Answer to Question #267104 in Microeconomics for argho

Question

Suppose, the government has decided that the free-market price of sugar is too low. Government has imposed a binding price floor of per kg sugar at 60 taka, whereas, the market price was 50 taka per kg before the announcement.

a. Explain the effects of this flooring price on the demand and supply of the sugar market. In your graph, show the effects of the price changes on quantity demanded and quantity supplied. Does it create excess supply or excess demand? What will happen to the market price?

b. In the above situation, who (buyers or sellers) is going to get the benefit from such policy? Explain it in your own words (clue: use a graph where a Price flooring is binding).

Answer 1

(a)

Price floor is normally set above the equilibrium price and as a result the quantity supplied exceeds the quantity demanded and thus an excess supply is created.

As shown in the graph, the equilibrium market price is $P^*$ and the equilibrium market quantity is $Q^*$ .

Consumers' demand for sugar equals producers' supply at price $P^*$ .

With the establishment of a price floor, PF, the market price cannot fall below it.

At the price floor level, demand by consumers is $QD$ , which is less than $Q^*$ due to the downward sloping demand curve. Producers'supply on the other hand is $QS$ , which is more than $Q^*$ due to the upward sloping supply curve. As a result, excess supply of $QS-QD$ is created.

(b)

Sellers are the beneficiaries of such a policy. This is because, the higher price(price floor) above the equilibrium price makes up for the lower quantity that is supplied.