Examination Tips

HKCEE F 4 Economics

 

 

 

 

 

 

 

 

 

 

 

 

Topic 6: Market Intervention

 

To a great extent, market relies on the price to

allocate scarce resources. However, the government

may intervene with the market in order to achieve

certain goals. If the market exchange is not allowed,

other non-price competition will be used to allocate

scarce resources. In this chapter, we will see how

the government intervention like the price controls

(price ceiling and price floor), quantity control

(quota), taxation and subsidization affects the

allocation of scare resources.   

 

This topic is very important in the public examination.

Students should understand each form of market intervention,

verbally and graphically and its effects. Moreover, students must

study this topic, topic 4 and 5 at the same time. This is because

many questions in CE are associated with what total revenue

changes or how the price of substitutes or complements changes

when there is market intervention on one good.      

 

6.1. Price Control (1): Price Ceiling *****

                   ( 91, 93, 94, 95, 99, 01)

   

   Price ($)                            S 

              D                        

 

       Pe

       

       Pc

 

         0        Qs    Qe     Qd          Quantity

                 Figure 1 Effects of price ceiling

     

      Price ceiling set by the government means that it

      sets a maximum controlled price on a good.

      Then the sellers are not allowed to charge

      higher than that price ( Pc in figure 1).

 

      The effects on price , quantity transacted,

      quantity demanded, quantity supplied

       & Total revenue ( Figure 1):

     1. Price will fall from Pe to Pc

     2. Quantity transacted will fall from Qe

       to Qs.

     3. Quantity demanded will increase from

       Qe to Qd.

     4. Quantity supplied will fall from Qe

       to Qs.

     5. Total revenue ( Price X Quantity transacted)

       will fall from Pe X Qe to Pc X Qs

 

     Remarks

    1. Effective Price ceiling VS Ineffective Price ceiling

         

   Price   D                            S

P1

 

P0

 

 

     S                     D

         0         Q1       Q0    Q2         Quantity

               Figure 2 Effects of Ineffective price ceiling

 

       Effective Price ceiling means the maximum

       price set below the equilibrium level which

       results in shortage.

      

       Ineffective price ceiling means the maximum

       Price ( P1 in figure 2) set above the

       equilibrium price ( P0 in figure). It

       results in surplus at which quantity

       supplied ( Q2) is larger than quantity

       demanded (Q1).

 

       Effective Price ceiling would lead to

       quantity transacted and market price

       to fall. However if there is ineffective

       price Ceiling, market Price ( P0)

       and quantity transacted (Qo)

       remain unchanged.

 

    2. Effective price ceiling leads to non-price competition

      When there is price ceiling, seller cannot raise the price.

      Other non- price methods are needed to allocate the

      Resources. These methods can be :

(a) First come, First served ;

      (b) Drawing lot

 

    3. The maximum price control will give rise to a black

      market in which goods are sold illegally at prices

      higher than the regulated price.

 

    4. Case Study of Price Ceiling: Overcrowding in MTR Trains

 

 

 

 

                   

   Price($)     D       S          Price($)       D      S 

 

                                        Pb

        Pa                              Pa                           Peak congestion fare (Pb-Pa)    

 

 

          0          Q1    Q3      Q     0         Q1  Q2  Q3

   Figure 3 excess demand of MTR under rush hours       Figure 4 One way of reducing overcrowding:

                                                           imposing peak-hour surcharges

 

       During the rush hours, the number of passenger is greater

       than the maximum capacity of the MTR service. This

       leads to the overcrowding condition.

      

 

       Overcrowding in MTR trains means there is

       excess demand of MTR service. Graphically, fares

       (Pa) are below the equilibrium at which quantity

       demanded (Q3) is greater than quantity supplied (Q1).

       Supply of the MTR Service during the peak hours

       should be vertical ( Figure 3) because

       MTRC cannot increase more of quantity of the

       MTRC service supplied where the maximum

       capacity is reached.

 

       In order to have less overcrowding of passengers

       during peak hours, peak congestion fare

       ( Pb-Pa in Figure 4) is needed to add

       to the normal fare ( Pa in Figure 4)

       As a result, fares will rise from Pa to Pb. The

       Quantity of the MTR service demanded by

       The passengers decrease from Q3 to Q2.

       The extent of excess demand is lessened

       From Q3-Q1 to Q2-Q1( Figure 4 ).

       There will be less overcrowding

       during rush hours.       

 

      Examination Tips on 6.1:

     1.Examination Records.

(a)   In CE, students were asked to use

Demand-supply diagram to describe

Shortage situation

 

        (b) Questions were also associated with how total

           Revenue changed when price and quantity

           Transacted changed.

 

        (c) Students were also examined to explain how

           price and quantity transacted when ineffective

           price ceiling was imposed.

            

       2. Student’s weakness in CE

(a)  They weren’t aware that the question were

About the shortage concept.

(b)  They wrongly thought that change in

            total revenue solely depended on

            the price elasticity of demand.

(c)  Students didn’t know what was effective

Or ineffective price ceiling and their

Implications to price and quantity

Transacted.

 

      3. Study Guide

         Make sure that you have a clear understanding

         about shortage, excess demand and price

         ceiling, so you can apply them to real situation.

         Price Ceiling set by the government is the

         maximum price of the good. It is effective

         when it is set below the market clearing price.

        

         Shortage (excess demand) is quantity

         demanded greater than quantity

         supplied at a price below equilibrium

         level. There is no tendency for price to

         change because of price ceiling.

     

         Change in Total revenue have nothing

         to do with the price elasticity of demand

         when price and quantity transacted changes

         in the same direction. However, if price

         And quantity transacted changes in opposite

         directions, we should consider the demand

         elasticity.

 

         In addition, you must understand what is

         effective price ceiling and what is not.        

 

6.2. Price Control (2): Price floor******( 96, 97, 99, 01 )

   

  Price($)      D           

         Pf                          S

 

         Pe 

 

 

 

           0       Qd   Qe      Qs         Quantity

                  Figure 5 Effects of price floor

 

      Price floor set by the government means that it

      sets a minimum controlled price on a good.

      Then the buyers are not allowed to pay less

      than the minimum price ( Pf in figure 5).

 

      The effects on price , quantity transacted,

      quantity demanded, quantity supplied

      & Total revenue ( Figure 5):

      1. Price will rise from Pe to Pf

      2. Quantity transacted will fall from Qe

        to Qd.

      3. Quantity demanded will fall from

        Qe to Qd.

      4. Quantity supplied will increase from Qe

        to Qs.

      5. Total revenue ( Price X Quantity transacted)

        will increase or decrease depending on

        the price elasticity of demand. If it is

        elastic, seller’s total revenue will

        fall. If it is inelastic, his total revenue

        will increase. However, if the government

        buys the surplus, seller’s total income will

        Increase.

     

      Examination Tips on 6.2:

     Please refer to Topic 4, Examination Tips on 4.15.

 

6.3. Effects on the removal of price control on Total Revenue

    ***(91, 95)

    1. Total revenue increases after the removal of price ceiling

       

    Price($)      D                   S

 

        Pe

 

 

        Pc

 

        0          Qs     Qe       Qd           Quantity

               Figure 6 the removal of price ceiling

 

      The price ceiling (Pc) leads to the excess demand at

      which quantity demanded (Qd) is greater than

      quantity supplied (Qs), that is also quantity

      transacted. Thus total revenue is Pc X Qs.

 

      After the removal of price ceiling, the price

      Will go back to the equilibrium level. The

      quantity transacted and market price will

      increase to Qe and Pe respectively. The

      total revenue will increase from Pc X Qs

      to Pe X Qe.      

 

     2. Total revenue increases or decreases after the removal of price floor

       

      Price      D                   S

         Pf       

      

         Pe

 

      

 

        0           Qd    Qe  Qs                Quantity

                Figure 7 the removal of price floor

 

      The price floor (Pf) leads to the excess supply at

      which quantity supplied (Qs) is greater than

      quantity demanded (Qd) which is also quantity

      transacted. Thus total revenue is Pf X Qd.

 

      After the removal of price floor, the price

      will go back to the equilibrium level. The

      quantity transacted will increase from

      Qd to Qe but market price will decrease

      from Pf to Pe. The total revenue will increase

      or decrease depending the price elasticity of

      demand. If demand is elastic, the total revenue

      will increase. If demand is inelastic, total

      revenue will decrease.   

     

      Remarks:     

    Change in Total revenue have nothing

      to do with the price elasticity of demand

      when price and quantity transacted change

      in the same direction. However, if price

      and quantity transacted change in opposite

      directions, we should consider the demand

      elasticity.    

 

      Examination Tips on 6.3:

     1.Examination Records.

      In CE, students were examined to explain

        how total revenue changed when there was

        removal of price ceiling

                       

       2. Student’s weakness in CE

They wrongly thought that change in

         total revenue solely depended on

         the price elasticity of demand.

 

     3. Study Guide

         The total revenue will increase

         or decrease depending the

         price elasticity of demand.

 

6.4. Quantity Intervention: Quota ****(97, 98, 01)

   A quota is a limit placed on the maximum quantity

    of goods that are sold. This means sellers are incapable of

    of selling more that amount.

 

   1.A kinked supply curve and Quota:

 

  Price($)    D           S1 ( kinked Supply)

                                              S2

      P1

      P2

      P3

 

              S1                              D

         0             Q1   Q2                     Quantity

                 Figure 8 A kinked supply curve and Quota

 

     If a quota is imposed, supply curve(S2) will become

     a kinked supply. The reason for that is:

     as the government set a quota at Q1, the

     seller can increase quantity supplied

     when prices are below P3. When price

     at P2, quota keeps the quantity

     supplied remain unchanged. If the

     price increases to P1, the quantity

     supplied also remains unchanged.

     That is why supply curve becomes

     a kinked supply curve when a quota

     Is imposed.

   

   2. The effects on Quantity demanded, Quantity

     supplied, Quantity transacted , quality change

     of a good and total revenue ( figure 8) :

     (a) The quantity demanded will fall from

       Q2 to Q1.

     (b) The quantity supplied will decrease

       from Q2 to Q1.

     (c) The quantity transacted will decrease

        from Q2 to Q1.

    (d)Total revenue will increase or decrease

depending on the price elasticity of

demand since the price of good

increases but the quantity transacted

decreases.  

   (e) Quality of a good will be improved

      since a quota sets the maximum

      quantity of goods the producers

      can buy. As the quantity of a

      good is restricted, the producers

      would improve the quality of goods

      so that a higher price can be set on

      their goods

 

      Examination Tips on 6.4:

     1.Examination Records.

      (a) In CE, students were examined to show

           graphically & verbally, the effects of

           quota on the market price

           of and the quantity of import.

 

        (b) Questions also were associated with what

           the effective quota was.

     

      2. Student’s weakness on CE

        They knew the effects of Quota on the market

        price of and quantity of import. But they didn’t

        what the effective quota was.

            

    3. Study Guide

       (a) The effective quota is imposed to make sure

          that new quantity transacted is lower than

          the equilibrium quantity transacted before

          the quota is imposed. 

 

       (b) Students must be able to describe the

          effects of quota, verbally and graphically.    

          Moreover, notice that how the effects

          Of quota of one good affects the price

          Of its substitutes and complements.

   

6.5. Unit Tax****(91, 92, 93, 97, 01)

  1. What is Unit Tax?

     If the same amount of tax is imposed on every

     unit of the goods , then that tax is called

     Unit/per-unit tax.

 

  2. The effects on Quantity demanded, Quantity

    supplied, Quantity transacted, Tax burden,

    consumer’s burden & seller’s burden

    (figure 9) :

            

            Consumer’s Burden  

  Price($)                                 S2

             D                            

                                              S1

      P1                                 

      P2                                   Tax Rate

      P3

 

                                              D

         0             Q1   Q2                     Quantity

        

           Seller’s Burden

                 Figure 9  Effects of per-unit tax

 

      As per-unit tax is imposed, the supply curve will shift

      leftwards. Its effect is:

(a) Quantity demand, Quantity supplied and

quantity transacted are the same( Q2)

and they are reduced to Q1.

(b) The market price will increase from

P2 to P1.

(c) Tax burden is created. Tax burden is

Tax rate X quantity transacted.

      (d) Consumer’s Tax burden is

         (P after tax – P before tax) X Quantity Transacted.

         This means that (P1-P2) X Q1 in Figure 9.

(e) Seller’s Tax burden is

         (P before tax – P net of tax) X Quantity Transacted.

         This means that (P2-P3) X Q1 in Figure 9.

 

   3. The determination of the share of tax burden between

     producers & consumers: The extent of the distribution

     of tax burden is dependent of the price elasticity of

     demand and supply.

 

     There are two basic conditions to be considered:

(a) If Elasticity of demand(Ed) is greater

than elasticity of supply(Es). This

means the consumer burden is

less than producer burden.

     (b) If Elasticity of demand(Ed) is less

Than elasticity of supply(Es). This

Means the consumer burden is

        greater than producer burden.

  

     Examination Tips on 6.5:

     1.Examination Records.

      (a) In CE, students were examined to show,

           verbally and graphically, how unit tax

           will affect the equilibrium price and

           quantity of a good and substitutes.

                  

        (b) They needed to show how tax burden

           was shared between sellers and consumers,

           graphically and verbally.

 

      2. Student’s weakness on CE

        The performance was good but they made a mistake

        to show consumer’s and producer’s burdens in graphic

        Diagram. 

    

    3. Study Guide

        (a) You must know how the tax burden is shared between

           sellers and buyers, graphically and verbally.

           Please refer to Section 6.5, Point 2.

 

        (b) You must know how the effects of unit tax of one good

           affect the price of its complements and substitutes.   

 

6.5. Unit Subsidy**

    1. What is Unit Subsidy?

      The same amount of subsidy

      is imposed on every unit of 

      goods in order to encourage production. 

    

   2. As per-unit subsidy is imposed, the supply curve        

     will shift rightwards( Figure 10). Its effect includes:

       

           Producer’s Benefit  

  Price($)                                 S1

             D                               S2

      P1                                      

      P2                                         Subsidy rate

      P3                                       

 

                                        D

         0             Q1   Q2                     Quantity

        

           consumer’s Benefit

           Figure 10 Effects of per-unit subsidy

 

    (a) Quantity demand, Quantity supplied and

       Quantity transacted are the same( Q2)

       And increase to Q2.

    (b) The market price will decrease from

       P2 to P3.

    (c) The amount of Subsidy is created. It is:

       Subsidy rate X quantity transacted.

       (P1-P3) X Q2 in figure 10.

    (d) Consumer’s Benefit is

       (P2 – P3) X Quantity Transacted.

       in Figure 10.

(e) Producer’s benefit is

       (P1 – P2) X Quantity Transacted.

       in Figure 10.

 

 3. The determination of the share of subsidy between            

   producers & consumers: the extent of the distribution

   of subsidy is dependent of the price elasticity of

   demand and supply.

 

     There are two basic conditions to be considered:

(a) If Elasticity of demand(Ed) is smaller

Than elasticity of supply (Es). This

means the consumer benefit is

greater than producer benefit.

     (b) If Elasticity of demand(Ed) is greater

Than elasticity of supply(Es). This

means the consumer benefit is

       less than producer benefit.

 

     Examination Tips on 6.5:

1. Examination Records.

No question set for section 6.5 in Paper 1.  

     

    2. Study Guide

        (a) Students is possibly examined how the subsidy is

           shared between sellers and buyers, graphically.

           and verbally, Please refer to Section F, Point 2.

 

        (b) Moreover, students are possibly examined how the

           Subsidy of the good affects the equilibrium price

           and quantity of complements and substitutes.