IB Economics HL 3.2 Variations in Economic Activity Aggregate Demand and Aggregate Supply Topic Practice

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, high levels of inequality and youth unemployment 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 providing temporary subsidies for food and fuel. It did not impose a price ceiling for essential food.

(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. In addition, the taxes on alcohol and tobacco were raised. 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 %. The supply of tea also fell. However, the global price of tea rose, because Kenya is a major exporter of tea. Therefore, the revenue from selling tea increased by 12 % due to its price inelastic demand.
Text B - Unequal distribution of the benefits of economic growth in Kenya

(1) Although economic growth has contributed to reductions in absolute poverty since the early 2000s, 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. As a result, agricultural investment and output have fallen. Meanwhile, the output of manufactured goods and services has increased significantly.

(2) Electricity is used by 90 % of urban households but only 36 % of rural households. Rural households also have much more limited access to clean drinking water and less health insurance coverage than urban households.

(3) 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, and have become approximately equal for boys and girls in primary and secondary schools.

(4) 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) Most households still use fossil fuels for cooking and the carbon emissions from trucks, cars, and industry are very high. Therefore, the International Monetary Fund (IMF) recommends the implementation of a carbon tax. Climate-related policies and investments, such as renewable energy and forestry programmes, will reduce environmental disasters and increase economic growth and jobs in the formal sector.

Using an AD/AS diagram, explain how the change in Kenya's balance of trade in goods and services between 2015 and 2022 may have affected its real GDP (Table 2).

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Text D - Overview of the Philippines

(1) The Philippines is a country in the Asia-Pacific region. Growth rates of gross domestic product (GDP) in the 2020s are expected to average 5 % per year. With increasing urbanization, a growing middle class and a large, young population, the Philippines' economic growth is based on strong consumer demand.

(2) Although the primary sector is still important, there is stronger growth in the services sector, including tourism and insurance. Remittances from overseas workers also contribute a lot to national income.

(3) The government has made progress in reducing poverty, partly due to policies that encourage workers to leave agriculture for higher wage jobs in other sectors. However, poverty reduction is proceeding slowly, with more than 70 % of the labour force still working in low-wage jobs in the informal economy. The Philippines is vulnerable to natural disasters, such as earthquakes and droughts, which damage the economy and most severely affect the poor who work in farming and fishing. Fish stocks are falling due to illegal fishing and climate change. Agricultural productivity is low and unsustainable practices have caused deforestation.

(4) Infrastructure and public services, including health care and education, are inadequate in many rural areas and there is poor nutrition in low-income households. Rising food and fuel prices will further reduce real incomes. For the lowest income earners, food amounts to 60 % of total expenditure, while the highest income earners spend only 28 % on food. This can be explained by the low-income elasticity of demand (YED) for food.

(5) An expansionary fiscal policy has caused a persistent budget deficit. Higher global energy prices and the depreciation of the peso ( PHP, the Philippine currency) have added to inflationary pressures. In response, the central bank raised its interest rate several times, from 2\% in 2021 to 5.5\% in 2022.

(6) The Philippines has experienced more free trade in agricultural goods following its membership of the ASEAN economic community (a free trade area). For example, a quota on pork imports into the Philippines has been removed.

(7) However, to help local farmers, a 35 % tariff has been placed on rice imported into the Philippines, even though rice and other cereals account for a large proportion of imports. Tariff revenues are used to provide subsidies for modern farm equipment, seeds and training for rice farmers. The aim is to create a more efficient and competitive agricultural sector.
Text E - Reduction of poverty rates in the Philippines

(1) In order to achieve the first Sustainable Development Goal (SDG), the government of the Philippines aims to eliminate extreme poverty by 2040. In 2019, taxes were increased on tobacco, alcohol and e-cigarettes, partly to fund an expansion of the public health care system.

(2) Another programme provides regular cash payments to mothers, conditional on their children regularly attending school and receiving preventive health check-ups. Therefore, it is reducing poverty, improving human capital and increasing gender equality. According to a World Bank study, the Philippines' programme is one of the most efficient social support systems in the world: it costs only 0.4 % of GDP, yet covers nearly 20 million people.

(3) The government gives fuel subsidies to private bus drivers who provide transport in rural areas. In addition, the bus drivers are asking for an increase in the legal minimum price that they charge passengers, although the minimum (floor) price is already above the equilibrium price.
Text F - Infrastructure and job creation in the Philippines
Infrastructure in the Philippines, including infrastructure related to information technology, is being improved, in order to create jobs and connect the poor to more opportunities and basic services. Many projects are financed by Official Development Assistance (ODA), which includes loans and grants. The ODA funding also supports programmes for youth employment and for improving skills. Training is provided for priority areas: agricultural businesses, construction, information technology, management, tourism, and firms run by women entrepreneurs.

* estimate

Using an AD/AS diagram, explain the likely effect on the Philippines' real GDP as a result of higher global energy prices (Text D, paragraph 5).

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Text D - Overview of Bhutan

(1) Bhutan is a lower-middle income country in southern Asia. It is mountainous, water is plentiful, and 60 % of the territory is protected forest. Since 2008, Bhutan has measured its economic development by changes in its "Gross National Happiness" (GNH) index. The index considers factors such as income inequality, environmental conservation, sustainable development, and gender equality, in addition to the components of the Human Development Index (HDI).

(2) The pursuit of GNH has involved using government programmes to spread the benefits of economic growth across all social groups. An example of this is the construction of large hydropower plants, not only for the export of electricity but also to ensure that remote communities can buy power at low prices. Hydropower is a renewable method of producing electricity using the natural flow of water. With these new plants, all rural and urban areas had access to electricity by 2019.

(3) Government intervention in the market for electricity has been necessary due to the high cost of resources. Both the production and distribution of electricity are therefore controlled by state
owned enterprises. Bhutan's government has relied on India for grants and loans to finance hydropower projects.

(4) Sales of surplus electricity to India, amounting to over 70 % of electricity generation in 2021, have increased the funds available to the government for investment in healthcare and education. These revenues have also helped to finance the expansion of essential infrastructure, particularly road networks. The government's aim has been to reduce poverty and to improve well-being, especially in rural areas.

(5) Hydropower has proved to be an important source of economic development. However, the private sector faces a lack of investment for multiple reasons, including high transport costs and a small domestic market. This has limited the creation of new private-sector jobs. Furthermore, a sustainability tax of 100 USA dollars (USD) per night for tourists helps with Bhutan's conservation efforts. The tax reduces Bhutan's competitiveness as a tourist destination.

(6) Agriculture is vital to Bhutan's largely rural population. This sector employed 55 % of the workforce in 2021. However, most agricultural produce, such as rice, is consumed by farming households rather than sold in the market. By 2021, the country was importing about 50 % of its food. The growing food demands of urban areas could have negative consequences for the balance of payments.

(7) Agricultural output is constrained by many factors, including a lack of machinery, irrigation and affordable credit. Bhutan's partnership with the United Nations International Fund for Agricultural Development has provided funds for investment in the agricultural sector, such as irrigation systems, roads connecting farms to markets, and storage facilities. However, the GNH emphasis on sustainability could restrict growth in this sector. For example, to preserve biodiversity, there are restrictions on the use of chemical fertilizers.
Text E - Youth unemployment in Bhutan*

(1) The youth unemployment rate for Bhutan in 2021 was 20.9 %. However, youth unemployment in towns was much higher than in rural areas. Approximately 60 % of the total unemployed youth were female.

(2) There is a mismatch between the needs of employers and the skills of young people. Apart from this problem, the private sector requires government assistance in creating job opportunities so that young people can find employment outside of the public sector. Moreover, a lack of finance discourages the youth from entrepreneurship, further reducing their work prospects and the growth of Bhutan's economy.
Text F - Bhutan's trade relations with India
Bhutan has a free trade agreement with India, removing all tariffs between the two countries. In 2021-2022, about 80 % of Bhutan's international trade was with India. India's top imports from Bhutan include electricity, metals, and cement. Bhutan relies on India for goods such as fuel, cars, and rice. Transactions between the two countries are straightforward, as the central bank of Bhutan ensures the ngultrum (Bhutan's currency, BTN) is fixed to the rupee (India's currency, INR) at the exchange rate of 1 BTN=1 INR.
* aged between 15 and 24

Using an AD/AS diagram, explain the likely effect on Bhutan's potential (long-term) output of further government investment in hydropower projects (Text D, paragraph 2).