IB Exam Review: Paper 1 – Developmental Economics (2)

a) Explain the various types of aid which a developing country might receive.

The largest source of assistance received by developing countries today is aid. There are three types of aid; humanitarian, bilateral, and multilateral. Humanitarian aid can be provided by individual countries or by a United Nations agency.

Humanitarian is usually provided to help resolve a specific problem. For example, if a country was experiencing a drought, they could receive food that would normally grow there. If a country is experiencing problems with diseases, they could receive medical aid.

Bilateral aid is provided my individual countries. This, unlike humanitarian aid, is a loan. The receiving country can use the money to do as it sees fit. A real world example of this is when the United Kingdom provide Turkey with funds and experts to help them build a dam.

The final form of aid is multilateral aid. Multilateral aid is when countries pay money to a central organization which then distributes the money based on criteria they choose. The country that, by their criteria, is in the worst situation receives the most funding.

b) “Aid is an effective means of promoting the development of poorer countries.” Evaluate this statement.

Economic development is defined as an increase in the quality of life and therefore the standard of living of the citizens in a country. Aid, whether it is humanitarian, bilateral, or multilateral can help provide the resources and/or funds to improve the standard of living and therefore undergo economic growth. There are several positive and negative consequences as well as long term effects to providing a country with aid.

Aid involving monetary funds can be utilized to improve the production and the infrastructure of the country. This would lead to increased wages due to higher quality products and higher standards of living due to the improved infrastructure. However, to start a country down this path it must break the poverty cycle. This can also be done if the funds are allocated correctly; specifically local investment.

There are also some negative consequences to aid. Foreign aid may lead to dependence on support and the country may never be able to break the poverty cycle and start to develop. Foreign aid is only a short term solution. In the long run, the country must be able to provide the funds to further develop on its on. Yes, aid may be to help the country get on its way, but unless the country is able to become self sufficient it will keep requiring aid. In this case aid would be a hinderance rather than a benefit to economic development. In the short run aid may be an easy solution but in the long run in cause more problems than it solves.

IB Exam Review: Paper 1 – Developmental Economics

a) Explain three institutional factors that may contribute to potential economic growth in developing countries.

It is not enough for a country in increase it’s output to develop. They must also have a solid infrastructure to develop economically, a macroeconomic goal. There are five main institutional factors that may contribute to potential economic growth in developing countries, however only three will be discussed. The first is a good educational system. Part of developing a country is educating the population. An educated population is more likely to make better decisions not only in business but also in their personal life. These decisions may contribute to increasing their standard of living, which is a major part of developing a country. (Increase in productivity)

A second institutional factor is a good health care system. The work force must be healthy to be able to maximize production. Education is useless if the people are not healthy enough to work and vice versa. By improving the health of workers you are increasing the number of years workers are able to work, therefore increasing quantity of workers. Also, healthy workers will produce a better quality product. Therefore health care is an essential factor that could contribute to potential economic growth.

One more institutional factor that may contribute to potential economic growth is a stable banking system. A good banking system allows business to acquire the funds they require to grow. This will also provide stability which is essential in increasing investment, both domestic and foreign. Investment is essential in developing businesses and potential economic growth.

b) Evaluate the view that economic growth will lead to economic development.

Economic growth can be defined as an increase in output whereas economic development is a improvement in standard of living of the population.

There are several negative and positive consequences that arise with economic growth. The first negative consequence is the inequality of income distribution. As businesses grow, the income of the owners and individuals higher up on the chain is going to increase. They will most likely use this money to better their lives; buy a new house, send their children to school, better their standard of living. This will increase the gap between the richest and the poorest people in the country. Another negative consequence is pollution, a negative externality. As production increases, as will the number of vehicles needed to transport materials and products and the pollution will increase. Also, if the products are produced in a factory, the factory is a large source of pollution. Pollution, as is evident in India, can severely impact people’s lives. Individuals are more susceptible to diseases from polluted air or water. This would decrease the standard of living. In this situation, although economic growth was achieved, economic development was not.

However, there are instances where economic growth will lead to economic development. As individuals’ incomes increase, they may hire a driver or a maid. The wealth gained by this individual will trickle down to the poorer people in the population. This is known as the trickle down effect. Another instance where economic growth and therefore increased incomes would lead to economic development is increased consumption. The now richer population have the ability to provide education, food, shelter, and health care to their families, although in the short term this is a smaller proportion of people than would not gain from economic growth. However, in the long term it the benefits will outweigh the costs and growth will lead to development.

Summative Paper 1 Reflection

The main problem for me was not paying attention to little details. They were “silly mistakes” and could have been avoided easily by simply referring to the specific labels in the diagram (e.g. Q1). If I pay more attention to small details like this I think I could achieve a 7 on the actual IB exam.

Preliminary Information for Swaziland

GDP Per Capita: $4,500

Population Growth Rate: 1.213% (102th Worldwide)

Unemployment Rate: 40% (2006 est.)

GDP by Sector:

Agriculture 8.6%

Industry 42%

Service 49.4% (2009 est.)

Swaziland has a relatively high GDP per capita considering that is in the bottom 60 nations of the world. It has normal population growth rate. The most concerning thing is the fact that 40% of the population is unemployed. If they found a way to decrease their unemployment rate their GDP could potentially sky rocket and they would be lifted out of the bottom 60. However, it is promising that a majority of their GDP is based on service rather than the primary sector (agriculture).

(a) Explain three types of protectionism that a government might adopt in the context of international trade. (b) Evaluate the extent to which protectionism may be justified in international trade.

Definitions:

Protectionism – A policy introduced by the government which inhibits international trade such as tariffs, subsidies, and quotas.

Tariffs

A tariff is a tax on imports, which can either be specific (so much per unit of sale) or ad valorem (a percentage of the price of the product). Tariffs reduce supply and raise the price of imports. This gives domestic equivalents a comparative advantage. As such, tariffs are distorting the market forces and may prevent consumers from gaining the benefit of all the advantages of international specialisation and trade. The impact of a tariff is shown in Figure 1 below.

The tariff has the effect of shifting the world supply curve vertically upwards by the amount of the tariff. The level of imports will fall from QaQd to QbQc. The government will also raise revenue, shown by the blue shaded area. The level of domestic production will increase from 0Qa to 0Qb.

Quotas

Quotas have the effect of restricting the maximum amount of imports allowed into an economy. Once again, they reduce the amount of imports entering an economy and increase the equilibrium price within the market. The government receives no revenue from a quota, as it does with a tariff, unless it can set up a system of licences.

Export subsidies

Export subsidies allow exporters to supply the market with more product than the natural equilibrium would have allowed. Foreign consumers will enjoy increased economic welfare as the price of their purchases fall. Domestic employees might enjoy more wages and job security. But taxpayers are footing the bill for this. Domestic firms might divert trade into exports and ignore the home market. This could lead to increases in domestic prices.

The impact of a subsidy is shown in Figure 2. The supply curve is shifted vertically downwards by the amount of the subsidy and this leads to a lower equilibrium price and a higher quantity being traded.

• Tariffs are taxes that a government can put on a product of a foreign company trying to export to said country. They generate government revenue. They rise the price of cheaper imported goods to allow domestic producers to compete with international producers. However, they also let inefficient producers back into the market and take away the product form consumers that cannot afford it at a higher price.
• Quotas limit the amount of a product that can be imported. This means that the supply will decrease.

Finally, for evaluation we must evaluate the pros and cons of the various types of protectionism. Moreover, discuss in which situations (infant industry and dumping) in which protectionism is acceptable.

Playing with Money

Over the past few years the U.S. has been accusing China of manipulating their currency and deliberately keeping their currency weak to encourage exports.

It was only recently (2005) that China agreed to cease their fixed exchange rate, when the value of one currency in terms of another currency is set by the government, with the U.S. and move to a free floating managed exchange rate, when market forces are the driving mechanism to set the exchange rate with some assistance from the government, like many other countries in the world including Japan. When China announced the change they were about to make U.S. Secretary of Treasury John W. Snow said, “They’ve put in place a mechanism that provides room for significant movement over time in the currency, and they’ve expressed a commitment to using market forces to let the currency move.”

However, accusations that the Chinese government have resorted back to their old ways and manipulating their currency significantly have arisen recently. The Chinese want to keep the value of the currency low so it can continue it’s high exports. The U.S. is upset because if the Chinese currency is so weak, even U.S. citizens will by Chinese products. This means that locally produced products will not be necessary and U.S. jobs will be lost. Theoretically, China’s weak currency should appreciate due to high demand for it by virtually the entire developed world and the system should self correct itself, however the Chinese currency remains weak. This is the basis of the accusations made by the U.S.

China has had a surplus for nearly the past 20 years. It’s most recent current account balance was $297,100,000,000.

The U.S. currency will benefit from depreciation. The U.S. has been in debt since 1992 and has been buying more than they can afford. Their current account deficit is currently $14.1 billion according the Bureau of Economic Analysis. Depreciation would allow the U.S. to increase it’s exports and rid itself of some of it’s debt. Because the dollar is so strong it makes it difficult for the U.S. to export but easy for them to import because everything is so cheap, comparatively. The balance of payments is a self correcting system and if the U.S. would not have used their credit cards for everything and spent way beyond their means, they would experienced a depreciation that would have made foreign products more expensive and decreased spending internationally.

If China’s Yuan were to appreciate they would experience a decrease in exports because their currency would appreciate and their products would become slightly more expensive to the world. This is why China wants to keep their currency low. If they are manipulating their currency, it is a logical thing to do because it would benefit economic growth. However, it does not benefit economic development. Furthermore, currency manipulation is prohibited by the World Trade Organization and if China is manipulating their currency they should stop.

U.S. Current Account Deficit (via Dalia’s Economic Blog)

I like how you used many graphs and lots of data to help explain the situation. You also went back to 1991, the last year the U.S, had a surplus. Good history research. I see IB HL History is paying off.

As we all know, the US is currently has a current account deficit. The current account is the sum of the balance of trade, net factor income, and net transfer payments. A nation is said to have a trade deficit if it is importing more than it exports. We can see on the graph below how the annual US current account deficit has grown. In 2004 the trade deficit was negative $617.7B which represents most of the current account deficit. The US has not … Read More

via Dalia's Economic Blog

Australia’s Deficit

Australia currently has a current account deficit. According to an article by Bloomberg.com, this is due to two major events. The first is that due to Australia’s appreciating currency, the world’s products have become cheaper for Australians to purchase so residents are spending more than they earn. This applies to business firms as well. Importing products has become cheap, but due to the increase in value of the Australian dollar, Australia’s products have become more expensive for the world and Australian exports have decreased. According to the Bureau of Statistics, Australia’s exports account for 0.4% of the net GDP.

The second issue is that Australia is borrowing money from overseas to compensate for the lack of investment made by local savings. If Australia does not stop spending recklessly, they may find themselves in a situation similar to that of the United States today.

China’s Surplus

Over the past years China’s current account surplus has been steadily increasing. The table below illustrates the current account surplus in U.S. dollars from 2004 to 2010.

These figures are massive. The surplus in 2009 was 6 percent. This is nothing compared to it’s peak at 10.7 percent in 2007. Coupled with the rate at which China’s economy is growing, one can extrapolate that the dollar amount of the surplus is massive. This is largely due to it’s business partnership with the United States.

One article published a few days ago illustrates this point very well. The article has lots of useful data. A current account surplus is not as big of a problem as a deficit, but it too yields consequences. That much excess income could be used to increase the standard of living and boost aggregate demand of an economy to accomplish macroeconomic goals economic growth and development. Because there is so much surplus, it may indicate that China is improving it’s country to it’s full capacity. It’s government may be underperforming.

Despite these problems having a surplus this large will definitely provide a cushion for unforeseeable years that may yield economic turmoil.

Data Response Formula

After doing a few data responses in a row, I have composed a formula that will ensure I high mark.

The best thing to do with the definitions is just memorize them. If you are hesitant whether or not to include something, include it because it usually the difference a 1 and 2 out of 2.

For the diagrams, be neat. In the explanation discuss why the shift occurred using economic terms with reference to the P’s and Q’s.

The evaluation is by far the most difficult. Consider the acronym CRAMPSS. The most useful are always stakeholders, causes and consequences, special circumstances, and pros and cons. Discuss the effect with respect to each of these aspects in details. Next discuss what they should do with reference to economic theory. Finally, for the last 2 points, discuss the motive behind the action taken. Bring out the heart of the article. Bring up things that were mentioned in the article and elaborate on them with reference to economic theory.