IB Economics HL 2.5 Elasticities of Demand Topic Practice

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 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. However, such revenues are unpredictable and probably unsustainable.

(3) After the rapid depreciation of the 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. 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 to correct the welfare loss that occurs in the education market, but they are inadequate.
Text E - Papua New Guinea's balance of trade and trade strategies

(1) The surplus on PNG's balance of trade in goods is due to the extraction sector, which earns 90 % of its export revenues. When global commodity prices were high, exports generated growth. Less than 10 % of export revenues come from agriculture, forestry and fishing, although these sectors employ more people. Over 85 % of PNG's exports go to just five countries. 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 been attempting various trade strategies, including export promotion, import substitution and economic integration. 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. Unfortunately, the tariffs on machinery harmed some exporting industries by raising production costs. Additionally, there are restrictions on the exports of some primary goods. For example, exports of logs are restricted in order to encourage timber processing within PNG. However, the tax on log exports caused some logging companies to close down.

(3) PNG has large trade surpluses (based on gas, minerals, and timber exports) with Australia and China, but it wants to diversify and promote agricultural exports. Therefore, it is now negotiating free trade agreements with both countries.

(4) The overall trade surplus will possibly decrease. Exports of gold and copper are not growing strongly. The main agricultural and forestry exports are palm oil, coffee, cocoa and timber, but PNG's shares in the global markets for these items have declined. PNG's vulnerability to climate change is particularly concerning, due to its need to promote agriculture for future export growth and to raise rural incomes.
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) 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.

1. Capsicum prices reach NZ $\$ 24$ 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.

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 $\$ 2$ billion per year.
${ }^{1}$ duopoly: a market dominated by two firms
${ }^{2}$ OECD: The Organisation for Economic Co-operation and Development

Note that a widget is an imaginary product.

In the country of Laurania, the widget industry operates as an oligopoly. The Minister for Finance is worried that the firms in the industry might abuse their power by acting together as a monopoly, and has said that the industry's concentration ratio is cause for concern.

Using a diagram (or diagrams), explain why a profit maximizing firm might charge a higher price in one market than in another.

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 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. However, such revenues are unpredictable and probably unsustainable.

(3) After the rapid depreciation of the 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. 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 to correct the welfare loss that occurs in the education market, but they are inadequate.
Text E - Papua New Guinea's balance of trade and trade strategies

(1) The surplus on PNG's balance of trade in goods is due to the extraction sector, which earns 90 % of its export revenues. When global commodity prices were high, exports generated growth. Less than 10 % of export revenues come from agriculture, forestry and fishing, although these sectors employ more people. Over 85 % of PNG's exports go to just five countries. 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 been attempting various trade strategies, including export promotion, import substitution and economic integration. 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. Unfortunately, the tariffs on machinery harmed some exporting industries by raising production costs. Additionally, there are restrictions on the exports of some primary goods. For example, exports of logs are restricted in order to encourage timber processing within PNG. However, the tax on log exports caused some logging companies to close down.

(3) PNG has large trade surpluses (based on gas, minerals, and timber exports) with Australia and China, but it wants to diversify and promote agricultural exports. Therefore, it is now negotiating free trade agreements with both countries.

(4) The overall trade surplus will possibly decrease. Exports of gold and copper are not growing strongly. The main agricultural and forestry exports are palm oil, coffee, cocoa and timber, but PNG's shares in the global markets for these items have declined. PNG's vulnerability to climate change is particularly concerning, due to its need to promote agriculture for future export growth and to raise rural incomes.
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) 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.

Define the term price inelastic indicated in bold (Text D, paragraph 2).

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 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. However, such revenues are unpredictable and probably unsustainable.

(3) After the rapid depreciation of the 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. 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 to correct the welfare loss that occurs in the education market, but they are inadequate.
Text E - Papua New Guinea's balance of trade and trade strategies

(1) The surplus on PNG's balance of trade in goods is due to the extraction sector, which earns 90 % of its export revenues. When global commodity prices were high, exports generated growth. Less than 10 % of export revenues come from agriculture, forestry and fishing, although these sectors employ more people. Over 85 % of PNG's exports go to just five countries. 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 been attempting various trade strategies, including export promotion, import substitution and economic integration. 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. Unfortunately, the tariffs on machinery harmed some exporting industries by raising production costs. Additionally, there are restrictions on the exports of some primary goods. For example, exports of logs are restricted in order to encourage timber processing within PNG. However, the tax on log exports caused some logging companies to close down.

(3) PNG has large trade surpluses (based on gas, minerals, and timber exports) with Australia and China, but it wants to diversify and promote agricultural exports. Therefore, it is now negotiating free trade agreements with both countries.

(4) The overall trade surplus will possibly decrease. Exports of gold and copper are not growing strongly. The main agricultural and forestry exports are palm oil, coffee, cocoa and timber, but PNG's shares in the global markets for these items have declined. PNG's vulnerability to climate change is particularly concerning, due to its need to promote agriculture for future export growth and to raise rural incomes.
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) 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.

Calculate the expected percentage change in the quantity of copper demanded if the price of a pound (lb) of copper falls from USD 5.00 to USD 4.60 (Text E, paragraph 1).

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 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. However, such revenues are unpredictable and probably unsustainable.

(3) After the rapid depreciation of the 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. 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 to correct the welfare loss that occurs in the education market, but they are inadequate.
Text E - Papua New Guinea's balance of trade and trade strategies

(1) The surplus on PNG's balance of trade in goods is due to the extraction sector, which earns 90 % of its export revenues. When global commodity prices were high, exports generated growth. Less than 10 % of export revenues come from agriculture, forestry and fishing, although these sectors employ more people. Over 85 % of PNG's exports go to just five countries. 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 been attempting various trade strategies, including export promotion, import substitution and economic integration. 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. Unfortunately, the tariffs on machinery harmed some exporting industries by raising production costs. Additionally, there are restrictions on the exports of some primary goods. For example, exports of logs are restricted in order to encourage timber processing within PNG. However, the tax on log exports caused some logging companies to close down.

(3) PNG has large trade surpluses (based on gas, minerals, and timber exports) with Australia and China, but it wants to diversify and promote agricultural exports. Therefore, it is now negotiating free trade agreements with both countries.

(4) The overall trade surplus will possibly decrease. Exports of gold and copper are not growing strongly. The main agricultural and forestry exports are palm oil, coffee, cocoa and timber, but PNG's shares in the global markets for these items have declined. PNG's vulnerability to climate change is particularly concerning, due to its need to promote agriculture for future export growth and to raise rural incomes.
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) 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.

Determine whether revenue earned from copper exports will rise, fall or stay the same after the reduction in price.

1. Capsicum prices reach NZ $\$ 24$ 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.

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 $\$ 2$ billion per year.
${ }^{1}$ duopoly: a market dominated by two firms
${ }^{2}$ OECD: The Organisation for Economic Co-operation and Development

With reference to Figure 1, explain why the price elasticity of demand for capsicums would change if the price continued to increase beyond NZ $\$ 24$ per kg.

Explain two reasons why the demand for primary commodities might be price inelastic.

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.

Calculate the expected percentage change in the quantity of PNG's exports if world incomes rise by 3.5 % (Text E, paragraph 1).

Explain the importance of income elasticity of demand (YED) for the primary, manufacturing and service sectors of the economy when real incomes are rising.