Question

The government has decided that the free-market price of cheese is too low. Farmers complain that the price floor has reduced their total revenue. Is this possible?

a) Suppose the government imposes a binding price floor in the cheese market. Use a supply and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese?

b) In response to farmers' complaints, the government agrees to purchase all of the surplus cheese at the price floor. How much in total revenue is received by the farmers? Of this amount how much is paid by buyers? By taxpayers?

Answer 1

Refer Explanation section

Explanation:

* The government has decided that the free-market price of cheese is too low. Farmers complain that the price floor has reduced their total revenue. Is this possible?* **

Floor price is the minimum price fixed by the government to protect the interest of the producers, especially the farmers.

When the market price is low`[P_1]` , the government will fix a higher price`[P_2]`. This is the minimum price the buyers are expected to pay.

Sometimes, this price may not be remunerative. It may not be high enough, as the producers expect. This very often happens in India. Though the government fixes a minimum price for sugarcane, the farmers are not happy. They demand a higher price.

b)Suppose the government imposes a binding price floor in the cheese market. Use a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese?

Sometimes the floor price of cheese`[P_2]` may bind the buyers. Then, buyers decide how much of cheese to be bought. They buy `M_1` units of cheese. There is excess supply of `M_1M_3` units.

b) In response to farmers' complaints, the government agrees to purchase all of the surplus cheese at the price floor. How much in total revenue is received by the farmers? Of this amount how much is paid by buyers? By taxpayers?

Revenue received by the farmers `OP_2E_3M_3`.
Of this amount paid by the buyers `OP_2 E_2M_1`
Tax payer's amount `M_1E_2E_3M_3`