|What is a price support|
Price support is where the government agrees to purchase all output for a specified price. For example, the government agreeing to purchase all milk for $1 per litre would be an example of a price support.
|Price support in a diagram|
If there was no price support, the market where produce output which corresponds to price PE and quantity QE . (If PE and QE are confusing, imagine that PE is $4 and QE equals 20). Now suppose that the government sets the minimum price as Ps (imagine that it's now $5). This would cause supplier to wish to increase their output to QS (imagine it's 25). However, because the price has increased demand decreases so the amount demanded is now only PE (you can imagine it is 15 units).
Because the quantity demand is not the same as the quantity supplied, the government must purchase the surplus. The surplus amount is equal to QS - QD and the cost of purchasing is equal to Ps * (Qs - QD) or the area shaded in blue.
This area is also the dead-weight loss. This is because this amount of money is being spent on purchasing the good but it will not be used for anything.
|Price support v Price floor|
As you may have noticed, a price support is very similar to a price floor. However, there are some differences between the policies.
- The quantity that is sold under a price support are higher than a price floor. If the government only set a price floor, the quantity produced would be QD instead of Qs .
- The dead weight loss is higher for a price support than price floor. In the above example, the entire area blue is the dead weight loss. However, the dead weight loss for a price floor is only the area shaded green on the example below. For a better understanding of price floor, see here
- Price supports are guaranteed to increase the welfare of the supplier, whereas price floors do not necessarily increase the produce surplus. It is possible that the area shaded green could be so large that C and B are smaller than B in the original situation. That is not possible for a price support because the government purchases all output at the specified price. The diagram below shows the supplier surplus when there is a price support. The supplier surplus is the entire area labelled in red.