Government may also intervene in markets to help the sellers by setting a price floor for a good. The idea of a price floor is that there is a minimum price for which a good will sell. The government will take steps to insure that the good does not sell for less than the price floor.
Figure 5.3 is a depiction of the market for corn. The current equilibrium price is $2.50 per bushel while the equilibrium quantity is 400 million bushels per month. Suppose the government places a price floor of $2.00 per bushel on corn (as shown by line Pf). This means that corn is not to be sold for less than this amount. What effect will the $2.00 price floor have on the market in Figure 4.4? Clearly none, since the current equilibrium price of corn is $2.50, which is above the price floor. So a price floor that is below the current equilibrium price has no effect on the market.
Figure 5.4 effectively reproduces the market for corn as depicted in Figure 5.3, where the equilibrium price of corn is $2.50 per bushel and the equilibrium quantity is 400 million bushels per month. Let the government set a price floor of $3.00 per bushel for corn, which, of course, is above the current equilibrium price of corn (this is shown by line Pf). At that price, the quantity demanded of corn is 350 million bushels per month while the quantity supplied is 450 million bushels per month. There clearly is an excess supply of corn at the price floor. Sellers wish to sell an additional 100 million bushels of corn per month over what buyers wish to buy. Suppose the government did nothing else at this point but pass a law saying it was illegal to sell or buy corn for less than $3.00 per bushel. Would the sellers be better off? As a group they clearly would be. Their total revenue from selling corn has increased from $1000 million per month ($2.50 times 400 million bushels) to $1050 million ($3.00 times 350 million bushels). This is because the demand for corn is inelastic so a price increase leads to more revenue.
While farmers as a group are better off because they have more revenue, some farmers would be worse off because they have corn that they are unable to sell. Instead of receiving $2.50 per bushel as before, some farmers now get nothing. They would not be very happy. Politically, it is evident that the government would not be able to enact the price floor and then do nothing else. So what will be done in practice is the government purchases the excess supply of corn at the price ceiling (100 million bushels per month in our example for a total of $300 million). This allows farmers to sell their entire quantity supplied at $3.00 per bushel-either in the market or to the government.
The government is now in the corn business. What could it do with all of the corn that it buys up? There are several possibilities. One is that it could store the corn. The corn could be saved for future use as, for example, in a drought. In such a time when market supplies would be low, the government could release corn from its own stocks to add to the market supply. This sounds prudent, though in practice, the government has only rarely been required to draw upon its surplus stocks. A second possibility is for the government to sell the surplus corn to other countries. We may not need it, but perhaps other countries will. That is quite possible, but at what price is the government going to be able to export the corn? Clearly not $3.00, the price it paid for the corn. Most likely, the government will sell the corn to other countries at $2.50 per bushel, the equilibrium price. So now the government is buying up corn at $3.00 per bushel and selling it to other countries for $2,50 per bushel. Who makes up the loss? Most likely, taxpayers will be required to pick up the tab. A third possibility is for the government to give the surplus away. This is a common way to dispose of surplus stocks. Various government giveaway programs and reduced price sales of food exist.
What kinds of signals are being sent to producers and consumers when price floors are used? Because the price is being held above equilibrium, consumers are being told to use less of the good while the higher price is a signal to producers to produce more of the good. Yet there is a surplus of the good at the price floor! Clearly, the reactions of buyers and sellers to a price floor are really opposite of what is efficient. To encourage sellers to produce more of a surplus good is a waste of resources. To induce buyers to economize on their use of a surplus good also makes little sense. Too much corn is being produced. At the price floor, buyers are willing to pay only $2.25 for the last bushel of corn, which has a marginal cost of $3.00 to produce. This is clearly inefficient. Therefore, most economists do not support price floors. Such floors may be well intentioned (to help certain groups which may need assistance), but their effects on markets are undesirable. If the goal is to help some group by increasing its members' income, it would be better to give direct cash assistance to the members than to cause inefficiency in markets by placing price floors on some goods. This is basically the approach the government takes now to the farm program. Target prices are set for various farm products and then deficiency payments are made directly to farmers equal to the difference between the actual price of a farm product (such as corn) and the target price.
Alternatives to a price floor would include either to try to increase the demand for the good or reduce the supply or some combination of the two. It can be seen that if either supply decreases or demand increases, the equilibrium price of the good will rise and perhaps lead to a situation where a price floor is no longer necessary. The government has tried to reduce the supply of farm products through various types of acreage allotment programs, soil bank conservation, etc. However, these have had limited effectiveness in reducing supply. Through advertising, farmers have attempted to increase the demand for various products-milk, beef, pork, etc. It is difficult to discern how effective these campaigns have been.
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