BU224M2-2: Examine changes in price and quantity caused when governments take actions to modify market outcomes

6

Governmental price Setting

Elizabeth Guy

Purdue Global

07/28/2021

a. 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.

Consumer surplus = 0.5 * Demanded Quantity @ equilibrium * change in price from equilibrium.

Change in price from Equilibrium = $100-$50 = $50

Demanded Quantity = 500

Consumer surplus = 0.5* 500*50= 12500

b. How much producer surplus is created when there is no price floor? Show your calculations.

Producer surplus = (Market Price – Lowest selling price) * Sold quantity

Producer surplus = $50-$0

Thus, to produce 500 units there is cost of $50 per unit.

Not correct. Area of surplus = Base X Height X .5 of the triangle

c. What is the total surplus when there is no price floor? Show your calculations.

Total surplus = 12500 + 50 = 12550

Not correct.

d. After the price floor is instituted, 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? Show your calculations.

Consumer surplus = 0.5 * Demanded Quantity @ equilibrium * change in price from equilibrium.

Change in price from Equilibrium = $100-$70 = $30

Demanded Quantity = 300

Consumer surplus = 0.5* 300*50= 7500

Not correct. The price floor now transfers some of the consumer surplus to the producer/seller, and thus the producer surplus is larger. However, deadweight losses ensue as well, taking some surplus from both. Consumer surplus and producer surplus will be determined by finding the area of the triangle, where base X height X .5.

e. After the price floor is instituted, the Chairman of Productions 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. How much producer surplus is created with the price floor? Show your calculations.

Producer surplus = Quantity supplied by Producers – Quantity supplied to consumers

Producer surplus = 700-300

Thus, there is a surplus of 400 barrels per month

Not correct. The price floor now transfers some of the consumer surplus to the producer/seller, and thus the producer surplus is larger. However, deadweight losses ensue as well, taking some surplus from both. Consumer surplus and producer surplus will be determined by finding the area of the triangle, where base X height X .5.

f. The Chairman of Production’s 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’s office spend on buying up gosum berries? Show your calculations. 

Producer surplus = Quantity supplied by Producers – Quantity supplied to consumers

Producer surplus i.e., bought by the chairman = 700-300 = 400

Price per barrel = $70

Chairman purchase Expenditure = 400 * $70 = $28,000

g. The Emperor of Gondwanaland must collect taxes from the people to pay for the purchases of surplus gosum berries by the Chairman of Production’s Office. As a result, total surplus (producer plus consumer) is reduced by the amount the Chairman of Production’s Office spent on buying surplus gosum berries. Using your answers for problems d, e, and f above, what is the total surplus when there is a price floor? Show your calculations.

Consumer surplus after legal price= 0.5* 300*50= 7500

Producer surplus = 700-300

Thus, there is a producer surplus of 400 barrels per month

Total surplus = 7500 + 400

Total surplus after taxes = 7900 – 400

Total surplus after taxes = 7500

Your answers in e and f are causing this to be incorrect.

h. How does this compare to the total surplus without a price floor from question c above? Is it more, or less, and by how much?

The total surplus after a price floor reduces as compared to without a price floor. Because the market works as a perfectly competitive market such that the quantity and equilibrium price lead to the optimum efficiency thus reducing the consumer or producer surplus has a ripple effect to the total surplus.

You will take the total from c and minus it from that of g, but it is contingent upon your answers in e and f being correct as well.

REFERENCES

Burtraw, D., Löfgren, A., & Zetterberg, L. (2014). A price floor solution to the allowance surplus in the EU emissions trading system. Issue Brief, 14-02.

Smith, V. L., & Williams, A. W. (1981). On nonbinding price controls in a competitive market. The American Economic Review, 71(3), 467-474.