negative output gap and minimum prices

Question 1

Negative output gap

Answer 1

A negative output gap occurs when an economy actual output is below its potential output.

the economy is initially in equilibrium where the average price level is p and real output is y is less than potential output yf. hence there is a negative output gap in order to close the negative output gap, the government can use expansionary demand side policy such as decreasing the interest rate

this makes borrowing cheaper encouraging households and firms to borrow to increase durable consumption and investment

as consumption and investment are components of AD, AD shorts right to AD1.

this creates a new equailbrum with an increased real output and an increased average price level p1. As actual output is now equal to potential output the negative output gap is closed

Question 2

minimum prices

Answer 2

The market is initially in equilbrum where Q quantity of agricultural goods are brought and sold at price P. At the minimum price pin Q1 quantity is demanded and Q2 quantity is supplied leading to excess supply.

consumers lose out as they now pay higher price pmin reducing their real incomes and reducing consumer surplus from area to area

lower income groups are likely to be disproportionally affected as they spend a high proportion of their income on agricultural goods

some producers benefit from receiving a higher price for the good but some lose out as they sell less of the good

producer surplus changes from area to area whether it rises or falls depends on the price elecatsicy of demand of the product. As a result of the minimum price social surplus is lost so the market is now allocatively ineffiecnet

Question 3

maximum prices

Answer 3

the market is initially in equilibrium where Q quantity of rental accomnadtaion is rented at price P. At the maximum price max Q1 quantity is supplied and Q2 quantity demanded leading to excess demand.

consumers benefit as they now pay a lower price increasing their real incomes. Lower incomes groups are likely to the disportionately benefited as they spend a higher proportion of their income on necessities such as rental accomfdation

however Q2-Q1 consumers lose out as they are not able to access the good producers lose out as they receive a lower price and sell less. Total producer revenue falls with producer surplus also falling from area to area

There is a loss of social surplus equal to the area xyzzy therefore there is an underproduction and allocative ineffiecenty at quantity Q1