key term - Price Floor

Definition

A price floor is a government-imposed minimum price for a good or service, which is set above the equilibrium market price. It is a type of price control that establishes a lower limit on the price that can be charged for a particular product or service.

5 Must Know Facts For Your Next Test

1. A price floor is intended to protect producers from low prices, but it can lead to a surplus of the good or service in the market.
2. When a price floor is set above the equilibrium price, it creates a surplus, as the quantity supplied exceeds the quantity demanded at the higher price.
3. Price floors are often used in agricultural markets to ensure a minimum income for farmers and prevent prices from falling too low.
4. The minimum wage is a well-known example of a price floor, where the government sets a minimum hourly wage that employers must pay their workers.
5. Price floors can have unintended consequences, such as creating inefficiencies in the market and leading to a deadweight loss for society.

Review Questions

• Explain how a price floor affects the equilibrium price and quantity in a market.
  • When a price floor is implemented, it is set above the equilibrium price. This means the quantity supplied will be greater than the quantity demanded at the price floor, resulting in a surplus. The price floor prevents the market from reaching the equilibrium price and quantity, leading to an inefficient allocation of resources and a deadweight loss for society.
• Describe the potential consequences of a price floor in a market.
  • The primary consequence of a price floor is the creation of a surplus, as the quantity supplied exceeds the quantity demanded at the higher price. This surplus can lead to a buildup of unsold inventory, which may require government intervention to purchase or store the excess supply. Additionally, price floors can distort market signals, leading to inefficiencies and a deadweight loss for society. They may also discourage producers from innovating or improving their products, as they are guaranteed a minimum price.
• Analyze the role of price floors in agricultural markets and the minimum wage.
  • $$\text{Price floors are often used in agricultural markets to ensure a minimum income for farmers and prevent prices from falling too low.}\text{The minimum wage is a well-known example of a price floor, where the government sets a minimum hourly wage that employers must pay their workers.}\text{In both cases, the price floor is intended to protect producers (farmers or workers) from low prices or wages. However, these price floors can lead to unintended consequences, such as creating surpluses, distorting market signals, and potentially reducing overall economic efficiency.}$$

Related terms

Equilibrium Price:

The price at which the quantity supplied and the quantity demanded of a good or service are equal, resulting in a stable market condition.

Surplus:

A situation where the quantity supplied exceeds the quantity demanded at the current market price.

Minimum Wage:

A price floor set by the government for the minimum hourly wage that employers must pay their workers.