Question 1:

Read the extracts and answer the questions that follow.

Text A — 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
the 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 B — 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 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 C — 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.
Table 1: Market Data for Wheat in Lebanon

Price (US$) Quantity Demanded (tons) Quantity Supplied (tons)

20 500 700

18 550 650

16 600 600

14 650 550

12 700 500
a) (i) Define the term supply indicated in bold (Text A, paragraph 2). [2 marks]
(ii) Define the term natural resources indicated in bold (Text B, paragraph 3). [2 marks]

b) (i) Sketch a demand and supply diagram to show the impact of the removal of subsidies on
necessities such as wheat, medicine, and fuel. [4 marks]

(ii) Sketch a demand and supply diagram to show the impact of an indirect tax on the market
for social media applications such as WhatsApp (Text B, paragraph 1). [4 marks]

c) Using a PPC diagram, explain the impact of the damage to the major buildings in Beirut on
Lebanon’s productive capacity (Text A, paragraph 2). [4 marks]

d) Using a supply and demand diagram, illustrate equilibrium, excess demand, and excess
supply of wheat (indicated in Table 1) at different prices. [4 marks]

e) Using a circular flow of income diagram, explain the impact of decreased government
spending and increased taxes (indicated in Text C, paragraph 1) on the Lebanese economy.
[4 marks]

f) Using a supply and demand diagram, explain how fall in prices of wheat (indicated in Table 1)
could affect consumer surplus, producer surplus, and social surplus in the market.
[10 marks]

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