IB Econ HL 2.7.3 Consequences of intervention

[Maximum number: 4]

"Best Meals" is one of many small catering companies, each of which prepares a variety of different meals for airlines in Country X. Table 1 shows the costs of production in US dollars (US$) on a per hour basis for "Best Meals".

Table 1

The information that follows refers to the aviation industry, which is considered a significant contributor to global warming and climate change.

$Table 2: Energy used and carbon dioxide ( \(\mathrm{CO$

Table 2: Energy used and carbon dioxide ( \(\mathrm{CO

${ }^{1}$ joule: a standard unit of energy
${ }^{2}$ passenger kilometre: one passenger travelling one kilometre

Table 3: Estimates of price elasticities of demand (PED) for leisure and business air travel and estimates of income elasticities of demand (YED) for domestic and international air travel routes

- The aviation sector creates emissions that account for about 4.9 % of human made global warming and its share of greenhouse gas emissions is rapidly growing.
- A flight from San Francisco to Paris can produce around 1.25 metric tons of carbon emissions per passenger. This is more $\mathrm{CO}_{2}$ than the average person in certain countries generates in an entire year.
- The energy source for aircraft is not easily substitutable. Road and rail-based passenger vehicles can switch from carbon-based fuels to renewably sourced electricity. Aviation emissions are thus not expected to be easily reduced.
- The aviation industry's growth has also accelerated as a result of subsidies, including general sales tax and fuel tax exemptions, which are unavailable to other modes of transport.

The catering companies buy tomatoes from the domestic market to prepare their meals. Figure 1 illustrates the domestic market for tomatoes, which is perfectly competitive. S is supply and D is demand.

Figure 1

In order to support the incomes of the tomato farmers, the government of Country X has set a price floor (Pmin) at US$2.80 per kilogram.

With reference to Figure 1, explain how the price floor will impact on allocative efficiency in the market for tomatoes.

Level	Descriptor	Marks
0	The work does not meet a standard described by the descriptors below	0
1	The written response is limited. - The market equilibrium moves away from D=S(MB=MC) / OR excess supply is created [1] - So allocative efficiency is no longer achieved because of overproduction ( OR that social surplus is not maximized) [1]	1-2
2	The written response is accurate Allocative efficiency requires MB=MC for the last unit traded [1]. This occurs at 16,000 kg, where MB=MC=US\$2.40 [1]. At the US\$2.80 price floor, suppliers offer 20,000 kg but buyers demand only 12,000 kg [1]. Without government purchases, only 12,000 kg are traded; at that quantity MB=US\$2.80 exceeds MC=US\$2.00, so mutually beneficial trade is lost and allocation is inefficient [1]. Alternatively, if the government purchases the surplus and total production reaches 20,000 kg, MC=US\$2.80 exceeds MB=US\$2.00 at the last unit, giving overproduction and inefficiency. Credit a clearly stated, internally consistent interpretation. Candidates who do not make reference to the diagram may be awarded a maximum of [3].	3-4

If the government purchases the 8,000 kg unsold surplus and it has no additional consumption value, an alternative approach is to calculate the welfare loss resulting from the price floor
Change in CS =-5600
Change in PS $=0.5 \times 0.4 \times(16000+20000)=7200$ [1]
Change in G $=-2.8 \times 8000=-22400$ [1]
Net welfare loss =-5600+7200-22400=-$ 20800 [1]
Any valid working is sufficient for [1]

OFR applies if the change in CS, PS or G is incorrect, but the calculation of net welfare loss is accurate.

Therefore the market is not allocatively efficient [1]

IB Economics HL 2.7.3 Consequences of Intervention Questions

Exam points

IB Economics HL 2.7.3 Consequences of Intervention Questions question 1