IB Economics HL 2.3 Competitive Market Equilibrium Topic Practice

CourseCourseConceptConcept

Covered syllabus points

2.3.1—Market equilibrium2.3.2—Changes in equilibrium2.3.3—Price mechanism2.3.4—Consumer and producer surplus2.3.5—Allocative efficiency2.3.6 (HL)—Surplus calculations

Question 1

[Maximum number: 5]

The market for corn on the island of Nissos is perfectly competitive. The demand and supply for corn in Nissos are given by the functions

Qd=10−0.5PQs=−2+P\begin{aligned} & Q d=10-0.5 P \\ & Q s=-2+P \end{aligned}

where Q d is the quantity of corn demanded per month in millions of kilograms ( kg ), Q s is the quantity of corn supplied per month in millions of kg and P is the price per kg of corn in dollars ($).

Question (a)

(a)

Calculate the monthly equilibrium quantity of corn in Nissos.

[ 2 ]

Question (b)

(b)

Plot and label on Figure 1 the market demand curve and the market supply curve for corn in Nissos.

Figure 1

Figure 1

[ 2 ]

Question (c)

(c)

Using Figure 1, calculate the consumer surplus in Nissos at the market equilibrium.

[ 1 ]

Question 2

[Maximum number: 2]

Read the extracts and answer the questions that follow.
Text A - Overview of the economy and government policies in Kenya

Read the extracts and answer the questions that follow.
Text A - Overview of the economy and government policies in Kenya

(1) Kenya, in East Africa, is achieving high annual economic growth rates, averaging above 5 %. Living standards are improving and employment is increasing in the manufacturing, tourism, construction and education sectors. Kenya's high growth is also changing the distribution of income and affecting the environment. However, climate change and high levels of inequality may reduce future growth rates.

(2) Floods and droughts are severe and frequent. In 2022-2023, droughts caused agricultural output to fall, affecting the employment of 40 % of the population and doubling the number of people with insufficient food. The government took measures to increase food supplies, such as reducing the tariff on imports of rice.

(3) The rising price of food is the main cause of inflation in Kenya. The central bank used a contractionary monetary policy in 2022 and 2023 to reduce inflation and to prevent the depreciation of the country's currency (Kenyan shilling, KES).

(4) The budget deficit as a percentage of gross domestic product (GDP) became smaller in 2023 because government expenditure grew more slowly than GDP. Moreover, economic growth resulted in higher tax revenue from both income tax and a 16 % indirect tax on goods and services. The government is also receiving revenue from the sale of some state-owned enterprises (SOEs). A World Bank programme, aimed at an expansion of "green" energy in Kenya, provides financial and technological support to the Kenya Power and Lighting Company, an SOE that has been making losses.

(5) The currency depreciation in 2022 boosted exports. Services, which are approximately 38 % of total exports and include tourism and financial services, are growing faster than exports of goods. Manufactured goods account for 37 % of total exports and agricultural goods account for 25 %. Revenue from exports of tea, flowers, vegetables, meat, and coffee are volatile and unpredictable. The droughts in 2022-2023 reduced output, which lowered export revenue from vegetables and flowers by almost 20 %.
Text B - Unequal distribution of the benefits of economic growth in Kenya

(1) Although economic growth has reduced absolute poverty, inequality remains a problem, particularly between the formal and informal sectors and between the urban and rural areas. Rural poverty is caused by low agricultural productivity and farmers' limited access to markets, finance, and technology.

(2) However, the level of education has improved significantly, with a literacy rate of over 90 %. Secondary school attendance rates have increased from 13 % in 2003 to 49 % in 2022, despite the costs of attending school. In 2022, the government introduced a fund (the Hustler Fund), partly financed by foreign aid. The fund provides low-interest loans to women, young people, and small firms, for education or investment.
Text C - Reducing and adapting to climate change in Kenya

(1) Global warming is affecting the Kenyan economy. Consequently, agricultural output and tourism, which account for 70 % of employment and most exports, will probably decline. Therefore, GDP could fall by 2 % annually. However, Kenya has relatively low carbon emissions, particularly because renewable resources generate 90 % of electricity, a figure that is planned to rise to 100 % by 2030.

(2) Measures taken by other economies to reduce carbon emissions provide opportunities for Kenya, because the markets for "green" goods are expanding. Kenya is able to sell tradable permits (carbon credits) to high-emitting countries due to its reforestation programmes. However, there are challenges for Kenya. The production of exports, such as coffee, needs to meet strict sustainability regulations imposed by the European Union (EU) on imports.

(3) The International Monetary Fund (IMF) recommends that climate-related considerations should be part of macroeconomic and infrastructure policies. It also recommends that carbon taxes should be imposed to reduce the use of fossil fuels by firms. Rapid urbanization is increasing the need for electric vehicles and improved public transport. Energy efficiency measures, fuel substitution, and switching to rail transport will not only lower transportation costs but also reduce the trade deficit. This is because fossil fuels used for transportation and manufacturing are imported.

(4) Kenya is able to obtain finance and technology for investment in climate-related projects, such as renewable energy and forestry programmes, through foreign aid and partnerships with the private sector. Overall, these policies will reduce environmental disasters and increase economic growth and jobs in the formal sector.

Table 1: Tea production in Kenya

Table 1: Tea production in Kenya

Table 2: Economic data for Kenya

Table 2: Economic data for Kenya

Table 3: Development data for Kenya

Table 3: Development data for Kenya

\footnotetext{
*estimate
}

Sketch a demand and supply diagram to indicate how droughts caused the price of food to rise in Kenya (Text A, paragraphs 2 and 3).

Question 3

[Maximum number: 10]

With reference to demand and supply in competitive markets, explain how the economic question "what to produce" is answered.

Question 4

[Maximum number: 2]

Country X and Country Y are capable of producing both apples and bananas. Assume a two-country, two-product model.

Country Y has absolute advantage in the production of both apples and bananas, and comparative advantage in the production of bananas.

The market for oranges in Country Z is illustrated on Figure 5.

Figure 5

Figure 5

The domestic demand and supply for oranges are given by the functions

Qd=300−100PQs=−60+60P\begin{aligned} & Q d=300-100 P \\ & Q s=-60+60 P \end{aligned}

where P is the price of oranges in dollars per kilogram ( $\$ per kg ), Q d is the quantity of oranges demanded (thousands of kg per month) and Qs is the quantity of oranges supplied (thousands of kg per month). The world price of oranges is $2\$ 2 per kg.

Due to increased awareness of the possible health benefits of vitamin C , the demand for oranges in Country Z increases by 60000 per month at each price.

Calculate the change in social (community) surplus as a result of the increase in demand for oranges.

Question 5

[Maximum number: 4]

Firm A, a firm with monopoly power, is producing at a level of output Q' equal to 150000 units per month for which the following are true (all figures are in dollars ($)):

Table 1

Table 1

The values in Table 1 imply the following:

P=AR>MR>AC>MC\mathrm{P}=\mathrm{AR}>\mathrm{MR}>\mathrm{AC}>\mathrm{MC}

Explain why allocative efficiency is achieved, in the absence of externalities, at a level of output where price (average revenue) is equal to marginal cost.

Question 6

[Maximum number: 2]

1. Capsicum prices reach NZ $24\$ 24 per kilogram
The price of capsicums, a common vegetable in New Zealand, reached an all-time high of NZ$24 per kilogram (kg) in 2021. Vegetable prices in New Zealand rose 15% in 2021, driven by higher prices for cucumbers, lettuce, capsicums and broccoli.
A consumer prices analyst said "prices for many vegetables typically rise in winter. However, we are seeing larger rises than usual for this time of the year and for a greater number of vegetables." It has been suggested that price increases are larger than usual because of the market power of the supermarkets in New Zealand.
Figure 1 illustrates a decrease in supply in the market for capsicums in New Zealand.

Figure 1

Figure 1

High profits: New Zealand considers breaking up supermarket duopoly¹
New Zealand's supermarket industry is dominated by two huge firms, Foodstuffs and Woolworths. Together, their stores control about 85 % of the total market, giving them significant market power.
A report by the New Zealand Commerce Commission has found that these supermarkets are making huge profits and charging some of the highest prices in the OECD².
A government official said the government would "do whatever it takes to make sure New Zealanders get a fair deal at the checkout".
The major retailers appear to avoid competing strongly with each other, particularly on price. Meanwhile, competitors wanting to enter the market or expand face significant barriers to entry, including a lack of suitable sites for large scale stores.
The government has strict regulations limiting the sites that can be used for building supermarkets. The big supermarkets have been buying the limited sites in order to prevent competitors from entering the market.
It has been reported that the entry of a German retailer into the Australian supermarket industry, which was also dominated by two firms, has increased competition, cut prices by around 13 % and saved customers more than NZ $2\$ 2 billion per year.
1{ }^{1} duopoly: a market dominated by two firms
2{ }^{2} OECD: The Organisation for Economic Co-operation and Development

Figure 2 illustrates a market in which two firms act as a monopolist in the market for cheese by colluding on the price they charge.

Figure 2 illustrates a market in which two firms act as a monopolist in the market for cheese by colluding on the price they charge.

Calculate the loss in consumer surplus resulting from the increase in the price of capsicums from NZ$18 per kg to NZ$24 per kg.

All question bank results loaded