Price+Floor

A price floor is a minimum legal price that is imposed on a market above the price that otherwise would be achieved in equilibrium.
 * Definition and explanation of a Price Floor:**



A price floor is placed on a market with the goal of keeping the price high, presumably based on the notion that the equilibrium price is too low. If imposed on a competitive market free of market failures, a price floor creates a surplus, or excess supply. A surplus develops because more is being produced than consumers are willing to purchase at that price. In the context of the labor market, there are more people looking for work than there are jobs to go around at that wage, and unemployment results. In the context of a product market, the surplus translates into unsold inventories. In a free market, price would fall to alleviate the unemployment or excess inventories, but the price floor prevents this mechanism from working. Buyers end up paying a higher price and purchasing fewer units. There are times when the excess unsold inventories are purchased by the govenment and this is common with agricultural products, such as cheese. A price floor places a downward limit on the price of a good. Buyers and sellers can exchange the good at prices more than the floor, but not less. The primary goal of a price floor is to keep the price of a good high and thus generate more revenue to the sellers. Examples of markets that have been subject to price floors are agricultural goods and labor.

A good example of how price floors can harm the very people who are supposed to be helped by undermining economic cooperation is the minimum wage. Legislating a minimum wage is commonly seen as an effective was of giving raises to low-wage workers. Unfortunately, the effect of the price floor is a surplus. In this case, it is a surplus of workers, which is referred to as unemployment. A wage floor hits workers with limited skills, primarily young people. According to Dwight R. Lee, a Ramsey Professor of Economics and Private Enterprise at the University of Georgia, the minimum wage reduces the cost of discriminating on non-economic grounds in hiring. With more young people applying for jobs than employers want to hire, and with no legal way of paying a lower wage, it costs nothing to exclude some applicants from consideration. If an employer has a choice between hiring the mayor's son or a poor kid from the other side of the tracks who would be willing to work for less, the mayor's son is almost sure to get the job. The poorer kid would have a far better chance if he could communicate his willingness to work by accepting the lower wage that is now outlawed. Lee also notes that the political demand for minimum wage does not come from low-wage workers. It is mainly coming from the labor unions. Unskilled nonunion workers can compete with skilled union workers only by offering their services for less. Increasing the minimum wage limits this competition, allowing union workers to demand higher wages that would otherwise be possible.
 * Real world examples:**

http://www.fee.org/publications/the%2Dfreeman/article.asp?aid=3795

In the agriculture market, a price floor will create a surplus of goods. For example, in 2004, the state of Maine proposed a bill that would create a price floor in their diary market. The goal of the price floor was to protect farmers from price drops. The government buys the excess inventory in many cases to prevent waste.

(Mack, Sharon Kiley, “Bill to Secure Maine Dairy Prices Gets Preliminary Legislative Approval” //Bangor// //Daily News (ME),// April 14, 2004 Newspaper Source Database Accession # 2W61070990285)

Questions: 1. In a market the equilibrium price is $7.00. A price floor is mandated at $6.50. Which of the following is true? A) There will be a supply shortage. B) There will be a surplus of demand. C) There will be no effect on the market. The answer is C. A price floor must be set above the market equilibruim price for it to have any effect in the market.

2. The minimum legal price that can be charged in a market is: A) a price ceiling. B) the full economic price. C) producer surplus. D) a price floor. The answer is D. This question is simply providing the definition of a price floor. The entire definition would read as follows : The minimum legal price that is imposed on a market above the price that otherwise would be achieved in equilibrium.

3. Price floors can lead to A) surplus B) shortage C) nash equilibrium The answer is A. If imposed on a competitive market free of market failures, a price floor creates a surplus.

4. If a surplus exists, who will sometimes agree to purchase the surplus? A) Goodwill B) Government C) Customers D) Foreign Suppliers The answer is B. Sometimes the government agrees to purchase the surplus. This is the case with price floors on many agricultural products, such as cheese.

5. The equilibrium is set at a price of $5 and quantity at 20 units. What will happen if the government imposes a price floor at $8, which causes quantity demanded to be 10 units and quantity supplied at 30 units? A) Shortage of 20 units B) Surplus of 20 units C) Shortage of 10 units D) Surplus of 10 units The answer is B. At the price floor, you should take the quantity supplied minus the quantity demanded to get the quantity of unsold products. (30-10=20)