Price Floor
What is Price Floor?
A price floor is a government-imposed minimum price that must be paid for a good or service.
Price floors are typically set above the equilibrium price to support producers' incomes. However, they can lead to surpluses, as quantity supplied exceeds quantity demanded at the floor price. Examples include minimum wage laws.
Price Floor: a worked example
A state sets a wage floor in a low-skill labor market where labor demand is Ld = 500 - 20W and labor supply is Ls = 100 + 30W, with W the hourly wage and L the number of workers. Equating them, 500 - 20W = 100 + 30W gives 400 = 50W, so the equilibrium wage is $8 with 340 workers hired. A floor of $10 changes both sides: Ld = 500 - 200 = 300 and Ls = 100 + 300 = 400. The labor surplus is 400 - 300 = 100 workers, which is the unemployment the floor creates. Employment falls from 340 to 300, so 40 workers who held jobs at $8 lose them, while 60 new job seekers are drawn in by the higher wage and find nothing. The 300 who keep working earn $2 more per hour.
The mistake students make with price floor
A frequent miscount measures the surplus as only the rise in quantity supplied and ignores the simultaneous fall in quantity demanded. The surplus is the full horizontal gap at the floor price, so both movements belong in the total. Students also claim a floor helps every seller. Sellers who still transact do better at the higher price, but those squeezed out by the drop in quantity demanded sell nothing at all. Finally, a floor beneath the equilibrium price binds on nothing, and the market clears exactly as it would without the rule.
Price Floor questions
Does a price floor cause a surplus or a shortage?
A binding price floor causes a surplus. The floor holds the price above equilibrium, so quantity supplied exceeds quantity demanded and the unsold difference accumulates. In a goods market that surplus shows up as unsold inventory, and in a labor market it shows up as unemployment. A floor set below the equilibrium price binds on nothing and the market clears as usual.
Is the minimum wage a price floor?
Minimum wage laws are the standard price floor example, applied to the market for labor. The wage is the price, workers are the suppliers, and firms are the demanders. When the legal minimum sits above the market clearing wage, quantity of labor supplied exceeds quantity of labor demanded, and that gap appears as unemployment among workers who would have been hired at the lower wage.
Why does a price floor create deadweight loss?
Deadweight loss appears because trades that would have benefited both sides stop happening. At the floor price, some buyers who valued the good above its production cost drop out, and the surplus those transactions would have generated vanishes instead of moving to someone else. On a graph the loss is the triangle between the demand and supply curves, running from the reduced quantity out to the equilibrium quantity.
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