Price floor

A price floor is a government- or group-imposed limit on how low a price can be charged for a product.^[1] In order for a price floor to be effective, it must be greater than the equilibrium price.

Effectiveness of price floors

An ineffective 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 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

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. In order to maintain the price floor over the long term, the government may need to take action to remove it.

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 are 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. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.

Example

This is commonly seen in agriculture. Often the government wishes to maintain high prices of agricultural goods to keep a large number of farmers working. To limit the surplus, however, government will often pay some farmers not to plant crops, this can be known as a subsidy check.

Price floors are also commonly imposed on the hospitality industry. Many jurisdictions mandate a minimum price that licensed establishments must charge for alcoholic beverages in an effort to prevent over consumption. If minimum prices are set too high they can induce people to drink in unlicensed settings where consumption may be less controlled.

See also

• Price ceiling
• General equilibrium
• Resale price maintenance

References