IB Economics - Revision Notes and Past Paper Questions 2012

1. Introduction

2. Markets

3. Theory of the Firm

4. Market Failure

5. Macro- Economics

6. International Trade

7. Development

How will you be assessed?

Advice on how to answer Paper 1, Paper 2 and Paper 3.

Use of definitions and terminology.

What is application and analysis?

What is evaluation and what do you need to do to et the evaluation marks?

Syllabus Details Section 1 – Introduction to Economics

Growth and Development. Positive and Normative Economics. Opportunity Cost. Production Possibility Curves. Types of Economy.

Growth and Development

Definitions of growth, development, and sustainable development with diagrams.

Past Paper Questions - Growth and Development

November 2005 Paper 2

• Explain why economic growth is likely to generate external costs, which are a threat to sustainable development.

May 2006 Paper 1
• Explain how an increase in the quantity and quality of a nations factors of production can promote economic development.

May 2007 Paper 2
• Examine the possible consequences of a high real rate of Economic Growth for sustainable development.

November 2009 Paper 2
• Explain how the measurement of economic growth differs from the measurement of economic development.

May 2010 Paper 1
• Explain the difference between economic growth and economic development and how they are measured.


Positive and normative concepts

Past Paper Questions - Positive and Normative statements

November 2009 Paper 3
• Identify positive and Normative statements

Opportunity Cost.

Defence spending or merit goods? be able to illustrate this.

Past Paper Questions - Opportunity Cost

November 2005 Paper 2.

• Using an example explain how the concept of opportunity cost is a key element in the theory of comparative advantage.


Production Possibility curves.

Definition and diagrams showing opportunity cost, actual and potential output. Where are we if resources are unemployed? What point is unattainabl and why and how do we get there? What will cause a shift of the PPF?

Past Paper Questions - Productiion Possibility Curves

May 2005 Paper 2
• Use PPC diagrams to explain the difference between actual output and potential output and between economic growth and economic development.

May 2008 Paper 2
• Explain what is meant by a production possibility curve and use a production possibility curve diagram to explain the concepts of scarcity, choice and opportunity cost.

May 2009 Paper 2
• Using a production possibility curve (PPC) diagram, explain the relationship between the economic concepts of economic goods, factors of production and opportunity cost.
• With reference to the concept of economic growth, explain the difference between a movement along an existing production possibility curve (PPC) and an outward shift in a production possibility curve (PPC).

May 2010 Paper 3
• Using an appropriate diagram explain the likely long term impact of a rise in sea levels on the productive capacity of the Vietnamese economy.


Types of Economic System

Basic economic questions - answered through an economic system
Mixed economies

• public sector
• private sector

Past Paper Questions - Types of Economic System

May 2005 - Paper 1
• Explain the main characteristics of a market economy.

November 2008 Paper 2
• Explain how the three basic economic questions would be answered in a free market economy and in a centrally-planned economy.


Central planning versus free market

Economies in transition.

Section 2 - Markets - Supply, Demand and Elasticity.

Markets. Price Controls - Maximum and Minimum Prices Cross Price Elasticity of Demand. Price Elasticity of Supply.
Demand and Supply. Price Elasticity of Demand. Income Elasticity of Demand. Indirect Taxes.

Markets

Describe markets with relevant local, national and international examples.

Markets in China which show market structures that would be an excellent starting point for an extended essay.

Homogeneous goods? Anecessary condition for perfect competition.

How are the stores pictured competing?

How do the stores attract the customers? Rows of stalls selling the same products and yet surviving? How do they attract customers.

How are the stores differentiated? These two stalls appear to sell the same products at exactly the same prices.


Hl and SL students need a brief description of perfect competition, monopoly and oligopoly and monopolistic competition, using the characteristics of the number of buyers and sellers, type of product and barriers to entry.

Types of competition
High levels of competition     Low levels of competition, high barriers to entry, few sellers, type of product .....

Perfect competition.

Examples include ..... because

Monopolistic competition.

Examples include ..... because .....

Oligopoly.

Examples include ..... because .....

Monopoly.

Examples include ..... because .....and market share is greater than .....%


The Market Mechanism - Demand and Supply

Demand

State, the Law of demand with diagrammatic analysis, and the determinants of demand? Distinguish between a movement along and a shift of the curve. Important exam point here is that the diagrams need fully labelled axis and the curves need arrows to show the shifts as well as the change in the Price and Quantity.

1.Taste and preferences
2. Income / buget constraint
3.Relative prices of different goods including substitutes and complementary goods
4. Number of consumers/ buyers
5. Expectations about the future

The Power of Advertsing - one of the factors that can cause the demand curve to shift is advertising (A in PASIFIC). Clearly Simon Cowell feels that advertising is very important. During last nights Super Bowl in the US, Simon and his new show had a 30 second advert. With an estimated 100 million viewers watching the Super Bowl it seems like a good idea.

But how much would you pay to place an advert in this slot?

Costs and benefits would be the evaluation with a conclusion.

 

Importance of price as a signal and as an incentive in terms of resource allocation.

Questions on this often appear and want you to shift supply and demand curves as tastes, income, incentives all change. key words are "dynamic process"


Higher Level Extension Topic

Exceptions to the law of demand (the upward-sloping demand curve), ostentatious (Veblen) goods, role of expectations and Giffen goods.

Supply


Definition of supply, law of supply with diagrammatic analysis, effect of taxes and subsidies on supply. You must be clear about the defference between specific taxes which shift the curve parallel and include taxes per opacket, or per litre, and ad-vaslorem taxes which are a percentage tax such as VAT and GST.

Fundamental distinction between a movement along a supply curve and a shift of the supply curve.

1. Prices of different goods including substitutes
2. Number of suppliers
3. Production function and technology
4. Prices of different inputs including wage rates, interest.
5. Producers' future expectations.


Examples of supply and demand side shocks. Japanese earthquake (exogenous shock) triggers yen and stock markets fall (link to hot money; confidence, animal spirits; supply-side issues)

Equilibrium market clearing price and quantity

Diagrammatic analysis of changes in demand and supply to a new equilibrium. Important here to use arrows to show how price and quantity change and where the curves shift from and to. Advice on labelling diagrams.

Past Paper Questions - Supply and Demand

May 2005 Paper 3.

The text refers to the “current decline in the US dollar”. Using a supply and demand diagram, explain one possible reason for this.

May 2006 Paper 2.

Using demand and supply analysis, explain how resources are allocated through changes in price in a market economy.

Scarcity, demand and supply, shifting curves and the effect on price, the dynamic process.

May 2007 Paper 3.

The increased domestic demand, along with the push to make more goods for the international market, has increased China's consumption of just about everything”. Using an appropriate diagram, explain how increased domestic demand in China may impact upon prices and output in China. [4 marks]

May 2008 Paper 3

Define equilibrium price.

Using information from the text and your knowledge of economics, evaluate the role of falling prices in reallocating resources in Australia's wine market.

Evaluation should include - impact on stakeholders, SR and LR, adv and disadvantages.

May 2009 Paper 3.

Using a demand and supply diagram for haircuts, explain how a shortage of staff in the hairdressing industry could affect the price of haircuts.


Price Controls - Maximum and Minimum Price / Subsidies

"Maximum price: causes and consequences •

Minimum price: causes and consequences •

Price support / buffer stock schemes • .....stabilise prices and incomes in agricultural markets.

Examples include .....

Cotton Price Stabilization Board
International Coffee Agreement
International Tin Council

Commodity agreements - international agreements to stabilise prices in the interest of producers and consumers. They include mechanisms to influence market prices by adjusting export quotas and production when market prices reach certain trigger price levels. They sometimes employ buffer stocks which release stocks of commodities onto the market when prices rise to a certain level and build them up when they fall.

Past paper Questions. Price Controls - Maximum and Minimum Price / Subsidies

May 2005 paper 3.

Define minimum Price.

Define Subsidy.

November 2005 paper 3.

Define Maximum Price.

May 2008 Paper 2

A concert is to be held in a stadium with limited seating capacity. The organizers set the ticket prices at a level below the equilibrium price. Using a diagram, explain the possible consequences of their decision.

November 2009 - Paper 1.

Explain how buffer stock schemes / commodity price agreements may be used to reduce wide fluctuations in primary commodity prices.

May 2010 - Paper 2.

With the aid of a diagram explain the impact on producers and consumers of a subsidy on a good.

Flash Cards - Demand and Supply

Price Elasticity of Demand

Differing elasticities, their formulas, values and diagrams - all essential.

Price elasticity of demand (PED)

Formula - % change in QD / %change in P.

Definition - Key word is "responsiveness".

Possible range of values - is the good is relatively elastic (PED is greater than 1) or relatively inelastic (PED is less than 1).

Diagrams illustrating the range of values of elasticity,

Varying elasticity along a straight-line D curve,

A good's PED is determined by numerous factors;

1. Number of substitutes: the larger the number of close substitutes for the good then the easier the household can shift to alternative goods if the price increases. Generally, the larger the number of close substitutes, the more elastic the price elasticity of demand.
2. Degree of necessity: If the good is a necessity item then the demand is unlikely to change for a given change in price. This implies that necessity goods have inelastic price elasticities of demand.
3. Price of the good as a proportion of income: It can be argued that goods that account for a large proportion of disposable income tend to be elastic. This is due to consumers being more aware of small changes in price of expensive goods compared to small changes in the price of inexpensive goods.

4. Percentage of income spent on the good - evaluate this then by talking about changed spending habits over a number of months..

Past Paper Questions - Price Elasticity of Demand

November 2008 Paper 1

Explain the determinants of price elasticity of demand. [10 marks]

“A deterioration in a country's terms of trade will always be disadvantageous for the current account balance.” Evaluate this statement using the concept of price elasticity of demand.

Define TOT - causes (lower demand for imports and higher demand for exports) exchange rate deterioration, technological advances bringing down production costs in some countries.

marshall Lerner states that the BOP will improve if the sum of exports and imports is greater than 1 and so consumers switch to cheaper domestic goods and overseas consumers buy our exported goods however J curve shows that in the SR the BOP will deteriorate at first and then improve.


Cross price Elasticity of Demand

CPED = % Change in Quantity Demand for Good X / (% Change in Price for Good Y.

Significance of sign with respect to complements (negatively sloping) and substitutes (positively sloping) and their diagrams..

 

 

PCs and Smartphones - Competitive Demand

PC usage is falling and both the volume of users and daily data usage on smart phones continues to surge. The PC is under competitive threat from many angles - smart phones, tablets and ultra-light but feature heavy laptops. This Business Insider Chart might prompt some discussion from students

Past Paper Questions - Cross Price Elasticity of Demand.

2005 Paper 3

Define Cross Elasticity of Demand - responsiveness of the demand for a good to a change in the price of another good.

May 2006 Paper 2

Define cross elasticity of demand and using diagrams, explain what determines whether cross elasticity of demand is positive or negative.

May 2009 Paper 3

Define cross-elasticity of demand.

Using an appropriate diagram, explain why the demand for rail travel increases when the petrol (gasoline) prices rise.

May 2010 - Paper 1

Explain the importance of price elasticity of demand and cross elasticity of demand for business decision making (10).

Evaluate the view that governments can best reduce smoking by substantially increasing taxes on cigarettes (15).


Income Elasticity of Demand


• Definition, Formula (IEoD = % Change in Quantity Demanded) / (% Change in Income), Normal goods , Inferior goods.

Past Paper Questions - Income Elasticity of Demand.

November 2008 Paper 3

Define the following terms indicated in bold in the text - subsidies and income elasticity of demand.


Price Elasticity of Supply

Price elasticity of supply
• Definition, Formula , Possible range of values, Diagrams illustrating the range of values of elasticity. If supply is inelastic then the values run from zero to 1. When supply is elastic then the values run from 1 to infinity.

The determinants of price elasticity of supply:

1. The number of producers -- The more producers there are, the easier it should be for the industry to increase output in response to a price increase. Supply will thus be more elastic.
2. The existence of spare capacity -- The more capacity there is in the industry, the easier it should be to increase output if price goes up. This makes supply more elastic.
3. Ease of storing stocks-- if it is easy to stock goods, then if the price rises the firm can sell these stocks and so supply is more elastic. In the case of goods such as fresh products, it may not be easy to store them and so the supply will not be very flexible.
4. The time period -- Over time the firm can invest in training and more equipment and more firms can join the industry, so supply should be more flexible, more elastic.
5. Factor mobility -- i.e. the easier it is for resources to move into the industry, the more elastic supply will be.
6. Length of the production period -- i.e. the quicker a good is to produce, the easier it will be to respond to a change in price; supply in manufacturing is usually more price elastic than agriculture.

 

Past Paper Questions - Price Elasticity of Supply

May 2010 Paper 2.

With the aid of a diagram, explain why the price elasticity of supply is likely to change over time.

Applications of concepts of elasticity
• PED and business decisions - the effect of price changes on total revenue.
• PED and taxation. This question would focus on real world examples particularly the taxes on de-merit goods.

Diagrams required.

You will need to be able to draw the diagrams that show how the different elasticities affect the producer consumer burden of the tax.

Cross-elasticity of demand: relevance for firms


• Significance of income elasticity for sectoral change (primary › secondary › tertiary) as economic growth occurs.

Real world examples - think of a country(s) that is going through sectoral change. How will the demand in these countries be changing as consumers get wealthier? think about the evaluation ..... the effect on workers who will lose their jobs.

 


Higher level extension topics - Indirect Taxation.

Flat rate and ad valorem taxes - key here is the slope of the curve, consumer and producer burden, the incidence and real world examples.

Implication of elasticity of supply and demand for the incidence (burden) of taxation.

Past Paper Questions - Indirect Taxation

May 2005

Using an appropriate diagram, explain how an indirect tax can change the free market price level and the allocation of resources.

November 2006 Paper 2.

Use a diagram to explain how the incidence (burden) of a tax is shared among producers and consumers when an ad valorem indirect tax is placed on a good which has relatively inelastic demand.

November 2006 Paper 3.

Using an appropriate diagram, explain how the granting of subsidies to EU sugar producers will give them an advantage over other producers.

May 2008 Paper 3

Using an appropriate diagram, explain the likely impact of removing the 10 % indirect tax on wine (an ad valorem tax) on the supply of, and demand for, wine.

November 2009 paper 2

Using appropraite diagrams explain why the relative burden (incidence) of an indirect tax on the producer and the consumer varies, depending on the PED for the product.

 Flash cards Elasticity

Syllabus Details Section 3– Theory of the Firm - Higher Level Only.

Cost Theory Monopoly. Oligopoly.
Perfect Competition. Monopolistic Competition. Price Discrimination.

Cost theory.

Types of costs: fixed costs, variable costs (in the short run at least one FOP is fixed in the long run they can all be variable), Total costs, average and marginal costs, accounting cost + opportunity cost = economic cost. Short-run
Law of diminishing returns - as successive untits of the variable factor are added the extra output (marginal) at first increases and then decreases.

This gives us the AP MP curves.
• Total product, average product, marginal product.
• Short-run cost curves - the key here is to remember that the marginal drives the average so marginal cost curves fall and then rise and MC cuts AC at its lowest point after which AC starts to rise.

Fixed costs are the costs of doing nothing and so they either stay constant or fall as output increases.

Long-run
• Economies of scale. To make this diagram look much better show the short run cost curves and the MES and then area of the curve that shows diseconomies of scale. The curve is then labelled LRAC.

Revenues
• Total revenue = PxQ.

AR = TR/Q (P)
• Marginal revenue = change in TR / change in Q.

Past Paper Questions - Costs and Revenue Curves

May 2005 Paper 2
Explain the relationship in the short run between the marginal costs of a firm and its average total costs. - Start by defining all terms.


• definition of short-run
• definition of marginal cost (MC)
• possible explanation of MC in terms of marginal product (MP) – diminishing returns
• definition of average total cost (ATC)
• diagram showing marginal cost (MC) and average total cost (ATC)
• possible explanation of ATC in term of average product (AP) – diminishing returns
• MC cuts ATC at lowest point
• Explanation in terms of impact of marginal cost (MC) changes on average total cost
(ATC)
• derived from MP cuts AP at highest point.

November 2005 paper 2
Using appropriate diagrams explain the difference between the law of diminishing returns and economies of scale.

SR + LR

Definition of the low of DMR and EOS.

Diagram - either product curves or SR cost curves. EOS diagram using long run cost curves.

Explain the diagrams and the links between the concepts.

May 2007 Paper 2
E xplain the law of diminishing returns using average and marginal product curves.

May 2008 Paper 3
Explain why average cost might fall in the long run.

May 2008 Paper 2
Using at least one diagram explain the difference between profit maximization and sales revenue maximization as the goals of firms. A firms goals include Profit max, Sales revenue max, managerial utilty max.

November 2008 Paper 1
Explain the concepts of allocative (the point where resources are producing an optimal combination of output - in other words not a level which includes market failure) and productive (technical) efficiency - operating at the lowest point on the cost curve..

May 2008 Paper 2
Using at least one diagram explain the difference between profit maximization and sales revenue maximization as the goals of firms.

November 2009 paper 1

Although a firm may pursue a range of goals, economists usually assume that profit maximisation is the main goal. Discuss this statement.


   

Profit


Distinction between normal (zero) and supernormal (abnormal) profit
• Profit maximization in terms of total revenue and total costs, and in terms of marginal revenue and marginal cost.
• Profit maximization assumed to be the main goal of firms but other goals exist (sales volume maximization, revenue maximization, environmental concerns, managerial utility).

Perfect Competition

Assumptions - many suppliers, homogeneous products, perfect information, no externalities, equal access for all firms to resources, no barriers to entry and exit.
• Demand curve facing the industry and the firm in perfect competition
• Profit-maximizing level of output and price in the short-run - supernormal profits and long-run when firms have joined the industry, supply has increased and prices have fallen.
•The possibility of abnormal profits/losses in the short-run and normal profits in the long-run as firms who are making losses leave the industry and so supply falls and prices rise.
• Shut-down price, break-even price

Allocative efficiency - value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in production. price = marginal cost.

Productive efficiency - when the output is produced at minimum average total cost (AC).

For example we might consider whether a business is producing close to the low point of its long run average total cost curve. When this happens the firm is exploiting most of the available economies of scale. Productive efficiency exists when producers minimise the wastage of resources in their production processes.

Efficiency in perfect competition. See presentation diagramsTriple A - Notes to Work through

Past Paper Questions - Perfect Competition

May 2005 Paper 1
Whatever the type of market structure profit maximization will always be the only goal of firms. Discuss.

May 2005 Paper 1
Explain how profit is determined in perfect competition.

May 2006 Paper 2
Using appropriate diagrams discuss whether monopoly is more or less efficient than perfect competition.

November 2007 Paper 1.

Perfect competition is a more desirable market form than monopolistic competition. Discuss.

November 2007 - Paper 2

With the help of a diagram explain when a firm should shut down in the short run.

November 2008 paper 3
Using a diagram explain how abnormal profits can disappear in the long run.

May 2009 - Paper 1

Evaluate the view that greater economic efficiency will always be achieved in
perfect competition as compared to monopoly.

Essay Plan for Perfect Competition - Explain how profit is determined in perfect competition. (10 marks).

• Definition of profit / normal profit /abnormal profit / loss
• Definition of perfect competition
• Abnormal profit in the short run only
• Losses in the short run only
• Normal profit in the short and long run
• Diagrams to illustrate the above


Monopoly

See presentation diagrams

Past Paper Questions - Monopoly

November 2006 Paper 2
A monopoly firm decides to maximize revenue rather than profits. Use a diagram to explain what will happen to price and quantity.

May 2007 Paper 1
Explain how barriers to entry may affect market structure.

Evaluate the view that monopoly is an undesirable market structure .

November 2007 Paper 2
Explain the concept of a natural monopoly.

Monopolies are inefficient and therefore always act against the public interest. Discuss.
November 2008

Evaluate the view that the government should regulate competitive behaviour.

May 2009 Paper 2
Explain why the marginal revenue curve is identical to the average revenue curve for a firm in perfect competition but not identical for a monopoly.

May 2007 Paper 2
Explain the law of diminishing returns using average and marginal product curves.

May 2009 Paper 1.
In the theory of the firm, a distinction is made between short-run cost curves and long-run cost curves. Using appropriate cost curve diagrams, explain this distinction.

May 2010 - Paper 2.
With the aid of at least one diagram explain one way a consumer might gain from the behaviour of a monopolist and one way a consumer might lose from the behaviour of a monopolist.

 


Monopolistic Competition

See presentation diagrams

Past Paper Questions - Monopolistic Competition

November 2005 paper 1
Explain the differences between monopolistic competition and oligopoly as market structures.

November 2007 Paper 1
Explain the difference between short run equilibrium and long run equilibrium in monopolistic competition.

November 2008 paper 2
Using a diagram explain the difference between short run and long run profit maximization positions of a firm in monopolistic competition.

Which market structure does the MP3 player industries most closely represent?

May 2009 Paper 3
Using an appropriate diagram, explain how a firm in monopolistic competition can earn abnormal/economic profit. [4 marks]

Using information from the text/data and your knowledge of economics, evaluate the costs and benefits of monopolistic competition for consumers and producers.

Oligopoly


• Assumptions of the model
• Collusive and non-collusive oligopoly
• Cartels
• Kinked demand curve as one model to describe interdependent behaviour
• Importance of non-price competition
• Theory of contestable markets

See presentation diagrams

Triple A - notes and reading with examples - Theories of Oligopoly and Forms of Collusion.

Past Paper Questions - Oligopoly

May 2005 Paper 3
Using an appropriate diagram explain why prices in a collusive oligopoly are not likely to fall.

To draw an appropriate monopoly demand curve illustrating that
the firm will produce where MR=MC and an explanation that the
collusive agreement may lead to the formation of a profit
maximizing monopoly structure
and so the price will be stable at
the level where MR=MC.

or "The Kinked Demand Curve" drawn and explained.

Discuss the differences between a collusive and non-collusive oligopoly.

Evaluate the benefits and costs of collusive practices by large companies.

An explanation of collusive practices
• that companies collude and work together like a profit maximising
monopolist, fixing either prices or output and giving each other quotas

Benefits to firms
• increases industry prices and profit
• supernormal profits will encourage the development of new
technologies/reinvestment of profits
• economies of scale could be created

Costs to firms
• risk of penalty

Benefits to consumers
• New technologies as a result of the investment of supernormal profits

Costs to consumers
• consumers will not be paying the lowest price possible (“American
consumers paid US$320 more than they should have”)
• large companies can control supplies
• can result in allocative and productive inefficiency.

May 2008 Paper 1
Explain how a firm operating in an oligopolistic market might attempt to increase its market share.
Evaluate the view that producers and not consumers are the main beneficiaries of oligopolistic market structures.

May 2009 Paper 2

Explain why prices tend to be relatively stable in a non-collusive oligopoly.

November 2009 - Paper 2.

Explain the nature of competition in a non-collusive oligopoly.


Price discrimination

A monopolist may be able to engage in a policy of price discrimination and charge a different price to different groups of consumers for an identical good or service, for reasons not associated with the costs of production. Charging different prices for similar goods is not price discrimination. For example, price discrimination does not does not occur when a rail company charges a higher price for a first class seat. This is because the price premium over a second-class seat can be explained by differences in the cost of providing the service.
Conditions required for price discrimination to work.

1. Monopoly power
Firms must have some price setting power - so we don't see price discrimination in perfectly competitive markets.
2. Elasticity of demand
There must be a different price elasticity of demand for the product from each group of consumers. This allows the firm to extract consumer surplus by varying the price leading to additional revenue and profit.
3. Separation of the market
The firm must be able to split the market into different sub-groups of consumers and then prevent the good or service being resold between consumers. (For example a rail operator must make it impossible for someone paying a "cheap fare" to resell to someone expected to pay a higher fare. This is easier in the provision of services rather than goods.
The costs of separating the market and selling to different sub-groups (or market segments) must not be prohibitive.
Examples of price discrimination
There are numerous good examples of discriminatory pricing policies. Distinguish between discrimination (based on consumer's willingness to pay) and product differentiation - where price differences might also reflect a different quality or standard of service.1. Cinemas and theatres cutting prices to attract younger and older audiences

2. Student discounts for rail travel, restaurant meals and holidays

3. Car rental firms cutting prices at weekends4. Hotels offering cheap weekend breaks and winter discounts

The aims of price discrimination
1. To increase the total revenue and/or profits of the supplier 2. To help off-load excess capacity 3. To take market share away from rival firms. Some consumers do benefit from this type of pricing - they are "priced into the market" when with one price they might not have been able to afford a product. For most consumers however the price they pay reflects pretty closely what they are willing to pay. In this respect, price discrimination seeks to extract consumer surplus and turn it into producer surplus (or monopoly profit).

Past Paper Questions - Price Discrimination

May 2005 Paper 3
Explain how it is possible for a music company to charge different prices in different countries - note the rubric and diagram requirement.

The way i would approach this is to say that different countries have different levels of GDP per capita and so in the wealthier countries music downloads are more expensive.

Rubric

1 Identification of appropriate theory.
An explanation of how profit can be maximised through price discrimination in the different countries or the use of a diagram illustrating price discrimination. 1 to 2.

2 Correct application of appropriate theory.
An explanation of how profit can be maximised through price discrimination due to different price elasticities of demand, with producers charging a higher price in markets where demand is less price-elastic. A diagram is not necessary. 3-4


May 2006 Paper 3 (repeated November 2006)
Explain the conditions necessary for price discrimination to take place.


November 2006 Paper 1
Discuss the advantages and disadvantages of price discrimination for producers and consumers.


November 2009 Paper 1

Explain why a firm might practice price discrimination and the necessary conditions for it to take place.


May 2010 Paper 2

Explain why an airline would want to practice price discrimination. Under what conditions would the airline be able to do so?


Definition of price discrimination
an explanation of why an airline would want to practice price discrimination
1. it can earn higher revenues and earn greater economic (supernormal) profits through the capture of consumer surplus
2. it can drive higher cost competitors out of the market by lowering prices for some consumer groups, and therefore it can increase its monopoly power
3. an explanation of how an airline can practice price discrimination:
4. an airline can split the market and discriminate between different buyers: they can charge the elderly lower prices on certain days, give discounts for students’ weekend travel, offer lower fares to travellers who make advance bookings and charge higher fares to those making their travel plans closer to the day of travel
conditions for price discrimination:
1. the producers have price setting ability because the market is imperfect, and can distinguish between separate groups of buyers on the basis of age, income etc.
2. consumers have different price elasticity of demand i.e. different demand curves for different consumers e.g. holidaymakers, business people and therefore some consumers are willing to pay higher prices than others
3. producers must be able to keep the markets separate.

Rubric - 9 to 10 marks.

Clear understanding of the specific demands of the question.
Relevant economic theory clearly explained and developed.
Relevant economic terms clearly defined.
No major errors.
Where appropriate, diagrams included and explained.
Where appropriate, examples used.

Revision Game - Flash cards

Simulations and Activities

Theory of the Firm - In the news.

Section 4 Market Failure

What is Market failue?

The under provision of certain types of good and the overconsumption of others. This is linked to the overprovision of demerit goods such as cigarettes and alcohol which Governments around the world are trying to educate consumers to either stop (smoking) or consume responsibly (alcohol).

Gruesome new warnings on cigarette packets.

Research shows that these images and warnings have a dramatic effect on the consumption of cigarettes, when Thailand adopted health warnings for all cigarette packets, the number of regular smokers declined by almost 20%. Similarly, a study in Canada found that 15% of Canadian smokers had been deterred from having a cigarette when showed the picture warnings.

• Positive and negative externalities, with appropriate diagrams - see revision presentation and click here for the simulation.

Short-term and long-term environmental concerns, with reference to sustainable development. a pattern of resource use that aims to meet human needs while preserving the environment so that these needs can be met not only in the present, but also for generations to come.

A solution to the worlds energy crisis? Pig fat into Bio Diesel.

African flowers are better for the environment because they are not grown in heated green houses?


Government Responses to the over-consumption of merit goods.

 

Market Failure - Simulations and activities

Types of Goods - Self Test Questions

Market Failure Flash Cards

Past Paper Questions Market Failure

May 2005 Paper 3
Using an appropriate diagram explain how the provision of a vaccine would generate positive externalities. (4 marks)

November 2005 Paper 2

Explain why economic growth is likely to generate external costs, which area threat to sustainable development. (10 marks)

November 2005 Paper 3
Using an appropriate diagram explain how the establishment of a new shopping mall will create external costs. (4 marks)

May 2006 Paper 1

Carefully distinguish between merit goods, demerit goods and public goods. (10 marks)

Evaluate the view that governments should always intervene in markets for goods such as cigarettes and alcohol. (15 marks)

May 2006 Paper 3

Evaluate the externalities to be considered in determining whether water should be supplied and sold by the private sector. (10 marks)

November 2006 Paper 3

Using an appropriate diagram, explain how traveling by commercial airlines may be a source of market failure.

Evaluate two possible solutions to the environmental problems caused by commercial airlines travel.

November 2008 Paper 2

Explain how the burning of fossil fuels (e.g. coal) by industries could create a market failure and a threat to sustainable development.

May 2009 Paper 2

Explain how direct provision of a public good by the state (government) can correct the problem of market failure.

With the aid of a diagram, explain how the application of a flat rate tax (a specific / fixed amount) could reduce the amount of pollution produced by a chemical factory.

May 2005 Paper 3

Using an appropriate diagram explain how the provision of a vaccine would generate positive externalities. (4 marks)

November 2005 Paper 2

Explain why economic growth is likely to generate external costs, which are a threat to sustainable development. (10 marks)

November 2005 Paper 3

Using an appropriate diagram explain how the establishment of a new shopping mall will create external costs. (4 marks)

May 2006 Paper 1

Carefully distinguish between merit goods, demerit goods and public goods. (10 marks)

Evaluate the view that governments should always intervene in markets for goods such as cigarettes and alcohol. (15 marks)

May 2006 Paper 3

Evaluate the externalities to be considered in determining whether water should be supplied and sold by the private sector. (10 marks)

November 2006 Paper 3

Using an appropriate diagram, explain how traveling by commercial airlines may be a source of market failure.

Evaluate two possible solutions to the environmental problems caused by commercial airlines travel.

November 2008 Paper 2

Explain how the burning of fossil fuels (e.g. coal) by industries could create a market failure and a threat to sustainable development.

May 2009 Paper 2

Explain how direct provision of a public good by the state (government) can correct the problem of market failure.

With the aid of a diagram, explain how the application of a flat rate tax (a specific / fixed amount) could reduce the amount of pollution produced by a chemical factory.

Market Failure Flash Cards

Section 5 Macro Economics

1. What you need to know  
2. What you need to be able to draw and explain.  
3. What you need to be able to evaluate.  

Note - If you do a macro question look for any sub-question on development that could be "hidden" in there.

it is strongly suggested that you read the chapter on macro-economic equilibrium .

What you need to know.

Explain the circular flow of income (Economic Activity).

Define and explain injections and wirhdrawls and show all of this in a diagram.

The circular flow of income shows flows of money - producers (firms) and consumers (households) - the fundamental process of satisfying human wants.
As we have already seen, a free market economy consists of two components, or sectors, as they are called. These are firms and households. People in households work for firms (selling their factor services) and receive wages in exchange. On the scale of the whole economy, this is known as national income - the total amount of income earned over a given time period. This money is spent on food, clothing, transport, entertainment etc, and so it returns to the firms. This is the circular flo

Define and explain national Income and the three ways to measure this.

The total economic activity - the total of goods and services produced in a country.

Expenditure - the sum of expenditures in the economy
Income - the sum of all factor incomes (Factor income is the returns received on factors of production: rent is return on land, wages on labor, interest on capital, and profit on ...)
Output - the sum of output (value added) produced in the economy
All three approaches are should give you the same final figure for national output.

The video clip in China is a great example to use in an essay on economic growth / national income.

Problems of measuring national Income include .....

1. Shadow Economy.

2. Government Spending on Public Goods often not correctly valued.

3. Unpaid (voluntary / subsistence) work not included.

 

 

Distinguish between .....

Gross and net .....

National and domestic

Nominal and real

Total and per capita

Growth and development.

GDP and GNP as a measure of growth.

What are the limitations of GDP as a measure to compare welfare between countries? What alternative measures exist to measure welfare?

Aggregate Demand

Define aggregate demand and explain its components. Explain the detrerminants of the components of AD and explain the causes of shifts of the AD curve (monetary policy, fiscal policy and changes to business confidence). Show all this in a diagram.

Aggregate Supply

Define SRAS and explain causes of shifts in words and with diagrams. Define LRAS, explain the causes of an increase in LRAS. Distinguish between "Keynesian" and neo-classical LRAS and be able to show all this in a diagram.

Equilibrium level of national income and full employment

Define and distinguish between the equilibrium level of national income and full employment level of national income and show on a diagram.

Inflationary and deflationary gaps.

Define and explain using diagrams.

Business cycle

Explain using a diagram.

Essential Macro Economics Diagrams

 
1. Four sector circular flow diagram with injections and withdrawls. Try to use a real economy so that the diagram is in context. Be sure to show firms, households, government and clear injections and withdrawls. 10. Real wage unemployment. Occurs when TU's or Govt. push the wage rates upwards and disequilibrium between AS and AD of labour exists.
2. The AD curve. Axis labelled "Average Price Level" and "Real Output = Nat Income". Shows total demand and so output in the econnomy and international sector at different price levels. A fall in prices leads to an increase in real output. 11. Cost push inflation. Axis labelled "Average Price Level" and "real Output". SRAS shifts in to SRAS1 pushing up costs.
3. The SRAS curve. Axis labelled "Average Price Level" and "Real Output". SR increases in output usually only achieved with increases in AC. These are passed on as higher prices. 12. Demand deficient unemployment. Axis labelled "Average (real) Wage Rate" and "No. of Workers). Show AD shifting in and the unemployment created if wages are not adjusted down.
4. The Keynesian LRAS. Axis as above. The LRAS has 3 segments. 1-Output can be increased without an increase in price due to spare capacity. 2-As spare capacity is utilised output increases but with an increase in costs as FOP cost more. 3-Output cannot be increased because all factors are being used. 13. Demand pull inflation. AD shifts out to AD1 along the SRAS pushing prices up.
5. Neo-Classical LRAS curve. The curve is set by the quantity and quality of factors of production in the economy and so is perfectly inelastic at full employment Y1. 14. Short run Philips curve. Shows the trade off between unemployment and inflation. As unemployment falls the wage rates rise. Show the SRPC intersectiing the Unemployment rate axis and label the NRU.
6. The equilibrium level and the full employment level of national income. In the SR its the AD - SRAS equilibrium that shows SR equilibrium output. The long run equilibrium level of national income is where AD is equal to LRAS. The full employment level is where all factors are employed. Keynesians believe that the two do not necessarily coincide. 15. Long run Philips curve. This shows that in the SR the unemployment rate can be lowered using demand side policies, but in the LR the SRPC will shift back out and unemployment will return to the NRU but with wages at a now increased level. In the LR unemployment can only fall using supply side policies.
Inflationary and deflationary gaps 16. Lorenz curve.
7. Business cycle. 17. Laffer curve. Shows the relationship between direct tax rates and government revenue. At tax rates of 0% and 100% governemnt revenue would be zero. There is a rate X% where tax revenue is maximised
8. An expansionary demand side policy. Fiscal or monetary policy shifts AD curve out expanding the economy with the trade of of higher prices. The accelerator and the multiplier (HL only).
9. Supply side policy + Keynesian and neo-classical LRAS. Improvments to FOP shifts the LRAS curve out.  

What you need to be able to evaluate.

1. The consequences of supply side policies. be able to discuss three policies, the stakeholders who would be affected and the SR LR impications.
An example question ..... “Higher economic growth can only be achieved through the implementation of supply-side policies.” Discuss. (May 06) 15 marks.
Answers may include:
• definition of economic growth
• illustration of economic growth in terms of an outward shift of the PPC/LRAS curve
• distinction between actual and potential growth
• explanation of linkages between supply side policies and growth
• importance of AD
• Reward references to the Keynesian Monetarist debate
• demand side policies and the multiplier effect
• interdependence of supply side and demand side policies

This is potentially a big question for candidates to tackle. Do not expect answers to be able to cover the greater part of the above. Good candidates should be able to show how supply side policies can increase economic growth. They also need to be able to discuss this in the context of alternative demand side policies.
2. The effect of an increase or decrease in interest rates.
 
3. The view that controlling inflation should be the main objective of government.

For
The main priority should be to tackle inflation in the economy because of the various negative effects of inflation:

1. Making the economy internationally uncompetitive

2. Diversion of money into unproductive assets to hedge against inflation.

3. Cost push inflation and unemployment may result - perhaps even an inflationary spiral.

4. Redistribution from creditors to debtors (the real value of debts falls).

Against

1. Inflation might not be high by international standards and so need to look at relative inflation rate.

2. Rising prices may aid in the process of resource allocation.

3. Focusing on inflation may mean higher unemployment which has more damaging effects on society (financial, economic and social) - particularly the weakest in society.

Alternatively, it could be argued that economic growth should be more of a priority because this determines living standards and the growth of real incomes will automatically increase government tax revenue and enable a redistribution of income without any groups losing out.

Alternatively, it could be argued that a satisfactory balance of payments should be more of a priority because a deficit needs to be sorted out and cannot be sustained indefinitely as it may require painful deflationary policy to sort it out if it persists.

Alternatively, it could be argued that a more equal distribution of income / wealth should be more of a priority because poverty is a waste of human resources and has adverse social effects.

Inequality is not required for economic efficiency and so a more equal distribution of income will not affect efficiency and any redistribution of income may boost aggregate demand as lower income groups are likely to have a higher MPC.

4. Whether inflation or deflation poses the greater economic problem.
 
5. Whether demand side policies are the most effective ways to reduce unemployment.
 

Past Paper Questions

 
May 2005 Paper 1

(a) Using suitable examples, explain the difference between the multiplier and the accelerator. [10 marks]

(b) Evaluate the proposition that the most effective way to reduce unemployment is through the use of demand-side policies. [15 marks]

May 2005 Paper 2
What are the likely consequences of deflation for a country’s economy?
Use the Phillips Curve to explain the concept of the natural rate of unemployment.
May 2005 Paper 3

Define the following terms indicated in bold in the text:
(i) GDP (Gross Domestic Product).
(ii) Aggregate demand.

Using an appropriate diagram, explain how a fall in interest rates might stimulate aggregate demand in the USA.

Draw a diagram to explain what phase of the trade/business cycle the US economy is in.

Using information from the text and your knowledge of economics, evaluate the view that a cut in interest rates is all that would be necessary to stimulate an economic recovery in the USA.

Define the following terms indicated in bold in the text:
(i) economic growth.
(ii) regressive taxes.

Using an appropriate diagram, explain how an indirect tax can change the free market price level and the allocation of resources.Explain using an appropriate diagram, the relationship between tax revenue and income tax rates suggested by Arthur Laffer. [4 marks]

Using information from the text and your knowledge of economics, evaluate the likely impact of income tax cuts on economic growth in an economy. [8 marks]

Define the following terms indicated in bold in the text:
(i) current account deficit.
(ii) subsidy.

The text refers to the “current decline in the US dollar”. Using a supply and demand diagram, explain one possible reason for this. [4 marks]

Using an AD/AS diagram explain the relationship between the “high value” of the dollar and the “lost jobs” referred to in the text.

Using information from the text and your knowledge of economics, evaluate the likely impact of the depreciation of the dollar on the domestic US economy.

November 2005 Paper 1

Explain the relationship between the Lorenz Curve and the Gini Coefficient.Evaluate the effectiveness of the various methods that governments may use to redistribute income.

November 2005 Paper 2

Explain the multiplier effect of an increase in government spending.
November 2005 - Paper 3.
Define the following terms indicated in bold in the text:
(i) Current account
(ii) GDP per capita.
Using an appropriate diagram, explain the phrase, “…the Gini coefficient still stands at approximately 0.57, one of the highest figures in the world”.Using information from the text, the figures, and your knowledge of economics, evaluate the situation facing the Chilean economy. [8 marks]

Define the following terms indicated in bold in the text:
(i) investment
(ii) inflation.

Using an appropriate diagram, explain what is meant by the economy “operating below capacity”. [4 marks]

Using an appropriate diagram, explain how the Swiss National Bank may be able to bring about the desired change for the Swiss franc. [4 marks]

(d) Using information from the text, the diagrams, and your knowledge of economics, evaluate the performance of the Swiss economy. [8 marks]

May 2006 Paper 1
(a) Explain the difference between demand-side and supply-side economic policies.
(b) “Higher economic growth can only be achieved through the implementation of supply-side policies.” Discuss.
May 2006 - Paper 2.
Using AD/AS diagrams, analyse the likely impact on an economy of the following:
(a) a general rise in wage costs
(b) the discovery of new raw material sources
(c) capital stock increases.
May 2006 Paper 3

Define the following terms indicated in bold in the text:
(i) unemployment rate.
(ii) business/trade cycle.Using an appropriate diagram, explain how a government may attempt to close a deflationary gap. [4 marks]

Explain why deflation (a downward movement in the average level of prices) creates conditions that make it “unfavourable” for businesses to invest.

Using information from the text and your knowledge of economics, evaluate the extent to which unemployment would still be a problem if inflation were allowed to increase. [8 marks].

Using an appropriate diagram, explain how an increase in interest rates may have caused a decline in retail sales. [4 marks]

With reference to the diagrams, explain the relationship between the level of interest rates in Australia (Diagram 1) and the value of the Australian dollar. [4 marks]

Using information from the text and your knowledge of economics, evaluate the use of interest rates as a tool for controlling inflation. [8 marks]

November 2006 Paper 1

Explain how interest rates can be used to bring about an increase in economic activity. [10 marks]

Discuss the strengths and weaknesses of demand-side policies. [15 marks]

What are the causes of inflation? [10 marks]

Evaluate the possible effects of a persistently high inflation rate on a country’s current account balance and its exchange rate.

November 2006 Paper 2
Explain how an increase in government spending can lead to crowding out.
November 2006 Paper 3

Define the following terms indicated in bold in the text:
(i) GDP
(ii) (ii) current account deficit.

Using an appropriate diagram, explain how making the labour market more flexible may “ease some of the problems relating to rising unemployment”.

Using an AD/AS diagram, explain one possible reason why Czech consumer prices might have risen since 2003.

Using information from the text and your knowledge of economics, evaluate two possible measures that could be adopted by the Czech government to reduce the current account deficit.

May 2007 Paper 1
Explain why a government might find it difficult to maintain a low rate of Inflation as the economy approaches full employment.Evaluate the proposition that the priority in economic management should be the maintenance of low unemployment.
May 2007 Paper 2
“Macroeconomic equilibrium does not necessarily occur at full employment.” Explain this statement using the concepts of inflationary and deflationary gaps.
May 2007 Paper 3
Using a Lorenz Curve diagram, explain what happened to the distribution of income in the UK between 1984 and 1988.
November 2007 Paper 1
Using one or more diagrams, explain the difference between the equilibrium level of national income and the full employment level of national income.
Evaluate the policies a government may use to increase the full employment level of national income.
November 2007 Paper 3

Define the following terms indicated in bold in the text:
(i) inflation
(ii) supply-side policies.

Using an appropriate diagram, explain to what extent the data for Greece, from the beginning of 2003 to the beginning of 2005, supports the theory suggested by the short-run Phillips curve.

Using an appropriate diagram, explain why the Greek budget deficit may be causing crowding out as suggested in the last line of the text.

Using information from the text and data, and your knowledge of economics, evaluate the policies that might be used by the Greek government to improve the performance of its economy.

Define the following terms indicated in bold in the text:
(i) recession
(ii) consumption

With the help of an appropriate diagram, explain how the fall in lending after 1998 contributed to the “decade long period of slowdown and recession”.

Using the circular flow of income diagram, explain the link between saving and investment implied in the text.

Using information from the text and your knowledge of economics, evaluate the consequences of increased lending on the Japanese economy.

May 2008 Paper 1

“The effect of a decrease in aggregate demand on output and the price level depends on the shape of the aggregate supply curve.” Explain this statement.

Evaluate the likely effects of a falling rate of inflation on the performance of an economy. [15 marks]

May 2008 Paper 2
A government decides to raise personal income tax rates. Using diagrams, explain one possible demand-side consequence and one possible supply-side consequence of this decision
May 2008 Paper 3

Define the following terms indicated in bold in the text:
(i) nominal
(ii) inflationary gap.

Using information from the text/data and your knowledge of economics, evaluate the consequences for New Zealand of raising domestic interest rates.

November 2008 Paper 1
Evaluate the possible effects of a decrease in direct taxation on a country’s Inflation rate, unemployment rate and balance of payments.
November 2008 Paper 2
Explain two ways a government can reduce its natural rate of unemployment.
November 2008 Paper 3

Define the following terms indicated in bold in the text:
(i) current account deficit
(ii) multiplier

Using an AD/AS diagram, explain why “lower oil prices are a positive sign for the inflation outlook”.

Using an appropriate diagram, explain why the rising current account deficit “could have serious implications for the rand”.

Using information from the text/data and your knowledge of economics,

Evaluate the likely effects of the “tightened interest rates” .

Define the following terms indicated in bold in the text:
(i) infrastructure
(ii) investment

Using information ….. explain why there is evidence that the demand for oil was price inelastic in 2005.

Using an AD/AS diagram, explain the effect that the changing current account balance is likely to have on inflation.

May 2009 Paper 1

Explain the possible causes of a rise in the rate of inflation in an economy.

Evaluate the possible impact on economic performance that may result from a government decision to bring inflation under control. [15 marks]

May 2009 Paper 2

With reference to one factor, explain why some factors might shift the SRAS (Short-Run Aggregate Supply) curve, but leave the LRAS (Long-Run Aggregate Supply) curve unchanged.

Oil prices have risen in recent years. Explain the likely impact on the terms of trade and the current account balance of a country that depends on oil exports for most of its revenue.

Explain three possible limitations of using GDP as a measure to compare welfare between countries.

May 2009 Paper 3

Using an AD/AS diagram, explain how supply-side policies could affect real output in the long-run.

Define real GDP

Using an appropriate diagram, explain how investment in human resources can lead to an increase in the potential output of a country.

Using an AD/AS diagram, explain how an increase in investment expenditure can, potentially, increase employment .

Section 6 International Economics

Reasons for Trade HL Economic Integration Exchange Rates Terms of Trade
Protectionism WTO HL Exchange Rates HL Terms of Trade.
Economic Integration Balance of Payments HL Balance of Payments  

Reasons for Trade

• Differences in factor endowments - you need real world examples of countries and where there advantage lies.
• Variety and quality of goods made available to consumers. Ikea is one of the UK's most popular brands.
• Gains from specialization - increased qulaity and falling costs (economies of scale).
• Political gains through favoured trading partners.

Reasons for Trade - Higher level extension topic

• Absolute and comparative advantage (numerical and diagrammatic representations)
• opportunity cost
• limitations of the theory of comparative advantage

Free Trade and Protectionism

Definition of free trade as favoured by the WTO.
Types of protectionism
• Tariffs - diagram essential.
• Quotas
• Subsidies - when the question asks for a diagram other than tariffs this is the diagram to draw.
• Voluntary Export Restraints (VERs)
• Administrative obstacles
• Health and safety standards and Environmental standards.

Justification of Protectionism.

• Infant industry argument

• Efforts of a developing country to diversify

• Protection of employment

• Source of government revenue

• Strategic arguments

• Means to overcome a balance of payments disequilibrium

• Anti-dumping Arguments against protectionism

• Inefficiency of resource allocation

• Costs of long-run reliance on protectionist methods

• Increased prices of goods and services to consumers

• The cost effect of protected imports on export competitiveness

• Common markets

Economic integration

Globalization

Trading blocs

• Free trade areas (FTAs)
• Customs unions

 
 

HL Integration


• Trade creation and trade diversion
• Obstacles to achieving integration
• reluctance to surrender political sovereignty
• reluctance to surrender economic sovereignty

World Trade Organization (WTO)

• Aims
• Success and failure viewed from different perspectives

Balance of payments

• Current account
• Balance of trade
• Invisible balance
• Capital account

Exchange rates

• Fixed exchange rates
• Floating exchange rates
• Managed exchange rates
• Distinction between
• depreciation and devaluation
• appreciation and revaluation Effects on exchange rates of
• trade flow
• capital flows/interest rate changes
• inflation
• speculation
• use of foreign currency reserves


HL Exchange Rates



• Relative advantages and disadvantages of fixed and floating rates
• Advantages and disadvantages of single currencies/monetary integration
• Purchasing power parity theory (PPP)

HL Balance of Payment Problems


• Consequences of a current account deficit or surplus
Methods of correction
• managed changes in exchange rates
• reduction in aggregate demand/expenditure-reducing policies
• change in supply-side policies to increase competitiveness
• protectionism/expenditure-switching policies
• Consequences of a capital account deficit or surplus Higher level extension topics
• Marshall-Lerner condition
• J-curve

Terms of trade

Definition of terms of trade.

The terms of trade measures the rate of exchange of one good or service for another when two countries trade with each other.

For international trade to be mutually beneficial for each country, the terms of trade must lie within the opportunity cost ratios for both country. See the worked example here that we used for comparative advantage. In this example the TOT must lie between 2.5 and 4 to make the trading beneficial for both countries.

Consequences of a change in the terms of trade for a country's balance of payments and domestic economy

If export prices are rising faster than import prices, the terms of trade index will rise. This means that fewer exports have to be given up in exchange for a given volume of imports.
If import prices rise faster than export prices, the terms of trade have deteriorated.

A greater volume of exports has to be sold to finance a given amount of imported goods and services.
The terms of trade fluctuate in line with changes in export and import prices. Clearly the exchange rate and the rate of inflation can both influence the direction of any change in the terms of trade.

The significance of deteriorating terms of trade for developing countries.

key here is to remember that typically Developing Countries will be exporting low value goods and primary products and importing high value capital goods and components.

Developing countries can be caught in a trap where average price levels for their main exports decline in the long run. This depresses the real value of their exports and worsens the terms of trade. A greater volume of exports have to be given up to finance essential imports of raw materials, components and fixed capital goods.

The problems intensified in 1998 with the collapse in the currencies of many Asian developing countries. A big fall in the terms of trade signifies a reduction in real living standards since imports of goods and services have become relatively more expensive.

Higher Level Terms of Trade

Measurement of terms of trade. Terms of Trade Index - ToT = 100 x Average export price index / Average import price index
• Causes of changes in a country's terms of trade in the short-run and long-run
• Elasticity of demand for imports and exports

Past Paper Questions

May 2005.Paper 1.

Describe the factors which might cause a change in a country’s terms of trade
Evaluate the significance for less developed countries of a deterioration in the terms of trade.
May 2005 - Paper 2.

Why might a government prefer to negotiate Voluntary Export restraints (VER) rather than impose tariffs as a means of restricting international trade.
May 2005 Paper 3.
With the help of a supply and diagram, show the effects of the US tariff on imported steel.
With the help of an appropriate diagram, explain one other protectionist policy (other than a tariff), which the American government might use to support the domestic steel industry.
Using the information from the text and your knowledge of Economics, evaluate the arguments for and against the protectionsim in the steel industry.
November 2005.Paper 1.
Explain the concepts of trade creation and trade diversion
Evaluate the advantages and disadvantages of joining a trading bloc
November 2005 Paper 2.
With reference to the Marshall-Lerner condition, explain how the depreciation of a country’s exchange rate might affect its current account balance.
Explain the difference between outward-orientated and inward-orientated growth strategies.
November 2005 Paper 3.
Using an appropriate diagram, explain the likely effect of importing higher priced baby chicks from Australia and the EU on the market for chickens.
Using an appropriate diagram, explain how the Swiss National Bank may be able to bring about the desired change for the Swiss franc.Define dumping.
With the help of a supply an demand diagram, show the effects of the US tariff on imported steel.
With the help of an appropriate diagram, explain one other protectionist policy (other than a tariff) which the American government might use to support the domestic steel industry.
Using information from the text and your knowledge of economics, evaluate the arguments for and against the protectionism in the steel industry.
May 2006 Paper 1.
Explain why an improvement in a country’s term of trade does not always lead to an improvement in its balance of payments on current account
An economy is currently experiencing a deficit on the current account of its balance of payments. The government is considering either allowing the exchange rate to fall or reducing aggregate demand
May 2006 Paper 2.
Using an appropriate diagram, explain who gains and who loses from the introduction of a tariff.
May 2006 Paper 3.
Define interest rates and exchange rate appreciation.
Using an appropriate diagram, explain how an increase in interest rates may have caused a decline in retail sales.
With reference to the diagrams, explain the relationship between the level of interest rates in Australia (Diagram 1) and the value of the Australian dollar (diagram 2).
Using information from the text and your knowledge of economics, evaluate the use of interest rates as a tool for controlling inflation.
Define anti-dumping.
Using information from the text and your knowledge of economics, evaluate the costs and benefits of membership of a free trade area for a country.
November 2006 Paper 1

Evaluate the effectiveness of Foreign Direct Investment (FDI) as a means of achieving economic growth and economic development in a less developed country

November 2006 Paper 2
Explain the link between the Marshall-Lerner condition and the J-Curve effect.
November 2006 Paper3
Define Managed exchange rates
Using an appropriate diagram, explain how the actions of central banks have led to downward pressure on the US dollars.
Using information from the text and your knowledge of economics, evaluate the possible consequences of the strengthening euro on the countries which use the euro.
Define Dumping, Deteriorating terms of trade, Foreign direct investment, Investment.
May 2007 Paper 1
Explain the various factors which may affect an exchange rate in a floating exchange rate system
May 2007 Paper 2.
.

Distinguish between an outward-orientated and an inward-orientated growth strategy.

Using the principles of comparative advantage, explain why economic theory suggests that countries should specialize and trade with each other

November 2007 Paper 1
Explain three factors that influence the value of a country’s exchange rate
Evaluate government/central bank intervention in the foreign exchange market to reduce the value of the exchange rate
November 2007 paper 2
Explain reasons for an improvement in a country’s terms of trade.
May 2008 Paper 1.
Explain the principle of comparative advantage and the benefits which might arise from free trade
Evaluate the importance of membership of a trading bloc for the export performance of a countryPaper 2.
Explain reasons for an improvement in a country’s terms of trade.

November 2008 Paper 1.

“deterioration in a country’s term of trade will always be disadvantageous for the current account balance”. Evaluate this statement using the concept of price elasticity of demand.
November 2008 Paper 2.
Using a diagram of a numerical example, explain how the concept of comparative advantage determines which goods or services a country should export.
November 2009 Paper 1.
Explain the importance of price elasticity of demand in relation to a country’s balance of payments on current account
Evaluate the view that supply-side policies are more successful in correcting a country’s current account deficit than demand-side policies
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

aterials
• Human factors: the quantity and/or quality of human resources
• Physical capital and technological factors: the quantity and/or quality of physical capital
• Institutional factors that contribute to development
• banking system 5.1 Sources of economic growth and/or development
• Natural factors: the quantity and/or quality of land or raw m
• education system
• health care
• infrastructure
• political stability
5.2 Consequences of growth
• Externalities
• Income distribution
• Sustainability
5.3 Barriers to economic growth and/or development
• Poverty cycle: low incomes › low savings › low investment › low incomes
• Institutional and political factors
• ineffective taxation structure
• lack of property rights
political instability corruption
• unequal distribution of income
• formal and informal markets
• lack of infrastructure
21
Diploma Programme guide:Economics, February 2003
• International trade barriers
• overdependence on primary products
• consequences of adverse terms of trade
• consequences of a narrow range of exports
• protectionism in international trade
• International financial barriers
• indebtedness
• non-convertible curre

capital flight
SYLLABUS DETAILSSocial and cultural factors acting as barriers
• religion
• culture
• tradition
• gender issues
5.4 Growth and development strategies
• Harrod-Domar growth model
• Structural change/dual sector model
• Types of aid
• bilateral, multilateral
• grant aid, soft loans
• official aid
• tied aid
• Export-led growth/outward-oriented strategies
• Import substitution/inward-oriented strategies/protectionism
• Commercial loans
• Fair trade organizations
• Micro-credit schemes
• Foreign direct investment
• Sustainable development 5.5 Evaluation of growth and development strategies
• Evaluation of the following in terms of achieving growth and/or development
• aid and trade
• market-led and interventionist strategies
• The role of international financial institutions
• the International Monetary Fund (IMF)
• the World Bank
• private sector banks
• non-governmental organizations (NGOs)
• multinational corporations/transnational corporations (MNCs/TNCs)
• commodity agreements

Section 7 Development Economics

Development Economics Introduction.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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