A price floor is a price control that sets a minimum price for goods or services. It acts as an artificial prop to keep prices above equilibrium, thus protecting producers from price competition.
A price floor is one of the leading governmental tools used to keep prices stable while ensuring that businesses remain profitable. It is most commonly used in agricultural and labor markets but can also be applied to other industries.
For example, the government can establish a price floor on milk to guarantee farmers a stable income level. This political action shields producers from market fluctuations by mandating the lowest amount of money they can ask for their products.
So, a price floor is a mandated cost limit put in place by the government or another organization, which prevents companies from charging too low of a price for their products, goods, commodities, and services.
Definition of Price Floor
A price floor is a government-mandated minimum cost that producers in an industry are allowed to charge for their goods and services (Prag, 2020).
Price floors are intended to ensure that producers receive a stable income while also protecting consumers from unfair price gouging.
According to Arnold (2015), a price floor “is a government-mandated minimum price below which legal trades cannot be made” (p. 111).
A price floor, also known as “price support,” acts as a safeguard to maintain the price of an item above a certain level. Blocking prices from dropping below this threshold allows them to remain stable and secure for producers and consumers alike (Free, 2010).
For example, if the government sets a price floor of $10 per gallon on gasoline, it would be illegal for gas stations to charge less than this amount.
So, in simple words, a price floor is a government-imposed regulation that prohibits the price of an item from falling below a certain level.
10 Examples of Price Floor
- Agricultural products: Milk prices are a classic illustration of a price floor. Although consumers don’t always pay extra for milk, the government often aids in sustaining prices by subsidizing them or compensating farmers directly. This measure is meant to ensure that dairy farms continue operating even when there’s an oversupply of milk- which typically leads to lower costs under normal market conditions.
- Rent control: In many cities, rent control protects tenants from being evicted due to escalating rent prices. This price floor is used to regulate the cost of rent and prevent landlords from taking advantage of tenants.
- Interest rates: Interest rate floors, which apply to the interest charged on loans or deposits, are especially relevant as they refer to the minimum return for that money each quarter or time frame specified. In other words, an interest rate floor ensures a certain level of financial security by guaranteeing a specific lowest value over time – even when market fluctuations occur.
- Minimum wage: The minimum wage is a price floor intended to maintain workers’ rights and help ensure they are not exploited as labor resources. This measure protects workers from unfair working conditions and inadequate pay, which is why it’s a mandatory requirement in most countries.
- Carbon pricing: Carbon pricing is a policy measure that places costs on producing carbon-emitting fuels and other sources of greenhouse gas emissions. Such a price policy enables governments to curb emissions and incentivize the development of more sustainable energy sources.
- Harmful Drinks: The government also uses price floors to regulate the cost of adult beverages. The assumption is if these beverages were too affordable, people would consume more of them, thus leading to more significant health problems.
- Natural gas: Price floors are also used to protect natural gas suppliers who, due to the market’s volatility, can experience significant fluctuations in pricing. If prices fall too low, it can be difficult for suppliers to break even.
- Electricity: In some cases, governments can use price floors to protect electricity suppliers from experiencing losses due to market price fluctuations. This is especially important for rural areas, as these communities often lack access to alternative energy sources.
- Insurance products: Insurance companies, particularly in the health insurance industry, often use price floors to protect their profitability. When setting the floor, companies typically calculate their business costs and other factors, such as the probability of a claim being made. It is done to guarantee that they can cover their expenses and remain profitable.
- Fishing Licenses: The government sometimes sets a price floor for fishing licenses to control fishing activities. This measure can raise the entry cost for fishing which will prevent overfishing and protect fish populations, ensuring sustainability in the sector.
- Renewable Energy Certificates: Governments often establish a price floor for Renewable Energy Certificates (REC) to promote green energy output. By guaranteeing these certificates a minimum price, the government ensures that renewable energy producers can afford the necessary technology and remain competitive.
- Airline Tickets: Regulated airlines often have a minimum ticket price to ensure profitability and cover high operational costs. This price floor helps maintain a functional and competitive airline industry despite considerable competition and fluctuating fuel prices.
- Child Care Services: In some regions, a price floor can be set for child care services to ensure child care providers are paid sufficiently. The goal is to strike a balance between affordable child care and a living wage for service providers.
- Anti-Dumping Measures: A government may set a price floor on agricultural products if foreign suppliers begin to dump their surplus at a very low price, which would price out the local producers if there weren’t a price floor.
- Mortgages: Imagine a situation where the economy is overheating, causing inflation. The central bank may choose to raise interest rates with the intent to create a de facto price floor on the price of variable-rate mortgages. This prevents people from taking out mortgages and forces mortgage holders to pay more on their mortgage each month, which can help curb inflation.
Price Floor vs. Price Ceiling
Price floors and price ceilings are two government-imposed regulations that affect the prices of goods and services. The former is a minimum price set for a particular product, while the latter is a maximum price that can be charged for an item (Coyne, 2015).
Price floors aim to protect consumers from exploitation and ensure that producers receive a fair income for their products. They are typically implemented in industries where producers are vulnerable to price fluctuations (Arnold, 2015).
In contrast, price ceilings protect consumers from being exploited by businesses. Typically they’re imposed on basic services and items like utilities, foodstuffs, and healthcare to ensure customers are not subjected to unfair prices (Coyne, 2015).
Overall, price floors and ceilings are both tools for governments to regulate the pricing of goods and services to protect producers and consumers from exploitation.
These policies are critical in markets without competition, where a single company can dictate prices.
Economic Effects of Price Floors
The direct economic consequence of a price floor is an increase in supply and a simultaneous decrease in demand, resulting in the formation of a surplus.
When the market floor price is higher than its equilibrium balance, producers suffer from revenue losses as their products remain unsold. This can mean a decrease in consumer consumption since there is less supply on hand and souring sales for companies (Arnold, 2015).
Contrary to popular belief, setting a price floor can yield positive monetary outcomes for businesses. The increased demand encourages companies to produce more of their product, consequently leading to job growth and an advantageous economic ripple effect.
Ultimately, the implementation of price floors can result in increased prices for consumers. This policy directly impacts their buying power and further worsens economic inequality among different groups of people.
Therefore, governments must consider the potential economic effects of implementing price floors on goods or services before taking any action.
Advantages of Price Floors
Price floors can be beneficial for producers and consumers alike. Unlike price ceilings, price floors protect producers from exploitation by ensuring buyers are willing to pay a fair market wage for goods or services.
The implementation of price floor policy often leads to an increase in production levels, resulting in the creation of new jobs and higher wages. It can help to stabilize the market by preventing producers from experiencing financial losses due to price fluctuations (Dufwenberg et al., 2006).
Price floors also benefit consumers as they can effectively reduce prices on essential goods or services. This policy helps people with lower incomes obtain basic necessities at a more affordable rate (Arnold, 2015).
Overall, price floors can bring positive outcomes for both producers and consumers. However, governments should consider potential costs before implementing this policy to ensure that it will not lead to economic disruption.
Disadvantages of Price Floors
Price floors can be damaging to the economy as they often cause an imbalance in supply and demand.
Setting a price floor higher than the equilibrium point results in enhanced costs for producers, leading to fewer commodities available on the market. This policy creates an overabundance of supply, heightening consumer prices and decreasing company profits (Hirshleifer et al., 2005).
Furthermore, implementing a price floor can decrease consumption as people have less money to spend on goods and services. It can adversely impact employment levels as businesses struggle to profit with fewer customers.
Additionally, when producers are obligated to sell their goods at prices they deem inadequate, it can be detrimental to their motivation to invest in new projects or grow their business.
So, such a policy can be a significant problem for developing economies as it prevents them from growing and becoming competitive with other countries.
To protect buyers and sellers from being taken advantage of, the government implements a price floor policy which sets the minimum cost for goods or services.
This method not only defends individuals but can also lead to increased production and employment rates.
Price floors can be a beneficial policy for producers in competitive markets, allowing them to receive a fair market wage for their goods or services. It also has the potential to reduce consumer costs on essential items and create employment opportunities.
However, this policy must be implemented carefully to avoid economic disruption. Setting prices too high may lead to overproduction and an imbalance in supply and demand.
Arnold, R. A. (2015). Macroeconomics. Thomson South-Western.
Coyne, C. J. (2015). Flaws and ceilings price controls and the damage they cause. London Institute of Economic Affairs.
Dufwenberg, M., Gneezy, U., Goeree, J. K., & Nagel, R. (2006). Price floors and competition. Economic Theory, 33(1), 211–224. https://doi.org/10.1007/s00199-006-0152-0
Free, R. C. (2010). 21st century economics: A reference handbook. Sage.
Hirshleifer, J., Glazer, A., & Hirshleifer, D. (2005). Price theory and applications: Decisions, markets, and information. Cambridge University Press. Prag, J. (2020). Microeconomic essentials understanding economics in the news. Cambridge.