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Question 2 - Price Floor The Agricultural Society persuades the government, in the interest of food...

Question 2 - Price Floor

The Agricultural Society persuades the government, in the interest of food security, to impose a price floor on local carrots in order to keep carrot farmers in the business.

(a) Assess the welfare implications of this measure.

(b) Assess the effectiveness of this measure in keeping farmers in carrot farming.

Learning Activity 5.2: Taxation

Question 3 - Taxation

Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased.

(a) Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers?

(b) Now draw a supply-and-demand diagram for the beer market with the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? Has the quantity of beer sold increased or decreased?

(c) Can you identify any government revenues?

(d) Is there any inefficiency, and if so, can you define it and label it on the graph?

(e) If the producer has an inelastic supply curve, which market participant has the bigger tax burden? Explain.

Question 4

Given:

QD = 160 -5P

QS = -11 + 4P

In addition, the government imposed a $3.00 tax on the buyer.

Calculate the following:

(a) The equilibrium price and equilibrium quantity.

(b) Consumer and producer surplus before the tax.

(c) Consumer surplus after the tax.

(d) Producer surplus after the tax.

(e) Deadweight loss.

(f) Government revenue.

Solutions

Expert Solution

Question 2- Price Floor

a)

When a price floor is imposed, the government sets a price for the commodity at a higher level than the market equilibrium level. Therefore, at this level the demand falls due to higher prices but since the producers are able to charge more, therefore, supply rises. This creates a wedge between the quantity demanded and the quantity supplied, as a result there is surplus in the market and the market functions at an inefficient level of output.

Since the market now functions at an inefficient level of output where the demand is not equal to the supply of the product therefore, there is dead weight loss in the economy. Due to this the overall surplus for the economy reduced, however, at this price level the producer surplus increases since they are now able to charge more but consumer surplus falls since at higher prices the consumers are buying less.

Therefore, in totality we can say that although imposing a price floor is beneficial for the producers, it reduces the surplus for the consumers, creates dead weight loss in the economy and reduces the overall surplus in the economy since the market is not functioning at the efficient level of output.

b)

When price floors are imposed above the equilibrium price, it raises the prices in the markets and as a result ptoduction becomes more attractive for the producers, therefore, producers increase their supply. Although the producers surplus increases due to increase in prices, a binding price floor benefits only some sellers because not all are able to sell as much as they would like in the legal market.

In this case due to an increase in the price level, the quantity at which the market functions reduces while the prices increase, this can either increase the total revenue for the farmers or decrease the total revenue for the farmers. The farmers would stay in the production only if they benefit from this price rise and not lose on their revenue due to a fall in the quantity demanded. As a result we can say that when demand for goods in inelastic, the increase in price will not impact the quantity demanded as much and the farmers will be able to generate a higher revenue and stay in the production of carrots. However if the demand is elatic then an increase in price would lead to a higher decrease in the quantity demanded thereby reducing the total revenue of the farmers leading to a loss for them. In such a situation the farmers would not want to continue with the production.

Therefore, a binding price floor can benefit some while it might not incentivize the others to remain in the market.


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