What is a Price Floor?
Definition: Price floor denotes the lowest amount that consumers can pay for goods and services. Likewise, the term is used to denote the minimum wage that employers can pay employees for service rendered.
Understanding Price Floor Example
Often called price supports, price floor plays a crucial role in ensuring price does not fall below a certain level. For this reason, a number of countries have passed legislation geared towards price regulation. The laws have consequently created price supports for agricultural produce to support farmers. Likewise, some regulations dictate the lowest amount that employers can pay workers.
Governments play a pivotal role in enabling price floors. For instance, a government can enter a market and buy up a product to do away with surplus and ensure prices do not fall below a certain level. In the absence of the government, demand might fall substantially, forcing suppliers to cut prices in a bid to attract consumers.
The price floor is most effective when they are set above the equilibrium, which is the point where the demand and supply curve intersect. However, the price level, at times, presents a string of challenges.
In the chart above, the price equilibrium is at Po, which is where the supply and demand curve intersects. Similarly, the price floor is set slightly above at Pf.
From the chart above, it is clear that buyers are not willing to buy as many products at the Price floor level depicted by a decline in demand to Qd from the demand at equilibrium, which was Qs. In contrast, suppliers are willing and ready to supply more products at the price floor level as supply is seen increasing to Qs from QO. Suppliers, in this case, are willing to supply more products to take advantage of the high price level compared to the equilibrium price.
In the chart above, it is clear price floors create a problem as suppliers and buyers find it difficult to agree on the right price to buy and sell the products. Similarly, quantity demanded is lower at the price floor or consumed than the quantity supplied, resulting in what is often dubbed surplus.
Protecting Price Floor
If a surplus is continues in the market, then there is always a likelihood of price plunging, after sometime, bellow the equilibrium level. In order to avert such a scenario, the government might step in and buy any surplus in the market as a way of ramping up demand. For instance, there was a time the U.S government bought grain surplus from U.S farmers and gave it a donation to African countries
In addition to buying surplus from the market to ensure the price floor level holds, a government might opt to impose the price floor a move that many at times cause surplus to be wasted. Minimum wage operates the same way, as employers must pay workers at the set price and not anything less.
In a bid to ensure the price floor level holds, a government can decide to control how much is produced. By preventing too many suppliers in the market, such regulations can help balance the forces of demand and supply. A lack of surplus in the market would in return force consumers to buy goods at the set price which in this case is the price floor level.
Similarly, the government can protect the price floor level by incentivizing consumers. The issuance of subsidies can go a long way in strengthening consumer’s purchasing power allowing them to buy the goods at the price floor level.
Summary
Price floor is simply a lower boundary for which an item can be sold. The boundary is normally set to ensure prices don’t fall below certain levels as a way of protecting the existence of producers in the market. While price floor helps producers, it tends to affect consumers negatively as they are forced to pay more than the equilibrium price.