Price+floor

We are doing the price floor experiment on aplia right now. I'm buyer and won't pay more than $45 with the price floor of $50. Now I know just how it feels to be affected by price floors. . . . . . . . . . check back for updates on price floors later.

Price Floors
A price floor is a limit at which the lowest legal price that a good or service can be sold. They are used to protect suppliers and the most common price floor application is the minimum wage. Effective price floors are set above the competitive equilibrium. A price floor below the equilibrium will not affect the market price, since market forces will cause the price to rise above the floor. Graphically, a price floor is drawn as a horizontal line at the dollar amount of the floor. Line will be above the equilibrium price. Below is a graph found at [|www.fundamentalfinance.com]. At the price floor line, you will notice that there will be less demanders of the good than at equilibrium. At the same time, there will be more suppliers willing to supply the good.



The amount of supply in excess of the demand at the price floor is called a surplus. The surplus creates a problem and will cause the government to either purchase the surplus supply or have to strictly enforce the floor. The government could also pay suppliers not to produce or pay for at least part of the price of the good for consumers. Any method is either expensive or takes a lot of effort to enforce.

While probably done with good intentions, price floors are not helpful to society in the long run. Because of the difference between the price the demanders are willing to pay and the equilibrium price, a deadweight welfare loss occurs. The deadweight welfare loss is the loss of the consumer and producer surplus. Graphically, as illustrated below, the deadweight loss is the triangular region below the demand curve, above the supply curve and to the left of the equilibrium.



Question: What happens when government raises the minimum wage above market levels?

I. The quantity of labor demanded increases. II. The quantity of labor demanded decreases. III. The quantity of labor supplied increases. IV. The quantity of labor supplied decreases.

A. I and IV B. Only II C. II and III D. Only I E. Only III F. Only IV

Answer: C. As the minimum wage rises above market levels, the quantity of labor supplied increases (some potential workers unwilling to work at the market wage are willing to work at the higher minimum wage); but the number of workers demanded by employers falls because employers must pay a higher wage.

Question: When government adopts a price floor to support an agricultural crop:

A. Consumers benefit through lower prices. B. The result is a surplus if the price floor is set above the market price. C. A shortage is likely unless farmers increase production. D. A shortage is likely unless farmers decrease production. E. The result is a surplus if the price floor is set below the market price.

Answer: B. Price supports raise the prices received by farmers and paid by consumers. A price floor has no effect if set below the market price, but results in a surplus (the quantity supplied is greater than quantity demanded) when the price floor is set above the market price. Because a price floor is a minimum price rather than a maximum price, adopting a price floor does not lead to a shortage.

Question: Is a price floor set above the market equilibrium effective?

Answer: Yes, a price floor above the market equilibrium will reduce demand and inrease supply.

Question: Is a price floor set below the market equilibrium effective?

Answer: No, a price floor below market equilibrium will have no effect on the market since the competitive market quantity supplied and demanded will already be above the floor price.

Question: Which is an example of a price floor? A. Government subsidy on corn B. Rent controls in cities C. Usury laws on interest rates D. Federal mininum wage

Answer: D. Since the minimum wage sets the lowest allowed price for labor, it is an example of a price floor. The others are examples of price ceilings.

References:

Baye, Michael R., //"Managerial Economics and Business Strategy"//, McGraw-Hill Irwin. 2006.

//"Price Floors"//. FundamentalFinance.com. http://economics.fundamentalfinance.com/micro_price-floor.php Accessed on September 19, 2007.

//"Effect of Price Controls on Equilibrium Quantities I"//. Aplia.com. http://courses.aplia.com/ Accessed on September 19, 2007.