How to Structure a 15-Mark Economics Essay in IB Economics

Model answer (13–15 band)

An indirect tax is a tax imposed by the government on producers of a good or service, which increases the cost of production and is typically passed on, at least in part, to consumers through higher prices. A market is any arrangement that brings buyers and sellers together. Stakeholders include consumers, producers, workers, the government, and society as a whole. This essay will discuss how an increase in indirect tax affects the market equilibrium and the welfare of different stakeholders.

When an indirect tax is imposed or increased, the supply curve shifts upward (leftward) by the amount of the tax, from S₁ to S₁ + tax, as shown in the diagram below. This is because producers must now pay the tax per unit on top of their production costs, effectively raising the minimum price at which they are willing to supply each unit.

As a result, the market equilibrium moves from Q₁ to Q₂ — a lower quantity — and the price consumers pay rises from P₁ to Pc. However, producers do not receive the full price Pc; after paying the tax, they receive only Pp. The tax burden is therefore shared between consumers (who pay more) and producers (who receive less). The relative burden depends on the price elasticity of demand (PED) and price elasticity of supply (PES): when demand is inelastic, consumers bear most of the burden because they cannot easily reduce consumption.

The shaded triangle labelled DWL represents the deadweight loss — a net loss of economic welfare to society. Transactions that would have taken place between Q₂ and Q₁ no longer occur, meaning both consumer and producer surplus are permanently lost, not transferred to anyone.

A clear example is the UK Sugar Tax introduced in 2018 on soft drinks containing more than 5g of sugar per 100ml. The tax shifted the supply curve of sugary drinks upward, raising retail prices by approximately 10–20%. Consumers faced higher prices, but many reformulated drinks to reduce sugar content, meaning the tax also acted as an incentive for producers to change behaviour. Government revenue was generated — around £340 million annually — which was directed toward school sports programmes.

However, there are important consequences for different stakeholders to consider. Consumers on low incomes are disproportionately affected because indirect taxes are regressive — they take a larger proportion of income from the poor. A family spending a higher share of their income on taxed goods experiences a greater welfare reduction than a wealthier household. Workers in affected industries may face reduced hours or job losses if producers cut output in response to falling demand. Producers, particularly small firms with thin margins, may absorb much of the tax and see profits squeezed, potentially leading to business closures.

Furthermore, the effectiveness of the tax depends on the elasticity of demand. For goods with inelastic demand — such as tobacco or petrol — the tax raises significant revenue but does little to reduce consumption, meaning the welfare loss is borne overwhelmingly by consumers. Conversely, for goods with elastic demand, the tax may significantly reduce quantity but generate less revenue.

There are also macroeconomic consequences. A widespread increase in indirect taxes raises the general price level, contributing to cost-push inflation. If the tax covers many goods, this can reduce real incomes and dampen consumer spending, potentially slowing economic growth in the short run.

In conclusion, an increase in indirect tax has mixed consequences. It generates government revenue and can discourage consumption of harmful goods, but it reduces market output, creates deadweight loss, and disproportionately burdens low-income consumers. The net effect depends heavily on the elasticity of demand for the taxed good and the extent of the tax increase.

Model answer (13–15 band)

A current account deficit occurs when a country's total payments to the rest of the world for goods, services, income, and current transfers exceed its total receipts. A fall in the exchange rate (depreciation or devaluation) means the domestic currency is now worth less in terms of foreign currencies. This essay will evaluate whether exchange rate depreciation is the best method to correct a current account deficit.

When a currency depreciates, exports become relatively cheaper in foreign markets, making them more competitive. At the same time, imports become relatively more expensive for domestic consumers. If the Marshall-Lerner condition holds — that is, if the sum of the price elasticities of demand for exports and imports is greater than one (PED_X + PED_M > 1) — then the value of exports rises while the value of imports falls, improving the current account balance.

This can be shown on an AD/AS diagram. The increase in net exports (X − M) shifts aggregate demand rightward from AD₁ to AD₂, increasing real GDP from Y₁ to Y₂ and raising the price level from PL₁ to PL₂.

A relevant example is Japan between 2012 and 2015 under "Abenomics". The yen depreciated by approximately 30% against the US dollar, which improved the competitiveness of Japanese exports — particularly automobiles and electronics. Japan's trade balance improved in the short run as export volumes increased. This suggests that currency depreciation can be effective in correcting a current account deficit.

However, there are significant limitations to relying on exchange rate depreciation. First, the J-curve effect suggests that in the short run, a depreciation may actually worsen the current account deficit before improving it. This is because import and export contracts are fixed in the short term — the higher price of imports increases the import bill before volumes adjust. Only once consumers and firms respond to relative price changes (typically 6–18 months) does the current account begin to improve.

Second, depreciation causes imported inflation. If a country is heavily dependent on imported raw materials and intermediate goods — as many developing economies are — then a weaker currency raises production costs, contributing to cost-push inflation. This erodes the initial competitive advantage and may offset the improvement in the current account.

Third, the effectiveness depends on elasticity of demand for exports and imports. If demand for exports is inelastic (for instance, commodities with few substitutes), the volume of exports may not increase significantly even with a lower exchange rate. Similarly, if imports are necessities with inelastic demand (energy, medicine), the quantity of imports will fall little despite higher prices.

Alternative approaches may be more effective depending on the underlying cause of the deficit. Expenditure-switching policies such as tariffs or import quotas can directly reduce imports, though they risk trade retaliation and WTO disputes. Supply-side policies — such as investment in education, infrastructure, or R&D — can improve export competitiveness in the long run by increasing productivity, though these take years to have effect. For instance, South Korea's long-term investment in technology and education transformed it from a current account deficit economy in the 1980s to a persistent surplus economy, without relying on currency manipulation.

In conclusion, a fall in the exchange rate can help correct a current account deficit, but it is unlikely to be the "best" solution on its own. Its effectiveness is conditional on the Marshall-Lerner condition being met, involves the J-curve delay, and carries the risk of imported inflation. A more sustainable approach typically involves combining short-run exchange rate adjustments with long-run supply-side reforms to address the structural causes of the deficit.