A2.04.06: Price Floors Flashcards
Define price floors
A legal price enacted by governments and usually above equilibrium price. Price charged must not be lower than the legal minimum price.
Illustrate the diagram for price floors and describe it
- Minimum price line is drawn at a higher price labelled Pf (price floor)
- DWL is to the left pointing to the social optimum point. This is created due to producer revenue falling from Pf x Qs to Pf x Qd
- S Labour and D labour labelled
- First intersection of Minimum price line with D is labelled Qd on x-axis and second is Qs
- There is a contraction in D labour and an extension in S labour
- Excess supply / surplus is area above social optimum and represents a gain in social surplus
- first intersection of minimum price with D labour x Qd is cost of govt. purchases (Opportunity cost of tax revenues) however, excluding gain in social surplus, that area represents wasted potential welfare
- Some PS is gained but Some CS is lost
State 2 reasons why price floors are enacted
- To protect producers from price volatility (price fluctuations) thus, guaranteeing their incomes
- To solve market failure
Explain the stakeholder impacts as a result of Price Floors (on consumers, producers, govts, and stakeholders in other countries)
- Consumers: Worse off as they pay higher prices whilst buying smaller quantities. (some CS is lost)
- Producers: Gain as employment increases on account of greater production
- Govts.: Buy the excess supply thus, increasing the burden on their budget resulting in less govt. expenditure, therefore, incurring opportunity costs. There are also extra costs of storing the surplus or subsidising it for sale to other countries (export)
- Stakeholders in other countries: US or European Union (developed countries) rely on price floors for agricultural goods to support their farmers.
State 3 assumptions that are made when governments buy the excess supply after enacting price floors. What does this not apply for though?
- They sell it to developING countries at low prices (in effect-dumping)
- Sold below cost to charities
- Destroyed
This does not apply for demerit goods
Define minimum wage
A piece of legislation set by govts. that stipulates a minimum per hour rate of payment
Explain the use of and the impact of price floors for labour markets
- Incomes in the free-market are determined by the quality and quantity of the in-demand productive resources that you own
- Thus, ownership of these resources isn’t equally divided and so it is inevitable that there will be income inequality and disparity in living standards
- Due to this, govts ensure that even the lowest paid jobs pay a sufficient income to afford the worker a decent quality of life; govts legislate minimum wages to ensure these workers earn enough income to satisfy their basic needs.
Explain the market/stakeholder impact of price floors for labour markets
- Minimum wages raise costs of production for users of low-skilled workers which reduces their willingness to supply their product thus, creating underproduction of goods and services
- Moreover, the labour market isn’t cleared thus, leaving a surplus (excess supply) of labour and unemployment increases
- Furthermore, there is an increased emergence of black markets for illegal workshops and underpayments
- It is often the case that the quality of labour increases, as the limited jobs available compels workers to become more competitive, in order to be more attractive to employers given the surplus (excess supply).
Explain the impact and use of price floors for farming
- Due to price volatility (price changes) and inelastic nature of supply and demand of agricultural commodities, the income farmers receive is highly unpredictable leading to poverty, large unemployment and potential issues with food security
- As a result, govts. Impose minimum prices and directly purchase the surplus (excess supply) so as to guarantee the farmer’s income and protect producers, in general, from price volatility
