Question

Suppose the market for apples is perfectly competitive. a) Suppose the government wants to boost the income of producers. Explain how they could use a minimum price (a price floor) or price support to do this. b) Which policy would producers prefer?

Answer 1

In this case all firms are price makers as market is perfectly competitive. No firm can determine prices. If government wants to support income then they can put price floor.

price flooring is minimum legal price that has to be paid by the sellers. When govt. believes that market prices are too low the it applies flooring. For. ex. wages in a certain city may be very low then govt. may fix minimum wages that have to be paid. Other example can be minimum price support for farmers where. govt. guarantees. minimum price per unit weight.

Economic impact can be shown as below: When market had a equilibrium price P*, govt. thought it was too low and hence price flooring at price Pf is put. Now at price Pf demand is D and supply is only S, hence there is excess of goods.

Initial equilibrium is disturbed. Consumers will be worse off in terms of price but will have to face excess. Producers are better off as they get higher prices and society as a whole is also worse off due to misallocation of resources. Govt. has to pay excess guaranteed price and hence this spent money has opportunity costs.

Government can subsidy and hence producers get more prices. This option is better as at least there is new equilibrium and producers get more prices at Pp even though consumers pay less prices.In my opinion due to new equilibrium being achieved this is a better option.