Question

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Suppose that you are a cow farmer whose cows produce large quantities of milk for suppliers. The government has decided to increase the minimum price of milk to $3.75 per gallon. Describe the pros and cons to this new price with respect to the producer and consumer. Be sure to include in your answer: price floors

Answer 1

An increase in minimum price (imposed above free-market equilibrium price to be effective and binding) will decrease the quantity demanded and increase the quantity supplied. This will lead to a surplus, and market quantity traded will decrease. Since market price will increase, consumer surplus (CS = area between demand curve and price) will decrease, lowering consumer welfare. At higher price, producer surplus (PS = area between supply curve and price) will increase, raising producer welfare. However, since all intended beneficiaries (farmers) cannot sell their product at higher price and market quantity trade falls, this will lead to a deadweight loss.

In following graph, D0 and S0 are demand and supply curves intersecting at point E with equilibrium price P0 and quantity Q0. Free-market CS is area AEP0 and PS is area BEP0. When minimum price is raised to Pf (floor price), quantity demanded falls to Qd and quantity supplied rises to Qs, leading to a surplus of (Qs - Qd). CS decreases to area AFPf, causing a loss to consumers equal to area P0EFPf. Producer surplus increases to area BGFPf, causing a gain to producers equal to area (BGFPf - BEP0). There is a deadweight loss equal to area EFG.