What is economics Paper 2

IBDP Economics  HL – Introduction to economics – what is economics -Paper 2 Exam Style Practice Questions

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Exam Style Question for IBDP Economics HL- what is economics -Paper 2

Can the Democratic Republic of the Congo achieve its economic potential?

  1. The Democratic Republic of the Congo (DRC) is a nation of great potential. It has large mineral resources and an abundance of fertile land. The mining and export of cobalt, copper and gold are the main source of government revenue. However, the abundance of natural resources causes devastating conflicts as rebel groups fight for control of the DRC’s resources. With a population of 80 million and gross domestic product (GDP) per capita of only US$457, the DRC is one of the world’s poorest nations. It is ranked 176 in the world in terms of the Human Development Index (HDI).
  2. The government has been accused of relying too much on tariffs, but to improve living standards, the government needs revenue to spend on agriculture, electricity and roads. Furthermore, business owners in the DRC complain of corruption and increasing “red tape” (excessive regulations).
  3. The government believes that a strong agricultural sector could boost economic growth but only 10 % of the land is used for farming. Rice, maize and other crops grow well in the tropical climate and yet the government spends US$1 billion per year importing basic foods. According to a government spokesperson, the lack of infrastructure is a major barrier to the processing and transporting of agricultural products. The DRC’s road network is so bad that farmers and traders often make a two-week trip in small boats down the Congo River to sell their produce. The DRC has just 27 877 kilometres (km) of roads. It is estimated that 90 000 km of national roads and 150 000 km of rural roads must be built.
  4. In addition, the World Bank reports that only 17 % of the DRC’s population has access to electricity, despite the capacity of the Congo River to generate enough electricity to satisfy the needs of the region.
  5. To make matters worse, the regional conflicts have affected the availability of healthcare services. It is estimated that half of the health centres have been looted*, burnt or destroyed. Government expenditure on healthcare per capita remains one of the lowest in the world. Non-governmental organizations (NGOs) are relied on to protect the health and wellbeing of citizens. NGOs help to achieve this by distributing medicine and teaching families about hygiene and proper sanitation.

Question

Using a production possibilities curve (PPC) diagram, explain how the production possibilities (potential output) of the DRC might be affected if there were greater access to electricity (paragraph [4]).

▶️Answer/Explanation

For a PPC (outward shift) showing an increase in the potential output in the DRC
AND
for explaining that greater access to electricity may increase efficiency/productivity (increases the quality and/or the quantity of the factors of production) and hence increase potential output (productive capacity).

The strong Thai baht

  1. Thailand’s currency, the Thai baht, ended 2019 at its highest value in more than six years. With a 7.8 % gain against the United States dollar (US$), it was the currency that appreciated the most among major Asian currencies.
  2. The Thai baht’s appreciation was caused by several factors. Many foreign investors are attracted by Thailand’s economic stability, high levels of foreign reserves, low inflation rate and low unemployment (Table 1). However, the inflation rate is below the central bank’s target.
  3. Initially, the central bank of Thailand (BoT) was not too concerned, as the strong Thai baht was helping Thai importers and those who had foreign debts. Additionally, Thai producers could afford to import new technology and capital equipment. An appreciating currency could also help improve the country’s terms of trade.
  4. However, a strong currency can have severe consequences on an export-oriented country like Thailand. Exports account for 65 % of gross domestic product (GDP), and in 2019 exports declined by 7 %. Additionally, the tourism industry, which makes up approximately 20 % of GDP and accounts for 16 % of employment, started to express concern. Economic growth in 2019 was 3 %, down from 4.1 % in 2018.
  5. Therefore, towards the end of 2019, the BoT implemented measures to prevent further appreciation of the Thai baht. The BoT reduced controls on capital outflows to make it easier for Thai citizens to move money abroad. Additionally, restrictions were placed on the amount of money foreigners could hold in Thai bank accounts.
  6. The BoT is considering further measures including the use of foreign reserves, a decrease in the interest rate, and imposing controls on capital inflows, to prevent speculative inflows. However, these controls may impact the country’s credibility and financial markets. Expansionary monetary policy may also increase household debt which, at 78.6 % of GDP, is among the highest in Asia.
  7. The BoT is concerned about using foreign reserves, as this may result in Thailand being labelled a currency manipulator* by the US. Currently, Thailand’s overall large current account surplus is the only requirement it meets to be labelled a currency manipulator. However, Thailand’s bilateral trade surplus with the US is currently US$19 billion, which means it is close to meeting a second requirement. Thailand wants to avoid being labelled a currency manipulator as the US may use trade protection in retaliation.

Question

Using a production possibilities curve (PPC) diagram, explain how the importing of “new technology and capital equipment” might affect Thailand’s production possibilities (paragraph [3]).

▶️Answer/Explanation
For drawing a correctly labelled PPC diagram, showing an outward shift of the PPC
AND
For explaining that technology/capital equipment increases the quantity and/or quality/efficiency/productivity of resources/factors which will lead to outward shift the curve, therefore increasing potential output/production possibilities.

Text D — Overview of Malawi

  1. Malawi is a landlocked country in southern Africa. Its development plans contain 169 targets, based on the Sustainable Development Goals. Ineffective institutions and inequalities, however, make it difficult to reach every target. Although poverty in urban areas has declined, the level of absolute poverty has been increasing in rural areas where 85 % of the population lives. Causes of poverty include land degradation (80 % of the land is eroded or lacks nutrients), poor healthcare and rapid population growth. There is also a lack of human capital, which is often due to the difficulties that households have in obtaining loans for education or training. Approximately 75 % of households do not have access to formal banking services.
  2. Aid agencies are providing assistance. The World Bank’s Human Capital Project will increase investment and encourage reforms, such as promoting the education of teenage girls. In 2020, the World Bank also approved US$157 million (50 % as a loan and 50 % as a grant) for a government project. This project aims to increase sustainable land management practices and build water-related infrastructure, such as small dams and irrigation schemes.
  3. The government has encouraged the establishment of microfinance groups that act as rural banks. They provide some finance and guidance for programmes that introduce new types of crops and techniques in order to improve agricultural efficiency.
  4. Although 2019 was a difficult year due to drought, insect infestations, and a tropical cyclone, Malawi’s real gross domestic product (GDP) grew by 4.5 %. There is a large budget deficit and the amount of government debt (at approximately 60 % of GDP) is considered to be too high. Therefore, the government has announced plans to reduce its spending. Inflation had been forecast to increase to 14 % in 2020. Due to the planned contractionary fiscal policies, however, inflation may fall below 10 % from 2021 onwards.
  5. Export revenues account for over 30 % of GDP. Malawi aims to increase its exports of cotton, nuts, tea and sugar. Rising exports and lower fuel import prices could reduce the current account deficit. Despite the persistent trade deficit, Malawi is resisting calls for further trade protection. It has signed bilateral trade agreements with both South Africa and Zimbabwe. Tariffs are gradually being reduced, while other indirect and direct taxes are being raised.

Text E — Agricultural Production

  1. Approximately 80 % of the labour force is employed in agriculture, with few job opportunities available in manufacturing and services. Agricultural productivity is low for many reasons. The government promotes manufacturing industries and cultivation of crops for export by large-scale farms. However, small-scale and subsistence farmers have received little support in the past. Farmers use less fertilizer and irrigation than is typical in other countries. Only 3 % of cultivated land is irrigated, compared to the global average of 21 %. Other challenges are the inadequate road and rail links to markets and the limited availability of electricity and fuel.
  2. Maize is the most important staple food in Malawi. The government uses price controls when trying to ensure that maize is available at affordable prices for low-income households. However, the maximum price set by the government is often too low to persuade farmers to supply the maize or to provide them with sufficient revenue. In 2020, the maximum price was raised from 250 to 310 kwacha per kilogram. Even at the higher price, shortages remain.
  3. The government is planning to invest in commercial agriculture to improve productivity and promote diversification. The 2020 budget includes subsidies on fertilizer for 4.3 million small-scale farmers, which could possibly double maize output but may also pollute waterways. The support given to farmers will improve the nutrition of Malawians and stimulate the rural economy.

Text F — Tobacco Exports

Tobacco is Malawi’s major export, providing over 50 % of foreign currency earnings. Due to lower global demand and the purchasing policies of multinational tobacco firms, prices paid to farmers in Malawi are low and falling. To reduce costs, farmers resort to using child labour. Following allegations of labour exploitation, the United States has restricted tobacco imports from Malawi. There is concern that other importing countries might also impose restrictions.

Question

Sketch a production possibilities curve (PPC) diagram to show the effect of improved human capital on Malawi’s potential output (Text D, paragraph [2])

▶️Answer/Explanation

ext D — Overview of Lebanon

  1. Lebanon is in the Middle East, bordering the Mediterranean Sea, and is home to nearly 7 million people. Lebanon is in an economic crisis, facing a recession, huge government debt and rising income inequality, poverty and inflation. Corruption and poor governance have been blamed for misallocation of funds that has led to low levels of investment and extensive capital flight. Additionally, Lebanon has one of the most unequal distributions of wealth in the world. In 2019, the top 10% of income earners owned over 70% of personal wealth in Lebanon.

  2. Infrastructure in Lebanon is poor, water and sewerage systems are basic, and roads are inadequate. Electricity supply is unreliable with people going without power for much of the day. In 2020, major buildings including food storage buildings, schools and hospitals were damaged in Beirut (the capital city of Lebanon). This was concerning as 85% of the country’s food arrives through Beirut. Fortunately, humanitarian aid was given by the international community to help rebuild the damaged buildings.

  3. Despite a history of inflows from luxury tourism and remittances (money sent by a foreign worker to their home country), there is a persistent current account deficit. To help with this, the Lebanese central bank has used high interest rates to attract financial inflows. Additionally, the government has borrowed funds from overseas. However, the misuse of these funds and overspending have contributed to one of the highest foreign debts in the world. Lebanon recently defaulted on foreign debt repayments worth 1.2 billion euros, which damaged its international credit rating, making it difficult to access loans needed to help solve its current economic problems.


Text E — Further challenges facing Lebanon

  1. Social unrest is prevalent and intensified when the government suggested raising revenue by imposing an indirect tax on social media applications such as WhatsApp. As the government struggles to pay its debts, people are concerned that subsidies on necessities such as wheat, medicine and fuel will be removed.

  2. Mismanagement of the state-run electricity and telecommunications sectors has resulted in unreliable services and high telecommunication prices. The state-run monopoly firms make losses, and the electricity sector relies heavily on government subsidies, putting pressure on the budget deficit.

  3. Lebanon currently has a managed exchange rate system with the Lebanese pound (Lebanon’s currency) linked to the US dollar (US$). However, the government is finding it difficult to maintain the exchange rate at the desired level due to insufficient reserve assets. Recent falling remittances, low levels of exports and lack of foreign direct investment (FDI) are placing downward pressure on the Lebanese pound. Lebanon has limited natural resources and a small manufacturing industry, thus relies heavily on imports. As a consequence, the gradual depreciation of the Lebanese pound has led to cost-push inflation.


Text F — Reforms and strategies for economic recovery

  1. The Lebanese government is seeking help from the International Monetary Fund (IMF) to restructure the government debt and develop its infrastructure. However, loans from the IMF will require the following conditions to be met:
    • procedures and processes established to ensure good governance, including enforcement of anti-corruption laws
    • financial sector reforms implemented to build confidence in the banking system and laws to control capital flight
    • government spending reduced and revenue increased through higher corporate, wealth and personal income taxes for high-income earners. Introduction of a tax on imported luxury goods and an increase of indirect taxes
    • partially privatizing the electricity and telecommunications sectors to increase efficiency and encourage the exploration of new energy sources
    • transitioning from a managed to a floating exchange rate system.

  2. Other organizations are offering development aid to rebuild infrastructure and support small to medium-sized businesses to develop the manufacturing sector and attract FDI. Currently, the manufacturing sector accounts for only 12.5% of gross domestic product (GDP). Some experts recommend that Lebanon decreases its reliance on food imports by developing its own food industry. However, Lebanon must commit to establishing good governance systems before aid organizations will provide their support.

  3. Lebanon has resisted seeking help from the IMF and other agencies in the past due to concerns about high levels of interference and imposed conditions that may conflict with their own government objectives.

 

Question

Using a PPC diagram, explain the impact of the damage to the major buildings in Beirut on Lebanon’s productive capacity (Text D, paragraph [2]).

▶️Answer/Explanation
For a correct PPC diagram with appropriate labelling showing an inward shift of the curve.
AND
For an explanation that the damage leads to a decrease in quality/quantity of infrastructure/ capital/factors of
production/resources [1]
and therefore, decreasing productive capacity [1].

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