Price floor

Price floor

A price floor is a government- or group-imposed limit on how low a price can be charged for a product. [cite web
url=http://dictionary.reference.com/browse/Price%20floor
title=Price floor - Definitions from Dictionary.com
publisher=dictionary.reference.com
accessdate=2008-05-02
last=
first=] In order for a price floor to be effective, it must be greater than the equilibrium price.

Effectiveness of price floors

A price floor can be set above 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.

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.

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 that supply.

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, a surplus of labor is created (more people are looking for jobs than can find jobs). 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 equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.

ee also

*Price ceiling
*General equilibrium
*Resale price maintenance

References


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