Price Floor Flashcards
What is it?
A legally set minimum price – set above equilibrium.
At the equilibrium price, consumers are willing and able to buy the quantity demanded of the good, but firms are willing and able to supply the quantity supplied (which exceeds the quantity demanded). Therefore, a surplus of supply arises, equal to the difference between quantity supplied and quantity demanded.
If the market were free, the forces of demand and supply would force the price down to the equilibrium price. However, now this cannot happen due to the minimum price set by the government.
What happens if a price floor is set below the equilibrium price?
To have an effect, the price floor must be set above the equilibrium price. If the price floor were set below the equilibrium price, the market would self-correct. In this case, there would be no impact because the price would naturally remain at the equilibrium level, where the quantity demanded equals the quantity supplied.
Why are price floors imposed? (2)
1) To provide income support for farmers by offering them prices for their products that are above market-determined prices.
2) To protect low-skill, low-wage workers by offering them a minimum wage (Above equilibrium price).
Impact of minimum prices in market for agricultural products
The government imposes a minimum price, as a result, qty supplied extends and wty demanded contracts. There is now a surplus in the market a Qs is greater than Qd. The govt buys the excess so that farmers dont lose revenue.
Consequences of Price Floors (5)
1) Surplus – The price floor results in a larger quantity supplied (Qs) than the quantity demanded at market equilibrium.
Note that if the government did not buy the excess supply (which may lead to a black market), the price would remain above the equilibrium. Since sellers can’t attract more buyers, this often creates waste, as producers have more goods than consumers are willing to buy. For perishable goods, this means substantial waste.
2) Government measures to dispose of surpluses:
a) Storing the surplus - This incurs additional costs for storage on top of the cost of purchasing the excess.
b) Exporting the surplus internationally - Exporting typically requires subsidies to lower prices, as foreign countries may not want to buy it at a high price.
Both options involve subsidies and additional costs for the government. Therefore, either option to dispose of the surplus would be problematic.
3)Firm inefficiencies: Higher-than-equilibrium prices can lead to inefficiencies in production. Inefficient firms with high production costs do not face strong incentives to reduce costs or improve efficiency because the elevated price levels protect them from competition with lower-cost producers. This protection can reduce the pressure on firms to adopt more efficient production methods, invest in technology, or innovate. As a result, these firms may continue using outdated or inefficient processes, which leads to overall inefficiencies in the market. The lack of competition from more efficient firms can also result in higher prices for consumers and suboptimal resource allocation, further exacerbating economic inefficiencies.
4) Overallocation of resources to the production of the good and allocative inefficiency. Too many resources are allocated to the production of the good, resulting in larger than optimum qty produced. Whereas the optimum qty is equilibrium.
5) Negative welfare impact
a) Consumer surplus - Higher prices reduce consumer welfare as they pay more than the equilibrium price, leading to fewer purchases.
b) Producer Surplus Distortion - Producers may benefit from higher prices, but reduced demand and surplus goods can lead to inefficiencies and wasted resources.
c) Market Inefficiency: A price floor creates deadweight loss, reducing the total economic welfare as fewer transactions occur at the inflated price.
d) Unemployment and Wasted Resources: For example, a minimum wage or agricultural price floor can lead to job losses or unsold goods, reducing overall efficiency.
Consequences of price floor on stakeholders (6)
1) Consumers - Worse off - as they must now pay a high price for the good, while they also buy a smaller qty of it. It is clear from the loss of consumer surplus.
2) Producers - Better off -as they receive higher prices and produce larger quantities. Since the government buys the surplus, their revenue increases. Additionally, producers are protected from low-cost competition and do not face strong incentives to become more efficient. As a result, they are less likely to go out of business despite inefficiencies in their production processes.
3) Workers - Better off - as the price increases, leading to higher output. As production expands, more labor is required, which can result in more workers being employed.
4) Government - Worse off - because when govt buys the excess supply, it burdens the budget, leaving less funding for other societal needs. Additionally, after purchasing the surplus, the government incurs extra costs to either store or export the goods.
5)Taxpayers - Worse off - Their money isn’t being used to benefit them nor society. They bear the cost of price floors through higher taxes or reduced public spending. The government’s purchase, storage, and export of surplus goods place a financial burden on them, reducing overall societal welfare.
6) Stakeholders in other countries - Worse off - as many developed nations use price floors for agricultural products to support their farmers. When surpluses are exported, they can lower world prices due to the increased supply in global markets. The lower prices signal to local farmers in other countries that they should cut back on production, leading to an underallocation of resources for these products.
Objective of minimum wage laws?
To guarantee an adequate income for low-income workers, who tend to be mostly unskilled.
The demand for labor curve shows the quantity of labor that firms are willing and able to hire at each wage, while the supply curve shows the quantity of labor workers are willing to provide at each wage. The interaction of supply and demand determines the equilibrium wage, where the quantity of labor demanded equals the quantity of labor supplied.
Consequences of minimum wages (3)
1) The demand for labor curve shows the quantity of labor that firms are willing and able to hire at each wage, while the supply curve shows the quantity of labor workers are willing to provide at each wage. The interaction of supply and demand determines the equilibrium wage, where the quantity of labor demanded equals the quantity of labor supplied.
2) Rise of illegal or “underground” workers, often immigrants, who are willing to work for wages below the legal minimum. These workers may be employed informally by businesses looking to avoid the higher costs of paying the minimum wage. This can lead to exploitation, as these workers may lack legal protections and be paid less than the established minimum wage. Additionally, it can undermine the effectiveness of the minimum wage law by creating an informal labor market.
3) Misallocation of labor resources - The minimum wage prevents the market from establishing an equilibrium price for labor. Wages act as a signal and incentive for workers and firms, helping to determine the optimal allocation of resources in the labor market. When the minimum wage is set above the market-clearing level, it distorts these signals, leading to a misallocation of labor. This can result in excess supply (unemployment) or reduced demand for labor, as firms may not hire as many workers at the higher wage.
Consequences of min wage on stakeholders (3)
1) Firms - Worse off - because they face higher labor costs due to the minimum wage, which increases their overall cost of production. As a result, they may reduce output or raise prices, potentially losing customers and market share.
2) Workers - They are mixed - Those who keep their jobs benefit from higher wages due to the minimum wage law. However, some workers lose their jobs because the higher wage creates an excess supply of labor. The number of workers who lose their jobs is represented by the difference between the quantity of labor supplied (Qs) and the quantity of labor demanded (Qd). Additionally, the minimum wage causes extra unemployment, as more workers are willing to supply labor at the higher wage, leading to a further gap between the supply (Qs) and the demand (Qe) for labor.
3) Consumers - Worse off - the increase in labor costs leads to a decrease in supply of goods and services. As a result, prices rise, and the quantity of goods available decreases. This leads to higher prices for consumers, reducing their purchasing power and overall welfare.a
Long term impacts
1) Capital Substitution: Over time, businesses may substitute labor with capital (automation or technology) to reduce costs, leading to technological unemployment.
2) Business Failures: Small firms with lower profit margins may struggle, resulting in market exit and reduced competition.
3) Labor Market Adjustment: The labor market may adjust with changes in the wage structure as firms shift to higher-skilled workers and invest in human capital.
4) Wage Compression: The gap between low-skilled and high-skilled wages may narrow, causing wage compression as firms increase wages for low-skilled workers but must also raise wages for higher-skilled workers to maintain differentiation.
5) Long-Term Unemployment: The structural mismatch between the supply and demand for labor at the minimum wage rate can lead to persistent long-term unemployment for low-skilled workers.
Short term impacts
1) Increased Wages: Workers who remain employed benefit from a higher wage rate, leading to an increase in income.
2) Unemployment: The minimum wage creates a labor surplus (excess supply of labor) as firms reduce their demand for workers, leading to structural unemployment for those priced out of the market.
3) Price Increase: Firms may pass on the higher labor costs to consumers, causing cost-push inflation and a reduction in the quantity demanded of goods and services.
4) Reduced Labor Demand: Some firms may reduce hours worked or eliminate positions to cope with higher labor costs.
Advantages
Disadvantages
