ECON 1134 Exercise 4
1. Define price ceiling, price floor, and give an example of each.
2. What is the difference between fixed and variable costs?
3. Calculate the consumer surplus and producer surplus (in monetary value) for the
following market, and indicate them on the graph. Which curve is relatively more
elastic? Who earns more surplus in this market, consumers or producers? 4. Now calculate consumer and producer surplus for the following market, with a very
elastic demand curve. Who earns more surplus in this market, consumers or producers? 5. On the graph below, draw the effects of a price ceiling on welfare (consumer & producer
surplus). Label all shaded regions, and describe what is happening to each. 6. American agricultural policy has drawn sharp criticism, not only from economists, but
from other countries due to its negative impacts on international trade (which we will
discuss in lesson 8). The 1933 Agricultural Adjustment Act, ruled unconstitutional by the
Supreme Court in U.S. v. Butler (1938), paid farmers to destroy crops and livestock in
order to raise the market price. After 1938, it was modified to create ”price supports,”
which are a sort of hybrid between a price floor and a subsidy:
First, the government creates a price floor for crops above the market price. Second,
since this price floor creates a surplus of crops, the government purchases the entire
surplus from sellers to take it off the market. This roughly constitutes the basis of our
Farm bills today.
a. Assume the initial market price for corn is $5.00 per bushel, and 5 million bushels are
being exchanged. Draw on the graph below the price floor for corn set at $7 per
million bushels.
b. At $7 per bushel, how many bushels to buyers want to buy, and how many do sellers
want to sell? What is the result?
c. Now the government purchases the extra corn. How much does the government
have to spend?
d. Draw the welfare effects of this subsidy. Remember that the government must
purchase the surplus. Label all shaded regions, and describe what is happening to
each.
e. Calculate the benefit to producers (i.e. the marginal gain to producer surplus from
this policy) and the cost to consumers (i.e. the marginal loss to consumer surplus
from this policy). Compare the cost to taxpayers of this policy with the benefit (to
producers). Is this policy worth it?

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