Use a demand and supply graph to illustrate the effects of relaxing a minimum-price policy by allowing the price to decrease and narrow the gap between the controlled price and the equilibrium price. (Related to Application 3)

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Application 3 SHRINKING WINE LAKES APPLYING THE CONCEPTS #3: What are consequences of a price above the equilibrium price? Under the Common Agricultural Policy (CAP) the European Union uses a number of policies to support the agricultural sectors of member countries. Under a minimum-price policy the government sets a price above the market-equilibrium price. The EU guarantees farmers minimum prices for products such as grain, dairy products, and wine. This policy causes artifi- cial excess supply: if the minimum price exceeds the market- equilibrium price, the quantity supplied will exceed the quantity demanded. To support the minimum prices, the EU purchases any output that a farmer cannot sell at the guaranteed price and stores the excess supply in facilities labeled by the Euro- pean press as "butter mountains" and "wine lakes." In recent years the EU has reformed its agriculture policy by reducing and in some cases eliminating minimum prices. As a result, the butter mountains and wine lakes are shrinking. Related to Exercises 3.6 and 3.8. SOURCE: Europa, "Reform of the Common Agricultural Policy, Summaries of EU Legislation, europa.eu/legislation_summaries.