Question 1: Many governments control the price of tobacco by creating a price floor. If a government decides to create a price floor for a product, the economy will have a deadweight loss. Draw a supply and demand curve and show how the price floor will create deadweight loss. In your diagram, explain the areas for Consumer Surplus, Producer Surplus, and Deadweight Loss.
One of how the government intervenes in the market is creating price floors. If the government does not intervene, the market will naturally attain equilibrium. At equilibrium, sellers are willing to sell at the prevailing price, and buyers are willing to buy at the current price. At market equilibrium, the total quantity of goods supplied is the same as the total quantity of goods demanded by the consumers. Nevertheless, in some markets and economic circumstances, the government intervene to control and reshape the economy through price ceilings, taxes, and price floors. In many economies, the government uses price floors to control the price of tobacco to monitor the amount of consumption.
Price floors are the opposite of the price ceiling. It is an artificially introduced minimum price charged on a good. In the tobacco market, the price is set above the market price and is put to benefit sellers. The government set price floors to help tobacco farmers if the market price is slow that they cannot get enough returns to help in the production process. Don't use plagiarised sources.Get your custom essay just from $11/page
The diagram below shows the effect of price floors on the tobacco market. From the diagram, it can be noted that market equilibrium was at the intersection of the demand and supply curve. Before the price floors, the equilibrium price and quantity were at Po and Qo, respectively. The initial consumer surplus was the area of triangle ABC while producer surplus was at BCO. With the introduction of price floors by the government set above the equilibrium price level, quantity changed to Q2 with respect to p1 and Q1. In this case, the quantity supplied increased more than the quantity demanded given by Q2-Q1. After the price floor, consumer surplus is realized at area ADE while producer surplus increases from area BCO to area DEFG plus that of area GFO. One of the primary problems of a price floor is that it results in inefficiency due to the increase in surplus above the equilibrium. The efficiency, also known as deadweight, is given by area ECF, as shown in the diagram below.
Price floors are beneficial for the producers since it sets the lowest legal price that buyers can pay for tobacco in a market. It helps farmers get enough return to initiate the next production process. Price floors are used by the government in most agricultural products to ensure that buyers do not pay very little for the products. For season products, farmers are likely to receive low pay in low seasons, and with price floors, the farmers are protected from getting low payment. However, price floors have inefficiencies, also termed as a deadweight loss.
Question 2: Government regulations in some countries do not allow Milk price to be more than a certain price. Should we expect product shortage or product surplus in the market? Why? Draw the supply and demand graph and show this on the graph.
Price control by setting a price limit is termed as a price ceiling. A price ceiling is a price control mechanism in which the government sets an upper limit for a particular good, and sellers cannot charge more than the set price. In the milk market, the price ceiling is set below the market price since there will be no effect is it is set above or at exactly the market price. When the price ceiling is set below the market price of milk, then there is a possibility of milk shortages since producers will not be willing to supply enough milk at the prevailing price below the market price. For basic necessities that consumers cannot do without, producers tend to charge excessive prices above the equilibrium price. In such cases, the government can intervene by introducing a price ceiling that sets a maximum price that consumers can charge for the products. Further, for products that people can survive without, and the producers charge high prices, the government intervenes by installing a price ceiling that gives the maximum price that producers can charge the consumers.
In case the government sets the price ceiling to bellow the market price, then it will be effective. The biding price will be below Po. The price ceiling p1 corresponds to the quantity demanded of milk Q1, and the quantity supplied will be Q2. It can be noted that at p1, the quantity demanded of milk is Q1, and that supplied is Q2. This implies that the amount of milk demanded is higher than the amount of milk provided in the market. When the demand for milk is higher than the milk supplied, then there is a shortage of milk in the market that can be derived from Q1 minus Q2.
Government intervention through price ceiling helps stop price from going above a given level. Since the price ceilings are set below the market price, producers tend to lose from price ceilings. This makes them produce less and reduce the amount of supply in the market. With constant demand and constant price at the prevailing set price by the government, a decrease in supply results to excess demand. Price ceilings are benefits consumers by making staples cheap in the short run. However, a binding price has long-term demerits. Some of the long-term disadvantages are an increase in shortages, low quality of products, and extra charges. Due to low pay, producers may reduce the quality of products to incur low production costs. Most economies are worried about price ceilings because it is associated with deadweight loss. Inefficiencies in the economy reduce the rate of economic growth of a country by lowering the total production. Reduced production means a low economic growth rate, which is not desirable for most economies, especially in developing countries. Despite the demerits, price control via price ceilings protects consumers from exploitation by sellers.