IB Economics HL 2.5 Elasticities of demand Question Bank

Study the extract below and answer the questions that follow.
Fast-growing Turkish economy showing signs of overheating

(1) The impressive economic growth that Turkey has enjoyed from 2010-2012 may soon come to an end, as the country's economy shows signs of overheating. Although officials are still optimistic, economists are concerned about the inflationary gap, and note that the growing current account deficit makes Turkey vulnerable.

(2) At the crossroads of Europe and the Middle East, Turkey has benefitted from a boom in foreign investment and trade, and has been one of the engines of global growth from 2010-2012. The economy grew by 8.9 % in 2010 - one of the highest in the world - and the Organisation for Economic Co-operation and Development (OECD) expects it to have grown by a further 7.4 \% in 2011.

(3) However, analysts warn that the current growth rate is unlikely to last. "What GDP growth rates don't reveal is that the Turkish economy is now showing signs of overheating," said an economist at Capital Economics. The fast economic growth of 2010-2012 "was accompanied by a rapid widening of the current account deficit," which has jumped to 10 % of its GDP.

(4) "What is more, from 2010-2012, the current account deficit has mostly been financed with short-term borrowing, which means Turkey is facing a heavy external debt service burden of $ 135 billion (101 billion euros) in the period 2012-2013," warned the chief economist at Finansbank.

(5) Turkey's current account deficit, which surged from just over 2 % of GDP in 2009, is partially due to the rise in oil prices. Since Turkey is a large net oil importer, it is clearly worse off from higher oil prices. Turkey's net energy imports were equivalent to around 6 % of GDP in 2011 - accounting for over half of the total current account deficit of 10 % of GDP.

(6) There is more to Turkey's current account shortfall than simply the high cost of energy imports. The deficit has also widened due to rapidly rising domestic demand, suggesting that a period of weaker domestic demand is needed to put the current account on a sustainable footing.

(7) A financial services ratings agency warned recently that the high current account deficit makes Turkey vulnerable to sudden financial account outflows. There are concerns about the difficulty of attracting capital inflows to fund the current account deficit.
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'Fast-growing Turkish economy showing signs of overheating'; April 02, 2012; By Fulya Ozerkan]

Firm A produces cartons of coffee. Figure 1 illustrates the firm's total cost (TC) and variable cost (VC) at different output levels per month.

Study the extract below and answer the questions that follow.
EU court rules minimum price for cigarettes illegal

(1) The European Court of Justice has ruled that Ireland cannot impose a minimum price on cigarettes. It said that member countries would have to find other ways to combat smoking. This could be achieved by increasing indirect tax on tobacco, but imposing a minimum price would distort fair competition in the market. The ruling is designed to maintain the freedom of manufacturers and importers to benefit from lower costs and greater efficiency.

(2) The judgment said the aim of ensuring that tobacco prices are high can be "adequately" achieved by increasing tax, since any indirect tax rises are, sooner or later, reflected in an increased retail price, without removing the freedom of manufacturers to set prices.

(3) The Irish government had claimed that it needed to fix a high minimum price to discourage smoking. This followed government legislation to ban tobacco advertising and promotion in July 2009. According to a spokesperson from the anti-smoking group ASH (Action on Smoking and Health), this measure helped to prevent retail outlets from making young people feel attracted to buying cigarettes. "Close to 30 % of our population still smoke and 7000 die from tobacco-related disease each year," he said.

(4) It has been argued that increasing the price of cigarettes is one of the most effective ways of curbing harmful smoking and there is a need to make cigarettes less appealing, particularly to young people. The evidence is that banning advertising, introducing minimum pricing and increasing health warnings can all work.

(5) The head of a major retail organization has attacked the idea of minimum pricing for cigarettes. He argued that artificially fixing a minimum price would not be effective. Also, since the demand for tobacco is inelastic, raising the price would not work. Moreover, it was against the free market for a government to set prices for any product available to consumers, limiting their freedom to choose.

Figure 1 illustrates the production possibilities for rice and pencils in Country H. Resources in Country H are fully employed.

The demand for a product in a perfectly competitive market is given by the function

while market supply is given by the function

where P is the price per unit in dollars ($), Qd is the monthly quantity demanded and Qs is the monthly quantity supplied in thousands of units.

Read the extracts and answer the questions that follow.
Text A - Overview of Tanzania

(1) Tanzania is one of Africa's fastest growing economies with an average of 7 % annual economic growth since 2000. It is a politically stable country, rich in wildlife and natural resources. However, the growth has been concentrated in urban manufacturing, using capital intensive production. The benefits from this growth have not reached all people and significant inequalities exist between urban and rural areas. Although the relative poverty rate has fallen over the last 15 years, the number of people living in absolute poverty has increased.

(2) Most people are employed in the slow-growing agricultural sector that relies on unskilled labour. Although incomes increased from 2008 to 2018, the demand for agricultural goods only increased by 21 % during this time period. Over 70 % of Tanzania's population lives in rural areas, relying on subsistence farming with limited tradable crops. Only 30 % of land is being used for agricultural production. With investment, the remaining unused land could be developed and generate income for farmers.

(3) The rural sector struggles to meet Tanzania's food requirements due to low levels of skilled labour and productivity. Additionally, high youth unemployment leads to large numbers of unskilled rural youth migrating to the cities, often finding employment in the informal sector where wages and working conditions are poor. Insufficient investment and lack of government support for diversifying the agriculture sector have been blamed for the persistent inequalities and poverty.

(4) Tanzania's cities have experienced a growing middle class with strong purchasing power and political influence who have placed demands on the government for cheaper electricity, better infrastructure, and more imported goods. In response, the government provided subsidies for electricity in city centres and tax benefits to foreign companies operating in Tanzania. There is concern that these measures may worsen inequality and lead to social unrest.

(5) The growth of Tanzania's manufacturing and service sector was funded through aid and large government borrowing, resulting in high national debt. Most of the government borrowing was from foreign sources and in US dollars (US$), which is a concern due to a recent depreciation of the Tanzanian shilling (Tanzania's currency) against the US$. Some of the debt was borrowed domestically and placed upward pressure on interest rates. Higher interest rates have resulted in crowding out but helped keep inflation under control.
Text B - Strategies and opportunities for Tanzania

(1) Previous governments have used interventionist supply-side policies to improve access to water, education, and health services. However, the health service improvements are not keeping up with population growth and many young people are still not completing secondary school. Infrastructure has improved, but it is still insufficient as producers in the rural sector find it difficult to reach markets and access supplies.

(2) Aid organizations are currently supporting new sustainable businesses in rural areas through training programmes, especially for women and young people, who make up most of the unemployed in rural areas. Economists have advised the government to improve access to credit through microfinance organizations and to simplify regulations to make it easier to start new businesses.

(3) The government is establishing property rights in rural areas to provide security for farmers. Historically, farmers could easily lose their land, which reduced their incentive to invest in productive farming methods. The government wants to develop Tanzania's land resources and lower its reliance on imported food. To reduce food imports, a subsidy will be granted to dairy farmers to allow them to compete against imported dairy products.

(4) Tanzania is a member of the East African Community (EAC) customs union and common market. However, Tanzania needs to improve human capital and encourage diversification so that the benefits of regional integration can reach the poor. These policies can also help attract foreign direct investment (FDI). Opportunities for growth through trade will expand as the EAC works towards becoming a monetary union in 2024.
Text C - Oil pipeline to be constructed
Tanzania and Uganda plan to construct a major oil pipeline from Uganda through Tanzania, ending at a port in Tanzania. This will attract FDI which could help fund infrastructure and generate jobs. However, environmentalists are concerned about potential ecological damage due to the waste created during the construction of the pipeline. Economists have suggested the waste could be avoided through a circular economy approach in the planning and construction stage.

* Estimate