IB Economics SL 3.2.5 Long Run Shifts in Aggregate Supply Questions

Read the extracts and answer the questions that follow.

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).