The correct option is Government procurement of surplus produce.
Explanation
In microeconomic theory, a price floor (or minimum support price) is a government-imposed price control or limit on how low a price can be charged for a product. For a price floor to be effective, it must be set above the equilibrium price determined by market forces of demand and supply.
Analysis of the Mechanism:
- Creation of Surplus: When the government sets a price floor above the equilibrium price, the higher price incentivizes producers (farmers) to increase supply (Law of Supply). Simultaneously, the higher price discourages consumers, leading to a decrease in quantity demanded (Law of Demand).
- Market Imbalance: This divergence results in the Quantity Supplied exceeding the Quantity Demanded, creating a state of excess supply or surplus in the market.
- Government Intervention: To maintain the price floor and prevent market prices from crashing back to the equilibrium level due to the surplus, the government must intervene. This is typically done through the procurement of the surplus produce. If the government does not buy this excess stock, the price support policy fails as the unpurchased surplus would force prices down.
Option Analysis:
- Setting price floor below equilibrium is incorrect: Setting a price floor below the equilibrium is known as a non-binding price floor. It has no effect on the market outcome as the market naturally clears at a higher equilibrium price.
- Government procurement of surplus produce is correct: As explained, the direct consequence of the surplus generated by a binding price floor is the necessity for government procurement to sustain the support price.
- Excess demand is incorrect: Excess demand (shortage) occurs when a price ceiling is set below the equilibrium price, not when a price floor is set above it.
- Distress sale is incorrect: Distress sales occur when farmers are forced to sell at very low prices due to a lack of demand or storage. Price support programs are specifically designed to prevent distress sales.
Key Takeaway:
A price floor set above the equilibrium price invariably leads to excess supply (surplus). To sustain this floor, the government must act as a buyer of last resort and procure the surplus.