Question

The government has decided that the freemarket

price of cheese is too low.

a. Suppose the government imposes a binding

price floor in the cheese market. Draw

a supply-and-demand diagram to show the

effect of this policy on the price of cheese and

the quantity of cheese sold. Is there a shortage

or surplus of cheese?

b. Farmers complain that the price floor has

reduced their total revenue. Is this possible?

Explain.

c. In response to farmers’ complaints, the government

agrees to purchase all the surplus

cheese at the price floor. Compared to the

basic price floor, who benefits from this new

policy? Who loses

Answer 1

a.

Quantity supplied is greater than quantity demanded due to the price floor. There will be market surplus.

b.

If the price floor is greater than equilibrium price, there will be surplus of unsold goods because supply is greater than demand thereby reducing farmers revenue.

c

Farmers will benefit and consumer will suffer by purchasing at a higher price.