[Microeconomics] Price Floor

How it works

- Minimum legislated market price set and allowed by the government.

- It is set above the market equilibrium at Pmin.

- It is meant to protect income of suppliers.

Presence of surplus

- Rise in price leads to a decreases in QD an increase in QS, ceteris paribus. There will be a surplus of QDQS units of [good].

- Demand elasticity explanation.

- Supply elasticity explanation.

Eg. DD elastic, SS inelastic.

- As such, the increase in P is likely to cause a more than proportionate decrease in QD. There will be a severe surplus. The government should asses between the price and degree of surplus. the higher the price floor, the more severe the surplus. 

DWL

- Before the implementation of a price floor, the consumer surplus is Area DE0P0 and producer surplus is Area DE0O. Consumers enjoy larger Q but higher P. Consumer surplus decreases to Area XXX and producer surplus increases to Area YYY, incurring a DWL of Area ZZZ.

Evasion of PF

- Firms will surplus may have incentive to evade PF and sell goods below legislated price. This is especially true for firms which sell products with price elastic demands. When they decrease the price of their good, there will a more than prop decrease in QD, allowing the firm to earn a higher revenue.

Buy up surplus

- To ensure that revenue of law-abiding producers do not fall, the government can buy up the surplus. However, this is financially costly, with the expenditure denoted by Area ABCD.

- If goods are perishable, they cannot be stored. If they are non-perishable, they will incur high storage costs.

- Selling the surplus in the international market will depress world price even further due to increase in world supply as most surpluses are offloaded into the world market.

Quota

- Artificially lower SS restricts producers to quota.

- By lowering Q transacted, it causes market price to increase, rendering price control unnecessary. However, the loss of consumption due to the disruption of market forces will lower economic welfare.

Cushion inefficiency

- The price floor enable profits to be protected as they are set higher than the free market equilibrium price.

- There may be less need for producers to find more efficient production methods and cut cost. This cushions inefficiency.

Alternative Goods

- High price may discourage firms from producing alternative goods which they could produce more efficiently or are in higher demand, but have a lower market price.