Unit 6 Microeconomics Assignment: Price Floor

Unit 6ab224 Microeconomicsunit 6 Assignment Price Floor

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, at the same time, making buyers worse off, and that buyers cannot be made better off without making sellers worse off. This assignment presents a scenario in which a government tries to improve the financial position of sellers in such a market by instituting a legal price floor that is significantly above the equilibrium price. A price floor is the lowest legal price at which a seller can sell a product. The task involves calculating consumer surplus, producer surplus, and total surplus both before and after the implementation of the price floor, as well as understanding the economic impacts of these changes.

Paper For Above instruction

The case of Gondwanaland’s gosum berries provides an insightful example of how government intervention through a price floor can impact market equilibrium, consumer and producer surpluses, and ultimately, overall economic welfare. Before analyzing the specific impacts, it is essential to understand the basic economic concepts at play, including consumer surplus, producer surplus, and total surplus, as well as how they are affected by changes in market prices due to government policies.

Consumer Surplus and Producer Surplus in a Free Market

Consumer surplus (CS) represents the difference between what consumers are willing to pay for a good and what they actually pay. In a free market, it is the area below the demand curve and above the market price, up to the quantity exchanged. Producer surplus (PS), on the other hand, is the difference between the market price and the minimum price producers are willing to accept, represented by the area above the supply curve and below the market price. Total surplus (TS) is the sum of consumer and producer surpluses, reflecting the overall economic welfare generated by the market.

Market Equilibrium Without Price Floor

According to the scenario, the equilibrium price for gosum berries is $50 per barrel, with an equilibrium quantity where consumers are willing to pay up to $100. At this equilibrium, the maximum price some consumers are willing to pay does not directly affect the equilibrium calculations but provides context for the demand curve. The market achieves maximal efficiency when supply equals demand at $50, with consumer and producer surpluses maximized accordingly.

a. Consumer Surplus without Price Floor:

Given the demand curve, consumers are willing to pay up to $100, but the equilibrium price is $50. If the equilibrium quantity (Qe) is not provided directly, it can be determined through the demand function or geometric assumptions, but for simplicity, it can be summarized that consumer surplus (CS) is the area of a triangle with height equal to the difference between the maximum willingness to pay ($100) and the equilibrium price ($50), and base equal to the equilibrium quantity (Qe).

CS = 0.5 × (Maximum willingness to pay - Equilibrium price) × Equilibrium quantity

Assuming the equilibrium quantity, Qe, is 600 barrels (as an illustrative estimate), then:

CS = 0.5 × ($100 - $50) × 600 = 0.5 × $50 × 600 = $15,000

b. Producer Surplus without Price Floor:

Producer surplus is the area between the equilibrium price and the minimum acceptable price, which often corresponds to the supply curve. Assuming linear supply, and given the equilibrium price of $50, if producers' minimum acceptable price (their marginal cost) is less than $50, producer surplus is the area above the supply curve and below the market price, up to Qe.

Suppose the supply curve intersects the vertical axis at a cost of $20 per barrel, and the equilibrium quantity is 600 barrels:

PS = (Market Price - Minimum acceptable price) × Quantity / 2

PS = ($50 - $20) × 600 / 2 = $30 × 600 / 2 = $9,000

c. Total Surplus without Price Floor:

TS = Consumer Surplus + Producer Surplus = $15,000 + $9,000 = $24,000

Implementation of Price Floor at $70

With the government setting a price floor at $70 per barrel, which is above the equilibrium price of $50, the market experiences a shift. The quantity demanded at this higher price decreases; in this case, consumers buy only 300 barrels per month, indicating a decrease in quantity demanded due to higher prices. At the same time, producers are willing to supply more—700 barrels—but consumers only purchase 300 barrels at the new price.

Consumer Surplus After Price Floor

The new consumer surplus is the area of the triangle between the maximum willingness to pay ($100), the new price ($70), and the quantity purchased (300 barrels).

CS = 0.5 × (Maximum willingness to pay - Price floor) × Quantity purchased

CS = 0.5 × ($100 - $70) × 300 = 0.5 × $30 × 300 = $4,500

Producer Surplus After Price Floor

Producers now receive $70 per barrel, and their total production capacity is 700 barrels. Assuming their minimum acceptable price remains at $20, producer surplus is the area above the supply curve below the market price, up to the quantity sold (300 barrels).

PS = (Price floor - Minimum acceptable price) × Quantity sold / 2

PS = ($70 - $20) × 300 / 2 = $50 × 300 / 2 = $7,500

Cost of Surplus Purchase by the Government

The surplus amount is the difference between the quantity produced and the quantity sold to consumers. Producers produce 700 barrels but sell only 300 to consumers. The government, via the Chairman of Production, purchases the remaining 400 barrels to support the price floor.

The government spends:

Amount spent = Surplus barrels × Price floor = 400 × $70 = $28,000

Total Surplus with Price Floor

However, the total economic surplus is reduced because the government purchases surplus barrels, which incurs a cost. The combined consumer and producer surpluses are:

TS = Consumer Surplus + Producer Surplus - Government expenditure

TS = $4,500 + $7,500 - $28,000 = -$16,000

Comparison with No Price Floor

Initially, total surplus was $24,000 without a price floor. After the intervention, total surplus decreases to -$16,000, reflecting a significant loss of economic welfare due to the government purchases and market distortions.

This demonstrates that while the price floor was designed to help producers, it resulted in a net welfare loss, with efficiency and consumer welfare both declining.

Conclusion

Government interventions such as price floors intended to protect specific groups of producers can inadvertently cause market inefficiencies, reduce total welfare, and distort the normal functioning of the market. The analysis of the gondwanaland case illustrates how these policies impact consumer and producer surpluses, as well as the overall economic efficiency. Policymakers should carefully weigh the benefits against the opportunity costs and unintended consequences of such interventions, considering alternative measures that may better balance social and economic objectives.

References

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