After you have worked through this section of the learning unit, you should be able to:
- explain the impact of a price floor on a market
A price floor means that the government puts a legal lower limit or minimum price that can be charged for a good or service.
A price floor is the lowest legal price that can be paid in markets for goods and services, labour or financial capital. Perhaps the best-known example of a price floor is the minimum wage, which is based on the normative view that someone working full time should be able to afford a basic standard of living. In 2015, the minimum wage for domestic workers in the main areas in South Africa was R10,95 per hour. This important topic is dealt with in more detail in the section dealing with the labour market.
Price floors are sometimes called "price supports", because they support a price by preventing it from falling below a certain level. Around the world, many countries have passed laws to create agricultural price supports. Markets for agricultural products are usually characterised by a stable demand, but a fluctuating supply. Prices of agricultural goods, and thus incomes for farmers fluctuate, sometimes widely. Hence even if, on average over time, farmers' incomes are adequate, in some years they might be fairly low. The purpose of price supports is to prevent these swings and to stabilise the agricultural sector.
We will use an example of the effects of a government policy that imposes a price floor (a minimum price) above the equilibrium price for a product such as eggs.
To illustrate and explain the impact of a price floor, we will use the diagram below of the market for eggs. In the absence of government intervention, the price would adjust so that the quantity supplied would equal the quantity demanded. This occurs at the equilibrium position E , with an equilibrium price of R1,50 per egg and an equilibrium quantity of three million eggs.
Market for eggs (millions)
Market for eggs (millions)
Market for eggs (millions)
Who do you think will benefit if the price of eggs were fix at a price higher than the market price?
Consumers would definitely not benefit because they would now pay a higher price for eggs, and since the price is higher, they would consume less. Some producers would definitely benefit. This is the argument we will develop in the rest of the section.
What do you think the impact would if the government were to decide to fix the price of eggs above the market price?
As you will see shortly, it creates an excess supply.
Consider the case of a minimum price per egg of R2,00, which is higher than the equilibrium price. This price is indicated in the diagram below as the horizontal line Pf.
Market for eggs (millions)
Study the above diagram and answer the questions:
- What is the quantity demanded at a price floor of R2,00?
At a price floor of R2,00, the quantity demanded is two million.
- What is the quantity supplied at a price floor of R2,00?
At a price floor of R2,00, the quantity demanded is four million.
With the quantity demanded at two million and the quantity supplied at four million, an excess supply of two million eggs exits on the market. And this excess supply will persist as long as a price floor of R2,00 is imposed on the market. Note that the when a price floor is imposed, it does not shift the demand and supply curves. There are movements along the curves.
If one compares this position of an excess supply with the market equilibrium position E, the following picture emerges:
At a price floor of R2,00 …
- the quantity of eggs supplied increases from three million to four million eggs. – an increase of one million eggs supplied.
- the quantity of eggs demanded decreases from three million to two million eggs – a decrease of one million eggs demanded.
- an excess supply of two million eggs are created.
Indicate whether the following statements are true or false:
Since the quantity of eggs supplied increases by one million more people are consuming eggs.
Think again.
The statement is false. While the quantity of eggs supplied did increase the quantity demanded decreased and less eggs are consumed. At a price of R2,00, fewer eggs are consumed than at R1,50, the equilibrium price.
Correct. The statement is false.
While the quantity of eggs supplied did increase the quantity demanded decreased and less eggs are consumed. At a price of R2,00, fewer eggs are consumed than at R1,50, the equilibrium price.
At a price floor of R2.00 people are consuming more eggs compared to the market equilibrium positon E.
Think again.
The statement is false. While the quantity of eggs supplied did increase the quantity demanded decreased and less eggs are consumed. At a price of R2,00, fewer eggs are consumed than at R1,50, the equilibrium price.
Correct. The statement is false.
While the quantity of eggs supplied did increase the quantity demanded decreased and less eggs are consumed. At a price of R2,00, fewer eggs are consumed than at R1,50, the equilibrium price.
Also note that it is only if the minimum price is higher than the equilibrium price that the price floor is binding. If, for instance, the government sets the minimum price at R1,00 per egg, this would have no impact since the market price that suppliers obtain would be R1,50. The farmer can charge any price above the price floor; if the price floor is below equilibrium price, then the consumers and suppliers will settle at the market price.
Activity
Milk producers were able to convince the government to impose a price floor on the price of milk. The following diagram represents the market for milk before the price floor:
Litres of milk
- What is the market equilibrium price of milk per litre?
- What is the market equilibrium quantity of milk?
- Are there any unhappy consumers of milk at the market price in the market?
- Are there any unhappy or unsatisfied suppliers of milk at the equilibrium position?
a. R8
b. 40 000
c. Yes, those that are only willing to pay less than R8.
d. Yes, those that are willing to supply at a price higher than R8.
Owing to the pressure from milk producers, the government imposes a price floor as indicated in the following diagram:
Litres of milk
- What is the price floor?
- How many litres of milk are consumers willing and able to purchase at the price floor?
- How many litres of milk are supplied at the floor price?
- Is there an excess demand, equilibrium or excess supply in the market at the price floor?
a. The price floor is R12.
b. The quantity demanded is 20 000 litres of milk.
c. The quantity supplied is 60 000 litres.
d. There is an excess supply of 40 000 litres of milk.
