Name: George Lim Boon Khang

Student Id: U2003464/1

1.) In a situation where there is disparity between MSC and MPC or MSB and MPB for a
market at Q* level of production, what does this mean? Explain.
Answer: In this case, the disparity between MSC and MPC or MSB and MPB for a
market at Q* level of production is deadweight loss. The deadweight loss will exist when
there are positive or negative externalities due to the economy activities. However,
externalities can be positive when the action of one-party benefits to another party.
Conversely, externalities can be negative when the action of one party costs another party.
For example, there is positive externality when MSB is larger than MPB. The social efficient
production should be at Q* level of production where MSB = MSC. In this case, we can say
that deadweight loss will cause market inefficiency because nobody knows where is the loss
coming from when there is market failure.
2.) Externalities are one example of market failure. Provide one real case example to describe
externalities (what is the type of externalities and who are the parties involved in the
situation).

Practice - Market for Milk

Price $ Quantity of Milk Demanded Quantity of Milk Supplied

5 10 50
4 20 40
3 30 30
2 50 20
1 80 10
 

a.       Chart the supply and demand curve and mark the equilibrium point.

Ans:
b.       If suddenly the price raised to $5 and there is over supply of milk because customers
buy less milk due to high price. There will be surplus of milk. Mark the surplus area

Ans: Surplus area is AB.

c.       What if the price dropped to $1 and customers demand more quantity of milk but
producers limit their production? There will be shortage of milk. Mark the shortage area

Ans: Shortage area is CD.

d.       What will happen to demand, supply, price, and quantity of milk if the government
provides a subsidy to milk manufacturers.

Ans: If the government provide a subsidy to milk manufacturers, the cost of

production will decline. The manufactures will be happy and supply more milk even the price
increases. This is because they can afford the cost of production. The curve of supply of Milk
will shift to the right and the curve of demand of milk will remain same.

e.       What will happen to demand, supply, price and quantity of milk if the price of
substitute product (soya milk) decreases.

Ans: When the price of substitute product (soya milk) declines, the demand for milk
will decrease. This is because household preferred to buy the product where is lower price.
So, the curve of demand for milk will shift to the left and the new equilibrium point will
exist. The curve of supply of milk will remain unchanged.

f.        Assumes the price of a complement (cornflakes) decreases.

Ans: When the price of a complement (cornflakes) decreases, the demand of

cornflakes will be increased. Consequently, the demand of milk will also increase. This is
because the relationship between cornflakes and milk are positive. The curve of demand of
milk will shift to the right and the supply curve of milk will remain unchanged. The new
equilibrium point will shift upward.

g.       There is a recession and incomes fall (assume that milks are a normal good)

Ans: When there is a recession and incomes fall, consumers are unable to purchase
normal good. This is because the purchasing power of consumers is decreased. Besides that,
firms will also go bankrupt due to the state of the economy declines. In this case, we can say
the demand curve of milk and the supply curve of milk will shift to the left simultaneously.
The equilibrium price remains unchanged, and the equilibrium quantity of milk will decrease.