Economics 101

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a. Explain why the introduction of a minimum price above the equilibrium price reduces social welfare. “A minimum price occurs when a price is set by the government and firms cannot charge less than this” (Gillespie, 2011) in order for the minimum price to be effective it must be above the equilibrium price - this occurs when supply and demand are balanced whilst disregarding all external factors. (Figure 1) (Gillespie, 2011) The formation of equilibrium comes when the goods demanded are equivalent to the goods provided (DS); this allows the government to set a price floor (P1); this benefits society as in order for the market to be efficient minimum price must be above the; as when the supply produced exceeds (Q1) that demanded (Q2) by the public this allows consumers who can afford the goods or services to purchase regardless of the prices – this is beneficial to the reduction of social welfare as will suppliers have excess quantity, this drives as a trigger for producers to reduce their prices towards the price floor in order to increase demand for their product or service to make optimal profits allowing for consumers to get the best price as well as increasing consumer surplus for the original consumers. (Figure 2) ([price_controls_ceiling, n.d.) With the minimum price being below the equilibrium the demand will be excessive (Qd) in comparison to the supply produced (Qs) meaning that for the price the buyers are willing to pay the suppliers are only willing to supply a said amount of goods or services; causing the consumer surplus and the producer surplus to be lost due to the reduced quantity manufactured, this area then becomes dead weight loss; this can be avoided through the relocation of resources, though this creates a situation “in which nobody in an economy can be made better off without somebody else becoming worse off” (Nuttall and Lobley, 2001) known to be Pareto efficiency; as a result reducing wastage in resources which can impact negatively causing an increase in social welfare and ultimately clarifies that having the minimum price above equilibrium reduces social welfare. b. Explain why a profit maximizing firm produces the output that equates marginal revenues to marginal costs (MR=MC).
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