Ae b3c1

NSS Exploring Economics 3 (Second Edition)
Questions and Answers to Exercises
Chapter 16 Competition and efficiency
Questions
p.42
Task 16.1
Do you know the meaning of efficiency in economics?
p.45
Test yourself 16.1
Refer to the following table.
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
p.47
Task 16.2
Who is right? Why?
NSS Exploring Economics 3 (Second Edition) 1 Pearson Education Asia Limited 2014
Questions and Answers to Exercises (Chapter 16)
p.49
Task 16.3
Peter is right. Can you explain why?
p.52
Test yourself 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.
Effective price ceiling Effective price floor

Is MB greater than, equal to or
smaller than MC at quantity MB > / = / < MC MB > / = / < MC
transacted?
Change in TSS / / uncertain / / uncertain
Yes / No Yes / No
Achieve efficiency in resource
(underproduction / (underproduction /
allocation?
overproduction) overproduction)
Change in Q / / uncertain / / uncertain
Change in P / / uncertain / / uncertain
Change in CS / / uncertain / / uncertain
Change in PS / / uncertain / / uncertain
Test yourself 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.
Test yourself 16.4
Applying what you have learned in this chapter, explain why an effective minimum wage
may NOT benefit the workers.
p.54
Test yourself 16.5
Summarise the effects of an effective quota in a perfectly competitive market by choosing the
correct answers in the table below.
Is MB greater than, equal to or smaller than

MB > / = / < MC
MC at quantity transacted?
Change in TSS / / uncertain
Yes / No
Achieve efficiency in resource allocation?
(underproduction / overproduction)
Change in Q / / uncertain
Change in P / / uncertain
Change in CS / / uncertain
Change in PS / / uncertain
p.56
Test yourself 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. Governments tax revenue
d. Total social surplus
p.57
Task 16.4
Carrie: I think a subsidy is different from other government measures such as unit tax, price
ceiling and price floor.
Peter: Why?
Carrie: Both consumers and producers enjoy the benefit of a subsidy. Thus, no one suffers
from it. The total social surplus must increase.
Peter: Oh! I guess you have missed something.
Do you agree with Carrie? Has Carrie missed anything?
pp.61-62
Exercises
Multiple Choice Questions
1.
Efficiency in resource allocation implies that
A. the total social surplus is maximised.
B. marginal benefit is equal to marginal cost.
C. there is no deadweight loss.
D. All of the above
2.
Resource allocation of a good is inefficient if
A. the marginal benefit is greater than zero.
B. the marginal cost is zero.
C. the marginal benefit is greater than the marginal cost.
D. the total benefit is maximised.
3.
The following diagram shows the demand and supply curves of a good in a perfectly
competitive market.
If a price ceiling is set at P1, then

A. the consumer surplus is equal to Area ABP2.
B. the producer surplus is equal to Area P2BGF.
C. the deadweight loss is equal to Area CEG.
D. the total social surplus is equal to Area ABGF.
4.
Study the following diagram.
Suppose that a price floor is set at P1 in the above diagram. Which of the following areas
represents the deadweight loss due to the price floor?
A. Area (F + E)
B. Area (A + B + C)
C. Area (C + E)
D. None of the above as there is no deadweight loss.
5.
Suppose that a unit tax is imposed on the producer of a good. This would lead to
(1) a reduction in consumer surplus and producer surplus.
(2) an increase in total consumer expenditure on the good.
(3) underproduction.
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
6.
Suppose that a government provides a subsidy to Good X. Which of the following statements
about the subsidisation of production of Good X is FALSE?
A. The subsidy will lead to an increase in government expenditure.
B. The subsidy will lead to an increase in the consumption of Good X.
C. The subsidy will lead to a reduction in the production of Good X.
D. The subsidy will lead to a deadweight loss.
7*.
The following diagram shows the demand and supply curves of Good X in a perfectly
competitive market.
Suppose D and S1 are the original demand and supply curve; S2 is the new supply curve after
a subsidy was provided by the government to the producers of Good X. After the provision of
the subsidy,
A. the sum of consumer surplus and producer surplus will increase by Area P3CFEP1.
B. the deadweight loss is equal to Area CFE.
C. the total subsidy amount is Area P3CEP1.
D. the price (including the subsidy) that the producers receive will fall from P2 to P1.
8.
Which of the following would raise the consumer surplus?
A. Effective price floor
B. Per unit subsidy
C. Quota
D. Per unit tax
p.63
Short Questions
1.
What is efficiency in resource allocation? What is the condition of efficiency in resource
allocation? (4 marks)
2.
Use a supply-demand diagram to illustrate how a perfectly competitive market can lead to
efficient allocation of resources. (6 marks)
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)
4.
Explain how a price ceilings would lead to inefficient allocation of resources. Illustrate your
answer with a supply-demand diagram. (5 marks)
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)
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)
pp.63-64
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 the supply-demand diagrams in (a). (6 marks)
2.
The following is information about the market for LCD televisions:
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)
3.
The following is information about the market for MP3 players:
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
c. Is 2,000 units an efficient level of output? Is there underproduction or overproduction of
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)
p.65
Economics in the news
1.
Do you suggest banning smoking? Why or why not? Explain with the economic concepts you
have learned.
2.
Why has the government imposed a tax on cigarettes? What are the effects of an increase in
the cigarette tax on smokers and cigarette producers?
Answers
p.42
Task 16.1
In economics, efficiency in resource allocation is attained when the total social surplus is
maximised.
p.45
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 (Underproduction)
b. Deadweight loss = $0 Efficient
c. Deadweight loss = MC of 5th unit MB of 5th unit = $5 Inefficient (Overproduction)
p.47
Task 16.2
Peter is right. Even though the market price decreases, consumers as a whole may not gain
because the quantity transacted decreases after the imposition of an effective price ceiling.
Consumer surplus (CS) may decrease. The change in consumer surplus depends on the size
of the gain in CS (due to price decrease) relative to the loss in CS (due to quantity decrease)
(refer to Fig. 16.6).
p.49
Task 16.3
As discussed in Chapter 6 of Book 1, some workers will become unemployed. In terms of
producer surplus (PS), workers as a whole may be worse off if the gain in PS (due to wage
increase) is smaller than the loss in PS (due to quantity decrease) [refer to Fig. 16.8(b)].
p.52
Test yourself 16.2
Test yourself 16.3
a. TSS will decrease but market efficiency is achieved.
b. TSS will increase and market efficiency is achieved.
Test yourself 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) [see Fig. 16.8 (b)].
p.54
Test yourself 16.5
p.56
Test yourself 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.
p.57
Task 16.4
No, Carrie is wrong.
Carrie has missed the point that the subsidy is paid by the government. The total subsidy paid
by the government is greater than the increase in the sum of CS and PS. The economy as a
whole suffers as TSS decreases.
pp.61-62
Exercises
Multiple Choice Questions
1. D
2. C
3. D
4. A
5. B
Option (2): The change in total consumer expenditure on the good depends on the price
elasticity of demand between the old price and new price (after tax).
6. C
Option C: A subsidy provided for a good will increase its supply. Both the production and
consumption of the good will increase.
7. A
The deadweight loss (Area BFC), total subsidy amount and price (including subsidy)
should be measured at the new quantity, not the original quantity.
8. B
p.63
Short Questions
1.
Efficiency in resource allocation is attained when the total social surplus (TSS) is maximised.
(2 marks)
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 marks)
2.
Indicate on the diagram:
D curve = MB curve (1 mark)
S curve = MC curve (1 mark)
Equilibrium point (1 mark)
Verbal elaboration:
In a perfectly competitive market, the demand curve reflects the MB curve while the
supply curve reflects the MC curve. (1 mark)
When the market is in equilibrium, the demand curve intersects the supply curve, so MB
= MC. (1 mark)
This means the allocation of resources is efficient. (1 mark)
3.
a. Deadweight loss is
potential gains not being captured when MB > MC; (1 mark)
the loss in total social surplus when MB < MC. (1 mark)
b. Indicate on the diagram:
Effective price floor (1 mark)
Loss in PS > Gain in PS OR Loss in PS = Gain in PS (1 mark)
Verbal elaboration:
No. (1 mark)
If the gain in producer surplus is smaller than (or equal to) the loss in producer
surplus, the producer surplus will decrease (remain unchanged). (1 mark)
4.
Effective price ceiling (1 mark)
MB > MC (1 mark)
Deadweight loss (1 mark)
Verbal elaboration:
An effective price ceiling will lower the quantity transacted below the efficient level.
(1 mark)
Therefore, resource allocation is inefficient. (1 mark)
5.
Minimum wage (effective price floor) (1 mark)
Deadweight loss (1 mark)
Verbal elaboration:
The effective minimum wage will lower the quantity transacted below the efficient level.
(1 mark)
MB > MC at the new quantity transacted. (1 mark)
The shaded area represents the deadweight loss from underproduction. (1 mark)
6.
Effective quota removed (1 mark)
Gain from removal of quota = Deadweight loss under quota (1 mark)
Verbal elaboration:
After the removal of an effective quota, perfectly competitive market equilibrium is
attained. (1 mark)
The quantity transacted will increase so that MB = MC. (1 mark)
Efficiency in resource allocation will be achieved. The gain in TSS will be the
deadweight loss under the quota. (1 mark)
pp.63-64
Structured Questions
1a.
Decrease in supply under a unit tax (1 mark)
Change in equilibrium under a unit tax (1 mark)
Increase in supply under a unit subsidy (1 mark)
Change in equilibrium under a unit subsidy (1 mark)
i. Verbal elaboration:
The market price of a good will increase under a unit tax but will decrease under a unit
subsidy. (1 mark)
ii. Verbal elaboration:
The quantity transacted of a good will decrease under a unit tax but will increase under a
unit subsidy. (1 mark)
1b.
MB > MC under a unit tax (1 mark)
Deadweight loss under a unit tax (1 mark)
MB < MC under a unit subsidy (1 mark)
Deadweight loss under a unit subsidy (1 mark)
Verbal elaboration:
In both cases, MB MC. Thus, the total social surplus can be increased by adjusting
(increasing or decreasing) the output level. This implies that there is a deadweight loss from
government intervention. (2 marks)
2a.
Equilibrium price is $8,000. (1 mark)
Equilibrium output level is 3,500 units. (1 mark)
2b.
Yes. The output level is efficient. (1 mark)
This is because marginal benefit equals marginal cost (= $8,000) at that output level. (1 mark)
2c.
i. Since the maximum price is effective, the output is less than the efficient level (of 3,500
units). (1 mark)
Thus, there is a deadweight loss associated with underproduction. (1 mark)
ii. Since the maximum price is not effective, the output is still at the efficient level. (1 mark)
Thus, there is no deadweight loss. (1 mark)
3a.
It is inefficient. There is underproduction. (2 marks)
This is because MB > MC ($500 > $300) at this output level. (1 mark)
3b.
It is inefficient. There is overproduction. (2 marks)
This is because MB < MC ($200 < $400) at this output level. (1 mark)
3c.
It is efficient (there is no underproduction or overproduction) (2 marks)
This is because MB = MC ($350 = $350) at this output level. (1 mark)
3d.
i. The quantity transacted will be restricted to the quota limit of 1,000 units. (2 marks)
ii. Indicate on the diagram:
S curve = MC curve (1 mark)
D curve = MB curve (1 mark)
Effective quota of 1,000 units (1 mark)
Verbal elaboration:
The quantity transacted is not efficient. There is underproduction. (2 marks)
This is because MB > MC at this output level. (1 mark)
p.65
Economics in the news
1.
Free answer.
Teaching notes:
The argument can be based on efficiency. As long as smoking can generate a positive total
social surplus, the government should not ban smoking.
Besides efficiency, students may also consider other problems caused by smoking. For
example, it harms the health of workers and so may affect labour productivity.
2.
The government imposed a tax on cigarettes to prevent children and teenagers from smoking,
as well as to encourage people to quit smoking.
An increase in the cigarette tax will
reduce smokers quantity demanded and CS.
reduce cigarette producers quantity sold and PS.

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NSS Exploring Economics 3 (Second Edition)

Questions and Answers to Exercises

Chapter 16 Competition and efficiency

Who is right? Why?

Peter is right. Can you explain why?

Effective price ceiling Effective price floor

Test yourself 16.3

Is MB greater than, equal to or smaller than

If a price ceiling is set at P1, then

a. What are the equilibrium price and output level? (2 marks)

a. Is 1,000 units an efficient level of output? Is there underproduction or overproduction of

Test yourself 16.4

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