Price Floor

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Definition of a Price Floor:

A price floor establishes the minimum legal price for a good or service. A minimum wage is an example of a price floor.

Here is a short video further explaining the concept of a price floor.

Detailed Explanation:

Price floors protect suppliers and are common for agricultural products. Their objective is usually to protect the nation’s food supply by shielding farmers from large drops in prices that could put them out of business. A price floor has no bearing on the quantity supplied and demanded when the floor is below the equilibrium price. When the price floor is above the equilibrium price, a surplus is expected, in which case the quantity producers are willing to supply exceeds the quantity that buyers demand. Without a floor, market forces would push down the price, forcing producers to cut production to bring the quantity supplied and demanded into equilibrium. Market forces are restricted by the price floor set by the government. Sometimes, as with agriculture, the government can be the buyer of last resort. Companies face the temptation of illegal activity such as bribery and corruption of government officials to sell their surplus.

The minimum wage is an example of a price floor. When the minimum wage is set above the market wage, more workers would enter the work force. The higher wage would reduce the number of workers demanded by employers. The gap between willing workers and employed workers would widen - increasing unemployment. Only those employees retaining their jobs would be helped by an increase in the minimum wage. Those seeking but unable to find work would find it more difficult. Employees who lose their jobs from lay offs precipitated by the increase would not benefit. Costs would increase for employers. Consumers may also pay when companies increase their prices in response to their increase in costs. 

The supply and demand graph below illustrates how a minimum wage can increase unemployment. The equilibrium wage is $7.00 per hour. A minimum wage of $7.50 is established. At $7.50, employers would hire 2.75 million workers (A on the graph below). Unfortunately, 250,000 workers are laid off. Meanwhile, the higher wage attracts 150,000 more workers. The total unemployed is now 400,000, the 250,000 who lose their job plus the 150,000 who enter the workforce.

chart showing impact of minimum wage

Dig Deeper With These Free Lessons:

Supply and Demand – The Costs and Benefits of Price Controls
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Managing Supply Using Tariffs, Subsidies, Quotas & Licenses

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