Economic effect of price floors
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Question 5 :
Suppose the government sets an effective price floor in the market for oranges and agrees to buy all oranges that go unsold at that price. The oranges purchased by the government are discarded. Using graphs, illustrate the number of oranges purchased by the government, & illustrate the gains and losses to all relevant groups of Americans and the deadweight loss.
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The solution discusses the economic effect of price floors.
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See the attached file. The equilibrium price and quantity are P and Q. When the government creates the price floor at P1, demand falls to Q1 because of the higher price. Quantity supplied increases to Q2, because growing oranges is more profitable at the higher price. The government buys Q2-Q1 at price P1. P2 is the price that would normally be required to cause consumers to purchase quantity Q2.
The welfare loss to consumers is the pink shaded area plus the green shaded area. This represents the utility that they must give up because of ...
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