20 Economics for the IB Diploma

5 a The supply of oil is price inelastic in the short run due to the time needed to raise investments into the
exploration, extraction, purification and distribution of oil. Hence, only in the long run can there be an
increase in the supply of oil (albeit a non-renewable resource).
Alternatively, students could argue that supply can be somewhat price elastic if suppliers are operating
below their productive capacity and/or have buffer stocks of oil that can be released onto the market.
Award 1 mark for an answer that shows limited understanding of the demands of the question.
Award 2 marks for an answer that shows good understanding of the possible value of PES for oil in the
short run.
b In the long run, the supply of oil is more price elastic as new oil fields and sites might be discovered and/or
improved technologies lead to more efficient extraction of oil. However, in the very long run, oil as a finite
resource means that the price elasticity of supply will eventually become lower. This is especially the case as
suppliers switch to alternative energy sources such as electric powered cars.
Award 1 mark for an answer that shows some understanding of the demands of the question.
Award 2 marks for an answer that shows good understanding of the possible value of PES for oil in the
long run.
c The commonly prescribed medicines are likely to be mass produced, using automated technologies. This
means the output of the health products can be changed with relative ease in order to meet changes in the
market price of the product.
Award 1 mark for an answer that shows some understanding of the demands of the question.
Award 2 marks for an answer that shows good understanding of why the PES of commonly prescribed
medicines is price elastic.

8 Role of government in microeconomics

1 a Equilibrium exists where demand = supply, i.e. at P = $20 both demand and supply equal 20,000 units.

Award 1 mark for correctly identifying the equilibrium price.

b A price ceiling refers to the legal maximum price for a particular good (such as food products) or service
(such as healthcare). It is a form of government intervention designed to protect individuals and
households on low income as market prices could mean they are unable to afford important goods and
services (such as housing).
Award 1 mark for a definition that shows a limited understanding of the term price ceiling.
Award 2 marks for a good definition that shows a clear understanding of the term price ceiling.
c The minimum price of $25 means that demand = 15,000 units whereas supply = 24,000 units. Hence, there
is excess supply (or a surplus) of 9,000 units.
Award 1 mark for a brief answer that shows a limited understanding of the demands of the question.
Award 2 marks for a good understanding of the impact of a price floor on the product, with reference made
to the resulting excess supply.

2 a n At P = $4, both demand and supply equal 6,000 units.

n Hence, the equilibrium price is $4.
Award 1 mark for correctly identifying the equilibrium price.
b n At P = $5, demand = 5,000 while supply = 7,000 units.
n Hence, the excess supply = 2,000 units.
Award 1 mark for stating the correct value of excess supply.
 Unit 2 Microeconomics 21

c n The $2 per unit tax shifts the supply curve parallel to the left by the vertical distance of the tax.
n Hence, the new supply at each price level now needs to be $2 more to create willingness and ability to
supply, e.g. supply was 3,000 units at $1 but now needs to be $3 due to the tax.
n Similarly, 5,000 units were previously supplied at $3, but to supply the same amount now requires a
price of $5.
n Hence, at $5, both demand and supply equal 5,000 units, i.e. the new equilibrium price is $5.
New Original
Qd Price Qs Qd Price ($) Qs
3,000 7 7,000 3,000 7 9,000
4,000 6 6,000 4,000 6 8,000
5,000 5 5,000 5,000 5 7,000
6,000 4 4,000 6,000 4 6,000
7,000 3 3,000 7,000 3 5,000
8,000 2 8,000 2 4,000
9,000 1 9,000 1 3,000

Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
d n At the equilibrium price of $5, quantity (output) = 5,000.
n Hence, total tax revenue = $2 × 5,000 = $10,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
e Consumers used to pay $4 but now pay $5. As the tax per unit is $2, this means consumers pay $1 per unit
of the tax burden (or $5,000 tax burden in total).
Award 1 mark for a brief answer that shows some understanding.
Award 2 marks for a clear understanding of how much of the tax incidence is borne by the consumer.

3 a n At P = $6, both demand and supply equal 60,000 units.

n Hence, the equilibrium price is $6 and the equilibrium quantity traded is 60,000.
Award 1 mark for identifying the correct equilibrium price, and 1 mark for the equilibrium quantity.
b n The subsidy enables supply to shift to the right, with the vertical distance between the two supply curves
being equal to the per unit subsidy (of $1).
n Previously, a price of $6.50 was required to generate supply of 70,000 units.
n Now, with the $1 per unit subsidy, the same 70,000 units can be supplied at a price of $5.50.
n Hence, the equilibrium price is now $5.50 and equilibrium output is 70,000 units.
New Original
Qd Price ($) Qs Qd Price ($) Qs
30,000 7.5 30,000 7.5 90,000
40,000 7.0 40,000 7.0 80,000
50,000 6.5 90,000 50,000 6.5 70,000
60,000 6.0 80,000 60,000 6.0 60,000
70,000 5.5 70,000 70,000 5.5 50,000
80,000 5.0 60,000 80,000 5.0 40,000
90,000 4.5 50,000 90,000 4.5 30,000

Award up to 2 marks for the correct answers, and 1 mark for showing appropriate working out.
22 Economics for the IB Diploma

c n The per unit subsidy = $1, and the quantity supplied = 70,000 units.
n Hence, the total cost of providing the subsidy = $70,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
d n The total subsidy (calculated in the previous question) = $70,000.
n However, as consumers received only $0.50 of the $1 per unit subsidy (they used to pay $6, but now pay
$5.50), their incidence of the subsidy = $35,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.

4 a n Per unit tax = $20 − $10 (the vertical distance between the two supply curves) = $10.
n Quantity traded = 30,000 units.
n Hence, total tax revenue = 30,000 × $10 = $300,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
b n Consumers used to pay $15 but now pay $20, i.e. an extra $5 per unit.
n Equilibrium quantity is now 30,000 units.
n Therefore, the total tax burden to consumers = 30,000 × $5 = $150,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
c n Consumers used to spend $15 × 40,000 units = $600,000.
n They now spend $20 × 30,000 units = $600,000.
n Therefore, there is no change in total consumer spending after the tax.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
d n The welfare loss is the loss of consumer surplus and producer surplus following the change in price from $15.
n It is equal to the triangular area [($20 − $10) × (40,000 − 30,000] ÷ 2 = $50,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
e n Producer surplus is the difference between what suppliers receive ($10 after imposition of the tax) above
the price they are willing and able to supply.
n The new producer surplus is shown by the area above the supply curve, under the horizontal price
level ($10).
n Hence, producer surplus = ($10 × 10,000) + [($10 − $0) × (30,000 − 10,000)] ÷ 2 = $100,000 +
$100,000 = $200,000.
35

S+tax
30

S1
25

20
Price ($)

15

10

5
D

0
10 20 30 40 50 60
Quantity (’000 units)

Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
 Unit 2 Microeconomics 23

f n Previous consumer surplus = [($35 − $15) × 40,000] ÷ 2 = $400,000.

n New consumer surplus = [($35 − $20) × 30,000] ÷ 2 = $225,000.
n Therefore, the change in consumer surplus = $400,000 − $225,000 = $175,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.

5 a At the minimum price of $30, there will be excess supply of 4,000 units. This is because at $30, supply
will be 7,000 units whereas demand will only be 3,000 units. Thus, a surplus exists due to the price floor.
Award 1 mark for a brief answer that shows some understanding of the demands of the question.
Award 2 marks for a good answer that shows a clear understanding of the resulting excess supply due to the
imposition of the price floor.
b n Consumers used to spend $20 × 5,000 units = $100,000.
n At the higher price of $30, they now spend only $30 × 3,000 = $90,000.
n Therefore, the change in consumer spending = −$10,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
c n Producers used to earn $20 × 5,000 units = $100,000.
n At the higher price of $30, they now earn:
l From consumers: $30 × 3,000 = $90,000

l From the government: $30 × 4,000 excess supply = $120,000

l Thus, total earnings are now $210,000.

n Therefore, the change in producer revenue = +$110,000.

Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.
d n The total amount spent on buying the excess supply = $30 × 4,000 = $120,000.
n If the government exports the excess supply, it receives $20 × 4,000 = $80,000.
n Hence, taxpayers have to pay for the difference, i.e. $40,000.
Award 1 mark for the correct answer, and 1 mark for showing appropriate working out.

9 Market failure – externalities (externalities and

common pool or common access resources)
1 a The original equilibrium is where D = S1, i.e. P3 and Q1.

Award 1 mark for identifying the correct answers.