A price floor
is a government- or group-imposed limit on how low a price can be charged for a product. For a price floor to be effective, it must be greater than the equilibrium price.
Effectiveness of price floors
A price floor can be set above the free-market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
equilibrium price. In the first graph at right, the dashed green line represents a price floor set below the free-market price. In this case, the floor has no practical effect. The government has mandated a minimum price, but the market already bares a higher price.
By contrast, in the second graph, the dashed green line represents a price floor set above the free-market price. In this case, the price floor has a measurable impact on the market. It ensures prices stay high so that product can continue to be made.
Effect on the market
A price floor set above the market equilibrium price has several side-effects. Consumer
Consumer is a broad label for any individuals or households that use goods generated within the economy. The concept of a consumer occurs in different contexts, so that the usage and significance of the term may vary.-Economics and marketing:...
s find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply (known as a surplus) of the product in the market. To maintain the price floor over the long term, the government may need to take action to remove this surplus.
A historical (and current) example of a price floor are minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...
laws, laws specifying the lowest wage a company can pay an employee (employees are suppliers
of labor and the company is the consumer
in this case). When the minimum wage is set higher than the equilibrium market price for unskilled labor, unemployment
Unemployment , as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks...
is created (more people are looking for jobs than there are jobs available). A minimum wage above the equilibrium wage would induce employers to hire fewer workers as well as cause more people to enter the labor market, the result is a surplus in the amount of labor available. The equilibrium wage for a worker would be dependent upon the worker's skill sets along with market conditions.
This is commonly seen in agriculture. Often the government wishes to maintain high prices of agricultural goods to keep a large number of farmers working. To limit the surplus, however, governments often pay some farmers not to plant crops, this can be known as a subsidies
Price floors are also commonly imposed on the hospitality industry. Many jurisdictions mandate a minimum price that licensed establishments must charge for alcoholic beverages in an effort to prevent over consumption. If minimum prices are set too high they can induce people to drink in unlicensed settings where consumption may be less controlled.
Previously, price floors in agriculture have been common around Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...
. Nowadays EU uses a "softer" method: if the price falls below an intervention price, EU buys the product so much that this decrease in supply raises the price to the intervention price level. Because of this, "butter mountains" now lie at EU stockhouses, not at the producers' stockhouses. Because of this problem, the EU also plans to stop these price controls and just pay former farmers regardless on what they do, so as not to cause any undesired indirect effects on the economy.