Economics for the IB Diploma

Exam practice: paper 2 (SL and HL)

Chapter 18 Foreign sources of finance and foreign debt
Chapter 19 Consequences of economic growth and the balance between markets
and intervention

Text/data 25

Malawi’s foreign debt and human development

1 Malawi, one of the poorest countries in the world, net exporter of maize to other countries. The World Bank 7
has benefited enormously from debt relief, though its criticised this policy as being ‘better for food security but
experience shows that the Heavily Indebted Poor Countries worse for market development’.
(HIPC) Initiative of the World Bank and International In 2006, $2.3 billion of Malawi’s debt was cancelled. Its
Monetary Fund (IMF) is not without flaws. remaining debt is 25% of national income, and its debt
repayments have fallen to about $30 million a year. This
2 Malawi accumulated much of its debt during the 1970s has allowed Malawi to greatly increase social spending. It
and 1980s when rich-country commercial banks and has abolished primary school fees, helping more than one
governments lent large sums to developing countries as million children go to school. In spite of its low income
the price of oil increased and the value of their exports levels, Malawi is making good progress with respect to
fell. During the 1980s and 1990s, though Malawi spent human development. Also, debt cancellation has helped
an average of $100 million per year on debt repayment, the economy grow. Economic growth was 8.5% per year
its foreign debt as a share of national income rose from in 2006–9, compared to 2.5% in 2002–5.
70% in 1980 to 150% in 2000. The economy stagnated,
and GNI per capita fell. GNI per capita
(US $ ppp)
3 Malawi entered the HIPC programme in 2000 but did not
receive cancellation of some of its debts until 2006. During Adult access to
this period, debt repayments amounted to $440 million, literacy rate improved
involving a huge opportunity cost. By 2005, Malawi sanitation
was spending 9.6% of national income on foreign debt (% ages facilities
servicing and only 4.6% on public provision of health care, 16 and older) (% of population)
while 74% of the population lived on less than $1 a day.
Maternal
4 One reason for the delay in debt cancellation was that mortality rate
Malawi had to fulfill several requirements imposed by the (per 100,000 live births)
World Bank and IMF in order to qualify for debt relief.
This included privatisation of state-owned enterprises, Malawi
elimination of agricultural subsidies and cuts in public Average for countries in same income group
spending.
Development diamond for Malawi
5 In 2001–2 and again in 2004–5, the removal of support for
farmers together with drought resulted in a serious food Source: The World Bank, World Development Report, 2010.
crisis in which thousands of people died of hunger and
millions suffered. Due to food shortages, Malawi had to Source : ‘Malawi’, Jubilee Debt Campaign (http://www.jubileedebt-
import maize at a much higher cost than the cost of the campaign.org.uk).
original agricultural subsidies.

6 In the mid-2000s the government went against World
Bank and IMF demands and re-introduced seed and
fertiliser subsidies, with the result that Malawi became a

Question B.19 (b) Explain why foreign debt servicing has opportunity

(a) (i) Describe the meaning of foreign debt costs. [4 marks]
identified in bold in the text (paragraph 2).
[2 marks] (c) Explain why the burden of debt has led to pressure

in favour of debt cancellation for heavily indebted

(ii) Outline one reason why countries borrow from countries. [4 marks]

foreign creditors. [2 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 38

Exam practice: paper 2 (SL and HL)

(d) Using information in the text and your (b) Explain why the servicing of foreign debt causes
problems for the balance of payments. [4 marks]
knowledge of economics, discuss the potential

effects of Malawi’s debt relief on its growth and (c) Using a diagram, explain why drought and the

development. [8 marks] removal of subsidies caused a food crisis

Question B.20 (paragraph 5). [4 marks]

(a) (i) Outline why Malawi’s debt relief was a type of (d) Using information in the text and your knowledge

‘conditional assistance’. [2 marks] of economics, discuss the strengths and weaknesses

of interventionist policies in economic growth and

(ii) Outline the meaning of privatisation development. [8 marks]
identified in bold in the text (paragraph 4).
[2 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 39

Exam practice: paper 2 (SL and HL)

Text/data 26

Ending Tanzania’s vicious cycle of poverty

1 Fifty years after its independence, Tanzania remains one of condition that the government reduces public spending, 6
the poorest countries in Africa, with 33% of the population privatises state enterprises and pursues market-oriented 7
living in extreme poverty. The country is still in a vicious reforms.
cycle of poverty, with low incomes, low saving and low The World Bank is very active in Tanzania with loans
investment. in various sectors including health, higher education,
transport, electricity provision and food security. The IMF
2 Tanzania is one of the largest recipients of Official is stepping up lending for the country’s balance of payments
Development Assistance (ODA) in the form of grants, difficulties that have emerged due to the financial crisis.
concessional loans and debt relief. About 35% of It claims that its approach to poor countries has changed
government spending depends on foreign aid. and that it no longer imposes unreasonable conditions that
prevent governments from spending on merit goods like
3 The government is trying to attract foreign direct investment education. However, according to a recent report, ‘It is still
(FDI) to support broad-based economic growth that is imposing conditions to this very day and these conditions
needed to achieve poverty reduction targets. However, continue to block spending on education.’
FDI to date has been concentrated mainly in mining and The World Bank and IMF consider Tanzania to be a
tourism, which do not offer the necessary linkages with the success story. Inflation has fallen, real GDP is growing
rest of the economy, and therefore have had little impact on rapidly, exports are increasing, and its public finances
economic growth. are under control. As a result, it is also becoming more
interesting to foreign direct investors. Critics argue that
4 In the mid-1960s the government had begun a programme these successes have come at a huge human cost in terms
of self-reliance and import substitution, aimed at of continued poverty and deprivations in large portions
promoting heavy industry and self-sufficiency in food. of the population, and there are questions over whether
This involved the expansion of infrastructure and state- economic growth is affecting the poor. Regarding the
owned, capital-intensive industries that by the mid-1970s Millennium Development Goals (MDGs), progress has
were the main importers and exporters in a highly state- been made in school enrolment, gender equality and
regulated economy. By the mid-1980s Tanzania faced gender empowerment, but little progress has been achieved
hyperinflation, huge budget deficit and trade deficit, and with infant and under-five mortality rates, which remain
a very heavy dependence on foreign aid. very high. Maternal deaths are rising due to poor health
services.
5 In contrast to countries such as the East Asian Tigers that
successfully moved from import substitution to export Source: ‘Breaking the vicious cycle of poverty’ in Business Times, 20
promotion strategies, Tanzania, like many other African August 2010; ‘IMF: Dr. Death? Case study of how the global banker’s
countries, went straight into market and trade liberalisation shock therapy helps economies but hammers the poor’ in Time
policies from the mid-1980s. Tanzania lowered import Magazine, 17 April 2000; ‘Overview of aid in Tanzania’, Development
barriers, leading to de-industrialisation and loss of jobs, Partners Group ( http://www.tzdpg.or.tz/); ‘Hungry children do not
as inefficient domestic firms were unable to compete with make good learners’ in the Guardian, 28 April 2009.
imported goods from Asia (often subsidised) and from
Europe where there were economies of scale and lower
costs of production. Since the mid-1990s its policies have
been determined by the World Bank and International
Monetary Fund (IMF), which have extended loans on

Question B.21 (c) Explain why countries borrow from the

(a) (i) Define the term grant identified in bold in the International Monetary Fund. [4 marks]

text (paragraph 2). [2 marks] (d) Using information in the text and your
knowledge of economics, compare and contrast
(ii) Define the term budget deficit identified in the effectiveness of import substitution and
export promotion policies as strategies to achieve
bold in the text (paragraph 4). [2 marks] economic growth and development. [8 marks]

(b) Explain the possible role of foreign direct

investment in helping a poor country break out of

the poverty cycle. [4 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 40

Exam practice: paper 2 (SL and HL)

Question B.22 Question B.23

(a) (i) Define the term concessional loan identified (a) (i) Define the term inflation identified in bold in
in bold in the text (paragraph 2). [2 marks]
the text (paragraph 7). [2 marks]

(ii) Define the term trade deficit identified in (ii) State two types of market-oriented reforms.
[2 marks]
bold in the text (paragraph 4). [2 marks]

(b) Explain how the poverty cycle is transmitted from (b) Explain the difference between foreign aid and
multilateral development assistance. [4 marks]
generation to generation. [4 marks]

(c) Explain whether the capital-intensive production (c) Explain why economic growth, while necessary for
economic development to occur over long periods
methods often used in import-substitution of time, may not lead to economic development.
[4 marks]
strategies are likely to represent a type of

appropriate technology in economically less

developed countries. [4 marks] (d) Using information in the text and your knowledge
of economics, examine the view that the World
(d) Using information in the text and your knowledge Bank and International Monetary Fund (IMF) have
played a role in making Tanzania’s growth and
of economics, discuss the strengths and weaknesses development ‘a success story’ (paragraph 7).
[8 marks]
of market-oriented policies in economic growth

and development. [8 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 41

Exam practice: paper 2 (SL and HL)

Chapter 19 Consequences of economic growth and the balance between markets and
intervention

Text/data 27

Economic growth and development in Latin America

1 In 1672, Potosi, Bolivia, a major centre of Spanish silver democratisation and the rising revenues made possible by 7
mining, was one of the largest and richest cities in the the commodity boom, have transformed Latin American
world. Today, it is poor and beset by conflict. This is but economies. Increasing revenues have also led to stronger 8
one example of commodity booms gone bust, showing that social policies aiming to strengthen the social safety net 9
quick riches made possible by rising commodity prices do and to reduced inequalities.
not seem to last. Poverty has been falling almost everywhere, and income
distribution is becoming less unequal in many countries,
2 In Latin America, 93% of the population and 97% of though it still remains more unequal than in any other
economic activity are concentrated in countries that are continent. Poverty has been falling due to more rapid
commodity exporters. It is therefore important that World economic growth and better social policies. Transfer
Bank economists discovered some trends suggesting that payment programmes (cash transfers) have become more
the most recent commodity boom may have more positive widespread, and there are about 110 million people in the
results than in the past. continent benefiting from these. There is evidence that
these have increased school enrolment and attendance, and
3 An important reason for this expectation is good have also increased maternal health care and vaccinations.
governance. National governments and financial The cash transfer programmes have helped reduce income
institutions in Latin America today have greatly improved inequality, while better-educated workers earn higher
their ability to manage commodity windfalls, using them incomes.
for long-term growth rather than for short-term gains. In addition, living standards have improved because birth
rates have fallen dramatically, allowing the family’s income
4 For example, in Chile, where exports are dominated to go a longer way in satisfying material needs. Also, trade
by commodities (75%), the decision was made years liberalisation has led to lower prices for consumers.
ago by its leaders to save a large percentage of earnings Yet progress is still fragile. The goal of economic
from the copper boom and to spend the rest wisely. development requires more reforms, including building
Chile’s investments in innovation have increased by 24% further on the social safety net, improving the equality
annually over the past five years, and it has also invested of opportunity for the less privileged, improving the
heavily in education. tax system, parts of which are regressive, building
infrastructure, reforming public health care and improving
5 Another reason for optimism is that commodity the quality of public education. Average spending per pupil
production in Latin America is changing. While in the past remains very low compared to the levels of developed
multinational corporations benefited the most, extracting a countries.
country’s resources and leaving it poorer, today commodity
extraction is linked to activities that benefit the country. For Source: ‘A special report on Latin America: a Latin American
example, in Peru an extensive network of local businesses decade?’ in The Economist, 11 September 2010; ‘A special report
is tied to the operations of a gold mine. on Latin America: societies on the move’, in The Economist,
11 September 2010; ‘Latin America’s commodity dependence’ in
6 Latin America pursued strong market-oriented reforms the Japan Times, 5 October 2010.
during the 1980s and 1990s, involving abandoning
import-substitution in favour of trade liberalisation
policies, lowering restrictions on foreign direct
investments and reducing state-ownership of firms.
These changes, together with macroeconomic stability,

Question B.24 (c) Draw a diagram and use it to explain how the

(a) (i) Define the term social safety net identified use of health care services gives rise to positive
in bold in the text (paragraph 6). [2 marks]
consumption externalities. [4 marks]

(ii) Define the term economic growth identified (d) Using information in the text and your knowledge
in bold in the text (paragraph 7). [2 marks]
of economics, evaluate the use of interventionist

(b) Explain why good governance is important in policies in efforts to achieve economic

economic development. [4 marks] development. [8 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 42

Question B.25 Exam practice: paper 2 (SL and HL)

(a) (i) Define the term transfer payments (c) Explain why economic growth may have either
identified in bold in the text (paragraph 7). positive or negative effects on income distribution.
[2 marks] [4 marks]

(ii) Define the term regressive identified in bold (d) Using information in the text and your knowledge
of economics, discuss the view that the pursuit of
in the text (paragraph 9). [2 marks] economic development should involve a balance
of interventionist and market-oriented policies.
(b) Explain import substitution as a trade strategy for [8 marks]
economic growth and development. [4 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 43

Exam practice:
paper 3 (HL)

Introduction to paper 3

Paper 3 is for HL only.

Duration of paper 3 Paper 3: HL
Focus and structure of paper 3
1 hour
Structure of questions and marks
earned in paper 3 Paper 3 focuses on the entire syllabus, including SL/HL core and HL topics.
Students must answer two questions from a choice of three.
Assessment objectives in paper 3
Maximum marks earned in paper 3, and Each question consists of several parts (a), (b), (c), and so on. The number of parts
percentage in total IB Economics grade varies from question to question. Students must answer all parts.
Each question earns a maximum of 25 marks.

Paper 3 examines assessment objectives 1, 2 and 4.

Since the student must answer two questions, paper 3 earns a maximum
of 50 marks.
Paper 3 accounts for 20% of the student’s overall grade at higher level.

Organisation of paper 3 questions (b) Outline the meaning of the negative slope in this
in the CD-ROM
function. [2 marks]
Paper 3 questions are organised by syllabus section and
by chapter within each section.1 Each question includes In the demand function Qd = 35 − 5P, Qd represents
some quantitative question parts (based on assessment quantity of good Z demanded per month in
objective 4), as well as non-quantitative question parts thousands of units, and P represents the price per
(based on assessment objectives 1 and 2). Note that unit of Z in $.
you will find markschemes to many of the paper 3
questions on the teacher support website at ibdiploma. (c) Construct a graph of the corresponding demand
cambridge.org.
curve. [1 mark]

(d) Calculate the values of Qd when P = $3, and P = $4.
[2 marks]

Section 1 Microeconomics (e) Calculate the values of P when Qd = 5 thousand,

and Qd = 25 thousand. [2 marks]

Chapter 2 Competitive markets: (f) Calculate the vertical and horizontal intercepts
demand and supply
using the function. [2 marks]

(g) Identify the vertical and horizontal intercepts on

Question 1 your graph. [2 marks]

(a) In a demand function of the general form Qd =
a – bP, outline the meaning of the parameter a and

of the parameter −b. [2 marks]

1 In your paper 3 exams, it is likely that some questions will cover material from more than one chapter. Here, questions have been
written so that they correspond to individual chapters. This has been done to give you practice in answering questions as you complete
each chapter.

© Cambridge University Press 2012 Economics for the IB Diploma 1

Exam practice: paper 3 (HL)

(h) Assume that due to an increase in income levels, each price. Determine the new supply function.
[2 marks]
5 thousand fewer units of Z are demanded at each

price. Determine the equation for the new demand (i) Calculate the new vertical and horizontal

function. [2 marks] intercepts using the function. [2 marks]

(i) Identify the vertical and horizontal intercepts of (j) Graph the new supply curve, including only

the new demand function in your graph and graph positive values for Q s, up to the point where

the new demand curve. [3 marks] P = 4. [1 mark]

(j) Assume that due to a change in tastes, 10 (k) Assume that due to a reduction in the number of

thousand more units of Z are demanded at each firms in the industry, 5 thousand fewer units of

price (relative to the initial demand function). Z are supplied at each price (relative to the initial

Determine the equation for the new demand supply function). Determine the new supply

function. [2 marks] function. [2 marks]

(k) Draw the new demand curve on your graph. (l) Draw the new supply curve on your graph.
[1 mark] [1 mark]

(l) If the slope changes to −3, state the new demand (m) If the slope changes to +15, state the new supply
function, and outline how the change in slope function, and outline how the change in slope
affects the steepness of the demand curve. affects the steepness of the supply curve.
[2 marks] [2 marks]

(m) Outline the relationship between an individual (n) Outline the relationship between an individual
consumer’s demand and market demand.
[2 marks] firm’s supply and market supply. [2 marks]

[Total: 25 marks] [Total: 25 marks]

Question 2 Question 3

(a) In a supply function of the general form In the demand function Q d = 35 − 5P and the supply
function Q s = −10 + 10P, Q d and Q s are quantities
Q s = c + dP, outline the meaning of the demanded and supplied per month in thousands of
parameter c and of the parameter +d. [2 marks]
units of good Z, and P is price in $.

(b) Outline the meaning of the positive slope in this (a) Calculate the equilibrium price and quantity.
[2 marks]
function. [2 marks]

In the supply function Q s = −10 + 10P, Q s (b) Plot the demand and supply curves, and identify
represents quantity of good Z supplied per month the equilibrium price and quantity on your graph.
in thousands of units, and P represents the price [4 marks]
per unit of Z in $.
(c) When P = 6, and P = 2, determine whether there is

(c) Construct a graph of the corresponding supply excess demand or excess supply, and calculate the

curve, including only positive values for Q s, up to amount of this in each case. [6 marks]

the point where P = 5. [1 mark] (d) Explain how excess demand and excess supply
work to restore equilibrium in the market.
(d) Calculate the values of Q s when P = $3 and P = $4. [4 marks]
[2 marks]

(e) Calculate the values of P when Q s = 10 thousand, (e) Due to an increase in resource prices, 15 thousand

and Q s = 25 thousand. [2 marks] fewer units of Z are supplied at each price. State

(f) Calculate the vertical and horizontal intercepts the new supply equation and plot the new supply

using the function; which of these does not appear curve on your graph. [2 marks]

in your graph? [3 marks] (f ) Determine the new equilibrium price and quantity
mathematically and on your graph. [3 marks]
(g) Identify on your graph the intercept with a positive
(g) Explain how price works as a signal and incentive
value. [1 mark]
to restore equilibrium in the market following the
(h) Assume that due to a new technology,
5 thousand more units of Z are supplied at decrease in supply. [4 marks]

[Total: 25 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 2

Exam practice: paper 3 (HL)

Chapter 3 Elasticities (a) Calculate the price elasticity of demand for meat,

Question 4 and state if the demand for meat is price elastic or
The following is a demand schedule for good Z.
inelastic. [2 marks]

Price per unit ($) 5 10 15 20 25 30 (b) Calculate the cross-price elasticity of demand
between meat and fish, and outline the
relationship between meat and fish. [2 marks]

Q demanded 30 25 20 15 10 5 The price of pizzas falls by 15%, the quantity
per week of pizzas demanded increases by 14% and the
quantity of colas consumed increases by 17%.
Total revenue Answer parts (c) and (d) on the basis of this
information.
(a) Plot the demand curve for good Z to show it is

linear. [1 mark] (c) Calculate the price elasticity of demand for pizzas,

(b) Calculate price elasticity of demand (PED) for an and state if the demand for pizzas is price elastic or

increase in price from $5 to $10. [2 marks] inelastic. [2 marks]

(c) Calculate price elasticity of demand (PED) for an (d) Calculate the cross-price elasticity of demand for

increase in price from $20 to $25. [2 marks] pizzas and colas, and outline the relationship

(d) Using your results of parts (b) and (c), explain between pizzas and colas. [2 marks]

what happens to PED along a straight-line demand Your annual income increased from $16 000 to
$20 000. Your spending on purchases of bread fell
curve. [2 marks] by 5%, while your spending on purchases of food
in general and eating out in restaurants increased
(e) Calculate the percentage change in quantity by 15% and 30% respectively. Answer parts (e) and
(f) on the basis of this information.
demanded that will result from an increase in price

of 10% if PED = 2, noting if quantity increases or

decreases. [2 marks]

(f) Calculate total revenue that corresponds to each (e) Identify the relevant elasticity of demand concept,

price and quantity combination. [2 marks] and use it to calculate this demand elasticity for

(g) Using the concepts of price elastic and price each of the three items. [7 marks]

inelastic demand and your calculation of PED for (f) Using the elasticity values you have calculated,

a price increase from $5 to $10 in part (b), explain outline which item is likely to be an inferior good,

what happens to total revenue as a result of the a necessity and a luxury good. [3 marks]

increase in price of good Z. [3 marks] It is found that when the price of good X increased
by 5%, the quantity of X supplied increased by
(h) Using the concepts of price elastic and price 2% after one month and by 7% after one year.
Answer parts (g), (h) and (i) on the basis of this
inelastic demand and your calculation of PED for a information.

price increase from $20 to $25 in part (c), explain

what happens to total revenue as a result of the

increase in price of good Z. [3 marks] (g) Calculate price elasticities of supply for the two

(i) Using respective formulae, explain the difference time periods. [2 marks]
between the slope and price elasticity of demand
along a straight-line demand curve. [3 marks] (h) Outline in which period supply was price elastic
and in which it was price inelastic. [2 marks]

(j) State the numerical values of perfectly elastic and (i) Outline two possible factors that might account for
perfectly inelastic demand, and draw diagrams to
illustrate the difference between them. [4 marks] the different elasticity values. [2 marks]

(j) Explain what will happen to quantity supplied if

(k) Explain what will happen to quantity demanded if price increases by 10% and PES = 0. [1 mark]

price increases by 5% and PED = 0. [1 mark] [Total: 25 marks]

[Total: 25 marks]

Question 5 Question 6
The price of meat increases by 10%, the quantity When the price of good Alpha increases from $100 to
demanded of meat falls by 12% and the quantity of $125, the quantity of good Beta purchased falls from
fish consumed increases by 9%. Answer parts (a) and 10 units to 8 units. Answer parts (a) and (b) on the
(b) on the basis of this information. basis of this information.

© Cambridge University Press 2012 Economics for the IB Diploma 3

Exam practice: paper 3 (HL)

(a) Calculate the cross-price elasticity of demand for (c) Using the demand and supply functions above,
calculate price elasticity of demand (PED) and price
Alpha and Beta. [1 mark] elasticity of supply (PES) for a price increase from
$1.00 to $1.50, and state if demand and supply are
(b) State the relationship between Alpha and Beta. price elastic or price inelastic in this price range.
[1 mark] [6 marks]

The following table provides cross-price elasticity (d) The government imposes an indirect (excise) tax
(XED) values for five pairs of goods. Answer parts
(c) and (d) on the basis of this information.

of $0.75 per unit of Zeta. State the new supply

Pair A & B C & D E & F G & H I & J function, and draw the new, post-tax supply curve
XED +0.3 +0.7 −0.4 −0.8 0.0
in your diagram. [3 marks]

(e) Use the demand function and the new supply

(c) Explain the likely relationship between the goods function to calculate the post-tax equilibrium price

in each pair. [3 marks] and quantity in the Zeta market. [2 marks]

(d) Explain how this relationship compares for (i) pairs (f) State the price paid by consumers, the price
A & B and C & D, and (ii) pairs E & F and G & H. received by producers, and the quantity that is
[4 marks] bought and sold. Show these in your diagram.
[4 marks]
(e) A firm that produces desktop and laptop computers
estimates the cross-price elasticity of demand for (g) Calculate government revenue that arises from the
the two types of computer is +1.2. The firm plans
to lower the price of its desktop computers by 10% imposition of the tax. [1 mark]
to encourage sales. Explain the likely effects of this
pricing decision on its sales of laptops. [3 marks] (h) Calculate the tax incidence on consumers and the

tax incidence on producers. [2 marks]

(i) Using the results of your elasticity calculations

(f) Outline why the mathematical value of PED is in part (c), explain why the tax incidence on

usually negative. [2 marks] consumers and producers differs. [3 marks]

(g) State the numerical values of perfectly elastic and [Total: 25 marks]
perfectly inelastic supply, and draw diagrams to
illustrate the difference between them. [4 marks] Question 8

(h) Draw two unit elastic supply curves in the same Riverland has a competitive market for good kappa.
diagram, showing their point of intersection.
[2 marks] Demand for kappa is given by Q d = 10 − P, and supply
of kappa by Q s = − 4 + P, where P is price in Rvl (the
(i) Draw a price elastic and a price inelastic supply local currency), and Q d and Q s are the quantity of
kappa demanded and supplied in units per day.
curve, and outline how you distinguish between

them. [2 marks] (a) Calculate the equilibrium price and quantity in the

(j) Using respective formulae, outline the difference kappa market. [2 marks]
between the slope of a linear supply curve and
price elasticity of supply along a supply curve. (b) Graph the demand and supply curves up to a price
[3 marks]
of Rvl 10. [2 marks]

(c) The government imposes an indirect (excise) tax of

[Total: 25 marks] Rvl 2 per unit of kappa. Draw the new supply curve

Chapter 4 Government intervention in your diagram. [1 mark]

(d) State the new supply function. [2 marks]

Question 7 (e) Use the demand function and the post-tax supply
function to calculate the post-tax equilibrium price
The demand and supply functions for good Zeta are and quantity; show these in your diagram.
[2 marks]
given by Q d = 10 − 4P and Q s = −2 + 8P, where Q d and
Q s are quantity demanded and supplied respectively in (f) Explain why the imposition of the tax of Rvl 2
units per day, and P is the price of Zeta in $.
per unit of kappa does not increase the post-tax

(a) Calculate the equilibrium price and quantity in the equilibrium price by Rvl 2. [2 marks]

Zeta market. [2 marks] (g) State the amount of tax incidence on consumers

(b) Graph the demand and supply curves up to a price and on producers per unit of kappa, and outline

of $2.00. [2 marks] how these are related to the government’s revenue

per unit of kappa. [3 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 4

Exam practice: paper 3 (HL)

(h) State the total amount of tax paid by consumers a subsidy of Rvl 2 per unit of kappa, together with a
purchase programme for the excess supply of kappa.
and the total amount paid by producers, and

indicate how these are related to the government’s (a) Using the same demand and supply functions as

total revenue from this tax. [3 marks] in question 8 (Q d = 10 − P and Q s = −4 + P) graph
the pre-subsidy demand and supply curves (up to
(i) In your diagram, identify consumer surplus,

producer surplus, government revenues and a price of Rvl 10), and calculate equilibrium price

welfare (deadweight) loss that result in the post-tax and quantity. [4 marks]

situation. [4 marks] (b) State the new supply function that results
following the granting of the subsidy. [2 marks]
(j) Explain the relationship between marginal

benefits and marginal costs at the new post-tax (c) Using the demand function and the new supply

equilibrium, and describe the impact of the tax on function, determine the new equilibrium price and

allocative efficiency. [4 marks] quantity. [2 marks]

[Total: 25 marks] (d) Draw the new supply curve in your diagram,

Question 9 (continued from question 8) and show the price paid by consumers, the price

received by producers, and the quantity bought

(a) Draw a demand and supply diagram showing and sold. [4 marks]

competitive market equilibrium; identify consumer (e) Explain why the equilibrium quantity produced

and producer surplus. [2 marks] has increased following the granting of the

(b) Using the concepts of marginal benefits and subsidy. [2 marks]
marginal costs, explain the significance of
competitive market equilibrium for allocative (f) Explain how the subsidy of Rvl 2 per unit of kappa
efficiency (assuming no market failures). is shared by consumers and producers. [3 marks]
[2 marks]
(g) Identify in your diagram the gain in consumer
(c) Calculate social surplus (consumer plus producer surplus and the gain in producer surplus that
results from the granting of the subsidy. [4 marks]
surplus) at competitive market equilibrium before
(h) Explain the relationship between marginal benefits
the imposition of the tax. [4 marks]
and marginal costs at the post-subsidy equilibrium,
(d) Calculate consumer and producer surplus after the
and describe the impacts of the subsidy on
imposition of the tax. [4 marks]
allocative efficiency. [4 marks]

(e) Calculate the change in consumer and producer [Total: 25 marks]
surplus due to the imposition of the tax.
[2 marks] Question 11 (continued from question 10)

(f) Calculate consumer expenditure and producer (a) Calculate consumer expenditure and producer
revenue before the imposition of the tax. revenue before the subsidy is granted. [2 marks]
[2 marks]
(b) Calculate consumer expenditure and producer
(g) Calculate consumer expenditure and producer revenue after the subsidy is granted. [2 marks]
revenue after the imposition of the tax. [2 marks]
(c) Calculate the change in consumer expenditure

(h) Calculate the change in consumer expenditure and and producer revenue due to the granting of the
producer revenue due to the imposition of the tax.
[2 marks] subsidy. [2 marks]

(d) Calculate the amount of government spending on

(i) Calculate the increase in government revenue due the subsidy. [2 marks]

to the imposition of the tax. [1 mark] (e) Calculate consumer and producer surplus in

(j) Explain why social surplus (the sum of consumer competitive market equilibrium before the subsidy
surplus, producer surplus, and government
revenue) after the imposition of the tax is less than is granted. [4 marks]
social surplus before the imposition of the tax.
[4 marks] (f) Calculate consumer and producer surplus after the

granting of the subsidy. [4 marks]

(g) Calculate the change in consumer surplus and

[Total: 25 marks] producer surplus due to the granting of the

Question 10 subsidy. [2 marks]
The government of Riverland decides it would like to
encourage the production of kappa, and so removes (h) Identify in your diagram (of question 10) the
the tax on kappa (see question 8), and grants instead
welfare (deadweight) loss that arises due to the

subsidy. [1 mark]

© Cambridge University Press 2012 Economics for the IB Diploma 5

(i) Explain why social welfare is reduced after the Exam practice: paper 3 (HL)
granting of the subsidy, even though consumer
and producer surplus have increased. [4 marks] (k) Calculate the number of unemployed workers,
showing how many of these are due to the fall in
(j) Outline two reasons why governments grant quantity of labour demanded and how many due
to an increase in quantity of labour supplied.
subsidies. [2 marks] [3 marks]
[Total: 25 marks]
[Total: 25 marks]
Chapter 5 Market failure
Question 12
No topics covered by HL paper 3.
A market is defined by the following equations: Qd
= 14 − 2P, and Qs = 2 + 2P, where P is in $ and Qd and Chapter 6 The theory of the firm I:
Qs are quantity demanded and supplied of good Z in Production, costs, revenues and profit
tonnes per day.

(a) Calculate the equilibrium price and quantity and Question 13
graph the demand and supply curves. [4 marks] The following table provides data for the total product
(TP) of good Z and units of a variable input (labour) of
(b) The government imposes a price ceiling at P = $2. a firm.
Draw the price ceiling in your diagram. [1 mark]

(c) Calculate the shortage (excess demand). [1 mark]

(d) Calculate the change in consumer expenditure and Units of Total Marginal Average
variable product (TP) product (MP) product (AP)
the change in producer revenue that arise due to
input (thousand (thousand (thousand
the price ceiling. [3 marks] (labour) kilograms) kilograms) kilograms)

(e) Use your diagram to show the welfare effects 0 −
1 3
(deadweight or welfare loss) arising from the price 2 7
3 12
ceiling. [2 marks] 4 16
5 19
Suppose the market defined above is an agricultural 6 21
product market in which the government imposes 7 22
a price floor at P = $5, with government purchases 8 22
of the excess supply. 9 21

(f) Draw a diagram illustrating the price floor in
relation to equilibrium price and quantity.
[1 mark]

(g) Calculate the surplus (excess supply). [1 mark]

(h) Calculate the change in consumer expenditure, (a) Fill in the missing figures for marginal product
the change in producer revenue, and government
expenditure needed to purchase the surplus (MP) and average product (AP). [2 marks]
(excess supply) and maintain the price floor.
[5 marks] (b) Outline whether the data describe production in

(i) Use your diagram to show the welfare effects the short run or in the long run. [2 marks]
(deadweight loss) arising from the price floor.
[2 marks] (c) Using two diagrams, plot the TP curve in one and
the MP and AP curves in the other, illustrating how
Now suppose that the equations above define the product curves are related to each other.
instead a labour market, where P denotes the [6 marks]
hourly wage in $, and Qd and Qs refer to quantity
of labour demanded and supplied in millions of (d) Describe the law that explains the shape of the
unskilled workers. The government imposes a
minimum wage of $4.00 per hour. product curves. [2 marks]

(e) State the number of units of variable input with

which diminishing returns begin, and show this in

(j) Draw a diagram illustrating the minimum wage in your diagram. [2 marks]

relation to the equilibrium wage and quantity of The table on page 7 shows how total product
changes in response to changes in quantities of
labour. [2 marks] inputs for three firms.

© Cambridge University Press 2012 Economics for the IB Diploma 6

Exam practice: paper 3 (HL)

Land (number Labour Firm 1 Firm 2 Firm 3 (a) Outline whether this firm is operating in the short
of hectares) (number of
100 100 100 run or in the long run. [1 mark]
1 workers) 220 180 200
2 350 250 300 (b) For each level of output, find TFC, TVC, AFC, AVC,
3 10
ATC and MC. [6 marks]
20
(c) Assuming that this firm has no influence over
30
price, and sells each unit of output at €20 per unit,

calculate TR, and using the total revenue and total

(f) State which firm is experiencing constant, cost approach, find the profit-maximising level of
increasing or decreasing returns to scale.
[2 marks] output.* [3 marks]

(d) How much economic profit or loss will the firm

(g) Construct a long-run average total cost curve, and earn? [2 marks]

referring to economies and diseconomies of scale, (e) Calculate marginal revenue; using the MC = MR

identify the range in which each of the above three rule, find the profit-maximising level of output and

firms is most likely operating. [3 marks] check if your results match with your answer for

(h) Describe two factors leading to economies of scale, part (c). [2 marks]
and two factors leading to diseconomies of scale.
[4 marks] (f) Using the data in the table, plot the TC and TR

curves and find the profit-maximising level of

(i) Construct a diagram illustrating the relationship output graphically.* [3 marks]
between short-run and long-run average total cost
curves, and outline how average costs relate to (g) Plot the MC and MR curves and find the profit-
each other in the short run and long run.
[2 marks] maximising level of output graphically. (Does your

answer match with your answer to part (f) and

your calculations?) [3 marks]

[Total: 25 marks] (h) Using your data, plot the MC, ATC and AVC curves

in a single diagram. [3 marks]

(i) Outline the reason for the shape of the curves you

plotted in part (h). [2 marks]

Question 14 [Total: 25 marks]
Consider the following data on output and total cost
corresponding to each level of output. Question 15
Consider the following data.
Output (or 0 1 2 34 5 6
total product) 10 50 60 65 75 95 140 Output (or total 0 12 34 5
(thousand units) product) (units)
– 30 25 20 15 10
Total cost (TC) Price ($) 5 25 40 50 65 85
(thousand €) –
Total cost (TC) ($)
Total fixed cost –
(TFC) (thousand €) Marginal cost
(MC) ($) –
Total variable cost
(TVC) (thousand €) Total revenue –
(TR) ($)
Average fixed cost
(AFC) (€) Average revenue
(AR) ($)
Average variable
cost (AVC) (€) Marginal revenue
(MR) ($)
Average total cost
(ATC) (€) (a) For each level of output, calculate/state MC, TR,

Marginal cost AR and MR. [4 marks]
(MC) (€)
(b) Graph the MC and MR curves. [2 marks]
Total revenue (TR)
(thousand €)

Marginal revenue
(MR) (€)

* You are reminded to read the note at the bottom of Test your understanding 6.8, page 164 in the textbook.

© Cambridge University Press 2012 Economics for the IB Diploma 7

Exam practice: paper 3 (HL)

(c) Would the profit-maximising firm produce (d) Identify the firm’s long-run shut-down price.
(i) 2 units of output, (ii) 4 units of output? Explain. [1 mark]
[4 marks]
(e) Identify the price at which this firm would earn

(d) Calculate the amount of profit or loss earned by normal profit, and state how much output it would

the profit-maximizing firm. [2 marks] produce at this price. [2 marks]

(e) State a level of output at which this firm earns (f) State the condition for productive efficiency;
identify the level of output at which this firm
negative economic profit, and calculate this would achieve productive efficiency. [2 marks]

amount. [3 marks]

(f) State the relationship between average revenue (g) State the condition for allocative efficiency;

and price. [1 mark] identify the price per unit of output at which this

(g) Outline the factor responsible for the downward- firm would achieve allocative

sloping MR curve (or why the MR curve is not efficiency. [2 marks]

horizontal). [2 marks] (h) Outline four assumed characteristics of perfect

(h) State the cost figure that represents the firm’s total competition. [4 marks]

opportunity costs at the profit-maximising level (i) Given a price of £20 per unit, calculate the amount

of output. [1 mark] of economic profit (positive or negative) that this

(i) Outline the difference between implicit and firm would make if it profit maximises, and outline

explicit costs, and their relationship to whether the firm would stay in business in the

economic costs [3 marks] short run. [3 marks]

(j) State three alternative goals of firms (other than [Total: 25 marks]

profit maximisation). [3 marks] Question 17
The following table shows price, quantity and cost
[Total: 25 marks] data of a firm.

Chapter 7 The theory of the firm II: Market Price Quantity Marginal Total Marginal Average
structures ($) (units) cost (MC) revenue revenue revenue
($) (TR) ($) (MR) ($) (AR) ($)
Question 16
61 5
The following table provides output and cost data for a
firm in perfect competition.2 52 3

Units of Total Total Average Average Marginal 43 2
output cost variable total variable cost
(TC) cost 34 3
0 (£) cost cost (MC) (£)
1 (TVC) (£) (ATC) (£) (AVC) (£) 25 5
2 50
3 16 7
4 80
5 (a) Calculate/state total revenue, marginal revenue
6 90
and average revenue. [3 marks]
95
(b) Construct a graph plotting marginal revenue,
105
average revenue and marginal cost, and show the
125
170 demand curve facing the firm. [4 marks]

(c) Identify the market structure that cannot represent

this firm. [1 mark]

(a) Fill in the columns for TVC, ATC, AVC and MC. (d) Outline how the price elasticity of demand
[4 marks]
changes along this demand curve (no calculations

(b) Construct a graph plotting the ATC, AVC and MC necessary). [3 marks]

curves. [3 marks] (e) Referring to the concept of price elasticity of

(c) Identify in your diagram the firm’s short-run break- demand, determine the maximum level of output

even price and shut-down price, and outline how this firm would be willing to produce and outline

you found them. [4 marks] why the firm would not be willing to produce

more. [3 marks]

2 This question is partly based on material from Chapter 6. Economics for the IB Diploma 8

© Cambridge University Press 2012

Exam practice: paper 3 (HL)

(f) Determine the revenue-maximising level of output Year 2008 2009 2010 2011
301.5 311.3 309.7 314.0
and the profit-maximising level of output, and Nominal GDP 100.0
(billion Ftl) 104.2 102.7 103.9
identify them both on your graph. [3 marks] –
GDP deflator
(g) Describe three assumed characteristics of a
Real GDP
monopoly. [3 marks] (billion Ftl)

(h) Describe three assumed characteristics of Real GDP
growth
monopolistic competition. [3 marks]

(i) If average total costs of the firm at the profit-

maximising level of output are $3, find the firm’s

economic profit or loss per unit of output and its (f) Outline the difference between nominal GDP and

total economic profit or loss. [2 marks] real GDP. [3 marks]

[Total: 25 marks] (g) Using the information in the table, identify the

Section 2 Macroeconomics base year. [1 mark]

Chapter 8 The level of overall (h) Calculate real GDP for 2008, 2009, 2010 and 2011.
economic activity [4 marks]

Question 18 (i) Calculate the rate of growth in real GDP for 2009,
The following are data from the national income
accounts of the country of Lakeland for the year 2007 2010 and 2011. [3 marks]
(in million Lkl, the national currency).
(j) For 2010, explain why the fall in nominal GDP was
accompanied by an increase in real GDP.
[2 marks]

(k) Identify a year in which a decrease in real GDP

Investment spending 300.7 occurred and a year in which a decrease in real
Net income from abroad −147.4
Government spending 350.3 GDP growth occurred. [2 marks]
Income sent abroad
Exports of goods and services 173.2 [Total: 25 marks]
Consumption spending 95.3
Income from abroad 950.9 Chapter 9 Aggregate demand and
Imports of goods and services 25.8 aggregate supply
Green GDP 132.4
850.3 Question 19

(a) Explain verbally (i.e. not using formulae), how the
Keynesian multiplier leads to changes in real GDP.
[3 marks]

(a) Calculate Lakeland’s gross domestic product (GDP) (b) Outline why knowledge of the multiplier could be

in 2007. [3 marks] important to policy-makers. [1 mark]

(b) Calculate Lakeland’s gross national income (GNI) (c) Outline the meaning of leakages (withdrawals) and

in 2007. [1 mark] injections, and describe how they are related to the

(c) Identify one factor that can account for the size of the multiplier. [4 marks]
difference in Lakeland’s GDP and GNI. [2 marks]
(d) Outline the meaning of a marginal propensity to

(d) Lakeland’s population in 2007 was 1.2 million. consume (MPC) of 0.75. [2 marks]

Calculate Lakeland’s GDP per capita and GNI per (e) If the MPC in an economy is 0.75, calculate the
expected change in real GDP, given an increase in
capita in 2007. [2 marks] investment spending of £200 million. [3 marks]

(e) Outline two factors that might account for the (f) Outline the meaning of the marginal propensity to
save (MPS), marginal propensity to tax (MPT) and
difference between Lakeland’s GDP and its green the marginal propensity to import (MPM).
[3 marks]
GDP. [2 marks]

The following data are from Flatland’s national (g) State the relationship between the MPC and the
accounts (in billion Ftl, the national currency).

MPS, MPT and MPM. [1 mark]

© Cambridge University Press 2012 Economics for the IB Diploma 9

(h) Suppose Riverland has a real GDP of 470 million Exam practice: paper 3 (HL)
Rvl. If in Riverland, the MPS + MPT + MPM = ¼,
calculate the new level of real GDP following a (g) Calculate the rate of inflation/deflation in
decrease in exports of 5 million Rvl. [3 marks] Riverland in 2008-9, 2009–10 and 2010–11.
[3 marks]
(i) Riverland would like to increase its real GDP
by 40 million Rvl and decides to do so through (h) Distinguish between deflation and disinflation,
an increase in government spending. Using the and identify one year in which each occurred.
information in part (h), calculate the amount by [4 marks]
which government spending should increase.
[2 marks] [Total: 25 marks]

(j) Using the Keynesian AD-AS model, draw a diagram Chapter 11 Macroeconomic objectives II:
Economic growth and equity in the
to show the impact of the multiplier on aggregate distribution of income

demand and real GDP. [3 marks] Question 21
The following table shows data from Snowland’s
[Total: 25 marks] national income accounts.

Chapter 10 Macroeconomic objectives I: Year 2009 2010 2011
Low unemployment, low and stable rate
of inflation Real GDP (million Snl) 5000 5100 5151

Real GDP per capita (Snl) 2000 1980 1960

Question 20 (a) Calculate the rate of growth in real GDP for 2010
The following labour statistics refer to Riverland in
2010. and 2011. [2 marks]

(b) Calculate the rate of growth in real GDP per capita

Population Labour Discour- Under- Part- Full-time for 2010 and 2011. [2 marks]
force aged employed time workers
workers workers workers (c) Explain how it is possible for real GDP to be
increasing while real GDP per capita is falling.
4 500 200 2 500 000 250 000 150 000 200 000 1 900 000 [2 marks]

(a) Define ‘unemployment’. [2 marks] The following table shows income shares of
population quintiles in Riverland and Lakeland.

(b) Calculate Riverland’s unemployment rate in 2010. Lowest Highest
[2 marks]
20% 2nd 20% 3rd 20% 4th 20% 20%

(c) Outline the meaning of ‘discouraged workers’. Lakeland 9% 14% 18% 23% 36%
[2 marks]

(d) Outline the meaning of ‘underemployed workers’. Riverland 4% 7% 12% 19% 58%
[2 marks]
(d) Outline the meaning of ‘quintiles’ in the table, and

Riverland’s basket of goods and services consumed outline how the data would differ if income shares
by the average household in the course of a year
includes three items (X, Y and Z), as shown below. were shown by population deciles. [2 marks]

(e) Analyse the data on income shares and explain

which of the two countries has a more equal

Good Quantity Price per Price per Price per Price per distribution of income. [3 marks]

or in basket unit (Rvl) unit (Rvl) unit (Rvl) unit (Rvl) (f) Construct Lorenz curves for Lakeland and
Riverland, and explain which of the two countries
service (weight) 2008 2009 2010 2011 has a more equal distribution of income.
[6 marks]
X3 5 5 6 5

Y2 3 4 6 5 (g) Based on your curves for part (f), explain which

Z7 6 7 7 7 of the two countries, Lakeland or Riverland, has a

(e) Calculate the value of the basket in 2008, 2009, higher Gini coefficient, and what this means for its

2010 and 2011. [4 marks] income distribution in comparison with the other

(f) Using 2008 as the base year, construct a price index country. [2 marks]

for the period 2008–11. [6 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 10

(h) Outline the maximum and minimum values that Exam practice: paper 3 (HL)

can be taken by a Gini coefficient. [2 marks] paid in each state on four different annual income
levels (in Snl, the national currency).

(i) Draw a diagram showing an initial Lorenz curve, Annual Upper Snowland Lower Snowland
and a possible Lorenz curve that would result if income Amount of Amount of income
the government of the country placed increased tax paid annually
emphasis on indirect taxes and lower emphasis on (Snl) income tax paid
direct taxes as sources of government revenue. annually (Snl) (Snl)
[2 marks]
25 000 5750 5750

(j) Outline whether income distribution is likely to 36 000 8280 7200
become more or less equal following the change in
the government tax policies described in part (i). 43 000 9890 8170
[2 marks]
47 000 10 810 8460

[Total: 25 marks] (f) Explain what type of tax system Upper Snowland

and Lower Snowland each has, progressive,

Question 22 proportional or regressive. [4 marks]
The following table provides information on income
tax rates in Mountainland (in Mnl, the national (g) Explain which of the three tax systems shown
currency).
in the tables above, Mountainland’s, Upper

Snowland’s or Lower Snowland’s, is most

appropriate as a method to make the distribution

Annual income (Mnl) Marginal tax rate (%) of income more equal. [4 marks]
0–7,000 0
7001–20 000 10 [Total: 25 marks]
20 001–45 000 25
45 001–100 000 35 Chapter 12 Demand-side and
100 001 or more 45 supply-side policies

No topics covered by HL paper 3.

(a) Distinguish between marginal and average tax Section 3 International economics

rates. [2 marks]

(b) Calculate the amount of income tax paid by Chapter 13 International trade
families with an annual income of (i) 10 000 Mnl,
(ii) 35 000 Mnl, and (iii) 107 000 Mnl. [3 marks] Question 23

(c) For each of the family incomes in part (b), calculate

the corresponding average tax rate, and state the Suppose a simple world economy with two countries,
Oceanland and Grassland, each of which produces two
corresponding marginal tax rate. [6 marks] goods, seafood and dairy products. Oceanland has an
absolute advantage in the production of both seafood
(d) The family with an annual income of 35 000 Mnl and dairy products, while Grassland has a comparative
spends 30 000 Mnl on goods and services, which advantage in the production of dairy products.
includes spending on indirect taxes of 6000 Mnl.

(i) Calculate the indirect tax rate. (a) Draw a diagram showing the absolute and
comparative advantages of each country.
(ii) Calculate spending on indirect taxes as a [3 marks]
fraction of annual income.

(iii) Calculate this family’s total average tax rate, (b) State which products each country should
including direct and indirect taxes. [3 marks]
export and import, according to the theory of
(e) Explain whether a constant indirect tax rate
comparative advantage. [2 marks]
applied uniformly on all spending is progressive,
(c) Show points of possible production and
proportional or regressive. [3 marks]
consumption for each of the two countries, after
Snowland consists of two states, Upper Snowland
and Lower Snowland. Each state has its own specialisation and trade according to comparative
income tax system with its own tax rates. The
following table shows the amount of income tax advantage. [2 marks]

(d) Outline two possible sources of comparative

advantage. [2 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 11

Exam practice: paper 3 (HL)

The following data show the quantity of output (c) Draw a diagram showing the price of seafood,
that can be produced by country X and country domestic quantity produced, domestic quantity
Y if all their resources are used to produce either consumed, and the quantity of imports (i) with
good A or good B. the tariff, and (ii) after removal of the tariff.
(The diagram does not have to be drawn to scale.)
Production possibilities of country A and country B [4 marks]

Good A Good B (d) Calculate the change in consumer expenditure
(units per day) (units per day)
on seafood in Riverland due to the removal of the
40 20
Country X tariff. [2 marks]
Country Y 50 100
(e) Calculate the change in domestic producer revenue

from seafood in Riverland due to the removal of

(e) Calculate the opportunity cost of good A and good the tariff. [2 marks]

B in country X, and the opportunity cost of good A (f) Calculate the change in the government budget in
Riverland due to the removal of the tariff.
and good B in country Y. [4 marks] [2 marks]

(f) State which country has a comparative advantage

in good A, which in good B, and which has an (g) Calculate the change in foreign producers’ export
revenue from seafood exports to Riverland.
absolute advantage in both goods. [3 marks] [2 marks]

(g) Using the data in the table, draw a diagram

illustrating the comparative advantage of each (h) State two stakeholders who gained from the

country. [4 marks] removal of the tariff. [2 marks]

The following questions are based on the diagrams (i) State two stakeholders who lost from the removal
below, illustrating production possibilities curves.
of the tariff. [2 marks]

(i) (ii) (j) Given the information above about Riverland,

country A
good Y country A explain who has a comparative or absolute
good Y
country B country B advantage in seafood production, Riverland or its

0 good X 0 good X trading partners. [3 marks]

(k) Using your diagram from part (c), show the

(h) In diagram (i), can either country benefit from amount of welfare that was gained by Riverland
specialisation and trade? Outline why or why not.
[2 marks] when the tariff was eliminated (i.e. welfare loss

that was regained). [2 marks]

(i) In diagram (ii), state which country has the [Total: 25 marks]
comparative advantage in which good, and which
country has the absolute advantage in both goods. Question 25
[3 marks] Flatland had an import quota of 150 000 kg of dairy
products per week, because it wanted to protect its
[Total: 25 marks] dairy industry. As a result of the quota, domestic
producers were selling 350 000 kg of dairy products per
Question 24 week, at a price of 20 Ftl (the domestic currency) per
Riverland had a tariff of 5 Rvl per kg of seafood. kg. Due to complaints by its World Trade Organization
Domestic production of seafood with the tariff was (WTO) trading partners, Flatland was forced to
70 000 kg per week, domestic consumption was eliminate the dairy quota. The elimination of the
150 000 kg per week, and the price was 25 Rvl per kg. quota caused the price of dairy products to fall to 15
Because of World Trade Organization (WTO) rules, Ftl per kg, domestic production dropped to 250 000 kg
the government of Riverland was forced to eliminate per week, and imports increased to 400 000 kg
the seafood tariff. As a result, domestic production fell per week.
to 50 000 kg per week and consumption increased to
180 000 kg per week. (a) Calculate the quantity of domestic consumption of

dairy products before the removal of the quota and

(a) Calculate the quantity of seafood imports in after the removal of the quota. [2 marks]
Riverland with the tariff and the quantity of
imports after the tariff was eliminated. [2 marks] (b) Calculate the amount by which imports increased
following the removal of the quota. [1 mark]

(b) Calculate the price of seafood paid by consumers (c) Draw a diagram showing the price of dairy
products, domestic quantity produced, domestic
and the price received by producers in Riverland

after the tariff was removed. [2 marks]

© Cambridge University Press 2012 Economics for the IB Diploma 12

Exam practice: paper 3 (HL)

quantity consumed, and the quantity of imports (i) (b) Calculate the total amount of cereals consumed
with the quota, and (ii) after removal of the quota. per week in Grassland before the removal of the
(The diagram does not have to be drawn to scale.) subsidy and after the removal of the subsidy.
[2 marks]
[4 marks]

(d) Calculate the change in consumer expenditure on (c) Calculate the quantity of imports per week after

dairy products in Flatland due to the removal of the removal of the subsidy. [2 marks]

the quota. [2 marks] (d) Draw a diagram showing the price of cereals,
domestic quantity produced, domestic quantity
(e) Calculate the change in domestic producer revenue consumed, and the quantity of imports (i) with the
subsidy, and (ii) after removal of the subsidy. (The
from dairy products in Flatland due to the removal diagram does not have to be drawn to scale.)
[4 marks]
of the quota. [2 marks]

(f) Calculate the change in foreign producers’ export
revenue from dairy exports to Flatland. [2 marks]

(g) Calculate the amount of quota revenue that was (e) State/calculate the change in consumer
generated when the quota was in place. [2 marks]
expenditure on cereals arising from the removal of

(h) Assuming that the quota revenues were given to the subsidy. [1 mark]

foreign producers, calculate the total effect on (f) Calculate the change in producer revenue from
sales of cereals due to the removal of the subsidy.
foreign producers from the removal of the quota, [2 marks]

taking into account both export revenues and

quota revenues. [2 marks] (g) Calculate the change in the government’s budget

(i) State two stakeholders who gained from the due to the removal of the subsidy. [2 marks]

removal of the quota. [2 marks] (h) Calculate the change in foreign producers’ export
revenue from cereal exports to Grassland.
(j) State one stakeholder who lost from the removal of [2 marks]

the quota. [1 mark]

(k) State one important difference between imposing a (i) State two stakeholders who gained from the
tariff and imposing an import quota. [1 mark]
removal of the subsidy. [2 marks]

(l) Using your diagram from part (c), show the (j) State one stakeholder who lost from the removal of

amount of welfare that was gained by Flatland the subsidy. [1 mark]

when the quota was eliminated (i.e. welfare loss (k) State one stakeholder who was unaffected by the

that was regained). [2 marks] removal of the subsidy. [1 mark]

(m) State two economic benefits for the Flatlander (l) Outline two arguments that could be used to

or global economy (other than impacts on justify the use of subsidies as a trade protection

stakeholders) that might arise from the removal of measure. [4 marks]

the import quota. [2 marks] [Total: 25 marks]

[Total: 25 marks]

Chapter 14 Exchange rates and the balance
of payments

Question 26 Question 27
Grassland used to grant a subsidy on cereals of Suppose a traveller from Riverland, whose currency
5 Gsl (the local currency) per kg. Due to the subsidy, is the Rvl, would like to visit Mountainland, whose
domestic production was 150 000 kg per week, and currency is the Mnl. The two currencies initially
imports amounted to 75 000 kg per week. The price exchange at the rate of 1 Mnl = 2.5 Rvl.
paid by consumers was 25 Gsl per kg. A number
of Grassland’s trading partners complained that (a) Find the value of 1 Rvl in terms of Mnl. [2 marks]
Grassland was dumping its cereals in the international
market, and threatened to impose anti-dumping (b) The traveller from Riverland would like to bring
tariffs. Grassland therefore removed its subsidy on
cereals. Following the removal of the subsidy, domestic 1500 Rvl with her to Mountainland converted into
cereal production fell to 80 000 kg per week.
Mnl. How many Mnl will she receive when she

(a) Calculate/state the price received by producers exchanges 1500 Rvl? [2 marks]

when they were receiving the subsidy and after the (c) While in Mountainland, the traveller from
Riverland runs out of Mnl but wants to buy some
removal of the subsidy. [2 marks] presents for her friends that cost 175 Mnl. Given

© Cambridge University Press 2012 Economics for the IB Diploma 13

Exam practice: paper 3 (HL)

the exchange rate above, how many Rvl must and excess demand or excess supply of Mnl that
results when the Mnl is pegged at 2.3 Rvl.
she exchange in order to make these purchases
[4 marks]
in Mnl? [2 marks]

(d) While exchanging Rvl for Mnl, the traveller (h) If the government of Mountainland were to peg

discovers that the exchange rate has changed, and (fix) the Mnl at 1 Mnl = 1.7 Rvl, calculate Qd and
Qs at this exchange rate, and the size of the surplus
now stands at 1 Mnl = 2.7 Rvl. How many Rvl must (excess supply) or shortage (excess demand) of Mnl

she exchange to get 175 Mnl at the new exchange

rate? [2 marks] in the foreign exchange market. [3 marks]

(e) Distinguish between currency appreciation and (i) State whether the Mnl would be overvalued or

depreciation, and state which currency appreciated undervalued at 1 Mnl = 1.7 Rvl. [1 mark]

and which depreciated. [4 marks] (j) Describe two policies that the government or

(f) Calculate the percentage appreciation of the central bank of Mountainland could pursue
appreciating currency and the percentage
depreciation of the depreciating currency. to maintain the value of the Mnl at
[4 marks]
1 Mnl = 1.7 Rvl. [4 marks]

[Total: 25 marks]

(g) Identify three factors that may have led to the

exchange rate change between the Mnl and Question 29
The table below shows the balance of payments
the Rvl. [6 marks] accounts of Oceanland for the year 2010 (all figures in
billion Ocl, the national currency).
(h) Draw a diagram illustrating how one of the factors

you identified above caused a change in the value

of the appreciating currency. [3 marks] Billion Ocl
+25
[Total: 25 marks] −11
+3
Question 28 Current account +1
We are given the demand function Qd = 8 – 4P, and Exports of goods +3
the supply function Qs = −6 + 3P, where Qd and Qs are Imports of goods +2
quantity of Mnl (Mountainland’s currency) demanded Balance of trade in goods
Exports of services +1
and supplied in millions per day, and P is the price of Imports of services −2
Balance of trade in services +6
the Mnl in terms of Rvl (Riverland’s currency). Balance of trade in goods and services −2
Income +4
(a) Calculate the equilibrium exchange rate for the Current transfers
Balance on current account
Mnl in terms of Rvl. [2 marks] Capital account
Capital transfers
(b) Calculate the equilibrium quantity of Mnl bought Transactions in non-produced,
non-financial assets
and sold per day. [2 marks] Balance on capital account
Financial account
(c) State what kind of exchange rate system allows the Direct investment
Portfolio investment
Mnl to settle at its equilibrium value determined Reserve assets
Balance on financial account
by demand and supply. [1 mark] Net errors and omissions
Balance
(d) Suppose the government of Mountainland decides

to peg (fix) the Mnl at 1 Mnl = 2.3 Rvl. Calculate

Qd and Qs at this exchange rate, and the size of
the surplus (excess supply) or shortage (excess

demand) of Mnl in the foreign exchange

market. [3 marks]

(e) State whether the Mnl would be overvalued or

undervalued at 1 Mnl = 2.3 Rvl. [1 mark]

(f) Describe two policies that the government or
central bank of Mountainland could pursue to
maintain the value of the Mnl at 1 Mnl = 2.3 Rvl.
[4 marks]

(g) Plot the demand and supply curves for the Mnl,
and identify the equilibrium Mnl exchange rate

© Cambridge University Press 2012 Economics for the IB Diploma 14

Exam practice: paper 3 (HL)

(a) Outline the role of the balance of payments. (a) State the equation that was used to calculate the
[2 marks] terms of trade indices in the table above.
[2 marks]
(b) Fill in the blanks in the table above. [8 marks]

(c) State which of the three accounts are in deficit and (b) Explain the meaning of ‘1990 = 100’ in the

which in surplus. [3 marks] heading of the table above. [2 marks]

(d) Explain the role of reserve assets of +4 billion Ocl (c) Calculate the percentage change in the terms
of trade in the period 1970–81 for the (i) the
in the financial account. [4 marks] oil-exporting countries, (ii) non-oil exporting
developing countries, and (iii) developed countries.
(e) The government and/or central bank decide to [3 marks]

allow the Ocl to depreciate in order to correct the

problem in the current account. It is estimated (d) Identify which group of countries experienced a

that over the short term (less then 6 months), on deterioration and which an improvement in their

average the price elasticity of demand for exports is terms of trade. [3 marks]

0.49 and the price elasticity of demand for imports

is 0.39. Explain the likely effect of the depreciation (e) Using the concept of specialisation of exports,

of the Ocl on Oceanland’s current account during suggest a factor that can account for the much

this period. [2 marks] larger change in the oil-exporting countries’ terms

(f) It is also estimated that 6 months or more of trade compared to the other two groups of

following the depreciation, on average the price countries. [4 marks]

elasticity of demand for exports is 0.75 and the (f) With reference to the changes in the terms of trade

price elasticity of demand for imports is 0.83. of oil-exporting countries in the period 1970–81,

Explain the likely effect of the depreciation of the explain how long-term changes in the terms

Ocl on Oceanland’s current account during this of trade may result in a global redistribution of

later period. [2 marks] income. [4 marks]

(g) State the condition that allows you to answer parts (g) The oil shocks of 1973–74 and 1979–81 were the
result of restrictions in the global supply of oil.
(e) and (f) above. [1 mark] Using a demand and supply diagram for the global
oil market, show the effect of these restrictions on
(h) Explain the J-curve effect as it relates to the likely the equilibrium price and quantity of oil.
[2 marks]
changes in Oceanland’s current account, resulting

from the depreciation of the Ocl. [3 marks]

[Total: 25 marks] (h) The huge change in the terms of trade of the

Chapter 15 Economic integration and the oil-exporting countries over the period shown in
terms of trade
the table resulted in very large trade and current

account surpluses for these countries. Using

Question 30 your answer to part (g) and the concept of price
The following table presents terms of trade indices
(indexes) for three country groups in selected years during elasticity of demand for exports, explain how this
the period 1970–81, constructed by the International
Monetary Fund on the basis of export and import price was possible. [5 marks]
data. The table illustrates changes in the terms of trade
occurring after the oil price shocks of 1973–74 and [Total: 25 marks]
1979–81, which resulted in very large oil price increases.
Section 4 Development economics
Terms of trade indices (indexes), selected years, 1990 = 100
No topics covered by HL paper 3.

Oil-exporting Non-oil exporting Developed
countries developing countries countries

1970 21 126 110
108
1973 29 122 97
96
1974 70 119 87

1979 87 112

1981 119 109

Source: International Monetary Fund, International Financial Statistics Yearbook 1996.

© Cambridge University Press 2012 Economics for the IB Diploma 15

Important diagrams to remember

Chapter 2 Competitive markets: demand and supply

(a) Demand of consumer A (b) Demand curve of consumer B (c) Market demand

5price of chocolate bars ($) P ($) P ($)
4
3 5 5
2 4
1 DA demands 4
0 2 4 6 8 10 12 +3 of other
+ consumers = 3
quantity of chocolate 2 in the
bars (per week) 1 market 2

DB 1 Dm

0 2 4 6 8 10 12 0 2 4 6 8 10 12 14
quantity of chocolate quantity of chocolate bars
bars (per week) (thousands per week)

Figure 2.2 Market demand as the sum of individual demands

(a) A movement along the demand curve, (b) A shift of a demand curve, caused by a change in
caused by a change in price, is called a a determinant of demand, is called a ‘change in
‘change in quantity demanded’ demand’

P P
change in demand

A change in decrease increase D2
P1 quantity in D in D

demanded D3 D1

P2 B

D

0 Q1 Q2 Q 0Q

Figure 2.4 Movements along and shifts of the demand curve

© Cambridge University Press 2012 Economics for the IB Diploma 1

Important diagrams to remember

(a) Supply of firm A (b) Supply of firm B (c) Market supply
P$
5 price of chocolate bars ($) SA 5 P$
4 4
3 SB 5 Sm
2 +3
1 supplies 4
2 3
1 + of other = 2
firms in

the market

1

0 200 400 600 0 200 400 600 0 2 4 6 8 10 12
quantity of chocolate quantity of chocolate quantity of chocolate
bars (per week) bars (per week)
bars (thousands per week)

Figure 2.6 Market supply as the sum of individual supplies

(a) A movement along the supply curve, (b) A shift of the supply curve, caused by a
caused by a change in price, is called a change in a determinant of supply, is called a
‘change in quantity suppied’ ‘change in supply’

P P
S S3 S1
S2
P2 B
decrease increase
change in in supply in supply
A quantity
P1 P1
supplied

0 Q1 Q2 Q0 Q3 Q1 Q2 Q

Figure 2.8 Movements along and shifts of the supply curve

price of chocolate bars ($) S
5 surplus

4

3 equilibrium market equilibrium
price

2

1 shortage D

equilibrium quantity

0 2 4 6 8 10 12 14

quantity of chocolate bars
(thousands per week)

Figure 2.9 Market equilibrium

© Cambridge University Press 2012 Economics for the IB Diploma 2

Important diagrams to remember

(a) Increase in demand (b) Decrease in demand

initial S final S

P equilibrium c final P equilibrium initial
P2 equilibrium
equilibrium P1 b a
a P3 D1
P1 b c
D2
0 Q1 D3 Q
D1 0 Q3 Q1

Q2 Q

Figure 2.10 Changes in demand and the new equilibrium price and quantity

(a) Increase in supply (b) Decrease in supply

initial S1 final S3
equilibrium equilibrium
b S2
P P S1
P1 a c final P3 c

P2 equilibrium P1 b a initial

equilibrium

D D

0 Q1 Q2 Q 0 Q3 Q1 Q

Figure 2.11 Changes in supply and the new equilibrium price and quantity

(a) Adjustment of price to increased demand P1 S = MC
Allocative
PS P2 efficiency:
P3 consumer at market
C equilibrium
P2 surplus MB = MC and
Pe producer social surplus
AB is maximum
P1 D2 surplus
P4 D = MB
shortage = P5 Q

D1 excess demand P6
0 Qa Qb Qe
0 Q1 Q3 Q2 Q

Figure 2.16 Price as a signal and incentive Figure 2.17 Consumer and producer surplus in a competitive market

© Cambridge University Press 2012 Economics for the IB Diploma 3

Important diagrams to remember

Higher level topic

P ($) Qd = 14 – 2P P ($)
5
Qd = 19 – 2P 5
Qd = 14 – 2P
4 Qd = 10 – 2P
4
3 Qd = 14 – 4P

aa 3 absolute

2 decreases increases 2 value of b
increases

1 1

0 2 4 6 8 10 12 14 16 18 20 0 2 4 6 8 10 12 14 16 18 20
quantity of chocolate bars (thousands per week) quantity of chocolate bars (thousands per week)

Figure 2.12 Shifts of the demand curve (changes in a in the Figure 2.13 Changing the slope of the demand curve (changes in b in the
function Qd = a – bP ) function Qd = a – bP )

P ($) Qs = –1 + 2P Qs = 2 + 2P Qs = 6 + 2P P($)
5 5 Qs = 2 + 2P
4 cc 4 value Qs = 2 + 4P
3 decreases increases 3 of d
2
1 increases

0 2 4 6 8 10 12 14 16 18 2
quantity of chocolate bars (thousands per week) 1

Figure 2.14 Shifts of the supply curve (changes in c in the supply 0 2 4 6 8 10 12 14 16 18
function Qs = c + dP ) quantity of chocolate bars (thousands per week)

Figure 2.15 Changing the slope of the supply curve (changes in d in the
function Qs = c + dP )

© Cambridge University Press 2012 Economics for the IB Diploma 4

Important diagrams to remember

Chapter 3 Elasticities Frequently encountered cases (b) Price elastic demand: 1 < PED < ∞

(a) Price inelastic demand: 0 < PED <1 P
P

5% P2
P1
P2
10% D

P1 D Q 0 Q2 Q1 Q
Q2 Q1 10%
0
5%
Special cases
(c) Unit elastic demand: PED = 1 (d) Perfectly inelastic demand: PED = 0 (e) Pefectly elastic demand: PED = ∞

P PD P

P2 P1 D
5% Q
D Q1 Q 0
P1 Q0

0 Q2 Q1
5%

Figure 3.1 Demand curves and PED

P ($)

50 f PED = 4 elastic portion of
45 demand curve

40 e

35 inelastic portion
d PED = 1
30 of demand curve

25 c

20
15 b PED = 0.25
10 a

5

0 10 20 30 40 50 60 70 80 90 100
units of good A

Figure 3.2 Variability of PED along a straight-line demand curve

© Cambridge University Press 2012 Economics for the IB Diploma 5

(a) PED > 1 (elastic demand) (b) PED < 1 (inelastic demand) Important diagrams to remember
P P
(c) PED = 1 (unit elastic demand)
PED > 1 P

P2 C PED > 1
P1 PED = 1
PED = 1
P2
PED < 1 P2 PED < 1 C
P1
AB C P1

D AB D A B D
Q Q
0 Q2 Q1 0 Q2 Q1 Q 0 Q2 Q1

Figure 3.5 PED and total revenue

(a) Primary commodities: supply shifts with inelastic demand (b) Manufactured products: supply shifts with elastic demand
S2
S2
P S1 P S1
P2 S3
P2 S3
P1 P1
P3 P3

D D
0 Q2 Q1 Q3 Q
0 Q2 Q1 Q3 Q

Figure 3.6 Price fluctuations are larger for primary commodities because of low PED

(a) Inelastic demand S2 (b) Elastic demand S2
P final P
tax S1 tax
equilibrium per final
equilibrium S1
Pt unit per
Pt unit
P1
P1 initial initial
equilibrium 0 Qt equilibrium

D D
0 Qt Q
Q

Figure 3.7 PED, indirect taxes and government tax revenue

© Cambridge University Press 2012 Economics for the IB Diploma 6

(a) Substitutes and positive XED : demand for Pepsi® Important diagrams to remember
PS
P

YED < 0 0 < YED < 1 YED > 1

inferior income income
good inelastic elastic

D2 D increases demand, demand,
as price of normal normal
good good
Coca-Cola®

D3 D1 increases

D decreases as price D2 D1 D3 D4
of Coca-Cola® decreases 0Q

0Q

Figure 3.9 Demand curve shifts in response to increases in income for
different YEDs

(b) Complements and XED : demand for tennis balls
PS

D2 D increases
as price of
D1 tennis rackets
D3 decreases

D decreases as

price of tennis rackets increases

0Q

Figure 3.8 Cross-price elasticities

Frequently encountered cases

(a) Price inelastic supply: PES < 1 (b) Price elastic supply: PES > 1
P
P
S S

P2 P2
10% 10%

P1 P1

0 Q1 Q2 Q0 Q1 Q2 Q
5% 15%
Special cases
(c) Unit elastic supply: PES = 1 (d) Perfectly inelastic supply: PES = 0 (e) Perfectly elastic supply: PES = ∞
P S1 PS P

S2 0 Q1 Q P1 S
S3 0Q

0Q Economics for the IB Diploma 7

Figure 3.11 Supply curves and PES

© Cambridge University Press 2012

(a) Primary commodities: demand shifts with inelastic supply Important diagrams to remember

PS (b) Manufactured products: demand shifts with elastic supply
P
P2
P1 P2 S
P3 P1
P3 D2
D2
D3 D1 D3 D1
0Q 0Q

Figure 3.13 Price fluctuations are larger for primary commodities because of low PES

© Cambridge University Press 2012 Economics for the IB Diploma 8

Important diagrams to remember

Chapter 4 Government intervention

(a) Specific tax (a) Market outcomes: specific tax
P
S2 (= S1 + tax) P government S2 (= S1 + tax)

tax per revenue tax per
unit
S1 unit S1
Pc

P*
Pp

0Q 0 D
Qt Q* Q

(b) Ad valorem tax (b) Market outcomes: ad valorem tax
P
S2 (= S1 + tax) P government S2 = S1 + tax
revenue

tax per S1 tax per
unit Pc unit S1

tax per P*
unit PP

0Q D
0 Qt Q* Q

Figure 4.1 Supply curve shifts due to indirect (excise) taxes Figure 4.2 Impacts of specific and ad valorem taxes on market outcomes

P S1

Pp subsidy
per unit
P*
S2 = S1 – subsidy

Pc

D

0 Q* Qsb Q

Figure 4.8 Impacts of subsidies on market outcomes

© Cambridge University Press 2012 Economics for the IB Diploma 9

Important diagrams to remember

P

PS

welfare loss S = MC

Pe a b
Pe d
Pc
c
shortage = D Pc
excess demand
e D = MB
0 Qs Qe Qd Q Qs Qe Qd Q
0

Figure 4.12 Price ceiling (maximum price) and market outcomes Figure 4.13 Welfare impacts of a price ceiling (maximum price)

excess supply =

P excess supply = S P surplus

surplus S

Pf Pf

Pe Pe D+
government

purchases

D D
0 Qd Qe Qs Q 0 Qd Qe Qs Q

Figure 4.15 Price floor (minimum price) and market outcomes Figure 4.16 An agricultural product market with price floor and
government purchases of the surplus

P excess supply =
surplus
a
Pf S = MC

b f D+
Pe c government
e
d welfare purchases

0 loss D = MB

Qd Qe Qs Q

Figure 4.17 Welfare impacts of a price floor (minimum price) for
agricultural products and government purchases of the
surplus

© Cambridge University Press 2012 Economics for the IB Diploma 10

excess supply of labour Important diagrams to remember

P

price of labour (wage) = labour surplus supply
= unemployment of

labour

Wm a welfare loss S
Wm
We c
b e
We
demand D
for d Qd Qe Qs Q

labour 0

0 Qd Qe Qs Q

quantity of labour

Figure 4.19 Labour market with minimum wage (price floor) Figure 4.20 Welfare impacts of a minimum wage

Higher level topics

(a) Inelastic demand S2 = S1 + tax (a) Inelastic supply S2 = S1 + tax
P P S1
tax per
Pc unit Pc tax per
P * consumers unit
S1
producers D
P* consumers Q
Pp Pp
producers 0 Qt Q*

D

0 Qt Q* Q

(b) Elastic demand S2 = S1 + tax (b) Elastic supply
P P
tax per
Pc Pc consumers S2 = S1 + tax
P* unit S1
consumers tax per
D
Q* Q unit S1

P* producers
Pp
Pp producers

0 D

0 Qt Qt Q* Q

Figure 4.6 Incidence of an indirect tax with inelastic and elastic demand Figure 4.7 Incidence of an indirect tax with inelastic and elastic supply

© Cambridge University Press 2012 Economics for the IB Diploma 11

Important diagrams to remember

P P S2 = S1 + tax

consumer tax per S1 = MC
surplus unit
S = MC after the tax

consumer Pc
surplus
government a
P* revenue from b
producer P* the tax welfare loss = a + b
surplus
Pp
D = MB
producer
surplus
after the
tax

D = MB

0 Q* Q 0 Qt Q* Q

(a) Consumer and producer surplus in a competitive (b) Consumer and producer surplus with an indirect

free market: maximum social surplus (excise) tax: welfare loss

Figure 4.4 Effects of indirect taxes on consumer and producer surplus

(a) Consumer and producer surplus in a competitive (b) Consumer and producer surplus with a subsidy: welfare loss
free market: maximum social surplus P

P

consumer S = MC Pp gain in producer a S1 = MC
surplus P* surplus subsidy
P* D = MB per unit
producer Q gain in consumer
surplus surplus S2 = S1 – subsidy
Pc
0 Q* welfare loss

D = MB

0 Q* Qsb Q

Figure 4.10 Effects of subsidies on consumer and producer surplus

© Cambridge University Press 2012 Economics for the IB Diploma 12

Important diagrams to remember

Chapter 5 Market failure

P
S = MPC = MSC

Popt

D = MPB = MSB

0 Qopt Q
allocative efficiency
is achieved

Figure 5.1 Demand, supply and allocative efficiency with
no externalities

MSC (a) Welfare loss MSC
P external
Popt cost S = MPC P external
Pm
Popt cost S = MPC
Pm
welfare loss

D = MPB = MSB D = MPB = MSB
Q
0 Qopt Qm 0 Qopt Qm
Q

Figure 5.2 Negative production externality Figure 5.3 Welfare loss (deadweight loss) in a negative
production externality

MSC
P
Popt S = MPC
Pm

0 Qopt Qm D = MPB = MSB
Q

Figure 5.4 Government regulations to correct negative production
externalities

© Cambridge University Press 2012 Economics for the IB Diploma 13

Important diagrams to remember

(a) Imposing an indirect tax on (b) Effects on external costs of a tax on (c) Tradable permits
output or on pollutants emissions (carbon tax)
P S of tradable
P MSC = MPC + tax MSC1 = MPC + tax permits
Pc = Popt tax = external cost P MSC2
P2
S = MPC S = MPC
P1 D2
Pm Pm D1
Pp
0 Q1 Q
D = MPB = MSB D = MPB = MSC

0 Qopt Qm Q 0 Qopt1 Qopt2 Qm Q

Figure 5.5 Market-based policies to correct negative production externalities

P (a) Welfare loss S = MPC = MSC
S = MPC = MSC P
external
Pm welfare loss cost
D = MPB
Pm D = MPB
Popt external Popt
MSB
cost 0 Qopt Qm Q

0 Qopt Qm MSB
Q

Figure 5.6 Negative consumption externality Figure 5.7 Welfare loss (deadweight loss) in a negative
consumption externality

(a) Government regulations and advertising (b) Market-based: imposing an indirect tax

P P MPC + tax

external tax =
cost external

S = MPC = MSC Pc cost
S = MPC = MSC
Pm
Pm
Popt D1 = MPB
Pp
D = MPB

D2 = MSB MSB
after demand decreases

0 Qopt Qm Q 0 Qopt Qm Q

Figure 5.8 Correcting negative consumption externalities

© Cambridge University Press 2012 Economics for the IB Diploma 14

Important diagrams to remember

(a) Welfare loss

S = MPC P
P S = MPC

external external
benefits benefits

MSC MSC
Pm Pm
Popt
Popt welfare loss
D = MPB = MSB
0 Qm Qopt Q D = MPB = MSB
0 Qm Qopt Q
Figure 5.9 Positive production externality
Figure 5.10 Welfare loss (deadweight loss) in a positive
production externality

(a) Direct government provision (b) Granting a subsidy S = MPC
S = MPC P
subsidy =
P Pm spillover benefit
Popt
spillover MSC
benefit
0 Qm Qopt D = MPB
MSC Q
Pm

Popt

D = MPB
0 Qm Qopt Q

Figure 5.11 Correcting positive production externalities

© Cambridge University Press 2012 Economics for the IB Diploma 15

P Important diagrams to remember

P

S = MPC = MSC

Popt

Pm MSB welfare loss S = MPC = MSC

external
benefit

D = MPB Popt

0 Qm Qopt Q external
benefits
Pm

Figure 5.12 Positive consumption externality MSB

D = MPB

0 Qm Qopt Q

(a) Legislation or advertising Figure 5.13 Welfare loss (deadweight loss) in a positive
consumption externality
P
S = MPC = MSC

Popt

Pm D2 = MSB

external
benefit

D1 = MPB

0 Qm Qopt Q

(b) Direct government provision

P
S = MPC = MSC

S + government
provision

Pm

Pc MSB

D = MPB

0 Qm Qopt Q

(c) Granting a subsidy

P S = MPC = MSC

subsidy = MPC –
external subsidy
benefit

Pm

Pc MSB

D = MPB

0 Qm Qopt Q

Figure 5.14 Correcting positive consumption externalities

© Cambridge University Press 2012 Economics for the IB Diploma 16

Important diagrams to remember

Chapter 6 The theory of the firm I: Production, costs, revenues and profit

Higher level topics

(c) Total product curve

units of output TP (c) Total cost, total variable cost and total
fixed cost curves
0
units of variable input (labour) TC
TVC

costs

units of output TFC
0 output, Q
AP
MC
0 MP
units of variable input (labour) ATC
AVC
(d) Marginal and average product curves

Figure 6.1 Total, marginal and average products

units of output (AP, MP) costs

AP AFC
MP
0 0 output, Q
units of variable input (labour) (d) Average cost and marginal cost curves
Figure 6.2 Total, average and marginal cost curves
MC
costs (AVC, MC) AVC

0 output, Q Figure 6.3 Product curves and cost curves are mirror images due to the law of
diminishing returns
© Cambridge University Press 2012
Economics for the IB Diploma 17

(b) Long-run average total cost curve in relation to Important diagrams to remember
short-run average total cost curves
(c) Economies and diseconomies of scale

a SRATC1 LRATC economies diseconomies
b SRATC2 of scale of scale LRATC

costs
costs
SRATCm

0 output, Q

0 Q1 Q2

output, Q

Figure 6.5 The long-run average total cost curve

(a) Profit-maximising firm produces at Q2 and (b) Profit-maximising firm produces at Q2 and (c) The loss-minimising firm produces at Q2
makes economic profit: TR – TC = c – d makes zero economic profit: TR – TC = 0 (if it produces) and makes a loss = TC – TR

(it earns normal profit) = a – b (negative economic profit since

TR < TC )

TC TC TC
TR a TR
TR
a b
costs, revenues e
costs, revenuesc
costs, revenuesaf

d
b

0 Q1 Q2 Q3 Q 0 Q1 Q2 Q3 Q 0 Q1 Q2 Q3 Q

Figure 6.10 Profit maximisation using the total revenue and total cost approach when the firm has no control over price

(a) Profit maximisation TC (b) Loss minimisation TC
TC, b
TR TR TC,
TR
a

TR

0 Q max Q 0 Q1min Q

Figure 6.11 Profit maximisation using the total revenue and total cost approach when the firm has control over price

© Cambridge University Press 2012 Economics for the IB Diploma 18

Important diagrams to remember

Chapter 7 The theory of the firm II: Market structures

Higher level topic

PP
S

Pe Pe D

0 D 0 Q
(a) Individual firm Q (b) Market/industry

Figure 7.1 Market (industry) demand and supply determine demand faced by the perfectly competitive firm

TR P, MR, AR
TR 40
30
70 20
60 10
50 D = P = MR = AR
40 0 1234567Q
30 (b) Marginal and average revenue
20
10

0 1234567Q

(a) Total revenue

Figure 7.2 Revenue curves under perfect competition

price, MC ATC
revenue, 1 AVC
costs

P = minimum ATC = break-even price P > ATC P1 2
firm makes normal profit, firm makes economic
or zero economic profit (supernormal) profit P2 3

P = minimum AVC = shut-down price ATC > P > AVC P3 4
firm is indifferent between producing firm makes loss but P4 5
continues to produce P5
at a loss or not producing 0 Q5 Q4 Q3 Q2 Q1
P < AVC output, Q
firm makes loss
and shuts down

Figure 7.4 Summary of the perfectly competitive firm’s short-run decisions, and the firm’s short-run supply curve

© Cambridge University Press 2012 Economics for the IB Diploma 19

Important diagrams to remember

(a) Economic profitprice, revenue, costs MC ATC AVC price, revenue, costs(b) Zero economic profit (normal profit)
P1 total profit a P1 = MR1 = AR1 = D1
0 MC
b profit ATC
Q AVC
Q1
Q P2 P2 = MR2 = AR2 = D2
= break-even price
(break-even point)

0 Q2 Q

(c) Economic loss: the firm continues to produce (d) Loss in the short run and the shut-down price

price, revenue, costs MC price, revenue, costs MC
ATC ATC AVC
AVC
e
c P3 = MR3 = AR3 = D3
loss
P3 total loss d total loss f P4 = MR4 = AR4 = D4
0
Q P4 loss = AFC = short-run
Q shut-down price
Q3 Q 0
Q4 Q

(e) The loss-making firm that will not produce

price, revenue, costs MC
ATC AVC

g

P5 h P5 = MR5 = AR5 = D5
0 Q5 Q

Figure 7.3 Short-run equilibrium positions of the perfectly competitive firm

(a) The firmprice, costs, revenue MC (b) The industry S
Pe LRATC P
D
SRATC Pe Q
D = MR

0 Qf Q 0 Qi

Figure 7.5 The firm and industry long-run equilibrium position in perfect competition

© Cambridge University Press 2012 Economics for the IB Diploma 20

Important diagrams to remember

(a) The firm From economic (supernormal) profit to normal profit
(b) The industry
P1
P2 P S1

costs, revenue, P MC ATC S2
2
a P1 1
b D
P2

0 Q2 Q1 Q 0 Q1 Q2 Q
(c) The firm
From loss to normal profit
P1 (d) The industry
P2
0 costs, revenue, P MC ATC P
a
S2

P2 2 S1

b 1
Q1 Q2 P1

Q D
0 Q2 Q1 Q

Figure 7.6 From short-run equilibrium to long-run equilibrium

P S = MC
MC

costs, revenue, P ATC consumer

surplus

Pe P = MR = Pe Pe

producer

surplus

0 Qe Q0 D = MB
(a) The firm Qe Q

(b) The market/industry

Figure 7.7 Productive and allocative efficiency in perfect competition in the long run

© Cambridge University Press 2012 Economics for the IB Diploma 21

Important diagrams to remember

total revenue ( )(a) Total revenue (a) price, costs, revenue MC
a ATC
40 Pe
35 profit b
30
25 TR 0 MR D = AR
20 (b) Q max Q
15
10 Q Pe loss
5
MC
0 1 2 3 4 5 6 7 8 9 10 11 c ATC
d
(b) Marginal and average revenue price, costs, revenue

PED > 1 PED = 1

15 (price-elastic (unit elastic demand)

demand)

price, revenue ( ) 10 PED < 1 MR D = AR
(price-inelastic 0 Qlmin Q

demand) Figure 7.11 Profit maximisation and loss minimisation
in monopoly: marginal revenue and cost approach
5

P = AR = D

0 Q
1 2 3 4 5 6 7 8 9 10 11

-5
MR

Figure 7.10 Revenue curves in monopoly

price, costs, revenue MC costs LRATC

Pπ
Pr

D = AR 0 D Q
Figure 7.13 Natural monopoly
0 Qπ Qr Q minimum efficient
MR scale

Figure 7.12 Comparison of profit maximisation and revenue maximisation
by the monopolist

© Cambridge University Press 2012 Economics for the IB Diploma 22

Important diagrams to remember

(a) Industry in perfect competition (b) Monopoly MC
S = MC
Pm b
a a
Ppc P = MRpc
Ppc
D = MB
0 Qpc Q

Figure 7.14 Higher price, lower output by the firm in monopoly
price, costs, revenue D = MB
price, costs, revenue

0 Qm Qpc Q

MRm

(a) Perfect competition (b) Monopoly

P S = MC P consumer MC
surplus welfare (deadweight) loss
A D = MB
consumer Q C E
Pm F
Ppc surplus
D
producer
surplus producer D = MB
B surplus Q

0 Qpc 0 Qm Qpc
MRm

Figure 7.15 Consumer and producer surplus and welfare (deadweight) loss in monopoly compared with perfect competition

(a) Perfectly competitive firm (b) Monopoly

price, costs MC
price, costs, revenue
MC ATC
ATC Pe

Pe

0 Qpe Q D

at long-run equilibrium 0 Qm MR Q
production takes place at min ATC
(productive efficiency), and at long-run equilibrium
Pe = MC (allocative efficiency) production takes place at greater than
min ATC (productive inefficiency), and
Pe > MC (allocative inefficiency)

Figure 7.16 Allocative and productive inefficiency in perfect competition and monopoly

© Cambridge University Press 2012 Economics for the IB Diploma 23

Important diagrams to remember

(a) Economic profit (b) Normal profit (c) Losses
Pe
price, costs, revenue economic price, costs, revenue losses MC ATC
(supernormal) price, costs, revenue
profit MC ATC

MC Pe

Pe
ATC

D = AR D = AR D = AR
Q Q
0 Qe Q0 Qe 0 Qe MR
MR
MR

Figure 7.21 Short-run equilibrium positions of the firm in monopolistic competition

Intergalactic Space Travel’s price

High price Low price

price, costs, revenue MC Universal Space Line’s price High price 40 70
Pe ATC million million

40 Zs 10 Zs
million million
4 2
Zs Zs

D = AR

0 Qe Qc Q Low price 10 20
million million
MR 70 20
million Zs million Zs

Zs 3 Zs 1

Figure 7.22 Long-run equilibrium of the firm in monopolistic Figure 7.23 Game theory: the prisoner’s dilemma
competition

price, costs, revenue Pe MC ATC P
a
profit P1 Z MC1
b MC2

D = AR D
MR 0 Q1 Q

0 Q max Q MR

Figure 7.24 Profit maximisation by a price-fixing cartel Figure 7.25 The kinked demand curve

© Cambridge University Press 2012 Economics for the IB Diploma 24

P P Important diagrams to remember
P1
P2 P MC

D1 Q 0 Q2 D2 MR = MR1 + MR2
0 Q1 (b) Market 2 0 Q3 Q
MR2 (c) Market 1 and market 2
MR1 Q
(a) Market 1

Figure 7.26 Third-degree price discrimination

© Cambridge University Press 2012 Economics for the IB Diploma 25

Important diagrams to remember

Chapter 8 The level of overall economic activity

entrepreneurship land, labour, capital,
resource
capital, markets entre
seholdrenitnetr,cewosmta,gpeerso, fit) costs of prod
preneurship
uction

h ex
land, labour, households firms
hou (consumers) (businesses)
in (
es
goods peonudsietuhroeld revenues
and services product goods and servic
markets

Figure 8.1 Circular flow of income model in a closed economy with no
government

households factor incomes firms
(consumers) (wages, rents, interest, profit) (businesses)

saving consumer expenditure
taxes
ng on imports (spending on goods and services)

financial markets investment ding on exnptosrptesnding

spendi government governme
other countries spen

Figure 8.3 Circular flow of income model with leakages and injections

© Cambridge University Press 2012 Economics for the IB Diploma 26

Important diagrams to remember

real GDP actually achieved

real GDP peak contraction long term growth trend,
expansion or potential GDP
peak

trough

trough

0 time (years)
Figure 8.4 The business cycle

actual GDP > potential GDP;
there is an output gap:
unemployment < natural
rate of unemployment

expansion: contraction: actual GDP
unemployment unemployment
c
falls increases

d

real GDP be long term
growth trend, or
potential GDP =
full employment GDP;
a actual GDP < potential GDP; there is an unemployment =
output gap: unemployment > natural natural rate of
unemployment
rate of unemployment

0
time (years)

Figure 8.5 Illustrating actual output, potential output and unemployment in the business cycle

© Cambridge University Press 2012 Economics for the IB Diploma 27

Important diagrams to remember

Chapter 9 Aggregate demand and aggregate supply

(a) The aggregate demand curve (a) The upward-sloping SRAS curve
SRAS

price level price level

AD 0 real GDP
0 real GDP (b) Shifts in the SRAS curve

(b) Shifts in the aggregate demand curve SRAS3 SRAS1 SRAS2

price level price level

AD3 AD1 AD2 0 real GDP
0 real GDP Figure 9.2 The short-run aggregate supply curve (SRAS )

Figure 9.1 The aggregate demand (AD) curve

(a) The economy with a deflationary (b) The economy with an inflationary gap (c) The economy at the full employment
(recessionary) gap level of output

SRAS SRAS

price level AD SRAS
price levelYp Ye
price levelreal GDP AD
Ple Ple Ple Yp = Ye
AD 0 real GDP

0 Ye Yp 0
real GDP

Figure 9.4 Three short-run equilibrium states of the economy

© Cambridge University Press 2012 Economics for the IB Diploma 28

(a) Changes in aggregate demandprice level Important diagrams to rememberprice level

SRAS (b) Changes in short-run aggregate supply

Pl2 SRAS3
Pl1 SRAS1
Pl3 AD2
Pl3 SRAS2
AD3 AD1 Pl1
0 Y3 Y1 Y2 Pl2

real GDP AD
0 Y3 Y1 Y2
Figure 9.5 Impacts of changes in short-run macroeconomic equilibrium
real GDP

(a) Changes in aggregate demand (b) Changes in short-run aggregate supply
LRAS
LRAS
SRAS
Pl3 SRAS2
Pl1 SRAS1
Pl2 AD3
price level price level Pl2 SRAS3
AD2 AD1 Pl1

0 Yrec Yp Yinfl real GDP Pl3

AD
0 Y2 Yp Y3 real GDP

recessionary inflationary recession with higher real
(deflationary) gap gap inflation GDP with lower

('stagflation') price level

Figure 9.6 Possible causes of the business cycle

price level LRAS
SRAS

AD
0 Yp

real GDP

Figure 9.7 The LRAS curve and long-run equilibrium in the monetarist/
new classical model

© Cambridge University Press 2012 Economics for the IB Diploma 29