Question

Government intervene market by using a system called supply management and one of the ways is to impose a price floor. Explain why the actual loss caused by the price floor may be even larger than the deadweight loss.

Answer 1

Price floor is discussed below. It is the minimum limit imposed on the market price such that consumers have to pay at least this price. This reduces quantity demanded, raises quantity supplied and hence create a surplus of unsold goods. Now deadweight loss is area D + E. But there is a surplus of unsold goods which, if not sold, has a value greater than the deadweight loss. If it is sold to government than it is the government that bears additional deficit. Hence the actual loss caused by the price floor may be even larger than the deadweight loss.