Question

About 100 million pounds of jelly beans are consumed in the United States each year, and the price has been about 50 cents per pound. However, jelly bean producers feel that their incomes are too low and have convinced the government that price supports are in order. The government will therefore buy up as many jelly beans as necessary to keep the price at \(\$ 1\) per pound. However, government economists are worried about the impact of this program because they have no estimates of the elasticities of jelly bean demand or supply. a. Could this program cost the government more than \(\$ 50\) million per year? Under what conditions? Could it cost less than \(\$ 50\) million per year? Under what conditions? Illustrate with a diagram. b. Could this program cost consumers (in terms of lost consumer surplus) more than \(\$ 50\) million per year? Under what conditions? Could it cost consumers less than \(\$ 50\) million per year? Under what conditions? Again, use a diagram to illustrate.

Short answer

Yes, this program could potentially cost the government and consumers more than $50 million per year depending on the elasticity of supply and demand. If supply is elastic, it will result in larger surplus which the government has to purchase, costing more than $50 million. Similarly, if demand is elastic, there will be a larger decrease in consumer surplus, costing consumers more than $50 million. On the contrary, it can cost less if supply and demand are inelastic.

Step-by-step solution

Understanding Price Supports

Price supports are minimum prices set by a government for certain commodities to ensure that their incomes are not too low. In this case, the government decides to set the price at $1 per pound to increase the income of jelly bean producers.

Estimating Government Cost

The cost for the government to implement this program depends on the quantity of jelly beans that the government would need to buy in order to maintain the $1 per pound price. If the price elasticity of supply is higher, jelly bean producers will increase production, leading to more surplus that the government has to buy. This could potentially cost the government more than $50 million per year. Conversely, if the price elasticity of supply is lower, producers won't increase their production that much and the government won't need to buy as many beans, potentially costing less than $50 million per year.

Estimating Consumer Cost

The cost for consumers depends on the price elasticity of demand. If demand is more elastic, consumers respond to the price increase by significantly decreasing their consumption, resulting in a large loss in consumer surplus, potentially costing more than $50 million per year. But if demand is less elastic, consumers do not reduce their consumption significantly, resulting in a smaller loss in consumer surplus, potentially costing less than $50 million per year.

Diagram Illustration

Begin by drawing a diagram with 'Quantity of Jelly Beans' on the x-axis and 'Price per Pound' on the y-axis. Draw a downward sloping demand curve and an upward sloping supply curve, showing the initial equilibrium price at 50 cents per pound. After implementing the price support, draw horizontal line at the new price level of $1 per pound, creating a surplus of supply. The area representing the cost to the government will be the difference in quantities multiplied by the difference in prices. Similarly, the area of the consumer surplus before and after price support represents the cost to consumers. Vary these areas based on changes in elasticity for different scenarios.