A price floor is a government- or group-imposed price control or limit on how low a price can be charged for a product. A price floor must be higher than the equilibrium price in order to be effective.
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.
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
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.
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, employers hire fewer workers. Consequentially, unemployment is created (more people are looking for jobs than there are jobs available). At the same time, a minimum wage above the equilibrium wage would allow (or entice) more people to enter the labor market because of the higher salary. The result is a surplus in the amount of labor available. The equilibrium wage for workers would be dependent upon their skill sets along with market conditions.
This model makes several assumptions which may not hold true in reality, however. It assumes the costs of providing labor (food, commuting costs) are below the minimum wage, and that employment status and wages are not sticky. Unemployment in the United States, however, only includes participants of the labor force, which excludes 37.2 percent of Americans as of June 2016.
Previously, price floors in agriculture have been common in Europe. Today the EU uses a "softer" method: if the price falls below an intervention price, the EU buys enough of the product that the decrease in supply raises the price to the intervention price level. As a result of this, "butter mountains" in EU warehouses have sometimes resulted.:40-43
- "Price floor – Definitions from Dictionary.com". dictionary.reference.com. Retrieved 2008-05-02.
- CBO-The Effects of a Minimum Wage Increase on Employment and Family Income-February 2014
- "Labor Force Statistics from the Current Population Survey". Retrieved 13 August 2016.
- Davig Begg, et al., Economics, 4th edition, McGraw-Hill 1994