The market equilibrium price for coffee beans in Ecuador is $2.75/pound, a price at which growers are unable to make a profit. Due to the lack of profits, many growers have stopped production and the output of coffee beans has fallen from 400 tons per year (capacity for the region) to 250 tons per year. As a result of pleas from the growers, the government steps in and sets a floor price for coffee beans at $3.50/pound. What market response would you expect from this government action? How would supply, demand, and price change? Use a graph to illustrate your answer.
When the government sets a floor price for coffee beans at $3.50/pound, it means that no coffee beans can be sold below this price. To understand the market response to this government action, we need to consider the effects on supply, demand, and price.
1. Supply: Initially, due to the lack of profits at the market equilibrium price of $2.75/pound, many growers had stopped production, leading to a decrease in the supply of coffee beans. However, with the introduction of the floor price, growers have an incentive to resume production as they can now sell their beans at a higher price without incurring losses. Therefore, the output of coffee beans is expected to increase.
2. Demand: The change in demand depends on several factors, such as consumer preferences, alternative options available, and price elasticity of demand. Without additional information, it is difficult to predict the precise change in demand. However, if we assume that the demand remains relatively constant, without any significant changes, we can illustrate this as a horizontal line on the graph.
3. Price: The new floor price of $3.50/pound becomes the minimum price at which coffee beans can be sold in the market. As a result, the price will increase from the initial equilibrium price of $2.75/pound to the floor price of $3.50/pound. This price adjustment represents an upward shift.
Now, let's illustrate these changes on a supply and demand graph:
Price
|
$3.50 | S
| /
$2.75 | /
| / D (Initial Demand)
| /
| /
$0 -------------------
0 Quantity
In the graph above:
- The initial equilibrium price is at $2.75/pound.
- The initial quantity supplied is 250 tons per year, and the initial quantity demanded is 400 tons per year.
- With the introduction of the floor price, the supply curve (S) will shift to the right, indicating an increase in the quantity supplied as growers resume production.
- The new equilibrium price will be at $3.50/pound, which is the floor price set by the government.
- The new equilibrium quantity will be the point where the new supply curve intersects the horizontal demand curve.
Overall, the market response to the government setting a floor price for coffee beans would lead to an increase in supply, an uncertain change in demand, and an increase in the market price to $3.50/pound.