Paper 3 question on indirect taxation, PED, PES
Paper 3 sample question
IB Economics Paper 3 includes two compulsory questions. This is a sample Paper 3 question. The time allowed for Paper 3 is 105 minutes, so students should spend 52.5 minutes on each question.
This Paper 3 style question is on behavioural economics, oligopoly and demerit goods.
Question
This question is worth [30 marks]. This paper is based on the new syllabus and contains a policy response question.
(a) The village shop in Carthy has the following weekly demand and supply functions for 1 Ltr bottles of wine:
Price ($) | Quantity Demanded | Quantity supplied |
4 | 1,200 | 600 |
6 | 1,100 | 800 |
8 | 1,000 | 1,000 |
10 | 900 | 1,200 |
12 | 800 | 1,400 |
14 | 700 | 1,600 |
i. Calculate the price which would result in a demand of 500 bottles per week. [2 marks]
$18
ii. Calculate PES and PED for wine in the store between 8$ and 10$. [4 marks]
PES = 20% / 25% = 0.8 and PED = 10% / 25% = 0.4
(b) On the graph paper provided, draw the demand and supply curves using a price range from $2 to $14 per bottle. [2 marks]
(c) Following a negative report from the government’s health department the government imposes a flat rate tax of $5 per litre bottle.
On the graph, plot the new supply curve to illustrate the effect of the indirect tax, showing the burden of tax paid by both the consumer and producer, as well as the welfare loss. [4 marks]
(d) Suggest reasons why the government may have chosen to add a flat rate tax rather than an ad valorem tax to the production of wine. [4 marks]
The primary benefit of a flat tax rate is its simplicity; all products are taxed at the same rate, making it easier to collect and record.
Another benefit is that unlike ad valorem taxes a flat rate tax allows the government to disproportionately tax lower priced (and potentially) lower quality wine produce to deter consumption amongst young consumers.
(e) Explain the significance of price elasticity of demand theory in any government decision to reduce consumption of certain goods and services. [4 marks]
If the PED for a product is lower than the PES then the resulting fall in quantity demanded will be proportionately lower than the increase in price, reducing the effectiveness of any tax placed on a good or service. Taxing such goods, however, will generate significant revenues for the government which can be used to finance the provisions of public services.
Alternatively responses may use the example of PED elastic goods and services which are more responsive to changes in price and therefore more likely to result in a significant change in consumption.
(f) Using your knowledge of economics suggest alternative policies available to the government that might be successful in reducing alcohol consumption. [10 marks]
Command term: Recommend—present an advisable course of action with appropriate supporting evidence/reason in relation to a given situation, problem or issue.
A suitable policy that might be effective in reducing alcohol consumption e.g. a tax on alcohol and would be illustrated by diagram 1:
Explanation of how the price of alcohol, without government intervention, would be illustrated by P1 and Q1, where MPC of alcohol equals MPB. The overconsumption of alcoholic drinks is shown by Q1-Q2.
When the tax is imposed on alcoholic drinks, equal to the MSC of production the price rises to the socially optimum level of P2, eliminating the welfare loss.
Identify the strengths of the policy in terms of satisfying both consumers, government and society.
Evaluation/synthesis might include a discussion of the weaknesses of the policy, such as the low PED elasticity of alcohol making the product tax less effective. Responses might also note that such a tax is regressive in nature.
The response should also include an overall justification of the policy in terms of whether the country will benefit from the policy or not?
Other examples of relevant policies include:
- legislation e.g. raising the minimum legal drinking age
- restricting the sales of alcoholic beverages
- imposing a minimum price for alcohol
- conducting marketing campaigns that promote sensible alcohol consumption.
Responses in section (f) should be graded according to the following mark bands:
Maximum mark [10 marks]
Criteria | Mark |
There is no clear policy answer to the question but some limited:
| 1-2 |
There is a policy answer to the question with limited:
| 3-4 |
There is a clear policy answer to the question with satisfactory:
| 5-6 |
There is a clear policy answer to the question with good:
| 7-8 |
There is a clear policy answer to the question with excellent:
| 9-10 |
This question paper is available as a PDF file at: 
P3 question on tax
The mark scheme is available as a PDF file at: Carthy mark scheme