Lesson preview · Unfamiliar scenarios
Scenario practice: a market and an economy
~10 min · Free to read
Imagine two news alerts on the same morning. The first: the worst drought in decades has hit Country X’s coffee farms. The second: Country X’s economy shrank last year, and more people are out of work. A scenario question hands you a situation you haven’t seen and asks you to explain it with tools you already have. Here is a checklist for each kind: one market, then a whole economy.
Key Term
Six questions for any market
- What changed, and whose decision does it touch first? Buyers’ tastes and incomes affect demand. Costs, weather and technology affect supply.
- Which way does that curve shift? One cause moves one curve.
- What happens to price and quantity? Find where the new curve crosses the other one.
- By how much? When supply shifts, the elasticity of demand decides whether the price or the quantity changes more. If demand is price inelastic, buyers cut back by a smaller percentage than the price rises, so the price takes most of the change.
- Is anyone outside the deal affected? That’s an externality: a cost or benefit that lands on third parties, people who aren’t buying or selling.
- What could the government do, and could it make things worse?
The drought hit growers, not coffee drinkers, so only supply moved. The price rose and the quantity fell. Coffee drinkers have few substitutes they like, so demand is inelastic. The price rose by a bigger percentage than the quantity fell, so growers’ total revenue (price times quantity) went up. The steep demand curve on the diagram shows that inelastic demand. One cause moves one curve, and elasticity tells you whether the price or the quantity changes more.
Trap · Common Misconception
"The government should just step in"
Suppose Country X’s government caps the price of coffee beans at its old level. The price where the market would now settle is higher, so the cap binds: it stops the price rising that far. Buyers want more beans than growers sell, so there’s a shortage. Some buyers pay less; others get nothing. A government fix is worth it only if it leaves people better off than the market would. Before you recommend one, say who gains, who loses and what could go wrong.
Key Term
Three steps for an economy's data pack
For a whole economy, you get a data pack: a few years of figures. Read it in three steps.
- Find the phase of the business cycle. The cycle is the rise and fall of real GDP (gross domestic product): the economy’s output, with price rises taken out. Growth that is positive but slowing is still an expansion. Only negative growth means output is shrinking: a contraction.
- Name the main problem. Rising unemployment with low inflation points to too little spending. Rising inflation with very low unemployment points to too much.
- Recommend a policy mix, then judge it. The mix has two parts. Fiscal policy is the government’s taxes and spending. Monetary policy is the central bank’s choice of interest rate. Say how each works, how long it takes and what could go wrong.
A data pack is a snapshot of one stretch of this wave. Falling output, rising unemployment and cooling inflation mean the economy is heading for a trough, the wave’s low point. Fast growth, very low unemployment and rising inflation mean it is near a peak, the high point. Match the pattern first, then choose the policy.
Worked Example
Here is Country X’s data pack. Its central bank aims for 2% inflation. Find the phase of the cycle and the main problem, then recommend and evaluate a policy mix.
| Year 1 | Year 2 | Year 3 | Year 4 | |
|---|---|---|---|---|
| Real GDP growth (%) | 3.0 | 2.2 | 0.6 | −1.4 |
| Unemployment (%) | 4.5 | 4.6 | 5.3 | 6.9 |
| Inflation (%) | 2.4 | 2.5 | 1.9 | 1.0 |
| Consumer confidence (100 = normal) | 104 | 101 | 93 | 86 |
| Value of the currency (Year 1 = 100) | 100 | 99 | 96 | 91 |
Trap · Common Misconception
"They moved together, so one caused the other"
In Country X’s data pack, the currency fell in the same years that unemployment rose. A headline says the weak currency cost jobs. But two figures moving together (a correlation) don’t prove that one caused the other. Before you claim a cause, ask whether a third factor could drive both, and explain how each link would work.
Your turn: a data-response question worth 5 marks. Country W's central bank aims for 2% inflation. Real GDP growth was 2.5% in Year 1, 0.4% in Year 2 and −0.9% in Year 3. Unemployment was 5.0%, 5.3% and 6.2%. Inflation was 1.6%, 1.3% and 0.9%.
(1 mark) By how many percentage points did unemployment rise from Year 1 to Year 3?
(2 marks) Which phase of the business cycle is Country W in by Year 3?
(2 marks) What is Country W's main problem?
Practice · 1 / 6
After the drought in Country X, the price of coffee beans rises by 40% and the quantity bought falls by 10%. What is the price elasticity of demand (PED), and what happens to growers’ total revenue?
Next
Like what you read?
Sign up free to save your progress, get spaced reviews tuned to you, and work through the whole course with interactive graphs and adaptive practice.