Suppose an industry trade group has convinced legislators that a ...

[SO00]

Suppose an industry trade group has convinced legislators that a price floor should be used so that producer surplus is maximized in the market for milk. The group argues that such a policy would save the family farm. Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve, determine the resulting price, output and social welfare from such a policy. Compare this result to the competitive equilibrium.
 
  What will be an ideal response?

Question 2

Suppose a consumer advocacy group has convinced legislators that vitamin pills should be free to consumers. Such a policy would enhance the health of the citizenry, they argue. Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve, determine the resulting output and social welfare from such a policy. Compare this result to the competitive equilibrium.
 
  What will be an ideal response?

[bhavsar]

Answer to Question 1

Producer surplus is maximized at a price that is midway between the supply curve and the demand curve intercept. Compared to the competitive equilibrium, a lower quantity is sold at a higher price. The area from this new quantity to the competitive quantity in between the demand and supply curves represents the loss of consumer surplus that is not gained by anyonethe deadweight loss.

Answer to Question 2

Consumer surplus is maximized when price equals zero. Output will be the quantity where the demand curve hits the quantity axis. The social welfare is less than the competitive result because for quantities beyond the competitive equilibrium, producers incur a cost for which they are not reimbursed. Some of this loss represents a transfer to consumers (the area under the demand curve to the right of the equilibrium quantity). The area above the demand curve and below the supply curve for quantities beyond the equilibrium quantity represents the deadweight loss.