Government

Intervention in Milk Industry

GOVERNMENT INTERVENTION IN MILK INDUSTRY

PREPARED FOR

Dr. Tamgid Ahmed Chowdhury

Professor, School of Business & Economics

COURSEWORK

BUS 525 (Managerial Economics) | Section -2 | Fall 2017

PREPARED BY

• Syed Mahmudul Muddassir 171 5077 060

• Syeda Fatema Tuz Zohra 172 5163 660
• Sadnan Shoumik Islam 173 5326 660
• Nabila Farooque 162 1674 660

December 13, 2017

 Government Intervention in Milk Industry

TABLE OF CONTENTS

INTRODUCTION .............................................................................................................. 3
PRICE SUPPORT .............................................................................................................. 4
SOLUTION TO THE CASE ................................................................................................ 5
Analysis A ................................................................................................................................. 5
Analysis B ................................................................................................................................. 6
Analysis C ................................................................................................................................. 7
Analysis D ................................................................................................................................. 8
CONCLUSION ................................................................................................................. 10

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 Government Intervention in Milk Industry


INTRODUCTION

This report has been prepared exclusively for the purpose of a course of BUS 525 – Managerial
Economics – Section 2, Instructed by Dr. Tamgid Ahmed Chowdhury, Professor. This report outlines
a solution on given case about Government intervention in Milk Industry – the case refers to the
Price Support Theory.

The Milk industry of Bangladesh holds great potential for sustainable development of the country.
As like other basic foods, Milk is one of them. Consumer reaction to the price increment for one of
the daily necessary foods is always depressing. The given case talks about the price support in the
milk industry by Govt. to encourage the producers.

The discussion of gain & loss, because of price support, towards consumers and producers will be
analyzed by evaluating change in consumer surplus and change in producer surplus.

Will the outcome have a social welfare or dead weight loss due to change in price?

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PRICE SUPPORT

A price support is usually initiated by the government with the intended effect of keeping the
market price of a good higher than the competitive equilibrium level.

It’s the minimum legal price a seller may charge, typically placed above equilibrium. In contrast to
price floor, it is the support of certain price levels at or above market values by the government.

A price support scheme can also be an agreement set in order by the government, where the
government guarantees to purchase the surplus amount at a fixed price. For example, if price
support were initiated for the milk industry, the government would be bound to purchase the
resulting surplus from the milk producers. The schemes are usually taken as a contribution for some
development activities for the unprivileged people.

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SOLUTION TO THE CASE

Analysis A

Market Equilibrium: Consumers and producers react differently to price changes. Higher prices
tend to reduce demand while encouraging supply, and lower prices increase demand while
discouraging supply. Market equilibrium is a market state where the supply in the market is equal
to the demand in the market. If a market is at equilibrium, the price will not change unless an external
factor changes the supply or demand, which results in a disruption of the equilibrium.

Given, Given,
Demand equation: Supply equation:
P = 225 – 15Qd P = 25 + 35Qs
ð 15Qd = 225 – P ð 35Qs = -25 + P
P % & '(
ð Qd = 15 - ð Qs =
15 )(

At equilibrium, Qd=Qs
Therefore,
% % & '(
15 − =
+( )(
)(%
ð 525 − = P – 25
+(
)(%
ð + P = 525 + 25
+(
ð 50P = 8250
ð P = 165 cents or $1.65

To find out the quantity traded, let’s input the value of equilibrium price in the demand function.
Therefore, Price
($)
P = 225 – 15Qd SS
ð 165 = 225 - 15Qd
''(&+-( 2.25
ð Qd =
+(
ð Qd = 4 millions

Therefore, 1.65 E
Equilibrium Price, P* = 165 cents ($1.65)
Equilibrium Quantity, Q* = 4 million

DDc
0.25

0 4 mil. Quantity Traded

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Analysis B

Description: If we consider the Milk Industry, reference to graph above, a price of $1.65 per liter
has been determined as the equilibrium price with the quantity at 4 million. Now, the government
can determine a price support which must be set above the equilibrium price. The reason is if
government set the price below the equilibrium price level then producer will not receive any
benefit from government intervention, but rather they’ll have a less profit.

Note, govt. guarantees to buy the surplus amount from the market that the producers cannot sell.
This will create new demand in the market – demand of the government and consumer combined.

Government intervenes by guaranteeing milk purchase at $2.00 per liter causing the following
changes in the milk industry –

• By guaranteeing milk purchase at $2, the government creates a new demand curve
(government and consumer).
• The new demand curve (Dc+g) shifts to the right signifying an increase in demand due to a
factor other than price.
• The guaranteed purchase ensures that the (Dc+g) intersects the supply curve (S) at exactly
$2 creating a new market equilibrium.
• Therefore, new equilibrium (E’) shows price at $2 results in quantity traded at 5 million
liters per month.

Guaranteed Price = 200 cents or $2 Price
($)
New quantity supplied at $2, SS
P = 25 + 35Qs
'..&'(
Qs = 2.2
)(
Qs = 5 Million 5
$ E’
New quantity demand at $2 2.00
P = 225 – 15Qd
1.6 E
'..&''(
Qd = 5
&+(
Qd = 1.67 Million DDc+g

DDc
0.25

0 1.67 mil. 4 mil. 5 mil. Quantity Traded

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Analysis C

With this system of price support, the government promised to buy the surplus amount that the
consumers aren’t buying due to the price hike from $1.65 to $2.00. Thus, the amount government
purchases per month would be the difference between the new Qd (1.67 million) and new Qs (5
million).

Therefore,

Amount of Government Purchase = (5 - 1.67) million litres/month

= 3.33 million liters per month

Government would be buying the aforementioned amount of milk per month at a price of $2.00.

Therefore,

Total cost to government = (5 – 1.67) * $2

= $6.66 million

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Analysis D
When it comes to price support, government’s purchase of the excess supply is key to successful
execution of the strategy, which means that the strategy might not be successfully implemented
without government funding to purchase the surplus amount of milk. When it comes to source of
government funding, majority of government income is derived from taxation although other
sources contribute too. There are two types of taxes – direct/income tax and indirect tax (GST).

Direct tax is imposed on income of individuals or organizations or corporations who are also
consumers and producers of the society. Thus it can be assumed that the consumers and
producers are the ones who are actually paying for the milk government purchases each month
to support to milk industry and funnel some money to the producers of milk industry.

Having said that, it can be surmised that there would be obvious changes in consumer and
producer surplus due to this government intervention in milk industry.

Producer surplus measures the difference between the amount a producer receives and the
minimum amount the producer is willing to spend for a good. The difference is called the surplus
amount. Producer surplus is the benefit the producer receives for selling the good in the market.

Consumer surplus measures consumer benefit, which is calculated by analyzing the difference
between what consumers are willing and able to pay for a good or service relative to its market
price. A consumer surplus occurs when the consumer is willing to pay more for a given product
than the current market price.

In other words, the consumer surplus and producer surplus together generate greater overall
economic welfare.

Graphical & Mathematical Representation

Before Price Support

Original Consumer Surplus (CS) = 1+2+4
Original Producer Surplus (PS) = 3+5
CS = (2.25-1.65) * 4 * 1/2 = 1.20 mil.
PS = (1.65-0.25) * 4 * 1/2 = 2.80 mil.

After Price Support
New Consumer Surplus (CS’) = 1
New Producer Surplus (PS’) = 2+4+3+5
CS’ = (2.25-2.00) * 1.67 * 1/2 = .2088 mil
PS’ = (2.00-0.25) * 5 * 1/2 = 4.375 mil.

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Shown below is a tabular representation of the amounts of consumer and producer surplus and
the social gains and losses incurred by the price support strategy. A full comparison between
change in consumer surplus, producer surplus is shown in the table above.

At Equilibrium With Price Support Change

Price $1.65 $2.00 $0.35

Quantity Traded 4 million liters 1.67 million -2.33 million

Consumer Surplus 1.20 million 0.2088 million -0.9912 million

Producer Surplus 2.80 million 4.375 million 1.575 million

Government Cost 0 6.66 million 6.66 million

Dead Weight Loss 0 -6.08 million -6.08 million

The consumer surplus has decreased

from 1.20 to 0.2088 million. At the
same time, producer surplus has
jumped from 2.80 to 4.375 million –
nearly doubled. Such is the impact of
price support.

It’s noteworthy that the dead weight

loss due to this government
intervention is -6.08 million. Most of
the govt. cost incurred to make the
purchase of surplus (unsold) milk
account for this dead weighted loss,
which is shown in the graph with the
area marked in grey line.

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CONCLUSION

In conclusion, even though the case involves dead weight loss, price support is an excellent form
of government intervention in the market. The best policy of course is to leave the industry at
market equilibrium. Any government intervention shifts the equilibrium for goods and services
away from its optimal level having an effect on both producer and consumer surpluses. However,
government normally intervenes in the market with a set objective to provide benefit to a specific
party (consumer or producer) and thus it’s considered successful as long as government’s
objective is met.

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