key term - Price Floors

Definition

A price floor is a government-imposed minimum price that must be charged for a good or service. It creates a lower limit on the price, preventing the market price from falling below a certain level. Price floors are often implemented to protect producers and ensure a minimum income for them.

5 Must Know Facts For Your Next Test

1. Price floors lead to a surplus of the good or service, as the quantity supplied exceeds the quantity demanded at the artificially high price.
2. The presence of a price floor results in a deadweight loss, as it prevents the market from reaching the equilibrium price and quantity.
3. Price floors are often implemented in agricultural markets to ensure a minimum income for producers and stabilize prices.
4. Minimum wage laws are a common example of a price floor, where the government sets a minimum hourly wage that employers must pay their workers.
5. The effectiveness of a price floor depends on whether it is set above or below the market equilibrium price.

Review Questions

• Explain how a price floor affects the market equilibrium and the resulting surplus.
  • A price floor set above the market equilibrium price will create a surplus, as the quantity supplied will exceed the quantity demanded at the artificially high price. This surplus will lead to an inefficient allocation of resources, as producers will be incentivized to produce more than consumers are willing to purchase at the price floor.
• Describe the concept of deadweight loss in the context of a price floor and its impact on overall economic efficiency.
  • The imposition of a price floor results in a deadweight loss, which is the loss in total economic surplus (the sum of consumer and producer surplus) that occurs when the market equilibrium is not achieved. This deadweight loss represents a decrease in overall economic efficiency, as the market is not able to allocate resources in the most optimal way. The size of the deadweight loss depends on the difference between the price floor and the market equilibrium price, as well as the elasticity of supply and demand.
• Analyze the potential benefits and drawbacks of implementing a price floor, particularly in the context of agricultural markets and minimum wage laws.
  • Price floors can provide benefits to producers by ensuring a minimum income and stabilizing prices, which can be particularly important in volatile agricultural markets. However, the drawbacks include the creation of a surplus, deadweight loss, and potential distortions in the allocation of resources. In the case of minimum wage laws, a price floor can help support low-income workers, but it may also lead to job losses and reduced employment opportunities if the minimum wage is set too high. Policymakers must carefully weigh the tradeoffs when considering the implementation of a price floor in order to achieve the desired outcomes while minimizing the negative economic consequences.

Related terms

Price Ceiling:

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

Surplus:

A surplus occurs when 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 total economic surplus (the sum of consumer and producer surplus) that occurs when the market equilibrium is not achieved.