Producer and Consumer Surplus with Price Floors

 

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, set the price floor at $70 per barrel. These berries are a food staple of the Gondwanalandians and contributes directly to their health and long life (average lifespan of 150+ active years).

In that particular year the amount of gosum berries produced at the $70 price floor was 700 barrels per month. To support the price of gosum berries, the Chairman of Production’s Office had to purchase 400 barrels per month.  The accompanying diagram shows supply and demand curves illustrating the market for Gondwanaland gosum berries.

 

  1. In the absence of a price floor, the maximum price that a few of the consumers are willing to pay 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.

Consumer surplus is defined as the area below the demand curve but above the market price(Sun, Delucchi, Lin & Ogden,  2014) In our case the consumer surplus is represented by the area between price of $50 and $100 against quantity of 500.

Consumer surplus        = ½ (50*500)

= 50,000

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  1. How much producer surplus when there is no price floor?

Producer surplus is the area below the price curve but above the supply curve. (Sun, Delucchi, Lin & Ogden, 2014)

Producer surplus         = ½ (50*500)

=50,000

  1. What is the total surplus when there is no price floor? Show your calculations.

 

Total surplus    = 50,000 +50,000

= 100,000

 

  1. 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 with the price floor?

Consumer surplus after the price floor            = ½ (30*300)

= 4,500

How much producer surplus is created with the price floor? Show your calculations.

Producer surplus after price floor       = ½ (70*700)

= 24,500

  1. e) 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 surplus gosum berries? Show your calculations.

= 700 barrels  – 300 barrels

= 400 barrels

= 400*70

= 28,000

 

  1. f) The Emperor of Gondwanaland must collect taxes from the people to pay for the purchases of surplus gosum berries by the Chairman of Production’s Office. As a result, total surplus (producer plus consumer) is reduced by the amount the Chairman of Production’s Office spent on buying surplus gosum berries. Using your answers for parts d, e, and f, what is the total surplus when there is a price floor? Show your calculations.

Total surplus    = 24500 + 4500

= 29000

  1. g) How does this compare to the total surplus without a price floor from part c?

The price floor has reduced the total surplus in the market.

 

References

Sun, Y., Delucchi, M. A., Lin, C. Y. C., & Ogden, J. M. (2014). The producer surplus associated with gasoline fuel use in the United States. Working paper, University of California at Davis.


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