Economic Surplus and Price Controls

Total Economic Surplus: Maximized at competitive equilibrium where marginal benefit equals marginal cost.

• Breakdown can occur due to externalities or public goods.

Government Intervention in Markets: Can lead to deadweight loss.

• Price Controls: Two basic types:

  • Price Floors: Minimum price set by the government (e.g., minimum wage).

  • Price Ceilings: Maximum price set by the government (e.g., rent control).

Price Floors:

• Designed to ensure a price doesn't fall below a certain level.

• Common in agricultural products to support farmer income.

• Example using tacos:

  • Competitive equilibrium price = $3, quantity = 600 tacos.

  • Consumer surplus = difference between what people are willing to pay and market price.

  • Producer surplus = difference between what suppliers are willing to sell and market price.

Impact of Price Floor:

• If set below equilibrium (e.g., $2), it doesn't affect the market (binding), as market price is higher.

• If set above equilibrium (e.g., $4):

  • Demand decreases (only 300 tacos bought at $4).

  • Supply increases (900 tacos supplied at $4).

  • Surplus: 600 tacos (900 offered - 300 bought).

Consumer and Producer Surplus Changes:

• Before price floor, consumer surplus = areas a + b + c.

• After price floor, consumer surplus = area a only (lost areas b and c).

• Producer surplus = $4 per taco, but only 300 sold; losses from areas c and e.

• Deadweight Loss:

  • Represents lost economic surplus due to non-traded surpluses (areas c + e).

Effects on Producers:

• Gain area b from consumer surplus but lose areas c and e due to reduced trade.

• Typically, producers may be better off (area b > area e), but overall economic surplus decreases due to deadweight loss.

Handling of Surplus Products:

• In cases of agricultural products with price floors, government often buys up excess production or destroys it.

Next Topic: Focus on labor price floors (minimum wage) in the following video.