MODULE 2

ECONOMIC POLICY ANALYSIS

BSc Economics — Comprehensive Examination

Lecturer-Style Textbook Notes | Full Coverage | Units 1 – 7
COURSE DESCRIPTION
This module examines how governments intervene in the economy in order to achieve their desired
economic goals. We study fiscal policy, monetary policy, trade policy, development policy, and the
economic effects of major shocks such as disease outbreaks and pandemics. A strong understanding of
this module prepares you to analyse real-world policy debates, evaluate government budgets, and
understand how institutions like central banks and the IMF work to stabilise economies.
By the end of this module you should be able to distinguish between different types of economic policy,
evaluate government tools for controlling inflation and unemployment, and apply policy analysis to the
Sierra Leone context.
UNIT 1: INTRODUCTION TO ECONOMIC POLICY

1.1 What is Economic Policy?

Economic policy refers to the deliberate actions taken by governments and central banks to influence
the performance of a national economy. Simply put, it is what a government does — or chooses not to
do — in order to guide the economy toward desired objectives.
Think of it this way: if the economy were a ship, economic policy would be the steering wheel. The
captain (government) uses it to keep the ship on course — avoiding the rocks of recession on one side
and the whirlpool of inflation on the other.

KEY DEFINITION
Economic Policy: A deliberate set of actions and decisions taken by governments and monetary
authorities to influence the level and direction of economic activity in order to achieve specific
macroeconomic objectives.

1.2 Objectives of Economic Policy

Every government designs its economic policies around certain goals. These goals are sometimes called
the 'magic square' of macroeconomic policy objectives. You need to know all four — and be ready to
explain what each means and how it is measured.

OBJECTIVE EXPLANATION
Full Employment Government aims to minimise unemployment — ideally keeping it
at or below the natural rate (around 4–5%). High unemployment
means wasted human resources and social hardship.
Price Stability Government tries to keep inflation low and stable — typically
targeting around 2–5% annually. High or volatile inflation erodes
purchasing power and creates uncertainty.
Economic Growth Sustained increase in real GDP over time. Growth improves living
standards, generates tax revenue, and funds public services.
Balance of Payments The country should not run persistent deficits in its external
Equilibrium accounts. A healthy external position means the country can pay for
its imports and service its external debts.
Income Redistribution Policies should reduce inequality and ensure the benefits of growth
(Equity) reach all segments of society — not just the wealthy.
External Balance Maintaining a stable exchange rate and sustainable external debt
 levels.

In Sierra Leone's context, the key policy objectives include controlling inflation (which has historically
been high), promoting growth in agriculture and mining, reducing unemployment among youth, and
managing the external debt burden.

1.3 Instruments of Economic Policy

An instrument is the specific tool a government uses to achieve a policy objective. Just as a doctor uses
different medicines for different illnesses, governments use different policy instruments for different
economic problems.

INSTRUMENT TYPE SPECIFIC TOOLS PURPOSE

Fiscal Policy Government spending and Boost aggregate demand; fund
taxation public goods
Monetary Policy Interest rates, money supply, Control inflation; influence
reserve requirements credit and investment
Trade Policy Tariffs, quotas, trade Protect domestic industries;
agreements regulate imports
Exchange Rate Policy Fixed or managed exchange Stabilise currency; influence
rates competitiveness
Income Policy Wage controls, price controls Directly limit inflationary
pressure
Supply-Side Policy Deregulation, privatisation, Increase productive capacity of
education the economy

1.4 Government Intervention — Why Does It Happen?

Classical economists argued that free markets should be left alone — that the 'invisible hand' of the
price mechanism would allocate resources efficiently. However, experience has shown that markets
frequently fail. Government intervention becomes necessary when:

• Markets produce too little of goods with positive externalities (e.g., education, healthcare)
• Markets produce too much of goods with negative externalities (e.g., pollution, cigarettes)
• Private firms will not supply public goods because they cannot exclude non-payers
• Monopoly power allows firms to restrict output and charge excessive prices
• Information is distributed unequally, causing consumers or workers to make poor decisions
• The economy falls into recession and private spending alone cannot restore full employment
 LECTURER'S NOTE:
In examinations, students often confuse INSTRUMENTS with OBJECTIVES. Remember: objectives
are the goals (e.g., low inflation), while instruments are the tools used to reach them (e.g., raising
interest rates). Always distinguish these clearly in your answers.

1.5 Economic Stabilisation

Economic stabilisation refers to policies aimed at reducing the amplitude of the business cycle —
smoothing out the booms and busts that naturally occur in a market economy. There are two main
types of stabilisation policy:

• Automatic Stabilisers: These work without any deliberate government action. For example,
when the economy contracts and unemployment rises, the government automatically pays out
more in unemployment benefits — which partially offsets the fall in consumer spending.
Progressive taxation also works as an automatic stabiliser: when incomes fall, people pay less
tax, leaving more disposable income.

• Discretionary Policy: These require conscious decisions by policymakers. For example,

parliament may vote to increase public works spending during a recession, or a central bank
may decide to cut interest rates to stimulate borrowing and investment.
UNIT 2: MARKET FAILURE

2.1 What is Market Failure?

Market failure occurs when the free market mechanism, left to its own devices, fails to allocate
resources efficiently. In other words, the market produces either too much or too little of certain goods,
or fails to produce them at all. This creates a justification for government intervention.
It is important to understand: market failure does not mean the market has 'crashed' or stopped
working. It means the market has produced an inefficient outcome from society's point of view.

KEY DEFINITION
Market Failure: A situation in which the free market fails to allocate resources in a Pareto-efficient
manner, resulting in a net loss of economic welfare to society.

2.2 Public Goods

Public goods are a major cause of market failure. A public good has two special characteristics that make
it impossible for private firms to supply it profitably:

• Non-excludable: Once the good is provided, it is impossible to prevent people who have not
paid from consuming it. Example: street lighting. Once a street lamp is switched on, everyone
who walks past benefits — even those who contributed nothing to its cost.

• Non-rival: One person's consumption of the good does not reduce the amount available for
others. If one person walks under a street light, this does not diminish the light available for the
next person.

These two characteristics together create the free rider problem: rational individuals will not pay
voluntarily for a public good because they know they can consume it without paying once it is provided.
As a result, private markets will under-supply or completely fail to provide public goods. This is why
governments must step in and provide them, financed through taxation.

EXAMPLE WHY IT IS A PUBLIC GOOD

National defence One person's protection does not reduce another's; cannot exclude
non-taxpayers from defence umbrella
Street lighting One person walking under a lamp doesn't dim it for others;
everyone benefits regardless of payment
 Flood control systems A flood barrier protects all residents in an area, not just those who
funded it
Clean air (policy) Air quality cannot be withheld from non-payers; everyone breathes
the same air
Public health campaigns Broadcasting health information benefits all listeners equally

2.3 Externalities
An externality is a cost or benefit that falls on a third party — someone who is neither the buyer nor the
seller in a transaction. Externalities are a major cause of market failure because they mean the market
price does not fully reflect the true social cost or benefit of an activity.

2.3.1 Negative Externalities (External Costs)

A negative externality occurs when production or consumption imposes costs on third parties who are
not compensated. The producer or consumer does not pay for these costs, so the market overproduces
the good relative to the socially optimal level.

Classic examples: a factory emitting toxic smoke (pollution), cigarette smokers affecting non-smokers
(passive smoking), loud music from a nightclub disturbing nearby residents.

In a free market, the firm only considers its private costs — the cost of inputs like labour, raw materials,
and electricity. It ignores the external costs imposed on society. This means: Private Cost < Social Cost,
and the market produces too much of the good at too low a price.

GOVERNMENT CORRECTION: The government can impose a Pigouvian tax equal to the external cost,
forcing the firm to 'internalise' the externality. It can also use regulations, standards, and permit
schemes.

2.3.2 Positive Externalities (External Benefits)

A positive externality occurs when production or consumption generates benefits for third parties who
do not pay for them. The market therefore underproduces the good relative to what is socially optimal.

Classic examples: vaccination (you benefit when your neighbour gets vaccinated because the disease
spreads less), education (an educated workforce increases productivity economy-wide), research and
development (innovations benefit the whole industry).

GOVERNMENT CORRECTION: Subsidies to producers or consumers, direct government provision, or

regulation requiring minimum consumption (e.g., compulsory schooling).
 EXAMPLE TYPE GOVERNMENT CORRECTION
Factory pollution Negative Tax on emissions; regulation;
pollution permits
Passive smoking Negative Smoking bans in public places;
tobacco tax
Vaccination Positive Free vaccination programmes;
subsidised healthcare
Education Positive Free state education; student
grants and loans
Road congestion Negative Congestion charges; investment
in public transport
R&D / Innovation Positive Subsidies to research; patent
protection

2.4 Monopoly Power

When a single firm dominates a market, it has the power to restrict output and charge prices above the
competitive level. This leads to an inefficient allocation of resources: output is too low, prices are too
high, and there is a deadweight loss to society — meaning some transactions that would benefit both
buyer and seller never take place.
In a perfectly competitive market, P = MC (price equals marginal cost), which is the condition for
allocative efficiency. A monopoly produces where MR = MC but charges a price P > MC, which is
allocatively inefficient.

Government correction: Competition law and anti-monopoly regulation (e.g., a competition

commission), price regulation (e.g., requiring a monopoly to charge P = MC or P = AC), or breaking up
monopolies.

2.5 Information Asymmetry

Information asymmetry occurs when one party in a transaction has more or better information than the
other. This can lead to poor decisions and market failure.

• Adverse Selection: This happens BEFORE a transaction. Because one party has more
information, the market ends up attracting the 'wrong' participants. Classic example: in the
market for health insurance, people who know they are high-risk are more likely to buy
insurance than healthy people. If insurers cannot distinguish high-risk from low-risk customers,
premiums rise, healthy customers leave, and eventually only high-risk customers remain — the
market unravels.
 • Moral Hazard: This happens AFTER a transaction. Once insured, a person has less incentive to
take precautions because someone else bears the cost of their risky behaviour. Example: a
person with fully comprehensive car insurance may drive less carefully than someone who is
uninsured.

2.6 The Free Rider Problem

We already touched on this under public goods, but it deserves its own treatment. A free rider is
someone who consumes a good without paying for it — benefiting from the contributions of others.
The free rider problem arises because rational individuals, acting in their own self-interest, will not
contribute to the provision of a public good if they can enjoy it for free. If everyone reasons this way, the
good will be under-provided or not provided at all. This is why government provision, financed through
compulsory taxation, is necessary.

EXAMINATION TIP:
When answering a question on market failure, always: (1) Define the type of market failure, (2)
Explain why the free market fails in that specific case, (3) State the welfare consequence
(under/over-production, welfare loss), and (4) Suggest the appropriate government corrective
measure. Use real-life examples from Sierra Leone wherever possible.
UNIT 3: FISCAL POLICY

3.1 What is Fiscal Policy?

Fiscal policy refers to the use of government spending and taxation to influence the overall level of
economic activity. It is one of the two main instruments of macroeconomic management — the other
being monetary policy.
The government can either stimulate a sluggish economy by spending more and taxing less
(expansionary fiscal policy), or cool down an overheating economy by spending less and taxing more
(contractionary fiscal policy).

KEY DEFINITION
Fiscal Policy: The deliberate use of government revenue (taxation) and expenditure to influence the
aggregate demand, economic output, and overall macroeconomic conditions of a nation.

3.2 Government Expenditure

Government spending is the most direct way a government can influence aggregate demand. When the
government builds a school or a road, pays its civil servants' salaries, or transfers money to poor
households, it is directly injecting money into the economy.

3.2.1 Types of Government Expenditure

• Current Expenditure: Spending on the day-to-day running of government. This includes wages
of public sector workers (teachers, nurses, soldiers, police), spending on goods and services, and
transfer payments (social grants, pensions, subsidies).

• Capital Expenditure: Spending on long-term assets that increase the productive capacity of the
economy. Examples: roads, hospitals, schools, bridges, dams, and other infrastructure.

• Transfer Payments: Payments to individuals that are not in exchange for any productive service
— for example, unemployment benefits, student bursaries, and old age pensions. These
redistribute income but are not counted directly in GDP because no production takes place.

3.3 Taxation
Taxes are compulsory payments made to the government by individuals and firms. They are the main
source of government revenue and a key instrument of fiscal policy.
3.3.1 Types of Taxes

• Direct Taxes: Levied directly on income or wealth. The person on whom the tax is legally
imposed is also the one who bears the burden. Examples: Personal Income Tax (PAYE),
Corporation Tax, Capital Gains Tax, Property Tax.

• Indirect Taxes: Levied on spending and can be shifted from producer to consumer. The legal
liability and the economic burden fall on different people. Examples: Value Added Tax (VAT),
Goods and Services Tax (GST), Customs Duties, Excise Duty.

• Progressive Tax: The tax rate rises as income increases. Higher earners pay a larger proportion
of their income. Income Tax in most countries is progressive. This is considered fair (based on
ability to pay) but can reduce incentives to earn more.

• Regressive Tax: The tax takes a larger proportion of income from the poor than from the rich. A
flat-rate sales tax is regressive because poor households spend a higher fraction of their income
on consumption.

• Proportional Tax: Everyone pays the same percentage of their income regardless of how much
they earn.

3.3.2 Principles of a Good Tax System

Adam Smith laid down four canons (principles) of taxation, which remain highly relevant today:

1. Equity — taxes should be fair; those with higher incomes should pay more
2. Certainty — taxpayers should know exactly what they owe and when
3. Convenience — taxes should be easy and convenient to pay
4. Economy — the cost of collecting the tax should be low relative to revenue raised

To these, modern economists add: Simplicity (the tax system should be easy to understand), Flexibility
(it should respond to changing economic conditions), and Efficiency (it should not distort economic
decisions more than necessary).

3.4 Budget: Deficits and Surpluses

The government budget is the statement of planned government revenues and expenditures for the
coming fiscal year. The budget position is the difference between revenues and expenditures:
 Budget Balance = Government Revenue (T) − Government
Expenditure (G)

• Budget Surplus (T > G): The government collects more in taxes than it spends. This is
contractionary — it removes more money from the economy than it injects.

• Budget Deficit (G > T): The government spends more than it collects. This is expansionary — it
injects more into the economy than it removes. The deficit must be financed through borrowing
(issuing government bonds) or printing money.

• Balanced Budget (T = G): Revenue exactly equals expenditure. In theory, a balanced budget
fiscal expansion is still possible — the balanced budget multiplier shows that equal increases in
G and T raise national income by the same amount.

3.5 Expansionary Fiscal Policy

Expansionary fiscal policy is used when the economy is operating below its potential output — during a
recession, when unemployment is high, or when aggregate demand has fallen. The government
deliberately increases spending, cuts taxes, or both, in order to boost aggregate demand and bring the
economy back to full employment.

The mechanism works as follows: The government increases spending on, say, a road construction
project. Construction companies receive contracts and hire more workers. Those workers earn wages
and spend them at local shops. Shop owners then have more revenue and may also hire more workers
or invest in their businesses. This chain reaction is the multiplier effect — a given increase in
government spending generates a multiplied increase in national income.

Fiscal Multiplier = 1 / (1 − MPC)

Where: MPC = Marginal Propensity to Consume = ΔC / ΔY

WORKED EXAMPLE:
Suppose the government of Sierra Leone increases spending by SLL 500 billion on new school
buildings. The MPC in the economy is 0.8.

Step 1: Calculate the multiplier.

k = 1 / (1 − 0.8) = 1 / 0.2 = 5

Step 2: Calculate the change in national income.

ΔY = k × ΔG = 5 × 500 = SLL 2,500 billion

CONCLUSION: An initial government spending increase of SLL 500 billion generates a total increase
 in national income of SLL 2,500 billion through the multiplier process.

3.6 Contractionary Fiscal Policy

Contractionary fiscal policy is used when the economy is overheating — when aggregate demand is
growing too fast, causing inflation to rise. The government deliberately reduces its spending, raises
taxes, or both, in order to reduce aggregate demand and bring inflation under control.
The process is the reverse of expansionary policy: higher taxes reduce household disposable income, so
consumers spend less. Reduced government spending means fewer contracts for businesses, fewer jobs
in the public sector, and less money circulating in the economy.

TYPE OF FISCAL POLICY WHEN USED / EFFECT

EXPANSIONARY Used during recession; increases G and/or cuts T; boosts AD;
reduces unemployment; risks higher inflation
CONTRACTIONARY Used during boom; reduces G and/or raises T; reduces AD; controls
inflation; risks higher unemployment

3.7 Public Debt

When the government runs a budget deficit, it must borrow to finance the gap. It does this by issuing
government bonds (treasury bills and treasury bonds), which are purchased by banks, insurance
companies, pension funds, and sometimes foreign investors. The accumulation of annual deficits creates
the national debt — the total stock of outstanding government borrowings.

In Sierra Leone, the government borrows both domestically (from the banking sector and the public) and
externally (from the IMF, World Bank, bilateral donors, and international capital markets). Managing this
debt is a critical challenge.

3.7.1 Problems with High Public Debt

• Crowding Out: Heavy government borrowing pushes up interest rates, which discourages
private sector investment — the government 'crowds out' private borrowers.
• Debt Servicing Burden: A large proportion of government revenue must be used to pay interest
on existing debt, leaving less for productive spending on health and education.
• Reduced Fiscal Space: With high debt, the government has less room to use expansionary policy
during future recessions.
• Currency and Credit Risk: If the government borrows in foreign currency, currency depreciation
can make the debt more expensive to service.
3.8 Fiscal Policy in Sierra Leone
Sierra Leone's fiscal policy has historically been shaped by a combination of limited tax revenues, heavy
dependence on external aid and borrowing, and large public sector wage bills. Key features of Sierra
Leone's fiscal context include:

• The National Revenue Authority (NRA) is responsible for domestic tax collection, including
income tax, GST, and customs duties.
• The country relies heavily on revenues from natural resources — particularly iron ore,
diamonds, rutile, and bauxite — making government finances vulnerable to commodity price
shocks.
• The IMF and World Bank have supported Sierra Leone through Extended Credit Facility (ECF)
programmes, which typically require fiscal discipline — reducing the deficit and improving
revenue collection.
• The COVID-19 pandemic (2020–2021) forced a large expansion of public spending on health and
social support while revenues fell, causing the deficit to widen significantly.
UNIT 4: MONETARY POLICY

4.1 What is Monetary Policy?

Monetary policy refers to the actions taken by a country's central bank to control the supply of money
and credit in the economy, typically with the aim of achieving price stability (controlling inflation) while
supporting sustainable economic growth and employment.
While fiscal policy is controlled by the government (Minister of Finance and Parliament), monetary
policy is normally the responsibility of the central bank — in Sierra Leone, this is the Bank of Sierra
Leone (BSL). The central bank has operational independence from the government in most modern
economies.

KEY DEFINITION
Monetary Policy: The process by which a central bank controls the supply of money and credit and
the level of interest rates in order to achieve macroeconomic objectives, primarily price stability.

4.2 Tools of Monetary Policy

The central bank has several key instruments at its disposal:

4.2.1 Open Market Operations (OMO)

This is the most commonly used monetary policy tool. The central bank buys or sells government
securities (bonds and treasury bills) in the open market to influence the money supply.

• To expand money supply: The central bank buys government bonds from commercial banks.
Banks receive cash in exchange, increasing their reserves and their ability to lend. This pushes
interest rates down and stimulates borrowing and spending.

• To contract money supply: The central bank sells government bonds to commercial banks.
Banks pay cash, reducing their reserves and their capacity to lend. This pushes interest rates up
and discourages borrowing.

4.2.2 Reserve Requirements

Commercial banks are required to keep a certain percentage of their deposits as reserves — either as
vault cash or as deposits at the central bank. This is called the reserve requirement or cash reserve ratio
(CRR).
If the central bank raises the reserve ratio, banks must hold more reserves and have less money to lend
out — the money supply contracts. If it lowers the reserve ratio, banks can lend more — the money
supply expands.

Money Multiplier = 1 / Reserve Ratio (r)

If r = 0.10 (10%), then the money multiplier = 1/0.10 = 10
An initial deposit of SLL 1 billion creates SLL 10 billion in total
money supply

4.2.3 Bank Rate / Policy Rate

The bank rate (also called the discount rate or monetary policy rate) is the interest rate at which the
central bank lends money to commercial banks. When commercial banks need liquidity, they can
borrow from the central bank as lender of last resort.

• Raising the bank rate: Makes borrowing more expensive for commercial banks. They pass this
cost on to their customers by raising lending rates, which discourages borrowing and reduces
the money supply. This is anti-inflationary.

• Lowering the bank rate: Makes borrowing cheaper, encouraging commercial banks to borrow
more and lend more to businesses and households. This expands the money supply and
stimulates economic activity.

4.2.4 Interest Rate Policy

More broadly, the central bank influences the whole structure of interest rates in the economy. By
setting its own policy rate, the central bank signals the direction of monetary policy, and commercial
banks adjust their own lending and deposit rates accordingly.
Higher interest rates: discourage consumer borrowing, reduce business investment, attract foreign
capital inflows (strengthening the exchange rate), and reduce aggregate demand — all of which help
control inflation.

4.2.5 Inflation Targeting

Many modern central banks operate under an inflation targeting framework — they explicitly announce
a target inflation rate (e.g., 2% in the UK, or a range such as 5–10% for developing countries) and adjust
monetary policy instruments to keep inflation close to that target.
In Sierra Leone, the Bank of Sierra Leone conducts monetary policy under a framework that seeks to
keep inflation within a target band, though achieving this is challenging given the structural factors
driving inflation (food prices, fuel costs, exchange rate depreciation).
4.3 Functions of a Central Bank
Understanding the role of the central bank is essential for both monetary policy and banking questions
in the examination.

FUNCTION EXPLANATION
Sole Currency Issuer The central bank has the exclusive authority to issue banknotes and
coins. In Sierra Leone, the Bank of Sierra Leone issues the Leone
(SLL/SLE).
Banker to the Government The government maintains its main accounts at the central bank.
The BSL manages government receipts and payments and may
advance short-term credit to the government.
Banker to Commercial Banks Commercial banks hold reserve accounts at the central bank and
can borrow from it. The central bank clears inter-bank transactions.
Lender of Last Resort When commercial banks face a liquidity crisis, they can borrow from
the central bank to avoid collapse. This prevents bank runs from
spreading.
Monetary Policy Controller The central bank uses its instruments (OMO, reserve ratio, bank
rate) to achieve price stability and support economic growth.
Foreign Exchange Manager The central bank manages the country's foreign exchange reserves
and may intervene in the foreign exchange market to stabilise the
currency.
Prudential Regulator The central bank supervises and regulates commercial banks to
ensure they operate safely and maintain public confidence in the
financial system.
Government's Advisor The central bank provides the government with economic analysis
and advice on financial and monetary matters.

4.4 Comparison: Fiscal Policy vs Monetary Policy

This is one of the most frequently asked comparison questions in the examination. Study this carefully.

ASPECT FISCAL POLICY MONETARY POLICY

Controlled by Government (Ministry of Central Bank (Bank of Sierra
Finance) Leone)
Main tool Government spending and Interest rates, money supply,
taxation reserve requirements
Speed of implementation Slow — requires parliamentary Faster — central bank can act
approval for budget changes relatively quickly
Effectiveness against inflation Moderate — contractionary Strong — raising interest rates
fiscal policy can reduce AD directly targets inflation
Effectiveness against recession Strong — government spending Moderate — lower rates may
directly boosts AD not stimulate if confidence is
low (liquidity trap)
Risk Political pressure to overspend; Blunt instrument — affects all
rising public debt sectors equally
Sierra Leone context Constrained by low revenue Constrained by underdeveloped
base; IMF conditions financial markets
UNIT 5: TYPES OF ECONOMIC POLICY

5.1 Overview of Policy Types

Economic policy is not monolithic — it takes many forms depending on the objective being pursued and
the institutional mechanism through which it operates. A thorough understanding of the different types
of policy will help you structure examination answers clearly.

5.2 Major Policy

Major policy refers to the principal policy instruments that have a direct and significant impact on the
overall level of economic activity. These are the primary levers of macroeconomic management.

• Fiscal Policy — government spending and taxation

• Monetary Policy — money supply, interest rates, and credit control

These two are regarded as 'major' because they are the most powerful and widely used tools of
macroeconomic stabilisation. They directly influence aggregate demand across the whole economy.

5.3 Supportive Policy

Supportive policy refers to measures that complement and reinforce the major policies rather than
operating independently as primary instruments. They support the achievement of policy objectives but
are not sufficient on their own.

Examples of supportive policies include:

• Incomes policy — wage and price controls that directly limit inflation without relying on changes
in aggregate demand
• Exchange rate policy — managing the currency to support export competitiveness or price
stability
• Financial regulation — ensuring a stable and well-functioning banking system supports
monetary policy transmission
• Labour market policy — training programmes that reduce structural unemployment, supporting
full employment objectives
5.4 Implied Policy
Implied policy refers to the unintentional or implicit policy effects that arise from government decisions
that were not primarily intended to be economic policy instruments. When the government makes a
decision for political, social, or administrative reasons, it often has economic consequences.

Example: If the government passes a law requiring firms to pay higher minimum wages, this was
primarily a social policy — to improve living standards for low-paid workers. But it has an implied
economic policy effect: it raises business costs (potentially causing inflation), may reduce employment in
low-wage sectors, but also increases consumer spending power.

Similarly, when the government invests heavily in education infrastructure, this is social policy — but it
implies supply-side economic benefits through higher productivity and human capital development.

5.5 Development Policy

Development policy refers to policies specifically designed to promote long-run structural
transformation of the economy — moving from low-productivity, low-income activities to higher-
productivity activities that generate sustainable improvements in living standards. It is especially
relevant for developing countries like Sierra Leone.

Development policy focuses on:

• Building productive infrastructure — roads, ports, energy, water — to reduce costs and improve
connectivity
• Developing human capital through investment in health and education
• Attracting foreign direct investment and promoting technology transfer
• Agricultural transformation — improving productivity in food and cash crop production
• Industrialisation and value-addition — processing raw materials domestically rather than
exporting them unprocessed
• Financial sector development — expanding access to credit for small businesses and farmers

In Sierra Leone, development policy is guided by frameworks such as the National Development Plan
(NDP) and its Medium-Term National Development Plan (MTNDP), which set priorities and spending
targets for key sectors.

5.6 Trade Policy

Trade policy refers to government measures that regulate and influence international trade flows —
what the country imports, what it exports, and on what terms.
TRADE POLICY INSTRUMENT HOW IT WORKS
Tariffs Taxes on imported goods. Raise the domestic price of imports,
making them less competitive. Protect domestic producers but raise
prices for consumers.
Import Quotas Quantitative limits on the volume of specific goods that can be
imported. Create scarcity of imported goods in domestic market,
raising their price.
Export Subsidies Payments to domestic producers to reduce their costs and enable
them to sell at lower prices in foreign markets.
Trade Agreements Bilateral or multilateral agreements that reduce barriers to trade
(e.g., AfCFTA, ECOWAS).
Export Bans Prohibiting the export of certain goods — often used to ensure food
security or retain raw materials for domestic processing.
Standards and Regulations Non-tariff barriers such as sanitary, phytosanitary, and technical
standards that imported goods must meet.
UNIT 6: HEALTH SHOCKS AND ECONOMIC
EFFECTS

6.1 Introduction
This unit examines how major health crises — particularly epidemic and pandemic diseases — affect the
economy and force changes in economic policy. Sierra Leone has been directly affected by two major
health shocks in recent years: the Ebola epidemic (2014–2016) and the global COVID-19 pandemic
(2020–2022). Both cases are highly relevant for examination questions on fiscal response, health
economics, and development policy.

6.2 The Ebola Epidemic in Sierra Leone (2014–2016)

The West African Ebola outbreak was one of the worst public health crises in the region's history. Sierra
Leone, Guinea, and Liberia were the three countries most severely affected.

6.2.1 Economic Impact of Ebola on Sierra Leone

• GDP Growth Collapsed: Sierra Leone's GDP growth rate fell sharply from around 20% in 2013
(driven by iron ore exports) to approximately -21% in 2015. This was one of the steepest single-
year GDP contractions ever recorded for the country.
• Mining Sector Disruption: The major iron ore mines were forced to suspend operations due to
the crisis. This was catastrophic for export revenues, which depended heavily on iron ore.
• Agricultural Disruption: Quarantine restrictions, fear of movement, and loss of agricultural
labour due to illness and death severely disrupted food production and supply chains.
• Trade and Commerce Contracted: Markets closed, border trade stopped, and many businesses
reduced or suspended operations. Consumer demand fell dramatically as households cut
spending out of fear and reduced income.
• Human Capital Loss: The epidemic killed thousands of skilled and unskilled workers, including a
disproportionate number of healthcare workers — which further weakened the health system's
capacity.

6.2.2 Fiscal Policy Response to Ebola

• Emergency Public Health Spending: The government dramatically increased spending on

containment measures — isolation units, contact tracing, protective equipment, and emergency
treatment centres.
 • International Aid and IMF Support: Sierra Leone received emergency financial support from the
IMF (through the Rapid Credit Facility), World Bank, and bilateral donors to help finance the
fiscal response without catastrophic debt accumulation.
• Revenue Shortfall: With the economy contracting, tax revenues fell sharply, worsening the
budget deficit. The government had to rely almost entirely on external grants and concessional
loans.

6.3 The COVID-19 Pandemic (2020–2022)

The COVID-19 pandemic was a global shock of unprecedented scale. Though Sierra Leone suffered fewer
direct COVID deaths than many countries, the economic effects were severe — particularly through
trade disruption, falling commodity prices, reduced remittances, and reduced aid flows.

6.3.1 Economic Impact of COVID-19

• Economic Contraction: Sierra Leone's GDP growth slowed significantly in 2020 as global demand
collapsed, trade routes were disrupted, and domestic economic activity contracted.
• Remittance Reduction: Diaspora remittances are a significant source of income for many Sierra
Leonean households. As COVID shut down labour markets globally, remittances declined.
• Commodity Price Volatility: Falls in global commodity prices (iron ore, diamonds, rutile) reduced
export revenues and government royalties.
• Supply Chain Disruption: Imports of essential goods (medicines, fuel, food) were disrupted,
causing shortages and price increases.
• Education Disruption: School and university closures resulted in significant losses of human
capital development, particularly affecting poor households who lacked access to remote
learning.

6.3.2 Fiscal and Policy Response to COVID-19

• Increased Health Expenditure: Emergency spending on PPE, testing kits, quarantine facilities,
and COVID vaccination programmes (supported by COVAX and other international initiatives).
• Social Protection Expansion: The government introduced or expanded cash transfer
programmes and food relief to vulnerable households to cushion the economic shock.
• Tax Relief Measures: Temporary reductions in certain taxes and fees to reduce the burden on
businesses, particularly in hard-hit sectors like hospitality and transport.
• IMF Rapid Financing: Sierra Leone received emergency financing from the IMF under the Rapid
Credit Facility (RCF) in 2020, providing budget support to finance the increased health and social
expenditure.
• Debt Accumulation: Despite international support, the fiscal deficit widened, and public debt
increased. Managing this debt accumulation became a major post-pandemic policy challenge.
6.4 Key Policy Lessons

• Fiscal Buffers Matter: Countries with fiscal savings and low debt going into a crisis are much
better able to respond with emergency spending without jeopardising debt sustainability.
• Health System Investment is Economic Policy: Underinvestment in healthcare creates macro-
economic vulnerability. The Ebola and COVID crises both demonstrated that weak health
systems are not just a humanitarian problem — they are a macroeconomic risk.
• External Support is Vital but Uncertain: Developing countries like Sierra Leone cannot always
rely on external support arriving quickly or in sufficient quantities. Building domestic fiscal
capacity is essential for long-term resilience.
• Supply-Side Diversification Reduces Vulnerability: Over-reliance on a single commodity (iron ore)
made Sierra Leone's economy extremely vulnerable to sectoral shocks. Diversification into
agriculture, manufacturing, and services would reduce this vulnerability.

EXAMINATION TIP:
If an essay question asks about economic policy responses to a crisis, structure your answer
around: (1) The nature and magnitude of the economic shock, (2) The specific fiscal policy
measures adopted, (3) The role of monetary policy, (4) International institutional support
(IMF/World Bank), and (5) Medium-term challenges. Always use data and Sierra Leone examples.
UNIT 7: TARIFFS AND QUOTAS

7.1 Introduction to Trade Restrictions

Although free trade is generally recognised as beneficial — as demonstrated by the theories of absolute
and comparative advantage — most governments in practice impose some restrictions on international
trade. These restrictions are collectively called trade barriers or protectionist policies.
Protectionism is the use of government policy to restrict imports and protect domestic industries from
foreign competition. While it may benefit certain domestic producers in the short run, it generally
reduces economic efficiency and consumer welfare. However, there are legitimate arguments in its
favour, which we will examine.

7.2 Tariffs
A tariff is a tax imposed by a government on imported goods. It is the most common and transparent
form of trade restriction.

KEY DEFINITION
Tariff: A tax levied by a government on imported goods, intended to raise the domestic price of
imports and thereby make domestic products more competitive in the home market.

7.2.1 Types of Tariffs

• Specific Tariff: A fixed monetary amount charged per unit of the imported good, regardless of its
value. Example: SLL 50,000 per tonne of imported rice.

• Ad Valorem Tariff: A percentage of the value of the imported good. Example: 20% of the c.i.f.
value of imported textiles. This is the most common type and is responsive to changes in the
price of the imported good.

• Compound Tariff: A combination of a specific and an ad valorem tariff applied simultaneously to

the same good.

7.2.2 Effects of a Tariff — The Full Analysis

When a government imposes a tariff on an imported good, several economic effects occur
simultaneously. You must be able to explain all of them in examinations.
Suppose the world price of rice is PW = SLL 200 per kg and the government imposes a tariff of t = SLL 50
per kg. The domestic price rises to PD = PW + t = SLL 250 per kg.

EFFECT EXPLANATION
Domestic price rises The tariff raises the domestic price from PW to PD = PW + t. This is
the fundamental first-order effect.
Domestic production Higher price gives domestic producers an incentive to produce
increases more. Domestic supply expands up the supply curve. Domestic
producers gain — they sell more at a higher price. This is the
PRODUCTION EFFECT.
Domestic consumption falls Higher prices mean consumers buy less of the good. Consumer
demand contracts along the demand curve. Consumers lose — they
pay more and consume less. This is the CONSUMPTION EFFECT.
Imports fall Imports = domestic demand − domestic supply. Since demand falls
and domestic supply rises, imports fall. This is the TRADE EFFECT —
the main purpose of the tariff.
Government revenue The government collects revenue = tariff rate × volume of remaining
imports. This is the REVENUE EFFECT. Unlike a quota, a tariff
generates government revenue.
Consumer surplus loss Consumers pay higher prices and buy less. Consumer surplus is
reduced. The loss in consumer surplus = ABCD (on a supply-demand
diagram).
Producer surplus gain Domestic producers gain from higher prices and higher output.
Producer surplus increases by area A.
Deadweight welfare loss Even after accounting for producer gains and government revenue,
there is a net welfare loss to the economy. This is represented by
triangles B and D — resources wasted in inefficient domestic
production (B) and consumption forgone (D).

WORKED NUMERICAL EXAMPLE — TARIFF ANALYSIS:

Given: World price PW = 200, Tariff t = 50 per unit

At PW = 200: Domestic demand = 1000 units, Domestic supply = 400 units
At PD = 250: Domestic demand = 800 units, Domestic supply = 600 units

Step 1 — Volume of imports before tariff:

Imports = 1000 − 400 = 600 units

Step 2 — Volume of imports after tariff:

Imports = 800 − 600 = 200 units
 Step 3 — Government tariff revenue:
Revenue = tariff × imports = 50 × 200 = 10,000 units of
currency

Step 4 — Change in import volume:

Reduction in imports = 600 − 200 = 400 units

CONCLUSIONS: The tariff reduced imports by 400 units (from 600 to 200). Domestic production
rose by 200 units (from 400 to 600). Consumer demand fell by 200 units. Government collected
10,000 in revenue.

7.3 Import Quotas

An import quota is a quantitative restriction on the volume or value of a specific good that may be
imported during a given period. Unlike a tariff, a quota directly limits the physical quantity of imports
rather than raising their price.

KEY DEFINITION
Import Quota: A limit set by government on the quantity or value of a specific imported good that
may enter the country during a defined period (usually one year).

7.3.1 Effects of an Import Quota

The price effects of a quota are similar to those of a tariff — domestic price rises, domestic production
increases, consumption falls. However, there is one crucial difference:

Under a TARIFF — the government collects revenue from the tax on imports.
Under a QUOTA — the government does NOT automatically collect revenue. Instead, the difference
between the world price and the higher domestic price is captured as quota rent by whoever holds the
import licence. If import licences are auctioned by the government, it collects revenue equivalent to a
tariff. But if they are given away to importers, the quota rent goes to private importers.

ASPECT TARIFF IMPORT QUOTA

Mechanism Tax per unit imported Direct limit on quantity
imported
Price effect Domestic price = World price + Domestic price rises to clear the
tariff restricted supply
Government revenue YES — tariff × imports Only if licences are auctioned;
otherwise NO
 Import volume Falls (demand response) Fixed by the quota limit
Transparency High — rate is publicly known Lower — allocation of licences
can be opaque
Response to demand shifts Imports adjust; price stays at Price adjusts; import volume
PW+t stays fixed
Welfare cost Deadweight loss triangles B + D Same triangles PLUS possible
quota rent loss

7.4 Arguments For and Against Protectionism

There are legitimate arguments both for and against trade protection. Economists generally favour free
trade, but acknowledge that in certain circumstances, temporary protection may be justified.

7.4.1 Arguments FOR Protectionism (In Favour of Trade Barriers)

5. Infant Industry Argument: Developing countries may need to protect new industries from
established foreign competitors while they build up scale, develop technology, and reduce costs.
Once the industry matures and becomes internationally competitive, the protection is
withdrawn. This is the most widely accepted argument for temporary protection.

6. Employment Protection: Cheap imports can displace domestic workers. Tariffs and quotas
maintain jobs in protected industries, even if at higher cost to consumers. This argument is
especially politically powerful during recessions.

7. National Security / Strategic Industries: Some industries (defence, food production,

pharmaceuticals) are considered too important to leave to foreign suppliers. Disruptions to
supply could have catastrophic national security consequences.

8. Revenue Generation: For developing countries with weak income tax systems, import tariffs can
be an important source of government revenue. Sierra Leone relies on customs duties as a
significant revenue source.

9. Correcting a Balance of Payments Deficit: Import restrictions reduce the import bill, improving
the current account of the balance of payments.

10. Protecting Against Dumping: Dumping occurs when a foreign firm sells its goods in another
country below the cost of production (often subsidised by its home government). Import duties
can offset the unfair competitive advantage.
7.4.2 Arguments AGAINST Protectionism

11. Higher Consumer Prices: Tariffs and quotas raise domestic prices, reducing consumer purchasing
power and living standards.

12. Misallocation of Resources: Resources are directed toward inefficient domestic production that
would not survive without protection, reducing overall economic welfare.

13. Retaliation Risk: When one country imposes tariffs, trading partners may retaliate with their
own tariffs — potentially triggering a trade war that reduces total trade and harms all parties.

14. Reduced Competition: Protected domestic industries face less competitive pressure to innovate,
improve quality, or reduce costs — leading to inefficiency over time.

15. Welfare (Deadweight) Loss: The standard welfare analysis shows that the gains to producers and
the government are smaller than the losses to consumers — creating a net welfare loss.

SIERRA LEONE CONTEXT:

Sierra Leone uses tariffs extensively through the ECOWAS Common External Tariff (CET) structure,
which applies common tariff rates to imports from non-ECOWAS countries. Key tariff categories
range from 0% (essential medicines, capital equipment) to 35% (finished consumer goods, luxury
items). Customs and excise duties are administered by the National Revenue Authority (NRA).
MODULE 2 — EXAMINATION GUIDE AND
SUMMARY

Key Formulas to Memorise

1. Fiscal Multiplier = 1 / (1 − MPC)

2. ΔY = Multiplier × ΔG (change in income from change in govt
spending)
3. Money Multiplier = 1 / Reserve Ratio (r)
4. Budget Balance = T − G (surplus if positive; deficit if
negative)
5. Tariff Revenue = Tariff Rate × Volume of Imports
6. MPC = ΔC / ΔY

Likely Essay Questions and How to Approach Them

Q1: Explain the main causes of market failure and discuss appropriate government corrective
measures.
APPROACH: Define market failure. Cover all six causes: public goods (with non-excludable/non-rival),
negative externalities, positive externalities, monopoly power, information asymmetry (adverse
selection + moral hazard), and free rider problem. For each, explain the nature of the failure and the
appropriate government remedy. Use real-world Sierra Leone examples throughout.

Q2: Compare and contrast fiscal policy and monetary policy as instruments for controlling inflation.
APPROACH: Define both policies. Explain the transmission mechanisms of each. Compare using a table.
Discuss the conditions under which each is more effective. Address limitations of both. Conclude with
reference to the Sierra Leone context (Bank of Sierra Leone's monetary policy; fiscal constraints from
donor conditions).

Q3: Examine the economic effects of a tariff using a supply and demand diagram.
APPROACH: Draw a clear diagram with world price PW, tariff-inclusive price PD = PW + t, showing
domestic supply and demand curves. Identify and label: the increase in domestic production, fall in
consumption, fall in imports, government revenue rectangle, producer surplus gain, consumer surplus
loss, and deadweight welfare loss triangles B and D. Explain each area in words.
Q4: Analyse the economic impact of the Ebola epidemic (or COVID-19) on Sierra Leone and assess the
government's policy response.
APPROACH: Describe the nature of the health shock. Quantify the GDP/growth impact. Cover:
contraction of output, revenue loss, increased spending demands, role of IMF/World Bank. Evaluate
fiscal policy response. Discuss monetary policy context. Identify structural vulnerabilities exposed. Draw
policy lessons.

Q5: Distinguish between the infant industry argument and the employment protection argument for
trade protection. Which is more persuasive?
APPROACH: Define and explain each argument carefully. Give examples relevant to Sierra Leone and
West Africa. Evaluate the strengths and weaknesses of each. Reach a reasoned conclusion. Note that
most economists regard the infant industry argument as more intellectually rigorous, provided the
protection is temporary and conditional.

Quick Revision Checklist — Module 2

• I can define economic policy and list its main objectives

• I can explain all six causes of market failure with examples
• I can distinguish between public goods, merit goods, and private goods
• I can explain positive and negative externalities with diagrams
• I understand adverse selection and moral hazard
• I can explain fiscal policy tools — spending, taxation, and borrowing
• I can calculate the fiscal multiplier and apply it to numerical questions
• I can distinguish between expansionary and contractionary fiscal policy
• I can explain all monetary policy tools — OMO, reserve ratio, bank rate, interest rates
• I can compare fiscal and monetary policy in a structured table
• I know the functions of the central bank and the Bank of Sierra Leone
• I understand the economic effects of Ebola and COVID-19 on Sierra Leone
• I can explain the effects of tariffs on domestic price, production, consumption, imports, and
welfare
• I can compare tariffs and quotas
• I can evaluate arguments for and against protectionism

END OF MODULE 2 — ECONOMIC POLICY ANALYSIS

BSc Economics Comprehensive Examination Revision Notes