Recognizing that, in a perfectly competitive market, the equilibrium price and q
ID: 1139042 • Letter: R
Question
Recognizing that, in a perfectly competitive market, the equilibrium price and quantity represent the most efficient operation of that market. That optimum efficiency means that sellers cannot be made better off without, at the same time, making buyers worse off, and that buyers cannot be made better off without making the sellers worse off.
In this Assessment, you will demonstrate your understanding and ability to correctly calculate the consumer surplus, producer surplus, and total surplus both before a price floor is established and after a price floor is enacted. Additionally, you will 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 Assessment 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.
Directions:
Using the Word template provided, answer the following questions based on the situation.
Questions
Suppose that the Gondwanaland chairman of production, who sets the governmental price floor for gosum berries, in an effort to assist the gosum berry producers to have a higher income, sets the price floor at $70 per barrel. In that particular year, the amount of gosum berries produced at the $70 price floor was 700 barrels per month. With the price floor at $70 per barrel, consumers would only buy 300 barrels of gosum berries per month. Under pressure from the suppliers of gosum berries, the chairman of production’s office decided to purchase the 400 unsold barrels per month.
The accompanying diagram shows supply and demand curves illustrating the market for Gondwanaland gosum berries. Utilizing this information, answer the following questions.
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.
b. How much producer surplus when there is no price floor? Show your calculations.
c. What is the total surplus when there is no price floor? Show your calculations.
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 when a $70 per barrel price floor is set by the government? Show your calculations.
e. How much producer surplus when a $70 per barrel price floor is set by the government? Show your calculations.
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? From where does the money come for the government to purchase the unsold gosum berries? Show your calculations.
g. What is the total surplus in this situation when a $70 per barrel price floor is set by the government? Show your calculations.
h. In this situation, how does the total surplus, when a $70 per barrel price floor is set by the government, compare to the total surplus without the price floor? Show any calculations and explain your reasoning.
i. From any differences you found between the total surplus when a $70 per barrel price floor is set by the government and the total surplus without a price floor, what do you conclude about the government's use of price floors in perfectly competitive markets? Show any calculations and explain your reasoning.
Explanation / Answer
Answer : a) Without price floor,
Base = Equilibrium quantity level = 500 barrel
Height = Consumer's maximum willing price level - Actual equilibrium market price level = 100 - 50
=> Height = $50
Consumer Surplus = 0.5 * Height * Base = 0.5 * 50 * 500 = $12,500
Therefore, without price floor the consumer surplus is $12,500.
b) Without price floor,
Height = Producer's accepted equlibrium price level = $50
Base = Equilibrium quantity level = 500 barrel
Producer Surplus = 0.5 * Height * Base = 0.5 * 50 * 500 = $12,500
Therefore, without price floor the producer surplus is $12,500.
c) Thotal surplus = Consumer Surplus + Producer Surplus
Without price floor the total surplus becomes,
Total Surplus = $12,500 + $12,500 = $25,000.
d) With price floor,
Height = Consumer's maximum willing price level - Actual equilibrium market price level = 100 - 70
=> Height = $30
Base = Consumer's purchasing quantity = 300 barrel
Consumer Surplus = 0.5 * Height * base = 0.5 * 30 * 300 = $4,500
Therefore, with price floor the consumer surplus is $4,500.
e) With price floor,
Height = Producer's accepted price level = $70
Base = Consumer's purchasing quantity = 300 barrel
Producer Surplus = 0.5 * Height * Base = 0.5 * 70 * 300 = $10,500
Therefore, with price floor the producer surplus is $10,500.
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