In a free-market economy, the equilibrium price is determined where the demand for the good is equal to the supply of the good. However, sometimes the government intervenes in the market by the means o price controls. The price floor can be understood as the minimum price of a product as fixed by the government which at which the seller has to sell the good (Libich, Stonecash, Gans, Byford, Mankiw & King, 2017).
If the price floor is set below the equilibrium price for a good, then the price floor is not effective since the main purpose of setting the price floor is to protect the prices from decreasing below a certain level (Libich et al. , 2017). The price floor will be binding when the price which is fixed by the government is above the equilibrium price level. At a price higher than the equilibrium level, the quantity supplied will be more than the quantity demanded. As a consequence, there will be an excess supply of the good or surplus in the market. This is shown by the diagram given below
Minimum wage can be understood as the lowest possible compensation that organizations must legally provide to their employees for their services (Taylor & Mankiw, 2011). It is a price floor and to make it effective the government fixes the minimum wage higher than the equilibrium wage rate. At a wage rate higher than the equilibrium wage rate the supply of labor will be more than the demand for labor, thereby, leading to a surplus of labor in the market. The firms have to bear more cost as the wage rate is fixed as a result they lay off some workers. This results in a rise in the unemployment rate for unskilled workers. Thus, minimum wages result in unemployment of unskilled labor (Taylor & Mankiw, 2011).
There are various agricultural products on which the government imposes a price floor since the price floor leads to surplus production, the government purchases the extra produced quantity (Tragakes, 2011).
The price floor is binding when the price is set above the equilibrium price level. Moreover, minimum wages cause a surge in unemployment of unskilled labor. The government fixes the price floor on various agricultural products.
Libich, J., Stonecash, R., Gans, J., Byford, M., Mankiw, G., King, S. (2017). Principles of economics. Australia: Cengage Learning Australia.
Taylor, M. P., Mankiw, N. G. (2011). Economics. United Kingdom: South-Western Cengage Learning.
Tragakes, E. (2011). Economics for the IB diploma with CD-ROM. United Kingdom: Cambridge University Press.
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