5. Suppose that you are the economic advisor to a local government that has to deal with a politically embarrassing surplus that was caused by a price floor that the government recently imposed. Your first suggestion is to get rid of the price floor, but the politicians don’t want to do that. Instead, they present you with the following list of options that they hope will get rid of the surplus while keeping the price floor. Which of the following suggestions could work
a. Restricting supply.
b. Decreasing demand.
c. Purchasing the surplus at the floor price.

Question

5. Suppose that you are the economic advisor to a local government that has to deal with a politically embarrassing surplus that was caused by a price floor that the government recently imposed. Your first suggestion is to get rid of the price floor, but the politicians don’t want to do that. Instead, they present you with the following list of options that they hope will get rid of the surplus while keeping the price floor. Which of the following suggestions could work
a.     Restricting supply.
b.     Decreasing demand.
c.     Purchasing the surplus at the floor price.

BlackTom AI · Accepted Answer

A binding price floor set above the market equilibrium causes a surplus because at the floor price Pf quantity supplied (Qs) exceeds quantity demanded (Qd).

1. Relevant concepts
- Price floor: minimum legal price; binding if Pf > Pe (equilibrium price).
- Surplus (excess supply): S = Qs(Pf) − Qd(Pf).
- Supply and demand shifts: restricting supply shifts the supply curve left (reduces Qs at any price); purchasing surplus removes excess from the market; decreasing demand shifts the demand curve left (reduces Qd).

2. Step-by-step reasoning with simple algebraic supply and demand
Let Qd(P) = a − bP and Qs(P) = c + dP, where a,c,b,d > 0. At the imposed floor Pf > Pe:
- Qd at Pf = a − bPf
- Qs at Pf = c + dPf
Surplus S = Qs(Pf) − Qd(Pf) = (c + dPf) − (a − bPf) = (c − a) + (d + b)Pf.

3. Intermediate/calculation steps
- Compute S explicitly when Pf is known via S = (c − a) + (d + b)Pf.
- To eliminate surplus while keeping Pf, you must make Qs at Pf equal Qd at Pf (i.e., reduce Qs or increase Qd or remove the excess from the market).

4. Why options a and c work
- a. Restricting supply: shifting supply left by an amount Δ reduces Qs(Pf) to Qs'(Pf) = Qs(Pf) − Δ. Choose Δ = S so Qs'(Pf) = Qd(Pf). Thus a supply restriction can eliminate the surplus while leaving the floor in place.
- c. Purchasing the surplus: the government can buy S units at Pf. If it purchases exactly S = Qs(Pf) − Qd(Pf), the market clears (private market sales = Qd) while the floor and price paid to suppliers remain Pf. So buying the surplus directly removes excess supply.

5. Why option b is incorrect
- b. Decreasing demand shifts demand left, lowering Qd(Pf). That increases S = Qs(Pf) − Qd(Pf), making the surplus larger, not smaller. So decreasing demand cannot eliminate a surplus created by a binding price floor.

6. Conclusion
Both restricting supply (a) and purchasing the surplus (c) can remove the surplus while keeping the price floor; decreasing demand (b) would worsen it. This confirms the correct answer: a and c.

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