AB 224 Unit 6 Assignment

Unit 6 Assignment Template:

Name: –

Course Number:– AB224

Section Number:– 2

Unit Number:– 6

Date:–

Problem 1

Suppose that the U.S. Department of Agriculture (USDA) administers the price floor for cheese, set at $0.17 per pound of cheese. (In real life the actual price floor was officially set at $16.10 per hundredweight of cheese. One hundredweight is 100 pounds.) At that price, according to data from the USDA, the quantity of cheese produced in 2009 by U.S. producers was 212.5 billion pounds, and the quantity demanded was 211 billion pounds. To support the price of cheese at the price floor, the USDA had to buy up 1.5 billion pounds of cheese. The accompanying diagram shows supply and demand curves illustrating the market for cheese.

In the absence of a price floor, the maximum price that a few of the consumers are willing to pay is $0.20 for a pound of cheese whereas the market equilibrium price is $0.13 per pound. The graph also shows that the minimum price at which a few of the producers are willing to sell is $0.06 per pound. In the absence of a price floor, how much consumer surplus is created?

Remember that you must divide by 2 (same as multiplying by .5) to get area of a triangle. The formula for the area of a triangle is: area = (b * h) * .5

If there is NO price floor:

Consumer’s Surplus, CS, would be found by calculating the area of the triangle for consumers. The formula would be the amount purchased multiplied by the total of the maximum price, which is the highest price at which some consumer will purchase some of the item, minus the actual price, set by equilibrium or by law, and that new total multiplied by .5, which is the same as dividing the amount in half.:

CS = [amount bought x (the maximum price – the actual price) ] x 0 .5

CS = [ 211.5______ Billion pounds x ( $ _.20 – $ ___.13) ] x 0.5 = $_7.40______ Billion

How much producer surplus?

The same procedure is used to compute the Producer’s surplus, PS, only subtracting the lowest price a producer will supply at and subtracting it from the actual selling price.

PS= [ _211.5_____ Billion pounds x ( $___.13_- $ .06) ] x 0.5 = $ 7.4 Billion (Krugman & Wells, 2005).

What is the total surplus?

To get the total surplus, TS, you must add the consumer’s surplus and the producer’s surplus together.

TS = $ .07_Billion $ + $_.07_Billion $ = $ .14 Cent or 7.4 + 7.4 = 14.8 billion

The maximum price that a few of the consumers are willing to pay is $0.20 per pound of cheese, and the price floor is set at $0.17 per pound. With the price floor at $0.17 per pound of cheese, consumers buy 211 billion pounds of cheese. How much consumer surplus is created now?

If there IS a price floor:

CS: [ _211 Billion pounds x ($20 – $.17 ) ] x 0.5 = $3.615 Billion

The minimum price at which a few of the producers are willing to sell a pound of cheese is $0.06, and the price floor is set at $0.17 per pound. With the price floor at $0.17 per pound of cheese, producers sell 212.5 billion pounds of cheese (some to consumers and some to the USDA). How much producer surplus is created now?

If there IS a price floor:

PS: [ 212.5 Billion pounds x ($.17- $.06)] x 0.5 = $ 11.6875 Billion

The surplus cheese USDA buys is the difference between the quantity of cheese producers sell (212.5 billions of pounds of cheese) and the quantity of cheese consumers are willing to buy at the price floor (211 billions of pounds of cheese). How much money does the USDA spend on buying up surplus cheese?

The USDA spends 255 billion on buying the surplus cheese 212.5-211=1.5 or 1,500,000,000 x .17 =255,000,000.

212.5-211 = 1.5 Billion pounds x $.17 = $255 Billion

Taxes must be collected to pay for the purchases of surplus cheese by the USDA. As a result, total surplus (producer plus consumer) is reduced by the amount the USDA spent on buying surplus cheese. Using your answers for parts d-f, what is the total surplus when there is a price floor?

After the price floor, total surplus is:

[ (PS) $ 8.46 Billiion + (CS) $ 8.44 Billion] – $ 16.55 Billion spent by USDA = $16.65 Billion (Krugman & Wells, 2005).

How does this compare to the total surplus without a price floor from part a?

Prior to the price floor, total surplus was: $ 7.4 Billion

After the floor, total surplus is: $ 16.65 Billon

Therefore, the total surplus is 16.65 billion. It is more than without floor price of part a (State whether it is more or

less.)

References:

Krugman, P., & Wells, R. (2005). Microeconomics (3rd ed.). New York: