand for money is a direct proportional and positive
function of the level of income and is expressed as Lt = kY
where
Lt is the transactions demand for money,
k is the proportion of income which is kept for transactions purposes, and
Y is the income.

ii Precautionary Motive
The term “Precautionary Motives” refers to the desire to hold cash balances in order to meet
expenditures which may arise due to unforeseen circumstances such as sickness and accidents.
Uncertainties are a reality of life. We can never be quite certain what payments we have to make
in the future. Lacking certainty we, therefore, arm ourselves with money against emergencies.
Like the transaction motive, it is relatively interest-inelastic unless the rate of interest is really
very high.
As the case of transactions motive, the amount of money an individual holds for precautionary
purposes is also dependent on the level of Income. The higher the level of income, the more the
amount held for precautionary purposes. Both Keynesians and monetarists agree on this point.
But the post -Keynesian economists believe that like transactions demand, it is inversely related
high interest rates. The transactions and precautionary demand for money will be unstable,

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particularly if the economy is not at full employment level and transactions are, therefore, less
than the maximum, and are liable to fluctuate up and down. Since precautionary demand, like
transactions demand is a function of income and interest rates, the demand for money for these
two purposes is expressed in the single equation below:
M1 = L1 (Y, r) where the amount held under these two motives ( M1) as a function (L1) of the
level of income (Y), and (r) is the interest rate.
iii Speculative Motive
The third reason why people hold money is to enable them speculate on the possible outcome of
business events. If people expect prices to fall in the near future, for instance, they can suspend
further purchase now, and hold more money waiting to buy when prices will fall. In the same
way, if people think that prices are relatively low now and expect prices to rise in the near future
they will use their money to buy financial assets which they will sell later when prices will rise.
The amount of money for speculative purpose is not based on the level of income. It is
determined by what people expect to gain or to lose by holding other assets. This expected gain
or loss depends on the interest rate.
Lord Keynes used movement in bond prices to illustrate the speculative motive for holding
money and how this is influenced by interest rates. This is expressed in the equation below as:
V = R/r
where V - is the current market value of a bond
R - is the annual return on the bond and
r - is the rate of return currently earned or the market rate of interest.

3.4 Determinants of Money Demand

Apart from the factors identified by Keynes, other factors were later identified by Professor
Milton Friedman in his modern quantity Theory of Money. These include the price level, the rate
of change of prices or inflation real permanent income or wealth and return on bonds and
equities. Therefore, the determinants of money could be seen as
(a) Income Demand for money varies directly with the level of income, that is, the higher the
level of income, the higher the level of income, the higher the level of money demand.
(b) Interest Rate Demand for money varies inversely with the interest rate.
(c) Price level There is direct positive relationship between money demand and the price level.
(d) The Rate of Price Changes Inflation rate varies inversely with money demand. This is a
weak determinant of money.
(e) Real Permanent Income Real permanent income or wealth varies directly with money
demand.

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(f) Return on Bonds and Equities The higher the return on bonds and equities the lower the
demand for money.
3.5 Quantity Theory of Money
The classical quantity theory of money was developed by Irwin Fisher in 1911 and was generally
accepted view until the 1930’s about the relationship between the amount of money in economy
or circulation and the level of prices. It is a theory about how much money supply is needed to
enable the economy to function. The quantity theory took the view that money was used only as
a medium of exchange to settle transactions involving the demand and supply for goods and
services. The theory is based on the simple identity between total money spend and the price
level in the economy. This is illustrated with an equation.
MV = PT
Where
M - is the money supply
V - is the velocity of circulation i.e. the rate at which money changed hands in the society.
P - is the Price level
T - rate of Transaction

Given the assumption that ‘V’ and ‘T’ are constant, the price level ‘P’ varies directly with the
amount of change in money supply i.e. P = MV T
3.6 Criticisms of Quantity Theory of Money
Today, no one accepts that the influence which money has on the economy can be explained in
terms of a simple quantity theory. To a lesser or greater extent, they would question the three key
assumptions necessary to convert the equation of exchange into a theory of the determination of
prices. As we have seen, these three key assumptions were:

 the velocity of circulation of money is constant.

 the stock of money is an instrument which can be controlled. ·
The validity of these three assumptions is critically on the grounds that
(a) prices cannot respond quickly to changes in money supply;
(b) an increase in the distribution of wealth might result from an increase in the money supply
and price levels;
(c) if people expect price to rise, they might decide to hold more of their wealth in physical
asset and less in money and so the velocity of circulation will fall;
(d) people must be fooled by inflation.

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Does it offer an adequate explanation of inflation?

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CHAPTER THREE
SUPPLY OF MONEY
CONTENTS
1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Supply of Money - Meaning
3.2 Determinants of Money Supply
3.3 Money Stock Composition - (Measuring Money)
3.4 Factors that affect Money Supply
3.5 Problems in defining Money Supply

1.0 INTRODUCTION
A type of financial asset that has long been believed to have special macro-economic
significance is money. Money is the economist’s term for assets that can be used in making
payments such as cash and cheque accounts. One reason that money is important is that most
prices are expressed in units of money used in the three markets in our model of the macro-
economy. The three markets are the labour market, the goods market and the asset market. By
asset market we mean the entire set of markets in which people buy and sell real and financial
assets, money just like every other commodity or financial asset has its own demand and supply.
In this unit, we shall consider the Supply of Money, in the asset market.
2.0 OBJECTIVES
At the end of the unit, you should be able to:
 define the Supply of Money.
 understand the determinants of Money Supply.
 estimate the money stock.
 identify the problems associated with the definition of money supply.
3.0 MAIN CONTENT
3.1 Supply of Money
The supply of money in any economy at any particular period is the total sum of all money held
by all members of the society. Generally, money supply is taken as the total amount of money in
circulation at any given time e.g. notes and coins and demand deposits in commercial banks.
Afolabi (1991) explained “Supply of Money” as the amount of money which is available in an
economy in sufficiently liquid and spendable form. “What constitutes the components of this

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supply of money depends on what has been officially accepted as the constitutes of Money
Supply for that country”. Thus, each country’s money supply definition may be unique.
Ajayi and Ojo (1981) defined money supply in Cameroon as the total sum of currency outside
the banks, demand deposit at Commercial Banks, domestic deposits with the Central Bank less
Federal and State Government’s demand deposits with the Central Banks. They proved that the
preponderance of the money supply in Cameroon consisted of currency outside banks and this
probably still applies.
Bowden (1986:114) an American author simply defined it as the actual number of “spendable
dollars” in existence. At first instance, his definition appears to refer only to the physical dollar
in circulation. But notice that he put the “spendable dollars” in quotes. He used this term to
include money created by the banking system such as demand deposits, which can be used to pay
for debts by the issuance of cheques. Money supply is, therefore, the quantity of money available
for spending at each point in time.
3.2 Determinants of Money Supply
It is normally assumed that the nominal money supply is exogenously determined i.e. it is
supplied by the monetary authority or Central Bank. But the real money supply is endogenously
determined since the price level variation cannot be fixed.
Ajayi and Ojo (1981) have also established that the following three economic factors determine
the supply of money or the quantity of money in the economy.
(a) The behaviour of banks concerning the amount of reserves that they want to hold. This
decision on reserves is a function of the profit maximising behaviour of banks and the
expectation of the managers with respect to economic environment
(b) The behaviour of the non-bank public with respect to the way they divide their wealth or
money holdings between cash and demand deposits (i.e. the proportion of total wealth that
people want to hold in cash).
(c) The behaviour of the Monetary authorities with regards to the decisions about the size of
the monetary base, Legal reserve ratio, and the discount rate. (The monetary base is the currency
in circulation plus all the assets that banks are allowed to count while computing their legal
reserve ratio).
In determining the level of money through the exogenous factors, the government increases or
reduces the supply in accordance with the desired economic target they want to achieve.
Ojo, M. O. (1993) puts it this way “a Monetary Control framework begins by establishing a link
between the monetary control instruments and the ultimate target for output, growth, inflation
and the balance of payments”.

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3.3 Factors that affect Money Supply

The general belief is that the BEAC issues notes and coins on behalf of the Federal Government,
it must be the Central Bank that determines the stock of money supply, this may not be entirely
true.
Afolabi (1991) has given five factors that could affect money as follows:
(i) Monetary base or High Powered Money: The money supply will naturally increase if the
Central Bank expands the monetary base. The monetary base or high powered money is the total
of bank reserves plus currency in the hand of the public.
(ii) Credit Creation: When banks create credit, the credit will in turn lead to demand deposit and
so on.
supply of Money 1s The extent to which commercial banks are allowed to create credit will
therefore affect the extent of money supply.
(iii) Portfolio behaviour of the Public: If most people keep their money in the bank, the
banking system will have Liquid reserves to lend out and create derivative deposit which is the
deposit created through lending. If the marginal propensity to hold currency increase, the
Liquidity of commercial bank will go down and money supply will similarly fall.
(iv) Reaction policies of the Central Bank: Monetary policies of the BEAC applied in reaction
to the dictates of the economy will have effects on money supply.
(v) Foreign Exchange Transactions: Domestication of Foreign Exchange will have the
tendency to increase domestic money supply.
Specifically, money supply is also influenced by the other following factors:
(a) Total reserves supplied by the Central Bank: If the total reserves supplied by the Central
Bank is high, money supply will be high.
(b) Reserve Requirements: If the reserve requirement - percentage of commercial banks
deposits legally required to be kept with the Central Bank is high money supply will be low.
(c) If the non-bank public increases its demand for time deposits, money supply will increase.
(d) Demand for Currency: If the non-bank public increases its demand for currency, money
supply will increase.
(e) Demand for excused reserves: If commercial banks demand for excess reserves increases,
money supply increases.
(f) Interest Rates: There is a positive relationship between money and interest rate. That is, the
higher the interest rate the higher the money supply.

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(g) The Bank Rate: If the rate at which commercial banks borrow from the Central Bank or
discount bill rises, money supply falls.
3.5 Problems in Defining Money Supply
There were difficulties with the monetarist thesis, neither of which was satisfactorily resolved.
First, in an advanced and more important an evolving-financial system, it was not possible to
define the tock of Money in an unambiguous way, or at least there were a number of different
but equally valid definitions of the money supply and there was no strong reason for choosing
one in preference to any other. As we have seen, money can be defined either narrowly or
broadly. However, there are or have been within the Cameroonn institutional context a number
of different definitions of the money supply. The definitions change frequently as does the
popularity of one measure over another which partly illustrates the difficulty in trying to pin
down the concept.
Examine the problems in defining money supply.
4.0 CONCLUSION
Money supply represents the total amount of money in the circulation of a given country. It
comprises all those things which possess the characteristics of money. In Cameroon,
money supply are broadly classified into two: (i) Narrow Money Supply (M1) and (ii) Broad
Money supply (M2).
In Modern economics, the money supply is determined by the Central Bank such as Bank of
England, BEAC
The terms ‘money supply and ‘money stock’ are used inter-changeably. The problem of defining
money supply is still associated with a considerable degree of controversy.

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CHAPTER FOUR
TYPES OF FINANCIAL INSTITUTIONS
CONTENTS
1.0 Introduction
2.0 Objectives
3.0 Definitions
3.1 Financial Institutions
3.2 Types of Financial Institutions
3.3 Bank Financial Institutions
3.4 Non-Bank Financial Institutions
1.0 INTRODUCTION
In the last unit, we discussed exhaustively the supply of money and now we want to focus on the
Financial Institutions that are responsible for the supply of money. The Financial Institutions
operate and function in an economic system. In its ordinary usage, the word “System” can be
used to refer to “a group of related parts working together”. This is the sense in which it is used
here - the financial institutions working together to provide the financial services required in an
economy. The Cameroonn Financial System comprises the banking system (all the banks) the
non-bank financial institutions, the regulatory bodies, and other financial market participants,
that play the role of financial intermediation in the Cameroonn economy. The Central Bank of
Cameroon Briefs (1996) defined a financial system as “a conglomerate of various
institutions, markets, instru- ments, and operators that interact within an economy to provide
financial services. Such services may in- clude resource mobilisation and allocation of financial
intermediation and facilitation of foreign exchange transactions to enhance international trade.
2.0 OBJECTIVES
At the end of this unit, you should be able to:
 define Financial Institutions fully. 
 recognise the various types of Financial Institutions.
 arrange Financial Institutions into bank and non-bank financial institutions.

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3.0 Definitions
3.1 Financial Institutions
Financial institutions are institutions which serve the purpose of channelling funds from lenders
to borrowers. They hold money balance of, or borrow from individuals and other institutions, in
order to make loan or other investments. Finance has to do with money. It is an organised system
of managing money i.e. a system of lending and borrowing money.
A Financial Institution acts as an intermediary between those individuals or firms who wish to
lend and those who wish to borrow. The existence of financial intermediaries reduces the risks
by allowing specialist institutions to evaluate the credit worthiness of borrowers. The risk
reduction may encourage lending and thus reduces the interest rate of most individuals and risk
averters.
Institutionally, it is common to distinguish between banks and non-bank financial institutions.
The importance of the former is that their liabilities enter the common definitions of the money
supply. The liabilities of non-bank financial institution may enter some money supply definitions
or they may be classed as “near money” depending on their liquidity. Examples of non-bank
intermediaries/ institutions listed in terms of decreasing liquidity are: Building societies, Savings
banks, Hire purchase, Insurance companies, Pension funds and Investment trusts
3.2 Types of Financial Institutions
Financial Institutions can be broadly classified into two: banks or bank financial institutions in
the banking sector and non-bank financial institutions.
Commercial, Central, Merchant and Development banks are in the banking sector while Building
Societies, Hire Purchase Companies, Insurance Companies, Pension Funds and Investment Trust
are non-bank financial institutions.
While liabilities of banks form part of the money supply, the liabilities of non-bank financial
institutions do not for they are referred to as “near money”.
In Cameroon, the following types of financial institutions can be identified.
 Traditional Financial Institutions –
 Commercial Banks - Central Banks –
 Development Banks –
 Insurance Companies –
 Community Banks –
 Savings and Loan Associations –
 Investment and Unit Trusts –
 Credit and Cooperative Societies –

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 Pension Scheme (CNPS), (NSI)

 Financial Companies
3.3 Bank Financial Institutions
Structurally, the bank-financial institution is made up of:
Types of Financial lnstitutions
(a) The Supervisory and Regulatory Authorities: They comprise the BEAC which is the
Principal regulatory body, Ministry of Finance. COBAC, APECAM NCC. These Supervisory
bodies are also referred to as monetary authorities.
(b) The Banking System (Banks): The banking system comprises all the banks that operate
within the economy. This includes commercial banks, merchants banks, development banks and
other specialized banks. Apart from few development banks, all these banks collect deposits,
and give out loans. They are key actors in performing the role of financial intermediation.
3.4 Non-Bank Financial Institutions
Apart from banks, there are other institutions that perform the role of financial intermediation.
These other institutions are called non-bank financial institutions. At times, they are simply
referred to as other financial institutions. These institutions include finance house, savings and
loan institutions, insurance companies, the discount houses, Bureau de Change, Pension and
other trust funds. There are also informal savings and loan associations like cooperative
societies, ESUSU or Isusu groups known as “Ajo” and Alashie in Hausa language. An Isusu
group is an association of like-minded individuals who contribute a pre-determined amount of
money which is given to each member of the group one after the other after each collection. The
amount may be contributed on weekly or monthly basis.
4.0 CONCLUSION
Financial Institutions are establishments that issue financial obligations such as demand deposits
in order to acquire funds from the public. The institutions then pool these funds and provide
them in larger amounts to businesses, governments or individuals. Examples are commercial
banks, insurance companies, savings and loan associations. In some countries, financial
institutions are also known as “Financial Intermediaries”.
Financial Institutions can be classified into bank and non-bank Financial institutions. Bank
Financial Institutions include the central banks, the commercial banks and the development
banks. Non-bank financial institutions include discount houses, issuing houses, insurance
companies, building societies and the stock exchange. These institutions operate in markets with
instruments to acquire funds from the public for investment.

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UNIT 5 FUNCTIONS OF FINANCIAL INSTITUTIONS

CONTENTS
1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Definitions
3.2 Banks Financial Institutions
3.2.1 BEAC
3.2.2 Commercial Banks
3.2.3 Merchant Banks
3.2.4 Development Banks
3.3 Other (Non-Bank) Financial Institutions
3.3.1 Insurance Companies
3.3.2 Finance Companies
3.3.3 Primary Mortgage Institutions
3.3.4 National Economic Reconstructions Fund
3.3.5 Traditional Financial Institutions
3.3.6 Discount Houses
3.3.7 Cameroonn Social Insurance Trust Fund
3.3.8 Thrift and Credit and Co-Operative Societies
3.3.9 Investment and Unit Trusts
3.3.10 Savings and Loans Associations
3.4 Specialised Banks (Non-Conventional Banks)

1.0 INTRODUCTION
In the last unit, we have been able to compose and specify what financial institutions are. This
will help to assemble the functions of the various financial institutions in this unit.
Having defined what financial institutions are legally, the laws also establishes different types of
financial institutions. The types of financial institution depends on the law establishing it and its
functions. Depending on the stage of economic political and technological developments in a
nation, each nation has the authority to grant licences to various types of financial institutions.
3.0 MAIN CONTENT
3.1 Definitions

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Financial institution is an institution either public or private that collects funds from the public
or other institutions and invests them in financial assets.

3.2 Banks Financial Institutions

3.2.1 BEAC (assignment; write an essay on the functions, composition, structure of BEAC)
3.2.2 Commercial Banks
The Banks and other financial institutions Decree No 25 of 1991 defined a commercial bank as
“any bank in Functions of Financial Institutions Cameroon whose business includes the
acceptance of deposits withdrawable by cheques. This definition presents the major
distinguishing functions of commercial banks from other banks. According to Osumbor (1984)
in his book Business Finance and Banking in Cameroon, commercial banks are unique in their
performance of services and are distinguished from other forms of financial institutions or
intermediaries because of the following functions:
 Accept deposits from customers i.e. savings, current or demand deposit, fixed deposit or time
deposit. Lend money to approved customers i.e. overdraft, loan. 
 Allow the use of cheque 
 Safe-keep valuable assets for customer. 
 Provision of standing order facilities. 
 Give business advice to their customers. 
 Agents of government for monetary policy. 
 Assists customers for acquisition and sales of shares. 
 Issue of discount bills of exchange i.e. payment on behalf of customer. Commercial bank
creates money, this is done through deposits. Money created = Original Deposits. Cash
ratio or reserve requirements. 
 They are involved in agricultural financing. 
 They offer employment opportunities. 
 They act as guarantors to their customers. 
 They solve problem of foreign exchange. 
 They issue traveller’s cheques. 
 Their activities accelerate the economic development of a nation since they act as
intermediaries between large number of depositors and borrowers.
 These banks could assume the responsibility of carrying out the duties of attorney, executor
and trustee.
3.2.3 Merchant Banks
According to the Cameroonn Banking Amendment Decree (No. 88) of 1979, Merchant Bank
means any person in Cameroon who is engaged in wholesale banking, medium and long-term
financing equipment leasing, debt factoring, investment management issue and acceptance of
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bills and the management of unit trust. They are also called Acceptance Houses or Discount
Houses. Functions or services of merchant banks are often divided into two classes - banking
and corporate finance services.
Banking Services / Functions: 
 Acceptances of Merchant Banks (MB) accept bills of exchange from importers and exporters
which are easily rediscountable. 
 Loans and Advances - MB provides loans and advances of short, medium and long term
nature. 
 Deposits - MD accepts the following deposits- current account deposits for corporate clients,
fixed-term deposits accounts for both corporate and noncorporate clients and Negotiable
Certificates of Deposits. 
 Equipment leasing - MDs lease equipment, machine, tools, motor vehicles to farmers and
industrialists. 
 Foreign Exchange Services: MBs as authorised dealers performing foreign exchange
services: Corporate Finance Services. 
 Project Financing: MBs finance the construction of new projects or ventures. 
 Issuing House Services or Public Issue - MBs provide services to clients who want to raise
money from the public through the offer for subscription of shares/ securities. 
 Investment and financial advisory services. 
 Portfolio management. 
 Money Market Services. 
 Help to finance international trade 
 Debt factoring - Taking over the debts of a firm and thereafter provides her with the amount
to finance the businesses.
Assignment; Compare functions of Merchant Banks with that of Commercial Banks. ?
3.2.4 Development Banks
Development banks are financial institutions which are set up to provide banking services that
will help in the development of a particular sector or aspect of the economy. They are normally
government owned institutions set up for the sole purpose of enhancing economic development
rather than for profit motives. The major reason for the introduction of development banks is to
bridge the gap in the provision of long-term finance for individuals. The existing Commercial
and Merchant banks specialise in the provision of short term and medium-term finance because
of their deposit structure. They could provide the much needed long-term finance. Another
reason is the exigency of providing credit facilities to the priority sector of the economy. Other
banks are reluctant to give such credit facilities because of the high-risk involved. Instances of
such sectors are Agriculture, Commerce, Cooperatives, and small scale industries. This is what
Professor G. O. Nwankwo (1980) called the “gap thesis” and “exigency thesis”.

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Examine the main functions of the various types of Development Banks.

3.3 Other Non-Banks Financial Institutions

3.3.1 Insurance Companies

Primarily, insurance companies provide against the various risks that often arise within the
economy. They do these by spreading the losses to the unfortunate few over many people. In
performing these functions, they collect premiums from several insured. This role is similar to
the mobilisation of savings by banks in the sense that a large amount of money is pooled together
as premium. The amount so collected by the government securities, public sector enterprises,
and shares of private companies. By doing this, they have performed the role of financial
intermediation, Insurance companies in turn insure the Cameroonian reinsurance corporation
 Insurance companies provide the most effective method of handling many of the pure risks
encountered by individuals and firms.
 Insurance companies facilitates risk transfer. They accumulate substantial funds which are
used for long-term investment. 
 Through their life and pension businesses they help to develop the financial markets  They
help to mobilise national resource by encouraging individuals to save. 
 They operate pension scheme on behalf of companies. 
 They grant loans to mortgages. 
 They act as underwriters in the capital market. 
 Insurance policies are used as collateral securities for bank loans. 
 They help to improve the balance of payments position of the country by insuring imports
and exports and through reinsurance, Marine Insurance facilities international trade. 
 It promotes bilateral and multi lateral trade. 
 Insurance gives the entrepreneur the confidence and provides him the security needed to
venture into uncertain areas. It reduces the burden of losses of the entrepreneur. 
 Information released by insurers on incidence of certain risks enable people to take more
measures to avoid such loss. 
 It provides employment opportunities to people
3.3.2 Finance Companies
Finance Houses mobilise funds from the public mainly through the issuance of money market
instruments like certificates of deposits, and other commercial papers. They provide these funds
to investors in the form of short-term and medium-term finance such as local purchase order
(LPO) financing, leasing, hire purchase, debt factorising and investment in securities. These
assets being financed by them often act as a security for their lending.
These are sometimes referred to as Hire Purchase Companies.

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3.3.3 Primary Mortgage Institutions

These are institutions involved in mortgage financing apart from the Mortgage Banks. They are
referred to as primary because they deal directly with individuals and firms, while the Federal
Mortgage Bank serves as a supervisory body. These institutions are also involved in the financial
intermediation process. They mobilise savings from savers and borrow from other institutions to
finance the development of the housing sector.
A mortgage bank is a financial institution established for the acceptance of fixed deposits from
members of the public with the aim of encouraging them to build their own house by offering
them long-term loans. They are also known as building societies.
Functions of Mortgage Banks

 They accept fixed deposits from members of the public.

 They encourage members of the public to save money.
 The construct and provide houses to low group.
3.3.5 Traditional Financial Institutions
Traditional financial institutions are traditional credit groups such as “Esusu” which were
originally the insti- tutional agencies for credit supply to members and Esusu or Nsusu or Asuu.
It is a kind of cooperative which consists of people who agree to contribute a certain sum of
money and hand it over to a member of the group. They take the form of associations of people
in the same place of work who matually agree to come together in order to encourage one
another to save, lend and manage money.
Functions of Traditional Financial Institutions
 They encourage their members to form the habit of saving money. 
 They encourage their members to invest the money they have saved. 
 They lend money to their members. 
 They save their members the pains of going to banks to borrow. 
 They inculcate the principles of democracy in their members. 
 They discourage their members from being extravagant.
3.3.6 Discount Houses
Discount houses are institutions that specialise in the provision of discounting and discounting
facilities, buying and selling of securities, especially government securities. They act as financial
intermediaries. They also issue their own securities to banks as a mean of raising funds.
3.3.8 Thrift and Credit and Co-operative Societies

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The main functions of Thrift, Credit and loans Cooperative societies is to raise investment
finance. Members pays an agreed sum of money every month into a common fund. The members
borrow at a certain interest rate. This type of Co-operative society is a savings club and is
popular amongst traders, artisans and peasant farmers.

Functions:
 It is a valuable means of mobilising some capital for investment  .
 Members obtain loans easily from their society and there is no requirement for a collateral.
The only condition required is an approved project plant for which the loan is required. 
 Members form the habit of saving a little of their income, especially in the rural areas, where
banking facilities are scarce.
 Exposure of monthly meetings and regular co-operative education means greater enlightment
for members.
3.3.9 Investment and Unit Trusts
The function of investment and unit trusts is to raise collective capital from the public and to
direct such funds into profitable investment channels. The two different types of organisation
enable the small investors with limited capital to spread his risks over a wide range of securities
under full time specialist management.
A unit trust on the other hand, is a method of investment whereby money subscribed by many
people is pooled in a fund, the investment and management of which is subject to the legal
provisions of a trust deed.
3.3.10 Savings and Loans Associations
These are said to be the best known non-bank intermediaries. These associations were originally
organised to make mortgage loans to their own members, but they have increasingly emphasised
theirs as savings institutions, catering to small investors and local governments and even state
government.
The principal asset of these associations is conventional mortgage loans for family dwellers
while their liabilities consist of depositors funds, principally from the government and share
accounts savers. The associations normally in good time pay interest which is usually higher than
that paid by commercial banks on their savings deposits. They are also allowed to issue large
denomination of certificates of deposits.
(i) the provision of basic credit requirements of under-privileged who are involved in
legitimate economic activities in both urban and rural areas and who cannot normally
benefit from the service of the orthodox banking system due to their inability to provide
collateral security.

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CHAPTER FIVE
INFLATION
CONTENTS
1.0 INTRODUCTION
In the last unit, we examined the control of financial institutions and the consequent role that the
various supervisory and regulatory authorities play in the determination of money supply. In this
unit, we shall review inflation.
The economic spectre of the economic depression period was the demoralising level of
unemployment. The implementation of economic policies following the war allowed over 30
years of unemployment problems. The worry of unemployment has given way to a concern over
inflation, the condition of generally rising prices and the bulk of post economic policies may be
seen as a continuing fight to restrain price increases and the distortions created by them.
In a very general sort of way, inflation simply means rising prices. Although prices do not
always change together, the interdependence of different parts of the economy does tend to
punch up all prices together. The main purpose of this chapter is to examine some of the
causes/theories of inflation and to see if they are applicable in Cameroon situation. In earlier
units, the causes of inflation have already been considered implicitly. Firstly, an excess of
aggregate demand over aggregate supply when output cannot increase will cause a rise in prices.
This sort of inflation is called “demand inflation” (sometimes also demand-pull-for some
obvious reasons). For these reasons inflation is usually an important element in an excess
demand situation. The second type of inflation already considered is what might be called
“monetary inflation”, that is rising prices caused by increases in the money supply.
3.0 MAIN CONTENT
3.1 Meaning/Definitions of Inflation

Inflation has become a household word in Cameroon. It is no longer a strange economic jargon
to any student. There is hardly any Cameroon citizen who does not worry about rising prices and
the high cost of living. In the ordinary sense, inflation is seen as an increase in the average level
of prices. In economics, it is defined as a condition in which supply persistently fails to keep
pace with the expansion of demand. It is a state of disequilibrium in which too much money is
chasing too few goods.
Inflation is a period of general increases in the price of goods and services in an economy.
Inflation can be measured using the following methods.

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(a) Consumer Price Index - It measures inflation at the price where goods are consumed.
(b) Wholesale Price Index - In this, inflation is measured at the wholesale stage.
(c) Gross Development Product Deflator - More often this is used to measure variations in the
computation of economic activity in developing countries.
None of these indices will give an unbiased result because at any point in time, there is a new
product being introduced in the economy.
3.2 Types of Inflation
(a) Demand-Pull Inflation: This is induced by excessive demand not matched with increase in
supply. Here, too much money is chasing too few goods. Give a fixed stock of goods, any
increase in demand brought about by increase in people’s disposable income will force prices up
in the market.
(b) Cost-Push Inflation: This is induced by rising cost of production, particularly rising wages.
If we take the four factor rewards/wages, profit, interest and rent, we would note that only wages
could be influenced considerably by human factors.
(c) Hyper-Inflation: This occurs when the level rises at a very rapid rate. In this case, money
loses its function as a store of value and its medium of exchange function may be affected if
people are unwilling to receive it, preferring trade by barter.
This was the situation in Germany after World War II in 1945 when people preferred cigarette to
money.
The main cause of hyper-inflation is an enormous expansion of the money supply.
STUDENTS ASSESSMENT EXERCISE
(i) Distinguish between the various kinds of inflation relating yours to the Cameroonn Economy.
(ii) “Trade Union cause Inflation”. Comment.
3.2.1 IMPORTED INFLATION
If a country depends so much on imports, inflation in the exporting country will readily be
transmitted to the importing country. Let us assume that Cameroon imports commodity X from
Britain and at the same time produces some small but inadequate quantity of that commodity X.
If there is inflation in Britain and assuming that commodity X must be imported because it is
essential and from Britain, the importation will be at the inflated price and this will force
domestic prices upwards because the imported ones would have to be sold side by side with
their local counter parts and the high price will be transmitted especially if there are no
differences in quality or preference.
3.3 Causes of Inflation in Cameroon

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Generally, the following could be said to be the causes of inflation.

(1) Excessive Money Supply: Excessive money supply through poor monetary policy or other
methods invariably lead to inflation in Cameroon, the 1974 Udoji Salary Award and the 1981
Minimum Wage Act injected a lot of money in the economy thus causing inflation.
Expansionary monetary policy is also a contributory factor.
(2) Fall in the Supply of Goods and Services: Agriculture is virtually abandoned in Cameroon.
It is only left to the aged in the remote villages who practice subsistent farming using out-dated
or archaic methods. This shortage of commodities has been one of the most influential causes of
inflation in Cameroon today. Rising wages also increase production costs. This, thus, leads to
decreased supply of commodities thereby causing rise in prices. Thus, the prices of few
commodities that found their ways into the country and those produced locally were soaring.
(3) Budget Deficits or Government Expenditure Programme: Almost all the governments of
West African countries have been experiencing budget deficits since the 1970s. There is also
enormous increase in government expenditure on development programme and other capital
projects or expenditures. These have contributed greatly to inflationary trends.
(4) Imported Inflation: Almost all our manufactured goods in Cameroon are imported from the
advanced nations of the world who are currently experiencing inflation. This means a direct
importation of these higher prices to West African nations. Importation of goods from countries
suffering from inflation could lead to imported inflation into the country which also increase
domestic price.
(5) Rural-Urban Drift/Migration: The mass drift to urban areas has left the Agricultural sector
unattended to. Moreover, the little goods and services in the urban areas are grossly inadequate
hence inflation results.
(6) Increase in population Explosion: There is enormous increase in the population of West
African nations in particular and the whole world in general. For Cameroon, her estimated
population increased from about 15m in 1963 to more than 18.5m in 1991.
(7) Activities of Middlemen and Monopolistic Tendencies: There are too many middlemen in
the chain of distribution of goods and services in Cameroon. These people are very exploitative
hence they hoard available goods in order to sell at higher prices in “Black Markets”.
(8) Excessive Demand by Consumers: Increase in the purchasing power of consumers leads to
higher demands and thus inflation. This is the case in Cameroon due to higher wages resulting
from frequent upward salary adjustments and revisions.
The inflation we have in Cameroon can be rightly described as demand-pull because there has
been an upward trend in demand for goods and services for the past thirty years which may be
the result of a rising standard of living of many Cameroons.

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(9) Higher Production Costs: Higher wages, as is the case in Cameroon are higher costs of
production.

They may hinder increased productivity, thereby resulting to inflation or the higher production
costs are passed onto consumers in the form of higher prices on commodities.
(10) War-Caused Inflation: During wars like Cameroonn/Biafran War, efforts were directed to
production of war equipment or armaments. Labour which could have produced foods was
deployed to the war fronts. Hence, demand could not equate supply. Inflation therefore resulted.
(11) Wage Increase Unrelated to Production: Since there have been general wage increases, the
most notorious was the Udoji wage review reports, the implementation of which almost troubled
the wage levels of most of the working groups. The most recent of this wage increase in the
country is the SAP relief and 45% wage increase. These wage increases were unrelated to
increases in productivity of workers. Hence high wages means high prices.
(12) Bad Management of Resources: The large-scale fraud and corruption which has started
since the oil boom era of early 1970s has been increasing the tempo of inflation in Cameroon.
Contracts most of which were not executed, were unbelievably inflated. Large sum of money
were siphoned into private pockets, some particular individuals become richer than the states.
Thus, money lost its traditional value. In pursuit of FCFA (XAF), most people abandoned
productive employment to become sales agents, contractors, importers and exporters. The effects
of all these were the disappearance of many essential and other goods from the Cameroonn
Market, coupled with usually rising prices.
STUDENTS ASSESSMENT EXERCISE
(i) To what extent is it possible to regard inflation as a purely monetary phenomenon? (ii)
Examine the quantity theory of money. Does it offer an adequate explanation of inflation?
3.4 Effects of Inflation (Problems)
(i) Distributive Injustice: Inflation imposes a lot of distributive injustice on the society by re-
distributing income in favour of one group to the disadvantage of the other groups. Examples are
discussed below:
(a) People on fixed income suffer: Such people like pensioners, fixed salary earners etc,
because there is no in-built flexibility in their income to make their income adjust in line with the
continuous rise in the prices of goods and services they buy. Thus the quantity of good and
services that their money income can buy will be diminishing progressively until they succeed in
improving their lot through bargaining for higher wages. On the other hand, those whose income
are flexible will benefit from inflation because they can always increase their income ahead of
price increase. Business men and other profit earners thus benefit from inflation (b) Inflation

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imposes adverse effects on savings: This is because real value of savings cannot be maintained.
By discouraging savings, inflation could be perpetuated because people will want to keep their
wealth in real assets as opposed to money. The Central Bank can, however, maintain the real
level of savings by adjusting interest rates but this will be an extra cost to the economy.
(c) Inflation Reverses the Position of Debtors and Creditors: Debtors gain while creditor lose.
The only way which the creditor could be saved is by imposing an interest rate which should
reflect the inflation rate; otherwise he will get cheap money back for dear money lent out.
(ii) Loss of Confidence in Money: At the extreme case of Hyper-inflation, there would be
economic depression such that business men may not know what to charge for their products like
the 1930s inflation in Germany when a packet of cigarette sold for millions of German marks
and buyers too will not know what to pay. In such severe cases, money virtually become
worthless. Suppliers of productive factors want to be paid in kind and not in cash, and creditors
will keep away from debtors as they do not want to obtain such cheap money from debtors.
Money will be deprived of its functions as an exchange medium and as a standard for deferred
payment. We have seen above that because of inflation, savings will fall thus money will cease
to be a store of value. As a measure of value or unit of account, money will also fail because the
instability of its own value will make it difficult for it to measure other values. With all these
developments, money will become virtually useless and this may bring a tendency for the society
to go back to barter exchange and subsistent production.
(iii) Expectation Effects: As a buyer, if I expect that price will rise tomorrow, I will want to buy
today so as to avoid paying higher price tomorrow whereas as a seller, I would wish to withhold
stock until the price rises tomorrow.
A situation of scarcity will, therefore, arise today and the current high demand will create
inflation today. This makes economist believe that “inflation will occur if people expect it to
occur”.
(iv) Wrong Investment Priorities: Inflation will precipitate wrong investment because it is only
those items whose prices are rising that people will concentrate production upon whereas they
may not be actually important. It follows in real life that ostentatious goods and such goods like
beer will attract more attention than essential items like agricultural products.
(v) Inefficiency and Poor Quality: In an inflationary period, goods will no longer be of the
required standard because of the haste to make profit. Emergency contractors and innumerable
unskilled people will go into contract jobs and such jobs as distributorship, increasing
distribution cost which is an aid of inflation.
(vi) Distortion of Government Development Plans: the costs of major investments are
disturbed by inflation such that government development plans are severely distorted. This may
lead to re-appraisal and deficit financing and some projects might be dropped out of the plan for

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reason of prohibitive cost. During inflation, new plans become difficult to formulate because
the planner will not know the prices to use.
(vii) Distortions in Accounting Reports
(viii) Balance of Payment Effect: Because domestic prices are higher, home made goods would
become more expensive relative to those in other countries. The country, therefore, becomes a
dumping ground for foreign goods, a good place to sell but a bad place to buy from and this will
have significant impact on foreign exchange earnings and on the balance of payment situation.
General Ways of Controlling Inflation in Cameroon
(1) Price Control Measure: This involves the setting up of Price Control Board by the
government which fixes maximum prices charged for certain commodities experiencing
inflation. Experience, however, has shown that this system bedeviled with a myriad of problems
does not work. The Cameroonn case is typical example. What usually results are hoarding,
profiteering and black-marketing, thus negating the initial aims.
(2) Wage Control or Wage Freeze: Most of governments place freezes on wage increases as a
measure to combat inflation but this policy does not work or is ineffective since workers have
deviced methods of making the government or employers of labour dance to their tune. These
ways include go-slow, work-torule, industrial actions, etc. These are most often used in
democratic nations/ societies.
(3) Monetary Policy: This involves the use of traditional monetary instruments to reduce the
quantity of money in circulation. These include increase in the Bank or Discount Rate, increase
in the Liquidity ratio, use of open market operation - contractionary monetary policy in this case,
sectoral allocation or special directives, etc., however, the experience in the developing world
has these traditional instruments of monetary policy have a lot of deficiencies hence their
effectiveness.
(4) Fiscal Policy: A combination of increase in personal income tax and reduction in
government expenditure may prove effective especially when inflation is demandpull in nature.
These reduce the purchasing power of consumers thus reducing demand and prices of
commodities.
(5) Total Ban on the importation of certain items : Especially when inflation is imported, the
government is strongly tempted to place total ban on the importation of certain non-essential
items. However, retaliation by other nations and political pressure lead to the lifting of the ban no
sooner than it was placed hence the ineffectiveness of such a policy.
(6) Increase in the Production of Goods and Services: Increase in the production of goods and
services is the most effective measure to inflation. Increase in the supply of products will
naturally force prices down. In Cameroon, concrete efforts should be made to increase
production of essential but scarce commodities.

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(7) Over-hauling of the entire Distribution Network: Only genuine distributors should be
appointed and any one found hoarding and profiteering should be prosecuted to serve as a
deterrent to others.

CHAPTER SIX
DEFLATION
CONTENTS
1.0 INTRODUCTION
The last unit was dominated by the discussion on inflation. In this unit, we shall concentrate on
deflation in order to be able to distinguish between two of them.

When the prices of most goods and services are rising over time, the economy is said to be
experiencing inflation. Prior, to 1950, several European countries including Germany, France
and Italy had periods when prices rose very rapidly. This usually occurred during wartime and in
the years of rationing that followed.

These wartime periods of inflation were often followed by periods of deflation, during which the
prices of most goods and services fell. In some countries, such as Sweden, the Netherlands and
the U.K., the result of these offsetting periods of inflation and deflation was that over the long
run, the level of prices was fairly constant. The last significant deflation in Europe occurred
during 1929 - 33, the initial phase of the Great Depression. Since then, inflation without
offsetting deflation has become the normal state of affairs. Deflation is a situation in which the
prices of most goods and services are falling over time.

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79

2.0 OBJECTIVES

At the end of this unit, you should be able to:

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 define deflation.  determine the effects of deflation.  suggest the various ways of
controlling deflation. 3.0 MAIN CONTENT

3.1 Meaning/Definitions and Causes of Deflation

Deflation is a reduction in the general price level due to a decrease in the economic activity of a
nation. The price levels as well as national income; output and employment will all fall. During
the twentieth century, the only sustained period of deflation in the U.K. existed between 1920
and 1938 when the general prices level fell by almost 50%. Government introduced deflationary
policies for several reasons to decrease the rate of inflation, to cut the volume of import or to
prevent the economy from becoming “overhead.” Among the deflationary policies available to
the government are increases in level of taxation, and “credit sequences.”

Deflation is also the conversion of a factor such as a wage, the cost of raw materials, etc, from a
nominal to a real amount, when measured in monetary terms. For example, the nominal increase
in the price of consumer durables must be divided by the rate of inflation to arrive at the real
increase in the price. Also, Deflationary Gap is the difference between the amount that is actually
spent in an economy and the amount that would have to be spent in order to maintain output at a
level corresponding to employment.

Furthermore, Deflation refers to a persistent fall in general price level due to a reduction in the
amount of money in circulation. It is the opposite of inflation.

It is a continuous fall in the price level of goods and service in a country as a result of decrease in
the volume of money in circulation used in the exchange of large available goods and service.
From the foregoing, the cause of Deflation is summarised below. · Under population ·
Increase in production · Increase in taxation · Increase in bank rate · Compulsory bank
savings · Executive price control
Surplus budget or reduction in government expenditure.
STUDENTS ASSESSMENT EXERCISE
(i) Explain the term Deflation and examine its causes. (ii) (ii) Distinguish between Deflation
and Inflation.

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3. 2 Effects of Deflation
Since deflation is the opposite of inflation, its effects are the opposite of the effects of inflation
already discussed in Unit Seven.

(a) Effects on Incomes People with fixed incomes - salary earners, pensioners benefit from the
fall in price level while people whose income are not fixed lose. Income of businessmen,
manufactures, shareholders fall because of fall in profits. The real value of fixed income earners
rise when prices fall.
(b) Fall in investment and employment: Fall in profits leads to decline in investment and
consequently in employment. The total output (or national income) working through the
multiplier process also falls.
(c) Borrowers lose while lenders gain, since the repaid debts can buy more because of falling
prices
(d) Exports are encouraged while consumption of imported goods fall because their prices are
relatively dearer than domestic projects.
(e) Due to falling imports and rising exports, foreign exchange rises while balance of payments
problems or deficits are eliminated or corrected.
The effects of deflation are further summarised as follows: 
Money gains more value
It encourages export
It discourages imports
Decrease in investment
It encourages savings
Reduction in profit
Fall in prices of goods and services
It causes unemployment
Money lenders gain at the expense of borrowers
Improvement in the balance of payments
Fixed income earners will gain
It will instill sense of hardwork on the people.
Discuss the effect of Deflation.
3.3 Control of Deflation
The terms deflation, reflation “both refer to demand. Deflation means a reduction in demand.
Reflation is the opposite - an increase in demand. The odd one out is inflation, since it refers to

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prices. Curiously or perhaps not so curiously, there is no single word, which is the opposite to
inflation - we have to use a phrase such as “ a fall in the price level.”
Deflation can be checked by reversing those measures for checking inflation: Specifically, these
measures are as follows:

(a) Government should encourage investment by reducing the bank rate thus making it cheaper
for investors, businessmen and consumers to borrow money. That is, expansionary monetary
policy that liberalises credit facilities can remedy deflation.
(b) Reduction of Taxes The government should also reduce taxes (particularly income taxes)
to increase people’s disposable income and thus purchasing powers.
(c) Increase in Government Expenditure The Government expenditure should rise in order to
increase employment and personal income of consumers.
(d) Increase in Salaries and Wages
The control of Deflation is further summarised as follows:-
(i) Deficit budget (ii) Increase in wages (iii) Reduction in bank rate (iv) Reduction in income tax
(v) The use of Open Market Operation

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CHAPTER SEVEN
TOOLS OF MONETARY POLICIES
CONTENTS
1.0 INTRODUCTION
In this unit, we will focus our attention on the effectiveness of monetary policies in changing the
level of real income. We will attempt to delineate the conditions that are favourable and those
that are unfavourable for the successful operation of the respective policies. We will also resort
to the findings of empirical research to see the impacts of the policies.
As we have seen, in the previous units from our study of financial institutions, the Government
needs to influence the level of employment, the rate of inflation or economic growth, or the
balance of payments, it will implement some kind of monetary policy. Such a policy is designed
to influence both the supply of money and its price. If the volume of money circulating in the
economy is increased, the level of Aggregate Monetary Demand (AMD) is likely to rise. If the
price is the money, that is the rate of interest payable for its use, is reduced, the level of AMD is
again likely to be stimulated.
3.0 MAIN CONTENT
3.1 What Is Monetary Policy? - The concept of Monetary policy
Simply put, monetary policy is a government policy about money. It is a deliberate manipulation
of cost and availability of money and credit by the government as a means of achieving the
desired level prices, employment output and other economic objectives. The government of each
country of the world embarks upon policies that increase or reduce the supply of money because
of the knowledge that money supply and the cost of money affect every aspect of economy. By
affecting the aggregate demand, money supply affects the level of prices and employment. It also
affects investment levels, consumption, and the rate of economic growth. An increase or
reduction in the cost of money (interest rate) affects all these variables. One idea is central in
this and other definitions given above - that monetary policy focuses on money supply as a
means of achieving economic objectives. If the government thinks that economic activity is very
low, it can stimulate activities again by increasing the money supply. But when the economy is
becoming so much that the rate of inflation is high, it will reduce the supply of money. This will

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reduce aggregate demand in and the general price level. However, it can also lead to
unemployment and stunted economic growth. As you will see later, there is often a conflict
between the objectives of monetary policy. It is difficult to achieve all the objectives
simultaneously. Monetary policy is a major economic stabilisation weapon which involves
measures designed to regulate and control the volume, cost of availability and direction of
money and credit in an economy to achieve some specified macroeconomic policy objectives.
Monetary policy is administered by the BEAC, in some cases with degree of political/
Government Interference. As a watchdog of the economy, the Central Bank has the duty of
ensuring that policies are set in motion to ensure that the monetary system is directed towards
achieving national objectives.
Monetary policy is the control of the supply of money and liquidity by the Central Bank
through “open market” operations and changes in the “minimum lending rate” to achieve
the government’s objectives of general economic policy.
The control of the money supply allows the Central Bank to choose between “a tight money” and
“easy money” policy and thus in the short to medium-run to affect the fluctuation in output in the
economy. Monetary policy could, therefore, generally be defined as follows:
(a) As an attempt to influence the economy by operating on such monetary variables as the
quantity of money and the rate of interest; OR
(b) As a policy which deals with the discretionary control of money supply by the monetary
authorities in order to achieve stated or desires economic goals; OR
(c) As steps taken by the banking system to accomplish, through the monetary mechanism a
specific purpose believed to be in the general public interest; OR
(d) The use of devices to control the supply of money and credit in the economy. It has to do
with the controls that are used by the banking system.
(i) What is monetary policy? (ii) Who carries out monetary policy in Cameroon? (iii) Distinguish
between contraditionary and monetary policy.
3.2 Objectives of Monetary Policy
Generally, the objectives of monetary policy in various countries are the same as the economic
objectives of the government.
In Cameroon, the objectives of monetary policy as explained by the government of BEAC are as
follows:
(i) Promotion of price stability
(ii) (ii) Stimulation of economic growth
(iii) (iii) Creation of employment
(iv) (iv) Reduction of pressures on the external sectors, and

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(v) (v) Stabilisation of the FCFA exchange rate (ogwuma 1997:3). These are discussed
briefly in turns:
(i) Promotion of Price Stability This involves avoiding wide fluctuation of prices which are
highly upsetting to the economy. Not only do such wide prices gyrations produce windfall profits
and losses, but they also introduce uncertainties into the market that make it difficult for business
to plan ahead. They therefore, reduced the total level of economic activity. (ii) Slowly rising
prices, slowly falling prices and constant prices (though the last option is rather unrealistic in the
world). (ii) Stimulation of economic Growth i.e. - Achievement of a High, Rapid and
Sustainable Economic Growth: This mean maximum sustainable high level of output, that is, the
most possible output with all resources employed to the greatest possible extent, given the
general society and organizational structure of the society at any given time. This highly
desirable economic growth implies raising people’s standard of living. The growth of the
economy is the wish of every government and monetary authorities. Therefore, when growth is
achieved, it should be sustained.
(iii) Creation of Employment: Attainment of High rate or Full Employment: This does not
mean Zero unemployment since there is always a certain amount of frictional voluntary or
seasonal unemployment (Acklay, 1978). Thus, what most policy makers aim is actually
minimum unemployment and the percentage that varies among countries.
(iv) Reduction of pressures on the external sectors - i.e. Maintenance of balances of payments
Equilibrium: This involves keeping international payments of receipts in equilibrium, that is,
avoiding fundamental or persistent disequilibrium in the balance of payments positions. Usually,
however, nations worry about persistent balance of payments deficits. (v) Stabilisation of
FCFA (XAF) Exchange Rate - This involves avoiding wide swings (undue and unnecessary
fluctuations) in the currency exchange rate. This is meant to help in protecting foreign trade.
Instability in the economy creates an atmosphere of uncertainty for the investors and discourages
them from investing while stability encourages investment. Monetary policy will, therefore,
endeavour to achieve economic stability so as to encourage both local and foreign investors to
invest in the economy.
The above discussed objectives of monetary policy are achieved through the manipulation of the
monetary policy tools by the BEAC (BEAC).
Examine fully the objectives of monetary policy in Cameroon.
3.3 Stance of Monetary Policy
The stance of monetary policy refers to the position taken by (BEAC) - the monetary authorities
about whether to increase or reduce the supply of money in the economy during a policy period,
usually one year. This gives rise to two types of monetary policies, namely expansionary or a
monetary ease policy, and contractionary or stringent or tight monetary policy.

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Monetary policy is said to be an expansionary or a monetary ease policy when the monetary
authorities decides to increase the supply of money or reduce the cost of money in the economy
so as to stimulate an increase in economic activities. This can be accomplished through the
buying of securities in the open market, a reduction in interest and discount rates, a reduction in
reserve requirements, and relaxing of credit controls, among others.
A contractionary stringent or tight monetary policy does the opposite of an expansionary policy.
Monetary policy is said to be contractionary, stringent, or tight when the monetary authorities
embark on policies that will reduce the supply of money or increase the cost of money in
economy, in other to generate a contraction in economic activities. The effect of contractionary
policies is to reduce the general price level and curb inflation. However, it will equally lead to a
reduction in the level of investment, employment, output and economic growth.
The government switches from contractionary to expansionary policies as the need arises
depending on the economic objectives, which she is giving priority. In Cameroon, the stance of
monetary policy adopted has been varying from one regime to another.
Differentiate between Expansionary and Contractionary monetary policy. Examine/
discuss why both are necessary.
3.4 Monetary Policy Instruments/Weapons/Tools
Instruments of monetary policy are many and varied. Their respective effects on the economy
also vary in terms of where they start and transmission route. Sometimes, some tools are not
compatible with others i.e. in which case, the adoption of one set instruments will negate or be at
cross purposes with the effects of others. That is why monetary authorities usually consider the
operational efficiency, the technical features, the lags and other effects of any given instruments
before it can be used.
Instruments or tools of monetary policy can be classified into two:-
(a) Quantitative Instruments (Traditional and Non-Traditional).
(b) Qualitative Instruments (Ranlett, 1977).
A. Qualitative Instruments These are “impartial or impersonal” tools which operate primarily
by influencing the cost, volume, and availability of bank reserves. They lead to the regulation of
the supply of credit and cannot be used effectively to regulate the use of credit in particular areas
or sectors of the credit market.
Quantitative tools are further classified into traditional or market weapons and nontraditional
tools or credit direct control of bank liquidity.
1. Traditional or market weapons. This are called market weapon because they rely on market
forces to transmit their effects to the economy. Specifically, these tools include Open Market
Operations (OMO), Discount Rate Policy and Reserve Requirements.

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(i) Open Market Operations This is the buying and selling of securities by the monetary
authorities in the open market. Securities are sold to reduce money supply and bought to increase
money supply.
(ii) Discount Rate Policy or the Rediscount Rate Policy or Bank Rate Discount rates are
interest rates paid in advance based on the amount of credit extended by increasing the
rediscount rates that Central banks charges from borrowing for the Central Bank and makes
banks to increase their own discount rates and interest rates. This discourages banks lending and
reduces money supply. A reduction in rediscount rates increases the supply of money. Interest
rates is the cost of borrowed money. An increase in interest rates discourages people from
borrowing from banks. This reduces money supply. A reduction in interest rate does the
opposite.
(iii) Reserve Requirements/ Required Reserve Ratios The monetary authorities set a
minimum level of reserves that will be maintained by banks. In Cameroon, banks maintain two
types of reserve - Cash Ratio, and Liquidity Ratio. An increase in bank reserves reduces money
supply by reducing bank loanable funds, while a decrease in reserves increases the supply of
money.
(a) Non-traditional Instruments or Direct Control of Bank Liquidity: These tools are non-
market tools that strike directly at bank’s Liquidity. They include supplementary reserve
requirements and variable Liquidity ratios.
(b) Supplementary reserve requirements or special deposits: The Central Bank here requires
banks to hold over and above the legal minimum cash reserves, a specified percentage of their
deposits in government securities such as stabilisation securities issued by the Central Bank,
hence it is also called special deposits policy. The main objective is to influence banks’ lending
by freezing a certain percentage of their assets.
(2) Variable Liquid Assets Ratio Here, Banks are required to diversify their portfolio of liquid
assets holding. These means that banks are required to redefine the composition of their Liquid
assets portfolios at different times to reduce or increase their credit base.
B . Qualitative or Selective Controls or Instruments These confer on the monetary
authorities the power to regulate the terms on which credit is granted inspecific sectors. These
powers or control seek typically to regulate the demand for credit for specific uses by
determining minimum down payments and regulating the period of time over which the loan is
to be repaid. In other words, they involve official interference with the volume and direction of
credit into those sectors of the economy which planners believe are a crucial importance to
economic development. These tools include moral suasion and selective credit controls or
guidelines.
(1) Moral Suasion Moral suasion is an appeal of persuasion from the Central Bank to other
banks to take certain actions in line with government economic objectives. Unlike directives, no

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penalty is attached to non-compliance to moral suasion. Banks have the freedom not to comply,
but they often comply so as to have a good relationship with the Central Bank.
This involves the employment of persuasions or friendly persuasive statements, public
pronouncements or outright appeal on the part of monetary authorities to the banks requesting
them to operate in a particular direction for the realisation of specified government objectives.
(2) Selective Credit Controls and Guideline
These are specific instructions given by the Central Bank to other banks which they must comply
with. Such directives come in the form of credit ceilings, special deposits and sectoral allocations
of credits, among others. This can be used to increase or reduce money supply.
The selective control or directives can be in form of:
(a) Credit Ceiling: Every year the Central Bank dictates the rate of credit expansion in the
economy.
(b) Sectorial Allocation of Credit: The Central Bank divided economic activities in the country
into sectoral allocations. The divisions are agriculture, forestry, fishing, mining, quarrying,
manufacturing and real estate.
(c) Interest Rate Ceiling: The interest rate may be controlled to favour particular sectors.
(d) Loans to Rural Borrower: This is aimed at improving investment in the rural areas.
(e) Grace Period on Loans: Longer period may be granted to some important sector like
agriculture.
(f) Refinancing Facilities
(g) Indigenisation of Credit
(1) “ If you control the supply of money you control the economy.” Comment. (2) Explain
the monetary steps that should be taken to induce conditions of full employment. (3) What
effects does a rise in interest rate have on the price of gilt-edged securities?
EXPANSIONARY AND CONTRACTIONARY MONETARY POLICY For monetary
authorities to influence the quantity of money supply in the economy, either expansion any or
contractionary monetary policy. When the money supply is increased, it is an expansionary
policy and when money supply is decreased, it is a contractionary monetary policy.
EXPANSIONARY MONETARY POLICY: This is a monetary policy used to overcome a
recession or a depression or a deflationary gap. When there is a full in aggregate demand for
goods and services a deflationary gap emerges.
Demand and Supply of Goods expantionary monetary policy.

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CONTRACTIONARY MONETARY POLICY Policy which is used to overcome inflation gap.

During an inflationary period, there is general and persistent rise in prices of goods and services
without corresponding rise in the outputs.
Demand and Supply of Goods expansionary monetary policy.
9 Limitations of Monetary Policy in Cameroon When monetary policy is used to influence the
level of income, its potential effect is lessened because of the lack of consumer and investor
responses to interest rates changes. Other things may occur to dampen the effect of monetary
policy on the level of income and keep spending from rising or falling when the Central Bank
engages in activities such as open market purchases.
(a) There is the existence of a largely non-monetised sectors which hinders the success of
monetary policy. Most of the people live in the rural areas where there is absence of financial
institutions and knowledge. Thus, monetary policy fails to effect the lives and activities of this
bulk of the people of these economies.
(b) The money and capital markets are both inadequate and undeveloped. These markets lack
in securities (shares, stocks, and bonds and bills which limit the success of monetary policy.)
(c) Most of the banks in the banking system possess high liquidity so that they are not affected
by the credit and hence monetary policies of the monetary authorities. (d) There is the large-
scale operation of non-bank financial intermediaries, most of which are not under the control of
the Central Banks.
Commercial banks are just only one of many types of financial intermediaries that exist in
money using economies. In Cameroon today, there are many savings and loans Associations,
Insurance Companies and Finance Companies that handle huge sum of money. The activities of
these non-bank financial intermediaries if not checked may render Central Bank’s expansionary
or contractionary policies ineffective.

(e) In addition, bank money or demand deposits comprise a small proportion of the total money
supply in these countries, rendering the monetary authorities ineffective in monetary control.
(f) Monetary policy is hindered by time lags (recognition, administrative and result lags).
(g) It conflicts with government policies. (h) Monetary policy is influenced by politics and
hence it is an attempt to fulfill political ambitions of parties in office. (i) There is the problem of
inability to predict how people will react to any monetary policy measure.

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UNIT EIGHT
INTERNATIONAL TRADE
CONTENTS
1.0 INTRODUCTION
So far in the previous units, we have examined domestic economic problems and noted that the
Government has monetary and fiscal policies at its disposal for dealing with them. The
technicalities of these policies have been considered in the previous units, but the extent to which
they are effective is frequently limited by the repercussions they may have on the external
trading position of the country.
Although early writers recognised the existence of International Trade they felt that it was not
much different from domestic trade to warrant the existence of a separate theory. The fist
economist to propound the classical theory of International Trade was Adam Smith in his much
celebrated work published in 1776 and titled “An Inquiry into the Nature and causes of the

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wealth of Nation” other classical economists that helped publicise the theory included David
Ricado, John Stunt Mill, Alfred Marshall and others.
While trying to demolish the classical proposition for a separate theory, Ohlin (1933) argued that
“International Trade” should be regarded as a special case within the general concept of
International Economies. He further argued that nations engage in trading for the same reasons
for which individuals or groups within the country trade with each other instead of each one
producing his own requirement. That reason is that they are enabled to exploit the substantial
advantages of division of labour to their mutual advantage. Trade between different countries
developed first where one country could produce something desirable which others could not.
International Trade, therefore, owes its origin to the varying resources of different regions.
3.0 MAIN CONTENT
3.1 Concepts, Reasons and Importance of International Trade
International Trade refers to the buying and selling of goods and services between countries e.g.
between Cameroon and the United States of America, Ghana or Britain, etc.
In other words the term “International Trade” refers to the exchange of goods and services that
take place across International Boundaries.
International Trade also is simply defined as the trade across the borders of a country. This may
be between two countries, which is called bilateral trade or trade among many countries called
multilateral trade. International Trade is also referred to as International specialisation or
International division of labour. The essence of International Trade is to enable countries obtain
the greatest possible advantage from the exchange of one kind of commodity or another.
International Trade is across the borders involving different nationalities with different languages
and currency. e.g. Cameroon and England.
Another distinguishing feature is the presence of single currency in domestic trade and
multiplicity of currency in international trade.
The third feature of International Trade that makes it distinct is the controls and regulations
inherent in the existence of boundaries. Such controls take the form of import restrictions,
protectionism, custom duties and other controls, which do not exist, in domestic trade. Critics
cannot disprove the fact that both the payment and every aspect of international trade are highly
controlled.
The next difference is the presence of linguistic, cultural and political differences between the
people of one country and those of another international trade. Although critics argue that
language and cultural barriers can still be present in domestic trade in a country with more than
one official language and cultures, the fact still holds that people from the same country tend to
have a way of understanding themselves more even when their cultures and languages differ.
This makes the domestic trade to have less barriers than international trade.

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The fifth point to consider is the difference in geographical and transportation, more complex
and costlier whether by land, sea or air in international trade. The packaging, insurance, banking
and other processes involved in international trade do not apply in the national or domestic trade.
Other differences include differences in the legal systems of various countries, difference in
customer demands and also the issue of balance of payment.
From the foregoing, it becomes clear that even when there are some similarities in home and
foreign trade they are not exactly the same. It needs be stated, however, that both types of trade
are not independent of each other. Both domestic and foreign trade helps to satisfy the needs of
the citizens of a country.
No country in the world produces all that her people need. Thus, International Trade is as
important as domestic trade if not more.
Nations trade with each other due to the following reasons:
(a) Necessity: - No country is self-sufficient which means that they have to buy from other
countries those things they cannot produce.
(b) Because of the uneven distribution of National resources: National resources are not
distributed evenly in all countries e.g. in Cameroon we have oil, tin, coal, etc., but Ghana has
Gold, etc. Different countries have different mineral resource endowment. Such mineral deposits
include coal, tin ore, oil, gold, lead, etc. A country largely supplies of one but with less of others,
hence such a country will trade with countries that have such so as to obtain the one she does not
have.

(c) Differences in climate: Some crops can only do well under certain climatic conditions e.g.
tropical crops such as cotton, cocoa, etc., will not do well in Temperate zones and vice versa.
Many commodities, particularly agricultural products are produced under different climatic
conditions. Tropical countries produced Cocoa, palmoil products, rubber, etc., while variation of
diary products are produced in the temperate regions, hence the need to exchange.
(d) The existence of special skills in some countries: Some countries have acquired worldwide
reputation at making certain products e.g. Switzerland is known for making watches. Japan is
known for making electronics, etc.
The inhabitants of a region may develop a special skill for the production of a commodity, which
in time may acquire a special reputation for quality. Wines such as champagne sherry, port,
chianti owe their distinctive qualities partly to the special flavour of locally grown grapes and
partly to the local method of manufacture, Scotch and Irish Whisky have similarly acquired
distinction.

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By exchanging some of its own products for those of other regions, a country can enjoy a much
wider range of commodities than otherwise would be open to it.
(e) Differences in tastes: Countries have to import different or some commodities required by
citizens which they cannot produce in great quantities e.g. manufactured goods, shoes, plastics.
(f) Differences in Industrial development and the level of Technology: The more advanced
countries are developed both industrially and technologically hence the developing nations have
to import most manufactured goods from them.
The advanced technology in most of the developed countries enable them to produce a good
number of machines and equipment, which the less developed countries could not produce. By
trading they can exchange.
(g) Access to Capital: International Trade enables countries with limited capital to either
borrow from capital rich countries or attract direct investment into the countries and thus enjoy
the benefits of imported capital and technology.
STUDENTS ASSESSMENT EXERCISE
1. What gives rise to international trade? 2.
2. Are there any circumstance in which international trade should be discouraged by the
government of a country? 3. Explain carefully the circumstances in which nations find it
beneficial to trade with each other.
3.2 Classical Theories of International Trade
The classical economists led by Adam Smith and David Ricardo presented two important
explanation to justify International Trade. One is the absolute cost difference in production of
various commodities at different countries. The other argument, which in fact incorporates the
first, is the theory of comparative advantage.
Absolute Costs Differential Argument: This argument holds that where one country can produce
a given commodity at a lower absolute cost than another both countries will benefit more from
international trade by allowing the country that can produce it at a lower absolute cost to
specialise in this production while the other country buys from them.
According to Smith (1776), trade between two countries will take place if each of the two
countries can provide one commodity at an absolute lower cost of production than the other
country because of the difference in absolute cost and the absolute advantage that one has over
the other.
STUDENTS ASSESSMENT EXERCISE
What do you understand by the theory of comparative costs? Can it be applied to home trade?
3.3 Advantage of International Trade

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Basically, trade between nations become necessary for the same reason that an individual
engages in trade with another. No nation is so independent that it produces within its borders all
that her citizens need. Butressing this point, Vaish (1981) observed that “since the creation of
earth its inhabitants, natural resources and man’s innate abilities were not uniformly apportioned
by the Almighty God to all parts of the globe and to all persons and since techniques of
production do not advance at equal rates among all nations, regional specialisation in production
offers ample scope for international trade.
 International trade is, therefore, of much benefit to both consumers in term of improved
satisfaction and living standards, the country and the word in general in terms of better
utilisation of the world resources and increased international understanding, which helps to
promote world peace.
 One of the outstanding benefits of international trade is that it encourages international
division of labour and specialisation, which in turn increases the wealth of the nation.
 By encouraging specialisation, more goods and services are produced, and at reduced prices.
This reduces the monopolistic tendencies of local suppliers. International Trade also make it
possible for each county to have access to world’s raw materials and other resources, which
the Almighty God had distributed unevenly to various countries.
 International trade provides revenue for the countries concerned. In Cameroon for example,
import and export duties form a great percentage of the total revenue from taxes.
 Another advantage of international trade is that it provides employment for many inhabitants
of the countries concerned. For example, many people in West Africa are engaged in
importation and exportation of goods.
STUDENTS ASSESSMENT EXERCISE
(i) Comment on the view that an extension of international trade will raise the living standards
of all those countries which engage in it. (ii) Should two countries trade if one of them is more
efficient at producing everything? (iii) Why do countries trade with each other?
3.4 Disadvantage of International Trade
Despite all the advantages of trade between countries, it is criticised on the basis of some
observed disadvantages.
1. Any nation that is solely dependent on the sale of a single major product is liable to
adversities of a decline in world demand for the product e.g. the onoeconomies of Cameroon and
Ghana which depends solely on crude oil and cocoa respectively.
2. Economically, weaker nations are likely to be dominated by the more advanced countries of
the world. West African nations are subjected to economic subservience by their former colonial
masters.
3. International trade leads some nations not to make serious efforts to be self-reliant.

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4. International trade can also lead to over-production of goods and services, which can rise to
depression.
5. It breeds mistrust, suspicions, jealousies and unhealthy competition among countries and these
have often accounted for wars and other forms of unrests in the world.
6. Over-dependence of some countries on others for the supply of some products may result in
lack of development of knowledge and skill along the lines of the dependant nations. In times of
war, dependent nations economically can be at great disadvantage.
7. Some economies concentrate on the production of certain commodities at the expense of
many essential ones. It could be a source of handicap in times of war. This is because the other
country can place an embargo on these goods that the nation highly depended upon.
8. The next argument is that international trade can stifle local industries and cause
unemployment to result from such industries. It is also said to cause economic instability because
the economic problems of a supplier country may affect the buyer country. Moreover, goods that
are currently imported at lower prices can rise in prices in the future.
3.5 .1 Restrictions to International Trade and Specialisation
Barriers to international trade could be both natural and artificial. These barriers include: (a)
Linguistic or Language Barrier: All over the countries of the world, different languages are
spoken. For instance, in France, they speak French, in Britain they speak English, in Spain they
speak Spanish while in Cameroon the official language is English in addition to numerous other
local languages. The problem of communication arises when different languages engage in trade.
However with Western education and the increased use of English Language all over the world,
this natural barriers is being broken.
(b) Distance Barrier: Nations are thousands and millions of kilometers apart. This delays
messages or goods involved in foreign trade. However, the development of modern
communication system like the telephone and modern transport systems has helped to minimise
this natural barrier.
(c) Religious Barrier: Religion also poses a barrier in foreign trade. For instance, in West
Africa, cow meat is a good source of protein but in some parts of India and other Asian
Countries, cow meat is forbidden. This can go a long way in hindering the development of
foreign trade, especially when people are dogmatic and fanatical about their beliefs and religious
practices.
(d) Communication Barrier: In many developing countries, telephone and the telex system are
not developed while the existing ones are poor, inefficient and inadequate.

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(e) Transport Barrier: Many developing nations have very poor and inadequate transport
systems and network such as inaccessible roads, under developed maritime system and poor
airport services constituting delays in international transactions.
(f) Currency differences Barrier: Each country uses its domestic currency in domestic trade. For
instance, in Cameroon, FCFA (XAF) is used, in Ghana, cedi is used, in Britain the British
sterling or pound is used while in America, the American dollar is used. Most of these local
currencies are not convertible currencies and cannot be used in the settlement of international
transactions. This poses the problem of being involved in securing foreign exchange involving
convertible currencies such as the US dollar, the pound sterling.
(g) Measures and Weights Barriers: Technical problems arise since different countries use
different units of measures and weights. For instance, Cameroon has gone metric and hence uses
metres, etc., as well as grammes, kilogrammes, etc. However, some other nations she trades with
still use yards, feet, and inches as well as ounces and pounds.
(h) Traditional differences Barriers: The traditions and customs of different countries differ and
thesemay pose a problem to foreign trade.
(i) Ideological differences Barrier: The countries in the Western bloc practice capitalism while
those in Eastern bloc used to practice socialism, capitalism or mixed economies. Many a time,
these ideological differences pose a great obstacle to foreign trade since nations under different
idealogical learnings may refuse to trade with each other. Where they do trade at all, a lot of
caution and restrictions are adopted.
(j) Economic Independence/Self-reliance barrier: Many countries today want to be economically
independent and self-reliant so that they reduce their participation in foreign trade even when
they do not have comparative cost advantage in the goods they produce in as much as this is a
good policy. It can limit or hinder foreign trade.
(k) Protectionist Policy Barrier: Many countries take measures to protect their economies
from dumping from overseas or to protect strategic sectors of their economy such as agriculture.
This limits the extent of foreign trade.

(l) Trade Inbalance Barrier: When many developing nations experience continuous trade
inbalance with some advanced nations, there is the tendency to limit their imports from those
nations so as to improve their balance of trade and hence balance of payments.
(m) Foreign Exchange barrier: Many developing nations such as Cameroon lack enough
foreign exchange to purchase foreign goods. Such nations will thus reduce imports and hence
their participation in foreign trade.

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(n) Credit Shortage barrier: In many countries, credit facilities are inadequate or lacking such
that there is not enough money to engage in external trade. (o) Artificial Barriers: Government
also takes measures to restrict foreign trade. Such measures include the imposition of custom
duties, import and export duties placing bans on some goods, placing quantitative controls or
quotes exchange controls, and non-tariff barriers, etc.
Factor Mobility: Factors of production, especially labour, are not mobile. Raw materials are
subjected to controls which include sanctions. If factors of production are not mobile,
specialisation is limited to the extent of international restrictions.
Imperfect competition between countries: Sometimes there is opposition from groups with
vested interest. This prevents free trade among nations and makes difficult the operation of the
comparative advantage principle. Multi-lateralism: The theory of comparative costs assumes
trade to be bilateral, that is between two country .es that specialise. The real world, however, is a
system of multiliteralism in which many countries trade with one another at the same time.
Among countries that produce cheaply, some may have greater advantage over others, while
some countries may prefer to buy from one country rather than from one another. This factor
sometimes leads to an unfavourable balance of trade for countries that import more than they
export to other countries.
3.6 Instruments of Foreign Trade Protection and Promotion
In an ideal world in which the principle of comparative costs specialisation is practiced, there is
free trade and no duty is placed on traded goods. Almost all countries around the world impose
some form of restrictions on the flow of international trade. Despite the advantages of foreign
trade, different governments place restrictions on it. These restrictions take different forms as
described below:
(a) Import Duties of Tariffs: These are charges or taxes levied by the government on goods
imported into the country. The major objective of imposing such duties is to raise revenue or to
restrict the importation of the concerned goods.
(b) Export Duties or Tariffs: These are charges of taxes levied by the government on goods
exported out of the country. It may be to raise revenue or to discourage the exportation of certain
commodities that are in short supply locally.
(c) Import Quotas or Quantitative Restrictions: These are direct restriction on the quantity of
goods that can be bought into the country. This limits importation. Embargo is also a form of
quantitative control.
(d) Exchange Control: This includes the rationing of foreign exchange available for purchases
e.g. through import licencing or through the foreign exchange market (FEM). Exchange control
measures specify the value of foreign exchange.

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(e) Non-Tariff Barrier: This may take the form of administrative practices, such as deliberately
channelling government contracts to home companies even where their tenders are not
competitive or insisting on different technical standards.
(f) Total Ban: This involves placing total ban on the importation of certain commodities,
especially harmful and non-essential goods. It may also be to encourage the local production of
such goods and save foreign exchange e.g. Cameroon has placed total ban on the importation of
wheat (before December, 1992) barley, vegetable oil, etc. Occasions may also arise when the
government places total ban on the exportation of certain commodities to meet local demand. For
instance, in January, 1988.
(g) Export Promotion Incentives/Subsidies: Nations such as Cameroon (since 1986) give export
promotion incentives in order to stimulate non-oil exports to earn longer foreign exchange. This
reduces hitherto imported items. Standards and complex customs regulations such as import
deposit schemes and pre-shipment inspections are trade protection measures.
The Case for Protection Why Nations impose Restrictions on Foreign - International Trade.
(a) Infant Industry Argument: Nations impose restrictions in order to protect new or infant local
industries from foreign competition with respect to long-standing but similar large industries.
(b) Revenue Argument: Nations impose duties or restrictions in order to earn enough revenue to
execute other projects locally. This is particularly so in the case of the imposition of import
duties. (c) Balance of Payments Arguments: Some countries impose restrictions to improve
their balance of payments via import restrictions or to correct balance of payments deficits.
Measures taken here include those which restrict imports and stimulate.
(d) Anti-dumping Argument: Countries take measures to prevent the dumping of cheap
commodities in their countries.
(e) Employment Stimulation Argument: Restrictions are also used as a deliberate instrument of
planning to stimulate employment. This is done by encouraging local production of hitherto
foreign imported goods by businessmen.
(f) Changing Pattern of Consumption Argument: The government also imposes restriction to
discourage the consumption of some commodities which are either considered harmful or non-
essential. Those considered harmful are meant to protect the health of the nationals while the
non-essential but expensive ones are placed on restrictions to change consumption pattern while
generating revenue to the government as well as redistributing income.
(g) Bargaining Power Argument: Some countries also impose restrictions on foreign trade in
order to have bargaining power during negotiation at trade conferences.

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(h) Self-Sufficiency Argument: Some countries impose restriction on certain goods to enable
them to be self sufficient in the production of those commodities. This helps to eliminate or
reduce foreign domination and neo-colonialism.
(i) Self-Reliance Argument: Some nations tend to rely on their abilities, initiatives and resources
in the production of certain commodities hence they impose restrictions on certain goods.
(j) Recovery from Depression Argument: During periods of economic depression when there is
low economic activity and rising unemployment, imports are usually restricted to stimulate the
domestic economy.
(k) Strategic Sectors Argument: Strategic tariff could be imposed to protect some strategic
sectors of the economy such as industries whose products may be essential in times of war or
international crisis.
Also protection given to agriculture in most developing nations even when comparative costs are
high compared to other nations could be seen as a measure to protect a strategic sector of the
economy.
STUDENTS ASSESSMENT EXERCISE

(i) Explain carefully the circumstances in which nations find it beneficial to trade with
each other. (ii) “Government can always justify the establishment of trade barriers”.
Examine critically the arguments in favour of trade barriers.

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CHAPTER NINE
THE BALANCE OF PAYMENTS
CONTENTS
1.0 INTRODUCTION
In the analysis of comparative costs in Unit Eleven, we confined ourselves to trade by barter,
deliberately excluding any idea of money of currency. In practice, it is the use of different
(token) currencies that causes most of the problems associated with International Trade. This unit
shows the need for careful recording of international transactions, the nature of these
transactions, recent changes in their structure as far as the Cameroon economy is concerned, and
the methods available for dealing with short-term Balance of Payments difficulties.
3.0 MAIN CONTENT
3.1 Balance of Trade - Meaning/Definitions
Foreign Trade is made up of Exports and Imports.
Exports are the goods and services which a country sends to other countries (abroad) in return for
some payment made in foreign exchange. We have “visible exports” and “invisible exports”.
Exports of goods refer to visible exports while exports of services refer to invisible exports.
Imports are goods and services which are brought into a country from foreign nations for which
the receiving country pays for in foreign exchange. There are also “visible and invisible”
imports. Imports of goods are visible imports while imports of services are invisible imports.
Cameroon’s major imports include manufactured goods, machinery, transport, equipment,
chemicals, foods and live animals, etc. Balance of Trade shows a country’s receipts and
payments for goods and services, such as crude oil, cocoa, machines, equipment, baking, etc.
That is, it deals with exports and imports of goods and services which may be visible or
invisible. Visible trade is that concerned with buying and selling of goods. Invisible trade
consists of services provided to or by other nations, e. g. Insurance, Banking, etc. It can also be
called Balance of Current Accounts.
3.2 Terms of Trade and Measurement
Terms of Trade means the rate at which one country’s products exchange with those of another
and this depends on the countries’ prices of exports and imports. That is, it is the rate at which a
nation’s exports exchange for its imports.
To say that the terms of trade of a country is favourable means that the prices of its exports are
higher relative to the prices of its imports. Otherwise, it is unfavourable if the prices of imports
are higher relative to the prices of exports.

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The measurement of TOT is given as follows:

TOT = Index of Export Prices x 100 Price Index of Import Duties
1 – Bilateral Trade - This means trade between two countries
- Multilateral Trade - This occurs when there are more than two
(2) countries involved in trade.
Cameroon exports barrels of crude oil, Cocoa, tin and some other commodities to the rest of the
world. At the same time, Cameroon imports machinery, milk, ink, writing paper, services of
exports and so on from other countries. With the income earned from exports, Cameroon is able
to buy a certain amount of imports. It follows that a certain amount of exports has to be exported
to the rest of the world before Cameroon can import a certain quantity of import. This rate of
exchange between Cameroon’s exports and imports it gets from the rest of the world is
Cameroon’s terms of “Trade”. In other words, the term of Trade of any country is the rate at
which its exports equates its imports at any given time.
The terms Trade change from time to time, following the prices of traded commodities. If the
price of motor cars rise in Japan, Cameroon will have to sell more barrel of crude oil assuming
that there is no change in the price of crude oil in order to buy the number of motor cars. In this
case, the terms of trade are unfavourable to Cameroon. If the price of oil rises in favour of
Cameroon, Japan will have to sell more cars to buy the same quantity of crude oil from
Cameroon. In this case, we say that the terms of Trade are favourable to Cameroon as its exports
if it exports the same amount of crude oil but get more cars from Japan.
Briefly, if a country gets more imports for a given amount of exports, the term of trade are
favourable to the country. If on the other hand, the same country gets less imports for the same
amount of exports the terms of Trade are unfavourable to the country. The terms of Trade are
important determinants of the balance of payments.
The concepts of the terms of Trade is of great importance in the theory of International Trade
since it measures the terms on which a country’s exports are exchanged for its imports. It thus
determines how much a country gains from foreign trade. Because money is so important in
foreign trade, the terms of Trade are measured as a ratio of changes in exports and import prices.
STUDENTS ASSESSMENT EXERCISE
(i) How does changes in the terms of Trade effect the economies of trading nations? (ii) How
are the terms of Trade of a country measured? Is it important in the terms of trade bound to lead
an improvement in the balance of Trade? (iii) How is a country affected by a change in its
favour of the terms of Trade?

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3.3 The Concept of the Balance of Payments

A country’s balance of payments refers to a systematic record of all economic transactions
between the residents of the reporting country and residents of foreign countries during a given
period of time, usually a year. An economic transaction, as used here, is an exchange of value,
typically an act in which there is transfer of title to an economic good, the rendering of services
or the transfer of title to assets from one country’s residents to another.
Thus, the balance of payments is a statistical record which summarises all transactions which
take place between the residents of a country and the rest of the world. It is a statement of a
country’s economic transaction with other countries and it shows, for that accounting period
usually a year, total income (receipts) and total expenditure (payments) and the balance of
income over expenditure. The transactions include buying, selling, borrowing and lending,
investment and disinvestment, income from investment and repatriation of profits and dividends,
in addition to gifts and grants, etc. All transactions which entail inflow of payments are taken as
credit plus entries while debit or minus entries are those transactions which generate an outflow
of payments.

Thus, a balance of payments account refers to a classified summary of the money value of all
international transactions of an economy, in some form of aggregation, pertaining to a given
period of time, usually a year.
Both in the accounting and economic sense, a country’s balance of payments must always
balance since every purchase of goods and services by a country is recorded both as a credit item
(the goods received and as a debt item) (the debt owed by the purchasing country to the
supplier). This is an accounting procedure based on common sense rather than on mere fancy.
3.4 The Reasons for Measuring the Balance of Payments
(a) To measure performance
A country’s Balance of Payment may be likened to the annual income and expenditure of a
household, although the comparison must not be carried too far. The household receives income
by supplying the services of factors of production and spends that income on the purchase of
goods and services it requires. If the household spends all its income, no more and no less, it is in
the same position as a country whose Balance of Payments just balances, if it spends more than
its income either by borrowing or drawing on past savings, the household has a balance of
payments deficit for the year, if its expenditure falls short of income, it may regard itself as
having a balance of payments surplus.

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(b) To protect the foreign currency reserves

Goods imported from abroad have to be paid for in currency acceptable to the supplier.
Individual importers do not keep stocks of foreign currencies needed to buy goods overseas but
they can acquire them from the BEAC (BEAC). A second important reason for keeping track of
the Balance of Payments is that a deficit leads to the reduction in these reserves and prolonged
deficits force the Government (BEAC) to take restrictive actions in order to preserve the
currency for essential purposes.
(c) To inform governmental authorities of the international position of the country.
(d) To aid governmental authorities in reaching decisions on monetary and fiscal policy on the
one hand and trade and payment questions on the other.
(e) They are used to measure the resource flows between one country and another.
(f) Information on payments and receipts in foreign exchange constituting a foreign exchange
budget, helps to assure monetary authorities that the country could go on buying foreign goods
and meeting payments in foreign currency when they become due.
(g) To measure the influence of foreign transactions on national income.
Revision questions/ assignments
(i) Define the terms “Balance of Payments” and Balance of Trade”
(ii) (ii) There is no reason to expect the balance of Trade to balance. But the balance of
payment must always balance. Discuss.
(iii) (iii) What are invisible exports and invisible imports? Give examples of both and
discuss their relatives importance for Cameroon.
(iv) (iv) Can a deterioration in a country’s international terms of Trade cause an
improvement in that country’s balance of Trade?
3.5 The Components/Structure of the Balance of Payments
Lipsey (1983), said that a more analytically convenient way to present a nation’s balance of
payment is to divide it into three components, viz Current Account, Capital Account, and
Official Financing.
The Capital Account
These records transactions related to movement of long and short-time capital i. e. it shows the
volume of private foreign investment and public grants and loans from individual nations and
multilateral donor agencies such as UNDP and the World Bank. It includes direct investment,
portfolio investment, long-term capital and short-term capital. The capital account will be a
deficit if payment exceed receipts but a surplus if receipts exceed payments. .

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The Current Accounts The account of import and export goods and services is known as the
current account. This is the basic component of the balance of payments. It equally has the
largest entries. The current account is further divided into two sections: merchandise trade items
and service transaction items.
The merchandise items refer to the import and export of goods (merchandise). This is also
known as visible items or visible trade items. The service items are known as invisible items.
The difference between the debit and credit entries in the current account is known as balance of
Trade.
The balance of Trade is said to be “favourable” or surplus if exports (sources of foreign
exchange) exceeds imports (use of foreign exchange). It is also said to be “unfavourable” or
“deficit” if the imports exceed exports.
In most cases, when the balance of payment is said to be in deficit or in surplus, reference is
being made to the current account or one account heading not to the total of all balance of
payment entries. This is because, in totals the balance on the Capital Account normally offsets
the balance on current account. An excess of imports over exports (a debit balance on current
account), creates an international debt obligation which is an equivalent credit balance in the
capital account.
(a) The Central Bank may borrow, say from the IMF and this represents a capital inflow and is
hence a credit item on the balance of payment. Repayment of old IMF is a debit item.
(b) The Central Bank may run down its official reserves of gold and foreign exchange and this
is a credit item since it gives rise to a sale of foreign exchange and a purchase of FCFA (XAF).
(c) The Central Bank might borrow from other Central Banks though a network of arrangement
and these will be on the credit side of the BOPs account.
There is also a Cash Account showing how cash balances (foreign reserves) and short term
claims have changed in response to current and capital account transactions. Such a cash account
is, thus, the balancing items which is lowered (i. e. a net outflow of foreign exchange) whenever
total disbursements on the current and capital account exceed total receipts (Todaro, 1977).
3.5.1 Balance of Payments Disequilibrium
A state of disequilibrium occurs in the balance of payments when an adverse or unfavourable
balance results in movements in short-term capital and or adjustments to reserves.
Disequilibrium has two aspects: surpluses and deficits. A country is said to have a surplus in the
balance of payments if its income flow exceeds its expenditure flow. On the other hand, a
deficit or debit in balance is of two kinds: temporary and fundamental. A deficit is
temporary, if it can be corrected or adjusted within a short-time. It is persistent, if it is of long
duration. If it is not corrected, reserves will run out and other countries will lose confidence in

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the country. As a result, such a country will find it difficult in raising external loans for the
development of its economy.
The following are the causes of disequilibrium in the balance of payments.
(i) excessive importation of goods and services
(ii) deficiency in domestic output
(iii) inadequately patronage of home made goods which are regarded as inferior goods
(iv) high-level of importation of technical know-how in developing countries,.
Such as disequilibrium may be due to factors which cause an imbalance in trade account
and/or in capital account. The factors include:
(a) Persistent inflationary pressures at home hence the nation’s cost-price structure makes it
unprofitable for foreigners to import from this country, but making imports to rise.
(b) Inflationary pressures in trading partners’ economies hence the country in question is
forced to import at higher prices and hence bear the burden of high wages and other types of
exploitation by the richer economies.
(c) Servicing of existing debts through fresh loans without generating an adequate export
surplus.
(d) Political disturbance such as war of threat of war which result in large imports of arms,
ammunitions, food and strategic raw materials for stockpiling. This sudden spurt in imports and
possibly a planned reduction in exports result in a deficit in the trade and payments.
(e) Economic calamities such as drought, flood, earthquake or general crop failure which
increase imports reduce exports.
(f) Lacks of capacity to meet changing requirements of importers due to lack of
resourcefulness, diversification and resiliency. This exports lag behind imports more so when the
latter is influenced by demonstration effect, (Bhatia, 1984).
Thus, while a temporary balance of payments can be financed (official financing) by running
down foreign currency reserves and by foreign borrowing, these cannot go on indefinitely since
such financing cannot carry a persistent balance of payments deficit. This calls for corrective
action/policy on the part of the government. Government corrective action can be grouped into
two broad categories: Expenditure Reducing Policies and Expenditure Switching Policies.
(a) Expenditure Reducing Policies
These are meant to achieve a deflation of aggregate demand in the economy such that the
demand for imports will reduce. Also, it is expected that domestic industry, faced with a
contraction of demand in the domestic market, will attempt to export more aggressively.
Specific expenditure reducing policies include:

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(i) Fiscal Policy: This involves increase in taxes and decrease in government
expenditure. This is expected to lower purchasing power in the domestic economy
and hence lower imports of goods and services, and therefore correct the persistent
deficits in the BOPs.
(ii) Monetary Policy: This involves measures which include contraction for restrictions
on money supply, raising interest rates and restriction of credit. Again, this lower
people’s purchasing power and hence lower demand for imports.

CHAPTER TEN
SCOPE OF PUBLIC FINANCE
CONTENTS
1.0 INTRODUCTION
Public finance is not a new field of study. It dates from emergence of governments which means
that it is not as old as governments. From time immaterial, governments imposed taxes to raise
enough revenue only to cover the cost of administration and defence. The state is supposed to
provide security and prohibit or regulate those activities by individuals or by groups within the
society which might injure the community as a whole. To provide for these necessary services,
government began to raise money in form of taxes. This is why taxes were regarded as payment
for services rendered by the government. Today, the number of services which the governments
provide have increased tremendously. Government development expenditure, roads and
equipment required to provide government social and economic services.
Since independence in 1960, the government has sought to control the level of economic activity
by alterations in fiscal policy, and it has used monetary policy mainly to create the general
economic atmosphere. “Public Finance” is the term applied to the study of the methods
employed by the government to raise revenue, and the principles underlying Government
expenditure.
It is important to understand that Government expenditure is just as much as part of public
finance as adjustments to taxation.
In order to emphasise this, we shall in this unit examine the expenditure side of government
before investigating the main sources of revenue and later examine the role of fiscal policy in the
next unit.
3.1 Meaning of Public Finance
Public Finance refers to that branch of economics that is concerned with the revenue,
expenditure and debt operations of the government and the impact of these measures. It identifies
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and assesses the effects of governmental financial policies. That is it tries to analyse the effects
of government taxation and other sources of revenue and expenditure on the economic situations
of individuals, institutions and the economy as a whole. It develops techniques and procedures to
increase that effective in effect, it looks into the financial problems and policies of the
government at different levels and studies the inter government financial relations.
Public finance can be defined from two major perspectives. Firstly, Public Finance can be
defined from the perspective in which finance is defined as money. If this view is held, then
Public Finance as a technical term would refer to the pool of resources (borrowed or earned)
available to government for the satisfaction of public wants. As a course of study, public finance
can be defined as that part of economics that deal with the economic behaviour of governments.
It discusses the various ways by which the government carries out its allocative, redistributive
and stabilisation functions in the economy. This will include government taxing, spending,
borrowing, transfers, aids subsidy and other operations that pertain to the use of scarce resources
of government.
In common usage, the term public finance means the financing of the government including the
economics of finance as well as the social effect and consequences of government policies.
Public Finance can equally be called the study of public sector economics. It is an aspect of
economics which deals with government revenue and expenditure.
The study of public finance involves a detailed analysis of the various sources from which the
government derives its income, the items on which the government spends its money and the
impact of such government revenue sources and government expenditure on different aspects of
the economy.
3.2 Distinguish between Public Sector and Private Sector of the Economy
It is usually necessary to look at the economy from the point of view of the degree of influence
and economic resources of the government and of individuals. In this context, we are talking of
public and private sectors of the economy.
Public Finance is described as that branch of economics which studies the economic bahaviour
of governments. Economics itself is the study of man making decision in a world where scarcity
of resources relative to human wants makes choice a necessity. Economists have broadly divided
the economy into two related sectors. i.e.
(a) Private Sector and
(b) Public Sector
Though the end problem in both sectors are the same, that is, the satisfaction of human wants,
their behaviour and decision making processes vary. Hence their separate treatment in economic
analysis.

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The public sector refers to all production that is in public hands. That is, in public sector, the
organisation that produces goods and services is owned by the state. It is thus a combination of
control, government, state government, local authorities, the nationalised industries, public
corporations, government administration, defence and similar public service, including
commercial and non-commercial undertakings of the government. Some public sector activities
are in the form of “nationalised industries” put differently, this sector is that portion of the
economy whose activities (economic and non-economic) are under the control and direction of
the Federal/State/Local Government.
The private sector refers to that part of the economy not under direct government control. It
entails all production that is in private hands. There, the organisation that carries out the
production is owned by households or other firm. Beyond the productive activities of private
enterprises (the sole Proprietorship, Partnership, Private Limited Liability Company, Public
Limited Company and Cooperative Societies), the private sector also includes the economic
activities of non-profit-making organisation and private individuals. Put differently, this sector is
that part of an economy whose activities are under the control and direction of nongovernmental
economic unit such as households and firms.
Modern private economy is market oriented and operates on the principles of economic
efficiency con-sumer preference and market exclusion. This implies that resources should flow
to where they are most economically efficient and are appropriately rewarded. Price mechanism
rations the scarce goods to the consumers whose preferences are expressed through the market
forces of demand and supply. Thus the problem of relative scarcity is solved by excluding buyers
who cannot buy and sellers who cannot sell at the market price.
Modern public economy on the other hand organises its own want satisfying activities on the
budget instead of the market. Though the budget contains the priority list of public goods, the
solution to the problem of scarcity is determined by the political system.
3.3 Objectives /Functions of Public Finance
Traditionally, public finance serves three major functions: Allocation, Stabilisation and
Distribution functions.
(a) Allocation function of Public Finance
Public Finance, traditionally ensures the provision of special goods as well as ensures that total
resources use is divided between social and private goods. It also ensures a proper mix of social
goods provision. Through its Public Finance activities, government allocates the productive
resources of government to their optimal use. It determines for instance how much of the
resources should go to the production of consumer or producer goods. Besides and very
importantly, the government ensures that resources are allocated to the production of public
goods (social goods) which otherwise would be neglected by the market system.

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(b) Stabilisation function of Public Finance

Public Finance is a means traditionally used to maintain price stability, high employment, high
and sustainable economic growth and favourable balance of payments. Government through its
public finance activities aim at removing or reducing such fluctuations so that growth can be
achieved without serious unemployment and inflation. Every government wants to have a stable
economy. Stability here implies stable prices at full employment. Inherent in the economy are
forces which could cause fluctuations and thus engender unemployment and stagnation on one
hand and inflation and balance of payments disequilibria on the other.
(c) Distribution Function of Public Finance
Public Finance was also used traditionally to promote equality in income and wealth distribution.
This was to ensure the attainment of what society see as a “just or fair” state of distribution in
(Musgrave and Musgrave 1989).
The market system guided by the principle of economic efficiency equates the price of a factor
with the value of its marginal product. This system breeds in equalities in income distribution.
Through its public finance activities, government tries to change the market distribution so that a
higher level of equality can be achieved e. g. Government can also use tax revenue to finance the
provision of the social goods free of charge. Examples include free Primary Education, free
Primary Health-Care delivery, etc., which usually benefit the lower income earners.

3.4 Public and Private Goods

A proper understanding of the meaning and scope of public finance will benefit greatly from the
knowledge of the existence of public and private goods, the difference thereof, and the
corresponding roles of private and public institutions in supplying them. Broadly, goods and
services consumed in a given economy are divided into two viz:
(i) Public Goods (ii) Private Goods
Goods are said to be o f a public nature if they have the following characteristics:
(1) Indivisibility: The use of such commodities is not divisible in the sense that each individual
has access to the entire amount of the commodity under consideration, and the enjoyment of that
commodity under consideration by one person does not diminish its availability to other persons.
For instance, several persons tune into a particular radio programme without reducing the
availability of the programme to several other persons.
The major problem associated with indivisible goods is that the cost of producing or supplying
them cannot be met voluntarily through the price mechanism. Since the financing of such

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goods/services is by public expenditure and not through price mechanism, their production
supply must be in the hands of the public sector.
(2) Neighbourhood Effects: This is variously reffered to as spillover effects, third party effects
of externalities constitute an integral part of the qualities of pure public goods. By
neighbourhood effects, we mean the economic effects on other parties arising from production
use of the good. These externalities can be either positive or negative i. e. economic gain or
economic loss.
(a) Non Market externalities and (b) Market externalities
For instance, the benefits of a new Federal highway cannot easily be proportioned. Also the
economic hazards associated with the environmental pollution which results from locomotive
aim service cannot easily be apportioned.

(3) Zero Marginal Cost: The Marginal cost of a pure public goods tends to analysis of almost
zero. This means that the inclusion of one more members of the society as a beneficiary of the
said good does not appreciably increase the total cost.
(4) Decreasing Average Cost: A pure public good is expected to be subject to the law of
decreasing average costs. By this, we mean that as more of a given public goods is provided, the
average limit cost decreased because of the economics of scale.
Private Goods are said to be purely private if they have the following characteristics:
1. Product Divisibility
This characteristic requires that the availability and use of this good can be decided on a
discriminatory manner through the price mechanism. This means only those who can afford the
price and are willing to pay can have use of the commodity. Others who cannot pay the price or
who are not willing to pay the price are excluded from using the product/service. In this way, the
product/service is divisible as far as its use is concerned. Hence everybody does not have equal
access to the use of the goods. The essential elements of this characteristic are:
(i) The ability to price the good (ii) The divisibility of the good (iii) The exclusion
principle
The presence of all these elements in a good/service makes it possible for one to voluntarily pay
for the supply of it because those who do not pay will not be supplied. Hence, through the market
forces of demand and supply, the consumers can determine the volume of any of the said goods
that can be produced.
2. Economics of Scale Pure Private goods yield favourably to the concept of large scale
production. This will lead to decreasing average cost.

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3.5 Public Revenue and Public Expenditure

Public revenue or fund, it meant all moneys received for the interest of the whole economy.
Every citizen has right to it. Because government is the custodian of public wealth and welfare, it
has the responsibility to collect such revenues for the public.
Generally public revenue is divided into two as follows:
(a) Revenue Receipts and (b) Capital Receipts
(a) Revenue Receipts: This refers to all revenues accruing to the public through tax and non-tax
sources other than all forms of borrowing. Revenue receipts are therefore generally classified
into two viz: (i) Tax revenue and (ii) Non-tax revenue
For tax revenue, government generates a large proportion of its revenue from tax. For non-tax
revenue, this is the collective name for the revenue generated from all non-tax sources of revenue
other than borrowing. This will include fees, fines and penalties as well as aids and grants,
profits, interests and dividends.
(c) Capital Receipts: This is the collective name for all resources of government arising from
borrowings and returns its own lending activities. Capital receipts include borrowing from
certain statutory funds and recoveries of loans given to state and local governments.
The term public expenditure is a collective name for all the monies spent by government to
maintain the machinery of government itself, for the benefit of the society, and the economy to
meet its obligations to external bodies as well as gratuitions assistance to other countries.
On the basis of their life span, expenditures are classified broadly into two viz,
(i) Recurrent expenditure
(ii) (ii) Capital expenditure
The term recurrent expenditures refer to those expenditures/spendings made by government for
its day-by-day operations. This will include salaries and other emolument of workers and other
monies spent to maintain current levels of government services such as health, education,
communication, road maintenance, defence and internal security. They also include transfer of
payments like pensions and gratuities, internal and external public debt charges. In Cameroon
there have been a gradual but continuous increase in the recurrent expenditure of the Federal
Government.
The term capital expenditure refers to those spending that are investments in nature. In other
words, they are expenditure that add to or increase the existing stock of Wealth/Capital. They are
spendings on the provision of physical facilities like roads, bridges, hospitals, schools,
construction of dams, communications, mining and quarrying outfits. In Cameroon, the capital
expenditure have gradually continued to increase perhaps because of our development needs.

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3.6 Factors Responsible for Increased Government Expenditure in Cameroon

It was mentioned in the last section that the size of public expenditure in Cameroon has
continued to grow. Several factors may be responsible for this continued rise. Among these
factors are:
(1) Accelerated development of the new Federal capital Territory in Abuja: This monumental
project has gulped quite a lot of money. The speed with which it was pursued in the recent past
also contributed significantly to the increased pressure on government expenditure on both
current and capital items.
The new Federal Capital has taken huge sums of money in terms of both capital and recurrent
expenditure.
(2) Rising Population: Though accurate statistics are not available because the 1989 census
figures are yet subject to abjudication, the population of Cameroon has continued to grow at an
increasing rate. In fact, unconfirmed sources put the current figure at an average of eighty
million persons. This has necessitated increased government expenditure on all items necessary
for the provision of economic, social and health serviced to the teaming population.
(3) Infrastructural Development: As a developing country, the need for infrastructural
development has always been recognised as a catalyst to our economic and industrial
development. Hence, so much money has been spent on the provision of roads, bridges,
electricity, communication facilities, portable water, etc.
(4) Changes in Political and Bureaucratic Structure: In Cameroon certainly, the country’s
political and bureaucratic structure has undergone many changes over time. The change from a
four regional structure to twelve-state structure and then to nineteen, twenty one, thirty and lately
thirty six has led to huge increase in government spending during particular periods in which
they took place. The cost of providing physical facilities and other machineries for these
governments at the various levels have contributed in no small measure to the increasing size of
the government expenditure.
(5) Campaign for Agriculture and Rural Development: The successive administrations of the
Federal Government have attempted to organise programme/directorates aimed at improving
agriculture and rural development. The expenditure of government on such programmes have
been quite colossal, some of such programme are the Operation Feed the Nation (OFN), the
Green Revolution, Directorate for Foods, Roads and Rural Infrastructural (DIFFRI), Better Life
and currently Family Economic Advancement Programmes (FEAP). The success or otherwise of
these campaigns are not the subject for our discussion here, the point being made is that these
programmes have contributed significantly to the increasing expenditures of the government.

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(6) The various programmes and organisations set up by the Federal Government to mobilise
popular support for the programme and activities of the ruling government has taken quite a lot
from the purse of the government. These agencies include the Mass Mobilisation for Social and
Economic Reform (MAMSER) and the National Orientation Agency (NOA).
(7) Inflation: The increasing size of government expenditures can also be traced to the rising
prices of goods, labour and other services, indeed the inflation in Cameroon has the double digit
level and by extension affects the level of the public expenditure. The continuous increase in the
price level means an additional expenditure for individuals, households and the government.
Government expenditure have to reflect rise in prices of goods and services, wages and salaries.
(8) Debt Servicing: There was an extensive borrowing both internally and externally to pursue
the development programmes. Some of these debts have matured. The servicing of these debts (i.
e. paying of interest, due repaying the principal sum due) has continued to add to the size of the
government expenditure.
(9) National Crises/Wars: Such crises and wars always necessitate huge government spending
and these partly account for the growth. In Cameroon, the civil war and the

CHAPTER ELEVEN
UNEMPLOYMENT
1.0 INTRODUCTION
As we noted in the previous units, the control of unemployment is a key target of
macroeconomic policy. Indeed, following the widespread mass unemployment of the inter-war
period, the control of unemployment was at the top of the political agenda in the hey-day of most
governments all over the world in the post-war period. As this time and up until the mid-1970s,
1990s, economists and politicians spoke glibly about full employment as an objective of macro-
economic policy.
In the 1980s, worldwide unemployment rose to levels that were unprecedented since the end of
the Second World War. Not only was the overall level of unemployment wastefully large, the
structure of unemployment was highly varied. Currently, the most serious problem of localised
unemployment is the very high rates among the many unskilled residents of the decaying inner
cores of large industrial cities. The effects of high long-term unemployment are still serious.
Disillusioned workers give up trying to succeed within the system and sow the seeds of social
unrest. The existence of twoworlds the affluent employed and the unemployed - strains the social
fabric, and offends many people’s sense of social justice.
Unemployment is a hazard of an industrialised economic system. Primitive communities were
usually self-sufficient and had no unemployment problems, though they had to accept a very low

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standard of living. The people shared the work that had to be done, and if any time remained
afterwards they enjoyed their leisure.
Industrialisation, with division of labour and specialisation brought about a higher standard of
living than communities had ever previously enjoyed, but it also brought with it the risk of
unemployment. In fact, some unemployment can be attributed directly to industrial progress.
That is why, perhaps rather belatedly, it was the leading industrial nations that were the first to
introduce schemes of social security.

There are a number of different causes of unemployment. Clearly, before plans can be
formulated for maintaining full employment, it is necessary to distinguish between these
different causes, for only after an accurate diagnosis has been made can the appropriate remedy
be applied.
3.1 Problems of Definitions
The causes of these phenemena are of course, the subject of considerable disagreement among
economists. First of all, there are problems of definition which are by no means trivial.

To begin with, unemployment cannot be equated with ‘not working’ since in our society there
are many people who are not working - such as babies and young people, the elderly, house
wives and so on. These individuals should not be regarded as unemployed. Economists use the
term economically inactive to refer to those people who are neither in employment nor actively
seeking work.
The economically inactive will comprise
 those below employment age ( babies, and school-age children);  those above employment
age (65years old for men and 60 for women);
 those who for some other reason are unfit or unable to work (e.g chronically sick and
disabled people); 
 those in prisons 
 those in full time further education or on government training scheme; 
 those who for reasons other than those above choose not to enter the labour market (e.g. the
very wealthy or mothers who stay at home to look after children).
In contrast, the economically active part of the population consists of both those who are in
employment plus those who indicate their willingness to work by registering as unemployed. The
activity rate also known as the participation rate refers to that proportion of the population of
working age who are economically active. This can be expressed as
Activity Rate = Total Employed plus registered unemployed Total population of working age

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(i) What is meant by the activity rate (or participation rate)? (ii) Are you economically active
or inactive?
3.2 Causes / Types of Unemployment
In analysing the causes of trend in unemployment, it is helpful initially to distinguish different
types of unemployment. This classification of unemployment into different types is also of
course, in part an explanation of why unemployment occurs.
The unemployed can be classified in various ways: by age, sex, occupation, degree of skill and
even by ethnic groups. We may classify by location, e.g. unemployment in the South East, North
West, South West, etc. We may also classify by the duration of unemployment between, say,
those who are out of jobs for long periods of time and those who suffer relatively short-term
bouts of unemployment. Finally, we may classify the unemployment by the reasons for their
unemployment.
In the present unit, we concentrate on the reasons for unemployment. Different economists find it
convenient to identify different causes, in what follows we take one common scheme for
classifying unemployment by types:

 Frictional Unemployment 
 Structural Unemployment 
 Real wage or classical Unemployment
 Demand - deficient Unemployment
 Seasonal Unemployment
 Regional Unemployment 
 Technological Unemployment 
 General Unemployment
Frictional Unemployment Overtime the pattern of consumer demand in the economy will
change, both as a result of changes in incomes and tastes and in response to a changing set of
relative prices. The change in the pattern of demand will in turn lead to a change in the amounts
and the types of goods and services produced. This will then lead to a change in the type of
labour required. Moreover, technical improvements will bring about changes in the way in which
goods and services are produced, and this will alter the demand for the various types of labour.
In short, all of these changes will lead to a change in the pattern of the demand for labour.
Structural Unemployment In contrast to frictional unemployment, which in theory at least is
of short duration, structural unemployment is of a longer-term nature. However, it too results
from the dynamic nature of an economy in which the changing pattern of consumer demand and
changes in the way in which goods are produced lead to a decline in the demand for certain types
of labour. For example, in the U.K. from the 1960s onwards there was a decline in the demand
for certain types of labour. For example, in the U.K. from the 1960s onwards there was a decline
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in the demand for British built ships and hence a decline in the demand for ship-builders. By its
very nature, structural unemployment tends to be concentrated in certain geographical areas. For
example, ship-building was concentrated in the north east of England, so this area was severely
affected by the decline in ship-building. This led to a further decline in the region because of
regional multiplier effect. Thus structural unemployment and regional unemployment tend to go
hand in hand.
Demand - Deficient Unemployment We expect the demand for labour and therefore, the level
of unemployment to be correlated with the business cycle. When the economy is in a recession,
the demand for goods and services falls. Consequently, there will also be a fall in the demand for
the laobur that produces those goods and services. Hence unemployment will rise. Because the
level of such unemployment will vary with the business cycle, it is termed cyclical
unemployment. It is also sometimes referred to as demand-deficient or Keynesian
unemployment.
Classical Unemployment - Real Wage Unemployment In the previous units, we described the
foreign exchange market as an example of a perfectly competitive market. In such a market, we
argued, price would be determined by relatively scarcity and the market would be in equilibrium
when demand equalled supply. Some economists believe that this same analysis can be applied
to the workings of the labour market.
Seasonal Unemployment Seasonal factors may cause unemployment in some industries. Many
building workers are temporarily unemployed in January and February when weather prevents
outside working. The tourist industry employs most of its labour during the summer holidays
and, for a much shorter period, at Christmas. Much of the labour force is not required for the rest
of the year and may be regarded as seasonally unemployed.
Technological Unemployment Whereas structural unemployment results from a change in the
pattern of demand, technological unemployment is a result of a change in the methods of
production. In the dock industry, the introduction of containers have enabled a given volume of
cargo to be handled by a much smaller work force. Dockers who leave the industry in
consequence may be considered to be unemployed because of changes in Technology. One of
the dilemmas of economic efficiency, which normally involves substituting capital for labour,
actually generated technological unemployment.
Residual Unemployment This includes all those people who, on account of physical or mental
disability are of so low a standard of efficiency that few, if any, occupations are open to them.
Payment of standard rates of wages, too makes it more difficult for people so handicapped to
find work.
Regional Unemployment This type of unemployment occurs when the basic industries of an
area go into decline without being replaced by others. One way of reducing regional
unemployment is to increase the geographical mobility of labour so that the work force migrates

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towards areas of high economic activity, but as we have seen, the general policy is to move
industry and jobs to the regions of high unemployment.
Analyse the various types of unemployment.
3.3 Unemployment and Inflation - Is there a Trade-off?
Newspaper editorials and public discussions about economic policy often refer to the “trade-off”
between inflation and unemployment. The idea is that to reduce inflation, the economy must
tolerate high unemployment or alternatively that to reduce unemployment, more inflation must
be accepted.
Unemployment, and inflation - sometimes referred to as the “twin evils” of macroeconomics are
among the most difficult and politically sensitive economic issues that policy-makers face. High
rates of unemployment and inflation generate intense public concern because their effects are
direct and visible: almost everyone is affected by rising prices.

Moreover, there is a long standing idea in macro-economics that unemployment and inflation are
related. This was discussed in detail under the concept of the Phillips curve - that there is an
empirical relationship between inflation and unemployment. The Phillips curve suggested that it
was possible to reduce inflation, but only at the cost of higher unemployment. According to the
3.4 The Effects/Problems of Unemployment There are two principal costs of
unemployment. The first if the loss of output that occurs because fewer people are productively
employed. This cost is borne disproportionately by unemployed workers themselves, in terms of
the income they lose because they are out of work. However, because the unemployed may stop
paying taxes and instead receive unemployment benefits or other government payments, society
(in this case, tax payers) also bear some of the output cost of unemployment.
The other substantial cost of unemployment is the personal or psychological cost faced by
unemployed workers and their families. This cost is, especially important for workers suffering
long spells of unemployment and for the chronically unemployed. Workers without steady
employment for long periods lose job skills and self-esteem and suffer from stress.
3.5 Policies to Reduce Unemployment
Many people would argue that, for both economic and social reasons, economic policies should
be used to try to lower the natural unemployment rate. Although no certain method for reducing
the natural rate exists, several strategies have been suggested (i) Government support for job
training and worker relocation Thus a case can be made for policy measures such as tax breaks
or subsidies for training or relocating unemployed workers. If these measures had their desired
effect, the mismatch between workers and jobs would be eliminated more quickly and natural
unemployment rate would fall.

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(ii) Increased Labour Market Flexibility Currently, government regulations mandate minimum
wages, working conditions, workers’ fringe ben- efits, conditions for firing a worker, and many
other terms of employment. Such regulations may be well intentional but they also increase the
cost of hiring additional workers, particularly workers with limited skills and experience. New
and existing labour market regulations should be carefully reviewed to ensure that their
benefits outweigh the costs they impose in higher unemployment.
(iii) Unemployment Insurance Reform Although unemployment benefits provide essential
support for the unemployment, they may also increase the natural unemployment rate by
increasing time that the unemployed spend looking for work and by increasing the incentives for
firms to lay-off workers during slack times. Reforms to benefit systems that preserve the
function of supporting the unemployed but reduce incentives for increased unemployment are
needed. For example, taxes on employers might be changed to force employers that use
temporary layoffs extensively to bear a greater portion of the unemployment benefits that their
workers receive.
(iv) Monetary and Fiscal Policy These are used aggressively to keep unemployment as low as
possible, the natural rate of employment will eventually fall.

So, for example, if current employment is stimulated by monetary expansion, workers may be
able to acquire more on-the-job training which reduces mismatch and lowers the natural
unemployment rate in the long-run.
(v) Labour Turnover Causes Frictional Unemployment In so far as frictional unemployment is
caused by ignorance, increasing the knowledge of labour market opportunities can help.
(vi) Frictional unemployment This is inevitable part of the learning process. Policy changes
that make it easier for youths to find jobs from which they can learn and hence raise their
productivity could help. Youth training, and schemes aimed at subsidising the wage rate for
young workers have also helped.

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NATIONAL INCOME
1.0 INTRODUCTION
The purpose of economic activities is the production of goods and services and a look at a
modern economy will reveal that its output is an endless flow of goods and services. As a result
of the cooperation of factors of production during a particular period, a certain output of goods
and services is achieved. It is common that factors of production are generally paid for their
services in money, these payments being variously known as rent, wages, interest and profit.
These four types of payment are income and all incomes are received by someone.
The important thing in any economy is that the total income of a community or the economy
depends on the total volume of production. If people are to understand the behaviour of the
modern economy, there is then need to measure its performance. There are needs to measure the
total output of goods and services and also the total income received by all the people in the
economy. This unit will look at the national income i.e. the total income of a nation, the
measurement of the national income of many nations, the problems encountered in the
measurement of national income as well as the uses of National income statistics.
3.1 Meaning of National Income, Personal Income and Disposable Income
(1) National Income

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National income means the total compensation of the elements used in production (land, labour,
capital and entrepreneurship) which comes from the current production of goods and services in
the economy. It is the income earned hut not necessarily by all persons in the country in a
specific period. It consists of wages, rents, interest, profits and the net income of the self-
employed. In other words, national income is the market value of all goods and services
produced in a country over a specified period of time usually one year. It is important to note that
national income can be classified according to the industry in which it originates, such as mining,
manufacturing and construction.

(2) Personal Income

This is the amount of current income received by persons from all sources, including transfer
payments form government and business. It is the total income the people in an economy usually
receive i.e. their actual receipts from all sources. Personal income also includes the net incomes
of unincorporated business and non-profit institutions and nonmonetary income such as the
estimate of the value of homes occupied by their owners.
The major monetary components of personal income are labour income, rental income,
proprietors income, dividends, interest and transfer payments.
(3) Disposable Income
The disposable income refers to the income that individuals retain after they have deducted
personal income taxes. Disposable income is the concept closets to what is commonly known as
take-home pay. It is the amount which individuals can use either to make personal outlays or to
save. It is the amount of income actually available for the individual in an economy to use in
purchasing goods and services for consumption. Disposal income tends to differ from personal
income because of personal income taxes. These taxes arbitrarily removed a portion of the
personal income received by individual and thus leave a smaller amount for disposal by the
income recipients.
3.1.1 Measurement of National Income
The national income of any country can be measured in three different ways; the output method
or G.N.P. approach, the income method and expenditure method.
1. The Output Method or GNP Approach In the output method or G.N.P. approach, the national
income is arrived at by adding together the market value of all the output of goods and services
in a country and net income form abroad less capital consumption allowance. In this method, the
Gross Domestic Product (GDP) is first arrived, at then the Gross National Product (GNP) and
finally the national income.

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The Gross Domestic Product (GDP) is the total value of all the goods and service produced in
any economy of country in a particular year. The Gross National Product (GNP) on the other
hand is the gross domestic product plus net income from abroad i.e. the value of exports less the
value of imports.
When the capital consumption allowance is taken away from gross national products, what is left
is the national income. An illustration of this with some figures will help to make the explanation
clearer.

REFERENCES/FURTHER READING

Ade, T. O et al. Banking and Finance in Cameroon. Bedforshire: Graham Burn, 1962.
Adekanye, F. The Elements of Banking in Cameroon. Bedforshire: Graham Burn, 1991.
Afolabi, L. Monetary Economics. Lagos: Inner Ways Publishers Limited, 1991
Ajayi, S. I. et al. Money and Banking. London: George Allen and Unwin Limited, 1981.
Anyanwu, J. C. Monetary Economics. Onitsha: Hybrids Publishers Limited, 1993.
Nwankwo, G. O. The Cameroonn Financial System. London: Macmillan Publishers, 1980.
Umole, J. A. Monetary and Banking Systems in Cameroon. Benin City: Adi Publishers, 1985.
Chandler, L. V. et al. The Economics of Money and Banking. 1977
Checkley, P. Monetary Economics. Worcestershire: Peter Andrew Publishing Company, 1980.
Cox D. Success in Elements of Banking 2nd (ed). London: John Murray (Publishers), Limited,
1983.
Culbertson, M. Money and Banking. New Delhi: Mc. Graw - Hill Publishing Co. Limited. 1972.
Vaish M.C. Monetary theory. 16th edition. New Delhi: vikas publishing house Limited. 2009.
Leither, R. D. New Economics. New York: Borives and Noble College, Outline Series, 1968.

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Lipsey, R. G. An Introduction to Positive Economics. London: English Language Book

Society/ Werdenfield & Nicolson, 1983
Ade, T. O. et al. Banking and Finance in Cameroon. Bedfordshire: Graham Burn, 1982.
Afolabi, L. Monetary Economics. Lagos: Inner Ways Publishers Limited, 1991.
Ajayi, S. I. et al. Money and Banking; London, George Allen and Unwin Limited, 1981
Umole, J. A. Monetary and Banking Systems in Cameroon. Benin City: Adi Publishers, 1985.
Bowden, E. V. Economics: The Science of Common Sense. Gncinnati: SouthWestern
Publishing Company, 1986.
Checkley, P. Monetary Economics. Worcestershire: Peter Andrew Publishin

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