NSS Exploring Economics 3 (Second Edition)
Consolidation Worksheets
Chapter 16 Competition and efficiency
Test yourself
16.1 Refer to the following table.
Quantity(units) / MB ($) / MC ($)
1 / 13 / 1
2 / 11 / 2
3 / 8 / 3
4 / 4 / 4
5 / 0 / 5
Calculate the value of the deadweight loss for each of the following output levels. Based on your result, determine which of them is inefficient.
a. 2 units
b. 4 units
c. 5 units
Answers:
a. Deadweight loss = (______of 3rd unit – ______of 3rd unit) + (______of 4th unit – ______of 4th unit) = $__ + $__ = $__ Efficient / Inefficient
b. Deadweight loss = $__ Efficient / Inefficient
c. Deadweight loss = ______of 5th unit – ______of 5th unit = $__ Efficient / Inefficient
16.2 Summarise the effects of an effective price ceiling and an effective price floor in a perfectly competitive market by choosing the correct answers in the table below.
Answers:
Is MB greater than, equal to or smaller than MC at quantity transacted? / MB > / = / < MC / MB > / = / < MC
Change in TSS / / / uncertain / / / uncertain
Achieve efficiency in resource allocation? / Yes / No
(underproduction / overproduction) / Yes / No
(underproduction / overproduction)
Change in Q / / / uncertain / / / uncertain
Change in P / / / uncertain / / / uncertain
Change in CS / / / uncertain / / / uncertain
Change in PS / / / uncertain / / / uncertain
16.3 Suppose the government has imposed an effective price ceiling on rental housing. Without using a diagram, what can you tell about the change in TSS and the state of market efficiency under each of the following situations?
a. The price ceiling becomes ineffective due to a decrease in demand for rental housing.
b. The government removes the price ceiling.
Answers:
a. TSS will increase / decrease but market efficiency is / is not achieved.
b. TSS will increase / decrease and market efficiency is / is not achieved.
16.4 Applying what you have learned in this chapter, explain why an effective minimum wage may NOT benefit the workers.
Answers:
In terms of producer surplus (PS), workers as a whole may be worse off under an effective minimum wage if the gain / loss in PS (due to wage increase) is greater / smaller than the gain / loss in PS (due to quantity decrease).
16.5 Summarise the effects of an effective quota in a perfectly competitive market by choosing the correct answers in the table below.
Answers:
Is MB greater than, equal to or smaller than MC at quantity transacted? / MB > / = / < MCChange in TSS / / / uncertain
Achieve efficiency in resource allocation? / Yes / No
(underproduction /overproduction)
Change in Q / / / uncertain
Change in P / / / uncertain
Change in CS / / / uncertain
Change in PS / / / uncertain
16.6 Suppose the government increases a unit tax on a good. Explain how this would affect the following:
a. Consumer surplus
b. Producer surplus
c. Government’s tax revenue
d. Total social surplus
Answers:
a. Increase / Decrease. This is because the market price increases / decreases and the quantity consumed increases / decreases.
b. Increase / Decrease. This is because both the price received and the quantity sold increase / decrease.
c. Uncertain. The change in tax revenue depends on the ______of demand and supply.
d. Increase / Decrease. Even if the tax revenue increases, the extra tax revenue collected is still greater / smaller than the increase / decrease in the sum of the consumer surplus and the producer surplus.
Short Questions
1. What is efficiency in resource allocation? What is the condition of efficiency in resource allocation? (4 marks)
Answers:
Efficiency in resource allocation is attained when the total social surplus (TSS) is ______.
When only consumers and producers are in the market, TSS is the sum of the consumer surplus (CS) and the producer surplus (PS). ______is attained when the sum of CS and PS is maximised. This requires that the marginal benefit of a good be equal to its ______.
2. Use a supply-demand diagram to illustrate how a perfectly competitive market can lead to efficient allocation of resources. (6 marks)
Answers:
In a perfectly competitive market, the demand curve reflects MB / MC curve while the supply curve reflects MB / MC curve.
When the market is in equilibrium, the demand curve intersects the supply curve, so ___ = MC.
This means the allocation of resources is efficient.
3. a. What is deadweight loss? (2 marks)
b. ‘An effective price floor will increase producer surplus.’
Do you agree with the above statement? Illustrate your answer with a diagram. (4 marks)
Answers:
a. Deadweight loss is
potential gains not being captured when MB > / = / < MC;
the loss in total social surplus when MB > / = / MC.
b. Yes / No.
If the gain in producer surplus is smaller than (or equal to) the loss in producer surplus, the producer surplus will ______(remain unchanged).
Show the gain and the loss in producer surplus in the following diagram respectively.
4. Explain how price ceilings would lead to inefficient allocation of resources. Illustrate your answer with a supply-demand diagram. (5 marks)
Answers:
An effective price ceiling will raise / lower the quantity supplied above / below the efficient level.
Therefore, resource allocation is efficient / inefficient.
Show the deadweight loss in the following diagram.
5. The Hong Kong Government has set a minimum wage for foreign domestic helpers. Use a diagram to show the deadweight loss arising from such a policy. (5 marks)
Answers:
The effective minimum wage will raise / lower the quantity transacted above / below the efficient level.
MB / = / < MC at the new quantity transacted.
The shaded area represents the deadweight loss from overproduction / underproduction.
Show the minimum wage in the following diagram.
*6. Suppose an effective quota is initially imposed on Good X. Assess the effects on efficiency if the quota is removed. Illustrate your answer with a supply-demand diagram. (5 marks)
Answers:
After the removal of an effective quota, perfectly competitive market equilibrium is attained.
The quantity transacted will increase so that MB > / = / < MC.
Efficiency in resource allocation will be achieved. The gain in TSS will be the deadweight loss under the quota.
Structured Questions
1. a. With the use of supply-demand diagrams, compare the effects of a unit tax and a unit subsidy on the following:
i. the market price
ii. the quantity transacted (6 marks)
*b. In light of your answer in (a), explain why there is a deadweight loss when the government imposes a unit tax or provides a unit subsidy. Illustrate your answer with the use of supply-demand diagrams in (a). (6 marks)
Answers:
a. i. The market price of a good will increase / decrease under a unit tax but will increase / decrease under a unit subsidy.
ii. The quantity transacted of a good will increase / decrease under a unit tax but will increase / decrease under a unit subsidy.
b. In both cases, MB ≠ MC. Thus, the total social surplus can be increased by adjusting (increasing or decreasing) the ______. This implies that there is a deadweight loss from government intervention.
Show the deadweight loss in the following diagrams.
2. The following is information about the market for LCD televisions:
Price ($) / Quantity demanded (units) / Quantity supplied (units)10,000 / 3,000 / 5,000
8,000 / 3,500 / 3,500
6,000 / 4,000 / 2,000
4,000 / 4,500 / 500
a. What are the equilibrium price and output level? (2 marks)
b. Is the output level in part (a) efficient? Explain your answer. (2 marks)
*c. Explain if there is any deadweight loss in the following cases:
i. The government sets a maximum price at $6,000 per unit; (2 marks)
ii. The government sets a maximum price at $10,000 per unit. (2 marks)
Answers:
a. Equilibrium price is $______.
Equilibrium output level is ______units.
b. Yes / No. The output level is efficient / inefficient.
This is because marginal benefit ______marginal cost (= $8,000) at that output level.
c. i. Since the maximum price is effective / not effective, the output is more than / still at / less than the efficient level (of 3,500 units).
Thus, there is a deadweight loss associated with overproduction / underproduction.
ii. Since the maximum price is effective / not effective, the output is more than / still at / less than the efficient level.
Thus, there is no deadweight loss.
3. The following is information about the market for MP3 players:
Quantity (units) / Marginal benefit ($) / Marginal cost ($)1,000 / 500 / 300
2,000 / 350 / 350
3,000 / 200 / 400
4,000 / 50 / 450
a. Is 1,000 units an efficient level of output? Is there underproduction or overproduction of MP3 players? Explain. (3 marks)
b. Is 3,000 units an efficient level of output? Is there underproduction or overproduction of MP3 players? Explain. (3 marks)
c. Is 2,000 units an efficient level of output? Is there underproduction or overproduction of MP3 players? Explain. (3 marks)
*d. Suppose the government imposes a quota of 1,000 units on MP3 players.
i. What is the quantity transacted in this case? (2 marks)
ii. Is the quantity transacted efficient? Is there any underproduction or overproduction? Explain your answers with a supply-demand diagram. (6 marks)
Answers:
a. It is efficient / inefficient. There is underproduction / overproduction.
This is because MB MC ($500 > $300) at this output level.
b. It is efficient / inefficient. There is underproduction / overproduction.
This is because MB MC ($200 $400) at this output level.
c. It is efficient / inefficient (there is no underproduction or overproduction).
This is because MB = MC ($350 = $350) at this output level.
d. i. The quantity transacted will be restricted to the quota limit of ______units.
ii. The quantity transacted is efficient / not efficient. There is underproduction / overproduction.
This is because MB > MC at this output level.
Suggested Answers
Test yourself
16.1 a. Deadweight loss = (MB of 3rd unit – MC of 3rd unit) + (MB of 4th unit – MC of 4th unit) = $5 + $0 = $5 → Inefficient
b. Deadweight loss = $0 → Efficient
c. Deadweight loss = MC of 5th unit – MB of 5th unit = $5 → Inefficient
16.2
Effective price ceiling / Effective price floorIs MB greater than, equal to or smaller than MC at quantity transacted? / MB MC / MB MC
Change in TSS
Achieve efficiency in resource allocation? / No (underproduction) / No (underproduction)
Change in Q
Change in P /
Change in CS / uncertain
Change in PS / uncertain
16.3 a. TSS will decrease but market efficiency is achieved.
b. TSS will increase and market efficiency is achieved.
16.4 In terms of producer surplus (PS), workers as a whole may be worse off under an effective minimum wage if the gain in PS (due to wage increase) is smaller than the loss in PS (due to quantity decrease).
16.5
Is MB greater than, equal to or smaller than MC at quantity transacted? / MB MCChange in TSS
Achieve efficiency in resource allocation? / No (underproduction)
Change in Q
Change in P /
Change in CS
Change in PS / uncertain
16.6 a. Decrease. This is because the market price increases and the quantity consumed decreases.
b. Decrease. This is because both the price received and the quantity sold decrease.
c. Uncertain. The change in tax revenue depends on the elasticities of demand and supply.
d. Decrease. Even if the tax revenue increases, the extra tax revenue collected is still smaller than the decrease in the sum of the consumer surplus and the producer surplus.
Short Questions
1. Efficiency in resource allocation is attained when the total social surplus (TSS) is maximised.
When only consumers and producers are in the market, TSS is the sum of the consumer surplus (CS) and the producer surplus (PS). Efficiency is attained when the sum of CS and PS is maximised. This requires that the marginal benefit of a good be equal to its marginal cost.
2. In a perfectly competitive market, the demand curve reflects MB curve while the supply curve reflects MC curve.
When the market is in equilibrium, the demand curve intersects the supply curve, so MB = MC.
This means the allocation of resources is efficient.
3. a. Deadweight loss is
potential gains not being captured when MB MC;
the loss in total social surplus when MB MC.
b. No.
If the gain in producer surplus is smaller than (or equal to) the loss in producer surplus, the producer surplus will decrease (remain unchanged.)
4. An effective price ceiling will lower the quantity supplied below the efficient level.
Therefore, resource allocation is inefficient.
5. The effective minimum wage will lower the quantity transacted below the efficient level.
MB MC at the new quantity transacted.
The shaded area represents the deadweight loss from underproduction.