Question

1. Suppose the government passes a law which says that milk cannot be sold for less than $5 per gallon.

1. What do we call this type of policy?
2. Draw two diagrams, one which shows the market for milk with this policy and one that shows the market without the policy.
3. Who is hurt by this policy? Who benefits from this policy? Explain.
4. Is this policy efficient? Explain

Answer 1

A. This type of policy is called price floor- the price of the good cant be below that set floor.

B. First lets show the market before the price floor. This is shown below-

The market is in equilibrium and the price is P (P<5), the quantity is Q.

Now lets see after the policy-

The new price ceiling is 5, which is higher than the equilibrium price. At this price the demand is Qd and the supply is Qs.

C. Customers are hurt with this policy. Their total surplus goes down after the floor. The producers benefit as their total surplus goes up as they capture some of the consumer surplus,

D. No this policy is not efficient. Free markets are always the most efficient. This policy leads to decrease in overall societal surplus (Consumer+Producer surplus). As shown in the diagram, it also leads to an oversupply of Qs-Qd.

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