Question

b) The Namibian government through the Ministry of Agriculture, Water and Land Reform (MAWLR) has decided that the agricultural freemarket price of milk is too low. Supposed the government imposes a binding N$4 price floor in the milk market above the equilibrium price of N$3. The price floor will increase the quantity supplied with 36% and reduces the quantity demanded by 6.25%. The equilibrium quantity is 80 Litres

i) Suppose the government imposes a binding price floor in the milk market. Draw a supply-and-demand diagram to show the effect of this policy on the price of milk and the quantity of milk sold. Is there a shortage or surplus of milk? (6)

ii) Dairy farmers complain that the price floor has reduced their total revenue. Is this possible? (2)

iii) In response to farmers’ complaints, the government agrees to purchase all the surplus milk at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

Answer 1

b)i) The graph below shows the market equilibrium when there is no government interference. When the government puts a price floor of $4, above the equilibrium price, then there is a surplus.

Given the data of the increase in quantity supplied and decrease in quantity demanded, it can be said that the demand is inelastic and the supply is elastic. This is also shown in graph. When the price rises to $4, the change in demand is less and the change in supply is more.

There is surplus in the economy at price floor. The suppliers would be supplying more at a high price and the demand would reduce at a higher price.

ii) The dairy farmers who have been able to sold their milk at $4 are benefitted. But this is less than the equilibrium which existed before the price floor. Hence the sellers who are not able to sold are the ones who are at loss because of the price floor. So their revenue would have declined.

Also as given in the question, the quantity supplied increased by 36%, which implies that this increased suppliers along with few sellers who were able to sell at equilibrium are losing. Hence there has been a loss of revenue for some, while a gain for others.

iii) Given that there is surplus of milk now that the price floor is imposed, if the government is willing to buy the surplus milk at basic floor price, then the suppliers would be benefitted and the government would bear the loss. This is because the suppliers would sell to customer as long as the demand and supply are equal at $4 price. When the supply is more at that price, it would be sold to the government.