Suppose that market for good X is free and competitive, where the equilibrium price and quantity are $30 per tons and 10 million tons per year respectively. The producers of good X complain to the government that the current market price is too low to provide them with sufficient income, and they want the government to set a price floor of $40 per ton and to purchase all resulting surplus in order to guarantee that the price support is maintained. Some government advisors are concerned by the fact that elasticities of demand and supply for good X are unknown and therefore, this price support policy could be too costly for the government.

Question:

Under what conditions could this price regulation cost the government

1, more than $200 million per year

2, less than $200 million per year

3, equal to $200 per year

(Hint: Make some reference to elasticity.)

Explain your reasoning carefully, and illustrate with appropriate diagram using demand and supply curves.