Farming is a risky yet essential business where a good harvest can actually result in lower prices and profits for producers. Farmers throughout history have thus sought policies to guarantee stable prices and profits. This question considers a price guarantee, a policy intended to help producers that has some unintended consequences.
The graph below shows the market for corn with an initial equilibrium at (12,6).
Suppose that Congress implements a price guarantee to ensure that farmers get steady income. Congress agrees to keep the price at $8 by directly purchasing any extra corn produced and then reselling it at whatever price the market will accept. The government will pay the difference in prices.
Graph the price guarantee as a line extending horizontally from $8 to the supply curve.
What quantity will be produced with the guarantee in place? million bushels
What price would result in a quantity demanded equal to the amount produced with the price guarantee? $ per bushel. This is the buyer’s price with the guarantee.
On the graph, use the straight-line tool to draw the buyer’s price as a horizontal line from the vertical axis to the demand curve. Then use the area and label tools to draw and label the deadweight loss generated from the price guarantee. For full credit, your graph should include two horizontal lines (the seller’s price and the buyer’s price) and a shaded area that is labeled as the deadweight loss.
The price guarantee results in entry into the market, represented by the section of the supply curve that is above the original equilibrium price but below the price guarantee. What is the additional producer surplus to these farmers who enter the market because of the guarantee? million dollars
The price guarantee also results in additional buyers entering the market, represented by the section of the demand curve that is below the original equilibrium price but above the buyer’s price with the guarantee. What is the additional consumer surplus to these new consumers? million dollars
Calculate the deadweight loss from the subsidy. million dollars
Government officials are frustrated that the price guarantee is both costly and wasteful, especially for new entrants into the market that are not efficient producers. They thus propose the following scheme in an attempt to maintain support for farmers at a lower cost: Farmers who entered the market only after the price guarantee was put in place will be offered $2 per bushel not to grow corn. They will be paid based on how many bushels they produced previously.
Recall that these farmers are represented by the part of the supply curve above the initial equilibrium price of $6 but below $8.
What will be the total cost to the government of this new scheme? million dollars
What is the deadweight loss under the new scheme? million dollars
price on y axis, bushels of corn in millions on x axis
demand curve: x int (24,0) y int (0,12) slope = -2
supply curve line: (0,0) slope = 1/2