Price Floors: Surpluses and Lost Gains from Trade

Price Floors

• Sometimes the government intervenes by keeping the price above market levels

  • Ex: minimum wage

• Price floor: minimum price allowed by law

  • Prices can’t legally go below the floor

• Debate on minimum wage:

  • An increase in the minimum wage will lift many individuals out of poverty and have little impact on unemployment
  • An increase in the minimum wage will result in lots of unemployment and have little impact on poverty

• Create 4 important effects:

  1. Surpluses
  2. Lost gains from trade (deadweight loss)
  3. Wasteful increases in quality
  4. A misallocation of resources

Surpluses

• Surplus: the quantity of something supplied exceeds the quantity demanded
• Minimum wage creates unemployment because at a high enough wage, none of us would be worth employing
  • It will decrease employment among low-skilled workers
  • The more employers have to pay for low skilled workers, the fewer low-skilled workers they will hire
  • Ex: young people are more likely to be made unemployed by minimum wage because they lack substantial skills

Lost Gains From Trade (Deadweight Loss)

• If employers and workers could bargain freely, the wage would fall and the quantity of labor would traded would increase to the level of market employment
• There are substitutes for minimum wage workers
  • Higher minimum wages increase incentive to move production to other places where wages are lower
  • Many minimum wage jobs are service jobs that can’t be moved abroad but firms can substitute capital (in form of machines) for labor