Question

Draw the graph of a market where a binding price floor has been introduced. Analyze the welfare effects by pointing out the change in economic surplus and its reallocation from one party to the other. Show those effects on the graph.

Answer 1

PRICE FLOORING-

when government determines minimum price for any goods and services, this practice is known as price flooring.this kind of practice is generally seen in the labor market where government fixes a minimum wage rate for all the workers.no workers can be hired below this wage rate.

we can understand this concept with following example-

STAGE-1

• suppose initially the equilibrium was taking place with the help of demand and supply of labor.therefore the equilibrium was determined at E point and there was no deadweight loss.QN number of labors were employed at W wage rate.we can see this on the following graph.

STAGE-2

• now suppose for the protection of the interest of labors government passed a rule that no contractor would be able to hire any worker unless he is ready to pay W' wages which is more than the previous level of wages.this step would discourage the producers and contractors and they would decrease their demand for labor and due to increased wage rate the no of labors would increase and there would be deadweight loss.
• consumer surplus has been declined and producer surplus has been increased as we can see.this is because producers are not willing to carry on the production process and doing this would increase their cost of production and decline in the profit margin.

we can see the impact on another graph which is given below-

when wage rate has been decline then the demand for labors has been declined to QD and supply has been increased to QS.eventually the wage rate would decline and equilibrium would be restored to earlier level that is point E.