Price floor
Definition
A price floor or minimum price is a lower limit placed by a government or regulatory authority on the price (per unit) of a commodity.
A price floor is a form of price control. Another form of price control is a price ceiling.
Effects of price floors
Price floors set below the market price have no effect
If the price floor is set below the market price, it has no effect on the market price.
Price floors set above the market price cause excess supply
A price floor set above the market price causes excess supply, or a surplus, of the good, because suppliers, tempted by the higher prices, increase production, while buyers, put off by the high prices, decide to buy less. This leads to a deadweight loss. The picture below illustrates this. Here, the distance AB measures the surplus when the price floor is set at the price level of the line AB, which is higher than the equilibrium price (i.e., the market price).
The situation may be resolved in any of the following ways:
- The regulatory agency setting the price floor agrees to purchase all excess inventory.
- Lower effective prices by means of additional services (a form of non-price competition) or special discounts and rebates on related products.
- A black market, where the goods are sold for less than the price floor (typically, though, black markets are used to handle shortages or scarcity due to price ceilings).