Suppose that in a small country the equilibrium price of cor

Suppose that, in a small country, the equilibrium price of corn is $300 per ton and that the government establishes a price floor at $400 per ton by promising to buy any resulting surplus. A few years later, the demand for corn increases because a foreign country removes a quota and begins importing five tons of corn per year, regardless of price. After this increase in the demand, what is the impact of the $400 price floor on the market for corn?

1. the price floor will have no impact on the market for corn

2. the price floor will cause the demand for corn to shirt to the left

3. the price floor will now cause a shortage of corn

4. the price floor will still cause a surplus of corn to be produced

Solution

The right answer is 4, the price floor will still cause a surplus of corn to be produced.

Price floor is the price set by the government over and above the equilibrium market price. Price floor creates surplus of product in the hand of suppliers, since demand falls due to high price. It is given that the surplus products are taken by governments.

Since the demand increases, a portion of surplus would be sold out. But it is limited up to 5 tons only. The rest of the products should be tried to sell in the domestic market causing surplus quantity.