There is no graph for this problem. 2. The U.S. Department of Agriculture (USDA)

Question

There is no graph for this problem.

2. The U.S. Department of Agriculture (USDA) sets a price floor for butter, which in 2008 was set at $1.05 per pound. At that price, the quantity of butter supplied in 2010 was 1.7 billion pounds, and the quantity demanded was 1.6 billion pounds. To support the price of butter at $1.05 per pound, the USDA therefore had to buy up 100 million pounds of butter. The diagram above shows the supply and demand curves in the market for butter a. Without the price floor, how much consumer surplus is created? How much producer surplus? What is total surplus? b. After the price floor is implemented, how much consumer surplus is created? c. After the price floor is implemented, producers sell 1.7 billion pounds of butter (some to consumers and some to the USDA). How much producer surplus is created now? d. How much money does the USDA spend on buying up surplus butter? (Assume they do not resell the butter) e. Any money spent by the USDA comes from government tax revenue, which comes from taxes paid by individuals and businesses in the country, thus this spending reduces the total benefits to society (total surplus). What is the total surplus with this price floor? How does this compare to the total surplus without a price floor? Is there any deadweight loss created? f. Who is better off and who is worse off as a result of this price floor?

Explanation / Answer

Concept

Consumer Surplus is the monetary benefit which a consumer derives from a good or service than the price they pay to consume it. In this particular case, consumer is willing to pay a price of $1.05 per pound of butter. At that price, the quantity demanded is 1.6 billion pounds. But the monetary benefit which they derive from butter than the price they pay is consumer surplus.

In this graph, the traingular portion above $1.05 is the consumer surplus.

The triangular area of demand curve above the Price line but below the demand curve is Consumer Surplus.

Consumer Surplus is calculated by the area of a triangle.

Area of Triangle = 1/2 (Base * Height)

Base = 1.6 (Quantity of butter)

Height = 1.15 - 1.05 (Price Axis) = .10

= 1/2 (1.6 * .1)

= .08

Thus Consumer Surplus = .08

Producer Surplus is the profit drawn by the producer by selling off the goods and services over and above the price at which they are willing to sell. If the price line is set, the producer has to sell at the price line only instead of the other prices he was willing to sell.

So in this case, price line is set for the butter and the producer sells it at equillibrium price set by the government instead of other prices he is willing to sell. So the Producer surplus is the area of a triangle below the price but above the supply curve.

Producer Surplus = Area of triangle below the price and above the supply curve.

Area of Triangle = 1/2 (Base * Height)

Base = 1.70 (Quantity of Butter Axis)

Height = 1.05 - 0.85 (Price Axis) = .20

So, Area = 1/2 (1.7 * .2)

= .17

So,Producer Surplus = .17

Social Welfare is the sum total of ConsumerSurplus and Producer Surplus

Thus, Social Welfare = Consumer Surplus + Producer Surplus

Consumer Surplus = .08

Producer Surplus = .17

Thus Social Welfare = .08 + .17

Social Welfare = .25

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