Price Floor

Definition

A price floor is a government-imposed minimum price that must be charged for a good or service. It sets a lower limit on the price, preventing the market price from falling below this predetermined level.

5 Must Know Facts For Your Next Test

1. A price floor is typically implemented to protect producers from low market prices and ensure a minimum income for them.
2. The most well-known example of a price floor is the minimum wage, which sets a lower limit on the price of labor.
3. When a price floor is set above the equilibrium price, it creates a surplus in the market, as the quantity supplied exceeds the quantity demanded.
4. Price floors can lead to inefficiencies and deadweight losses by preventing the market from reaching its equilibrium price and quantity.
5. The market system is an efficient mechanism for information because it allows prices to adjust to reflect the true scarcity of resources and the preferences of buyers and sellers.

Review Questions

• Explain how a price floor affects the equilibrium in a market for goods and services.
  • When a price floor is implemented, it sets a minimum price that must be charged for a good or service. If the price floor is set above the equilibrium price, it creates a surplus in the market, as the quantity supplied exceeds the quantity demanded at the price floor. This leads to a situation where producers are willing to supply more than consumers are willing to buy, resulting in an inefficient allocation of resources and potential deadweight loss.
• Describe how a price floor can impact the market system's ability to efficiently allocate resources.
  • The market system is an efficient mechanism for information because it allows prices to adjust to reflect the true scarcity of resources and the preferences of buyers and sellers. However, a price floor disrupts this process by preventing the price from reaching its equilibrium level. This can lead to inefficiencies, such as the creation of a surplus, and a misallocation of resources. The price floor prevents the market from reaching the point where the quantity supplied equals the quantity demanded, which is the most efficient allocation of resources.
• Analyze the potential consequences of a price floor on the overall welfare of a market.
  • A price floor can have significant consequences on the overall welfare of a market. By setting a minimum price above the equilibrium level, a price floor creates a surplus, which leads to a deadweight loss. This means that the total surplus (the sum of consumer and producer surplus) is reduced, resulting in a decrease in overall market welfare. Additionally, the price floor can distort the information provided by the market, making it less efficient in allocating resources and meeting the preferences of buyers and sellers. This can have far-reaching implications for the market system and the economy as a whole.

Related terms

Price Ceiling: A price ceiling is a government-imposed maximum price that can be charged for a good or service, setting an upper limit on the price.

Surplus: A surplus occurs when the quantity supplied exceeds the quantity demanded at the prevailing market price.

Deadweight Loss: Deadweight loss refers to the reduction in total surplus (the sum of consumer and producer surplus) caused by a market distortion, such as a price floor or ceiling.