Suppose the domestic demand and supply for corn intersects at p∗ — and suppose further that p∗ also happens to be the world price for corn. (Since the domestic price is equal to the world price, there is no need for this country to either import or export corn.) Assume throughout that income effects do not play a significant role in the analysis of the corn market.
A. Suppose the domestic government imposes a price floor p̅ that is greater than p∗ and it is able to keep imports of corn from coming into the country.
(a) Illustrate the disequilibrium shortage or surplus that results from the imposition of this price floor.
(b) In the absence of anything else happening, how will an equilibrium be re-established and what will happen to producer and consumer surplus?
(c) Next, suppose the government agrees to purchase any corn that domestic producers cannot sell at the price floor. The government then plans to turn around and sell the corn it purchases on the world market (where its sales are sufficiently small to not affect the world price of con). Illustrate how an equilibrium will now be re-established—and determine the change in domestic consumer and producer surplus from this government program.
(d) What is the deadweight loss from the price floor with and without the government purchasing program?
(e) In implementing the purchasing program, the government notices that it is not very good at getting corn to the world market — and all of it spoils before it can be sold. How does the deadweight loss from the program change depending on how successful the government is at selling the corn on the world market?
(f) Would either consumers or producers favor the price floor on corn without any additional government programs?
(g) Who would favor the price floor combined with the government purchasing program? Does their support depend on whether the government succeeds in selling the surplus corn? Why might they succeed in the political process?
(h) How does the deadweight loss from the price floor change with the price elasticity of demand?
B. Suppose the domestic demand curve for bushels of corn is given by p = 24−0.00000000225x while
the domestic supply curve is given by p = 1+0.00000000025x. Suppose there are no income effects to worry about.
(a) Calculate the equilibrium price p∗ (in the absence of any government interference). Assume henceforth that this is also the world price for a bushel of corn.
(b)What is the quantity of corn produced and consumed domestically? (Note: The price per bushel and the quantity produced is roughly equal to what is produced and consumed in the U.S. in an average year.)
(c) How much is the total social (consumer and producer) surplus in the domestic corn market?
(d) Next suppose the government imposes a price floor of p̅ = 3.5 per bushel of corn. What is the disequilibrium shortage or surplus of corn?
(e) In the absence of any other government program, what is the highest possible surplus after the price floor is imposed—and what does this imply about the smallest possible size of the deadweight loss?
(f) Suppose next that the government purchases any amount that corn producers are willing to sell at the price floor p̅ but cannot sell to domestic consumers. How much does the government have to buy?
(g)What happens to consumer surplus? What about producer surplus?
(h)What happens to total surplus assuming the government sells the corn it buys on the world market at the price p∗?
(i) How much does deadweight loss jump under just the price floor as well as when the government purchasing program is added if p̅ = 4 instead of 3.5? What if it is 5?