ECW1101 (Semester 1, 2018)

Tutorial Test 3 (Week 11)

ONE of the following four questions will be randomly selected and students will be asked to answer
it during tutorials in Week 11. This is a closed-book, closed-note test. Students will have 15 minutes
to complete it. The test is worth 5% of the total assessment for this unit (each question will be graded
out of 10 marks but will be converted to 5%). Diagrams and definitions should be used where
applicable. Students MUST go to their allocated tutorial class.

Important notes:
There is no need to define consumer surplus, producer surplus and social surplus.
You should think of how best to answer the questions given the 15-minute time constraint, your
answers should be concise. Some students tend to repeat their points. Detailed explanation does not
necessarily mean that the answers have to be long. The same point can be expressed efficiently in one
short sentence rather than a few long-winded sentences. We emphasise on the quality rather than
quantity of your answers.

* These are application-type questions that are rather challenging. In most parts, you will not be able
to obtain the answers directly from the textbook. They can only be answered after you fully understand
the concepts. Due to the required diagrams from these questions, an extra sheet (2-sided) will be
provided this time. By attempting these questions, you are also revising for the final exam (will cover
the entire syllabus) which worth a lot more. Cheers 

Question 1
Chickenpox vaccination creates a positive consumption externality by reducing the spread of
contagious virus. Suppose that the positive external social benefit created by chickenpox vaccination
is equal to $120 per dose. The perfectly competitive equilibrium price of chickenpox vaccination in
is $150 per dose.

(a) On a diagram show the equilibrium in the chickenpox vaccination market. Also show the quantity
of vaccination that would maximise social surplus from the vaccination market. Is this equal to
the perfectly competitive equilibrium quantity? Fully explain your answer. [3 marks]

(b) An economics student in ECW1101 class suggests an alternative policy. She says that if the
government gives a $120 per dose subsidy on vaccination then this will maximise social surplus.
Is she correct? If she is correct, show the social gain under the student’s policy compared to the
perfectly competitive equilibrium. If the student is incorrect, show the deadweight loss under her
policy. [7 marks]
Question 2
Suppose there is a perfectly competitive market for pizzas. The perfectly competitive equilibrium
price in this market is $10 per pizza. The perfectly competitive equilibrium quantity is 1000 pizzas.

(a) The government introduces a price floor for pizzas. The minimum price is set at $15 per pizza.
The government does nothing else except for making it illegal for anyone to sell pizzas at a price
less than $15. Use a diagram to show the quantity of pizzas sold after the government introduces
the minimum price. What is the deadweight loss of this policy? Show the deadweight loss on your
diagram. Why does this area represent a deadweight loss. Are pizza consumers better or worse
off after the minimum price law is introduced? What about producers? [4 marks]

(b) Now suppose that the government sets a minimum price of $15 for each pizza AND agrees to buy
any pizzas that are offered for sale at this price but are not purchased by consumers. Any pizzas
bought by the government are thrown in the garbage (i.e. they are thrown away and not eaten).
(i) On a new diagram, show the quantity of pizzas sold under the new government policy.
[1 mark]
(ii) Show the number of pizzas (if any) that are bought by consumers. [1 mark]
(iii) Show the number of pizzas (if any) that are bought by the government. [1 mark]
(iv) Show the deadweight loss on your diagram. Explain briefly in words why this is a
deadweight loss. Compare the deadweight loss under the new policy to the deadweight
loss in part (a) of this question (it is advised that you provide a table for such a comparison,
as in the textbook). [2 marks]
(v) Do producers prefer the policy under part (a) or (b) of this question? What about
consumers? Briefly explain your answer in words. [1 mark]
Question 3
The small island of Erangel has a perfectly competitive market for rental housing. The supply curve
for rental housing is upward sloping and the demand curve for rental housing is downward sloping.
The equilibrium price of rental housing is $1000 per month with 5000 houses rented.

(a) Using a diagram, illustrate the perfectly competitive equilibrium in the Erangel rental housing
market. Use your diagram to label the level of consumer surplus, producer surplus and social
surplus at this equilibrium. [4 marks]

(b) The government of Erangel has decided that the price of $1000 per month for rental housing is
too high. Shu Min, argues for a subsidy. “If we subsidise the price of rental housing by $200 per
month, then buyers will only have to pay $800 per month in rent. And it will only cost the
government $200 on the 5000 rental houses, which is $1,000,000”.

Do you agree with Shu Min’s statement? Use a diagram to show the likely outcome of a $200
subsidy on rental housing. Will the subsidy cost the government $1,000,000, more than
$1,000,000 or less than $1,000,000? What is the effect of the subsidy on consumer surplus,
producer surplus and social surplus? [6 marks]
Question 4
Malaysia is an exporter of coal. Initially, the world price of coal is $100 per tonne. But it costs $20
per tonne to transport coal from Malaysia to overseas, and Malaysian coal exporters pay these
transportation costs. So Malaysian coal producers only receive $80 per tonne after they pay for the
transportation costs.

(a) Using a diagram, illustrate demand and supply in the Malaysian coal market. What is the
domestic price of coal in Malaysia (this is the price that the domestic consumers pay)? What
is the consumer and producer surplus that is created in Malaysia from the production and sale
of coal? Be sure to label your diagram carefully. [3 marks]

(b) The Malaysian government decides that it is unfair for coal producers to pay to transport coal
overseas. To help coal producers, the government decides to pay coal producers $20 for every
tonne of coal that they export. The government does not pay any money for coal sold in
Malaysia.
(i) How does it affect the price of coal in Malaysia? [1 mark]
(ii) On a new diagram, show the effect of this government policy (indicate the quantity
bought and sold domestically, export quantity). [2 marks]
(iii) What is the effect on consumers’ and producers’ surplus and government revenue?
[2 marks]
(iv) Does the policy lead to a deadweight loss? If so, illustrate the loss and explain what it
means. If not, explain why the policy does not lead to a deadweight loss. Be sure to
fully explain your answer. [2 marks]