sample answers 2 10- 5 10 etc

5/26/2018 Sample Answers 2 10- 5 10 Etc

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7. Microeconomic

What you should know

Markets

You should be able to:

dene markets and explain the importance of price as a signal and as an

incentive in terms of resource allocation

dene demand, explain the law of demand and its exceptions, identify the

determinants of demand, distinguish between a movement along a demand

curve and shift of the demand curve, and show all of the above in diagrams

dene supply, explain the law of supply, identify the determinants of supply,

explain the effects of taxes and subsidies on supply, distinguish between a

movement along a supply curve and shift of the supply curve, and show all of

the above in diagrams

explain the causes and consequences of maximum and minimum prices,

explain price support and/or buffer stock schemes and commodity agreements

and show all of the above in diagrams.

Elasticities


dene price elasticity of demand (PED), give the equation, explain the possible

range of values, explain the determinants of PED, explain how PED varies

along a straight-line demand curve, and show all of the above in diagrams

dene cross elasticity of demand (XED), give the equation, explain the possible

range of values in relation to substitutes and complements, and show all of the

above in diagrams

dene income elasticity of demand (YED), give the equation, explain the

possible range of values in relation to luxury goods, normal goods, and inferior

goods, and show all of the above in diagrams

dene price elasticity of supply (PES), give the equation, explain the possible

range of values, explain the determinants of PES, and show all of the above in

diagrams

explain how PED, XED, and YED may be of use to rms and the government

when making economic decisions.

365_IB Prep Econ SL ch07.indd 17


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icroeconomics

Essential definitions

Market failure


dene market failure, explain different reasons for market failure, including

monopoly power, public goods, merit goods, demerit goods, positive and

negative externalities, and show all of the above in diagrams

explain sustainable development

explain possible government responses to market failure, including legislation,

direct provision of public and merit goods, taxation, subsidies, tradeable

permits, extension of property rights, positive and negative advertising, and

international cooperation among governments.

Markets

A marketis where buyers (consumers) and sellers (producers) come together to

establish an equilibrium price and quantity for a good or service. It does not need

to be an actual place. An example would be the market for MP3 players.

Demandis the willingness and ability to purchase a quantity of a good or service

at a certain price over a given time period.

The law of demandstates that as the price of a good or service rises, the quantity

demanded decreases, ceteris paribus.

Ceteris paribusis a Latin expression that means let all other things remain

equal. It is an assumption made by economists in order to construct economic

models.

The demand curveis a graphical representation of the law of demand. It is

(usually) a downward-sloping curve (or line) illustrating the inverse relationship

between price and quantity demanded.

Supplyis the willingness and ability of a producer to produce a quantity of a good

or service at a certain price over a given time period.

The law of supplystates that as the price of a good rises, the quantity supplied

increases, ceteris paribus.

The supply curveis a graphical representation of the law of supply. It is an

upward-sloping curve (or line) illustrating the direct relationship between price

and quantity supplied.

Equilibrium priceis the market clearing price. It occurs where demand is equal

to supply.

A maximum priceis also known as a ceiling price. It is a price set by the

government, above which the market price is not allowed to rise. It may be set to

protect consumers from high prices, and it may be used in markets for essential

goods, such as rice or house rentals.Continued



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Markets (continued)

A minimum priceis also known as a oor price. It is a price set by the

government, below which the market price is not allowed to fall. It may be set to

protect producers producing essential products from facing prices that are felt to

be too low, such as many agricultural products in the European Union (EU).A buffer stock schemesets a maximum and a minimum price in a market to

stabilize prices.

Elasticities

Price elasticity of demand (PED)is a measure of the responsiveness of the

quantity demanded of a good or service to a change in its price.

Elastic demandmeans that a change in the price of a good or service will cause

a proportionately larger change in quantity demanded and inelastic demand

means that a change in price of a good or service will cause a proportionately

smaller change in quantity demanded.

Cross elasticity of demand (XED)is a measure of the responsiveness of the

demand for a good or service to a change in the price of a related good.

Substitute goodsare goods that can be used instead of each other, such as butter

and margarine. Substitute goods have positive cross elasticity of demand.

Complement goodsare goods that are used together, such as DVD players and

DVD discs. Complement goods have negative cross elasticity of demand.

Income elasticity of demand (YED)is a measure of the responsiveness of

demand for a good to a change in income.

Anormal goodhas a positive income elasticity of demand. As income rises,

demand increases.

Inferior goodshave a negative income elasticity of demand. As income rises,

demand decreases.

Price elasticity of supply (PES)is a measure of the responsiveness of the quantity

supplied of a good or service to a change in its price.

An indirect taxis an expenditure tax on a good or service. An indirect tax is shown

on a supply and demand diagram as an upward shift in the supply curve, where

the vertical distance between the two supply curves represents the amount of the

tax. A specific taxis shown as a parallel shift. An ad valoremtaxis shown as a

divergent shift.

Market failure

Market failureis the failure of

markets to produce at the socially

efcient level of output.

Positive externalitiesarebenecial effects that are enjoyed

by a third party when a good or

service is produced or consumed.

Negative externalitiesare the bad

effects that are suffered by a third

party when a good or service is

produced or consumed.

Public goodsare goods or services

that would not be provided at

all by the market. They have the

characteristics of non-rivalry and

non-diminishability, for example,ood barriers.

Merit goodsare goods or services

considered as benecial for people

and that would be under-provided

by the market and so under-

consumed, for example, education

and health care.

Demerit goodsare goods or

services considered to be harmful

to people and that would be over-

provided by the market and so over-

consumed, for example, cigarettes

and alcohol.



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icroeconomics

Diagrams to remember

Circular flow of income diagram

Markets

Equilibrium

Quantity of tea (kg)0

Price oftea ($)

Pe

Qe

S

D

The equilibrium point is where the quantity demanded of a

good or service at a given price is the same as the quantity

supplied. In this case, at a price Pe, the quantity of tea

demanded and supplied is Qe.

An increase in demand

Quantity of computergames (000s)

S

P2

P1

0Q

1Q

2

D1

D2

Price of computergames ($)

An increase in demand for computer games (D1to D

2) could

be caused by a change in any of the determinants of demand,

for example, an increase in consumer incomes or a decrease

in the price of computers, a complement. The result is

an increase in quantity (Q1to Q

2) and an increase in price

(P1to P

2).

An increase in supply

Quantity of computer

games (000s)

D

P1

P2

0Q

1Q

2

S1 S2

Price ofcomputers ($)

An increase in the supply of computers (S1to S

2) could be

caused by a change in any of the determinants of supply, for

example, a fall in the cost of factors used to make computers

or an improvement in technology. The result is an increase in

quantity (Q1to Q

2) and a fall in price (P

1to P

2).

A maximum price

Quantityof housing

0

Rent ($)

Pe

Qe

S

PMax

Q1

Q2

Excessdemand D

Maximumprice

A maximum rent (a rent control) of PMax

is placed upon rented

accommodation. This keeps the rents low, but it means that

there will be an excess demand for rented accommodation of

Q1to

Q

2.

Continued



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Markets (continued)

A minimum price

Quantity of corn(000s tonnes)

0

Price ofcorn($)

Pe

Qe

S

PMin

Q1

Q2

Excess supply

D

Minimumprice

A minimum price of PMin

is placed upon the corn market. This

keeps the price of corn high, but it means that there will be an

excess supply of corn of Q1to Q

2.

A specific tax on a product

Number of loavesof bread (000s)

0

D1

Price ofbread ($)

S1

ST

PT

R

P1

QT

Q1

Indirect tax

The imposition of an indirect tax of PTR shifts the supply curveupwards from S

1to S

Tand raises the price to consumers from

P1to P

T. The quantity demanded and supplied falls from Q

1to

QT. The revenue per unit received by the producers falls from

P1to R. The government will receive tax revenue of P

TR per

unit for QTunits.

Elasticities

Price elasticity of demand (PED) values for a normal

demand curve

Quantity ofsh (tonnes)

PED>1

0

D1

Price ofsh ($)

PED


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icroeconomics

Circular flow of income diagram

Market failure

Negative externalities of production

Quantity ofchemicals(tonnes)

0

Price of chemicals ($)

MSB

P*

Q*

Welfare lossMSC

P1

Q1

MPC

Negativeexternalitya

The chemical rm is polluting the atmosphere as it produces.Thus the cost to society (MSC) is greater than the private cost

(MPC). There is a loss of welfare for society as chemicals are

overproduced. A negative externality, a cost to third parties,

has been created. This is a market failure, as the market does

not produce at the socially efcient level of output (Q*).

Positive externalities of production

Quantity ofchemicals(tonnes)

0

Price of chemicals ($)

MSB

P1

Q1

Potentialwelfare gain MSC

P*

Q*

MPC

Positive

externality

a

The chemical rm is giving training to its workers. Thus the

private cost (MPC) is greater than the cost to society (MSC).

When the workers move on, there is a positive benet to the

rms that employ them, the third parties. In a free market,

the level of output is Q1; this is a market failure because the

socially efcient level of output is Q*, and so the market is

under-producing. The shaded area shows the potential welfare

gain that could be achieved.

Negative externalities of consumption

Quantity ofair travel(miles)

0

Price of air travel ($)

MSB

P1

Q*

Welfare loss MSC

P*

Q1

MPB

Negativeexternality

By consuming air travel there are more ights, and so thirdparties are affected by increased noise and air pollution. The

benet to the individuals who are ying (MPB) is greater than the

benet to society (MSB). There is a loss of welfare and a negative

externality has been produced. In a free market, the level of

output is Q1; this is a market failure because the socially efcient

level of output Q* is not achieved and air travel is over-consumed

Positive externalities of consumption

Quantity ofvaccinations

0

Price of vaccinations ($)

MSB

P*

Q1

Potentialwelfare gain

MSC

P1

Q*

MPB

Positiveexternality

By paying for and being vaccinated, individuals gain benet

for themselves (MPB). In addition third parties who have not

been vaccinated stand less chance of getting the disease, since

there are fewer carriers. Thus they also benet, and the totalbenet to society (MSB) is greater than MPB. In a free market,

the level of output is Q1; this is a market failure because

the socially efcient level of output Q* is not achieved, as

vaccinations are under-consumed. The shaded area shows the

potential welfare gain that could be achieved.



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the advantages and disadvantages of minimum and maximum prices

the likely success of a buffer stock scheme

the effects of government subsidies given to cotton farmers

the effects of government intervention in the markets for demerit goods

the advantages and disadvantages of government policies to control pollution.

Remember to make reasoned judgments or conclusions.

You should be able to evaluate:

Using supply and demand analysis, explain why the price of agricultural goods

tends to fluctuate more than the price of manufactured goods.

10 mark

The following is a typical question from

paper 1 part (a) and you should spend

approximately 25 minutes on it.

[Taken from SL paper 1(a) November 200

How do I approach the question?

Start by dening demand and supply and then draw a

demand and supply curve diagram to explain how price is

determined.

Introduce the topic of agricultural goods and give an example,

such as rice, which you can then use for the rest of the answer.

Dene PED and PES and explain that the PED and the PES for

agricultural goods tend to be relatively inelastic, particularly

in the short run, due to the inability to increase quantity (PES)

and the dependence on agricultural goods (PES). Draw and

label a diagram for rice with steep, relatively inelastic demand

curves and inelastic supply curves and show a shift in the supply

curve. Explain that the supply of agricultural goods tends to be

rather volatile, because they are dependent on the weather; use

the diagram to explain that a change in supply with inelastic

demand and supply will lead to relatively large changes in price.

Introduce the topic of manufactured goods and give an

example, which you will then use for the rest of the answer.

Explain that the PED and the PES for manufactured goods

tend to be relatively elastic. Draw and label a diagram for your

example with at, relatively elastic demand and supply curves

and show a shift in the supply or the demand curve.

Explain that the PED for your example will be relatively elastic,

because the industry is very competitive, and that the PES

is relatively elastic because it is relatively simple to increase

supply in response to price changes. Explain that a change in

demand or supply with relatively elastic demand and supply

will lead to relatively small changes in price.

Explain that, as can be seen from the diagrams, the price

of agricultural goods tends to uctuate more than the price

of manufactured goods and that this is because of different

elasticities of demand and supply. The unpredictable supply

caused by the weather is also crucial for price instability.



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icroeconomics

What are the key areas from the syllabus?

Interaction of demand and supply

Elasticities

Applications of concepts of elasticity

What needs to be defined?

Demand

Supply

Elasticity of demand Elasticity of supply

What diagrams do I use?

Basic demand and supply curve diagram

Shifts in demand and supply curves for agricultural goods

Shifts in demand and supply curves for manufactured goods

This answer achieved 2/10

In an economy the supply and demand depend on each other. It is important to have a stableeconomy. This can be shown or noticed if the market is in an equilibrium. However, the price changescontinuously for every good, so that the demand and supply side have to regulate and change in orderfor the markets to exist. The price of an agricultural good tends to fluctuate more than the price ofmanufactured goods. Agricultural goods depend on the season. It is a scarce resource land. Since itis not a stable product the demand and supply side change. As the productivity of the good increaseswhich means more supply the price will definatly increase as well.

This can be seen on Figure 1.1.

P

P1

Po

S

D

QO Q1

Supply Price

Supply curve

Q

Fig 1.1

This is only a move along the curve. However, as the price of productivity of the good increases thesupply will decrease.

Demand, supply, and equilibrium

could all have been defined. The

student introduces the idea of

seasonality, but the last sentence is a

significant error. If supply increased, price

would fall.

The diagram does not tie in with

the previous sentence. The change

shown requires a shift of the demand

curve and the statement as the price

of productivity of the good increases the

supply will decrease makes no sense in

the circumstances.



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D

S0S1P

P1PO

Q1 QO Q

price production supply

Production costs

Fig 1.2

On the other side if the production price decreases there will be more supply. This is also dependable onthe if the good for example corn has been grown well this year. The more the farmer has for supplythe higher the prices can be. However it is quiet normal to storage agricultural goods in case of ashortage.

Agricultural goods also depend on the demand of the buyers. If the demand for a seasonal good isweak because of a substitute for example the prices will decrease of that particular good.

S

DOD1Q1 QO Q

POP1

P

substitute = demand price

Fig 1.3

This causes a shift to the left of the demand curve.

However, if there is a shortage of an agricultural good and it is important to everyday life then theprices will increase. Shown on Figure 1.4

S

D2D1

QQ2Q1

P1

PMore demand higher prices

demand price

Fig 1.4

This diagram suggests that if

production costs increase, supply will

fall. While correct, it is hard to see

the significance.

The student makes another

significant error in thinking that

increased supply will lead to higher

prices.

The comment includes economic

terminology, but makes little sense

and has little to do with the question,

so the diagram is redundant.

The student mentions a shortage,

and yet shows a shift of the demand

curve, which makes no sense.



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icroeconomics

Manufactured goods are stable. They are always produced constantly and do not depend on weatheror a season. They are available throughout the whole year long. Thats why the demand depends onhow the product is advertised, on taste and preferences and on the joined demand. There are noshortages of surpluses in manufactured goods such as there are in agricultural goods.

Surplus

Floor

Ceiling

Shortage

P

Q1 Q

P1

min

max

D

S Max + MinPrices

Fig 1.5

The student showed little understanding of the specific demands of the question. There was little recognition of relevant economic

theory and none of the relevant terms were defined. There were significant errors. This puts the response into level 1 and explains the 2

marks given.

The student never seemed to understand the terms being used and this could be seen from the lack of definitions and the confusion

between productivity of the good, price of productivity, production costs, and production price. The student also wrote away

from the point and did not engage with the question being asked and so level 2 could not be awarded.

Examiner report

The first three sentences are relevant

and correct, but then the student

once again strays from the question

asked.


The student provides reasonable

definitions and makes his or her

understanding of the basic concept

of elasticity clear.

Supply is the amount that the producer is willing and is available to sell of a product. Demand is theamount consumers are willing to buy. When demand and supply intersect, there is an equilibriumpoint. This point sets the price for the product. It is the price set by the forces of demand and supply.Elasticity is the responsiveness of a change of price in the quantity demanded of a product. The morethe vertical the demand curve is, the more inelastic the product. This means that when the pricechanges, the quantity demanded will not be affected by much. On the other hand, if the product iselastic a change in price will bring about a much greater change in the quantity demanded. This ismainly because of the availability of substitutes of the product, the needs of the people and other thingssuch as if the product is addictive for example nicotine in cigarettes.



11/13

The student showed some understanding of the specific demands of the question and recognized some of the relevant theory. Some

relevant terms were defined, but not all. There were errors in the explanation. This puts the response clearly into level 2 and explains

the 5 marks given.

The main weakness was a lack of planning and insufficient explanation. The diagrams were rather simplistic and there was no direct

comparison of the relative elasticity values between manufactured and agricultural goods and so level 3 could not be awarded.

Examiner report

P1

P$

Pe

S

D

q1 qe q

In the diagram above we can see the price equilibrium (Pe) set by the forces of S and D. The quantitydemanded at that price will be Qe. With a change in price, the quantity demanded will fall drasticallyfrom Qe to Q1, a much greater change in quantity than in price. This would be the diagram formanufactured goods.

On the other hand, we can say that the agricultural goods are inelastic because of the reasonsmentioned before. Agricultural goods dont have substitutes, you choose to consume or not consume,

you cannot choose another option. This lets prices fluctuate much more than on manufacturedproducts that prices cannot fluctuate very much because people will choose the other substitutes.

S

q

P$

P1

Pe

p

Dq1 q

q

In the diagram above one can see how a change in price will bring a much smaller change in thequantity demanded. This would definitely be the diagram for agricultural products.

The diagram is incomplete. If the

student wants to show a change away

from the equilibrium, then he or she

must show a shift of a curve, in this

case a shift of supply to the left.

This is a reasonable explanation,although it does tend to generalize

about agricultural goods.

The diagram is once again

incomplete, in the same way as was

the previous diagram. However, it

does support the point made and,

along with the brief explanation, infers

some understanding of the question.

The explanation does not say why

the price may have changed. Also,

the student does not explain why

this would be the diagram for

manufactured goods. There is no mention

of elasticity.



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icroeconomics


A good definition of supply was

followed by the introduction of

supply elasticity and another good

definition. The student refers to the

diagram to follow and adds a definition

of demand.

The fluctuation in the price of agricultural produce may be due to the inelastic nature of its supply.Supply here refers to the quantity of a good or service that producers are willing to put on the marketat a given price over a specific period of time. This supply is inelastic in nature due to the process ofproduction of agricultural goods, the elasticity of supply referring to measure of responsiveness ofchanges in the supply of a good due to changes in the goods own price. Hence, given that farmproduce is inelastic in supply, a minor change in its demand can lead to a huge fall in price as shownin the following diagram. Demand referring to the amount of a good or service that consumers arewilling to buy at a given price over a specific period of time.

Quantity of farm produceq3 q1 q2

p2

p1

p3Price

offarmp

ro

duce

D''

DD'

S

When demand rises to D, perhaps due to a favourable change in tastes and preferences, price ofagricultural produce rises to P

2. When demand falls to D, perhaps due to the development of

synthetic substitutes such as artificial sweeteners to replace real sugar, price falls to P3.

Fluctuations in price can also be due to changes in supply. This may be due to weather or technologicaladvancements. Take for example, a sugar cane farm here in Swaziland. In a good year, withabundant rainfall, there is excess supply. In a year of drought however, supply will again fall. This

can be represented in a diagram as shown on the following page.D S'' S

S'

P3P1P2

q3 q1 q2

Priceo

ffarmp

ro

duce

Quantity of farm produce

S' good yearS'' year of drought

As seen from the diagram, in a good year, supply shifts to the right causing equilibrium price to fall toP2while in a bad year (year of drought) supply shifts to the left causing equilibrium price to rise to P

3.

The previously discussed problems are not as prevelent in the manufacturing industry. Given thatsupply of manufactured goods is elastic due to the non-complexity of the production process, shifts indemand of manufactured products does not result in much of a change in price. Also, supply ofmanufactured products is more constant, again due to the nature of its production process.

The student now uses another good

diagram to explain and develop the

answer in relation to how changes

in supply will also lead to large

fluctuations in prices for agricultural

goods.

The student suggests how the

market for manufactured goods is

different and why there would not

be such large fluctuations in price.

The student supplies an accurately

drawn diagram and a good

explanation of why the demandmay have changed, giving realistic

factors, and using the diagram to

illustrate the points made.



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The student understood the specific demands of the question and explained and developed relevant theory. Economic terms were

defined in all cases and there were no significant errors. Some diagrams were introduced and explained. This puts the response clearly

into level 3 and explains the mark of 8.

The student concentrated too much upon agricultural goods and their prices and did not really go into enough detail regarding

manufactured goods. No examples were given and there was no use of a diagram to show the relatively elastic demand, so level 4 could

not be awarded.

Examiner report

Evaluate the proposition that government intervention in the market for tobacco is

justified.

15 mark

The following is a typical question from

paper 1 part (b) and you should spend

approximately 35 minutes on it.

[Taken from SL paper 1 May 200

How do I approach the question?

First, you need to identify what the question is asking you to

evaluate, which in this case is the proposition that government

intervention in the market for tobacco is justied. That is,

should governments intervene in the tobacco market or not?

So now you should explain that tobacco is a demerit good,

in the form of cigarettes, and dene demerit goods. You may

also explain that cigarettes are an example of a market failure

in that they are over-provided and are over-consumed. Then

draw a negative externalities (of consumption) diagram,showing that the marginal social benet (MSB) of cigarettes

is less than the marginal private benet (MPB), and so the

consumption of cigarettes causes a negative externality. Then

you should explain the diagram.

You may now explain the two main methods of government

intervention in tobacco markets: indirect taxes on cigarettes,

and increased regulation (such as bans, age restrictions, and

health warnings). You may also draw a diagram to show the

effect that these would have on the tobacco market.

Now introduce and explain the arguments for government

intervention, which may include reducing negative

externalities and thus market failure, more socially efcient

allocation of resources, improved health in the work force,

and a source of government revenue.

Now you should offer arguments against government

intervention, which may include distorting the role of prices

in the market, loss of employment in the tobacco industry,

reduction of consumer choice, the creation of parallelmarkets, and the cost of negative advertising.

Now evaluation can take place. You might compare the

arguments for and against intervention and then decide that

the arguments for are more weighty than the arguments

against, since the intervention will affect more people

positively than negatively and will lead to a more socially

efcient allocation of resources.


sample answers 2 10- 5 10 etc

Documents

diagrams dene supply

supply curve

demand curveis

law of supply

thedeterminants of demand

straightline demand

dene market failure

determinants of supply