Unit 6bu224 Microeconomics: Price Floor Assignment

Unit 6bu224 Microeconomicsunit 6 Assignment Price Floor

This assignment involves analyzing the effects of a government-imposed price floor in a perfectly competitive market, specifically focusing on the market for Gondwanaland gosum berries. You will examine changes in consumer surplus, producer surplus, and total surplus before and after the implementation of a price floor set significantly above the equilibrium price. Additionally, you will assess the economic impact of government purchases of unsold surplus and the implications for overall market efficiency and social welfare.

Paper For Above instruction

In a perfectly competitive market, the equilibrium price and quantity are characterized by the point where supply meets demand, reflecting the most efficient allocation of resources. At this point, total surplus—comprising consumer and producer surplus—is maximized, indicating optimal economic efficiency. However, when a government intervenes to support producers—such as through establishing a price floor—market equilibrium is distorted, often resulting in inefficiencies and welfare reductions.

Analysis of the Market without Price Floor

Initially, the market for Gondwanaland gosum berries is in equilibrium at a price of $50 per barrel, with the maximum consumers are willing to pay reaching $100 per barrel. Consumer surplus (CS) is the benefit consumers receive when they pay less than what they are willing to pay. It can be calculated as the difference between the maximum price consumers are willing to pay and the market price, multiplied by the quantity purchased:

CS = (Willingness to Pay - Market Price) × Quantity

Thus, with a maximum willingness to pay of $100 per barrel, and the equilibrium price at $50, consumer surplus is:

CS = ($100 - $50) × Quantity

Assuming the quantity sold at equilibrium is the entire quantity consumers are willing to buy at $50, the consumer surplus equates to $50 multiplied by the quantity involved. Since the problem states the consumer surplus as $50, we can interpret that as the total consumer surplus in the equilibrium state, corroborated by demand data.

Similarly, producer surplus (PS) is the gain producers make when selling at the market price above their minimum acceptable price, which is generally represented by the difference between the selling price and the marginal cost (or the willingness to sell at a lower price). Given the symmetry, the producer surplus at equilibrium is also $50.

Hence, total surplus (TS), which is the sum of consumer and producer surplus, amounts to $100. This represents the most efficient allocation of resources in the absence of government intervention.

Impact of the Price Floor at $70

When the government sets a price floor at $70 per barrel, it prevents the market price from falling below this level. Given that demand at $70 is less than at $50 (since fewer consumers are willing to buy at higher prices), the quantity demanded decreases to 300 barrels per month. At this higher price, consumers experience a reduction in consumer surplus because they are still willing to pay up to $100 but only purchase 300 barrels at $70, leading to a decreased consumer surplus calculated as:

Consumer Surplus (CS) = (Willingness to Pay - Market Price) × Quantity

Willing to pay maximum $100, actual price $70, and quantity 300, the consumer surplus becomes:

CS = ($100 - $70) × 300 = $30 × 300 = $9,000

However, in considering total consumer surplus, the 'willingness to pay' per barrel is $100, but only 300 barrels are purchased, so the total consumer surplus is $30 per barrel times the 300 barrels, amounting to $9,000. The earlier calculation of $30 per barrel aligns with this.

Producer surplus, on the other hand, increases because producers sell at $70, which is higher than the equilibrium price. The surplus for producers is the difference between the price and their minimum acceptable price per unit, which, assuming it's aligned with supply curves, is $70 - marginal cost, but in this simplified model, labeled as $30. Total producer surplus is then:

Producer Surplus (PS) = (Market Price - Minimum Acceptable Price) × Quantity

Which equals $30 per barrel multiplied by 300 barrels, totaling $9,000.

The government, through the Chairman of Production’s Office, must purchase the excess supply—the quantity producers intend to supply but that consumers do not purchase at this high price—thus, 700 barrels are produced but only 300 are sold. The government intervenes by purchasing the surplus barrels at $70 each, leading to expenditure of:

Cost = Quantity surplus × Price = 400 barrels × $70 = $28,000.

This purchase acts as a subsidy funding, impacting overall economic efficiency and resource allocation.

Economic Implications of Surplus Purchases and Welfare Effects

The government expenditure on purchasing surplus gosum berries affects overall welfare, which can be calculated by subtracting the total spent by the government from the combined consumer and producer surpluses. The total surplus without intervention was $100, but with intervention, the surplus reduces due to government costs.

The total surplus post-intervention can be calculated as:

Total Surplus = (Consumer Surplus + Producer Surplus) - Government Expenditure

From the previous parts, the total consumer surplus is $9,000, and total producer surplus is also $9,000. The government spends $28,000 to buy the surplus 400 barrels. Therefore, the net total surplus becomes:

Total Surplus = $9,000 + $9,000 - $28,000 = -$10,000

This negative surplus indicates a welfare loss resulting from the government intervention, highlighting market inefficiency introduced by the price floor and government purchases.

Comparison of Surpluses and Market Efficiency

Compared with the initial state—where total surplus was $100—post-intervention total surplus is significantly lower, illustrating the economic cost of price floors and government purchases. This welfare loss underscores the inefficiency of market interventions that distort supply and demand equilibrium, leading to deadweight losses and resource misallocations.

In conclusion, while price floors can support producers' income, they often come at the expense of overall market efficiency and consumer welfare. The case of Gondwanaland’s gosum berries exemplifies how government interventions, such as purchasing surplus, impact economic welfare and highlight the importance of careful policy considerations balancing equity and efficiency.

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