Analyse externalities and common-access resources using social costs, social benefits, diagrams and government responses.
Examine the view that the best allocation of resources, from society's point of view, occurs where the marginal private benefit equals the marginal private cost.
Read the extracts and answer the questions that follow.
Text D - Macroeconomic policies in Uruguay
(1) Compared to many other Latin American countries, Uruguay has a high Human Development Index (HDI). This is due to its higher gross national income (GNI) per capita and wider access to health care and education.
(2) One aim of Uruguay's fiscal policy has been income redistribution. For example, in 2017 the tax rate applied to the highest income bracket was raised from 25 % to 36 %. Spending on social programmes, which are targeted towards the poor, has also increased. However, while expenditure on schools is benefitting all families, expenditure on higher education still tends to favour higher-income families, because there are relatively few students from low-income families in universities.
(3) Recently, concern about a growing budget deficit has led to new budget guidelines being implemented. These guidelines aim to reduce borrowing and the national debt by encouraging the government to increase tax revenue and/or reduce expenditures. The main policy goal of Uruguay's central bank is to keep a low rate of inflation. It has announced that it will reduce the inflation target to below 6% by September 2022.
(4) Several constraints to growth remain, which may limit progress towards sustainable development. Despite plans to upgrade road networks and construct a new central railway, investment in infrastructure needs to be increased further. Education and training could also be improved to meet the needs of new sectors, such as the information and communication technology (ICT) industry.
(5) State-owned enterprises, including railways and suppliers of fuel, water and electricity, are a significant part of the Uruguayan economy. The prices charged by these enterprises tend to be high relative to prices in other countries. As part of a strategy to eliminate excessive costs, the government has proposed measures to improve efficiency in state-owned enterprises and to gradually reduce prices.
(6) The International Monetary Fund (IMF) considers that more labour market flexibility is needed to make it easier for workers to change jobs and for firms in growing sectors such as ICT to hire workers. The government is, therefore, considering deregulation of the labour market.
(7) Overall, by boosting competitiveness and private investment through supply-side policies, the government aims to raise growth and employment.
Text E - Health care system in Uruguay
The public and private sectors that offer health care in Uruguay were combined into one system in 2007, with both overseen by the government and both eligible to receive subsidies. Most medical care is free for low-income patients. The first row of data in Table 3 shows that per capita demand for health care increased by 54.22 % from 2010 to 2018 . The advantages are seen in longer life expectancy figures, which imply an increase in productivity, and other benefits.
Table 3: Health care expenditure and GNI per capita for Uruguay
Text F - Trade and exchange rates
(1) Over 50 % of Uruguayan exports are forestry and agricultural goods, including soybeans, rice, and cattle meat. Increasing global demand and a significant rise in commodity prices from 2000 to 2012 encouraged investment in the agricultural sector. However, the price of soybeans has been declining since 2013, partly due to rising productivity in agriculture. Climate-related shocks, such as droughts in 2017 and 2020, and economic crises in the major export markets of Brazil and Argentina have also caused difficulties for producers.
(2) Therefore, Uruguay aims to diversify its export markets. For example, with the growth of the ICT sector, Montevideo (the capital city of Uruguay) has become a leading software development centre. In addition, Uruguay is broadening its markets towards Europe and Asia. Under a proposed trade agreement between the European Union (EU) and the South American trade bloc, Mercosur (Argentina, Brazil, Paraguay, Venezuela, and Uruguay), 93 % of all tariffs will gradually be eliminated. However, a quota will be imposed on cheese imports from the EU.
(3) To help the economy adjust to external shocks and to avoid large fluctuations in the exchange rate of the peso (Uruguay's currency), the central bank uses its plentiful reserve assets of foreign currencies. In 2019, the decline in agricultural export revenues put downward pressure on the peso exchange rate. However, the central bank was able to prevent a large depreciation by using its reserve assets in the foreign exchange market.
Table 4: Economic data for Uruguay
Table 5: Development data for Uruguay
Table 6: Balance of payments data for Uruguay in 2019
Using an externalities diagram, explain why the government should subsidize health care (Text E).
Explain why the exploitation of common access resources, such as uncontrolled fishing, might pose a threat to sustainability.
Evaluate whether the use of carbon taxes is the most effective way for the government to deal with the threat to sustainability posed by the use of fossil fuels.
Explain why the exploitation of common access resources, such as uncontrolled fishing, might pose a threat to sustainability.
Read the extracts and answer the questions that follow.
Text A - Overview of the economy and government policies in Kenya
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 reducing the tariff on imports of rice. It did not impose a price ceiling for essential food, as food shortages might result.
(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. 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 %.
Text B - Unequal distribution of the benefits of economic growth in Kenya
(1) Although economic growth has reduced absolute poverty, 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.
(2) 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. 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) Measures taken by other economies to reduce carbon emissions provide opportunities for Kenya because the markets for "green" goods are expanding. Kenya is able to sell tradable permits (carbon credits) to high-emitting countries due to its reforestation programmes.
(3) The International Monetary Fund (IMF) recommends that climate-related considerations should be part of macroeconomic and infrastructure policies. It also recommends that carbon taxes should be imposed to reduce the use of fossil fuels by manufacturing firms. Rapid urbanization is increasing the need for electric vehicles and improved public transport. Energy efficiency measures, fuel substitution, and switching to rail transport will not only lower transportation costs but also reduce the trade deficit. This is because fossil fuels used for transportation and manufacturing are imported.
(4) Kenya is able to obtain finance and technology for investment in climate-related projects, such as renewable energy and forestry programmes, through foreign aid and partnerships with the private sector. Overall, these policies will reduce environmental disasters and increase economic growth and jobs in the formal sector.
Table 1: Balance of payments accounts for Kenya in billions of USA dollars (USD)
Table 2: Economic data for Kenya
Table 3: Development data for Kenya
Using an externalities diagram, explain how a carbon tax could reduce the market failure due to the use of fossil fuels by manufacturing firms in Kenya (Text C, paragraph (3).
Evaluate two possible government responses that could be used to address the problem of demerit goods.