HKDSE Economics in Life – Microeconomics 3

Chapter 13 Efficiency, Equity and the Role of Government (I)

Multiple Choice Questions

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Which of the following curves can show consumers’ willingness to pay and marginal benefit to

customers?

A. marginal cost curve

B. supply curve

C. demand curve

D. total product curve

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When a consumer gets more goods,

A. the marginal benefit remains unchanged.

B. the marginal cost drops.

C. the marginal cost increases.

D. the marginal benefit drops.

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When a consumer gets more goods, he/she is less willing to pay for additional goods. That means the

marginal benefit drops when a consumer gets more goods.

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© Aristo Educational Press Ltd. 13-1

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Consumers will keep on buying a good until

A. the marginal product equals the marginal cost.

B. the marginal benefit equals the marginal product.

C. the marginal benefit equals the price.

D. the marginal product equals the price.

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Marginal benefit reflects consumers’ willingness and ability to pay, and price reflects the amount that

consumers need to pay for the good. If consumers can get more benefit than the price he or she paid for

the last unit of the good, the consumer continues to buy until the marginal benefit is equal to the price.

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Which of the following is not a characteristic of the marginal benefit?

A. It is assumed that the marginal benefit is diminishing.

B. It measures the maximum willingness to pay for an additional unit of a good.

C. Consumers continue to buy until the marginal benefit equals zero so that total benefit can be

maximised.

D. At equilibrium, it is the same as the marginal cost of production.

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To maximise total benefit, consumers continue to buy until the marginal benefit is equal to the price,

but not zero.

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© Aristo Educational Press Ltd. 13-2

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Consumer surplus refers to

A. the difference between the maximum amount a consumer needs to pay and the actual amount

he or she pays.

B. the difference between the maximum amount a consumer is willing to pay and the actual

amount he or she pays.

C. the difference between total cost and total revenue.

D. marginal benefit.

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Consumer surplus refers to the difference between the maximum amount a consumer is willing to pay

and the actual amount he or she pays.

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Which of the following statements about consumer surplus is CORRECT?

A. It is equal to the marginal benefit at the equilibrium quantity.

B. It is consumers’ gain from market exchange.

C. It is the maximum amount a consumer is willing to pay.

D. It is equal to the difference between total benefit and total cost.

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Consumer surplus refers to the difference between the maximum amount a consumer is willing to pay

and the actual amount he or she pays. It is equal to the difference between total benefit and total

expenditure. It measures consumers' gain from market exchange.

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© Aristo Educational Press Ltd. 13-3

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Marginal benefit derives ___________ and marginal cost derives ___________.

A. demand … supply

B. supply … demand

C. demand curve … supply curve

D. supply curve … demand curve

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Marginal benefit refers to the benefit derived from consuming an additional unit of a good. How much

a consumer is willing and able to pay for a good depends on the benefit that he or she can get from the

good. Demand is therefore derived from marginal benefit. Marginal cost is the change in total cost

resulting from producing one additional unit of output. How much a firm is willing and able to produce

depends on the cost of production of a good. Supply is therefore derived from marginal cost.

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Firms will keep on producing a good until ____________.

A. the total cost is minimised

B. the marginal cost is minimised

C. the marginal cost equals the price

D. the marginal cost drops to zero

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Firms produce a good until the marginal cost equals the price. When the marginal cost equals the price,

the firm cannot gain more profit by producing an additional unit of good. Therefore, the firm stops

producing more.

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© Aristo Educational Press Ltd. 13-4

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Suppose there is no production cost for good X.

Unit price

A
P
B
C
D
0 Quantity
Q

In the above diagram, consumer surplus is equal to area _________________ and producer surplus is

equal to area _________________.

A. A… B

B. B …A

C. A… B + C

D. C…A

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Consumer surplus = total benefit (A + B + C) – total expenditure (B + C) = A

Producer surplus = total revenue (B + C) – total cost of production (=0) = B + C

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© Aristo Educational Press Ltd. 13-5

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Study the following table:

Unit price ($) Quantity demanded (units) Quantity supplied (units)

0 4 0

1 3 1

2 2 2

3 1 3

4 0 4

Suppose the market price is $2 per unit. The total social surplus is _________.

A. $1

B. $2

C. $5

D. $6

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Total social surplus = consumer surplus + producer surplus

The consumer surplus = $(3 + 2) – $(2  2) = $1

The producer surplus = $(2  2) – $(1 + 2) = $1

Therefore, the total social surplus = $(1 + 1) = $2

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Suppose the technology of computer production improves. Which of the following statements is

CORRECT?

A. The consumer surplus increases.

B. The producer surplus decreases.

C. The total social surplus decreases.

D. Both the consumer and producer surpluses decrease.

© Aristo Educational Press Ltd. 13-6

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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When the technology of computer production improves, the supply of computers increases. The

consumer surplus, the producer surplus and the total social surplus all increase.

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Efficiency is a condition where

A. consumer surplus is maximised.

B. producer surplus is maximised.

C. total social surplus is maximised.

D. all wants are satisfied.

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Efficiency is attained when total social surplus is maximised. Total social surplus is the sum of

consumer surplus and producer surplus. It is possible for consumer (producer) surplus to increase at the

expense of producer (consumer) surplus. Hence, maximisation of one of them does not imply

maximisation of their sum.

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When marginal benefit is not equal to marginal cost,

A. social cost is minimised.

B. efficiency is attained.

C. total social surplus is maximised.

D. current output may be less than the efficient output level.

© Aristo Educational Press Ltd. 13-7

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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When marginal benefit is not equal to marginal cost, total social surplus is not maximised. If marginal

benefit is greater than marginal cost, the output is less than the efficient quantity. If marginal benefit is

less than marginal cost, the output is greater than the efficient quantity.

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Suppose the current output is less than the efficient output level. Which of the following is CORRECT?

A. Total social surplus is maximised.

B. Marginal benefit is less than marginal cost.

C. Total social surplus increases if output level increases.

D. Efficiency is attained.

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When output is less than the efficient output level, total social surplus is not maximised and efficiency

is not attained. The extra benefit to society from increasing output (marginal benefit) is greater than the

extra cost to society (marginal cost). Therefore, total social surplus increases if output level increases.

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Suppose the current output is greater than the efficient output level. Which of the following is

INCORRECT?

A. Marginal social benefit is less than marginal social cost.

B. Total social surplus increases if output level increases.

C. There is a deadweight loss.

D. The sum of consumer surplus and producer surplus has not been maximised.

© Aristo Educational Press Ltd. 13-8

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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If the current output is greater than the efficient output level, the marginal social benefit is less than the

marginal social cost. If we reduce output level, total social surplus increases. This means that the sum

of consumer surplus and producer surplus has not been maximised. There is a deadweight resulting

from overproduction.

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In which of the following situations is efficiency attained?

A. Total social benefit is equal to total cost.

B. Marginal social benefit – marginal social cost = 0.

C. The sum of all individual sellers' producer surpluses is maximised.

D. The sum of all individual buyers' consumer surpluses is maximised.

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Efficiency is attained when total social surplus is maximised. Total social surplus is the sum of

consumer surplus and producer surplus. It is maximised when the marginal social benefit of the last

unit is equal to the marginal social cost. Alternatively, this condition can be stated as marginal social

benefit – marginal social cost = 0.

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When marginal social benefit is equal to zero at the current output,

A. total social surplus is maximised.

B. total social cost is minimised.

C. the output is equal to the socially optimal output level.

D. total social benefit is maximised.

© Aristo Educational Press Ltd. 13-9

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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D
Unit price

S = MSC

P0

D = MSB

0 Q0 Quantity

When the marginal social benefit of the last unit is equal to the marginal social cost, total social surplus

is maximised. This output level, where total social surplus is maximised, is the socially optimal output

level. Unless marginal social cost = 0, marginal social benefit = 0 does not imply marginal social

benefit = marginal social cost.

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Under a market economy, _____________ determines resource allocation.

A. violence

B. central command

C. price mechanism

D. businessmen

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Under a market economy, price serves the function of allocating goods to buyers who have the highest

value for the good and thus price mechanism determines the resource allocation.

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© Aristo Educational Press Ltd. 13-10

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Which of the following are the functions of price?

(1) to maximise the profit of producers

(2) to distribute the goods to users

(3) to allocate resources in markets

(4) to solve the problem of scarcity

A. (1) and (4) only

B. (2) and (3) only

C. (1), (2) and (3) only

D. (2), (3) and (4) only

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Distributing the goods to users with the highest value for the goods and allocating the resources in

markets are the two main functions of price.

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A deadweight loss exists when

A. potential gain from market exchange is not fully captured.

B. marginal benefit equals marginal cost.

C. efficiency is achieved.

D. total social cost is minimised.

© Aristo Educational Press Ltd. 13-11

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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A deadweight loss exists when there is some potential gain which has not been captured. It indicates

that efficiency is not achieved. Minimisation of total social cost requires marginal social cost be equal

to zero. A deadweight loss exists when marginal (social) benefit is not equal to marginal (social) cost

and it is not necessary for marginal (social) cost to be zero.

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There will be no deadweight loss if

A. it is possible to increase the sum of the gains of all market participants.

B. the difference between marginal benefit and marginal cost is minimised.

C. consumers’ gain from market exchange is maximised.

D. there is no pollution.

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A deadweight loss exists when some potential gains have not been captured. Maximisation of total

social surplus requires the marginal (social) benefit of the last unit being equal to the marginal (social)

cost. Therefore, a deadweight loss exists whenever marginal (social) benefit is not equal to marginal

(social) cost, which is just another way of saying that the difference between marginal benefit and

marginal cost is not minimised.

Pollution is just one possible source of deadweight loss. Deadweight loss may still exist even if there is

no pollution, e.g. when a per-unit tax is imposed on a perfectly competitive market.

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© Aristo Educational Press Ltd. 13-12

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Which of the following are the effects of imposing a price ceiling?

(1) producer surplus increases

(2) potential gain from market exchange is not fully captured

(3) forms of competition other than price competition exist

(4) there is an excess supply

A. (1) and (2) only

B. (2) and (3) only

C. (1), (3) and (4) only

D. (1), (2), (3) and (4)

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A price ceiling leads to an excess demand rather than an excess supply. Consumers need to compete for

the goods by non-price means, e.g. queuing up. Producer surplus decreases as the price decreases.

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After the imposition of an effective price ceiling, which of the following is INCORRECT?

A. Producer surplus must decrease.

B. Consumer surplus must increase.

C. Total social surplus must decrease.

D. Both market price and quantity transacted must decrease.

© Aristo Educational Press Ltd. 13-13

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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After the imposition of an effective price ceiling, consumer surplus may increase or decrease. Some

consumers can buy the good at a lower price (i.e. there is a gain in consumer surplus), but some

consumers cannot buy the good after the price ceiling is imposed because quantity supplied is reduced

(i.e. there is a loss in consumer surplus). Therefore, the net effect on consumer surplus depends on the

relative sizes of the gain and the loss.

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Study the following table:

Unit price ($) Quantity demanded (units)

12 0

9 1

6 2

3 3

0 4

Suppose the original market price is $6 per unit.

If the government imposes a price ceiling at $3 per unit, how does the consumer surplus change?

A. Increases

B. Decreases

C. Remains unchanged

D. There is insufficient information to determine.

© Aristo Educational Press Ltd. 13-14

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Since the price ceiling is set at a level below the original equilibrium price, it is an effective one. When

the market price decreases, the quantity supplied decreases. Without the information about the supply

schedule, we cannot find the new quantity supplied and hence the new quantity transacted (or quantity

demanded). Without the information about the quantity demanded, we cannot find the new consumer

surplus. Hence, D is the answer.

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Which of the following are the effects of imposing an effective minimum price control?

(1) a deadweight loss exists

(2) marginal benefit equals marginal cost

(3) there is excess supply

(4) non-price competition exists

A. (1) and (4) only

B. (2) and (3) only

C. (1), (3) and (4) only

D. (1), (2), (3) and (4)

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A minimum price control leads to an excess supply and a deadweight loss. Producers need to compete

for customers by non-price means.

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© Aristo Educational Press Ltd. 13-15

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Study the following table:

Unit price ($) Quantity demanded (units)

12 0

9 1

6 2

3 3

0 4

The original market price is $6 per unit.

Suppose the government imposes an effective price floor at $9 per unit. How does the consumer

surplus change?

A. increases by $3

B. decreases by $3

C. increases by $6

D. decreases by $6

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Original consumer surplus = $(9 + 6) – $(6  2) = $3

New consumer surplus = $9 – $(9  1) = $0

Consumer surplus decreases by $(3 – 0) = $3

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After the imposition of an effective price floor, which of the following is CORRECT?

A. Producer surplus must increase.

B. Consumer surplus must decrease.

C. Total social surplus must increase.

D. Both market price and quantity transacted must decrease.

© Aristo Educational Press Ltd. 13-16

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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After the imposition of an effective price floor, consumer surplus must decrease as price increases.

Moreover, some producers can sell goods at a higher price (i.e. there is a gain in producer surplus), but

some producers cannot sell goods because the quantity demanded is reduced (i.e. there is a loss in

producer surplus). Therefore, the net effect on producer surplus depends on the relative sizes of the

gain and the loss.

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Study the following table:

Unit price ($) Quantity supplied (units)

20 5

16 4

12 3

8 2

4 1

0 0

Suppose the original equilibrium quantity is 2 units. If the government now imposes a quota of 4 units,

the producer surplus will __________.

A. remain unchanged.

B. increase by $20.

C. increase by $28.

D. increase by $36.

© Aristo Educational Press Ltd. 13-17

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Original producer surplus = $(8  2) – $(4 + 8) = $4

Since the quota limit exceeds the original equilibrium quantity, the quota is ineffective. Hence, there is

no change in the producer surplus.

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Which of the following statements about the effects of a quota are correct?

(1) Producer surplus increases.

(2) Because of the resulting higher price, all producers gain.

(3) There may be competition among producers for the quota.

(4) There is a deadweight loss resulting from underproduction.

A. (1) and (2) only

B. (3) and (4) only

C. (1), (3) and (4) only

D. (1), (2), (3) and (4)

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The effect of a quota on producer surplus is uncertain: although some producers can sell the good at a

higher price (i.e. a gain in producer surplus), other producers quit the market or reduce their output (i.e.

a loss in producer surplus). The net effect on producer surplus depends on the relative sizes of the gain

and the loss. Moreover, if the quota is not exclusively assigned to particular sellers by the government,

there is competition for the quota rights among producers.

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© Aristo Educational Press Ltd. 13-18

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Which of the following statements about quota is INCORRECT?

A. An effective quota will lead to a deadweight loss.

B. Quota is a maximum limit on the quantity of goods supplied.

C. Total social surplus increases after the imposition of an effective quota.

D. Quantity transacted decreases after the imposition of an effective quota.

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After the imposition of an effective quota, total social surplus decreases, so there is a deadweight loss.

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Study the following table:

Unit price ($) Quantity supplied (units)

20 5

16 4

12 3

8 2

4 1

0 0

Suppose the government imposes an effective quota of 3 units. What is the amount of producer

surplus?

A. $8

B. $12

C. $24

D. $36

© Aristo Educational Press Ltd. 13-19

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Producer surplus = $(3  12) – $(4 + 8 + 12) = $12

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The imposition of a per-unit tax by the government leads to inefficiency in resource allocation. The

amount of efficiency loss is equal to ______________.

A. the total amount of government tax revenue

B. the decrease in producer surplus

C. the increase in consumer surplus

D. the sum of decreases in consumer and producer surpluses exceeding the government tax

revenue

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The imposition of per-unit tax decreases consumer and producer surpluses. However, the sum of

decreases in consumer and producer surpluses is larger than the government tax revenue. This

difference between the sum of the decreases in consumer and producer surpluses, and the tax revenue,

is a deadweight loss to society.

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© Aristo Educational Press Ltd. 13-20

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Suppose Good Y does not involve production.

Unit price

P0

A D

Quantity of Good Y
0 Q0

If the government imposes a per-unit subsidy on Good Y, the new producer surplus will be ________

Area A.

A. smaller than

B. larger than

C. equal to

D. There is insufficient information to determine the answer.

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Before the provision of per-unit subsidy, the producer surplus is equal to Area A. Since the supply

curve is perfectly inelastic, all the subsidy benefit goes to the producers. Therefore, the new producer

surplus is greater than Area A.

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© Aristo Educational Press Ltd. 13-21

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Which of the following about the effects of a per-unit subsidy is CORRECT?

(1) All consumers gain.

(2) All producers lose.

(3) There is an underproduction of goods.

(4) Government expenditure on subsidy is greater than the sum of the increases in consumer and

producer surpluses.

A. (1) and (2) only

B. (1) and (4) only

C. (3) and (4) only

D. (1), (2), (3) and (4)

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After the provision of per-unit subsidy, both consumer surplus and producer surplus increase.

Therefore, both consumers and producers gain in this sense. However, the sum of the increases in

consumer and producer surpluses is smaller than the government expenditure on subsidy. Furthermore,

the new equilibrium quantity is greater than the efficient output level, so there is an overproduction.

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The provision of a per-unit subsidy by the government leads to a deadweight loss. The amount of

deadweight loss is equal to ______________.

A. the total amount of government subsidy

B. the increase in producer surplus

C. the increase in consumer surplus

D. the amount of the government subsidy which is above the sum of the increases in consumer

and producer surpluses.

© Aristo Educational Press Ltd. 13-22

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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The provision of a per-unit subsidy increases consumer surplus and producer surplus. However, the

sum of the increases in consumer surplus and producer surplus is smaller than the total government

subsidy expenditure. That part of government subsidy is a deadweight loss.

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Which of the following statements about the effects of a per-unit subsidy is CORRECT?

A. It maximises total social surplus by increasing both consumer surplus and producer surplus.

B. Consumer surplus decreases.

C. Producer surplus increases.

D. The sum of the increases in consumer and producer surpluses is equal to the total

government subsidy.

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After the imposition of a per-unit subsidy, both producer surplus and consumer surplus increase.

However, the sum of the increases in consumer surplus and producer surplus is smaller than the total

government subsidy. Total social surplus therefore decreases, so there is a deadweight loss.

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Which of the following about externalities is CORRECT?

A. If the government does not intervene in the market, externalities do not exist.

B. Government solutions involve lower transaction costs.

C. Transaction costs involved in market exchanges affect the likelihood of reaching market

solutions.

D. If property rights are well-defined, actions will be taken to correct externalities.

© Aristo Educational Press Ltd. 13-23

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Externalities arise whenever a person's activity affects the well-being of an external party but no one

pays or receives compensation. They are not necessarily caused by government actions. Moreover,

government solutions to correct externalities also involve transaction costs, e.g. the costs of identifying

and measuring externalities. Market solutions also involve similar types of transaction costs. If these

transaction costs are greater than the externalities themselves, or if they are greater than the transaction

costs involved in government solutions, they would not be adopted. Therefore, transaction costs affect

the likelihood of adopting market solutions to correct externalities. Lastly, even if property rights are

well-defined, when the transaction costs involved in reaching market and government solutions are

greater than the externalities themselves, nothing would be done.

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Externalities

A. must be eliminated by government intervention.

B. may lead to under-production in an economy.

C. must lead to over-production in an economy.

D. may exist even if transaction costs are zero.

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If externalities exist, there may be under-production or over-production. It may be solved by market or

government solutions. If transaction costs are zero, a socially optimal resource allocation must be

achieved.

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© Aristo Educational Press Ltd. 13-24

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

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Which of the following statements about “beneficial externality” is CORRECT?

A. When a person engages in an activity that imposes costs on other parties, a beneficial

externality exists.

B. A good with beneficial externality is often under-produced.

C. When there is a beneficial externality, the market equilibrium quantity is greater than the

socially optimal quantity.

D. The marginal social benefit curve is below the marginal private benefit curve.

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When there is a beneficial externality, the marginal social benefit curve is above the marginal private

benefit curve. Therefore, the market equilibrium quantity is smaller than the socially optimal quantity

and there is an underproduction of goods.

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Which of the following about a divergence between private and social costs is CORRECT?

A. It exists whenever a person’s activity affects other parties.

B. Only the government has the ability to eliminate it.

C. Its presence indicates inefficient resource allocation.

D. None of the above is correct.

© Aristo Educational Press Ltd. 13-25

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

Even when a person's activity affects the well-being of other parties, if an appropriate amount of

compensation is given out, there is no divergence between private and social costs. Moreover, both

market and government solutions can be employed to correct the divergence between private and social

costs. Furthermore, the presence of divergence does not indicate inefficient resource allocation. For

example, if the cost of correcting the divergence is greater than the divergence itself, no corrective

action will be taken. Resource allocation is still efficient as there are no better options available.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000041|!|

A divergence between private and social costs

A. will exist even if efficiency is attained.

B. will exist if there is traffic congestion.

C. must be the result of government intervention.

D. should be eliminated by the government.

##

When traffic congestion occurs, each road user slows down other users and hence imposes time cost on

one another. The social cost generated by one user is his or her time cost plus the time cost imposed on

other users by him or her; the private cost is the time cost incurred by him only as he does not need to

compensate others for the time cost imposed on them. Therefore, there is a divergence between private

and social costs.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-26

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000042|!|

Which of the following statements about “detrimental externality” is INCORRECT?

A. When a person engages in an activity that imposes costs on other parties but does not pay

any compensation for that effect, there is a detrimental externality.

B. There is always an overproduction of the good with a detrimental externality.

C. The marginal social cost curve is below the marginal private cost curve.

D. The market equilibrium quantity is greater than the socially optimal quantity.

##

When there is a detrimental externality, the marginal social cost curve is above the marginal private

cost curve.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000043|!|

In case of market failure, the government ____________ intervene because _____________.

A. should; market failures can be corrected by government action only

B. should; the benefit from intervention is more than the cost of intervention

C. may not need to; the cost of intervention may be greater than the benefit from intervention

D. may not need to; there are no benefits from government intervention

##

Although government intervention can be employed to correct externalities, it should only be

undertaken when the benefit from intervention is greater than its cost and when it is the least costly

solution. Therefore, it is not necessary for the government to intervene in the market whenever there

are externalities.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-27

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000044|!|

Which of the descriptions about the efficient level of pollution is correct?

A. It refers to zero pollution level.

B. It is attained when there is no external cost of pollution.

C. It is attained when pollution permits are allowed to trade freely.

D. It is attained when total social cost is minimised.

##

The efficient pollution level is attained when the marginal benefit of pollution is equal to the marginal

cost, and this pollution level may not correspond to zero output level. By allowing free exchange of

pollution permits, the marginal benefit of pollution will eventually be equal to its marginal cost and the

efficient level of pollution can be attained. On the other hand, zero pollution, zero external cost of

pollution or minimisation of total social cost imply zero output level.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000045|!|

Suppose after the opening of a stadium in Tseung Kwan O, the market value of nearby property

decreases. Which of the following statements is CORRECT?

A. The government should compensate the nearby property owners.

B. The government should install a noise reduction wall for the nearby residents.

C. The government should move the stadium to another district.

D. There is not enough information to determine.

© Aristo Educational Press Ltd. 13-28

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

A fall in the market value of the property near the stadium implies the negative external effects

outweigh the positive effects. However, it does not imply anything about what types of solutions

should be undertaken. We need to know the distribution of property rights, the types of solutions

available and the transaction costs involved in different solutions before we can reach any conclusions

on the appropriate actions to be undertaken.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000046|!|

Suppose a bakery gives out a smell which is enjoyed by its neighbouring residents. Which of the

following statements regarding this situation is CORRECT?

A. If the government provides subsidy to the bakery, the production of bread will be at the

socially optimal level.

B. The marginal social benefit curve for the bakery's bread is above the marginal social cost

curve.

C. The bakery will increase its bread production after the government provides a subsidy to it.

D. There will still be divergence between private and public benefits even if the government

provides subsidy to the bakery.

##

If the government provides a subsidy for bread production, the marginal private cost of producing

bread will decrease and the bakery will increase its bread production. However, this does not guarantee

a socially optimal output of bread or the disappearance of divergence between private and social

benefits, as the new marginal private cost curve may not coincide with the marginal social cost curve.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-29

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000047|!|

A detrimental externality

A. means that resource allocation must be inefficient.

B. occurs whenever a person’s action causes harm to other people.

C. must be eliminated through private contracting among the affected parties.

D. may be solved by taxation.

##

The presence of externalities, whether detrimental or beneficial, does not indicate that resource

allocation is inefficient. As long as the marginal external effect is zero, resource allocation is efficient,

no matter how large the total amount of externality is. Hence, A is incorrect.

When a person's action causes harm to other people, if he pays for his damage, there may not be any

externality. So B is incorrect.

There are many solutions to externality besides private contracting among the affected parties e.g.

levying taxes. Hence, C is incorrect.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000048|!|

Which of the following is INCORRECT?

A. Externalities may be eliminated by exchanges between market participants without the need

of government intervention.

B. With government intervention, externalities never exist.

C. The lower the transaction costs of exchanges, the more likely a solution for externality can

be achieved by market forces.

D. If property rights are well-defined, market forces can be used to achieve an efficient

outcome.

© Aristo Educational Press Ltd. 13-30

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

Government intervention cannot eliminate all externalities, especially when the government cannot

accurately measure the external costs and benefits.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000049|!| (2012)

Under which of the following situation may efficiency not be attained?

A. Total social surplus is maximised.

B. The consumer surplus is equal to the producer surplus.

C. The marginal benefit is equal to the marginal cost.

D. There is no deadweight loss.

##

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000050|!| (2012)

The divergence between private and social benefits

A. will not exist if resource allocation is directed by market prices.

B. will not exist in a society without private property rights.

C. implies that the market equilibrium quantity is lower than the socially optimal quantity.

D. implies that there is an over-production in an economy.

© Aristo Educational Press Ltd. 13-31

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

The divergence between private and social benefits implies that there is a beneficial externality. The

marginal social benefit curve is above the marginal private benefit curve. Therefore, the market

equilibrium quantity is lower than the socially optimal quantity.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000051|!| (2012)

As compared to weekdays, the number of tourists visiting the Hong Kong Disneyland increases during

public holidays. As a result, the queuing time for photo shooting with the Disney cartoon characters

increases. Which of the following is CORRECT?

A. A divergence between private and social costs is implied.

B. The divergence between private and social costs declines when an extra fee is charged by the

Disneyland for photo shooting with the Disney cartoon characters.

C. From the viewpoint of society, the number of visitors in the Disneyland during public

holiday is beyond its optimal quantity.

D. All of the above is correct.

##

Option A is correct. Each tourist queuing for photo shooting imposes time cost on others. To a queuing

tourist, the private cost is only his time cost incurred as he does not compensate others for the time cost

imposed on them. To society, the social cost generated by a queuing tourist is his time cost (private

cost) plus the time cost imposed on others (external cost). Therefore, there is a divergence between

private and social costs.

Option B is correct. The marginal private cost would increase when extra fee is charged. The

divergence between private and social costs thus declines.

Option C is correct. As the marginal private cost is lower than the marginal social cost, the equilibrium

number of visitors is beyond the optimal quantity.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-32

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000052|!| (2014)

A poor harvest of coffee beans raised the price of coffee at a coffee shop. Which of the following

statements is CORRECT?

A. Consumer surplus of people buying the coffee at the coffee shop decreased.

B. Demand for the coffee of the coffee shop decreased.

C. Sales revenue of the coffee shop decreased.

D. None of the above.

##

The actual amount paid by the people buying coffee increased while the maximum amount that they are

willing to pay remained unchanged. Consumer surplus thus decreased.

Option B is incorrect. The increase in the price of coffee leads to a decrease in its quantity demanded,

instead of a decrease in demand.

Option C is incorrect. The price of coffee increased while its quantity transacted decreased. The change

in sales revenue is uncertain, depending on the price elasticity of demand.

##

@@x)cro,1@@

[[]]

|!|1eEMB0130000053|!| (2014)

If the market equilibrium output level is below the efficient output level,

(1) the marginal benefit is larger than the marginal cost at the market equilibrium output level.

(2) total social surplus will increase if output is raised towards the efficient output level.

(3) the consumer surplus and producer surplus are maximised at the market equilibrium output

level.

A. (1) only

B. (2) only

C. (1) and (2) only

D. (2) and (3) only

© Aristo Educational Press Ltd. 13-33

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000054|!| (2014)

Refer to the following demand-supply diagram of good X.

Unit price
S
P1

P0

D D

0 Quantity

Suppose the government lowers the price ceiling of good X from P1 to P0. Consumer surplus

A. will increase.

B. will decrease.

C. will remain unchanged.

D. may increase, decrease or remain unchanged, depending on the price elasticity of demand.

##

As P1 is an ineffective price ceiling, the price of good X will remain unchanged at P0 after the reduction

in the price ceiling. Consumer surplus will thus remain unchanged.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-34

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000055|!| (2014)

Refer to the following demand-supply diagram of a good. The government sets a price ceiling on the

good at P1.
Unit price

P1

D D

0 Quantity

An increase in demand for the good will result in

A. an increase in producer surplus.

B. an increase in the quantity transacted of the good.

C. a decrease in consumer surplus.

D. an increase in deadweight loss.

##

When demand for the good increases, its quantity transacted is further away from the efficient output

level. Therefore, the deadweight loss increases.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000056|!| (2014)

After the government lowers an effective price floor on a good,

A. consumer surplus will decrease.

B. deadweight loss will decrease.

C. producer surplus will decrease.

D. excess supply will increase.

© Aristo Educational Press Ltd. 13-35

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

Total social surplus will increase (deadweight loss will decrease) if output is increased towards the

efficient output level.

Option C is incorrect. The change in producer surplus is uncertain.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000057|!| (2014)

Suppose the supply curves of clothing and fabric are upward sloping. Imposing an effective quota on

fabric will result in

(1) a decrease in producer surplus in the fabric market.

(2) a decrease in total social surplus in the fabric market.

(3) a decrease in consumer surplus in the clothing market.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

For (2), the market equilibrium output level of fabric is below the efficient output level after imposing

the quota. Marginal benefit is greater than marginal cost. There is a deadweight loss (a decrease in total

social surplus).

For (3), an increase in the market price of fabric causes the supply of clothing to decrease. Consumer

surplus in the clothing market thus decreases.

(1) is incorrect. After imposing the quota, the change in producer surplus in the fabric market is

uncertain.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-36

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000058|!| (2014)

Which of the following are results of the government abolishing a per-unit sales tax on a good?

(1) an increase in total sales revenue (excluding tax)

(2) an increase in total social surplus

(3) an increase in consumer surplus

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

For (1), as both the price received by producers and the quantity transacted increase, total sales revenue

(excluding tax) increases.

##

@@x)cro,1@@

[[]]

|!|1eEMB0130000059|!| (2014)

Suppose a government cuts the per-unit subsidy on a good. Which of the following statements is

INCORRECT?

A. Producer surplus will decrease.

B. Consumer surplus will decrease.

C. The price paid by consumers will increase.

D. Deadweight loss will increase.

##

After cutting the per-unit subsidy, the market equilibrium output level is closer to the efficient output

level. Deadweight loss will decrease.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-37

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eEMB0130000060|!| (2014)

A country’s wildlife zoo has raised two rare leopards recently. To the zoo, which of the following are its

private benefits?

(1) an increase in the number of tourists visiting the restaurants around the zoo

(2) an increase in the number of tourists visiting the zoo

(3) an increase in the sales revenue of related souvenirs

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

(1) is incorrect. This is the external benefit brought by raising the two leopards.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000061|!| (2014)

A food processing factory emits oil fumes that have a negative effect on neighbouring farms. Which of

the following statements is CORRECT?

(1) From the viewpoint of society, there is an over-production.

(2) The government should fine the factory to improve economic efficiency.

(3) If the neighbouring farms are owned by the factory, there is no divergence between private

and social costs.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

© Aristo Educational Press Ltd. 13-38

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

For (3), if the neighbouring farms are owned by the factory, production of the factory does not impose

an external cost on others. Therefore, there is no divergence between private and social costs.

##

@@x)nil,1@@

[[]]

|!|1eEMB0130000062|!| (2014)

A property developer builds a large shopping mall. Which of the following are the external

costs/benefits brought about by the construction of the mall?

(1) The prices of nearby residential flats increase because of the new shopping mall.

(2) The construction of the shopping mall creates a wall effect (屏屏屏屏).

(3) The property developer has to pay interest for lending funds.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

For (1), building the shopping mall raises the value of the nearby residential flats (brings an external

benefit), and the property developer does not receive any compensation.

For (2), building the shopping mall causes a negative effect on the nearby environment (imposes an

external cost), and the property developer does not give any compensation.

(3) is incorrect. It is the private cost for the property developer building the shopping mall.

##

@@x)nil,1@@

[[]]

© Aristo Educational Press Ltd. 13-39

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

Short Questions

|!|1eESB0130000001|!|

“The marginal benefit of a free good is positive.” Do you think this statement is correct? Explain.

(4 marks)

##

It is incorrect. (1 mark)

Free goods refer to those goods that people do not prefer more of as the quantity available is sufficient

to satisfy all human wants. (1 mark)

Marginal benefit refers to the benefit derived from consuming an additional unit of a good. (1 mark)

As people do not prefer more of a free good, the benefit derived from consuming an additional unit of a

free good is zero. Therefore, the marginal benefit of a free good is zero. (1 mark)

##

@@x)cro,4@@

[[]]

|!|1eESB0130000002|!|

(a) How does an increase in price affect consumer surplus? Explain with the aid of a diagram.

(3 marks)

(b) How does an increase in price affect producer surplus? Explain with the aid of a diagram. (3

marks)

##

(a) An increase in price leads to a drop in consumer surplus.

Consumer surplus decreases from P0P1A to P0P2B when the price increases from P1 to P2. (1 mark)
Unit price

P0

P2 B

A
P1

0 Quantity
Q2 Q1 (2 marks)

© Aristo Educational Press Ltd. 13-40

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) An increase in price leads to an increase in producer surplus.

Producer surplus increases from 0P1C to 0P2D when the price increases from P1 to P2. (1 mark)

Unit price

D
P2

C
P1

0 Quantity (2 marks)
Q1 Q2
##

@@a)nil,3@@

@@b)nil,3@@

[[]]

|!|1eESB0130000003|!|

Study the following table:

Unit price ($) Quantity demanded (units) Quantity supplied (units)

0 6 0

15 5 1

30 4 2

45 3 3

60 2 4

75 1 5

90 0 6

(a) When the output is 4 units, is the total social surplus maximised? If no, at which output level will

the total social surplus be maximised? Explain your answer. (4 marks)

(b) Calculate the maximised total social surplus. (3 marks)

© Aristo Educational Press Ltd. 13-41

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a) At this output level, the marginal benefit ($30, as reflected by the demand schedule) is less than

the marginal cost ($60, as reflected by the supply schedule). Therefore, the total social surplus is

not maximised when the output is 4 units. (2 marks)

When the output is 3 units, the marginal benefit is equal to the marginal cost ($45). The total

social surplus is maximised. (2 marks)

(b) Total social surplus = consumer surplus + producer surplus

Consumer surplus = $(75 + 60 + 45) – $(45  3) = $45 (1 mark)

Producer surplus = $(45  3) – $(15 + 30 + 45) = $45 (1 mark)

Therefore, total social surplus = $(45 + 45) = $90 (1 mark)

##

@@a)nil,4@@

@@b)cal,3@@

[[]]

|!|1eESB0130000004|!|

Study the following table:

Unit price ($) Quantity demanded (units) Quantity supplied (units)

10 5 1

15 4 2

20 3 3

25 2 4

30 1 5

(a) What is consumer surplus? Calculate the consumer surplus. (4 marks)

(b) What is producer surplus? Calculate the producer surplus. (4 marks)

(c) What is total social surplus? Calculate the total social surplus. (4 marks)

##

(a) Consumer surplus refers to the difference between the maximum amount a consumer is willing to

pay and the actual amount he or she pays. (2 marks)

Consumer surplus = $(30 + 25 + 20) – (20  3) = $15 (2 marks)

© Aristo Educational Press Ltd. 13-42

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) Producer surplus refers to the difference between the minimum amount a producer would accept

to produce a good and the actual amount he or she actually receives. (2 marks)

Producer surplus = $(20  3) – (10 + 15 + 20) = $15 (2 marks)

(c) Total social surplus is the sum of consumer surplus and producer surplus. (2 marks)

Total social surplus = $(15 + 15) = $30 (2 marks)

##

@@a)cal,4@@

@@b)cal,4@@

@@c)cal,4@@

[[]]

|!|1eESB0130000005|!|

“When efficiency is achieved, consumer surplus is equal to producer surplus.” Is this statement correct?

Explain your answer with the aid of supply-demand diagrams. (5 marks)

##

No. (1 mark)

When efficiency is achieved, total social surplus is maximised. This means that the marginal benefit of

the last unit is equal to the marginal cost. (2 marks)

Unit price Unit price
S

Consumer
surplus
S
Consumer
Producer
surplus
surplus
Producer surplus

D D

0 Quantity 0 Quantity

In the above two diagrams, efficiency is achieved but consumer surplus is not equal to producer

surplus. Therefore, we can conclude that consumer surplus is not necessarily equal to producer surplus

even when efficiency is achieved. (2 marks)

##

@@x)nil,5@@

[[]]

© Aristo Educational Press Ltd. 13-43

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eESA0130000006|!|

(a) What is the “invisible hand” in a market economy? (2 marks)

(b) State TWO functions of price in market economy. (4 marks)

##

(a) The “invisible hand” in a market economy is another name for price mechanism, which refers to

the use of price to allocate resources in the market economy. (2 marks)

(b) Rationing function: Prices help to distribute goods to users with the highest value for the goods.

Under the price system, people who are willing and able to pay the price get the scarce goods.

(2 marks)

Allocative function: The price mechanism or the “invisible hand” determines the resource

allocation in a market economy. When the price of a good increases (decreases), more (fewer)

resources are allocated to produce the good. (2 marks)

##

@@a)nil,2@@

@@b)nil,4@@

[[]]

|!|1eESB0130000007|!|

Study the following table:

Unit price ($) 0 10 20 30 40 50

Quantity supplied (units) 0 1 2 3 4 5

Suppose the market price is $40 per unit.

(a) Define “deadweight loss”. (2 marks)

(b) Suppose the government imposes an effective price ceiling at $20. Determine the change in

producer surplus. (3 marks)

##

(a) A deadweight loss occurs when there is potential gain that cannot be captured. (2 marks)

© Aristo Educational Press Ltd. 13-44

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) Original producer surplus = $(40  4) – $(40 + 30 + 20 + 10) = $60 (1 mark)

New producer surplus = $(20  2) – $(20 + 10) = $10 (1 mark)

Producer surplus decreases by $(60 – 10) = $50 (1 mark)

##

@@a)nil,2@@

@@b)cal,3@@

[[]]

|!|1eESB0130000008|!|

(a) Suppose producers in Country A are not allowed to charge a price higher than $10 per unit for

their products. Which kind of market intervention is it? (2 marks)

(b) Some economists are against market intervention on the grounds of efficiency. Explain their

viewpoint. (3 marks)

##

(a) It is an upper limit imposed by the government on the price that sellers can charge, so it is a price

ceiling. (2 marks)

(b) If the market is allowed to operate without any market intervention, the equilibrium price acts as a

signal to allocate resources efficiently and thus maximises the sum of consumer and producer

surpluses. Some economists think the government cannot make the economic well-being of a

society better than when the market operates freely. Intervention methods, like price ceiling, price

floor, quota, etc, cause the market to deviate from being efficient. (3 marks)

##

@@a)cro,2@@

@@b)nil,3@@

[[]]

|!|1eESB0130000009|!|

Mr Chan owns a factory producing chemical products. His factory puts some dangerous chemical

waste on an abandoned car park which is also owned by Mr Chan.

(a) What is a detrimental externality? Is there a detrimental externality in the above case? Explain

your answer. (4 marks)

(b) Is resource allocation efficient in the above case? Explain your answer. (3 marks)

© Aristo Educational Press Ltd. 13-45

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a) A detrimental externality exists when a person’s action imposes a cost on other parties, but he or

she does not give any compensation for that effect. (2 marks)

There is no detrimental externality as there are no other parties affected: both the factory and the

car park are owned by the same owner. (2 marks)

(b) Yes. (1 mark)

Since the car park is also owned by Mr Chan, he includes the damage to the car park in the

production cost of the factory. (1 mark)

Therefore, his factory produces at the efficient output level, where the marginal social benefit is

equal to the marginal social cost. (1 mark)

##

@@a)nil,4@@

@@b)nil,3@@

[[]]

|!|1eESB0130000010|!|

In Hong Kong, many big housing estates have restaurants operating inside them. These restaurants

often give out offensive cooking ordours.

A resident of these housing estates said, “The presence of this annoying smell indicates that resource

allocation by market forces is inefficient.” Comment on the validity of his statement. (7 marks)

© Aristo Educational Press Ltd. 13-46

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

There are detrimental externalities from these restaurants, e.g. noises and the smell from them. (1 mark)

There may also be beneficial externalities from these restaurants, e.g. convenience for residents and

their friends. (1 mark)

It is possible that the external benefit outweighs the external cost so that the proximity of the

restaurants results in a rise in property value. Society is better off when these restaurants operate inside

these housing estates. (2 marks)

Moreover, even if the property rights over clean air are well-defined, private contracting between the

residents and the restaurants is impossible when the cost of reaching an agreement is prohibitively high.

Society is better off if there is no private contracting between the parties involved and the detrimental

externalities remain. (2 marks)

Therefore, the statement is incorrect, as the presence of the negative externalities may not indicate

inefficient resource allocation. (1 mark)

##

@@x)nil,7@@

[[]]

|!|1eESB0130000011|!|

(a) What is a positive externality? (2 marks)

(b) Suppose your neighbour plays violin and you think his music is wonderful. He continues to play it

until the marginal benefit to you is zero. Is there a positive externality? Is the amount of music

efficient? (4 marks)

##

(a) A positive externality exists when a person’s action generates a benefit to other parties, but the

“doer” does not receive any compensation. (2 marks)

(b) There is a positive externality as your neighbour’s playing of violin generates a benefit to you, but

he does not receive any compensation from you. (2 marks)

The amount of music is efficient as the marginal external benefit of his music (i.e. the marginal

benefit to you) is equal to zero. (2 marks)

##

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[[]]

© Aristo Educational Press Ltd. 13-47

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eESB0130000012|!|

The following is a conversation between Paul and Helen.

Paul: “If there is a beneficial externality, there is a divergence between private and social benefits.”

Helen: “The government can help remove the beneficial externality by levying taxes.”

Explain whether Paul and/or Helen is/are CORRECT. (6 marks)

##

Paul is correct. (1 mark)

If there is a beneficial externality, a person’s action generates benefits to other parties but the doer does

not receive any compensation. So there is a divergence between private and social benefits. (2 marks)

Helen is not correct. (1 mark)

Taxation can be used to eliminate a detrimental externality, not a beneficial externality. Instead, the

government can provide a subsidy equal to marginal external benefit to induce a greater amount of

activities that generate beneficial externalities. The subsidy shifts the MPB curve upwards, and the new

MPB curve coincides with the MSB curve. Then, the new quantity reaches the socially optimal level.

(2 marks)

##

@@x)nil,6@@

[[]]

|!|1eESB0130000013|!|

(a) Do the pollutants from cars cause detrimental externality? Why? (3 marks)

(b) Suggest and explain ONE method for the government to solve the air pollution problem

mentioned in (a). (4 marks)

##

(a) Yes. (1 mark)

This is because pollutants from cars do pollute the air that other people have to breathe, but car

users do not give any compensation to the affected parties. A detrimental externality exists in this

case. (2 marks)

© Aristo Educational Press Ltd. 13-48

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) The government can levy a tax on car users. (1 mark)

The tax would shift the marginal private cost (MPC) curve of using cars upward by the size of the

tax. If the tax accurately reflects the external cost of using cars, the new MPC curve coincides

with the marginal social cost (MSC) curve. In the new market equilibrium, the use of cars reaches

the socially optimal level. (3 marks)

##

@@a)nil,3@@

@@b)nil,4@@

[[]]

|!|1eESB0130000014|!| (2012)

Refer to the following diagram. P0 and Q0 are the equilibrium price and equilibrium quantity of

motorbikes respectively under a free market.

Unit price
S = MC

P0

D = MB D

0 Q0 Quantity of motorbikes

(a) Suppose the government imposes an effective quota on motorbikes. How would the consumer

surplus and producer surplus change? Explain with the aid of a diagram. (6 marks)

(b) Based on the diagram you have drawn in (a), explain why the market of motorbikes deviates from

efficiency after the quota is imposed. (2 marks)

© Aristo Educational Press Ltd. 13-49

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a) As the quota restricts the quantity of motorbikes supplied, it leads to an increase in the price and a

decrease in the quantity transacted of motorbikes. The consumer surplus would decrease from

area acP0 to area abP1. (2 marks)

The producer surplus would increase from area P0ce to area P1bde. (2 marks)

Unit price Sq
S = MC
a

P1 b
c
P0

D = MB D
e
(2 marks)
0 Q1 Q0 Quantity of motorbikes

(b) After the quota is imposed, total social surplus in society is reduced and there is a deadweight loss

(area bcd). Therefore, the market of motorbikes deviates from efficiency. (2 marks)

##

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@@b)nil,2@@

[[]]

© Aristo Educational Press Ltd. 13-50

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eESB0130000015|!| (2014)

The diagram below shows the market supply and demand curves of good X. The government has

imposed a price ceiling on good X at Pc.

Unit price
S

Pc

D
0 Quantity

(a) Indicate the consumer surplus and producer surplus in the above diagram. (2 marks)

(b) Suppose there is an increase in the production cost of good X. How would this affect the price,

quantity transacted, consumer surplus and producer surplus of good X? (5 marks)

##

(a)
Unit price Consumer surplus
S
Producer surplus

Pc

D
0 Quantity
(2 marks)

(b) Supply of good X will decrease. The price will remain unchanged at Pc. The quantity transacted

will decrease. Consumer surplus and producer surplus will decrease. (5 marks)

##

@@a)nil,2@@

@@b)nil,5@@

[[]]

© Aristo Educational Press Ltd. 13-51

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eESB0130000016|!| (2014)

The diagram below shows the market supply and demand curves of good X. The government sets a

quota on the good at Q1.

Unit price
S

D
0 Q1 Q2 Quantity

Suppose the government increases the quota limit to Q2. With the aid of the above diagram, explain

how consumer surplus and economic efficiency would be affected by the increase in the quota limit.

(7 marks)

##

The effective quota (Q1) becomes an ineffective quota (Q2). The price will decrease from P1 to P* and

the quantity transacted will increase from Q1 to Q*. Total social surplus will increase (the deadweight

loss will disappear) and economic efficiency will be improved. Consumer surplus will increase.

(4 marks)
Unit price Increase in total social surplus
S Increase in consumer surplus

P1

P*

D
(3 marks)
0 Q1 Q* Q2 Quantity

##

@@x)nil,7@@

[[]]

© Aristo Educational Press Ltd. 13-52

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eESB0130000017|!| (2014)

In Hong Kong, drivers are prohibited from leaving vehicles idling. Offenders are required to pay a

penalty.

(a) Suggest ONE reason to explain why leaving vehicles idling cause a detrimental externality.

(2 marks)

(b) Explain why a penalty helps discourage drivers from leaving vehicles idling. (2 marks)

##

(a) Leaving vehicles idling causes air pollution/heat/noise nuisances, imposing negative impact on

other road users and passers-by without offenders paying any compensation (external cost).

(2 marks)

OR any reasonable answer (2 marks)

(b) When the offenders are fined, the private cost of drivers leaving vehicles idling will increase. The

incentive for drivers to turn off their engines and not leave vehicles idling will increase. (2 marks)

##

@@a)nil,2@@

@@b)nil,2@@

[[]]

© Aristo Educational Press Ltd. 13-53

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

Long Questions

|!|1eELB0130000001|!|

Study the following table which shows the consumption data of Good X:

Quantity (units) Total benefit ($) Marginal benefit ($) Average benefit ($)
1 8
2 7
3 7
4 5
5 30

(a) Fill in the missing values in the above table. (5 marks)

(b) (i) What is consumer surplus? (3 marks)

(ii) What are the quantities demanded for Good X at the prices of $5 and $7 respectively?

Explain how you arrive at your answer. (4 marks)

(c) The following shows consumers’ marginal benefit for Good Y:

Quantity (units) Marginal benefit ($)

1 5
2 6
3 7
4 8
5 9

Is the quantity demanded for Good Y at the price of $5 the same as the one where marginal benefit

= price? Why or why not? (7 marks)

(d) “The marginal benefit curve of a good must be the demand curve for it.” Based on your answers

in (b) and (c), evaluate the above statement. (5 marks)

© Aristo Educational Press Ltd. 13-54

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a)
Quantity (units) Total benefit ($) Marginal benefit ($) Average benefit ($)
1 8 8 8
2 15 7 7.5
3 21 6 7
4 26 5 6.5
5 30 4 6
(0.5 mark  10 = 5 marks)

(b) (i) Consumer surplus refers to the difference between the maximum amount a consumer is

willing to pay and the actual amount he or she pays. (3 marks)

(ii) When the price is $5, the quantity demanded is 4 units. (1 mark)

At the price of $5, 4 units is the quantity which maximises the consumer surplus (MB = P =

$5). (1 mark)

When the price is $7, the quantity demanded is 2 units. (1 mark)

At the price of $7, 2 units is the quantity which maximises the consumer surplus (MB = P =

$7). (1 mark)

(c)
Quantity Marginal benefit Consumer surplus ($)
(units) ($)
1 5 5 – 5= 0
2 6 (5 + 6) – 5  2 = 1
3 7 (5 + 6 + 7) – 5  3 = 3
4 8 (5 + 6 + 7 + 8) – 5  4 = 6
5 9 (5 + 6 + 7 + 8 + 9) – 5  5 = 10
(5 marks)

When the price is $5, if the consumer chooses to buy 1 unit, where MB = P = $5, his consumer

surplus is not maximised. (1 mark)

When marginal benefit is increasing, the greater the quantity, the greater the consumer surplus.

Therefore, a consumer who aims to maximise consumer surplus would not choose the quantity

where MB = P. (1 mark)

© Aristo Educational Press Ltd. 13-55

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(d) Answer in (b) shows that when marginal benefit is decreasing, quantity demanded is the quantity

where the marginal benefit is equal to the price. (1 mark)

Answer in (c) shows that when marginal benefit is increasing rather than decreasing, quantity

demanded is no longer the quantity where the marginal benefit is equal to the price. (1 mark)

The marginal benefit curve is the demand curve when the marginal benefit curve is downward

sloping. (1 mark)

The marginal benefit is no longer the demand curve when the marginal benefit curve is not

downward sloping. (1 mark)

The statement is incorrect. (1 mark)

##

@@a)cal,5@@

@@b)nil,7@@

@@c)cal,7@@

@@d)nil,5@@

[[]]

|!|1eELB0130000002|!|

According to a recent survey, Mongkok is one of the most light-polluted areas in Hong Kong. The

brightness level of billboards in Mongkok is unacceptably high. Some residents complain that light

from billboards make it difficult to sleep well at night. Some experts even warn that light pollution

leads to serious health hazards.

(a) (i) Define “detrimental externality”. (2 marks)

(ii) Is there a detrimental externality in the above case? Explain. (3 marks)

(b) With the aid of a diagram, compare the equilibrium quantity of billboards in Mongkok with the

socially optimal quantity. (6 marks)

(c) Explain two methods by which the government can solve the light pollution problem brought by

billboards in Mongkok. (6 marks)

(d) Can market forces be relied to solve the light pollution problem brought by billboards in

Mongkok? Use an example to explain. (4 marks)

© Aristo Educational Press Ltd. 13-56

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a) (i) When a person engages in an activity that imposes costs on other parties, but does not pay

any compensation for that effect, a detrimental externality occurs. (2 marks)

(ii) Yes. (1 mark)

The light of the billboards adversely affects the life and damages the health of residents in

Mongkok, but the users of the billboards do not give any compensation to the residents.

Thus, there is a detrimental externality. (2 marks)

(b) The marginal social cost curve (MSC) is above the marginal private cost curve (MPC) in this case

because MSC includes the external cost imposed on society. The intersection of the marginal

social benefit (MSB) curve and the MSC curve (A) determines the socially optimal quantity. On

the other hand, the intersection of MPC and MSB (B) determines the equilibrium quantity of

billboards. (2 marks)
Unit price

MSC
MPC
A
B

MPB = MSB

0 Q1 Q2 Quantity
(3 marks)

So, the equilibrium quantity of billboards in Mongkok (Q2) is greater than the socially optimal

quantity (Q1). (1 mark)

(c) The government can impose a new law which fines those users who allow the brightness level of

their billboards to exceed a certain limit. (3 marks)

The government can tax the billboard users. The amount of tax can be adjusted to make the new

marginal private cost curve (MPC) coincide with the marginal social cost curve (MSC). In the

new market equilibrium, the quantity of billboards reaches the socially optimal level. (3 marks)

OR Any reasonable answer with explanation

© Aristo Educational Press Ltd. 13-57

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(d) Yes. (1 mark)

Suppose the residents have rights to require the users to demolish all billboards. The users are

willing to pay money to the residents for permission to continue to use the billboards. This

amount of money would add to the users’ marginal private cost of using the billboards and hence

reduce the divergence between private cost and social cost. The market then attains efficiency.

(3 marks)

OR Any reasonable answer with explanation

##

@@a)nil,5@@

@@b)nil,6@@

@@c)nil,6@@

@@d)nil,4@@

[[]]

© Aristo Educational Press Ltd. 13-58

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eELB0130000003|!|

Study the following table which shows the production data of factory A, whose production pollutes the

nearby factory B:

Factory A’s output Factory A’s total cost of Total damage to Factory B ($)

(units) production ($)

1 1 2

2 3 4

3 6 6

4 10 8

5 15 10

6 21 12

Suppose Factory A operates in a perfectly competitive market where the market price is $5.

(a) What is the socially optimal level of output for Factory A? Explain your answer. (4 marks)

(b) If Factory A totally disregards its damage to Factory B, what is its output? Is it the same as the

socially optimal output level? Explain your answer. (3 marks)

(c) Suppose the owner of Factory A has acquired Factory B.

(i) What is the new output level of Factory A? Is it the same as the socially optimal output

level? Explain your answer. (5 marks)

(ii) “Whenever there is a divergence between private and social costs, the government must

intervene to guarantee an efficient outcome”. In light of your answer in (c)(i), comment on

the validity of the statement. (6 marks)

© Aristo Educational Press Ltd. 13-59

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a)

Factory A’s output (units) Factory A’s marginal cost of Marginal damage to Factory B

production ($) ($)

1 1 2

2 2 2

3 3 2

4 4 2

5 5 2

6 6 2

(2 marks)

The socially optimal output level is 3 units, where the marginal social cost (= $3 + $2) is equal to

the marginal revenue (= $5). (2 marks)

(b) If the factory completely disregards the damage to Factory B, it produces at the output level where

marginal revenue is equal to the marginal private cost. (1 mark)

At 5 units of output, the marginal private cost of $5 is equal to the marginal revenue. (1 mark)

This level of output (5 units) is greater than the socially optimal level (3 units). (1 mark)

(c) (i) If Factory A and Factory B are jointly owned by the same owner, the owner takes into

account the damage to Factory B in deciding the output level of Factory A. (1 mark)

Factory A's marginal cost now includes the marginal damage to Factory B, as shown below:

Factory A’s output (units) Factory A’s new marginal cost of production ($)

1 3

2 4

3 5

4 6

5 7

6 8

(3 marks)

It now produces at 3 units of output, where the new marginal cost is equal to the marginal

revenue. (1 mark)

It is the same as the socially optimal level of output. (1 mark)

© Aristo Educational Press Ltd. 13-60

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(ii) As shown in (c)(i), after taking over Factory B, the owner takes into account the damage to

Factory B in deciding the output of Factory A. The former external cost becomes part of his

private cost. Since his marginal private cost is the same as the marginal social cost, the

output chosen by him is the socially optimal level. (2 marks)

Therefore, whenever the marginal private cost of a person’s activity is the same as the

marginal social cost, the level of activity chosen by him is efficient. (1 mark)

Market forces can be relied to correct the divergence as long as the person responsible for

the former external cost becomes part of his private cost. Private contracting between the

affected parties can lead to an efficient outcome. (2 marks)

Therefore, it is not necessary for government to intervene whenever there is divergence

between private and social costs. (1 mark)

##

@@a)cal,4@@

@@b)nil,3@@

@@c)cal,11@@

[[]]

|!|1eELB0130000004|!|

It is believed that scientific research provides a beneficial externality because other people can benefit

from the findings without paying for them.

(a) Illustrate the above situation in a diagram. (2 marks)

(b) What is the condition for efficiency? What is the condition for socially optimal resource

allocation? (2 marks)

(c) What is the condition for market equilibrium? (1 mark)

(d) Is the market equilibrium in the above situation efficient? If not, how can government intervention

improve the situation? Explain with the aid of a well-labelled diagram. (6 marks)

© Aristo Educational Press Ltd. 13-61

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a)

Unit price

MSB: Marginal social benefit

MPB: Marginal private benefit

MSB

MPB

0 Quantity of scientific research

(2 marks)

(b) Condition for efficiency: MSB = MSC (1 mark)

Condition for socially optimal resource allocation: MSB = MSC (1 mark)

(c) Condition of market equilibrium: MPB = MPC (1 mark)

© Aristo Educational Press Ltd. 13-62

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(d)
Unit price

MPC = MSC
MEB

MSB

MPB

0 Q1 Q2 Quantity of scientific research

(2 marks)

At the market equilibrium, MSB is greater than MSC, so the market equilibrium is inefficient.

(2 marks)

The government can improve the situation by giving out a unit subsidy to the producer. The unit

subsidy should be equal to the difference between MSB and MPB (i.e. marginal external benefit,

MEB). Hence, the MPB curve shifts upwards and the new MPB curve coincides with the MSB

curve. The new market equilibrium quantity is equal to the efficient quantity. (2 marks)

##

@@a)nil,2@@

@@b)nil,2@@

@@c)nil,1@@

@@d)nil,6@@

[[]]

|!|1eELB0130000005|!|

In Hong Kong, the government fully subsidises education except in the areas of tertiary education,

tutorial classes and interest courses.

(a) Which kind of externalities does education provide? Explain your answer with examples.

(2 marks)

(b) Using the concept of externality and your answer in (a), explain why the government adopts the

current policy. (4 marks)

(c) From the standpoint of society, will there be an underproduction or overproduction of education if

the government does not adopt the current policy? Explain your answer. (3 marks)

© Aristo Educational Press Ltd. 13-63

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

##

(a) Education provides beneficial externalities to society. (1 mark)

Educated people tend to be more polite and helpful to others. They are also less likely to act in

antisocial way. (1 mark)

(b) As mentioned in (a), education provides beneficial externalities to society. There is a divergence

between private benefit and social benefit. Government subsidies can reduce the difference

between private and social benefits. (2 marks)

However, most of the benefits from tertiary education, tutorial classes and interest courses tend to

be captured by recipients of education, i.e. the divergence between private and social benefits is

less serious. Hence, the government need not heavily subsidise them. (2 marks)

(c) Without government subsidisation, at the market equilibrium, the marginal social benefit is greater

than the marginal social cost. Further provision of education can increase the welfare of society.

Hence, there will be an underproduction of education if the government does not adopt the current

policy. (3 marks)

##

@@a)nil,2@@

@@b)nil,4@@

@@c)nil,3@@

[[]]

|!|1eELB0130000006|!|

Traffic congestion of the Cross Harbour Tunnel is a serious social problem in Hong Kong. A report

found out that people spent more than half an hour on average in traffic congestion.

(a) Are there any externalities in the above case? Explain your answer. (3 marks)

(b) In the above case, how can the tunnel company lessen the congestion problem? Explain with the

aid of a supply-demand diagram. (5 marks)

##

(a) When traffic congestion occurs, each tunnel user slows down other users and hence imposes time

cost on one another. The social cost generated by one user is his or her time cost plus the time cost

imposed on other users by him or her; the private cost is the time cost incurred by him or her only,

as he or she does not need to compensate others for the time cost imposed on them. Therefore,

there is a divergence between private and social costs. (3 marks)

© Aristo Educational Press Ltd. 13-64

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) The company can increase the toll charges. With an increase in toll (from P0 to P1), the quantity

demanded decreases and the excess demand (from ED0 to ED1) decreases. Hence, an increase in

toll charge lessens the congestion problem. (2 marks)

Unit price
S
ED0: Excess demand under P0

ED1: Excess demand under P1

P1 ED1
P0
ED0 D
0
Quantity of
tunnel service
(3 marks)

##

@@a)nil,3@@

@@b)cro,5@@

[[]]

|!|1eELC0130000007|!| (2012)

Speeding is a serious offence and is one of the major causes of traffic accidents in Hong Kong. Any

driver found breaking speed limits will be liable to prosecution under the law. However, there were

people killed by speeding every year.

(a) What is “detrimental externality”? (2 marks)

(b) Is there any detrimental externality brought about by speeding? Explain. (3 marks)

(c) Suppose it is found that the general public considers the penalty for speeding is not strong enough

and suggests increasing the penalty so as to strengthen the deterrent effect. With the aid of a

diagram, explain how a heavier penalty can help to reduce the number of speeding cars. (6 marks)

##

(a) Detrimental externality exists when a person’s action imposes a cost on other parties, but he/she

does not give any compensation for that effect. (2 marks)

© Aristo Educational Press Ltd. 13-65

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) Yes. (1 mark)

Drivers who break speed limits put other road users’ safety at risk and also pose threats to them.

However, they do not give any compensation to other road users. Thus, there is a detrimental

externality. (2 marks)

(c) If a heavier penalty is imposed, those drivers’ marginal private cost would increase, and the MPC

curve would shift upwards (from MPC to MPC’). The number of speeding cars would reduce

from Q0 to Q1.

(3 marks)

Unit price

MSC
MPC’
MPC

MPB = MSB

0 Q1 Q0
Quantity of
speeding cars

(3 marks)

##

@@a)nil,2@@

@@b)nil,3@@

@@c)nil,6@@

[[]]

© Aristo Educational Press Ltd. 13-66

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

|!|1eELB0130000008|!| (2014)

The diagram below shows the market supply and demand curves for good X. The government has

imposed a price floor on the good at P1.

Unit price
S

P1

D
0 Quantity

(a) Is the price floor effective? Explain. (2 marks)

(b) “Producers may benefit from the price floor.” Do you agree with the statement? Explain your

answer with the aid of the above diagram. (6 marks)

(c) Suppose the government raises the price floor. Explain if the adjustment in price floor improves

economic efficiency. (3 marks)

##

(a) Yes. (1 mark)

This is because it is set above the equilibrium price. (1 mark)

(b) Yes. (1 mark)

Under the price floor P1, to some producers, their producer surplus increases as the price

increases. To other producers, their producer surplus decreases as the quantity transacted

decreases. If the loss in producer surplus is smaller than the gain in producer surplus, producer

surplus will increase. (3 marks)

Unit price
Loss in producer surplus
S
Gain in producer surplus

P1

D
(2 marks)
0 Q1 Quantity

© Aristo Educational Press Ltd. 13-67

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(c) No. (1 mark)

Raising the price floor will cause the price to increase and the quantity transacted to decrease.

This will lead to an increase in deadweight loss / a decrease in total social surplus. (2 marks)

##

@@a)cro,2@@

@@b)nil,6@@

@@c)nil,4@@

[[]]

|!|1eELB0130000009|!| (2014)

Refer to the following market supply and demand schedules for a good.

Unit price ($) Quantity demanded (units) Quantity supplied (units)

0 6 0

5 5 1

10 4 2

15 3 3

20 2 4

25 1 5

30 0 6

(a) Find the equilibrium price and quantity of the good. (2 marks)

(b) Suppose the government levies a per-unit tax of $10 on the producers of the good.

(i) Calculate the change in consumer surplus and producer surplus after levying the tax. Show

your steps. (6 marks)

(ii) Explain whether levying the tax is efficient from society’s point of view. (3 marks)

##

(a) Equilibrium price: $15 (1 mark)

Equilibrium quantity: 3 units (1 mark)

© Aristo Educational Press Ltd. 13-68

 HKDSE Economics in Life – Microeconomics 3
Chapter 13 Efficiency, Equity and the Role of Government (I)

(b) (i) Before levying the tax,

consumer surplus = ($25 + $20 + $15) – ($15  3 units) = $15 (1 mark)

producer surplus = ($15  3 units) – ($5 + $10 + $15) = $15 (1 mark)

After levying the tax,

consumer surplus = ($25 + $20) – ($20  2 units) = $5 (1 mark)

producer surplus = ($10  2 units) – $15 = $5 (1 mark)

Both consumer surplus and producer surplus would decrease. (2 marks)

(ii) No. After levying the tax, quantity transacted decreases to 2 units. At this level, marginal

benefit ($20, as reflected by the demand schedule) is higher than the marginal cost ($10, as

reflected by the supply schedule). There is a deadweight loss and total social surplus is not

maximised. (3 marks)

##

@@a)nil,2@@

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@@c)nil,3@@

[[]]

© Aristo Educational Press Ltd. 13-69