IBDP Economics 2.1 Demand SL Paper 2 - New Syllabus
Question
Read the extracts and answer the questions that follow.
Text A — Overview of the economy and government policies in Kenya
Kenya, in East Africa, is achieving high annual economic growth rates, averaging above 5 %. Living standards are improving and employment is increasing in the manufacturing, tourism, construction, and education sectors. Kenya’s high growth is also changing the distribution of income and affecting the environment. However, climate change, high levels of inequality and youth unemployment may reduce future growth rates.
Floods and droughts are severe and frequent. In 2022–2023, droughts caused agricultural output to fall, affecting the employment of 40 % of the population and doubling the number of people with insufficient food. The government took measures to increase food supplies, such as reducing the tariff on imports of rice. It did not impose a price ceiling for essential food, as food shortages might result.
The rising price of food is the main cause of inflation in Kenya. The central bank used a contractionary monetary policy in 2022 and 2023 to reduce inflation and to prevent the depreciation of the country’s currency (Kenyan shilling, KES).
The budget deficit as a percentage of gross domestic product (GDP) became smaller in 2023 because government expenditure grew more slowly than GDP. Moreover, economic growth resulted in higher tax revenue from both income tax and a 16 % indirect tax on goods and services. The government is also receiving revenue from the sale of some state-owned enterprises (SOEs). A World Bank programme, aimed at an expansion of “green” energy in Kenya, provides financial and technological support to the Kenya Power and Lighting Company, an SOE that has been making losses.
The currency depreciation in 2022 boosted exports. Services, which are approximately 38 % of total exports and include tourism and financial services, are growing faster than exports of goods. Manufactured goods account for 37 % of total exports and agricultural goods account for 25 %. Revenue from exports of tea, flowers, vegetables, meat, and coffee are volatile and unpredictable. The droughts in 2022–2023 reduced output, which lowered export revenue from vegetables and flowers by almost 20 %.
Text B — Unequal distribution of the benefits of economic growth in Kenya
Although economic growth has reduced absolute poverty, inequality remains a problem, particularly between the formal and informal sectors and between the urban and rural areas. Rural poverty is caused by low agricultural productivity and farmers’ limited access to markets, finance, and technology.
However, the level of education has improved significantly, with a literacy rate of over 90 %. Secondary school attendance rates have increased from 13 % in 2003 to 49 % in 2022, despite the costs of attending school. In 2022, the government introduced a fund (the Hustler Fund), partly financed by foreign aid. The fund provides low-interest loans to women, young people, and small firms, for education or investment.
Text C — Reducing and adapting to climate change in Kenya
Global warming is affecting the Kenyan economy. Consequently, agricultural output and tourism, which account for 70 % of employment and most exports, will probably decline. Therefore, GDP could fall by 2 % annually. However, Kenya has relatively low carbon emissions, particularly because renewable resources generate 90 % of electricity, a figure that is planned to rise to 100 % by 2030.
Measures taken by other economies to reduce carbon emissions provide opportunities for Kenya because the markets for “green” goods are expanding. Kenya is able to sell tradable permits (carbon credits) to high-emitting countries due to its reforestation programmes.
The International Monetary Fund (IMF) recommends that climate-related considerations should be part of macroeconomic and infrastructure policies. It also recommends that carbon taxes should be imposed to reduce the use of fossil fuels by manufacturing firms. Rapid urbanization is increasing the need for electric vehicles and improved public transport. Energy efficiency measures, fuel substitution, and switching to rail transport will not only lower transportation costs but also reduce the trade deficit. This is because fossil fuels used for transportation and manufacturing are imported.
Kenya is able to obtain finance and technology for investment in climate-related projects, such as renewable energy and forestry programmes, through foreign aid and partnerships with the private sector. Overall, these policies will reduce environmental disasters and increase economic growth and jobs in the formal sector.
Table 1: Balance of payments accounts for Kenya in billions of USA dollars (USD)
| 2023 | |
|---|---|
| Exports of goods | 8.66 |
| Imports of goods | 20.90 |
| Balance of trade in goods | |
| Balance of trade in services | |
| Income | −2.67 |
| Current transfers | 6.98 |
| Current account balance | −6.32 |
Table 2: Economic data for Kenya
| 2015 | 2022 | |
|---|---|---|
| Real GDP (USD billion) | 70.12 | 94.80 |
| Real GDP per capita (USD) | 1497 | 1755 |
| Inflation rate (%) | 6.60 | 7.70 |
| Net portfolio investment (USD billion) | 0.16 | −0.70 |
Table 3: Development data for Kenya
| 2015 | 2022 | |
|---|---|---|
| Population (million) | 46.85 | 54.03 |
| Gini coefficient | 0.408 | 0.387* |
| Employment in the informal sector (% of total employment) | 83 | 83 |
| Human Development Index (HDI) | 0.561 | 0.601 |
* estimate
(a) (i) Define the term tariff. [2]
Answer / Explanation
A tariff is a tax or duty imposed by a government on imported goods. It is a form of trade protection that raises the price of imports and makes domestic goods relatively more competitive.
(a) (ii) List two components of the Human Development Index (HDI). [2]
Answer / Explanation
Any two:
- Life expectancy at birth
- Mean years of schooling
- Expected years of schooling
- GNI per capita at purchasing power parity (PPP)
(b) (i) Calculate Kenya’s balance of trade in goods for 2023. [1]
Answer / Explanation
Balance of trade in goods = Exports of goods − Imports of goods
= 8.66 − 20.90
= −12.24 billion USD
Kenya therefore had a trade deficit in goods of USD 12.24 billion.
(b) (ii) Calculate Kenya’s balance of trade in services for 2023. [2]
Answer / Explanation
The current account is:
Balance of trade in goods + Balance of trade in services + Income + Current transfers = Current account balance
−12.24 + X − 2.67 + 6.98 = −6.32
X = −6.32 + 12.24 + 2.67 − 6.98
= 1.61 billion USD
Therefore, Kenya had a surplus in the balance of trade in services of USD 1.61 billion.
(b) (iii) Sketch a demand and supply diagram showing that a price ceiling on essential food may cause a shortage. [2]
Answer / Explanation
The price ceiling (Pc) should be set below the equilibrium price. At Pc, quantity demanded (Q2) exceeds quantity supplied (Q1), creating a shortage/excess demand equal to Q2 − Q1.
(c) Using an AD/AS diagram, explain why a contractionary monetary policy may reduce inflation in Kenya. [4]
Answer / Explanation
A contractionary monetary policy may involve raising interest rates or reducing the money supply. Higher interest rates increase the cost of borrowing, reducing household consumption and firms’ investment. Consequently, aggregate demand (AD) decreases and shifts left from AD1 to AD2.
The new equilibrium occurs at a lower price level. Therefore, the rate at which the general price level is increasing, or inflation, is reduced.
(d) Using a poverty cycle diagram, explain how the Hustler Fund could reduce poverty in Kenya. [4]
Answer / Explanation
The Hustler Fund provides low-interest loans to women, young people and small firms. Greater access to finance can increase investment and spending on education.
Higher investment in education increases human capital and productivity. Higher productivity can increase output and employment, leading to higher incomes. Higher income then reduces poverty and helps break the poverty cycle.
A poverty cycle can therefore be represented as:
Low income/poverty → low investment/education → low productivity → low output/growth → low income/poverty
The Hustler Fund can interrupt this cycle by increasing access to finance for investment and education.
(e) Using an externalities diagram, explain how a carbon tax could reduce the market failure due to the use of fossil fuels by manufacturing firms. [4]
Answer / Explanation
The use of fossil fuels by manufacturing firms creates a negative externality of production, such as pollution and carbon emissions. Therefore, the social cost of production (MSC) is greater than the private cost (MPC), causing the market to produce more than the socially optimal quantity.
A carbon tax increases firms’ costs of production, shifting the MPC curve upwards, towards the MSC curve. This raises the price and reduces the quantity produced.
Consequently, the market quantity moves closer to the socially optimal quantity, reducing the welfare loss and correcting or reducing the market failure.
(f) Using an exchange rate diagram, explain the likely effect on the exchange rate for the Kenyan shilling (KES) of the change from 2015 to 2022 in Kenya’s net portfolio investment. [4]
Answer / Explanation
Net portfolio investment fell from USD 0.16 billion in 2015 to −USD 0.70 billion in 2022. This represents a reduction in net capital inflows and an increase in net outflows.
There is therefore less demand for Kenyan shillings because foreign investors purchase fewer KES assets, while increased outflows may involve selling KES. The demand for KES shifts left.
This causes the exchange rate/value of the Kenyan shilling to fall, resulting in a depreciation of the KES.
(g) Using information from the text/data and your knowledge of economics, discuss the consequences of high economic growth in Kenya. [15]
Answer / Explanation
High economic growth can generate significant benefits for Kenya, but it can also create costs. The overall consequences depend on how broadly the benefits of growth are distributed and whether growth is environmentally sustainable.
Improved living standards: Economic growth can increase real GDP and real GDP per capita, allowing households to consume more goods and services. Kenya’s real GDP increased from USD 70.12 billion in 2015 to USD 94.80 billion in 2022, while real GDP per capita increased from USD 1497 to USD 1755. The HDI also increased from 0.561 to 0.601. This suggests that economic growth has contributed to improvements in living standards and human development.
Growth has also contributed to reductions in absolute poverty since the early 2000s. However, rural poverty remains significant, particularly because of low agricultural productivity and limited access to markets, finance and technology. Therefore, the benefits of growth have not been equally distributed.
Economic diversification: Growth in manufacturing, tourism, construction and education indicates that Kenya’s economy is becoming more diversified. Expansion of the secondary and tertiary sectors can reduce excessive dependence on primary products and make export revenues more predictable.
However, rapid expansion of manufacturing and services may occur alongside neglect of agriculture. Lower agricultural output can contribute to higher food prices and food insecurity, particularly when droughts reduce agricultural production.
Inflationary pressures: Economic growth can increase aggregate demand and potentially create demand-pull inflation. Kenya’s inflation rate was 6.60 % in 2015 and 7.70 % in 2022. However, the text indicates that rising food prices were the main cause of inflation, suggesting that cost-push factors were particularly important. Currency depreciation may also have increased the domestic price of imports.
Income distribution: Growth can generate employment and increase incomes, but its distribution may be unequal. Kenya’s Gini coefficient fell from 0.408 in 2015 to 0.387 in 2022, suggesting a reduction in income inequality. Nevertheless, inequality between formal and informal sectors and between urban and rural areas remains a concern. Some sectors and urban areas may benefit more from growth than rural agricultural communities.
Employment: Economic growth creates employment opportunities, particularly in manufacturing, tourism, construction and education. However, youth unemployment remains a problem, while 83 % of employment remained in the informal sector in both 2015 and 2022. This suggests that growth has not fully translated into formal, secure employment and may contribute to structural unemployment.
Government finances and spending: Higher economic growth can increase tax revenues. This may reduce the budget deficit and provide the government with greater resources for infrastructure, education, transfer payments and programmes such as the Hustler Fund. Such spending can increase human capital and productive capacity, potentially supporting further economic growth and improving income distribution.
International trade and financial flows: Growth of manufacturing and services can diversify exports and make export revenues more predictable than when an economy relies mainly on primary products. However, stronger economic growth may eventually reduce Kenya’s dependence on foreign aid and international support as its income level rises.
Environmental sustainability: Economic growth can increase pollution, carbon emissions, deforestation and pressure on natural resources. Greater urbanization can also increase demand for transport, creating negative externalities. These effects may reduce the sustainability of economic growth.
However, Kenya is also using growth-related resources and external finance to invest in renewable energy, forestry and other climate-related projects. Renewable resources already generate around 90 % of Kenya’s electricity, and climate-related investment could support both environmental sustainability and employment.
Overall judgement: High economic growth has produced important benefits for Kenya, including higher real GDP per capita, improved human development, greater employment opportunities, increased government revenue and some reduction in income inequality. However, the benefits are not evenly distributed, with rural poverty, informal employment and environmental pressures remaining significant. Therefore, the quality and sustainability of growth are more important than the growth rate alone. Policies that promote human capital, rural development, formal employment and environmental sustainability are necessary to ensure that economic growth leads to broad-based economic development.