Price Floor

Posted in Finance, Accounting and Economics Terms, Total Reads: 58
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Definition: Price Floor

Price floor is the minimum price set by the government below which a product or service cannot be sold in the market. The most example is the minimum wage set up by the govt. for labourers.


For Ex- If min. wage for the labourer is set at Rs. 100 per day then they cannot be paid less than that howsoever minimal work it would be.

 

Effect of price floor on the market:

A price floor creates surplus in the market. Let’s understand this with the help of the graph


Point E denotes the market equilibrium price i.e. prices decided by demand and supply. Government will impose price floor denoted by dotted line F. A price floor below equilibrium price will be irrelevant as the market will not sell the commodity below equilibrium price. Owing to the price floor there will be surplus of commodity in the market as consumers will buy less due to rise in prices while producers will produce more to earn more profits.

Also price floor causes net decrease in total economic surplus known as deadweight loss. This happens because price of good is increased leading to lower consumer surplus (Monetary gain availed by consumers by paying lesser price than they are willing to pay) which compensates the increase in producer surplus (Monetary gain obtained by producers by selling at higher price than they are willing to sell). There is decrease in sales due to increase in prices leading to lower economic surplus (Consumer surplus + Producer Surplus)

 

Excess Supply issue

Due to price floor there is excess supply which has only two options. First, it is bought by the government and stored by it to sell it off at some other time or secondly it is kept as inventory at producer’s store who bears cost of storing it.

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