For the purpose of this paper demand and supply analysis is used to show how it can be applied to a wide variety of economic problems. In the first section consumer and producer surplus is better defined and explained to understand the welfare effects of a government policy. In other words, consumer and producer surplus can evaluate who gains and who loses from a given policy, and also by how much. Also note that these two concepts of surplus can also be used to demonstrate the efficiency of a competitive market.

In the sections to follow minimum prices, price supports, and related policies will be discussed in more detail. To assist the theory, demand-supply analysis will be used to understand and assess these policies.

Consumer and Producer Surplus

To understand consumer and producer surplus better the principles of price ceilings and floors will be discussed. As opposed to price floors, a government-imposed price ceiling means that the price is set at a lower level than the price in the prevailing market. Likewise, price ceilings will cause the quantity of a good demanded to rise. This happens because at lower prices consumers want to buy more. On the other hand, the quantity supplied will fall because producers are not willing to supply as much at lower prices. As a result of this a shortage will occur, which also indicates excess demand. Note that those consumers who can still buy the good will be better off because they now pay less. However, supply will fall, forcing producers to provide less of their goods.

The following section provides a more detailed explanation of the welfare gained or lost by both consumers and producers, should certain prices be imposed. For the purpose of this section the assumption follows that consumers and producers buy and sell at the prevailing market price in an unregulated, competitive market.

However, for some consumers the value of the good in question exceeds the prevailing market price. This also means that the consumer would be willing to pay more for the good if it was expected. Therefore, consumer surplus is the total benefit that consumers receive beyond what they pay for the good (Pindyck and Rubinfeld, 2005:300). For example if the market price of a product is R7, but the consumer is willing to pay R10 for it, then his net benefit will be R3.

Consumer surplus can also be explained with the assistance of demand and supply curves. In this respect consumer surplus can be interpreted as the area between the demand curve and the market price. Pindyck and Rubinfeld (2005:300) also states that consumer surplus measures the net benefit to consumers in the aggregate, therefore, this analysis can be used to better understand the gains or losses induced from government interventions.

On the other hand, producer surplus is the equivalent measure for producers (Pindyck and Rubinfeld, 2005:301). If goods were to be produced at a price lower than the market price, then more could be produced. Therefore, producers will enjoy a benefit, or rather a surplus, from selling those units. This surplus is the difference between the market price the producer receives and the marginal cost of producing the units. It can also be better explained as the area above the supply curve up to the market price.