Question

The basic model of supply and demand shows an equilibrium where supply crosses the demand curve. In the cases of a price ceiling or a price floor, the market would reach a different equilibrium. Use the concepts of consumer surplus and producer surplus to evaluate the welfare effects of these price controls.

Answer 1

A.

Effect of Price Floor on consumer and producer surplus

Before price floor,

Consumer surplus = area of a+b+c

Producer surplus = area of e+d

Now with the price floor, the price increases which decreases quantity to Q1. So now the,

Consumer surplus = area of a

Producer surplus = area of b+e

Deadweight loss = area of c+d

For the increased price the CS gets reduced as the area b moves to producer surplus.

B.

Effect of Price ceiling on consumer and producer surplus

Before price ceiling,

Consumer surplus = area of a+b+c

Producer surplus = area of e+d+f

Now with the price ceiling, the price decreases which decreases quantity to Q1. So now the,

Consumer surplus = area of a+b+e

Producer surplus = area of f

Deadweight loss = area of c+d

For the decreased price the CS increases as the area e moves to consumer surplus.

So both price controls would lead to market inefficiency by area of c+d