Economics

Higher Level
Paper 3

Instructions to candidates:
● You are permitted to use a calculator for this paper
● Use fully labelled diagrams where appropriate
● Answer all the questions
● Your answers must be written in the boxes provided
● Unless otherwise stated in the question, all numerical answers must be given exactly or correct to
two decimal places
● You must show all of your working
● Total marks 50

1. Juke ltd. sells 200 units of its product each day at a price of $4, with a known price elasticity of demand of
-2.0.
a. Calculate Juke ltd.’s sales revenue [2]
Sales Revenue = 200 * 4 = $800

Therefore Juke ltd.’s sales revenue is $800 dollars

b. Calculate the new sales revenue if Juke increases its price by 20% [3]
New Price = Price x (1 + price increase)= 4 * 1.2 = 4.8

New Demand = Demand x (1 + demand increase)= 0.6 * 200 = 120

Sales Revenue = 120 * 4.8= $576

Therefore the new sales revenue when Juke increases price by 20% is $960

c. Explain whether raising its price was a good decision for Juke ltd. [2]
It was a poor decision since the elastic price elasticity of demand of -2 of Juke ltd. shows iit is an inferior good.

Meaning that an increase in price in the good will result in less consumers being willing and able to purchase

Juke goods. Therefore, Juke ltd. will have a decrease in revenue when it raises its prices.
 2. The government of Country Y decides to impose an indirect tax of $10 per widget. With reference to
Figure 2 (below), explain how the incidence of taxation on consumers and/or producers will be influenced
by the price elasticity of supply. [4]
In general, when a product is price elastic of demand (PED>1), a tax of $10 per widget will cause producers to

have to bear the cost of the tax. This is because if the producer were to raise the price of the product to account

for the additional tax, due to the high elasticity of supply, consumers will be far less willing/able to buy

the product resulting in lost revenue for the producer. In this case, it would be better for the producer to view

the tax as an extra production cost, rather than implementing it into the actual price. In relation to the PES,

since it is perfectly elastic where the price varies with no change in quantity supplied, further solidifies the

Previous statement because an increase in tax will not change the amount of product produced.
 3. Assume the income elasticity of demand for cigarettes in a particular country is known to be +0.14.
a. If there is a 3.5% increase in real household income, explain what happens to the demand for
cigarettes. [2]
The income elasticity of demand for cigarettes of 0.14 is inelastic, where for every 1% increase in household

income there is a 0.14% increase in demand for cigarettes. Therefore an increase of 3.5% of income would

cause a 0.49% increase in demand for cigarettes.

b. Using your answer from the question above, briefly explain what the figure suggests about the
demand for cigarettes. [2]
An increase of only 0.49% in demand of cigarettes when there is an increase of 3.5%, where for every 1%

Increase in household income there is a 0.14% increase in demand for cigarettes. Making the income elasticity

of demand inelastic, and since it's so low and positive, it suggests that for some cigarettes is an essential good.

4. Suppose that real household income in France is expected to rise by 1% this year. Calculate the sales
volume for chanel perfume, given sales of 50,000 units in the previous year and a known income elasticity
of demand of +3.25. [2]
New Demand = (YED/100) * 50 000 + 50000 = 51625

Therefore given the elastic YED of 3.25, the new demand for sales given an rise in income of 1% is 51625 units

5. Study the estimates of the YED for various products in a country, then answer the questions that follow.

Product YED (estimate)

Petrol (gas) +0.25

Soft drinks -0.33

Domestic holidays +1.36

Public transportation -0.22

a. Identify one inferior good and one luxury good from the products shown in the table. [2]
Soft drinks is inferior

Domestic holidays is luxury

b. Explain which of the given suppliers would gain the most from an economic boom. [2]
Petrol and domestic holiday supplies would gain the most since they are normal goods (YED>1). Therefore

when there is an increase in income such as when there is an economic boom, more consumers will be willing

and able to buy more normal good, in this case Petrol and domestic holidays.
 c. Explain which of the given suppliers would gain the most from an economic downturn (recession)
[2]
Soft drinks and public transport would gain the most from a recessions since they are inferior good (YED<1)

Therefore, when there is a decrease in income such as when there is an economic recession, more consumers

will opt for cheaper, sometimes unhealthier substitutes, in this case, soft drinks and public transport.

d. If average household income increases by 3.5%, calculate the percentage change in the demand
for public transportation and domestic holidays. [2]
Percent change demand (public t.)= YED * percent change in income = -0.22 * 3.5 = -0.77%

Percent change in demand (domestic h.)= YED * percent change in income =1.36 * 2.5 = 4.76%

e. Using the figures in the table, explain why the government is more inclined to tax petrol(gas) rather
than to tax providers of domestic holidays. [3]
The government is more inclined to tax petrol than tax providers because petrol, being an essential good is far

less income elastic, YED of 0.25, than domestic holiday, YED of 1.36. This low income elasticity of petrol

allows producers to raise prices of the product, since consumers will have to purchase it anyway. Whereas if

a producer raised the price of domestic holidays due to a tax increase, consumers will be far less willing and

able to purchase a holiday, resulting in less tax money being earned.

6. Explain why, for a linear demand curve, the price elasticity of demand is not represented by the slope of
the demand curve. [4]
This is because to calculate price elasticity it is: percent change in quantity demanded / percent change in

Price. Not: (Quantity demanded 1 - Quantity demanded 2) / (Price 1 - Price 2). The reason why price elasticity

of demand is not represented by slope of the linear demand curve is because price elasticity changes

throughout the line, which is not represented by just the slope. The slope will generalize all of the different

elasticities, providing an inaccurate, and unhelpful measurement.

7. The price of a restaurant meal is $6 and the daily quantity supplied is 400 meals. If the PES is known to be
+1.25, calculate how a fall in price to $5.40 per meal will affect the quantity supplied. [2]
PES = Qdc%/Pc%

Qdc% = PES * Pc% = 1.25 * 10% = 12.5%

Therefore, a fall in price to $5.40 from $6 will cause an increase of quantity supplied of 12.5%, 400 to 450 meals
 8. Good J and Good K are both produced in Zestria. The price elasticity of demand for Good J, a primary
commodity, is –0.2. The price elasticity of demand for Good K, a manufactured good, is –2.3. Explain why
this occurred. [4]
The small PED of -0.2 of Good J versus the greater PED of -2.3 of Good K is because Good J is a primary

commodity whereas Good K is a manufactured good. Primary commodities like Good J generally have few, to

no substitutes, making it an essential good. If there is low supply of Good J and the price increases, the

quantity demanded will hardly change. On the other hand, manufactured goods like Good K generally have

plenty of substitutes, making it non-essential. So, if there is an increase in price of Good K, consumers will

simply switch to a cheaper alternative explaining its high price elasticity, in contrast to Good J.

9. Price of corn increases by 10% leading to an increase in quantity supplied of 1%. Comment on the value
of PES. [4]

This extremely low PES of 0.1 of corn shows that it is an essential good, making it likely that it is a primary

commodity with few to no substitutes. For every % that the price of corn increases by, the quantity supplied

increases by just 0.1%. This shows that the PED is also very low since a large price increase, results in

little change in demand, which in turn shows a small change in quantity supplied.

10. The following table provides data on the price and quantity demanded (per month) of three goods in
Zestria.
Good A Good B Good C

Price Quantity Price Quantity Price Quantity

($ per unit) Demanded ($ per unit) Demanded ($ per unit) Demanded

January 8 160 10 200 15 125

2014

February 6 220 10 190 25 100

2014
 a. Calculate the price elasticity of demand for Good A, Good B, and Good C between January 2014
and February 2014. Comment on your results. [6]
PED (good a) = Qdc%/Pc% = 37.5%/-25%= -1.5

Therefore, good a is price elastic, and an inferior good. For every 1% increase in price, -1.5% decrease demand

PED (good b)= Qdc%/Pc% = -5%/0= 0

Good b is perfectly price elastic, zero change in price and changes in demand

PED (good c)= Qdc%/Pc% = -20%/67%= -0.3

Good is price inelastic and is an inferior good, for every 1$ increase in price, -0.3 decrease in demand

b. How could the producer of Good C increase their total revenue? [2]
Since good C is price inelastic and an inferior, a way to increase the total revenue would be to slightly decrease

the price, since consumers will be more willing and able to purchase a cheaper inferior good, since it is a

substitute for other goods. However not too much since it is relatively price inelastic and a major change in

price will not result in a major change in quantity demand, which would lead to a decrease in revenue.