Minimum Price (Price Floor)- Full Market Impact Flashcards
(24 cards)
Minimum Price (Price Floor) - Definition and Purpose
A type of price control enacted by the government.
A fixed price set above the equilibrium market price.
Legally prevents prices from falling below this level.
Purpose: Primarily to protect producers (e.g., farmers) from price volatility, ensuring a minimum income and preventing collapse during periods of low prices.
Can also be used to address market failures by discouraging consumption/production of demerit goods.
Why set a Minimum Price Above Equilibrium?
Because the government believes the equilibrium price is too low to provide producers with a sufficient or stable income, especially in volatile markets like agriculture or primary commodities.
Benefit of Minimum Price for Producers (specifically)
Provides a guaranteed minimum price for their goods, protecting them from sharp falls in price and ensuring a minimum level of revenue and living standards, particularly important for those facing price volatility.
How Minimum Prices can address Market Failure
By raising the price of a good (e.g., a demerit good like alcohol), it discourages consumption and potentially production, helping to reduce the negative externalities associated with its use.
Industries often targeted by Minimum Prices
Agriculture (to protect farmers), Primary Commodities, and sometimes goods with significant negative externalities (demerit goods) like alcohol or tobacco.
Minimum Price (P min) on a Supply/Demand Diagram
A horizontal line drawn above the initial equilibrium price (P1).
* Represents the legal floor below which the price cannot fall.
Impact of Pmin > P1 on Quantity Demanded
Causes a contraction in demand. As the price increases from P1 to Pmin, the quantity demanded falls from Q1 to QD (movement along the demand curve).
Impact of Pmin > P1 on Quantity Supplied
Causes an expansion in supply. As the price increases from P1 to Pmin, the quantity supplied rises from Q1 to QS (movement along the supply curve).
Result of Pmin > P1 on the Market
Creates a situation where Quantity Supplied (QS) > Quantity Demanded (QD). This results in an excess supply or surplus equal to the difference between QS and QD.
Problem of Excess Supply (Surplus) from Pmin
Inefficient use of resources:** Resources were used to produce goods that consumers are not buying.
* Burden on Producers: They have produced QS but can only sell QD, impacting their revenue and profits.
* Disposal Issues: Producers face the cost and dilemma of what to do with the surplus (destroying it is wasteful, storing it incurs costs).
Why Excess Supply is a Problem for the Government (when setting Pmin)
The government’s aim with Pmin is often to help producers, but the resulting surplus creates new problems (inefficiency, storage costs) that may require further government intervention (e.g., buying the surplus).
Intervention Buying
When the government buys the excess supply (surplus) created by a minimum price set above equilibrium, to support producers and prevent the surplus from crashing the market price.
Cost of Intervention Buying to the Government (on a diagram)
The area representing the surplus (QS - QD) multiplied by the minimum price (Pmin). On the diagram, this is the rectangle with height Pmin and width (QS - QD). (You described this as area QDaQSbPmin).
Producer Revenue With Government Intervention Buying
Producers sell the total quantity supplied (QS) at the minimum price (Pmin). Revenue = Pmin * QS. This is the total area under the Pmin line up to QS (Area PminQS O on your implied diagram).
Producer Revenue Without Government Intervention Buying
Producers can only sell the quantity demanded by consumers (QD) at the minimum price (Pmin). Revenue = Pmin * QD. This is the area PminQD O on your implied diagram. Producers are left with unsold surplus.
Impact of Intervention Buying on Producer Revenue (Compared to no intervention)
Intervention buying significantly increases producer revenue compared to a situation where the surplus is unsold, as producers are guaranteed the minimum price for their entire output (QS) instead of just the quantity demanded (QD).
Deadweight Welfare Loss (from Minimum Price) - Concept
A loss of economic efficiency that occurs when the market is not producing at the socially optimal quantity. With a minimum price, the quantity traded is reduced to QD (because demand contracts), which is less than the initial equilibrium quantity (Q1), leading to a loss of potential gains from trade.
Deadweight Welfare Loss (from Minimum Price) - Location on Diagram
The triangular area between the demand and supply curves, for the quantities between the new quantity traded (QD) and the initial equilibrium quantity (Q1). (You labelled this as Area DBL or similar on your diagram). It represents the value of mutually beneficial trades that no longer occur.
Impact of Minimum Price on Consumers
Pay higher prices (Pmin > P1).
* Negative: Consumer surplus is reduced/eroded.
* Negative: Quantity consumed is lower (QD < Q1).
* Negative: Less choice/availability.
* Regressive Impact: Higher prices take a larger proportion of income from low-income households than high-income households.
* Indirect Negative (if IB occurs): Higher taxes, cuts in other government spending, or national debt/interest payments due to the cost of intervention buying.
Impact of Minimum Price on Producers With Intervention Buying
Positive:** Guaranteed minimum price (Pmin) for all output (QS).
* Positive: Significant increase in revenue (Pmin * QS) compared to equilibrium.
* Positive: Producer surplus increases.
* Positive: Protection from price volatility and potential collapse, helping them stay in business.
Impact of Minimum Price on Producers Without Intervention Buying
They get a higher price (Pmin) but can only sell the quantity demanded (QD).
* Mixed/Uncertain: Revenue (Pmin * QD) may be higher or lower than equilibrium revenue (P1 * Q1) depending on the elasticity of demand.
* Negative: Left with unsold surplus, incurring storage costs or facing losses from disposal.
Government Objectives/Motivations for Setting Minimum Price
Protecting vulnerable producers (e.g., farmers).
* Maintaining/sustaining a specific industry.
* Addressing market failures (discouraging consumption/production of demerit goods).
* Achieving income support goals for a group.
Government Concerns/Drawbacks of Setting Minimum Price
Cost of Intervention Buying:** Can be very expensive.
* Opportunity Cost: Money spent on IB could be used elsewhere.
* Burden of Surplus: Dealing with the excess supply (storage, disposal).
* Impact on Consumers: Higher prices, regressive effects.
* Risk of Unintended Consequences: Black markets, smuggling.
* Inefficiency: Creating a deadweight welfare loss.
* Potential International Issues: If trying to sell surplus abroad below cost.
