The government has decided that the free market price of tobacco is too low.

a. Suppose the government imposes a binding price floor in the tobacco market. Use a supply and demand diagram to show the effect of this policy on the price of tobacco and the quantity of tobacco sold. Is there a shortage or surplus of tobacco? What does the market outcome depend on?

b. Tobacco producers complain that the price floor has reduced their total revenue. Is this possible? Explain.

c. In response to producers’ complaints, the government agrees to purchase all of the surplus tobacco at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?