Some behavioral economics links for IB economics students

'Behavioral economics' is the new kid on the block for IB economics students (syllabus section 2.4).  Specifically the new IB Economics syllabus expects candidates not only to be able to explain  (AO2) but also to be able to respond to essay questions that have 'discuss', 'evaluate', 'examine', to what extent' etc. (AO3) as command terms (also using real world examples).  The following is directly from the 2020 syllabus:

Behavioral economics—limitations of the assumptions of rational consumer choice

• Biases—rule of thumb, anchoring and framing, availability
• Bounded rationality
• Bounded self-control
• Bounded selfishness
• Imperfect information

Behavioral economics in action (HL only)

• Choice architecture—default, restricted, and mandated choices
• Nudge theory

There are plenty of sources for instructors to use beyond IB dedicated Textbooks and Study Guides.  I asked my Year 1 kids to prepare and present BE LOs in class.  I gave them lots of articles, papers, interviews, talks on these issues to consult.  I initially had assigned the works for all so that all would study and take notes on all issues (it would be like a flipped classroom thing that I rarely, if ever, attempt) and then, the day before the presentations, I narrowed down to a specific bias or issue for each student (or duet) to 'teach'.  It worked out ok; a few kids did a superb job.

There is one more site that I did not give my students before this assignment (now they are obviously aware of it) that I think may prove very useful for all.  It has tons of interesting and useful information, the surface of which I have only scratched.

These are a few links related to issues of (at least some) interest to IB Economics students:

Anchoring bias  

The availability heuristic

The framing effect

The restraint bias (self-control)

On bounded rationality

On heuristics - rules of thumb

On Herbert Simon

On Richard Thaler

On Daniel Kahneman

All of the above and much more are found here, at The Decision Lab.  Definitely worth visiting.

Another related and very interesting site worth visiting is BEworks (also a Canadian consulting firm; Dan Ariely is co-founder and chief behavioral scientist there - he has an interesting article in the 2021 BE works Choice Architecture Report that one may download for free.

"...bottom line is that climate policy has not progressed over the last three decades": The "wobbly" Paris Agreement and the "syndrome of free riding"

The two opening paragraphs of the article this post is all about should really catch the attention of all IB Higher level and Standard level candidates (and, teachers IMO).  Section 2.8 of the new (current) syllabus is "Market failure—externalities and common pool or common access resources". Candidates are expected to know how to clearly and with the use of appropriate diagrams explain negative externalities of production as well as common access resources and to also explain responses that include international agreements.  

Of particular interest and significance is the next learning outcome which is an AO3.  AO3 means that these topics can feature in questions that use as command terms 'evaluate', 'discuss' and 'examine', typical in part (b) of Paper 1 (HL&SL) essays where real world examples are expected (and will make the difference in allocating marks).  Here is the learning outcome: "Strengths and limitations of government policies to correct externalities and approaches to managing common pool resources including:...degree of effectiveness'.  The syllabus continues with this AO3 learning outcome: Importance of international cooperation" that includes "Challenges faced in international cooperation" as well as "Monitoring, enforcement".

It should be clear from the above that IB Economics students (HL&SL) should invest some time on studying the 2015 Paris Agreement as they should be able to present, explain and evaluate / discuss this agreement as a most important 'example' of international cooperation  (you can read the official agreement here and read about it in a nutshell from the UNCC here). 

The article I was referring to in the opening sentence of this post was published in Foreign Affairs.  It is by William Nordhaus, who received in 2018 the Nobel Prize "for integrating climate change into long-run macroeconomic analysis" (see also this to get an idea about his most impressive career/work and interests).  The article is titled "The Climate Club: How to Fix a Failing Global Effort".  These are the opening paragraphs:

Climate change is the major environmental challenge facing nations today, and it is increasingly viewed as one of the central issues in international relations. Yet governments have used a flawed architecture in their attempts to forge treaties to counter it. The key agreements, the 1997 Kyoto Protocol and the 2015 Paris climate accord, have relied on voluntary arrangements, which induce free-riding that undermines any agreement.

States need to reconceptualize climate agreements and replace the current flawed model with an alternative that has a different incentive structure—what I would call the “Climate Club.” Nations can overcome the syndrome of free-riding in international climate agreements if they adopt the club model and include penalties for nations that do not participate. Otherwise, the global effort to curb climate change is sure to fail.

The problem with the Paris Agreement is that after 25  "climate meetings (COPs) (and here) there is very little progress in meeting the goals as "there is no binding international agreement on climate change". 

As mentioned in the title of this post, at the heart of the problem is the 'syndrome of free riding':

The reason is free-riding, spurred by the tendency for countries to pursue their national interests. Free-riding occurs when a party receives the benefits of a public good without contributing to the costs. In the case of international climate change policy, countries have an incentive to rely on the emission reductions of others without making costly domestic reductions themselves.

Nations have failed to stop nuclear proliferation, overfishing in the oceans, littering in space, and transnational cybercrime. 

and, Nordhaus continues:

When it comes to climate change policies today, nations speak loudly but carry no stick at all.

Are we doomed? Are there 'solutions' as a dear colleague likes saying? 

The key to an effective climate treaty is to change the architecture, from a voluntary agreement to one with strong incentives to participate. 

Successful international agreements function as a kind of club of nations. Although most people belong to clubs, they seldom consider their structure. A club is a voluntary group deriving mutual benefits from sharing the costs of producing a shared good or service. The gains from a successful club are sufficiently large that members will pay dues and adhere to club rules to get the benefits of membership.

The principal conditions for a successful club include that there is a public-good-type resource that can be shared (whether the benefits from a military alliance or the enjoyment of low-cost goods from around the world); that the cooperative arrangement, including the costs or dues, is beneficial for each of the members; that nonmembers can be excluded or penalized at relatively low cost to members; and that the membership is stable in the sense that no one wants to leave.

So, what are the conditions?

The first is that participating countries would agree to undertake harmonized emission reductions designed to meet a climate objective (such as a two-degree temperature limit). The second and critical difference is that nations that do not participate or do not meet their obligations would incur penalties. 

Please, do read the article for the specifics that Nordhaus proposes.

And, do jot down a few points to remember in a May or November IB Economics exam.

Remember, that questions relating to issues of global importance are always sought by examiners / question-setters.  It only makes sense. 

PS: You could also read about the main points of the Nordhaus article 

Maxims for thinking analytically

A very interesting book recently came to my attention while I was visiting the US.  It's title is "Maxims for Thinking Analytically: The Wisdom of Legendary Harvard Professor Richard Zeckhauser".  It is exactly what the title suggests.  I managed to read only about half of it as I bought it only a couple of days before my return flight so I had to mail it back home together with quite a few other books I had purchased (max 23 kilos allowed...).  Still, not here...

I can't wait to get it and finish reading it.  Easy to read but forces you to reflect and to often re-evaluate decisions made without deeper thinking.

This is from a post in Jeffrey Frankel's blog Views on the Economy and the World (Frankel, a renowned macroeconomist, is a colleague of Zeckhauser at Harvard) on this book:

I recommend it highly. This is not a collection of tangential papers published together in someone’s honor.  Rather each chapter consists of an immortal maxim of Richard’s together with applications to real-world decision-making, whether at the personal or public-policy level. There are 19 such pithy insights, such as “Think probabilistically about the world,” or “Good decisions sometimes have poor outcomes,” or “Eliminate regret.”  Dan skillfully weaves into each of his chapters concise contributions from a big set of Zeckhauser-admirers, including Max Bazerman, Jason Furman, Hsien Loong Lee, Jennifer Lerner, Barry Nalebuff, Larry Summers, among many others. My own contribution is to Chapter 10.  Richard’s 10th maxim is: “Errors of commission should be weighted the same as errors of omission.” 

Worth reading the rest of Frankel's post and, of course, buying and reading Zeckhoauser's book!

The national debt expressed as a proportion of GDP - and the Furman & Summers point (among lots of other interesting points for IB Economics students)

From my experience (not though from last year as all my classes were online) incorporating podcasts in teaching IB economics can be very effective. The podcast must of course be at an appropriate level for students taking IB HL (or, SL) economics.

In addition, at least in my opinion, the teacher must only focus on specific bits of the podcast, either to start a classroom discussion on a specific issue of interest, or to assign homework that expects students to explain or evaluate a position expressed in the podcast.  Focusing on bits is absolutely necessary if the podcast is long and/or if segments of it become too involved for their level.

David Beckworth, a senior fellow at the Mercatus Center at George Mason University,  hosts the Macro Musings Podcasts which are always excellent (for teachers) and sometimes appropriate (at least bits of them) for IB Economics students.

  

One recent very interesting podcast was an interview of Jason Furman titled Jason Furman on Overheating, Inflation, and Fiscal Policy in an Era of Low Interest Rates .  

Jason Furman is a senior fellow at the Peterson Institute for International Economics and a professor of the practice of economic policy jointly at the Kennedy School of Government and at the department of economics at Harvard University.

In this interview Furman, prompted by Beckworth, starts by explaining the two things that are a concern to him if inflation accelerates (namely that real wages decrease exacerbating inequality and the risk of recession if the central bank raises interest rates too quickly); he continues explaining the importance of anchored inflationary expectations (and there’s lots of discussion with Beckworth on the debate about whether inflation in the US is now transitory/temporary or persistent - in which case the central bank must start worrying); he also makes the case why a higher than 2% inflation target (perhaps even 4% even though Furman likes 3%) may be preferable – it gives policymakers more flexibility plus, given sticky nominal wages, the resulting decrease in the real wage will permit employment levels to be maintained; and then gets into some more esoteric issues (that are not accessible to IB Economics students in my opinion).

What is though most interesting for IB economics students (higher level only) is found later on in their conversation when Furman presents the paper he co-authored with Larry Summers “A Reconsideration of Fiscal Policy in the Era of Low Interest Rates". 

This is the paragraph that is worth some discussion given that the new IB Economics syllabus has now included a discussion of what a sustainable level of  national debt is and explicitly expects students to know that the size of the national debt should be expressed as a percentage of GDP (“Measurement of government (national) debt as a percentage of GDP”).  This of course makes sense…

but, Furman goes on saying that:

…our biggest argument is that debt-to-GDP is a misleading metric because debt is a stock. It's what you have at a point in time. Income is a flow. If you compare your debt to today's income, it's incredibly high. If you compare it to your income over the course of the next decade, it's a whole lot lower. That's more than just a cutesy observation when you combine it with the fact that interest rates have fallen on a sustained basis. You look across the G7 and the real interest rate has fallen from about 4%, 30 years ago, to around 0%, just prior to the pandemic. And that means that you can, from a fiscal sustainability perspective, pay your debt off over a longer period of time…

and continues by explaining…

So we (F&S) argue that the right way to look at it is from a flow-flow perspective. What's the flow you need to pay each year, and what's the flow of income you have each year. We go a little bit further into a place that I don't haven't noticed others do, but maybe they have. I'm sure somebody has. Which is that the relevant way to think about interest is the real interest payments. If you're in a world of higher inflation, you're inflating away more of your debt. You don't mind the portion of interest that's just covering inflation. What your mind is the portion above and beyond that. And so, our preferred metric for fiscal sustainability is looking at real debt service as a share of GDP.

This Furman & Summers point about the right metric to judge the sustainability of a country’s debt can be explained I think to IB HL economics students.  If explained and if understood then (strong) candidates could incorporate the discussion in a debt related paper 1 question related to debt sustainability.  I think that could push their response easily towards a Level 5.  

All about investing (interesting for IB Economics students but NOT in the new IB Economics Syllabus)

 Throughout these past years, students have invariably been asking to devote some time to issues of (financial) investment.  They all want to know more about the stock market, how stock prices are determined, bonds, cryptocurrencies, you name it.  I don't have the time to spend more than perhaps a period on these questions   which is a pity. It is perhaps the only questions I do not (try at least) to provide an answer.

So, I was pleasantly surprised today when I found out that there is a series of short 'lessons' for high school students on exactly this stuff. 

It is the Planet Money 2021 Summer School series and you may find the first episode  on the Stock Market here.

Planet Money has also many episodes that directly link to the new IB Economics Syllabus requirements like this most recent one on three reasons for the housing shortage in the US but the new Paper 1 requires real world examples and some of what is explained applies elsewhere.  The issue would relate to maximum prices (price ceilings), in this case why in many cities rent controls are imposed or discussed/ debated.

Planet Money has many episodes that are of direct interest to our IB Economics Syllabus.  Check out past episodes here.

A primer on inflation: A must read for all IB Economics students

 

Page One Economics is a tremendous resource for IB Economics teachers and students.  I’ve been using it for a number of years, and I always look forward to a new edition. The latest one  Inflation Expectations, the Phillips Curve and Fed's Dual Mandate written by Jane Ihrig, Ekaterina Peneva, and Scott A. Wolla is a jewel for us.

It starts off by clearly explaining what is meant by price stability. Price stability is one of the main goals of macroeconomic policy. Interestingly, it does not mean zero inflation.  Instead, the Federal Reserve (the US central Bank), as well as all central banks, considers that “a moderate, stable and positive rate of inflation is most consistent with its price stability mandate.” Why not target zero (0%) inflation?  It is explained beautifully in the article.  To protect the economy from deflation is one reason (deflation is when the average price level is decreasing which induces households to postpone purchases and thus forces firms to cut wages and/or jobs leading to a deflationary spiral).  The rate of inflation cannot be pinned at any level but tends to fluctuate, so entering negative territory is to be avoided. Also, there is an upward bias in measuring inflation meaning that if measured inflation is 0.5%, it could actually be minus 0.4% having entered deflation territory (see the Ellie Tragakes IB Economics textbook on this overestimation bias or the Oxford Economics Study Guide).  In addition, if inflation is extremely low for a long period, typically interest rates are also close to zero leaving no room for an interest rate cut if the economy faces the risk of recession.  This is the ZLB ('zero lower bound' problem – see the new Oxford IB Economics Study Guide for a brief explanation of this).  So, what do central banks mean by ‘price stability’?  If 0% inflation was not desirable as a target, what rate of inflation should central banks aim for? We know that high inflation is costly for many reasons.  Inflation decreases the purchasing power of all households with fixed money incomes (like wage earners or pensioners); it increases income inequality as low income individuals can only save any income they do not spend in bank savings accounts where the real interest rate earned (their real return of return) may be negative (remember, the real interest rate is the nominal interest rate minus (expected) inflation) and they cannot borrow to purchase (invest in) assets whose market value is expected to rise faster than inflation (while richer folk can invest in real estate, art, gold, etc.); it distorts the signaling power of relative price changes leading to allocative inefficiency; it leads to increased uncertainty that stifles investment and it renders exports less competitive in foreign markets, among other costs.  Where does this leave us? Well, the Fed, as most central banks did, gravitated to a 2 percent ‘healthy compromise’. So, for most central banks their announced target has been to achieve and maintain inflation “below, but close to 2 percent”.  The 2% target has become the orthodoxy despite being a rather arbitrary choice.  The story behind the choice is actually pretty funny. 

The St. Louis article, after explaining why now the US central Bank has chosen the Personal Consumption Expenditures Price Index (PCEPI) over the CPI (from my understanding the PCEPI also corrects for the substitution bias that plagues the CPI – note here that IB Economics students should stick with the CPI as it is the CPI that is in the new IB syllabus), continues with a short but beautiful exposition of the Phillips Curve which all IB Economics students should read.  The Phillips Curve reflects that (at least in the short run) there is a trade off between inflation and unemployment  

"which policymakers considered when setting monetary policy: They could pursue an economy with lower unemployment if they were willing to accept higher inflation. Conversely, if policymakers wanted to pursue lower inflation, they would have to accept higher unemployment and lower economic activity."

Interestingly enough this “tradeoff has weakened”.  There is evidence that the “Phillips Curve has flattened” (see "Is the Phillips Curve alive?") which allows them to pursue lower unemployment without having to accept higher inflation.” Now, in the US, “…policymakers are willing to allow employment to expand as long as inflation expectations are anchored around the 2 percent target.”

The important phrase to note from the last quote is the phrase ‘… inflation expectations are anchored’. Expectations about future inflation are perhaps the most important determinant of inflation.  Why? Because “they influence peoples’ decisionmaking today, which then impacts future inflation.”  Read the box on page 4 of the St. Louis article as this is explained in a way that all IB Economics students will understand.  If a firm believes that inflation will be around 2% this year and next year and the year after, it will increase its prices and wages by 2%, and based on this expectation, plan its investments. Similarly with households.  It follows that if expectations are anchored at 2% then inflation will indeed prove to be 2%. 

This brings us to my earlier July 2 post on the Summers-Krugman inflation debate where Krugman distinguishes between 'transitory' inflation and ‘hard core’ inflation.  I mentioned in the earlier post Krugman’s definition of transitory inflation as “easy come, easy go” but you will find a fuller explanation in the box titled “What is transitory inflation” on page 5.  You will then understand why the Fed has recently slightly changed its target to what is referred to as “flexible average inflation target”  (FAIT).  Inflation can now exceed 2%, as long as, on the average, it remains at 2%.  This really boils down to as long as peoples’ expectations about future inflation remain anchored at 2% and a higher rate of inflation does not become ‘embedded’ in their expectations. 

This St. Louis article is a great resource for not just my but for all IB Economics students.  Not only will it help them better understand inflation and policymaking (remember the Paper 3 new ‘recommend a policy’ part) but also provide them with plenty of real world information to satisfy a number of possible Paper 1 macroeconomics questions.

Please read the St. Louis Page One Economics article!

 

IB Economics New Syllabus Paper 3 (micro calculations)

 

Focus on micro P3 calculation topics (new IB Economics syllabus)

The new IB Economics syllabus has changed quite significantly concerning Paper 3.  In terms of microeconomics related calculations, there are significantly fewer.  No need to bother anymore with linear demand and supply functions (a good development IMO, since candidates taking any IB math level know how to fool around with linear functions and many of the related calculations in past paper 3 questions could often be solved by inspection - no need even for a simple calculator); no need to fool around with fixed and variable costs and their averages (which again I think proved of little value); and, focusing on micro questions only, no need to know how to calculate MP, AP and TP from tables (data) or from diagrams.  IB Economics candidates now need to know what marginal whatever and average whatever are (HL only), and this is achieved in the new syllabus from requiring them to understand how to play (make calculations) only with MC, AC, MR, AR and also TR (from data tables). 

The new IB economics syllabus includes the following (micro related) calculations:

Calculation (HL only): consumer surplus and producer surplus from a diagram

Calculation: PED, change in price, quantity demanded or total revenue from data provided

Calculation: YED, change in income, quantity demanded from data provided

Calculation: PES, change in price or quantity supplied from data provided

Calculation (HL only): the effects on markets and stakeholders of:

• price ceilings (maximum prices) and price floors (minimum prices)

• indirect taxes and subsidies.

Calculation (HL only): welfare loss from a diagram

Calculation (HL only): profit, MC, MR, AC, AR from data

I will try to upload here some examples for these topics, taken mostly from my OUP Economics Skills and Practice volume.

BUT…

To me, the trickiest point perhaps that (HL) IB economics candidates should have in mind relates to indirect taxation.  It is very simple, but it differs a bit from the treatment in the old syllabus.  The new economics syllabus is not explicit about this (correct) twist but if one checks out the specimen paper 3 provided to all teachers (and thus to all students) you’ll see what I mean and why all HL IB economics candidates must have this in mind {see specimen question 2a(ii)}.

Assume I went out to buy myself a shirt.  I come back home and my wife asks me how much did I pay.  I reply that I paid 93 euros.  The tax rate (VAT) in Greece is (unfortunately) 24% on most items. (a GST or sales tax in other countries)

The questions are:

(a) how much was the tax paid (in euros)

(b) what was the price of the shirt I bought net of tax (i.e. before the VAT/sales tax was applied).

We must realize that the 93 euros I paid included the tax.  So how do we go about answering the above questions?

First some notation. Let:

* P(wt) be the price paid (say, for the shirt) with the tax 

* t be the tax rate; in this case, say 24%

* Po be the price (of the shirt) net of tax i.e., before the 24% tax was applied

Then it should be that:

P(wt) = Po + tPo (i.e., the net of tax price plus the amount of the tax paid on the item)

P(wt) = Po (1+t)

So Po = P(wt) / (1+t)

Using our figures:

Po = 93/1.24 So Po = 75 euros (this is the net of tax price of the shirt on which the 24% sales tax was applied)

And thus, the tax I paid on the shirt I bought was P(wt) – Po or, 93 – 75 = 18 euros

(or equivalently, tPo= 0.24*75 = 18 euros)

I will try to post on a regular basis not only articles on issues that may be of interest to IB Economics students but also questions that I will construct, mostly P3 questions and P2 questions that may help.  I’ll also try to provide some insights on Paper1, part(b), questions, focusing mostly on the role of investigations that IB economics candidates should now regularly undertake in their classes to be able to effectively use real world examples (note the plural and the verb ‘use’ – not list or mention) in their responses.

 

This is great for IB economics kids (and, not only)

Our World in Data has tons of information on a myriad of variables where all IB (not just Economics candidates) will find stuff they are interested in.  For example:

On outdoor air pollution

On child and infant mortality

On life expectancy

On smoking

On alcohol consumption

On fossil fuels

On homelessness

On happiness and life satisfaction

and on much more

You can fool around here: Our World in Data

Preannounced sales tax increases as a form of unconventional expansionary fiscal policy

Fiscal policy is a short run demand management stabilization policy that includes changes in government expenditures (G) and/or in taxes (T).  Mind you that it is changes in direct taxes that are considered part of the fiscal policy arsenal.  More specifically, if an economy is about to enter, or is in a recession (or suffers from a large negative output gap), then the government can decrease direct taxes (T). Disposable income (Yd) will increase and thus consumption expenditures (C) and aggregate demand (AD) will increase leading to an increase in overall economic activity (remember, disposable income (Yd) is income minus direct taxes plus transfer payments {so: Yd = Y – T + Tr}, and is not the same as the real income which is money divided by the average price level). On the other hand, if an economy is overheating then policymakers could increase (direct) taxes so that Yd decreases, decreasing consumption expenditures and thus AD (this analysis could also refer to corporate -profit- taxes but let's keep it simple). 

What about changes in indirect taxes?  We treat these at the IB Economics course as possibly affecting the short run aggregate supply.  If they increase across the board (say, an increase in a country’s VAT / GST to 20%) this will increase production costs of firms and as a result decrease the SRAS, shifting it to the left.  This is the typical impact of a change in indirect taxation on an economy according to the IB Economics syllabus).

BUT:

In a recent paper in the American Economic Journal: Macroeconomics, titled  “Shopping for Lower Sales Tax Rates ” the authors (Scott R. Baker et al.) show that “shoppers do actually adjust spending on all kinds of items when state or local (sales) taxes change”. They used data for more than 150,000 households across 40 states to examine whether spending changed in response to increases in sales taxes (the full paper found here).

The researchers found that “…in the month before an increase, consumers stocked up on storable goods, like laundry detergent and alcohol, while they were less expensive.” The same authors find in another recent paper that car sales increased by over 8% in the month before a 1% increase in the sales tax rate!  Click  here for this paper.

The question is ‘so what?”  Why would a HL or SL IB Economics candidate be interested in this finding? Well, the answer is that it provides an alternative policy choice to policymakers who face the threat of recession and are constrained by interest rates at, or very close to zero (the ZLB -zero lower bound- problem) and also by little room for conventional expansionary fiscal policy.

"This research suggests that sales tax adjustments can be a way to stimulate spending at a time when monetary policymakers can’t turn to lowering interest rates because they are already near zero."

Policymakers confronted with the risk of a recession may announce that “..there's going to be a temporary sales tax cut that's going to be paid for by a sales tax increase in the future” 

Their finding imply that this may “induce people to spend more now, buy cars, or buy other things when they are in the low tax environment”. 

NOTE

If you are to include this finding in a paper 1 (essay) response, make sure you first clearly explain the conventional tools for stimulating an economy.  Only then you can explain this finding making sure you remember to quote the title of the paper, the journal and one of the authors.  

Lastly, an absolutely excellent short piece on fiscal policy where everything an IB Economics student need to know is clearly explained is a 2020 article in the (free) IMF journal Finance and Development titled Fiscal Policy: Taking and Giving Away” by Mark Horton and Asmaa El-Ganainy.  

May I remind IB Economics students that they should make sure to subscribe to the Finance and Development IMF publication.  It has very many, easy and interesting articles that can help them achieve high grades in exams. 

 

Big tobacco: High taxes in the North and their unintended consequences in the South

 

Negative consumption externalities are a most important topic in the new IB economics syllabus. A negative consumption externality arises when the consumption of a good imposes costs on 3rd parties for which they do not get compensated.  Tobacco (smoking) and alcohol (drinking) are prime examples.  The consumption of both not only harms those who consume these 'goods' but also society at large.  

Taxation on alcohol is considered ineffective (but a great way to collect high tax revenues which can also be used to finance other policies aimed at decreasing consumption of these 'demerit' goods).  Why won't even a high an indirect tax be effective in lowering consumption of alcohol?  Because taxes on alcohol lead to a "chain of substitutions".  There are very many different types of alcohol (vodka, whisky, wine, beer, tequila, rum, cider, ouzo, you name it...) and each type has zillions of brands and qualities and thus prices range from very low to extremely high. A high tax on alcohol (say 50%) would induce this "chain of substitutions": many consumers, especially individuals in lower socio-economic status (SES) groups where greater prevalence of harmful alcohol consumption (binge drinking) is documented will simply switch to equally strong but cheaper and often lower quality alcohol or brands.  Note though that the minimum unit price (MYP) policy implemented in Scotland and Wales (for which, BTW, you can not use a typical demand and supply diagram that we use to illustrate a minimum price on, say, corn, because the markets for vodka, whisky etc. are not perfectly competitive and there is no supply curve  in markets where firms are price setters) is considered most effective especially if complemented by other policies, such as increased education and awareness in the population (note that also some techniques -nudges- associated with behavioral economics have also produced promising results).

Cigarettes are a different story.  Why? Because even though there are again many brands of cigarettes, they are typically sold at roughly the same price.  An indirect tax can thus prove effective but only if it is high enough (very high) so that the post-tax price rises to the elastic section of the demand for cigarettes curve.  Remember that PED is affected by the number and closeness of available substitutes, whether the good is addictive (tobacco is very addictive)  but also, and most importantly, by the proportion of income spent on the good.  So a low indirect tax will not lead to a significant decrease in smoking (but it will fill the state's coffers with a lot of tax revenues) and will thus prove ineffective.  But a very high tax has a greater chance of proving effective because if smokers continue to smoke as much, their monthly expenditure on cigarettes will become a much too high proportion of their monthly income and many will be forced to cut back and even kick the habit as all are aware of the fact that smoking is a killer.  

But what about 'close substitutes'? That's a big one these days.  In order for a tobacco tax to prove effective it must be imposed on all tobacco-related products and this will have to include heat-not-burn nicotine delivery systems (like IQOS, devised and marketed by -take a guess- Philip Morris International, one of the biggest 'big tobacco' companies) and e-cigarettes (like JUULs).  In addition, the state must make sure that no illegal markets arise (relatively easy if there is the political will).

So, assume that with the high taxes that many countries have imposed and with the impact other necessary complementary policies sales of cigarettes do go down in many advanced economies

Well, unfortunately this would not be the end of the story for  the huge tobacco multinationals.

Watch this (very short): Big Tobacco Goes South 

In the search for new consumers, Big Tobacco is setting its sights on markets in the Global South, using the same tactics that hooked smokers in rich countries decades ago. But with weak health-care systems and low regulatory capacity, the developing world will have a harder time fending off the industry’s marketing blitz.

Remember though that in many countries in the South, the State needs high tax revenues to be able to finance pro-development projects: so they are caught between a rock and a hard place...

PS: I've quit very many years now but the first couple of years of my graduate work in the States I was, unfortunately, a smoker.  I still remember when, late one night, I ran out of cigarettes and, not having a car during my 1st year, I called a cab to get to the nearest ‘Store 24’ and buy me a pack.  The driver took me there and when he saw what I bought, he remarked “Oh, you went to buy coffin nails, I see’. Still, haven’t forgotten his comment.

IB Economics: new syllabus: sections 2.11 and 3.4 On market power, possible abuses of and impact on wages and income inequality

There is significant emphasis in the new IB Economics syllabus on market power, its abuse and the impact on income distribution.  This Project Syndicate video (Project Syndicate a source mostly of great short articles) explains the rise in concentration in many markets and the impact it has had on wages and consequently on income distribution in 2 minutes and 32 seconds.  A nice intro perhaps on the risks of market power being abused and also of possible use in student inquiries on market power and income distribution.  Very topical of course. We'll be focusing on abuse of market power and on income distribution issues a lot.

Watch here: The rise of monopsony power

Causes of inflationary pressures and the Summers-Krugman ‘debate’ (useful for the Paper 1(b) real world example requirement)

 

 

Larry Summers is a most respected Harvard economist (check out here his very impressive cv – BTW, he entered MIT at 16!)  who has lately been very much in the news as he fears that inflation is knocking on the US economy’s door as a result of a the $1.9 trillion Biden American Rescue Plan. 

Interestingly, Summers had re-introduced in 2013 a depression-era term, ‘secular stagnation' to describe the slow growth, low interest rates and no sign of inflation that characterized the US and other advanced economies (see his article titled “Accepting the Reality of Secular Stagnation” in the March 2020 issue of “FINANCE & DEVELOPMENT” a free publication of the IMF that all IB Economics students should subscribe to; link to Summers F&D article here).  He then claimed that “it may have become all but impossible to boost growth by using the age-old trick of lowering interest rates to encourage more investment and consumer spending. The answer, he argued, was for governments to spend more instead” (see this article in The Conversation here; see also this Summer's article. 

But, today, it was perhaps Mr. Summers’ Washington Post February 4 article "The Biden stimulus is admirably ambitious. But it brings some big risks, too" that started the debate about whether as a result of the increased government spending there is risk of inflation now in the US. He explained why in his opinion this risk is real:

“First, unemployment is falling, rather than skyrocketing as it was in 2009, and the economy is likely before too long to receive a major boost as covid-19 comes under control. Second, monetary conditions are far looser today than in 2009 given extraordinary Federal Reserve policies, the booming stock and corporate bond markets, and the weakness of the dollar. Third, there is likely to be further strengthening of demand as consumers spend down the approximately $1.5 trillion they accumulated last year as the pandemic curtailed their ability to spend and as promised further fiscal measures are undertaken.”

He pressed further in a May 24 Washington Post article  “The inflation risk is real”  where he wrote:

“Fed and Biden administration officials are entirely correct in pointing out that some of that inflation, such as last month’s run-up in used-car prices, is transitory. But not everything we are seeing is likely to be temporary. A variety of factors suggests that inflation may yet accelerate — including further price pressures as demand growth outstrips supply growth; rising materials costs and diminished inventories; higher home prices that have so far not been reflected at all in official price indexes; and the impact of inflation expectations on purchasing behavior. Higher minimum wages, strengthened unions, increased employee benefits and strengthened regulation are all desirable, but they, too, all push up business costs and prices.”

But the US was in need of expansionary fiscal policy. So what is Summers' policy advice? He specifically asks: “So how best can we (the US) contain overheating risks and promote sustainable growth while also making necessary investments in infrastructure, greening the economy and helping low- and middle-income families?". He explains:

"First, starting at the Fed, policymakers need to help contain inflation expectations and reduce the risk of a major contractionary shock by explicitly recognizing that overheating, and not excessive slack, is the predominant near-term risk for the economy. Tightening is likely to be necessary, and it is critical to set the stage for that delicate process....Second...unemployment benefits enabling workers to earn more by not working than working should surely be allowed to run out.  Third, it is essential to make long-term public investments to increase productivity and enable more people to work" (his point here is to have redirected a big chunk of the Rescue Plan to (long-term) public investments).    

On the other side of the story, we find a most prominent name, Paul Krugman, the 2008 recipient of the Economics Nobel Prize (also a most impressive CV - click here)

Krugman argues for a while now that the rise in the rate of inflation is not to worry much about.  He considers that the size of the American Rescue Plan ($1.9 trillion) was necessary.  He explains here  in his revived blog that this plan should not be confused with typical expansionary fiscal policy initiative to close an output gap as this was not “a conventional recession — a decline in output due to insufficient aggregate demand”. He further explains that the size is not too big, given the circumstances; and, that there may be some risk of overheating but this risk is small and can be controlled by the Fed (the US central bank) tightening policy (i.e. increasing interest rates). 

A February 2021 YouTube debate between Summers and Krugman can be viewed here (longish- but try to watch until 40:48 ). You may find a summary here) 

Krugman’s most recent (June 21, 2021) New York Times article is titled “The Week Inflation Panic Died” (see here). He had been arguing that there are two types of inflation: “The key thing to understand is that there are really two kinds of inflation.”  The one type is ‘hard-core’ inflation which is when inflation becomes embedded in the economy (i.e. in the expectations of firms and workers) and then “transitory inflation...which is easy come, easy go” and policymakers should “worry only if core inflation looks as if it’s getting too high (or too low)”, i.e. if it becomes embedded in expectations.  He continues: “The Fed has been arguing that recent price rises are similarly transitory. True, they’re not coming from food and energy so much as from pandemic-related disruptions that caused surging prices of used cars, lumber and other nontraditional sources of inflation. But the Fed’s view has been that this episode, like the inflation blip of 2010-11, will soon be over.  And it’s now looking as if the Fed was right. Lumber prices have plunged in recent weeks. Prices of industrial metals like copper are coming down. Prices of used cars are still very high, but their surge has stalled and they may have peaked. Core inflation wins again.”

See also his April 16 article: "Krugman Wonks Out: The Case for Supercore Inflation. It’s going to be a year of bottlenecks and blips" and his May 21, 2021 “Krugman Wonks Out: What We Talk About When We Talk About Money” 

I'd like to add that I have been relying a lot for my IB Economics classes (when classes were not virtual...) on podcasts.  One that is very relevant (and, easy to understand) is this Post Reports podcast (June 17, 2021) Inflation, inflation, inflation (listen only only up to 12:50 for this issue; a must for IB Economics students).

One last point: if the US central bank (the Fed) is forced to increase interest rates because the Summers' scenario of inflation materializes and manages to do so without staring a recession, then there is an interesting benefit for the US economy: it will once again be able to lower interest rates (from say 4% to 1%) to fight a future recession.  The Fed now faces the ZLB (zero lower bound) constraint: with interest rates pretty much at 0%, there is virtually no room for cutting interest rates as deep negative interest rates are considered 'unchartered territory' (but if interested, see Rogoff's idea here)

Hope this provides some background information for investigations that you may conduct on several macro issues that may feature on an IB P1(b) econ exam.

PS: Concerning the distinction between 'embedded' inflation and transitory inflation (or 'blips' as Krugman refers to them in one of the above articles) we can realize why inflation (in the IB and not only) is defined as a 'sustained increase in the general price level'.  See for example Ellie Tragakes' excellent textbook, p.309. Unless inflation is considered sustained (i.e. at risk of becoming embedded in expectations), a central bank (like the Fed now) will not increase interest rates.

 

IMF: Back to Basics

Was looking at the IMF Blog and I found a collection of all past Back to Basics short articles that aim at explaining fundamentals to students.  I've used several in the past and most are wicked good and fully compatible with the IB Econ Syllabus. 

You can find these titles here.

Enjoy!

Great for IB students: Trade diversion in action and the role of macro aggregates on trade balances

Just listened to a most useful and clear trade talk/podcast that focuses on KORUS, the Korea-US Free Trade Agreement that went into effect in 2012.  A University of California Davis professor explains in most simple terms concepts of international trade that all IB Econ students should be aware of.

Kadee Russ discusses the results of a 2019 paper she co-authored with Deborah L. Swenson to the hosts of Trade Talks, a podcast about the economics of trade and policy, Soumaya Keynes and Chad P. Bown.  It is a question and answer podcast that navigates us through real international trade patterns.

Listen in class to The Surprising Story of the US Trade Deficit with South Korea.  It is rewarding!

(the NBER working paper for the more ambitious can be found (free) here).

The limits of monetary policy?

Despite the work I have editing a new book (writing it with a colleague who happens to be an ex-student (IB) of mine), I just cannot ignore the news, especially when a lot has been going on lately in the world.

What am I referring to?

• the escalating trade war between the US and China 
• the rising chances for a no deal Brexit
• China and the Hong Kong protesters
• Italy's political instability
• and, unfortunately, quite a few other 'developments'

Since I need to maintain focus on IB Economics, I will refer to an article in today's NYT titled One Crazy Day Showed How Political Chaos Threatens the World Economy What is of special interest to me and the course I teach are a couple of points made by Jerome Powell, Fed Chairman (the Fede is the Central Bank of the US) and by Mark Carney, the Governor of the Bank of England, about the limits of monetary policy.

This quote from the article refers to Jerome Powell:

Mr. Powell delivered a nuanced speech signaling the Fed was committed to a “risk management” approach, of adjusting policy to try to prevent bad things from happening. His words kept the Fed’s options open.

But he made clear that a breakdown of global trade relations was not the kind of thing that the Fed’s interest rate policies were well suited to addressing.

“While monetary policy is a powerful tool,” Mr. Powell said, “it cannot provide a settled rule book for international trade.” The central bank can only adjust policy to try to respond to the ways trade policy changes affect the overall outlook.  The implicit message: If erratic trade policy undermines the economy, the Fed’s tools are likely to have only limited ability to overcome the damage. Interest rate cuts in that situation would be like giving pain relievers to someone with a broken bone — better to have than not, but unable to solve the underlying problem.

And this one to Mark Carney:

 Also speaking at the Jackson Hole symposium was the Bank of England governor, Mark Carney, who described a limited ability to use monetary policy to offset the damage from Britain’s potentially messy exit from the European Union this fall.

“In the end, monetary policy can only help smooth the adjustment to the major real shock that an abrupt no-deal Brexit would entail,” Mr. Carney said, and that ability would be constrained by the need to keep inflation under control.

Food for thought! 

The new IB Economics Syllabus

 I assume that most probably, the new Economics Syllabus for first teaching in August 2020 and first assessment in May 2022, will be out very soon.   

There are nine key concepts around which the course will be structured: scarcity, choice, efficiency, equity, economic well-being, sustainability, change, interdependence and intervention.  The initial decision to dump the theory of the firm and market structures thankfully does not seem to be the case as section 2.11, in the January 2019 updated syllabus outline, is on Market Power. 

Since to teach market power, and to ensure that students do understand its meaning and  implications, the basics of the theory of the firm and of market structures are necessary, I assume that they will also be present in the new syllabus.  We'll see. 

Otherwise, there is little in the latest outline to fully grasp the differences between the new and the current syllabus. 

In the area of assessment, what makes me wonder a bit is where it is stated that in the 'new' Paper 3:

 "students will work with new quantitative and qualitative data demonstrating a deeper understanding of a real-world issue scenario, using the theories, models, ideas and tools of economics and culminating in policy advice"

"Policy advice"!  I know a few governments (😜) that would need some good policy advice now! This new expectation is both interesting and will be a nightmare to mark (and to come up with an appropriate MS and provide guidance to examiners ).  We'll also see how this one works. 

The last item that makes me a bit curious (I was initially going to use the word 'worried'...) refers to the Internal Assessment.  It states in the outline:

"Each of the three commentaries should use a different key concept as a lens through which to analyse their commentaries"

The 10 'key concepts' are in italics above.  First of all, I would assume that a commentary can 'use' more than one 'key concept'.  But I am not at all sure what exactly the verb 'use' means.  Most, if not all of these concepts permeate all of economics.  And, of course, the question is how can a teacher or a moderator judge whether (and to what extent) a commentary does indeed 'use' a key concept'?. We'll also see this one in practice.

A more general point.  I've been teaching for a long-long time Economics (IB for 25+ years) and I have a decent (terminal degree) background in pure Economics.  I have to admit that I am not so sure what much of the language used in curricula and other IB guides/documents really means.  I am afraid that the program has been hijacked by many who have basically a solid background in Education (but a minimal background in a discipline) and who are forcing fashionable concepts and terms without a clear knowledge of how exactly these apply to each discipline.  More like buzzwords...

I do know that a solid background in Physics is needed to teach Physics and a solid background in Economics is needed to teach Economics.  Sometimes, it seems, this background is just not there.  Einstein had said that 'if you can't explain it to a six year old, then you don't understand it yourself'.

I am afraid that lots we lately find in many IB documents cannot be explained to a six year old.

PS: I had promised that I would maintain this blog last year (and, I am afraid the year before).  I didn't.  Let's see if I keep a new promise to maintain it this time.  The fact that real world examples are lately in such high demand by examiners and what's going on in the real world will be even more important when teaching the new syllabus, makes me hopeful that I will at least try harder this time around.  The goal is to facilitate both students and colleagues of IB Economics .  😁

IB Economics HL (and SL): Two interesting articles on International Economics for Year 2 candidates

I am enjoying the last few days of my summer vacation reading articles from several news sources (not fake at all, IMO...).  Two of these I would like to share with my Year 2 students as they relate to the material we will be covering this fall.

The first one is Argentina, Combating Plummeting Currency, Raises Interest Rate to 60% from the New York Times. The first paragraph clearly explains the issue:

Argentina’s central bank ramped up interest rates by 15 percentage points on Thursday in a bid to slow the fall of its plunging peso, part of a sell-off among emerging market currencies.  (I like the use of 'ramped up!)

The Peso is depreciating rapidly (making imports much pricier and thus feeding inflationary pressures as a result of 'fears the country would not be able to make its debt payments'.  These fears explain the 'sell-off' mentioned above. 

What is also a driving force behind the depreciation of the Argentinian Peso, the Turkish Lira and the South African Rand is that the Chairman of the US Fed (the US central bank) has credibly signaled that the US is sticking to its decision (see Fed's Powell Just Wants to Be Understood) to increase interest rates (which makes US bonds and dollar deposits more attractive to financial investors): Pesos, Liras and Rands are sold, to buy US dollars, driving the value of the dollar up and the value of these currencies down.  Add to this the debt issues Argentina is facing and the unwillingness of Turkey to tighten monetary policy and you get the plummeting currencies.  A pretty typical story for the currencies of emerging economies.

The second article, again from the New York Times, is E.U. Says It’s Ready to Abolish Car Tariffs, Shifting Position.  Quoting:

Cecilia Malmstrom, the European commissioner for trade, told members of the European Parliament that the bloc was willing to reduce “car tariffs to zero, all tariffs to zero, if the U.S. does the same.”

“It has to be reciprocal,” she said. “We would do it, if they do it. That remains to be seen.”

This is an interesting development for many reasons.  It may be interpreted as a winner for US President Trump and his aggressive policy stance ('...may please the Trump administration').  But is also forces the US to play by the EU's bold proposal: will the US auto industry be able to thrive in an zero car tariff world?  We'll see how this one plays out.

IB Economics: Advice on essay writing (paper 1) continued...

In the first part of this post (August 12) I focused on my so-called 'Type A' candidate, a 'candidate who is aiming to achieve a 6 or a 7 in Economics and to study in a top university after graduation'.  This candidate was very well versed in theory, had practiced a lot of essay writing but often was not able to achieve top marks in a P1 essay, i.e. achieve even Level 3 or especially Level 4.  From my experience, this was either the result of poor time management and/or of not embedding their response within a real world context.  They would define, draw, explain and discuss beautifully, but, often,  all of their work was "in a vat" i.e. they never related it to the real-world.

I define Type B IB Economics candidates as individuals who have not studied much and, most importantly, have not practiced much essay writing.  How can one help these guys?

One thing that I have been doing for many tears is to hand out (to all of my students) my file with all past IB Econ essay questions (the file goes back to 1998 for the HL essays and to 2005 for SL). 

If these essays are grouped together by syllabus section or, even in much smaller syllabus chunks, (say, all essays that relate monopolistic competition or even, to why in monopolistic competition firms earn only normal profits in the long run; or, all essays that relate to unemployment or, just to structural unemployment) then, (interested; a sine qua non condition) students, realize that question setters really have a limited choice set!  There is only so much variation that the learning outcomes of our syllabus permit.
 
For example, let us look at two groups of questions:

Group I:

Using demand and supply analysis, explain how resources are allocated through changes in prices in a market economy; Using diagram(s), explain the signaling and incentive functions of price; Explain the role that prices play in the allocation of resources in free market economies; Explain how changes in price work to reallocate resources in a market; Explain how scarce factors of production are allocated by the free market.

Focusing now these, what is the crux of these questions?  What does the examiner expect for sure?

Well, all these questions Group I deal with how free (competitive) markets manage to allocate scarce resources.  I would suggest that the answer in a nutshell relates to the signaling and incentive roles of prices.  Without these two terms, the question cannot really be answered (in my opinion, at least). 

What terms should one necessarily define?  I think that it would be a good idea to define resources, allocation of resources, a free (competitive) market as well as demand and supply. 

Which diagram?  A simple demand and supply diagram pertaining to some specific market with the demand shifting to the right following an increase in demand for this product.

How about the real-world example?  I encourage my students to use a great example (again, in my opinion), the case with quinoa.  Quinoa was/is a staple food of the populations of the Andes which became very fashionable to eat in the US and later Europe and Asia when an American TV persona, Oprah Winfrey, made it known to her zillions of viewers. Quoting from the Economist:

In 1993 a study by NASA, America’s space agency, stated: “While no single food can supply all the essential life-sustaining nutrients, quinoa comes as close as any other in the plant or animal kingdom.” But it took adulation from the likes of Oprah Winfrey (who in 2008 included it in her 21-day “cleanse” diet) to give the grain global appeal. Now, wherever yuppies can be found, it can be too, usually lurking near Puy lentils or goji berries in a salad. (see Quinoa: Against the grain)

Demand for quinoa, in other words, increased dramatically!  Its price started rising, and candidates have to explain here the ‘signaling’ role (that this increase in price emits information to market participants) and then to explain the ‘incentive’ role  (that producers as a result of higher profit margins have the incentive to offer more quinoa -extension of supply- while some consumers cut back or drop-out - contraction of demand…blah, blah, blah).

Eventually, the new equilibrium Q is greater than the original one and, since you can’t produce something out of nothing, more scarce resources (land, workers, machines) are channeled into quinoa production.  The end.  But, this example is great, as of course (…see the articles below for a nice story that can be used to illustrate tons of econ concepts)

So, it may be a good idea to ask candidates to:

a. Think of the ‘answer’ in a nutshell (usually, but not always, possible)
b. Think of the relevant terms to define
c. Think of the diagram(s) to use and to explain
d. Think of the real-world example within which (hopefully) the response may be embedded

Now, for the Group II essays.

Group II essays:

Explain the difference between short run equilibrium and long run equilibrium in monopolistic competition; Explain why firms in monopolistic competition can make economic (abnormal) profits only in the short run; Explain why a firm in monopolistic competition will make only normal profit in the long run. 

What is the answer in a nutshell to pretty much all of these?  I think that the examiner expects candidates to explain how entry of new firms (or, also, exit of some existing firms) in such a market ensures that in the long run monopolistically competitive firms earn only normal profits.

What terms should one necessarily define?  I think that one must define carefully a monopolistically competitive market (and within this, define differentiated product using a couple of examples as well as barriers to entry) and provide a couple of generic examples.

Which diagram(s) should one use?  Well, I think that one definitely needs to carefully draw a monopolistically competitive market where the firm in focus makes supernormal (abnormal) profits (i.e. positive economic).  This would illustrate the short run equilibrium position.  And, then of course, one where this monopolistically competitive firm is making only normal profits (and define this term correctly – see below) i.e. zero economic profits. This would be the long run position (one could draw also the case of losses BUT…see below). 

How about the real-world example?  Well, I would suggest that students narrow down the generic example used to an actual real-world example they are aware of.  For such questions I guide my students to a specific restaurant-café market in the northern suburbs of Athens where there were initially only few firms, but their number has increased (and somewhat, stabilized).  Or, I like the story of the frozen-yogurt fad in my city where the number of sellers surged and then, when the fad was over, it decreased and seems to have also stabilized.  Any food market in any (US) mall could also help or the food stalls in many cities around the world. 

So, my advice to my Type B kids:

Group similar essays together.  This for me is the single most important task for these (all, really!) students.  Then, help them find the (at least the most important) relevant terms that must be defined, Then, guide them to think of the diagram(s) for each group; and, to think of a real-world example for each group.

So, these guys must during the last couple of months have outlines for the limited number of essay groups they come up with.  Teachers may of course facilitate the process.

There is, unfortunately, in many schools, a third type of candidates.  These guys may go through the 2 DP years doing almost no work.  I am usually fortunate enough not to have such a group (even though occasionally, there is a kid who can rightfully claim membership…). In this case, I have been forced to focus mostly on macro (as it has significantly fewer essays to worry about): unemployment, inflation and growth (perhaps, somethings on income distribution that may even be useful for P3).  Perhaps also on a few micro topics (like comparing PC and monopoly; pollution; alcohol). And, then pray a lot! 

Now:

Issues I have seen related to the concept of economic profits in the IB:

Normal profit is defined as the minimum return a firm (an entrepreneur) requires to earn to be willing to remain in the present line of business.  This minimum is equal to what this firm (these resources) could have earned in the next best alternative with the same risk. 

It follows that supernormal (or, abnormal) profits are any profits above this minimum. 

If supernormal profits exist, then other firms (entrepreneurs) will want to take advantage of this opportunity and try to enter this market (here: role of barriers). 

If more firms do enter then:
(a) in the PC setup, the market supply increases (shifts to the right), decreasing the price and squeezing economic profits down to zero.  If losses exist (so firms are making less than what they could have earned in their next best alternative), then exist will decrease market supply, raising the price until no more firms have the incentive to exit

(b) in a MC setup, since there is NO supply curve, the induced entry of new firms will “shrink and tilt” the demand that the incumbent firms face for their product (decrease and flatten it - i.e. make it more price elastic as consumers face more and closer substitutes) until these supernormal profits are competed away.  With losses, the opposite, of course.

Kids always ask why is it that firms making normal profits i.e. zero economic profits are willing to continue to operate? 

They must understand that normal profit is an element of economic costs, as normal profits represent the minimum required to be earned to secure the 4th scarce factor of production, entrepreneurship!  Remember, to secure the scarce factor ‘labor', wages have to be paid and all realize that wages are an element of cost!  This is a point of course that requires quite a few examples (and, some time…) but, in the end (usually), candidates really understand the idea and its implications.  So, one cannot define normal profits as zero economic profits!  This is just a condition: if economic profits are zero, it means that the firm (the entrepreneur) is earning the minimum required to remain in this line of business!

Lastly, concerning the trade-off mentioned above on whether to include a 3rd diagram in the Group II essays.  Diagrams must be drawn in the same manner as in a Grand Prix, Ferrari car mechanics change tires: very fast and very precise.  But, in my experience, students take longer than necessary.  So, I would advise against using (drawing) a 3rd diagram and, instead, briefly explaining that if there are losses, then exit will take place until supernormal profits are competed away.  The opportunity cost of drawing a 3rd diagram may be too high and not worth paying it.

PS: Some interesting articles on the quinoa story include: Quinoa brings riches to the Andes, Overproduction and Consumption Threatens Andes Superfood Haven, The Quinoa Boom Goes Bust in the Andes

PS2: Interested IB Economics teachers can access my files with all past IB Economics essays (for HL Economics and for SL Economics) at MyIB.