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Homework answers / question archive / Figure 3
Figure 3.24 (b) shows a price floor example using a string of struggling movie theaters, all in the same city. The current equilibrium is $8 per movie ticket, with 1,800 people attending movies. The original consumer surplus is G+H+J, and producer surplus is I + K. The city government is worried that movie theaters will go out of business, reducing the entertainment options available to citizens, so it decides to impose a price floor of $12 per ticket. As a result, the quantity demanded of movie tickets falls to 1,400. The new consumer surplus is G, and the new producer surplus is H + I. In effect, the price floor causes the area H to be transferred from consumer to producer surplus, but also causes a deadweight loss of J + K. This analysis shows that a price ceiling, like a law establishing rent controls, will transfer some producer surplus to consumers, which helps to explain why consumers often favor them. Conversely, a price floor like a guarantee that farmers will receive a certain price for their crops will transfer some consumer surplus to producers, which explains why producers often favor them. However, both price floors and price ceilings block some transactions that buyers and sellers would have been willing to make, and creates deadweight loss. Removing such barriers, so that prices and quantities can adjust to their equilibrium level, will increase the economy's social surplus.
s G T $12 P $600 ? H Price floor w V Price ceiling $8 $400 K X D D 1,400 15,000 20,000 Q 1,800 Q (a) Reduced social surplus from a price ceiling (b) Reduced social surplus from a price floor Figure 3.24 Efficiency and Price Floors and Ceilings (a) The original equilibrium price is $600 with a quantity of 20,000. Consumer surplus is T + U, and producer surplus is V+W+X. A price ceiling is imposed at $400, so firms in the market now produce only a quantity of 15,000. As a result, the new consumer surplus is T + V, while the new producer surplus is X. (b) The original equilibrium is $8 at a quantity of 1,800. Consumer surplus is G + H+ J, and producer surplus is I + K. A price floor is imposed at $12, which means that quantity demanded falls to 1,400. As a result, the new consumer surplus is G, and the new producer surplus is H+ I.
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Answer – From the figure 3.24 (b) given in the question, we see that the government tries to help struggling movie theatres by imposing a price floor. The price floor imposed at $12, which is above the equilibrium market clearing price of $8 is binding. Governments impose a minimum price on movie theatres in order to ensure that the market price of movie theatres does not fall below a certain level that would threaten the financial existence of the producers.
Now, let us evaluate whether this price floor will actually help struggling movie theatres. We see that the producers are better off as a result of the binding price floor because the higher price (which is above the equilibrium market clearing price) makes up for the lower quantity sold. We see that before imposition of price floor, the total revenue earned = $8 * 1800 = $14,400. On the other hand, after imposition of price floor, the total revenue earned = $12 * 1400 = $16,800. Moreover, producer surplus also increases because from the figure we can see that Area (I + K) < Area (H + I). So, the effect of the price floor on producers is obvious – because the producers are better off. So, the price floor imposed by the government actually helps the struggling movie theatres.
