Question

In: Economics

The market for milk is initially in equilibrium with a downward-sloping demand line and an upward-sloping...

The market for milk is initially in equilibrium with a downward-sloping demand line and an upward-sloping supply line. The government imposes a binding price floor on milk. Which of the following is a consequence of the price floor?

(I) The price increases

(II) The quantity demanded decreases

(a) Only I.

(b) Only II.

(c) Both of them

(d) Neither of them.

Solutions

Expert Solution

ANSWER-

option c. Both of them

Price floor is the minimum price at which sellers may sell a particular good or service. Price floor is fixed by the government to assure suppliers a remunerative price for their products. A binding price floor is set ABOVE the Equilibrium price. Hence, PRICE will INCREASE. At a price above the Equilibrium price, the quantity demanded by buyers will DECREASE ( according to the law of demand quantity demanded increases as price falls and decreases as price increases) .

Hence, both ( I ) and ( II) are correct. As a result of an imposition of price floor which is set above the Equilibrium price, the PRICE OF MILK will increase which will lead to A DECREASED IN QUANTITY DEMANDED.

Option a is incorrect because not only ( I) but ( II) is also correct. As price will increase due to imposition of price floor, quantity demanded by buyers will decrease ( according to the law of demand)

Option b is incorrect because not only ( II) but (I) is also correct. A binding price floor is set above the Equilibrium price and hence price will INCREASE.


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