Question

Suppose the government sets an effective price floor (that is, a price above equilibrium) in the market for oranges and agrees to buy all oranges that go unsold at that price. The oranges purchased by the government are discarded. Illustrate the number of oranges purchased by the government. Illustrate the gains and losses to all relevant groups of Americans and the deadweight loss.

Answer 1

The market for oranges is shown below. The market equilibrium is at E where the market price is Pm and quantity is Qm. The government has set an effective price floor Pf which is a price level above the market clearing price Pm. due to this there is a surplus of oranges not purchased by consumers equivalent to QgQf. Government has decided to purchase all the unsold oranges at the price floor which is this surplus of oranges. Government is therefore purchasing QgQf number of oranges which is shown in the diagram below.

Consumer surplus is reduced from area AFE to an area ADB. Producer surplus is increased from an area HFE to an area HDC. Because government is purchasing the surplus it has to spend money which can be shown by the area BCQgQf. this is the cost incurred by the government. The deadweight loss from this event is equal to the area CQgQfB.