Price Floor Below Equilibrium Effect

For a price floor to be effective it must be set above the equilibrium price.

Price floor below equilibrium effect. In the first graph at right the dashed green line represents a price floor set below the free market price. Consider the figure below. Price floors are only an issue when they are set above the equilibrium price since they have no effect if they are set below market clearing price. If it s not above equilibrium then the market won t sell below equilibrium and the price floor will be irrelevant.

However price floor has some adverse effects on the market. A non binding price floor is one that is lower than the equilibrium market price. Drawing a price floor is simple. For a price floor to be effective it must be set above the equilibrium price.

Simply draw a straight horizontal line at the price floor level. In this case the floor has no practical effect. This graph shows a price floor at 3 00. A price ceiling is a legal maximum price but a price floor is a legal minimum price and consequently it would leave room for the price to rise to its equilibrium level.

In the absence of government intervention the price would adjust so that the quantity supplied would equal the quantity demanded at the equilibrium point e 0 with price p 0 and quantity q 0. A price floor could be set below the free market equilibrium price. Government set price floor when it believes that the producers are receiving unfair amount. If it s not above equilibrium then the market won t sell below equilibrium and the price floor will be irrelevant.

When they are set above the market price then there is a possibility that there will be an excess supply or a surplus. The equilibrium market price is p and the equilibrium market quantity is q. In the diagram above the minimum price p2 is below the equilibrium price at p1. The government has mandated a minimum price but the market already bears and is using a higher price.

Figure 2 illustrates the effects of a government program that assures a price above the equilibrium by focusing on the market for wheat in europe. Price floor is enforced with an only intention of assisting producers.