4.3 Minimum Price (Price Floor)

Question 1

What is a minimum price and why do governments impose it?

Answer 1

A minimum price is a price floor that is set above the equilibrium market price. Governments impose minimum prices for several reasons. First, to protect producers of primary commodities from price volatility. Second, to discourage consumption of de-merit goods. Finally, to reduce income inequality and protect workers in the labor market.

Question 2

Minimum Price (Price Floor Diagram)

Answer 2

• with intervention buying, revenues for the producer increase from P1CQ10 to P2BQsO.
• This is known as intervention buying, which has a cost equal to the rectangle ABQdQs.

Question 3

How can minimum prices help protect producers of primary commodities?

Answer 3

Minimum prices can protect producers of primary commodities by providing a stable income for farmers, especially when the free market price would otherwise be much lower. This allows farmers to sustain their livelihoods and provide for their families, allowing the industry to survive in a country. The demand and supply of primary commodities are highly price inelastic, meaning that when either the demand or the supply shifts, often due to changing weather conditions, price swings can be large, destabilizing the income of agricultural producers.

Question 4

How do minimum prices discourage consumption of de-merit goods?

Answer 4

Minimum prices can be used to discourage consumption of de-merit goods like alcoholic drinks by raising the price above the free market price. This internalizes the negative externality and discourages consumption, solving overconsumption issues and bringing the market to the allocative efficient production level, eradicating a prior misallocation of resources.

Question 5

How do minimum wages reduce income inequality and protect workers in the labor market?

Answer 5

Minimum wages reduce income inequality and protect workers in the labor market by protecting workers from extreme low pay and discrimination that might exist in the labor market. Low wages can prevent a decent standard of living, promoting poverty, which can be overcome if the government sets a minimum wage above the free market equilibrium wage, guaranteeing those in employment with low skills, on the lower end of the pay spectrum, an increase in pay with an improvement in their standards of living. The gap between the rich and poor in society will decrease, reducing income inequality.

Question 6

Diagramatically

What is the impact of a minimum price or price floor?

Answer 6

A minimum price or price floor is set above the free market equilibrium price, increasing prices from P1 to P2. As a result, there is an extension of supply to Qs and a contraction of demand to Qd, causing an excess supply (a surplus) of AB to exist in the market.

Question 7

How do consumers lose out when a minimum price is implemented?

Answer 7

Consumers lose out when a minimum price is implemented because they must now pay higher prices from P1 to P2, which reduces their consumer surplus. The poor will suffer proportionately more than the rich as they are regressive, meaning they take a greater proportion of the poor’s income than they do of the rich, which could widen income inequality in society.

Question 8

What is an evaluation of the impact of a minimum price on consumers?

Eval - Domestic Producers

Answer 8

Consumers may instead like the fact that their own domestic producers are remaining in the industry providing them with local produce rather than non-home produced imports. They may be willing to pay a higher price to buy local produce and thus not suffer as the theory suggests.

Question 9

What is another evaluation of the impact of a minimum price on consumers?

Eval - Intervention and Tax rises

Answer 9

In the primary commodity sector, there is usually some form of intervention buying of the excess supply produced. This comes at a cost to the government, which could mean future tax rises burdening consumers or cuts to public services in the future. In this sense, consumers lose out in both the short run and long run.

Question 10

How do producers benefit from a minimum price?

Eval - Intervention buying

Answer 10

Producers benefit from a minimum price, especially if there is intervention buying of the excess supply produced. The demand and supply of primary commodities are highly price inelastic, implying that when either the demand or the supply shifts, often due to changing weather conditions, price swings can be highly volatile, destabilising the income of agricultural producers. A minimum price allows the industry to survive in a country. Furthermore, with intervention buying, revenues for the producer increase from P1CQ10 to P2BQsO.

Question 11

What is an evaluation of the impact of a minimum price on producers?

Eval - whether intervention actually takes place

Answer 11

• This beneficial impact on the producer depends heavily on whether intervention buying actually takes place. In developing countries, governments may not be able to afford it, leaving the producers to deal with storing or destroying the excess stock - a waste of resources and a hit to profitability for the producer going against the intentions of the policy.
• If the minimum price is used to solve de-merit good market failure, however, there would be no buying up of the excess stocks, thus producers are more likely to suffer if excess stock is produced.
• However, if there is inelastic demand for the product being sold and producers do not produce the excess supply knowing it will simply be left unsold, producers will still see an increase in their revenues and profitability as less is being produced now.

Question 12

What is the difference between price elasticity and inelasticity of demand?

Answer 12

Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. A price elastic demand means that a small change in price causes a larger change in quantity demanded. In contrast, a price inelastic demand means that a change in price causes a proportionately smaller change in quantity demanded. The demand and supply of primary commodities are highly price inelastic.

Question 13

Diagramatically

What is the cost of intervention buying for the government?

Answer 13

The government, having created the excess supply, must now buy it up, which is costly. This is known as intervention buying, which has a cost equal to the rectangle ABQdQs.

Question 14

What is the first major issue with intervention buying for the government?

Answer 14

The first major issue with intervention buying for the government is what to do with the excess stock. Destroying it would be highly wasteful, storing it very expensive, and dumping it abroad politically sensitive given the impact dumping has on producers abroad.

Question 15

What is the second major issue with intervention buying for the government?

Answer 15

The large financial cost of intervention buying needs to be funded, perhaps by tax rises in the future or spending cuts to public services, both of which will hurt consumers. In distorting efficient market outcomes, the government has reduced total consumer and producer surplus in the market, generating a deadweight welfare loss of triangle ACD, reducing society surplus.

Question 16

What is an evaluation of the issue of excess stock for the government?

paying farmers to leave land aside

Answer 16

Governments can overcome the issue of what to do with the excess stock by paying farmers to leave land aside that they would have ordinarily used to produce crops instead of having to buy up excess stocks. This still carries an opportunity cost given the spending involved, but the issue of wasteful allocation of resources by destroying the stock once bought is taken away.

Question 17

What is an evaluation of the cost of intervention buying for the government?

the benefits of the policy may outweigh the costs

Answer 17

Despite the huge cost of intervention buying, if producers remain in the market and consumers are willing and able to buy local produce at a higher price, the benefits of the policy may outweigh the costs, reducing the government failure argument, especially in developing countries where the agricultural industry is often dominant, and farmers experience low standards of living.

Question 18

What is an evaluation of the impact of a minimum price on de-merit goods?

a black market may form

Answer 18

In the case of discouraging the consumption of a de-merit good like alcohol, a black market may form where consumers can find an alternative supply at a lower price. This could be highly dangerous for the consumer as they do not know exactly what is in the product they are consuming. It may be worse for them than the product consumed legally, worsening the extent of the negative externalities generated. Once more, the government has created a new market failure (an unintended consequence), which needs spending to police. If significant, the costs of the policy will outweigh the benefits resulting in government failure.

Question 19

What is an evaluation of the impact of a minimum price on market welfare?

sociial welfare in the market not resulting in the welfare loss theory

Answer 19

If the government successfully manages to reduce the over-consumption of de-merit goods like alcohol, social welfare will improve in the market not resulting in the welfare loss theory suggests. Instead, there would be an improvement in the allocation of resources and a welfare gain for society.