The U.S. Department of Agriculture (USDA) administers the price floor for milk,

Question

The U.S. Department of Agriculture (USDA) administers the price floor for milk, set at $0.10 per pound of milk. (The price floor is officially set at $9.90 per hundredweight of milk. One hundredweight is 100 pounds.)

At that price, according to data from the USDA, the quantity of milk produced in 2003 by U.S. producers was 170 billion pounds, and the quantity demanded was 169 billion pounds.

To support the price of milk at the price floor, the USDA had to buy up 1 billion pounds of milk.



a. In the absence of a price floor, how much consumer surplus is created?


How much producer surplus?


What is the total surplus?



b. With the price floor at $0.10 per pound of milk, consumers buy 169 billion pounds of milk. How much consumer surplus is created now?



c. With the price floor at $0.10 per pound of milk, producers sell 170 billion pounds of milk (some to consumers and some to the USDA). How much producer surplus is created now?


d. How much money does the USDA spend on buying up surplus milk?


e. Taxes must be collected to pay for the purchases of surplus milk by the USDA. As a result, total surplus (producer plus consumer) is reduced by the amount the USDA spent on buying surplus milk. Using your answers for parts b—d, what is the total surplus when there is a price floor?


How does this compare to the total surplus without a price floor from part a?

Thank you for your efforts and help on this in advance, as this truly is a struggle for me.

Explanation / Answer

a. In the absence of any price floor, consumer surplus is the area below the demand curve but above the equilibrium price of $0.08: it is (($0.14 $0.08) × 169.5 billion)/2 = $5.085 billion. And producer surplus is the area above the supply curve but below the equilibrium price of $0.08: it is (($0.08 $0.02)× 169.5 billion)/2 = $5.085 billion.
Total surplus therefore is $5.085 billion + $5.085 billion = $10.17 billion.

b.With the price floor at $0.10 per pound, consumer surplus is the area below the demand curve but above the price of $0.10: it is (($0.14 $0.10) × 169 billion)/2 = $3.38 billion.

c. With the price floor at $0.10 per pound, producer surplus is the area above the supply curve but below the price of $0.10: it is (($0.10 $0.02) × 170 billion)/2 = $6.8 billion.

d. The USDA buys 1 billion pounds of milk at a price of $0.10 per pound, for a total of $0.10 × 1 billion = $0.1 billion.

e. Total surplus when there is a price floor is consumer surplus plus producer surplus minus the money spent by the USDA. It is $3.38 billion + $6.8 billion $0.1 billion = $10.08 billion.

This is less than the $10.17 billion total surplus without any price support.

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