Book 3_Chapter 16: Competition and Efficiency

16.1 How conditions for efficiency Textbook P.45

How to achieve market efficiency???

Consideration of TWO parties
1. ____________________ 2. _____________________
A buyer will keep consuming until _________________________________________.
A seller will keep producing until __________________________________________.

16.2 Market inefficiency--Overproduction

P
S

P0

D
0 Q
Q0
Suppose the market price of a goods is set at P0, what will be happened if consumers consume
more than Q0 while suppliers produce more than Q0?
Regards to consumer surplus: Regards to producer surplus:

Given the price at P0 with quantity demanded at Given the price at P0 with quantity supplied at
Q1 ,then: Q1 ,then:

Marginal benefit from consumption is Marginal cost of production is

bigger / smaller than the given price. bigger / smaller than the given price.

At a result, there is a __________ in producer

At a result, there is a __________ in consumer
surplus (Area _____________)
surplus (Area _____________)

When the market exchange quantity is at Q1, total social loss equals to ___________________.

P. 1
16.3 Market inefficiency--Underproduction

P
S

P0

D
0 Q
Q0
Suppose the market price of a goods is set at P0, what will be happened if consumers consume
less than Q0 while suppliers produce less than Q0?
Regards to consumer surplus: Regards to producer surplus:

Given the price at P0 with quantity demanded at Given the price at P0 with quantity supplied at
Q2, we can see that: Q2, we can see that:

Price is lower than the marginal benefit until Price is higher than the marginal cost until
______________________________________. ______________________________________.

At a result, consumer surplus is / is not At a result, producer surplus is / is not

maximized. The potential gain in CS is regarded maximized. The potential gain in PS is regarded
as a loss in CS. as a loss in PS.

How to maximize the total social surplus in the above

Efficiency in resource allocation is attained when the total social surplus is

maximized.
Deadweight loss is the loss in TSS when the output level is not at the
efficient level. Thus, total social surplus is not maximized as MB does not
equal to MC.

P. 2
16.4 Invisible hand and Functions of prices

Invisible hand refers to mechanism of a free market, which relies on market

prices to coordinate resource allocation and output distribution.

Basic functions of prices* Textbook P.49-50

1. Transmit information about market demand and supply conditions
2. Rewards and penalizes the misbehaviors in the market
3. Allocating resources (i.e. Demand ­ Þ Qs­ , more resources are allocated to produce the
profitable items)
4. Distributing output (Þwho will get the outputs)

AL02-10 Market price

A. is a criterion which determines who wins and who loses.
B. Is the maximum amount a consumer is willing to pay at the margin.
C. May not be necessary in directing the use of scarce resources.
D. All of the above.

DSE 2015 Q.4a - Read the following news extract.

The strong preference for small flats has pushed the prices of the flats 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)

P. 3
16.5 Deviations from the efficiency
(Change in PS, CS and TSS under government intervention)
Price ceiling Textbook P.52-53 Illustration
An effective price ceiling should set _______ the
P equilibrium price at Pc. Þ P ­ / ¯ to _____
S Qs ­ / ¯ to _____ Qd ­ / ¯ to _____ Qt =____

Original CS= ________

New CS = ___________
Change of CS is ___________________
P0
Original PS= ________
New PS = ___________
Change of PS is ___________________

Original TSS=_____________
D
0 Q After the price ceiling, TSS ­ / ¯ since quantity
Q0 transacted has ____________.

At Q1, MB > / </ = MC, ___________________ is

observed.
by Bart Yip Therefore, deadweight loss ( ) is found.

Price floor Textbook P.54-55 Illustration

P An effective price floor should set _______ the

S equilibrium price at Pf. Þ P ­ / ¯ to _____
Qs ­ / ¯ to _____ Qd ­ / ¯ to _____ Qt =____

Original CS= ________

New CS = ___________
Change of CS is ___________________
P0
Original PS= ________
New PS = ___________
Change of PS is ___________________
D Original TSS=_____________
0 Q
Q0 After the price floor, TSS ­ / ¯ since quantity
transacted has ____________.

At Q1, MB > / </ = MC, ___________________

is observed.

Therefore, deadweight loss ( ) is found.

by Bart Yip

P. 4
Quota Textbook P.61-62 Illustration
An effective quota should set _______ the
P equilibrium quantity at Qq.
S0
Þ P ­ / ¯ to _____

Qs ­ / ¯ to _____ Qd ­ / ¯ to _____ Qt =____

Explain the impact on the efficiency.

P0

D
Q0 Q
0

by Bart Yip

Remarks
Both price controls and quota cause UNDERPRODUCTION and inefficiency in resource
allocation.

P.63 DSE trap 16.2 & 16.3

P. 5
Per-unit tax Textbook P.64-65 Illustration

An imposition of a per unit tax reduces supply. It

will shift the supply curve _________________

Þ P ­ / ¯ to _____ Qt ­ / ¯ to ____
P S0
TSS ­ / ¯ since quantity transacted has
___________.

P0 At Q1, CS = _____________ > /< / = Original CS

which is ____________

P1 is the market price. However, the sellers only

receive ________ for Q1 quantity transacted.

D As a result, PS after tax is the area of

0 _______________ or area of ________________
Q0 Q

Area represents the reduction of TSS:

________________ or ___________________

Is the above mentioned area equals to the total loss

(deadweight loss) that caused by the tax???????
Ans:______

Redistribution of the surplus

Although both sellers and buyer lose the surplus after
Total social surplus under tax
the imposition of tax, some of the surplus is actually
= PS+ CS+ Government tax revenue
captured by _________________ which is
represented by the area _______________________

The surplus is redistributed from the market to the

government.
As a result, ONLY the area of ______________ is
the deadweight loss. (No party can obtain it, a
definitely loss in society)

by Bart Yip

P. 6
Per-unit subsidy Textbook P.66-67 Illustration

An imposition of a per unit subsidy increases

supply. It will shift the supply curve
_________________
P
Þ P ­ / ¯ to _____ Qt ­ / ¯ to ____

S0
TSS ­ / ¯ since quantity transacted has
___________.

P0 At Q1, CS = _____________ > /< / = Original CS

(area__________)

At Q1, PS = _____________ > /< / = Original PS

(area__________)
D
Total social surplus SEEMS to be greater (due to an

0 Q0 Q increase in CS & PS) than before.

However, it is enlarged because of the government
support (the subsidy spending).

Redistribution of the surplus

Although both sellers and buyer gain more surplus
after receiving the subsidy, the government PAID the
amount, which is represented by the area
____________________________________
Total social surplus under subsidy
= PS+ CS- Government subsidy The surplus is redistributed from the government to
expenditure market (buyers and sellers).

As a result, the area of ______________ is the

deadweight loss. (No party can obtain it, a definitely
loss in society)
.

by Bart Yip

P. 7
 Book 3_Chapter 15 & 16:
Summary and consolidation
AL03 11 In production, resource allocation is said to be efficient when,
A. the marginal cost of production equals to the marginal use value (marginal benefit).
B. the marginal use value equals to the product price.
C. the marginal cost of production equals to the marginal revenue.
D. the marginal cost of production equals to the average cost of production.

AL02 10 Market price

A. is a criterion which determines who wins and who loses.
B. is a maximum amount a consumer is willing to pay at a margin.
C. may not be necessary in directing the use of scarce resources.
D. All of the above.

In chapter 15 & 16, you have learnt:

1. MC is supply curve (perfect competitive market) & MB is demand curve
2. Consume surplus/ Producer surplus / Total social surplus
3. Δ in TSS after Δ in demand/ supply curve
4. Δ in TSS under government interventions
5. Efficiency
6. Deadweight loss
7. Efficient output and equilibrium output

1. MC is supply curve Textbook P.21-22 (perfect competitive market) & MB is demand curve

MC=Supply --- In perfect competitive market, profit maximizing output level is reached when the
firm produces at P=MC.
Given an upward sloping MC curve, firm keeps supplying the goods when market price > MC.
MC curve is actually a supply curve which relates P to Qs.

MB=Demand --- Self maximizing consumption level is reached when the consumer consumes at
P=MB.
Given a downward sloping MB curve, consumer keeps buying the goods when MB > market price.
MB curve is actually a demand curve which relates P to Qd.

MC answers
AL03,11 A AL02,10 D

P.8
2. Consume surplus/ Producer surplus / Total social surplus
Definition Equation Efficient
condition
Consumer The extra amount a consumer is Total benefit (TB) – Total P=MB
surplus (CS) willing to pay above what he/she expenditure (TE)
actually pays for a given quantity =SMB-P*Q
demanded.

Producer The extra amount a producer Total revenue (TR) – Total P=MC
surplus (PS) actually receives above the minimum variable cost (TVC)
amount he/she must receive to =P*Q-SMC
produce a given quantity.

Total social It is the total surplus of all No government intervention MC=MB=P

surplus economic agents involved. =CS+PS MSS=0
(TSS) =(SMB-P*Q) – (P*Q-SMC)
=SMB-SMC
or TB-TVC

Under per-unit tax

=CS+PS+Gov’t tax revenue

Under per-unit subsidy

=CS+PS-Gov’t subsidy exp.

3. Δ in TSS after Δ in demand/ supply curve

Assumption: Parallel movement of the curve
TSS will increase if Qt increases, vice versa. (Given that NO deadweight loss is found)

4. Δ in TSS under government interventions

Price Price floor Quota Per-unit tax Per-unit subsidy
ceiling
Effects on P P¯ , Qt ¯ P­ , Qt ¯ P­ , Qt ¯ P­ , Qt ¯ P¯ , Qt ­
& Qt

Effects on TSS¯ TSS¯ TSS¯ TSS¯ TSS¯

TSS ¯ (CS+PS) >­gov’t ­ (CS+PS) <­gov’t
Inefficiency Inefficiency Inefficiency revenue expenditure

Inefficiency Inefficiency

P.9
5. Efficiency
Condition: MB=MC, at which
I. No deadweight loss is found
II. The sum of CS and PS is maximized without government intervention
III. TSS is maximized
IV. TB-TVC is maximized
V. No over/under-production of goods and services

6. Deadweight loss
It refers to the loss in total social surplus when the output level is not at the efficient level. Thus,
total social surplus is not maximized as MB does not equal to MC.

7. Efficient output and equilibrium output

Equilibrium output = the point which demand meets supply
[At Q0 without government intervention or at Q1 if quota is imposed]
Efficient output = the point which TSS is maximized. [At Q0] P S1
S0

P0

D
8. Externality V.S. Efficiency Q1 Q0 Q
Externality
Positive externality = MSB > MPB

Negative externality = MSC > MPC

Inefficiency
Over-production = MSC > MSB

Under-production = MSB > MSC

P.10