PROBLEM SET FOR CHAPTER 01

1. Xuan is willing to exchange 3 shirts for a food can without changing her
satisfaction. Whereas, Thu is willing to exchange 2 food cans for 3 shirts. Is this
distribution pattern between shirts and food cans a Pareto efficiency? If not,
why? Can you recommend another distribution pattern to make Xuan better-
off without harming Thu’s well-being? To make Thu better-off without harming
Xuan? Or to make both better-off?

2. To remain level of output in car production industry unchanged, if one unit of

capital is withdrawn, 10 units of labour must be supplemented. However,
withdrawing a unit of labour in cotton production industry must be
compensated by 1/4 unit of capital in order to remain level of output in this
industry unchanged. How to increase level of output in car production without
reducing level of output in cotton production of the economy?

3. An economist observes: “Beer consumption seems to be stagnant. Previously,

if one wishes to consume one can of beer, he must exchange with 3 boxes of
cigarette. At the current time, only one box of cigarette can exchange for a can
of beer. However, the production of the economy has still maintained the
exchange rate of a can of beer for 3 boxes of cigarette”. If this observation is
precise, how the production structure of the economy should be adjusted to
increase social welfare, given the current input endowment
 ANSWERS FOR PROBLEM SET IN CHAPTER 1
Problem 1: Xuan vs. Thu
1. Denote F for Food, S for Shirts then we have:
1
Xuan: MRSFSXuan = or for Xuan: 1F = 1/3 S or 3F = 1S
3
FS 2
Thu: MRS Thu = or for Thu 1F = 2/3 S or 3F = 2S
3
⟹ MRS (Xuan) ≠ MRS (Thu)
⟹ This is not Pareto efficiency.
Guide: Here, you know that Thu values S at a relatively cheaper price than Xuan does. That
means S should be transferred from lower valuing person (Thu) to higher valuing person
(Xuan). That is basis to move to section 2 below.
2. For Xuan: 3F = 1S implying that if she has to forgo 3F, she will ask to be
compensated by 1 S so that her utility is unchanged.
For Thu: 3F = 2S implying that if she receives additional 3F, she is willing
to release 2S without changing her utility.
Then, the proposed new distribution pattern will be:
+ Take 3F away from Xuan and give them to Thu
+ Take 2S from Thu and give 1S to Xuan. Thus, one extra S remains.
At this point, utility of both Xuan and Thu is unchanged while there is an
extra S.
3. Suggest different distribution patterns for the extra S:
+ If the extra S is given to Xuan, so it makes Xuan better-off without
harming Thu’s well-being.
+ If the extra S is given to Thu, this makes Thu better-off without harming
Thu’s well-being.
+ If the extra S is divided into 2 parts (not necessary to be equal), each of
whom is given to each person, then this makes both better-off.

Problem 2:

a) MRTScar = 10, implying that for car production: 1L = 10K

MRTScotton = 4, imlying that for cotton production: 1L = 4K
  MRTScar ≠ MRTScotton

 The production sector has not yet been Pareto efficient.

Guide: Here, you know that L is more costly in producing car than in producing cotton. That
means L should be transferred from cheaper sector (cotton) to more expensive one (car) to
equalize labor cost in both sector. That is basis to move to section b below.

b) To achieve Pareto efficiency, we need:

- For cotton production, if the sector has to release 1L, it will require to get
additional 4K to remain its output unchanged.
- For car production, if the sector receive additional 1L, it will be willing to
release 10K without changing its output level.
Therefore, the proposed new distribution pattern will be:

- Take 1L away from cotton production to add into car production, then get
back 10K from car production
- Send back 4K to cotton production and keep extra 6K.

At this point, output levels of both sectors are unchanged while there is extra 6K.

c) To “increase” the output of car without affecting the output of cotton:

Put all 6 redundant capital units in the automobile industry.

Problem 3:
a) Name: Denote product of Beer as X, Cigarette as Y
MRTXY = 3 implying that for efficient production sector, 1X = 3Y (input mix to
produce one can of Beer is enough for producing 3 boxes of Cigarette)
MRSXY = 1 or for efficient consumption: 1X = 1Y. That means utility that one can
of Beer brings to consumers is equal to that brought by 1 box of Cigarette.
Guide: Here, you know that producing Beer is more costly of input mix than producing
Cigarette. That means the economy should produce less costly product (X) and cheaper product
(Y). That is basis to move to section b below.
 MRTXY > MRSXY
 The economy does not achieve overall Pareto efficiency
b) To get overall Pareto improvement, the economy should reduce production
of 1X, so that the available input mix allows the economy to produce
additional 3Y.
Whereas, if consumers have to consume less one unit of X, they require to be
compensated by only one unit of Y. The extra 2Y produced by the economy will
give consumers additional utilities, without a need to utilize more inputs. That is
Pareto improvement relative to the initial production structure.
 PROBLEM SET FOR CHAPTER 02: LECTURES 5+6
PUBLIC GOODS

1. A market survey for consumption of a commodity X in a locality shows that

demand for good X can be presented by two groups of consumers. Demand of
Group A is presented by a function of P = 100 - 4Q, while that of Group B by a
function of P = 40 – Q, in which P is measured as VND million and Q as unit. MC
for producing an additional unit of X is MC = 20.
(a) What is the market demand for good X if
- X is private good
- X is public good
(b) What is the efficient level of good X to be produced if
- X is private good
- X is public good
(c) Assume that good X is a private good but very important for community
health. The government decides to provide good X for free without quantity
limit. How many units of good X will be provided, and what is deadweight
loss of this government decision?

2. A product of milk powder is consumed by two persons X and Y. Since X has now
children, her demand for milk powder is as low as QX = 12 - 0,6P. Y has many
kids, so her demand for milk powder is as high as QY = 18 - 0,4P, in which P is
price of milk powder measured by USD, and QX and QY are personal demand for
milk powder, measured by box.
(a) What is market demand for milk powder?
(b) If milk powder is privately provided in a perfect competition market and
marginal cost of producing additional box of milk powder is USD 10, what is
price of milk powder? How many boxes will be consumed efficiently by X
and Y?
(c) Since milk is a necessity, the government concerns that the poor may not
afford to buy milk for their children. Thus, the government decides to
provide milk powder for free without quantity limit. In this case, how many
 boxes of milk powder is demanded by X and Y? How much is deadweight
loss of this policy?
(d) Being aware of over consumption of milk powder once it is provided freely,
the government decides to limit the milk powder quota of 10 boxes per
household. How much is deadweight loss now?

3. There are two families sharing a common yard. Marginal benefit (MB) of clean
yard for Family 1 is MBI = 11 - 2Z, while for Family 2 is MBII = 9 - Z, in which Z as
number of cleaning service purchased. Cost for cleaning service is 5 RM (RM is
hypothetical currency unit).
(a) What is efficient level of cleaning services being purchased? In this case, how
much each family has to pay?
(b) If Family 2 plans to be the free rider, so that the Family demonstrates its fake
demand for cleaning as MBII’ = 6 – Z, how many cleaning services will be
purchased? What is ‘free riding” benefits enjoyed by Family 2?
 ANSWERS
PROBLEM SET OF LECTURE 05
Problem 1:
We have: PA=100 – 4Q  QA= 25 – ¼ PA
PB=40 – Q  QB= 40 – PB
MC = 20

a) When X is private good, it means PA= PB= PAB

Quantity demanded in the market is horizontal summation of quantity demanded
by A and B:
If P ≥ 40 then Q= 25 – ¼ P
If P ≤ 40 then Q= QA + QB= 25 – ¼P + 40 - P = 65 – 5/4P
The efficient level of good X is produced when
P=MC= 20  Q= 65 – 5/4*20 =40 (units)
b) When X is public good, it means QA=QB=QAB
Quantity demanded in the market is vertical summation of quantity demanded by
A and B:
If Q ≥ 25 then P= 40 – Q
If Q ≤ 25 then P= PA + PB= 140 – 5Q
The efficient level of good X is produced when
P = PA + PB =MC= 20  Q= 140 – 5*Q= 20  Q = 120/5 = 24 (units)
c) Since the government provides private good X for free (or P = 0), quantity
demanded will reach to the maximal consumption at 65 units (see Figure 1)
above:
Q = 65 – 5/4P = = 65 – 5/4* 0 = 65
The deadweight loss is the triangle EFQ, where the height is equal to MC (or 20),
and the base is between the optimal output level of 40 units and the maximal
output level of 65 units. Thus,
DWL = 1/2 * 20 * (65 – 40) = 250 (VND million)

Problem 2:
a) Market demand for milk powder:
QX = 12 - 0,6 P (0 < P < 20)
QY = 18 - 0,4 P (0 < P < 45)
Q∑ = QX + QY = 12 – 0,6P + 18 – 0,4P = 30 – P (0 < P < 20) AND
Q∑ = QY = 18 - 0,4 P (20 < P < 45)
b) If milk powder is privately provided in a perfect competition market and MC =
10 USD, price of milk powder is:
P = MC = 10  QX = 12 – 0,6 x 10 = 6
 QY = 18 – 0,4 x 10 = 14
  Q* = QX + QY = 6+ 14 = 20 (boxes)
c) The government decides to provide milk powder for free without quantity limit
P=0
 Boxes of milk powder is demanded by X and Y: Q∑ = 30 – 0 = 30 (boxes)
 Qm = 30 (boxes).

Deadweight loss of this policy: DWL = SEFQm

When P = MC = 10  EQ* = FQm = 10
Q*Qm = EF = Qm – Q* = 30 – 20 = 10 (boxes)
 DWL = SEFQm = 1/2 x EF x FQm = 1/2 x 10 x 10 = 50 (USD)
d) DWL = DWL of overconsumption (SAMN) + DWL of underconsumption (SABC)
MC = 10  Q1 = QX = 6, Q2 = QY = 14, Q*/2 = 10
 AB = 10 – 6 = 4
AM = 14 – 10 = 4
Q*
/2 = 10  For Person X at Q*/2, we have 10 = 12 – 0,6P  PXQ* = 10/3
 AC = 10 – 10/3 = 20/3
For Person Y at Q*/2, we have 10 = 18 – 0,4P  PYQ* = 20
 AN = 20 – 10 = 10
 DWL = SAMN + SABC = 1/2 x AM x AN + 1/2 x AB x AC
= 1/2 x 4 x 10 + 1/2 x 4 x 20/3 = 100/3 (USD)
Problem 3:
a) Since the cleaning service is public good for both families, the aggregate
demand for yard cleaning (or marginal social benefit) will be vertical summation of
individual families’ demand.
Marginal social benefit (MSB) of yard cleaning for both families is:
MSB = MBI + MBII = 20 – 3Z
The cost for cleaning service of 5 RM is also marginal cost of the service: MC = 5
The efficient level of cleaning services being purchased is achieved when MSB =
MC, or:
20 – 3Z = 5 ⇔ Z = 5 (times)
The amount of money Family 1 has to pay is:
For last time of cleaning: MBI = 11 – 2 x 5 = 1 (RM)
Total payment: TPI = 1 x 5 = 5 (RM)
The amount of money Family 2 has to pay is:
For last time of cleaning: MBII = 9 – 5 = 4 (RM)
Total payment: TPII = 4 x 5 = 20 (RM)

b) If Family 2 plans to be the free rider, the fake marginal social benefit of year
cleaning for both families will be:
MSB’ = MBI + MBII’ = 17 – 3Z
In this time, the number of cleaning services will be purchased is:
17 – 3Z = 5 ⇔ Z = 4 (times)
The amount of money family 2 has to pay this time for each time of cleaning is:
MBII’ = 6 – 4 = 2 (RM)
If family 2 do not lie, the amount of money family 2 has to pay for each time (with
Z = 4) is:
MBII = 9 – 4 = 5 (RM)
The “free riding” benefits enjoyed by Family 2 for each time of cleaning is: MBII –
MBII’ = 3 (RM)
Total free riding benefit enjoyed by Family 2 is:
3 x 4 = 12 (RM)
 PROBLEM SET FOR CHAPTER 02: LECTURE 07
EXTERNALITIES

1. There are two plots of land: once for rice plantation (Plot A) and the other for
maize plantation (Plot B). If plot A is sprayed with pesticide, its annual yield will
increase according to the following function: Qrice = 10 – 2*Qpes. in which, Qrice is
additional output gained (measured by ton) if an additional unit of pesticide is
used. Qpes is number of pesticide units used. However, thank for adjacent
location to plot A, the likelihood to be damaged by pests in plot B has been
reduced. Thus, its yield has also increased by Qmaize = 5 – Qpes, in which Qmaize is
additional maize yield gained in plot B (measured by ton) if an additional
pesticide unit is sprayed in plot A. Price of rice is 5 RM per ton (RM is
hypothetical currency unit), while price of maize is 2 RM per ton and price of
pesticide is 6 RM per unit. Question:

(a) What is the efficient level of pesticide used by the landowner of plot A if he
concerns only his utility? How about if the utility of the landowner of plot B
is taken into account as well?
(b) In the former, what is deadweight loss of social welfare?
(c) What is the compensation amount that Plot B landowner should pay for Plot
A landowner to encourage him spraying more so that Plot B landowner can
enjoy the spillover effect of spraying?

2. MC for producing an additional ton of chemicals follows the function of MC =

100 + 5Q, while demand for such chemicals follow the function of Q = 60 - 1/3
P (in which, P and MC are measured as USD million per thousand tons, Q as
thousand tons). However, the chemical firm has used a common pond to
dispose its production waste. A fishery cooperative also uses the pond as its
fishing source. It is estimated that the waste disposed from production of an
additional ton of chemicals can reduce the fish catching volume by 4 tons. Fish
price is USD 10,000 per ton. The cooperative decides to sue the chemical firm
for the damage it suffers from chemical production.
(a) Before the sue, how much is optimal level of chemical production?
(b) If the court decides to limit chemical production at the socially optimum
level, how much will the chemical firm produce?
(c) What is deadweight loss of chemical production if the court does not
interfere?
(d) If the court decides that the firm has to compensate to the cooperative, what
is efficient level of compensation per ton of chemicals produced? In this case,
how much the chemical firm has to pay for the cooperative?
 ANSWERS
PROBLEM SET OF LECTURE 06
Problem 1:
a) The efficient level of pesticide used by the landowner of plot A if he concerns
only his utility: MPB = MC
MPB = Price .Q rice = 5.(10 - 2Q pes ) = 50 - 10Q pes
MC = 6
=> 50 - 10Qpes = 6
=> 44 = 10Q pes => Q pes = 4,4 (unit) = Q1
When the utility of the landowner of plot B is taken into account, his utility
will present MEB of the pesticide use in plot A:
MEB = Pmaize . Q maize = 2.(5 - Q pes ) = 10-2Q pes
Then, MSB = MPB + MEB, or
MSB = MPB + MEB = 50 - 10Q pes + 10-2Q pes = 60-12.Q pes
=> 60-12Q pes =6
=> 12Q pes = 54 => Q pes =4,5 (unit) = Q 0
1
b) Deadweight loss of social welfare: SABC = (Q 0 - Q1 ). MEBQ1
2
1
 SABC = (4,5-4,4).(10 - 2.4,4) = 0,06 (RM)
2
c) The compensation amount that Plot B landowner should pay for Plot A
landowner:
The amount of compensation per unit of pesticide is MEBQ0 = 10-2.4,5 = 1 (RM)
∑ 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = SMNBE
=>∑ 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = BE. Q 0 = MEBQ0 . Q 0 = 4,5(10-2.4,5) =4,5(RM)
Problem 2:
The loss of fish catching output of 4 tons due to waste disposal is marginal
damage (or MEC) created by the chemical production. Therefore,
MEC = Pfish * Qloss = USD 10,000/tons * 4 tons = USD 40,000 (per 1 tons of chemical
produced) or = USD 40 mil. (per 1,000 tons of chemical produced).
In which, Qloss is loss of fish catching output due to chemical production.
MPC = 100 + 5Q and MSC = MPC + MEC = (100 + 5Q) + 40 = 140 + 5Q
Since QD = 60 – 1/3*P => P = 180-3Q = MB

a) Before the sue, the optimal level of chemical production is achieved when
MB = MPC
=> 180 - 3Q = 100 + 5Q
=> Q =10 (thousand tons of chemical production) = Q1

b) The social optimum level of chemical production is achieved when: MSC =

MB
 => MSC = MB
=> 140 + 5Q = 180 – 3Q
=> Q = 5 (thousand tons of chemical production) = Q0
c)

Deadweight loss of chemical production if the court does not interfere is

DWL = SABC = ½ (Q1 – Q0) * MEC(Q1)
= ½ (10- 5). 40 = USD 100 (million)
d) If the chemical firm has to compensate to the cooperative, the efficient level
of compensation per ton of chemicals produced should be equal to MEC(Q0) or
USD 40 million (per thousand tons of chemical production). Thus, total payment
from the chemical firm to the cooperative will be:
MEC(Q0)*Q0 = 40 * 5 = USD 200 (million)
 PROBLEM SET FOR CHAPTER 3
1. A demographic and income survey conducted periodically in a hypothetical
country shows that the country has 10 inhabitants with their income levels of
VND million 14, 1, 4, 2, 10, 1, 20, 2, 40, 6 per month respectively.
(a) Graph the Lorenz curve of this country.
(b) What is approximate value of its Gini coefficient?

2. Two person A and B in a hypothetical country shares a gross national income of

Y = VND million 24. Utility of each person is defined in accordance with his or
her income level. Specifically, the total utility function of person A is UA = 120 +
12 IA - IA2 while that of person B is UB = 72 + 20 IB - IB2. Denote respectively IA, IB
as income level of A and B (measured by VND million), and UA and UB are
measured by unit of utility.

(a) What is the maximum level of social welfare in accordance with the
utilitarianism? In this case, what is income level of A and B?
(b) Similar question as (a), but following the maximin criterion?
(c) If only B’s utility is concerned, how will your answer in (a) be changed?
 ANSWER KEY
PROBLEM SET FOR CHAPTER 3
1. Exercise 1

Arrange personal income: 1-1-2-2-4-6-10-14-20-40

a. Personal income distribution table:

Group 1 2 3 4 5 Total
income
Income 1-1 2-2 4-6 10-14 20-40
Total 2 4 10 24 60 100
income
% income 2 4 10 24 60 100
% accrual 2 6 16 40 100
income
% accrual 20 40 60 80 100
population
b.

B=B1+B2+B3+B4+B5

B=1/2.20. (10-4 ).( 2+6+16+40+100/2).2 =0,228

=> Gini coefficient: g=1-2B =1-2.0,228 =0,544

Exercise 2:

Since UA= 120+12 IA- IA2 => MUA= - 2IA+12

UB=72+20IB- IB2 => MUB = -2IB+20

a. Accordance with utilitarianism

MUA= MUB and IA+IB=24  -2IA+12=-2IB+20 and IA+IB=24

 IA=10 (A’s income is 10 million dong)

IB=14 ( B’s income is 14 million dong)
 Total social welfare maximum level
Wmax =UA+UB= 120+12.10-102+72+20.14-142=296

b. If we follow the maximum criterion

UA=UB and IA+IB=24  120+12 IA- IA2 =72+20IB- IB2 and IA+IB=24

 IA=9, IB=15
 Wmax =UA+UB =120+12.9-92+72+20.15-152=294

c. With all values of IB in the range 0<= IB<= 24

When IB increase, UB also increase

 UB max when IB=24

If only B’s utility is concerned
 W=UB
 Wmax=UBmax => IB=24=>IA=24-24=0
=> W= UB=72+20.24-242=-24
 Additional problem for Chapter 2 on Public Goods

Demand for traffic on a highway is Q = 800,000 – 4P, of which Q is traffic volume

(measured by number of turns per days), P is road toll (measured by dong per turn). The
highway faces traffic congestion if daily traffic volume exceeds 500.000 turns. At that
time, marginal cost of highway usage rises following the function MC = Q, of which MC is
marginal cost to serve additional traffic turn, measured by dong per turn, while Q is extra
traffic volume exceeding the volume at congestion point.
a. Shall we collect road toll? If yes, how much is efficient toll level?
b. If in peak days of traffic, travelling is still free of charge, how much will be social
deadweight loss?
c. If toll collection is allowed, but transaction cost doubles the efficient toll level, how
much is deadweight loss due to toll collection?
d. How much the toll-charge deadweight loss is relative to free-of-charge deadweight
loss? Should the toll be still collected even if transaction cost is included? Why?

Problem Chapter 6: Impact of Taxation

Demand curve for a cigarette is QD = 72 - 2P while supply curve is QS = 12 + 4P, where P

is measured by VND thousand per box, and Q by hundred thousand boxes. The
government decided to levy a consumption tax of VND 6,000 per box.

a. What is pre- and after-tax gross revenue?

b. What is tax burden paid by consumers and producers?

c. What is tax-induced deadweight loss from consumers’ and producers’ sides?

d. What is total tax revenue and total deadweight loss of the society?

1|Page Note: Open Book

Problem Chapter 6: Impact of Taxation

Demand curve for a cigarette is QD = 72 - 2P while supply curve is QS = 12 + 4P,

where P is measured by VND thousand per box, and Q by hundred thousand
boxes. The government decided to levy a consumption tax of VND 6,000 per box.
Before tax:
We have: QD = QS
→ 72 – 2P = 12 + 4P
→ P0 = 10 (VND thousand per box)
→ Q0 = 72 – 2x10 = 52 (hundred thousand boxes)
After tax:
There are two approaches to calculate after-tax price and quantity.
Approach 1: Estimate after-tax demand function, the equilibrate it to supply
function
Because the government decided to levy a consumption tax of VND 6,000 per
box, so:
QD’ = 72 – 2(Pp – 6) = 60 – 2Pp
We have: QD’ = QS
→ 60 – 2Pp = 12 + 4Pp
→ Pp = 8 (VND thousand per box) and Pc = 8 + 6 = 14.
→ Q1 = 44 (hundred thousand boxes)
Approach 2: Create a set of
functions to estimate
Pc - Pp = 6
72−Q1
Pc at Q1 =
2
12−Q1
Pp at Q1 =
4
So,
72− Q1 Q −12
- 1 =6
2 4
Or Q1 = 44 (VND thousand)
=> Pc = 14 (VND thousand)
Pp = 8 (VND thousand)
 a. What is pre- and after-tax gross revenue?
- Pre-tax gross revenue = GR0 = P0.Q0 = 10.52 = 520 (hundred million
VND) or 52 billion VND
- After-tax gross revenue = Q1.Pc = GR1= 44.14 = 616 (hundred
million VND) or 61.6 billion VND
b. What is tax burden paid by consumers and producers?
- Tax burden paid by consumers = Tc = Q1.(Pc – P0)
= 44.(14 – 10) = 176 (hundred million VND) or 17.6 billion VND
- Tax burden paid by producers = Tp = Q1(P0 – Pp) = 44(10-8) = 88
(hundred million VND) or 8.8 billion VND
c. What is tax-induced deadweight loss from consumers’ and producers’
sides?

- Tax-induced deadweight loss from consumers’ sides: ΔWc =

1 1
x (Pc – P0)(Q0 – Q1) = x(14 – 10)x(52-44) = 16 (hundred million
2 2
VND) or 1.6 billion VND
- Tax-induced deadweight loss from producers’ sides: ΔWp =
1 1
x (P0 – Pp)(Q0 – Q1) = x(10 - 8)x(52-44) = 8 (hundred million
2 2
VND) or 0.8 billion VND
d. What is total tax revenue and total deadweight loss of the society?
- Total tax revenue: T = Q1 x t = 44 x 6 = 264 (hundred million VND)
or 26.4 billion VND
Another approach: T = Tc + Tp = 17.6 + 8.8 = 24.6 (billion VND)
- Total deadweight loss: ΔW =
1 1
x (Q0 – Q1).t = x (52-48) x 6 = 24 (hundred million VND) or 2.4
2 2
billion VND
Another approach: ΔW = ΔWc + ΔWp = 1.6 + 0.8 = 2.4 (billion VND)