Question

The Department of Agriculture of Economica (DAE) administers the floor price of milk at $4 per pound of milk. To support the price of milk at the price floor, the DAE had to buy up the surplus.

Suppose the Economica's market demand and supply of milk are as given below:

Q=120-20P            (Market demand)

Q = 20P                   (Market supply)

Refer to the above-market demand and supply equations to answer the following questions.

i) Use the equations to draw the market demand and supply curves and determine the equilibrium quantity and equilibrium for milk.

ii) Explain floor price and the purpose for the government to implement the policy.

iii) Use the equations to determine the quantity demanded and quantity supplied of milk at the floor price. Explain the market outcomes of the floor price.

iv) Calculate the consumer surplus and producer surplus in the absence of a price floor.

v) Calculate the consumer surplus and producer surplus with the price floor at $4 per pound of milk.

vi) Use the results in parts (iv) and (v) to explain the impact of floor on the economic welfare of consumers and producers.

vii) Calculate the deadweight loss of floor price policy and explain the result.

viii) How much money does the DAE spend on buying up surplus milk?

Answer 1

i)

 

At market equilibrium,

 

Demand = Supply

 

=> 120 - 20P = 20P

 

=> 20P + 20P = 120

 

=>  40P = 120

 

=> P = 120/40

 

=> P = 3

 

Q = 20*3 = 60

 

ii)

 

Price floor is imposed above the equilibrium price which is a government limit to protect the producers so, that they receive a minimum price for it's goods.

 

iii)

 

At Price floor = 4,

 

Quantity Demanded = 120 - 20*4 = 40

 

Quantity Supplied = 20*4 = 80

 

Surplus = 80 - 40 = 40

 

iv)

 

v)

 

vi)

 

So, Consumer welfare decreases as consumer surplus decreases . And  producer welfare increases as producer surplus increases.

 

vii)

 

viii)