key term - Legal Minimum Price

Definition

A legal minimum price is a government-mandated price floor that sets the lowest allowable price at which a good or service can be sold. It is an intervention in the market to prevent prices from falling below a certain level, often implemented to protect producers or workers from low incomes.

5 Must Know Facts For Your Next Test

1. A legal minimum price is a type of price floor, set above the equilibrium market price to protect producers or workers from low incomes.
2. When a legal minimum price is implemented, it creates a surplus of the good or service, as the quantity supplied exceeds the quantity demanded at the higher price.
3. The surplus generated by a legal minimum price leads to deadweight loss, as it reduces overall economic efficiency and consumer and producer surplus.
4. Legal minimum prices are often used in agricultural markets to guarantee a minimum income for farmers, or in labor markets to set a minimum wage.
5. The effectiveness and impact of a legal minimum price depends on factors such as the level at which it is set, the elasticity of demand and supply, and the presence of substitutes or alternatives.

Review Questions

• Explain how a legal minimum price affects the equilibrium price and quantity in a market.
  • When a legal minimum price is set above the equilibrium market price, it creates a surplus of the good or service. The quantity supplied at the higher minimum price exceeds the quantity demanded, leading to a surplus. This surplus results in a deadweight loss, as the market is no longer operating at the equilibrium point where the quantity supplied equals the quantity demanded.
• Describe the potential consequences of implementing a legal minimum price.
  • The implementation of a legal minimum price can have several consequences. First, it creates a surplus of the good or service, as the quantity supplied at the higher price exceeds the quantity demanded. This surplus can lead to storage costs, waste, or the need for government intervention to purchase the excess supply. Additionally, the deadweight loss associated with the surplus reduces overall economic efficiency, as some consumers who would have been willing to purchase the good at the equilibrium price are priced out of the market.
• Analyze the factors that determine the effectiveness and impact of a legal minimum price.
  • The effectiveness and impact of a legal minimum price depend on several factors. The level at which the minimum price is set relative to the equilibrium market price is crucial, as a higher minimum price will result in a larger surplus and greater deadweight loss. The elasticity of demand and supply for the good or service also play a role, as more inelastic markets will experience larger surpluses and deadweight losses. Additionally, the presence of substitute goods or alternative sources of supply can influence the impact of the minimum price, as consumers and producers may be able to find alternatives to the regulated market.

Related terms

Price Floor:

A price floor is the lowest legal price that can be charged for a good or service, preventing the market price from falling below that level.

Surplus:

A surplus is a situation where the quantity supplied of a good or service exceeds the quantity demanded at the prevailing market price.

Deadweight Loss:

Deadweight loss is the loss in economic efficiency that occurs when the equilibrium price and quantity are not achieved, such as when a price floor or ceiling is implemented.