Price Supports:Supply Restrictions, Import Quotas and Tariffs

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Microeconomics ECO402

Lesson 28

Price Supports

Price

To maintain a price Ps

the government buys

quantity Qg . The change in

consumer surplus = -A - B,

and the change in producer

surplus is A + B + D

D+

Quantity

The cost to the

government is the

speckled rectangle

Price

Ps(Q2-Q1)

Total welfare loss

D-(Q2-Q1)ps

Total

Welfare

Loss

D+

Quantity

Question:

Is there a more efficient way to increase farmer's income by A + B + D?

Price Supports and Production Quotas

Production Quotas

The government can also cause the price of a good to rise by reducing supply.

What is the impact of controlling entry into the taxicab market?

134

Microeconomics ECO402

Supply Restrictions

Supply restricted to

Price

Supply shifts to S' @

·CS reduced by A + B

·Change in PS = A - C

Quantity

·P

Price

is maintained with

and incentive

·Cost to government = B + C + D

Quantity

ĆPS =A - C + B + C + D

=A + B + D.

The change in consumer and producer surplus is the same as with price supports.

Ćwelfare = -A - B + A + B + D - B - C - D = -B - C.

Questions:

How could the government reduce the cost and still subsidize the farmer?

Which is more costly: supports or acreage limitations?

135

Microeconomics ECO402

The Wheat Market in 1981

·AB consumer loss

Pric

·ABC producer gain

By buying 122

million bushels

the government

P0 = $3.70

increased the

market-clearing

P0 = $3.46

price.

D + Qg

1,800

2,56 2,6302,68

Quantity

Supporting the Price of Wheat

1981

Change in consumer surplus=(-A -B)

A = (3.70 - 3.46)(2,566) = $616 million

B = (1/2)(3.70 - 3.46)(2,630 - 2,566)

= $8 million

· Change in consumer surplus: -$624 million.

Cost to the government:

$3.70 x 122 million bushels = $452 million

Total cost = $624 + 452 = $1,076 million

Total gain = A + B + C = $638 million

Government also paid 30 cents/bushel = $806 million

The Wheat Market in 1985

Price

To increase the

price to $3.20, the

government bought

P0 =

466 million bushels

$3.20

and imposed

a production quota

of 2,425 bushels.

P0 =

$1.80

D+

1,80 1,95

2,23 2,42

Quantity

136

Microeconomics ECO402

1985

Government Purchase:

· Government cost = $3.20 x 466 = $1,491million

· 80 cent subsidy = .80 x 2,425 = $1,940 million

· Total cost = $3.5 billion

Import Quotas and Tariffs

Many countries use import quotas and tariffs to keep the domestic price of a product above

world levels

Import Tariff or Quota That Eliminates Imports

In a free market, the

Price

domestic price equals the

world price PW.

By eliminating imports,

the price is increased to

PO. The gain is area A. The

loss to consumers A + B + C,

so the deadweight loss

is B + C.

How high would

a tariff have

to be to get the

Import

same result?

Quantity

The increase in price can be achieved by a quota or a tariff.

Area A is again the gain to domestic producers.

The loss to consumers is A + B + C + D.

If a tariff is used the government gains D, so the net domestic product loss is B + C.

If a quota is used instead, rectangle D becomes part of the profits of foreign producers, and

the net domestic loss is B + C + D.

Question:

Would a country be better off or worse off with a quota instead of a tariff?

137

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