In our treatment of price floors, we illustrated the case of a government program that purchases any surplus produced in the market. Now consider a price ceiling—and the analogous case of the government addressing disequilibrium shortages through purchases on international markets.
A. Suppose, for instance, that the U.S. demand and supply curves for coffee intersect at p∗ which is also the world price of coffee.
(a) Suppose that the government imposes a price ceiling pc below p∗ for domestic coffee sales. Illustrate the disequilibrium shortage that would emerge in the domestic coffee market.
(b) In the absence of any further interference in the market, what would you expect to happen?
(c) Next, suppose that, as part of the price ceiling policy, the government purchases coffee in the world market (at the world market price p∗) and then sells this coffee at pc domestically to any consumer that is unable to purchase coffee from a domestic produce. What changes in your analysis?
(d) Illustrate— in a graph with the domestic demand and supply curves for coffee — the deadweight loss from this government program (assuming that your demand curve is a good approximation of marginal willingness to pay).
B. Suppose demand and supply are given by xd = (A − p)/α and xs = (p −B)/β (and assume that demand is equal to marginal willingness to pay).
(a) Derive the equilibrium price p∗ that would emerge in the absence of any interference.
(b) Suppose the government imposes a price ceiling pc that lies below p∗. Derive an expression for the disequilibrium shortage.
(c) Suppose, as in part A, that the government can purchase any quantity of x on the world market for p∗ and it implements the program described in A(c). How much will this program cost the government?
(d)What is the deadweight loss from the combination of the price ceiling and the government program to buy coffee from abroad and sell it domestically at pc?