Solved: Country A, Country B, and Country C are experiencing different economic... [IB Economics]

Question

HLPaper 3

Country A, Country B, and Country C are experiencing different economic challenges. Country A has recently implemented a subsidy on agricultural products to support domestic farmers. Meanwhile, Country B faces high inflation, leading to an increase in interest rates by its central bank. Country C, an export-oriented economy, is experiencing a decline in its balance of trade due to global demand fluctuations.

###Table 1: Market Data for Country A’s Agricultural Goods**

Price per Unit ($)	Quantity Demanded (thousands)	Quantity Supplied (thousands)
10	200	150
15	180	180
20	160	210
25	140	240

The government of Country A has decided to provide a subsidy of $5 per unit on agricultural goods.

Table 2: Inflation and Interest Rates in Country B

Year	Inflation Rate (%)	Interest Rate (%)
2021	3.2	4.5
2022	5.8	6.0
2023	7.1	7.5
2024	9.3	9.0

Table 3: Trade Data for Country C

Year	Exports ($ billion)	Imports ($ billion)
2021	85	70
2022	90	78
2023	88	82
2024	80	85

The government of Country C is considering trade policies to address the trade imbalance.

Using information from Table 1, calculate the price elasticity of demand (PED) when the price changes from $15 to$ 20.

[2]

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Solution

Correct approach:

The price increases from $15 to $20, while quantity demanded falls from 180 to 160 (thousands).

Percentage change in quantity demanded = $\frac{160 - 180}{180} \times 100 \approx -11.11\%$ .
Percentage change in price = $\frac{20 - 15}{15} \times 100 \approx 33.33\%$ .

1 mark

Correct final answer:

PED = $\frac{-11.11\%}{33.33\%} \approx (-)0.33$ .

1 mark

Explain why the subsidy provided by Country A’s government is likely to affect the equilibrium price and quantity.

[4]

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Solution

A subsidy is a government payment that reduces producers’ costs of production. 1 mark
Lower production costs shift the supply curve to the right (increase in supply). 1 mark
With a greater supply at each possible price, the new market equilibrium generally results in a lower price for consumers. 1 mark
The lower price encourages more quantity demanded, leading to a higher equilibrium quantity exchanged in the market. 1 mark

Using information from Table 2, calculate the percentage change in the inflation rate from 2021 to 2024.

[2]

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Solution

Correct approach

The inflation rate rises from 3.2% (2021) to 9.3% (2024).

$\text{Percentage change} = \frac{(9.3 - 3.2)}{3.2} \times 100$

1 mark

Correct final answer:

Percentage change = $\frac{(9.3 - 3.2)}{3.2} \times 100 \approx 190.63\%$ .

1 mark

Using information from Table 2, calculate the difference between the real and nominal interest rates in 2023 if the expected inflation rate was 5.5%.

[2]

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Solution

Correct approach:

Nominal interest rate in 2023 (i $_{nom}$ ) = 7.5%.
Real interest rate (i $_{real}$ ) = i $_{nom}$ − $\text{Expected Inflation Rate}$ = 7.5% − 5.5% = 2.0%.

1 mark

Correct final answer:

Difference between the real and nominal interest rates = 2.0 percentage points.

1 mark

Define the term balance of trade.

[2]

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Solution

The balance of trade is the difference between the value of a country’s exports and the value of its imports of goods and services 1 mark

over a given period, usually annually. 1 mark

Using information from Table 3, calculate the trade balance of Country C for the year 2024.

[2]

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Solution

Correct approach:

Trade balance = Exports − Imports
Exports in 2024: $80 billion
Imports in 2024: $85 billion

1 mark

Correct final answer:

Trade balance = Exports − Imports = 80 − 85 = −$5 billion

1 mark

Sketch a supply and demand diagram to illustrate the impact of the subsidy on Country A’s agricultural market.

[2]

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Solution

Correct labeling of axis and curves

1 mark

Shows a shift of supply curve to the right, hence increasing the quantity supplied and profit while decreasing the cost of production

1 mark

Using information from Table 3, explain how the trend in Country C’s trade data could affect its exchange rate.

[4]

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Solution

The data show that Country C’s trade surplus has been shrinking, turning into a deficit in 2024 (Exports USD 80 billion vs. Imports USD 85 billion).
A persistent or growing trade deficit means more spending on imports relative to income from exports, reducing net demand from $D_1$ to $D_2$ for the domestic currency in foreign exchange markets.
Lower net demand for the currency tends to put downward pressure on its value, resulting in a depreciation of the exchange rate from $e_1$ to $e_2$ .

2 marks for correct diagram OR explanation

4 marks for correct diagram AND explanation

Using the text/data provided and your knowledge of economics, recommend a policy that Country B’s central bank could implement to control inflation while maintaining economic growth.

[10]

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Solution

Below is an example answer:

DEFINITION

Inflation: A sustained increase in the general price level.
Economic growth: An increase in a country's real output (real GDP) over a period time.

MONETARY POLICY TO REDUCE INFLATION

Higher interest rates reduce inflationary pressures by discouraging consumption and investment, leading to lower aggregate demand.
The upward trend in Country B’s interest rates (4.5% to 9.0%) has attempted to tackle the inflation surge from 3.2% to 9.3%.
A targeted or gradual approach to further tightening can moderate price increases without severely harming domestic demand.

Diagram

An aggregate demand (AD) and aggregate supply (AS) diagram, where contractionary monetary policy shifts AD to the left, reducing the price level (from P to P1).
The reduction in output should be kept minimal if the central bank raises rates gradually, preventing a sharp decline in real GDP.

MAINTAINING ECONOMIC GROWTH

Excessively high interest rates risk reducing investment and consumption to the point of slowing real GDP growth.
A measured increase in rates can stabilize price expectations, reducing the likelihood of a wage-price spiral, while leaving enough room for businesses to borrow at feasible rates.
Sustained investor confidence depends on predictable policy. If the central bank clarifies its inflation target and commits to moderate adjustments, firms can plan long-term capital investments without fear of abrupt borrowing cost spikes.

CONCLUSION

A carefully calibrated, incremental rise in the interest rate is recommended to bring inflation closer to a manageable level while preserving growth prospects.
This policy uses the central bank’s main instrument—monetary policy—to address inflation, referencing how prior rate increases have partially contained price rises.
By maintaining a balance between controlling excessive price pressures and supporting business expansion, Country B can achieve lower inflation in tandem with steady economic growth.

(Other recommended policies may also be valid).

Economics International Baccalaureate (IB) Practice Question: Country A, Country B, and Country C are experiencing different economic challenges. Country A has recently implemented a...