Chapter 1, Problem 1FQ

Step 1/2
Goods and services in all the countries are produced by public sector as well as private sector.
Public goods are those goods which are non-rival as well as are non-excludable, that is, use of
good by one does not decrease the availability of goods to others, and it is not possible to stop
the person from using the good even when he is not paying for the good. Private goods are
mainly those goods which are rival as well as excludable.

Step 2/2
When there is intervention of government then there is generation of inefficiency which leads to
dead weight loss in the economy. The main central questions that concerns the economics of
public sector are as follows:

• What goods and services should be produced by public sector and what should be produced
by private sector?

• How goods or service should be produced by government? They decide whether to utilize
private-public partnership, or should be produced using capital of government only, etc.

• The public good produced by public sector should focus on all or some special groups like
poor, industries, old, etc.

• The decision in public sector is result of collective decision making. So last question is how the
decision of proper utilization of resources in public sector should be made?

Chapter 1, Problem 1QP

Positive statements are those which are based on facts and normative statements are those
things that is ought to be. Here, the statement (a) is normative where the author is just telling
about the things that he thought should happen, while statement (b) is positive because they are
based on actual facts and numbers.

It can be seen that there is disagreement between both the statements. The source of
disagreement here is about objectives. The objective of first statement is to provide price
subsidies while the second statement is about problems with first approach and suggestion to
provide direct money to farmers.

It also talks about the difference in nature of economy as per their perception like one thinks that
help by government effects everyone equally while some think that the benefits of programs of
government do not reach every one equally.

Chapter 1, Problem 2FQ

There have been varieties of views regarding the economic role of government. Starting with
eighteenth centuries, the view was that government should intervene and promote trade. This
was the time when industrialization has started in many countries and lacking any precedence,
business community was seeking support business and regulatory support from the
government.

Then next idea was that when businesses are driving themselves and profit is the motive behind
all then the growth in economy would be maximum. The reason was that after increase in
government intervention, there was decline in business and economic efficiency as government
involvement was more than needed.

After that came the era where there was mix of economists where some believe that
government should intervene because of social reasons like maintaining increasing inequality,
providing public goods, etc. Since, there have been several changes in government stance of
involvement i.e. it has produced certain goods and then they privatized those institutions,
regulating and deregulating industries, etc.

Chapter 1, Problem 2QP

Step 1/13
The economic growth and uplift of society in a country is taken care by the government of the
country. In order to serve better to the citizen, many of the government policies run in the
country. It could be health facility, unemployment allowance and many other services are
provided by the government to make the society better.

Step 2/13
When government of a country enact a law (especially to make the economy better off) the
outcome of this action impact other field in positive or negative term. This is called unintended
consequences.

Step 3/13
a.

Rent control is made through government intervention. In order to control rent prices,
government fixes the highest price of rent (i.e. price ceiling) that an house owner can charge.
The consequence of this would result in lower rent prices and higher demand for houses but
owner would not be willing to give their houses on rent.

Hence the demand for houses for rent increases but the houses for rent supplied decreases.
Step 4/13
b.

Minimum wage is also decided by the government of the country. This means that the employer
must be given the wages decided by the government and not less than that. The imposed rate if
greater than market equilibrium wage rate, this would increase the wage rate and so would be
the supply of labour in the market. While on the other hand employer would not be willing to hire
more of the labour at this cost.

Hence price floor results in higher unemployment.

Step 5/13
c.

Medicare would lead to a problematic situation. The lifestyle of aged people would be careless
as they know that the medical bills related to their health as it would be paid by the insurance
company. Hence this would create extra financial burden on the insurance companies.

Step 6/13
d.

In any country, city is supposed to be the most developed area as compared to suburb regions.
This is the reason why people migrate to city leaving their houses in order to live a better
lifestyle. Connectivity to city from suburb area would result in higher level of migration of people
to the city and this would increase the demand for houses in the suburb, increasing demand
would increase the construction and would also put pressure on the city in terms of noise, air
and water pollution.

Step 7/13
e.

Centralization of central city schools would result a single nature of school. But the demand for
private schools would increase as people would think of better education quality would be
gained by making the admission of their children in public school and it would result in increased
private schools.

Step 8/13
f.
The purpose of agriculture price support was to uplift the lifestyle of farmers. The consequences
would result in higher production of crop by farmers and this increases the total supply of
agriculture product in the market. Increased supply and lower demand would result in lower
price of the agriculture produce.

Step 9/13
g.

In order to save the non-renewable energy sources, the speed of vehicle with maximum speed
of 55 kilometer per hour is set. This would not be beneficial for people having vehicle or
travelling with it. This would also consume their time and hence they would opt for the faster
commute option. This would reduce the demand for the gasoline.

Step 10/13
h.

The expenses of the parent would be increased in order to get their child insured (i.e. who is
currently underinsured). Parents would be willing to get their child insured with the scheme first
and they could even avoid their own insurance.

Step 11/13
i.

Banning the advertisement of cigarette would not make aware people about the challenges they
could face by its consumption. On the other hand, people working in the cigarette manufacturing
company would be unemployed due to lower level of sales. The health industry would grow as
the patient with respiratory problem would be increased (government spending increases
through social security system).

Step 12/13
j.

National testing standards for schools would result in reduction of the kind of schools that was
not practicing the standard level of education system. The imposition of national

Step 13/13
testing standard would reduce the number of schools practicing unfair education system. The
reduction in number of schools would further reduce the revenue for the central or state or local
government.

Chapter 1, Problem 3FQ

It is true that government intervention leads to decline in economic efficiency; however it is also
true that government intervention is very necessary for social and regulatory reasons. So, there
need to be balance and for that economist need to study the economics of public sector. The
various steps in study of economics of public sector are as follows:

• Economist and regulators need to evaluate and decide on the different alternatives for which
government should intervene and also the aspect of intervention.

• Understanding and evaluating the outcomes of the government activities and intervention.

• All the policies that are an alternative should be evaluated.

• Then the political concerns, aspirations and effect of these policies are evaluated and
interpreted.

Chapter 1, Problem 3QP

Step 1/6
Any plan in the country is developed based on some facts, collected using past data and taking
future consequences into consideration.

Step 2/6
In economics, normative analysis indicates ‘what should be’ done to make the situation better
off while on the other hand, positive analysis indicates ‘what is’ the current scenario.

Step 3/6
Hence both of the economic analysis has its own importance in order to make the society better
off and it also highlights some of the facts that could be considered for the improvement of the
policy in near future.

Step 4/6
Normative statement:

The social security is the facility given to the weaker section of people and they are categorized
in terms of age starting from 60 years and more. The social security is funded by the
government (i.e. funding is done from the revenue generated from levying taxes). The social
security should be given to people with age group 60 years and plus and the benefit should not
be lowered.

Step 5/6
Positive statement:

The social security benefits the weaker section at present in the way that it would help the
country grows as the social security would itself advocate the social development in the society
and other countries in the world would get a good message from this country.

Step 6/6
Challenge of money for the government:

The fact is very true and clear that providing social security to the needy people would increase
the burden of the budget for the government. On the other hand, it is a non-profit deed for the
government as it does not generate any revenue.

Further, providing a higher level of benefits like pensions would even be reducing the GDP of
the country.

Thought it could be a loss to the government yet a citizen of the country is benefited and brings
prosperity in the society.

Chapter 1, Problem 4FQ

When government wants to implement or enforce some policy then there are many alternatives
for that policy and economists seldom agree about the effects of these policies. The two main
sources of such disagreement between economists are as follows:

• The first source is that economists are not able to agree upon the behavior of the economy
when some policy is implemented. For example, for a health policy, some economist think that it
would increase the burden on private insurance because of moral hazard while other think that it
will reduce burden on private insurers.
• The second source of disagreement is on the basis of values. For example, one economist
would see that social welfare programs are loss of efficiency while others would say that it is
necessary as social goods supersede economic loss.

Chapter 2, Problem 1FQ

Step 1/2
The government sector is responsible for creating welfare in the economy. It gains its revenue
primarily through taxes.

Step 2/2
There are many roles of government, and some of those are as follows:

• Government is the one which makes laws and regulation which make the legal structure of the
country.

• Government tries to manipulate several industries in economy by either taxing them or giving
subsidies.

• It provides goods and services to people and also take care of the public goods.

• Government also acts as purchaser of goods and services like buying construction material
and construction services for infrastructural development, giving salaries to government
employees, etc.

• Government tries to maintain equality in economy by redistributing income through way of

imposing taxes.

• Government runs social welfare programs for needy people like poor, old, sick, etc.

Chapter 2, Problem 1QP

Step 1/3
Government has some primary roles to play which provide the legal framework within which all
economic transactions occur. There are four activities of government; these activities are
production of goods and services, regulation, and subsidization or taxation of private production,
the purchase of goods and services and redistribution of the payment. These four components
the most convenient way to manage the vast area of government activities, but the nature of the
government expenditure
Step 2/3
The adjustment that government makes in looking at education expenditure be the redistribution
of the resources. But for the best result government should expense on the production of
education opportunities. Rather distribution resources with in the sector. So the government
might adjust the distribution of resources for producing new employment opportunity.

Step 3/3
Social security always focuses on the middle income group. Government should adjust social
security by focusing all income groups, because social security should require for all. The
benefit of social security should be adjusted not only basis. Of needs but also the beneficiaries
fulfill certain others eligibility criteria’s

Chapter 2, Problem 2FQ

Step 1/4
Goods and services in all the countries are produced by public sector as well as private sector.
Public goods are those goods which are non-rival as well as are non-excludable, that is, use of
good by one does not decreases the availability of goods to others, and it is not possible to stop
the person from using the good even when he is not paying for the good. Private goods are
mainly those goods which are rival as well as excludable.

Step 2/4
The major expenses made by government are as follows:

• Social security payments made to retired old people.

• Interest payment made on government debts.

• Subsidies provided by government to different programs.

• The purchase for defense and military purposes.

• All other purchases made by government for various other purposes.

• The payments made for education field related programs by the government.

• All types of other transfer payments from government like unemployment benefit, child care,
etc.
Step 3/4
It has been seen that defense expenditure has decreased over time from 10 percent of GDP in
1967 to 3.7 percent of GDP by 2000 of country U. However, there was little increase in defense
expenditure as percent of GDP by 2010 because of disputes with some countries. There has
been continuous increase in public expenditures i.e. transfer payments and interest payment. It
was 9 percent of GDP in 1930 and increased to 36 percent of GDP by 2009. The reason was
that there was introduction of several new programs and increasing debt led to increase in
interest payments.

When compared to government expenditure of other countries especially the developed ones,
the government expenditure of country U is less in comparison to most.

Step 4/4
The expenditures of federal government are interest payments on federal debts, expenditure on
national defense, several social and welfare programs as run by federal government like social
security, health programs, etc. The expenditures of state and local government are expense on
education, that is, elementary, secondary as well as higher education, state and local
infrastructure development programs, expenditure on local and state police, and several health
and welfare programs as run by state and local government.

Chapter 2, Problem 2QP

Step 1/8
Government has some primary roles to play which provide the legal framework within which all
economic transactions occur. There are four activities of government; these activities are
production of goods and services, regulation, and subsidization or taxation of private production,
the purchase of goods and services and redistribution of the payment. These four components
the most convenient way to manage the vast area of government activities, but the nature of the
government expenditure is ambiguous.

Step 2/8
(a)

For education sector the government plays the role of a regulator. Government regulates
resources (human resource to education sector) for example, if government provides aid to the
infrastructure of the educational institution. That means, government regulates the money on
that sector.
Step 3/8
(b)

Government plays a role of purchaser of final goods and services directly. For example
government can purchase a product or services by using this product and service, people can
maximize its utility.

Step 4/8
(c)

Transportation is the service which is provided by the government. Government here plays the
role of the regulator. For example, government provides public transport for helping travailing as
well as transporting goods and services

Step 5/8
(d)

In credit market government plays a role of producer. For example the government provides
credit to firms at low level of interest rate, so they can now produce goods and services that will
reflect on the national income.

Step 6/8
(e)

In insurance market, government plays a role of a purchaser of service. The government can
purchase insurance. But in some situation government can regulate insurance service to the
public.

Step 7/8
(f)

In case food market, the government plays a role of regulator. The government regulates the
total amount of foods grains among the population through rationing.

Step 8/8
(g)
In case of housing, government should play double role of producer and regulator. Government
provides a house building to the resident and distributes these buildings according to all income
groups

Chapter 2, Problem 3FQ

Step 1/5
Government has some primary roles to play which provide the legal framework within which all
economic transactions occur. There are four activities of government; these activities are
production of goods and services, regulation, and subsidization or taxation of private production,
the purchase of goods and services and redistribution of the payment. These four components
the most convenient way to manage the vast area of government activities, but the nature of the
government expenditure is ambiguous.

Step 2/5
The government can finance its expenditure through taxation. Government can impose tax (both
direct and indirect) on the production units for goods and services. Tax receipts help the
government to maintain its expenditure. In economy at the equilibrium government expenditure
must be equal to tax. So government expenditure always is financed by the taxation.

Step 3/5
The sources of tax revenues for national government include income tax (individual) payroll
taxes, corporate tax and agriculture income tax. These taxes are imposed by national
government and tax revenue must be financed to central government expenditure.

Step 4/5
The sources of tax revenues for state and local government include sales tax, stamps and
registration duty, state excise duty, motor vehicles tax. These taxes are imposed by local and
state government and tax revenue must be financed to local and state government expenditure.

Step 5/5
Taxes have changed over time due to financial condition of the economy. Government can
subsidies the production sector to increase the total production and then government imposes
taxes on the production sector for financing government expenditures.

Chapter 2, Problem 3QP

a.

Here, the health care programs which are run by government are example of conventional
expenditure because these were the direct expenses made by the government. When people
make medical expenses and then reduce this amount from taxable income as itemized
deduction then that is tax expenditure. If the medical expenses made by individuals is not
allowed to be deducted as deductions, but government provides cash reimbursement for such
expenses which is equal to tax reduction amount then it can be seen that tax expenditure gets
converted to conventional expenditure.

Step 3/4
b.

The expenditure made by government to provide cheaper accommodation to people by either

selling houses at cheaper rate or by providing subsidy for rent payment, is example of
conventional expenditures. There is provision in tax structure where the mortgage interest paid
could be deducted from taxable income which is an example of tax expenditure. Now, if
government provides subsidies in interest rates instead of giving deduction for mortgage interest
then this tax expenditure converts to conventional expenditure.

Step 4/4
c.

The public schools that are run by government are example of conventional expenditure
because these were the direct expenses made by the government. When government provides
tax exemption to privately-funded schools then that is tax expenditure. Now, if government
provides subsidies to private schools instead of giving them tax exemption then it can be seen
that tax expenditure gets converted to conventional expenditure.

Chapter 2, Problem 4QP

Step 1/3
Public finance is the part of the subject which explains the role of the government in the
economy. It is the part of economy which helps to assess the government revenue and
expenditure of the authorities. Activities of the government take place at several levels deferral,
state and local. The primary role of the government is to provide the legal procedure in which all
economic transactions take place.
Step 2/3
If there arises budget deficit, the government should take action by sustaining same level of
government expenditure. In that situation government should borrow from other country or else
government can borrow from public. That is known as public debt. Government can sell bond
paper to the public in return; government can earn money to overcome the budget deficit. But
when the government would able to get budget surplus, government would then purchase bond
paper from public.

Step 3/3
Government would promise to keep down government expenditure 3% for sustaining growth
rate. But in reality, the expenditure would increase to 5%. To keep the growth rate same, the
government should reduce the government expenses. To reduction the government
expenditure, the government would increase rate of interest. That means people now hold more
money more than before. The level of investment expenditure would decrease as rate of interest
increases. Due to this, the aggregate demand would reduce; it would lead the result of
decreasing government expenditure

Chapter 3, Problem 1FQ

Resources are scarce so economics becomes the study of choices which would lead to optimal
utilization of resources. The economy is in efficiency when there is Pareto optimality i.e.
resources are utilized in such a way that no one could be made better off without making
someone else worse off. This is when economy is said to be efficient or Pareto efficient. In such
condition there are no deadweight losses, the economy is performing at long-term stability.

So, this is possible when the increase in cost because of production of one additional unit of
good and service is equal to increase in revenue from that additional unit of good and service. It
means that economy is efficient when marginal cost of production is equal to marginal revenue.

Chapter 3, Problem 1QP

Step 1/4
The market is said to be efficient when the production of commodity and the distribution of the
resources are optimal. It means that there is no undervalued or overvalued situation for
consumers, producer or government. It states that everyone is better off in society.

Step 2/4
Setting the price for different class:
The airline can consider two passengers differently based on the classes they have chosen.
There have been generally two sorts of classes in the airline. One is considered as economy
class and another one is premium class or business class. Hence passenger opted for the
economy class has comparatively lower prices than that of business class.

Step 3/4
Facilities provided to both sorts of passengers:

Passenger opted for the business class gets the comfortable seats as compared to that of
economy class. He is given a superior facility as compared to the passenger who opts the
economic class.

Step 4/4
Exchange efficiency:

Even being in different classes, both of the passengers have a common washroom to use. They
even have the same food that is served. Hence the passenger who opts for the business class
would think that even after paying higher prices for the seat, he is not getting a special benefit.
The airline experience benefits from receiving higher prices for the business class while the
passenger would experience a loss.

Chapter 3, Problem 2FQ

Resources are scarce so economics becomes the study of choices which would lead to optimal
utilization of resources. The economy is in efficiency when there is Pareto optimality i.e.
resources are utilized in such a way that no one could be made better off without making
someone else worse off. So, this is possible when the increase in cost because of production of
one additional unit of good and service is equal to increase in revenue from that additional unit
of good and service. It means that economy is efficient when marginal cost of production is
equal to marginal revenue.

The conditions of efficiency are as follows:

• Exchange efficiency: The goods and services produced in the economy should be used and
consumed by those who assign highest value to those products. So, the marginal rate of
substitution between goods will be equal.
• Production efficiency: The production set should be such that it is not possible to raise
production of one good or service without compromising the production of other good or service.
The marginal rate of technical substitution between inputs will be equal.

• Product mix efficiency: The product mix the production quantity should correspond to the
demand or desire of that good by people. Marginal rate of substitution and marginal rate of
transformation will be same.

Chapter 3, Problem 2QP

Step 1/3
The exchange efficiency indicates that there could be no trade between parties. One party could
not be better off without making another party worse off. The benefit would be enjoyed by an
only single party.

Step 2/3
Doctor’s fee:

A doctor can charge a fee depending upon his willingness. He can charge the amount as per
the capacity of the patient. As per his own decision, he could make the profit and would not be
worse off if charges minimum fee from the people, unable to pay.

Step 3/3
The implication of exchange efficiency:

As per the concept of exchange efficiency, there could be no trade between the parties. In the
case of the doctor’s fee, both of the parties benefit or sometimes it exhibits that the nature of the
transaction is of mixed efficiency.

Hence, considering the above case it is understood that the doctor’s fee is not coming under the
exchange efficiency

Chapter 3, Problem 3FQ

Step 1/4
Marginal rate of substitution for public goods is equal to the units of private goods which all
individuals are ready to give up in exchange for one unit of public good. Marginal rate of
transformation is number of units of private goods needed to be sacrificed for production of one
unit of public good.

Step 2/4
The conditions of efficiency are as follows:

• Exchange efficiency: The goods and services produced in the economy should be used and
consumed by those who assign highest value to those products. So, the marginal rate of
substitution between goods will be equal.

• Production efficiency: The production set should be such that it is not possible to raise
production of one good or service without compromising the production of other good or service.
The marginal rate of technical substitution between inputs will be equal.

• Product mix efficiency: The product mix the production quantity should correspond to the
demand or desire of that good by people. Marginal rate of substitution and marginal rate of
transformation will be same.

Step 3/4
In case of a competitive market the economy is efficient because all the three mentioned
conditions are fulfilled in competitive market. Here, the marginal rate of substitution is always
equal to price ratio because till the time they are different someone is earning benefit, so he will
keep consuming more till the time marginal rate of substitution is same as price ratio. This will
fulfill the condition of exchange efficiency because now the marginal rate of substitution is same
for all goods.

In a competitive industry the price of input resources are same for all the firms so the price ratio
will be equal for all the firms which will be equal to marginal rate of technical substitution for
inputs, so condition of production efficiency is fulfilled in competitive markets.

It is known that in a competitive industry, the marginal rate of substitution is equal to price ratio.
Now, the marginal rate of transformation will also be equal to price ratio because if there is
benefit in any one good then there will be increase in supply as more firms will enter and it will
keep happening till the time marginal rate of transformation is equal to price ratio. So, in
competitive industry, marginal rate of substitution is equal to marginal rate of transformation
which is condition for product mix efficiency.

Step 4/4
Besides, in a competitive industry, no firm can a charge a price higher than the market
equilibrium price as the firm charging a higher price will not be able to sell anything. This
ensures that each firm is selling at the market equilibrium where efficiency is achieved.
Chapter 3, Problem 3QP

Step 1/6
The trade takes place between two parties or any other parties in case all the trading parties are
better off with the deal. As per the exchange efficiency, one party cannot take benefit until
another party is worse off and hence in this situation, the trade does not take place.

Step 2/6
The situation for exchange efficiency:

The situation of exchange efficiency would happen when the market is experiencing the
imperfect competition, there are some externalities that affect the market and public goods.

Step 3/6
Imperfect competition in the market:

The imperfect competition is the situation where producers or market player has the power to
decide the price of the commodity. As they are the only producers in the market, people would
tend to purchase the product at the stipulated price by the producers and the revenue so
generated through sales maximizes the firms or producers’ profit.

Step 4/6
Introduction of externalities:

In order to gain the maximum market share and maximize the profit, firms used to increase the
production to achieve economies of scales (i.e. per unit cost of production decreases).
Increased production further increases air pollution for other producers and individuals. This is
called the externalities. The cost to society is not calculated against the production of the goods.

Step 5/6
Public goods:

In case of usage of public goods, people tend to enjoy the product or services provided by the
government. People tend to enjoy the benefit carelessly as they have not to pay for the services
or product. Hence only one party benefits the most while on the other hand government has to
bear the cost of the product or service provided publically.
Step 6/6
Refer to the above reasons that cause the exchange efficiency does not indicate or tells about
the price that and individual or society has to bear. Hence the information about the actual price
to the society against the benefit a producer maximizes is inefficient. Therefore, the exchange
efficiency takes place.

Chapter 3, Problem 4QP

Step 1/6
The trade takes place between two parties or any other parties in case all the trading parties are
better off with the deal. As per the exchange efficiency, one party cannot take benefit until
another party is worse off and hence in this situation, the trade does not take place.

Step 2/6
The situation for exchange efficiency:

The situation of exchange efficiency would happen when the market is experiencing the
imperfect competition, there are some externalities that affect the market and public goods.

Step 3/6
Imperfect competition in the market:

The imperfect competition is the situation where producers or market player has the power to
decide the price of the commodity. As they are the only producers in the market, people would
tend to purchase the product at the stipulated price by the producers and the revenue so
generated through sales maximizes the firms or producers’ profit.

Step 4/6
Introduction of externalities:

In order to gain the maximum market share and maximize the profit, firms used to increase the
production to achieve economies of scales (i.e. per unit cost of production decreases).
Increased production further increases air pollution for other producers and individuals. This is
called the externalities. The cost to society is not calculated against the production of the goods.

Step 5/6
Public goods:
In case of usage of public goods, people tend to enjoy the product or services provided by the
government. People tend to enjoy the benefit carelessly as they have not to pay for the services
or product. Hence only one party benefits the most while on the other hand government has to
bear the cost of the product or service provided publically.

Step 6/6
Refer to the above reasons that cause the exchange efficiency does not indicate or tells about
the price that and individual or society has to bear. Hence the information about the actual price
to the society against the benefit a producer maximizes is inefficient. Therefore, the exchange
efficiency takes place.

Chapter 3, Problem 5QP

Step 1/4
Economic efficiency refers to the optimal production and allocation of resources in the economy.
The economic efficiency is made up exchange efficiency, production efficiency and product mix
efficiency.

Step 2/4
The primary factor of production:

The production of a commodity is made using input resources. It is mainly considered as the
capital and labour as a scarce factor of resources. The usage and intensity of resources vary
from producers to producers and even from one country to another.

Step 3/4
Usage of a factor of production in the industry:

The corporations:

The corporations are supposed to be capital intensive and they are capable of producing goods
that are capital intensive. The corporations have no budget constraints and this is the reason
they use capital as an input in the production of the commodity.

Unincorporated enterprises:

The unincorporated enterprises are unorganized and the reason behind this is the budget
constraints they have. They prefer to produce the commodity that is labour intensive in nature.
Lack of budget restricts them to the adoption of new technology and enabling capital intensive
production.

Step 4/4
Effect of tax applied:

The imposition of tax on usage of capitals would lead to the increased cost of production for
commodity and that in result will affect the production level of the commodity in the near future.

Reduced production of the commodity would reduce the demand for the capital and labour and
this would increase the unemployment in society. Hence the reduced quantity of commodity
would reduce social welfare. The resources would not be allocated efficiently. Therefore, the
production efficiency of the economy reduces with reduced production of the commodity.

Chapter 3, Problem 6QP

Step 1/5
The economy evaluates the welfare of society and is a vast sector to explore. Our daily lives are
closely related to the economy. The product mix efficiency depends upon the value proposition
of individuals for a commodity. If the production cost is lower for the commodity preferred by the
individual, the production for the commodity would be higher along with another commodity.

Step 2/5
The marginal rate of transformation explains the number of units of one good to be stopped in
order to produce one extra unit of another good. Considering the production factors and the
technologies so used are constant.

The marginal rate of substitution describes the rate at which an individual or consumer can give
up the quantity of one good in exchange for another good while the level of utility is the same in
this case.

Step 3/5
The exhibit of no product mix efficiency:

In case of production of cars and shirts, the economy would not exhibit the product mix
because, in order to do so, the marginal rate of transformation should be equal to individuals’
marginal rate of substitution.

The imposition of a tax on cars:

The imposition of a tax on cars would increase the final price of the car and people would tend
to postpone their buying decision for it. On the other hand, the production of shirts would
increase but not with the same amount as the marginal rate of substitution will not be equal to
the increased price ratio.

Step 4/5
The tax so levied on the use of capital will be concerned with the production efficiency the
reason being at the point where production efficiency is experienced, the economy would not be
able to produce more unit of one commodity without reducing the output of another commodity.

The corporations would be compelled to reduce the supply of the capital due to imposition of tax
and hence the higher usage of total capital input would be reduced in the economy that brings
the imbalance in the economy.

While in the case of shirt production, companies can produce more units by using capital and
reducing the number of labors.

Step 5/5
The production efficiency would be affected because the marginal rate of technical substitution
within labour and capital would be different from that of for corporation producing shirts.

Chapter 3, Problem 7QP

Step 1/7
Public goods are those that are available to another person after consumption by one
person and are free to consume. Private goods would be enjoyed by the person who
pays for it and would be available in reduced quantity for other persons.

Step 2/7
Refer to figure 3.7 that represent the indifference curve for the combination of public
and private goods as follows:
The above figure represents the different combination of public and private goods.

Step 3/7
The economy could produce one more unit of public goods and ten units of private
goods. Increasing one more unit of the public good would reduce the quantity of private
good by two units.

Therefore in order to produce two units of public goods, eight units of private goods.

Refer to table 3.7 that represent the data for the combination of public and private
goods as follows:
Refer to figure 3.7.1 that represents the production possibilities frontier for public and
private goods as follows:
Refer above figure that represents the production possibilities frontier for change in the
production of public and private goods.

Step 4/7
Refer to figure 3.7.1, the maximum production of private goods is equal to 12 units and
at this point, the production of public goods is equal to zero.

The maximum production of public goods is equal to 06 units and at this point, the
production of private goods is equal to zero.

Step 5/7
Refer to table 3.7 that represent the data due to change in the production function. At
the point where the production of the public good is equal to 05 units, the production of
the private good is equal to 02 units.

Step 6/7
Therefore, the economy could produce the production of 05 units of public goods only
with a combination of 01 unit of private good but the point so obtained would be below
the possibility curve and this represents the inefficient production.
Step 7/7
The utility would be maximized at the point where the production possibilities curve and
the indifference curves are tangent to each other. Or the units of private and public
goods are equal. Therefore the point at which the utility is maximized is equal to 04

Chapter 4, Problem 1FQ

Step 1/2
Market failure:

Market failure is a situation in which there is no Pareto efficiency in market which leads to
collapse of market and market forces of demand and supply fail to provide efficient goods.

Step 2/2
Explaining the principal reasons as to why markets fail to produce efficient outcomes:

The principle reasons why markets fail to produce efficient outcomes are as follows:

1. Failure of competition:

To have efficient outcomes, market should be perfectly competitive, imperfect market in case of
monopolistic competition, monopoly, oligopoly leads to inefficient outcomes.

2. Public Goods:

Public goods are those goods which are not supplied by market and if supplied they are in very
limited quantity. Private players do not enter in production of such goods. Because of lack of
free competition, there is inefficiency in outcomes.

3. Externalities:

Externalities exist when action of one or more firms affect actions of other firms and distort free
trade and leads to market failure.

4. Incomplete market:
Incomplete market refers to that market when market fail to provide goods and services even
though cost is less than one is ready to pay. In this situation market failure exists.

5. Information failures:

If market and government started working and supplying goods on the basis of little and
unproved information. This leads to market failure.

6. Unemployment, Inflation and disequilibrium:

Periodic episodes of high employment, recession and inflation in economy lead to market
failures.

Chapter 4, Problem 1QP

Step 1/2
Market failure:

Market failure is a situation in which there is no Pareto efficiency in market which leads to
collapse of market and market forces of demand and supply fail to provide efficient goods.

Step 2/2
Discussing as to what market failure might be used as a partial rationale:

a. Automobile safety belt requirement:

Incomplete market is the rationale for automobile safety belt requirement under complementary
market that to drive car seat belt is compulsory.

b.Regulations on automobile pollution:

It falls under negative externalities as a part of externalities because action of one firm affects
the other firm or cost the other.

c.National defence:

National defence is fall under Public good which private players reluctant to supply.

d.Unemployment compensation:
Unemployment compensation is given by government to correct market failure due to
unemployment inflation and disequilibrium.

e. Medicare (medical care for aged):

This sector suffers inefficiency due to failure of competition. As private players charge hefty
amount which distort free competition.

g. Medicaid (medical care for the indigent):

This sector suffers inefficiency due to failure of competition. As private players charge hefty
amount which distort free competition.

h.Federal deposit insurance programme:

It falls under market failure due to incomplete market.

i.Law requiring lenders to disclose the true rate of interest they are charging on loans:

It falls under market failure due to incomplete market and undisclosed information.

J.National weather service:

National weather service falls under public good which private players reluctant to supply.

k. Urban renewal:

l. Post office:

Post office falls under public good which private players reluctant to supply.

m. Goverment prohibition of the use of narcotics:

It falls under externalities because of use narcotice cost other issues.

n.Rent control:

Rent control is due to inflation and it falls under market failure due to unemployment inflation
and disequilibrium.

Chapter 4, Problem 2FQ

Explaining role government play in making it possible for markets to work at all:

The principle reasons why markets fail to produce efficient outcomes are failure of competition,
public Goods, externalities, incomplete market, information failures unemployment, Inflation and
disequilibrium. Government intervene in market to overcome such failure by establishing and
enforcing property rights and contracts to make market to work themselves.

Chapter 4, Problem 2QP

Explaining how to design market failure approach:

a.Farm Price supports:

To give farmer fair price of their produce, government give farm price support. So that farmers
do not suffer from market failure. Government can design this scheme in such a way that
farmers who are not able to sell their product at better price can sell their produce directly to
government owned fair price shop and in this way market failure is addressed.

b. Oil import quotas (in the 1950s):

Oil import quota program was a program to stop import of oil into United States. This program
can be designed in such a way that requirement of oil of nation can addressed with self
sufficiency.

c. Special tax provision of energy industry:

Energy sector like coal, nuclear energy is harmful for environment, as they cause pollution.
Energy sector has negative externalities which is one of the reasons for market failure because
as energy sector get benefits but other sector do not reap reward for it. Government should
charge special tax from this sector can must use this tax for recovering cost incurred protecting
environment.

Chapter 4, Problem 3FQ

Explaining as to why might the government intervene in the markets allocation of resources,
even when it is Pareto efficient:

There are two arguments, even if markets are Pareto efficient.

1. First argument is income distribution. Pareto efficient market says nothing about the income
distribution. Competitive market can result in unequal distribution of income and in this situation
government role is to intervene to redistribute income and maintain equality.

2. The second argument for government intervention is individual perception and his focus on
his welfare.

________________________________________________________________________

Merit goods:

Goods which are compelled by government to consume for example elementary education are
called merit goods.

________________________________________________________________________

Explaining the government role in redistribution:

Competitive market can result in unequal distribution of income and in this situation government
role is to intervene to redistribute income and maintain equality

Chapter 4, Problem 3QP

Explaining the market failure and how they can be addressed:

a. Student loan programme:

If there is an increase in demand of student loan then players starts charging high rate of
interest and thereby making huge gain and most of student who are poor can not avail loan, this
result in market failure as there is no Pareto efficiency. To address this problem government
intervene by providing government guarantee on loan and making it less difficult to avail loan.

B.Public elementary education:

Public elementary education is a merit good. Elementary education is compulsory by

government. Poor people cannot afford high fees of elementary education charged by private
education institution. This result in market failure as only people who can afford can avail
service. To address this situation government provide free elementary education by running
government aided education system.

c. Public support for universities:

Market failure in higher education system is due to the high fees charged by private institution
and universities which only higher class can afford and this leads to disequilibrium in education
system.

d.Social security:

Social security is helping citizens by providing them the monetary assistance for old age and
other life benefits. This is a public good which are not provided by market private players and
therefore government addresses by providing old age pensions, and other benefits.

Chapter 4, Problem 4FQ

Explaining the market failure approach to the role of government:

The situation identified by government to do something to correct market failure provides a

basis for market failure approach. It is largely a normative approach. Many government
programmes to correct market failure are justified by market failure approach. This approach
asks to government how it can address market failures and inadequacies and role it has to
balance the economy. Government should not only take into accounts programmes objectives
but also their implementation.

Chapter 4, Problem 4QP

Step 1/3
Public expenditure program:

Step 2/3
The public expenditure programs of government are that program, which are designed
by government for welfare of economy at large such as social security program etc.

Step 3/3
Diagram showing average and marginal cost cure and marginal cost and average
cost:
______________________________________________________________________
__

a.Efficient level of output:

The efficient level of output at which price equal to marginal cost is at Qc in above
diagram.

______________________________________________________________________
__

Explain why if firm charged a price equal to marginal cost, it would operate at
loss:

If price is equal to marginal cost, it would operate at loss as marginal cost is less than
average cost.

______________________________________________________________________
__

b. Showing the monopoly level of output at which marginal revenue equals to

marginal cost:

In the above diagram, monopoly level of output is at Qi where marginal revenue is equal
to marginal cost.

______________________________________________________________________
__
Explaining why monopoly level of output is smaller than efficient level of output:

The monopoly level of output is lower than the efficient level of output due to
inefficiencies associated with imperfect competition.

______________________________________________________________________
__

c. Showing the level of output of government monopoly that was instructed to

just break- even:

The level of output of government monopoly that was instructed to just break- even is at
Qi where marginal revenue is equal to marginal cost.

______________________________________________________________________
__

Explain as to how the level of output compare with efficient level of output and
the private monopoly level of output:

The government monopoly level of output is less than efficient level of output due to
inefficiencies associated with imperfect competition and would operate at loss as
marginal cost is lower than average cost.

However, a private monopoly would typically charge more than a government a run
monopoly and maximize profit. And government run monopoly which didn’t receive any
subsidy would only seek to breakeven.