NSS Exploring Economics
15
Exam Practice 3
The marginal benefit curve is downward sloping. To maximise one’s gain, one would consume up
to the unit at which one’s marginal benefit is equal to the price (MB = P). Then all units with
MB ≥ P are bought, while no units with MB < P are bought.
Price ($ / unit)
3.
the unit at which one’s marginal benefit is equal
to the price (MB = P).
If the marginal cost curve is upward sloping, to maximise one's gain, a producer would supply up
to the unit at which the market price is equal to one’s marginal cost. Then all units with P ≥ MC
are supplied, while no units with P < MC are supplied.
P1
Q1
Suggested answer
A supply curve tells us the quantities supplied at different prices while a marginal cost curve
tells us the marginal costs at different quantities. Marginal cost refers to the cost of producing an
extra unit of a good. In a perfectly competitive market, whenever the market price (P) of a unit
of a good is larger than its marginal cost (MC), a producer would supply that unit and gain the
difference between P and MC. Whenever P < MC, a producer would not supply that unit. Or else,
the producer would lose the difference between MC and P.
To maximise one’s gain, one would consume to
0
Consumer surplus and producer surplus
D = MB
Quantity of Good X (units / period)
Notice that the producer's quantity supplied at a particular price is the unit at which MC = P,
which is a point on the marginal cost curve. For example, refer to the graphs below, at P0, the
quantity supplied is Q0 at which MC0 = P0. Similarly, the quantities supplied at different prices can
be derived. The marginal cost curve of a producer is actually his supply curve.
Normally, a change in price has no effect on the marginal benefit curve. Since the marginal
benefit curve is downward sloping, when the price rises, a consumer would consume fewer units
until the MB rises and equals P again. Hence, a change in price would bring a movement along
the MB curve until the condition of MB = P is restored.
$
$
Price ($ / unit)
MC curve
When price rises, one would consume fewer
P1
MC curve = Supply curve
At Q1, MC1 = P1
units until MB rises (along the MB curve) and
equals P again.
P0
P2
P1
0
?
Q2
Q1
D = MB
Quantity of Good X (units / period)
0
?
Typical Question 3 Marginal cost curve and supply curve
Question analysis
1.
Key words: ‘explain’, ‘marginal cost curve’, ‘supply curve’ and ‘ perfectly competitive market’.
2.
4
Answering techniques
•
•
Define supply curve and marginal cost curve.
•
Explain why the supply curve is the marginal cost curve in a perfectly competitive market.
Explain why the profit-maximising quantity supplied at a certain price is the one at which
MC = P in a perfectly competitive market.
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Q0
Q1
Quantity
0
Q0
Q1
Quantity supplied
Typical Question 4 Water-diamond paradox
Water is much more useful than diamonds but is much ‘cheaper’ than diamonds. Explain.
[Note: In this question, ‘cheaper’ means that the benefit obtained per dollar spent on water
(= total benefit of water ÷ total expenditure on water) is larger than that of diamonds.]
Explain why the producer’s marginal cost curve is his supply curve in a perfectly competitive
market.
1.
At Q0, MC0 = P0 and
hence Q0 is quantity
supplied at P0.
Question Analysis
Key words: ‘water’, ‘diamonds’, ‘more useful’ and ‘cheaper’.
2.
Answering techniques
•
•
•
Explain the meaning of ‘more useful’ and ‘cheaper’.
Explain why water is more useful than diamonds.
Explain why water is cheaper than diamonds.
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17 The roles of government (I): market failure
3.
‘Social cost is the same as external cost.’
Correction
Social cost is equal to the sum of private cost and external cost.
Explanation
Social cost is the cost borne by society as a whole, including all economic agents. So, social
cost is equal to the sum of private cost (of the economic agent taking the action or making
the decision) and external cost (of all other economic agents without paying or receiving
compensation). It is not the same as the external cost.
4.
‘The existence of pollution implies inefficiency.’
Correction
The existence of pollution does not necessarily imply inefficiency.
Explanation
Pollution harms the environment. It is costly. However, provided that all costs due to
pollution are counted in the private cost of the decision maker (for example, the polluters
may need to buy pollution permits before production, or the victim has to bear the cost
of pollution and pay for its reduction), the marginal social benefit will still be equal to the
marginal social cost. Efficiency can be attained. Provided that the benefit is larger than the
cost, an optimal level of pollution may not be zero.
5.
‘A public good is a good provided by the government.’
Correction
A public good is a good which is non-rival and non-excludable in consumption. It can be
provided by the public sector as well as the private sector.
Explanation
A public good is defined according to the nature of the good (non-rivalry in consumption)
as well as the delineation and enforcement of its property rights (non-excludable in
consumption), irrespective of its supplier. It can be provided by the public sector as well as
the private sector.
D Multiple Choice Questions
Choose the BEST answer for each question.
1.
Market failure means
A.
B.
C.
D.
the market fails to attain equilibrium.
market participants fail to maximise their objectives in the market.
the market fails to allocate resources efficiently.
the market fails to distribute income equitably.
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17 The roles of government (I): market failure
NSS Exploring Economics Exam Practice 3
c. After the imposition of the environmental levy, has the efficiency of using plastic bags
* improved? Explain.
(6 marks)
F Structured Questions
Write your answers in the space provided.
1.
In the past, supermarkets in Hong Kong distributed plastic bags free of charge. After the
introduction of the environmental levy, supermarkets are charging customers $0.5 per plastic bag
distributed.
a.
Were plastic bags that were distributed free of charge free goods?
b.
Before the introduction of the environmental levy,
i.
ii.
(3 marks)
2.
what were the private cost and social cost of using these zero-priced plastic bags? Was
this an example of divergence between private and social costs?
(5 marks)
Congestion has long been a serious traffic problem in Hong Kong. Electronic road pricing has
been proposed as a solution to the problem.
a. What is the cost of driving? How does congestion affect the cost of driving?
(6 marks)
did the use of these plastic bags achieve efficiency? Explain your answer with the aid of
a diagram.
(6 marks)
b. Explain why congestion causes a divergence between private and social costs.
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16 © Pearson Education Asia Limited 2010
(3 marks)
18 The roles of government (II): equity & income inequality
Remark: Use the following table to help memorise the main differences between efficiency and
equity.
Efficiency
?
Equity
What is the criterion used?
The maximisation of TSS
The achievement of
fairness in income
distribution, the criteria
for which are different to
different people
Positive or normative?
Positive
Normative
Can be tested by facts?
Yes
No
Typical Question 2 Measuring equity in income distribution
What is the Gini coefficient? What are the limitations of using the Gini coefficient to measure
equity in income distribution? List THREE limitations.
1.
Question analysis
Key words: ‘Gini coefficient’, ‘limitations’ and ‘equity in income distribution’.
2.
Answering techniques
Define the Gini coefficient.
List three limitations of the Gini coefficient.
Suggested answer
The Gini coefficient is defined mathematically based on the Lorenz curve (
in the diagram
below). It is the ratio of the area that lies between the line of perfect equality and the Lorenz
curve (Area A) to the total area under the line of equality [Area (A + B)].
100
0
A
A+B
lin
e)
That is, the Gini coefficient =
ity
(o
r
45
-d
eg
r
ee
A larger Gini coefficient implies a more uneven
income distribution.
(Remark: The 45-degree line is also called ‘line of perfect
equality’ as it shows an extreme case where every
household earns an equal share of society’s total
income.)
ua
l
eq
er
fe
ct
of
p
Li
ne
Cumulative percentage of income
3.
A
B
Cumulative percentage of households
100
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