Chapter 3: Problem 11

If a price floor benefits producers, why does a price floor reduce social surplus?

Short Answer

Expert verified

A price floor benefits some producers by ensuring a minimum income, but reduces social surplus as it creates an excess supply, disturbs the natural balance between supply and demand, and forces consumers to pay a higher price. This results in a decrease in consumer surplus, as well as a decrease in producer surplus for those producers unable to sell their products due to reduced demand. The net effect is a reduction in social surplus, as the benefits to some producers are outweighed by the losses experienced by consumers and other producers.

Step by step solution

Defining Price Floor and Social Surplus

A price floor is a government-imposed limit on how low a price can be charged for a product or service. The purpose of a price floor is to protect producers and maintain a minimum level of income. Social surplus is the sum of producer surplus and consumer surplus. Producer surplus is the difference between what producers are willing to accept for their goods or services and the actual price they receive, while consumer surplus is the difference between the highest price a consumer is willing to pay and the actual price they pay.

Effects of a Price Floor on Supply and Demand

When a price floor is implemented above the market equilibrium price, it disturbs the natural balance between supply and demand. Producers are willing to supply more at the price floor, while consumers are willing to buy less, creating an excess supply or surplus. As a result, producers may benefit from the higher prices, but at the cost of reduced demand for their products.

Reduction in Consumer Surplus

Under a price floor, consumers are forced to pay a higher price than they would have in a free market. This reduces consumer surplus as they are paying more than they would have been willing to pay under normal market conditions. Furthermore, some consumers may choose not to buy the product at all, further decreasing consumer surplus.

Reduction in Producer Surplus for Some Producers

Although some producers benefit from the higher price under a price floor, others may not be able to sell their products due to the reduced demand. Thus, they may be unable to take advantage of the price floor and may even face losses due to the excess supply. This results in a decrease in producer surplus for those producers.

Reduced Social Surplus

As we have seen, both consumer surplus and producer surplus can be negatively affected by a price floor. The reduction in consumer surplus and producer surplus for some producers contributes to a decrease in social surplus. Therefore, although price floors may be beneficial for some producers, they can lead to a reduction in social surplus as the benefits to those producers are outweighed by the losses experienced by consumers and other producers.