Price floor
A price floor is a government- or group-imposed limit on how low a price can be charged for a product.[1] For a price floor to be effective, it must be greater than the equilibrium price.
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[edit] Effectiveness of price floors
A price floor can be set above the free-market equilibrium price. In the first graph at right, the dashed green line represents a price floor set below the free-market price. In this case, the floor has no practical effect. The government has mandated a minimum price, but the market already bears a higher price.
By contrast, in the second graph, the dashed green line represents a price floor set above the free-market price. In this case, the price floor has a measurable impact on the market. It ensures prices stay high so that product can continue to be made.
[edit] Effect on the market
A price floor set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply (known as a surplus) of the product in the market. To maintain the price floor over the long term.
[edit] Minimum wage
A historical (and current) example of a price floor are minimum wage laws, laws specifying the lowest wage a company can pay an employee (employees are suppliers of labor and the company is the consumer in this case). When the minimum wage is set higher than the equilibrium market price for unskilled labor, unemployment is created (more people are looking for jobs than there are jobs available). A minimum wage above the equilibrium wage would induce employers to hire fewer workers as well as cause more people to enter the labor market, the result is a surplus in the amount of labor available.[citation needed] The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.
[edit] Europe
Previously, price floors in agriculture have been common around Europe. Nowadays EU uses a "softer" method: if the price falls below an intervention price, EU buys the product so much that this decrease in supply raises the price to the intervention price level. Because of this, "butter mountains"[2] now lie at EU stockhouses, not at the producers' stockhouses. Because of this problem, the EU also plans to stop these price controls and just pay former farmers regardless on what they do, so as not to cause any undesired indirect effects on the economy.
[edit] See also
[edit] References
- ^ "Price floor - Definitions from Dictionary.com". dictionary.reference.com. http://dictionary.reference.com/browse/Price%20floor. Retrieved 2008-05-02.
- ^ Davig Begg et al., Economics, 4th edition, McGraw-Hill 1994, s. 40-43
