Market failure—market power Paper 2

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Exam Style Question for IBDP Economics HL- Market failure—market power -Paper 2

Solar power in Kenya

  1. Kenyan shopkeepers are able to use mobile phones and a small deposit to buy solar panels. This gives them 24-hour access to electricity and also lowers their fuel bills. Before this, the shopkeepers struggled to get a connection to electricity. M-Kopa is the company that provides these solar panels.
  2. M-Kopa estimates that 80 % of its customers live on less than US\($\)2 a day, and without access to credit, are caught in a poverty trap (poverty cycle). Many of them rely on subsistence farming or run a small business as their source of income. Energy accounts for a significant amount of their spending.
  3. Kopa means “to borrow” in Swahili, and each panel the company sells is in effect a loan of about US\($\)165. M-Kopa’s solar panels cost US\($\)200. Clients pay US\($\)35 upfront and agree to make a daily payment of 45¢ for a year, after which the solar panel is theirs.
  4. When M-Kopa’s customers are reaching the end of their loan terms, an M-Kopa representative calls to offer another product, in exchange for reopening the account and making payments for another few months. M-Kopa has sold around 325 000 solar panels so far and 50 000 of their buyers, who have already paid off their loans, have extended their credit to buy other products offered by M-Kopa. Ideally, these new products will also save customers money over time. They include fuel efficient stoves that save charcoal, a bicycle that cuts transportation costs and water tanks to store rainwater. M-Kopa also sells Samsung smartphones and offers loans to pay for school fees.
  5. M-Kopa is replacing kerosene lamps with solar power technology. Kerosene lamps emit a dangerous smoke that burns the eyes, irritates the throat and slowly turns walls and ceilings black. They are also expensive. According to a 2014 survey, an average household in Kenya, without access to electricity, spends about US\($\)164 a year on kerosene. M-Kopa estimates that a customer saves about US\($\)750 over the first four years by switching to solar panels. Given Kenya’s climate, solar power is an obvious source of energy.
  6. Since its commercial launch in October 2012, the company’s total revenue has risen rapidly, from US\($\)15 million in 2014 to US\($\)30 million in 2015, and the company says it will double this in 2016. Every day, about 600 new customers are purchasing solar panels, meaning that the company is extending loans of almost US\($\)100 000 a day to people who might otherwise not have access to credit.
  7. According to a company representative, “If you take the long-term view and if you treat low-income people as customers, not charity cases, you can change the world. In our view, it is one of the advantages that foreign direct investment can bring to a country. Our customers’ lives are improved as our lives are improved”

Question

Define the term total revenue indicated in bold in the text (paragraph [6]).

▶️Answer/Explanation
An explanation that it is one of the following:
 
  •  total revenue is the income that a firm generates (in a given time period) by selling goods or providing services to its customers

OR

  •  total revenue equals the price multiplied by the quantity of the product sold (for a given time period) OR price \(\times\) output (or equivalent formula).

Solar power in Kenya

  1. Kenyan shopkeepers are able to use mobile phones and a small deposit to buy solar panels. This gives them 24-hour access to electricity and also lowers their fuel bills. Before this, the shopkeepers struggled to get a connection to electricity. M-Kopa is the company that provides these solar panels.
  2. M-Kopa estimates that 80 % of its customers live on less than US\($\)2 a day, and without access to credit, are caught in a poverty trap (poverty cycle). Many of them rely on subsistence farming or run a small business as their source of income. Energy accounts for a significant amount of their spending.
  3. Kopa means “to borrow” in Swahili, and each panel the company sells is in effect a loan of about US\($\)165. M-Kopa’s solar panels cost US\($)200. Clients pay US\($\)35 upfront and agree to make a daily payment of 45¢ for a year, after which the solar panel is theirs.
  4. When M-Kopa’s customers are reaching the end of their loan terms, an M-Kopa representative calls to offer another product, in exchange for reopening the account and making payments for another few months. M-Kopa has sold around 325 000 solar panels so far and 50 000 of their buyers, who have already paid off their loans, have extended their credit to buy other products offered by M-Kopa. Ideally, these new products will also save customers money over time. They include fuel efficient stoves that save charcoal, a bicycle that cuts transportation costs and water tanks to store rainwater. M-Kopa also sells Samsung smartphones and offers loans to pay for school fees.
  5. M-Kopa is replacing kerosene lamps with solar power technology. Kerosene lamps emit a dangerous smoke that burns the eyes, irritates the throat and slowly turns walls and ceilings black. They are also expensive. According to a 2014 survey, an average household in Kenya, without access to electricity, spends about US\($\)164 a year on kerosene. M-Kopa estimates that a customer saves about US\($\)750 over the first four years by switching to solar panels. Given Kenya’s climate, solar power is an obvious source of energy.
  6. Since its commercial launch in October 2012, the company’s total revenue has risen rapidly, from US\($\)15 million in 2014 to US\($\)30 million in 2015, and the company says it will double this in 2016. Every day, about 600 new customers are purchasing solar panels, meaning that the company is extending loans of almost US\($\)100 000 a day to people who might otherwise not have access to credit.
  7. According to a company representative, “If you take the long-term view and if you treat low-income people as customers, not charity cases, you can change the world. In our view, it is one of the advantages that foreign direct investment can bring to a country. Our customers’ lives are improved as our lives are improved”.

Question

Using a theory of the firm diagram, explain the output and pricing decision of M-Kopa if it chooses to pursue the goal of revenue maximization (paragraph [6]).

▶️Answer/Explanation
For drawing a correctly labelled diagram of the market for solar panels with the revenue maximizing level of output set at MR = 0 and price (P)
AND
Revenue maximization is when MR = 0. M-Kopa will continue to increase output as long as selling any extra panel will increase its total revenue (MR is positive) (until the point where selling an extra panel will decrease total revenue).

Filipino rice farmers prepare for trade liberalization

  1. To meet its obligations under World Trade Organization (WTO) rules, the president of the Philippines has asked the government to eliminate the current quota system for rice imports. As an important part of food security measures, the government wants to achieve self-sufficiency in the production of rice. To support this goal, the WTO allowed the Philippines to extend its rice quota until June 2017 to allow more time for local farmers to prepare for free trade.
  2. The current quota system for rice imports makes domestic prices rise dramatically during periods of low domestic supply.
  3. Eliminating the quota on rice aims to make the rice market more competitive, which could reduce the price of rice by as much as 7 Philippine pesos (PH₱) per kilogram (kg). The National Economic and Development Authority has estimated that lower rice prices could save Filipino households as much as PH₱2362 per year. However, if the rice quota is eliminated, economists have warned that the government must prepare local rice producers so that they can either compete with rice imports or move to producing other crops. “Currently Filipino farmers cannot compete with Vietnamese farmers who may enjoy economies of scale” declared one economist. “The solution is to bring down the cost of production of rice.”
  4. To help Filipino farmers to adjust to competition from lower-priced rice imports, the government has allocated funds to the Rice Competitiveness Enhancement Fund. This fund will provide support to farmers in order to increase productivity by supplying high-yield seeds and fertilizer. It will also provide subsidies to encourage the use of agricultural machinery and will offer support services and training to farmers.
  5. Apart from being an essential food for many Filipinos, rice is also an important input for the food industry. The plan to remove the import quota will reduce the inflation rate in the Philippines by up to 0.4 %. In July 2018, the central bank governor reported that inflation had reached 5.7 %, well above the government’s target range of 2 % to 4 %. He stated that “supply-side factors are the main drivers of the present inflation. These factors include rising international oil prices, higher indirect taxes and poor weather conditions that have affected food supply”. The president stated that the removal of the rice quota was one solution to ease the rising inflation.

Question

Using a perfect competition diagram, explain whether farmers in the Philippines are making an economic profit or loss (Table 1).

▶️Answer/Explanation
For a perfectly competitive firm diagram showing the ATC curve above the AR curve at a level of output indicating a loss
AND
an explanation that they are making a loss, because ATC (PHP12.41) is above AR (PHP12.19)

Economic development in Honduras and Guatemala

Honduras

  1. Honduras is a developing country in Central America. While historically dependent on the export of primary products, Honduras has more recently diversified its exports to include clothing and automobile components. Honduras’ economy depends heavily on exports to the United States (US) and, to a lesser extent, on remittances (money sent by a foreign worker to their home country).

  2. In rural areas, approximately one out of five Hondurans lives in absolute poverty. The country is also vulnerable to external shocks and has experienced worsening terms of trade. Revenue earned by the agricultural sector has decreased by one-third over the past two decades. This is partially due to the declining prices of the country’s export crops, especially bananas and coffee beans.

  3. The Dominican Republic-Central America Free Trade Agreement (CAFTA-DR) has helped attract foreign direct investment (FDI). However, a threat to future FDI inflows is Honduras’ high level of crime and violence. It has one of the highest murder rates in the world.

    Guatemala

  4. Guatemala shares a border with Honduras. Guatemala has the largest population and the biggest economy in Central America. Guatemala is the top remittance recipient in Central America as a result of large numbers of Guatemalans living and working in the US. These inflows on the current account are equivalent to two-thirds of the country’s export revenue and about 10 % of its gross domestic product (GDP).

  5. The agricultural sector employs 31 % of Guatemala’s labour force. Key agricultural exports include sugar, coffee, bananas and vegetables. The CAFTA-DR has reduced the barriers to FDI, resulting in increased investment and diversification of exports, particularly in iron, steel and non-traditional agricultural exports (such as high-priced fruits and vegetables). While the free trade agreement has improved the conditions for investment, FDI continues to be limited by concerns over security, the lack of skilled workers and poor infrastructure.

  6. With some of the worst poverty, malnutrition and infant mortality rates in the region, Guatemala’s economic development is slowing. Those worst affected live in rural areas. Faster economic growth is crucial to achieving the country’s medium- and long-term poverty reduction objectives.

Question

Using a perfectly competitive firm diagram, explain the effect of declining prices of coffee beans on the profits of Honduras’ coffee farmers in the short run (paragraph [2]).

▶️Answer/Explanation
For a perfectly competitive firm diagram showing the ATC curve and the AR curve and a fall in price showing and showing the resulting profit/ at the profit-maximizing (loss-minimizing) level of output.
AND
for an explanation that lower coffee prices will reduce the AR (total revenue) at the new profit maximizing (loss-minimizing) level of output (for which MC = MR). At this output average total costs are greater than AR and therefore the Honduran coffee farmers will incur a loss (in the short run).

South Sudan joins the East African Community

  1. The East African Community (EAC) is the most integrated trading bloc in Africa. In 2005, the members established a customs union, and then in 2010 it became a common market. There are ambitious plans to establish a monetary union by 2024.
  2. According to a recent report, the region is wealthier and more peaceful as a result of the increased integration. Economic models suggest that bilateral trade between member countries was 213 % higher in 2011 than it would have been without the integration. This is despite the fact that progress on fully eliminating trade barriers has been rather slow and there are still a large number of non-tariff barriers.
  3. Until recently the customs union was made up of Burundi, Kenya, Rwanda, Tanzania and Uganda. Very recently, South Sudan joined the bloc. This presents a tremendous opportunity for South Sudan, which was recently recognized as an independent country.
  4. South Sudan is one of many developing countries that are dependent on oil exports for the majority of its export revenues and oil prices have been falling due to increased supply of oil in the market. The deteriorating terms of trade have resulted in a worsening of the current account and lower government revenues. Regional economic integration might help South Sudan to diversify its economy.
  5. Agriculture is one potential area that South Sudan could focus on to diversify its economy. According to some estimates, 70 % of land is suitable for agriculture, but less than 4 % is currently being cultivated. The large flood plains in the country are suitable for rice production and the hope is that South Sudan can develop a comparative advantage in this essential food.
  6. South Sudan is landlocked and most of its road network is unpaved. This is just one example of its poor infrastructure. Since infrastructure is an expensive investment, regional cooperation will be vital for improving its road systems. Furthermore, effective transport links to sea ports in Kenya and Tanzania will allow for greater trade and therefore economies of scale.
  7. In the short term, there will be challenges for South Sudan associated with joining the common market. For example, before Rwanda joined the EAC in 2007, there were lower tariffs on many imported inputs. However, the cost of living for the poor population rose because of trade diversion that occurred after joining the EAC. South Sudan is likely to face the same problem.
  8. Labour costs in South Sudan are higher than those of other member countries and years of conflict have left the population with low levels of education and skills. This may present a barrier for South Sudan in attracting foreign direct investment, despite being part of the common market.

 

Question

Using a cost diagram, explain how membership in the common market may allow producers in South Sudan to gain economies of scale (paragraph [6]).

▶️Answer/Explanation
For drawing a cost diagram showing a LRAC with two points indicating a fall in average costs at a higher level of output.
AND
For an explanation that as South Sudan has access to a larger market, it will allow its producers to operate at a higher level of output resulting in economies of scale and a fall in LRAC/AC.

São Tomé and Príncipe Economic Development Challenges

  1. São Tomé and Príncipe (STP) is an island nation and is one of the smallest economies in Africa. STP faces many economic development challenges including: a limited range of export products (mostly commodities) and markets, limited human capital, insufficient infrastructure, vulnerability to supply-side shocks due to climate change, limited access to credit, political instability and poor governance. All these challenges have led to a high dependence on foreign aid.

  2. International organizations estimate that approximately 50 % of STP’s population is living in relative poverty. Its economic growth rate has been consistent at 4–5 % between 2013 and 2018, but the International Monetary Fund (IMF) suggests that STP will need an economic growth rate of 6 % to have an impact on the poverty rate.

  3. To increase economic growth and reduce its dependence on foreign aid and cocoa exports (80 % of its total exports), STP is planning to extract offshore oil and develop the comparative advantage it has in tourism. Over 50 % of its exports go to the European Union. It is hoped that diversifying STP’s exports will increase the number of its potential trading partners. To achieve this aim, STP is seeking membership with the World Trade Organization (WTO) and the Central African Economic and Monetary Community. Developing export markets could help STP benefit from economies of scale and overcome the restrictions of its geographical remoteness and high transport costs. However, STP will need help from multinational oil companies to exploit its oil reserves, and the government needs to improve transparency to ensure that oil revenues are used to support economic development.

  4. In STP, foreign aid accounts for 57 % of gross domestic product (GDP) and 93 % of public investments, including a significant portion of health and education spending. In addition, concessional loans have been provided by the IMF. However, STP had to agree to decrease the budget deficit as a condition of the loan from the IMF.

  5. There are some government officials who believe that aid will not solve the economic development challenges in STP. It did not meet the nutrition targets set by the Millennium Development Goals and continues to struggle with providing adequate clean water and nutritional intake for its population. Clean water is becoming scarce in STP due to business pollution and poor household sanitation, which is also spreading diseases. Other environmental concerns are climate change, deforestation and erosion of coastal areas due to the sand extracted for the construction of roads and buildings.

Question

Define the term economies of scale indicated in bold in the text (paragraph [3]).

▶️Answer/Explanation
Long run average costs/cost per unit decrease as output increases
OR
Average costs/cost per unit decreases as output increases when all inputs are changed

Fiji’s challenges and opportunities

  1. In 2016, the island nation of Fiji suffered from cyclone Winston (a tropical storm), costing more than 40 lives and damaging its infrastructure. One of the country’s four sugar mills was severely damaged, harming raw sugar processing. Processed sugar is, in addition to bottled water and tourism, a major export in Fiji. A recent study found that the damage from the cyclone continues to have a lasting effect on communities as fisherwomen report fewer and smaller crabs and fishes. The social safety net is limited and there are calls for the government to help the citizens who have been affected by the cyclone. However, the government had to use its budget to rebuild infrastructure.

  2. The government has prepared several strategies to strengthen the economy. These include financial support for sugar cane producers, diversification of its agricultural produce, better access to finance and encouragement of investment. The government has committed to provide equal opportunities for all: promoting the participation of women in education and political leadership, because Fiji has one of the lowest female participation rates in politics in the world.

  3. To support its sugar cane farmers, the government provides a 55 % subsidy on pesticides (products that kill weeds) used in farming. However, small farmers are complaining about the excessive paperwork that needs to be completed to receive the subsidy and there is potential for corruption. Fiji competes with Brazil, which has an absolute advantage, in the world market for sugar.

  4. To diversify, the government plans to expand the ginger and coconut industries. Both industries are economically and environmentally sustainable. The industries provide an increased number of Fijians with a worthwhile income. Coconut production plays a very important role in Fiji’s economy, particularly in the more isolated rural communities, where formal employment is scarce and where alternative cash crops (crops grown to be sold for profit) do not exist. Coconut is a staple food and is vital for food security (ensuring that people have access to enough food), but is also important for health, economic and cultural reasons. New market opportunities have emerged in high-value products – green coconut products, such as coconut water, are becoming increasingly popular throughout the world.

  5. The Asian Development Bank encourages Fijian farmers to access “green finance”. These financial investments support economic development through sustainable development initiatives and policies. Under the government’s new reforms, farmers are able to use assets such as crops and contracts as collateral for loans, creating improved access to finance. However, to increase incomes, farmers will also need to improve their financial knowledge.

Question

Using a costs diagram, explain how the expansion of the coconut industry could lead to economies of scale (paragraph [4]).

▶️Answer/Explanation
A costs diagram showing LRAC with two points indicating a fall in average costs at a higher level of output.
AND
Explaining that as output increases, LRAC/AC/costs per unit can decrease due to; specialization/marketing/managerial/technical/financial (or any explained example of these) economies.

Text A — Overview of Vietnam

  1. Economic reforms in Vietnam during the past 30 years have led to rapid economic growth, which has transformed a poor nation into a lower middle-income economy. The percentage of the population with an income of less than US$1.90 a day declined from 38 % in 2002 to below 2 % in 2018.
  2. Vietnam used to be a food-insecure nation, in which many people sometimes lacked access to affordable food, but it is now a leading exporter of basic food commodities. It also aims to become an exporter of high quality and processed food products. However, agricultural production only accounts for 18 % of gross domestic product (GDP), although it uses 40 % of the land and employs 43 % of the labour force. Due to the growing rural population, land is often divided up between a greater number of farmers, causing some farms to become smaller. These farms have fewer opportunities to benefit from economies of scale and lower average costs of production.
  3. Vietnam’s rapid growth and industrialization, focused on export-oriented manufacturing, have had a harmful impact on the environment. Electricity consumption has tripled since 2010, growing faster than GDP. Electricity generation, which mainly uses fossil fuels, accounts for approximately 60 % of Vietnam’s carbon emissions. Demand for water continues to increase. Unsustainable exploitation of natural resources, such as land, fisheries, and timber, could negatively affect prospects for long-term growth. In addition, Vietnam’s primary sector is highly vulnerable to the climate and is therefore subject to supply shocks.
  4. Vietnam has signed several free trade agreements (FTAs). Its first FTA was a partnership with Japan in 2008. Both Vietnam and Japan are members of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which took effect at the beginning of 2019. These FTAs also promote inward foreign direct investment (FDI). In addition, Vietnam has introduced policies to attract foreign investment, such as tax incentives and spending on infrastructure.
  5. Japan is the biggest provider of foreign aid to Vietnam and the largest source of FDI. Japanese firms and aid agencies are jointly financing large-scale projects, including port infrastructure and a high-speed railway, which will reduce the Hanoi to Ho Chi Minh journey time from about 35 hours to under six hours. Other Japanese-funded aid projects are in the areas of health care, education, and the environment.

Text B — Trade and investment flows between Vietnam and Japan

  1. Japan imports seafood and consumer products such as textiles, leather shoes and processed foods from Vietnam, because Vietnam has a comparative advantage in such items. Conversely, Vietnam imports machinery, technology, and raw materials for production from Japan. Gradually barriers to trade are being removed. In 2020, Vietnam began exporting lychees (a luxury fruit) to Japan after five years of negotiations on quality standards. The improved access to the Japanese market has increased the number of consumers and the revenue earned by Vietnamese lychee farmers.
  2. Japanese firms invest in Vietnam, particularly in urban areas, because wages are low and they can export from Vietnam to other CPTPP members and to China and Indonesia. Panasonic, a Japanese multinational company (MNC), relocated a major factory, which manufactures refrigerators and washing machines, from Thailand to Vietnam in 2020. The construction of a coal-fired power plant is mainly funded by Japanese firms. The Japanese government is promoting further investment by subsidizing over 30 firms that are relocating from China to Vietnam. Most of these firms are food processors or producers of manufactured goods (for example, medical equipment).

Text C — Roles of the central bank in Vietnam

  1. The central bank in Vietnam has been lowering interest rates since mid-2019. However, it has kept the minimum reserve requirement at 3 % of commercial bank deposits, despite suggestions that this requirement could be lowered.
  2. The central bank also regulates the exchange rate of the dong (Vietnam’s currency). It actively intervenes in the foreign exchange market to stabilize the rate when necessary. In April 2020, there was downward pressure on the dong due to the lower interest rates and fewer foreign tourists. However, the central bank has a large amount of reserve assets, which were used to prevent the dong from depreciating.

Question

Explain two economies of scale which may not be available to smaller farms (Text A, paragraph [2]).

▶️Answer/Explanation

Two valid explanations of how/why the economies of scale decrease (long run) average costs.
For example, small farms:

  • are unable to use (apply) division of labour or employ specialist managers, which could increase efficiency
  • are less likely to use large machines/capital equipment which can increase capacity / efficiency
  • are less likely to buy in bulk and therefore pay higher prices for inputs
  • cannot spread costs over large quantity of output for transport or marketing
  • have to pay higher interest rates on loans.

Text D — Overview of Lebanon

  1. Lebanon is in the Middle East, bordering the Mediterranean Sea, and is home to nearly 7 million people. Lebanon is in an economic crisis, facing a recession, huge government debt and rising income inequality, poverty and inflation. Corruption and poor governance have been blamed for misallocation of funds that has led to low levels of investment and extensive capital flight. Additionally, Lebanon has one of the most unequal distributions of wealth in the world. In 2019, the top 10% of income earners owned over 70% of personal wealth in Lebanon.

  2. Infrastructure in Lebanon is poor, water and sewerage systems are basic, and roads are inadequate. Electricity supply is unreliable with people going without power for much of the day. In 2020, major buildings including food storage buildings, schools and hospitals were damaged in Beirut (the capital city of Lebanon). This was concerning as 85% of the country’s food arrives through Beirut. Fortunately, humanitarian aid was given by the international community to help rebuild the damaged buildings.

  3. Despite a history of inflows from luxury tourism and remittances (money sent by a foreign worker to their home country), there is a persistent current account deficit. To help with this, the Lebanese central bank has used high interest rates to attract financial inflows. Additionally, the government has borrowed funds from overseas. However, the misuse of these funds and overspending have contributed to one of the highest foreign debts in the world. Lebanon recently defaulted on foreign debt repayments worth 1.2 billion euros, which damaged its international credit rating, making it difficult to access loans needed to help solve its current economic problems.


Text E — Further challenges facing Lebanon

  1. Social unrest is prevalent and intensified when the government suggested raising revenue by imposing an indirect tax on social media applications such as WhatsApp. As the government struggles to pay its debts, people are concerned that subsidies on necessities such as wheat, medicine and fuel will be removed.

  2. Mismanagement of the state-run electricity and telecommunications sectors has resulted in unreliable services and high telecommunication prices. The state-run monopoly firms make losses, and the electricity sector relies heavily on government subsidies, putting pressure on the budget deficit.

  3. Lebanon currently has a managed exchange rate system with the Lebanese pound (Lebanon’s currency) linked to the US dollar (US$). However, the government is finding it difficult to maintain the exchange rate at the desired level due to insufficient reserve assets. Recent falling remittances, low levels of exports and lack of foreign direct investment (FDI) are placing downward pressure on the Lebanese pound. Lebanon has limited natural resources and a small manufacturing industry, thus relies heavily on imports. As a consequence, the gradual depreciation of the Lebanese pound has led to cost-push inflation.


Text F — Reforms and strategies for economic recovery

  1. The Lebanese government is seeking help from the International Monetary Fund (IMF) to restructure the government debt and develop its infrastructure. However, loans from the IMF will require the following conditions to be met:
    • procedures and processes established to ensure good governance, including enforcement of anti-corruption laws
    • financial sector reforms implemented to build confidence in the banking system and laws to control capital flight
    • government spending reduced and revenue increased through higher corporate, wealth and personal income taxes for high-income earners. Introduction of a tax on imported luxury goods and an increase of indirect taxes
    • partially privatizing the electricity and telecommunications sectors to increase efficiency and encourage the exploration of new energy sources
    • transitioning from a managed to a floating exchange rate system.

  2. Other organizations are offering development aid to rebuild infrastructure and support small to medium-sized businesses to develop the manufacturing sector and attract FDI. Currently, the manufacturing sector accounts for only 12.5% of gross domestic product (GDP). Some experts recommend that Lebanon decreases its reliance on food imports by developing its own food industry. However, Lebanon must commit to establishing good governance systems before aid organizations will provide their support.

  3. Lebanon has resisted seeking help from the IMF and other agencies in the past due to concerns about high levels of interference and imposed conditions that may conflict with their own government objectives.

Question

Define the term monopoly indicated in bold (Text E, paragraph [2]).

▶️Answer/Explanation
An understanding that it is a market structure where there is only one firm/dominant firm in the industry.
And one of the following:
 
  • High barriers to entry.
  •  Unique product/no close substitutes
  • Or any other characteristics.

Text D — Overview of Lebanon

  1. Lebanon is in the Middle East, bordering the Mediterranean Sea, and is home to nearly 7 million people. Lebanon is in an economic crisis, facing a recession, huge government debt and rising income inequality, poverty and inflation. Corruption and poor governance have been blamed for misallocation of funds that has led to low levels of investment and extensive capital flight. Additionally, Lebanon has one of the most unequal distributions of wealth in the world. In 2019, the top 10% of income earners owned over 70% of personal wealth in Lebanon.

  2. Infrastructure in Lebanon is poor, water and sewerage systems are basic, and roads are inadequate. Electricity supply is unreliable with people going without power for much of the day. In 2020, major buildings including food storage buildings, schools and hospitals were damaged in Beirut (the capital city of Lebanon). This was concerning as 85% of the country’s food arrives through Beirut. Fortunately, humanitarian aid was given by the international community to help rebuild the damaged buildings.

  3. Despite a history of inflows from luxury tourism and remittances (money sent by a foreign worker to their home country), there is a persistent current account deficit. To help with this, the Lebanese central bank has used high interest rates to attract financial inflows. Additionally, the government has borrowed funds from overseas. However, the misuse of these funds and overspending have contributed to one of the highest foreign debts in the world. Lebanon recently defaulted on foreign debt repayments worth 1.2 billion euros, which damaged its international credit rating, making it difficult to access loans needed to help solve its current economic problems.


Text E — Further challenges facing Lebanon

  1. Social unrest is prevalent and intensified when the government suggested raising revenue by imposing an indirect tax on social media applications such as WhatsApp. As the government struggles to pay its debts, people are concerned that subsidies on necessities such as wheat, medicine and fuel will be removed.

  2. Mismanagement of the state-run electricity and telecommunications sectors has resulted in unreliable services and high telecommunication prices. The state-run monopoly firms make losses, and the electricity sector relies heavily on government subsidies, putting pressure on the budget deficit.

  3. Lebanon currently has a managed exchange rate system with the Lebanese pound (Lebanon’s currency) linked to the US dollar (US$). However, the government is finding it difficult to maintain the exchange rate at the desired level due to insufficient reserve assets. Recent falling remittances, low levels of exports and lack of foreign direct investment (FDI) are placing downward pressure on the Lebanese pound. Lebanon has limited natural resources and a small manufacturing industry, thus relies heavily on imports. As a consequence, the gradual depreciation of the Lebanese pound has led to cost-push inflation.


Text F — Reforms and strategies for economic recovery

  1. The Lebanese government is seeking help from the International Monetary Fund (IMF) to restructure the government debt and develop its infrastructure. However, loans from the IMF will require the following conditions to be met:
    • procedures and processes established to ensure good governance, including enforcement of anti-corruption laws
    • financial sector reforms implemented to build confidence in the banking system and laws to control capital flight
    • government spending reduced and revenue increased through higher corporate, wealth and personal income taxes for high-income earners. Introduction of a tax on imported luxury goods and an increase of indirect taxes
    • partially privatizing the electricity and telecommunications sectors to increase efficiency and encourage the exploration of new energy sources
    • transitioning from a managed to a floating exchange rate system.

  2. Other organizations are offering development aid to rebuild infrastructure and support small to medium-sized businesses to develop the manufacturing sector and attract FDI. Currently, the manufacturing sector accounts for only 12.5% of gross domestic product (GDP). Some experts recommend that Lebanon decreases its reliance on food imports by developing its own food industry. However, Lebanon must commit to establishing good governance systems before aid organizations will provide their support.

  3. Lebanon has resisted seeking help from the IMF and other agencies in the past due to concerns about high levels of interference and imposed conditions that may conflict with their own government objectives.

Question

Using a monopoly diagram, explain why a profit-maximizing state-run telecommunications firm might be making a loss (Text E, paragraph [2]).

▶️Answer/Explanation
For a correct profit maximizing monopoly diagram with appropriate labelling showing a loss.
AND
High costs, due to inefficiencies/mismanagement OR/AND insufficient D(AR) due to poor service [1],
losses will arise because AC/TC is greater than AR/TR/price [1] (at the profit maximising/loss minimising output).
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