What is a Price Floor?

//What is a Price Floor?
What is a Price Floor? 2017-10-09T06:10:26+00:00

Definition: Price floor is a price control typically set by the government that limits the minimum price a company is allows to charge for a product or service. Its aim is to increase companies’ interest in manufacturing the product and increase the overall supply in the market place.

This control may be higher or lower than the equilibrium price that the market determines for demand and supply.

What Does Price Floor Mean?

What is the definition of price floor? The government intervenes to maintain the prices at a level that encourages production when the market mechanisms determine a high or a low equilibrium price. Typically, a price floor is imposed when the economic activity slows down, and the supply of certain products is low, resulting in an increase in prices at levels that consumers cannot handle.

In other cases, the government intervenes to maintain the prices of production factors at a higher level than the equilibrium price to protect the income of producers.

Although in the real world price ceiling are much more common controls, floor limits do still exist.

Let’s look at an example.

Example

Governments may set a price floor for labor to protect the workers’ rights and boost employment. Because of the minimum wage, workers cannot accept a wage below a certain amount and employers cannot hire a worker for less than the minimum wage. Price floors are effective when set above the equilibrium price. For example, the equilibrium price for labor is $6.00 and the price floor is $7.25. In this case, the supply for employment is greater than the demand of jobs due to the price control that creates a surplus.

The quantity supplied for labor is more than the equilibrium quantity, and people who are looking for a job will not be satisfied. On the other hand, employers are unwilling to pay this price because it’s higher than the market equilibrium, but they have to. Thus, employers will try to cut back their employees and reduce their hiring rates in an effect to slide the surplus closer to the demand curve.

Another example is when government tries to benefit business. They may set a price floor for an agricultural product to motivate producers to keep farming this crop, fearing that the supply of this good may decrease in case farmers switch to other commodities.

Summary Definition

Define Price Floor: Price floor is a price limit that governments enact making it illegal to purchase goods or services for less than a minimum amount.