5. For the last 70 years the U.S. government has used price supports to provide

Question

5. For the last 70 years the U.S. government has used price supports to provide income assistance to American farmers. At times the government has used price floors, which it maintains by buying up the surplus farm products. At other times, it has used target prices, a policy by which the government gives the farmer an amount equal to the difference between the market price and the target price for each unit sold. Consider the market for corn depicted in the accompanying figure.


Price of corn quantity of corn (bushels)
Per bushel demand supply
$5 800 1200
4
3 1000 1000
2
1 1200 800
0

a. If the government sets a price floor of $5 per bushel, what does that mean and how will it affect supply and demand (illustrate on the supply and demand curve below)? How many bushels of corn are produced by the farmer? How many bushels of corn are purchased by consumers and at what price? How many bushels of corn are purchased by the government and at what price? How much does the program cost the government? How much revenue do corn farmers receive? (10 points)





b. Suppose the government sets a target price of $5 per bushel for any quantity supplied up to 1,000 bushels What does that mean and how will it affect supply and demand (illustrate on the supply and demand curve below)? How many bushels of corn are purchased by consumers and at what price? How many bushels of corn are purchased by the government, if any? How much does the government pay the farmer and at what price? How much revenue do corn farmers receive? (10 points)



c. Which of these programs (in parts a and b) costs corn consumers more? Explain.
Which program costs the government more? Explain. What are the inefficiencies that arise in each of these cases (parts a and b)? (20 points)

Explanation / Answer

PLEASE RATE!!!!!!! a. With a price floor of $5, the quantity of corn supplied is 1,200 bushels. The quantity demanded is only 800 bushels: there is a surplus of 400 bushels. The government therefore has to buy up the surplus of 400 bushels, at a price of $5 each: the program costs the government 400 × $5 = $2,000. Corn farmers sell 1,200 bushels (800 to consumers and 400 to the government) and therefore make 1,200 × $5 = $6,000 in revenue.a. With a price floor of $5, the quantity of corn supplied is 1,200 bushels. The quantity demanded is only 800 bushels: there is a surplus of 400 bushels. The government therefore has to buy up the surplus of 400 bushels, at a price of $5 each: the program costs the government 400 × $5 = $2,000. Corn farmers sell 1,200 bushels (800 to consumers and 400 to the government) and therefore make 1,200 × $5 = $6,000 in revenue. b. If the government sets a target price of $5, the market reaches equilibrium at a price of $3 and a quantity of 1,000 bushels. There is no surplus (or shortage). The government does not buy any corn under this policy. For each bushel sold the government pays farmers $2 (to make up the difference between the market price of $3 and the target price of $5), so the government pays a total of 1,000 × $2 = $2,000. Corn farmers sell 1,000 bushels and make $5 for each bushel ($3 come from consumers and $2 from the government), for a total of $5,000 of revenue.c. The price-floor policy is more expensive for consumers: they pay $5 per bushel (compared to the $3 under the target-price policy). Both policies are equally expensive for the government. Both cost the government $2,000. c. The price-floor policy is more expensive for consumers: they pay $5 per bushel (compared to the $3 under the target-price policy). Both policies are equally expensive for the government. Why a Price Floor Causes Inefficiency: Inefficient Allocation of Sales Among Sellers Price floors lead to inefficient allocation of sales among sellers : those who would be willing to sell the good at the lowest price are not always those who actually manage to sell it. Wasted Resources: Like a price ceiling, a price floor generates inefficiency by wasting resources . A target price is a form of a government subsidy (negative of a tax) on a commodity. With a subsidy, government generally sets some price level that consumers will pay for commodity: -?Then subsidizes firms to a level where they will satisfy quantity demanded at this price -Results in same efficiency losses as a target price? Problems arise when subsidies are removed: -Firms must cut back on production, given the lower price -In short run, may result in price dropping to below SAVC for some firms -Forcing these firms to shut down Adjustment process can be hard on an economy where a large share of industry had been subsidized and all subsidies are removed at once: -Significant short-run unemployment of resources may occur

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