What is a Price Floor?
Definition: The government of a country can set a price floor for a good or a service. It is the minimum price below which transactions will not be permitted. For example, a price floor could be set for the corn that farmers produce. Hence, if this is fixed at $150 per metric ton, buyers would have to pay at least that amount to buy corn. A minimum wage is also a type of a price floor.
What does Price Floor mean?
Governments use price floors to prevent prices of certain goods or services from falling below the limit that they set. But this step can disturb market forces.
Consider a situation where the price of grain, as determined by the forces of supply and demand, is $180 per metric ton. But the government sets prices at $200. What will be the result of this step?
Suppliers of grain will be willing to provide greater quantities as the price that they will get is higher. However, at this higher price, demand will fall as consumers would switch to other alternatives. There would be a supply-demand imbalance and unsold grain would pile up with farmers.
What could be the possible solution to this problem? The options before the government would be to:
⇨ Buy up the surplus grain from the market. This would result in an expenditure for the government. They would also have to decide about what to do with the grain that they have purchased.
⇨ The government could decide not to interfere. If they did this, some farmers would not be able to find buyers for their produce.
⇨ The government could subsidize buyers to buy the grain at the floor price.
As you can see, each of these options does not seem to be an optimal solution.
Example of a Price Floor
The minimum wage is an example of a floor price. When the government sets a minimum wage, employers have to pay a certain minimum rate per hour to their employees. They cannot hire workers below this rate.
Most American states have set a minimum hourly wage. Here is an illustration that shows the minimum wage in some states:
State Minimum wage rates in the United States as of January 1, 2018, by state (in U.S. dollars)
Source – Statista
The minimum wage is set at $12.5 per hour in the District of Columbia. Other states, notably Georgia, where the minimum wage is $5.15, have lower price floors.
Is it a good idea to set a minimum wage? There are pros and cons to taking this step. On the positive side, it assures workers that they will be able to earn an amount that provides them with a certain standard of living. But if the wage floor is set too high, it could result in employers cutting down on the number of people that they hire.
A price floor is a government-imposed minimum rate for a certain good or service. It could benefit a certain section of the people that it affects but could prove to be a disadvantage for others.