Illustrate the impact of a price support measure imposed by the government on the market of a commodity under the following conditions: (i) When the price floor is fixed at a price lower than the equilibrium price. (ii) When the price floor is fixed at a price equal to the equilibrium price.

Impact of Price Support Measures on Commodity Market

Price support measures, such as price floors, are government interventions to control the prices of commodities. The impact of these measures varies depending on how the price floor is set in relation to the market equilibrium price.

1. Price Floor Lower than Equilibrium Price

When the government sets a price floor that is lower than the equilibrium price, it typically has minimal impact on the market. In this scenario, the market forces are allowed to function normally since the equilibrium price, where the quantity demanded equals the quantity supplied, is above the government-mandated minimum price.

a. Market Equilibrium Maintained: The market continues to operate at the equilibrium price, as it is higher than the price floor. Producers and consumers make their decisions based on market dynamics, not the price floor.

b. No Excess Supply: Since the market price is above the price floor, there is no incentive for producers to increase supply beyond what the market demands. Thus, no surplus is created by the price floor.

2. Price Floor Equal to Equilibrium Price

Setting a price floor equal to the equilibrium price also does not significantly disrupt the market. This is because the price floor is set at a level where the market naturally clears.

a. No Immediate Market Distortion: Initially, the market operates as it would without government intervention, with quantities supplied and demanded remaining at equilibrium levels.

b. Potential for Future Market Imbalance: While there is no immediate effect, the presence of a price floor at this level can lead to future imbalances. If market conditions change (e.g., demand decreases), the price floor can prevent the price from adjusting to a new equilibrium, potentially leading to excess supply.

Conclusion

In both scenarios where the price floor is set below or at the equilibrium price, the immediate impact on the market is minimal. The market continues to function at or near the equilibrium levels of price and quantity. However, setting a price floor at the equilibrium level can lead to future market imbalances if market conditions change. It is when the price floor is set above the equilibrium price that significant market distortions, such as surpluses, typically occur.