Microeconomics

Revision Exercise 3
1.

Intel Corporation has developed a new computer chip on which it immediately

acquires a patent.
(a) Draw a diagram to show the consumer surplus, producer surplus, total surplus
and deadweight loss in the market for this new computer chip.
Ans:
The patent gives the company a monopoly, as shown in Figure 3.3. At a quantity of
QM and price of PM, consumer surplus is area A + B, producer surplus is area C + D,
and total surplus is area A + B + C + D. The deadweight loss is E.
Figure 3.3

(b) If Intel can implement perfect price discrimination, what will happen to the
consumer surplus, producer surplus, total surplus and deadweight loss? Explain
your answer.
Ans:
If the firm can perfectly price discriminate, it will produce quantity QC and extract all
of the consumer surplus. Consumer surplus is zero and producer surplus is A + B + C
1

+ D + E. Total surplus is also A + B + C + D + E. The deadweight loss is reduced to

zero. There is a transfer of surplus from consumers to producers of areas A + B.

2.

Recent rainstorm has destroyed part of the vegetables in the Pearl River Delta. How
does it affect:
(a) the price of vegetables;
Ans:
Since rainstorm has destroyed part of the vegetables in the Pearl River Delta, the
supply of vegetables declines, so the price of vegetables rises.

(b) the marginal product of the vegetable growers; and

Ans:
Since there are fewer vegetables in a given area of the field due to rainstorm, the
marginal product of vegetable grower declines.

(c) the marginal revenue product of the vegetable growers.

Ans:
Marginal revenue product (MRP) is equal to price times marginal product. Since the
price of vegetables rises and the marginal product of vegetable growers declines, the
marginal revenue product of vegetable growers could rise or fall, depending on
whether the marginal product falls more or less than the price rises. If the marginal
product falls more than the price rises, MRP will fall, and vice versa.

3.

Substantial foreign capital has been flowing into the mainland of China since the early
1980s, how does it affect the wages and workers employed in China? Explain with a
diagram.
Ans:

Capital inflow in China increases the stock of capital available for working with the
existing pool of labour in China, which increases the marginal product of labour. The
marginal revenue product of labour increases and the labour demand curve shifts
rightward. Both equilibrium wage and quantity of labour will rise.
Figure 3.4

4.

Suppose you live in a university hall. You are a non-smoker but you share a room with
a smoker. Your roommate generates second-hand smoke which you dont like very
much. According to Coase theorem, how can you tackle this externality?
Ans:
According to the Coase theorem, you and your roommate will bargain over whether
your roommate will smoke in the room. If you value clean air more than your
roommate values smoking, the bargaining process will lead to your roommate not
smoking. But if your roommate values smoking more than you value clean air, the
bargaining process will lead to your roommate smoking. The outcome is efficient as
long as transaction costs do not prevent an agreement from taking place. The solution
may be reached by one of you paying off the other either not to smoke or for the right
to smoke.

5.

(a) Explain with a diagram how the bubble gum market may create negative
externalities.
Ans:

Bubble gum may exhibit negative externalities because individuals chewing it may
disturb others by blowing bubbles, chewing the gum noisily, or making the streets
dirty.
Figure 3.5

Figure 3.5 illustrates the negative externality from bubble gum. Notice that the social
cost curve is above the supply curve and the social value curve is the same as the
demand curve.
The market equilibrium level of output is denoted Qmarket and the efficient level of
output is denoted Qoptimum. The quantities differ because in deciding to buy bubble
gum, people don't account for the costs they impose on other people.

(b) If the external costs of each pack of bubble gum are $0.5, describe a policy that would
result in the efficient outcome.
Ans:
A government policy that would result in the efficient outcome would be to tax people
$0.50 for every pack of bubble gum they buy. This would shift the supply curve up to
the social cost curve, and the market quantity would decrease to the optimum quantity.

6. The Consumer Council regularly tests the safety of consumer goods and the test result is
released on the web to the public free of charge. Does this information qualify as a
public good? Why or why not?

Ans:
The information is nonexcludable, because it is provided to the public free of charge.
In addition, the receipt of the information by one individual does not preclude the
receipt of the information by another. Thus, the good is nonrival in consumption. Since
the good is both nonexcludable and nonrival in consumption, it is a public good.