Price floor

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A price floor is a government- or group-imposed price control or limit on how low a price can be charged for a product.[1] A price floor must be higher than the equilibrium price in order to be effective.

Effectiveness of price floors[edit]

An ineffective, non-binding price floor, below equilibrium price.

A price floor can be set below 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.

An effective, binding price floor, causing a surplus (supply exceeds demand).

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.

Effect on the market[edit]

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. The equilibrium price is determined when the quantity demanded is equal to the quantity supplied.

Minimum wage[edit]

An example of a price floor is minimum wage laws; in this case, employees are the suppliers of labor and the company is the consumer. When the minimum wage is set above 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 allow more people to enter the labor market, the result is a surplus in the amount of labor available. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.

Europe[edit]

Previously, price floors in agriculture have been common around Europe. Nowadays the EU uses a "softer" method: if the price falls below an intervention price, the EU buys the product so much that this decrease in supply raises the price to the intervention price level. Because of this, "butter mountains" now lie at EU stockhouses, not at the producers' stockhouses.[2]

See also[edit]

References[edit]

  1. ^ "Price floor – Definitions from Dictionary.com". dictionary.reference.com. Retrieved 2008-05-02. 
  2. ^ Davig Begg et al., Economics, 4th edition, McGraw-Hill 1994, s. 40–43

Further reading[edit]