Primary Product Dependency

Question 1

Complete the list below to show the nine constraints on growth and development:

Answer 1

1. Poor education - limits human capital
2. Poor infrastructure - increases transport costs
3. Poor health - makes workers less productive
4. Population growth - can lead to overcrowding in schools and hospitals
5. Savings gaps - where there is a difference between the amount of money saved in banks and the amount of money required for loans
6. Dead capital - where there are no property rights
7. Corruption - where government officials use public funds for private gain
8. Being landlocked - where countries have no coast
9. Infant Industries - where industries are too young to benefit from economies of scale

Question 2

What is the first key characteristic of primary products ?

Answer 2

The demand for primary products does not respond very much to a change in the price. This means that the price elasticity of demand is inelastic.

Question 3

Price elasticity of supply

Answer 3

Price elasticity of supply measures how much quantity supplied will respond to a change in price.

Question 4

Oil is a primary product, and the oil and gas sector accounts for approximately 50% of Saudi Arabia’s Gross Domestic Product. A change in the price of oil does not have a significant effect on the demand for oil in Saudi Arabia.

Which of the following describes the supply curve for oil in Saudi Arabia ?

Answer 4

Oil is a primary product, so it has an inelastic price elasticity of supply. This is because there is a limited amount of oil, so it is difficult to find new oil reserves in order to increase supply. It takes time to find new reserves and to extract the oil from them. So, even if price increases, it will take a long time for supply to respond.
An inelastic supply curve should be steep and upward sloping. An increase in price will only cause a small increase in quantity as shown below.

Question 5

What would a graph for primary products look like?

Answer 5

Primary products have inelastic demand and inelastic supply.
An inelastic supply curve should be steep and upward sloping. An increase in price will only cause a small increase in quantity as shown below.
An inelastic demand curve should be steep and downward sloping. A decrease in price will only cause a small increase in quantity as shown below.

Question 6

Which of the following shows an impact of very inelastic supply and demand ?

Answer 6

The supply and demand curves for primary products are very steep. This means that any change in supply or demand leads to a very large change in price as shown below.

Question 7

Primary Product

Answer 7

A product made from raw materials.

Question 8

Price Instability

Answer 8

Small changes in the supply and demand for primary products can lead to big changes in price.

Question 9

Which of the following shows a likely impact of low profits in Chile ?

Answer 9

The Chilean government receives less corporation tax revenue

Question 10

Which of the following explains why price instability can constrain growth and development ?

Answer 10

Unstable prices make it much harder for investors to predict future prices. This makes it harder for them to predict their future revenue and therefore their future profit. This means that investment will decrease

Question 11

Which of the combinations below shows the impact of low investment ?

Answer 11

Unstable prices -> Low levels of investment -> Keeps AD left -> Limits real GDP -> Limits economic development

Unstable prices -> Low levels of investment -> Decreases productivity -> Left shift of LRAS -> Decrease real GDP -> Limits economic development

Unstable prices -> Low levels of investment -> Decrease productivity -> Increase unit costs -> Increase prices -> Less competitive -> Less profit -> Less corporation tax revenue -> Less government spending on development

Question 12

How can unstable prices constrain economic growth and development ?

Answer 12

Unstable prices make it much harder for investors to predict future prices. This makes it harder for them to predict their future revenue and therefore their future profit. This means that investment will decrease

The chains of reasoning here are:
Unstable prices → Low levels of investment → Keeps AD left → Limits real GDP → Limits economic development
Unstable prices → Low levels of investment → Decreases productivity → Left shift of LRAS → Decrease real GDP → Limits economic development
Unstable prices → Low levels of investment → Decrease productivity → Increase unit costs → Increase prices → Less competitive → Less profit → Less corporation tax revenue → Less government spending on developmen

Question 13

Which of the above combinations shows the correct chain of reasoning for the operation of a buffer stock scheme in a good harvest?

Answer 13

In a good harvest, there is a high supply and a low price. The government wants to bring the price back up towards the average, so they are trying to decrease the supply of grapes.
They buy up grapes, which means that there are fewer grapes in the market. Supply is therefore decreasing. This will increase the equilibrium price back towards the average price, Pa. These grapes go into the buffer stock and so the number of grapes in the buffer stock will increase.

Question 14

Buffer Stock Scheme

Answer 14

A scheme where the government buys and sells primary products from a market in order to reduce price fluctuations.

Question 15

Which of the following shows the likely impact of a reduction in price instability ?

Answer 15

Stable prices make it much easier for investors to predict future prices. This makes it easier for them to predict their future revenue and therefore their future profit. There is more certainty and so investment will increase

Question 16

Which of the following will occur when the government sets a price range for a buffer stock scheme ?

Answer 16

The floor is the lower limit in the price range and it is set below the average price.
The ceiling is the upper limit in the price range and it is set above the average price.

Question 17

Which of the following describes the main purpose of buffer stock schemes ?

Answer 17

Buffer stock schemes keep prices within a certain range, which increases price stability and therefore reduces fluctuations in prices. Price stability makes it much easier to predict future prices, which means that investors find it easier to predict future profits. This means that investment is likely to increase, which will increase economic growth and development.

Question 18

Which of the above combinations shows the correct chain of reasoning for the operation of a buffer stock scheme in a bad harvest ?

Answer 18

In a bad harvest, there is a low supply and a high price. The government wants to bring the price back down towards the average and, so they will try to increase the supply of grapes.
They release grapes on to the market, which means that there are more grapes in the market. Supply is therefore increasing. This will decrease the equilibrium price back towards the average price, Pa.
These grapes have left the buffer stock and so the number of grapes in the buffer stock will decrease.

Question 19

What are the chains of reasoinign for more stable prices

Answer 19

More stable prices -> Easier to predict prices -> Higher levels of investment -> Shifts AD right -> Increases real GDP -> Increases economic development

More stable prices ->Easier to predict prices -> Higher levels of investment -> Increases productivity -> Right shift of LRAS -> Increases real GDP -> Increases economic development

More stable prices -> Easier to predict prices -> Higher levels of investment -> Increase productivity -> Decrease unit costs -> Decrease prices -> More competitive -> More profit -> More corporation tax revenue -> More government spending on development

Question 20

Limitation of buffer stocks

Answer 20

Buffer stocks may not lead to growth and development because farmers have an incentive to over produce . This is because the government has guaranteed to buy any excess stock. This means that buffer stocks can quickly become very expensive to run, meaning the government has less money available to spend on development .

Question 21

Which of the following explains why a buffer stock might increase economic growth and development ?

Answer 21

With less price instability, it will be easier for investors to predict prices and profits. This will increase the level of investment. This will cause aggregate demand and long run aggregate supply will shift to the right. This will increase real GDP, which will lead to economic development.

Question 22

Which of the following explains why a buffer stock might not actually increase economic growth and development ?

Answer 22

There are a number of problems with buffer stock schemes:

1. They can encourage overproduction, as they offer a guaranteed price to farmers. This means that the scheme can be very expensive, which would mean that the government has less money available for development.
2. There are high administration costs for running a buffer stock scheme, which can be an example of government failure.
3. If there are several bad harvests in a row, the government may not have any stock left to release onto the market.
4. There are high storage costs for storing the primary product and it may be perishable (go off!).

Question 23

Which of the following is a characteristic of primary products like sugar ?

Answer 23

The price elasticity of supply, price elasticity of demand and income elasticity of demand for primary products are all inelastic. Supply and demand don’t respond much to a change in price and demand doesn’t respond much to a change in income.

Question 24

What is the likely income elasticity of demand for manufactured products ?

Answer 24

The income elasticity of demand for manufactured products is likely to be elastic, which means that a change in income will lead to a more than proportionate change in demand.

Question 25

Swaziland imports manufactured capital goods and exports sugar. The price of sugar increases a little bit and the price of capital goods increases a lot. What is the likely impact on Swaziland’s terms of trades ?

Answer 25

Terms of Trade = Index of Export Prices/Index of Import Prices
Swaziland exports sugar - the price of this has gone up a little which means that the numerator (top of the fraction) is slightly larger.
However, they import capital goods which have increased in price a lot. The denominator (bottom of the fraction) is therefore much larger.
This will decrease or worsen the terms of trade as you are dividing by a bigger number.
More intuitively, if you are receiving less money for your exports and paying more money for your imports then you will be worse off.

Question 26

What is the likely income elasticity of demand for manufactured products ?

Answer 26

The income elasticity of demand for manufactured products is likely to be elastic, which means that a change in income will lead to a more than proportionate change in demand.

Question 27

Swaziland imports manufactured capital goods and exports sugar. The price of sugar increases a little bit and the price of capital goods increases a lot. What is the likely impact on Swaziland’s terms of trades ?

Answer 27

Terms of Trade = Index of Export Prices/Index of Import Prices
Swaziland exports sugar - the price of this has gone up a little which means that the numerator (top of the fraction) is slightly larger.
However, they import capital goods which have increased in price a lot. The denominator (bottom of the fraction) is therefore much larger.
This will decrease or worsen the terms of trade as you are dividing by a bigger number.
More intuitively, if you are receiving less money for your exports and paying more money for your imports then you will be worse off.

Question 28

As world income grows, what will happen to the terms of trade for countries who import manufactured products and export primary products ?

Answer 28

Worsens
As world income grows, demand for primary products will only increase a bit, while demand for manufactured products will increase a lot. This means that the price of manufactured products will increase by much more than the price of primary products.
This means that the denominator (bottom) of the terms of trade fraction will be increasing by more than the numerator (top).This will decrease or worsen the terms of trade as you are dividing by a bigger number.
More intuitively, if you are receiving less money for your exports and paying more money for your imports then you will be worse off.

Question 29

Prebisch-Singer Hypothesis

Answer 29

The Prebisch-Singer Hypothesis says that, as world incomes rise, countries who depend on the export of primary products and the import of manufactured products will see their terms of trade deteriorate or worsen .

Question 30

Which of the following will happen if Swaziland’s terms of trade deteriorates ?

Answer 30

As their terms of trade deteriorates, the money they earn from their primary product exports will be able to buy fewer imported capital goods.

Question 31

What are the chains of reasoning for woesening terms of trade

Answer 31

The chains of reasoning here are:
Worsening terms of trade -> Can afford fewer capital imports -> Low levels of investment -> Keeps AD left -> Limits real GDP -> Limits economic development
Worsening terms of trade -> Can afford fewer capital imports -> Low levels of investment -> Decreases productivity -> Left shift of LRAS -> Decrease real GDP -> Limits economic development

Question 32

A deterioration in the terms of trade will mean that

Answer 32

A deterioration in the terms of trade will mean that countries can’t afford as many capital imports .

Question 33

What to developed countries export&import

Answer 33

Developed countries generally export manufactured goods, which are income elastic. They import primary goods, which are income inelastic.

Question 34

Which of the following is most likely to occur as a result of an increase in world incomes ?

Answer 34

As world incomes increase, demand for manufactured goods and primary goods will increase. As manufactured goods are income elastic, demand for them will increase by a lot. This will then cause a big increase the price of manufactured goods.
As primary goods are income inelastic, demand for them will increase by less. This will then increase the price of primary goods by less than the price increase for manufactured goods.

Question 35

Which of the above combinations is most likely to be true for developing countries as global incomes increase ?

Answer 35

Developing countries generally import manufactured goods which are income elastic. They export primary goods, which are income inelastic.
As world incomes increase, demand for manufactured goods and primary goods will increase. As manufactured goods are income elastic, demand for them will increase by a lot. This will then cause a big increase the price of manufactured goods.
As primary goods are income inelastic, demand for them will increase by less. This will then increase the price of primary goods by less than the price increase for manufactured goods.
Since developing countries mainly export primary products and import manufactured products, the price of their imports will increase by more than the price of their exports. This will then worsen their terms of trade.

Question 36

Which of the following will occur as a developing country’s terms of trade deteriorates ?

Answer 36

As their terms of trade deteriorates, the money that developing countries earn from their primary product exports will be able to buy fewer imported capital goods.
The chains of reasoning here are:
Worsening terms of trade → Can afford fewer capital imports → Low levels of investment → Keeps AD left → Limits real GDP → Limits economic development
Worsening terms of trade → Can afford fewer capital imports → Low levels of investment → Decreases productivity → Left shift of LRAS → Decrease real GDP → Limits economic development

Question 37

2 ways primary product dependency can constrain growth and development through

Answer 37

1. Price instability

2. A deterioration in the terms of trade as described by the Prebisch- Singer hypothesis.

Question 38

What is the name of the practice where firms avoid corporation tax by “selling” the product within the business at very low prices?

Answer 38

Transfer pricing occurs where the firm in one country might “sell” the product to the same firm in a different country at a very low or a very high price. This doesn’t affect the overall firm’s profits but it means that they can declare all of their profit in whichever country has the lowest rate of corporation tax.

Question 39

Limitation of industrialisation

Answer 39

Industrialisation may not lead to development if firms use transfer pricing to avoid paying corporation tax.

Question 40

Prebisch-Singer Hypothesis

Answer 40

As world incomes rise, countries who depend on exporting primary products will see a deterioration in their terms of trade.

Question 41

Lewis Model

Answer 41

As countries industrialise, manufacturing firms will make more profit and increase investment. This will increase their demand for labour which will increase wages and attract even more workers into the manufacturing sector.

Question 42

Industrialisation

Answer 42

Where the main industry in a country shifts from agriculture to manufacturing.

Question 43

Which of the following describes what is meant by industrialisation?

Answer 43

Industrialisation occurs when the main industries in an economy shift from agricultural to manufacturing.

Question 44

Which of the following explains why manufacturing firms in developing countries are often able to make supernormal profit?

Answer 44

Before industrialisation, there will be very few manufacturing firms in developing countries. This means that a new manufacturing firm is likely to be a monopsony, as they are the only firm hiring workers. In a monopsony, there is only one employer. Workers therefore have no choice but to work for them. This means that the firm can keep wages super low and still attract workers.

Question 45

Chain of reasoning for lewis model

Answer 45

Very few manufacturing firms → Monopsony power → Low wages → Supernormal profit → Investment → Increased productivity → Increased labour demand → Increased wages → Workers move from agriculture to manufacturing → Increases output → Increases supernormal profit for manufacturing firms

Question 46

Which of the following statements about industrialisation is true?

Answer 46

Industrialisation means that a country reduces its dependence on primary products and increases output of manufactured goods.

The Prebisch-Singer Hypothesis and price instability are both caused by a dependence on primary products, and so less dependence on primary products will mean that they are less affected by both of these

Question 47

How much is lost with transfer pricing

Answer 47

The Global Financial Integrity Research group estimates that several hundred billions of dollars a year are lost through transfer pricing. Transfer pricing occurs when multinational firms ‘sell’ their product at different prices within the firm in order to make profit in whichever country has the lowest rate of corporation tax.
While industrialisation increases the number of manufacturing firms in an economy, it can actually reduce corporation tax as they are more likely to use transfer pricing in order to avoid it

Question 48

ten constraints on growth and development:

Answer 48

1. Poor education - limits human capital
2. Poor infrastructure - increases transport costs
3. Poor health - makes workers less productive
4. Population growth - can lead to overcrowding in schools and hospitals
5. Savings gaps - where there is a difference between the amount of money saved in banks and the amount of money required for loans or lending
6. Dead capital - where there are no property rights
7. Corruption - where government officials use public funds for private gain
8. Being landlocked - where countries have no coast
9. Infant Industries - where industries are too young to benefit from economies of scale
10. Primary Product dependency

Question 49

10 strategies for growth and development:

Answer 49

Complete the list below to show the strategies for growth and development:

1. Improving education - increases human capital
2. Promoting Foreign Direct Investment - increases productivity
3. Aid - donations to countries in need
4. Improving education- can reduce population growth as birth rates will decrease
5. Microfinance - providing small loans to small businesses or individuals
6. Allocating property rights - so that people can use assets as collateral
7. Fair Trade - to ensure producers are paid a fair price
8. Debt relief - so countries no longer have to pay money back
9. Protectionism - increase trade barriers so that infant industries can grow
10. Buffer stock schemes and industrialisation - reduce the problems of primary product dependency by stabilising prices and moving to a manufacturing industry.

Question 50

Prebisch-Singer Hypothesis

Answer 50

• as world incomes rise, countries who depend on exporting primary products will see a deterioration in their terms of trade.

Question 51

Lewis Model

Answer 51

Lewis Model - As countries industrialise, manufacturing firms will make more profit and increase investment. This will increase their demand for labour which will increase wages and attract even more workers into the manufacturing sector.

Question 52

Harrod-Domar Model

Answer 52

Harrod-Domar Model - A model to explain how low savings make it difficult for firms to be able to invest which limits economic growth.

Question 53

The chains of reasoning for increase in investment

Answer 53

The chains of reasoning are:
Increase investment → Increase AD → Increase economic growth → Increase economic development
Increase investment → Increase productivity of capital → Right shift of LRAS → Increase economic growth → Increase economic development
Increase investment → Decrease unit costs → Decrease prices → More competitive → More profit → More corporation tax revenue → More spending on development