2019 May (AD/AS Deflationary Gap) Paper 1 HL

 2019 May (AD/AS Deflationary Gap) Paper 1 HL

3. (a) Explain how a deflationary gap might occur.

 

Definition

 

Deflationary Gap – when the AD curve shifts left of full employment also called a recessionary gap. Actual output is below the full employment output level due to a decrease in AD. Price Level (PL) has decreased.

 

Diagram

Explanation

 

As consumer confidence in the economy falls consumers decide to spend less money on goods and serves causing AD to shift left below the full employment output level, PL decreases and output decreases and the economy to fall into a recession or a deflationary gap.

To fix a deflationary gap the appropriate Fiscal Policy would be to increase (Gs) government spending or decrease taxes causing consumers to have more income and therefore spend more increasing consumption and shofting aggregate demand back toward full employment. Monetary policy can correct a deflationary gap by inreasing the money supply causing the AD curve to shift to the right back toward full employment.

 

2019 (PED Indirect Tax) Paper 1 HL

 2019 (PED, Indirect Tax) 

Paper 1 HL

2. (b) Examine the significance of price elasticity of demand for the decision making of firms and governments.

 

Definitions

PED – a measure of the responsiveness of the quantity demanded to a change in the price along a given demand curve.

 

Indirect Tax = is a tax placed on the producer (produced goods and services) which is then (partly) passed on to the consumer in the form of a higher price.

Total Revenue and elasticity of a good = If the demand for a good is elastic and the firm (gov) increases the price the Qd for the good will decrease by a larger percentage than the price change causing the total revenue for the firm (gov) will decrease. If the demand for the good is inelastic and the firm (gov) increases the price the Qd for the good will decrease by a smaller percentage than the price change causing the total revenue for the firm (gov) will increase.

An indirect tax will raise the price of a good causing the supply curve to shift left and the Qd to decrease, there is a loss of Consumer Surplus and Producer Surplus and DWL. Usually if there is an indirect tax consumers and producers will share the tax meaning that some of the tax will be paid for by consumers while some will also be paid for by the producers. 

Of course the producers would like to make the consumer pay all of the tax but if the demand for the good is elastic and the producer forces the whole indirect tax onto the consumer the price will rise by the amount of the tax and then a larger percentage (compared to the price increase) of consumers will stop buying the product causing the firm's total revenue to decrease.

Understand that the more inelastic the demand, the people buying the good will still purchase much of it even when the price increases. This implies that if the government is trying to gain revenue by the imposition of the indirect tax it would do well to tax goods that have an inelastic price elasticity of demand. If the government is trying to stop people from consuming a product such as taxes, and the cigarettes demand is very inelastic the indirect tax must be higher than if the good has a very elastic demand to get people to forego consumption.

Answers may include:

definition of price elasticity of demand (PED), diagrams to show the relationship between PED, price changes and the total revenue offirms; the relationships between PED, the size of an indirect tax, tax incidence, quantityproduced/consumed and government tax revenue, explanations of the relationship between: PED, price changes and total revenue of firms; how PED affects government tax revenue, production/consumption and tax incidence, examples of PED proving significant for firms and governments in practice, synthesis and evaluation (examine).

• Examination may include: the differing incidence of indirect tax on consumers and firms due to differing price elasticities, the impact of PED on the uses of tax/subsidy to address market failure, the impact of time on PED (and total revenue) when price changes, the difficulty of estimating PED values for firms, other factors affecting demand that cause a change in total revenue/tax revenue. 

• Classic Example of government taxes destroying the yacht industry back in 1990: the government decided to make the rich pay more and decided on a 10% luxury tax all yachts produced would be effective. I think we can understand that a luxury goods elasticity of demand is fairly elastic. When the taxes were imposed the rich simply bought other goods or bought in other countries or just decided not to buy a yacht. It destroyed the boat building industry. Read below.

  https://www.washingtonpost.com/archive/business/1993/07/16/how-to-sink-an-industry-and-not-soak-the-rich/08ea5310-4a4b-4674-ab88-fad8c42cf55b/

• 
  

2019 May (PED) Paper 1 HL

 2019 May (PED) Paper 1 HL

2. (a) Explain why the price elasticity of demand (PED) varies along the length of a straight-line demand curve.

 

Definitions

PED – a measure of the responsiveness of the quantity demanded to a change in the price along a given demand curve.

 

Demand Curve – a graph showing the demand for a commodity changes with a change in its price.

 

Graph/Diagram

 

Demand is price elastic in the upper sections of any linear demand curve and price inelastic in the lower half. It will be unit elastic at the midpoint.

Explanation

 

When the price is greater for a commodity the PED for that good will be greater than 1 and will be called elastic meaning that as the price increases by a percentage the quantity demanded will decrease by a greater percentage. If the price is low for the commodity the PED for the good will be relatively inelastic implying that as the price increases the quantity demanded of the good will fall by a smaller percentage than the price increase.

Example

A good example using a demand schedule, curve and actually calculating the PED change would be helpful to show what you know.

Go to the link below from 2015 paper 3 HL

https://econowaughib.blogspot.com/2020/07/2015-ped-paper-3-hl.html

2019 May (Monopoly/ Natural Monopoly) Paper 1 TZ1

 2019 May (Monopoly/ Natural Monopoly) 

Paper 1 TZ1

1 (b) Evaluate the view that monopoly is an undesirable market structure as it fails to achieve productive & allocative efficiency.

 

Definitions

 

Monopoly – Industry served by one firm.

 

Barriers of Entry – obstacles that prevent other firms from entering a particular industry

 

Allocative Efficiency – optimal quantity of goods produces based on society’s preferences (P = MC)

 

Productive Efficiency – production of goods at their lowest cost

 

Natural Monopoly – most efficient number of firms is one

Diagram of Monopoly

A monopoly due to barriers of entry can keep competitors out of the market/industry allowing it to charge higher prices and producing less output. A monopolist given a choice will produce at profit max which is where its MR = MC (marginal revenue = marginal costs) at this point the price is greater than the MC (allocative efficiency = P = MC) and the price is greater than the minimum of the ATC (productive efficiency = P = minimum of the ATC) This is undesirable as prices are higher than society would like them to be and less output is produced causing a (DWL) dead weight loss or welfare loss to society.

 

In some instances monopolistic firms are desirable in that the industry they are in (electricity, transportation, water) would be better served by one firm being the producer and distributer of the service/good. Natural monopolies exist when an industry is most efficient with only one firm taking advantage of the economies of scale available. Ex. Industries with high sunk costs. Natural Monopolies tend to be forced/regulated to lower prices and produce higher output due to the fact government protection in keeping competitors at bay from entering the industries and competing with the firms. As natural monopolies take advantage of these EOS they could focus more financing toward research and development in the hopes of implementing more innovative techniques to lower costs and maintain economic profits. Of course natural monopolies could also use the government protection to be the only supplier of the good and produce low quality products and services and in extreme cases with no competition workers can become apathetic producing less output and lower qualities with no desire to maximize profits (x-inefficiency). Think of a firm with management so comfortable with the prevailing profits due to lack of competition that they hire more middle management to lighten their work load to make their work life easier will increasing costs to the company. The number of workers has increases with higher costs but output hasn’t increased.

 

John Hicks, who won the Nobel Prize for economics in 1972, wrote in 1935: “The best of all monopoly profits is a quiet life.” He did not mean the comment in a complimentary way. He meant that monopolies may bank their profits and slack off on trying to please their customers.

When AT&T provided all of the local and long-distance phone service in the United States, along with manufacturing most of the phone equipment, the payment plans and types of phones did not change much. The old joke was that you could have any color phone you wanted, as long as it was black. However, in 1982, government litigation split up AT&T into a number of local phone companies, a long-distance phone company, and a phone equipment manufacturer. An explosion of innovation followed. Services like call waiting, caller ID, three-way calling, voice mail through the phone company, mobile phones, and wireless connections to the internet all became available. Companies offered a wide range of payment plans, as well. It was no longer true that all phones were black. Instead, phones came in a wide variety of shapes and colors. The end of the telephone monopoly brought lower prices, a greater quantity of services, and also a wave of innovation aimed at attracting and pleasing customers.

2019 May (Output/Costs/Revenues) Paper 1 TZ1

 2019 May (Output/Costs/Revenues) Paper 1 TZ1

1.     (a) Explain the relationship between the law of diminishing returns and a firms short-run cost curves.

Definitions

Law of Diminishing Returns – as an increasing number of variable inputs (think labor) are added to at least one fixed input (think factory) marginal product first increases and then eventually decreases, or, the marginal cost first decreases and then increases.

 

Costs of Production – costs related to the production of a good (fixed and variable)

Specialization - the understanding that as workers specialize in each task to produce a good or service they become more efficient at the task and therefore can produce more in working together.

There of course is a optimum number of workers for efficiency and a limit, if my taco truck can only hold 5 workers then trying to stuff 10 into the truck to increase production will obviously not work as they bump into each other getrting into each others way in the production process.

 

Short Run – at least one variable is fixed and unchangeable (think the factory) in the short-run we can’t buy/build a larger factory (its fixed) but we can play with other variables such as more or less labor, machines etc. In the Long run we can not only change all of the labor, machines etc but we can also buy/build a larger factory.

 

Long Run – all variables are flexible and can be changed.

 

Diagrams

Explanation

 

Diminishing returns is the understanding that as we add more inputs (workers) to the fixed capital in the production process we will initially get an marginal (per worker) increase in production due to specialization which would cause the costs per worker to decrease as each worker is producing more output per worker but at some point if we keep hiring worker their output will start to decrease (can only have so many people working in our taco truck) as they start bumping into each other and slowing down the process and therefore causing the marginal costs to continually increase as each worker hired produces less and less.

 

Notice that where MP is maximized the MC is minimized – if the workers numbers are at the optimum position then they are maximizing their output per worker, adding more workers just slows down the process causing less production per worker and therefore marginal costs increase.

 

 Jacob Clifford does it well - https://www.youtube.com/watch?v=_TQ62MwzSrY

as does Jason Welker - https://www.youtube.com/watch?v=09sOhhoB-20

2019 Nov (Supply-Side, Growth) Paper 1 HL

 2019 Nov (Supply-Side, Growth) Paper 1 HL

(4) (b) Discuss the view that interventionist supply-side policies are the most effective way for a government to achieve economic growth.

 

Definition

 

Supply-Side Policies – aim at positively affecting the production side of the economy.

 

Interventionist Supply-Side Policies – means the government directly participates in improving the quantity and quality of factors of production to improve total productive capacity.

 

Economic Growth – is the increase in real output in an economy over a period of time.

 

Diagram

 

Show either an increase in both AD & LRAS or the PPC (shifting out) to show economic growth.

 

Interventionist Supply-Side Policies

 

(1)  Investment in Human Capital – The government can invest in education and training and raise the productivity level of its workers. (More educated workers tend to produce more) Ex. Singapore has focused on developing its human capital from its establishment, through mandatory education and incentives for firms to train their employees.

 

(2)  Investment in New Technology – The government can have policies to encourage research and development or to invest in new technology. Ex. During the Cold War era in 1960, the US invested heavily in space technology as it was falling behind the Soviet Union. Due to governmental policy, there was a rapid advance in aerospace technology.

 

(3)  Investment in Infrastructure – The government can invest in essential facilities and services such as roads, airports, and sewage treatment that add to the capital stock of the economy and are necessary for successful economic activities. Ex. Heavy investment in high-speed broadband networks during the dot-com bubble in the early 2000s has provided the necessary infrastructure for data-heavy internet uses today such as video-streaming and cloud computing.

 

(4)  Investment in Industrial Policies – The government may use targeted industrial policies to promote in key growth areas of the economy through the use of tax allowance, tax credits or subsidized lease programs. Ex. Korea and Taiwan have used active government support and directives in strategic industries (such as shipbuilding and microchip manufacturing) to drive economic growth.) The Hong Kong government has offered incentives e.g. rental subsidies to IT startups.

 

Strengths of Interventionist Supply-Side Policies

 

(1)  Addressing market failures resulting from positive externalities – Certain types of investment (such as education and infrastructure) have large positive externalities and would be unprovided under a market system. Government involvement would address the under-provision of the investments.

 

(2)  Creation of Employment – Most interventionist policies have an element of increased government spending and this has the dual effect of creating employment during the use of the policy (jobs provided by construction projects) and after the implementation policy (increased business demand with better roads).

 

(3)  Impact on Economic Growth – Investment in factors of production is essential for sustained growth in the long-term. Policies that directly increase such investment, or encourage private investment, have a positive impact on economic growth.

 

Weaknesses of Interventionist Supply-Side Policies

 

(1)  Impact on Government Budget – Interventionist policies involve higher government spending which increases the government’s budget. Increased government spending has to either come from increased taxes, selling of state owned enterprises, or raising debts.

 

(2)  Time Lag – It takes time to implement interventionist polices and it takes time for these policies to be fully realized. Ex. The construction of hospitals and ports obviously have benefits to society but might not be realized for a number of years.

2019 Nov (Multiplier GDP) Paper 1 HL

 2019 Nov (Multiplier GDP) Paper 1 HL

(4) (a) Explain the effect an increase in investment might have on RGDP using the Keynesian multiplier.

 

Definitions

RGDP – Real GDP is an inflation-adjusted measure that reflects the value of all goods and services produced in an economy in a given year (expressed in base-year prices) and are often referred to as “constant-price”, “inflation-corrected”, or “constant-dollar” GDP.

Investment – addition of capital stock to the country

 

Keynesian Multiplier - below

(AD to AD1 is the initial increase in investment but then the multiplier effect pushes AD to AD3. Therefore the RGDP (Real Output) also increases)

An initial increase in investment, a component of AD, leads to multiple successive increases in AD and RGDP.

 

Explanation – When there is an injection into the system (government expenditure, investment) incomes increase by the amount of the injection at first. However, the increase does not stop there. Assume MPC = 0.5, such that 50% of the additional household income is spent on consumption. With an initial injection of $100, total income increases by $100. The $100 is then paid out to households as factor income (wages) by firms. Household income increase by $100. As MPC is 0.5, households spend 50% of their income, which is $50 spent as consumption expenditure to firms then firms gain $50 and again pay $50 as factor income to household (workers). From the $50 income households now spend $25 on consumption.

 

This in essence is the Keynesian Multiplier formula 1/(1-MPC) or 1/MPS, if the MPC = 0.5 then the MPS = .5 therefore 1/.5 = 2 and the 2 is the Multiplier.

 

An initial increase in investment of $100 x 2 = $200 is the total income (RGDP) generated by the initial increase in income (investment) of $100.