Modified Markets (Unit 2 Topic 1)

Price Floor

A price floor is a government-imposed minimum price set above the market equilibrium price (Pe). Because the floor price (Pf) exceeds equilibrium, quantity supplied (Qs) exceeds quantity demanded (Qd), creating a persistent market surplus and deadweight welfare loss.

 

How it occurs: When governments intervene to keep prices artificially high, producers are incentivised to supply more while consumers demand less. The gap between Qs and Qd represents unsold surplus — goods produced but unable to find buyers at the mandated price. A non-binding floor set below equilibrium has no market effect.

 

Why it matters: Price floors distort market signals, misallocate resources, and reduce overall economic efficiency. Deadweight welfare loss represents mutually beneficial trades permanently prevented. Surpluses create storage, disposal, and opportunity cost burdens. Workers or producers may benefit short-term while consumers and overall welfare suffer.

 

Solutions:

• Government purchasing — buying surplus production to support the floor price

• Export incentives — redirecting surplus production to international markets

• Production quotas — limiting supply to reduce surplus while maintaining price

• Gradual deregulation — phasing out floors to restore market efficiency

 

Real-world examples:

• Minimum wage legislation setting a floor on labour markets

• Agricultural price supports guaranteeing farmers minimum prices for wheat, dairy, and sugar

• European Union Common Agricultural Policy maintaining artificially high farm gate prices

• Minimum alcohol pricing policies setting floors on per-unit alcohol sales