Price floor

Definition

A price floor is a government-imposed minimum price that must be paid for a good or service, which is set above the market equilibrium price. This intervention is intended to ensure that sellers receive a minimum income for their products, thereby protecting producers in certain industries. However, when a price floor is established, it can lead to surpluses, as the quantity supplied exceeds the quantity demanded at that set price.

5 Must Know Facts For Your Next Test

1. Price floors are commonly used in agricultural markets to ensure farmers receive a fair income for their crops.
2. When a price floor is set above the equilibrium price, it results in excess supply or surplus, as consumers buy less at the higher price.
3. Governments may use price floors to stabilize markets and prevent prices from falling too low during economic downturns.
4. Examples of price floors include minimum wage laws, which guarantee workers a minimum hourly wage, potentially affecting employment levels.
5. The effectiveness of a price floor depends on the elasticity of demand; if demand is inelastic, the surplus created can be more pronounced.

Review Questions

• How does setting a price floor above the equilibrium price affect market behavior?
  • When a price floor is set above the equilibrium price, it creates a situation where the quantity supplied exceeds the quantity demanded. This leads to a market surplus, meaning there are more goods available than consumers are willing to purchase at that higher price. As sellers try to sell their excess inventory, they may lower their prices informally, creating pressure against the established floor.
• Discuss the potential economic consequences of implementing a price floor in an industry.
  • Implementing a price floor can lead to various economic consequences such as surpluses and inefficiencies in resource allocation. Producers may produce more than what consumers are willing to buy at that higher price, leading to unsold stock and wasted resources. Additionally, if producers expect guaranteed income from the price floor, they may not have the same incentive to innovate or improve efficiency, which can hinder long-term growth in the industry.
• Evaluate how consumer behavior might change as a result of government-imposed price floors and analyze its broader implications on the economy.
  • Consumer behavior tends to adjust when a price floor is imposed; as prices rise above equilibrium, consumers may seek substitutes or reduce their consumption of the affected goods. This shift can lead to decreased overall demand in that market segment and possibly ripple effects across related markets. In broader terms, persistent surpluses can distort market signals, create inefficiencies, and ultimately lead to misallocation of resources throughout the economy.

Related terms

price ceiling: A price ceiling is a government-imposed maximum price that can be charged for a good or service, aimed at making essential products more affordable for consumers.

market surplus: A market surplus occurs when the quantity supplied of a good exceeds the quantity demanded at a given price, often resulting from price floors.

elasticity of demand: Elasticity of demand measures how much the quantity demanded of a good changes in response to a change in its price, impacting how effective price controls can be.