Question

Suppose that a country’s government decides that since rice is the main food source (i.e., a staple crop) for rural households, that a lower price for rice should help rural households. Currently the price of rice is P_r, but the government decides to implement a price ceiling for rice. That is the government mandates that rice be sold at P_c, where we have that P_c < P_r. However, note that rural households also grow rice. Use the agricultural household model figures to answer the following questions.

1. Use a figure to show the household as a consumer. Show whether the household (only as a consumer) is better or worse off as a result of the policy. Please use proper labels.
2. Now use a figure to show the household as a producer. Show whether the household (only as a producer) is better or worse off as a result of the policy. Please use proper labels.
3. Now consider the household as both a producer and a consumer. Show that the household may be better off or worse. Please create two figures to do this. Please use proper labels.
4. What types of households will be better off as a result of the policy?
5. What types of households will be worse off as a result of the policy?
6. Explain to the government of this country the relevance of what you have found using this model.

Answer 1

A. The initial situation (without price ceiling) is shown below. This is not the answer of the question. This is for better understanding. The answer is after that.

The price is Pr and the quantity supplied is Q*. The Consumer surplus is CS and the producer surplus is PS, as shown.

Now, the price ceiling is introduced. The situation becomes like shown below (this is the answer)-

The new price is Pr. As shown, the consumer surplus is now higher (the areas shown as CS). Though the ceiling has introduced a shortage (shown). The new quantity is Qs. The household as a consumer is better off, as shown.

B. We can use the same graph as above,

The household as a producer is worse off, because the producer surplus is now lower (shown as PS), as compared to earlier (initial situation, graph 1 in part A).

C. Again, using the same graph-

Taking both producers and consumers, we can see that the total surplus (CS+PS) is lesser in the new situation (with ceiling) than it was earlier (no ceiling, graph 1 in part A). This loss is shown as Deadweight Loss (DL) in the above graph. Because of this loss overall. overall we are worse off.

D. As shown in part A, consumers will be better off.

E. As shown in part B, producers will be worse off.

F. The relevance of this is what markets are most efficient at free market equilibrium (the initial condition) and result in highest surplus to the society as a whole. Any tinkering with free market (price floors or price ceilings etc) result in an efficiency and surplus loss to society. Hence, free markets should not be disturbed as much as possible.

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