In a perfectly competitive market, the equilibrium price and quantity represent the most efficient operation of that market. Optimum efficiency means that 1) sellers cannot be made better off without, at the same time, making buyers worse off, and 2) that buyers cannot be made better off without making the sellers worse off. This assignment presents a scenario in which a government tries to improve the financial position of the sellers, in such a perfectly competitive market, by instituting a legal price floor that is significantly above the equilibrium price. A price floor is the lowest price for which a seller can legally sell the product.
You will focus on calculating the consumer surplus, producer surplus, and total surplus both before a price floor is established and after a price floor is enacted. You will also demonstrate an understanding of the impact on the entire economy, based on any changes in taxes required, if the government is to purchase any extra product that is not sold to consumers.
This assignment presents a scenario in which a government tries to improve the financial position of the sellers, in such a perfectly competitive market, by instituting a legal price floor that is significantly above the equilibrium price. A price floor is the lowest price for which a seller can legally sell the product.
Questions
Suppose that the Gondwanaland Chairman of Production Office determines that gosum berry producers are not receiving enough revenue at the $50 equilibrium price and decides to implement a price floor of $70. This causes the demand for gosum berry barrels to decrease from 500 barrels per month to 300 barrels per month. Also, in response to the new regulated price of $70, gosum berry producers increase production from 500 barrels to 700 barrels per month. The Chairman of Production Office then purchases the 400 barrel per month surplus.
The accompanying chart and diagram illustrate the market for Gondwanaland gosum berries. Using this information, answer the following questions.
Price Quantity Supplied Quantity Demanded
$120 1,200
$110 1,100
$100 1,000 0
$90 900 100
$80 800 200
$70 700 300
$60 600 400
$50 500 500
$40 400 600
$30 300 700
$20 200 800
$10 100 900
$0 0 1,000
In the absence of a price floor, the maximum price that a few of the consumers are willing to pay is up to $100 per barrel of gosum berries. The market equilibrium (E) price is $50 per barrel. How much consumer surplus is created when there is no price floor? Show your calculations.
How much producer surplus is created when there is no price floor? Show your calculations.
What is the total surplus when there is no price floor? Show your calculations.
(Enter your response here.)
After the price floor is implemented, the legal minimum price that can be charged by suppliers is $70 per barrel. The maximum price that a few of the consumers are still willing to pay is $100 per barrel of gosum berries. With the price floor at $70 per barrel, consumers buy 300 barrels of gosum berries per month. How much consumer surplus is created with the price floor (CSpf)? Show your calculations.
After the price floor is implemented, the Chairman of Production Office buys up any barrels of gosum berries that the producers are not able to sell. With the price floor, the producers sell 300 barrels per month to consumers, but the producers, at this high price floor, produce 700 barrels per month. Keeping in mind that the Chairman of Production Office buys up any barrels of gosum berries that the producers are not able to sell, how much producer surplus is created with the price floor (PSpf)? Show your calculations.
The Chairman of Production Office buys any barrels of gosum berries that the producers are not able to sell. With the price floor, the producers sell 300 barrels per month to consumers, but the producers, at this high price floor, produce 700 barrels per month. How much money does the Chairman of Production Office spend on buying up surplus gosum berries? Show your calculations.
The emperor of Gondwanaland must collect taxes from the people to pay for the purchases of surplus gosum berries by the Chairman of Production Office. As a result, total surplus with a price floor (TSpf) is reduced by the amount the Chairman of Production Office spent on buying surplus gosum berries. Using your answers for questions 4, 5, and 6 above, what is the total surplus when there is a price floor (TSpf)? Show your calculations.
How does the total surplus with a price floor (TSpf) (from question 7) compare to the total surplus without a price floor (TS) from question 3 above? Explain if it is more or less, and by how much? Show your calculations.
