Suppose an industry trade group has convinced legislators that a price

Suppose an industry trade group has convinced legislators that a price floor should be used so that producer surplus is maximized in the market for milk. The group argues that such a policy would save the “family farm.” Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve, determine the resulting price, output and social welfare from such a policy. Compare this result to the competitive equilibrium.

What will be an ideal response?

ANSWER

Producer surplus is maximized at a price that is midway between the supply curve and the demand curve intercept. Compared to the competitive equilibrium, a lower quantity is sold at a higher price. The area from this new quantity to the competitive quantity in between the demand and supply curves represents the loss of consumer surplus that is not gained by anyone—the deadweight loss.