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HKDSE Economics Practice Paper: Market Structures, Production and Efficiency (12 Questions, 100 Marks, 75 Minutes, with Answers)
HKDSE Economics: Market Structures, Production and Efficiency
S5 economics practice paper: diminishing returns, short-run cost, shutdown decisions, monopoly pricing, economies of scale, price discrimination and Hong Kong competition law.
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Paper details Level: S5 | Subject: Economics | Time: 75 minutes | Marks: 100 | Questions: 12 | Answers included
Section A: Production, Cost and Short-Run Decisions (32 marks)
Answer all questions in Section A.
| # | Question | Answer and marking notes |
|---|---|---|
| 1 | (Short-run production and diminishing returns) A firm employs workers with fixed capital. The total product of the 1st to the 4th worker is 10, 24, 36 and 44 units. (a) Find the marginal product and average product of the 3rd worker (3 marks). (b) State from which worker diminishing marginal returns begin and support it with data (3 marks). (c) Explain why average product falls after the 4th worker joins (2 marks). | Answer: (a) MP = 36 – 24 = 12 units; AP = 36 / 3 = 12.0 units. (b) The 2nd worker adds 14 units while the 3rd adds only 12 units, so diminishing marginal returns start with the 3rd worker. (c) The 4th worker adds 8 units, below the existing AP of 12.0 units, pulling the average down to 11.0 units. Marking notes: award MP for the difference in total product and AP for total product divided by the number of workers; vague statements without data earn nothing. |
| 2 | (Short-run cost) A firm has fixed cost of 120 dollars. Total variable cost is 480, 800 and 1200 dollars at outputs of 10, 20 and 30 units. (a) Find total cost and average cost at 20 units (3 marks). (b) Find marginal cost when output rises from 20 to 30 units (3 marks). (c) Explain why average cost can still fall when marginal cost is rising (2 marks). | Answer: (a) TC = 120 + 800 = 920 dollars; AC = 920 / 20 = 46.0 dollars. (b) MC = (1320 – 920) / (30 – 20) = 40.0 dollars. (c) Marginal cost of 40.0 dollars is still below average cost of 46.0 dollars, so the extra units pull the average down to 44.0 dollars. Marking notes: MC must be the change in total cost divided by the change in output, not the difference between two average costs. |
| 3 | (Shutdown decision of a perfect competitor) A perfectly competitive firm faces a market price of 25 dollars. At an output of 15 units, total variable cost is 300 dollars and fixed cost is 90 dollars. (a) Find total revenue at 15 units (3 marks). (b) Compare the profit from producing with the profit from shutting down immediately (3 marks). (c) State the short-run shutdown condition (2 marks). | Answer: (a) TR = 25 x 15 = 375 dollars. (b) Profit from producing = 375 – 300 – 90 = -15 dollars; profit from shutting down = 0 – 90 = -90 dollars; the difference is 300 dollars, so shutting down loses more. (c) The short-run shutdown condition is price below the minimum average variable cost; here AVC = 20.0 dollars and price is 25 dollars, so the firm keeps producing. Marking notes: reward the idea that fixed cost is already committed and must be paid either way. |
| 4 | (Profit maximisation of a monopolist) A monopolist faces the demand curve P = 100 – 2Q, with constant marginal cost of 20 dollars and zero fixed cost. (a) Find the profit-maximising output and price (3 marks). (b) Find the profit of the firm (3 marks). (c) Compare price with marginal cost and explain the implication for resource allocation (2 marks). | Answer: (a) MR = 100 – 4Q; setting MR = MC = 20 gives Q = 20 units and P = 100 – 2 x 20 = 60 dollars. (b) Profit = (60 – 20) x 20 = 800 dollars with zero fixed cost. (c) Price of 60 dollars exceeds marginal cost of 20 dollars, so consumers value the marginal unit more than it costs to produce; output is below the allocatively efficient level and a deadweight loss arises. Marking notes: MR must be derived before equating to MC; solving P = MC is a conceptual error. |
Section B: Market Structure, Surplus and Pricing (34 marks)
Answer all questions in Section B.
| # | Question | Answer and marking notes |
|---|---|---|
| 5 | (Economies of scale and minimum efficient scale) A firm has long-run average cost of 40, 32, 26, 26 and 33 dollars at outputs of 100, 200, 400, 800 and 1600 units. (a) State the output range with economies of scale and explain (3 marks). (b) Find the minimum efficient scale and give the reason (3 marks). (c) Explain why long-run average cost rises beyond 800 units (3 marks). | Answer: (a) Economies of scale exist from 100 to 400 units, where long-run average cost falls from 40 to 26 dollars. (b) Minimum efficient scale is 400 to 800 units, where long-run average cost reaches its lowest level of 26 dollars. (c) Beyond 800 units diseconomies of scale appear: more management layers, higher coordination and supervision cost and over-crowded production push long-run average cost up to 33 dollars. Marking notes: the range must be read from falling long-run average cost, not from the largest output. |
| 6 | (Surplus and deadweight loss) Market demand is P = 100 – 2Q and marginal cost is constant at 20 dollars. A monopolist supplies 20 units at a price of 60 dollars; under perfect competition price equals marginal cost. (a) Find the competitive price and output (3 marks). (b) Find consumer surplus under monopoly (3 marks). (c) Find the deadweight loss caused by monopoly (3 marks). | Answer: (a) Under perfect competition P = MC = 20 dollars, giving Q = 40 units and P = 20 dollars. (b) Consumer surplus under monopoly = (100 – 60) x 20 / 2 = 400 dollars. (c) Deadweight loss = (60 – 20) x (40 – 20) / 2 = 400 dollars. Marking notes: surplus is the triangular area below demand and above price, so the division by two is required. |
| 7 | (Price discrimination) A firm separates two markets and has constant marginal cost of 10 dollars. Demand in market A is P = 50 – Q and in market B is P = 30 – Q. (a) Find the profit-maximising output and price in each market (3 marks). (b) Find the total profit of the firm (3 marks). (c) State two conditions for practising price discrimination (2 marks). | Answer: (a) In market A, MR = 50 – 2Q, so MR = 10 gives Q = 20 units at P = 30 dollars. In market B, MR = 30 – 2Q, so MR = 10 gives Q = 10 units at P = 20 dollars. (b) Total profit = (30 – 10) x 20 + (20 – 10) x 10 = 400 + 100 = 500 dollars. (c) Two conditions: resale between markets must be impossible, and the markets must have different price elasticities of demand so the less elastic market can be charged more. Marking notes: each market needs its own MR; merely stating that markets are separated is not enough. |
| 8 | (Oligopoly and games) Two firms choose a high price or a low price. Profits in ten thousand dollars are: both high, 30 and 30; A high and B low, 10 and 45; A low and B high, 45 and 10; both low, 20 and 20. (a) Find the Nash equilibrium and explain (3 marks). (b) Explain how this situation is a prisoners dilemma (3 marks). (c) Explain why a verbal agreement is hard to sustain (2 marks). | Answer: (a) The Nash equilibrium is both firms choosing a low price, earning 20 and 20. Whatever the rival does, a low price pays more (45 against 30 if the rival is high, 20 against 10 if the rival is low), so a low price is a dominant strategy for both. (b) Joint high prices give 30 and 30, better than 20 and 20, yet each firm gains by cutting price secretly, so both end up in the inferior outcome: a prisoners dilemma. (c) The agreement is not binding; a firm that expects the rival to keep the agreement gains immediately by cutting price, and with few firms cheating is easy to detect and imitate. Marking notes: the payoff matrix must be checked cell by cell; an unsupported assertion earns nothing. |
Section C: Efficiency, Regulation and Hong Kong Cases (34 marks)
Answer all questions in Section C.
| # | Question | Answer and marking notes |
|---|---|---|
| 9 | (Three types of efficiency) At an output of 100 units a firm charges 20 dollars, its marginal cost is 20 dollars and its average cost is 18 dollars at its minimum point. (a) Judge whether the firm achieves productive efficiency and explain (3 marks). (b) Judge whether it achieves allocative efficiency and explain (3 marks). (c) Explain how dynamic efficiency differs from these two (3 marks). | Answer: (a) Productive efficiency is achieved: average cost of 18 dollars is at its minimum, so output is produced at the lowest unit cost with no waste. (b) Allocative efficiency is achieved: price of 20 dollars equals marginal cost of 20 dollars, so the marginal value to consumers equals the marginal cost of production. (c) Productive and allocative efficiency are static; dynamic efficiency concerns innovation and new technology that lower cost or raise quality over time, and a statically efficient market may generate too little profit to fund research. Marking notes: link productive efficiency to minimum AC and allocative efficiency to P = MC. |
| 10 | (Natural monopoly and regulation) In an industry long-run average cost falls continuously as output rises, and marginal cost is below average cost. (a) Explain why supply by a single firm is more cost effective (3 marks). (b) If the government requires marginal cost pricing, what happens to the firm (3 marks). (c) State one drawback of average cost pricing (2 marks). | Answer: (a) Long-run average cost falls continuously with output, so one firm supplying the whole market avoids duplicating networks and produces at the lowest unit cost: a natural monopoly. (b) Marginal cost pricing sets price below average cost, so the firm makes a loss on every unit and cannot recover its cost in the long run; it may leave the market. (c) Average cost pricing lets the firm break even, but price exceeds marginal cost, output stays below the allocatively efficient level and a deadweight loss remains; the regulator also depends on cost information supplied by the firm, which may be inflated. Marking notes: the loss under marginal cost pricing follows from MC being below AC. |
| 11 | (Hong Kong market structure case) Compare Hong Kong supermarkets with fresh food stalls in wet markets. (a) Compare them on the number of firms, product differentiation, barriers to entry and price influence (3 marks). (b) Explain why supermarkets have greater pricing power (3 marks). (c) State two possible effects of market concentration on consumers (3 marks). | Answer: (a) Supermarkets: few firms (oligopoly), differentiated brands and services, high barriers to entry from shop space, capital and supply chains, and noticeable price influence. Fresh food stalls: many sellers, homogeneous products, low barriers to entry and almost no price influence, close to perfect competition. (b) Large chains buy in bulk and obtain lower wholesale prices; brands, locations and one-stop shopping differentiate them, so demand is less elastic and a small price rise does not drive all customers away. (c) Consumers may face higher prices or fewer choices, reducing consumer surplus; on the other hand standardised quality and reliable supply can reduce shopping time. Marking notes: all four characteristics must be compared explicitly. |
| 12 | (Competition Ordinance) The Hong Kong Competition Ordinance contains conduct rules and a merger rule. (a) State which conduct rule price fixing breaches and explain (3 marks). (b) State the scope of the merger rule (3 marks). (c) Explain why collusive agreements are hard to sustain in practice (2 marks). | Answer: (a) Price fixing breaches the First Conduct Rule, which prohibits agreements that have the object or effect of preventing, restricting or distorting competition, including price fixing, output restriction and market sharing. (b) The merger rule applies only to mergers involving holders of carrier licences under the Telecommunications Ordinance; mergers in other industries are not covered. (c) Each member gains by cutting price or raising output secretly; the agreement is not legally enforceable, and with few sellers and observable prices cheating is quickly detected, so cooperation collapses into competitive outcomes. Marking notes: the First Conduct Rule and the merger rule must be distinguished; claiming that the merger rule covers all industries is a factual error. |
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