IB Economics SL 2.1 Demand Question Bank

Study the extract and data below and answer the questions that follow.
Ecuador sees 2014 trade deficit falling with new import rules, but at what cost?

(1) In the period from January to May 2014, Ecuador posted a trade surplus of US$483 million, moving from a deficit of US$626 million one year before.

(2) The government has been implementing an import-substitution policy to reduce the trade deficit. On 4 December 2013, Ecuador's Foreign Trade Committee established new quality control measures for the importation of 293 items, including cosmetics, toys, toothpaste, meat and cereals. In order for goods on the list to be imported a certificate needs to be obtained, ensuring that the products meet quality control standards. There are up to 13 steps to be taken before a product may enter as a result of the excessive regulations holding up the certificates.

(3) The import-substitution policy also involves a move to provide support to domestic industries. The president firmly believes in the benefits of sheltering infant industries. He has complained about imports such as coconut water, banana puree or cornflakes, which he believes could be produced by domestic industries, supported by appropriate policies. In addition, he points out that Ecuador is a top exporter of fine aroma cocoa, but imports approximately US $\$ 25$ million worth of chocolate per year. Other measures to protect domestic industries include anti-dumping measures and higher tariffs on raw materials and capital equipment that are available in Ecuador.

(4) In the month since this intervention started, different businesses have begun to feel both the advantages and disadvantages. Pica, one of the largest companies in the plastic industry, has taken advantage of the policy. The reduction in the importation of certain products has allowed them to increase their own production.
5 In contrast, Toni Industries, one of the most important dairy businesses in the country has suffered. It has complained that cornflakes, which the company uses as a complementary good to one of its key products, could not get through customs because it did not have the quality control certificate.

(6) Many industry analysts and economists argue that closing off imports will isolate the country and create a false sense of competitiveness. They are also concerned that the government seems to be assuming that other countries will not react. Some argue that the government should seek to create incentives for investment, like tax benefits, or legal security, which would allow the entry of new competitors into the Ecuadorean markets.

www.latinvex.com, 19 March 2014 and www.blogs.wsj.com, 14 July 2014]

Define the term complementary goods indicated in bold in the text (paragraph (5).

Explain the view that an increase in price will lead to a decrease in the quantity demanded whilst an increase in demand will lead to an increase in price.