Suppose the government imposes a price floor in a perfectly competitive market, assuming that the laws of demand and supply hold.

Then, the more elastic -in the market equilibrium - the market supply is, the smaller the deadweight loss will be.

Question

Suppose the government imposes a price floor in a perfectly competitive market, assuming that the laws of demand and supply hold.

Then, the more elastic -in the market equilibrium - the market supply is, the smaller the deadweight loss will be.

BlackTom AI · Accepted Answer

First, let's restate the scenario in plain terms: A price floor is imposed in a perfectly competitive market, and we assume standard demand and supply curves hold. The statement claims that as the market supply becomes more elastic at the market equilibrium, the deadweight loss (DWL) will be smaller.

Option analysis:
- True: If we suppose the statement that a more elastic supply would reduce DWL, we need to justify why elasticity would shrink DWL. In reality, with a price floor above the equilibrium price, the quantity supplied at that floor exceeds the quantity demanded, creating a surplus. The deadweight loss arises from the reduced traded quantity (relative to the equilibrium) and the inefficiency from not producing/consuming at the equilibrium level. When supply is more elastic, producers respond more to price changes by increasing quantity supplied for any given price floor, which widens the gap between Qs (quantity supplied) and Qd (quantity demanded). This enlarges the triangle areas representing DWL, not reduces them. Therefore, the claim that higher elasticity of supply reduces DWL is not supported by standard DWL analysis in price-floor scenarios. It is generally the opposite: greater elasticity tends to increase DWL because quantity distortions become larger as price floors bind.

- False: The opposite relationship is typically true. In a price floor scenario, increasing the elasticity of supply (and/or demand) tends to enlarge the deadweight loss. The intuition is that a more elastic supply means producers increase output more when the price floor is in effect, creating a larger excess supply and a larger gap between the negotiated (equilibrium) quantity and the traded quantity under the floor. Since DWL is tied to the forgone trades between the equilibrium quantity and the constrained quantity, a larger elasticity expands the DWL triangles. The same logic holds for demand elasticity: higher demand elasticity also tends to increase the DWL under a binding price floor because the quantity transacted moves further away from the efficient equilibrium.

- Additional notes on the typical diagram: The deadweight loss under a binding price floor is the sum of the two triangular regions between the supply and demand curves from the equilibrium quantity to the traded quantity under the floor. As either elasticity rises, the slope of the curves becomes steeper, causing a larger quantity misallocation and larger DWL. Thus, the assertion that elasticity of supply reduces DWL contradicts the standard DWL geometry.

In summary, evaluating the logic of the statement reveals that higher elasticity of supply does not lead to smaller deadweight loss in the presence of a price floor; it generally leads to a larger DWL due to a greater quantity distortion.

SIPAIA6400_001-002_2025_3 - Microeconomic Analysis for International and Public Affairs Problem Set 2, Individual Portion

Suppose the government imposes a price floor in a perfectly competitive market, assuming that the laws of demand and supply hold. Then, the more elastic -in the market equilibrium - the market supply is, the smaller the deadweight loss will be.

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