Suppose that you are the economic adviser to a local government in Uttarakhand,

Question

Suppose that you are the economic adviser to a local government in Uttarakhand, India that has to deal with a politically embarrassing surplus that was caused by a price floor on milk that the government recently imposed. Your first suggestion is to get rid of the price floor. Explain how and why price floors distorts markets.

Since the politicians don’t want to get rid of the price floor, they present you with the following list of options that they hope will get rid of the surplus while keeping the price floor. Identify each one as either could work or can’t work. Explain your answers. Based on your analysis, what is your recommendation and why.

a. Restricting supply

b. Decreasing demand

c. Purchasing the surplus at the floor price

Explanation / Answer

a) The price floor is the limit artificially where the product can't be sold below that price. This price is generally above the equilibrium price. A price higher than the equilibrium price distorts market because the demand is lower at a high price and the supply is higher. Apart from it, a higher price will allow the suppliers to supply more and more to increase their profit.

This causes a surplus in the market. A distorted market is a situation when the demand and the supply are not equal in the market.

b) i) restricting supply will hurt the farmers who are supplying milk in the market. it will make the farmers poor and not suitable in the market like India. The farmer's income is also important.

ii) Decreasing demand is not possible because the demand is already low because of the high price in the market. decreasing it further will only aggravate the problem.

iii) This can be done. purchasing the surplus form the market will allow the market to reach an equilibrium. The surplus will be bought by the government and it will increase the demand in the market and keep it in equilibrium.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.