What are the effects of a price floor on market outcomes?

A price floor can lead to surplus supply, market inefficiency, and potential welfare loss.

A price floor is a minimum price set by the government for a particular good or service, above the equilibrium price. This is usually done to protect the interests of the producers. However, it can have several effects on market outcomes.

Firstly, a price floor can lead to a surplus of supply. When the price is set above the equilibrium level, it encourages producers to supply more as they can earn higher profits. However, consumers are less willing to buy the good or service at the higher price, leading to a decrease in demand. This mismatch between supply and demand results in a surplus, where the quantity supplied exceeds the quantity demanded.

Secondly, price floors can result in market inefficiency. In a perfectly competitive market, the equilibrium price is where the quantity supplied equals the quantity demanded, leading to allocative efficiency. However, when a price floor is imposed, this balance is disrupted. The price no longer reflects the true value of the good or service to consumers and producers, leading to a misallocation of resources. Producers may overproduce, wasting resources, while consumers may under-consume, leading to potential welfare loss.

Furthermore, price floors can lead to unintended consequences. For example, in the labour market, a minimum wage (a type of price floor) can lead to unemployment. If the minimum wage is set above the equilibrium wage, firms may not be able to afford to hire as many workers, leading to job losses.

Lastly, price floors can also lead to the creation of illegal markets or 'black markets'. If the legal market price is set too high, consumers and producers may turn to illegal markets where the good or service can be bought and sold at a lower price. This can lead to a loss of government revenue and potential legal issues.

In conclusion, while price floors may be implemented with good intentions, they can lead to a range of negative market outcomes, including surplus supply, market inefficiency, and potential welfare loss. Therefore, governments need to carefully consider the potential impacts before implementing such measures.