Price Floor in Economics: Definition & Examples

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  • 0:00 Definition Of Price Floor
  • 1:04 The Minimum Wage
  • 1:47 Agricultural Produce
  • 2:33 Alcoholic Beverages
  • 3:04 Effects Of Price Floors
  • 4:50 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

This lesson will discuss the economic concept of the price floor, and its place in current economic decisions. It will provide key definitions and examples to assist with illustrating the concept.

Definition of Price Floor

In a highly competitive beauty industry, the owner of Images Beauty Salon decides to undercut her local competitors by offering identical services for half the price. But, how might this be accomplished? Could she pay her employees less? Possibly.

To figure this out, first we must discuss a price floor, which, in economics, is a minimum price imposed by a government or agency, for a particular product or service. An effective price floor needs to be higher than the equilibrium price, the price at which supply and demand are equal. If not, the market would not sell below the equilibrium, and the price floor would mean nothing. Additionally, sellers who charge a price lower than the imposed floor price would be breaking the law.

Today, there are a few instances where a price floor has been imposed, for protecting various groups of people. Let's look at some common examples.

The Minimum Wage

Using the example from above, the owner of Images Beauty Salon might not be able to charge $20 for a perm when the competing salons are charging $40-$60 each, if this means paying her employees less than minimum wage to make a profit. The minimum wage is the price that employers pay for labor, and a common example of a price floor. The federal minimum wage is, as of 2015, $7.25 per hour; this is established by the Federal government and applied across the United States.

States have various, higher minimum wages, but paying an employee less than $7.25 an hour would be illegal. This price floor protects the employees from being exploited.

Agricultural Produce

In many industrialized countries, such as the United States and the countries within the European Union, price floors are set on agricultural produce to try to protect the farmers. These price floors serve to encourage farmers to increase production and for attracting new investors to become involved in the industry.

For example, let's talk about Farmer Brown, who usually produces 3,000 pounds of tomatoes a year and is able to sell it to the local grocers for $30,000, instead of the $10,000 he might have made ten years ago. If you were Farmer Brown, wouldn't you consider using the extra $20,000 you made to expand your farm? I sure would; maybe produce more tomatoes or diversify into potatoes and kale.

Alcoholic Beverages

In the case of the price floors set for alcoholic beverages, the rationale is to prevent over-consumption. The assumption is that if alcoholic beverages were too affordable, someone who normally could only afford a six-pack of beer could afford a keg. This may translate to other problems, such as driving while intoxicated, and other social issues. While this move may decrease the demand, it increases the supply, as producers want to provide more of a product to the market at a higher price - the law of supply.

Effects of Price Floors

The following is a list of the effects of price floors. Depending on your perspective, each can be negative or positive.

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