Practise IB Economics HL 2.5.7 by calculating YED and evaluating how income changes affect demand across sectors and firms using comparative evidence.
Text E - Papua New Guinea's balance of trade
Read the extracts and answer the questions that follow.
Text D - Overview of Papua New Guinea
(1) Papua New Guinea (PNG) consists of hundreds of small islands near Australia. Over 50 % of the labour force is employed in agriculture, forestry and fishing. The extraction sector, which mines non-renewable minerals (gold and copper) and extracts energy products (oil and gas), provides 30 % of the gross domestic product (GDP). The mining operations, usually carried out by foreign-owned firms, sometimes cause environmental damage and disputes over land rights.
(2) The lack of substitutes and the difficulty of extracting gold, copper and gas cause both global demand and supply to be price inelastic. Consequently, changes in global demand result in volatile prices, which lead to macroeconomic instability because the extraction sector in PNG is so large. Fiscal policies have been unable to reduce the business cycle fluctuations. Tax revenue has declined as a percentage of GDP partly due to lower commodity prices and thus business tax revenue. The government could get more revenue from the extraction sector through ownership or part-ownership of the firms. Alternatively, taxes on the use of natural resources or higher business taxes could be imposed. However, such revenues are unpredictable and probably unsustainable.
(3) After the rapid depreciation of the Papua New Guinea kina (PGK), PNG's currency, between 2012 and 2015, the central bank moved away from a floating exchange rate system to a managed exchange rate system. It used reserve assets in the foreign exchange market to prevent excessive currency depreciation, thereby lowering cost-push inflationary pressures. However, this intervention caused the PGK to become an overvalued currency. Therefore, the International Monetary Fund (IMF) recommended less intervention in the foreign exchange market so the PGK would gradually depreciate.
(4) Official development assistance (ODA) is providing funds and technical assistance to improve infrastructure and therefore assist economic growth, which is one of the objectives of aid. The other two objectives are promoting effective governance and improving health and education. The World Bank's aid programme provides advice and funds for investment in human capital, especially for women and children's education. The government provides subsidies for schools, but they are inadequate, and government spending per student has declined due to the growing population. Many women work in the informal sector where they earn lower wages, contributing to rising gender inequality in PNG.
(5) The IMF's aid is in the form of loans at low interest rates. Its programme aims to support growth that also benefits women and minorities, while improving the management of government (national) debt. It sets performance criteria, including reductions in the government's budget deficit.
(6) There is criticism that too much aid is for improving governance and more should be allocated to infrastructure, including transportation networks, water, sanitation and electricity, which is accessible to only 21 % of the population.
Text E - Papua New Guinea's balance of trade
(1) The surplus on PNG's balance of trade in goods is due to the extraction sector, which earns 90 % of its export revenues. Less than 10 % of export revenues come from agriculture, forestry and fishing, although these sectors employ more people. Studies show that PNG exports have a high income elasticity of demand (YED =+3.0 ), but price elasticities of demand are low, particularly for mineral exports such as copper (PED =-0.18 ).
(2) PNG has relatively low tariffs on most imports. However, tariffs on manufactured items, including machinery for palm oil production, were increased in 2019 to protect local manufacturing companies.
Text F - Foreign direct investment and Papua New Guinea
(1) The capital and financial accounts on the balance of payments have large deficits. The outflows are mainly due to the repayment of loans that were used to develop the extraction sector. Most inward foreign direct investment (FDI) has been for mining and energy extraction projects. The FDI inflows fall once the project is completed.
(2) FDI into other sectors is low due to regulations and inadequate infrastructure. The regulations limit certain economic activities and restrict land purchases to PNG citizens and state-owned enterprises. However, increased competition from foreign firms could raise efficiency in some industries.
(3) PNG is setting up special economic zones in certain regions, which provide tax exemptions and eased regulations. The aim is to encourage FDI into tourism and industries that process agricultural and fishing products. Aid agencies recommend using FDI for renewable energy and environmental projects.
Table 4: Economic and development data for Papua New Guinea
Table 5: Balance of payments data for Papua New Guinea
Figure 1: Real GDP annual growth rates in Papua New Guinea between 1996 and 2022
Calculate the expected percentage change in the quantity of PNG's exports if world incomes rise by 3.5 % (Text E, paragraph 1).