Question

v

Question #1: Suppose that you are the economic advisor to a local government that has to deal with a politically embarrassing surplus that was caused by a price floor that the government recently imposed. Your first suggestion is to get rid of the price floor, but the politicians don’t want to do that. Instead, they present you with the following list of options that they hope will get rid of the surplus while keeping the price floor. Identify each one as either could work or can’t work.

1. Restricting supply.
2. Decreasing demand.
3. Purchasing the surplus at the floor price.

Answer 1

In this figure, equilibrium price is P* and quantity is Q*. Now a price floor is imposed in the market at price=P_floor. At this price quantity supplied i.e QS is higher than the quantity demanded i.e Qd. Hence there is excess supply or surplus in the market given by (Qs-Qd).

1. restricting supply: Here to eliminate the surplus in the market, government can restric the quantity supplied at a level where Qd=Qs. In the case quantity supplied becomes equal to quantity demanded and the government can get rid of the surplus. Hence, this is an effective method to eliminate surplus in the market.
2. Decreasing demand: Here in case of price floor quantity demanded is smaller than the quantity supplied. Hence if the government decreases demand, then quantity demanded will even be smaller than Qd and hence surplus in the market will further rise. Hence this is not an effective method to reduce surplus in the market.

3. Purchasing the surplus at the price floor price: If the government purchases the surplus amount (Qs-Qd) at price P_floor, then all the surplus will be eliminated in the market and hence it is an effective method to reduce surplus in the market.