Minimum Price as a Price Control

Definition

• A minimum price (price floor) is a fixed price set by the government, usually above the equilibrium market price.
• It prevents prices from falling below a certain level, hence the term "price floor".

Purpose of Minimum Prices

• Protect Producers: Shields producers, especially in agriculture and primary commodities, from price volatility.
  • High price volatility in these markets can lead to significant revenue and living standard fluctuations.
  • Protects producers from price falls, guaranteeing a minimum income.
• Market Failure Mitigation: Raises prices to reduce consumption/production of harmful goods (e.g., alcohol).

Diagrammatic Analysis

• Initial market at equilibrium price P1Q1.
• Minimum Price (P min) set above equilibrium causes:
  • Price Increase: From P1 to P min.
  • Demand Contraction: Demand decreases from Q1 to QD due to higher prices.
  • Supply Expansion: Supply increases from Q1 to QS due to higher prices.
  • Excess Supply (Surplus): Created as supply > demand (QD < QS).

Market Implications

• Producers' Burden: Increased production costs with unsold surplus.
• Government Intervention: Government may purchase surplus (intervention buying), cost calculated as the area QDQSBC on the diagram.
• Producer Revenue Impact:
  • With intervention buying: Revenue = P min × QS
  • Without intervention buying: Revenue = P min × QD

Deadweight Loss

• Intervention leads to lower overall market quantity, creating a deadweight welfare loss.
• Illustrated as triangle A, B, D on the diagram.

Stakeholder Impacts

Consumers

• Negative Impact:
  • Higher prices reduce consumer surplus and affordability.
  • Regressive effect, disproportionately affecting low-income households.
  • Long-term burden due to taxpayer funding of intervention purchases.

Producers

• Varied Impact:
  • Positive if intervention buying occurs: Increased revenue and producer surplus.
  • Uncertain without intervention buying.

Government

• Concerns:
  • Achieving goals of protecting industries and addressing market failures.
  • Negative consumer effects, including regressive impacts and potential black markets.
  • Costs and handling of surplus, potential international issues if surplus is dumped.

Conclusion

• Minimum prices have noble intentions but cause significant market distortions and inefficiencies as shown in the diagram.