Analyse how demand and supply interact to determine equilibrium, shortages, surpluses, prices and quantities in IB Economics SL.
Read the extracts and answer the questions that follow.
Text A - Overview of Uruguay
(1) With a population of only 3.5 million, Uruguay is one of the smallest nations in South America. Its membership of the MERCOSUR common market allows Uruguayan producers tariff-free access to 290 million consumers in Argentina, Brazil and Paraguay.
(2) Agriculture accounts for 8 % of Uruguay's gross domestic product (GDP) and 65 % of its export revenue. Exports have increased since the early 2000s, partly due to China's rising demand for commodities. In particular, Uruguay's soybean producers benefitted from significantly higher prices during the commodity boom. China is now Uruguay's most important export destination, with soybeans accounting for over 50 % of its exports to China.
(3) Uruguay's real GDP increased by an average of 5.39 % per year from 2005 to 2014. However, the economy slowed considerably when the commodity boom ended in 2015. It slowed further because of decreased regional demand when the largest members of MERCOSUR, Argentina and Brazil, faced a recession in 2017. Uruguay's real GDP grew on average by 1.04 % per year from 2015 to 2018.
(4) With the increasing importance of China and the European Union (EU) as export markets, Uruguay has managed to reduce its dependency on MERCOSUR. However, attempts to diversify its exports away from agriculture have not been successful. The end of the commodity boom contributed to a fall in export revenue and the depreciation of the peso (Uruguay's currency). The currency has lost over 25\% of its value since 2015.
(5) Inflation stayed at a relatively high rate of 8 % in 2018 due to the weaker currency. The unemployment rate also increased to 7.9 % as a result of the economic slowdown. The higher cost of living and the lower rates of employment could inhibit efforts to reduce inequality and poverty levels.
(6) Despite rising inflation and unemployment, Uruguay's minimal corruption, abundant natural resources and access to a large common market continue to attract foreign direct investment (FDI). Investments in the paper and wood industries have made forestry one of the country's fastest growing industries. Increased FDI inflows have also prevented the peso from depreciating further.
Text B - The EU-MERCOSUR free trade agreement
(1) The EU and MERCOSUR are finalizing the terms of a free trade agreement, which would enable Uruguay to increase its exports to the 27 EU member states. The EU currently buys 11 % of all Uruguayan exports, mostly animal products, paper, vegetables and wood.
(2) Once the free trade agreement comes into effect, almost all agricultural and industrial tariffs between the EU and MERCOSUR will be removed. The imports of beef, poultry and sugar will not be included in the list of tariff-free products but will be subject to very large quotas. This will allow increased exports of these products to EU countries.
(3) The free trade agreement may cause bankruptcies in the manufacturing sector and higher structural unemployment in Uruguay. EU exports to Uruguay largely consist of manufactured goods, such as chemicals, machinery, transport equipment and plastics, which are in high demand despite the current tariffs of up to 35 %.
(4) One third of FDI into Uruguay comes from the EU. Anticipation of the free trade agreement has led to more EU investments in Uruguay's forestry sector. Environmental organizations have warned that the free trade agreement could be a threat to sustainability as South American forests are cleared to create land for cattle farming, paper and wood production. The deforestation might also disrupt water sources that supply rural villages, depriving the villagers of clean water.
Text C — Uruguay seeks trade agreements outside MERCOSUR
(1) Members of MERCOSUR have differing views on trade policies. Brazil, Paraguay and Uruguay believe in trade liberalization and want to increase competition through a reduction of the common external tariff. On the other hand, Argentina wants to maintain the high external tariff to protect industries from cheap imports from China and to avoid prolonging its current recession.
(2) Uruguay has expressed its desire to seek trade agreements apart from MERCOSUR, which is prohibited by the common market's rules. If Uruguay pursues separate bilateral agreements, it is likely to lose its MERCOSUR membership and the benefits of any existing free trade agreement.
Table 1: Current account data for Uruguay (US\$ billion)
Table 2: Selected income data for Uruguay
Using a demand and supply diagram, explain how China might have contributed to the Uruguayan soybean producers' higher (total) revenue (Text A, paragraph 2).
Study the extract below and answer the questions that follow.
Urban farms to feed Cuban cities
(1) The Cuban government has launched a project to surround its cities and towns with thousands of organic farms to make the growing of fruit, vegetables and the raising of livestock low cost and environmentally friendly.
(2) The government hopes this new approach to urban farming will make food cheaper and more abundant. It is also hoped that transport and fuel costs will be reduced and that urban dwellers will be encouraged to leave their city jobs and work in the farming sector. The farms are mostly privately-owned with some cooperatives, and more land has been leased to them. These private farmers and cooperatives own about 40 % of Cuba's farmland and produce about 70 % of food grown.
(3) In the past farmers had to purchase their subsidized resources from the government. However, they can now purchase their own seed, equipment and other materials directly from suppliers. They can choose what they want to grow. Farmers are also allowed to sell some of their produce to licensed government sellers or sell directly to consumers at roadside stands. Farmers can also vary the price of the products they sell. These changes allow for greater reliance on the price mechanism and for a more efficient allocation of resources.
(4) However, the Cuban government still plays a major role in production and support of the rest of the agricultural economy. It continues to hold a monopoly over essential foods such as rice, beans, pork and bananas by controlling the production, distribution and land use for these foods. Prices for these commodities are set by the government, which also provides infrastructure, schooling and overall direction to the economy. Nevertheless, poor planning and corruption continue to be obstacles to economic development.
(5) Not all urban farmers can see the long term benefits of this and are concerned about greater competition between producers and the possibility of rising input prices which may result if subsidies end. However, they are encouraged that the reforms allow them to make more decisions about what to produce and how to sell. They believe that more food will be available for sale and consumption. Foreign and local experts welcome the project and expect that as the market mechanism becomes more important, economic growth and economic development will be stimulated.
Explain why a "greater reliance on the price mechanism" might result in "a more efficient allocation of resources" (paragraph (3).
Explain the concepts of consumer surplus and producer surplus.
