Complete The Square In Microeconomics

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In a perfectly competitive market, the equilibrium price and quantity represent the most efficient operation of that market. Optimum efficiency means that sellers cannot be made better off without making buyers worse off, and vice versa. When the government intervenes by establishing a legal price floor significantly above the equilibrium price, it impacts the market dynamics, including consumer surplus, producer surplus, and overall total surplus. This assignment explores these effects through a scenario involving the market for gosum berries in Gondwanaland, where the government sets a price floor at $70 per barrel, with accompanying calculations of surpluses before and after the intervention, as well as the broader economic implications of government purchases of excess supply.

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Introduction

Market efficiency in perfect competition is characterized by the equilibrium point where supply equals demand, maximizing total surplus, which is the sum of consumer and producer surpluses. However, government interventions such as price floors can distort this balance, leading to potential inefficiencies and economic losses. The case of Gondwanaland’s gosum berries provides a practical illustration of how price floors influence market outcomes, particularly when set above the equilibrium price, affecting consumer behavior, producer incentives, and government expenditures.

Analysis of Market Equilibrium without Price Floor

Initially, the market for gosum berries functions under perfect competition with an equilibrium price of $50 per barrel. At this point, supply equals demand, and total surplus is maximized. Consumers willing to pay up to $100 per barrel derive consumer surplus, calculated as the difference between their maximum willingness to pay and the market price. In this case, the consumer surplus per unit is $50 ($100 - $50), and with a given quantity, total consumer surplus (CS) can be estimated.

Similarly, producer surplus (PS) exists because producers are willing to supply at prices below their minimum acceptable, which is determined by production costs and willingness to sell at certain prices. At equilibrium, the producer surplus also amounts to $50 assuming symmetric supply and demand curves.

The total surplus (TS), being the sum of CS and PS, is therefore $100 ($50 + $50). This scenario exemplifies a highly efficient market where resources are allocated optimally, and no further gains can be made without disadvantaging either consumers or producers.

Effects of Implementing a Price Floor at $70

Introducing a price floor at $70 per barrel, which exceeds the equilibrium price, leads to immediate market distortions. Consumers now buy only 300 barrels per month at this higher price, despite their willingness to pay up to $100 per barrel. Consequently, consumer surplus diminishes. The total consumer surplus at $70 per barrel is calculated based on the new quantity purchased, which is 300 barrels; the consumer surplus per unit is now reduced to $30 ($100 - $70).

Total consumer surplus becomes $9,000 (300 barrels * $30). This represents a significant decline from the initial $50 per unit surplus when the price was at equilibrium. The reduction reflects the decreased consumer benefit due to higher prices and reduced consumption.

Furthermore, producer surplus increases because producers receive a higher price per barrel ($70 instead of $50). Producer surplus per unit is now $20 ($70 - $50), leading to a total producer surplus of $6,000 for the 300 barrels sold (300 * $20). While producers gain from higher prices, the overall efficiency is compromised as some consumers are priced out of the market, leading to deadweight loss.

Market Surplus and Government Purchases

At this price floor, producers produce 700 barrels, but only 300 barrels are sold to consumers. The excess 400 barrels represent surplus supply that cannot be sold at the higher price unless purchased directly by the government or a regulatory body. The government, in this scenario, opts to purchase all unsold barrels to support the farmers and maintain market stability, spending $70 per barrel on those 400 surplus barrels, totaling $28,000.

This government intervention effectively absorbs the surplus, stabilizing prices but incurring significant public expenditure. This expenditure could potentially be financed through taxation, which in turn impacts the overall economy's efficiency, as the government’s purchase does not add to consumer or producer surplus but redistributes resources.

Impact on Total Surplus and Economic Efficiency

Calculating the total surplus after the price floor reveals a decline from the initial $100, indicative of economic inefficiency. The total surplus after intervention can be approximated by summing consumer and producer surpluses but subtracting the costs incurred by government purchases: $9,000 (CS) + $6,000 (PS) - $28,000 (government expenditure) = -$13,000. Recognizing that the government’s expenditure exceeds the combined surpluses exemplifies deadweight loss and the inefficiency introduced by the price floor.

The reduction of total economic welfare signifies that the intervention, while aimed at supporting producers, results in resource misallocation, reduced consumer benefits, and increased government costs, illustrating the typical negative effects of minimum price controls in markets.

Comparison and Broader Implications

This analysis underscores that setting a price floor above equilibrium disrupts market efficiency. The associated deadweight loss reflects unmet consumer demand and overproduction, which leads to economic inefficiencies and increased fiscal burdens on the government. The scenario emphasizes the importance of careful policy design—balancing support for producers and overall market efficiency—where excessive price floors can hamper market signals and resource allocation.

Moreover, the economic impact extends beyond the market for gosum berries, influencing broader macroeconomic stability through taxation and government expenditure. Policymakers must weigh these trade-offs carefully, considering whether the social benefits of higher producer income outweigh the costs incurred elsewhere in the economy.

Conclusion

In conclusion, setting a price floor significantly above the market equilibrium leads to a decline in total surplus, representing economic inefficiency. While producers benefit from higher prices, consumers face reduced surplus and consumption levels, and the government incurs substantial costs in purchasing surplus supply. This scenario exemplifies the potential drawbacks of market interventions and underscores the importance of maintaining market-based pricing mechanisms to foster optimal resource allocation and economic welfare. Policymakers should be cautious in implementing such measures, ensuring that the benefits justify the costs and potential distortions introduced into the market.

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