Supply-side policies, economic growth, elasticity, and
informal economy (HL and SL)
Answers
a. Define the term Informal economy. [2] (Paragraph 9)
The informal economy is economic activity that exists outside state regulation and control.
b. Explain two disadvantages to Colombia of its large informal economy. [4] (Paragraph 9)
Two disadvantages of a large informal economy might be:
• Enterprises in the informal economy do not pay taxes and the government does not receive
income from them to contribute to funding public services.
• Enterprises in the informal economy draw skilled workers away from the formal economy.
c. Recent data show that the quantity demanded of Colombian coffee has fallen by 6%. Based on
the data in Table 1 calculate the:
(i) % change in the price of coffee [2] (Table 1)
-6% / % change in P = -0.65
-6% / -0.65 = +9.23
(ii) % change in income [2] (Table 1)
-6% / % change in Y = 0.81
-6% / +0.81 = +7.4
d. (i) State the equation for price elasticity of supply. [1] (Table 1)
% change in QS / % change in P = PES
(ii) Outline what might happen to the price elasticity of supply figure of 0.27 in the long run. [2]
(Table 1)
PES becomes more price elastic in the long run as producers have time to respond more actively to
change supply when price changes.
e. Using the data in Table 2, calculate the:
(i) Real GDP in 2020, 2021, 2022 and 2023. [2] (Table 2)
(ii) Economic growth rate in 2020, 2021 and 2022. [2] (Table 2)
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Nominal GDP GDP deflator Real GDP$Bn Economic growth
$Bn %
2019 321 100 321
2020 274 95 288 -10.28
2021 314 104 302 4.86
2022 364 115 317 4.97
f. Based on the data in Table 2, explain what might happen to Colombian household income and
employment in 2020. [4] (Table 2)
In 2020 the Colombian real GDP fell by 10.28% which could lead to a fall in household income as
total income in the Colombian economy falls and there is a rise in unemployment as fewer workers
are needed to produce the country’s output.
g. Using an AD/AS explain how an increase in consumer and business confidence might have led to
an increase in Colombia’s economic growth in 2021. [4] (Paragraph 6)
As consumer and business confidence increase
in Colombia, this may lead to a rise in the
country’s consumption and investment which
increases aggregate demand. The rise in
aggregate demand in Colombia is shown in the
diagram with AD shifting to AD1 leading to a
rise in real GDP from Y to Y1 which leads to a
rise in Columbia’s economic growth in 2021.
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h. Using the information from the text and your knowledge of economics, evaluate the Colombian
government’s decision to use supply-side policies to increase the country’s economic
development. [15]
Total [40]
Answers might include:
• Definitions of interventionist supply-side policies, market-based supply-side policies and
economic development.
• Explanation that interventionist supply-side policies in Colombia might lead to economic
development in the following ways:
• Reducing corporation tax (market-
based supply-side) on business
profits in Colombia may lead to a rise
in foreign direct investment in the
country which increases Colombia’s
long-run aggregate supply and the
country’s long-run economic growth
and development. This is shown in
the diagram with LRAS shifting to
LRAS1 and real GDP increasing from
Y to Y1. ‘Colombian government is
using low corporation rates (profits
tax) to encourage foreign direct
investment.’
• Using subsidies and government grants to support manufacturing businesses in Colombia
(Interventionist supply-side). This could increase Colombia’s potential output and cause
LRAS to LRAS1 in the diagram. The long-term economic growth this might create can lead to
economic development. ‘Government provides subsidies, tax advantages and investment
grants to manufacturing firms.’
• Reducing trade barriers and agreeing to trade agreements (Market-based supply-side) made
by the Colombian government might lead to lower-priced imported inputs for Colombian
businesses and mean that Colombia's firms face lower trade barriers when they export.
These trade benefits could make the Colombian economy more efficient and increase long-
run economic growth which can lead to economic development. ‘To enter into trade
negotiations with its major trading partners to reduce trade barriers’.
• Increased spending by the government on education (Interventionist supply-side) may
reduce income inequality (improve Colombia’s Gini coefficient) and increase equity in
Colombia. Greater equity and equality are characteristics of economic
development. ‘Colombian government is also committed to reducing income inequality’.
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• The Colombian government’s decision to introduce a microfinance scheme (Interventionist
supply-side) for new businesses in Colombia may raise income levels amongst the poorest in
the country which reduces the country’s poverty rate and leads to economic
development. ‘Develop a microfinance scheme to give low-income households the chance
to develop small businesses’.
Evaluation
Reducing tax in Colombia may mean the government has less income to spend on public services
and increase income inequality. ‘Reductions in corporation tax might increase income inequality’.
Increased spending on public services like education comes with an opportunity cost in terms of
spending on other government services like transport and healthcare.
There are problems with the microfinance scheme because it can lead to corruption. ‘Some
concerns about corruption associated with the scheme’.
Reducing trade barriers to increase free trade and encourage trade may lead to an industrial decline
in sectors that cannot compete and cause unemployment.
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InThinking www.thinkib.net/Economics
