Answer to Question #189650 in Microeconomics for richa

Question

Indian government realized free market price of wheat is very low. To increase farmers’ welfare government took the following steps: a) Suppose the government imposes a binding price floor in the wheat market. How this policy will affect the price, quantity demanded and quantity supplied of wheat. b) Wheat farmers complained that this binding price floor reduced their revenue. Explain how it reduced their revenue. c) In response to wheat farmers’ complaints, government purchases all the surplus quantity at the minimum price decided by the government. Who are the beneficiaries and who loses due to this price floor?

Answer 1

a)

In case a floor of binding nature is imposed, then the new price is "over" the existing one(equilibrium). 

Now, the wheat that is being supplied will rise, and so will the price. The demand for wheat will fall.

In this, the original situation is at point E, with price at P and quantity Q. But with the floor of P1(orange line), the supply is of Q2 , demand is of Q1, price of P1. 

b)

It is seen, that the demand has fallen for wheat. This shows the adverse impact, since the sale will be much lesser. With prices as high as P1, the produce will go to waste as the demand falls to Q1. The area between the Q1 and Q2 is the supply that is in excess. 

The loss of the producers is shown in the area AEC, which is the deadweight loss. 

c) 

In this scenario, the ultimate beneficiary is the producer. This is because, even with the losses, the product got sold to the government. Thus, there was no waste or any long-term losses. 

The losses were borne by the government, and also consumers. The government had to spend on the produce, to save them from losses. The consumers lost owing to the exceptionally high prices, that they could not afford.