Monday, September 15, 2014

Gonvernment Intervention 4 - Price Floors

Price Floors

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Remember (floors are high) - When drawing an effective price floor it must be drawn above the                                                         equilibrium.

Price floors are also known as minimum price, refers to setting a price higher than the market equilibrium by the government and no seller can sell the good at a lower price than the set minimum price.

Government reasons to set a price floor.
  • to protect the sellers and stabilize their incomes - agricultural products
  • to prevent deprivation for disadvantaged sellers - minimum wage
The graph above has a binding price floor that is set higher than the equilibrium price. This causes an excess supply of products. The high price causes the quantity demand to decrease allowing a glut or a surplus to form. The high prices help the producers (red area above) and hurts the consumer (blue area) as their surplus shrinks,,, the yellow triangle area is dead weight loss (DWL) or a loss to society in that these trades were not allowed to happen. 

mjmfoodie video - price floors and ceilings Watch It!!!

Impacts of a Price Floor

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1.    Government measures to dispose of the surplus:

The price floor (high price) causes a surplus or excess supply. What's to be done with this excess. In some instances the government decides to buy the excess supply. The governments buying is described as actions necessary to keep the price high. The expense is financed by the taxpayer and incurs a loss to society.

Buffer stock schemes are not on the AP, (or I haven't found any examples) but the concept of the governments intervention and especially the effects are relevant.

2.     Producers gain and consumers loose:

Producers now receive a higher revenue than before, and are better off. However, consumers lose as they are forced to pay a higher price and (enjoy less of the products).

Venezuela Toilet Paper Shortage: Government To Import 50 Million Rolls 

3.      Loss of Social Welfare:

Less trade less goods and services being enjoyed. Therefore, the people are worse off.
Go back and look at the yellow triangle above.

4.      Inefficient Resource Allocation:

Since the government has started the program to buy the surplus of goods it stands to reason that producers to overproduce, causing inefficient resource allocation. (more resources, land, labor, will be used for producing the (government purchased good) and less for producing other goods.

AP Price Floor Problems

1995 AP Microeconomics Exam

Answer - (D) The price floor would tend to create a shortage of the good in the market.

2000 AP Microeconomics Exam

Answer - 18. (B) WYZ
                             Competitive equilibrium means the equilibrium before the price floor.

Answer - 19. (C) decreases from OS to OR

2008 AP Microeconomics Exam

Answer - (A) a surplus and the price will eventually fall.


Welker on Price Controls

Ghana Buffer Stock Schemes - Almost makes you believe it.

Milton Friedman on Price Controls - Watch! I think he nails it.

Is Price Gouging Immoral? Should It Be Illegal?

Library of Economics & Liberty

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