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IB ECONOMICS HL

Internal Assessment Economics Commentaries Example 1

UPDATED ON - 17 APR 2020
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Table of Contents

 

  1. Article 1

  2. Commentary on Article 1

  3. Article 2

  4. Commentary on Article 2

  5. Article 3

  6. Commentary on Article 3

 

Alcohol consumption increases

KITTY HOLLAND

 

The amount of alcohol being consumed by Irish adults increased last year for the second year in a row, provisional figures from the Central Statistics Office and Revenue Commissioners show.

 

Dr. Tony Holohan, Chief Medical Officer at the Department of Health, told the Joint Oireachtas Committee on Health he “just got the provisional figures from the CSO” which showed the average per capita consumption of pure alcohol increased from 11.9 liters in 2010 to 12 liters (11.97 liters) last year.

 

“That’s against the background of the increased affordability of alcohol.”


Dr. Holohan was addressing the committee as chairman of the Department’s steering group the National Substance Misuse Strategy, along with Minister of State for primary care, Róisín Shortall. The strategy aims to cut average alcohol consumption to 9.1 liters of alcohol per adult.

 

The Committee also heard about plans to end home deliveries of alcohol.

 

The Alcohol and Beverage Federation of Ireland argues alcohol consumption has been declining since the high point of 2006 when the average was 13.4 liters per adult.

 

Ms. Shortall told the Committee she planned to end ’distance sales’ of alcohol, to include the purchase of alcohol on-line from supermarkets, from takeaway and off-license delivery services.

 

“I’ve spoken to the Garda Commissioner in recent months and he’s coming back to me on it. The question is whether we need a change in law or greater enforcement of legislation.”

 

There was unanimous support from all members of the Committee for the Strategy, which calls for a ban on all sponsorship by drinks companies of sporting and large outdoor events, a ban on all outdoor advertising of alcohol, an increase in excise duties on some alcohol products and the introduction of a minimum price per gram of alcohol.

 

Chair Jerry Buttimer (Fine Gael) said it was “important our unhealthy relationship with alcohol is faced head-on. We must have the courage of our convictions”.Denis Naughton (Fine Gael) said: “We all accept the huge and damaging impact alcohol is having on Irish families.”

 

He criticized supermarket advertisements this weekend “focusing on special drinks promotions for St Patrick’s Day”. Asked about plans to commence 2008 legislation to compel supermarkets to segregate alcohol from other groceries, Dr. Holohan said the steering group’s wish had been to ban alcohol from being sold in ’mixed trading’ outlets altogether.

 

“But the pragmatic point of view was to use legislation already in place.”

 

This, combined with a minimum price per gram of alcohol to end alcohol being sold very cheaply, would have an impact on overall alcohol consumption.

 

Asked what sort of minimum price the Department was looking at, he said the Scottish parliament was planning a price of between 5c and 10c per gram of alcohol.

 

If a minimum price of 7c per gram were legislated for here, a 500 ml can of beer with an alcohol content of four percent have to cost at least €1.40, he said. Or a 750ml bottle of wine with an alcohol content of 13 percent would be priced at a minimum of €6.82.

 

The ’unit’ measurement was confusing he said. For example, a strong, craft beer contained more alcohol than a light larger and yet a half pint of ’beer’ was said to be one unit.

 

The legislation would be introduced to ensure all alcoholic products were labeled with details of how many grams of alcohol and calories were in the product. “Then there will be no confusion, no ambiguity.”

 

Commentary:

 

The article explains the measures taken by the Irish Government to curb binge alcohol drinking in Ireland. Excessive consumption of alcohol causes social damage such as damage to public property by intoxicated people, increased costs to public hospitals for treating alcoholic patients, and lower productivity owing to diminishing health. Thus, excessive consumption of alcohol causes a negative consumption externality [ a burden/cost endured by third parties arising from the consumption of a good, where MSB (Marginal Social Benefit) < MPB (Marginal Private Benefit) 1]

The socially optimal level of alcohol (Qsocially optimal/ intersection of MPC and MSB) is lower than the market-determined level of alcohol (intersection of MPC and MPB). This is because the MSB of consuming alcohol is less than its MPB. To ensure minimal spillover costs to society, the Irish Government must interfere in the free market and shift the MPB curve leftward ( reduce overall demand)and/ or shift the MPC curve upward (increase costs of production and thus reduce overall supply).

 

Attempts made by the government would work to the extent of reducing the ease of availability of alcohol (e.g. ending home deliveries and distance sales of alcohol). However, due to alcohol’s low elasticity (due to low substitutability and addiction some people might have to it), these attempts wouldn’t substantially reduce demand for alcohol. Price controls like a minimum price and increasing excise duties, both of which the Government has decided to introduce, would be more effective in influencing demand for alcohol.

 

A legally set minimum price imposed by the Government is a price above which sellers of the minimum price-imposed good cannot legally sell their goods. Fig 1.2 illustrates the effect of a minimum price of 7c/g on alcohol.

 

A restricting minimum price of 7c/g of alcohol which is more than the prevalent price/g for alcohol (Original) would result in reducing demand from Qe to Qd but would also simultaneously lead to an excess supply of alcohol. Owing to the surplus, there is a possibility of the excess alcohol being sold at a cheaper rate in the underground market as an attempt by firms to get rid of excess stock.

 

Another option to reduce demand for alcohol is to increase excise duties, (a form of indirect tax), on alcoholic products. An excise tax is a flat rate tax since it is specific ( x cents per liter). The incidence of this tax increase can be represented in Fig 1.3.

An increase in excise duties would increase the costs of producing alcohol, hence shifting the supply curve upward by a vertical distance equal to the tax increase. This reduces demand from Q1 to Q2. Because of the high inelasticity of alcohol, the tax incidence falls more on the consumers than on producers. (P2-P1)X(Q2) > (P1-P3)X(Q2) in Fig 1.3.

 

Due to the high tax incidence on consumers, demand is reduced. The increase in excise duties results in steep price rise, in the short run, as an attempt by firms to nullify extra costs in producing. The increased price of alcohol would also increase costs for foreign markets, thus reducing alcohol exports. The increased revenue, resulting from the price rise coupled with alcohol inelasticity, will attract new firms in the long run, eventually resulting in alcohol being produced efficiently. (production at minimum costs).

 

The Government earns more revenue from alcohol-producing firms (Q2X[P2-P3]), thereby reducing its fiscal deficit. This extra revenue could be used to initiate advertising campaigns highlighting the cons of excessive alcohol consumption and to fix the damage already caused. E.g. pay-back public hospitals the money used to treat illnesses from excessive alcohol consumption, spend money on fixing damaged infrastructure.

 

One important thing to consider would be that the increase in excise duties and the minimum price would substantially affect only those with lower income levels who rely on cheap alcohol, leading to disparity as the higher income consumers are not equally deprived.

 

In conclusion, the effectiveness of either policy would depend on various factors such as the demand for alcohol in various regions of Ireland and the distribution of income in the country ( the number of rich and poor). To successfully reduce demand for alcohol, a combination of policies to reduce the ease of availability of alcohol as well as price control measures must be implemented appropriately. One problem policymakers could encounter is the calculation of the inelasticity of the demand for alcohol in Ireland, which plays a key role in determining the level of minimum price or excise duty.

 

Inflation curbs India's scope to cut rates

 

Mumbai: The Reserve Bank of India's scope to cut interest rates further to boost growth is constrained by the threat of inflation, a central bank adviser said.

 

"They can't move to a stimulating stance," Ashima Goyal, a member of the bank's technical advisory committee, said in an interview in Mumbai yesterday. "They have to stay at a neutral stance as long as there are fears of persistence in inflation." The 12-person panel makes recommendations to Governor Duvvuri Subbarao before scheduled rate decisions.

 

Subbarao lowered borrowing costs in April for the first time since 2009 to bolster an economy growing at the slowest pace in three years, as policy gridlock in government deters investment and Europe's debt crisis hurts exports. He signaled that inflation risks from energy prices, rupee weakness, and India's fiscal deficit may limit room for more reductions.

 

"We are facing bottlenecks like food prices, coal, and land acquisition," said 56-year-old Goyal, an economics professor at the Indira Gandhi Institute of Development Research in Mumbai. The government must respond faster to such challenges, she said.

 

Prime Minister Manmohan Singh's administration is facing one of the toughest periods since taking office in 2004, as a record trade deficit pressures the rupee and the widest budget gap among major emerging economies unnerves investors.

 

Faltering efforts to liberalize the economy and uncertainty over tax changes have also hurt sentiment. Standard & Poor's cut India's credit outlook to negative from stable last month, putting at risk its investment-grade status.

 

Currency intervention

The rupee has weakened 6.1 percent against the dollar in the past six months, the worst performer in a basket of 11 major Asian currencies tracked by Bloomberg.

 

The BSE India Sensitive Index of stocks has slid 4.6 percent in the period.

 

"It's very important that the RBI continues to intervene in the market to smooth out the volatility," Goyal said, referring to the rupee. "The rupee around 50 per dollar is all right. You'll see some fluctuations around that level."Subbarao reduced the repurchase rate by a greater-than-forecast 50 basis points to 8 percent on April 17. He has also cut the amount of deposits lenders must set aside as reserves twice this year by a combined 125 basis points, to 4.75 percent, to ease cash shortages in the banking system.

 

Asia's third-largest economy expanded 6.9 percent in the 12 months through March 2012, the least in three years, government estimates show. Inflation eased to a 29-month low of 6.64 percent in April, according to the median estimate in a Bloomberg News survey ahead of a report due May 14. 

Growth outlook 

Inflation has moderated from more than 9 percent for most of 2011 after the Reserve Bank raised rates by a record 3.75 percentage points from mid-march 2010 to October last year. "The slowdown in output, fall in inflation, means they had to reduce the rates," said Goyal, a committee member since 2011. Further cuts are possible if inflation softens, she said.

 

Goyal predicted headline inflation, as measured by the wholesale price index, of 6 percent to 7 percent in the year through March 2013. Risks include larger rupee depreciation, an oil-price climb and a poor monsoon that affects crops, she said, adding the economy will expand about 7 percent this fiscal year.

 

India has joined nations from Brazil to the Philippines in cutting rates in 2012 as emerging markets seek a shield against European fiscal austerity and elevated US joblessness.

 

The recent decline in the currency is "very short-term" on concern about tax plans from the March 16 budget, Goyal said.

 

"If the government is going to continue with spending unrelated to taxes, that is a worry," Goyal said. "That is why some kind of credible commitment to cut the budget deficit by legislation in important."

 

Finance Minister Pranab Mukherjee retreated on some of the proposals two days ago, delaying a planned clampdown on tax avoidance by a year.

 

Commentary:


The article explains two serious macroeconomic issues that India is facing; high inflation (a sustained rise in the general price level ) and reducing growth rates. Fig 2.1 illustrates India’s current position in its business cycle. Since India’s GDP has only contracted once over the past 6 years3, the figure below plots GDP ‘Growth’ over time, instead of GDP over time.

India’s prospects of loosening monetary policy to boost growth are limited because of the existing high inflation coupled with “risks from energy prices, rupee weakness, and India’s fiscal deficit”. High energy prices would increase costs of production to firms thus reducing aggregate supply. Rupee weakness would make imported raw materials and capital, more expensive, thus eventually resulting in reduced aggregate supply. Thus, energy prices and rupee weakness count as risks to inflation because of the possibility of supply bottlenecks, which could worsen the current cost-push inflation.

 

At the same time, a rupee weakness could increase demand for domestic goods, thus increasing exports. However, this possibility is dampened by “Europe’s debt crisis” due to which exports to Europe are hurt.

 

Fig 2.2 depicts India’s reducing growth with high inflation

 

In Fig 2.2 above, while AD has increased concomitantly with the LRAS (AD1→AD2 and LRAS1→LRAS2), SRAS1 has shifted leftward (due to supply bottlenecks). This has caused the price level to rise from PL1 to PL2. Moreover, LRAS has only increased by 6.9%.

 

When Goyal, a member of the Reserve Bank of India’s technical advisory says, “ If the Government is going to continue with spending unrelated to taxes, that is a worry”, she is correct in pointing out that the high fiscal deficit has been inflationary. Moreover, it has also played a contributing role in lowering growth rates. This is possible because there has been a crowding-out effect.

The government, to fund its fiscal deficit, borrowed loans, which increased demand for loans from D0 to D1. This increased the Reserve bank and private banks’ interest rates from r0 to r1. Due to higher interest rates, private investment by firms reduced from I1 to I2 that led to a lower increase in AD. Owing to these reasons, there has been a reduction in the extent to which aggregate demand should have increased, according to government estimates, thus adding to India’s likely stagflation (reducing growth – high inflation).

 

If the Reserve Bank Of India increases rates, AD would reduce, which would reduce GDP further and pose a serious risk of stagflation; and if the RBI cuts rates, AD would increase which could worsen the cost-push inflation. Thus, there is a trade-off between growth and inflation.

 

However, an expansionary monetary policy might improve business sentiment in the current dull situation as firms would be offered an incentive to borrow and invest in capital. This could boost AS. However, at the same time, as mentioned before, there would also be a concomitant increase in AD. Thus interest rates must be adjusted accordingly.

 

Besides, the government can increase direct taxation for income groups above a certain income level. This would increase government revenue and reduce the fiscal deficit. The increased revenue can be used to subsidize firms which would lower costs of production to firms thus increasing the SRAS. The government can also reduce corporate taxes to boost supply, and marginally increase taxes on dividends so that SRAS increases and a check is kept on household disposable income. The government must exercise appropriate fiscal policies like reduced government expenditure, to cut the budget deficit, and must allocate more funds towards supply-side policies that focus on alternative sources of fuel. This is due to the severe impact price volatility of oil can have on the Indian economy.

 

In conclusion, India currently is operating in a stagflation-like environment and hence is very fragile. In the long run, India would see improvement in terms of growth and price level as the global economy would exercise expansionary policies and fiscal austerity to bring itself out of its debt crisis. The rupee will appreciate once India’s trade deficit is reduced, which would happen once exports to debt-ridden countries are increased. Rupee appreciation will eliminate most supply-bottlenecks. However, in the short-medium run, the Indian Government in co-ordination with the RBI must work on cutting the fiscal deficit and implementing supply-side policies, to pull India out of its current crisis. One problem that could arise is “policy gridlock” that might delay the implementation of policies. Moreover, “bottlenecks like food prices” may or may not be overcome depending on the current year’s rains.


Fears Of Currency Devaluation Mount In Egypt

by MERRIT KENNEDY
Khalil Hamra/AP
September 11, 2012


Egyptians have been struggling economically since the revolution last year that ousted President Hosni Mubarak. The Egyptian pound has remained relatively stable, though, because the central bank shored it up through foreign reserves, which prevented food prices from skyrocketing.

 

But despite increasing political stability, concerns about the currency remain.

 

The market has been volatile since Mubarak was ousted, swinging up and down with Egypt's political unrest.

 

Samer Atallah, an economics professor at the American University in Cairo, says that political uncertainty had been causing investors to flee.

 

But now, he says, "it's pretty clear, so I think it is plausible that investors, tourists, would start to go back to the country. I think the mood of stability — economic stability — is on the rise."

 

Wael Samir, the manager of small currency exchange, is also cautiously optimistic.

 

He says that for several months after the revolution, people were exchanging large sums of Egyptian pounds for dollars because they feared a major drop in the currency. Now, he says, business is running as usual, even though the pound has gradually dipped to its lowest level against the dollar in seven years.

 

So far, Egypt has managed to avoid the "doomsday scenario" of its currency bottoming out, by propping up the pound with foreign reserves. But now those reserves are running low, estimated at less than half of what they were in 2010.

 

To stave off devaluation, Egyptian President Mohammed Morsi has been courting foreign investors and has formally requested a $4.8 billion loan from the International Monetary Fund. If he's successful, these influxes of foreign currency would reduce the pressure on the pound.

 

Abdallah Khattab, an economic adviser to Morsi, says he's confident that the pound can remain stable.

 

"We are expecting more inflow of currencies in the coming months," says Khattab, "so for me, I see no reason for expecting devaluation for the currency."

Structurally, the Egyptian economy is ill. These injections of foreign currency just keep us afloat for a few years, and then the structural problems keep on arising

- Samer Atallah, an economics professor at the American University in Cairo


But Iman Ismail, the CEO of the Egyptian Mortgage Refinance Co., isn't as confident. She says the government could contain the impact of a managed, gradual devaluation. But because Egypt imports much of its food — it's the largest importer of wheat in the world — a major devaluation would cause the price of food to dramatically increase and heighten political instability.

 

"Depreciation would have a very negative impact on the vast majority of people," she says.

 

And even if Egypt manages to secure foreign investment and loans to avoid devaluation, economist Samer Atallah points to much larger economic issues.

 

"Structurally, the Egyptian economy is ill," he says. "These injections of foreign currency just keep us afloat for a few years, and then the structural problems keep on arising."

 

There is a widening trade deficit, and Egypt's industries don't match the skills of its labor force. More than a third of Egyptians live under the poverty line. Unemployment is high, and the gap between rich and poor is huge.

 

"It's overwhelming, the amount of problems they inherited from the Mubarak regime," says Atallah. "It is overwhelming."

 

Commentary:


The article describes the various macroeconomic problems faced by Egypt post-revolution that ousted ex-president Hosni Mubarak, the key problem being the widening trade deficit, which has caused severe downward pressure on the Egyptian Pound.

 

After the revolution, there was great political uncertainty which severely affected the current account that “caused investors to flee” It led to lower international investor confidence in Egypt, which reduced FII investments and FDI’s. It also caused reduced domestic investor confidence, capital flight, and speculation which caused citizens to sell their Egyptian Pounds in return for relatively more stable currencies, like the US Dollar.

In Fig 3.1, we can see that the above phenomena have caused a rightward shift of the supply of E£ (due to speculation and lower domestic investor confidence) and a leftward shift of the demand for E£ (due to lower international investor confidence). This has led to a new equilibrium exchange rate P2 and quantity Q2. The new exchange rate is relatively lower than the previous exchange rate, showing a depreciation.

 

According to the article, “Egypt has managed to avoid the doomsday scenario of its currency bottoming out, by propping up the pound with foreign reserves”. This means that Egypt is operating under a managed float exchange rate system with the Government currently preventing the E£ from depreciating to its lowest pegged levels by selling its foreign reserves. The sale of foreign reserves would increase the demand for the E£ and hence appreciate it relative to other world currencies.

 

However, these reserves “are running low”. Its expenditures on imports are increasing due to a depreciating currency, and aren’t being able to be met due to a lack of foreign reserves. Hence, the Egyptian Government is considering the devaluation of its currency, which is ‘the realignment of a fixed or pegged currency to a lower value.

 

The effects of a devaluation on the trade deficit would largely depend on the PED’s of Egypt’s imports and exports, according to the Marshall-Lerner condition. Egypt’s primary imports include food, commodities, equipment and wood products, while its exports include crude oil and petroleum products, cotton, textiles, metal products, chemicals, processed food.5, with crude oil constituting more than 80% of its exports6. Since most goods internationally traded are highly inelastic, (crude oil, chemicals, food, equipment), one can’t surely say that a devaluation would reduce the trade deficit in the short run primarily due to time-lags. However, in the long-run, there is a possibility of the PED of these goods of becoming elastic, which would then reduce the trade deficit. This can be depicted in the J-Curve below.

In Fig 3.2, we can see that Egypt’s trade deficit would worsen right after the devaluation, however, as time passes, the trade deficit would turn into a surplus in the long run since the long-run elasticity of demand of all of Egypt’s exports will be elastic.

 

While a devaluation might have positive effects on the trade deficit in the long-run, there are negative ramifications of the devaluation in the short-run. For example, devaluation would largely increase food prices and cause a severe deterioration in Egypt’s terms of trade. This could lead to political instability, worsening trade balance, increased debt and a possibility of cost-push inflation due to reduced SRAS as a reflection of high domestic prices. Moreover, a devaluation would also discourage international investors, since a devaluation would give the impression of an unstable economy.


Hence, devaluation would be very harmful to the economy in the short run. The article mentions the possibility of Egypt borrowing $4.8Billion from the IMF to fund its current account deficit. This loan would help Egypt prevent devaluation in the short-run.

 

However, the loan would only be a temporary solution and wouldn’t lead to a major long-term improvement since Egypt would have to pay back the loan with interest, meaning large outflows of foreign currency. Therefore, Egypt must primarily work on improving investor sentiment in the short-run as well as in the long run. This can be done by increasing the interest rates which would boost international money inflows. This would be an addition to the financial account which could counter the trade deficit in the current account. Moreover, Egypt must specifically concentrate on the expenditure-switching policy of implementing supply-side policies that would work to boost the competitiveness of Egyptian firms in the international market.
 

 

This would ensure cheaper, more competitive, diverse Egyptian exports. The only problem with this policy is a large amount of time before the actual effects are seen.

                                                    

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