Question

The Canadian government maintains price controls on many agricultural goods, including wheat and corn, two grain products produced by farmers in Canada. The resulting prices are higher than what would prevail in a free market.

a) Explain clearly why we have surpluses in these goods.

b) Suppose the government eliminated price supports for corn, but maintained them for wheat. What would happen to the prices of these goods, the quantities consumed by consumers of each good, and the size of the wheat surplus?

 

Answer 1

 

Price flooring is minimum legal price that has to be paid by the sellers. When govt. believes that market prices are too low then 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.

It is clear that Canadian govt. guarantees prices for wheat and corn to ensure that farmers have an income guarantee if crops come good. However, this raises its prices in markets and it may be possible that developing countries who do not give these price supports may see; wheat and corn at less prices.

a. 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(S-D).

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.

b. It is clear from above discussion that wheat price support will raise its prices, increase its supply and create storage problems. Corn will be sold and bought as per market forces and prices will change as per the world prices. Consumers may consume more corn as it might be cheaper.

Conclusion: When govt. has price controls then no new equilibrium is set in the market and hence market should be allowed to achieve it. Govt. can facilitate markets to cover shortage or absorb the excess.