Price floor
From Wikipedia, the free encyclopedia
A Price floor is a government-imposed limit on how low a price can be charged for a product. For a price floor to be effective, it must be greater than the equilibrium price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price.
A price floor can be set above or below the free-market equilibrium price. In the graph at right, the dashed 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.
In contrast, the solid green line is a price floor set above the free-market price. In this case, the price floor has a measurable impact on the market.
A price floor set above the free-market price has several effects. Demanders 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 of the product in the market. In order to maintain the price floor over the long term, the government must take action to remove that supply.
Price floors cause surpluses. 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 there is a minimum wage law, a surplus of labor is created (more people are looking for jobs than can find jobs). With this price floor, those who can find jobs, win (they were being paid a smaller wage, and now they get a higher wage), but unemployment also occurs. Because the supply of labor tends to be relatively inelastic, the sum of total wages paid to all workers usually raises if a price floor is set even if fewer people are being employed. Still there remains an excess supply (of labor) that the government must deal with. The most direct way of doing that is for the government to lessen the effect of the price floor by simply increasing demand (effectively buying the excess supply) - which, in the case of labor, means creating more jobs in the public sector (for example by starting new public projects, such as building roads or schools) and hiring people to do those jobs. In addition, there are also a number of macroeconomic policies that can reduce unemployment under certain circumstances.
