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© 2005 Thomson
CChapter 6hapter 6Price Ceilings and Price Ceilings and
Price FloorsPrice Floors
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Economic PrinciplesEconomic Principles
Government intervention in marketsPrice ceilingsPrice floorsParity pricingTarget pricesCrop limitation programs
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© 2005 Thomson
EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE FOR CIVILIAN AND DEFENSE GOODS
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 1: Production Exhibit 1: Production Possibilities Curve for Possibilities Curve for
Civilian and Defense GoodsCivilian and Defense GoodsThe production possibilities curve in Exhibit 1 provides information on:• The production possibilities curve shows the possible combination of civilian and defense goods that could be produced.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 1: Production Exhibit 1: Production Possibilities Curve for Possibilities Curve for
Civilian and Defense GoodsCivilian and Defense GoodsWhen there is a national security crisis, the number of civilian goods produced: • The production of civilian goods declines as more defense goods are produced.
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© 2005 Thomson
EXHIBIT 2 THE FISH MARKET BEFORE AND AFTER THE DRAFT
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Demand for fish doesn’t change just because there’s a national security problem.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
In Exhibit 2, the community’s predraft and postdraft demand for fish does not change.• Note that the demand curves before and after the supply curve has shifted are identical.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
After the draft, the quantity of fish supplied:• With fishermen being drafted and fewer boats in the water, the supply of fish declines and the supply curve shifts to the left.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
Postdraft, the equilibrium price of fish:• The equilibrium price of fish increases from $4 to $10 after the draft.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
After the draft, the quantity of fish bought and sold:• The quantity of fish bought and sold declines from 10,000 to 7,000 fish.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
The greater burden of the increased price for fish is felt by:
• The poor
• The rich
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
The greater burden of the increased price for fish is felt by:
• The poor
• The rich
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 2: The Market Before Exhibit 2: The Market Before and After the Draftand After the Draft
The greater burden of the increased price for fish is felt by:• The increase in the price of fish makes it unthinkable for the poor to purchase fish, while the rich hardly notice the increase and continue to buy fish.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Price CeilingPrice Ceiling
Price ceiling
• A maximum price set by government below the market-generated equilibrium price.
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© 2005 Thomson
EXHIBIT 3 SETTING A $4 PRICE CEILING IN THE FISH MARKET
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketIn Exhibit 3, when a $4 price ceiling is set, the market for fish:• When the price ceiling is set at $4, the quantity of fish demanded increases from 7,000 to 10,000.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketIn Exhibit 3, when a $4 price ceiling is set, the market for fish:• Based on the post-draft supply curve, the quantity of fish supplied falls from 7,000 to 4,000.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketIn Exhibit 3, when a $4 price ceiling is set, the market for fish:• Based on the postdraft supply curve, there is a shortage—an unsatisfied excess demand—of 6,000 fish.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketAllocate a shortage of goods:
• One method is through the use of ration coupons.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketAllocate a shortage of goods:
• Ration coupons are issued by the government, entitling the holder to purchase a specific quantity of a good at or below the price ceiling.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 3: Setting a Exhibit 3: Setting a $4 Price Ceiling in the $4 Price Ceiling in the
Fish MarketFish MarketAllocate a shortage of goods:
Ration coupons may be issued based on schemes such as:• First come, first served.
• Lottery.• Household size.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Price Ceiling and Price Ceiling and HousingHousing
Rent control is a government-set price ceiling on rent.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Price Ceiling and Price Ceiling and HousingHousing
Arguments against rent control:
• It dampens landlords’ incentives to properly maintain their existing rental units.
• It discourages many people from investing in new construction.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Price FloorsPrice Floors
Price floor
• A minimum price set by government above the market-generated equilibrium price.
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© 2005 Thomson
EXHIBIT 4 EFFECT OF NEW TECHNOLOGY ON THE FISH MARKET
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish Technology on the Fish
MarketMarketWhen a new technology is adopted, the supply curve in the fish market:• The supply curve shifts the the right.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish Technology on the Fish
MarketMarketAfter adopting the new technology, total revenue for the fisherman:
• Total revenue decreases.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish Technology on the Fish
MarketMarketAfter adopting the new technology, total revenue for the fisherman: • Prior to adopting the new technology, 10,000 fish were sold at an equilibrium price of $4 each, for a total revenue of $40,000.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 4: Effect of New Exhibit 4: Effect of New Technology on the Fish Technology on the Fish
MarketMarketAfter adopting the new technology, total revenue for the fisherman: • After adopting the new technology, 12,000 fish are sold at an equilibrium price of $2 each, for a total revenue of $24,000.
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© 2005 Thomson
EXHIBIT 5 SETTING A $4 PRICE FLOOR IN THE FISH MARKET
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 5: Setting a $4 Exhibit 5: Setting a $4 Price Floor in the Fish Price Floor in the Fish
MarketMarketIn Exhibit 5, when a $4 price floor is set, the market for fish:• The quantity of fish supplied increases from 12,000 to 15,000.• The quantity of fish demanded declines from 12,000 to 10,000. • A surplus, or excess supply, of 5,000 fish is created.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 5: Setting a $4 Exhibit 5: Setting a $4 Price Floor in the Fish Price Floor in the Fish
MarketMarketThe excess supply of fish can be dealt with:• The decision to support a price floor is a societal matter. • If the community represented by the government wants to support the fishermen through a price floor, then the government will buy the excess supply.
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© 2005 Thomson
EXHIBIT 6 GROWTH OF U.S. AGRICULTURAL PRODUCTIVITY THROUGHOUT U.S. HISTORY
* Precise data are not available.Source: James Zelner and R.M. Lamm, “Agriculture’s Vital Role for Us All,” Food—From Farm to Table, 1982 Yearbook of Agriculture, Department of Agriculture, Washington, D.C., p. 3.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 6: Growth of US Exhibit 6: Growth of US Agricultural Productivity Agricultural Productivity Throughout U.S. HistoryThroughout U.S. History
Agricultural productivity has increased in the U.S. because:• Changes in the dominant energy source technology used on farms.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 6: Growth of US Exhibit 6: Growth of US Agricultural Productivity Agricultural Productivity Throughout U.S. HistoryThroughout U.S. History
Agricultural productivity has increased in the US because:• Advances in modern chemistry to produce fertilizers, insecticides, crop ripeners and food preservatives.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
EXHIBIT 7 NUMBER AND SIZE OF U.S. FARMS
Source: Public Policy and the Changing Structure of American Agriculture, Congressional Budge Office, The Congress of the United States, Washington, D.C., September 1978, p. 2; Agricultural Statistics, 1995–1996, United States Department of Agriculture, Washington, D.C., 1996.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 7: Number and Size Exhibit 7: Number and Size of U.S. Farmsof U.S. Farms
Since 1945, the average size of U.S. farms: • The average size of US farms has steadily increased, from 195 acres in 1945 to 496 acres in 1995.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 7: Number and Size Exhibit 7: Number and Size of U.S. Farmsof U.S. Farms
The number of farms in the U.S.:
• The number of farms has declined from about 6 million in 1945 to about 2 million by 1995.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
EXHIBIT 8 INDEXES OF TOTAL FARM OUTPUT: 1950–99 (1996 = 100)
Source: Economic Report of the President, 2003, Washington, D.C., p. 439.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 8: Indexes of Total Exhibit 8: Indexes of Total Farm Output: 1950-99 Farm Output: 1950-99
(1996 = 100)(1996 = 100)Total farm output in the U.S. between 1950 and 1999 almost:• Fell by one-half
• Doubled
• Tripled
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 8: Indexes of Total Exhibit 8: Indexes of Total Farm Output: 1950-99 Farm Output: 1950-99
(1996 = 100)(1996 = 100)Total farm output in the U.S. between 1950 and 1999 almost:• Fell by one-half
• Doubled
• Tripled
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© 2005 Thomson
EXHIBIT 9 EFFECT OF NEW TECHNOLOGY IN FARMING
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 9: Effect of New Exhibit 9: Effect of New Technology in FarmingTechnology in Farming
As new energy source technologies and modern chemistry increase productivity and shift the supply curve to the right, price:
• Price declines with each shift of the supply curve to the right.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Parity pricing
• Parity pricing describes one criteria used to determine the level at which a price floor should be set.
Parity PricingParity Pricing
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
• It asks for equality between the prices that farmers have to pay for the goods they buy, and the prices they get for the goods they sell.
Parity pricing
Parity PricingParity Pricing
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Parity PricingParity Pricing
• Parity pricing was adopted by the government in 1933 when Congress passed the Agricultural Adjustment Act.
Parity pricing
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© 2005 Thomson
EXHIBIT 10SHOES AND CORN: SHIFTS IN DEMANDAND SUPPLY: 1914–2000
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-2000Supply: 1914-2000In Exhibit 10, the market for shoes changes from 1914 to 1964:• While the supply curve for shoes remained unchanged, the demand curve for shoes shifted to the right.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-64Supply: 1914-64In Exhibit 10, the market for shoes changes from 1914 to 1964:• The shift in demand raised the equilibrium price for shoes from $2 to $4.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-2000Supply: 1914-2000The market for corn changed in the same time period:• The demand curve for corn remained unchanged, while breakthroughs in technology and chemicals shifted the supply curve for corn to the right.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-2000Supply: 1914-2000The market for corn changed in the same time period:• The equilibrium price of corn declined from $2 in 1914 to $1 in 1964.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-2000Supply: 1914-2000Parity pricing affects the quantity of corn demanded and supplied:
• Parity pricing, setting a price floor of $4 for corn, restores the exchange parity between corn and shoes.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 10: Shoes and Corn: Exhibit 10: Shoes and Corn: Shifts in Demand and Shifts in Demand and
Supply: 1914-2000Supply: 1914-2000Parity pricing affects the quantity of corn demanded and supplied:• It also creates an excess supply of 50 million bushels of corn.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Parity Price RatioParity Price Ratio
Parity price ratio
• The relationship between prices received by farmers and prices paid by farmers.
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© 2005 Thomson
EXHIBIT 11 PARITY PRICE RATIOS OF PRICES RECEIVED AND PAID BY FARMERS: 1910–2000
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 11: Parity Price Exhibit 11: Parity Price Ratios of Prices Received by Ratios of Prices Received by
Farmers and Paid by Farmers and Paid by Farmers: 1910-2000Farmers: 1910-2000
Changes in the parity price ratio since 1910:• Except for the period between 1910 and 1920 and during the 1940s, the parity price ratio has been on the decline.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Commodity Credit Commodity Credit CorporationCorporation
The Commodity Credit Corporation (CCC)• The CCC is the federal agency established by the Agricultural Adjustment Act of 1933 to absorb the excess farm supply created by parity pricing.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Commodity Credit Commodity Credit Corporation’s Loans: Corporation’s Loans:
Public Law 480Public Law 480In 1954 Congress enacted the Food for Peace law:• Designed to help U.S. farmers, its impact on Third World countries has been the difference between survival and national disaster.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Target PriceTarget Price
Target price
• A minimum price level for specific farm goods that the government sets and guarantees.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Target PriceTarget Price
Target price
• A deficiency payment is a government payment to farmers based on the difference between the target price set by government and the market price.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Target PriceTarget Price
Target price
• Congress moved from parity pricing to setting target prices in 1973 with the passage of the Agricultural and Consumer Protection Act.
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© 2005 Thomson
EXHIBIT 12 COMPARING THE OUTCOMES OF PARITY AND TARGET PRICING
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 12: Comparing the Exhibit 12: Comparing the Outcomes of Parity and Outcomes of Parity and
Target PricingTarget PricingGovernment expenditures on corn differ between the parity system and the target system:With parity pricing, the government absorbs the excess corn supply: • Of 50 million bushels.• At a subsidy price of $4 per bushel.• A total subsidy of $200 million.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 13: Comparing the Exhibit 13: Comparing the Outcomes of Parity and Outcomes of Parity and
Target PricingTarget PricingGovernment expenditures on corn differ between the parity system and the target system:With target pricing:• Government guarantees farmers $4 per bushel.• Consumers purchase all 135 million bushels at the equilibrium price of $1 per bushel.• Government must make up the difference of $3 per bushel for a total of $405 million.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 13: Comparing the Exhibit 13: Comparing the Outcomes of Parity and Outcomes of Parity and
Target PricingTarget PricingThe crop restriction in target pricing affects the deficiency payment:• The crop restriction limits the number of acres a farmer can plant.• Reducing the quantity of corn supplied from 135 million to 100 million bushels.
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© 2005 Thomson
Gottheil - Principles of Economics, 4e
Exhibit 13: Comparing the Exhibit 13: Comparing the Outcomes of Parity and Outcomes of Parity and
Target PricingTarget PricingThe crop restriction in target pricing affects the deficiency payment:• Consumers pay the new equilibrium price of $3 per bushel.• Government pays the $1 per bushel deficiency payment.• The total payment is $100 million.
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