Price Floors

Price floor

A legally set minimum price is called a price floor. The price that can be legally charger by sellers of the good must not be lower than the price floor, or minimum price.

The price floor must be set above equilibrium price to have an affect, otherwise market would achieve equilibrium and the price floor would have no effect.

why do governments impose price floors?

1. To provide income support for farmers by offering them prices for their product above market-determined prices

2. to protect low-skilled, low-wage workers by offering them a wage above the level determined in the market.

possible consequences of minimum price

• produces surpluses.

• promotes the creation of black markets.

• the government needs to dispose of the surplus

• it might create firm inefficiency

• eliminates allocative efficiency and generates welfare loss.

• there are consequences for market stakeholders

consequences on stakeholders

• Consumers are worse off because they purchase a lower quantity at a higher price, and some consumer surplus is transferred to the producer.

• producer’s are better off, and there is an increase in producer surplus as they can sell ata higher price.

• workers in the industry are betert off as a higher output means more workers will be required to produce the good

• the government is wrosorse off becauit has to increase its expenditure. Expenditure by the government has an opportunity cost in terms of expspending infrastructure on healthcare, which may be foregone.

how to mitigate the consequences

the government can buy out the surplus.

Here are a few options of what the government can do with the excess supply.

• the government can store the good (however thre will be additional costs)

• sell the surplus abroad (dont dump)

• send the surplus as aid to developing countries

• burn the excess good.

where is the welfare loss?

With no further government intervention, the welfare loss is the area below the demand curve at minimum price and quantity Qd until quantity QE.

When the government buys out the extra supply, an extra welfare loss is created, where A becomes a consumer surplus, and b+d+c+e+f becomes a producer surplus.

consequences of minimum wages on the economy

• labour surplus and unemployment —> the price floor creates a surplus in labour, leading to unemployment as supply is greater than demand.

• illegal workers at wages below the minimum wage

• misallocation of labour resources

• misallocation in product markets

consequences of minimum wages for various stakeholders

• firms (employers) —> firms are worse off as they face higher costs of production due to the higher labour costs.

• workers (suppliers) —> some gain due to higher wages, but some lose because they lose hobs.

• consumers —> consumers are negatively affected because this leads to higher product prices and lower quantities.