Question

Suppose that market for good X is free and competitive, where the equilibrium price and quantity are $30 per tops and 10 million tons per year respectively. The producers of good X complain to the government that the current market price is too low to provide them with sufficient income, and they want the government to set a price floor of $40 per ton and to purchase all resulting surplus in order to guarantee that the price support is maintained. Some government advisors are concerned by the fact that elasticities of demand and supply for good X are unknown and therefore, this price support policy could be too costly for the government.

The question:
Could the impact of the price floor on the consumers of good X (in terms of the loss of consumer surplus) be more than $100 million, or less than $100 million, or equal to $100 million? What conditions would your answer depend on?
(Hint: make some reference to elasticity.)
Explain your reasoning carefully, and illustrate with an appropriate diagram(s) using demand and supply curves.

maximum 400 words.

Answer 1

The demand is relatively inelastic, consumer surplus has fallen but less than $100 million. Producer's surplus has increased.

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