Economic Systems and Market Failure: Question 7

Worked solution

Part (a): Defining a mixed economic system

A mixed economic system is one in which resources are allocated partly through the free market’s price mechanism and partly through government intervention. Left alone, Bellara’s cassava market would be a free market, with price adjusting to bring quantity demanded and quantity supplied into balance. But the government’s decision to set a minimum price is a deliberate intervention layered on top of this market, exactly the combination of market forces and government action that defines a mixed economy.

Part (b): Finding the free-market equilibrium from the table

The free-market equilibrium occurs where quantity demanded equals quantity supplied. Scanning the table:

• At $20, $Q_d = 100$ and $Q_s = 40$, demand far exceeds supply.
• At $25, $Q_d = 85$ and $Q_s = 55$, demand still exceeds supply.
• At $30, $Q_d = 70$ and $Q_s = 70$. These are equal.
• At $35 and $40, supply exceeds demand.

So the free-market equilibrium price is $30 per sack, with an equilibrium quantity of 70 thousand sacks per month.

Part (c): Calculating the surplus at the minimum price

The minimum price of $35 is set above the free-market equilibrium of $30. Reading the $35 row of the table:

$Q_d = 55 \text{ thousand sacks/month}, \qquad Q_s = 85 \text{ thousand sacks/month}$

The surplus is the amount by which quantity supplied exceeds quantity demanded at this price:

$\text{surplus} = Q_s - Q_d = 85 - 55 = 30$

So the minimum price creates a surplus of 30 thousand sacks of cassava per month.

Part (d): Consequence for the government, and a method to deal with the surplus

Consequence: farmers are willing to supply 85 thousand sacks at $35 per sack, but buyers are only willing to purchase 55 thousand sacks at that price. Unless someone buys the extra 30 thousand sacks, farmers cannot sell all of their output, and the minimum price cannot be maintained in practice. In many minimum-price schemes, the government itself steps in and buys the unsold surplus at the minimum price to guarantee farmers can sell everything they produce. Doing the arithmetic in pure numbers:

$35 \times 30\,000 = 1\,050\,000$

so buying up the entire surplus could cost the Bellaran government as much as $1,050,000 per month, a real burden on public funds.

Method: rather than letting the price collapse back to $30 (which would defeat the purpose of the minimum price), the government could buy the surplus cassava and store it as a buffer stock, releasing it back onto the market in a future period when supply is lower and the market price would otherwise rise above $35. This smooths farmers’ incomes over time without permanently abandoning the price floor. (Exporting the surplus abroad, or destroying it, are other methods a government sometimes uses, though these carry their own costs and drawbacks.)

Final answers

• (a) A mixed economic system allocates resources partly through the market and partly through government intervention, as illustrated by the minimum price imposed on Bellara’s otherwise free cassava market.
• (b) Free-market equilibrium: price $30 per sack, quantity 70 thousand sacks per month.
• (c) Surplus at the minimum price of $35 = 30 thousand sacks per month.
• (d) Consequence: an unsold surplus of 30 thousand sacks (up to $1,050,000 per month if the government buys it all). Method: buy and store the surplus as a buffer stock to release later.