Unit 2 Microeconomics (SL) | IB Economics Question Bank

[Maximum number: 25]

(a)

Explain why a government might decide to impose an indirect tax on the consumption of cigarettes.

[ 10 ]

(b)

Discuss the possible consequences of the imposition of an indirect tax on cigarettes for the different stakeholders in the market.

[ 15 ]

Answers may include:

- definitions of indirect tax and market

- theory to explain the implications for consumers; for producers; for the government

- diagram to show the application of a tax to illustrate the impacts on different stakeholders

- examples of use of indirect taxes and the impact on stakeholders in practice

- synthesis or evaluation (discuss).

Discussion may include: the advantages and disadvantages as applied to the different stakeholders and more generally in terms of society, for example reduced passive smoking for all as well as reduced consumption for individual consumers.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Opinions or conclusions should be presented clearly and should be supported by appropriate examples.

Assessment Criteria
Part (b) 15 marks

Level 0 (0 marks): The work does not reach a standard described by the descriptors below.

Level 1 (1-5 marks): There is little understanding of the specific demands of the question. Relevant economic terms are not defined. There is very little knowledge of relevant economic theory. There are significant errors.

Level 2 (6-9 marks): There is some understanding of the specific demands of the question. Some relevant economic terms are defined. There is some knowledge of relevant economic theory. There are some errors.

Level 3 (10-12 marks): There is understanding of the specific demands of the question. Relevant economic terms are defined. Relevant economic theory is explained and applied. Where appropriate, diagrams are included and applied. Where appropriate, examples are used. There is an attempt at synthesis or evaluation. There are few errors.

Level 4 (13-15 marks): There is clear understanding of the specific demands of the question. Relevant economic terms are clearly defined. Relevant economic theory is clearly explained and applied. Where appropriate, diagrams are included and applied effectively. Where appropriate, examples are used effectively. There is evidence of appropriate synthesis or evaluation. There are no significant errors.

[Maximum number: 25]

(a)

Explain the concepts of consumer surplus and producer surplus.

[ 10 ]

(b)

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.

[ 15 ]

Answers may include:

- definition of marginal private benefit (MPB), marginal private cost (MPC), allocation of resources

- diagram to show marginal private benefit in equilibrium with marginal private cost and community surplus being maximized

- explanation of why MPB = MPC (demand = supply) represents an optimal allocation of resources

- examples of marginal private benefits and costs or externalities

- synthesis and evaluation (examine).

Examination may include: the significance of external benefits and external costs for the socially optimum resource allocation (MSB = MSC), under-provision and over-provision at the free market price, other sources of market failure such as demerit goods, asymmetric information.

NB For a response that just evaluates the view without explaining it, a maximum of Level 2 should be awarded.

Assessment Criteria
Part (b) 15 marks

Level 0 (0 marks): The work does not meet a standard described by the descriptors below.

Level 1 (1-5 marks): There is little understanding of the specific demands of the question. Relevant economic terms are not defined. There is very little knowledge of relevant economic theory. There are significant errors.

Level 2 (6-9 marks): There is some understanding of the specific demands of the question. Some relevant economic terms are defined. There is some knowledge of relevant economic theory. There are some errors.

Level 3 (10-12 marks): There is understanding of the specific demands of the question. Relevant economic terms are defined. Relevant economic theory is explained and applied. Where appropriate, diagrams are included and applied. Where appropriate, examples are used. There is an attempt at synthesis or evaluation. There are few errors.

Level 4 (13-15 marks): There is clear understanding of the specific demands of the question. Relevant economic terms are clearly defined. Relevant economic theory is clearly explained and applied. Where appropriate, diagrams are included and applied effectively. Where appropriate, examples are used effectively. There is evidence of appropriate synthesis or evaluation. There are no significant errors.

[Maximum number: 4]

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 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).

[Maximum number: 20]

Study the extract below and answer the questions that follow.
Taxes on junk food and sugary drinks

(1) Some countries are considering indirect taxes on junk food or sugary drinks to reduce their consumption and increase government tax revenues. Over-consumption of goods with a high fat or sugar content has negative externalities, because it leads to obesity, serious health problems and additional health care costs. The principle behind such taxes is the same as taxes imposed on cigarettes and alcohol. These taxes are known as "fat taxes".

(2) In the United Kingdom (UK), discussions focus on a tax on processed foods, snacks and sugary drinks. Another possibility would be to impose a tax on full-fat milk, butter and cheese, in order to induce consumers to switch to less fattening substitute products with a lower fat content. Foods with a high fat content are linked to heart disease and premature death.

(3) In the United States, some states are considering imposing a tax on sugary drinks to raise funds for health care. Denmark already has a tax on these drinks and is planning a new tax on some high-fat dairy products.

(4) However, research indicates that such taxes would have a disproportionately large effect on low income households. One reason is that low income individuals tend to consume a larger amount of foods with a high fat content because these are cheaper. This is an important reason why low income individuals tend to be less healthy than wealthier people. It has also been argued that low income individuals respond to higher food prices by eating smaller quantities of healthy food.

(5) Food manufacturers have been angered by the idea of a "fat tax", arguing that the public would rebel against it.

(6) Studies have shown that the demand for most categories of foods and beverages is price inelastic. According to a representative of the Food and Drink Federation in the UK, "the fat tax may be a perfectly sensible issue to debate, but such a regressive taxation policy would reduce the purchasing power of consumers". He argues that it would be better if food manufacturers voluntarily improved their products. http://www.ncbi.nlm.nih.gov/pmc/articles/PMC280464; and
http://www.humanevents.com/2010/07/06/hard-truths-about-soda-taxes/
]

(a)

Define the following terms indicated in bold in the text:

[ 4 ]

(i)

indirect taxes (paragraph (1)

[ 2 ]

(ii)

price inelastic (paragraph (6).

[ 2 ]

(b)

Using an appropriate diagram, explain how consumption of unhealthy foods creates negative externalities (paragraph (1)).

[ 4 ]

(c)

Using an appropriate diagram, explain how a tax on foods with a high fat content is expected to impact on the market for substitute products with a lower fat content (paragraph 2).

[ 4 ]

(d)

Using information from the text/data and your knowledge of economics, evaluate the likely consequences of indirect taxes applied to junk food and sugary drinks.

[ 8 ]

Responses may include:
- explanation of how indirect taxes increase the price paid by consumers, causing a decrease in the quantity demanded and/or a switch to relatively cheaper products
- a diagram illustrating the effect of an indirect tax.

Arguments in favour of the indirect taxes on junk food and sugary drinks or arguments why the tax may be effective and/or desirable:
- a suggestion that if junk food has inelastic demand, the burden will fall mainly on the consumers (HL), which is appropriate since they are the ones consuming the products
- higher price of taxed goods may encourage consumers to switch to healthier products, which are substitutes (paragraph (2)
- a switch to healthier products (fall in demand for unhealthy foods) reduces the size of the negative externality and lowers health care costs (paragraph (1)
- government earns tax revenues (paragraph (3)) (this may be shown on a diagram)
- government tax revenues can be used to educate the public about the harmful effects of high-fat foods, causing demand for these to decrease (paragraph (3)
- low income individuals who are less healthy could become healthier
- government intervention may be necessary since manufacturers are unlikely to voluntarily improve their products (paragraph 6).

Arguments against the indirect taxes on junk food and sugary drinks or arguments why the tax may not be effective and/or desirable:
- foods and beverages have price inelastic demand (paragraph 6) because junk food is addictive (or healthy food is not seen as a substitute for junk food) and so there may be a proportionately smaller decrease in quantity demanded than hoped for
- the tax might have to be very high (and move into the elastic region of the demand curve) to have a significant impact on quantity demanded
- the tax might encourage consumers to buy the high fat content foods in neighbouring countries, which would have the effect of not reducing consumption and not contributing to higher tax revenues
- indirect taxes are regressive because they take a higher share of income from low-income households and so they affect low income individuals disproportionately (paragraph 6)
- low income individuals are also affected more than the wealthy because they consume more high-fat/sugary foods (paragraph (4)
- low income households may have a more price-inelastic demand than high income households because such goods are cheaper (paragraph (4)) and could respond by increasing their consumption of unhealthy foods and cutting back on their expenditures on healthy foods (paragraph (4)
- reduced revenues for producers of high-fat foods and sugary drinks might lead to unemployment in these industries
- an increase in demand for healthy foods could increase their price and make them even more unaffordable for low income households
- opposition to the tax (paragraph (5)) may prevent its long-term effectiveness.

Examiners should be aware that candidates may take a different approach which if appropriate, should be rewarded.

If there is no direct reference to the data, then candidates may not be rewarded beyond level 2 .

Effective evaluation may be to:
- consider short run versus long run consequences
- examine the impact on different stakeholders
- discuss advantages and disadvantages
- prioritize the arguments.

Level

0 No valid discussion.

1 Few relevant concepts recognized.
Little discussion or only basic understanding.
2 Relevant concepts recognized and developed in reasonable depth.
Some attempt at application and analysis.

3 Relevant concepts developed in reasonable depth, demonstrating effective evaluation, supported by appropriate evidence or theory.

IB Economics SL Unit 2 Microeconomics Question Bank

Covered syllabus points

Covered syllabus points

Unit 2 Microeconomics question 1

Question (a)

Question (b)

Unit 2 Microeconomics question 2

Question (a)

Question (b)

Unit 2 Microeconomics question 3

Unit 2 Microeconomics question 4

Question (a)

Question (i)

Question (ii)

Question (b)

Question (c)

Question (d)