NSS Economics (Book 3)

Chapter 16 (Efficiency and government intervention) -

Questions

Questions: P.1-P.10

A
Part A
Exercise 1 (DPQ4) – price ceiling Answers: P.11-P.16
(a) What is ‘deadweight loss’? (2 marks)

(b)
A teacher said, “An effective price ceiling may increase the consumer surplus.”
His student replied, “If this is the case, the price ceiling may enhance economic efficiency!”
(i) Do you agree with the teacher? Illustrate your answer in Figure 1. (3 marks)
(ii) Do you agree with the student? Explain your answer with the aid of Figure 2.
(5 marks)
Price Figure 1
S
D
Pc = price ceiling

Pc

Quantity

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 Price Figure 2
S
D
Pc = price ceiling

Pc

Quantity

Exercise 2 (D16Q11bd) – price ceiling

Medical service is one of the basic human needs.

Source A: a conversation outside a public clinic in Hong Kong

Son: Dad, I feel very ill.
Father: Oh no! There is a long queue waiting.
Son: Why don’t we go to a private doctor?
Father: The fee charged by public clinics is only $45, much lower than that charged by private
doctor.

a) With reference to Source A, explain with the aid of Figure 1 how the price set by public clinics
may lead to economic inefficiency in the provision of public medical service. (6 marks)
(Assume the supply curve in Figure 1 fully reflects the marginal social cost of public medical
service.)

Source B: an extract from the Hospital Authority webpage

The Hospital Authority is committed to providing community-based primary care services. Our
target patients include the elderly, low-income individuals, and patients with chronic diseases.

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b) Many people argue that public clinics should raise the fee to reduce the waiting time. Evaluate
this argument in terms of economic efficiency. (2 marks)

Figure 1: public medical service

Price ($)
D S

Quantity

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Exercise 3 (D12Q5ac) – price ceiling
Country A has imposed an effective price ceiling on Good X.
(a) Suppose Country A eliminates all illegal transactions of Good X. Can this price control ensure
all lower income buyers obtain the quantity of Good X they plan to purchase? Explain.
(4 marks)

(b) Suppose the effective price ceiling is lowered. Will the change in price ceiling improve
economic efficiency? Explain your answer with the aid of a diagram. (4 marks)

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Exercise 4 (D14Q9) – unit tax
Many countries have considered imposing ‘soft drink tax’ for health reasons. Suppose a country
decides to impose a per unit tax on the sellers for every bottle of soft drink sold in the market.
(a) Under what condition will the soft drink buyers in the country bear a greater tax burden than the
sellers? Illustrate your answer with a supply-demand diagram. (5 marks)
(b) Using the same diagram in (a), indicate the change in consumer surplus after the tax is imposed.
(1 mark)

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Exercise 5 (D20Q10cd) – tariff (i.e., unit tax)
Economists argue that tariff (= unit tax on imported goods) may harm both the consumers and
producers.

With reference to the above supply-demand diagram, complete the table below. (3 marks)

Before tariff After tariff

Consumers’ surplus Area adf
Producers’ surplus

b) The US government could impose quota to restrict imports. From the viewpoint of the US
government, state ONE advantage and ONE disadvantage of using tariff instead of quota to restrict
imports. (2 marks)

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Exercise 6 (D15Q3) - quota
An increase in an effective quota in the market of a good would lead to a reduction in deadweight loss.
Do you agree? Explain your answer with the aid of a diagram. (6 marks)

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Exercise 7 (D17Q11) – per-unit subsidy
The government of Country X introduces a per-unit subsidy to the education services of private
universities.
a) Under what condition would the students enjoy a larger share of subsidy benefit than the private
universities? Illustrate your answer with the aid of a diagram. (7 marks)

b) ‘The subsidy causes inefficiency even though both students and universities benefit.’ Defend the
statement by comparing the marginal cost and marginal benefit in diagram stated in (a).(3 marks)

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Exercise 8 (D18Q11c) – minimum wage (price floor)
Foreign domestic helpers are paid with a minimum wage at HK$4 410 per month for a two-year
contractual period in Hong Kong.

Suppose the minimum wage in the market of foreign domestic helpers in Hong Kong is effective.
With the aid of the following figure, explain how it may result in economic inefficiency. (4 marks)

Wage rate
D S Figure 1: foreign domestic
helpers in Hong Kong

Quantity
Answer:
Minimum wage is set (above / below) equilibrium wage. It may result in economic inefficiency as
marginal cost is ________________ than marginal benefit.
(Hints: then show the minimum wage, Q, DWL in the diagram above).

Exercise 9 (D19Q11b) – excess supply of seats

The Guangzhou-Shenzhen-Hong Kong Express Rail Link (High Speed Rail) was launched in
September 2018.

During non-holidays, there are a lot of empty seats on some trains of the High Speed Rail. With the
aid of the following figure, explain why the above situation may be inefficient. (4 marks)
S
Fares ($)
D

Number of passengers
Answer:
Fares are set (above / below) equilibrium wage during non-holidays. It may result in economic
inefficiency as marginal cost is ________________ than marginal benefit.
(Hints: then show the minimum wage, Q, DWL in the diagram above).

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Part B: Functions of Price (Ch15)
Exercise 1 (D15Q4a)
Read the following news extract.
The strong preference for small flats has pushed the prices of the flat under 400 square feet to a new
high in the past few months. It is expected that more and more small flats will be available for sale
in the coming future.

Explain ONE function of price which can be found in the above news extract. (2 marks)

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Chapter 16 (Efficiency and government intervention)
- Answer
Exercise 1 (DPQ4) – price ceiling
a) Deadweight loss is the loss in the total social surplus or the potential gains not fully captured when
marginal benefit does not equal marginal cost. (2 marks)
b) i) Yes (1 mark)
Indicate in the diagram:
 gain of consumer surplus (+) (1 mark)
 loss of consumer surplus (-) (1 mark)

ii) Indicate in the diagram:

 deadweight loss (DL) (1 mark)
 quantity is Qc (1 mark)

Verbal elaboration:
 No (1 mark)
 When price is set below equilibrium, the quantity transacted will be reduced. (1 mark)
 Marginal cost of sellers is lower than marginal benefit of consumers. / There is
deadweight loss. (1 mark)

Exercise 2 (D16Q11bd) – price ceiling

a) Illustrate in the diagram:
 Price set below equilibrium (1 mark)
 Correct position of Qt (1 mark)
 Correct position of deadweight loss (1 mark)

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 Verbal elaboration:
 Price is set at $45 which is below equilibrium (1 mark)
 Quantity transacted is below equilibrium quantity or there is underproduction or shortage
(1 mark)
 Marginal benefit is greater than marginal cost at quantity transacted (1 mark)

b) Efficiency:
The fee increase would improve efficiency as it results in a price closer to the
equilibrium level, thus narrowing the gap between marginal benefit and marginal
cost and reducing the size of deadweight loss. (2 marks)

Exercise 3 (D12Q5ac) – price ceiling

a) No, because (1 mark)
 there is excess demand / shortage (1)
 other competitive criteria / non-price competition, such as (2)
queuing, will emerge Max. 3
 the new competitive criteria do not necessarily depend on income (2)

b) No, because (1 mark)

there is greater deadweight loss. / total social surplus decreases. (1 mark)

Indicate in the diagram:

 Lowering of the price ceiling (1 mark)
 Correct position of increase in deadweight loss / loss in total social surplus (1 mark)

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Exercise 4 (D14Q9) – unit tax
a) The condition is that the elasticity of demand for the good is smaller than the elasticity of supply.
(1 mark)
Indicate in the diagram:
 Parallel upward shift of supply curve due to the per unit tax (1 mark)
 Price increases and quantity drops (1 mark)
 Correct positions of buyers’ tax burden and sellers’ tax burden (1 mark)
 Buyers’ burden > sellers’ burden (1 mark)

b) Indicate on the diagram:

Reduction in consumer surplus: buyers’ burden + area a (1 mark)

Exercise 5 (D20Q10cd) – tariff (i.e., unit tax)

a)

Before tariff After tariff

Consumers’ surplus Area adf Area abc
Producers’ surplus Area df0 Area bcg OR Area hi0

b) Advantage of using tariff over quota

 Generate tariff revenue for the government (1 mark)
Disadvantage of using tariff over quota
 The effect on the import volume depends on the price elasticity of demand for imported goods
but quota can restrict the import to the desired level. (1 mark)

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Exercise 6 (D15Q3)
Agree. (1 mark)
Verbal elaboration:
The increase in effective quota would raise the supply and thus raise the quantity transacted and reduce
the price. (1 mark)
The gap between marginal benefit and marginal cost is reduced as the quantity produced is increased
towards its efficient level. (1 mark)

Indicate on the diagram:

 Rightward shift of the supply curve corresponding to an increase in quota (1 mark)
 A reduction in P and a rise in Q (1 mark)
 Correct position for the reduction in deadweight loss (area wxyz) (1 mark)

Exercise 7 (D17Q11) – per-unit subsidy

a) Verbal elaboration:
The condition is that the elasticity of demand for education services is lower than the elasticity of
supply. (2 marks)
Illustrate in the diagram:
 Parallel downward shift of supply curve due to the per unit subsidy (1 mark)
 Correct position of New Price (P1) (1 mark)
 Correct position of New Quantity (Q1) (1 mark)
 Correct position of producer benefit and consumer benefit (1 mark)
 Consumer benefit > producer benefit (1 mark)

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 b) Verbal elaboration:
At Q1, marginal cost is larger than marginal benefit (1 mark)

Illustrate in the diagram:

 Correct position of marginal benefit (1 mark)
 Correct position of marginal cost (1 mark)

Exercise 8 (D18Q11c) – minimum wage (price floor)

Wage rate
D S Figure 1: foreign domestic
helpers in Hong Kong

W0 = min. wage

Deadweight
loss

Q1 Quantity
Verbal elaboration:
At Q1, marginal cost is smaller than marginal benefit (1 mark)

Illustrate in the diagram:

 Correct position of minimum wage (1 mark)
 Correct position of Q1 (1 mark)
 Correct position of deadweight loss (1 mark)

Exercise 9 (D19Q11b) – excess supply of seats

Fares ($)
D
S
Excess supply

F1

Deadweight
loss

Q1 Number of passengers

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 Verbal elaboration:
Fares are set above the market-clearing (or equilibrium) level. So marginal benefit of train
service is larger than marginal cost. (2 marks)

Illustrate in the diagram:

 Correct position of P and Q (1 mark)
 Correct position of deadweight loss (1 mark)

Part B: Functions of Price

Exercise 1 (D15Q4a)
Functions of price:
 Higher prices of small-sized flats would induce real-estate developers to direct more resources
towards the production of small flats. (Allocative function)
 Prices help transmit information about consumer demand relative to producer supply (Signal
function)
(2 marks for each relevant function, Mark the first ONE only)

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