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How do Economists Approach the World? · Paper 2 — Free Economics SL Practice Questions
1MasteryLAQEconomic models and assumptions10 marksPaper 2~15 min
Data
- Marginal propensity to save (MPS)
- Annual investment by firms
A small island nation, Viti Levu, relies primarily on subsistence farming and fishing. The government is considering introducing a tourism tax and wishes to predict its impact on national income. Economists propose using the basic circular flow of income model, assuming the economy is closed (no international trade) and that there is no government sector. The model includes only households and firms: households provide factors of production and receive income; firms produce goods and services.
(a)
State one leakage and one injection in the two-sector circular flow of income model described above. [2 marks]
(b)
Calculate the equilibrium level of national income for Viti Levu. [2 marks]
(c)
Explain why the assumption of no government sector limits the usefulness of this model for predicting the impact of the tourism tax on national income. [2 marks]
(d)
Using the data and your knowledge of the circular flow model, evaluate whether this two-sector model is an appropriate tool for predicting the macroeconomic impact of the tourism tax on Viti Levu's national income. [4 marks]
Solutions
2MasteryLAQEconomic models and assumptions10 marksPaper 2~15 min
Data
Variable — Value
Initial equilibrium price — USD 0.20 per kWh
Initial equilibrium quantity — 100 million kWh per day
Proposed carbon tax (on producers) — USD 0.05 per kWh
Price elasticity of demand (PED) —
Price elasticity of supply (PES) —
Electricity Market and Carbon Tax Policy
A government is considering introducing a carbon tax to reduce greenhouse gas emissions. An economist constructs a simplified economic model to predict the impact of the tax on the electricity market. The model operates under the following assumptions:
- All electricity producers are profit-maximising firms.
- Consumers have perfect information about the tax.
- The market is perfectly competitive in the long run.
- There are no external benefits or costs other than the pollution from electricity generation.
(a)
State what is meant by an economic model. [1 mark]
(b)
Using the data provided, calculate the new equilibrium price paid by consumers and the new equilibrium quantity traded after the carbon tax is introduced. Show all working. [3 marks]
(c)
Discuss the extent to which the assumption of perfect competition limits the usefulness of this model for predicting the real-world impact of the carbon tax on electricity markets. Refer to at least two distinct real-world market structures in your answer. [6 marks]
Solutions
3ChallengeLAQNormative vs positive economics10 marksPaper 2~15 min
A government is considering raising the legal minimum wage from USD 7.25 per hour to USD 15.00 per hour. An economist produces a report containing two statements:
- Statement 1: "A minimum wage increase to USD 15.00 per hour will reduce employment among low-skilled workers by approximately 5 percent."
- Statement 2: "A minimum wage increase to USD 15.00 per hour is a necessary step to ensure a fair standard of living for all workers."
(a)
Identify which statement is positive and which is normative. [1 mark]
(b)
Justify your answer to part (a) by explaining the distinguishing feature of each statement. [2 marks]
(c)
Using a labour market and the concept of price elasticity of demand for labour, explain how an economist would assess whether the predicted 5 percent fall in employment in Statement 1 is valid. [3 marks]
(d)
Evaluate the view that normative economics is less useful than positive economics for guiding government minimum wage policy. [4 marks]
Solutions
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