Question

Define a price floor and how it affects resource allocation in a market. Give a real world example of a price floor.

Answer 1

A price floor is a government- or group-imposed price control or limit on how low a price can be charged for a product. A price floor must be higher than the equilibrium price in order to be effective.

In a highly competitive beauty industry, the owner of Images Beauty Salon decides to undercut her local competitors by offering identical services for half the price. But, how might this be accomplished? Could she pay her employees less? Possibly.

To figure this out, first we must discuss a price floor, which, in economics, is a minimum price imposed by a government or agency, for a particular product or service. An effective price floor needs to be higher than the equilibrium price, the price at which supply and demand are equal. If not, the market would not sell below the equilibrium, and the price floor would mean nothing. Additionally, sellers who charge a price lower than the imposed floor price would be breaking the law.

Price floor hurts society more than it helps. It may help farmers or the few workers that get to work for minimum wage, but it only helps those people by hurting everyone else. Price floors cause a deadweight welfare loss. The problem is that since it creates an excessive supply, usually the government ends up buying and stockpiling the extra quantity. Often the government destroys the surplus or allows it to spoil.

Examples

Chinese government set a price floor on rice. The governments impose price floors in agriculture in order to convince farmers to keep farming rice. they are afraid of those farmers start grow others good instead of rice. than the market will break balance, consumers won’t have rice anymore because farmers are not growing others which can give them more benefit. in this case, demand is the citizens. Farmers are the producers. rice is an inelastic good in China, because people can not live without it, so a bit higher price doesn’t change a lot in quantity demanded. but for those families which live in poverty, a high price can also cause problems for them, so government is buying the surplus and give them to poverty areas to balance the market. or there will occur a black market, they sell rice at a lower price than the price floor and that will break the market. So government intervention is indispensable.

or

The Minimum Wage

Using the example from above, the owner of Images Beauty Salon might not be able to charge $20 for a perm when the competing salons are charging $40-$60 each, if this means paying her employees less than minimum wage to make a profit. The minimum wage is the price that employers pay for labor, and a common example of a price floor. The federal minimum wage is, as of 2015, $7.25 per hour; this is established by the Federal government and applied across the United States.

States have various, higher minimum wages, but paying an employee less than $7.25 an hour would be illegal. This price floor protects the employees from being exploited.