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for
Contents
Introduction
Unit
1
1.1
Unit
the
can’t
Demand
2.2
The
2.3
Are
2.4
What
2.5
The
2.6
Spillover
2.7
Are
2.8
From
2.9
Market
3
to
and
get
what
invisible
we
you
want
8
boxing
ring
17
24
rational?
elasticities
visible
The
hand
really
do
we
supply:
28
and
tickling
have
in
common?
hand
31
40
effects
51
doomed?
61
lighthouses
to
law
and
order
64
power
66
Macroeconomics
Measuring
3.2
Aggregate
3.3
The
3.4
Macroeconomic
3.5
Inequality
3.6
Policies
4
4
Economics
always
3.1
Unit
Programme
Microeconomics
2.1
Unit
Diploma
Introduction
Y
ou
2
to
economic
demand
monetarist
The
and
and
the
76
aggregate
Keynesian
supply
take
81
88
objectives
91
poverty
109
1
18
global
4.1
Why
trade?
4.2
Why
is
4.3
Big
4.4
The
most
4.5
Can
we
4.6
The
great
4.7
Is
economy
131
there
groups,
there
vs.
activity
protection?
little
a
groups
important
import
137
too
145
price
for
a
country
much?
162
divide
way
150
168
out?
177
Index
189
Online
support
material
can
be
found
at
www.oxfordsecondary.com/ib-course-prep
Introduction
I N T R O D U C T I O N
The
Diploma
group.
In
subjects,
Programme
addition
the
course
communication
Y
ou
may
through
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learning
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ou
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Introduction to the diploma programme
Approaches
The
A
TL
to
Learning
categories
engaged
learners.
are
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They
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TL)
group
include
of
strategies,
thinking,
attitudes
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communication,
skills
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research
skills.
Meaning
ATL Skill
Thinking
Emphasis is placed on skills such as metacognition, reection and critical thinking.
Self-management
Self-management covers a wide variety of skills in two categories:
Communication
•
aective skills: resilience, self-motivation and mindfulness
•
organizational skills: managing your time and your tasks and goal-setting.
Communication includes the ability to listen, read and understand as well as to write,
formulate arguments and communicate in a variety of forms.
Research
Research skills include practising responsible and ethical research and information
literacy during independent, self-managed, inquiry learning.
Social
Social skills involve practising self-management of emotions and behaviours while
working collaboratively with others towards a common goal, focusing on the ability to
understand the perspective of others.
K ey
The
■
■
f ea tur e s
economics
microeconomics,
apply
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with
develop
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and
some
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indicates
theories,
as
policy
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models,
economic
and
range
ideas
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of
economics
HL
are
in
students
the
and
develop
and
with
a
models,
ideas
and
tools
in
the
economy
analyse
and
decision
to:
theories,
global
problems
individuals
presented
analysing
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tools
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economic
students
appropriate,
of
syllabus
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and
and
issues
understanding
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macroeconomics
consequences
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topics.
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understanding
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and
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interactions,
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common
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evaluating
syllabus,
skills,
but
economic
HL
with
an
HL
students
relationships
extension
will
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need
order
to
to
in
further
provide
advice.
following
all
or
part
page
of
a
gives
all
sub-topic
the
is
IB
Diploma
covered
in
this
Programme
Economics
course
topics.
Bold
book.
5
Chapter in
Unit
Title
Sub-topic
this book
1
Introduction to
1.1 What is economics?
1.1
Economics
1.2 How do economists approach the world?
2
Microeconomics
2.1 Demand
2.2 Supply
2.1
2.3 Competitive market equilibrium
2.2
2.4 Critique of the maximizing behaviour of consumers and producers
2.3
2.5 Elasticity of demand
2.6 Elasticity of supply
2.4
2.7 Role of government in microeconomics
2.5
2.8 Market failure—ex ternalities and common pool or common
2.6
access resources
2.9 Market failure—public goods
2.7
2.8
2.10 Market failure—asymmetric information (HL only)
2.11 Market failure—market power (HL only)
2.9
2.12 The market’s inability to achieve equity (HL only)
3
Macroeconomics
3.1 Measuring economic activity and illustrating its variations
3.1
3.2 Variations in economic activity—aggregate demand and
3.2
aggregate supply
3.3
3.3 Macroeconomic objectives
3.4
3.4 Economics of inequality and pover ty
3.5
3.5 Demand management (demand side policies)—monetary policy
3.6
3.6 Demand management—scal policy
3.7 Supply-side policies
4
The Global
4.1 Benets of international trade
4.1
Economy
4.2 Types of trade protection
4.3 Arguments for and against trade control/protection
4.2
4.4 Economic integration
4.3
4.5 Exchange rates
4.4
4.6 Balance of payments
4.5
4.7 Sustainable development
4.8 Measuring development
6
4.9 Barriers to economic growth and/or economic development
4.6
4.10 Economic growth and/or economic development strategies
4.7
Introduction to the diploma programme
W hy
This
t his
book
provides
Economics
and
this
an
course.
theories
subject
book ?
and
as
to
course.
is
and
your
as
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TL),
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new
concepts.
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economics
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arise
TOK
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explore
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the
relationships
presented
in
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book
will
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help
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economics.
understand
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and
relationships.
economics
course
highlights
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economic
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have
local,
national
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global
manifestations.
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this
book
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TL:
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skills
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understanding,
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oxfordsecondary.com/ib-course-prep.
7
1
Introduction to Economics
This unit presents the fundamental issues of economics. Terms such
as “scarcity”, “choice” and “oppor tunity cost” are explained then
visualized through a simple but powerful diagrammatic model: the
production possibilities cur ve. The circular ow of income model is
presented to illustrate the basic interrelationships in an economy.
Key concepts such as equity, sustainability and interdependence
are also introduced, followed by a brief timeline of economic
thought that will help you understand the evolution of the subject.
In this unit you will learn about ...
➔
scarcity, choice and oppor tunity cost
➔
economic methodology
➔
the production possibilities model
➔
key ideas in economic thinking.
➔
the circular flow of income model
1 . 1
Y O U
C A N ’ T
A LW AY S
G E T
W H AT
Y O U
W A N T
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Explain whether the
better
problem of scarcity is
services.
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relevant for both rich and
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and
services
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satisfy
these
wants.
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poor countries.
resources
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limited.
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term
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whatever
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2.
used
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produce
goods
and
services;
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also
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“If in many countries a lot
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of food is thrown away
the
factors
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production,
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■
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inputs
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(such
as
land,
what extent do you agree
metals
and
mineral
deposits,
forests,
underground
water,
fish
with this statement?
stocks
and
the
atmosphere).
3.
■
Labour:
the
human
input,
both
physical
and
mental,
used
Think
of
three
choices
in
you
have
recently
ma d e.
production.
■
Capital:
tools,
Produced
equipment
means
and
of
production
(such
as
machines,
factories).
These
could
par ty ,
choosing
economics
mobile
■
Entrepreneurship:
the
willingness
individuals
take
and
ability
that
to
risks
and
to
manage
the
or
(cell)
other
of
to
to
a
stu d y
buying
phone,
a
for
Describe
th e
three
oppor tunity
factors
going
some
example.
have
be
cost
of
ea ch
production.
choice.
Scarcity
has
an
important
consequence,
it
necessitates
choice.
4.
Societies
must
choose
which
goods
or
services
to
produce
and
A
long
uncle
much
of
each
they
want,
given
the
available
resources.
If
no
scarcity,
no
choices
would
have
to
be
made.
Every
sacrice.
For
example,
choosing
to
produce
bought
corn
for
$10
using
land
implies
that
some
other
agricultural
market
product,
such
has
been
sacriced.
This
alternative
that
has
been
the
opportunity
cost
of
that
choice.
The
opportunity
cost
value
any
activity
is
the
value
of
the
next
best
If
resources
necessary,
and
were
unlimited,
no
it
for
opportunity
cost
of
sacrices
producing
would
would
be
any
to
good
problem
Since
resources
combination
and
also
idea
of
to
the
of
scarcity
are
best
which
that
possible
unlimited
it
second
is
any
that
scarce
waste.
how
scarce
wants.
The
important
important
making
their
of
a
services
is
studies
use
human
and
wasting
minimizing
science
has
scarce,
goods
avoid
One
is
to
drink
option
keep
it
is
for
unopened
not
sell
it .
Explain
oppor tunity
cost
in
zero.
efciency,
resources,
social
of
has
or
each
The
could
be
the
service
$200.
he
Another
and
the
has
he
alternative
him
sacriced.
and
of
it .
choosing
of
now
foregone
option
is
bot tle
as
sell
wheat,
a
and
the
increased,
available
your
choice
its
involves
ago
there
wine
were
time
how
to
produce
society
best
resources
above
the
an
denition
most
relates
use
economics
make
in
This
possible
Therefore,
societies
the
values
resources.
the
case.
consequence.
choices
of
is
that
attempt
to
classies
to
the
scarce
the
lead
to
satisfy
economics
TOK
as
a
social
science.
Social
sciences
study
human
behaviour
and
What distinguishes a social science
social
relationships
and
include
psychology,
anthropology,
political
from a natural science?
science
Besides
and
scarcity,
concepts
that
throughout
■
Equity:
is
others.
choice
are
this
this
book.
refers
associated
and
central
with
to
efciency,
economics
These
to
the
rising
are
idea
as
of
there
and
are
that
a
few
will
other
be
key
discussed
follows.
fairness.
In
economics,
inequity
inequality.
9
■
Economic
by
■
the
well-being:
members
Sustainability:
to
meet
its
to
current
an
this
needs
generations
that
of
this
relates
the
living
standards
enjoyed
economy.
refers
to
without
meet
to
their
generations
the
ability
of
compromising
own
needs.
should
be
It
the
present
the
ability
relates
good
to
generation
of
the
stewards
of
future
idea
the
environment.
■
Change:
the
economic
In
economics
the
level
economic
changes.
It
is
not
the
variable
■
that
of
Any
The
of
that
and
■
Intervention:
workings
best
creating
only
is
the
subject
of
outcome
Economics
room
extent
is
any
big.
More
within
but
into
a
whole;
it
of
the
zooms
deals
with
output,
are
being
no
as
and
as
prices
the
as
Note
the
often
that
not
that
the
outcomes.
microeconomics
is
and
or
markets.
the
economy
overall
the
with
individual
with
the
“macro”
concerned
with
in
in
contentious
consumers
such
and
a
small
concerned
aggregates
growth
other
Markets
market
deals
rms,
is
other.
considered
microeconomics
such
that
these
guarantee
means
it
in
interdependent.
of
activity.
branches:
economy;
each
involvement
improve
main
change.
impact
intervention.
is
will
“micro”
out
with
intervention
there
two
where
economy
Macroeconomics
unemployment,
also
specically,
parts
the
government
on
considered.
markets
government
is
change
in.
therefore
agents
be
the
consumers,
consequences
economic
intervention
divided
individual
units
as
for
of
debate,
of
despite
as
interact
will
government
organize
macroeconomics,
means
the
to
but
interested
such
economic
to
continuously
investigations
nations
therefore
refers
markets,
mechanism
fail,
and
of
this
must
it
variable
agent
unintended
interdependencies
of
agents
and
all
static;
typically
economic
indicating
intended
not
focus
economic
any
is
are
governments
action
agents,
an
economists
Interdependence:
producers,
world
level
of
economy.
The fundamental questions of economics
Let’s
return
forces
1.
What
about
2.
How
to
to
every
to
a
3.
For
whom
how
the
the
The
form
ways
of
extreme
10
or
of
to
be
will
All
goods
rely
All
of
command
produced
each
what
are
be
economy
the
capital
on
choices
labour?
about
distributed
and
lead
of
to
questions.
where
how
services.
less
less
amount
can
on
and
and
and
make
to
quantities.
choices
education
same
fundamental
economies
goods
labour
must
enjoy
economy,
in
capital
Scarcity
questions.
all
make
more
on
the
scarcity.
in
produce
using
more
enjoy
and
must
to
everyone
three
made
economies
everyone
the
be
of
fundamental
produced
order
services
organization
the
be
in
Should
Should
must
produced
and
problem
three
economies
produce?
answering
lies
Choices
perhaps
population.
services?
answer
resources
good
(machines)
economic
to
goods
produce?
their
Should
basic
produce?
which
to
use
the
economy
state
among
health
all
goods?
different
At
one
owns
all
1.1
capital
At
the
and
land
other
households
through
goods
what
in
on
the
the
roles
to
a
use.
the
market.
three
resulting
In
practice,
importance
of
goods
to
the
and
by
and
of
questions
decide
and
to
the
what
consumption
the
are
and
decisions
three
state
economies
state
where
supply
answers
questions.
produce
production
partly
all
the
economy,
fundamental
demand
given
fundamental
Households
what
economy,
are
three
markets.
decide
The
mixed
the
free-market
individual
questions
and
in
Firms
these
In
fundamental
through
the
answer
interaction
all
markets.
answers
lies
rms
consume.
resources
depend
so
extreme
and
their
to
and
You can’t always get what you want
and
partly
mixed,
markets
can
yet
differ
substantially.
The production possibilities model
The
production
simplied
It
refers
some
This
but
to
a
level
is
a
but
number
produce
of
by
the
and
is
production
Let’s
be
any
and
to
a
goods
national
two
all
of
on
amount
only
will
or
at
of
very
in
show
no
PPC
is
the
this
with
services.
enough
shows
that
time.
and
or
powerful
PPC
the
a
point
goods
resources
curve
a
resources
two
services
its
the
provides
see,
The
T
ypically,
to
maximum
economy
the
available
wasted
resources
concave
(that
is,
origin.
Assume
production
or
(PPC)
economy
you
goods
points
PPC.
the
xed
as
using
the
an
concepts.
efcient.
towards
visualize
resources
key
these
fully
a
curve
of
producing
still,
of
technology—so
in)
with
technology
combinations
bowed
picture
country
of
unrealistic
illustrate
can
possibilities
useful
services,
that
of
an
two
such
as
economy
goods:
wheat
X
devotes
and
and
Y
(X
cotton,
all
and
or
of
Y
its
can
health
care
defence.
Good
As
shown
using
all
in
its
Figure
1.1.1,
resources
to
at
point
produce
A
the
good
economy
Y
,
so
no
Y
A
is
amount
C
200
of
good
X
can
be
produced.
At
the
other
extreme,
point
D
B
illustrates
produce
that
good
the
X,
so
economy
good
Y
is
using
cannot
be
all
its
resources
produced.
At
160
to
point
E
100
C,
X
resources
and
good
X
good
X
can
Y:
and
be
are
allocated
the
200
in
economy
units
produced
of
but
the
production
can
good
only
produce
Y
.
At
160
300
point
units
of
of
D,
both
units
400
good
good
of
units
Y
.
of
Finally,
B
at
point
E,
500
units
of
good
X
can
be
produced
but
even
0
300
fewer
units
of
good
Y
,
only
100,
can
be
400
500
Good
X
produced.
Figure 1.1.1Production possibilities cur ve (PPC)
The
PPC
also
Figure1.1.1
good
X
it
shows,
will
This
is
This
sacrice
realize
of
requires
of
of
the
200)
if
to
good
of
OC
the
that
is
the
along
is
the
good
of
of
Y
and
economy
sacrice
X
must
what
chooses
PPC
is
an
are
of
one
explains
the
40
of
some
C
(OC)
of
to
of
100
fact
of
good
that
slope
of
good
point
Y
.
D.
the
units
of
Y
we
good
X
(160
scarcity
necessitates
negative
more
Specically,
units
The
good
As
produce
cost
additional
the
cost.
point
produced.
sacriced.
more
to
from
opportunity
that
units)
be
opportunity
production
the
producing
300
producing
other
choice
moving
instead
that
the
by
amount
that
units
instead
less
have
shown
additional
(400
illustrates
of
producing
the
PPC.
11
The
PPC
also
Consider
an
moving
additional
are
the
60
more
The
costly
it
start
is
for
other
more
to
that
X
is
D
Y
line
X
that
as
of
of
of
of
be
production
Y
its
than
cost
sacriced.
of
X
is
have
now
been
more
the
of
other
one
good,
to
being
good.
it
the
must
that
produce
a
increases
one
As
production;
appropriate
rather
opportunity
are
units)
specialized.
on
for
400
good
good
OC.
producing
of
produces
to
more
of
that
of
amounts
suitable
been
OC
160)
units
increasing
instead
units
tend
concave
because
the
The
economy
its
less
have
is
E.
increasing
are
of
units
100
40
the
resources
more
PPC
(500
instead
instead
that
point
additional
that
would
The
to
(100
sacrice
is
resources
straight
of
units
this
phenomenon
good
these
means
good.
of
good
concentrates
using
sloped
60
forced
resources
the
Good
as
This
reason
economy
of
the
point
units
producing
sacriced.
good,
from
100
units
However,
is,
illustrates
negatively
as
more
and
produced.
Y
What
if
the
economy
combination
F
available
there
is
increases,
origin,
as
0
Good
point
are
not
then
the
In
move
to
new
units
contrast,
in
It
at
if
inside
Figure
being
H
is
will
least
the
PPC
1.1.2?
fully
that
lie
one
if
producing
this
for
an
the
the
example,
inefcient
two
closer
goods
decreases,
closer
case
a
unemployment
somewhere
of
unemployment
combination
In
utilized,
therefore
follows
point
of
another
H
Point
combination.
fewer
produced.
will
as
operating
unemployment.
production
H
such
resources
is
to
the
to
will
the
curve
the
be
economy
itself.
X
Could
Figure 1.1.2Inside and outside the PPC
as
an
point
level
of
economy
F?
No,
If
more
or
improves,
(such
as
outward
do
Point
better
F
can
shift
is
an
the
of
a
point
output
resources
can
to
were
be
the
and
and/or
such
such
output
combination.
technology
initially
shown
PPC,
current
enjoy
production
available
that
This
outside
economy
unattainable
become
produced.
the
at
available
allow
resources
be
of
the
not
combinations
F)
operating
because
technology
combinations.
be
unattainable
through
an
PPC.
The circular ow of income model
The
us
circular
to
visualize
Let’s
two
ow
start
of
and
with
a
which
rms
of
offer
to
(for
that
they
goods
In
use
raw
place
to
view
by
that
of
two
sum
of
pay
the
fo r
or
the
that
allows
economy
form
produce
make
own
with
the
four
entrepreneurship—
factors
capital)
households
of
of
rent
and
production,
(for
prots
makes
goods
up
and
(for
income.
services
expenditures
on
the
rms.
ow:
ser vi ce s
the s e
and
the
payments
to
e c onomy
of
for
in
an
Households
capital
these
by
diagram
Consider
rms.
(for
production
k i nds
goo ds
and
interest
simple
economy.
households
produced
of
a
exchange
households;
services
basic
The
factors
mate rials,
money
12
sell
and
this
take
the
to
the
labour,
In
labour),
entrepreneurship).
Firms
rms.
payments
wages
is
explanation.
households
production—land,
they
offer
land),
model
understand
simple
“inhabitants”:
factors
income
thing s
the re
“re a l ”
in
in
tra ns a ctio ns
 ows
one
the
are
s uch
di rec tio n,
o p p osite
as
that
l a b our,
a nd
 ows
di rectio n.
of
1.1
Income:
Factors
rent,
of
wages,
production
interest
(land,
and
profits
labour,
(factor
capital,
You can’t always get what you want
payments)
entrepreneurship)
Households
Firms
Goods
Spending
by
and
households
services
on
goods
and
services
Figure 1.1.3Flows in an economy
In
Figure
money
The
ows
money
ows
the
1.1.3,
from
ows
of
to
let’s
a
and
Adding
a
services,
that
is
from
buy
capital
enabled
the
out
Adding
that
goods
tax
they
they
are
This
the
our
are
the
for
of
equal.
a nd
The
made
spending
the
the
by
goods
income
that
the
of
for
use
households
and
services
income.
basic
circular
more
known
ow
closely,
we
model
must
the
is
time,
income
Savings
and,
Firms
it
in
is
add
and
attract
a
income
households
they
Investment
In
and
this
through
and
leakage
when
savings
back
goods
investments
investments.
injected
is
only
spend
investment.
on
represent
turn,
not
also
Savings
Banks
their
their
saved.
as
ow.
for
but
is
are
then
way,
lend
income
investment.
sector
is
also
a
government
Households
paid
in
to
and
must
taxes
produced
roads
by
nance
pay
is
rms.
taxes.
and
How
This
therefore
The
so
not
does
this
this
implies
spent
government
government
schools,
circular
and
sector.
spending,
spending
on
uses
such
is
an
ow.
sector
trade
This
reect
is
be
all
services
same
sector.
collected
of
may
and
the
need
ow?
spend
services.
is
there
into
while
an
to
ow
For
circular
savings
foreign
represent
Exports
it
At
services
countries
exported
of
and
income
and
economies”
.
o ra ng e
payments
economy
goods
banking
to
back
a
equal
circular
ow.
rms
building
Adding
Most
the
revenue
injection
in
sector
part
circular
the
1.1.3
(as
payment
necessarily
on
economy
the
the
into
of
is
(as
government
part
Figure
further.
not
goods.
due
the
a
the
goods
that
a
every
affect
as
on
by
funds
leaks
In
do
injection
shown
injections.
circular
spend
in
real-world
spent
that
an
is
because
not
the
rms
banking
Households
are
households
step
the
leakages
shown
to
to
This
go
 ows
production)
back
resemble
re a l
blue.
ows
produced).
Now
in
rms
factors
that
th e
with
means
foreign
ones
household
foreign
injection
other
that
are
into
and
goods
imported.
spending
spending
back
countries
domestic
on
the
on
therefore
services
Imports
foreign
domestic
circular
are
and
are
goods
goods
a
leakage
and
and
“open
are
as
services.
services,
so
ow.
13
Income:
Factors
rent,
of
wages,
production
interest
(land,
and
profits
labour,
(factor
capital,
payments)
entrepreneurship)
Households
Firms
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goods
and
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services
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spending
Government
Impor ts
Expor ts
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countries
Figure 1.1.4Flows in an economy including leakages and injections
L TA
DP ready
Figure
1.1.4
which
includes
shows
the
expanded
version
of
the
circular
ow,
Thinking Skills
leakages
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Leakages
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consist
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income
and
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diagram showing the circular
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would be the eect on national
income if:
imports.
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of
exports.
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using
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and
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injections
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decided to initiate
terms
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the
circular
ow
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raise taxation.
smaller
c.
than
leakages,
the
income
ow
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the government of
a trading par tner
Ec onomic
me t hodolo g y
decides to relax
The
methodology
employed
by
economists
is
similar
to
that
impor t duties.
employed
models
show
Most
with
by
that
natural
are
then
simplied
models
about
the
be
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demand
hypotheses
conclusions
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to
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rise
based
and
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but
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on
also
for
consumer
models.
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o
construct
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be
models
example,
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hypotheses
that
rise.
aim
arrive
variables.
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general
incomes
observations.
constructed
to
economic
making
phenomena,
when
attempt
various
they
constructed
economic
will
often
from
are
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explain
described,
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causes
consumer
used
relationships
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diagrams.
scientists.
is
at
to
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it
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relationship
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the
meantime.
realistic? Do other disciplines make
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is
known
as
the
ceteris
paribus
assumption.
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Latin
ceteris
a similar assumption?
paribus
Models
translates
can
explaining
the
model
referred
14
to
be
and
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judged
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things
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predicting.
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as
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refutation.
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than
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normative
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economics?
proved
or
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Ec onomic
by
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simple
appeal
to
the
t houg h t
18th
century
Adam
Smith
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best
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More
pointed
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owned
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are
by
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means
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20th
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few
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proposals
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economy,
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well
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conceived
idea
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butcher,
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to
economics
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and
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advanced
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utility
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demand.
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relationship
economy
many
of
the
need
stabilization
for
government
and
intervention
policies.
the
economists.
most
to
Keynes
government
revolution
revolution
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free
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of
the
market.
government
solves.
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21st
not
demand,
herself,
scissors
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them
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return
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Keynesian
Keynesian
deregulation
calling
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economics,
economics.
labour
Classical
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we
or
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century
strongly
by
said:
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demand
and
policy
himself
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supply
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of
school
guides
Smith
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father
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produced
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Monetarist
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classical
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and
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lucky
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to
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demand
production,
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capitalism
for
or
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to
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self-interest”
.
Marshall
analysis
that
by
of
Classical
framework
that
hand”
outcome
own
considered
century
Alfred
Marx
is
foundation
person,
brewer,
their
19th
the
“invisible
each
Karl
facts.
economics:
this
incorporates
elements
of
century
psycholog y
have
and
emotional,
rules
biased
and
of
economics.
conventional
studied
and
the
social
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are
often
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rational
effects
factors
businesses.
decisions
of
study
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have
cultural
individuals
economic
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the
challenged
approach
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into
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on
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economic
economists
therefore
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be
cognitive,
decisions
argue
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Figure 1.1.5Economic thinking
15
Watch this
Key terms—test yourself
Search YouTube using these terms:
Dene these terms: scarcity, resources, oppor tunity cost, eciency,
Ariely control of our decisions TEDx.
social sciences, microeconomics, macroeconomics, leakages,
This video gives an insight into
injections, ceteris paribus
behavioural economics.
Focus point
Search the web
For a more comprehensive
timeline of economic thought,
search using these terms:
Economics
choices
an
is
that
attempt
the
lead
to
social
science
to
best
the
satisfy
that
studies
possible
unlimited
use
human
how
of
societies
scarce
wants.
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make
resources,
in
production
economics an illustrated
possibilities
model
and
the
circular
ow
of
income
model
are
timeline.
representations
shows
L TA
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Thinking Skills
can
the
produce
shows
of
the
possible
the
in
a
economy.
The
combinations
given
period
interrelationships
of
of
production
two
time.
between
goods
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rms
possibilities
that
circular
and
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curve
economy
ow
model
households
in
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economy.
Which two of the people
who have shaped economic
thought over the centuries
would you invite to dinner?
Explain your answer.
16
which
is
All
a
models
key
are
feature
of
built
on
the
economic
ceteris
paribus
methodology.
assumption
2
Microeconomics
Microeconomics focuses on the individual units of the economy:
consumers, rms and markets. This section examines the goals
of consumers and of rms. You will then learn how prices are
determined as well as how governments often inter vene in markets
to aect outcomes. This section also shows how markets are
responsible for the allocation of scarce resources; when and why
markets are often successful, but also when and why they may fail.
In this unit you will learn about ...
➔
demand and supply
➔
spillover effects
➔
the “invisible hand” and the “visible hand”
➔
overuse of common pool resources
➔
behavioural economics
➔
public goods
➔
elasticities
➔
market power.
2 . 1
D E M A N D
A N D
S U P P LY :
T H E
B O X I N G
R I N G
In this section you will learn about ...
➔
the meaning of the term “market”
➔
the buyers’ side: demand
➔
the sellers’ side: supply
➔
putting the two sides together.
17
The issue
We
have
what
is
make
all
its
up
the
understand
T he
A
market
is
most
found
at
markets
A
is
of
of
on
the
market
are
sellers
the
that
be
of
the
refers
able
ceteris
paribus.
factors
Think
as
week?
a
bananas
as
sh
world
of
as
A
but
pieces
them
open
that
together
a
for
“ght”
on
is
be
to
can
ring:
the
their
to
where
is
in
could
meet,
sellers
boxing
and
it
soybeans.
market
and
space
market
could
but
actually
a
buyers
a
market
market
as
an
market,
never
Therefore,
Their
the
be
buyers
as
better
a
also
The
just
not
in
be
dened
interact.
on
the
other
one
side
side
there
interaction.
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are
result
Demand
quantities
purchase
Remember
may
are
at
How
on
a
good
many
willingness
This
consumers
over
paribus
remain
bananas
bananas.
willing?
that
prices
ceteris
demand
your
for
of
various
that
affect
preference
you
a
(consumers)
depends
your
supply”,
the
puts
together—but
location.
as
allows
consumer.
This
reects
and
and
out
“mar k e t ”
thought
come
may
side:
to
that
lays
product.
to
and
puzzle
t er m
visualized
buyers
willing
other
the
market
buyer s ’
Demand
such
(producers).
price
T he
t he
internet.
might
the
supply
“demand
section
work.
goods
as
phrase
This
particular
such
the
the
commonly
a
mechanism
there
the
of
neighbourhood,
sellers
a
and
markets
sellers
international,
as
used
meaning?
demand
how
and
always
and
or
meaning
buyers
local
heard
precise
buy
you
depends
are
given
means
period,
that
all
constant.
would
to
Are
a
you
bananas,
able
on
buy
to
their
which
buy
price
per
as
many
and
your
income.
The law of demand
The
law
of
increases,
vice
P/unit
demand
the
versa—price
This
something
becomes
it
The
per
period
negative
demanded
P
and
directions.
of
on
B
states
quantity
the
the
negative
of
can
be
quantity
if
expensive,
is
the
paribus)
demanded
relationship
more
simple:
(ceteris
easy
people
price
change
to
of
a
decreases
in
tend
and
opposite
understand.
will
good
to
If
buy
less
time.
relationship
vertical
something
demanded
between
illustrated
axis
and
the
by
a
price
and
demand
quantity
the
curve.
demanded
quantity
Price
per
is
measured
period
is
on
2
the
A
P
horizontal
curve
If
the
has
a
price
axis.
Since
negative
of
the
slope.
bananas
relationship
This
rises
is
from
shown
P
to
P
1
period
drops
from
Q
to
1
Q
,
moving
,
is
negative,
in
Figure
quantity
the
demand
2.1.1.
demanded
per
2
along
the
demand
curve
from
2
D
point
A
leads
to
to
point
B.
Therefore,
a
change
in
the
price
of
the
good
0
Q
Q
Q/period
2
Figure 2.1.1The demand cur ve
18
shown
a
by
change
a
in
quantity
movement
along
demanded
the
in
demand
the
opposite
curve.
direction,
2.1
Demand and supply: The boxing ring
Non-price determinants of demand
Ceteris
paribus
requires
demanded
when
factors
referred
are
change
to
in
either
any
if
products
normal
and
if
that
of
same
lead
to
a
are
of
good
the
will
a
may
The
■
A
market
most
to
as
may
income.
lower
exist.
now
buy
These
quality
For
example,
less
tinned
find
and
or
the
of
a
are
good
more
versa.
desirable,
This
considered
other
one
for
if
good
because
such
the
bananas
for
a
vice
explains
they
product
other.
apples
will
substitutes
For
example,
become
increase
satisfy
may
if
more
the
price
Saanvi
of
a
for
if
the
usually
price
muffins
the
price
increase
complement
price
the
lattes
of
a
if
latte
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the
complement
consumers
future,
are
and
increased,
decrease.
near
goods
a
to
change:
in
of
has
that
muffin
which
may
demand
for
a
increases.
expect
then
goods
a
the
demand
price
for
it
of
now
increase.
number
number
the
to
for
products
usually
will
goods
price
goods:
Recently
decrease
product
a
advertising.
demand
demand
in
increases.
demand
Expectations
■
eating
demand”
.
referred
some
are
she
on
one
the
the
other
meat.
two
buy
of
good
demand
are
substitutes
increase
to
consumed.
breakfast.
cause
the
for
They
millions
in
a
consumers’
consumers
in
complement
jointly
for
So,
if
goods:
rise
switch
substitute
Prices
A
increase
may
expensive.
of
spend
These
in
and
fresh
will
typically
need.
an
Anwar
good
substitute
increases,
quality
increased
afford
preferences:
for
consumers
the
■
has
can
goods.
for
quantity
These
specically:
demand
better
affecting
constant.
determinants
increase.
increase
inferior
companies
Prices
■
an
factors
demand
More
income
to
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which
she
demand
why
as
for
other
remain
cause
decrease.
following
salary
as
T
astes
■
or
all
“non-price
may
expected
known
meat
as
these
goods.
products
Ting’s
to
that
changes
consumers’
is
decrease
are
of
increase
Income:
■
price
of
of
consumers:
consumers
market
demand
is
will
the
it
is
tend
sum
expected
to
of
that
increase
an
increase
market
individual
in
demand
the
as
demands.
Illustrating the eect on the demand cur ve of a
change in a non-price determinant
A
change
in
the
as
one
above
to
of
the
increase,
demanded
right.
to
the
If
a
demand
illustrated
shift
then
and
left,
as
for
the
a
product
demand
determinants
at
the
demand
of
each
price
original
decreases
shown
in
of
the
diagram
If
a
curve
of
will
demand
is
change
causes
quantity
demand
Figure
a
demand
more
then
on
curve.
P/unit
in
demand
the
good
shift
curve
to
is
the
will
shift
2.1.2.
D
D
0
As
shown
if
the
demand
for
bananas
increases,
the
demand
D
2
curve
shifts
to
the
right
from
D
to
D
0
.
At
each
and
every
1
0
Q/period
price,
quantity
bananas
demanded
decreases,
the
is
greater.
demand
If
curve
the
demand
shifts
to
the
for
left
Figure 2.1.2Shifts of the demand cur ve
19
from
D
to
D
0
TOK
less.
.
At
each
and
every
price,
quantity
demanded
is
1
Therefore,
a
change
in
one
of
the
non-price
determinants
of
To dene the term “demand”
demand,
shifts
the
demand
curve.
But
a
change
in
price
leads
to
a
and to state the law of demand
movement
along
the
demand
curve.
we need to assume ceteris
L TA
paribus, that all other factors,
DP ready
Thinking and communication skills
such as consumers’ income,
Investigating demand
remain constant. This is
because if the price of a good
1.
Prepare a large mind map, on screen or on a large piece of
increases, quantity demanded
paper, that explains what you have learned about the concept of
may not decrease if,
at the
demand. Include diagrams and examples.
same time, income increases.
2.
Working in a small group, identify dierent products for which
Do other areas of knowledge
you are aware that demand has changed. For example, think of
require a similar assumption?
what may have happened to the demand for rice or goji berries,
GPS devices or luxury travel in your town, your country or the
world. The time period of change may be a year or a decade.
Explain the change in demand. Include fully labelled diagrams.
T he
s eller s ’
Supply
refers
to
at
offer
Think
land
as
to
a
corn
would
the
various
per
you
prices
If
corn,
if
over
you
how
period
react
S upply
quantities
producer.
producing
offer
side:
be
the
of
a
good
given
were
a
would
affected
market
a
that
period,
farmer
your
by
price
ceteris
with
a
decision
the
of
producers
market
corn
willing
paribus
given
to
are
plot
produce
price
of
of
and
corn?
How
increased?
The law of supply
The
law
of
supply
quantity
supplied
and
versa.
vice
direction.
The
states
per
Price
that
period
and
reason
is
if
the
of
time
quantity
that
price
at
a
of
will
a
increase,
supplied
higher
good
move
price,
increases
ceteris
in
the
then
paribus,
same
protability
for
the
P/unit
rm
increases,
so
producers
will
have
the
incentive
to
produce
S
and
offer
units
of
more
a
units
good
per
period.
becomes
more
Also,
and
if
producing
more
costly
to
more
the
and
rm
more
then
it
Z
P
will
be
willing
The
positive
to
produce
and
offer
more
only
at
a
higher
price.
2
relationship
between
price
and
quantity
supplied
is
F
P
shown
The
If
on
a
supply
the
price
diagram
curve
of
is
corn
by
the
shown
rises
supply
in
from
to
P
1
from
Q
to
Q
1
point
Z.
,
moving
along
curve
Figure
the
P
that
has
a
positive
slope.
2.1.3.
,
quantity
supplied
increases
2
supply
curve
from
point
F
to
2
Therefore,
a
change
in
price
leads
to
a
change
in
quantity
0
Q
Q/period
Q
2
supplied
Figure 2.1.3The supply cur ve
supply
in
the
same
direction,
shown
by
a
movement
along
the
curve.
TOK
Do laws in economics, such as the law of demand and the law of
supply, have the same signicance as laws in the natural sciences? Is
it possible for economic laws to change over time? What about natural
science laws?
20
2.1
Demand and supply: The boxing ring
Non-price determinants of supply
Once
other
supplied
factors
change
either
in
are
any
can
of
the
specialty
the
apples
rise.
This
producing
Costs
an
of
tax
is
so
so
Prices
■
supply
the
if
they
of
Prices
of
another.
of
Emir
price
of
to
offer
to
supply
a
product
to
supply
price
The
■
If
to
an
of
a
in
her
supply.
market
A
to
if
The
in
the
and
price
his
of
Amara’s
barn
his
of
costs
for
costs
the
of
increased.
the
government
producers
of
tax
money
a
is
their
a
to
be
paid
An
to
the
production
payment
costs
imposes
subsidy.
increases
subsidy
decreases
technology
bakery
production
supply
lowered
has
pays
A
the
has
in
a
increase
converted
amount
good.
this
and
is
a
the
of
in
of
by
Internal link
the
production
See section 2.5 for more on indirect
taxes and subsidies.
price
her
of
land
of
for
increases,
At
the
for
land
will
in
the
competitive
same
produce
she
kiwis
will
to
kiwis
change
growing
decrease.
goods
cheese
Emir
same
are
to
rises,
growing
automatically
sheep
cheese.
her
avocados
from
kiwis
goods
compete
using
supply:
good
farms
supply:
therefore
farmer
joint
one
are
jointly
leads
and
will
to
the
wool
buy
time,
supplied
if
production
production.
more
though,
the
sheep
he
will
in
be
of
If
order
able
wool.
of
a
price
increase
less
it
decrease.
supply
more
a
in
or
owns
caused
milk
competitive
cheese
more
Expectations
■
in
goods
has
change
fixed
of
good
prices
Amara
This
if
a
affecting
These
supply.
use,
The
production
the
will
a
or
of
input
has
of
also
good
unit
some
in
decrease
cows.
factors
constant.
specically:
However,
supply
other
determinants
supply
input
a
will
a
Masha
avocados.
use
an
of
firms;
goods
avocados.
■
to
change
to
usually
per
supply
resources.
and
on
More
all
remain
non-price
cause
herdsman,
The
increases
of
as
pies.
lead
a
that
changes
production.
as
production
government
and
apple
milking
tax
a
of
uses
will
government
costs,
is
milk.
indirect
indirect
costs
Dan,
mechanical
to
decrease.
she
pies.
requires
price
may
production:
affect
apple
these
or
her
to
paribus
when
referred
of
increase
Costs
■
ceteris
again,
quantity
now
change:
in
and
the
if
near
take
producers
future,
advantage
expect
then
of
they
selling
the
may
it
at
a
price
of
decide
higher
later.
number
number
market
of
of
firms:
producers
supply
is
the
it
is
will
expected
tend
sum
of
to
that
an
increase
individual
increase
market
in
the
supply
as
the
supplies.
P/unit
S
Illustrating the eect on the supply cur ve of a change
2
S
0
in a non-price determinant
S
If
any
of
supply
to
the
as
As
the
non-price
curve
right
shown
shift.
whereas
in
Figure
will
Figure
2.1.4
determinants
a
An
increase
decrease
in
of
in
supply
supply
supply
changes
shifts
shifts
the
the
then
the
supply
supply
curve
curve
left,
2.1.4.
shows,
if
the
supply
of
corn
increases,
the
supply
0
Q/period
curve
will
shift
to
the
right
from
to
S
0
quantity
supplied
is
greater.
If
the
S
.
At
each
and
every
price,
1
supply
of
corn
decreases,
the
Figure 2.1.4Shifts of the supply cur ve
21
supply
curve
will
shift
to
the
left
from
S
Thinking ,
L TA
DP ready
to
S
0
price,
research and
communication
quantity
non-price
skills
change
supplied
is
determinants
in
price
leads
less.
of
to
Therefore,
supply
a
shifts
movement
.
At
each
and
every
2
a
the
change
supply
along
the
in
any
curve.
supply
of
the
But
a
curve.
Investigating supply
P u t t ing
1.
t he
t wo
side s
t o ge t her
Prepare a large mind
The
map, on screen or on
two
sides
examined.
a large piece of paper,
they
that explains what you
are
the
What
put
determine
have learned about the
of
market
remains
together
the
price
to
of
to
(or
be
ght.
the
boxing
seen
The
is
ring)
what
ght
have
been
happens
(their
separately
when
interaction)
will
good.
concept of supply. Include
When
will
the
ght
between
consumers
and
producers
stop?
diagrams and examples.
Most
2.
likely
As a class, discuss the
that
following. How might the
referred
supply of agricultural
of
a
products be inuenced by
of
the
the introduction of agbots
price
(agricultural robots)
and
in processes such as
willing
harvesting, fruit picking
equals
and soil maintenance?
market
is,
when
when
to
good
The
to
buy
and
able
quantity
for
to
the
per
to
longer
reached
have
a
as
the
ends
amount
offer
per
supplied.
avocados,
In
of
the
to
period;
The
that
outlined
price.
It
is
the
amount
is,
ghting;
This
point
the
is
price
outcome
are
willing
producers
quantity
“clears”
.
the
equilibrium
consumers
the
market
keep
equilibrium
when
good
equal
to
balance.
market
because
of
is
reason
equilibrium
here
period
a
point
equilibrium.
ght
reached,
able
no
have
market
referred
ght.
is
they
as
is
they
are
demanded
Consider
the
below.
How will low-skilled
Figure
2.1.5
shows
the
market
for
avocados.
Market
equilibrium
workers be aected?
is
formed
at
the
intersection
of
the
demand
and
supply
curve,
at
Search online for relevant
point
e.
The
equilibrium
price
is
and
P
the
corresponding
quantity
e
information.
is
the
equilibrium
quantity
either
Q
since
Q
at
P
e
price,
Q
>
d
P/unit
excess
S
to
demanded
in
higher
Q
market
than
.
If
Q
d
demand
,
Q
e
>
s
the
(Excess
is
Q
s
demand
increase.
or
Q
d
and
is
the
Q
.
At
any
say
that
price
at
will
some
supplied.)
as
a
there
is
excess
supply
in
the
there
result
price,
is
market
and
If
>
Q
the
tend
quantity
Q
s
that
other
s
we
s
when,
quantity
=
d
>
we
say
d
price
will
as
a
e
result
tend
to
decrease.
(Excess
supply
is
when,
at
some
price,
P
e
quantity
supplied
is
higher
than
quantity
demanded.)
Changes in market equilibrium
D
0
Q/period
Q
If
any
of
the
non-price
determinants
of
demand
or
supply
change
e
there
will
be
a
shift
in
either
the
demand
or
the
supply
curve
and
Figure 2.1.5The market for avocados
the
market
Consider
will
the
move
market
to
for
a
new
kale.
equilibrium.
Kale
is
a
green
leafy
vegetable,
recently
P/unit
listed
among
the
“superfoods”
which
has
made
it
increasingly
S
popular
.
a
As
such,
rightward
shift
demand
of
the
for
kale
demand
has
curve
increased,
in
Figure
which
is
shown
by
2.1.6.
g
Initially
market
equilibrium
was
at
point
h
with
the
market
price
P
2
h
of
kale
at
and
P
the
corresponding
equilibrium
quantity
at
1
P
Following
to
the
right
increase
from
D
to
in
D
1
D
2
intersection
Q
.
1
the
of
the
demand,
.
Market
the
demand
equilibrium
curve
is
now
has
at
shifted
the
2
supply
curve
S
with
the
new
demand
curve
D
2
D
at
point
g.
The
increase
in
demand
for
kale
has
led
to
a
higher
0
Q
Q/period
Q
2
market
price
(P
2
Figure 2.1.6The market for kale
(Q
2
22
>
Q
1
).
>
P
1
)
and
an
increase
in
equilibrium
quantity
,
2.1
Something
(see
similar
Figure
has
2.1.7).
happened
Weather
in
the
market
conditions,
for
droughts
Demand and supply: The boxing ring
P/unit
coconuts
in
particular,
S
2
and
farm
diseases
have
negatively
affected
the
supply
of
S
coconuts.
h
P
Initially,
market
equilibrium
was
at
point
j,
with
the
market
2
j
price
of
coconuts
at
and
P
the
equilibrium
quantity
at
Q
1
The
so
droughts
the
and
supply
diseases
curve
has
reduced
shifted
to
supply
the
left
of
coconuts
from
to
S
S
1
Market
the
equilibrium
demand
curve
is
D
P
.
1
now
and
determined
the
new
at
supply
the
and
.
2
intersection
curve
,
S
at
of
point
D
0
h.
Q
2
The
decrease
in
supply
has
therefore
led
to
an
Q
Q/period
2
increase
in
the
Figure 2.1.7The market for coconuts
market
price
>
(P
P
2
(Q
<
Q
2
)
and
a
decrease
in
equilibrium
quantity
1
).
1
L TA
DP ready
Thinking , research and communication skills
Demand and supply of agricultural products
1.
Consider the following statements.
a.
“New
methods
yields
price
b.
in
of
the
of
growing
production
crops
of
rice,
have
caused
causing
a
bumper
decrease
in
the
rice.”
“ The popularity of bananas is decreasing as consumers are
switching to other fruit options.”
Explain, using the determinants of demand and supply, and
appropriate diagrams, the changes in the market price and
equilibrium quantity for rice and bananas. Can you think of any
other factors that could aect the demand or the supply of
these goods?
2.
Agricultural product prices tend to be highly volatile. In a small
group:
a.
examine the factors responsible for the uctuating prices of
agricultural products
b.
investigate the problems associated with volatile prices for
countries that are dependent on agricultural expor ts.
Focus point
The
interaction
determines
will
the
rise.
If
the
between
price
there
equilibrium.
is
of
consumers
the
excess
The
product.
supply
equilibrium
and
If
price
price
producers
there
will
is
is
fall.
the
in
excess
Price
one
that
markets
demand
will
price
settle
clears
at
the
market.
Key terms—test yourself
Dene these terms: market, demand, supply, normal goods, inferior
goods, substitute goods, complement goods, competitive supply,
joint supply, equilibrium price, excess demand, excess supply.
23
2 . 2
T H E
I N V I S I B L E
H A N D
In this section you will learn about ...
➔
the role of the price mechanism
➔
market efficiency.
The issue
As
of
you
have
balance,
do
markets
supply?
hand”
T he
of
the
These
in
of
changes
in
and
the
will
pr ic e
themselves
is
price
be
this
at
changes
in
point
in
How
demand
mechanism
explained
a
happening?
or
this
the
and
“invisible
section.
mechanism
P/unit
in
price
nd
How
following
with
and
changes
to
point.
which
t he
demand
signals
lies
market,
cause
tend
equilibrium
answer
r ole
supply
markets
equilibrium
reach
The
Changes
both
seen,
the
price.
act
S
as
incentives
j
and
the
good
is
then
rationed
P
to
consumers.
Let’s
h
consider
f
P
the
example
kale
shown
of
in
the
market
Figure
for
2.2.1.
D
Initially,
the
market
is
in
D
equilibrium
at
point
h,
where
0
Q
the
price
of
kale
is
at
P
Q/period
Q
and
Figure 2.2.1The market for kale
quantity
in
is
at
demand,
shown
by
Q.
due
a
An
to
increase
a
favourable
rightward
shift
of
change
the
in
tastes
demand
and
curve
preferences,
from
D
to
D
.
is
At
1
P
,
there
since
now
quantity
upward
L TA
DP ready
is
excess
demand
demanded
pressure
on
for
kale
exceeds
price.
The
equal
quantity
price
of
to
line
segment
supplied.
kale
starts
This
(hf),
exerts
rising.
Thinking Skills
This
The price mechanism
increase
contains
before.
in
the
price
information
This
is
the
of
that
kale
is
a
signal
consumers
signalling
role
of
now
prices
to
producers
demand
in
a
more
market
of
kale.
kale
It
than
economy.
Let’s say the demand for kale
The
increase
in
the
price
of
kale
also
has
an
incentive
role.
It
decreases.
creates
1.
How would the price
it
is
the
now
incentive
more
to
farmers
to
produce
and
offer
more
kale
as
protable.
mechanism (that is, the
As
the
price
of
kale
increases
and
producers
increase
quantity
signalling and incentive
supplied,
there
is
an
extension
along
the
supply
curve,
from
functions of price
point
h
to
point
j.
The
price
will
keep
rising
as
long
as
there
changes) work following
is
excess
demand
in
the
market.
It
will
increase
to
quantity
2.
P
.
At
P
1
the decrease in demand?
demanded
is
again
equal
to
quantity
,
1
supplied
and
a
new
How would the
equilibrium
has
been
reached
where
more
kale
is
produced.
market move to a new
Note
that
an
equilibrium
price
also
has
a
rationing
function:
all
equilibrium?
consumers
24
who
are
willing
and
able
to
pay
it,
will
end
up
with
the
good.
2.2
The invisible hand
Resource allocation
An
increase
Producers
amount
labour
from
by
the
and
scarce
to
T
o
the
do
machines.
goods
change
price
demand
respond
offered.
other
the
the
in
and
in
the
a
good
increase
this
they
that
in
will
will
the
by
more
have
reallocation
of
increase
price
need
Resources
this
price
mechanism
for
of
good.
to
a
price.
increasing
resources,
be
the
such
diverted
resources
In
continuously
its
is
market
allocates
as
land,
away
determined
economy,
and
it
is
reallocates
resources.
L TA
DP ready
Thinking Skills
Reallocation of resources
Consider what would happen if the price of kale decreased.
1.
How would producers respond?
2.
How would resources be reallocated following the decrease in
price?
Mar k e t
e f f icienc y
What does demand also show?
Demand
to
buy
shows,
per
at
period.
each
If
price,
you
read
how
the
much
consumers
demand
curve
are
willing
vertically
(that
P/unit
is,
for
each
Q
go
all
the
way
up
until
it
meets
the
demand
curve),
f
it
shows
are
something
willing
Logically,
benet
to
pay,
this
they
most
at
the
interesting.
most,
maximum
enjoy
from
for
cannot
It
shows
each
be
additional
greater
consuming
that
how
than
unit.
much
unit
the
So,
people
of
a
good.
the
P
P
additional
2
market
z
P
demand
benet
Figure
also
shows
enjoyed
2.2.2
the
from
shows
marginal
each
the
benet—that
additional
demand
for
unit
is,
the
additional
consumed.
coffee.
We
realize
that
for
unit
D
Q
,
say
the
5th
unit,
consumers
would
be
willing
to
pay
P
1
1
Q
Q
2
the
most.
For
unit
Q
,
say
the
9th
unit,
they
would
be
MB
0
Q
at
=
dollars
willing
Q/period
to
2
pay
dollars
P
at
the
most,
while
for
unit
Q,
say
the
20th
unit,
they
Figure 2.2.2The consumer surplus
2
would
be
willing
Consumers
time
pay
only
is
coffee
Q,
as
more
The
over
is
P
the
of
as
the
the
P
these
what
the
market
the
additional
price
they
units
they
units
are
price
most.
of
a
charged.
will
were
good
prepared,
buy
If
all
willing
at
the
per
the
market
units
to
period
most,
up
pay
at
of
to
price
until
least
of
unit
or
price.
consumers
spend
consumer
by
at
consumers
actually
shown
dollars
market
then
market
they
to
is
of
the
what
surplus
than
each
excess
referred
as
dollars,
than
pay
purchase
long
greater
for
above
will
as
to
the
price
would
for
the
area
units
have
given
surplus.
shaded
for
a
In
been
prepared
amount
Figure
below
2.2.2,
that
consumed;
to
spend
purchased
the
demand
that
is,
is
consumer
curve
area
and
Pfz.
25
What does supply also show?
Supply
per
shows,
period.
that
is
Y
ou
shows
additional
known
unit.
The
at
the
can
the
also
That
the
how
read
must
cost,
(S)
also
rms
supply
require
minimum
curve
much
the
rms
marginal
supply
producing
price,
minimum
unit.
as
each
of
curve
to
be
be
the
the
willing
to
vertically.
paid
to
each
offer
Doing
offer
additional
producing
shows
are
each
cost,
which
additional
marginal
cost
(MC)
of
good.
P/unit
Figure
2.2.3
shows
the
supply
of
coffee.
Unit
Q
,
say
the
5th
unit,
1
S
=
MC
will
be
offered
if
the
price
received
is
at
least
P
dollars.
For
unit
1
,
Q
say
the
9th
unit,
rms
require
at
least
P
2
Q,
h
dollars
while
for
unit
2
say
the
20th
unit,
rms
require
at
least
P
dollars.
It
follows
that
P
if
the
offer
all
least,
P
market
price
units
or
up
more
is
determined
until
than,
Q:
the
for
at
each
marginal
P
,
of
then
these
cost
of
rms
units
will
the
producing
be
willing
rms
earn
to
at
these.
2
P
The
difference
between
what
rms
earn
and
the
minimum
they
J
require
is
known
as
the
producer
surplus.
In
Figure
2.2.3,
the
0
Q
Q
Q
2
Q/period
producer
Figure 2.2.3The producer surplus
price
surplus
and
above
is
given
the
by
supply
the
shaded
curve
for
all
area
below
units
sold;
the
that
market
is,
area
PhJ.
Optimum production from society’s point of view
If
the
just
the
world
the
right
20th
would
(MC)
also
unit
unit
have
of
be
unit,
market
amount
of
been
produced
(Q)
MB
for
is
coffee
of
coffee
it.
from
which
MB
illustrated
from
produced?
to
pay
What
greater
is
coffee
be
willing
producing
the
for
society’s
than
=
It
MC.
point
should,
more
the
65th
point
the
Figure
society’s
(MB)
about
in
of
than
is
of
the
unit
again,
up
is
Should
consumers
additional
That
as
true
what
view?
because
unit?
view
This
2.2.4,
for
until
cost
should
that
the
70th
MC.
P/unit
S
=
MC
MB
MB
P
=
MB
=
MC
MC
MC
D
=
MB
0
20
65
70
Q/period
Q
Figure 2.2.4The market for coee
From
society’s
amount
of
demand
and
intervene,
the
right
The
26
point
coffee
supply,
lead
to
amount
market
of
that
a
of
view,
should
without
market
coffee
achieves
what
Q
units
be
the
price
need
of
P
produced
is
of
coffee
produced.
known
for
per
from
as
are
just
Market
the
unit
the
forces
government
of
coffee
society’s
allocative
right
alone,
to
and
point
of
to
just
view.
efciency.
2.2
If
allocative
amount
of
of
efciency
the
resources
production
consumer
the
good
(land,
of
each
surplus
miracle
of
L TA
DP ready
is
is
achieved
produced,
workers
good.
and
Adam
and
The
the
then
but
also
social
only
just
machines)
producer
Smith’s
not
just
the
are
right
surplus—the
sum
right
amount
allocated
surplus—is
“invisible
the
The invisible hand
in
of
the
the
maximized.
This
is
hand”
.
Thinking Skills
Social surplus
What would happen to social surplus if for some reason more or less
than the socially optimal amount was produced?
TOK
Remember that demand refers to willingness but also to the ability of
people to buy a good at each price. Ability is linked to income. If there
is a lot of pover ty in a country, is it morally justied to consider that the
allocatively ecient level of output of any basic good is the best from
society’s point of view?
Focus point
The
in
change
price
the
and
in
thus,
allocation
lead
to
the
possible
behaviour
of
more
of
or
resources
optimal
allocation
less
of
a
follows.
amount
of
market
of
the
participants
good
In
is
this
good
leads
produced.
way,
to
A
market
produced
and
a
change
change
forces
to
the
in
alone
best
resources.
Key terms—test yourself
Dene these terms: marginal benet, consumer surplus, marginal
cost, producer surplus, allocative eciency, social surplus.
27
2 . 3
A R E
W E
R E A L LY
R AT I O N A L?
In this section you will learn about ...
➔
rational consumer choice
➔
behavioural economics in action.
The issue
The
goal
goods
of
and
Standard
as
consumers
services.
economic
irrational—but
may
actually
goal
of
the
rational
best
bill.
TOK
get
hours
later
,
a
providers,
their
may
section
not
any
utility
from
necessarily
difference
explores
how
in
consuming
be
the
case.
behaviour
economic
agents
on
who
after
could
costs
on
with
save
to
she
a
$50
More
self-interest,
utility)
by
surprisingly
decides
to
will
(or
specically,
make
weighing
high
nd
energy
optimal
this
utility
services.
up
the
all
benets.
another
the
maximize
and
pure
and
received
nds
is
goods
maximum
work
deal
Miranda
she
acting
relevant
better
choic e
consumer
provides
evening
could
this
considers
This
consuming
Miranda,
One
it?
rational
from
(that
information
Consider
theory
consumer,
choice
maximize
c on sumer
the
satisfaction)
to
“misbehave”
.
Ra t ional
The
is
is
However,
out
plan
or
solution—if
year
.
The
winter
electricity
whether
she
provider
.
she
rational
Six
switches
consumer
,
like
Is the assumption of rational
Miranda,
is
often
referred
to
as
a
homo
economicus:
a
self-interested
consumer choice realistic?
agent
who
seeks
optimal,
utility-maximizing
outcomes.
Behavioural economics
Behavioural
economicus;
assumed
If
we
(say
to
by
$10
per
out
how
much
time
and
other
say
that
As
a
also
28
face,
result
of
known
then
she
was
to
will
she
which
bounded
and
systematic
errors.
decisions.
has
worth
if
a
homo
that
six
monetary
hours
switching?
sacrice
cognitive
to
the
How
arrive
limits,
of
cannot
are
be
a
and
idea
leisure
decision?
constraints
which
That
refers
cognitive
of
time
sure
much
at
time
value
her
decision-making.
rationality,
constraints
makes
a
Miranda
consumer
to
is
the
limitations
always
choosing
the
complex.
rationality,
heuristics,
judgments
from
to
bounded
time
of
decision-makers
time
What
save
the
notion
theory.
really
need
optimal
have
and
it
the
rational
leisure
saving?
prohibitively
as
the
Miranda’s
information,
option
not
highlights
people
debunked
economic
would
issue
has
are
energy
money
people
“best”
hour)
the
barriers
that
restricted
that
effort
Miranda’s
to
people
standard
suppose
work
and
economics
which
people
are
However,
use
rules
shortcuts
these
rules
to
of
help
thumb,
them
typically
make
result
in
2.3
One
example
about
can
the
is
availability,
likelihood
think
of
decisions.
a
of
similar
For
occurrence
following
a
Another
people
rely
one
three
as
a
example,
is
of
of
576
piece
rst
shown
house
(as
anchor
Besides
by
framing
are
cheap
can
presented
with
a
Of
make
to
presenting
prefer
that
effect
is
or
chains
fact
the
the
is
is
false
an
insurance
then
all
world
by
a
place
not
a
asked
valued
of
re-
to
necessarily
write
by
the
This,
of
of
For
instance,
down
one
asked
that
real
when
decision.
to
the
estimate
houses
more
For
estate
the
highly.
is
the
serves
presented
course,
(for
with
example,
agent
houses
last
thousand
participants
settings.
perceptions
rst
their
consequent
that
to
which
since
burgers
a
new
can
known
lead
label
frames
to
whether
a
One
“9%
the
the
and
next
and
burger
same
biased
uses
because
inuence
will
Think
fat”
.
thumb,
are
two
label
as
fat.
the
fast
will
healthier
of
their
food
“91%
Individuals
amount
the
presented
choose
of
the
of
opportunities
people
people
way.
of
optimal
options
Most
burger.
contain
not
rules
signicantly
is
positive
the
it
are
how
frame.
in
uses
therefore
L TA
DP ready
refers
positive
other
and
importance
presented
both
can
that
showed
real
decisions
people,
particular
that
to
to
likelihood
takes
making
were
expensive).
Framing
negative
and
or
there
the
multiplied
individual
rationality
option
free”
an
that
they
lead
businesses.
effect.
choices.
to
inuences
bounded
individuals
They
easily
can
earthquake
though
were
Results
in
of
Anchoring
when
digits
how
judgments
low.
number
similarly
and
relatively
exploited
phone
telephone
works
even
is
make
This
found
information
point
houses.
Anchoring
an
of
576,000).
different
been
future
on
case.
purchase
participants
their
=
has
the
anchoring.
reference
higher-ending
as
near
experiment,
digits
prices
on
a
it
of
people
based
or
earthquake,
the
example
relevant
in
major
in
event
example
example,
increased
occurrence
an
where
Are we really rational?
fat
tend
despite
The
the
framing
choice.
Thinking , research and communication skills
Framing dierent options
In a small group, devise a number of simple but equivalent options
framed dierently. Present these options to other students and
record which ones they choose. Does framing matter?
B ehav iour al
People’s
choices
preferences.
is
in
their
intervention
make
T
oo
own
in
choices
ec onomic s
often
end
often
individuals
best
the
in
up
interest.
in
being
This
best
inconsistent
are
unable
opens
decision-making
their
ac t ion
interest.
the
process
Some
to
their
appreciate
door
to
with
for
motivate
examples
what
positive
people
to
follow.
Choice architecture
How
a
particular
have
a
signicant
default
choices.
choice
effect
The
is
presented—the
on
the
default
choice
choice
is
choice
made.
the
architecture—can
People
option
tend
that
a
to
make
consumer
29
“selects”
made
he
or
consumers’
choice
context
choice
in
which
architect
T
o
welfare,
the
to
default
rates
be
still
the
default
the
can
the
a
choice.
For
choices
default
are
option
responsible
decisions.
out
to
worker
if
then
organ
therefore
strongly
for
the
the
but
for
opt-out
An
to
from
can
be
set
individual
that
would
scheme
that
best
outcome
benet
pensions.
but
the
assumed
choice
death.
pension
up
is
desired
would
default
that
the
individual’s
that
set
upon
organizing
assumed
in
donation
signed
still
is
society
encourage
can
is
can
the
donated
of
It
what
behaviour
example,
being
opt
is
architect
automatically
A
the
particular
Similarly,
be
of
Default
about
donation,
organs
to
make
more
choice
organ
choose
nature
whoever
people
choice.
of
default.
workers
is
encourage
everybody’s
may
The
nothing.
behaviour.
knows
improve
higher
does
architect
interest.
as
she
automatically.
affects
The
if
not
enrollment,
This
would
is
the
not
be
default.
Nudges
TOK
Another
way
to
inuence
people’s
choices
is
through
nudges.
Debate the extent to which
Nudges
are
small
design
changes
capable
of
signicantly
changing
governments will nudge people
people’s
behaviour.
An
expert
can
nudge
people’s
choices
in
the
in the right direction.
direction
be
used
and
the
to
expert
tackle
services
(such
as
on
can
a
considers
the
be
to
growing
nudged
menu)
in
a
be
best.
obesity
to
display
manner
For
example,
problem.
that
products
induces
nudging
Sellers
or
of
lists
people
can
goods
of
to
products
buy
Search the web
healthier
foods.
One
example
could
be
putting
fruit
and
vegetables
Search using these terms: y
in
grocery
stores
at
eye
level.
Schiphol nudge washington
post. Professor Thaler is a
Nudging
can
also
be
used
to
induce
behaviour
that
is
leading behavioural economist
environmentally
friendly.
For
instance,
garbage
bins
to
dispose
of
and Nobel Prize winner. Read
about his favourite example of
“tweaking the environment” so
recycled
for
material
regular
can
waste.
be
twice
Having
less
or
even
room
three
for
times
general
bigger
waste
can
than
bins
nudge
that we change how we behave.
people
to
Defaults
requires
likely
recycle
and
nudges
some
that
the
L TA
DP ready
more.
can
but
intervention.
choices
should
Only
people
not
with
make
mislead
proper
are
better
people.
This
regulations
is
it
more
choices.
Thinking , research and communication skills
Choice architecture and nudges
Investigate how choice architecture and nudges inuence decision-
making in a par ticular context. Share this with your classmates.
Key terms—test yourself
Dene these terms: bounded
Focus point
rationality, rules of thumb
Behavioural
economists
have
challenged
the
traditional
rational
(heuristics), availability,
economic
decision
making.
They
have
showed
how
economic
anchoring, framing, default
agents
are
subject
to
bounded
rationality
choice, nudges.
which
30
lead
to
sub-optimal
decisions.
and
make
biased
choices
2 . 4
W H AT
D O
H AV E
I N
E L A S T I C I T I E S
A N D
T I C K L I N G
C O M M O N ?
In this section you will learn about ...
➔
price elasticity of demand (PED)
➔
income elasticity of demand (YED)
➔
price elasticity of supply (PES).
The issues
Price
elasticity
revenues
need
to
service
would
if
the
will
nd
goal
demand
expand
to
rising
Income
share
elasticity
effect
elasticity
P r ic e
demand
of
a
demand
supply
the
and
supply
(PES):
ela s t ici ty
not
of
to
A
to
in
demand
cigarette
are
more
or
tax
tax
elasticity
more
the
long
sector
of
explain
of
will
the
likely
term,
to
as
shrinks,
Growth
leads
services.
this.
increases,
understand
They
issues.
especially
quantity
good
government
price
over
always
their
charge.
the
a
income.
to
how
collect
of
agricultural
demand
not
us
on
rms
Also,
helps
equilibrium
helps
they
make
related
Some
and
is
to
just
other
the
If
price
knowledge
decline
(YED)
know
imposed
high
(YED):
rise,
the
to
consumers.
and
and
quantity
(PES)
to
how
relative
need
tax
growing.
incomes
and
price
on
manufacturing
of
of
is
a
why
these
economy
and
price
on
of
of
of
smoking
with
Firms
increase
shifted
explains
experience
elasticity
equilibrium
the
the
they
example,
decrease
section
grow
farmers
be
for
helps
if
(PED):
proportion
can
elasticity
when
and
Price
to
This
economies
a
affected
know,
(PED)
Income
demand
what
offer
to
is
revenues.
be
out
they
like
of
both
the
increase,
same.
but
Price
why.
(P ED)
What is PED?
Think
of
thinking
and
cannot
PED
tries
respond
as
tickling
that
the
PED
is
stop
to
to
two
your
friends.
behaviour
laughing.
measure
a
change
responsiveness
measured
demanded
over
as
the
its
of
the
looks
very
the
More
quantity
of
percentage
you
The
they
quantity
price.
ratio
at
odd.
Obviously,
how
in
One
is
have
demanded
to
percentage
change
friend
in
jumps
responded
formally,
demanded
the
expressionless,
other
of
PED
a
a
is
differently.
good
will
dened
change
change
up
in
in
price.
quantity
price.
%∆Qd
PED
=
%∆P
Internal link
Since
price
and
quantity
demanded
always
move
in
opposite
directions
Turn to section 2.1 for more on the
(the
law
of
demand),
PED
is
always
a
negative
number
.
Usually
the
law of demand.
minus
sign
is
ignored
and
PED
is
referred
to
as
a
positive
number
.
31
If
PED
is
greater
demanded
the
price
decreased
known
If
PED
is
of
is
the
3%
is
of
decreased
means
then
PED
0
good
only
is
by
is
1,
it
the
and
its
(ignoring
means
then
as
that
smaller
increased
1%
change
than
2%
1.5
the
in
quantity
change
in
quantity
the
price:
if
demanded
minus
sign).This
is
demand
and
known
that
bigger
proportionately
a
by
This
it
increased
elastic
between
price
sign).
good
price
demanded
1
proportionately
a
by
as
than
by
2%
PED
price
is
the
than
and
0.5
change
the
its
change
quantity
(again,
inelastic
in
quantity
in
price:
if
demanded
ignoring
the
minus
demand
Ex treme cases
■
PED
=
0
increase
This
is
in
if
be
■
→
∞
is
on
a
compared
at
some
the
that
if
vertical
no
some
will
be
then
price,
demand
price,
then
that
without
out.
for
If,
implies
need
systems,
lower-
we
may
income.
Again,
the
buy
the
vitally
goods
faced
that
will
for
demanded.
is
however,
many
demand
An
some
horizontal).
consumers
the
good
necessary
the
this
quantity
the
health-care
priced
the
If
curve).
medication,
demand
have
elastic;
in
if
countries’
importance.
market
even
necessary
they
demand
decrease
market
patients
(infinitely
at
in
to
a
very
inelastic
to
in
individuals
theoretical
horizontal
lead
example,
perfectly
offered
will
uninsured
rather
inelastic;
unlikely
good
focusing
PED
of
For
the
income
are
price
highly
needed.
even
(perfectly
by
firm
any
price
this
a
is
is
firm
so
is
small
quantity
to
decrease.
Search the web
■
To nd out more, search using
PED
a
=
1.
This
means
proportionately
that
equal
any
(in
change
the
in
opposite
price
would
direction)
lead
to
change
in
these terms: rectangular
the
quantity
demanded.
This
is
quite
unlikely.
Demand
has
a
hyperbola demand.
special
shape.
It
is
a
“rectangular
hyperbola”
.
What does PED depend on?
Common
to
■
determine
There
are
many
any,
increases.
switch
to
will
be
The
price
have
to
though,
public
transport
price
moving
elastic
The
is
a
closer
in
the
price
of
much
less.
fresh?
of
a
income
Who
also
a
for
for
good
good
will
that
following
it
B.
be
for
A.
affect
PED.
T
ry
examples.
Consumers
The
price
easier
which
work
may
the
the
for
of
of
have
both
consumers
the
of
choice.
salary
probably
long
two
goods
start
how
despair,
for
After
options,
with
gasoline
a
such
others?
hybrid
but
If
car
using
the
or
even
be
more
price
Eating
fresh
fish
term?
increases.
Now
and
expenditure
change?
other
buying
demand
the
Drivers
supermarket.
journeys
think
significantly
high
will
or
or
consider
car
Will
term
fish
a
substantially.
they
determine
price
the
Demand
sharing
healthy
Doesn’t
following
to
work.
earning
of
rises
they
short
considered
banker
or
fresh
factors
elastic?
drive
to
in
case
good?
wouldn’t
lasts
the
substitutes
which
gasoline
while,
factors
substitutes
In
price
of
determine
close
close
another
more
still
us
relevant
goods
higher
32
the
if
they
■
helps
fewer,
to
■
sense
consider
an
eating
on
a
two
unskilled
frozen
good
responsive
as
a
individuals:
worker
fish
earning
instead
proportion
demand
will
be
2.4
Now
■
let’s
consider
demand
for
an
addictive
What do elasticities and tickling have in common?
P ED
good—cigarettes.
→
∞
P/unit
Will
a
What
■
small
tax
about
convince
demand
for
many
smokers
everyday
to
a
quit?
necessities—would
you
P ED
consider
demand
for
these
to
be
price
inelastic
or
price
1
m
Illustrating PED
Perhaps
>
elastic?
surprisingly,
PED
is
not
the
slope
of
a
demand
curve.
PED
P ED
the
higher
the
original
price
is.
PED
varies
along
a
1
is
0
greater
=
<
P ED
<
0
straight-line
P ED
demand
curve
as
shown
in
Figure
2.4.1.
At
the
midpoint
m,
PED
=
0
is
b
equal
to
1.
At
point
a
it
tends
to
innity
and
at
point
b
it
is
equal
to
0.
0
Q/period
At
higher
prices
(above
point
m)
demand
is
price
elastic
(PED
>
1)
Figure 2.4.1PED
while
(0
Of
<
at
lower
PED
course,
already
<
prices
(below
point
m)
demand
is
price
inelastic
1).
this
makes
expensive
sense.
will
hurt
An
increase
consumers
in
price
more
when
than
if
a
the
good
good
is
was
cheaper.
A
price
inelastic
demand
(throughout
its
curve
A
leng th)
price
elastic
demand
(throughout
P/unit
its
curve
leng th)
P/unit
D
2
D
0
0
Q/period
Q/period
(b)
(a)
Figure 2.4.2aPrice inelastic demand b Price elastic demand
T
o
illustrate
from
the
a
demand
origin
and
that
steep,
is
considered
like
D
in
price
Figure
inelastic,
2.4.2a.
T
o
draw
it
illustrate
far
a
1
demand
and
at,
that
is
like
D
considered
in
Figure
price
elastic,
draw
it
far
from
the
origin
2.4.2b.
2
T
able
2.4.1
summarizes
information
about
elasticity
of
demand.
Demand is considered:
if PED > 1
So %ΔQd > %ΔP
Draw at but far from the origin
price inelastic
if 0 < PED < 1
So, %ΔQd < %ΔP
Draw steep but far from the origin
unitary elastic
if PED = 1
So, %ΔQd = %ΔP
Draw a cur ve that never touches either axis
if PED → ∞
So, consumers will buy any
price elastic
Draw parallel to the Q-axis
perfectly elastic
amount at some price
if PED = 0
So, when P changes,
Draw vertical to the Q-axis
perfectly inelastic
Qd does not
Table 2.4.1Elasticity of demand—a recap
PED and revenues
The
if
it
question
increases
increasing
that
a
price
price,
rm
can
faces
now
quantity
on
be
what
will
answered.
demanded
will
happen
Firms
to
know
decrease.
By
its
revenues
that
how
by
much,
33
P/unit
though?
or
b
P
This
services.
is
why
Would
rms
they
would
prefer
like
to
demand
know
to
be
PED
price
for
their
elastic
goods
or
price
2
inelastic?
+
The
answer
is
price
inelastic,
so
that
the
decrease
in
a
P
quantity
For
if
demanded
example,
quantity
In
Figure
if
a
is
proportionately
rm
increased
demanded
2.4.3
price
its
decreased
charged
less
price
only
by
increased
than
by
the
10%
6%,
so
from
it
increase
would
that
to
P
decreased
from
to
q
q
1
.
T
otal
PED
P
1
demanded
in
be
is
and
price.
happy
0.6.
quantity
2
revenues
(P
times
Q)
2
D
collected
0
q
will
increase
from
area
aP
0q
1
q
2
to
area
0q
1
bP
2
2
Q/period
T
able
2.4.2
summarizes
information
about
the
relationship
Figure 2.4.3Increase in price and
between
price
and
demand.
decrease in demand
L TA
DP ready
Thinking Skills
Demand
when price increases
If demand is price elastic
then, total revenues
(so, PED > 1)
(TR) will ↓
If demand is price inelastic
then, TR will ↑
when price decreases
then, TR will ↑
Sale prices and PED
Explain why a depar tment
store considering a “midnight
then, TR will ↓
(so, 0 < PED < 1)
madness sale” would be
Table 2.4.2Price and demand—a recap
interested in the PED of the
various items it oers.
PED and the government
Does
a
does.
it
government
If
it
hopes
to
product
elastic
unit
like
a
the
to
if
to
tax
the
tax
a
goal
that
of
would
respond
some
PED
on
countries
a
tax
the
also
of
so
a
at
Could
low
on
this
while
to
prefer
to
with
tax
tax
a
it
and
a
price
imposed
possible,
collect
such
as
it
per
would
will
high
and
others
of
how
their
cigarette
they
revenues,
Could
achieve
that
proportion
why
tax
cigarettes.
expensive
explain
in
course
government
as
prices
the
Of
goods)
demand.
very
higher
it
the
the
little
much
on
product
equal
product
cigarettes
tax
will
a
Since
inelastic
depends
relatively
or
as
products?
unit
taxes,
sold.
not
higher
good.
in
decrease
is
of
per
collected
price
make
is
PED
(a
demand
units
to
with
the
consumers
spent
revenues
of
the
tax
money
consumption
that
is
of
inelastic
demanded
goods
Remember
that
lot
T
ax
about
indirect
number
decrease
high
care
an
price
demand?
quantity
What
a
collect
with
times
prefer
but
imposes
are
this?
much
income
taxes
extremely
are
in
high?
PED of primary products
L TA
DP ready
Primary
products
include
agricultural
products,
such
as
coffee
or
Thinking Skills
cotton,
Primary products
Each
as
of
well
these
produce
Corn
as
metals
has
few,
Flakes
if
and
any,
using
minerals,
close
wheat.
such
as
substitutes.
Consider
copper
and
Kellogg’s
cerium,
a
zinc.
cannot
rare
earth
If, in a developing country
mineral.
Cerium
is
necessary
in
the
production
of
cars’
catalytic
that expor ts cocoa, weather
converters
as
it
enables
them
to
run
at
very
high
temperatures.
conditions lead to a record
Does
a
manufacturer
of
catalytic
converters
have
much
choice
suggest
about
the
if
supply, how will this aect its
the
price
of
cerium
rises?
What
does
this
PED
of
(expor t) revenues?
primary
products?
PED of manufactured products
Demand
laptops,
34
for
is
manufacturing
more
price
sector
elastic.
This
products,
is
such
because
as
cars
consumers
or
face
more
2.4
and
a
closer
substitutes.
Mercedes
on
may
be
manufactured
many
more
an
a
consumer
alternative
goods
consumers.
price
If
That
are
often
may
is
to
a
considering
consider.
big
explain
What do elasticities and tickling have in common?
Also,
proportion
why
buying
their
a
BMW
,
expenditures
of
income
demand
is
for
typically
elastic.
L TA
DP ready
Thinking and communication skills
Analysing reasons for PED
Refer to the information in the table below.
Product or ser vice
PED
Product or ser vice
PED
Salt
−0.1
Restaurant meals
−2.0
Gasoline, shor t run
−0.2
Vacations abroad
−3.2
Physicians’ ser vices
−0.6
Ford cars
−3.4
Gasoline, long run
−0.7
Table 2.4.3
In a small group, try to think of plausible reasons for each product’s PED. Present your ndings
on a poster and share it with the rest of your class.
Inc ome
ela s t ici ty
of
demand
( Y ED)
What is YED?
Income
elasticity
demand
as
the
the
of
following
ratio
of
the
percentage
a
demand
change
(YED)
in
percentage
change
in
is
the
responsiveness
consumers’
change
in
income.
quantity
It
is
of
measured
demanded
over
income.
%∆Qd
YED
=
T
ypically,
YED
is
a
positive
number
DP ready
since
income
(Y)
and
L TA
%∆Y
Thinking Skills
quantity
YED on ser vices and on
demanded
(Qd)
change
in
the
same
direction.
If
incomes
are
various products
increasing,
versa.
is
demand
These
are
the
for
most
normal
goods
goods
will
be
increasing
introduced
earlier
and
and
vice
their
YED
1.
positive.
Think of why demand for
most services is income
elastic while demand
If
incomes
in
an
economy
are
increasing,
demand
for
some
for many food items is
goods
may
increase
faster.
For
example,
incomes
may
increase
income inelastic. Explain
by
5%
and
quantity
demanded
for
a
product
may
increase
by
why the YED of inferior
+7.5
7.5%.
Using
the
formula
above,
YED
=
is
+1.5.
If
YED
is
products is negative.
+5
positive
a
and
greater
proportionately
than
greater
1
then
an
increase
increase
in
in
quantity
income
has
demanded.
led
This
to
Give examples.
is
2.
known
as
income
elastic
demand.
Demand
for
most
services
Consider the YED for
is
used cars in a city where
income
elastic.
consumers are poor, and
In
contrast,
but
at
a
if
incomes
much
demand.
For
demanded
slower
rate,
example,
increases
are
if
but
increasing
this
is
known
incomes
only
by
and
demand
as
increase
2%
then
increases
income
by
5%
YED
is
inelastic
and
quantity
equal
contrast it with a city with
high-income consumers.
Do you think that the YED
of a good is the same for
to
+2%
all consumers across all
=
+0.4.
This
+5%
potatoes
is
more
likely
for
many
food
products
like
income levels?
or
salt.
35
T
able
2.4.4
summarizes
information
about
YED.
Normal goods (YED > 0)
0 < YED < 1
YED > 1
Income inelastic demand
Income elastic demand
Examples: farm products; food; basic day-to-day
Examples: most ser vices; expensive (luxury)
goods and necessities (kale, rice, canned tuna,
goods (beauty treatments, cruises, cars,
pencils, haircuts)
dishwashers, iPhones, sail boats)
Inferior goods (YED<0)
Examples: used cars, low-quality clothing, lower-quality food
Table 2.4.4YED—a summary
Illustrating income elasticities
T
o
illustrate
Engel
differing
curves.
quantity
good)
is
In
Engel
demanded
on
the
that
is
also
increases.
must
an
upward
intersect
income
of
a
curve,
good
horizontal
sloping:
If
the
the
elasticities
as
more
Normal
income
demand
vertical
income
(or
,
axis.
is
axis
we
on
),
what
the
broadly,
goods
increases,
income
(E
is
use
are
vertical
have
elastic,
if
axis;
expenditures
an
quantity
whereas
called
the
Engel
on
the
curve
demanded
Engel
demand
curve
is
income
1
inelastic,
the
Engel
curve
must
intersect
the
horizontal
axis
(E
).
2
L TA
DP ready
Income
elastic
demand
Income
inelastic
demand
Thinking Skills
Y
Y
E
The Engel cur ve
E
Try to determine the Engel
2
curve if YED is equal to one
and if YED is negative.
0
0
Qd
(a)
Qd
(b)
Figure 2.4.4a and bNormal goods—diering income elasticities
L TA
DP ready
Thinking and communication skills
YED on eurozone products and ser vices
Product or ser vice
YED
Product or ser vice
YED
Public transpor tation
−0.26
Furniture
1.42
Dining out
1.54
Foreign travel
3.01
Petrol (gasoline)
0.46
Food
0.16
Electricity
0.24
Table 2.4.5
As a result of the eurozone crisis that star ted in 2009, incomes decreased and unemployment increased in
Spain, Por tugal, Greece and Ireland. Given the YED values in Table 2.4.5, think about the impact of this crisis
on the industries and activities listed. Do you think that in countries with incomes below the European Union
(EU) average, YED for food will be higher or lower than for countries with much higher incomes than the EU
average? Present your ndings for discussion in your class.
36
2.4
P r ic e
ela s t ici ty
of
supply
What do elasticities and tickling have in common?
(P E S)
What is PES?
Price
elasticity
supplied
to
a
percentage
change
in
of
supply
change
change
in
in
(PES)
price.
is
the
We
quantity
responsiveness
measure
supplied
it
as
(Qs)
the
over
of
quantity
ratio
the
of
the
percentage
price.
%∆Qs
PES
=
%∆P
Since
price
and
quantity
supplied
always
move
in
the
same
Internal link
direction
(law
of
supply),
PES
is
always
a
positive
number.
See section 2.1 for more on the law
If
PES
is
greater
supplied
price
by
If
of
7%
PES
is
a
the
good
is
price
inelastic
means
is
1.4.
0
by
a
by
good
only
5%
This
and
1,
is
it
and
by
quantity
as
price
the
than
the
is
in
change
that
3%
PES
change
the
its
known
smaller
then
the
than
means
increased
1.5%
that
greater
proportionately
of
increased
it
increased
PES
between
supplied
1,
proportionately
then
is
than
and
0.5.
its
quantity
in
price:
supplied
elastic
of supply.
if
the
increased
supply
change
in
quantity
change
in
price:
quantity
This
is
if
supplied
known
as
price
supply
Ex treme cases
■
PES
=
0
(perfectly
Anincrease
increase
market
in
in
where
change.
Supply
PES
A
of
→∞
without
PES
=
This
is
price
a
that
would
supplied.
elastic;
are
is
for
at
an
will
of
a
lead
fresh
sale
increase
by
no
increase
but
sellers
market
to
sh
unexpected
will
that
implies
willing
in
to
a
increase
to
are
their
supply;
supplied.
good
horizontal
curve
that
This
to
straight
case
price
is
no
satisfy
able
as
it
the
cannot
that
day
is
zero.
by
quite
3%
curve).
matter
demand
produce
how
at
much
that
and
is
price.
supply
more
costs.
line
through
means
proportionately
in
supply
production
any
theoretical
lead
An
a
Think
curve).
inelastic.
increase
rather
supply
price
available
producers
(unitary
of
there
The
sardinella
supply
sellers
any
1
quantity
of
(infinitely
means
price
morning
perfectly
demanded,
■
PES
vertical
supplied.
sardinella.
sardinella
horizontal
This
market
quantity
one
for
The
is
the
the
demand
quantity
■
in
inelastic;
equal
leads
that
the
any
change
to
a
3%
origin).
change
in
in
quantity
rise
in
unlikely.
What does PES depend on?
Again,
affect
common
PES.
T
ry
sense
to
will
help
determine
the
you
to
determine
relevant
factors
the
in
factors
the
that
following
examples.
■
A
it
firm
to
a
seller
sells
firm
will
plastic
that
it
be
flowers
sells
fresh
easier
to
and
stores
flowers
meet
an
in
significant
the
market.
increase
in
stock.
For
Contrast
which
demand?
37
■
T
wo
factories
are
producing
cement.
Factory
A
is
fully
utilizing
Search the web
its
capacity.
Factory
B
is
not;
it
has
plenty
of
spare
capacity.
For
PES also depends on how fast
which
factory
will
it
be
easier
to
meet
an
increase
in
demand
costs increase as output per
for
cement?
period increases. Search using
these terms: heavy mining
■
A
firm
supplying
gardening
services
employs
mostly
unskilled
trucks. Look at the images. For
workers.
A
medical
research
company
requires
very
highly
a mining company it must be
skilled
and
trained
workers.
Following
an
increase
in
demand,
very dicult to expand output
for
given the additional cost of
which
difficult?
acquiring such equipment. Is
one
Use
of
the
the
two
term
firms
will
“labour
expanding
mobility”
to
output
answer
be
more
this.
supply of ores price elastic or
Most
importantly,
the
time
period
determines
PES.
Three
time
price inelastic?
periods
run.
■
are
The
In
the
fixed.
■
meet
In
the
an
In
be
L TA
DP ready
run,
long
can
met.
it
run,
be
run,
PES
is
in
factors
factors
meet
thus
short
of
run
production
inelastic.
scale
can
to
but
an
factors
its
the
and
the
long
Firms
are
will
considered
not
be
able
demand.
(capital)
all
change
all
perfectly
considered
can
run,
criterion-based.
some
is
fixed
extent
the
firm
will
that
considered
■
momentary
is
increase
short
factor
some
the
momentary
Supply
to
one
used:
distinction
greater
it
fixed.
can
hire
increase
of
of
change
be
in
in
the
long
there
firm’s
more
is
at
least
premises
labour,
so
are
to
demand.
production
operations.
but
A
are
An
run
considered
increase
than
in
in
variable.
demand
the
short
A
can
run.
Illustrating PES
Thinking Skills
Again,
PES
is
not
the
slope
of
a
supply
curve.
It
can
be
shown
that
PES for a supply cur ve
if
supply
cuts
the
vertical
axis
then
it
is
price
elastic
(PES
>
1),
Based on Figures 2.4.5a and
whereas
if
it
cuts
the
horizontal
axis
it
is
price
inelastic.
2.4.5b, determine the PES for
Remember
that
we
are
talking
about
percentage
changes
of
price
any (linear) supply curve that
and
quantity
supplied,
and
not
absolute
changes.
Refer
to
Figures
goes through the origin.
2.4.5a
and
2.4.5b.
Price
(supply
P/unit
Price
elastic
“cuts”
(supply
ver tical)
Inelastic
“cuts”
ver tical)
P/unit
S
S
2
P
P
2
2
P
P
0
0
Q
Q/period
Q
Q
Q/period
Q
2
2
(a)
(b)
Figure 2.4.5a and bSupply—price elastic and price inelastic
This
price
is
not
from
proof,
P
to
P
1
percentage
2.4.5a,
as
but
is
is
the
quite
same
in
change
quantity
from
Q
1
quantity
supplied
Q
1
38
clear
in
that
Figures
the
percentage
2.4.5a
and
change
2.4.5b
but
supplied
to
Q
2
is
is
much
roughly
bigger
50%
of
in
the
in
the
2
change
the
it
Figure
initial
2.4
T
able
2.4.6
What do elasticities and tickling have in common?
summarizes
information
about
price
elasticity
of
supply.
Supply is considered:
price elastic
if PES > 1
so, %ΔQs > %ΔP
It must cut the ver tical axis
price inelastic
if 0 < PES < 1
so, %ΔQs < %ΔP
It must cut the horizontal
axis
if PES = 1
unitary elastic
so, %ΔQs = %ΔP
It must go through the origin
(any slope)
perfectly elastic
so, at that price, the rm is willing
if PES → ∞
Draw it parallel to the Q-axis
to oer as much as demanded
if PES = 0
perfectly inelastic
so, when P changes, Qs does not
Draw it ver tical to the Q-axis
Table 2.4.6Price elasticity of supply—a recap
So,
how
is
demand
Given
a
supply
sense
If,
is,
of
the
expand
P
and
on
demand
greater
price
however,
responsible
on
shift
as
easily
PES
has
output,
supply
proportionately
to
the
inelastic
the
the
effect
that
right,
the
so
an
more
(proportionate)
supply
was
more
for
increase
in
Q?
it
will
price
than
means
be
price
effect
that
price
elastic
price
that
then
on
rms
inelastic
price.
will
will
not
mostly
output
would
It
be
makes
able
to
increase.
expand
increased.
PES of primary goods and manufactured goods
Research and
Supply
of
primary
products
is
typically
price
inelastic.
L TA
DP ready
communication
Producing
skills
a
product
such
harvesting)
extremely
as
while
grapes
typically
increasing
expensive
mining
takes
output
in
months
mining
(from
planting
facilities
to
requires
equipment.
Research what rare ear th
minerals are. Select a few and
nd out what they are used
T
ypically,
supply
of
manufactured
products
is
price
elastic,
as
a
for. Explain to your classmates
sudden
increase
in
demand
can
usually
be
met
by
asking
workers
why we expect both PED and
to
work
overtime
or
by
hiring
more
labour.
Of
course,
the
rm
PES to be quite low in value.
must
have
other
necessary
inputs
available
and
some
unused
capacity.
Focus point
Elasticities
■
the
in
■
quantity
the
extent
demanded
to
changes
which:
following
a
change
in
price
or
income
the
quantity
Elasticities
rms
determine
and
are
supplied
therefore
changes
following
important
a
inuences
change
on
the
in
price.
decisions
of
governments.
Key terms—test yourself
Dene these terms: price elasticity of demand (PED), price elastic
demand, price inelastic demand, total revenues, income elasticity
of demand (YED), income elastic demand, income inelastic demand,
price elasticity of supply (PES), price elastic supply, price inelastic
supply.
39
2 . 5
T H E
V I S I B L E
H A N D
In this section you will learn about ...
➔
price ceiling (maximum price)
➔
price floor (minimum price)
➔
indirect taxation
➔
subsidies.
The issues
A
price
that
to
a
the
ceiling
highest
prices,
but
price
oor
producers,
expense
other
taxes
can
are
specic
be
are
imposed
a
by
outcomes,
examines
markets.
but
be
are
taxes
or
on
ad
of
governments
stakeholders
are
is
The
but
be
a
charged
form
a
in
control
for
a
refer
good.
The
excessively
high
arise.
of
price
oors
good
most
price
ceilings
against
Price
for
of
Price
cases,
control
act
and
government’s
goods
a
a
and
are
as
are
goal
this
in
may
effects
of
price.
a
that
the
to
comes
a
lowest
usually
is
the
set
in
protect
at
the
of
and
expenditures.
(or
Ad
unit
taxes)
valorem
taxes
they
are
affect
This
market
section
taxation.
intervention
government
certain
have
on
taxes
good.
allocation.
government
by
or
Indirect
reasons
indirect
achieving
and
the
Specic
resource
of
services
unit
many
of
payments
costly
examines
form
per
good’s
for
consequences
also
and
valorem.
amount
percentage
They
form
usually
market.
charged
farmers,
a
stakeholders.
successful
they
section
be
can
effects
a
is
market.
consumers
price)
in
a
that
markets.
“dollar”
are
in
protect
side
can
specic
the
Subsidies
may
that
product
They
taxes
price
to
impose
usually
of
Indirect
is
(minimum
can
price
agricultural
a
goal
price)
impose
undesirable
government
possible
maximum
can
possible
government’s
A
(or
government
goals
of
undesirable
subsidies
on
to
the
side
in
rms.
They
government
effects.
markets
and
This
on
stakeholders.
P r ic e
c eiling
(ma x imum
pr ic e)
Why do governments impose price ceilings?
A
price
ceiling
determined
this
level.
countries
40
by
is
Price
on
set
the
by
ceilings
basic
the
market.
government,
The
have
goods,
price
is
historically
usually
on
which
then
been
food
is
not
below
allowed
imposed
products
the
to
in
such
price
exceed
many
as
milk
or
2.5
bread,
but
also
on
gasoline
and
heating
fuel.
In
many
cities
around
The visible hand
P
(rent/
the
world,
authorities
have
also
imposed
rent
controls
in
the
rental
apar tment)
S
housing
ceilings
market.
Rent
therefore
cheaper
and
so
aim
more
controls
are
to
certain
make
affordable
examples
to
of
basic
low
price
goods
income
ceilings.
and
Price
services
consumers.
P
e
Analysing
the
impact
of
a
price
ceiling
A
B
rent
control
P
c
First,
let’s
housing
consider
less
the
case
affordable
for
of
a
rent
many
control.
High
households.
For
rents
make
example,
in
2019
D
the
average
monthly
rent
for
a
two-bedroom
apartment
in
London
0
Q
Q
s
was
in
over
the
$2,000
world
to
and
rent.
London
Because
is
among
of
this,
the
the
most
Mayor
expensive
of
London
cities
Q
d
(apar tments/period)
may
Figure 2.5.1Impact of rent control in the
impose
rent
control
The
in
rent
controls.
the
market
control
)
(P
Figure
for
is
2.5.1
rented
set
illustrates
apartments
below
the
the
in
impact
of
rent
rented apar tment market in London
London.
market-determined
rent
c
(P
)
and
represents
the
highest
possible
rent
landlords
can
e
legally
At
P
charge.
the
number
of
apartments
now
offered
for
rent
is
lower
than
c
the
number
of
apartments
tenants
are
willing
and
able
to
rent
(Q
s
<
).
Q
The
result
of
the
price
being
set
by
authorities
below
the
d
market
equilibrium
exceeds
for
rent
quantity
is
given
price
is
supplied.
by
–
Q
distance
Are
to
■
controls
controls
the
as
shortage
equal
to
line
quantity
of
demanded
apartments
segment
(Q
s
Q
s
available
)
or
d
(AB).
rent
Rent
shortage,
This
Q
d
a
make
following
Landlords
effective?
housing
more
affordable
but
they
can
also
lead
issues.
will
decide
according
to
their
own
preferences
who
TOK
they
will
without
is
also
or
rent
a
a
pet
high
their
property
or
households
to
risk
of
to.
For
example,
without
discrimination
to
young
based
on
households
children.
ethnic
There
background
When rent controls are
imposed, landlords have a
larger choice of tenants wanting
religion.
to rent their proper ty. What are
■
There
may
be
long
waiting
lists
for
tenants
who
want
to
rent
the ethical considerations of
a
property.
landlords’ decisions about who
■
Landlords
may
demand
unofficial
payments
in
addition
to
can rent their proper ty? Should
the
legal
maximum
rent
or
may
demand
large
deposits.
the government enact laws that
■
The
quality
will
earn
of
less,
maintenance
■
Some
the
available
There
and
on
landlords
through
■
rental
will
their
may
be
lower
more
not
will
have
deteriorate
the
incentive
as
to
landlords
carry
protect tenants from possible
out
abuse?
properties.
switch
company
properties
will
construct
property
to
Airbnb).
for
This
longer-term
incentive
housing
short-term
for
rentals
decreases
(such
the
as
number
of
leases.
real
estate
developers
to
units.
41
L TA
DP ready
Thinking , communication and research skills
Rental proper ty
1.
Explain whether it is always feasible for the
4.
In some cities, Airbnb is considered
government to plan and implement rent controls.
responsible for surging rents and for many
tenants being evicted. Search for relevant
2.
Describe the issues that arise if the rental
information. Describe whether rent controls
housing market is informal and so largely
would help or worsen the crisis.
invisible.
5.
3.
When a major company, such as Google or
Search online using the word “gentrication”.
Alibaba, decides to open new oces in a city,
In which cities have neighbourhoods recently
rents are expected to increase. However, the
undergone gentrication? Is there a link
increased economic activity will benet many
between gentrication and rents? Collect
people. In pairs, consider these issues and
relevant data. Share these with the rest of your
discuss policies that you would recommend.
classmates and hold a discussion on the role
of city authorities in these cases.
Price
A
price
fuel
and
ceiling
can
price
a
ceilings
be
result,
would
a
may
they
develop
Creativity, action, ser vice
as
ceiling
may
or
set
of
a
the
basic
same
below
the
price
good
supplied,
In
the
bakers
long
those
food
way
as
market
sellers
so
a
product
rent
or
legally
would
shortage
for
controls.
determined
can
demanded
and
to
to
stores
run
the
basic
can
or
as
price
exceed
of
The
charge.
the
As
the
good
use
Queues
as
Parallel
prepared
of
such
who
customers,
consumers
be
introduction
goods,
bakeries
quality
to
the
choose
regular
down.
may
tempted
after
customers.
emerge
term,
be
sell
markets
for
Sellers
important
may
arising
markets
set.
supplies
legal
could
in
is
grocery
before
in
to
prefer
even
markets)
bread
price.
good
appear
outside
bread
“black”
buy
be
for
exactly
maximum
quantity
the
price
customers
buy
market
in
consequences
controls
bread;
the
goods
result.
Similar
when
of
the
would
be
the
quantity
in
basic
analysed
ceiling
would
on
who
will
are
pay
bread,
buy
likely
markets
to
rent
their
attractive
are
people
available
cheaper
as
will
of
a
bread
to
rush
(known
unable
much
may
to
as
to
higher
worsen
inputs.
There may be areas or
DP ready
L TA
neighbourhoods in your
Thinking , research and communication skills
hometown where there has
been an increase in evictions.
Food price controls
Various cities have tenants’
In developing countries, spending on food takes up the biggest
protection or tenants’ rights
propor tion of household income. Therefore, when prices rise, the
centres. Investigate whether
eect on poorer families can be severe, forcing them to cut back on
such an organization exists
shelter, medicines, clothes and school books.
in your city or town and
1.
Explain why food price controls could help in such cases.
consider volunteering your
Also consider whether they could worsen the crisis. Collect
time. You may also organize
information from dierent online sources to suppor t your
a fundraising project to help
opinions.
the organization nance its
expenditures.
42
2.
As a class, discuss your views.
2.5
P r ic e
f loor
(minimum
The visible hand
pr ic e)
Why do governments impose price oors in
agricultural markets?
A
price
oor
above
the
to
below
fall
There
reduce
The
As
this
are
weather
■
price
set
for
the
supply
conditions,
supply.
leads
prices
such
as
and
the
the
share
therefore
for
of
or
authority,
not
allowed
oors
for
also
is
in
in
farmers’
affected
floods,
result
which
in
by
can
price
volatility,
farmers.
national
demand
is
price
products
supply
incomes
other
reasons.
and
in
or
price
impose
droughts
changes
sector’s
grow,
price
agricultural
unstable
agricultural
government,
following
in
of
These
to
economies
the
Governments
fluctuations
The
by
determined
level.
markets
incomes.
which
a
market
agricultural
■
is
income
agricultural
is
decreasing.
products
grows,
Internal link
but
more
slowly.
Therefore,
over
time,
farmers’
incomes
decrease
There is more on income elasticity of
relative
to
incomes
in
the
manufacturing
and
service
sectors.
demand in section 2.4.
■
T
o
protect
employment
agricultural
production,
moving
into
in
areas
rural
Analysing
For
a
the
the
India.
cities
will
price
equilibrium
The
including
Market
be
Indian
wheat.
rural
which
may
Price
floors
prevent
(urbanization).
to
of
be
price.
a
price
In
local
this
support
farmers
way,
from
employment
2.5.2
was
at
oor
effective
Let’s
government
Figure
equilibrium
areas.
preserved.
impact
minimum
market
in
it
take
has
k
lie
above
example
imposed
shows
point
must
an
the
with
price
Indian
the
the
from
oors
on
market
market
free
agriculture
23
for
price
in
crops
wheat.
of
wheat
P/unit
D
+government
purchases
being
and
P
respective
quantity
Q
e
the
.
The
price
oor
set
above
e
equilibrium
price.
At
,
P
S
farmers
can
offer
Q
min
while
is
consumers
purchase
units
of
wheat
s
Q
units.
A
surplus
occurs
when,
as
b
a
a
d
P
min
result
of
the
price
being
xed
above
the
market
equilibrium
price,
k
quantity
supplied
exceeds
quantity
demanded.
In
this
case
there
is
P
e
a
surplus
–
Q
Q
s
A
surplus
does
the
equal
to
line
segment
(Q
d
exerts
Q
d
a
downward
government
do?
In
pressure
order
for
on
the
)
or
distance
(ab).
s
the
price—so
minimum
what
price
to
be
D
maintained,
the
government
buys
the
surplus
at
the
promised
price
0
Q
Q
d
(that
is,
at
).
P
This
articially
increases
demand
(D
+
Q
e
s
Q/period
government
min
Figure 2.5.2Eect of a minimum price
purchases).
In
2017–18,
the
Indian
government
purchased
in the Indian wheat market
approximately
Winners
Farmers
This
and
are
can
be
With
than
the
off
controlled
for
in
rural
costs
in
of
fresh
may
is
used
these
their
for
be
countries
price,
for
incomes
benecial
areas
buyers
otherwise,
product
prices
tonnes
their
developing
would
production
as
particularly
minimum
they
higher
million
wheat.
losers
better
Employment
important
35
and
as
an
rms
are
increased
small-scale
protected,
that
of
have
the
less
input
in
will
be
large
of
or
stabilized.
farmers.
which
good
enjoy
and
is
especially
agricultural
product
the
good.
manufacturing
higher
.
This
pay
If
sectors.
more
the
price-
rms,
may
lead
then
to
goods.
43
Governments
surpluses.
are
forced
Specically,
to
spend
the
heavily
government
to
purchase
must
spend
the
(P
×
ab);
min
that
In
is,
the
Figure
an
promised
2.5.2,
amount
the
equal
price
oor
Indian
to
area
require
imposing
other
abQ
involved,
new
new
taxes
government
What
The
cost
imposing
can
the
later;
as
must
This
would
implies
nancing
now;
or
or
cutting
(such
government
government
.
amount
be
of
the
forced
that
surplus.
to
there
spend
is
an
s
taxes
project
the
government
Q
d
opportunity
times
make
on
do
a
this
expenditure
borrowing
back
the
decision
will
now
expenditures
building
with
more
and
on
some
schools).
surplus?
about
what
to
do
with
the
TOK
surplus
it
purchases.
V
ery
often,
these
agricultural
surpluses
are
Keeping in mind the
simply
destroyed.
For
example,
millions
of
tons
of
surplus
peaches
consequences that come with
have
been
buried
over
the
years
in
northern
Greece.
A
government
a price oor, how can we know
may
store
the
surplus
(if
they
are
non-perishable)
and
sell
them
when the problem that the
later
to
avoid
the
price
rising
too
much
as
a
result
of
a
crop
failure.
price oor intends to solve is
The
disadvantage
is
that
to
sell
this
gives
rise
to
additional
storage
costs.
signicant enough to justify the
Another
option
is
the
surplus
abroad.
However,
this
exerts
intervention?
pressure
to
producers,
L TA
DP ready
reduce
the
leading
to
world
price
of
international
the
good,
which
hurts
foreign
tensions.
Thinking , research and communication skills
Price oors on agricultural products
1.
Research whether your government is imposing or has in the recent past imposed a price oor
on the market for an agricultural product. Can you nd information on what the government did
with the surplus?
2.
Government suppor t for agricultural prices results in governments purchasing surpluses of
agricultural products. Why do you think governments cannot simply give the products away to
poor people? Discuss this question as a class.
Price
A
oors
price
wage.
oor
Many
minimum
instance,
at
1
1.97€
at
about
in
labour
the
that
2019,
per
per
level
of
market
have
wage
employers
the
hour,
$1.80
markets
labour
countries
wage
in
acceptable
L TA
DP ready
in
in
minimum
Greece
hour.
The
income
to
at
takes
laws
must
pay
wage
3.94€
aim
is
the
that
to
in
form
a
their
hour
minimum
the
workers.
Luxembourg
per
and
guarantee
unskilled
of
determine
a
in
For
was
set
Brazil
socially
workers.
Thinking and communication skills
Price oors in labour markets
1.
Draw a labour market diagram with money wage (W) as the ver tical axis and number of workers
(L) as the horizontal axis.
2.
Explain why a minimum wage policy is often criticized as leading to higher unemployment for
unskilled workers.
3.
In groups, discuss whether high employment for unskilled workers is a necessary consequence
of a minimum wage policy. Think about the following questions.
a.
What if employers in some industries were able to keep wages at ar ticially low levels?
b.
Would employers be more likely to do that in industries where there is one employer, a few
employers or many employers?
44
2.5
Indir ec t
The visible hand
t a x a t ion
Why do governments impose indirect taxes?
■
T
o
decrease
consumption
of
certain
goods
such
as
sugar,
alcohol
Internal link
or
tobacco
because
consumption
of
these
products
harms
See section 2.6 for more on demerit
not
only
consumers
but
also
society
at
large.
These
goods
are
goods.
referred
–
The
in
to
as
UK
April
–
of
2018.
Smoking
T
o
fossil
in
and
the
collect
gasoline
T
o
of
and
Greece
indirect
decrease
are
by
in
in
England
who
include
global
well
more
$250
regularly
a
much
higher
roughly
gas
than
£55
billion
billion.
industry
£12.6
as
billion
the
change
and
on
annually.
burning
emissions
warming
climate
which
are
climate
change.
economies,
health
documented.
be
able
taxes
collected
to
people
UK
than
collects
taxes
imports
the
society
thus
and
tax
diabetes.
fuels
of
sugar
for
greenhouse
for
a
beverages
more
effects
consumed
2
costs
to
revenues
from
risks
costs
fossil
environment
expenditures.
■
US
responsible
devastating
2017
the
leads
The
T
o
type
England
use
fuels
considered
■
and
decrease
of
health
consumption
annually
■
The
introduced
sugar-sweetened
developing
Alcohol
–
goods.
government
consume
risk
demerit
of
a
finance
€1.02
total
finance
certain
to
of
government
for
every
almost
government
industries
and
litre
€27
of
billion
in
expenditures.
thus
benefit
P/unit
domestic
than
$40
Analysing
firms
and
billion
the
employment.
from
effects
taxes
of
on
an
In
2018
the
US
collected
S
more
t
imports.
indirect
S
tax
b
P
c
1
Figure
2.5.3
illustrates
the
market
for
sugar
sweetened
beverages.
e
P
6
Initially,
equilibrium
market
price
was
at
P
and
equilibrium
quantity
P
p
at
Q.
An
indirect
production
vertically
tax
costs
increases
decreases
upwards
by
the
the
cost
supply,
amount
of
production.
shifting
of
the
it
tax,
to
the
from
An
left
S
increase
or
,
S .
to
better
a
in
yet,
Remember
,
t
D
the
supply
curve
also
reects
the
marginal
cost
of
production.
The
0
Q’
vertical
distance
between
S
and
S
(=
ab)
is
the
size
of
the
Q
Q
(drinks/period)
tax.
t
Figure 2.5.3Market for sugar-sweetened
Following
the
tax,
the
price
consumers
pay
will
rise
from
P
to
P
and
c
beverages
the
quantity
from
Q
to
of
Q'.
sugar-sweetened
Firms
will
earn
beverages
per
P
consumed
beverage,
which
will
is
decrease
equal
to
what
p
consumers
(P )
pay
minus
the
tax
(ab
=
P P
c
collected
times
by
the
the
c
government
number
of
are
beverages
equal
sold
to
(Q'),
).
The
tax
revenues
p
the
tax
thus
per
area
beverage
abP
(P
p
(ab)
).
c
PP
c
The
proportion
of
the
tax
that
consumers
pay
.
is
P
c
referred
as
the
incidence
of
the
tax
on
consumers.
This
is
P
p
The
incidence
less
of
of
PP
p
this
tax
on
producers
is
therefore
P
P
c
The
impact
Since
they
on
consumers
are
worse
various
pay
off.
a
p
stakeholders
higher
Consumer
price
and
surplus
consume
decreases
by
area
the
(1,
good,
2,
3).
45
Not
is
all
consumers
important
regressive:
The
to
“dollar”
same
the
income
this
of
run
as
then
they
this
the
of
of
in
Of
the
tax
will
if
paid
pay
by
As
the
to
a
such
taxes
a
of
are
tax
cigarettes
is
It
considered
more.
may
taxes
to
or
benet
products
poor.
be
proportion
indirect
the
may
the
others
individuals
greater
result,
as
rich,
proportionately
two
goal
buy
be
indirect
households
able
will
represent
goods,
income
be
as
person.
course,
demerit
not
mind
individuals
poorer
lower
may
same—some
amount
unfair.
consumption
the
income
amount
but
considered
drinks,
keep
lower
the
are
of
are
reduce
sugary
in
and
the
so
long
will
enjoy
betterhealth.
Producers
less,
by
their
area
not
5,
the
as
also
6).
as
and
collects
area
used
nance
suffers
a
for
The
tax
if
is
the
2,
price
5)
loss
tax
of
lose
in
unit
surplus
production
taxed
is
the
on
area
good
to
area
2,
tax
health
but
3,
4,
sold,
also
side
they
this
of
of
inelastic,
suggest
a
if
again
crucial
the
then
in
decreases
other
6).
in
6)
revenues
Scarce
activities
related
or
the
which
on
state
can
be
therefore
resources
may
tax
but
Society
output
consumption,
smaller
the
revenues
The
be
are
“good”
demerit
revenues
news
goods.
and
PES
price
and
of
is
to
will
indirect
success
collect
product
of
the
decrease
tax
size
size
tax.
in
much
If
lead
a
to
a
of
is
smaller
elastic.
relatively
decrease
What
does
tax?
revenues?
of
the
demand
relatively
such
high
the
the
will
was
of
how
decrease?
tax
demand
following
resulting
the
will
of
an
good.
bear
inelastic
vice
the
determining
PED
revenues
the
Given
tax
the
times
size
consumption,
is
once
collected.
of
the
the
the
T
ax
level
tax,
greater
the
the
tax
collected.
incidence
inelastic
if
in
good
determining
the
consumption
an
than
goal
are
PED
taxed
about
What
revenues
indirect
The
the
side
bigger
demand
is,
tax
of
tax
the
depends
the
on
market
incidence.
greater
the
both
which
So,
the
is
given
incidence
PED
more
PES,
on
and
price
the
L TA
Thinking Skills
PED and PES
Consider two goods with the same PES but diering PEDs. Using
appropriately drawn diagrams show:
1.
the role of PED on consumption levels
2.
the role of PED on the size of tax revenues collected
3.
the role of PED, given PES, on tax incidence.
more
consumers
versa.
DP ready
46
sell
includes
also
5,
services.
(3,
decrease
polluting
on
(1,
additional
and
equal
PED
consumption
the
4,
However,
role
consumption
of
the
per
incidence
What
in
the
less
producer
that
producing
education
the
impact
and
earn
workers.
welfare
society
They
decrease
producers
(1,
misallocated.
off.
Remember
rms
well
Consumers
to
worse
revenues
(4,
just
rms,
are
2.5
What
What
if
if
it
the
percentage
amount
of
analysis
be
an
tax
of
ad
was
the
the
is
to
tax
the
valorem
not
price
a
the
is,
now
same,
initial
tax?
specic
(that
would
exactly
parallel
are
is
The visible hand
amount
an
ad
depend
but
supply
the
per
unit
valorem
on
new
curve,
the
price.
supply
but
but
tax)?
a
The
The
curve
steeper.
All
“dollar”
logic
of
would
other
the
not
results
identical.
L TA
DP ready
Thinking Skills
Ad valorem tax
Draw a diagram showing the eect of an ad valorem tax on the market
of a good.
Interconnectedness in economics
Figure
2.5.3
reducing
the
the
of
inputs
rms
be
that
will
of
the
affected?
importance
why
other
lead
We
other
(and
a
of
so
on
a
the
that
cheaper)
to
also
are
good,
even
brands
this
The
example,
sugar,
an
of
What
good
about
that
is
taxed
consider
input
employment
who
sell
economics
assume
product
may
beverages.
broader
facilitate
beverages
be
in
the
in
the
in
these
beverages?
is
paribus
analysis
This
of
(that
but
in
rms
The
evident.
repercussions
ceteris
our
such
substitutions.
may
may
higher
induce
of
consequences
must
of
retailers
to
goal
is,
the
is
any
all
real
constant.
demerit
of
taxed
beverages
consequences
and
need
In
of
the
beverages.
assess
equal)
chain
drinks
possible
produce.
about
remains
achieve
producers?
production
sales
may
being
tax
to
sugar
rms
must
sugar-sweetened
alcoholic
all
of
could
sugar-sweetened
on
the
what
tax
interconnectedness
much
consumers
to
in
level
of
indirect
may
of
sugar
sugar-sweetened
choice.
not
a
tax
other
Also,
things
world
on
a
policy-makers
policy
An
such
involved
production
How
that
consumption
effects
uses
shows
all
sugar
switch
in
to
some
substitutes.
An
switch
to
indirect
to
Policy-makers
related
alcohol,
that
consumers
sugar.
to
or
means
induce
some
alcohol.
on
as
This
markets.
lower
must
A
tax
switch
tax
on
quality
consider
Unintended
avoided.
TOK
There is a lot of disagreement on the eects of a sugar tax. Search the
terms “sugar taxes a brieng IEA” and then “taxes on sugary drinks
WHO”. How can you explain the largely opposing views that are given?
What does this suggest about reason in economics?
Policy-makers often rely on indirect taxes as a source of tax revenues.
Indirect taxes are regressive. Is there an ethical dimension that
policy-makers should consider in relying on indirect taxes as a source
of revenue?
In groups, reect upon and discuss whether, or to what extent, a
government has the right or the obligation to steer consumers away
from consuming cer tain products.
47
L TA
DP ready
1.
Thinking , research and communication skills
Working in groups or pairs, prepare repor t cards on indirect
taxation. Each group or pair should try to use real-world examples
of two dierent indirect taxes in your country. Break down this
large task into smaller par ts.
a.
Focus on the eect on price, on quantity consumed and on
tax revenues collected.
b.
Explain whether, in your opinion, the outcome of each of
these taxes may have improved social welfare.
c.
Explain why dierent stakeholders are aected dierently.
Remember that many interconnections may exist.
Distinguish, if you think it is appropriate, between shor t-term
and longer-term eects.
2.
In your group or with your par tner share your ndings with the
rest of the class.
S ub sidie s
Why do governments spend so much on subsidies?
Governments
■
enjoy
justification
farm
fewer
imports
large
them
and
that
incomes.
subsidies.
cheaper.
agricultural
and
want
this
to
the
goods).
and
ensure
may
products
benefits
increase
Think
education.
of
been
farm
lead
for
lower
the
a
more
of
also
goods
that
society
at
generally,
their
education
Food
or
households.
also
more
lower
also
exports
country.
but
or,
producers
important
subsidies
to
consumption
vaccines
and
of
an
income
consumer
Subsidies
Health
groups
has
However,
This
individual
accessible.
certain
This
are
cost
and
referred
make
to
as
goods.
transport
is
also
often
subsidized
as
it
reduces
pollution
congestion.
Green
■
of
only
care
Public
■
not
more
merit
farm
cheaper
(merit
health
to
high
products
Governments
benefit
technologies
cheaper
Price
of
make
becomes
■
want
sufficiently
than
are
fossil
also
fuels
subsidized
inducing
as
firms
they
to
become
adopt
relatively
them.
per
kilog ram
Analysing
S
the
effects
of
a
farm
subsidy
g
First,
let’s
consider
a
farm
subsidy.
As
a
subsidy
is
a
payment
S
s
by
P
the
government
to
rms,
it
will
lower
their
production
cost.
p
b
f
Supply
of
the
agricultural
good
will
increase
and
shift
to
the
right
e
P
or,
P
better
yet,
vertically
downwards
by
the
amount
of
the
subsidy.
a
c
Remember
Figure
in
the
2.5.4
supply
illustrates
curve
the
is
also
the
payment
of
marginal
a
subsidy
cost
to
(MC)
rice
curve.
producers
India.
D
0
Q
Q’
Initially,
Quantity
Figure 2.5.4Eect of a per unit subsidy
to rice farmers in India
the
equilibrium
was
at
point
e
with
the
price
of
rice
at
per
period
P
per
kilogram
period.
paid
The
which
and
vertical
lowered
the
equilibrium
distance
(fg)
production
quantity
represents
costs
and
so
at
Q
the
kilograms
per
unit
increased
per
subsidy
supply
to
S
s
48
2.5
The
new
buyers
market
pay
equilibrium
decreasing
to
P .
is
at
point
a,
Production
with
and
the
price
that
consumption
of
The visible hand
rice
rice
c
increases
kilogram
to
Q'
sold
kilograms.
whatever
Indian
buyers
rice
pay
farmers
plus
the
will
earn
subsidy.
for
This
each
is
,
P
p
which
is
equal
to
plus
P
the
vertical
distance
(ab)
at
the
new
c
quantity
Q'.
paid
kilogram
or
per
its
equal
Government
a).
(P
times
This
expenditure
the
is
number
the
area
(P
c
The
It
rice
makes
producers
fund
or
the
in
public
with
cost
L TA
DP ready
and
and
government
may
require
imposing
consumption
must
revenues
nd
imposing
cut.
In
the
for
later,
for
(ab)
(0Q),
or
rice.
rice
taxes
to
now,
perhaps
example,
other
of
money
higher
taxes
project,
is
subsidy
produced
).
and
higher
smartboards,
the
p
increases
government-funded
schools
opportunity
The
This
now
another
abP
production
affordable
India.
subsidy.
borrowing
some
increases
more
equal
kilograms
c
subsidy
rice
will
of
equipping
words,
there
is
an
involved.
Thinking Skills
The impact of subsidies
“A farm subsidy (or, any subsidy) benets both producers and
consumers, as the former earn more (P
) and the latter pay less (P
p
).
c
Since both sides are better o, a government should subsidize all
producers.”
1.
Do you agree with the statement above?
2.
In your opinion, what is the necessary condition for a subsidy to
benet society at large and so to be considered ecient?
3.
The US has been paying large subsidies to its cotton producers.
Find out which countries are the “Cotton- 4 countries” in Africa.
Examine the impact of US cotton subsidies on the population of
these four countries. Present your ndings to the class.
TOK
Many people think that agricultural subsidies help small farms that are
family businesses. In many countries this is true. However, in many
advanced economies, the primary beneciaries typically include huge
agribusinesses producing commodities such as wheat, cotton, corn,
rice and soybeans.
Should low, or middle-income taxpayers in these countries pay
higher taxes to subsidize such large-scale agribusinesses? If these
agribusiness subsidies in advanced economies are eliminated, then
“net-food impor ting” developing nations (countries that rely on food
impor ts) may suer. Can you see why? What is the ethical dilemma
involved?
49
Rent
Rent
subsidies
subsidies
housing
the
will
by
one
It
landlords:
often
to
make
ticket
that
the
suggests
that
use
L TA
DP ready
rents
that
part
the
of
transport
prices
use
also
that
not
lower
income
diagrammatic
will
of
only
families
analysis
decrease
the
and
subsidy
to
is
so
will
make
identical
to
tenants
be
captured
beneciaries.
subsidies
public
suggests
and
are
to
The
reveals
tenants
cities,
Pollution
paid
reveals
also
transport
many
state,
are
affordable.
above—it
benet.
Public
In
more
of
lower.
public
cars,
a
is
heavily
In
this
transport
substitute,
congestion
in
the
subsidized
case,
the
services
becomes
city
by
law
the
of
demand
increases.
less
It
also
attractive.
decrease.
Thinking , research and communication skills
Subsidies—who pays, who benets
A subsidy can be thought of as a transfer of income away from
taxpayers to some specic population group. The number
of taxpayers in a country will be greater than the number of
beneciaries of a specic subsidy. This means that the burden
to each taxpayer is smaller than the help each beneciary of a
subsidy enjoys.
Describe what this suggests about which group will try to inuence
government decisions on whether to grant a subsidy.
Focus point
There
the
are
several
operation
impose
indirect
intervention,
these
of
come
ways
in
markets.
taxes
the
with
or
which
It
may
grant
government
the
set
government
price
subsidies.
aims
to
intervenes
ceilings
With
meet
all
or
price
these
certain
in
oors,
forms
objectives,
of
but
consequences.
Key terms—test yourself
Dene these terms: price ceiling (maximum price), price oor
(minimum price), indirect tax, specic tax, ad valorem tax, subsidies,
rent controls, shor tage, surplus, incidence of an indirect tax.
50
2.6
2 . 6
S P I L L O V E R
Spillover eects
E F F E C T S
In this section you will learn about...
➔
market failure
➔
negative production ex ternalities and negative consumption
ex ternalities
positive production ex ternalities and positive consumption
➔
ex ternalities.
The issue
“Rapid
human-induced
stability
of
the
“Excessive
health
alcohol
care
ideas
and
There
is
known
arise
one
as
failure.
spillover
the
what
Mar k e t
responsible
and
of
common
With
and
is
contributes
diffusion
serious
implications
for
productivity,
for
the
motor
to
less
lost
vehicle
crime
crash
and
higher
costs.”
poverty
and
leads
to
new
technology.”
thread
effects),
tools
of
policies
f ailur e
has
climate.”
use
expenses,
“Education
warming
planet’s
in
these
which
are
economics
can
be
and
statements:
a
main
we
devised
can
to
externalities
source
analyse
deal
with
of
(also
market
why
externalities
them.
ex t er nali t ie s
What is market failure?
The
“invisible
hand”
miraculously
leads
to
allocative
efciency—
Internal link
but
the
invisible
markets
do
not
hand
work
may
to
not
the
always
best
be
interest
our
of
friend.
society
Sometimes,
and
lead
Find out more about allocative
to
eciency in section 2.2
either
When
not
too
much
this
or
too
happens,
maximized
and
little
production
resources
so
the
are
or
consumption
misallocated,
market
social
of
a
good.
surplus
is
fails.
What are ex ternalities?
An
externality
activity
that
is
participants.
production
party
for
benets
For
to
account.
is
on
a
year,
the
third
third
Mr
third
party
the
positive
which
as
parties
gas
a
is
is
the
contrary,
on
if
not
risk
it
of
him
of
to
a
trafc
are
pay.
every
on
or
If
a
does
gets
becoming
a
for
u
ill,
the
third
creates
costs
are
externality.
morning,
congestion.
he
created
also
market
when
costs
negative
work
economic
the
arises
not
which
Kaplan
an
by
compensated,
does
and
benets
of
imposes
case
drives
others,
Mr
effect
account
externality
good
emissions
cost
the
an
a
side
into
which
who
externality.
reduces
of
party
it
a
taken
for
Kaplan,
imposing
On
viewed
specically,
greenhouse
therefore
it
a
be
properly
consumption
which
example,
adds
More
or
for
imposed
can
not
not
third
shot
but
He
take
is
into
parties,
every
also
reduces
51
Externalities
the
risk
train
for
Production
or
spreading
his
which
the
co-workers.
he
is
not
disease
He
is
to
his
fellow
therefore
compensated.
passengers
creating
Figure
2.6.1
a
benet
shows
on
to
the
the
others
four
Consumption
types
T
o
Negative
of
Positive
Negative
of
externalities.
analyse
externalities
fully,
it
is
necessary
to
keep
the
following
Positive
points
in
mind.
Figure 2.6.1The four ex ternalities
Remember
Since
the
benet
who
Remember
cost
is
good.
the
cost
This
consideration,
therefore
marginal
used
MPC
cost
the
An
cost
L TA
DP ready
on
shot
as
to
into
creates
and
the
others:
he
by
private
one
of
differs
T
able
the
the
full
benet.
benet
more
raw
cost
(MC).
unit
rms
the
of
process.
and
of
take
materials.
(MPC).
from
rm,
cost
that
value
2.6.1
the
The
and
If
Supply
is
one.
resources
MSC
also
the
into
there
private
all
Marginal
consists
any
summarizes
an
The
that
of
the
external
denitions
of
benets.
a
divergence
MSC.
For
MPB
the
benet
benets
cost
the
private
marginal
the
by
represents
externality,
the
the
(MB).
account.
private
reects
is
MSB
the
production
account.
and
work,
enjoys
or
enjoyed
an
production
society
specic
is
into
the
is
benet
demand
from
producing
of
consideration
costs
MPC
to
good
the
includes
marginal
(MSC)
marginal
there
taken
of
wages
cost
If
shows
costs
the
the
different
not
also
the
good,
(MSB)
is
the
cost
the
externality
Kaplan
u
in
taken
relevant
drives
full
into
is
producers
such
the
up
between
he
to
social
taken
not
supply
represents
externality,
are
that
the
(MPB).
benet
includes
shows
consuming
buying
society
effect
that
also
benet
by
social
external
from
are
private
enjoyed
marginal
any
demand
benet
consumers
marginal
that
<
of
example,
think
MPB
of
equal
to
MSB?
driving
to
work
MPB.
others
between
However,
and
so,
but
when
MSB
>
Mr
The
Mr
and
MSB,
Kaplan.
answer
he
also
Kaplan
or
When
is
no.
Mr
imposes
gets
a
the
MPB.
Thinking and communication skills
Private costs and benets; social costs
Cost or benet
Denition
Marginal private benet
The benet to the
(MPB)
consumer from each
and benets
additional unit consumed
This activity focuses on cases where there is a
divergence between MPC and MSC. Consider:
Marginal social benet
The benet that is
(MSB)
enjoyed by society from
each additional unit
a.
a cement producer dumping its waste
consumed
into the nearby river
b.
a bank providing specialized training to
Marginal private cost
The cost to the producers
(MPC)
of each additional unit
produced
its employees.
1.
2.
Would MPC be equal to MSC in a and b above?
For a and b, if you think that MPC and MSC
Marginal social cost
The cost to society of
(MSC)
each additional unit
produced
would not be equal explain which would be
Table 2.6.1Denitions of the relevant costs and benets
greater.
3.
Work in pairs to identify other possible
production or consumption activities that
could result in private costs or benets that are
dierent from social costs or benets. Share
your examples with the rest of your class.
52
2.6
Spillover eects
Market failure when a negati ve production
ex ternality arises
Power
plants
burning
to
of
global
their
into
MPC
coal
of
countries
releases
the
several
such
climate
MSC
exceeds
burn
coal
is
the
as
change
greater
,
cost
as
these
to
greenhouse
Power-generating
production,
account
but
society
many
warming.
costs
take
in
rms
input
the
gases
take
prices
costs.
of
electricity.
that
into
and
Therefore,
cost
rms
generate
The
contribute
consideration
wages,
the
electricity
but
supply
do
not
reects
generation
to
consider
.
M SC
P/unit
Figure
2.6.2
shows
the
market
for
electricity
in
a
S
country.
Since
there
are
no
side
effects
(that
welfare
externalities)
demand
supply
is
from
equal
though
the
to
is
consumption
both
only
MPB
equal
and
to
of
a
The
as
the
M SC
=
M SB
MSC
P
b
m
is
greater.
reects
that
The
the
the
difference
costs
of
burning
distance
ab
is
of
the
the
between
MPC
environmental
coal
causes
external
(that
cost
of
and
MSC
damage
is,
vertical
electricity
D
generation).
Market
forces
lead
to
output
at
Q
Q*
Q
m
P
where
the
demand
equals
supply
=
MPB
=
M SB
0
m
price
M PC
loss
electricity,
MSB.
MPC,
=
is,
Q/period
(or,
m
Figure 2.6.2Negative production ex ternality
MPB
of
=
MPC).
output
is
electricity,
It
is
However,
Q*
where
which
because
for
the
MSC
means
all
socially
=
that
units
MSB.
optimal
There
resources
between
Q*
is
are
and
level
overproduction
overallocated.
,
Q
MSC
>
of
Why?
MSB,
To nd out more about pollution
m
(that
is,
society
the
cost
from
to
society
consuming
is
greater
them).
All
than
units
the
benet
past
Q*
gained
should
Search the web
by
not
have
caused by industrial acivity,
search for India pollution ft.
Read the Financial Times ar ticle
been
produced
from
society’s
point
of
view;
there
is
a
welfare
(11 December 2018).
loss
shown
externality
by
the
caused
shaded
the
area.
market
The
to
presence
of
the
negative
fail.
Watch this
Dealing with negative production ex ternalities
Search in YouTube using these
Indirect
taxation
may
be
a
possible
way
of
dealing
with
negative
terms: China pollution under the
production
externalities.
Remember
that
an
indirect
tax
is
an
dome. Watch the documentary
additional
cost
externality
In
this
costs.
level
the
way,
As
of
a
of
production.
indirect
the
indirect
result,
output
tax
the
will
the
placed
tax
MPC
reach
In
will
and
the
case
must
negative
the
become
optimal
production
external
polluting
will
socially
a
equal
increase
MSC
of
rms’
equal
level.
about air pollution in China.
cost.
private
and
the
TOK
Unfortunately,
What are the problems in
the
size
of
the
necessary
tax
is
difcult
to
determine
because
knowing whether climate
external
costs
are
very
difcult
to
estimate.
change is produced by human
Alternatives
Governments
the
use
of
spreading
on
the
The
can
fossil
higher
the
tax
varies
the
incentive
carbon,
production
an
impose
of
the
of
switch
decrease
no
as
to
is
use
amount
of
charge
tax
the
is
is
the
burned.
tax.
fuels
that
external
cleaner
is
dependent
fossil
sources
the
on
taxes
fuel
higher
using
energy
using
a
carbon
the
the
rms
Therefore,
of
is
of
when
emitted,
alternative
result
which
The
emissions,
carbon.
a
tax,
released
carbon
carbon
even
coal.
The
that
activity?
tax
carbon
as
globe.
amount
to
a
such
carbon
with
or
indirect
fuels,
around
amount
the
less
to
Since
have
emit
costs
of
fuels.
53
Governments
may
be
reluctant
to
set
very
high
carbon
taxes
Search the web
as
they
hurt
businesses.
In
many
cases
the
carbon
tax
placed
Find out more about carbon
on
power-generating
rms
has
led
to
higher
energy
bills
for
taxes. Search for: carbon tax
households,
which
increases
the
cost
of
living
and
hurts
lower
working nyt. Select the New York
Times ar ticle (2 April 2019).
income
families.
L TA
DP ready
Thinking and communication skills
Taxing business activity
Indirect tax provides an incentive to rms to reduce output while
carbon tax creates an incentive to rms to pollute less. Discuss the
following in class.
1.
Which type of tax do you think is more appropriate?
2.
a.
Will all rms face the same costs of reducing pollution?
b.
What does this suggest about carbon taxes?
Besides
taxation
pollution
The
(or
permits,
government
pollution
in
its
the
than
P*.
over
or
a
and
the
power
system
pollution
other
say
permits
these
cost
as
the
value
industry
creates
on
total
heavy
reduce
known
the
hands
to
also
government
decides
country,
allowances),
This
another
cost
hand,
if
of
of
It
that
is
cheaper
of
permits
Government
are
have
buy
then
such
as
tradable.
an
incentive
emissions
permits
to
level
polluters
will
their
necessary
it
to
tradable
schemes.
pollution
P*.
permits
Firms
decrease
the
nd
trade
them
These
involves
acceptable
issues
which
auctions
can
and
then
of
incentives.
buying
rms
cap
maximum
plants.
they
response
to
at
a
lower
pollute.
permits
On
than
to
Watch this
decrease
pollution
will
go
ahead
decrease
by
those
and
buy
permits.
In
this
way,
Search YouTube using: EU ETS. You
pollution
will
rms
which
can
do
it
with
the
will nd a shor t illustration of how
least
cost.
In
2005
the
EU-15
began
implementing
its
Emissions
the “cap and trade” principle works.
T
rading
Scheme
greenhouse
gas
DP ready
to
reduce
pollution
L TA
emissions
in
from
Europe
key
have
industries.
been
Since
2005
falling.
Thinking and research skills
Reducing pollution
1.
Describe how easy or dicult is it for the government to decide
the maximum level of pollution allowed.
2.
Find a country with a “cap and trade” scheme and research how
eective the scheme has been in reducing pollution.
Governments
externalities
TOK
usually
can
through
involves
pollutants,
also
address
a
issue
of
negative
command-and-control
regulations
limiting
the
the
such
levels
of
as
limiting
output
of
production
approach.
the
This
emission
polluting
rms,
of
or
Is the optimal level of pollution
requiring
polluting
rms
to
install
technologies
that
reduce
zero? What knowledge issues
emissions.
Regulations
are
usually
easier
to
design
and
implement
are involved in assessing the
compared
to
taxation
or
tradable
permits.
Still,
it
may
be
costly
for
optimal level of pollution?
authorities
54
to
monitor
the
industries
and
enforce
the
regulations.
2.6
Spillover eects
Market failure when a negati ve consumption
ex ternality arises
There
they
are
are
some
consumed.
Alcohol,
for
violence,
The
parties.
costs
when
gained
society
as
less.
Figure
case
vodka,
the
both
are
2.6.3
lower
of
and
the
the
and
referred
productivity
of
is
do
of
the
market
MSB
external
is
curve
cost
effects
of
from
as
than
an
often
workplace
to
the
to
the
D
consumption.
production,
as
MPB
Note
on
enjoyed
drink,
supply
health
costs
The
MPB,
=
to
external
benet
alcoholic
below
and
consume.
the
goods.
leads
imposes
equal
when
demerit
consider
only
for
is
the
good
greater
demand
to
therefore
not
the
externalities
consumed
in
alcohol
much
so
shows
external
often
consumers
how
negative
excessively
consumers
where
no
MPC
by
whole
amount
there
are
when
However,
benet
generate
consumption
deciding
a
that
These
example,
accidents,
problems.
third
goods
in
is
this
curve
that
is
by
MSB
by
since
equal
to
MSC.
P/unit
S
=
M PC
=
M SC
P
m
M SC
=
M SB
welfare
loss
D
=
MPB
M SB
0
Q*
Q
Q/period
m
Figure 2.6.3Negative consumption ex ternality
Consumers
equals
buy
supply.
all
units
of
vodka
Consumption
is
up
to
the
therefore
at
point
where
and
Q
price
demand
P
m
Q
,
MSC
exceeds
MSB.
This
means
the
cost
.
At
m
to
society
from
the
m
consumption
society
Figures
Home
of
the
next
unit
of
vodka
is
compiled
Ofce
excessive
by
the
showed
use
of
UK’s
that
alcohol
in
Institute
the
UK
in
of
billion
per
year
to
the
National
■
£7.3
billion
per
year
to
the
economy
resulting
billion
criminal
The
from
socially
=
from
society’s
a
MSB.
welfare
alcoholic
alcohol
the
benet
year
All
and
2009–201
1
the
the
to
Health
due
Service
to
lost
productivity
abuse
society
level
units
point
loss
drink
period
Studies
because
of
alcohol-related
(www.ias.org.uk).
optimal
MSC
and
per
acts
Alcohol
the
£3.5
£1
1
than
cost:
■
■
greater
gains.
of
of
past
view.
shown
consumption
Q*
by
should
There
the
is
not
is
at
Q*
have
where
been
consumed
overconsumption
shaded
area.
The
of
market
the
for
good
the
fails.
55
L TA
DP ready
Research and communication skills
Ex ternal cost of consumption
1.
In pairs, collect information on the external cost of consumption
of tobacco, sugary drinks or junk food (dened as food high in
calories but with little nutritional value).
2.
Design a poster with relevant information to display in your
classroom.
Dealing with negative consumption ex ternalities
The
to
policy
reduce
Indirect
are
taxes
have
red
and
(PED).
demand
“a
This
chain
a
be
of
tax
or
remain
L TA
remember
relatively
that
a
where
falls
by
high,
For
to
low
For
a
and
the
perhaps
a
tax
costs
market
which
world
countries,
raises
higher
is
costs.
can
of
price.
then
The
reduce
costs.
much
while
example,
loss
of
incomes
tax
devices
is
than
tax
in
are
be
seek
may
to
buy
and
the
on
the
also
the
to
to
proven
good
in
Therefore
external
much
tobacco
revenues.
so
order
lead
less
in
products
implemented,
in
regressive,
in
price
switch
been
receives
have
food
to
may
government.
increases
affected
this
have
desired
euros
junk
necessary
smokers
the
Greece
million
even
elasticity
“sensitive”
be
that
may
to
and
price
However,
government
taxes
will
paid
low
very
may
instance,
the
690
indirect
be
goods.
less
the
have
sugar
consumers
tax
to
not
high
these
governments
a
that
may
tobacco
no
tend
alcohol,
very
of
Moreover,
successive
contributed
Thinking Skills
to
external
some
tax
good,
external
goods
T
obacco,
heating
market
revenue.
that
the
the
externality
the
around
in
drinks
that
leads
for
associated
substitutions”
.
consumption
costs
countries
sugary
it
consumption
generating
Recently,
Given
more
consumers
means
harmful.
black
on
supply,
consumption
e-cigarettes
to
most
products.
pay
addictive
addictive—so
reduce
In
good
simple?
of
to
DP ready
the
that
hikes.
to
negative
the
follow.
reduces
forced
a
of
placed
soon
Remember
are
of
option.
tobacco
been
and
consumption
that
case
one
may
is
the
on
also
meat
consumer
it
are
taxes
production
Is
in
consumption
taxes
there
on
aim
the
have
Also,
consumers
earning
most.
Preventing or reducing
Are
there
any
alternatives?
consumption of demerit
goods
Another
at
1.
option
preventing
or
for
governments
reducing
the
is
legislation
consumption.
and
This
regulation
may
aimed
involve
a
ban,
Describe the possible
such
as
the
ban
on
smoking
in
public
spaces
that
exists
in
many
drawbacks of introducing
countries.
It
may
involve
setting
a
minimum
age
at
which
a
person
legislation and regulation
can
legally
age
at
consume
a
good.
For
instance,
in
Egypt
the
minimum
to prevent or reduce
which
someone
can
purchase
or
drink
alcohol
is
21.
consumption of demerit
goods.
Another
goods
2.
approach
are
to
packaging
reducing
consumption
warnings.
of
Manufacturers
certain
of,
for
demerit
example,
Consider whether the
tobacco
products
and
alcoholic
drinks,
are
forced
by
law
to
include
complete elimination of
health
warnings
on
their
products.
Australia
was
the
rst
country
to
the consumption of these
introduce
the
plain
packaging
law,
which
demands
that
packaging
goods would lead to the
removes
all
branding
(colours,
corporate
logos
and
trademarks)
and
best outcome.
allows
56
manufacturers
to
print
only
the
brand
name
in
a
standardized
2.6
font,
in
addition
regulations
aim
consumption
Another
with
is
the
awareness
and,
the
in
of
be
the
nature
will
habit”,
advertising
In
some
to
a
through
the
habitual
even
their
prevent
the
oor
MSB
the
in
drinks,
young.
may
Its
such
of
also
be
have
be
seen
used
It
is
to
raise
consumption
given
such
as
consumers
may
not
in
to
example,
goods
existing
Nevertheless,
only
allow
goods
goal
However,
consumption.
that
for
For
UK.
with
goods.
therefore
demand
the
and
level.
advertising.
those
can
laws
and
optimal
consumption
sugary
reduce
these
associated
for
persuasion
price
towards
decrease
costs
especially
and
cases
or,
All
socially
Campaign
demand
actually
and
of
is
Food
and
incentivized
the
could
external
alcohol
persuasion
to
externalities
the
warnings.
demand
closer
reduce
addictive
not
health
reduce
get
Children’s
turn,
cigarettes,
the
authorities
negative
there
to
to
way
to
Spillover eects
yet
the
the
be
that
“taken
up
effectiveness
long
tackle
may
term.
consumption.
Search the web
For
a
instance,
“unit
of
the
Scottish
alcohol”
at
government
50p.
The
unit
has
of
set
a
alcohol
minimum
is
price
determined
at
for
10
To nd out more about public
health policy, search using
millilitres
of
pure
alcohol.
The
minimum
price
of
each
alcoholic
these phrases: WHO tobacco;
beverage
is
determined
by
the
number
of
units
of
alcohol
it
WHO alcohol. (WHO is the World
contains—that
all
types
alcohol
of
is,
the
drinks
equally
L TA
DP ready
number
and
all
of
units
brands
expensive,
and
times
with
so
the
50p.This
same
consumption
has
number
may
made
of
units
Health Organization).
of
decrease.
Thinking and communication skills
TOK
Become a policy-maker
Imagine you are a policy-maker and have to deal with a negative
To what extent can a
consumption externality of your choice.
government interfere in the
freedom of its citizens to
1.
Explain which policy you will choose and why.
2.
Present the issue and your chosen policy to your class.
consume?
Market failure when a positive production
ex ternality arises
Firms
For
to
producing
instance,
their
workforce.
training.
But
enjoys
the
means
there
are
when
benet
enjoyed
MPC
certain
rms
are
by
incurred
in
goods
the
These
a
of
third
by
rms
worker
the
external
incur
is
who
a
to
created
do
greater
positive
offer
private
join
workers
benets
rm
generate
industry
leaves
trained
parties
the
may
nance
not
without
pay
than
cost
another
by
the
for.
the
S
P/unit
=
externalities.
extensive
associated
rm,
paying
original
In
training
such
that
for
it.
rm
with
rm
This
that
cases,
the
MSC.
M PC
M SC
a
P
m
welfare
M SC
=
loss
M SB
b
D
=
MPB
=
M SB
0
Q
Q*
m
Q/period
Figure 2.6.4Positive production ex ternality
57
Figure
2.6.4
Supply
it
by
is
the
effects
shows
only
equal
amount
from
output
is
the
of
market
to
the
the
and
Q
at
MPC
external
consumption
at
D
price
=
P
m
MSB
exceeds
for
nancial
curve
and
benet.
MPB
,
=
where
services
the
Since
MSB.
in
MSC
there
curve
are
Market
demand
Singapore.
lies
no
below
external
determined
equals
supply.
At
Q
m
MSC,
because
at
m
Q
the
benet
to
society
gained
from
m
the
next
used
to
MSC
=
unit
produced
produce
MSB.
it.
For
is
The
all
greater
socially
units
the
optimal
to
Q
than
Q*
value
level
MSB
>
of
of
the
resources
output
MSC,
is
which
Q*
where
means
that
m
from
society’s
There
the
is
point
of
view
underproduction
associated
resources
are
welfare
loss.
allocated
L TA
DP ready
of
to
these
the
The
the
units
good
free
should
and
the
market
production
of
have
been
shaded
fails
the
produced.
area
because
shows
not
enough
good.
Thinking , research and communication skills
Search the web
Search using this phrase: Bilbao eect. Collect relevant information
and analyse this it with the economic tools you have just learned.
Give a brief presentation to your class.
Dealing with positive production ex ternalities
Despite
the
fact
that
underproduction
Policy-makers
output
This
that
be
cost
level
of
of
Is
it
that
with
the
Are
might
is
still
misallocation
granting
the
of
resources.
production
is
of
subsidies.
government
subsidy
will
the
with
of
the
to
become
socially
to
increases
equal
the
equal
optimal
production,
subsidy
ensure
to
the
any
and
increase
Remember
rms
supply
external
to
MSC
that
and
lowers
the
benet
and
the
of
level
level.
external
may
allocative
not
benets
enough
efciency
overproduction
opportunity
be
of
cost
the
of
or
are
Also,
funds
difcult
correct
indeed
good.
the
to
the
a
subsidy
needed
to
pay
alternatives?
government
government
have
may
response
may
associated
the
provision.
58
a
encourage
by
The
MPC
costs
lead
government
there
the
subsidy
reach
and
government-run
not
and
to
there
subsidy.
externalities
the
the
Therefore
there
the
with
payment
the
will
failure
Another
is,
created
simple?
associated
for
If
external
assess.
subsidy
a
then
production
is
aim
production.
of
market
is
output.
production
to
good
therefore
achieved
subsidy
their
As
the
are
levels.
can
a
of
benets
be
could
itself
with
its
provide
training
expertise
could
direct
the
schemes.
for
for
For
has
that
positive
example,
through
governments
successful
costs
that
workers
However,
opportunity
provision:
good
production.
training
required
signicant
be
provide
may
intervention.
associated
with
Also,
direct
2.6
Spillover eects
Market failure when a positive consumption
ex ternality arises
The
consumption
These
goods
are
of
some
often
goods
referred
creates
to
as
positive
merit
externalities.
goods.
P/unit
S
not
only
education
benets
is
the
a
merit
good
individual
because
receiving
it,
its
M PC
M SC
For
welfare
example,
=
=
loss
consumption
but
also
benets
M SC
society
in
and/or
shows
the
poverty
the
There
form
and
market
are
no
of
higher
greater
for
productivity,
social
university
external
effects
less
cohesion.
education
from
criminality
Figure
in
the
production,
=
M SB
2.6.5
P
US.
m
so
M SB
S
=
MPC
=
MSC.
However,
given
that
consumption
creates
D
external
benets
the
MSB
is
higher
than
the
MPC
and
so
curve
lies
above
the
MPB
curve.
Market
MPB
0
the
Q
Q*
m
MSB
=
Q/period
equilibrium
Figure 2.6.5Positive consumption
is
at
,
P
Q
m
This
At
greater
that
unit
to
level
Q*
society
of
than
consumption
Q
this
of
consumption
MSB
exceeds
MSC.
ex ternality
means
additional
is
.
m
the
the
is
at
should
cost
Q*
have
benets
from
good—each
to
society.
where
been
the
consumption
additional
The
MSB
=
socially
MSC.
consumed
optimal
Therefore,
from
of
university
society’s
each
enrollment
level
all
of
units
point
of
from
view.
m
There
area
is
underconsumption
shows
Educating
in
the
the
girls
of
university
associated
welfare
is
the
developing
perhaps
world.
The
loss.
single
education.
The
most
benets
market
shaded
fails.
valuable
extend
The
investment
beyond
increasing
Watch this
overall
fewer
economic
children.
productivity.
Her
children
An
will
educated
be
mother
healthier
and
will
more
have
likely
to
be
Search in YouTube using these
terms: Ntaiya empower a girl TED.
educated
thus
creating
a
virtuous
circle.
Watch the video of the talk on the
L TA
DP ready
impor tance of women’s education.
Thinking and research skills
Merit goods—education and health care
Given the signicant benets of education and health care (which is
also a merit good), why do you think these are still underconsumed?
Search the web
Find information on the web about the anti-vaccination movement. What
is taking place? What may be the impact on the market for vaccines?
Dealing with positive consumption ex ternalities
When
aim
positive
to
encourage
subsidies.
market
A
price
of
education
students
it
There
is
revenue
increases
good.
be
The
instance,
institutions,
may
that
the
For
externalities
consumption.
subsidy
consumption.
Is
consumption
able
if
tuition
to
One
way
supply
lower
the
fees
of
which
price
US
arise,
policy-makers
doing
then
induces
government
would
this
be
is
lowers
a
through
the
higher
level
subsidizes
lower
and
of
higher
more
enroll.
simple?
an
opportunity
used
to
cost
subsidize
associated
the
industry
with
subsidies.
cannot
be
used
The
to
tax
provide
59
other
to
goods
be
able
important
low
and
to
raise
for
income
the
government
consumption
developing
levels
and
to
subsidize
merit
to
enjoy
benets
health
Are
the
care
that
there
any
Governments
with
positive
countries
to
a
In
cases
goods.
may
and
That
education
is
may
must
low
the
way.
tax
enough
This
is
revenue,
such
their
tax
revenue
particularly
nations
so
it
countries
consumption
for
a
run
or
to
increase
through
that
in
of
have
may
may
relatively
be
be
difcult
unable
education
and
development.
care,
that
makes
free
signicant
schools
purchase
against
benets
are
burden
and
and
expenses
point
on
distribute
fall
of
such
to
disease.
these
direct
government’s
with
vaccinations
up
that
provide
Still,
equipped
on
many
as
provide
choose
the
laws
types
delivery.
hospitals
therefore
are
large,
directly
of
goods
compulsory
certain
very
of
example,
there
governments
at
For
education
countries
governments
some
care
consumption
legislation.
many
vaccinated
external
say
government
L TA
DP ready
be
the
be
professionals,
1.
to
health
The
these
try
Similarly,
to
provision
state
also
health
and
by
have
Developing
result,
crucial
legislation
age.
where
a
created
most
this
to
alternatives?
children
education
As
externalities
have
certain
require
are
in
countries.
therefore
goods.
needs
budget.
trained
for
free.
All
taxpayers.
Thinking Skills
What do you think happens when the government is forced to cut
back on its spending?
2.
In some cases, state schools have overcrowded classrooms, or
hospitals have no available beds or even not enough medical
equipment. What do these facts suggest?
Creativity, action, ser vice
The use of e-cigarettes and other similar devices has spread,
especially among the young. These devices are perceived as
healthier alternatives to cigarettes but recent data suggests that
health risks persist. Organize a campaign to raise awareness in your
local community about the eects of using e-cigarettes. You can
design several posters to inform the public. You may also organize
a fundraising event to suppor t teams or non-prot organizations
helping those who are trying to quit smoking.
Focus point
Externalities
Key terms—test yourself
external
and
are
costs,
spillover
the
consumption
market
above
costs
will
the
or
benets.
lead
to
socially
a
If
level
optimal
there
of
are
production
level.
If
there
are
Dene these terms:
external
benets,
the
market
will
lead
to
a
level
of
production
externalities, demerit goods,
and
consumption
below
the
socially
optimal
level.
As
a
result,
merit goods.
market
60
fails
and
government
intervention
may
be
required.
the
2.7
2 . 7
A R E
W E
Are we doomed?
D O O M E D ?
In this section you will learn about...
➔
common pool resources
➔
measures to control overuse of common pool resources.
The issue
Overshing
the
is
world’s
relates
to
forests
or
posing
a
why
depleting
sheries
the
overuse
even
for
maybe
pool
you
and
we
and
C ommon
Common
anyone
but
Examples
some
that
not
are
this
globe,
pool
resources
often
leads
sustainability.
such
as
problem
but
could
be
like
to
This
sheries
it
with
90%
collapse.
depletion,
section
to
explores
be
addressed.
certainly
issue
sheries,
their
tend
of
This
doesn’t
If
it
look
is
good
r e s our c e s
available
are
for
wildlife,
forests,
resources
anyone
has
pollutants,
to
irrigation
hunting
atmosphere
anthropogenic
the
facing
children!
include
the
to
or
that
doomed,
resources
sheries,
since
threat
pool
pool
common
resources
how
are
your
of
across
exploited
atmosphere,
signicant
common
overexploited
not,
the
oceans
fully
it
use
also
are
not
as
by
payment.
(groundwater),
pastures
used
owned
without
systems
grounds,
been
is
that
a
and
“sink”
considered
a
and
lakes.
of
Note
many
common
pool
resource.
Common
pool
excludable
one
person
shing
sh
as
these
will
they
one
in
are
waters.
be
their
limits
vessels
common
for
resources
and
ton
pool
the
is
amount
to,
as
course,
less
for
resource
if
all
two
rival
no
characteristics:
(that
is,
available
unregulated
able
Of
share
use
shing
one
one
other
for
be
can
the
One
a
For
catch
excluded
catches
vessels.
diminishes
they
are
non-
consumption
others).
areas
can
vessel
their
of
many
shing
sh
person’s
amount
example,
as
from
ton
by
in
there
use
of
a
TOK
available
others.
Is it possible to have knowledge
The
sh
or
result
is
stocks
why
as
in
fore s ts
of
the
the
of
pa r ts
accessed
“tragedy
meeting
ove r us e
many
many
commonly
the
an
a re
is
co mm on
of
the
of
wor l d
di sappe ar ing .
u sua lly
c o mm ons”
.
ne e ds
p ool
the
resource s.
are
A
ove r used
s everel y
resource
and
this
Sustainability
pres ent
wi thout
is
why
of the future?
dep l eted
tha t
is
can
This
is
k nown
be
as
dened
c om promi s ing
Watch this
Search in YouTube using these
terms: deforestation revolution
world issue. Watch the video by Rob
the
ability
of
future
g e ne rati ons
to
meet
the i r
own
need s.
Stewar t on deforestation and its
Sustainability
is
the re fore
threatene d
by
overexpl oi ta ti on
of
eects.
resources
currently
avai lable.
61
The
simplest
resources
is
Company.
Its
shing
vessels.
all
S
P/unit
=
to
terms
shes
activity
to
of
in
as
into
Lipet’s
of
of
is
area
common
Consider
Mexico,
stock
the
same
as
Seafood
common
pool
sh
available
for
they
of
Seafood
Lipet’s
a
therefore
amount
pool
imposing
will
sh.
have
This
Company
to
is
all
a
other
cost
sh
an
does
resource.
on
longer
external
not
take
this
=
account.
M PC
Figure
2.7.1
illustrate
=
the
in
the
cost
of
Company
vessels
cost
overuse
loss
a
M SC
Gulf
reduces
catch
the
externalities.
the
Seafood
shing
harder
analyse
M SC
S
welfare
in
It
Lipet’s
other
and
way
refers
the
to
overshing,
overuse
of
any
but
can
common
be
pool
used
to
resource
M SB
as
P
a
negative
production
externality.
b
m
The
by
MPC
the
The
D
=
MPB
=
M SB
of
overuse
curve
shing
external
sh
and
represents
companies
costs
the
private
that
reect
resulting
the
the
sh
in
costs
open
depletion
of
environmental
incurred
oceans.
the
stock
damage.
0
Q’
Q
m
Fishing
Q/period
eets
will
sh
up
to
while
Q
the
socially
m
optimum
is
lower
at
Q*.
The
line
segment
(Q*Q
)
m
Figure 2.7
.1Over shing
reects
Search the web
overshing.
Controlling overuse of common pool resources
Search using these terms:
In
some
in
controlling
cases,
regulation
by
governments
may
prove
effective
China sheries brink NYT. You
will nd a New York Times
ar ticle (30 April 2013) on
over shing and the possible
quotas
is
an
expressed
overuse
of
example.
in
tonnes)
common
Fishing
that
are
pool
quotas
set
for
resources.
are
catch
most
Setting
limits
shing
(usually
commercial
sh
stocks.
eect on developing countries.
The
for
EU
quotas,
of
has
set
preventing
a
there
certain
shing
longer
may
still
nationality
quota.
If
subject
L TA
DP ready
Search the web
shing
quotas
depletion
its
to
be
is
eet
the
of
for
sh
issues.
only
is
the
managing
stocks.
For
example,
subject
registered
of
However,
to
in
its
a
a
sheries
even
with
shipping
national
different
and
shing
company
government’s
country
it
is
no
quota.
Thinking Skills
Depleting sh stocks
To nd out more on over shing
In the ar ticle featured in “Search the web” opposite, Eric Pineda, a
and shing quotas, search
Chilean dock agent recognizes the declining catch, and states that he
for: mackerel plunder collapse
nyt. Read the New York Times
needs to increase his shing activity before there is nothing left at all.
ar ticle (25 January 2012) on
Explain what Pineda said, using the relevant framework and terms.
over shing. The ar ticle repor ts
how an EU shipping company
has managed to evade the EU
Other
regulations
may
involve
restrictions
regarding
hunting
quota.
seasons,
as
issuing
hunting
or
endangered
regulations
has
typically
of
of
permits
for
particular
establishment
as
involve
overuse
international
cooperation
62
are
the
or
the
ecosystems,
often
Regulations
However,
licences
shing),
well
costs
as
of
imposed
common
consequences,
governments
is
of
emission
by
in
to
national
detect
for
Such
violations.
governments.
resources
which
necessary.
(such
areas
standards.
monitoring
access
activities
protected
case
often
international
2.7
Educating,
especially
environmentally
of
controlling
young,
conscious
overuse
L TA
DP ready
the
of
about
behaviour
common
the
may
pool
importance
be
most
of
Are we doomed?
adopting
signicant
way
resources.
Research and communication skills
Search the web
Search using these terms: international agreements UN. Add “sheries”
then “forests”.
1.
Working in small groups, nd information on international
agreements that aim to limit the sustainability risks associated
with the overuse of common pool resources. Keep in mind that
the atmosphere is also a global commons. Make sure you include
information about the Paris Agreement of 2015.
2.
Present your ndings to your class.
Collective self-governance
A
different
proposed
approach
by
Economics
Elinor
in
is
the
self-governance
Ostrom,
2009.
The
the
idea
is
winner
that
a
of
of
the
group
the
commons
Nobel
of
users
Prize
of
a
Search the web
as
in
Search using these terms:
resource
Ostrom Nobel prize facts. You
will nd out about the rst
can
devise
frameworks
of
use
under
certain
conditions.
These
woman to receive a Nobel prize
frameworks
effectively
regulate
access
to
the
common
resource
and
in economics.
balance
resource
use
and
resource
renewal.
Creativity, action, ser vice
Despite the growing concern about environmental sustainability
there are still many who are unaware of the long-term eects of
several human activities on the environment. Organize a campaign to
increase awareness in your school about these issues. You may also
TOK
use social media to approach a greater audience. A fundraising CAS
project may help suppor t groups that work towards protecting wildlife.
Collective self-governance
Also consider organizing a day trip where you can actively par ticipate
implies that people cooperate.
in beach cleaning or tree planting or any similar activity needed by
How could reason and emotion
your local community.
aect their decisions?
Focus point
Key terms—test yourself
Common
not
take
others.
needs
pool
into
This
to
be
resources
account
poses
a
are
the
likely
effect
threat
to
of
to
be
their
overused,
use
sustainability
of
since
such
and
so
people
resources
their
do
on
overuse
Dene these terms: common
pool resources, sustainability.
controlled.
63
2 . 8
FROM
LIGHTHOUSES
TO
LAW
AND
ORDER
In this section you will learn about...
➔
public goods
➔
why public goods are a case of market failure.
The issue
What
do
order
public
they
lighthouses,
have
good.
are
a
not
simply
good
the
refer
is
automatically
consumption
■
are
to
one
its
■
benefits.
citizen
T
raffic
A
all
to
from
amount
behave
as
incurring
the
is
of
that
a
its
if
good,
free
a
of
and
a
and
why
not
fact,
a
it
public
is
non-
Non-excludability
to
one
Non-rivalry
the
person,
implies
amount
it
that
of
the
the
free-rider
If
security
from
benefits,
enjoying
this
a
are
is
provided
enjoying
this
safety
also
does
street
of
the
not
If
cannot
no
enjoying
public
the
service
have
does
not
through
enjoying
reduce
it.
the
And,
amount
there
is
for
light
other
operating
available
be
to
benets
are
left
be
to
no
from
of
a
one
motorist
can
by
other
good
it.
be
one
ship
ships.
enjoying
for
the
They
without
market,
output,
one
drivers.
used
all
pay
the
by
no
is
to
excluded
incentive
will
automatically
lighthouse
is
the
goods
are
traffic
available
lighthouse
its
problem
the
use
amount
people
riders;
cost.
is
others
others.
citizens
on
The
benefits.
they
the
to
safety,
lights
of
national
others.
drivers.
the
issue
other
enjoying
diminish
same
does
In
diminish
stop
enjoys
citizen
all
lighthouse—when
benets
of
is
to
available
one
lights—traffic
not
all.
not
it
state.
available
security—once
citizen
then
excluded
One
public good lighthouse.
one
available
to
are
characteristics:
non-rival.
to
does
impossible
amount
laws,
safety
does
Search using these terms:
If
or
is
order—if
available
Search the web
it
Law
one
available
law
examples.
the
of
is
goods
here;
the
two
becomes
and
others.
defence
and
good
person
diminish
if
■
consumption
public
you
by
following
lights
characteristics
f ailur e
confuse
provided
the
one
citizen
enforced
■
good
trafc
the
what
mar k e t
“public”
the
for
some
National
and
becomes
available
Here
explores
its
by
share
failure.
has
once
defence,
all
section
any
and
that
They
market
term
that
excludable,
good
of
to
one
implies
This
goods
let
national
common?
case
P ublic
Do
in
since
because
private
Investigate whether
rms
will
have
no
incentive
to
produce
and
offer
such
goods.
lighthouses have ever been
Thismeans
that
no
resources
will
be
allocated
privately owned.
public
64
good,
leading
to
market
failure.
to
the
supply
of
the
2.8
L TA
DP ready
From lighthouses to law and order
Thinking Skills
Broadcasting
Research some examples of over-the-air television and radio
broadcasting, based on the following questions.
1.
Do over-the-air stations have the proper ties of a public good?
2.
How can these television and radio stations be privately owned?
3.
How do these stations earn money?
4.
What is the dierence between over-the-air broadcasting and
cable television or Netix?
Public goods and market failure
The
government
Note,
though,
public
goods.
must
that
For
the
provide
public
government
example,
trafc
is
goods
not
lights
using
tax
necessarily
are
not
revenue.
producing
produced
by
the
TOK
the
On the basis of what knowledge
government
but
by
private
rms
who
are
contracted
by
the
state.
criteria do authorities weigh
Still,
there
are
opportunity
costs
associated
with
such
expenditure
the costs and benets of each
on
public
goods—this
expenditure
must
be
nanced
either
by
public good and decide which to
higher
taxes
now,
or
by
borrowing
now
and
higher
taxes
later,
or
provide?
by
reducing
some
other
government
expenditure.
Focus point
Public
that
goods
they
are
Therefore,
are
underprovided
non-excludable
without
by
and
government
the
their
market.
The
consumption
intervention
it
problem
is
would
is
non-rival.
not
Key terms—test yourself
be
Dene the term public goods.
possible
to
prevent
people
behaving
as
“free
riders”
.
65
2 . 9
M A R K E T
P O W E R
In this section you will learn about...
➔
maximizing profits
➔
perfect competition
➔
the meaning of economic costs
➔
monopoly and oligopoly
➔
when economic profits are zero
➔
concentration ratios
➔
homogenous and differentiated products
➔
abuse of market power.
➔
entry barriers
The issue
In
this
section
of
economic
costs
maximization
market
as
world
the
the
prot
costs
T he
An
The
in
on
assume
the
and
will
of
the
on
arising
The
idea
that,
market
follow
rm.
of
we
power
the
from
concept
prot
will
will
be
possible
its
investigate
also
risks
presence
as
using
real
f ir m s
that
between
(TC)
important
of
rms
of
point
to
resources
employed
makes
a
scarce,
restaurateur
economic
and
other
staff
earned
if
are
or
π
=
TR
owns
include
(explicit
had
is
For
the
not
costs)
rented
−
but
are
what
dened
collected
and
as
the
TC.
in
economics,
include
the
sacriced,
the
also
the
rent
property
to
of
all
whether
she
that
the
Hana,
premises
wages
since
value
consider
restaurant
her
(π)
(TR)
example,
only
prots—but
cos t s
that
costs
therefore
not.
Prots
revenues
remember
who
she
maximize
ec onomic
and
costs
to
mean?
total
economic
payment
Her
aim
really
the
production:
are
have
on
Following
meaning
maximization
meaning
sushi
explained
advantages
resources
rm
be
analysed.
discussion
possible
difference
total
be
focus
examples.
typically
does
a
initially
will
will
and
Z ooming
We
will
structures.
examined
well
we
she
pays
she
someone
a
uses.
her
chef
would
else
(implicitcost).
However,
(that
is,
economic
the
restaurant
to
her
locating
refers
to
equal
funds
for
to
alternative
66
order
best
it
that
use
what
with
that
to
must
Hana
keep
alternative,
elsewhere.
available
is
in
next
costs
money)
in
used
in
another.
could
same
include
to
operating
perhaps
Entrepreneurial
if
she
the
also
needs
one
The
have
risk.
as
it
capital
minimum
been
minimum
from
is
offering
her
and
not
another
is
business,
This
the
earn
also
are
minimum
to
switch
cuisine
scarce,
or
since
automatically
return
earning
return
sushi
in
Hana
the
requires
next
return
it
not
has
best
a
strange
2.9
name,
normal
down.
costs,
prots,
Normal
and
prots
part
of
and
are
the
if
it
is
not
therefore
rm’s
earned
also
implicit
an
a
rm
will
element
of
Market power
shut
economic
costs.
Marginal and average and their relationship
The
term
cost
“marginal”
(MC)
Marginal
is
produced
collected
Y
ou
unit.
(thus
per
the
will
average.
cost
of
if
quiz
your
average
sixth
will
after
will
TR/Q
and
ve
(the
increase;
average
P
the
cost
unit
per
(AR)
which
AR
are
quizzes
if
is
unit.
selling
of
the
score
output
price
at
equal.
average
quiz)
an
revenue
marginal
your
you
is
always
between
Marginal
more
from
“additional”
whereas
one
revenue
revenue
relationship
the
on
is
(thus
so
“additional”
.
producing
additional
(AC)
sold,
the
of
means
average
output,
example,
and
your
of
cost
the
and
is/was
aware
For
is
Average
unit
70%
quiz,
(MR)
TC/Q)
good
be
economics
additional
revenue
additional
which
the
in
you
60%
and
score
score
on
is
80%,
your
sixth
decrease.
Output required to maximize prot
How
much
maximize
revenue
the
output
prots?
from
cost
more
a
rm
answer
producing
additional
producing
should
The
and
incurred
and
more
is
choose
selling
to
one
produce
units
to
simple.
per
produce
As
long
more
it,
unit
the
period
as
rm
in
order
the
is
bigger
should
because
its
to
additional
than
keep
prots
on
will
be
increasing.
■
■
As
long
as
>
MC
a
firm
profits
will
be
increasing.
Profits
will
be
maximized
MR
MC.
=
Illustrating
Y
ou
are
Let’s
ve
If
MR
a
say
craft
that
pencils
the
that
What
if
the
$3.99?
seven
What
should
will
increase
=
per
be
MC.
Now
At
the
as
is
last
producing
unit
but
would
day?
your
They
that,
increasing
point,
from
prots
as
units
as
produced,
be
as
up
prots
it
one
cost
from
MR
until
will
is
you
would
from
made
and
ve
>
MC
be
and
$17.00.
the
and
equal
your
pencil
the
producing
producing
be
to
pencil,
of
pencil.
and
produce
increase
(MC)
that
these
sixth
$4.00
more
and
pencils.
selling
additional
would
increase
long
output,
your
an
additional
would
just
selling
prots
(MR)
the
have
producing
$1.00,
your
revenue
$4.00
that
it
Y
ou
making
collected
Y
es,
realizing
by
for
from
consider
producing
pencil?
still
pencils
Y
ou
MR
of
pencils.
earned
revenue
additional
was
of
prots
$14.
cost
sixth
seventh,
was
is
when,
continue
pencils
producer
the
additional
additional
sell
with
should
it
selling
to
$17.01.
prots
for
which
maximized.
What if economic prots are zero?
If
a
rm’s
Assume
at
least
referred
economic
that
a
rm
$10,000
to
as
to
prots
are
producing,
stay
normal
in
zero,
for
business.
prots
and
its
owners
example,
ice
Remember,
forms
part
of
will
be
cream
this
happy.
rolls
requires
$10,000
economic
is
costs.
67
Let’s
its
say
total
though
prots
The
the
economic
we
are
rm
also
ice
per
month
$15,000
return
able
in
the
deposit
enough
Think
of
the
services
or
services
and
in
■
many
The
is
bank.
ou t
the
new
for
a
market
corn
the
consumers
hair
be
earning
the
of
in
drop
bank
TR
are
$95,000
is
making
minimum
$25,000
per
making
per
bank
his
$76,000
is
in
$10,000
the
and
to
Ed
viewpoint).
in
rm
above
$4,000
his
If
which
normal
remain
amount
prots.
then
in
cotton;
city;
is
month
economic
month.
account
on
the
the
Ed
but
may
that
market
monopoly
are
and
market
market
of
cell
(cell
for
for
or
hair
cell
salon
phone
They
all
differ
perfect
restaurants
few
new
and
firms;
there
not
services
firms
is
or
is
from
(such
are
(identical).
considered
competitive
nothing
these
firms
are
to
prevent
sell
a
products
substitutes.
typically
firms
entering.
as
a
entry
products
products
oligopolistic.
and
The
cement
or
there
are
product
steel)
or
banks).
distribution
one
preventing
is
perfect
selling
prevent
substitutes
there’s
but
interdependent
phones
firms,
to
Monopolistically
but
phone
small
nothing
Differentiated
close
products)
Perfectly
Homogeneous
firms
new
farm
market.
many
consider
electricity
market
many
there’s
homogeneous
for
(or
very
market.
small
have
barriers
L TA
DP ready
firm
new
is
a
monopoly.
dominating
firms
from
the
In
a
market
and
entering.
Thinking Skills
Homogenous or dierentiated?
Determine whether the following products are homogeneous or
dierentiated: bottled mineral water, soybeans, natural gas, laptops,
copper, insurance policies and broccoli.
68
be
is
mar k e t s
distribution.
competitive
have
product.
preventing
either
cotton
salon
market
for
differentiated
there
will
and
business.
competitive.
many
markets
barriers
the
consider
market
These
The
TR
and
or
still
that
prot
electricity
consumers
for
have
into
or
product
into
that
differentiated
■
in
your
for
perfectly
markets
firms
markets
may
in
market
monopolistically
The
prots)
month
corn
is
since
economist’s
but
month
(within
prots
business)
$80,000,
f ir m s
for
in
if
month
$80,000,
(excess
rm
remain
of
it
per
respects.
products
■
per
restaurants
market
entry
to
market
considered
The
still
the
normal
still
However,
are
economic
homogeneous
■
the
per
prots,
deposits
only
are
prots
keep
him
competitive
of
costs
$80,000
normal
from
because
Ed,
are
$80,000
$10,000
cost
making
$6,000
for
Z ooming
to
costs
(negative
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Market concentration
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Find data and news ar ticles on the trend of concentration in the US.
Analyse the implications of the concentration in markets in the US. To
what extent should the US government have concerns?
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in
advertising,
various
an
ways:
electronics
a
rm
to deter collusion.
offers
extended
offers
volume
guarantees
discounts
on
on
its
products,
shampoo,
a
a
cosmetics
radio
station
company
organizes
competitions.
Is “big ” beautiful?
When
“big”
is
Larger-in-size
monopoly
They
sell
is
may
at
a
allow
them
power)
enjoy
many
2017
at
ways.
to
more
systems,
74
the
often
which
barriers
to
(R&D)
scale
new
8
at
a
This
consumers.
in
leading
entry
to
amounts
by
euros.
tyres
Daimler
These
driving,
and
new
and
in
and
vehicles,
cost.
to
surplus
allows
research
benet
expenditures
safety
as
oligopoly
This
(Mercedes
to
them
Consumer
money,
that
unit
enables
prots.
of
innovations
(referred
lower
monopoly
supernormal
autonomous
low-resistance
goods
(EOS).
to
enormous
billion
power
benets
expenditures
than
market
produce
of
maintain
often
R&D
developing
can
signicant
economies
rms
invest,
development
with
price,
Also,
these
to
rms
lower
higher.
beautiful
society
Benz)
were
and
in
rose
in
aimed
assistance
among
other
goals.
2.9
When
“big”
can
Market
power
be
allows
Market power
ugly
rms
to
raise
price.
The
fact
that
EOS
enables
Watch this
rms
that
to
produce
they
will
at
pass
a
lower
on
the
unit
cost
saving
to
does
the
not
necessarily
consumer.
They
mean
Search online using these terms:
may
TED talks Vestager. Watch the talk
choose
simply
to
enjoy
higher
prots.
The
outcome
depends
on
about market dominance.
whether
they
A bus e
Matters
face
of
any
current
mar k e t
become
worse
or
potential
competition.
po w er
if
in
a
leads
to
abuse
market
a
rm’s
dominant
or
Search the web
monopoly
position
of
that
position.
A
dominant
Search using these terms:
position
does
not
in
itself
constitute
a
reason
for
governments
podcast capitalisn’t regulating
or
competition
present
if
it
is
authorities
suspected
to
that
intervene.
a
rm
However,
acts
with
abuse
the
may
intention
be
facebook. You will nd a three-
par t discussion about whether
to
tech giants should be regulated.
eliminate
competitors
or
to
prevent
entry
of
new
rms.
Focus point
The
to
lack
low
world
Prices
enjoy
in
any
are
market
for
though,
most
market
which
power
then
power
consumers
therefore
economies
R&D,
rms,
of
prices
of
rms
scale
leads
and
welfare
do
often,
to
perfectly
to
have
but
as
by
and
a
not
some
result
of
competitors
of
higher.
their
But
size
when
or
rms
efciency.
degree
always,
innovations.
eliminate
competitive
allocative
market
Large
and
rms
block
In
may
of
real
power.
rms
may
invest
abuse
entry
leads
the
their
new
decreases.
Key terms—test yourself
Dene these terms: prots, economic costs, normal prots,
supernormal prots, economic losses, perfectly competitive markets,
oligopolistic market, monopoly, natural monopoly, homogeneous
products, dierentiated products, interdependence, entry barrier,
concentration ratio, price war, collusion.
75
3
Macroeconomics
Macroeconomics focuses on the economy as
a whole. Initially, this unit presents the tools
of aggregate demand and aggregate supply,
which are used to analyse an economy. You
will learn the meaning of phenomena that
feature in the daily news, such as ination,
unemployment and economic growth, as well
as how these are measured. Their causes and
consequences are then examined. Finally,
policies available in the macroeconomics
toolkit are explained and evaluated.
In this unit you will learn about:
➔
measuring economic activity
➔
macroeconomic objectives
➔
aggregate demand (AD) and aggregate
➔
inequality and pover ty
➔
macroeconomic policies.
supply (AS)
➔
Monetarist (New Classical) versus
Keynesian views
3 . 1
M E A S U R I N G
E C O N O M I C
In this section you will learn about:
➔
gross domestic product (GDP)
➔
gross national income (GNI)
➔
the business cycle.
The issue
Most
in
countries
order
to
measure
performance
at
76
gross
have
of
a
economic
their
domestic
system
of
activity
economies.
product
national
(GDP)
This
and
income
and
then
section
related
accounting
assess
looks
in
national
the
detail
income
A C T I V I T Y
3.1
statistics.
GDP
However,
it
when
is
within
look
or
a
the
total
closely
and
which
the
value
often
the
used
most
measure
of
appropriate
at
is
this
to
are
twice.
the
nal
“Within
those
the
of
economic
measure,
activity.
especially
good.
an
it
Steel
wording.
so
is
for
of
The
use.
nal
For
is
produced
year.
its
only
that
a
and
the
of
in
goods
the
is
an
good
GDP
to
goods,
services,
steel
lead
good
“Final”
Intermediate
goods
included
borders
of
Let’s
price.
intermediate
would
means
a
“value”
by
example,
an
already
physical
services
usually
multiplied
it
separately
the
and
time,
counting.
economy”
within
of
ready
and
(GDP)
goods
production
cars
Considering
areproduced
nal
period
quantity
double
production
cars.
all
a
its
are
to
avoid
of
denition’s
simply
inputs
pr oduc t
over
services
are
excluded
of
always
economy
service
cars
not
most
dome s t ic
an
goods
to
the
assessingwell-being.
Gr o s s
GDP
is
is
Measuring economic activity
input
while
as
part
counting
and
are
it
services
country.
How is GDP measured?
There
use
■
are
all
three
three
The
output
final
goods
such
as
The
=
–
investment
–
government
–
net
C
income
three
this
=
(X
–
M):
and
foreign
I
+
G
the
in
rents
methods
case?
of
goods
and
made
to
purchase
+
this
up
each
the
statisticians
sector
3
T
otal
+
and
…
by
all
the
sector,
sector
measures
by
of
banking.
+
spending
spending
spending
value
economic
transport
method
the
n
total
includes:
households
rms
(G)
spending
services
goods
(X
–
This
by
foreign
(exports)
and
consumers
minus
services
on
domestic
(imports).
M)
method
process
adds
and
up
by
all
the
the
income
factors
of
economy.
+
wages
+
described
all
three
Remember
value
2
(C):
production
the
by
output.
(I):
+
approach:
adjustments,
the
sector
spending
+
in
production
+
spending
on
=
produced
spending
goods
minor
Government
adds
manufacturing,
domestic
spending
GDP
GDP
.
method
approach:
domestic
The
The
1
on
consumption
exports
this
services
sector
spent
generated
is
and
–
GDP
calculate
approach:
expenditure
amount
■
to
agriculture,
GDP
■
ways
methods.
services
interest
above
are
methods
the
+
equivalent
give
circular
produced
prots
the
ow—in
is
equal
and,
same
to
an
with
result.
some
Why
economy
the
the
Internal link
expenditures
The circular model is explained in
did
not
were
disappear,
responsible
these
they
for
goods
were
the
and
services.
received
production
as
of
These
income
these
expenditures
by
goods
all
those
and
section 1.1.
who
services.
77
Gr o s s
GNI
is
a
na t ional
variation
measures
GDP
an
the
focuses
of
the
value
on
economy
production
of
inc ome
GDP
.
of
what
output
is
independently
involved.
factors
of
In
of
in
production
India.
Since
rm
in
GNI
in
the
India
since
received
by
country’s
located
sent
British
the
=
of
back
to
the
the
the
and
place
It
from
shareholders.
will
be
they
rm
it
by
will
the
of
not
be
British
included
includes
earn
operating
the
production
regardless
of
nationality
incomes
India,
it
of
factors
the
British
in
that
economy”—
the
on
created
the
GNI
corporations
an
of
the
a
states
boundaries
focuses
prot
UK.
generated
and
“within
Consider
taking
Y
et,
GDP
nationality
GNI
involved
is
of
within
the
location.
GDP
.
income
citizens
in
GNI
is
the
UK’s
produced
contrast,
production
their
denition
produced
independently
included
The
(GNI)
in
in
the
UK’s
India
income
where
of
they
is
a
are
world.
GDP
+
factor
income
from
abroad
–
factor
income
sentabroad
Nominal versus real values
Remember
multiplied
that
by
of
prices
or
nominal
that
consider
more
in
higher
be
the
Real
was
actual
which
GDP
the
good
value
or
is
service
value
is
of
measurement,
in
terms
due
If
GDP
$1
1
to
the
an
in
but
million
in
we
price
in
need
a
in
terms
nominal
prices.
in
2017
and
It
10%.
modied
economic
10%
whether
by
known
GDP
Now
produced.
increased
of
quantity
know
output
changes,
measures
changes
so
current
cannot
prices
output,
for
are
of
we
increase
same
GNI
$10
million),
adjusted
effect
was
of
the
measured
time
is,
real
the
a
expressed
changes
is
and
eliminating
at
was
of
Nominal
are
(that
output
GDP
value
following.
2018
measure
of
exist
GNI
gure
that
the
price.
as
the
could
T
o
version
real
GDP
.
activity
after
prices.
Per capita gures
Dividing
GDP
GDP
and
per
indication
W ha t
do
The
most
size
of
is
to
GNI
income
78
Of
a
to
goods
country
per
the
as
and
to
are
or
GNI
Per
can
to
is
used
provide
that
as
a
of
the
the
a
measure
have
to
an
economy.
the
economy
and
can
against
poorly
policies
time,
of
real
of
a
Per
standard
of
country
used
and
GDP
changes.
the
devise
adopted
indication
be
of
an
year
economy
price
population
the
policy-makers
over
rough
capita
provide
in
whether
one
measure
very
statistics
as
help
of
per
us?
performing
effect
gives
gures
income
previous
which
a
or
show
comparisons
the
country
capita
is
a
statistics
to
a
t ell
GNI
economy
extent
for
income
or
performance
isolate
services
capita
GDP
of
output
compared
an
also
they
of
income
the
course,
used
person
s t a t is t ic s
GDP
if
population
respectively.
per
use
national
policies
are
the
worse
compare
gures
in
that,
or
evaluating
successful.
real
or
t he s e
Also,
for
by
GNI
economy.
appropriate
used
capita
average
better
used
others.
GNI
important
the
doing
be
of
or
with
are
were
and
capita
of
the
living
access
has.
care.
Beyond
3.1
Per
capita
income
leaves
a
lot
to
be
desired
as
a
measure
Measuring economic activity
of
livingstandards.
■
As
an
the
average,
per
distribution
country
may
be
extraordinarily
■
Per
capita
environment
at
safe
■
Per
a
to
cost
Leisure
the
same
Living
to
the
The
to
the
level
citizens
allow
made
example,
of
For
all
have
differ
for
in
incomes
have
of
for.
but
cost
it
earn
to
on
a
earn
verylittle.
the
the
double
over
a
decade
degradation,
is
it
alsodoubled?
the
value
people’s
Per
a
leisure.
well-being,
capita
makes
of
income
but
level
difference
may
whether
week.
affected
of
huge
of
population
99%
the
by
current
population.
that
income
The
but
house
significantly
care
and
public
between
two
countries
affecting
spend
may
and
counteract
were
on
also
thus
or
the
contribute
show
to
an
for
free
up
that
cleaning
to
with
at
the
goods
as
income,
addition
education
standards.
other
activities
environmental
reasons,
living
available
more
expenditures
2010
the
these
been
to
a
include
services
education,
to
activity
the
Mexico
made
health
expenditures
economic
been
wealth
greatly
and
families
Certain
only
provide
public
may
care
not
the
about
income
well-being.
income,
health
to
of
to
per
of
environmental
dimension
hours
1%
information
capita
production
standards
fail
no
Per
bottom
at
capita
and
countries,
of
top
the
but
accounted
35
are
owns
family’s
capita
or
stock
family
living
not
the
but
per
statistics
two
60
standards
by
a
If
provides
country.
increased
pollution
that
is
a
rising
of
ignored.
in
work
be
effect
epic
in
because
important
be
car
■
an
income
incomes
may
income
importance
also
■
is
of
its
people
■
is
high
The
conclude
capita
capita
income
high
income
environment.
but
of
the
point
and
GDP
oil
with
of
delivery,
contributions
they
caused
the
per
services.
positive
have
same
High-quality
although
up
available
harm.
spill
no
have
in
For
the
Gulf
adjustment
catastrophe.
alternative
measures
to
assess
well-being
developed.
The Better Life Index (BLI)
The
BLI
has
been
Cooperation
an
overall
and
and
income,
conditions,
skills,
social
environmental
(peoples’
to
the
many
BLI,
the
below
quality,
in
and
their
with
security
a
higher
work
and
the
life
per
life
produce
earnings,
balance,
and
well-being
according
capita
to
education
governance,
subjective
compared
income
and
to
following
and
instance,
higher
Economic
internationally
jobs
and
For
for
designed
engagement
lives).
signicant
of
is
includes
work
having
(much
It
It
together
inequality,
civic
personal
with
terms
brings
status,
US—despite
faced
average
Organization
well-being.
wealth
health
countries
average)—is
of
the
(OECD).
that
connections,
satisfaction
other
index
measures
dimensions:
by
Development
well-being
comparable
housing
developed
the
inequality
GDP
than
OECD
and
ranks
balance.
The Happy Planet Index (HPI)
The
HPI
London
has
and
been
is
developed
designed
to
by
the
assess
New
Economics
whether
each
Foundation
country
is
able
of
to
79
L TA
DP ready
promote
the
well-being
of
its
of
three
Research, thinking , communication and social skills
National statistics and measures of well-being
residents.
It
variables:
average
average
is
made
up
life
subjective
expectancy
,
well-being
Visit your country’s national statistics web page (or the World Bank’s
and
ecological
footprint
(the
web page) and record GDP and GNI (nominal and real) data as well as
amount
of
land
required
to
income per capita gures for the past ve years.
1.
provide
a
country’s
with
their
inhabitants
Is there a dierence between nominal GDP and GNI? If so, explain
all
natural
resources
what could be the reason for this dierence.
and
2.
assimilate
Is there a dierence between nominal GDP and real GDP in any
Surprisingly
,
of the years recorded? If so, explain what could be the reason for
in
this dierence.
per
the
HPI
capita
Costa
3.
their
the
top
ranking
levels
Rica
wastes).
ve
have
below
ranked
countries
GDP
$1
0,000.
top,
with
Costa
Describe the overall trend in these indices over the ve-year
Ricans
having
a
signicantly
period. Explain what you can infer about the performance of your
higher
well-being
than
the
economy. Discuss this with the rest of your class.
residents
4.
of
many
rich
nations.
Find your country’s BLI or HPI scores or ranking. In groups,
discuss your ndings in terms of the factors you consider
T he
impor tant for well-being, and which factors you think should be
improved so as to achieve higher scores in the near future.
busine s s
Economic
activity
continuously
Real
c ycle
does
increase
not
over
time.
GDP
peak
T
ypically,
long-term
of
o
Figure
it
o
a
c
r
t
o
is
n
a
p
x
e
n
n
n
contraction.
of
The
expansion
business
are
followed
cycle,
by
illustrated
periods
in
line
c
trend
periods
an
3.1.1,
refers
economy’s
Between
real
time
to
GDP
and
t
these
t
1
short-term
over
the
uctuations
of
time.
economy
is
contracting
2
trough
since
real
recession
of
GDP
is
decreasing.
(technically
declining
real
for
GDP).
This
two
At
described
consecutive
the
t
is
economy
as
a
quarters
was
at
a
1
0
t
t2
t3
Time
peak
and
just
about
characteristic
Figure 3.1.1The business cycle
At
the
t
of
a
to
enter
recession
economy
is
in
a
recession.
is
rising
trough
and
The
major
unemployment.
just
about
to
2
L TA
DP ready
Research and
enter
recovery.
Between
time
and
t
t
2
thinking skills
Economic growth and the
expansion)
This
is
since
economy
upward
is
real
GDP
also
sloping.
is
economy
is
growing
(in
3
increasing.
growing
The
the
trend
over
line
the
is
long
the
term
average
as
the
annual
trend
line
long-term
business cycle
growth
1.
of
the
economy.
Search for and record
An
economy
is
growing
when
real
GDP
is
increasing,
and
it
is
the growth rate of the
contracting
when
real
GDP
is
decreasing.
The
growth
rate
of
an
economy in your country
economy
is
the
percentage
change
of
real
GDP
between
two
years.
over the past ve years.
If
2.
the
percentage
change
in
real
GDP
is
positive,
then
real
GDP
is
Which phase of the business
increasing,
suggesting
the
rate
that
the
economy
is
growing.
However,
if
cycle do you think the
growth
is
negative,
then
real
GDP
is
decreasing,
and
the
economy is in at present?
economy
but
in
but
(from,
at
Key terms—test yourself
Focus point
Dene these terms: gross
National
domestic product (GDP), gross
performance
national income (GNI), real
and
GDP/GNI, per capita GDP/GNI.
capita
be
recession.
decreasing
increase
80
is
a
income
income
used
with
say,
slower
statistics
care
as
can
in
it
be
can
if
the
growth
0.8%)
is
evaluating
countries
comes
to
employed.
be
real
economy
across
When
they
to
The
help
time,
policies.
that
2.1%
rate.
statistics
through
evaluating
Note
rate
GDP
not
positive
continues
yet
in
to
recession.
economic
as
well
assessing
However,
misleading.
is
as
in
devising
well-being,
they
have
per
to
3.2
3 . 2
Aggregate demand and aggregate supply
A G G R E G AT E
D E M A N D
A G G R E G AT E
S U P P LY
A N D
In this section you will learn about:
➔
aggregate demand (AD)
➔
aggregate supply (AS).
The issue
Phrases
often
such
appear
demand.
(AD)
This
and
supply
as
in
“weakened
the
be
therefore
on
domestic
includes
expenditures
expenditures
on
(I)
(G)
households,
must
this
looks
is
called
section
demand
shock”
decline
aggregate
together
and
consumption
and
(spending
by
exports
rms
and
subtract
period
time.
C
is
is
services
and
can
the
aggregate
on
(C)
some
government
I
(M).
+
because
G
AD
output
AD
a
not
at
produced,
shows
price
On
are
the
levels
in
diagram,
horizontal
all
the
say
in
planned
that
AD
axis
same
2019,
level
+
from
sector
.
AD
(spending
investment
goods),
of
the
make
(X
government
expenditures
are
–
on
foreign
M).
measured
sum.
However,
concepts.
in
of
a
at
So:
GDP
same
refers
services
originate
capital
Since
total,
by
the
GDP
Average
level
and
in
demand
with
and
foreign
expenditures
rms
+
the
of
non-durables),
imports
=
it
approach
goods
(X).
the
means
domestic
government
durables
and
aggregate
on
per
goods
the
familiar,
expenditure
where
levels
AD
If
this
“negative
economy-wide
(A D)
spending
price
rms,
households
we
(AD),
planned
households,
goods,
or
an
demand
in
demand
average
Spending
that
introduced
demand
total
different
by
describe
(AS).
Aggregate
the
demand”
to
economy-wide
will
A g g r e ga t e
to
news
GDP
country,
spending
at
is
price
(AP L)
actual
whereas
different
country.
is
illustrated
shows
real
by
GDP
the
and
AD
the
curve.
vertical
The
axis
shows
the
AD
average
goods
price
and
level,
an
services
in
index
the
of
the
average
economy.
The
of
AD
the
prices
curve
is
of
all
nal
negatively
0
sloped
on
because
domestic
at
a
goods
higher
and
average
services
price
level,
decreases,
as
planned
in
Figure
Real
spending
3.2.1.
GDP
(Y)
Figure 3.2.1The AD cur ve
Why is the AD cur ve downward sloping?
Y
ou
law
are
might
of
think
demand.
considering
that
the
downward
However,
an
when
increase
or
a
we
slope
is
a
consider
decrease
in
consequence
the
all
AD
curve,
prices,
not
of
the
we
just
in
81
the
price
of
one
good.
downward,
we
level
reduces
■
(APL)
The
wealth
deposits
less.
the
need
APL
to
and
of
understand
if
the
bonds
feel
rises
understand
spending.
effect:
People
T
o
then
C
why
Reasons
APL
rises
decreases.
poorer
and
falls,
why
they
the
a
rise
in
include
then
the
$100,000
tend
leading
AD
to
to
a
curve
the
the
real
in
average
price
following.
value
the
spend
slopes
of
bank
(C)
downward
bank
buys
less.
So,
sloping
if
AD
curve.
■
The
trade
effect:
expensive
tend
if
to
the
if
while
decrease
APL
rises
the
APL
imports
and
then
rises
seem
imports
NX
to
falls,
then
exports
relatively
increase
leading
become
cheaper.
to
so
a
NX
more
Exports
will
decreases.
downward
So,
sloping
ADcurve.
■
The
to
interest
hold
rate
more
demand
for
effect:
money
to
holding
buy
If
the
APL
the
increases,
same
(cash
goods
and
supply
of
then
and
checking
money
by
people
need
services.
The
accounts)
the
central
bank
price
is
level
the
money
increases.
Average
if
constant,
then
the
“price”
of
money
(which
is
the
(AP L)
interest
rate),
decrease
people
(such
rises.
However,
consumption
and
as
firms
borrow
houses)
factories).
So,
leading
a
to
if
and
and
the
from
capital
APL
downward
higher
interest
investment
banks
to
buy
equipment
rises
then
sloping
AD
C
rates
expenditures
durables
(such
and
I
as
as
decrease
curve.
AD2
Changes
in
the
APL
cause
movements
along
the
AD
AD
curve.
There
can
also
be
shifts
of
the
AD
curve.
As
AD3
shown
in
Figure
3.2.2,
an
increase
in
AD
means
that
0
Real
GDP
(Y)
there
is
a
shift
of
the
AD
curve
to
the
right
from
AD
1
to
Figure 3.2.2Shifts of the AD cur ve
.
AD
A
decrease
in
AD
means
that
the
AD
curve
2
shifts
to
the
left
from
AD
to
AD
1
These
shifts
of
components,
the
AD
which
curve
are
can
be
explained
3
caused
by
changes
in
its
below.
Factors aecting the components of AD
Consumption
This
is
spending
services
■
and
Interest
money
it
rates:
for
houses.
People
■
a
are
they
82
of
less
is
are
and
to
cut
the
they
right.
back
this
how
on
If
is
to
buy
price
is
a
are
a
and
paid
such
shifting
a
the
decrease
measure
of
about
to
feel
spend
afraid
spending,
of
borrowing
as
more
they
are
for
percentage.
durables
less,
likely
they
as
borrowing
following
secure
their
the
make
spend
seen
non-durables
following.
rates
so
durables,
expressed
borrow
and
reverse
on
rate
time
interest
confident,
will
theleft.
the
confidence:
households
curve
on
interest
usually
The
Consumer
AD
the
Higher
(C)
households
period
borrow
left.
they
by
depends
Households
the
expenditures
more,
the
or
curve
interest
to
rates.
optimistic
the
losing
shifting
AD
in
how
cars
expensive.
future.
shifting
their
AD
If
the
job,
curve
to
3.2
■
Household
own,
they
a
in
AD
and
■
such
owe.
rise
the
wealth:
so
as
property
Personal
which
they
it
■
is
and
■
their
they
the
■
banks
in
to
less
and
in
taxes:
business
taxes
to
increase
Government
and
merit
schools
past
and
with
a
to
shifts
decreases
disposable
paid.
left,
If
vice
versa.
money
using
credit
spending
curve
the
falls,
and
much
from
(such
as
will
as
then
the
Businesses
as
The
cards.
they
shift
left.
machines)
the
cost
and
of
will
these
AD
borrow
expenditures
curve
opposite
AD
in
shifts
effect:
to
the
the
AD
and
a
affect
such
as
if
they
AD
shift
in
in
feel
are
curve
results
causing
the
about
optimistic,
shifts
a
to
decrease
AD
advances
increases
will
be
are
AD
taxes
of
firms
they
in
in
curve.
quickly
AD
and
a
as
the
in
shift
to
the
decreased
levels
will
curve
of
to
first
debt
take
try
shifts
out
to
to
the
left.
(G)
affected
national
is
they
projects.
investment
will
hesitant
AD
in
curve.
high
be
so
result
AD
have
decrease
investment
curve
may
the
will
and
A
of
approved
The
shift
if
profits.
profitability
by
Governments
internet
If
technology
investments
it
businesses
the
leftward
increase.
decreases
example,
so
though,
firms’
the
business
make
how
curve.
borrowing,
AD
to
economy.
which
leftward
priorities.
fast
goods
have
the
to
expenditures
goods
For
in
expenditures
economic
the
AD
of
income
their
goods,
refers
invest
indebtedness:
and
services.
and
rates
projects
right.
Government
on
increase,
investments,
tend
debt.
are
how
or
The
increase.
capital
and
these
will
loans
to
to
borrowing.
this
increases
investment
decrease
capital
about
the
spending
more
back
pessimism,
spending
Business
of
which
(I)
on
by
more
because
what
example,
right.
likely
shift
Corporate
for
wealth
level
taxes
loans
debt.
rates
interest
the
sales
witness
the
shifts
refers
cut
will
will
An
fall,
minus
to,
spending,
prices
after
out
their
interest
industries
investment
more
households
estate,
due
disposable
curve
this
on
T
echnology:
More
AD
will
rms
Business
rightward
■
they
financed
more
right.
left
taxes,
taking
confidence:
future
are
the
from
spend
shifts
investment
■
if
from
so
Business
real
what
following.
Decreases
curve
or
of
wealth
determine
income
decrease
the
typically
left.
to
stock
these
income
and
by
rates:
borrowing
less
If
expenditures
on
Interest
the
lot,
to
spending
depends
are
a
try
Investment
This
is
owe
owe
first
value
deposits
leads
indebtedness:
households
will
the
household
right.
taxes:
raises
drops
Household
prices,
the
income
spending
in
to
consumption.
government
If
to
refers
bonds,
increase
curve
income,
■
stocks,
An
will
this
Aggregate demand and aggregate supply
a
the
spend
defence,
political
connections
government’s
to
education
priority
and
provide
to
and
equip
smartboards,
political
public
health
all
or
public
to
build
Internal link
more
regional
health
centres,
then
government
expenditures
will
Section 3.6 covers scal policy
increase.
However,
as
shown
later
in
this
unit,
governments
spend
in detail.
to
increase
AD.
This
is
referred
to
as
scal
policy.
83
Any
the
increase
AD
shift
in
curve
the
AD
exports
The
net
domestic
on
foreign
on
Income
of
increases,
increased
of
Exchange
■
currency
rate
of
abroad
to
the
T
rade
■
often
net
country
shifting
will
then
the
have
a
if
the
spending
be
on
between
minus
and
shift
spending
foreign
domestic
net
income
will
exports
will
of
our
increase.
imports,
tend
increases,
which
to
will
spending
spending
=
(X
–
trading
Part
are
increase
shifting
refers
the
pricier
the
of
M).
partners
their
our
if
AD
exports.
the
curve
to
impose
will
curve
reverse
to
and
the
income
to
the
the
so
If
rate
the
on
competitive
attractive
shifting
will
the
have
to
AD
the
the
trade
opposite
trade,
one
imports
exports
right.Relaxing
of
curve
left.
international
the
net
exchange
more
curve
to
country’s
government
restrictions
and
less
AD
restrictions
fall
one
and
increase,
the
If
of
currency.
exchange
shifting
to
price
cheaper
exports
governments.
imports
the
country’s
net
in
is
become
become
decrease,
this
rate
another
exports
result,
by
AD
the
L TA
DP ready
of
increase
decides
country,
of
exports
policies:
AD
government
expenditures):
will
imports
As
imposed
difference
revenues)
exchange
then
An
the
economy
an
terms
while
in
increase
versa.
rates:
right.
effect;
level
an
vice
domestically.
decrease
partners:
partners
decreases,
A
will
following.
their
in
is
(import
spending
and
spending
left.
(export
trading
trading
right,
the
gure
the
exports
its
right.
to
output
output
depends
The
the
exports
on
■
to
curve
Net
It
government
will
of
another
rise,
restrictions
effect.
Thinking , research and communication skills
AD and condence indicators
1.
Prepare a large mind map, on screen or on a large sheet of paper,
that explains what you have learned about AD. Include diagrams
and examples.
TOK
2.
Visit your country’s national statistics webpage. Find the
consumer and business condence indicators and record the
Consumer and business
trend in these indicators for the past 10 years. Analyse whether
condence aect the level of
there is a pattern.
AD. What knowledge issues
arise in attempting to measure
3.
Discuss in class what factors could have recently aected the
level of consumer condence in your country.
condence?
A g g r e ga t e
Aggregate
domestic
time.
much
supply
supply
rms
Note
are
that
rms
(AS)
AS
are
is
willing
is
not
(A S)
dened
as
to
at
the
planning
to
offer
same
offer
the
different
as
at
planned
real
APLs
GDP
.
different
level
AS
APLs.
of
per
period
shows
As
output
of
how
with
AD,
Internal link
AS
Find out more about the Monetarist
can
the
AD
be
shown
curve,
the
by
a
diagram
shape
of
the
of
the
AS
AS
curve
curve.
is
However,
rather
unlike
controversial
(New Classical) and the Keynesian
as
it
reects
the
views
of
the
two
main
schools
of
thought:
the
views of economics in section 3.3.
Monetarist
84
(or
New
Classical)
view
and
the
Keynesian
view.
3.2
Aggregate demand and aggregate supply
The Monetarist (New Classical) view of A S
Monetarists
between
short-run
The
New
short
AS
Classical)
run
(SRAS)
and
and
the
a
economists
long
run.
long-run
AS
As
make
a
a
result,
distinction
there
is
a
(LRAS).
SRAS
Within
which
is
(and
the
the
framework,
money
written
time
AS
on
period.
wages
a
are
short
xed.
paycheck:
Money
the
the
wages
The
run
the
money
dollars
are
is
(or
usually
period
wage
is
during
basically
equivalent)
determined
earned
what
per
by
Average
labour
contracts.
This
means
that
if
the
price
level
in
the
in
effect,
economy
changes,
as
long
as
price
level
contracts
(AP L)
are
SR AS
change
The
is
money
in
the
reason
that
remains
greater
wages
for
costs.As
biggest
will
not
adjust
to
match
the
level.
account
production
the
price
money
they
xed,
wages
long
part
unchanged.
protability,
of
If
are
the
closely
largest
as
money
rms’
the
of
wages
increases,
induces
them
to
AS
rms’
remain
production
APL
which
related
part
costs
rms
to
enjoy
offer
more
0
Real
output.
The
in
The
SRAS
Figure
axis
and
opposite
curve
3.2.3
the
is
holds
if
therefore
where
average
real
the
upward
GDP
price
price
is
level
the
on
as
the
short
run,
changes
in
the
APL
(Y)
Figure 3.2.3The SRAS cur ve
shown
horizontal
the
vertical
axis.
Average
level
In
GDP
decreases.
sloping,
on
is
level
cause
price
(AP L)
SR AS3
movements
SR AS
along
the
SRAS
SRAS
curve.
SRAS
means
curve.
There
can
also
be
shifts
of
the
SR AS2
the
right
As
shown
that
from
in
there
is
to
SRAS
Figure
a
shift
SRAS
1
means
that
the
.
3.2.4,
of
A
an
the
increase
SRAS
decrease
curve
in
in
to
SRAS
2
SRAS
curve
shifts
to
the
left
from
SRAS
1
toSRAS
3
Changes
in
SRAS
in
production
to
be
are
costs.
mainly
Note
caused
that
these
by
changes
would
have
0
Real
changes
in
simultaneously
just
rms
shift
■
if
the
is
firms’
SRAS
affect
of
in
If
increase
in
in
SRAS
shift
the
the
it
the
business
Higher
curve
the
rise,
to
SRAS
(Y)
curve
Figure 3.2.4Shifts of the SRAS cur ve
not
will
wages
for
in
of
the
can
If
in
SRAS
example,
the
oil
wage.
same
shifts
change
money
a
leftward
curve
the
as
for
in
to
SRAS
curve
in
the
the
changes
example,
increase,
shift
shifts
changes
way
if,
wages
the
right.
price
in
to
of
wages.
the
left;
a
right.
taxes:
taxes
the
economy,
SRAS
resulting
decrease,
price
the
GDP
will
occur.
money
curve
to
in
that
The
minimum
prices:
SRAS
Changes
and
wages:
in
wages
shifts
production.
rms
market.
production
decrease
the
most
energy
the
production
changes
money
change
costs
of
particular
curve.
affect
An
■
in
a
Changes
oil
a
following
Changes
there
■
of
costs
left.
curve
business
increase
Lower
to
the
taxes
affect
production
taxes
costs
costs
reduce
of
and
so
production
shift
costs
right.
85
Average
level
price
The
LRAS
(AP L)
LR AS
In
the
long
to
then
money
result,
by
no
of
will
also
of
the
isn’t
exible.
the
to
output.
show
not
They
rises
by
That
in
The
in
a
APL
if
so
curve
the
even
As
the
and
LRAS
in
2.4%
because
prices
that,
change
is
adjust
by
2.4%.
increases
increase
to
does
APL
increase
changing.
vertical
output
are
respond
level
match
drawn
wages
APL—if
longer
protability
level
the
their
wages
therefore
the
in
wages
increasing
rms’
money
changes
rms
money
0
run,
fully
long
the
is
run,
APL
Yf
Real
GDP
changes.
This
is
shown
in
Figure3.2.5.
Figure 3.2.5Figure 3.2.5 The LRAS cur ve
More
of
Internal link
all
adjustments
its
resources
potential
Unemployment is covered in more
depth in section 3.4.
interpret
At
the
have
and
output
this.
full
level
the
output,
been
there
is
full
which
an
in
to
of
does
to
long
at
run
produces
T
ake
mean
there
as
vertical
produce.
not
output
referred
is
the
economy
it
employment.
level
is
curve
since,
allow
employment
employment
LRAS
Yf,
made,
technology
Full
unemployment,
Average
specically,
potential
At
care
is
still
natural
level
whatever
this
level
how
zero
the
when
of
you
unemployment.
some
unemployment.
price
If
(AP L)
LR AS
the
LRAS
increases
and
the
curve
shifts
to
the
right
LR AS’
then
this
implies
increased,
capacity
An
■
has
increase
in
LRAS
increase
for
example,
to
the
that
in
can
the
an
level
economy’s
of
be
a
result
quantity
increase
immigration
capable
potential
the
of
output
has
productive
increased.
An
due
that
meaning
in
means
producing
of
the
factors
the
following.
of
production:
quantity
that
more
of
the
real
of
labour
economy
GDP
and
so
is
the
LRAS
0
Yf
Yf’
Real
curve
GDP
■
Figure 3.2.6Shifts of the LRAS cur ve
shifts
improvement
for
example,
the
productive
Improvements
to
improved
more
■
its
level
and
it
so
the
greater
the
and
the
can,
Therefore,
in
the
a
of
in
LRAS
shifts
technology:
curve
an
factors
W
orkers
curve
equipment
result,
of
education
labour
.
LRAS
LRAS
when
as
quality
levels
of
innovations
efficiency:
resources,
output.
Average
in
and
right.
quality
and
machines
output
Increases
the
An
improve
■
to
that
shifts
economy
produce
curve
shifts
and
to
the
right.
can
to
lead
produce
better
greater
to
more
right.
makes
a
skills
the
able
the
production:
become
these
are
to
of
use
quantity
of
of
right.
price
(AP L)
■
Institutional
changes:
improvements
in
the
institutional
AS
framework
amount
of
increase
the
bureaucracy
economy’s
facilitates
productive
economic
capacity.
activity
and
A
reduced
can
III
increase
II
the
output
produced,
so
the
LRAS
curve
shifts
to
the
right.
The Keynesian view of A S
In
the
the
AS
Keynesian
short
run
curve.
It
view
and
has
the
there
long
three
is
no
run
sections,
distinction
and
as
so
there
shown
in
between
is
only
Figure
one
3.2.7.
0
Yf
Real
GDP
Let’s
Figure 3.2.7The Keynesian AS cur ve
86
full
start
backwards.
employment
level
Section
of
III
output,
is
vertical
Yf.
In
the
at
the
Keynesian
3.2
framework
this
considered
as
in
the
the
other
This
is
huge
is
an
produced
as
full
coexists
with
continue
some
employment
bottlenecks
to
full
rise,
industries,
the
in
sooner
less
labour
the
II,
is
APL
no
is
unemployment
I,
at
signicantly
means
that
levels
of
rising.
an
upward
industries
This
in
some
Real
employment
wages
the
sloping
may
AS
economy
situation
in
industries.
available,
Section
unemployment).
Higher
capacity
full
Yf.
which
high
others.
other
the
usually
operating
Yf,
illustrates
some
spare
in
of
very
is
is
beyond
recession.
than
employment
because
is,
that
production:
but
output
deep
fact
there
economy
(that
section
the
output
increase
of
without
section,
to
The
level
in
of
that
cannot
capacity
economy
relates
level
implying
GDP
horizontal.
spare
be
This
Real
employment
be
can
employment
“wall”,
in-between
reach
will
full
could
curve.
to
end,
the
output
The
a
economy.
below
there
full
Aggregate demand and aggregate supply
is
referred
industries
output
may
conditions
rise
and
in
so
APL.
L TA
DP ready
Thinking , research and communication skills
Prepare a large mind map, on screen or on a large sheet of paper, that
explains what you have learned about AS. Include information about
the Keynesian view and the Monetarist (New Classical) view. Also
include diagrams illustrating each view.
TOK
Keynesians and Monetarists (or New Classicists) have dierent views
on the shape of the AS curve. Is there a “right” or a “wrong” view? What
are the factors that need to be considered? In which other area(s) of
knowledge are there dierent views on the same issue?
Focus point
Aggregate
on
per
demand
domestic
period
goods
of
time,
(AD)
and
services
includes
expenditures
net
(X
downward
level
of
average
differs
–
M).
sloping.
output
price
It
is
levels
the
(I),
per
the
at
of
by
supply
period
planned
different
government
rms
schools
total
are
of
(AS)
time.
AD
curve
refers
to
The
economic
price
levels
expenditures
expenditures
the
willing
spending
average
consumption
illustrated
Aggregate
domestic
between
to
and
investment
exports
refers
to
offer
shape
at
(G)
and
which
the
(C),
is
planned
different
of
the
AS
curve
thought.
Key terms—test yourself
Dene these terms: aggregate demand (AD), consumption
expenditures (C), investment expenditures (I), wealth, interest rate,
net expor ts, aggregate supply (AS).
87
3 . 3
T H E
M O N E TA R I S T
T H E
K E Y N E S I A N
V S .
TA K E
In this section you will learn about:
macroeconomic equilibrium
➔
— the Monetarist (New Classical) view
— the Keynesian view.
The issue
Average
price
Section
level
3.2
explained
what
makes
up
AD
and
AS.
(AP L)
This
section
uses
them
together
in
order
to
determine
SR AS
macroeconomic
economic
P
equilibrium
and
to
analyse
variations
in
activity.
Macr oec onomic
equilibr ium
The Monetarist (New Classical) view
Short-run
equilibrium
AD
0
Real
Y
GDP
In
(Yr)
level
Figure 3.3.1Shor t-run equilibrium
in
The
is
P
,
real
level
short
of
real
Figure
equilibrium
determined
either
Average
the
AD
GDP
or
as
macroeconomic
GDP
where
AD
and
equilibrium
SRAS
are
exists
equal,
as
at
the
shown
3.3.1.
level
at
of
the
SRAS
well
run,
GDP
is
intersection
will
as
real
cause
the
a
price
of
and
AD
change
average
price
Average
(AP L)
Y
level
in
the
and
the
average
SRAS.
price
A
shift
equilibrium
level
in
level
of
level.
price
(AP L)
SR AS
SR AS’
SR AS
P’
P’
P
P
AD’
AD
AD
0
0
Y
Real
Y’
GDP
(Yr)
Y’
(a)
Real
Y
GDP
(Yr)
(b)
Figure 3.3.2 a and bChanges in shor t-run equilibrium
As
shown
AD
which
GDP
to
Y
88
left
to
from
Y'
in
and
SRAS
to
an
to
Y
to
Figure
business
from
3.3.2a,
shifted
Similarly,
higher
the
Figure
has
increased
P'.
by
in
taxes
to
a
the
Y'
reduction
right
and
3.3.2b
has
SRAS'.
increase
in
from
so
a
did
rise
the
led
interest
rates
to
the
average
in
decreased
This
in
AD
AD'.
costs
SRAS,
to
a
average
of
As
has
increased
result,
price
level
production
which
decrease
price
a
level
has
in
from
GDP
P
P
caused
shifted
real
from
real
to
to
from
P'.
3.3
Long-run
In
the
The monetarist vs. the Keynesian take
equilibrium
long-run,
macroeconomic
equilibrium
will
necessarily
be
at
Internal link
the
economy’s
potential
or
full
employment
level
of
output.
ShortSee section 3.6 for more information
run
equilibrium
may
differ
from
the
potential
level
of
output
but
on managing the economy.
this
is
only
temporary.
return
to
wages
fully
Refer
to
the
full
In
the
long-run,
employment
level
of
the
economy
output,
as
a
will
result
always
of
money
adjusting.
Figure
3.3.3.
The
economy
is
at
equilibrium
at
Average
the
level
price
(AP L)
LR AS
potential
level
of
output,
Yf.
The
APL
is
at
(see
P
point
1
a
on
Figure
3.3.3).
condence
in
the
Now
,
say
economy
that
business
decrease.
AD
SR AS
and
consumer
SR AS2
decreases
a
P
shifting
the
AD
curve
to
the
left
from
to
AD
AD
1
and
b
2
P2
the
price
level
drops
from
to
P
P
1
.
Remember
that
in
the
2
P3
short-run
APL,
money
rms’
wages
are
protability
xed.
With
decreases
and
the
so
decrease
rms
will
in
c
the
reduce
AD
output,
moving
along
SRAS1
from
point
a
to
point
b.
This
AD2
means
that
real
GDP
falls
to
.
Y
When
the
equilibrium
0
2
Y2
level
of
real
output
is
below
the
full
employment
Real
Yf
GDP
(Yr)
(or
Figure 3.3.3Returning to full employment following a
potential)
level
of
output,
it
is
known
as
a deationary
decrease in AD
(or
recessionary)
gap.
In
this
case,
it
is
equal
to
Y
Yf.
2
However
,
are
in
according
exible,
the
which
APL.
Hence,
to
the
means
Remember
SRAS
increases
Monetarists,
that
they
that
money
and
shifts
in
will
the
wages
to
long-run
decrease
the
is
a
right
to
shift
to
money
match
factor
SRAS .
wages
the
for
decrease
SRAS.
Equilibrium
is
2
back
to
the
full
employment
level
of
output
Yf;
at
a
lower
price
level
P .
3
The
economy
has
therefore
moved
on
its
own
at
point
c.
Average
level
According
to
Monetarists,
an
economy
will
price
(AP L)
LR AS
recover
SR AS2
(that
is,
the
deationary
and
recessionary
gap
will
SR AS
close)
only
There
is
through
the
adjustment
of
money
wages.
c
P3
no
need
for
the
government
to
intervene.
P2
Something
similar
happens
if
there
is
an
increase
b
in
a
P
AD.
the
Again,
initially
potential
level
the
of
economy
output,
Yf,
is
at
with
equilibrium
the
APL
at
at
P
.
1
That
is
point
a,
shown
in
Figure
3.3.4.
Now,
say
AD2
that
a
AD
reduction
in
interest
rates
leads
to
an
increase
in
AD,
0
Yf
which
shifts
to
the
right
from
to
AD
AD
1
rises
from
to
P
P
1
the
short
Since
money
the
Y2
Real
GDP
(Yr)
APL
wages
are
xed
in
Figure 3.3.4Returning to full employment following an
2
run,
protability
.
and
2
the
and
increase
induces
in
the
them
to
APL
increases
increase
increase in AD
rms’
output,
moving
along
SRAS
1
from
point
a
to
point
b.
Real
GDP
is
now
at
.
Y
This
is
a
case
of
an
2
inationary
employment
gap:
(or
the
equilibrium
potential)
level
level
of
of
real
output;
in
output
this
exceeds
case,
Y Yf.
the
full
Money
2
wages
will
now
restore
the
full
employment
level
of
output.
In
the
TOK
long
As
run,
such,
money
the
wages
SRAS
will
increase
decreases,
to
shifting
match
to
the
the
left
to
increase
SRAS .
in
the
APL.
Equilibrium
Referring to the Keynesian and
2
is
P
back
.
The
to
the
full
economy
employment
has
therefore
level
of
moved
output
on
its
Yf;
own
at
to
a
higher
point
APL
of
c.
the Monetarist (New Classical)
models of macroeconomics: in
3
your opinion, what factors may
Again,
according
to
Monetarists,
an
inationary
gap
will
close
inuence a person’s preference
only
through
the
adjustment
of
money
wages.
There
is
no
need
for
for one view over the other?
government
T
o
recap:
in
adjustability
intervention.
the
of
Monetarist
money
(New
wages
in
Classical)
the
long
view,
run,
a
because
of
deationary
the
or
89
Average
price
AS
level
(AP L)
an
inationary
economy
will
(potential)
Now
let’s
gap
will
always
level
turn
of
to
macroeconomic
automatically
return
to
the
close
full
and
the
employment
output.
the
Keynesian
view
on
equilibrium.
AD1
The Keynesian view
AD2
The
deationary
gap
0
Y2
Yf
Real
GDP
(Yr)
Consider
the
operating
at
economy
full
shown
in
employment.
A
Figure
3.3.5,
collapse
in
initially
business
Figure 3.3.5The deationary (recessionary) gap
and
Average
price
consumer
which
shifts
condence
the
AD
causes
curve
to
the
a
decrease
left
from
in
AD,
to
AD
AD
1
level
.
2
(AP L)
Equilibrium
real
GDP
is
Y
below
the
full
employment
2
level
AS
of
output
(recessionary)
Yf.
The
gap
result
equal
to
is
Y
a
deationary
Yf.
2
b
P2
Will
the
own?
economy
According
return
to
to
full
employment
Keynesians,
the
answer
on
is
its
no.
a
P
According
“sticky
AD2
to
the
Keynesian
downwards”,
increase
but
they
do
in
view,
the
not
money
sense
easily
that
adjust
wages
they
are
may
downwards.
As
AD
such,
there
push
of
the
is
no
automatic
economy
output.
back
Therefore,
to
an
adjustment
the
full
economy
mechanism
employment
may
remain
to
level
stuck
in
0
Yf
Real
GDP
(Yr)
a
deationary
or
recessionary
gap
(that
is,
at
a
level
Figure 3.3.6The inationary gap
of
Is
there
to
L TA
DP ready
Thinking skills
a
way
increase
scal
The
out?
AD.
policy
real
or
GDP
that
Y
es—the
This
can
loose
inationary
be
is
below
the
government
achieved
monetary
full
employment
must
either
intervene
through
in
level).
order
expansionary
policy.
gap
Comparing the t wo
models
Figure
Yf.
A
3.3.6
rise
shows
in
an
business
economy
and
at
the
consumer
full
employment
condence
now
of
output
causes
AD
Answer these questions, relying
to
increase
which
shifts
the
AD
curve
to
the
right
from
1
on what you have learned in this
AD
.
Real
GDP
will
remain
at
Yf
(remember
the
“wall”).
The
2
section.
APL
will
though
rise
from
to
P
P
1
1.
to
AD
.
Distance
ab
is
referred
to
as
2
What are the main
the
inationary
gap.
Unlike
in
the
Monetarist
view,
the
gap
is
dierences between
now
on
the
vertical
axis—because
in
a
strict
interpretation,
full
the Keynesian and
employment
in
the
Keynesian
model
implies
no
unemployment.
the Monetarist (New
Classical) models?
Focus point
2.
To what extent are
Macroeconomic
equilibrium
is
determined
at
the
intersection
these models realistic
of
AD
and
AS.
Long
run
equilibrium
in
the
Monetarist
or
New
representations of the
Classical
model
will
always
be
at
the
potential
(full
employment)
real-world economies?
level
of
New
Classical
(full
Key terms—test yourself
of
output.
Short
model
employment)
money
return
to
wages
its
long
run
can
equilibrium
be
output,
will
run
either
but
only
guarantee
potential
output
below
that
or
in
the
above
temporarily.
the
output.
The
economy
In
the
Monetarist
the
or
potential
exibility
will
always
Keynesian
model
the
Dene these terms:
economy
can
get
stuck
at
a
level
of
output
below
potential
(full
deationary (or recessionary)
employment)
output
as
wages
are
“sticky
downwards”
.
There
is
gap, inationary gap.
no
automatic
There
90
is
a
adjustment
need
for
mechanism
government
to
restore
intervention.
full
employment.
3.4
3 . 4
M A C R O E C O N O M I C
Macroeconomic objectives
O B J E C T I V E S
In this section you will learn about:
➔
what we mean by economic growth
➔
shor t-term and long-term growth
➔
measuring economic growth
➔
consequences of economic growth unemployment: different
types of unemployment; the economic costs of unemployment
inflation, disinflation and deflation.
➔
The issues
This
section
focuses
unemployment
millions
latest
out
of
Initially,
distinguishing
each
growth
this
be
growth—which
The
section
difculties.
the
on
costs
are
not
is
on
of
data
of
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unemployment
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L TA
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rising.
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A focus on growth
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investment
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Illustrating shor t-term growth
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ou
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2
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Mea sur ing
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o
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93
L TA
DP ready
Research, thinking and communication skills
Recent economic growth in  ve countries
Research and determine the most recent economic growth rate for
your country as well as for four more countries of your choice. Try to
select countries from dierent regions of the world.
1.
Find annual real GDP gures for all ve countries for the most
recent ve-year period. Calculate the four annual growth rates
but also the growth rate for the ve-year period.
2.
Decide whether these growth rates are satisfactory. Explain why
is it perhaps dicult to decide. Explain what factors you have
to consider.
3.
Try answering question 2 again after you have read to the end of
this section.
C on s equenc e s
Does
economic
of
ec onomic
growth
Economic
growth
real
is
means
improve
that
an
gr ow th
living
standards?
economy’s
total
output
(its
Search the web
GDP)
rising.
Given
that
the
value
of
an
economy’s
total
Visit the site
output
(its
real
GDP)
is
the
reverse-side
of
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income
generated
www.countryeconomy.com.
in
the
production
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the
country’s
national
income)
the
You will nd many variables
for any country you may be
interested in. You can, for
following
should
population,
be
then
true.
income
If
an
per
economy
person
is
growing
(known
as
faster
per
than
capita
its
income)
example, see the evolution of
is
rising.
For
example,
if
an
economy
is
growing
by
5%
per
year
GDP and per capita GDP for any
but
the
population
is
increasing
is
increasing.
by
1%
per
year
then,
on
average,
country and for many years.
income
Higher
Watch this
of
per
per
person
capita
consumption
higher
incomes
income
of
goods
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levels
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allow
increased
services.
access
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average
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goods
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levels
enjoying
services.
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standards
for
release
growth
these
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terms: TED see how the rest of the
world lives Rosling. You will see
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statistics
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countries.
a photographic journey of how
families in more than 50 countries
Per
capita
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average
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W
e
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realize
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when
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T
alk on moral behaviour in animals. It shows the reaction of capuchin monkeys
to inequity. Search using the phrase: two monkeys were paid unequally: TED talk.
94
3.4
L TA
DP ready
Macroeconomic objectives
Research and thinking skills
Countries with similar per capita incomes
Carry out online research to nd pairs of countries with similar per
capita income levels.
a.
To what extent can you be sure that living standards in these
countries are also similar? Describe the concerns you have
about making an accurate analysis.
b.
What other information would you need to have in order to
investigate the extent to which living standards are similar or not?
Does
How
economic
does
single
can
economic
correct
improve
and
higher
spent
to
a
term
to
cash
and
increase
transfers
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capacity
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social
to
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poor,
productivity.
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poor
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alleviate
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higher
programmes
government
economies
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economy.
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income
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pension
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economies.
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but
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income
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growth
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these
driven
in
by
certain
benets
only
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will
handful
regions
of
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Inclusive Growth” by IMF
of
country
economist Jonathan Ostry (June
2018). It looks at why growth is
fragile when it is not inclusive.
(often,
the
coastal
regions).
It
may
rely
only
on
certain
skills,
You could instead listen to Ostry
often
of
the
more
educated.
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importantly,
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by including the word “podcast”
of
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assessment.
Unemploymen t
What do we mean by unemployment?
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the
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number
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3.4
L TA
DP ready
Macroeconomic objectives
Thinking skills
An example of US unemployment
Unemployment in the US had reached 10% in October 2009 and
remained above 8% until August 2012. In April 2018 it had decreased
below 4% and continued to decline.
Search the web
Search the web for: workers hardest recession recovery nyt.
Read the New York Times ar ticle (3 August 2018) on one aspect of
unemployment in the US manufacturing sector.
1.
The New York Times ar ticle mentioned that a substantial number
of “workers … on the sidelines” were gradually coming back to
work . Describe who these workers were. Explain why they were
rejoining the labour force.
2.
What does the ar ticle suggest about the reliability of published
unemployment statistics?
Reasons for inaccuracies
Causes
in the ocial gure
Underestimation
Hidden employment: involuntary par t-
timers, discouraged workers, workers
overqualied for their job
Overestimation
Workers claiming to be unemployed: to collect
benets or because their work is illegal
The ocial gure is an
Signicant dierences may exist between:
average
regions, genders, ethnicities, age groups
Table 3.4.1Problems when measuring unemployment—a recap
Type s
and
T
ypically,
unemployment
frictional,
■
cyclical
Seasonal
stay
and
Lachlan
are
periods
away
from
Frictional
jobs
for
better
For
to
a
■
a
Cyclical
the
to
in
time
four
types:
Ethan
met
Mia
Sydney
of
the
refers
are
have
Mia
to
to
in
job
and
seasonal,
though
job
who
to
are
are
winter,
asked
to
to
freezing
in
between
search
moved
quit
take
For
unemployment.
people
will
year.
Every
relating
having
decided
the
workers
risks
work
of
T
oronto.
people
It
time
seasonal
always
no
Sydney.
even
the
construction
experiences
There
who
to
construction
when
his
Ethan
vacancies
of
location.
job
in
some
do
time
exist
and
appropriate.
unemployment
in
as
particular
because
time.
people
in
are
recession,
is
Lachlan
follow
business
example,
job
or
job
skills
works
work
limited
example,
find
his
categorized
unemployment
jobs
Canberra
is
unemploymen t
structural.
of
temperatures—so
■
of
unemployment
example,
there
c aus e s
cycle
when
2012–13,
many
as
a
trainer.
found
a
new
when
gyms
When
job,
as
is
in
related
to
businesses
the
Milan
the
gyms
the
Italian
shut
Italian
recession
shrink
shut
economy
down
economy
re-opened
or
or
and
phase
down.
was
in
a
Giuseppe
recovered,
of
For
deep
lost
his
Giuseppe
expanded.
97
L TA
DP ready
Thinking skills
Illustrating cyclical unemployment
Think of the best way to illustrate cyclical unemployment in a
diagram. Remember that a decrease in AD leads to a deationary gap.
Draw your diagram on screen or on paper.
■
Structural
than
the
unemployment
other
economic
types
recovery.
unemployment:
Mismatch
the
skills
demand.
the
driving
have
lead
of
to
or
labour
that
that
be
benefits
to
require
may
it
in
to
firms
difficult
also
to
structural
driver
in
that
Austria.
mean
the
anymore.
but
but
The
Rainer’s
There
Rainer
may
does
advances
Artificial
exist
employers
be
not
are
a
intelligence
main
may
industries.
and
regulations
changing
from
pay
to
induce
to
of
past
vacancies
skills
T
echnological
laws
adjust
nature
way
causes
job
the
could
demand
many
result
persists
the
development,
training.
may
long-term
It
where
not
truck
trucks
in
labour
market
make
a
are
unemployment.
redundancies
refers
more
rigidities.
situation
software
necessary
unemployment
laws
the
not
a
explain
and
Rainer,
structural
Rigidities
the
in
of
words
driverless
will
jobs
the
cause
of
skills
available
T
wo
unemployed
Consider
introduction
is
unemployment.
mismatch
describes
of
of
a
for
high
the
dismiss
some
that
market
insurance
people
to
not
permit
conditions.
minimum
workers.
do
wage,
of
High
reject
their
Some
and
from
employees
unemployment
low-paid
work.
Types of unemployment and summary description
Seasonal: related to the
Cyclical: related to a downturn of the
time of the year
business cycle (or recession)
Frictional: refers to people
Structural: results from a mismatch between
between jobs
the skills of the unemployed and the skills
rms demand; or from labour market rigidities
Table 3.4.2Types of unemployment—a summary
Illustrating structural unemployment
S
Money
of
labour
wage
One
way
to
illustrate
structural
employment
is
to
(W)
show
a
labour
wage
leads
market
diagram
in
which
a
minimum
(ab)
excess
a
b
supply
(structural
of
labour
to
fewer
workers
being
demanded
unemployment)
by
Wmin
rms
than
minimum
At
the
the
wage
number
level.
minimum
wage
willing
This
is
work
shown
rms
W
to
are
in
at
that
Figure
willing
to
3.4.3.
hire
min
L
workers
while
L
1
individuals
are
offering
to
work.
2
There
is
excess
supply
of
labour
equal
to
L
L
1
which
represents
Another
way
to
a
type
of
illustrate
structural
structural
or
(ab),
2
unemployment.
unemployment
D
for
L1
L2
Labour
(number
of
is
labour
(L)
shown
labour
98
Figure
market,
in
3.4.4.
this
This
case
shows
the
a
market
particular
for
truck
workers)
drivers.
Figure 3.4.3Market for unskilled workers
in
drivers
There
is
because
a
of
decrease
the
in
advent
the
of
demand
driverless
for
truck
trucks.
3.4
Before
the
new
technology,
the
market
employed
L
truck
Macroeconomic objectives
Money
SL
wage
drivers.
The
arrival
of
driverless
trucks
will
decrease
the
(W)
demand
need
has
to
not
for
truck
hire
L'
truck
adopted
technology
drivers
the
leads
to
to
L'.
drivers
new
L'L
T
rucking
for
any
trucks
technology.
truck
rms
As
drivers
a
in
will
a
eet
result,
losing
now
that
the
their
only
new
W
jobs.
The natural rate of unemployment (NRU)
The
natural
rate
unemployment
of
unemployment
that
exists
when
(NRU)
the
refers
economy
is
to
the
operating
at
DL1
DL2
its
potential
level
of
real
GDP
.
The
NRU
reects
the
fact
that
L
’
some
unemployment
is
unavoidable
and
will
always
L
Labour
exist.
(number
There
will
always
be
some
people
who
are
seasonally
of
(L)
workers)
or
Figure 3.4.4Market for truck drivers
frictionally
The
NRU
C os t s
An
and,
does
of
most
not
importantly,
include
any
structurally
cyclical
unemployed.
unemployment.
unemploymen t
important
goal
of
policy-makers
is
to
ensure
that
high
levels
of
Search the web
employment
are
achieved
or
,
in
low
unemployment.
other
words,
to
achieve
and
maintain
Search the terms: self-driving
levels
of
This
is
an
important
goal
because,
as
vehicles truck drivers. You will
explained
below,
high
unemployment
imposes
signicant
costs
on
nd an informative ar ticle on
the
economy,
on
individuals
and
on
communities.
the role of automation in cer tain
types of jobs, including truck
Economic costs
■
Unemployment
production
higher
■
■
If
many
■
If
collects.
countries,
income
find
workers
and
eroded,
L TA
DP ready
the
and
is
may
employment.
young
It
also
implies
with
the
tax
increases
period
is
operating
“lost
a
output
loss
in
revenues
time,
as
its
GDP
.
the
government
of
inside
forever”;
expenditures
the
government
benefits.
high
and
decide
This
and
extends
for
a
long
period
of
time
widens.
high,
is
educated
this
economy
it
associated
some
inequality
unemployment
many
is
the
curve;
decreases
for
unemployment
unemployment
then
that
is
unemployment
government
pays
means
possibilities
unemployment
Rising
in
driving.
to
has
emigrate
often
leave,
decreases
its
been
to
referred
then
future
for
the
long
other
to
as
a
period
of
countries
“brain
country’s
time,
in
order
drain”
.
human
then
If
to
the
capital
is
growthprospects.
Research and thinking skills
Youth unemployment
Search the web
Search Google news for ar ticles about high youth unemployment in Greece following the 2010 debt crisis. Include
in your search the words “after:” and “before:” with specic dates. For example, use: Greece youth unemployment
after:2010 before:2014. Then change your search tex t to: “after:2014” and “before:2019” to gain information about the
issue through recent times.
1.
Record the changing youth unemployment gures in Greece for as many years as you can nd from
2010 onwards.
2.
Describe what might be the consequences for the Greek economy of high youth unemployment.
99
Private costs
■
Losing
if
your
what
you
limited
■
If
job
may
while
of
are
your
income
available,
working
and
from
they
they
working.
will
will
be
only
less
be
Even
than
paid
for
a
time.
remains
be
losing
benefits
lost
unemployed
and
this
will
for
long,
negatively
job-related
affect
prospects.
Businesses
currently
with
person
lost
loss
of
or
cannot
job,
people
drug
tend
elsewhere
They
their
Unemployed
alcohol
vacancies
working
unemployed.
■
means
earned
period
someone
skills
■
job
unemployment
or
often
abuse,
self-esteem
is
or
to
prefer
rather
be
no
sure
than
why
longer
suffer
inability
depression.
hire
a
someone
the
person
who
is
unemployed
working.
family
to
to
pay
breakdown,
debts,
Some
even
homelessness,
commit
suicide.
Social costs
■
In
cities
crime
■
Drug
and
and
and
violence
alcohol
businesses,
on
the
law
health
L TA
DP ready
regions
with
often
abuse
high
prolonged
unemployment,
increase.
may
enforcement
care
and
also
and
increase,
the
creating
judicial
costs
system,
as
for
well
as
system.
(Thinking and communication skills)
Unemployment and drug abuse
Search the web
Search using these terms: job loss drug use Atlantic.
You will nd an ar ticle from The Atlantic (19 July 201
7) repor ting
results from international studies on the relationship between rising
unemployment and drug abuse.
1.
Discuss in groups whether there is a role for the state in
minimizing the likelihood of drug abuse by individuals who are
distressed because they have lost their job.
2.
Implementing the ideas raised in your discussion may require
increased government expenditure. Is it possible that in the long
term this extra expenditure could be recovered?
DP ready
L TA
TOK
Thinking and communication skills
Are there ethical considerations in
ring a worker? Should the decision
Unemployment facts and issues
to terminate a worker ’s employment
be based only on prot related
1.
criteria? Should a company decrease
Prepare a mind map, on screen or on a large sheet of paper, that
presents what you have learned about unemployment. Try to
wages on all workers to contain
illustrate your points with real-world examples.
costs in a downturn instead of ring
some workers?
100
2.
Share your ideas with the class.
3.4
Inf la t ion ,
Ination
level
is
dened
(APL).
in
a
to
cases
If
country
before.
disinf la t ion
as
a
sustained
is
a
tendency
there
to
be
where
rising,
prices
Deation
and
then
are
refers
still
to
de f la t ion
increase
for
there
rising
periods
in
prices
is
Macroeconomic objectives
the
of
goods
ination.
but
at
when
a
the
average
price
and
services
Disination
refers
slower
rate
APL
decreasing.
is
than
Measuring ina tion, disina tion and de a tion
We
need
year.
an
We
to
use
average
consumer
included
take
for
of
a
simply
So,
if
was
of
place
number;
the
of
in
every
CPI
measure
CPI
every
year
that
few
is,
a
the
equal
a
to
for
The
This
every
goods
then
of
in
the
to
rate
CPI
be
of
to
do
every
this,
that
services
which
the
that
country
is
of
is
country
extensive
the
and
units
the
found
and
for
years
a
services
through
APL
without
of
(CPI)
and
month)
change
was
level
Index
goods
number
2017
142.22
Price
the
years.
number
for
price
determined
for
percentage
CPI
of
buys.
are
(even
country
the
prices
country
the
average
Consumer
the
a
the
are
surveys
is
as
a
measurement.
from
one
136.45
ination
the
for
pure
Once
ination
year
and
that
calculated
expressed
known,
the
to
the
CPI
2018
is
typical
is
next.
for
would
the
rate
2018
be:
142.22−136.45
×100
=
4.23%
136.45
Now
it
T
able
is
easier
3.4.3
to
shows
see
what
Japan’s
disination
actual
Year
Rate of ination
2014
2.76%
rate
and
of
deation
ination
for
actually
three
mean.
years.
Comment
Prices in Japan increased by 2.76% between 2013 and 2014. There was
ination in Japan
2015
0.80%
Prices in Japan in 2015 continued to increase but slower than they did
in 2014: they increased but only by 0.80% which is less than the 2.76%
ination rate in 2014.
There was disination in Japan
2016
–0.12%
Prices in Japan decreased in 2016 by 0.12%. The ination rate was negative.
There was deation in Japan.
Table 3.4.3Rate of ination in Japan 2014–2016. For more information see www.ination.eu/ination-rates/japan/
Dif f ic ul t ie s
The
difculties
in
in
mea sur ing
measuring
in f la t ion
ination
are
all
related
to
Search the web
shortcomings
of
the
CPI
(the
average
of
the
prices
of
all
the
goods
Search YouTube using the
and
services
that
the
typical
consumer
of
a
country
buys).
phrase: top 10 countries by
■
Who
is
this
one—the
“typical”
“typical”
consumer?
consumer
is
The
just
simple
an
answer
average
of
is
all
ination rate.
no
of
us.
You will see a video of the
countries with the top 10
Therefore
this
consumer
and
lives
is
both
a
bit
old
and
a
bit
young,
rich
ination rates between 1980
poor,
in
a
city
but
also
in
the
countryside
and
is
both
and 2018. Note that ex tremely
a
man
and
a
woman.
Actual
buying
patterns
of
any
particular
high ination is referred to as
group,
not
say
young
urban
couples
with
an
average
income,
are
hyperination.
measured.
101
■
Improvements
in
Milton
a
had
for
pay
40,000
with
is
bought
to
the
10%
effectively
New
the
in
yet
■
Every
are
car
tyres
more
The
enter
subscribe
our
a
to
in
last
a
he
year
new
can
published
This
Netflix
is
For
and
CPI.
to
accounted
$100
but
drive
inflation
daily
as
but
Spotify
is
new
but
are
he
thus
quality
bias.
included
in
consumers
neither
to
year
lasted
set
may
the
many
referred
set
If
kilometres
the
rate
to
for
.
this
old
60,000
example,
This
and
the
then
referred
almost
delay.
Italy’s
for
set,
kilometres),
lives
long
sufficiently
for
whereas
inflation.
after
not
($1
10)
(50%
true
included
product
of
cheaper
.
only
Italy
are
set
products
CPI
set
more
kilometres
new
overestimate
■
quality
as
services
the
new
bias.
month,
the
statistical
agency
of
a
country
sends
off
many
Research and
L TA
DP ready
young
employees
to
collect
the
prices
of
the
products
included
communication
in
the
CPI.
In
many
countries,
though,
more
and
more
people
skills
buy
Your family’s shopping
habits
lower.
If
(“brick
will
1.
more
and
the
and
tend
more
goods
statistical
mortar”)
to
online,
agency
stores,
overestimate
mostly
then
true
where
the
prices
collects
This
usually
prices
published
inflation.
are
is
from
inflation
referred
actual
rate
to
as
the
Find information on the
new
retail
outlet
bias.
goods and services that
are included in your
C aus e s
of
inf la t ion
The
way
country’s CPI. Can you
think of goods or services
easiest
to
recognize
the
reasons
prices
may
start
that you or your family
increasing
in
a
country
is
to
recall
the
simple
AD/AS
diagram.
buy that are not included
Prices
may
start
rising
if
AD
is
increasing
and
shifting
to
the
in your country’s CPI?
right,
2.
To what extent does your
family makes purchases
online? Compare the
prices paid for some of
especially
(potential)
as
output.
the
economy
This
ination.
However,
decreases
and
shifts
the
to
is
aptly
APL
the
is
may
left.
approaching
referred
also
This
is
to
be
as
full
employment
demand-pull
rising
referred
because
to
as
AS
cost-push
ination
these online purchases
with the prices charged for
the same goods in “brick
Demand-pull ination
and mor tar ” stores. Which
Demand-pull
ination
is
shown
in
Figure
3.4.5.
products are cheaper and
by how much? Present
AS
your ndings in class.
AP L
AP L2
AP L
AD2
AD
Y
Y2 Yfe
Figure 3.4.5Demand-pull ination
102
Yr
3.4
As
AD
APL
increases
is
rising
output
level
and
faster
(Yfe)
components
the
and
the
AD
faster
most
the
economy
is
shifting
closer
is.
AD
to
to
the
will
the
full
right,
the
employment
increase
when
any
of
its
increases—remember:
AD
The
curve
Macroeconomic objectives
common
=
causes
C
of
+
I
+
G
+
NX
demand-pull
ination
include
thefollowing.
■
Profligate
to
government
describe
often
as
even
a
purpose.
AD,
so
temporary
if
G
Optimistic
the
rises,
■
A
surge
in
operating
■
thus
Perhaps
money
is
be
spent
AD
may
full
and
an
their
word
are
a
and
will
chances,
serve
component
shift
used
Governments
re-election
activity
(G)
increase
firms
times
will
to
the
this
of
right,
be
may
will
spend
persist.
increasing
excessively
Since
and
C
in
and
shifting
to
I
are
the
inflationary.
also
to
prove
may
spend
to
inflationary
after
too
economy
inflation
also
now
higher
importantly,
chasing
government.
economic
will
the
if
the
economy
is
employment.
leading
into
of
and
good
proving
prefer
more
pumped
AD
expectations
households
■
AD,
exports
near
Inflationary
more,
of
a
is
inflationary.
that
potentially
by
maximize
expenditures
households
components
to
boost
then
proving
expectation
right,
spending
spending
Government
potentially
■
excessive
increase
spending—“profligate”
increase
before
rise
as
even
AD.
inflation
few
by
could
inflation
prices
results
goods.
the
If
when
too
country’s
too
much
central
much
money
bank,
is
it
will
follow.
Cost-push ination
Cost-push
left
as
the
upward
of
in
ination
Figure
also
down
a
3.4.6.
sloping
cost-push
slows
is
Note
section
ination,
(real
result
GDP
not
of
that
of
a
only
may
AS
the
decreasing
AS
curve
Keynesian
are
even
prices
and
can
AS
so
be
curve.
rising
decrease)
shifting
but
that
an
In
to
SRAS
the
growth
the
or
case
also
unemployment
rises.
AP L
AS2
AS
AP L2
AP L
AD
0
Y2
Y
Yr
Figure 3.4.6Cost-push ination.
103
The
■
most
common
Historically,
oil.
Oil
is
for
most
leading
the
decrease
will
rising
in
real
cost-push
and
and
if
its
increase.
prices
GDP)
but
and
ination
significant
predominant
processes
firms
to
of
sustained
still
production
causes
include
increases
form
of
price
increases,
AS
also
will
to
rising
energy
decrease,
slower
in
the
the
used
following.
price
in
most
production
and
growth
shift
(or
of
costs
left
even
a
unemployment.
Search the web
Search using these terms: oil crisis 1970s ination Britannica.
Read the shor t history of cost-push ination in the 1970s.
■
More
generally,
(rawmaterials
cost-push
■
Powerful
wages
their
inflationary
■
A
if
the
intermediate
imports
firms
in
in
the
price
manufacturing)
unions,
of
have
An
the
imports
A
expensive
in
been
increase
exchange
country
products.
more
successful
members,
pressures.
depreciation
inflation
increase
of
commodities
may
also
lead
to
inflation.
labour
for
an
used
achieving
responsible
in
wages
rate
a
may
lot
of
depreciation
so
higher
lead
raw
of
production
will
for
cost-push
also
to
money
decrease
cost-push
materials
the
and
currency
costs
for
AS.
makes
many
increase.
Why is ination feared?
Price
stability
is
another
responsibility
of
Bank
US
and
below,
the
but
central
close
L TA
DP ready
macroeconomic
banks
Federal
to,
to
achieve
Reserve
dene
goal
it.
and
The
price
it
is
the
European
stability
as
Central
ination
2%.
Thinking skills
Ination rate
1.
Why do you think that the goal is to maintain the rate of ination
close to 2%?
2.
Explain what kind of risk the economy would face if the
measured ination was at 0.2%. Consider the role of the quality
bias, the new retail outlet bias and the substitution bias. Revisit
this question when you have also studied the costs of deation.
C os t s
■
of
Inflation
two
—
in f la t ion
makes
reasons
The
fixed
case
with
for
If
Joey
this
who
as
more
$1000
income)
wage
per
decreases
can
Income
(real
such
earns
income
those
distribution
power
incomes,
consultants).
104
income
unequal.
There
are
this.
purchasing
money
decreases.
buy
for
adjust
if
month,
prices
their
inequality
of
those
earners
then
earning
pensioners,
what
increase.
earnings
widens.
and
Joey
This
(such
as
is
can
not
the
lawyers
or
3.4
—
Low-income
usually
on
place
such
an
less
as
interest
Higher
assets
a
the
as
faster
they
bank
is
3%
of
house
hurts
or
the
affects
can
so
the
The
of
a
to
real
their
country
which
the
in
are
defined
borrowing,
is
to
expected
borrow.
the
they
foreign
growth
paid
rate,
cannot
poor
because
in
rate
negative.
through
of
often
competitive
if
is
savings,
savings
interest
often
from
any
interest
5%
inflation,
price
especially
make
the
is
poor
income
less
growth
of
buy,
land,
exports
If
The
rate
inflation.
and
able
inflation
year.
the
transfers
are
accounts.
but
the
minus
than
expensive
adversely
if
households
a
inflation
Inflation
in
end
rate
income
sense,
more
at
such
increase
■
them
account
worth
the
families,
Macroeconomic objectives
In
rich.
become
markets.
the
to
This
country
is
export-driven.
■
Inflation
makes
whether
this
be
an
year
6%
the
it
or
have
the
of
risen
Inflation
■
price
is
of
■
buy
may
expensive,
interest
saving
of
people
be
leads
induce
so
often
the
that
people
to
save
durables,
spend
If
an
a
and
4%
could
that
prices
an
will
average.
increases
means
less
investment
will
affected.
power
of
in
relative
a
market
signal
prices
clear
to
are
rising
anymore
do
and
demand
more
resources.
less.
during
all
is
this
actually
of
before
more
and
sends
not
misallocation
negative
less—4%
is
It
mean
Some
allocation
kale.
year.
not
adversely
this
decide
inflation
uncertainty
is
is
If
4%.
whether
resource
more
to
next
does
signalling
rises,
signal
people
people
is
it
4%
by
by
More
judge
for
the
be
4%,
growth
kale
sure
to
especially
rate
to
want
is
prices
distorts
price
profitable.
will
unbalanced
face.
Long-term
cannot
goods,
and
firms
It
it
businesses
increased
other
difficult
inflation,
Inflation
Inflation
have
responsible
the
that
producers
kale.
is
for
prove
that
inflation
and
“noise”
.
If
result
if
that
it
changes
producers
a
as
will
variable
profitable.
economy.
as
more
uncertainty
Inflation
difficult
mean
goods
both
investment
prove
not
Also,
all
by
is
more
investment
does
3%.
prices
it
People
they
save
will
become
less.
As
inflationary
choose
even
the
to
more
real
periods,
decreases.
Deation
Deation
is
(measured
result
and
of
a
this
left.
right.
collapse
sales.
Firms
If
will
“good
it
starts,
in
some
On
a
be
it
AD.
forced
as
to
cut
this
AD
to
difcult
is
to
can
prices.
economy
always
in
in
be
also
increase,
increase
cut
the
to
cut
prices
can
that
prices
T
ypically,
Households
deation
expected
meaning
decreasing.
diagram
Deation
is
are
rms
expecting
the
deation”,
misleading.
ination,
CPI)
T
echnically,
capacity.
rms
the
forces
increase
the
negative
by
back
a
shown
make
bad
more
for
an
on
their
if
by
AS
not
this
average
is
a
spending
attempt
shifting
shifts
investments
does
Sometimes
has
the
desperate
result
AD
on
deation
to
AD
is
to
referred
economy
But
to
the
expand
materialize
factories.
to
then
to
this
because
as
is
once
stop.
105
Why is deation bad for an economy?
■
Deflation
begin
as
creates
people
purchases.
activity
■
Firms
This
to
to
A
prices
decreases
decrease
and
“deflationary
to
continue
AD.
Prices
(cyclical)
spiral”
to
fall
and
may
postpone
economic
unemployment
increase.
dismiss
increases
deflation.
expect
further
continue
continues
more
who
workers
(cyclical)
as
a
result
of
unemployment
shrinking
and
sales,
decreases
which
consumers’
confidence.
■
Firms
that
have
manufacturer
sold
pens
pens.
to
at
$1.60,
The
to
$2.00
When
it
expressed
firm
further,
the
is
in
as
Since
debts,
these
■
If
an
economy
makers
policy
close
may
may
to
option
■
if
be
as
power,
in
real
bank
owed
the
more
real
and
fall
pens.
of
debt
increased.
will
and
and
firms
crisis
caught
as
debt
not
be
able
non-performing
banking
many
will
in
a
policy
may
interest
(“bad”)
their
If
could
policy
policy-
Monetary
already
may
not
be
be
very
an
constraints.
decreases
face
is
higher,
investment
relative
price
misallocation
of
as
it
also
is
with
further.
changes
resources
lose
and
their
signalling
inefficiency.
Low and stable ination is a macroeconomic goal.
Explain why:
a.
governments want low ination
b.
policy-makers do not aim for a zero or a close-to-zero
ination rate.
106
off
loans.
spiral,
available.
rates
fiscal
pay
follow.
deflationary
tools
to
Thinking skills
2.
Describe the costs of high ination.
3.
Explain why policy-makers do not want deation.
4.
Policy-makers may aim at stable ination. Explain:
a.
what happens if ination is variable rather than stable
b.
what kind of issues variable ination presents to the
economy.
fall
(cyclical)
Low and stable ination
1.
pen
preferring
Prices
more
a
firm
pens
The
has
investing,
even
If
the
100,000
price
debt)
further.
decrease
terms.
when
bank
the
125,000
firm’s
will
will
businesses
to
bank
(the
AD
it
a
decrease
expansionary
inflation,
leading
L TA
DP ready
with
a
have
are
which
the
if
to
more
from
rise.
ineffective
that
as
accumulate
Using
there
Uncertainty
Just
first.
becomes
not
zero.
inflation,
■
will
extensive,
owe
borrowing
activity
will
is
goods
households
banks
are
it
forced
owes
of
debt
economic
many
it
avoid
its
unemployment
■
if
is
will
$200,000
each,
firm
terms
will
decrease
borrowed
borrowed
3.4
Macroeconomic objectives
Which is worse—ination or unemployment?
As
you
you
may
are.
For
have
xed-income
earn
a
expected,
wealthy
assets,
ination
would
and
less.
job,
unemployment
some
more
For
as
workers
savings
important
as
income
damage,
less
have
such
xed-interest
is
depends.
bonds,
the
to
say
is
their
depends
is
their
worse.
would
concern
Even
if
eroded
job
who
The
in
bonds
which
be
is
worth
keeping
these
by
on
wealth
$100,000,
return
costly.
which
keep
it
of
ination
year,
primary
more
of
First,
much
annual
whose
value
them
with
every
much
the
for
it
households,
their
workers
ination,
and
continue
ideological
leanings.
it
is
earning
a
livingwage.
More
generally,
Monetarists,
the
true
slows
the
be
to
the
increase
will
The
the
is
High
more
and
economy,
which
may
as
So
view
to
Runaway
unrest.
to
may
is
investments
have
who
of
carefully
are
or
level
your
future
that
growth,
considered
accelerating
slow
can
down,
severely
at
weigh
each
the
and
is
the
the
to
will
employment
social
a
of
the
emigrate,
income
The
prove
costly
growth.
leading
in
each
against
both
fabric
to
ination.
also
and
which
particulars.
affecting
ination
perhaps
will
investments
higher
savings,
time,
full
jobs
leanings,
the
than
adversely
of
to
more
and
maintained,
more
brightest
leads
costlier
as
output.
on
destroys
and
in
and
ideological
damage
costs
while
real
ination
inefciency
term,
return
ination
point
Policy-making
of
long
depends
youngest
to
achieved
the
eventually
economy
the
be
is
in
unemployment
Policy-makers
unemployment.
and,
leads
unemployment
you
would
ination
stability
will
considered
Ination
potential
the
induce
it
Friedman,
faster
economy’s
compromises
opposing
price
rate
prolonged
inequality.
If
economy
of
your
economy.
grow
costly
on
Milton
an
natural
Independently
one
as
of
growth.
economy
created.
and
depends
such
enemy
down
it
the
science
to
social
economy,
costs
and
of
an
art.
TOK
American President Harry Truman famously once asked for a “one-
handed economist” because he was frustrated by his economic
advisers always telling him “on the other hand …” and continuing “on
the other hand…”. If you are not familiar with this saying, search for it
on the internet.
What does Truman’s comment suggest about economics as compared
with natural sciences?
L TA
DP ready
Communication skills
Ination and deation
In a small group, prepare two mind maps. One should focus on
ination and the other on deation. Combine the two mind maps into
one as a poster. Explain the structure of your mind map poster to
fellow students.
107
Focus point
TOK
Economic
growth
must
be
inclusive
and
sustainable.
Non-inclusive
It was mentioned earlier that
growth
that
leads
to
increased
income
inequality
is
referred
to
as
policy-making is perhaps
ruthless
whereas
growth
that
leads
to
environmental
degradation
both a science and an ar t.
is
referred
to
as
futureless.
When
we
read
that
an
economy
is
Think of arguments to suppor t
growing,
we
must
pause
before
celebrating.
both viewpoints. Should we
perceive policy-makers strictly
as “technocrats”? Can they
measure everything and arrive
at conclusions that are devoid
Some
unemployment,
unavoidable
very
costly
but
for
individuals
high
an
and
the
natural
and
economy
the
unemployment,
persistent
and,
communities
of
rates
of
course,
they
live
may
be
unemployment
for
the
are
unemployed
in.
of ethics?
Price
stability
ination
and
to
and
also
a
deation
major
are
goal
also
for
costly
policymakers
to
an
because
economy,
to
both
businesses
households.
Whether
unemployment
signicant
stability
always
is
debate.
and
easy
high
to
In
or
any
levels
ination
case,
of
is
worse,
policymakers
employment,
a
is
try
a
subject
to
of
achieve
combination
price
that
is
attain.
Key terms—test yourself
Dene these terms: economic growth, shor t-term growth, long-
term growth, unemployment, hidden unemployment, discouraged
workers, seasonal unemployment, frictional unemployment,
cyclical unemployment, structural unemployment, natural rate of
unemployment, ination, disination, deation, CPI, demand-pull
ination, cost-push ination, real interest rate, commodities.
108
not
3.5
3 . 5
I N E Q U A L I T Y
A N D
Inequality and pover ty
P O V E R T Y
In this section you will learn about:
➔
equality and equity
➔
the meaning of economic inequality and measuring inequality
➔
the meaning of pover ty and measuring pover ty
➔
the causes of economic inequality and pover ty
➔
the impact of economic inequality
➔
progressive, propor tional and regressive taxation
➔
reducing inequality—the role of taxation and of other policies.
The issue
Inequality
the
world
they
to
is
today
need
to
acquire
some
becoming
even
inequality
and
ideas
of
distribution
the
are
Equali ty
The
Some
maintain
people
of
the
people
a
have
can
others
be
contentious
incomes
lifestyle,
necessities.
while
poverty
most
luxurious
basic
poor
and
This
are
above
while
and
and
in
what
others
section
rich,
measured
way
concerns
struggle
examines
examines
why
how
reduced.
equi ty
equality
of
one
and
income.
equity
Equity
often
means
arise
in
relation
fairness,
which
to
is
the
not
the
TOK
same
as
since
a
equality.
Y
et,
these
terms
are
often
used
interchangeably,
To what ex tent is equity an elusive
more
equitable
distribution
of
income
is
typically
concept?
interpreted
T he
the
of
wealth.
payments
assets
at
Assets
cars
or
include
boats.
income,
wealth.
wealth
the
income
the
US
top
10%
40%
in
or
and
Japan,
countries
households
just
over
Poland,
households
on
the
own
with
2%
what
use
own
of
Greece
and
over
wealth
may
of
and
Belgium
of
inequality,
is
twice
wealth
Wealth
where
and
the
top
as
the
is,
as
their
houses,
more
in
than
add
a
the
the
to
country.
level
highest
the
US
in
the
bottom
inequality
wealth.
such
is
In
of
debt).
and
different
from
factors
well
income
inequality
total
of
(their
as
Denmark.
total
wealth.
40%
be
income
generated
consume
their
of
own—that
bonds,
to
is
use
owe
inequality
Wealth
80%
total
the
they
and
than
wealth
average.
income
for
wealth
less
distribution
households
what
Netherlands
slightly
high
time
distributions
countries,
by
of
shares
can
inequali ty
unequal
minus
consume
income
inequality
distribution.
household
of
deposits,
may
the
period
time
Households
OECD
of
in
to
that
per
consists
bank
income
ec onomic
relates
point
followed
own
of
Remember
Wealth
their
Across
unequal
received
some
their
The
less
inequality
production.
of
a
meaning
Economic
and
as
10%
is
lowest
of
Interestingly,
Netherlands
and
109
Denmark,
where
they
are
own,
Also,
terms
households
countries
households
of
their
combined
income
with
L TA
DP ready
with
high
with
low
and
at
a
net
the
very
of
60%
equitable
wealth
some
levels
bottom
may
are
own
owe
income
not
more
distribution.
necessarily
substantial
than
poor
wealth
in
but
debt.
Thinking and communication skills
1.
Explain how wealth is dierent from income.
2.
Is it possible to have negative wealth?
3.
Work in pairs and identify examples of assets that low-income,
middle-income and high-income households might own. Share
your examples with the rest of your classmates.
4.
Go online and open the OECD repor t “Inequalities in household
wealth across OECD countries”. Go to page 15 and use Table 2.1
to identify the wealth distribution in Australia, Austria, Greece,
the UK , the US and the Slovak Republic. Try to think of factors
that may explain the dierences in wealth distribution in the six
countries. The factors may be historic as well as economic.
Mea sur ing
The
degree
through
of
the
inequali ty
income
use
of
the
inequality
Lorenz
in
an
curve
economy
and
the
can
Gini
be
measured
coefcient.
100%
)evitalumuc(
55%
emocni
lanoitaN
15%
7%
0%
20%
40%
Population
80%
(cumulatively
100%
ranked)
Figure 3.5.1The Lorenz cur ve
Population
cumulative
is
households.
income
the
110
On
received
population
people
represented
percentages,
is
the
on
vertical
population
only
7%
receive
of
So,
horizontal
the
axis,
cumulatively
represented.
receive
the
from
by
in
lowest
the
15%
of
axis
the
of
of
percentage
Figure
3.5.1
income,
national
the
the
income
the
graph,
highest
percentage
each
national
to
in
income
national
group
of
poorest
poorest
while
the
20%
40%
the
of
of
richest
3.5
20%
line
receive
of
perfect
people
earn
national
the
Lorenz
inequality
The
Gini
income
area
a
shift
coefcient
between
Lorenz
income
further
inequality.
half
the
the
to
can
Lorenz
the
“poorest”
be
shifts
income
of
the
also
Gini
diagonal
“poorest”
curve
of
right
towards
The
the
inequality
the
The
where
and
distribution
more
by
income.
equality,
income
As
the
curve
national
of
income.
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of
income
20%
diagonal,
unequal.
the
45%
is
to
a
of
40%
the
of
more
of
less
of
right
and
shift
and
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the
income
diagonal.
used
to
and
measure
is
the
the
dened
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as
degree
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of
ratio
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of
area
the
of
Gini
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all
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the
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income)
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1
(A)
=
area
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diagonal
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square:
Gini
The
further
becomes
shown
the
coefcient
curve
40%
line
Inequality and pover ty
0
(A
+
(perfect
(perfect
B)
equality—each
inequality—one
person
individual
income).
L TA
DP ready
Thinking and research skills
Gini values
Visit the World Bank webpage and search for the Gini index by country.
1.
Find your country and determine the Gini coecient.
2.
a.
Find countries with high Gini values and countries with low
Gini values.
b.
Outline possible reasons why income inequality is higher in
some countries and lower in others.
T he
meaning
Poverty
needs.
refers
There
Absolute
not
have
total
is
a
the
The
The
even
poor,
afford
the
if
measure
in
order
and
of
to
poverty
behind
can
meet
the
in
when
basic
the
distribution
is
their
of
the
poverty
basic
and
a
needs.
with
signicant
relative
consumption
absolute
situation
household
poverty,
identied.
be
who
to
minimal
is
relative
Relative
median
income
degree
that
necessities,
poverty.
household
does
poverty
national
within
of
the
relative
people
when
may
they
still
cannot
society.
po v er ty
a
needs.
can
cover
between
buy
lifestyle
sustain
medical
population
is
a
more
absolute
line
of
to
the
unequal
they
typical
to
income
the
idea
Mea sur ing
poverty
refers
more
be
inability
income
population,
po v er ty
distinction
sufcient
poverty.
T
o
the
poverty
compares
income.
to
of
family
Once
an
in
the
measured
earn
a
That
minimum
is
the
terms
of
poverty
by
taking
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income
minimum
food,
line
the
below
is
level
income
housing,
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percentage
the
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called
the
needed
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of
line.
amount
the
A
poverty
111
line
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be
The
World
threshold
$1.90
a
median
the
let’s
median
the
of
The
&
is
MPI
is
Nations
in
2010
only
to
by
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more
and
and
on
of
that
it
the
living
around
(MPI)
deprivations
the
has
they
of
their
are
100
Any
than
than
For
of
50%
example,
economy
household
income
The
with
fuel,
as
poor
is
for
in
standard
poverty
three
on
the
is
of
human
shelter
,
lack
vulnerability,
reason
Oxford
as
the
Poverty
the
countries
and
poor
captures
the
acute
years
to
of
are
by
assessed
schooling,
water,
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them
in
education,
drinking
measured
are
the
dimensions
identies
index
that
among
respect
is
United
this
measures
MPI
someone
index
and
of
developed
sanitation,
poverty
range
developing
nutrition,
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a
lack
well
people
faces
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the
an
Forthis
beyond
globe.
assets.
indicators,
the
less
beenconstructed.
(UNDP)
over
mortality,
cooking
less
poor.
in
insecurity
vulnerable
person
and
on
percentage
includes
poverty.
poverty
covers
standards.
child
housing
these
It
most
a
illness,
indicators.
Programme
each
intensity
L TA
DP ready
Index
determine
income.
attendance,
the
as
of
to
2015
indicators.
(OPHI)
order
In
considered
relative
malnutrition,
single
is
minimum
and
indicator
societies
electricity,
and
Initiative
indicators:
school
$10,000.
composite
deprivations
health
by
income
$10,000
unemployment,
Poverty
determine
different
line
single
hunger
,
captured
level.
living
earning
relatively
have
multidimensional
as
Development
in
we
below
absolute
are
line.
specifying
Development
based
helps
a
by
household
this,
poverty
They
poverty
Households
considered
falls
illiteracy,
not
Human
are
international
poverty.
50%.
of
an
day—households
measured
measure
such
per
annual
50%
Multidimensional
The
be
and
international
absolute
income
poverty
are
the
$1.90
can
income.
education,
which
national
usually
above
experiences
a
income
terms.
However
,
of
in
T
aking
described
to
median
annual
relative
basis
are
poverty
$20,000.
both
set
income,
say
which
at
Banksets
was
day
Relative
of
set
as
the
in
three
“MPI
or
poor”,
percentage
of
experiencing.
Thinking and research skills
A sur vey of pover ty
1.
Find data on absolute and relative pover ty in your country. Has
pover ty been increasing or decreasing over the recent years?
2.
Visit the webpage Our World In Data. Scroll down to the topic
“Growth & Inequality”. Choose “Global Extreme Pover ty”.
3.
a.
What is the number of people living in poverty across the world?
b.
Has the number been increasing or decreasing over time?
c.
Describe other trends in world pover ty that you notice.
Visit the United Nations Human Development Repor ts website and
go to “2019 Multidimensional Pover ty Index” under the “Data” tab.
a.
Identify the key ndings repor ted.
b.
Explain which dimension of this index you consider to be the
most impor tant.
112
3.5
C aus e s
The
■
of
following
Inequality
the
same
High
ec onomic
are
of
society
levels
were
of
obtain,
to
the
do
not
at
a
birth
their
large
type
of
this
have
inequality
born,
determine
determinants
opportunity:
circumstances
they
possible
inequali ty
of
occurs
access
to
such
as
their
degree
or
the
the
they
get
same
mean
the
poverty.
living
in
opportunities.
that
people’s
place
parental
educational
and,
and
people
gender,
their
po v er ty
inequality
when
opportunity
ethnicity
job
of
and
Inequality and pover ty
where
background
qualifications
ultimately,
their
they
level
ofincome.
■
Different
on
of
the
levels
payments
production
the
of
factors
resource
households
they
of
ownership:
own.
A
production
receive
highly
would
income
by
selling
unequal
lead
to
depends
a
the
factors
ownership
highly
of
unequal
incomedistribution.
■
Different
skills,
skill,
■
education
certain
religion
without
human
and
or
capital:
experience
experience
this
entails
characteristics,
or
freedom
gender.
to
choose
regard
for
When
and
such
as
their
power:
inequality
in
market
power
concentrated
earnings
Degree
low
the
T he
and
wealth,
or
the
poor,
can
and
differently
or
racial
occurs,
aspirations
also
social
hands
Also,
of
certain
a
support:
the
lower
arise
the
less
because
background,
individuals’
is
restricted
when
power.
few
social
preferences.
widening
government
income
firms
may
groups
This
there
Significant
could
are
market
lead
may
be
boost
to
granted
their
inequality.
the
will
greater
be
the
the
support
level
of
for
the
inequality
in
economy.
imp ac t
Economic
growth.
estimated
because
health
so
fact,
of
to
of
3
in
and
ec onomic
may
OECD
Gini
have
lower
care
to
of
inequality
In
inequality
and
privileges
of
in
inequality.
and
to
with
wages.
people
ethnic
refers
Workers
ability.
in
exclusive
lower
discrimination
pursue
capital
labour.
treating
disparities
economic
human
of
earn
Difference
power
■
of
Discrimination:
of
■
levels
education
have
of
education
lower
over
GDP
levels
labour
negative
countries,
points
cut
a
inequali ty
by
the
the
past
around
human
can
couple
8.5%.
capital.
lead
to
productivity,
impact
average
which
of
economic
of
is
is
suppressed
funds
human
results
in
decades
Growth
Lack
lower
on
increase
to
access
capital
in
slower
economicgrowth.
Moreover,
economy
is
usually
with
tends
buy
to
found
“squeezed”
will
high
by
luxury
also
safe
capital
lower,
the
inequality.
imported
as
be
among
expensive
seek
inequality,
goods,
ight.
overall
because
middle
the
and
spend
jewellery
abroad
Therefore,
for
when
rate
and
their
of
highest
classes,
High-income
houses
havens
the
savings
rate
which
individuals
much
of
foreign
savings
are
in
savings
usually
income
They
what
low,
the
typically
their
travel.
savings
of
are
in
the
is
on
may
known
level
of
113
investment
and
this
“rent
limits
political
such
higher
able
to
result
the
also
have
low
civil
High
bribery.
led
is,
to
a
or
be
conict
that
resources
the
improve
facilitates
lobbying,
are
from
fraction
credit.
borrow
and
allocated
productive
can
money,
the
they
expand
High
Extreme
a
may
not
business.
inequality
inequality
cost
also
of
When
growth.
stability.
may
also
excessive
diverted
other
start
rates.
inequality
as
or
growth.
slower
social
crime
are
or
cannot
increase
inequality
smaller
children
not
When
faster
loan
can
do
such
they
the
for
factors
High
actions
incomes
their
higher
and
progress.
and
undermines
with
upheavals
to
behaviours,
qualies
these
resources
growth.
refers
inequality
with
of
associated
any
could
educate
Inequality
in
which
that
individuals
The
economic
donations
that
population
be
Productive
rent-seeking
purposes
The
low.
seeking”
large
to
is
lives
lead
and
those
on
is
may
set
result
back
low
incomes
Watch this
to
support
populist
policies
that
can
prove
to
be
damaging.
The
Search YouTube using these
political
power
of
the
rich
and
hence
their
bargaining
power
are
terms: Wilkinson Inequality harms
strengthened
by
to
outcomes
high
inequality.
Usually,
the
rich
use
this
power
societies TEDx. Watch the video
on the consequences of economic
inequality.
encourage
inequality
because
off
from
and
makes
the
the
a
weak
powerful
socially
means
to
T
axes
are
Direct
include
taxes.
of
a
They
Indirect
MTR
are
direct
paid
to
taxes,
taxes
as
wages,
taxes
so
to
improve,
themselves
they
high
have
as
the
worse
incentive
and
taxes
indirect.
authorities
corporate
paid
rental
taxes
are
taxes
and
tax
are
income
property
taxes
and
worse,
on
income,
imposed
and
income
based
are
taxes
on
on
goods
taxpayers
taxes
all
and
forms
interest
on
the
inheritance
imposed
by
the
and
wealth
of
income
income
prots
ownership
of
of
and
a
assets.
taxes.
and
services.
They
are
ATR
called
indirect
sellers
of
the
because
good
or
consumers
service
pay
being
them
indirectly
through
the
purchased.
T
∆T
ATR =
MTR =
∆Y
Y
T
axes
the
Table 3.5.1MTR and ATR
can
as
the
taxes
tax.
tax
we
average
of
progressive,
base.
need
tax
A
tax
to
rate
explain
dene
The
base
earned,
refers
income
paid
in
the
taxes
MTR
if,
(the
is
income
MTR
or,
is
the
or
paid
as
tax
between
tax
rate
of
the
is
depending
tax
taxed
is
of
tax
taken
so
it
and
on
of
the
as
over
may
to
types
paid
paid
on
income
referred
these
(MTR)
percentage
ratio
a
the
the
result
last
tax
include
wealth.
income
A
TR)
greater
regressive
percentage
additional
whatever
as
or
the
difference
the
prots
progressive
increases,
is
to
and
marginal
The
A
TR
expenditures,
is
of
the
the
(A
TR).
income
tax
proportional
income
percentage
T
o
earned.
The
income,
between
The
rate.
additional
“dollar”
■
be
relationship
paid
as
114
such
Wealth
include
into
income
Corporate
corporation.
difcult
view
pr opor t ional
income
household
to
Even
it.
directly
personal
dividends.
very
likely
reform,
them.
t a x a t ion
are
Personal
are
efcient
distinguished
taxes
to
institutions
few
resist
P r o g r e s si v e,
r e g r e s si v e
favourable
increases,
also
than
the
increases.
the
A
TR.
percentage
Since
Under
the
of
A
TR
progressive
3.5
taxation,
a
bigger
individuals
proportion
or
of
households
income
as
with
tax
higher
than
the
incomes
ones
with
Inequality and pover ty
pay
lower
incomes.
A
■
tax
of
is
proportional
income
remains
paid
tax
if,
taxes
constant
proportional
same
in
so
as
the
MTR
system,
proportion
of
income
remains
all
income
increases,
constant.
is
equal
to
individuals
as
tax
the
The
the
or
percentage
A
TR
A
TR.
therefore
In
a
households
regardless
of
their
pay
level
the
of
income.
A
■
tax
is
income
the
regressive
paid
MTR
is
T
able
in
3.5.2
taxes
less
individuals
income
in
or
if,
as
income
decreases.
than
the
A
TR.
households
increases,
The
In
pay
a
a
A
TR
the
thus
regressive
bigger
percentage
decreases,
tax
so
system
proportion
of
of
poorer
their
taxes.
shows
how
a
progressive
income
tax
Income ($)
systemworks.
T
ax rate
0–10,000
10%
10,001–30,000
20%
30,001–55,000
30%
55,001 and above
50%
Table 3.5.2Example of a progressive income tax system
Using
T
able
earning
the
$60,000
rst
and
3.5.2,
$10,000
$30,000;
nally
50%
let’s
per
of
30%
on
calculate
year
this
on
would
income;
income
income
how
pay.
20%
much
The
on
between
between
tax
tax
an
paid
income
$30,001
$55,001
and
individual
will
be
10%
between
and
$55,000;
$60,000.
for
$10,001
and
So:
(0.1×$10,000)+(0.2×$20,000)+(0.3×$25,000)+(0.5×$5,000)=
$1,000+$4,000+$7,500+$2,500=$15,000
The
If
total
tax
income
income,
paid
taxes
on
the
were
regardless
$60,000
earned
proportional
of
the
then
amount,
is
$15,000.
everyone
would
face
earning
the
same
an
tax
rate,
Internal link
say
20%.
Income
taxes
are
never
regressive,
but
indirect
taxes
are.
There is more on taxation in
Let’s
see
why.
Consider
two
individuals
that
have
bought
the
same
section 2.5.
good.
say
Both
value
income,
the
added
the
tax.
amount
poorer
have
Y
et,
of
paid
since
tax
the
they
paid
is
a
same
do
not
greater
“dollar”
have
amount
the
same
percentage
of
of,
level
of
income
individual.
DP ready
Reducing
L TA
for
individuals
Research skills
Comparing tax rates
inequali ty
Find personal income tax
The role of taxation
rates, corporate tax rates and
T
axation
can
play
a
key
role
in
reducing
inequality.
The
idea
is
indirect tax rates that apply in
that
the
more
progressive
a
tax
system
is,
the
more
equal
the
your country. Compare with
after-tax
distribution
of
income
and
wealth
becomes.
Progressive
another country in your region
income
taxes
will
require
those
on
higher
incomes
to
pay
a
larger
of the world.
percentage
of
their
total
income
in
taxes
compared
to
those
on
115
low
incomes.
make
the
groups.
more
Also,
burden
In
both
this
groups
of
incomes
because
the
taxes
imposed
contrast,
return
Also,
the
on
paying
on
may
fewer
government
up
paying
than
often
the
rich
taxed
and
taxes.
In
to
of
decrease.
with
the
the
goods
assets,
legal
of
of
their
where
share
This
is
incomes
through
can
go
there
evade
or
indirect
cigarettes).
incomes
loopholes
completely
in
middle-
larger
or
as
which
tax
and
groups.
their
will
upper-income
However,
wages,
such
part
taxes
redistributed
low-
source
from
countries,
may
the
be
proportionally
largest
some
they
on
can
high-income
at
exploit
inheritance
heavily
can
taxes
nancial
able
reprisal,
the
and
wealth
a
the
purchase
derive
be
most
and
effective
withholding
physical
they
fall
as
taxes
are
(by
property
inequality
be
ending
in
tax
income
is,
not
poor
expenditures
the
that
may
income
their
of
cases,
equitably;
practice
progressive
By
from
the
unreported.
and
is
end
no
fear
up
of
taxes.
Other policies to reduce pover ty and inequality
Besides
taxation
policies.
■
These
T
ransfer
a
government
include
payments:
unemployment
These
the
inequality.
receiving
■
T
argeted
can
It
school
to
spending
or
care
health
on
services
to
the
and
and
the
Investment
human
in
and
the
lower-income
lead
to
The
minimum
to
wage
A
other
villages
of
is
the
and
clean
risk
of
income
that
dependent
the
on
people
them.
government
such
nutritional
in
as
education
order
to
make
Examples
urban
include:
fringe
areas;
supplementation
water
and
areas.
this
will
and
order
too
groups.
can
to
this
be
and
achieved
health
by
improving
services
population
increase
with
labour
for
better
productivity
wealth.
government
However
,
there
services
healthier
skills
the
in
of
groups
decrease
services:
education
incomes
wage:
workers.
rural
groups.
higher
minimum
skilled
rural
provision
and
use
allowances.
vulnerable
infrastructure
capital:
access
training
and
in
remote
quality
the
child
they
that
deprived
preschool
to
the
and
and
so
become
provide
most
projects
lunches
to
pensions,
and
most
note
goods
directly
electrification
the
the
may
education,
■
to
include
revenues,
payments
programmes;
■
tax
important
available
public
made
is
health
them
are
resort
benefits
these
subsidize
and
usually
disability
using
also
following.
these
and
payments
population
the
may
can
support
may
set
the
lead
to
or
increase
incomes
an
of
increase
low-
in
unemployment.
■
Universal
citizens
of
basic
of
money,
status.
which
a
income
this
is
country
or
a
regardless
of
theirincome,
T
ypically,
are
(UBI):
geographic
identical
funded
periodic
through
the
a
model
area
with
wealth
paid
by
a
or
payments
taxes
for
providing
given
all
amount
employment
are
made
those
with
to
all,
higher
Watch this
incomes.
This
sum
should
be
enough
to
take
care
of
basic
needs
Search YouTube using these terms:
but
not
enough
to
provide
a
lot
more.
However,
the
opportunity
UBI explained. Watch a video on
cost
of
funding
UBI
can
be
high.
how the UBI model could work.
voters
116
rejected
such
a
plan.
In
June
2016
Switzerland’s
3.5
Inequality and pover ty
TOK
Inequality may also arise because of dierences in qualications.
These are reections of a number of things such as natural ability,
attitudes towards study, the quality of tuition and income of parents.
Is there a role for the state in these cases? To what extent should the
state intervene to compensate for such dierences?
L TA
DP ready
1.
Thinking , communication and research skills
In class, discuss possible problems that the policies in the bullet
list above could cause.
2.
Search online using these terms: Bolsa Familia and
Opor tunidades. Collect information about these programmes.
To what extent were they successful? Share this information
with the rest of your class and discuss these programme’s
advantages and disadvantages.
Creativity, activity, ser vice
Get in touch with organizations assisting people in need in your
local community and nd out in what ways you could suppor t these
organizations. Arrange a “give away” event at your school—ask
people to bring in things they might no longer need including clothing,
books, cookware and kitchenware, linens or even small domestic
appliances. Donate the collected items to the organizations you got in
touch with so that they can distribute them to the needy. You can ask
to par ticipate in the distribution.
Alternatively, you could organize a fundraising event.
Focus point
Economic
and
of
inequality
wealth
consumption
inequality
or
growth
and
needs.
and
different
Economic
while
levels
social
investment
government
A
of
can
in
human
can
unequal
of
to
a
the
of
are
Progressive
reduce
are
can
among
taxation,
of
of
rise
on
to
minimal
both
reasons.
economic
transfer
the
income
cover
discrimination
these
impact
some
to
give
opportunity,
negative
capital
distribution
inability
reasons
capital
have
human
to
the
refers
Inequality
stability.
use
to
number
poverty.
inequality
and
refers
poverty
payments
measures
a
inequality.
Key terms—test yourself
Dene these terms: absolute pover ty, relative pover ty, direct
taxes, indirect taxes, progressive taxation, propor tional taxation,
regressive taxation.
117
3 . 6
P O L I C I E S
In this section you will learn about:
➔
monetary policy and the role of the central bank
➔
fiscal policy
➔
supply-side policies
➔
how policies may promote economic growth and keep
unemployment low and prices stable.
The issue
In
order
to
monetary,
these
achieve
scal
policies,
how
they
and
stability.
may
P olicie s — k ey
Demand-side
They
is
include
conducted
changes
in
conducted
the
by
government
focus
on
the
categorized
policies
aim
and
bank
supply
production
as
This
and
growth,
affect
use
section
explains
limitations
low
to
then
unemployment
of
demand
policy.
(AD).
Monetary
country
and
rates.
involves
Fiscal
changes
policy
involves
policy
in
the
is
level
of
taxes.
increase
side
market-based
the
interest
and
and/or
aggregate
scal
of
and
government
expenditures
Supply-side
to
policy
central
money
the
strengths
promote
aim
monetary
the
their
policy-makers
policies.
poin t s
policies
by
objectives,
supply-side
examines
evaluates
price
policy
and
the
aggregate
economy.
supply-side
supply
They
policies
or
(AS).
are
They
often
interventionist
policies.
Internal link
This section refers to AD, AS and the
Note
that
scal
and
monetary
policy
may
try
to
increase
AD,
but
LRAS cur ve. There is more in-depth
may
sometimes
decrease
AD,
while
supply-side
policies
aim
only
information in section 3.2.
to
increase
AS.
Macroeconomic
Demand-side
Fiscal
changes
in
policy:
government
expenditures
and/or
taxes
(G)
(T)
policies
policies
Supply-side
Monetary
changes
rates
(r)
policy:
in
or
interest
the
supply
money
Market-based
Interventionist
policies
policies
(Ms)
Figure 3.6.1Macroeconomic policies
118
policies
3.6
Mone t ar y
Policies
polic y
The role of a central bank
The
central
and
the
oriented
loans
the
of
rms.
for
bank
in
is
saying
crises
also
are
taxation
Most
They
other
supply
period
of
also
it
and
money
time,
and
out
the
expressed
as
all
rates.
is
policy
percentage.
By
and
grant
regulates
do
not
way
of
banking
revenues
by
prot-
central
that
from
payments.
affecting
rates
saving
are
another
sure
Interest
for
they
government
monetary
government
bank
The
government
reward
a
sure
make
all
the
banks
interest
prots.
which
to
makes
interest
of
central
making
resort”
and
paying
The
their
takes
collects
carries
thus
banks,
it
bank
are
money
the
over
increasing
the
cost
DP ready
a
the
money
vice
versa.
L TA
borrowing
It
sources
by
interest.
last
whatever
the
Commercial
deposits
increase
of
as
banks.
paid
to
“lender
does
importantly,
money
described
commercial
avoided.
and
are
lending
the
it
be
attract
they
of
risky
that
can
commercial
which
behaviour
engage
of
bank
bank
Research skills
Ination targets
supply,
the
central
bank
can
decrease
interest
rates
and
Find ination targets around
the world by searching the
Goals of monetary policy
web using these terms: central
The
single
most
and
maintain
important
goal
of
monetary
policy
is
to
achieve
bank news ination target.
price
stability.
For
the
UK,
the
US,
the
eurozone,
Record the lowest and the
Canada,
Sweden
and
other
central
banks
this
means
ination
rate
highest targets as well as the
below
but
close
to
2%.
For
the
Reserve
Bank
of
India,
it
means
countries for each extreme.
maintaining
If
the
ination
economy
monetary
is
policy
in
at
around
recession
can
be
used
4%.
or
to
at
risk
of
increase
entering
AD.
recession,
Unemployment
will
Internal link
decrease.
In
contrast,
if
growth
is
too
fast
and
there
is
a
risk
of
There is more on ination in
rising
ination,
monetary
policy
can
be
used
to
decrease
AD
to
section 3.5.
cool
off
the
regulating
term
If
if
AD
monetary
will
rate,
be
of
policy
is
price
decrease
policy
GDP
,
helps
later,
to
can,
are
and
decrease
business
manages
to
less
policy
to
So,
invest
and
inuence
by
the
short-
smoother.
and
economic
uncertainty.
can
trade-related
cycle
achieve
long-term
likely
face
pressures.
principle,
the
then
more
they
monetary
correct
in
and
stability,
Businesses
inationary
making
successful
price
stability
explained
which
real
is
long-term
accelerate.
there
and
monetary
uctuations
maintain
may
economy
growth
expand
Lastly,
the
as
exchange
issues.
Tools to conduct monetary policy
The
thus
■
central
bank
interest
The
central
This
is
cannot
bank
as
it
the
bank
out
provides
the
If
three
an
and
tools
change
you
bank
with
wants
of
central
decrease
of
the
a
must
account
amount
the
can
percentage
lend
central
RRR.
will
the
opens
limit
uses
to
affect
the
money
supply
and
rates.
a
to
bank
reserve
commercial
hold
as
loan,
it
that
loans
the
you
wants
to
to
the
can
make
increase
a
by
the
that
it
commercial
creates
payments.
money
make
ratio.
deposits
When
automatically
use
bank
bank’s
reserves.
decrease
a
requirement
supply
it
money
So,
can
increasing
money
if
the
supply
it
RRR.
119
Commercial
■
the
central
loans,
is
or
The
bank
rate
referred
rate
■
the
to
the
most
the
of
a
food
would
that
sell
banks
and
it
short-term
QE
is
a
deation.
It
difference
is
is
used
response
2009
bonds
while
to
it
the
was
make
more
to
such
interest
as
the
rate
discount
the
new
would
central
course,
the
buy
the
it
is
bank
increases
money
would
increased.
sold
central
$100
bank
the
from
supply
market
million
dollars
have
bonds
open
$100
enter
The
million
does
money
not
buy
supply
commercial
by
selling
bonds.
policy.
It
has
been
to
open
bank
market
does
commercial
own,
in
encourage
2001
and
nancial
adopted
used
unemployment
central
in
If
This
policy
to
million
Instead,
reduce
to
bank.
(QE)
from
Japan
low.
names,
government
banks
banks
by
if
similar
the
commercial
commercial
was
very
that
government
assets
new
and
central
banks
kept
were
supply
decrease
easing
grow
$100
Of
products.
relatively
economies
happen
can
is
monetary
bank
money
government
Quantitative
of
product,
short-term
this
different
tool
product.
food
buying
their
rate.
central
The
from
commercial
for
many
the
worth
by
in
If
like
charges
important
opposite
and
borrow
would
it
with
economy.
of
can
refinancing
operations.
worth
banks
crisis.
by
banks
them
by
to
to
the
but
only
lend
Bank
European
more
of
The
main
other
more
Federal
help
short-term
many
pump
US
The
the
buy
to
avoiding
operations.
not
order
recently
while
nancial
cash
into
aggressively.
Reserve
England
Central
in
QE
2008
followed
Bank
in
in
2015.
How does monetary policy work?
Monetary
the
risk
(tight)
using
means
increase.
durables
such
I
decrease,
Monetary
this
used.
as
then
AD
case,
cars
a
less
The
and
so
will
rates
costs
for
less
be
real
used
(loose)
decrease,
the
of
on
an
ination
the
rates
not
capital
and
on
to
houses.
spend.
gap
deationary
monetary
rms
on
goods.
inationary
a
money
increase.
less
course,
and
or
contractionary
spend
lowering
of
as
households
they
close
cost
that
to
decreases
save
less
and
to
so
and,
to
and
so
interest
both
spend
GDP
bank
and
incentive
AD
referred
above;
decrease,
also
also
is
central
they
expansionary
Interest
decrease
This
appliances
greater
can
and
to
explained
borrow
and
AD
policy
increasing
In
tools
borrowing
have
borrow
used
policy.
the
that
be
decreases.
Households
Households
Firms
can
ination
monetary
supply,
This
policy
of
If
C
and
canclose.
gap,
unemployment.
policy
borrowing
will
be
decreases,
Search the web
the
Search YouTube using these
incentive
AD.
This
to
save
sounds
decreases
easy,
but
as
and
will
so
be
more
is
explored
spent,
below,
increasing
it
does
not
terms: ECB price stability
alwayswork.
impor tant. Watch a shor t
video from the European
Central Bank on ination and
Positive features of monetary policy
monetarypolicy.
Monetary
■
policy
flexible—the
interest
120
rates
is:
monetary
policy
committee
meets
frequently
to
set
3.6
incremental—interest
■
rates
can
be
increased
or
decreased
Policies
by
Search the web
0.25%
at
a
time
Search using these terms:
reversible—if
■
it
becomes
clear
that
say,
interest
rates
were
conversation fed independence
decreased
reverse
more
than
direction
necessary,
and
increase
risking
interest
inflation,
rates
in
it
the
is
very
next
easy
to
meeting.
matters. Read a very shor t
ar ticle on the independence of
the US Federal Reser ve Bank.
In
addition,
and
monetary
politicians,
tested
in
the
short-term
term
even
US
and
policy
though
stability
L TA
DP ready
independent
this
elsewhere.
re-election
price
is
chances
to
the
of
the
independence
Politicians
and
less
care
about
government
has
recently
more
the
about
benets
been
their
of
long-
economy.
Thinking skills
Politicians’ involvement in monetary policy
1.
To what extent do you think politicians should limit their
Internal link
involvement in central bank decisions?
Recall what you learned in
2.
What are the risks of prime ministers or presidents interfering
section 3.4 about Truman’s
with monetary policy decisions?
In
the
rates
case
alone
borrow
more
if
an
of
may
more
not
and
borrowing
economy
ineffective.
turn
money
and
F is c al
convince
in
buy
deep
interest
a
If
spending
a
the
issue
is
households
more.
negative—a
there
will
not
recession,
rates
bank
have
will
is
that
and
low
a
easily
lower
pay
businesses
take
place.
policy
limit
a
interest
condence,
monetary
not
lower
of
to
then
So,
may
0%.
household
be
They
to
borrow
house.
polic y
government
changes
policy,
spend
and
is
Also,
cannot
The
monetary
one-handed economist.
in
conducts
government
scal
policy.
expenditures
Fiscal
(G)
policy
and/or
refers
taxes
(T)
to
to
affectAD.
Types of government expenditure
■
Capital
such
expenditures:
as
roads,
development
■
Current
■
do
spending
payments,
transfers:
not
include
ports,
airports,
schools
these
on
spending
and
research
infrastructure
and
hospitals.
include
school
on
and
the
salaries
hospital
of
public
supplies,
sector
also
subsidies.
T
ransfer
cash
bridges,
facilities,
expenditures:
employees,
paying
these
such
these
represent
a
as
pensions,
payments
contribution
are
to
unemployment
not
included
current
in
and
GDP
other
as
they
production.
Types of government revenue
■
Government
indirect
■
Government
sale
the
of
revenues
are
mostly
received
from
direct
and
taxes.
revenues
state-owned
private
sector
can
assets
also
include
(such
as
any
firms,
receipts
ports
or
from
the
airports)
to
(privatizations).
121
What are the goals of scal policy?
The
goals
of
monetary
the
most
If
AD,
and
accelerate.
is
will
of
not
or
improve
real
scal
the
GDP
,
does
means
not
different
policy
is
to
expenditures
available
increase
long-term
from
about
to
the
an
also
decits
and
not
will
if
will
scal
levels.
be
out
of
only
avoided
unsustainable
future
of
Perhaps
expenditures
growth
result
are
goals
economy
capital
long-term
may
large
lift
are
the
policies.
infrastructure,
but
growth
that
increase
uncertain
very
demand-management
also
policy
and
the
Businesses
more
willing
invest.
Fiscal
if
goal
which
less
are
are
so
debt
feel
both
government
Faster
“prudent”
national
to
the
increase
will
policy
as
important
recession.
that
scal
policy
policy
ination
shown
can
was
later
in
imbalances.
also
the
this
All
of
be
used
result
of
section,
these
to
decrease
proigate
it
ination,
government
can
also
be
are
also
goals
goals
used
to
of
particularly
spending.
decrease
monetary
As
trade
policy—
Internal link
but
there
is
one
goal
that
scal
policy
can
address
more
directly,
See section 3.5 on inequality.
which
is
to
decrease
income
inequality.
How does scal policy work?
Let’s
that
explain
a
how
scal
deationary
gap
policy
can
decreases.
be
used
The
to
increase
government
AD
will
so
increase
Search the web
government
expenditures
(G)
and/or
decrease
taxes
(T).
This
is
A recent example of
referred
to
as
expansionary
scal
policy
expansionary scal policy is
the US government’s response
If
government
expenditures
(G)
increase,
then
AD
will
directly
to the recession of 2008.
increase
as
increase
in
G
is
a
component
of
AD.
Interestingly,
the
resulting
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example,
drilling
increase
but
will
also
reducing
and
regulations
adversely
regulations
extraction
several
will
or
on
impact
on
toxic
environmental
decrease
the
emissions
the
production
environment.
and
substances
pollution,
and
safety
may
risks.
Issues with inter ventionist supply-side policies
Search the web
■
Interventionist
supply-side
policies
are
also
characterized
by
Search using these terms:
long
time
lags
as
it
takes
time
to
obtain
the
funds
for,
say,
deregulation trump
the
environment national
geographic. Or search using:
to
construction
of
a
new
airport
and
for
the
positive
effects
materialize.
climate deregulation trump
■
The
necessary
increase
of
government
expenditures
will
add
Reuters. Read about how
to
deregulation may negatively
aect the environment.
the
start
as
national
debt.
infrastructure
the
risk
of
borrowing
This
inflation
costs
is
why
projects
for
is
the
many
when
low
and
there
low
consider
is
a
it
sensible
deflationary
interest
rates
to
gap,
imply
low
government.
Ad vantages of supply-side policies
Market-based
economies
high
and
some
■
where
is
Labour
unions
costs
T
axes,
both
and
Interventionist
especially
for
specific
W hich
would
the
of
markets.
128
and
and
higher
and
issues
on.
policies
is
may
may
competitiveness
and
very
affect
of
lead
to
high
domestic
abroad.
markets
corporate,
policies
encourage
rates
better
of
may
may
policies
stock
of
the
of
and
supply-side
may
lead
to
prove
lead
greater
investment
are
countries,
poverty
abuses
that
barriers
to
work,
as
improved
labour
and
force
faster
considered
growth.
most
necessary,
follows:
human
capital
decrease
policies
to
can
can
income
target
accelerate
inequality.
specific
needs
in
economy.
should
policy
will
polic y - mak er s
depend
Examples
are
on
the
explored
issue
that
choo s e?
policy-makers
below.
growth
disagree
best
supply-side
on
intervention
following
in
innovation.
polic y
choice
in
necessary
society.
supply-side
areas
Long-term
are
considered
protection
product
and
decrease
focusing
Few
The
the
supply-side
Interventionist
are
are
government
country
developing
bigger
growth,
in
allocation
participation,
The
the
personal
Market-based
The
in
competition
resource
■
of
labour
damage
power
investment
■
and
that
both
Monopoly
hurt
■
extent
counter-productive.
products
■
the
policies
economies:
labour
■
supply-side
position
policies
Decreasing
businesses
that
can
are
competitive
to
promote
uniquely
excessive
lead
to
markets
long-term
suited
to
regulations
greater
levels
of
and
the
growth.
unleash
and
prot
motive
Market-based
the
power
administrative
output
and
of
costs
growth.
3.6
Decreasing
labour
prohibitively
and
high
lowering
choose
work
over
future
impact
only
of
the
on
reach
population
present.
the
is
condition
and
labour
productivity
Without
a
the
full
if
that
allow
and
are
pie,
more
but
investments
individuals
risks
writes
on
the
to
involved.
at
the
cost
concerning
assessment
of
their
distributional
consideration”
.
if
the
necessary
to
to
Lowering
generation
Ostry
potential
the
lead
lead
“some
into
markets
care
and
necessary
of
effect.
present
Jonathan
taken
or
can
also
there
the
supply-side
for
health
may
policies,
their
low,
education
as
same
rates
rates
size
be
Interventionist
necessary
tax
the
However,
and,
should
cannot
have
benet
supply-side
consequences,
Markets
not
generations
not
tax
leisure.
should
market-based
can
corporate
personal
Deregulation
of
costs
Policies
deliver
rms
are
in
this
long-term
can
and
up-to-date
capital
infrastructure
policies
everyone
human
the
access
is
not
respect
growth.
will
economy
a
Better
raise
to
grow.
telecommunications,
railroad
Search the web
and
highway
network,
rms
cannot
grow.
Search using these terms:
It
should
be
understood
that
markets
and
the
state
IMF Ostry growth inclusion.
have
You will nd a shor t ar ticle
complementary
roles
in
the
process
of
long-term
growth.
In
on the subject in the IMF F&D
addition,
all
inclusive
so
policies
should
ensure
that
the
resulting
growth
is
magazine.
where
that
growth
is
income
not
inequality
does
not
widen
to
the
point
resilient.
Ination
T
o
tackle
that
and
the
ination,
most
maintain
pressures
to
calm
are
the
important
Fiscal
taxes
important
price
rising,
compared
proigate
to
scal
One
if
may
claim
ination
to
use
Why?
on
SSPs
to
So,
rise,
again,
to
and,
SSPs
it
is
are,
of
to
is
is
be
ne
it
if
be
tax
monetary
not
cut
policy
has
rates
three
very
reversible.
increasing
government
time
was
is
for
supply?
forever
lags
the
result
policy
of
must
demand-pull.
the
The
to
be
higher
to
would
and
be
does
answer
any
is
expectations
higher
the
the
no.
effect
ination.
considered
have
What
government
have
inationary
that
interest
effective.
ination
even
achieve
inationary
and
monetary
logical
take
Remember
addition,
ination
creating
course,
In
shorter
more
to
policy
decreasing
if
meantime,
A
increase
has
aggregate
roof
ination.
tighter
so
is
that
incremental
tighter
policies
the
the
will
policy
W
ouldn’t
in
bank
monetary
course,
above
side
through
fueling
and
required.
clear
advantages.
cuts
increase
supply
Interventionist
would
the
is
central
bank
spending,
spending
try
gone
Of
policy
becomes
exible,
these
policy.
that
economy
have
is
monetary
cost-push?
Because
the
will
is
the
it
addition,
unpopular
Lastly,
by
It
of
government
accompanied
of
If
central
In
none
politically
expenditures.
goal
the
advantages.
has
monetary
stability.
economy.
policy
is
tighter
same
as
AD
effect.
job.
Unemployment
If
unemployment
expansionary
is
cyclical,
demand-side
monetary
policy
because
Monetary
policy
is
Increasing
the
the
government
recession
is
deep.
then
policy-makers
policies.
of
‘rst
the
T
ypically,
advantages
responder’
expenditures
Lower
interest
to
will
they
choose
will
discussed
economic
be
rates
will
distress.
necessary
may
choose
earlier.
prove
though
if
inadequate
to
129
encourage
and
business
taxes
In
may
is
it
a
convince
is
not
demand
requires
lower
is
Displaced
and
Improving
the
skills
the
For
good
the
idea
structural,
labour
spending
same
to
market
to
a
taxes
good
the
require
and
low
spend
often
tax
more.
because
policies
union
rms
exibility.
while
earlier
are
that
increased
labour
consumer
system.
skills
training
explained
decreased
of
decreasing
to
supply-side
will
reforms
and
of
acquire
education
market
wage
rms
change
then
have
because
reasons,
and
characteristic
workers
labour
and
households
requires
minimum
L TA
DP ready
a
necessary
unemployment
needed.
a
borrowing
condence.
not
addition,
certainty
If
more
exibility
(for
example,
power).
Thinking , social and communication skills
One country’s economic prole
Work in a small group.
1.
Choose a country. Research its present economic condition
and the economic challenges it faces, focusing on ination,
unemployment, growth rates and the level of debt as well
as the extent of income inequality. Use websites such as
countryeconomy.com, tradingeconomics.com, the IMF, the World
Bank , and any other site your teacher suggests.
2.
Assume that each of you is the chief economic advisor in the
country you have chosen. Based on your research, each member
of the group recommends shor t-term and long-term policies.
Constructively criticize any dierences in recommendations.
Reach a consensus.
3.
Create posters that communicate your research and your
ndings to the rest of the class.
Focus point
The
toolkit
that
demand-side
policies
and
to
always
careful
of
policies
(pro-market
disadvantages.
use
and
policymakers
an
The
depends
consideration
costs
is
(scal
and
thus
economy
also
their
the
as
to
are
supply-side
has
advantages
and
of
or
economy
crucial
livelihoods
includes
policies
each
short-term
Policies
the
and
Each
which
particulars
expected
for
disposal
monetary)
decision
necessary.
but
and
at
interventionist).
on
of
have
policy
faces.
long-term
for
the
ordinary
mix
A
benets
performance
people.
Key terms—test yourself
Dene these terms: demand-side policies, scal policy, supply-side
policies, central bank , commercial banks, Reserve Requirement
Ratio (RRR), discount rate, open market operations, quantitative
easing, contractionary (tight) monetary policy, expansionary
(loose) monetary policy, expansionary scal policy, deregulation,
privatization, trade liberalization, infrastructure, industrial policies.
130
4
The global economy
This unit focuses on issues related to international trade and
development. The ex tensive benets of free trade are explained,
along with acknowledgment that not everyone wins from free
trade. The methods and the arguments in favour of and against
protection will follow, as well as descriptions of the routes available
to countries to liberalize trade. You will also learn the factors
that aect the exchange rate of a currency and the basics for
understanding the balance of payments of a country. The meaning
of economic development is examined, together with the ways in
which it can be measured and its relationship to economic growth.
Factors that act as barriers to economic growth and development
are explored, as well as strategies that developing countries can
adopt to promote growth and development.
In this unit you will learn about:
➔
benefits gained from free trade
➔
why protection exists
➔
trade liberalization through two routes:
➔
the distinction between developed and
developing countries
➔
strategies that developing countries can use
to overcome barriers, and promote growth and
multilateral and regional
development.
➔
foreign exchange markets and exchange
rates the balance of payments (BOP) and
what it means to impor t too much
4 . 1
W H Y
T R A D E ?
In this section you will learn about:
➔
the benefits of free trade
➔
Adam Smith’s theory of absolute advantage and David Ricardo’s
theory of comparative advantage
➔
the limitations of complete specialization.
131
The issues
Countries
you
will
import
learn
engaging
in
trade
growth.
Y
ou
goods
country
a
example,
general
imports
is
will
the
a
no
a
T he
goods
there
is
Ifmonopoly
increases,
to
the
all
from.
the
tools
protability.
from
ores
to
rms
the
Free
exporting
think
world
trade
biggest
resources.
of
scale.
and
from
instead
is
of
of
more
variety
to
able
to
at
in
a
that
this
and
products)
able
Domestic
to
average
This
being
limited
transfer
costs
with
able
to
to
their
goods
trade
greater
to
as
may
choose
access
to
larger
benet
lower
markets.
to
all
of
For
Europe
markets.
is
country
permits
to
gas,
relevant
domestic
output
natural
possibly
This
meet
quality
necessary
lead
export
offer.
closely
oil,
mostly
small
export
(machinery,
any
and
is
a
and
rms
more
have
size
technology.
free
to
will
in
benet
capital
that
leads
of
such
forced
withstand
increasing
import
rms
grow
countries
the
to
goods
that
cost,
country,
to
markets
goods
decrease
are
domestic
capital
lower
be
of
what
nd
their
them
is
what
selling
prices
Firms
efcient,
foreign
limited
rms
all
no
competition
follow:
greater
in
Specialization
will
and
improves.
penetrate
Lower
faster
benet
to
being
particular.
are
from
an
explores
competition.
decreases
becoming
small
embodied
increased
offered
abroad.
Danish
permits
technology
The
of
allow
in
shows
benets
of
which
through
section
from
markets.
rms
also
minerals.
will
engine
consume
section
huge
enjoy
model,
There
only
a
available
domestically
example,
or
and
which
face
often
will
dome.
can
be
be
and,
this
section
t r ade
intermediate
They
not
economies
prices,
will
an
specialization
competition
or
not
specication,
materials
world
rms
enjoy
will
and
in
of
export
This
are
this
may
simplied
Lastly,
of
autarky.
costs,
will
and
and
there
products
cut
in
considered
very
population
domestic
imports
choice
raw
markets,
of
is
a
In
countries
impenetrable
fr ee
trade,
to
from
and
timber,
of
producers
exact
an
called
the
Consumers
equipment,
model,
The
benets
of
and
Their
Domestic
their
free
quality
innovate
this
services
power
competition
more.
and
trade
through
situation;
bene f i t s
When
and
is
services.
specialization.
inside
This
free
and
benets
specialize
from
exports.
desirable
buying
why
of
goods
possible
learn,
should
gains
produce.
not
and
country
and
export
the
also
limitations
Imagine
they
and
about
because
imports.
specialization
and
higher
of
levels
Search the web
of
consumption.
Search in YouTube using this
phrase: role trade growth world
bank. Watch the World Bank
Specialization,
diffusion
of
the
benets
technology,
of
the
more
competition,
possibility
of
the
economies
faster
of
scale
video on the role of trade in
and
the
increased
exports
of
the
country,
all
permit
an
economy,
suppor ting growth and reducing
especially
a
developing
economy,
to
experience
faster
growth.
For
pover ty in developing countries.
this
reason,
trade
A b s olu t e
Y
ou
should
crucial
132
be
in
referred
to
as
ad v an t age:
convinced
question
specialize
is
needs
and
that
an
A dam
free
answering.
export,
and
engine
trade
growth.
Smi t h
carries
Which
which
of
goods
goods
(HL)
benets,
should
should
it
but
a
a
country
import?
4.1
T
oanswer
by
this
question,
considering
two
goods.
theory
of
a
The
model
rst
absolute
we
will
with
simplify
two
countries
explanation
advantage
the
relied
on
published
in
Apples
situation
producing
Adam
1776.
Why trade?
30
Smith’s
A
25
country
of
a
has
good
produce
an
if
compared
more
equivalently,
fewer
absolute
units
it
can
resources.
A
advantage
to
with
its
trading
the
produce
country
same
a
in
the
production
partner,
it
resources
unit
of
should
the
thus
can
or,
good
20
using
specialize
15
in
and
export
that
good
advantage.
T
able
production
possibilities
and
country
and
4.1.1
Green,
bananas.
It
is
in
which
and
of
each
it
Figure
two
has
4.1.1
that
two
both
absolute
show
countries,
producing
assumed
an
the
country
goods:
10
Red
apples
countries
have
5
the
same
matters,
amount
each
numbers
are
of
labour
country
the
has
and
just
maximum
of
capital
one
unit
amount
of
or,
of
to
simplify
labour.
each
good
The
that
0
5
each
in
country
that
can
good’s
produce
if
it
uses
all
of
its
resources
10
15
20
Bananas
production.
Figure 4.1.1Production possibilities for countries
Red and Green–illustrating comparative advantage
Country Red
Country Green
Apple production: maximum
30
10
Banana production: maximum
10
20
Table 4.1.1Countries Red and Green apple and banana production—maximum
production of each good when using all available resources in that good’s production
It
should
as
with
the
produce
Green
20
be
the
and
What
if
as
in
T
able
Red
the
(say,
one
Green
export
only
apples
unit
can
advantage
can
absolute
in
advantage
of
labour)
produce
bananas
produce
while
10
only
as
it
it
can
should
apples,
can
10
bananas.
Green
in
apples.
produce
Red
should
specialize
in
bananas.
one
production
and
has
whereas
absolute
while
in
export
Red
resources
apples
bananas
specialize
that
same
30
has
clear
of
of
the
both
4.1.2
countries
goods?
and
has
What
Figure
the
if
absolute
the
advantage
production
in
the
possibilities
were
4.1.2.
Country Red
Country Green
Apple production: maximum
40
60
Banana production: maximum
20
90
Table 4.1.2Example production possibilities for Red and Green
In
this
more
20).
case,
apples
Green
goods.
Green
than
has
the
According
benecial
(with
Red
the
(60
absolute
to
Adam
specialization
same
versus
resources)
40)
and
advantage
Smith,
and
in
there
is
can
more
the
no
produce
bananas
production
room
for
both
(90
of
versus
both
mutually
exchange.
133
Bananas
100
90
80
70
Green
and
consumes
70
20
apples
bananas
60
50
40
30
20
Red
and
consumes
20
20
apples
bananas
10
10
0
20
30
40
50
60
Figure 4.1.2Introducing comparative advantage
C omp ar a t i v e
In
1817,
still
He
Ricardo
room
for
showed
advantage.
important.
lower
on
in
country
not
that
for
cost
than
in
D av id
the
cost
country.
its
a
good
trading
fewer
fewer
of
look
A
there
the
it
to
absolute
T
able
Focusing on country Green
is
a
a
cost
of
comparative
produce
4.1.3
produce
produce
is
opportunity
has
can
(HL)
exchange.
not
production
at
partner
.
to
and
and
country
that
bananas
apples
R ic ar do
above
specialization
should
of
case
comparative
absolute
each
sacrices
sacrices
is
we
production
country
even
benecial
and
good
the
that
matters
means
opportunity
which
which
Focusing on country Red
what
Relative,
each
advantage
showed
mutually
that
That
producing
ad v an t age:
an
at
a
focuses
apple
and
banana.
Analysis
It can produce either 40 apples or
It can produce either 60 apples or
Green can produce a banana
20 bananas. If it produces
90 bananas. If it produces 90 bananas
at a lower oppor tunity cost: it
20 bananas it will sacrice
it will sacrice 60 apples:
needs to sacrice
2
40 apples:
/
3
of an apple
whereas Red must sacrice
oppor tunity cost of
2 apples.
oppor tunity cost of
90 bananas = 60 apples.
20 bananas = 40 apples.
Green has a comparative
Dividing by 90:
advantage in banana
Dividing by 20:
oppor tunity cost of
production: it should specialize
2
oppor tunity cost of
1 banana =
/3 of an apple
in and expor t bananas.
1 banana = 2 apples
It can produce either 40 apples
It can produce either 60 apples or
Red can produce an apple at a
or 20 bananas. If it produces 40
90 bananas. If it produces 60 apples it
lower oppor tunity cost: it needs
apples it will sacrice 20 bananas:
will sacrice 90 bananas:
to sacrice
1
/
2
of a banana
whereas Green must sacrice
oppor tunity cost of
oppor tunity cost of
40 apples = 20 bananas.
60 apples = 90 bananas
Dividing by 40:
Dividing by 60:
oppor tunity cost of
oppor tunity cost of
it should specialize in and
1 apple = 1.5 bananas
expor t apples.
1.5 bananas.
Red has a comparative
advantage in apple production:
1
1 apple =
/2 of a banana
Table 4.1.2Analysis of comparative advantages for Red and Green
134
4.1
We
have
which
should
increase
Green,
apple
one
it
A
which
to
(that
is,
will
if
it
more
mutually
Green
one
than
one
sell
Looking
at
the
Red
will
be
half
of
banana,
So
it
earning
willing
to
Red
how
one
Red
sell
so
it
than
if
it
will
the
of
can
can
apples
they
sacrices
be
willing
opportunity
an
apple).
pay
experiences
exchange
other
to
sell
which
banana
one,
one
way
can
less
by
trade
and
and
two-thirds
to
the
an
produce
be
willing
apples,
the
of
(export)
to
will
two
producing
if
sell
cost
Red
than
occur
an
around
the
one
one
is
to
buy
leads
one
to
to
which
is
bananaitself.
countries
apple
if
it
one
is
apple
to
the
if
same
it
cost
trade
a
less
half
buy
one
one
apple.
conclusion:
earns
of
more
producing
acceptable.
pays
and
(import)
apple
opportunity
apple
which
(export)
banana
(export)
is
for
(import)
produce
bananas,
two-thirds
(export)
willing
buy
will
Now,
produce
than
Green
the
than
it.
will
be
opportunity
bananas.
one
DP ready
banana.
L TA
cost
to
should
apple.
will
a
more
banana
cost
in
banana,
benecial
for
bananas.
specialize
earns
one
opportunity
banana
country
consumption?
produce
(import)
which
produce
their
banana
buy
the
established
Why trade?
Thinking skills
Specialization and exchange
Using a numerical example
If
these
two
countries
trade
they
will
be
able
to
consume
and a diagram, explain
combinations
of
the
two
goods
that
are
outside
their
production
the case when there is no
possibilities.
For
example,
Red
can
sell
(export)
20
apples
for
oppor tunity for mutually
20bananas.
Therefore
it
could
consume
20
apples
and
20
bananas.
could
therefore
benecial specialization
Green
can
sell
(export)
20
bananas
for
20
apples.
It
and exchange between
consume
70
and
bananas
20
apples.
Both
countries
can
consume
two countries.
outside
their
production
possibilities
curves.
Sources of comparative ad vantage (HL)
Ultimately,
comparative
■
the
productivity
■
the
level
of
educated
more
advanced
can
be
the
available
More
technology
of
advantage
and
advances
produced
in
country’s
factors
on:
of
production
technology.
skilled
capital
depends
workers,
equipment,
faster
that
in
one
sector
and
can
labour
sector
with
working
produce
the
than
same
more
with
output.
another,
then
If
more
inputs.
Limitations of the model (HL)
Search the web
Despite
this
model
being
helpful
in
determining
which
goods
Search using this phrase: where
a
country
should
export
and
which
goods
it
should
import,
the
is the iphone made?. How many
model
does
not
fully
explain
actual
trade
ows.
The
limitations
countries are providing and
arise
from
the
underlying
assumptions
of
the
model.
exporting iPhone components to
Foxconn, an iPhone assembler,
■
It
is
assumed
that
goods
are
homogeneous.
This
may
be
the
before it is exported from
case
for
agricultural
goods
but
it
is
definitely
not
the
case
for
China? Do you think the US or
services
and
or
for
Germany
manufactured
produce,
goods.
export
and
For
example,
import
cars
both
because
Italy
China prot the most from the
cars
are
sale of an iPhone? Search for
the answer using these terms:
highly
differentiated
products.
Also,
a
country
may
export
a
country prots the
good
but
many
of
its
components
may
have
been
imported
from
most iphone.
a
number
of
countries.
135
It
■
Search the web
is
assumed
not,
as
there
that
are
opportunity
often
costs
economies
are
of
constant
but
they
are
scale.
Search using these terms:
It
■
is
assumed
that
factors
of
production
are
perfectly
mobile,
containers boost trade
easily
switching
from
producing
one
good
to
producing
Economist. You will nd an
another.
This
depends
on
whether
labour
is
geographically
and
interesting ar ticle from The
occupationally
Economist (22 May 2013)
on the benets of container
skills
or
may
mobile—but
not
be
able
to
a
worker
move
may
not
have
the
relevant
location.
shipping.
It
■
is
assumed
these
may
It
■
costs
not
is
that
are
often
always
assumed
there
are
country
of
that
must
products
tourism
will
in
then,
tourists
of
of
if
are
low
the
are
to
no
to
costs.
container
trade
that
Although
shipping,
a
If
a
that
recession.
as
and
risks.
happens
trade
but,
in
as
the
this
we
If
the
country
see,
(HL)
wide
the
aggregate
developing
a
relies
decreases
and
some
exporting
country
will
world.
speciali z a t ion
revenues
products,
barriers
restrict
specializing
decrease
export
leading
of
c omple t e
something
primary
transportation
because
barriers
diversify,
its
no
case.
there
of
order
arriving,
collapse,
exports
be
plenty
L imi t a t ion s
A
there
range
only
on
number
demand
relies
only
countries
of
(AD)
on
still
TOK
do,
then
a
world
recession
will
have
devastating
effect
on
exports
What are the advantages and
and
real
output.
In
addition,
there
is
greater
value
added
in
limitations of models in economics?
manufactured
L TA
DP ready
products.
Research and communication skills
Adam Smith and David Ricardo
1.
In a small group, nd out basic information about Adam Smith
and David Ricardo. Divide tasks between the people in your group
(that is, specialize) to prepare a shor t presentation.
2.
Present your ndings to the rest of the class.
Focus point
One
of
that
free
the
few
trade
advantage
is
ows
our
in
a
and
trade.
because
simple
an
also
specialization
engage
ideas
is
that
most,
engine
most
trade
its
model
if
the
all,
model
suggest,
is
economists
The
theory
benecial,
assumptions,
may
not
growth.
powerful
is
However,
of
of
theory
explaining
permitting
cannot
and
very
of
all
all
to
actual
trade
specialization,
risky.
Dene these terms: autarky, absolute advantage, comparative
136
is
why
Key terms—test yourself
advantage.
on
countries
explain
complete
agree
comparative
as
4.2
4 . 2
W H Y
I S
T H E R E
Why is there protection?
P R O T E C T I O N ?
In this section you will learn about:
➔
why protection exists
➔
types of protection
➔
arguments for and against protection.
The issue
Despite
the
Protection
country.
many
refers
This
and
evaluates
and
against
the
section
their
of
policies
free
that
analyses
impact.
It
trade,
aim
to
several
also
there
is
still
restrict
different
assesses
protection.
imports
types
of
arguments
into
a
protection
in
favour
of
protection.
Rea s on s
If
benets
to
f or
benets
of
pr o t ec t ion
free
trade
are
so
many
and
so
P/unit
S
extensive,
using
that
various
in
do
countries
trade
ght.
The
trade
losers
Figure
often
barriers?
unrestricted
winners.
to
why
are
4.2.1
The
there
often
restrict
simple
are
answer
losers
powerful
illustrates
this
trade
as
and
point,
is
well
as
willing
1
using
PA
the
example
called
of
the
wheat
market
in
a
country
Kay.
2
3
Sw
Pw
represents
P
the
autarky
price
(with
no
trade)
A
4
and
the
Q
autarky
quantity.
Assume
that
the
price
A
of
wheat
in
the
world
market
is
at
and
P
that
it
W
is
below
the
domestic
price
P
.
We
assume
so
the
world
that
A
Kay
is
a
very
small
country,
D
price
qs
is
P
not
affected
whatever
amount
Kay
QA
Q/period
qd
produces
W
or
consumes.
(horizontal)
Kay
thus
supply
faces
curve
a
at
perfectly
elastic
Figure 4.2.1The wheat market in Kay
P
W
Consumers
more
(qd
in
>
Kay
)
Q
are
and
better
pay
a
off
with
lower
free
price
A
wheat
in
Kay
trade.
(P
<
P
W
are
the
losers.
They
sell
less
They
).
consume
Producers
of
Search the web
A
wheat
(qs
<
)
Q
at
a
Search for a podcast using
A
lower
price
(P
the terms: imf podcast three
).
W
chief economists. The chief
It
is
time
surplus
to
and
apply
knowledge
welfare
analysis.
of
consumer
Y
ou
should
surplus,
be
able
to
producer
realize
economists of the IMF
, the World
that
Bank and the OECD
discuss
the role of trade liberalization
the
consumer
surplus
increases
by
areas(2,3)
while
the
producer
and of advances in digital
surplus
decreases
welfare
by
by
area(2).
Free
trade
therefore
increases
social
technology in
area(3)—but
domestic
producers
are
worse
off.
increasing
Since
income inequality within
they
are
a
of
lot
fewer
in
money,
number
so
they
than
will
be
consumers,
willing
to
they
lobby
each
and
lose
quite
pressure
the
countries, as well as the
consequences. Pay attention
to what the World Bank chief
government
for
protection.
economist says about winners
and losers from free trade.
137
Now
P/unit
assume
that
the
price
of
wheat
in
the
S
world
market
(P
)
is
higher
than
the
domestic
W
price
P
.
This
is
shown
in
Figure
4.2.2.
A
1
Now,
Sw
domestic
producers
are
better
off
with
Pw
free
trade
as
they
sell
more
(qs
>
)
Q
at
a
A
6
higher
2
price
>
(P
P
W
).
Domestic
consumers
A
3
are
PA
now
the
losers.
They
enjoy
less
(qd
<
Q
)
A
and
pay
a
higher
price
>
(P
5
P
W
).
A
4
In
this
case,
area(2,3,6)
by
the
while
area(2,3).
welfare
off,
by
producer
the
Free
consumer
trade
area(6).
though.
surplus
thus
the
surplus
increases
Domestic
Usually
increases
decreases
social
consumers
number
of
by
are
worse
consumers
is
D
large
qd
QA
qs
Q/period
(unless
relatively
loss.
the
few
This
good
rms)
means
is
and
that
it
a
capital
so
is
each
not
good,
bought
suffers
worth
it
a
to
by
small
them
to
Figure 4.2.2The price in the world wheat market is higher
organize
than the domestic price
L TA
DP ready
and
demand
protection.
Thinking skills
Issues relating to free trade
When free trade hur ts producers, many are forced to downsize or even close down. Workers lose their
jobs. Each of these displaced workers may not have the resources to lobby the government against free
trade and in favour of protection, but each one has a vote. When the negatively aected domestic industry,
and the resulting unemployment, are concentrated in one or a few areas, these votes may count a lot for
representatives of the area and for national elections.
Outline the risks involved.
Type s
of
pr o t ec t ion
P/unit
S
Taris
The
most
impose
a
common
tariff,
Figure
4.2.3
in
and
Kay
imported
Let’s
form
which
returns
shows
to
the
of
is
a
protection
tax
the
on
of
a
to
imports.
market
effect
is
for
tariff
wheat
on
wheat.
assume
that
initially
there
was
free
trade
ST
PT
and
that
the
world
price
was
at
.
P
Since
Kay
W
1
is
3
2
4
a
tiny
country,
it
faces
a
perfectly
elastic
Sw
Pw
(horizontal)
supply
for
wheat
at
S
.
At
that
W
price,
A
B
C
D
units
q
D
of
producers
wheat
will
while
be
Kay’s
willing
to
offer
consumers
will
1
be
0
Kay’s
buying
q
units
of
wheat
q
(that
per
period.
So,
2
q1
q3
q4
q2
Q/period
the
difference
q
2
–
is,
distance
1
q
1
q
)
2
Figure 4.2.3A tari is imposed
will
represent
imported
wheat.
Watch this
Search YouTube using this phrase: “Let’s T
alk T
aris”.
Watch the WTO video you will nd.
138
4.2
now
that
a
tariff
(P
P
W
As
a
result,
the
price
of
)
is
imposed
on
imported
wheat.
DP ready
T
wheat
in
Kay
rises
to
P
.
The
tariff
may
L TA
Assume
Why is there protection?
Thinking skills
be
T
imposed
of
on
wheat
sell
to
more
imported
sell
at
wheat
wheat
the
higher
>
(q
but
q
3
)
it
also
price.
and
so
allows
They
earn
now
more
domestic
have
the
revenues.
Impact of the wheat tari
producers
incentive
to
in Kay
Consumers
1
Refer to Figure 4.2.3.
are
not
happy.
They
pay
a
higher
price
(P
)
for
wheat
and
consume
T
less
units).
(q
Imports
of
wheat,
the
difference
between
1.
domestic
Determine the increase
4
consumption
)
(q
and
domestic
production
(q
4
units.
P
(P
W
The
)
government
per
unit
times
collects
the
tariff
number
of
revenues
units
(q
T
equal
decrease
to
(q
q
3
equal
q
3
to
),
3
)
to
the
imported.
in the revenues Kay’s
)
4
producers collect because
tariff
This
of the tari.
is
4
area(3).
2.
Using PED, explain why we
cannot be sure whether
Y
ou
should
realize
that
the
consumer
surplus
decreased
Kay’s consumers spend
by
area(1,2,3,4)
while
the
producer
surplus
increased
by
more or less on wheat as a
area(1).
The
tariff
because
area(3)
led
to
a
welfare
loss
equal
only
to
area(2,4)
result of the tari.
government
and
so
which
cannot
represents
represents
the
consumption
be
could
the
be
considered
resulting
tariff
spent
a
revenues
on
schools,
welfare
production
collected
loss
for
for
the
example,
Kay.
inefciency
by
Area(2)
and
area(4)
the
inefciency.
TOK
Spending
area(B
on
+
C
Remember
imports
+
D)
that
(the
while
the
import
after
tariff
is
bill)
the
paid
before
tariff
by
it
Kay’s
the
shrunk
tariff
to
was
Figure 4.2.3 suggests that it is
area(C).
consumers
and
straightfor ward to measure not only
who gains and who loses from taris
that
but also by how much. To what
area(3)
is
not
paid
to
the
foreign
exporters
but
is
collected
by
the
ex tent do you agree with this?
domestic
government.
L TA
DP ready
Thinking and research skills
Taris on various products
1.
Listen to the Planet Money podcast “ Taried”. Search using these terms: Planet money episode 835
taried. You will hear about an American pig farmer whose pigs lost 10% of their value as a result of
the Chinese taris imposed, as pork prices dropped in the US. Why did US pork prices drop when China
imposed a tari on US pork products? Hint: think of demand and supply and the size of China.
2.
Since protectionist policies increase output of domestic rms, it means that more jobs are created. Is
the employment eect on the country necessarily positive, though? Think of taris on impor ted steel.
Who buys steel and for what reason?
3.
Research online using these terms: US taris Canadian paper. You will nd several ar ticles. Using one or
more of these, outline the impact of this tari on the newspaper industry and other industries that use
paper as an input.
L TA
DP ready
Thinking and communication skills
Analysis of ar ticles on taris
Find and read the following ar ticles:
“Impor t Taris Squeeze Small Businesses Here and Elsewhere” by J Podsada
“ The Limits of ‘Made in America’ Economics” by A Lowrey
“New China Taris Increase Costs to U.S. Households” by M Amiti et al
1.
Working in small groups, write a summary of the main points made by each ar ticle.
2.
Groups present their ndings to the rest of the class and par ticipate in a class discussion.
139
Quotas
Another
P/unit
form
of
protection
is
to
impose
a
quota—a
Sd
quantitative
S’ (=
Sd
+
restriction
of
imports.
For
example,
the
quota)
EU
rule
in
place
in
2019
permitted
only
228,389
tons
quota
of
sheep
meat
and
goat
meat
to
be
imported
from
(400,000)
Quota
decreases
supply
from
New
Zealand
from
China.
annually
and
6600
tons
of
duck
meat
(pivots)
Sw
to
S’
Figure
4.2.4
illustrates
the
effect
of
a
quota
on
the
P’
market
3
1
for
wheat
in
country
Kay.
This
will
help
to
Sw
PW
analyse
the
impact
of
a
quota
compared
with
that
v
of
A
0
B
C
D
a
tariff.
D
Once
1
3
4
again,
initially
assume
free
trade
and
that
the
2
world
price
was
at
.
P
Kay
is
a
very
small
country
W
Figure 4.2.4A quota is imposed
wheat
at
so
it
faces
At
P
Kay
.
S
W
buy
perfectly
producers
elastic
offer
of
(horizontal)
q
W
units
q
a
units
and
per
period.
The
distance
q
2
T
o
matters
of
make
q
q
1
year,
means
from
would
that
as
is
a
So,
distance
allows
Kay
be
that
q
q
1
no
only
price
to
quota
simple
the
supply
of
as
is
wheat
was
much
as
its
and
S
set
equal
tons
its
wheat
of
to
to
be
consumers
plus
in
half
wheat
it
is
rms
that
by
imported
are
elastic
willing
Figure
shows
the
This
domestic
tons).
drawn
right
year.
perhaps
the
400,000
diagram
its
per
(horizontal)
domestic
and
to
of
wheat
supplied
demand
S'
of
innitely
amount
now
is
800,000
tons
tons
an
example,
and
quota
2
400,000
whatever
wheat
a
400,000
faces
the
(for
supply
of
at
longer
equal
the
set
import
each
supply
domestic
if
was
cannot
plus
effective
.
assume
2
At
will
offer
4.2.4
it
simple,
quota
Kay
like.
market
to
the
abroad.
supply
represents
2
importedwheat.
distance
per
q
1
of
for
consumers
1
wheat
quantity
supply
Kay
this.
parallel
to
amount
The
the
of
the
d
quota
q
q
1
v
(here,
and
by
400,000
lightly
trace
a
tons).
T
o
vertical
draw
line
to
this,
S
2
to
nd
the
point
v.
midpoint
From
of
point
W
on
S
,
now
draw
a
parallel
to
S
W
wheat
.
The
new,
effective
supply
of
d
for
Kay
is
S'
(or
more
precisely,
vS').
P
W
Note
that
supply
with
free
trade
was
at
S
.
Now,
it
has
pivoted
W
to
S',
as
the
quantity
that
can
be
imported
was
restricted;
was
S
d
just
the
price
of
domestic
supply.
wheat
Kay
domestically
in
>
(q
q
3
now,
The
the
collected
by
a
higher
of
imports.
is
140
off.
and
that
Since
typically
and
result
less
of
to
will
the
P'.
be
decrease
More
will
consumed
that
is
same
with
known
the
of
by
are
not
the
rms
(q
supply,
government
can
surplus
worse
rms,
and
is
sell
quantitative
surplus
<
q
it
and
by
is
).
Up
to
2
collects
now
in
also
Kay
restriction
by
by
area(1),
producers
the
no
typically
decreases
increases
off
the
produced
tariffs.
rents”
collected
foreign
for
who
the
consumer
is
one
“quota
producer
area(3)
the
quota
as
because
consumers
collected
a
as
exporting
only
the
in
be
4
the
welfare:
area(1,2,3,4)
illustrating
is
foreign
price
Concerning
better
is
Area(3)
at
)
a
increase
1
analysis
difference
revenue.
As
will
of
wheat
government
part
of
the
and
welfare
4.2
loss.
and
The
is
welfare
bigger
reects
the
loss
than
of
the
and
L TA
DP ready
quota
welfare
production
inefciency
a
is
therefore
loss
resulting
inefciency,
area(3)
the
quota
area(4)
rents
equal
from
the
that
to
a
Why is there protection?
area(2,3,4)
tariff.
Area(2)
consumption
foreigners
capture.
Thinking and communication skills
Tari versus quota
1.
If you were one of the foreign expor ting rms, would you prefer
Kay to impose a tari or a quota on your product, and why?
2.
A protectionist measure invites retaliation. Your country is
thinking of imposing a trade barrier to protect a domestic
industry but you want to minimize the probability of retaliation
by your trading par tner. Explain whether you would advise for a
tari or a quota.
3.
“ The eects on impor ts of a tari on the quantity of impor ts are
less cer tain than that of a quota.”
4.
a.
To what extent do you agree with this statement?
b.
Outline the connection here with price elasticities.
Prepare a poster that illustrates with one diagram the eects of
a tari and the eects of an equivalent quota (one that leads to
the same quantity of impor ts). Clearly indicate who wins and
who loses in each case. Make sure you also incorporate foreign
expor ting rms in your analysis.
Subsidies
Subsidies
lower
economy
with
decreases
supply
this
production
trade
import
diagram
and
costs
imports,
penetration.
that
and
the
Figure
illustrates
increase
the
supply.
increased
4.2.5
is
expected
a
In
domestic
simple
effects
an
open
supply
demand
of
a
and
subsidy
in
context.
Focusing
country
once
Kay,
again
we
on
the
assume
wheat
that
the
market
world
in
the
price
is
P/unit
small
at
S
and
P
a
W
Ss
Kay
has
a
perfectly
elastic
supply
of
wheat
at
S
.
Kay’s
W
farmers
offer
q
units
at
P
1
The
difference,
q
1
Kay
imports.
pays
and
to
its
The
wheat
increases
while
q
W
q
,
units
are
consumed.
2
reects
the
quantity
of
wheat
that
b
2
subsidy
(ab)
farmers,
their
supply
that
the
decreases
to
S
.
government
their
They
are
of
production
now
Kay
Pp
costs
willing
to
s
Sw
offer
more
wheat
at
.
P
Quantity
supplied
by
Kay
farmers
PW
W
increases
to
q
.
Since
the
price
in
Kay
remains
at
3
P
,
W
D
consumption
imported
of
wheat
decreases
to
is
q
q
3
They
unit:
sell
they
more
earn
wheat
the
not
.
affected
Farmers
but
in
the
Kay
quantity
are
better
q1
off.
q3
q2
Q/period
2
(q
>
q
)
3
1
world
price
and
they
plus
P
earn
the
more
subsidy
per
by
Figure 4.2.5The eect of a subsidy
the
W
government.
two
supply
Since
curves,
the
subsidy
they
now
is
the
earn
P
.
vertical
Their
distance
total
between
revenues
the
increase
p
from
area(A)
to
area(A,B,1,2).
Consumer
expenditures
on
wheat
141
are
the
same
as
the
price
they
pay
(P
)
and
they
still
consume
q
W
units,
to
so
the
spending
government
remains
is
the
at
2
area(A,B,C).
quantity
The
subsidized
cost
)
(0q
of
the
times
subsidy
the
per
3
unit
subsidy
P
(P
W
Concerning
consumers
domestic
or
welfare:
are
not
by
there
welfare
a
production
area(1,2).
the
from
area(1).
loss
the
equal
that
surplus
affected
import
Since
inefciency
consumption
consumer
adversely
producers
increases
is
)
p
to
if
a
is
unchanged,
subsidy
competition.
cost
of
the
area(2).
results
The
subsidy
This
from
is
used
producer
is
protect
surplus
area(1,2)
represents
the
so
to
subsidy.
the
There
is
no
inefciency.
L TA
DP ready
Thinking skills
Subsidy versus tari or quota
Using your knowledge and appropriate diagrams explain why:
1.
paying a subsidy to domestic rms as a method of protection
may be preferable to a tari or a quota
2.
a quota may minimize the probability of retaliation
3.
taris may be preferable for a developing country that needs to
construct more schools.
Administrative barriers
An
important
product
exported
country.
“red
to
or
and
administration
the
health
are
1982.
It
meet
of
is
ow
be
as
red
the
states
requirements
are
or
the
of
that
the
environmental
any
importing
bureaucracy
to
shipments
clear
decreases
regulations
to
trade
(known
as
requirements,
imports.
have
and
safety
excessive
known
safety
of
prepared,
costly
meant
the
barriers
imports
and
actually
example
to
is
international
health,
the
have
inspections,
but
must
the
restrict
Documents
of
in
Administrative
tape”),
aimed
principle
slow
tape
used
Poitiers
subject
customs.
the
claim
down
are
the
for
All
volume
to
protect
ow
this
of
of
of
to
this
trade.
consumers,
imports.
purpose
Some
A
famous
happened
in
effect.
Search the web
1.
Search the web to nd out why there is a trade issue between the UK
and the US concerning chlorinated chicken.
2.
Search for: car safety trade 533 npr. Listen to podcast #533 by Planet
Money on why car safety is a trade barrier.
3.
Search using these terms: latest Poitiers Lewis nyt.
Read a New York Times ar ticle (14 January 1983) about how France tried
to limit the impor ts of video cassette players from Japan.
142
4.2
A r gumen t s
There
are
at
most
the
which
■
several
are
common.
seemingly
probably
as
increase.
decreasing
industries.
■
Protection
is
competition
that
foreign
cannot
if
the
jobs
higher
and
circumstances,
to
is
are
lost
not
be
this
are
and
in
as
is
not
is
it
an
(such
costs
these
input
as
will
will
the
increase,
domestic
visible
as
the
a
when
field”
It
is
jobs
result
domestic
of
has
the
a
firms
because
higher
product.
way
claimed
labour
comparative
sometimes
this
when
often
questionable
In
assist
subsidies—sometimes
in
as
headlines.
use
playing
industry
importing
penetration,
winners,
employment
product
unfair.
responsible
of
look
criticism.
“level
governments
with
positive
industries
escape
a
creates
argument
protected
considered
wages
should
export
lost
domestic
foreign
businesses
increase
is
this
output
be
Let’s
industries.
production
may
validity
the
love
the
create
labour
The
then
disadvantage
country’s
to
domestic
productivity,
are
abroad
cheap
protection
attracts
their
usually
required
compete.
it
if
protection.
protected
domestic
Jobs
that
of
increase
then
supply.
from
and
will
other
politicians
that
the
Politicians
industry),
The
so
favour
However,
that
their
in
true,
industry
steel)
construction
gained,
jobs.
always
an
in
Remember
found
creates
Protecting
(such
pr o t ec t ion
arguments
invariably
Protection
is
f or
Why is there protection?
different
their
illegal
hurting
the
ones—
domestic
TOK
industry.
In
these
cases,
protection
may
be
justified.
An argument used by President
■
If
there
flood
is
the
indeed
unfair
market,
then
competition
the
from
domestic
abroad,
government
and
can
imports
claim
that
Trump in 2018 for imposing taris
on steel impor ts was that these
impor ts posed a “national security
dumping
is
taking
place.
Dumping
is
when
a
firm
sells
abroad
threat” to the US.
at
a
price
home
below
country.
average
In
these
cost
or
cases,
below
the
price
anti-dumping
it
charges
tariffs
that
in
its
equate
Watch this
the
foreign
price
to
the
domestic
price
are
imposed
and
the
Watch the following two videos.
World
T
rade
Organization
(WTO)
settles
the
dispute.
Search YouTube using the terms:
Trump taris are about national
L TA
DP ready
Research and thinking skills
security PBS newshour.
Or search using: Steel taris
Turkey’s steel quotas
national security issue fox news.
Find out why Turkey imposed quotas on steel impor ts in October 2018.
There are two sides to every
1.
Do you suppor t Turkey’s decision?
2.
Are there risks in declaring that emergency “safeguard”
argument. In a small group, debate
the merits of each side using reason
and evidence to suppor t your
measures are required?
■
In
developing
ineffective
from
■
If
import
may
can
because
partners,
who
with
collection,
may
be
also
be
any
the
be
used
are
rates
revenue
to
of
that
correct
much
employed
to
correction
may
high
poverty
and
governments
earn
important.
expenditures
protection
risky
tax
tariffs
Protection
countries
position.
a
higher
decrease
comes
at
growing
than
export
imports.
the
trade
revenues,
This
expense
deficit.
of
is
trading
retaliate.
143
■
Administrative
barriers
environmental
considerations.
decision
T
rade
■
that
of
on
the
barriers
has
scale
not
or
compete
may
have
open
argument
and
economic
sense
often
the
political
it
unwilling
or
because
to
of
face
can
be
is
an
in
levels
input,
other
them
less
been
is
that,
steel,
is
all
a
benefit
reach
“infant
countries.
of
have
for
It
infant
industry
new
from
a
grows,
of
so
does
to
can
to
makes
be
losing
This
needed
industry”
industries,
proven
fear
industry
economies
know-how
the
interests.
for
domestic
they
will
also
costs.
buyers
suffer
be
the
Higher
higher
them
a
other
but
its
unable
votes
result
of
in
If
the
raise
good.
decrease
firms;
in
they
their
their
will
costs
protected
production
to
the
production
employment.
force
in
to
and
businesses.
can
and
will
how
health
pr o t ec t ion
production
an
by
support
Buyers
as
This
growth
vested
prices
output
is
safety,
establish
to
necessary
the
infant”
competitive
of
the
households;
such
help
large
the
as
valid
problem
governments
withdraw
of
to
used
support
Some
industries
Protection
■
has
power.
The
for
claim.
markets.
again s t
increased
lower
acquired
increases
purchasing
the
erected
powerful
A r gumen t s
necessary
sufficiently
“perpetual
Protection
of
world
problem
or
Buyers
be
to
power.
inefficient
■
validity
grown
to
in
are
costs
lead
for
prices,
to
product
firms
making
exportmarkets.
industry
may
breed
inefficiency
as
it
faces
less
competition.
Consumer
■
choice
is
reduced
if
an
imported
product
is
more
expensive.
■
Protection
causes
an
■
Protection
results
in
increase
in
output
misallocation
of
that
is
domestic
inefficient.
and
world
resources.
Focus point
Search the web
Search using these terms: why
open markets matter OECD.
Read the ar ticle, which gives
Should
it
there
depends.
War
has
indeed
be
In
free
produced
been
trade
general,
an
or
trade
immense
engine
of
protection?
Predictably,
liberalization
benets
for
since
the
the
world.
the
answer
Second
Free
is,
World
trade
has
growth.
suppor ting data on the benets
of trade.
TOK
Does freeing up trade involve moral
issues? Should policy-makers be
However,
in
free
trade
withstand
import
displaced.
Freeing
order
in
for
other
that
the
are
competition
up
trade
governments
areas.
there
Most
displaced
to
also
may
may
shut
have
ensure
importantly,
workers
losers.
that
to
down.
be
a
should
new
skills.
that
Workers
gradual
resources
there
acquire
Businesses
can
be
cannot
will
be
process
be
in
reallocated
sufcient
Protection,
care
if
guided by moral judgments in their
needed,
should
be
temporary
and
not
a
result
of
pressure
from
policy prescriptions?
vested
interests.
Key terms—test yourself
Dene these terms: protection, tari, quota, administrative barriers.
144
4.3
4 . 3
B I G
G R O U P S ,
L I T T L E
Big groups, little groups
G R O U P S
In this section you will learn about:
➔
preferential trade agreements
➔
the role of the World Trade Organization (WTO)
➔
regional trading blocs (or agreements)
➔
trade creation and trade diversion.
The issue
Free
trade
countries
free
trade
serious
may
is
has
or
services,
two
regional
their
the
trading
blocs.
as
World
countries
labour)
the
the
and
route
trade
net
route
effect
4.2,
achieve
decrease
movement
of
liberalization.
the
explains
to
World
through
on
Historically,
section
to
protection
through
section
in
War
free
from
regional
the
growth.
progressively
to
moving
This
but
mentioned
barriers
of
that
t r ade
trade
the
these
T
rade
free
trade)
T
rade
formation
routes
and
two
■
between
several,
a
regional
between
between
to
trade
countries
is
any
barriers.
it
usually
is
a
If
agreement
the
bilateral
trade
between
agreement
is:
agreement
neighbouring,
countries
it
is
referred
to
agreement
several
referred
ag r eemen t s
agreement
lowers
between
■
and
losers
accelerates
Second
multilateral
(WTO)
preferential
is
and
process
■
■
norm;
the
other
and
also
effects.
countries
as
the
(when
capital
P r e f er en t ial
A
winners
trade
after
and
(the
routes:
Organization
of
been
started
trade
liberalization
has
both
and
integration
eliminate
goods,
not
efforts
economic
have
positive
as
many
countries
a
that
plurilateral
countries
may
not
be
in
the
same
region
it
agreement
through
the
WTO,
it
is
a
multilateral
agreement
Big
g r oup s
The World Trade Organization (WTO)
The
WTO
(General
was
between
23
eliminating
164
on
countries
tariffs
members
the
WTO
are
anchored
requires
established
Agreement
to
and
on
every
the
1995.
and
promote
other
representing
agreements
in
T
ariffs
are
free
trade
as
country
to
the
successor
a
trade
98%
of
1947
by
all
WTO
world
Nation
treat
of
the
out
trade.
(MFN)
or
currently
GA
TT
agreements
other
GA
TT
agreement
phasing
The
multilateral
Most-Favoured
member
is
barriers.
roughly
known
It
T
rade),
and
and
principle
member
has
that
countries
145
as
it
treats
it
most-favoured
trading
partner,
effectively
not
allowing
discrimination.
What
does
The
■
WHO
goods,
It
■
carrying
that
that
out
provides
their
It
■
provides
ensures
It
is
WTO
services
requiring
■
the
in
Evaluating
in
GA
TT
,
and
decreasing
resulted
and
a
the
in
World
from
However,
Bank
the
institution,
and
so
has
because
impose
The
it
to
their
are
and
cover
adhered
transparent
are
Body
dispute
must
developing
trade
trade-related
barriers
trade
data,
world
25%
in
the
and
to
by
by
disputes.
makes
countries
to
build
capacity.
settled
This
within
the
means
the
final
that
WTO.
The
decision,
which
accept.
world
managed
to
sanctions
on
Body,
the
been
70
60%
exports
in
the
“supreme
in
court”
This
to
has
OECD
imports)
has
as
increased
2017.
the
is
that,
trading
Rules
has
a
of
WTO
in
WTO
lose
so.
and
product)
uncertainty.
that
or
successful
According
order
the
quite
years
from
and
that
parties
of
world
resulting
rules
agreed
the
(sum
almost
decrease
have
past
(gross
benet
to
the
have
dramatically.
trade
output
established
members
WTO,
over
growing
1960
greatest
has
Appellate
implemented
policies
and
successor
trade
roughly
that
property.
assistance
Appellate
its
of
trade
negotiations
WTO
world
percentage
of
are
grievances
any
trade
reviews.
expertise
or
for
intellectual
additional
arbitrator
parties
forum
national
seven-member
The
and
periodic
disagreements
all
a
agreements
technical
the
do?
are
the
as
an
world
enforced
authority
to
dispute.
the
WTO,
consists
Search the web
of7
judges
whose
four-year
appointment
has
to
be
accepted
by
all
Search using these terms:
164
members,
each
with
the
right
to
veto
a
nomination.
The
US
transcript showdown at the
has
recently
been
blocking
the
appointment
of
new
judges,
and
by
WTO npr. Listen to the transcript
to understand, in simple terms,
the WTO arbitration process, as
the
end
that
of
the
2019,
dispute
there
were
settlement
only
two
system
judges
of
the
left.
WTO
There
will
be
is
the
risk
paralyzed,
well as the risks faced.
ending
from
The
TOK
23
years
resorting
WTO
from
to
to
resolution
trade
proved
resorting
2008–09
of
enforcement
prevented
countries
protection.
instrumental
escalating
recession
that
in
trade
following
the
preventing
protection
global
national
in
governments
response
nancial
crisis.
to
the
Members,
The WTO has been accused of not
paying sucient attention to child
labour issues and to production
bound
by
quotas
to
the
rules
appease
of
the
WTO,
domestic
did
not
political
resort
to
raising
tariffs
and
pressure.
processes in so-called “sweatshops”
(to learn more, search for this
term online). A question of ethics
Of
course,
164
the
WTO
members
it
is
has
very
been
subjected
difcult
and
to
time
plenty
of
criticism.
consuming
to
reach
With
an
is involved. Should child labour be
agreement.
The
WTO
has
been
accused
that
it
lacks
transparency
banned? Could that deprive the
in
its
decision-making
and
that
it
has
mostly
catered
to
the
needs
poor of a source of much-needed
of
advanced
economies,
neglecting
those
of
the
developing
world.
income, hurting the very people it
aims to help? Should a “fair” wage
be set across developing countries?
It
has
also
been
displacement
of
accused
labour
of
that
paying
trade
insufcient
attention
liberalization
to
the
unavoidably
brings
Could establishing a “fair” wage in a
about,
as
well
as
to
rising
income
inequality
issues.
According
to
developing country lead to a decrease
critics,
it
effects
of
also
does
not
sufciently
consider
the
possible
adverse
in its exports and so to slower
growth? Is any job better than no job?
been
146
trade
liberalization
sufciently
concerned
on
the
about
environment
the
issue
of
and
child
it
has
labour.
not
4.3
Few
has
would
been
disagree
positive.
international
L i t t le
that
It
body
the
would
WHO’s
be
regulating
truly
the
net
effect
on
frightening
rules
of
world
if
world
there
Big groups, little groups
welfare
were
no
trade.
g r oup s
Regional trading blocs (or agreements)
Bilateral
or
countries)
plurilateral
agreements
neighbouring
integrate
These
exist
countries
further
departing
(involving
from
agreements
agreements).
between
that
within
the
the
several
wish
to
group.
Most-Favoured
are
Under
known
the
as
WTO
but
groups
of
decrease
By
WTO
usually
this
(MFN)
regional
are
all
protection
denition
Nation
they
not
implies
WTO
trading
allowed
principle.
blocs
as
and
long
(or
as
Watch this
Search for: let’s talk WTO on wto.org.
Watch the shor t video on why the
trade
WTO is impor tant.
within
the
bloc
non-members
According
to
agreements
is
essentially
are
the
not
because
such
growing
demand
in
in
2019
force.
agreements
for
and
that
barriers
against
increased.
WTO,
(RT
As)
free
there
There
are
deeper
were
has
faster
to
294
been
a
regional
achieve
integration
trade
proliferation
and
between
of
because
RT
As
of
countries.
Types of trading bloc
■
Free
trade
agrees
while
to
agreement
phase
each
non-members
with
required
that
at
union:
addition,
members
■
Common
market
of
The
a
in
highest
an
economic
climate,
and
of
the
currency
of
and
the
is
can
share
a
union
into
flow
in
is
of
and
any
for
in
a
of
free
central
the
it
may
laptop
be
are
tariff.
union
tariff
into
and
flow
or,
if,
in
more
a
common
services
of
is,
labour
within
of
(citizens
membercountry).
bloc
to
other
evolve
into
Members
of
policies
(on,
policies
such
justice
addition
toward
inputs—that
union.
security,
a
them,
non-members.
goods
regulatory
as
of
0%
customs
other
the
well
health,
union
for
countries
prevent
through
evolve
flow
to
example,
toward
monetary
as
barriers)
external
may
free
common
common
qualify
policy
free
a
For
of
between
origin”
area
common
work
to
trade
of
the
evolve
also
issues),
monetary
share
a
group
components
to
investments)
environment,
a
to
integration
competition
Members
to
possibly
union
may
(or
tariff.
the
trade
there
country
form
economic
of
group
customs
addition
(cross-border
an
FT
A
agree
a
into
a
barriers
“rules
external
the
when
trade
tariff
goods
common
countries,
member
example,
a
market:
if,
member
capital
to
an
own
80%
within
(FT
A):
requires
lowest
Customs
generally,
its
FT
A
least
area
eliminate
shipping
the
manufactured
■
An
or
or
maintains
non-members.
country
out
adopt
and
a
for
as
on
migration.
common
bank.
Examples of regional trading blocs or agreements
(RTBs)
■
Free
trade
States,
come
area
Mexico
into
(FT
A):
and
force
by
the
prime
Canada)
the
end
example
agreement
of
2019.
It
is
the
which
is
USMCA
is
referred
(United
expected
to
as
the
to
new
147
NAFT
A
(the
Another
been
1994
example
recently
Darussalam,
and
Customs
which
is
the
American
ASEAN
established
Indonesia,
Thailand)
Myanmar
■
North
and
and
the
Viet
union:
includes
by
Free
the
T
rade
T
rade
original
Malaysia,
newer
Free
the
Agreement).
Area.
ASEAN
This
6
Philippines,
members
has
(Brunei
Singapore
(Cambodia,
Laos,
Nam).
the
Southern
Botswana,
African
Lesotho,
Customs
Namibia,
Union
(SACU),
South
Africa
world’s
oldest
and
Search the web
Eswatini,
was
established
in
1910
and
is
the
Go to https://r tais.wto.org and
customs
union.
The
European
Union
was
initially
a
customs
union
click on the right-hand side:
when,
in
July
1968,
the
six
member
countries
of
the
European
“search RTAs”.
Economic
Community
(EEC)
(Belgium,
Germany,
France,
Italy,
In “coverage of agreement”
Luxembourg
and
the
Netherlands)
eliminated
all
customs
duties
select goods; in “signatories”
between
select any country, then add to
them
and
adopted
a
common
external
tariff.
your search as in the following
■
Common
market:
the
European
customs
union
transformed
into
example. If you select India,
a
common
market
in
1993
when
adopting
the
four
freedoms
of
in “region” select “West Asia”,
movement
and then “ex tra regional”. The
of
goods,
services,
people
and
money.
results will be quite a few trade
There
are
other
RTBs
that
you
should
perhaps
be
aware
of,
such
as
agreements.
MERCOSUR,
L TA
DP ready
Research skills
Your country’s trade
COMESA
E v alua t ing
and
CPTPP
.
R TBs
Ad vantages of RTBs
agreements
■
It
is
much
easier
negotiating
with
for
a
just
country
a
few
to
other
reach
an
agreement
countries
rather
when
than
with
163
Using the procedure described
other
countries
within
the
WTO.
in “Search the web” above,
explore https://r tais.wto.org to
■
As
the
number
see agreements your country
members,
has signed.
a
multilateral
such
■
as
member
can
go
and
property
efforts
a
For
that
smaller
access
achieve
If
there
a
free
employment
of
have
movement
and
of
opportunities
smaller
started
deal
in
labour
RTB
areas
issues,
anti-corruption
permits
its
opportunity
more
within
increase,
cover
WTO
within
competition
and
the
become
to
the
have
with.
an
them
than
would
e-commerce
cannot
giving
scale
is
they
movement,
membership
market,
economies
is
alone
countries,
than
RTBs
labour
rights,
country
larger
countries
further
agreement.
investment
intellectual
to
■
of
RTBs
an
grow,
competitive.
RTB
resulting
firms
to
in
then
less
unemployment.
■
Countries
is
such
for
■
If
enjoy
especially
as
France
example,
the
RTB
stability
greater
true
has
the
leads
may
for
more
US,
to
bargaining
smaller
if
it
power
countries
bargaining
is
in
negotiations.
even
power
negotiating
increased
but
in
then
large
This
country
negotiations
through
prosperity
a
the
with,
EU.
greater
political
follow.
Disad vantages of RTBs
■
A
country
some
outside
148
will
sacrifice
decisions
the
will
country.
to
either
various
be
a
degrees
its
compromise
sovereignty,
or
will
be
as
made
4.3
RTBs
■
may
prove
developing,
countries.
negotiations,
or
China
weaker
A
■
major
in
negotiate
Tr ade
such
an
with
of
WTO
but
as
Doha
of
a
RTB
late
smaller
their
and
trade
round
2019
and
improves
agreement
example,
RTBs
multilateral
leads
against
smaller,
bilateral
such
as
countries,
trade
their
of
had
the
EU,
latter
is
through
negotiations
to
reach
an
welfare
trade
the
are
US
in
a
that
the
was
launched
(HL)
depends
creation
they
WTO.
agreement.
di v er sion
decreases
more
trade
the
proliferation
trade
yet
often
interests.
liberalization
t r ade
or
to
in
economies
defend
cr ea t ion
Whether
For
large
to
criticism
latest
2001
when
position
undermine
The
discriminatory
Big groups, little groups
than
on
whether
trade
diversion.
Since
tariffs
lowered,
and
each
comparative
to
lower
cost
of
from
a
Why?
cost
these
more
This
they
allowing
efcient
member
within
referred
as
group
more
more
to
as
lead
fully
to
a
exploit
from
any
from
these
higher
lower
creation
imports
to
are
switches
imports
trade
less
articially
but
members
Production
non-member
becomes
the
trade
may
between
can
have.
referred
agreement
eliminated
to
is
barriers
economies
members,
the
The
trade
advantage
members.
However,
other
being
switched
efcient
cheaper
maintained
member.
because
with
away
tariffs
outsiders.
are
This
is
diversion
Focus point
T
rade
liberalization
Organization
has
in
been
or
instrumental
promoting
grounds,
for
growth.
it
caters
more
that
it
neglects
the
group
prove
stumbling
multilateral
to
reach
has
its
the
proliferated
many
the
on
are
not
T
rade
WTO
therefore,
on
many
transparent,
economies
or
issues.
and
of
and,
advanced
more
efforts
World
The
criticized
countries
consensus
to
trade
deliberations
of
the
Blocks.
been
environmental
of
block
freer
also
interests
have
interests
smaller
it
through
T
rading
advancing
that
or
either
Regional
in
the
labour
agreements
advancing
a
to
proceed
But
example,
that
Regional
may
through
are
as
it
also
is
issues.
the
successful
easier
WTO
But
for
in
within
they
a
may
achieving
agreements.
Key terms—test yourself
Dene these terms: economic integration, trade liberalization,
preferential trade agreements, bilateral agreement, multilateral
agreement, the World Trade Organization (WTO), Most-Favoured
Nation (MFN) principle, Appellate Body (of the WTO), regional trading
bloc or agreement (RTB), free trade agreement (F TA), customs union,
common market, economic union, monetary union, trade creation,
trade diversion.
149
4 . 4
T H E
A
M O S T
I M P O R TA N T
P R I C E
F O R
C O U N T R Y
In this section you will learn about:
➔
foreign exchange markets
➔
exchange rate systems—floating (or flexible), fixed and
managed systems
➔
factors affecting exchange rates
➔
managed exchange rates and disequilibrium exchange rates
➔
the consequences of changes in the exchange rate on inflation,
economic growth, unemployment, the current account balance
and living standards.
The issue
The
exchange
price
and
in
an
everyone.
demand
factors
the
and
that
is
another
you
1.1288
$1.00
also
means
150
is
at
is
a
the
the
that
the
perhaps
is
the
helps
and
the
you
in
to
supply
known
the
most
affects
determined
(also
of
it
as
important
almost
a
free
everything
market
understand
of
the
a
currency
forex
consequences
of
by
the
in
market).
changes
in
the
economy.
mar k e t s
determined
on
a
currency
For
euro
to
a
its
value
whoever
on
is
up
buying
also
365
July
If
2019
we
expressed
of
that
with
the
the
days
in
in
year.
=
of
The
of
$1.1288,
both
terms
went
the
a
(forex)
terms
€1.00
one
dollars
in
divide
respect
euro
euros
selling
exchange
expressed
euro.
realize
goes
foreign
basis,
12
one
value
time
the
price
dollar
should
dollar
same
buy
of
in
24-hour
is
example,
price
Y
ou
the
it
demand
$1.1288
that
realize
market
of
€0.8859.
other—if
this
the
is
changes,
section
market
operates
currency.
get
it
price,
This
the
rate
rate
we
a
exchange
needed
=
currency
When
explanation
on
which
exchange
the
an
exchange
market,
Being
rate
For eig n
The
a
exchange
also
exchange
of
supply.
affect
foreign
There
so
rate
economy.
sides
the
euro,
is
the
inverse
to
the
dollar,
down.
foreign
and
vice
Y
ou
by
or
of
then
should
exchange
versa.
4.4
L TA
DP ready
The most impor tant price for a country
Research and thinking skills
Exchange rates
1.
Find the exchange rate of the currency of your country today
against a number of major world currencies. Find the same
exchange rates a month earlier.
a.
Has your currency increased or decreased in value during
this period?
b.
Calculate the percentage change.
For question 2, use the currency calculator at x-rates.com. It provides
more decimal places for greater accuracy in your conversions.
2.
Star t with US$1000 and visit the following countries sequentially.
Spend nothing but exchange your money every time you visit a
new country. Go from the US to the UK then France, Egypt, Turkey,
South Korea, Indonesia, Australia and nally New Zealand.
a.
Explain whether the number of units of one currency needed
to buy another reects anything about the “strength”
of a currency. Do prices of goods and services in each
country matter?
b.
Compare the value of a currency today with its value a
year earlier. Explain whether the terms “strengthening” or
“weakening” make more sense in this case.
E xchange
r a te
sys t em s
Search the web
There
are
three
exchange
rates
different
are
exchange
determined:
rate
systems
oating
(or
within
exible),
which
xed
Exchange rates of major
currencies may change by the
and
minute or even every second.
managed
exchange
rate
systems.
Search the web using: live
■
A
currency
is
traded
in
a
floating
(or
flexible)
exchange
foreign exchange rates.
rate
Add any two major world
system
if
there
is
no
government
or
central
bank
intervention
in
currencies to your search string
the
market.
to nd a site that shows char ts
■
In
a
fixed
exchange
rate
system
the
price
of
the
currency
with live changes. For example,
is
for sites that give you rates by
set
by
the
government
and
maintained
at
that
level
through
the minute, search using: live
appropriate
central
bank
intervention.
forex rupees to dollar. Or search
■
In
is
a
managed
allowed
float
but
whenever
considered
undesirable.
called
varies.
a
“managed
Fac t or s
Imagine
are
bought
supply
Pounds
are
People
and
forex
and
and
and
the
sell
by
pounds
in
countries
services
(that
by
or
are
intervention
of
of
by
change
such
using: live forex yen to dollar.
rate
the
is
interventions
using
this
system
of
(also
system).
this
this
only
UK
market
market
people
UK
exchange
speed
traded
participants
in
with
is,
periodic
frequency
where
in
the
exchange
the
pounds
demanded
is
direction
The
float”
market
sold
buy
system,
currencies
af f ec t ing
the
demand
Most
rate
there
authorities
course
■
to
exchange
other
for
r a tes
pounds
of
this
and
and
many
If
US
market.
what
what
for?
dollars
Who
Who
would
will
for?
reasons.
currencies
exports).
and
want
to
Americans
buy
are
UK
goods
buying
UK
151
goods
UK
and
pounds
School
UK
of
Some
to
deposits
firm
in
The
in
company,
Some
are
lot
A
tuition.
will
have
American
to
UK
is
be
sold
attending
exchange
The
to
her
the
US
exporting
so
that
London
dollars
to
education
to
make
investments
UK
pounds,
to
buy
a
will
If
an
have
to
or
wants
want
at
a
to
he
buy
if
he
to
to
UK
price
buy
up
or
to
to
UK
and
with
a
they
(for
make
his
in
can
new
US
UK
or
a
UK
UK.
hoping
to
These
make
in
dollars.
shares
the
profit.
a
deposits
bonds,
now,
make
UK
to
establish
make
factory
pounds
and
speculators
a
the
stocks,
pounds
to
set
firm
into
or
wants
UK
wants
buy
higher
as
UK
American
applies
if
bonds
or
sell
people
lose
a
money.
are
UK
supplied
need
firm
necessary
Some
or
to
to
take
pounds
&
US
Fitch
a
to
sell
order
will
for
to
want
to
of
UK
buy
firm
many
reasons.
import
shirts
have
the
make
to
new
advantage
the
in
for
(importing)
want
they
have
people
dollars
establish
make
by
buying
people
example,
will
An
have
buy
Abercrombie
■
for
want
people
People
■
will
to
referred
Pounds
pay
UK).
later
of
bought.
dollars
want
he
same
these
to
they
the
pounds,
be
US
her.
people
example,
■
can
then
Economics
pounds
services
■
services,
to
US
from
sell
UK
investments
in
pounds
and
US
services.
company
pounds
to
buy
US
(for
the
purchase.
US
higher
goods
the
bonds
the
US
to
or
US).
A
interest
buy
the
into
the
shares,
British
rates
to
buy
a
investor
on
dollar
necessary
US
US
firm
wishing
deposits
dollars
to
deposit.
L TA
DP ready
Thinking skills
Demand for dollars
Remember that the demand for one currency is the supply of another
currency. Look at the examples above based on demand and supply
of UK pounds, but think about the US dollar instead. Explain why US
dollars are demanded and supplied in the cases given.
T
rade
the
for
ows
demand
trading
example,
to
and
his
their
a
Mexican
family
to
sell
corporation
need
supply
currency
country
needs
will
and
cross-border
to
in
in
of
origin
sell
in
to
the
as
to
If
buy
give
are
rise
also
market.
US
Money
who
that
it
pesos.
other
most
This
for
money
send
a
prots,
US
it
dollars.
Internal link
Section 4.5 on a country’s balance of payments (BOP) has more information.
152
to
worker
consider
its
of
reasons
Consider,
sends
Now
repatriates
US
to
migrants
remittances.
Mexican
India.
rupees
There
in
month.
buy
ows
exchange
worker
referred
to
prots
Indian
currency.
foreign
every
is
dollars
earning
a
migrant
Mexico
US
of
the
investment
4.4
Focusing
now
on
the
US
Market
dollar–UK
Price
pound
market,
Figure
The most impor tant price for a country
4.4.1
shows
of
for
UK
pounds
pound
Supply
the
(in
US
(U K
equilibrium
exchange
rate
for
the
(U S
UK
Since
rate
US
of
expressed
Figure
of
the
the
the
4.4.1
UK
dollar,
in
the
pound
quantity
terms
focuses
pound
of
the
US
on
with
vertical
and
of
the
is
traded
the
U K)
exchange
to
the
horizontal
pounds
of
the
(x-axis)
per
e
price
is
period.
Demand
On
the
y-axis
the
price
of
the
and
investments
dollars.
respect
(y-axis)
pounds
impor ts
dollar/pound)
out
pound
of
dollars)
pound
(U K
is
for
expor ts
pounds
and
investments
expressed
dollars
per
Demand
UK)
US
one
for
nancial
the
in
UK
other
equal
(reecting
UK
so
pound
pounds
and
is
dollars
to
(for
it
gives
or
$/£.
UK
supply
imports
and
into
and
out
of
the
UK)
at
ows
of
Figure 4.4.1Equilibrium exchange rate for the UK pound against the
into
pounds
investment
the
exchange
for
UK
pounds
rate
Price
of
pound
Supply
e
;
say,
$1.26
per
U K)
US dollar
Market
ows
the
Pounds/period
exports
investment
the
US
(in
pound.
US
of
pounds
dollars)
(U K
impor ts)
1
(U S
Now
let’s
between
imagine
ignore
the
investment
two
that
countries.
only
export
dollar/pound)
ows
Instead,
and
e’
import
ows
(ab)
e
affect
and
demand
thus
Looking
its
at
exchange
and
supply
exchange
Figure
for
the
=
excess
UK
trade
supply
of
deficit
and
pounds
pound
rate.
4.4.2,
rate
is
at
e'.
exports
is
equal
assume
At
e'
the
that
the
value
Demand
of
UK
to
(e'a).
This
(U K
because
at
e'
foreigners
demand
for
pounds
is
expor ts)
(e'a)
Pounds/period
pounds
to
buy
UK
goods
and
services,
the
Figure 4.4.2UK pound–US dollar market: export and import ows
value
of
imports
at
e',
which
is
value
the
UK
exists
if
of
trade
(e'b).
are
the
also
exchange
the
price,
in
value
This
exceeds
on
of
reects
market.
case
of
goods
and
excess
is
valued
exports,
distance
of
there
the
imports
value
to
goods
the
If
UK
buy
the
equal
of
because
to
imports
export
this
is
offered
decit
expenditures
from
The
(ab).
and
at
we
A
say
trade
services
services(X)—or
supply
excess
exchange
for
UK
supply
rate,
will
(e'b).
that
decit
(M)
if
M
pounds
in
a
tend
Since
exceed
>
in
X.
the
market
to
fall.
The
DP ready
term
used
exchange
This
to
describe
rate
system
depreciation
cheaper
in
the
of
US.
a
decrease
is
the
UK
in
the
exchange
rate
in
a
pound
Thinking skills
oating
depreciation.
exports
L TA
then
to
imports
a
distance
foreign
(e'a).
pounds
has
revenues
This
equal
(e'b)
the
is
Analysis of an exchange
makes
UK
become
goods
more
and
services
competitive
rate
abroad
Analyse what would happen if
and
will
tend
to
increase.
At
the
same
time,
US
products
become
the exchange rate was below
more
expensive
in
the
UK
when
their
dollar
price
is
expressed
e
. Explain why the price of
1
in
pounds.
UK
imports
become
less
attractive
and
will
tend
to
the pound would increase
decrease.
So,
as
the
pound
depreciates,
more
pounds
will
be
or, using the correct term,
demanded
and
fewer
will
be
supplied;
the
trade
decit
shrinks
appreciate, and reach e
1
until
the
exchange
rate
reaches
e
1
153
Changes in demand and supply for a currency
As
explained
reect
trade
demand
right,
for
opposite
Egypt
be
the
leading
appreciate.
If
above,
ows.
to
an
exports
importing
buy
these
The
shift
the
decreasing
starts
The
to
right,
pound
import
demand
border
direct
and
They
buying
for
the
shares
of
mostly
South
in
The
to
the
If
they
This
currency
to
the
the
pound
decrease,
Egyptian
importers
pounds
will
then
the
of
the
pounds
buy
will
of
currency
also
will
more
increase
Egyptian
will
many
the
for
and
and
of
the
buy
for
an
pound.
happen
if
and
The
Egypt
increase
in
sell
long-term
the
about
their
ringgit
of
ringgit
will
The
won
of
assets
and
rm
or
demand
outlook
Malaysian
supply
FDI
investment.
the
right.
the
the
across
foreign
shares,
and
include
deposits
investments.
a
or
to
as
existing
is
cross-
will
the
(such
shifting
as
the
depreciate.
remittances
sell
currencies
currencies.
speculators
T
urkish
a
it
shifts
the
T
urkish
into
so
an
bonds
reect
investments
investments
well
capital
in
continuous
example
as
worried
The
and
currency
may
is
abroad,
may
portfolio
Portfolio
bonds
Korean
right.
buy
a
include
interest
increasing
owing
An
shift
opposite
nancial
become
value
demand
Remittances
more
value
and
increases
speculators
appreciate.
and
a
increase,
Egyptian
The
(FDI).
presence
buy
won
chart.
currency.
These
speculation
appreciate,
of
Egypt
reason
Egyptian
the
controlling
responsible
currency
The
Egyptian
supply
stocks
investors
ringgit
uctuations
some
as
of
short-term
a
bonds),
Currency
Currency
of
economy,
and
supply
If
the
ows.
new
Korean
Malaysian
prot.
a
are
foreigners
appreciate.
supply
investments
refers
establishing
supply
increase
price.
goods,
depreciate.
and
selling
borders.
to
the
less.
for,
buying
When
will
investment
foreign
for
goods
currency.
to
and
example,
will
its
more
foreign
Egyptian
in
for
for
pound
increase
Egypt’s
of,
occur.
starts
offered
demand
exports
Egyptian
to
If
will
the
If
liras
liras
of
to
Currency
ups
and
expect
will
rise
will
to
and
remittances
tend
owing
to
prot
speculation
the
hoping
a
downs
“self-fullling
country
make
seen
T
urkish
sell
the
is
in
any
lira
them
lira
by
to
later
will
at
indeed
expectations”
.
appreciate
into
the
Bangladesh
will
Search the web
increase
the
demand
for
the
Bangladeshi
taka
as
migrant
workers
Visit the Migration Data Por tal
living
and
working
in
the
eurozone
will
sell
euros
to
buy
taka
to
at migrationdatapor tal.org. Click
send
to
their
families.
on the Data drop-down menu
and then on the Development
tab on the left-hand side of the
TOK
page. Read information about
remittances that your country
receives and/or pays as well
as other migration-related
information.
154
Currency speculation may lead to sharp movements in the exchange rate of a
country. As outlined later in this section, movements in the exchange rate may
disrupt an economy and adversely aect living standards. Is there an ethical
basis to limit currency speculation?
a
4.4
The most impor tant price for a country
Illustrating changes in currency demand and supply
Figures
Swiss
If
4.4.3a
franc
investors
the
and
the
euro,
4.4.2b
francs
euro
an
who
they
Swiss
sale
and
of
own
will
assets.
of
euros
focuses
and
its
4.4.3b
show,
outow
on
the
effect
Swiss
on
from
the
from
to
e
)
(1/e
the
on
the
shows
the
which
of
implies
Swiss
and
euro.
shows
of
Notice
the
in
francs
Figure
purchase
franc.
that
the
condence
euro
the
on
eurozone.
safer
the
Swiss
effect
the
lose
buying
price
and
of
the
from
bonds
and
focuses
on
franc
e
example,
capital
and
euros
price
1
appreciated
an
deposits
4.4.2a
its
as
nancial
selling
Figure
effect
depreciated
euro
start
and
of
Swiss
that
Swiss
the
franc
2
to
(1/e
1
).
2
Market
Market
for
euros
(in
of
for
Swiss
francs
(SFr)
(€)
S
Price
of
€
1
€
Price
SFr)
(in
S
(SFr/€)
of
of
S
SFr
of
SFr
euro)
€
(€/SFr)
2
1/e
2
e
1/e
1
1
e
2
D
for
SFr
2
D
for
D
€
for
SFr
1
(a)
(b)
€/period
SFr/period
Figure 4.4.3 a and bThe eect on the Swiss franc of an outow of euros
Factors inuencing trade and cross-border
investment ows
Y
ou
have
learned
investment
ows
trade
and
If
ows
these
T
o
factors
recap:
the
supply
of
the
mostly
reect
Therefore,
ows
will
changes
■
interest
■
growth
Changes
change,
the
the
trade
exchange
ows
rate.
investment
exchange
rate
rate
depends
on
currency.
The
demand
and
trade
ows
and
affecting
affect
the
The
will
the
and
exchange
in
factors
are
that
inuence
explained
below.
change.
supply
for
of
investment
cross-border
rate.
cross-border
demand
the
cross-border
trade
and
ows
exchange
turn
These
and
a
the
currency
ows.
investment
factors
include
rates
rates
rates.
in
that
(BRL)
Rising
affect
in
in:
inflation
real
changes
cross-border
factors
in
■
Assume
that
ination
be
prices
competitive
decrease.
ination
rates
accelerates
in
Brazil.
How
will
the
Brazilian
affected?
in
Brazil
abroad
However,
mean
and
will
foreign
that
tend
Brazil’s
to
products
exports
decrease.
(imports)
become
Demand
will
be
less
for
BRL
will
relatively
155
more
attractive
have
If
to
sell
demand
rises
and
ination
in
funds.
and
If
(b)
return,
so
the
other
of
L TA
DP ready
rates
US
the
do
more
Brazil
foreign
and
tend
so
to
will
currency.
supply
of
BRL
depreciate.
Higher
currency.
is
the
rise
such
this
more
of
to
as
holder
that
(a)
US
US
interest
in
a
deposits
earn
the
a
US
more
investors
Demand
to
hedge
higher
nancial
leading
rates
or
dollar
offer
dollars.
right,
from
bond).
banks,
bonds
development,
the
the
pensions
They
and
earns
of
commercial
means
more
to
someone
the
managing
deposits
buy
Higher
to
attractive.
this
shift
return
interest
dollar
and
dollar.
T
o
left,
will
companies
currencies
of
buy
the
investors
or
advantage
the
rate
pay
become
of
to
shifts
BRL
of
more.
rates
bonds
increase
appreciation
BRL
and
the
interest
interest
take
more
then
nancial
bonds
will
price
the
(and
holders
T
o
sell
dollars
US
import
depreciation
companies,
US
money.
will
of
will
decreases
right,
to
that
think
supply
interest
money
insurance
Brazil
BRL
shifts
Remember
Now
and
for
leads
Changes
saving
so
for
rise
lead
in
to
an
dollar.
Thinking skills
Eect of US interest rates
1.
Explain the eect of higher interest rates in the US on other
currencies such as the BRL , the Mexican peso or the Indian rupee.
(Remember, investors will sell other currencies to buy dollars.)
2.
Explain what would happen to the other currencies if the US
Federal Reserve decreased US interest rates. Use appropriate
diagrams to illustrate your answer.
Changes
in
Remember
an
be
When
more
refers
This
to
dongs
increase
an
to
increase
an
may
buy
to
to
incomes
leads
Vietnam,
wants
will
and
and
its
real
it
necessary
to
the
income.
more
a
growing
depreciating.
will
have
dollars.
right,
If
imports
effect:
currency
imports,
the
shift
in
rising,
interesting
see
more
buy
are
to
sell
Supply
pushing
down
value.
also
direct
the
there
expected
of
there.
of
The
continue
(FDI).
higher
cases,
to
issue.
grow,
prots
Vietnamese
in
will
forecasts
for
the
investors
take
appreciation.
of
want
of
the
strong
this
by
or
buy
rise,
Vietnamese
who
advantage
expectations
to
will
Vietnamese
rms
Vietnam
need
dongs
the
then
companies
for
to
If
Multinational
Demand
nancial
companies
such
contrasting
multinationals
positive
attract
a
to
existing
investments.
The
is
investment
prospect
share
156
as
Vietnam
However,
is
growth
such
dong
rates
growing
Vietnamese
the
its
is
consumed.
economy,
of
that
economy
will
growth
to
attract
take
dongs
to
economy
stocks
expected
rise
may
its
will
of
in
lead
factories
make
up
of
controlling
building
pushing
foreign
advantage
acquiring
by
buy
growth
will
will
economy
these
value.
also
Vietnamese
share
to
a
prices.
currency
In
4.4
F i xed
What
if
exchange
the
exchange
r a te
rate
is
The most impor tant price for a country
sys t em s
set
by
the
government
or
the
central
Search the web
bank
of
a
country?
The
UAE
dirham
(AED)
has
been
xed
for
a
Search using these terms:
long
time
against
the
US
dollar
at
AED3.67
per
one
has
xed
US
dollar.
The
Denmark’s xed exchange rate
Danish
currency,
the
kroner
(Kr),
been
against
the
euro
policy.
at
a
“central”
rate
of
7.46
kroner
per
1
euro.
“Central”
means
that
Find out more about why
the
kroner
rate,
so
can
uctuate
between
within
Kr7.62
and
a
+/–
Kr7.29
2.25%
per
band
around
that
and how Denmark has been
successfully keeping the kroner
euro.
xed against the euro.
Maintaining a xed exchange rate
How
at
does
some
and
sell
a
central
level
the
or
currency
continuously
bank
must
buying
or
investors
idea
shift.
to
is
buy
so
T
o
intervene
selling
its
or
maintain
band?
the
in
the
If
the
the
foreign
currency
the
the
Firms
demand
maintain
sell
simple.
a
price
and
for
it
xed
of
currency
and
the
adjust
xed
still
supply
exchange
exchange
and/or
a
individuals
rate,
market
interest
of
a
and
buy
it
central
start
rates
to
induce
currency.
currency
tends
to
fall
then
the
central
DP ready
bank
by
must
buying
start
increase
the
buying
demand
currency
it.
How
for
itself
can
it
the
or
by
induce
currency.
inducing
It
can
do
foreign
investors?
By
this
Thinking skills
either
investors
increasing
L TA
The
bank
within
to
Central bank inter vention
interest
Explain what a central bank
rates
and
thus
making
deposits
denominated
in
its
own
currency
will have to do if the currency
and
domestic
In
xed
bonds
more
attractive.
tends to rise above the bank’s
a
the
xed
referred
level
as
of
exchange
level
to
as
the
of
in
a
currency
xed
“appreciation”
Let’s
illustrate
ctitious
Let
at
a
us
The
of
currency
and
the
used
a
$1.50/L.
and
the
it
that
the
government
sets
it
at
a
higher
system
the
Layla
Originally,
a
lower
level,
abandons
level,
and
it
is
it
the
Price
are
of
such
that
the
xed
to
are
“depreciation”
4.4.4.
Layla
is
This
(L)
xed
demand
as
features
and
its
against
)
(D
and
a
currency.
the
dollar
supply
1
conditions
is
referred
“revaluation”
whereas
xed level.
abandons
system.
Figure
with
the
at
government
oating
using
Laylaland
assume
if
“devaluation”
rate
in
above
If
sets
terms
exchange
are
country
further
parity
the
system,
devaluation.
revaluation.
used
rate
exchange
rate
is
(S
)
1
at
$1.50.
Layla
($/L)
S
of
L
1
S
of
L
2
1st
shift
(increase
in
impor ts)
h
f
$1.50
2nd
$1.40
shift
(response
by
CB)
D
for
L
2
D
for
L
1
Laylas
traded/period
Figure 4.4.4US dollar–Layla
157
Assume
that
increase
so
incomes
the
in
Laylaland
supply
of
sold
buy
Laylas
are
will
increasing.
increase
to
Imports
as
S
will
more
Laylas
2
will
have
to
exchange
to
market
distance
tend
T
o
to
be
(fh)
push
maintain
intervene
in
there
at
the
the
to
the
Layla
to
now
down
at
necessary
an
original
parity
order
is
the
excess
$1.50/L
to
a
increase
supply
for
the
rate
to
equal
This
will
($1.40/L).
central
Laylas
foreign
Laylas
rate.
exchange
Laylaland’s
demand
At
of
exchange
lower
$1.50/L,
dollars.
bank
.
D
It
must
can
do
2
this
either
market,
by
or
it
buy
(fh)
will
become
cannot
First,
can
Laylas,
it
has
in
and
a
exchange
by
the
central
direction
oat
The
or
systems
exchange
a
central
bank
over
vaults
Also,
capital
investors
Laylaland’s
to
a
probably
period.
continue
buying
interest
and
goods),
to
bonds
long
higher
consumption
of
the
undisclosed
band
intervenes
A
at
the
oats
country
steer
or
rates
business
decreasing
have
exchange
authorities
the
same
but
is
AD
but
the
a
the
to
In
rate
to
desired
in
a
managed
but
to
level.
to
some
intervention
move
currency
back
Within
decrease
some
equilibrium
exchange
rates.
maintain
starts
within
allow
most
periodic
undesirable.
may
the
try
time,
there
currency
above
the
we
the
oats
considered
below
to
and,
rate
rates
managed
system,
currency
band.
exchange
whenever
speed
undisclosed
bank
its
exchange
r a tes
system:
rate
movements
bank
at
xed
rate
exchange
rate
exibility.
domestic
(purchases
and
exchange
managed
in
market.
foreign
induce
and
interventions
reserves
exchange
oating
common
to
Laylas
the
recession.
Managed
Between
in
Laylaland’s
exchange
reduce
rates
in
these
dollar
spending
risking
of
Laylas
interest
attractive.
foreign
will
(fh)
deposits
either
limited
Laylaland
investment
buy
increase
more
the
to
since
continue
Laylas
in
starting
the
trade
The
at
an
central
desired
level.
The three systems—a nal note
This
Search the web
Search using these terms:
managed oat MAS 2019
section
xed
how
is
and
these
much
has
distinguished
managed
work
more
in
exchange
principle.
complicated
between
rate
In
oating
systems
the
because
real
in
world,
central
(or
order
the
banks
exible),
to
explain
classication
deal
with
the
(channelnewsasia.com).
exchange
rate
in
whichever
way
they
consider
most
appropriate
Find out about the managed
for
their
policy
objectives.
Fully
xed
and
free
oating
systems
oat system that operates in
Singapore.
are
rare
types
and,
of
degree
in
between
managed
and
exchange
the
economy
that
is,
frequency
be
rate
cheaper
aimed
may
below
exchange
at
its
is
and
try
of
are
They
central
very
differ
bank
exchange
to
keep
equilibrium
lower
more
penetrating
export-driven
158
there
many
different
regarding
intervention
the
in
foreign
markets.
Dis equilibr ium
An
them,
arrangements.
than
its
exchange
value.
its
growth.
China
The
rate
abroad.
markets
has
for
undervalued;
reason
equilibrium
competitive
export
r a tes
rate,
This
an
repeatedly
is
that
then
could
economy
been
if
the
exports
be
a
that
accused
will
policy
relies
on
ofthis.
4.4
How
rate
could
the
below
its
free
example,
keep
purchase
US
low.
and
There
may
authorities
dollars
are
US
Another
The
its
in
price
opposite
may
equilibrium
US
will
level?
will
the
occur.
risk
An
How
must
could
keep
the
US
Chinese
more
that
of
exchange
bank
economy
get
exports
US
expensive
in
may
for
have
interest
continuously
ination
China,
will
will
outcompeting
be
is
it
to
the
central
First,
and
China
maintain
Its
or
object
China
for
raises
also
yuan
involved.
markets
in
issue
low
country
selling
US
products
a
undervalued?
risks
The
cheaper
sell
well.
by
several
addition,
keep
yuan
retaliate.
articially
to
market
the
of
The most impor tant price for a country
to
rates
upset
being
rms.
and
In
will
selling
not
yuan
China.
try
to
keep
People’s Bank of China headquar ters
its
exchange
rate
overvalued;
that
is,
above
its
free
market
in Beijing
equilibrium
Countries
economic
order
out
of
and
would
to
the
create
not.
They
How
rate
above
keep
been
and
the
its
have
less
imports
rates
of
high
of
the
and
a
in
The
but
abroad
the
risks
as
the
These
industries
and
absurd
are
they
but
trying
trade
diversify
growth
overvalued
other
of
for
imports
to
it
is
produce
barriers
necessary
but
imported
parts.
equilibrium
high.
promote
for
they
prices
to
overvalued.
sounds
and
country
currency
complicated.
strategy
production
currency
good
keep
a
opportunities
This
tariffs
rate
domestically
competitive
currency
lacks
low.
machines
its
more
as
domestic
their
prices
market
buy
are
manufacturing
keeping
very
this
their
which
authorities
interest
cheaper
as
free
to
own
exchange
such
could
would
or
low,
out
using
overvalued
inputs
keep
sector,
By
for
substitution
substitute
import
block
domestically,
to
their
development.
keep
reasons
import
would
try
primary
articially
the
The
pursue
growth
countries
in
level.
that
maintain
level?
The
foreign
were
exports
the
central
exchange
that
imports
become
traditional
exchange
may
more
export
bank
market
have
expensive
sector
was
thuspenalized.
Ec onomic
c on s equenc e s
exchange
r a te
Movements
ination,
key
to
■
to
in
the
two
depreciation
more
market
Example:
Germany
be
€1.00
toy.
If
€1.00
Now,
Fitch
rate,
=
the
cheaper
think
and
and
an
of
$1.20.
a
An
priced
Italian
shirt
be
made
$120.00
in
of
issues
living
in
the
t he
including
standards.
exchange
The
rate
is
the
abroad
more
toy
car
in
produced
dollar–euro
would
at
therefore
expensive
need
€1.00=$1.10
sold
and
the
attractive.
BMW
Let
more
customer
changes
less
American
will
and
in
below.
imports
to
range
cheaper
miniature
depreciates
a
of
therefore
€1.00.
a
change s
growth
points
exports
therefore
of
affect
impact
makes
Germany
and
think
It
and
priced
euro
in
the
rate
output,
bullet
makes
competitive.
domestic
at
exchange
understanding
remember
A
the
unemployment,
of
$1.10
$1.20
then
in
in
exchange
the
to
the
US
rate
buy
toy
the
priced
market.
It
is
competitive.
by
the
would
US
company
US.
With
need
Abercrombie
the
€100.00
initial
to
&
exchange
buy
it.
After
159
the
depreciation
only
$1
10.00
shirt—the
buy
in
An
■
it.
the
so
of
more
Italian
The
shirt
eurozone
expensive
become
euro,
euros
customer
imported
and
appreciation
more
the
so
works
and
are
now
from
less
the
be
exchanged
now
need
US
is
to
buy
€109.09
now
for
the
euros
more
to
expensive
attractive.
other
and
thus
can
needed
will
the
abroad
cheaper
is
€100.00
way
thus
more
round.
less
It
makes
competitive,
exports
while
imports
attractive.
Eect on ination
What
if
Since
exports
while
the
currency
imports
exports
will
exports
(X
to
close
to
In
may
extent
decrease
that
in
a
AD
How
and
and
and
shift
output
to
the
less
ination
of
the
attractive
AD
to
so
right.
economy
affected?
competitive
imports
component
will
is
more
is
abroad,
domestically,
decrease.
net
Net
exports
Depending
operating,
will
on
tend
how
demand-pull
result.
the
intermediate
pricier
increase
are
and
addition,
the
M)
to
potential
ination
cheaper
become
tend
–
increase
depreciates?
become
depreciation
domestic
goods,
AS
and
the
so
brings
rms
buy
higher
to
about
rising
imported
cost
cost-push
of
their
import
raw
prices.
materials
inputs
may
T
o
and
lead
to
a
ination.
Eect on economic growth
If
the
currency
prices
more
depreciates,
decrease,
and
expensive.
net
exports
shifts
to
the
right,
grow,
but
there
L TA
DP ready
imports
AD
because
exports
will
may
become
tend
(NX),
real
a
a
to
less
increase
component
output
be
become
will
higher
of
competitive
attractive
and
of
shift
AD,
increase
risk
more
as
to
will
and
the
they
the
as
become
right
increase.
economy
If
AD
will
ination.
Thinking skills
Illustrating AD/A S
You have learned that if AD shifts to the right, real output will increase
and the economy will grow, but there may be a higher risk of ination.
Explain what this risk depends on. Use a Keynesian AD/AS diagram to
illustrate your answer.
Eect on unemployment
A
depreciating
and
therefore
tend
to
currency,
economic
decrease.
unemployment
An
as
as
explained
activity.
Cyclical
appreciation
net
exports
above,
and
will
increase
unemployment
tend
AD
may
will
to
increase
AD
will
cyclical
decrease.
Eect on the current account balance
The
If
basic
import
country
160
idea
of
the
current
expenditures
has
a
trade
account
exceed
decit.
A
export
is
simple.
revenues
depreciation
will
(M
>
X),
decrease
the
its
size
4.4
because
imports
trade
If
the
exports
become
surplus
(X
currency
become
less
>
more
competitive
attractive
M),
instead
a
and
and
decrease.
depreciation
appreciates,
will
increase
If
the
tend
exports
to
while
country
had
increase
become
The most impor tant price for a country
its
a
size.
less
Internal link
competitive
attractive
and
and
tend
tend
to
to
shrink
rise.
A
while
trade
imports
decit
(M
become
>
X)
more
will
tend
The current account is discussed in
to
detail in section 4.5.
widen
while
a
trade
surplus
(X
>
M)
will
tend
to
shrink.
Eect on living standards
The
typical
purchase
prices
the
of
cost
shrinks.
affects
living
This
the
of
the
the
consumers
depreciates,
goods
power
and
of
services
pharmaceuticals
will
then
the
increases—automatically
purchasing
to
fuel,
that
currency
country
The
access
depreciation
as
competing
and
disproportionately
also
will
on
may
will
many
less
households
mostly
food
hurt
grow
take
increase
are
lower
and
exports.
employment
with
the
attractive,
employment
to
also
increase
for
become
imports
effects
depreciation
L TA
DP ready
noted,
sector
opportunities
will
with
these
signicant
already
export
imports
course,
in
services
the
households.
income-earning
Since
goods
and
If
increases.
families—if
depreciation,
growth
goods
decreased
poorer
income
of
imports.
imported
of
imported,
A
basket
includes
also
and
appropriate
domestic
generate
living
The
and
skills.
rms
jobs.
standards
Of
require
a
place.
Thinking and communication skills
Eect of appreciation on living standards
In a small group, analyse the possible eects on living standards of a
sizeable appreciation of the currency. Present your ideas in the form
of a poster to discuss with the rest of the class.
Focus point
The
exchange
economy.
through
the
It
is
their
exchange
abroad
and
expensive
exchange
rate
all
arguably
determined
central
rate
thus
and
most
market
then
all
and
thus
forces
in
and
less
of
the
its
while
but
often
become
imports
the
exchange
for
such
is
If
cheaper
become
living
rate
an
governments,
Changes
variables
course
price
determination.
attractive.
macroeconomic
growth
important
exports
competitive;
Consequently,
policy-making
the
intervene
depreciates
more
affect
population.
by
banks,
domestically
rate
unemployment
the
is
more
in
as
the
ination,
standards
central
of
stage
for
decisions.
Key terms—test yourself
Dene these terms: exchange rate, oating (or exible) exchange
rate system, xed exchange rate system, managed exchange rate
system, remittances, por tfolio investment,
devaluation, revaluation.
161
4 . 5
C A N
W E
I M P O R T
T O O
M U C H ?
In this section you will learn about:
the balance of payments (BOP)—the current account, capital
➔
account and financial account
➔
the implications of a persistent current account deficit
➔
ways to correct a persistent current account deficit—
expenditure-reducing policies, expenditure-switching polices
and supply-side policies.
The issue
This
section
balance
and
a
what
if
it
balance
country
a
year.
is
to
a
an
be
of
with
Any
plus
referred
the
sign
to
transactions
too
as
of
a
account
record
explains
much
of
for
a
country—the
exports
what
and
p aymen t s
rest
that
of
(BOP)
the
leads
is
debit
considered
it
an
is
item.
from
is
a
world
to
referred
currency
a
is
the
what
and
BOP
can
be
imports,
includes,
done
about
it
problem.
and
of
It
section
import
a
important
payments
item
outow
an
(BOP).
The
to
b alanc e
a
to
more.
means
proves
with
examines
payments
little
it
T he
The
of
(B OP)
record
over
inow
to
as
a
T
able
period
with
4.5.1
point
transactions
of
item.
a
gives
of
all
currency
credit
recorded
the
a
of
of
view
time,
is
If
of
usually
recorded
an
negative
some
of
item
sign
leads
and
examples
Mexico’s
of
BOP
.
For Mexico’s BOP,
Item
Credit or
Plus or
debit?
minus?
currency inow or
outow?
Raquel, who lives in Mexico City, buys a $250 Italian jacket.
outow from Mexico
Jorje, a wealthy Mexican entrepreneur, buys $200,000
debit item
minus sign
outow from Mexico
debit item
minus sign
inow into Mexico
credit item
plus sign
inow into Mexico
credit item
plus sign
outow from Mexico
debit item
minus sign
inow into Mexico
credit item
plus sign
wor th of US stocks from the New York Stock Exchange.
Bob, an American college student, visits Mazatlan and
spends $1,200 on his stay.
Raquel’s mother receives $18,000 in dividends and interest
payments from US shares and bonds she owns.
Ar turo’s Steel Company, Mexico’s largest, acquires a Turkish
steel manufacturing rm for $1.2 billion.
Ar turo’s Steel Company earns $120 million in prots from
operations abroad.
Table 4.5.1Examples of BOP items (measured in US dollars)
Br eak ing
t he
B OP
in t o
piec e s
The components
The
BOP
current
162
is
broken
account,
down
the
into
capital
three
separate
account
and
the
sub-accounts:
nancial
the
account.
4.5
The
important
The
capital
ows,
include
shares,
T
able
account
income
account
ones
is
ows
records
deposits
us
are
small.
and
investments
and
presents
the
The
transfers
cross-border
portfolio
4.5.2
for
loans)
these
current
current
across
and
account
borders.
investments.
(buying
and
and
foreign
sub-accounts
nancial
direct
in
of
investments
bonds
investment
greater
trade
nancial
Cross-border
selling
accounts.
records
The
Can we impor t too much?
and
(FDI).
detail.
Balance of payments (BOP)
A . Current account (C A)
Net expor ts of goods and ser vices
If (X − M) > 0 then trade surplus
Exports of goods and ser vices – imports of goods and ser vices (X−M)
If (X − M) < 0 then trade decit
= Balance of trade in goods and ser vices
Net income from abroad
If income earned abroad exceeds
income sent abroad then (+)
= Income from abroad – Income paid abroad
If income sent abroad exceeds income
earned abroad then (−)
Net current transfers
If current transfers from abroad exceed
= Current transfers from abroad – current transfers sent abroad
(Current transfers include foreign aid and workers’ remittances)
current transfers sent abroad then (+)
If current transfers sent abroad exceed
current transfers earned abroad then (−)
Current account balance
If sum > 0 then current account surplus
= Sum of net expor ts of goods and ser vices plus net income
If sum < 0 then current account decit
plus net current transfers
B. Capital account (K A)
Net capital transfers
Capital transfers received – capital transfers sent
(Capital transfers include debt forgiveness, and buying and selling of non-produced, non-nancial assets such
as patents and trademarks)
Balance on capital account (K A)
If > 0 then capital account surplus
If < 0 then capital account decit
C. Financial account (FA)
Por tfolio investment
Net por tfolio investment
Inows and outows
= sales of bonds and
shares – purchases of
bonds and shares
If sales of domestic bonds and shares
exceed purchases of foreign bonds &
shares, then (+)
If purchases of foreign bonds and
shares exceed sales of domestic bonds
and shares, then (−)
Foreign direct investment (FDI) inows
and outows
Net FDI
= FDI inows minus FDI
outows
If FDI accepted from abroad > FDI made
abroad, then (+)
If FDI made abroad > FDI accepted from
abroad, then (−)
Changes in reser ve assets or ocial borrowing/lending
If (+) the reser ve assets decreased
(Reser ve assets include assets readily available to the central bank
If (−) then reser ve assets increased
for meeting balance of payments nancing needs; usually this refers
to US dollars but also gold etc.)
CA + K A + FA = 0
(Errors and omissions): balancing item (if above ≠ 0)
Table 4.5.2The three accounts of the BOP
163
L TA
DP ready
Research skills
Current account balances for ve countries
Determine the latest current account balance for ve countries,
noting the value of expor ts and impor ts of goods and services. Find
the information on the tradingeconomics.com website or any other
appropriate site.
A
current
and
A
account
services
current
plus
decit
net
account
results
income
surplus
if
plus
the
net
results
if
sum
of
current
this
net
exports
transfers
sum
is
is
of
goods
negative.
positive.
Interdependence bet ween the accounts
Let’s
and
ignore
also
account
The
goal
is
year)
or
M
CA
=
=
$1200.00
$
manage
from
answer
foreigners
what
if
$40.
is
with
reserves
that
a
this
the
of
must
the
bank
and
the
a
changes
sum
is
sum
in
not
the
are
all
the
foreign
is
it
if
is
why
is
there
a
be
have
item”,
at
an
Laylaland
(debits).
But
into
missing
The
answer
used
bank
$40
in
of
the
together
Laylaland’s
did
then
it
there
balance.
is
the
will
So,
ofcial
be
ofcial
abroad.
be
in
an
the
lend
of
the
$200,
they
decrease
BOP
reserves
because
to
Laylaland
into
be
that
account.
or
$1,200
equal
than
necessarily
surplus
borrow
we
“balancing
its
any
$1000.00
did
have
$40
central
must
exchange
must
must
from
nancial
to
still
necessary,
accounts
there
in
and
=
or
export
investment
insufcient,
and,
account,
zero,
That
nanced
the
decit
how
imports.
ensured
government
possibility
the
$160
month
spent
X
(credits)
This
Laylaland’s
of
issue
If
bank
reserves.
of
was
of
decit
the
accounts
issue.
the
account.
be
central
it
outows
its
nancial
must
found?
would
for
any
from
imports
$200
and
–F
A.
but
portfolio
Laylaland
inows
current
omissions.
BOP
decit
on
the
current
account)
Since
June,
inows
pay
=
account
the
expenditures.
current
(choose
in
more
and
that
revenues
investment
did
inows
Laylaland’s
the
and/or
the
the
in
nancial
there
If
way,
decit
reserves
CA
(credits)
is,
insignicant)
import
the
services.
was
direct
exchange
solve
by
than
and
capital
that
current
$200
$160?
investment
borrowing
a
Laylaland’s
account
and
of
the
June
investment
more
investment
so
of
and
sum
$1,000
Where
Laylaland
exchange
foreign
is
0
question
foreign
(dollar)
the
=
small
considering
collected
to
spend
only
simple:
the
current
In
of
were
foreign
foreign
if
were
Remember,
again
its
to
simple:
inows
Laylaland
The
exports?
is
F
A
goods
there
–200.00.
collected
by
of
is
ignoring
month
equal
imports
by
it
revenues
why
are
+
the
(as
little
Laylaland
services
on
we
CA
during
residents
The
164
why
country
and
(debits)
a
export
understand
or
that
the
goods
and
to
account
things
includes
(remember,
zero,
Assume
capital
simplify
only
accounts
equal
the
zero.
equal
If
there
current
by
in
account,
Remember
held
is
surplus
the
the
role
central
ofcially.
unavoidable
very
articial
bottom
entry
errors
of
that
the
solves
4.5
Unfortunately,
are
a
limited
country
(the
can
nervous.
The
currency
may
importantly,
account
the
foreign
US
is
have
it
Implic a t ion s
A
if
current
it
is
small
economy
T
o
the
as
a
as
set
up
the
It
This
may
more
to
a
do
It
to
not
increase
bonds.
and
of
nancing
current
future
If
the
credit
even
is
the
for
an
crisis.
but
persistent
that
be
a
The
most
current
import
its
there,
the
of
a
is
growing
long-term
and
as
is
growth
bonds,
factories—
currency
There
country
absorption.
stocks
such
the
especially
sign
country’s
exchange
the
rate
exports
current
inows
no
account
may
if
in
in
pressure
nancial
will
or
the
the
on
and
imports
import
worsen
are
investors
rates
will
depreciate.
will
if
shrink.
prices
may
policy-makers
pressures.
borrow
Growth
to
import
policy-makers
interest
rms
and
decit
increase
inationary
starts
cheaper
increase
situation
induce
state
or
to
will
less
slow
forced
to
to
to
buy
decrease
spend
down
as
it
adjustments
to
expenditure-reducing
labour
and
rising
correct
policies
to
from
and
that
domestic
AD
less
on
there
is
utility
the
to
state
of
sovereignty.
abroad
then
to
the
the
credit
economy’s
country,
attract
its
as
investors
to
face.
continue
Chronic
markets
imports.
for
ination,
can
all
long.
contribute
Policy-makers
imbalance.
They
the
They
uncompetitive
can
expenditure-switching
narrow
nance
international
on
required
as
order
downgrade
cannot
the
policies,
in
deprive
risk
they
decits
(such
economic
pressure
be
risk
economy.
rigid
of
may
more
would
account
exports
the
Moody’s,
rates
also
heavily
runs
put
assets
foreigners
loss
borrow
and
off
to
may
the
increased
and
sell
this
threaten
“ailing”
supply-side
to
harbours)
would
the
markets
uncompetitive
and/or
a
devalue
problem,
may
buy
from
makes
higher
decit,
interest
of
make
the
to
revenues
goods.
such
This
current
to
it
with
to
forced
are
product
a
implies
It
accounts.
the
The
and
increases
agencies,
sign
It
interests
problem
that
and
Persistent
a
a
account
higher
a
avoid
and
very
c ur r en t
greater
“trust”
willing
learned,
rates
forces
rating.
to
nanced
as
deal
airports
compensate
to
or
get
recession.
country
rating
GDP
.
lead
when
have
capital
a
debt
of
necessarily
nancial
ination.
revenues
foreign
of
decrease—the
households
risk
is
export
become
companies,
the
so
interest
durables
If
and
Remember
because
dollars)
lenders
below.
producing.
are
helpful
you
higher
also
country
depreciate.
prove
as
is
business
successfully
may
even
they
problem
expenditures
lead
it
decit
expensive,
However,
cause
any
issue
depreciate
root
not
foreigners
so
capital
currency
is
incomes
long-term
becomes
can
before
per sis t en t
decit
than
that
account
combined
a
it
of
adjustments
explained
of
higher
extent
current
the
as
long
make
proportion
more
prospects—and
to
is
reserves
de f ici t
account
consuming
so
signicantly
correct
This
case
only
must
to
must
special
for
country
decit.
ac c oun t
a
borrow
exchange
Can we impor t too much?
to
will
have
adopt
policies
decit.
165
C or r ec t ing
a
c ur r en t
ac c oun t
de f ici t
Expenditure-reducing policies
These
include
decreases,
imports
being
ination,
the
resulting
the
However,
and
the
decrease
absorbed.
country’s
decrease
current
slows
contractionary
then
in
account
such
down,
an
scal
in
Since
export
imports
monetary
a
income
decrease
in
and
increase
in
policies.
leads
AD
competitiveness
will
will
to
If
AD
fewer
also
decrease
increase.
exports
will
The
reduce
decit.
adjustment
incomes
unemployment
and
national
policy
decrease,
will
has
rms
its
fail
disadvantages.
to
grow
or
shut
Growth
down
increase.
Expenditure-switching policies
These
are
policies
that
imports
and
towards
imports
less
attractive,
A
sharp
depreciation
this
result.
less
attractive,
more
The
of
the
such
switching
which
or
a
will
also
goods
means
exports
expenditures
and
services.
making
devaluation
imports
from
Imports
also
are
trading
the
in
of
will
more
currency
more
become
away
They
them
the
become
the
may
not
more
lead
to
rate
expensive
increase,
rules
higher
from
have
cheaper
to
make
expensive.
will
expensive
as
will
the
any
be
achieve
and
abroad
if
of
prices
so
and
trade
risks.
benet
illegal.
together
ination.
with
quickly
violated,
tariffs
misallocation
dealt
will
carries
import
higher
effectively
route
considers
and
that
exchange
This
will
trade
appellate
inefciency
are
lower
become
WTO
is
exports
imposed.
partners
expense.
policy
pressures
benets
tariffs,
a
increase
inationary
WTO
only
but
at
competitive.
risk
with
Not
aim
domestic
then
be
lost.
barriers,
T
rade
If
any
such
frictions
comes
risking
at
as
with
their
sanctions
Protection
also
if
the
leads
to
resources.
Supply-side policies
T
ypically,
use
of
persistent
supply-side
uncompetitive
in
product
of
the
markets.
market
rules
The
may
to
■
and
key
use
decrease
state
Also,
unions.
be
economy.
markets,
regulation,
current
policies.
account
A
also
decit
require
is
a
There
may
be
too
businesses
may
be
burdened
may
labour
be
too
costs
regulations
to
decits
persistent
or
addressing
supply-side
monopoly
heavily
may
to
the
involved
high
and
in
an
power
excessive
the
to
of
current
the
of
monopoly
by
owing
presence
persistent
policies
power
be
much
sign
workings
rigid
labour
powerful
account
labour
decits
that:
render
product
markets
more
competitive
166
■
decrease
■
improve
labour
costs
incentives.
and
render
labour
markets
more
flexible
4.5
The
drawbacks
implement
they
are
as
are
that
often
powerful
implemented,
economies,
supply-side
though,
they
they
policies
domestic
take
are
long
are
interests
to
absolutely
have
difcult
block
an
to
them;
effect.
Can we impor t too much?
For
and
if
many
necessary.
Focus point
The
of
balance
currency
account,
account
and
must
payments
a
expenditures.
enough
investment
inows.
it
to
will
have
reducing,
It
account
important
investments.
earn
keeps
country.
capital
most
import
border
it
the
is
of
from
a
foreign
If
it
introduce
expenditure
it
of
broken
and
as
The
Since
track
is
the
all
nancial
primarily
nancial
country
and
into
to
pay
from
the
its
policies
to
correct
or
even
it
outows
current
The
export
records
for
its
such
cross-
and
persists
as
supply-side
current
revenues
imports
exports
imbalance
switching
and
the
account.
records
account
has
exchange
doesn’t
inows
down
then
expenditure
policies.
Key terms—test yourself
Dene these terms: balance of payments, credit item, debit item,
current account, nancial account, current account decit, current
account surplus, expenditure-reducing policies, expenditure-
switching policies.
167
4 . 6
T H E
G R E AT
D I V I D E
In this section you will learn about:
the meaning of sustainable development and the UN’s
➔
Sustainable Development Goals (SDGs)
➔
measuring development—commonly used indicators
➔
the relationship between economic growth and economic
development
barriers to growth and development—economic, social and
➔
political barriers.
The issue
Y
ou
are
and
developing
at
life
probably
around
countries
live
in
well
and
and
shelter,
This
barriers
the
T he
to
poor
wide
The
the
as
meaning
range
most
requires
a
human
balance
Sustainable
human
not
meet
must
generation
result
to
the
of
are
Some
eat,
and
inadequate
how
to
read
factors
are
food
or
and
that
therefore
its
act
as
responsible
de v elopmen t
concept
for
needs
our
age.
development
of
A
exists.
Commission
sustainable
the
of
development
present
generations
to
This
involves
in
the
therefore
might
needs.
have
next.
dimensions:
without
meet
their
own
means
both
of
necessitates
For
taken
the
into
are
needs
account,
of
to
given
future
maintain
impossible
supplies.
they
social
environment.
ability
it
and
promotion
and
the
failure
make
food
that
the
that
the
example,
could
sufcient
so
that
destruction
are
protection
economic
jeopardize
base
depleted
economic
environmental
them.
resource
be
three
and
generations
their
to
not
to
look
different
development
Brundtland
future
has
today
natural
the
of
in
a
conditions.
enough
of
take
explored.
central
the
people
know
and
developed
you
have
number
also
dened
which
future
generations
resources
168
to
adequate
future
of
of
between
actions
A
sustainable
progress
development
well-being
generations
an
does
not
if
1987).
well-being,
dimensions,
that
social
a
meets
ability
development
development,
is
of
that
that
the
do
sus t ainable
which
(Brundtland
Sustainable
and
is
Nations,
“development
needs”
of
than
concept
growth.
are
that
however,
they
divide,
not,
different
more
the
between
are
realize
development,
denitions
common
United
have
and
you
very
Others,
development
of
compromising
of
great
if
will
examines
and
distinction
under
homes,
economic
world’s
Sustainable
you
days
health
growth
the
Even
healthy.
section
to
of
world,
their
comfortable
relationship
for
the
start
clothed
write.
aware
countries.
for
Therefore,
available
from
one
4.6
T he
S us t ainable
De v elopmen t
The great divide
G o als
Watch this
TheSustainable
Development
Goals(SDGs)
are
17
global
goals
Search YouTube using these
set
by
by
the
theUnited
year
Nations
2030.
General
TheSDGsbuild
Assemblyin
on
the
2015
previous
to
be
met
Millennium
terms: michael green global goals
progress. Watch a 2018 TED talk
on the progress made towards
Development
Goals
(MDGs)
but
they
go
further
and
aim
to
achieving the SDGs.
promote
The
prosperity
goals
are
shown
L TA
DP ready
while
protecting
the
planet.
below.
Research and communication skills
One SDG investigated
Work in small groups to investigate an SDG. Each group chooses one
of the SDGs. Make sure that there is only one group investigating
a par ticular SDG. Each group searches online using this phrase:
sustainable development site:.un.org.
Look at the United Nations web page on the SDGs.
For your group’s SDG, investigate the progress that has been made
so far towards achieving that goal and the main challenges involved.
Present your ndings to the other groups.
Mea sur ing
Economic
but
what
de v elopmen t
development
exactly
development
is
improvement
in
is
a
it
is
and
an
aspect
how
can
we
multidimensional
living
standards,
of
sustainable
measure
concept
which
as
it?
it
involves
development—
Economic
refers
to
an
increased
per
169
capita
income
health
and
care
and
reduced
education,
can
that
dimension
L TA
DP ready
reductions
inequalities
development
indicators
levels,
of
be
the
poverty,
increased
of
income
measured
record
in
development,
or
employment
and
either
progress
wealth.
with
made
with
increased
the
the
of
to
opportunities
Economic
use
towards
use
access
of
a
single
particular
composite
indicators
Research and
that
are
summary
measures
of
several
dimensions
of
development.
thinking skills
Income levels in dierent
countries
1.
Search online using these
terms: World Bank map
income country. Select
the rst (WDI) web page.
Explore the map with the
World Bank’s classication
of countries by income
level.
Single indicators: per capita GDP or per capita GNI
Per
capita
information
a
positive
The
UN
GDP
the
the
low
level
per
high
for
a
keep
capita
GNI
for
a
to
some
on
GNI
to
this
is
records
income
of
For
and
is
low
$975
it
is
is
per
capita
example,
into
three
income.
per
between
country
there
well-being.
countries
below
country
as
and
basis.
place
provide
country,
income
capita
income
high
a
extent
income
systematic
middle
per
of
capita
countries
middle
and
per
income,
if
can
development
Bank
classify
uses
year
of
GNI
between
income
capita
per
capita
World
and
Bank
is
per
per
the
categories:
country
GNI
on
GNI
World
main
or
correlation
and
and
$1
1,905
a.
GDP
A
year.
$976
above
and
$1
1,906.
In which income group
The
middle
income
group,
which
is
quite
big,
is
split
between
does the majority of
the
upper
middle
income
and
the
lower
middle
income,
with
the
the world’s population
dividing
line
at
$3,855.
belong to?
T
o
b.
have
a
basis
of
comparison,
however
,
we
need
to
convert
each
In which regions
country’s
per
capita
income
gure
to
a
common
currency,
which
are the low-income
is
typically
the
US
dollar
.
Y
et,
prices
of
goods
and
services
can
vary
countries mostly
signicantly
across
countries.
A
haircut
in
Lagos
is
much
cheaper
concentrated?
than
2.
a
haircut
in
New
Y
ork.
Cost
of
living
differences
must
be
The United Nations has
considered
in
the
conversion
of
per
capita
income
to
US
dollars.
identied a subgroup
Therefore,
instead
of
the
market
exchange
rate
we
use
“PPP
dollars”
.
within the low-income
PPP
stands
for
“purchasing
power
parity”
dollars.
These
are
dollars
countries called the Least
of
equal
purchasing
power;
that
is,
they
buy
the
same
basket
of
Developed Countries. Use
goods
and
services
that
the
national
currency
buys.
Therefore,
we
the web to nd out which
can
classify
economic
development
based
on
GDP
or
GNI
per
capita
countries belong to this
expressed
in
PPP
dollars.
The
problems
with
this
system
are
that:
sub-group. What are the
■
the
cost
of
living
varies
a
lot
even
within
a
country
so
using
PPP
issues these countries
is
still
quite
imprecise
face that have put them
in the least developed
■
countries group?
increases
improved
income
in
per
capita
living
can
be
income
standards,
so
do
not
necessarily
classifications
imply
based
on
per
capita
problematic.
Other single indicators
According
to
the
denition
of
economic
development,
health
care
Internal link
and
education
are
important
parts
of
a
country’s
development
There is more on per capita income
process.
Keeping
track
of
health-related
and
education-related
in section 3.1.
indicators
■
helps
Health-related
life
births),
prevalence
49years),
(per
monitor
indicators
expectancy
live
170
to
at
birth
maternal
of
HIV
10,000
people).
include:
(years),
mortality
(%
physicians
progress
of
in
health
infant
ratio
population
(per
these
10,000
areas.
expenditure
mortality
(per
aged
people)
(per
100,000
15
hospital
capita,
1,000
live
between
or
per
births),
and
beds
4.6
Education-related
■
know
how
people
to
aged
indicators
read
25
and
years
school
age
children
L TA
DP ready
write),
and
enrollment—primary,
include:
mean
older),
secondary
enrolled
in
literacy
years
rate
of
and
tertiary
who
schooling
pupil–teacher
each
(%
ratio,
The great divide
(of
school
enrollment—(%
of
level).
Thinking , research and communication skills
Indicators—data from three countries
Choose three countries from each of the World Bank income groups.
Use the World Bank , the UN, the World Health Organization (WHO) or
perhaps the indexmundi websites for the following research.
1.
Find the GNI per capita in PPP dollars for each country and enter
the data into a table.
2.
Choose two health-related and two education-related indicators
and collect data on each of your chosen countries. Add this data
to your table. Compare and contrast the dierent indicators
across the dierent countries.
a.
Identify whether there is any country with low GNI per
capita that scores well in health-related or education-related
indicators.
b.
To what extent is it safe to infer the level of development of
each country from this data?
c.
There
the
Share your data and observations with the rest of the class.
are
many
different
other
aspects
single
of
indicators
economic
that
can
be
development,
used
such
as
to
measure
energy
Search the web
consumption
population
per
or
capita,
newspaper
percentage
of
GDP
circulation
derived
from
per
1,000
each
of
sector
of
the
Search using these terms:
World Bank development
economy
and
from
the
urban
population.
No
single
indicator
is
indicators. Explore the dierent
powerful
enough
to
illustrate
the
complex
issue
of
development
indicators that are available.
adequately.
It
is
therefore
preferable
to
rely
on
composite
indices.
Composite indicators
The
most
widely
Development
achievements
of
to
by
indicators
■
life
■
mean
■
GNI
Each
the
HDI
years
per
possible
value
successful
of
in
(in
US$
the
0
to
a
is
the
measures
terms
These
1
and
of
health,
three
Human
average
education
dimensions
are
and
measured
and
and
1
between
being
the
years
is
then
capita
it
distribution
and
so
ranked
of
1,
schooling
an
gender
with
The
each
0
as
a
being
composite
country
accordingly.
income
remains
or
0
highest.
dimensions,
per
However,
expected
PPP).
value
three
displacing
income
in
indicator
HDI
birth
value
development.
consider
at
takes
of
from
services.
schooling
capita
average
The
of:
of
dimension
composite
(HDI).
population
and
expectancy
lowest
is
goods
a
access
the
used
Index
as
it
index
receives
The
summary
average,
the
HDI
an
was
measure
does
not
inequalities.
171
L TA
DP ready
Thinking and research skills
HDI ranking
1.
Search online using these terms: HDI ranking. Go to the United Nations web page where you will nd a
list of all countries ranked according to their HDI value.
2.
a.
Record some rankings that surprise you.
b.
Were you expecting these countries to have scored higher or lower?
GNI per capita is included in the HDI measurement. There are countries with a higher HDI than GNI per
capita rank and others that have a lower HDI than GNI rank . Explain what this implies.
Other composite indicators
T
o
overcome
Nations
Inequality
the
IHDI
HDI,
there
The
the
the
to
genders
no
in
The
Another
Internal link
for
losses
three
GII
in
in
the
in
IHDI
(GII)
health,
HDI,
two
the
United
further
and
the
Gender
same
each
the
and
that
the
loss
in
The
from
would
and
and
in
girls
the
development
of
as
IHDI
inequality.
be
inequalities
women
education
dimensions
arise
HDI
measures
Often
three
dimension.
equal.
between
are
labour
women
due
to
areas.
indicator
the
are
the
(IHDI)
development
the
Index
captures
composite
nations
HDI
in
dimensions.
these
is
of
developed
inequality
inequality
against
in
development
well
development
Inequality
discriminated
inequalities
Programme
adjusted
capture
Gender
shortcomings
(GII).
measures
were
market.
the
Inequality-adjusted
Index
but
attempts
If
of
Development
indicators:
The
some
Happy
doing
at
that
could
be
Planet
Index
(HPI)
achieving
long,
used
to
that
happy
track
measures
and
how
sustainable
Section 3.1 has more information
about the Happy Planet Index (HPI).
lives
for
their
people.
Ec onomic
gr ow th
and
de v elopmen t
Watch this
Economic
growth
refers
to
increases
in
the
real
GDP
of
an
economy
Search YouTube using these terms:
Marks happy planet index. Watch a
TEDx talk by Nic Marks, the creator
through
A
time.
country
Growth
may
grow
does
not
without
necessarily
any
involve
development
development.
objective
being
of the HPI, on the impor tance of
met.
The
UN
Development
Programme
has
described
four
types
of
measuring success dierently.
growth
■
TOK
jobless
do
What knowledge questions might
that
not
impede
growth,
the
development
where
process.
employment
They
are:
opportunities
for
the
poor
expand
■
ruthless
growth,
■
futureless
where
income
inequality
widens
be encountered in constructing a
composite indicator to measure
development?
natural
■
As
resources
voiceless
such,
growth,
economic
development
growth.
absence
provide
will
Some
of
developing
where
where
growth
to
in
the
basic
the
countries
environment
individual
does
not
However,
economic
though,
the
is
degraded
and
depleted
occur.
growth
access
long-term,
172
growth,
social
term,
growing.
may
if
services
development
are
guarantee
that
development
development
short
empowerment
the
for
be
the
possible
poor.
behind.
economic
usually
policies
process
falls
requires
in
the
followed
In
the
necessitates
that
4.6
B ar r ier s
There
are
growing
a
to
gr ow th
number
and
of
and
factors
The great divide
de v elopmen t
that
prevent
some
countries
from
developing.
A pover ty cycle
Poverty
shown
which
locks
in
is
cannot
Figure
spent
save
necessary
natural
is
low
individuals
4.6.1.
Poor
entirely
money.
and
on
The
investments
physical
productivity
into
poverty
people
live
necessities.
absence
to
be
of
made,
capital
that
a
to
on
a
This
low.
low
or
poverty
very
low
means
savings
which
remain
leads
cycle
does
As
a
income
so
they
allow
that
result,
and
income,
that
not
implies
trap,
for
the
human,
there
they
are
Low
trapped
more
The
in
a
situation
where
their
poverty
leads
income
to
poverty.
poverty
cycle
is
transmitted
across
generations
as
Low
children
which
are
caught
limits
earnings.
barrier
longer
both
The
to
in
the
along
generations’
poverty
growth
trap
and
cycle
with
their
possibilities
therefore
development
for
poses
both
in
a
productivity
Low
saving
parents,
higher
signicant
the
short
and
Low
the
term.
investment
Figure 4.6.1The pover ty cycle
Economic barriers
Rising
Rising
not
economic
inequality
have
access
deprived
The
to
of
poor
invest
in
business.
domestic
goods
High
and
limited
their
This
that
education
skills
or
children’s
results
in
a
large
and
health
access
to
education
also
of
the
population
services.
credit.
or
reduces
reduced
and
part
The
does
economy
is
talents.
no
inequality
investments
and
lower
funds
to
start
the
cannot
or
overall
and
demand
They
expand
a
savings
resources
for
borrow
in
the
available
domestically
for
produced
services.
inequality
unrest
to
Rising
economy.
implies
their
have
inequality
and
also
political
increases
corruption.
instability,
It
discouraging
may
lead
domestic
to
social
and
foreign
Internal link
direct
investment
(FDI).
These
factors
lead
to
lower
growth
rates
Foreign direct investment (FDI) is
and
lower
incomes
for
the
poor,
thereby
restricting
economic
covered in section 4.7
.
development.
Lack
of
access
Infrastructure
transportation
to
infrastructure
refers
to
systems
telecommunications,
supplies,
sanitation
facilitator
and
of
schools
and
sewerage
countries,
is
of
of
limits
such
gas),
Infrastructure
a
poor
access
road
to
as
airports),
and
infrastructure
example,
and
and
technology
water
is
limits
a
major
growth
network
local
markets,
facilities.
funded
governments
parts
ports
capital
(electricity
systems.
Lack
For
costs
appropriate
physical
railways,
systems
activity.
prospects.
health
Infrastructure
many
(roads,
transportation
and
economy’s
energy
economic
development
increases
the
and
Africa
by
government
may
the
not
most
have
basic
but,
the
in
developing
required
infrastructure
resources.
does
not
In
exist
173
or
is
the
not
lack
suited
can
maintained.
of
to
be
access
a
of
Lack
employment,
levels
of
developing
limits
the
education
access
to
higher
more
facilities
risk
living
are
are
be
most
in
of
large
workers
This
This
and
in
that
labour-
there
less
is
less
growth
is
a
developing
adequate
in
which
health
prevents
and
people’s
decreased
labour
opportunities,
skilled
is
individuals)
absolutely
long-term
growth
better
and
necessary
and
health
to
improved
and
goals.
people
sector.
the
rely
growth
income
of
As
a
live
result,
production
on
a
and
single
and
and
boost
rural
of
commodity.
does
growth
areas
developing
export
development.
inelastic,
to
in
This
Demand
not
and
grow
for
fast
development
such
in
as
to
lower
cannot
barrier
the
their
world
because
it
EU
prices.
leads
protect
limits
the
and
their
Japan,
in
to
to
lower
the
countries
of
impose
from
developing
growth
and
lower
for
agricultural
also
of
international
incomes,
economies
obstructs
provide
form
opportunities
they
ability
the
Developing
exports
from
farmers,
and
mainly
their
Apart
offer
markets
the
employment
poverty.
further
US,
farmers,
expand
lower
tariffs—to
markets
farm
support
trade
foreign
countries
economy
lies
unregulated
Unregistered
unlicensed
taxi
outside
and
activities
drivers
However,
there
untaxed
include
and
is
the
no
often
formal
one
economic
the
jobs
of
become
protection
for
a
and
is
where
activities
street
way
to
development.
economy
unregistered,
survive.
many
low,
sector
countries
economies
This
informal
place.
they
international
Informal
are
technological
achieving
majority
even
to
support
increased
competition.
of
international
investment,
developed
access
to
results
barriers—mainly
174
usually
employment
development
in
In
poverty
fewer
lack
primary
or
or
formation
that
the
is
economies,
agricultural
to
on
Since,
countries.
compete;
markets.
the
primary
the
exports
agricultural
cannot
the
capital
results
fewer
productivity,
obstacle
access
subsidies.
of
capital
high-income
Developed
facing
countries,
major
developing
and
mostly
therefore
maintain
This
diseases,
themselves
in
to
available;
Remember
on
human
development.
overspecialized
primary
enough
Lack
labour
commodities,
a
not
(because
employed
have
primary
The
technologies
abundant
are
means
and
is
technology
workers).
relatively
poverty
of
education.
Human
higher
developing
nations
and
spreading
Dependence
that
(relying
on
the
is,
general,
technologies
resources
are
and
standards.
education
in
is
infrastructure
that
In
technologies
more
levels
individuals
of
poverty.
achieve
growth
health
improvements
can
(relying
of
capital
countries,
necessary
productivity,
and
technology;
labour
appropriate
income,
lack
production.
appropriate
human
economic
nations,
In
the
development.
Low
In
of
less
to
capital-intensive
countries,
production,
intensive.
and
into
of
labour-intensive
developing
factor
factors
distinguished
and
related
appropriate
country’s
machines)
most
to
Closely
take
vendors
for
workers,
people
who
may
4.6
become
while
subject
limited
result,
living
informal
are
to
exploitation
possibilities
standards
economy
and
exist
for
for
these
remains
be
exposed
education
workers
unregulated
and
are
the
to
health
dangers,
training.
low.
As
The great divide
long
development
As
as
a
the
prospects
limited.
Indebtedness
High
levels
countries
of
as
spending
indebtedness
their
and
borrowing.
repayments
and
available
invest
are
all
to
can
necessary
characterize
governments
High
mean
in
for
had
debt
that
health,
a
the
developing
history
of
levels
require
large
government
education
economic
many
past
growth
and
and
has
high-level
debt
reduced
infrastructure,
funds
which
development.
Geography
The
a
geographic
barrier
the
to
poorest
Examples
Africa,
which
and
is
regions,
them
to
for
huge
and
in
to
a
and
around
countries
depend
and
countries
This
and
makes
low-cost
are
in
geographic
as
cyclones,
number
of
small
are
and
it
be
for
in
In
Economic
trade,
landlocked
mountainous
particularly
locations
island
as
of
landlocked.
Laos.
difcult
manufacturing.
storms,
act
many
international
costly
may
such
world
landlocked.
on
may
example,
Bhutan
are
heavily
difcult
Bolivia.
farming
the
Nepal,
countries
For
that
oods
Also,
are
and
economies
for
some
exposed
droughts.
such
as
the
Haiti.
and
developing
on
crop
labour
tropical
endemic
of
more
countries
effect
even
in
climates
all
countries
landlocked,
example
applies
T
ropical
a
not
developing
development.
Afghanistan,
third
disasters
Philippines
Almost
one
engage
natural
This
are
many
and
development
If
developing
to
Asia
signicantly
countries.
of
growth
developing
in
roughly
growth
location
their
endemic
countries
climates.
diseases.
have
productivity,
productivity.
Climate
Places
are
tropical
water
These
also
that
diseases
scarcity
factors
plays
an
warm
climates.
tend
or
to
year,
has
availability
be
important
all
Climate
problematic
role
such
as
for
Watch this
Search YouTube using these terms:
tropical
Sachs Sustainable Development
Lecture 4 Chapter 2. Listen to
Africa,
generally
have
very
high
year-round
malaria
transmission.
a discussion of geography and
Since
development
depends
on
a
healthy
population,
regions
with
climate as barriers to development.
a
heavy
disease
P oli t ic al
burden
and
struggle.
s ocial
b ar r ier s
Weak institutional framework
There
are
inuence
many
economic
developing
and
does
not
in
health,
countries
are
are
low
and
and
institutions
development.
Specic
However,
framework
reasons
that
are
is
in
rather
given
weak
below.
structures
by
governments
infrastructure
and
social
institutional
this.
needed
education,
growth
the
for
taxation
revenues
economic
allow
legal
growth
countries,
Ineffective
T
ax
economic,
and
development.
because
incomes
make
other
T
ax
are
to
areas
revenues
low.
investments
Also,
important
in
for
developing
the
tax
system
175
is
ineffective
in
collecting
tax
procedures,
tax
exemptions
and
tax
authorities.
corrupt
Banking
Banking
services
as
producers,
growth
it
Property
in
the
to
wealthy
does
to
credit
development,
and
natural
many
not
farmers
and
access
and
physical
system
properly,
and
growth
human,
banking
for
due
complicated
with
political
inuence
system
economic
in
revenues
are
as
capital.
developing
traders.
Y
et
important
allow
the
countries
accommodate
and
very
they
The
poor
result
a
to
investments
commercial
does
and
is
for
not
function
small-scale
major
restraint
on
development.
rights
Search the web
Property
rights
involve
laws
that
ensure
legal
rights
to
ownership
Search using these terms:
and
transfer
of
ownership
from
one
owner
to
another.
In
De Soto proper ty rights Reuters.
Read a shor t ar ticle on the
impor tance of proper ty rights in
developing
countries,
and
enforced.
loss
of
This
property
leads
to
rights
lower
are
usually
investment,
not
as
well
there
is
dened
risk
of
the developing world.
the
investment,
Gender
inequality
In
developing
many
inequalities
social
with
the
by
To what ex tent can one condently
claim that an advanced economy is
in
corruption
country
is
economic
and
look
from
girls
having
and
compared
growth
growth
poor
good.
growth.
inequality.
limited
with
and
In
and
Gender
access
men
and
to
boys,
development.
if
development
governance.
practice,
they
incompetence
corruption,
growth
gender
for
back
inefciency,
and
limit
corruption
hold
suffering
corruption,
and
turn
is
opportunities
levels
policies
governance
women
in
there
consequences
governance
economic
TOK
result
can
countries
economic
signicant
Poor
High
and
which
carried
to
or
As
ideas,
may
all
of
be
the
damaged
these.
extremes,
because
can
Poor
stop
development.
a developed economy?
The
barriers
described
above
do
not
apply
equally
to
every
country.
Focus point
Thinking ,
Economic
L TA
DP ready
development
is
a
multidimensional
concept
that
refers
research and
to
an
improvement
in
living
standards
involving
increases
in
per
communication
capita
income
levels,
reductions
in
poverty,
increased
access
to
skills
health-care
Barriers in a developing
country
as
well
as
and
education,
reduced
growth
does
though
economic
not
increased
inequalities
guarantee
of
that
development
employment
income
economic
requires
and
opportunities,
wealth.
Economic
development
economic
will
growth.
occur,
There
Work in a small group. Choose
are
many
factors
that
act
as
barriers
preventing
countries
from
both
a developing country. Carry
growing
and
developing,
such
as
rising
economic
inequality,
lack
out an investigation exploring
of
access
to
health
care,
education,
infrastructure
and
appropriate
which barriers have been
technology
as
well
as
geography
and
climate.
more signicant in holding
back this country in its growth
176
and development process.
Key terms—test yourself
Present and discuss your
Dene these terms: sustainable development, economic development,
ndings in class.
Human Development Index (HDI).
4.7
4 . 7
I S
T H E R E
A
W AY
Is there a way out?
O U T ?
In this section you will learn about:
➔
foreign direct
➔
provision of merit goods
➔
women’s empowerment
➔
redistribution policies
➔
debt relief
➔
the World Bank and the
investment (FDI)
➔
foreign aid
➔
international trade
strategies
➔
diversification
➔
market-oriented supply-side
International Monetary
Fund (IMF)
policies (SSPs)
government inter vention
➔
➔
social enterprise
➔
microfinance
versus market-oriented
approaches.
The issue
This
section
countries
they
can
explores
overcome
use
to
pursued
signicant
benets
is
For eig n
Y
ou
are
are
country
dir ec t
are
in
facilities
and
with
rms
country.
a
in
strategies
in
investment
FDI
come
with
bring
the
designed.
corporations
countries.
Siemens
presence
one
and
more
Unilever.
FDI
in
investing
percentage
Some
than
(FDI).
country
includes
controlling
can
(F DI)
several
from
were
that
path.
HSBC,
their
direct
always
which
The
policies
strategies
not
multinational
operate
by
and
some
the
back,
development.
does
easy
developing
them
of
one
refers
to
productive
in
new
the
shares
of
companies.
FDI
would
access
mean
MNCs
operations
gain
an
Motors,
foreign
countries.
their
They
Kia
acquiring
local
developing
■
that
establish
another
Encouraging
expand
to
when
not
and
Also,
help
holding
approaches
inv e s t men t
investment
facilities
is
can
are
application
familiar
A
T&T
,
able
through
long-term
existing
out
that
that
growth
the
debatable.
their
companies
examples
of
expected
way
probably
(MNCs),
MNCs
as
were
the
their
some
highly
costs,
that
Therefore,
of
strategies
barriers
promote
appropriateness
be
the
the
to
in
more
have
MNCs
good
developing
more
markets
are
attracted
reasons
to
be
to
willing
to
nations.
and
so
they
can
expand
their
sales.
■
They
lower
■
If
can
in
lower
involved
rich
costs
developing
in
natural
of
production,
as
labour
costs
are
usually
countries.
extractive
resources
of
activities,
oil,
MNCs
bauxite,
can
copper
benefit
or
other
from
the
metals
and
An International Technology Park in
minerals
found
in
developing
nations.
Bengaluru, India
177
In
order
within
to
the
attract
developing
■
economic
■
large
■
public
and
and
profit
policy
certain
with
conditions
country.
political
growing
These
must
exist
or
be
created
include:
stability
markets
favourable
tax
treatment
and
ease
of
repatriation
■
low
■
high
■
infrastructure
■
membership
labour
costs
levels
avoid
■
FDI,
of
human
such
in
capital
as
free
roads
trade
and
and
areas
labour
ports
or
productivity
or
telecommunications
trading
blocs
to
tariffs
clearly
defined
property
rights
and
a
functioning
legal
system.
How does FDI help growth and development?
FDI
can
increase
employment
countries
as
The
workforce
local
creation
bring
and
the
improves
improvements
may
decit.
If
tax
funds
be
the
development
All
these
there
■
of
are
The
are
to
process.
of
Lastly,
can
In
all
and
the
increase
leads
addition,
This
and
of
also
the
inows
of
FDI
new
adopted
to
technological
and
a
taxes
trade
MNCs,
government
growth
which
as
exchange,
imports
assist
savings,
to
country
provide
will
can
well
and
skill
contributes
foreign
needed
facilities.
to
FDI
as
learned
developing
that
production
which
be
source
much
the
areas
their
developing
know-how,
capital
a
increase
other
country
are
in
businesses.
human
nance
will
in
can
local
inows
used
spend
developing
in
capital.
which
and
in
training,
managerial
government
revenues
to
amount
FDI
workers
receive
human
and
workforce
improvements.
which
local
may
technologies,
local
further
then
hire
organizational
production
by
MNCs
opportunities
and
funds
will
with
the
into
the
increase
the
investment.
improvements
contrasting
skills
used
of
to
the
fill
present
the
positive
results
of
FDI,
but
aspects.
local
only
workforce
the
low-skill
may
not
improve
positions
and
no
if
workers
training
is
provided.
■
The
technology
inappropriate,
■
MNCs
may
importing
domestic
■
The
tax
should
■
MNCs
hurt
local
contribution
as
in
a
use
firms
of
result
their
directions
such
as
environmental
178
creating
intermediate
may
process,
not
may
be
capital
intensive
employment
by
instead
thereby
positions.
eliminating
products
and
competition
of
buying
and
them
by
from
suppliers.
be,
policies
brought
MNCs
of
may
favouring
economic
power
unfavourable
through
protection
be
tax
to
weakening
laws.
considerably
less
than
it
conditions.
to
influence
the
government
development
labour
protection
laws
or
4.7
■
In
many
cases
the
operation
of
MNCs
has
caused
Is there a way out?
environmental
Search the web
damage
in
the
developing
country,
which
is
against
both
Use the web to nd information
development
and
sustainability.
about Shell’s operation in
These
FDI
facts
the
suggest
that
development
although
prospects
growth
of
the
may
country
come
may
about
not
through
necessarily
Nigeria. There are opposing
views. To what ex tent was
Shell’s presence in the country
improve.
benecial? What might be
the negative aspects of its
operation?
For eig n
Foreign
in
the
aid
aid
form
services
in
transfers
loans
to
refers
of
be
with
When
form
of
gifts.
not
be
■
considered
as
bilateral
Bilateral
or
aid
the
Aid
may
economy
NGOs
and
are
aim
Oxfam,
but
aid
that
also
is
developing
of
selling.
foreign
aid,
lower
Note
they
than
countries
goods
non-commercial,
and
at
to
transfer
governments
one
to
donor
the
involves
Nations,
come
provide
are
the
as
that
must
market
and
the
in
be
order
for
offered
interest
in
rates
periods.
of
donor
Assistance
from
the
countries
(ODA)
it
and
is
can
of
the
international
World
to
the
pursuing
to
Earth
other
aid
and
Bank
public,
WWF
smaller
from
organization
or
the
developing
one
IMF;
aid
flows
nation.
for
the
directly
are
such
organizations
objectives
the
flows
country.
non-governmental
services
many
country;
developing
an
organization
Friends
there
the
organizations
to
of
is,
funds
to
Development
involves
United
through
from
Aid
of
multilateral.
Multilateral
as
part
repayment
Ofcial
or
buying
terms—that
comes
to
advanced
■
involve
longer
aid
referred
transfer
grants,
concessionary
and
the
or
the
do
to
loans
public
or
that
interest
indirectly.
well-known
organizations
(NGOs).
NGOs
serve
similar
purposes.
Aid
is
that
is
aims
food,
aid
usually
offered
to
save
water,
may
violent
and
be
form
shelter
ODA
humanitarian
and
ensure
and
in
health
care.
emergency
natural
growth
also
access
and
For
to
development
development
Humanitarian
necessities
example,
such
aims
or
NGOs.
basic
situations
disasters
aid
by
to
aid
as
from
earthquakes
developing
objectives
aid
as
humanitarian
resulting
oods,
help
such
aid
and
countries
can
take
the
of:
a
aid,
where
of
aid,
economy,
tied
a
the
funds
particular
must
project
be
used
such
to
as
a
finance
dam,
a
the
road
hospital
programme
the
■
or
of
Development
construction
■
and
provided
their
form
through
conicts
project
or
the
lives
tsunamis.
achieve
■
in
aid,
donor
where
such
where
the
as
the
funds
health
funds
care
must
are
or
be
used
to
support
sectors
of
education
used
to
buy
imports
from
the
country.
179
Foreign
the
aid
views
is
a
that
highly
exist
debated
on
foreign
topic.
T
able
4.7.1
shows
some
of
aid.
Positive views
Negative views
Aid is linked with higher growth
Aid can lead to dependency, as
rates.
it creates the need for more and
more aid.
Aid can help developing countries
Aid may be abruptly terminated if a
escape the pover ty trap.
donor ’s budget changes.
Aid is eective when it is narrowly
Aid can be ineective when it is
targeted to specic pro-development
given to countries with corrupt
projects and objectives, such as
governments.
the prevention and elimination of
certain diseases.
Search the web
Aid is eective when it is
Aid can be ineective when it
reinforced by appropriate domestic
induces countries to postpone
policies and institutions in a non-
improvements of macroeconomic
corrupt government environment.
conditions.
Aid is eective when it is not
Aid can be ineective when the
tied to buying products from
technologies transferred and the
donor countries.
advice given are inappropriate.
Table 4.7
.1Positive and negative views of foreign aid
Search using the terms: Nobel
DP ready
L TA
prize Duo inter view.
Thinking , research and communication skills
Read or listen to the inter view
with Esther Duo, Economics
Foreign aid
Nobel prize winner in 2019,
together with Abhijit Banerjee
Watch this
and Michael Kremer. They
applied the randomized control
trial approach in order to learn
Search YouTube as follows to watch three videos.
■
Search using these terms: Sachs Ocial Development Assistance.
about the eectiveness of
Watch Jerey Sachs talking about the impor tance of foreign aid.
small-scale policy inter ventions
■
Search using: Easterly on foreign aid.
in helping improve the lives of
Watch an inter view with William Easterly arguing that aid does more
some of the world’s poorest
harm than good.
households.
This will give you an additional
■
Search using: Moyo Aid Tedx Brussels.
insight as to whether aid is
Watch Dambisa Moyo’s argument that aid has harmed the
eective or not.
African Continent.
1.
Make a list of the arguments you heard on the three videos that
you consider to be impor tant.
2.
As a class, discuss whether aid helps developing nations or not.
3.
The Global Fund to Fight AIDS, TB and Malaria (GFATM) is a form of
ODA. Investigate how this aid programme works.
a.
Explain the programme’s objectives.
b.
Analyse whether it has been successful in meeting
its objectives.
TOK
To what ex tent are developed nations morally obliged to assist developing
nations through foreign aid?
180
4.7
In t er na t ional
Developing
the
trade
t r ade
countries
strategies
can
Is there a way out?
s t r a t e g ie s
base
explained
their
growth
and
development
on
below.
Impor t substitution
Import
substitution
industrialization)
manufacture
aiming
goods,
to
and
that
the
entry
At
of
in
as
Latin
for
has
sector
can
some
parts
industries
employment
usually
of
may
not
the
use
by
and
by
a
in
is
is
Lastly,
to
overvalued
of
on
low.
create
primary
inefciency
exchange
poverty
established
methods
jobless
to
the
with
newly
are
developing
attempt
overvalued
the
to
established
inputs
increase
production
leading
quotas
kept
an
shoes,
Import
reliance
the
may
or
produced
newly
associated
Also,
to
and
number
Africa
which
population.
opportunities
the
rate
reduce
strategy
capital-intensive
followed
tariffs
manufacturing
and
thereby
textiles
industry.
as
protect
practised
exports,
as
begins
domestically
exchange
competition.
primary
such
such
to
Asia
a
substitution
country
these
imported
and
a
domestic
the
been
such
reduces
harm
its
and
time,
America,
Nevertheless,
protection
rate
imports
import
goods,
barriers
necessary
manufacturing
sector.
trade
as
where
with
promote
same
substitution
countries
imports
of
the
known
strategy
consumer
requires
prices
Import
a
simple
therefore
industries.
so
a
substitute
substitution
prevent
(also
is
growth
limiting
that
is
development.
Expor t promotion
Export
to
achieve
the
by
promotion
rst
and
government’s
rms
state
invest
in
is
to
development
and
communications
may
the
a
promotion
not
always
economy
recession,
barriers
export
the
revenue.
may
sector
will
the
be
by
For
enjoy
a
larger
grants
of
that
for
if
are
those
of
tax
trading
may
as
it
a
can
research
in
transport
countries,
on
exports
partners
but
as
into
T
rade
exports
the
this
makes
go
affected.
hurt
in
be
production.
worsen
involved
national
to
The
exemptions
well
strongly
East
exporting
example,
assist
may
help
workforce,
as
many
economies
distribution
share
For
dependence
instance,
while
and
the
can
the
China.
promotion
can
was
followed
as
course,
It
areas.
Japan
was
(known
export
skills
economies
income
behind
and
innovation,
Strong
developed
The
left
the
attempts
exports.
of
strategy.
successful
case.
exporting
imposed
sector
been
vulnerable.
for
key
infrastructure
has
be
in
to
its
strategy
investment
lead
country
Singapore
important
can
a
including,
development
improve
that
this
and
investments
and
Export
Kong
where
expanding
countries
subsidies,
education
by
adopted
very
and
large
strategy
growth
have
Hong
role
making
trade
other
growth
with
while
to
T
aiwan,
Tigers)
successful
a
economic
country
Korea,
Asian
is
the
and
rural
exporting
income.
Trade liberalization
T
rade
liberalization
refers
to
the
reduction,
or
complete
removal,
Internal link
of
protectionist
measures
that
prevent
free
trade,
such
as
tariffs,
See section 4.1 on free trade.
quotas
and
subsidies
to
domestic
producers.
181
This
will
allow
international
T
ogether
developing
markets
with
all
the
liberalization
can
liberalization
on
lack
skills,
means
still
its
that,
even
a
with
shares
in
greater
may
and
not
are
greater
range
world
of
to
expand
greater
benets
for
own
narrow
enjoy
other
allow
technology
export
export
and
countries
of
export
free
be
access
to
products
primary
global
and
Y
et,
trade
Developing
the
in
trade
growth.
enough.
on
exports
revenue.
trade,
economic
focused
their
markets,
will
countries
sector.
they
therefore
This
will
have
low
trade.
Economic integration
Regional
integration
benecial
market
of
the
for
a
each
the
Examples
level
include
the
Latin
a
a
Paraguay
group
of
attempts
have
21
of
in
the
nations
forming
while
infrastructure
is
and
Free
trading
avoid
Argentina,
costs
are
obstacles
can
markets
and
countries
(LAFT
A),
Brazil,
Uruguay,
Cooperation
Still,
developing
and
also
economies.
Ocean.
organizational
transport
It
developing
Association
among
the
political
developed
Pacic
prove
potential
countries’
greater
Economic
the
blocs
signicant
the
T
rade
may
the
countries.
among
among
border
to
of
developed
with
with
Asia-Pacic
that
size
helps
on
integration
union
countries
the
developed
countries
America
and
of
negotiations
customs
encountered
problems,
rm
dependence
economic
MERCOSUR,
and
of
developing
increases
barriers
member
power
of
bloc
exporting
providing
bargaining
among
trading
protectionist
decrease
while
as
(APEC),
many
countries
administrative
especially
high
since
poor.
Diversication
One
of
face
is
the
products.
and
This
major
their
Diversication
services
would
economic
higher
that
to
earnings.
allow
range
countries’
will
the
be
of
a
involves
of
skills
may
range
broadening
to
are
benet
Also,
will
create
new
technologies
from
they
jobs
in
to
and
stabilize
countries
of
the
able
products
demand.
which
and
developing
narrow
countries
economies
volatility,
of
many
on
manufactured
Diversication
However,
while
such
as
elasticity
price
improvement
broader
that
developing
growth
income
subject
problems
over-dependence
agricultural
range
will
no
and
can
to
have
longer
and
exports
benets
will
of
may
no
not
longer
guarantee
be
specialization
subject
in
the
that
to
the
developing
trade
form
of
protectionism,
efciency
L TA
Thinking and communication skills
Trade strategies
Discuss the following question in class. Which trade strategy
do you nd most eective in terms of encouraging growth and
182
to
the
production.
diversication
development?
be
export
lead
support
lost.
DP ready
goods
worldwide
services
incomes
order
of
produce.
4.7
Mar k e t- or ien t ed
The
idea
markets
for
behind
are
the
market-oriented
most
increase
costs
and
is
Labour
aim
to
Also,
labour
for
(SSPs)
growth
are
note
developing
S ocial
Social
and
is
in
that
turn
facing.
enterprise,
as
social
has
part
of
can
growth.
rms
of
More
to
cut
decreases
output.
In
market-oriented
led,
it
at
and
both
SSPs
is
effective
the
to
can
cases
and
costs
increases.
growth.
in
the
long
problems.
term,
monopoly
to
pricing.
afford?
related
to
particularly
income
short
SSPs
labour
accelerate
short-term
in
lead
result,
employment
be
with
countries
a
and
least
can
This
As
only
dealing
and
where
refers
it
can
For
to
inequality
the
labour
damaging
is
Bicycle
many
countries
routes.
in
to
can
types
This
develop
with
often
market
for
already
aid
be
the
in
high.
their
they
has
benet
benet
are
achieved
from
not
socially
in
line
social
addressed
tech
with
hub
the
professionals.
bicycles
to
response
through
Phandeeyar
were
assist
specically
local
facing.
increased
the
in
organizations
that
products
order
engaged
ground-breaking
technology
enterprise
can
a
greatly
of
can
built
terrain
challenges
of
is
non-profit
Myanmar
Company
African
entrepreneurship
L TA
DP ready
enterprise
that
growth
geographical
these
businesses
provideaspects
seeking
Southern
for-profit
Social
example,
economic
Buffalo
by
deregulation,
deregulation
levels
increases
of
inequality.
problems
those
country’s
the
while
investment
developing
conventional
connects
made
often
Developing
innovation.
with
economic
privatized
exibility.
SSPs
capable
activities.
funding
the
also
market-oriented
enterprise
through
are
increase
countries
and
en t er pr is e
beneficial
the
that
income
to
higher
market
unemployment
something
increase
The
not
privatization
forces
to
protability
may
privatization
Lastly,
for
policies
(S SP s)
growth.
market-oriented
they
this
leads
reforms
rms’
as
inefciencies,
and
market
increased
are
side
mechanism
contribute
economic
prots
such
motive
increase
However,
term;
and
prot
costs
faster
decrease,
Higher
the
decrease
production
there
policies,
efciency
specically,
to
effective
supply
policie s
development.
Market-oriented
Is
supply - side
Is there a way out?
people
The
progress
recognition
developing
that
world.
Thinking skills
Social enterprises
Identify any social enterprises operating in your local community or
in your country.
183
Micr o f inanc e
Micronance
the
very
existing
poor,
one,
weather.
created
focuses
poverty
nutrition
have
can
greater
them
was
help
offered
to
bargaining
initiated
several
it
can
school
a
power
small
by
nations
which
for
and
has
in
loans
business,
from
to
expand
disease
or
Yunus
an
bad
who
ago.
as
it
has
positive
improvements
Many
them
in
programmes
them
to
in
impact
health,
micronance
helped
such
enables
small
Muhammad
decades
allow
participation
very
arising
attendance.
women,
their
start
developing
and
primary
to
available
emergency
Bank
reduction
empowerment;
making
an
scheme
and
been
meet
Grameen
Micronance
on
helping
or
The
the
on
take
their
gives
part
loans
in
them
family
decision-making.
However,
to
some
studies
climbing
of
micronance
out
of
and
has
recently
analysts,
poverty
most
while
come
under
borrowers
some
are
attack.
do
getting
not
According
appear
trapped
in
a
to
be
spiral
debt.
Watch this
Search YouTube for the following videos.
Search using these terms: Wagner rethinking micronance.
■
Watch a video on what has gone wrong with micronance.
Search using these terms: duo anti pover ty ght.
■
Watch an inter view with Esther Duo, a leading MIT economist, on the aid
debate and on micronance.
L TA
DP ready
Thinking skills
The spread of micronance
Although initially intended for developing countries, in the recent
past micronance has expanded to advanced economies as a source
of credit. Explain why you think this has happened.
P r o v ision
of
mer i t
good s
Health and education
Health
Better
and
education
health
productivity
Improved
better
Something
education
that
is
are
that
At
basic
often
184
the
can
are
allow
health
time,
such
the
growth
can
as
school.
is
greater
Provision
of
development.
productivity
also
lead
individuals
importance
personal
be
and
to
to
and
since
development.
have
more,
opportunities.
interdependent.
because
therefore
development.
to
of
labour
this
employment
same
at
increase
growth,
further
they
skills
learned
programmes
and
adds
to
drivers
education
paid
education
attendance.
because
key
and
higher
vital
education
the
health
and
improves
and
is
are
a
of
Improved
critical
in
school
improves
and
health
substantial
and
health
factor
education
hygiene
of
health
health,
sanitation
and
education
importance
in
growth
4.7
Is there a way out?
Infrastructure
Infrastructure
production.
more
output
Irrigation
increases
Some
to
be
energy
workers
through
machines
have
and
major
illnesses
and
However,
it
be
allow
an
for
is
have
improvements
but
they
Also,
The
the
the
result
Her
that
in
they
women
only
and
are
way
extra
be
also
the
long-term
mortality
intervention.
politics,
Education
for
investment
the
of
funds
ready.
building
of
water
carry
may
out
well
as
which
that
in
would
developing
They
plan
roads,
and
for
ports
sanitation—
those
impede
plans.
investments
in
allowing
girls
for
is
she
a
better
to
the
and
inuence
considered
accelerating
by
will
country’s
but
and
have
output
can
gains.
make
sure
Educating
the
costs
educated
labour
outside
fewer
which
circle.
more
the
educating
ability
probably
decreasing
in
a
benet
through
child,
virtuous
children,
participation
them
She
per
will
is
earning
productivity
Lastly,
female
women
higher
available
creating
in
women
accelerates.
schooling.
and
improve
and
process
enjoy
of
healthier
higher
in
of
as
government,
short
girls
empower
will
year
can
as
provision
education
signicantly
income
health-care
to
to
educated,
decreases
lead
can
deprived
development
higher
will
do
mother
each
even
sanitation
preventing
development.
safe
to
corruption
inequality
Not
increasing
children
resources
and
from
powered
infrastructure.
important
for
to
the
lowered.
empo w er men t
educated
home
children,
poor
and
by
governments
education,
the
water
the
at
be
allow
output.
productivity
and
is
many
plans
to
electrically
and
on
of
systems
costs
population
health
example,
nancial
and
clean
a
growth
investment
governance
to
of
that
costs
agricultural
simple
government
by
growth
An
For
of
of
dependent
the
and
gender
most
girls.
largely
when
health
development.
the
noted
production
Therefore,
for
access
Women’s
also
deaths.
lowers
increased
Access
crucial
be
their
for
health
in
capital
Reducing
the
grids,
lack
poor
human
also
are
issue
power
allow
and
T
ransportation
levels
introduction
on
should
and
higher
equipment.
provision.
countries
and
the
premature
infrastructure
can
to
systems
effects
infrastructure
follow.
transported
contributes
Reliable
productivity
examples
force
of
women
as
well
policy.
many
as
development
the
most
inuential
process.
Search the web
Search using these terms: Rwanda success women empowerment. Read an
ar ticle on how women empowerment in Rwanda helped the country become
one of the fastest growing and developing nations in the African continent.
185
Redis t r ibu t ion
High
and
and
can
use
be
lower
that
with
incomes
national
inequality
many
Perhaps
a
income
to
education
better
and
and
increase
in
still
Another
This
be
can
so
generate
and
High
other
levels
of
taxation
quality
Y
et,
systems
and
distribution
and
health-care
which
will
will
incomes,
all
access
centres,
contribute
increase
growth
government’s
labour
and
lack
no
reducing
enforcing
reducing
use
become
will
and
towards
cannot
their
“dead
longer
of
resources
property
inequality.
resources
capital”
.
be
inequality
indebtedness
that
nance
Mone t ar y
World
extends
of
is
“dead”
while
in
IMF
the
giving
If
to
People
create
property
and
rights.
will
allowing
titles
be
for
are
used
to
growth
decit
setback
levels
enough
require
funds
cancelling
reduced.
for
a
developing
large
debt
spending
portion
This
development
t he
for
of
releases
in
debts:
some
the
funds
strategies.
In t er na t ional
(IMF )
development
loans
to
development
system,
financial
stabilizes
crises
has
assistance
developing
by
been
and
exchange
extending
for
structural
institution
almost
organization
countries
that
rates
loans.
exclusively
the
that
purpose
change.
oversees
and
In
the
helps
recent
focused
on
the
world.
Bank
loans.
recipients
adjustment
debt
is
and
financial
World
them
a
and
multilateral
lending
developing
Both
is
another
involves
economic
financial
countries
years,
a
high
repaid
Fund
Bank
is
allow
growth
long-term
IMF
global
be
B ank
promoting
The
that
not
relief
must
Wor ld
The
do
Debt
that
can
T he
186
the
development.
supplies
dening
help
assets
Remember
areas.
amount
that
on
rights
capital
income,
repayments
■
capital,
means
reduces
equitable
the
Schools,
higher
payments,
with
budgets.
more
water
T
axing
those
r elie f
nations.
■
focuses
their
the
to
a
redistribute
development.
Deb t
that
human
signicantly
provided,
care.
clean
lead
to
than
which
and
to
governments
payments.
heavily
transfer
low
improve
so,
growth
issue.
property
wealth,
to
Nevertheless,
an
policy
without
route
is
health
and
and
development.
may
useful
on
prevents
policies
do
ineffective
very
that
transfer
growth
have
on
T
o
redistributed,
more
run
wealth
sanitation
productivity
for
and
more
more
be
countries
usually
more
of
taxes
incomes
may
factor
implementing
spending
allows
major
importance.
income
higher
developing
one
Therefore,
and
and
is
particular
income
governments
an
of
progressive
households
to
inequality
development.
income
can
rising
policie s
agree
to
policies).
reduction,
and
The
the
loans
adopt
For
IMF
help
offered
particular
example,
privatization,
developing
are
policies
these
countries
conditional
by
require
(structural
policies
deregulation,
and
may
involve
improved
tax
4.7
collection
deprive
and
and
the
may
labour
borrowing
have
instance,
in
some
prevent
as
part
human
against
of
cut
However,
control
on
over
economic
and
World
budgets,
conditions
physical
development
L TA
DP ready
IMF
to
the
or
of
effects
cases,
nations
reforms.
country
negative
impoverished
services
market
for
capital
its
loans
domestic
development.
Bank
and
such
ofcials
even
lending.
to
affairs
For
have
privatize
Such
improvements
Is there a way out?
asked
health
measures
and
may
therefore
act
objectives.
Research and thinking skills
World Bank or IMF assistance
Research online to identify a country which has received nancial
assistance from either the World Bank or the IMF.
1.
Investigate and record the details.
2.
To what extent was the World Bank or IMF intervention successful
in terms of the country’s growth and development?
G o v er nmen t
in t er v en t ion
mar k e t- or ien t ed
Here
is
one
Should
oriented
market
The
is
also
and
to
in
that
the
any
for
do
the
as
to
on
the
idea
outcome.
the
market
incentives,
economic
for
market-
opposite?
based
government
vital
than
that
Indeed,
mechanism
use.
necessary
is
economics.
rather
possible
efciency
human
economy
is
possible
the
of
the
best
encourage
role
development
approach
to
best
government
essential
in
interventionist
they
allocative
provides
so,
for
lead
their
prot,
The
also
necessary
debates
more
should
always
lead
Even
crucial.
and
Or
a
market-oriented
market
growth.
appr o ache s
biggest
adopt
resources
incomes
is
a
powers
markets
directs
the
approach?
Adopting
free
of
countries
v er sus
in
activity
economic
building
capital
the
formation,
develop.
such
as
and
higher
generate
development
infrastructure
which
Remember
that
are
both
health
care
Internal link
and
education
are
merit
goods
so,
if
they
are
left
to
the
market,
See section 2.2 for more on
they
are
underprovided.
Public
nancing
is
essential
to
ensure
that
allocative eciency.
the
poor
have
However,
can
be
health
a
the
case
designed
cannot,
in
needed
ensure
banking
The
in
Overall,
not
is
also
tend
poor,
as
properly—which
is
to
experience
or
nor
governments
of
experiences
So,
for
key
of
the
reducing
are
the
are
low
and
poverty
basically
and
they
government
is
sectors
of
the
Unregulated
Nevertheless,
illegality,
played
schools
all.
them.
creating
have
to
markets
incomes
crises.
allow
in
as
regulate
one
public
comes
dollars”
.
opportunity
encourage
markets
it
their
their
needed
development
when
problematic
sector
to
functioning
countries—then
Y
et,
with
economic
regulating
national
successful
the
“vote
may
goods.
is
highly
banking
systems
governments
poor.
is
“ignore”
government
economy.
helps
are
therefore,
to
merit
developing
approach
to
to
government
conditions
market
The
if
the
access
which
equal
an
corrupt
neither
opportunities.
important
countries
in
role
East
in
the
Asia.
187
However,
Africa,
other
Latin
appears
A
in
to
America
have
been
market-oriented
government
there
and
is
the
and
That
including
Caribbean,
of
whereas
are
world,
the
more
failure.
government
L TA
DP ready
of
approach
failure,
market
the
parts
an
is
countries
government
in
often
obstacle.
preferable
good
is
the
some
to
when
governance
say,
that
the
there
is
is
needed
roles
of
when
the
market
complementary.
Thinking and communication skills
Government inter vention or market-oriented approach
TOK
Identify areas that are crucial for development where you think the
What knowledge criteria can
following question is par ticularly relevant. Should countries adopt a
economists use to decide on the
more interventionist rather than market-oriented approach—or
balance between markets and
inter vention?
vice versa?
Focus point
Creativity, activity, ser vice
There
are
several
strategies
that
can
be
used
to
promote
economic
Form a small group with some
growth
and
development.
In
some
cases
these
strategies
have
other students in your class.
worked
but
in
others
they
haven’t.
This
suggests
that
care
must
Search for any local social
be
taken
when
designing
and
implementing
policy
so
that
each
enterprises or micronance
strategy
matches
the
needs
of
the
particular
country
pursuing
institutions and volunteer
them.
There
is
no
uniform
approach.
your services. You could also
organize a campaign in order
to increase these enterprises’
Key terms—test yourself
popularity in your community,
188
so that more people become
Dene these terms: foreign direct investment (FDI), foreign aid,
aware of their work .
diversication.
Index
absolute
advantage
absolute
poverty
ad
valorem
taxes
administrative
advertising
aggregate
132–3
complement
composite
1
1
1–12
40,
47
concentration
barriers
142,
144
57
demand
deation
(AD)
81–4,
ination
growth
91–2
and
1
19,
policy
1
18,
supply
122–3,
(AS)
84–7,
equilibrium
and
126,
sector
subsidies
allocative
31,
48–9,
Appellate
93,
103–4
88–90
127
34,
70,
appreciation
(of
WTO)
154–5,
132,
156,
146
157,
160,
161
29
average
cost
(AC)
average
price
of
item
sector
basic
(APL)
(AR)
Better
Life
bilateral
black
13,
40–1,
behavioural
82,
67,
84–7,
88–9,
1
19–20,
borrowing
bounded
176
15,
condence
cycle
account
surplus
union
80,
165,
173,
184
83,
106,
83,
97,
175,
ow
101,
deationary
90,
1
19,
92
and
income
159,
model
common
common
104,
market
pool
comparative
competition
competitive
184,
demand
129–30,
160
186
curve
31–6,
150,
46,
demand-pull
ination
demand-side
policies
goods
depreciation
45–6,
104,
157,
89–90,
18–20,
120,
22–3,
25,
122
26,
72
151–7
56–7
129
1
18–24,
126–7
55–7
154,
156,
159–61,
166
183
166
products
provision
gap
102–3,
47,
153,
124,
differentiated
58,
68,
71,
73
60
164–5
rate
120
workers
41,
96
1
13,
172
101
10–1
1
1
19–20
147,
barriers
148
advantage
61–3
costs
economic
development
134–6
and
21
to
economic
and
66–8,
for
169–76
growth
172–6
177–88
growth
to
99
173–6
economic
strategies
barriers
132
173–5
economic
barriers
resources
182
63
174
supply
96,
15
economic
banks
commodities
99,
12–14
74
economy
commercial
97,
29–30
of
70,
164
105–6
diversication
command
163–5
148
demand
devaluation
122–3
157–8,
self-governance
collusion
88
14
economics
collective
85,
164–7
(recessionary)
disination
classical
129
52,
29–30
discrimination
circular
147,
choice
deregulation
28–9
1
19–20,
1
1,
166
162
discouraged
10,
160–1,
unemployment
discount
choice
120,
101
direct
bank
82–3
policy
154
current
demerit
1
19–21,
paribus
142
151–6
decit
elasticities
28–30
79
145
rationality
business
ceteris
81,
103–4,
account
demand
56
business
central
(C)
48–9,
investments
currency
(BLI)
42,
1
14,
162–7
42
agreement
markets
140,
69
(BOP)
economics
Index
139,
67
payments
goods
137–8,
162
speculation
deation
banking
102,
21,
current
default
of
45,
187
account
item
106
101–2
monetary
current
debt
balance
ination
92,
48
176,
production
cyclical
level
revenue
26,
(tight)
173,
cost-push
debit
average
25,
46,
90,
(CPI)
34,
customs
137
availability
surplus
cross-border
71
82,
Index
expenditures
credit
43–4
28–30
consumption
currency
26,
Price
171–2
73
consumption
costs
29
Body
condence
corruption
174
efciency
anchoring
autarky
1
18,
127
92,
macroeconomic
policy
choice
contractionary
88–90
79–80,
ratios
consumer
Consumer
102–3
equilibrium
agricultural
166
19
consumer
consumer
macroeconomic
aggregate
87,
105–6
economic
goods
indicators
91–6,
108,
1
13
173–6
development
172–6
189
and
exchange
strategies
economic
rates
for
integration
economic
losses
68,
economic
union
147
of
education
59–60,
9,
elasticities
scale
1
1,
sector
63,
171,
85,
9,
69,
12,
71,
53–4,
70,
72,
95–6,
72,
128,
9,
56–7,
vs
equilibrium
equilibrium
54,
price
22–3,
quantity
24,
22–3,
demand
excess
supply
22,
rate
34,
98,
84,
153,
Planet
151,
48,
104,
(loose)
122,
monetary
policies
expenditure-switching
exchange
policy
policies
90,
165,
Index
153–4,
158–61,
62,
consumption
production
95,
production
production
account
policy
13–14,
1
16,
174,
Index
178
(HDI)
171–2
markets
70–4
181
9,
(exible)
162–7
rates
45,
152,
153–4,
155–6,
159–61
137–44
62
54,
125
59–60
12,
86,
164,
66–75,
of
an
19,
indirect
1
1
1–12,
tax
45,
46
1
14–16
income
statistics
78–9,
94
136
trading
partners
84
165
distribution
95–6,
104–5
83
1
18,
rate
82,
57–8
163,
83–4,
81,
exchange
121–3,
system
127,
income
elastic
exchange
demand
income
elasticity
35
166
151,
157–8
rate
system
income
oating
1
13,
55–7
53–4,
consumption
exchange
135
106
96
of
xed
73,
105,
109–10
substitution
income
scal
69,
132–6
51–2,
12–13,
107,
competitive
national
1
1,
68,
82–3,
165
income
rms
96
160
incidence
nancial
12–13,
Development
incentives
of
172
1
1
1–12
83,
restricting
factors
79–80,
185
products
capital
and
positive
(HPI)
184,
166
imports
positive
76–7
78
120
import
negative
(GDP)
(GNI)
162–7
rates
84,
specialization
negative
187–8
121
income
1
1,
imperfectly
externalities
56
181
81–2,
exports
53–4,
approaches
165–6
Human
net
45–7,
62
59–60
123
human
and
58,
129
65
28–9
wealth
13–14,
56–7,
unemployment
income
exports
65
181
policy
expenditure-reducing
promotion
58,
165
households
export
40–50,
157–8
150–61,
158–9,
scal
expansionary
21,
128,
product
170,
homogeneous
expansionary
1
16
158
hidden
disequilibrium
95,
24
systems
rates
103
60
revenues
national
heuristics
exchange
40,
gross
10,
provision
54,
domestic
health
exchange
83–4,
122
inequality
126–7,
48–50,
gross
Happy
22,
81,
125
market-based
government
31
31
109
excess
124,
goods
taxes
168–9
&
legislation
subsidies
109
103,
intervention
regulations
183
74–5
44,
48–50
incentives
public
13–14,
127
64–5
poverty
policies
104
121–3,
goods
government
184–5
188
spending
subsidies
74
36
environment
equity
71,
86
entrepreneurship
equality
(EOS)
53–4,
barriers
policy
public
185,
expenditure
proigate
70
31–9
curves
entry
scal
182
131
176,
government
173
reducing
economies
Engel
145,
1
13–17,
8–16
efciency
economy
governance
109–1
1,
economic
energy
global
160
177–88
inequality
economics
156,
151,
inelastic
of
demand
demand
(YED)
31,
35–6
35
153–6,
income
inequality
94–5,
104–5,
108,
109–1
1,
127
158
indebtedness
foreign
aid
foreign
direct
investment
exchange
framing
markets
(FDI)
150–3,
154,
156,
163,
trade
of
policies
inequality
109–1
1,
132–6,
also
frictional
Friedman,
170–2
126
1
13–17,
agreement
64,
or
area
172,
inequality;
173
income
(FT
A)
147–8,
144
182
goods
19,
36
65
unemployment
Milton
employment
15,
86,
inequality
coefcient
gender
industries
97,
101–5,
and
exchange
and
policy
rates
129
155–6,
107
87,
172,
1
1
1
107–8,
99
89–90,
91,
176,
185
120,
122,
166
89–90,
122
107
inationary
190
79–80,
145–9
ination
Gini
development
industrial
inferior
free-riders
gender
186
157–8
infant
full
184,
29
trade
free
175,
177–9
see
free
106,
179–80
indicators
foreign
83,
informal
gap
economy
infrastructure
174–5
126,
173–4,
185
160
inequality
Index
injections
monetarist
13–14
institutional
framework
interconnectedness
86,
monetary
10,
73,
164–5
interest
83,
88,
89,
rates
82,
and
exchange
and
monetary
rates
International
Monetary
international
trade
interventionist
investment
in
R&D
investment
invisible
Jevons,
joint
Fund
policies
14,
74,
126
124,
105,
supply
12–13
money
wage
85,
128,
Keynesian
Stanley
economics
market
44,
demand
law
of
supply
nominal
15
68,
70,
71–2
145,
principle
145–6,
147
149
(MNCs)
177–9
vs.
of
69,
71
unemployment
real
values
(NRU)
99,
107
78
organizations
determinants
19–20,
(NGOs)
179
15,
86–7,
normal
goods
normal
prots
98–9,
125,
19,
35,
21–2
36
90
127,
130,
67,
68,
statements
69
14–15
183
30
20
56–7,
1
19,
Development
Assistance
markets
94,
161,
(ODA)
179
(LRAS)
86,
equilibrium
economics
market
93,
13
operations
cost
growth
curve
122,
120
objectives
10,
exchange
capita
GDP
capita
GNI
cost
rate
system
34–5,
(MB)
151,
25,
84,
private
marginal
revenue
26,
benet
(MR)
26,
45,
&
benet
52,
67,
market
equilibrium
&
market
power
52–3,
54,
55,
57–8,
market-based
68,
69–70
165–7
development
183,
186–8
175–6
96
154,
156,
163
59
statements
14–15
69
cost
52–3,
55,
57–8,
output
86,
91,
92–3
59
27,
1
1
1–13,
143
25–7
cycle
51,
53–60,
69–75,
22–3,
173
22–3
64–5,
70,
1
16–17,
187
72
preferential
price
147,
investments
reducing
failure
&
barriers
poverty
market
171
markets
69
poverty
efciency
170
52
48,
cost
67,
1
18–30,
growth
potential
market
80,
170,
158
positive
social
78–9,
78–9,
39
portfolio
marginal
26
competitive
pollution
(MC)
1
16
91–108
for
benet
59–60,
135
56–7
per
political
marginal
134,
76
products
marginal
production
per
policies
manufactured
1
1–12,
88–90
perfectly
macroeconomics
58,
128–9
packaging
equilibrium
macroeconomic
49,
89–90
92–3,
1
10–1
1
macroeconomic
9,
126
optimum
marginal
73–4
168–76
production
managed
70,
186–7
AS
long-term
68,
60
78–80,
opportunity
market
markets
15
open
Lorenz
104
(MFN)
corporations
monopoly
open
long-run
166
18
standards
long-run
129–30,
13–14
legislation
loans
Nation
rate
oligopolistic
living
127,
125
agreement
natural
Ofcial
leakages
123–4,
74
natural
nudges
of
89–90,
71,
non-governmental
Maynard
law
85–6,
70–1
normative
labour
15,
83
21
John
86,
power
multilateral
1
19–21,
competitive
70,
Most-Favoured
129
164
non-price
Keynes,
68,
multinational
24–7,
William
ows
monopoly
126–7,
81,
economics
147
money
monopoly
186–7
181–2
(I)
1
18,
union
monopolistically
(IMF)
107,
expenditures
hand
165
1
19–21
strategies
13,
106,
156
policy
policy
monetary
105,
Classical)
88–90
175–6
47
interdependence
(New
trade
agreement
145
1
13
24–6,
supply-side
41,
price
ceiling
(maximum
price)
price
elastic
demand
price
elastic
supply
price
elasticity
of
demand
price
elasticity
of
supply
price
oor
price
inelastic
demand
inelastic
supply
40–2
43
policies
124–5,
127–9,
32–5
183,
37,
38,
39
187–8
markets
Marshall,
Marx,
18–23,
Alfred
Karl
66–7,
69,
46,
37–9,
56
46
(minimum
price)
40,
43–4,
57
48,
59–60,
83,
184–5,
micronance
10,
37,
38,
39
186
price
microeconomics
32–4
70
price
makers
70
17
price
mechanism
price
takers
24–7
184
wage
44,
98,
economy
69
1
16
price
mixed
31–5,
31,
15
prots
goods
minimum
(PES)
15
maximizing
merit
(PED)
68–74
war
73
1
1
primary
products
34,
39,
136,
174
191
private
costs
privatization
producer
124,
surplus
production
133–4,
137–8,
139,
curve
140,
(PPC)
1
1–12,
92,
93,
possibilities
66–8,
progressive
property
69,
proportional
protection
public
176,
1
14–16,
taxation
137–44,
goods
transport
indirect
subsidies
48,
tax
subsidies
quantitative
easing
(QE)
consumer
ows
real
GDP
real
GNI
choice
78,
interest
80,
87,
88–90,
91,
140–2
48–9,
140–2
141–2
1
18,
124–9,
165,
166–7
43–4
rate
138–9,
revenue
refutation
13,
143,
46,
31,
policies
trading
1
14–16,
taxes
tax
blocs/agreements
(RTBs)
taxation
regulations
54,
175–6
130
62,
1
1
1,
152,
taxes
tax
98,
83,
policies
121,
ratio
(RRR)
122,
125,
45–7,
53,
56,
1
14
186
tax
7,
45–6
138–9,
83,
143
86,
resource
misallocation
25,
26,
27,
98–9,
126
46,
58,
revenues
12,
61–3,
34,
68
barriers
137–44,
181
106
trade
1
1,
173–4
105
trade
9,
93,
technology
1
19
total
allocation
creation
149
92
trade
decit
143,
153,
160–1
157
trade
33–4,
67–8,
69,
diversion
ows
152,
thumb
(heuristics)
liberalization
155–6,
policies
transfer
14,
105,
Jean-Baptiste
107,
144,
157–61
145,
146,
181–2
1
13–14,
84
payments
1
16,
186
173
15
unemployment
10,
125,
28–9
trade
12,
96–100,
107–8,
129–30,
160
1
1
universal
unemployment
short-run
AS
(SRAS)
short-run
equilibrium
85,
97,
88–9
basic
income
(UBI)
1
16
99
visible
hand
40–50
88
wealth
growth
82,
83,
92,
109–10,
1
15–16
91–2
well-being
10,
79–80,
168
42
women,
Adam
15,
social
barriers
social
costs
social
enterprise
empowerment
of
185
132–3
World
Bank
186–7
175–6
World
100,
1
14,
sciences
social
surplus
T
rade
Organization
(WTO)
173
183
zero
social
specialization
153–4,
134
trade
41,
149
121
trade
David
short-term
186
40,
49
resource
seasonal
34,
154
requirement
9,
1
15–16,
21,
1
12
appropriate
13,
127
41
subsidies
revaluation
1
15–16,
187–8
technology
resources
1
14,
taxes
tariffs
controls
scarcity
85
53–4
indirect
sugar
remittances
revenues
83,
1
15
56–7,
poverty
shortage
95,
147–9
income
Ricardo,
65,
14
regressive
savings
147
59–60,
186
direct
regional
of
168–76
105
carbon
reserve
61
80
redistribution
relative
10,
development
business
192
154–6
137–8,
93–4
taxes
Smith,
152,
46,
37–9
78
recession
Say,
150,
74
26,
12–13
tax
rules
71,
28
tariffs
rent
69,
20–3,
37–9,
policies
sustainable
rent
68,
137–9,
sustainability
rational
real
1
16
140–1
surplus
real
141–2
120
supply-side
quotas
140–2
130
45–6
protection
50
98–9,
32
curve
31,
137–9,
59–60,
19,
supply
elasticities
83
58,
prots
supply
currency
1
15
166
64–5,
&
48,
goods
supernormal
supply
48–50,
45–6
126–7
40,
goods
40,
45–6,
subsidies
merit
186
51–60,
impacts
unemployment
1
1–12
186
taxes)
structural
substitute
taxation
rights
model
70
(unit
effects
stakeholder
142
135
prots
taxes
spillover
183
26,
possibilities
production
public
specic
100
9,
16
26
132–6
economic
prots
67–8,
69,
72
145–7,
149,
166
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