An effective binding price floor causing a surplus supply exceeds demand.
Price floor effect producer surplus.
Price floors cause a deadweight welfare loss.
It ensures prices stay high causing a surplus in the market.
But since it is illegal to do so producers cannot do anything.
In this case the price floor has a measurable impact on the market.
A mandated minimum price for a product in a market.
Producers may be better off no different or worse off as a result of the measure.
When a price floor is set above the equilibrium price quantity supplied will exceed quantity demanded and excess supply or surpluses will result.
When price floor is continued for a long time supply surplus is generated in a huge amount.
The result is that the quantity supplied qs far exceeds the quantity demanded qd which leads to a surplus of the product in the market.
The effect of a price floor on consumers is more straightforward.
They may be worse off or no different.
Consumers never gain from the measure.
But the price floor p f blocks that communication between suppliers and consumers preventing them from responding to the surplus in a mutually appropriate way.
Consumer surplus always decreases when a binding price floor is instituted in a market above the equilibrium price.
The effect of a price floor on producers is ambiguous.
In the price floor graph below the government establishes the price floor at price pmin which is above the market equilibrium.
In effect the price floor causes the area h to be transferred from consumer to producer surplus but also causes a deadweight loss of j k.
Reasons for setting up price floors.
The total economic surplus equals the sum of the consumer and producer surpluses.
This mutual adjustment continues until the price reaches p where producer and consumer decisions are perfectly coordinated.
By contrast in the second graph the dashed green line represents a price floor set above the free market price.
A deadweight welfare loss occurs whenever there is a difference between the price the marginal demander is willing to pay and the equilibrium price.
Suppliers can be worse off.
In case of producer surplus producers would have reduced the price to increase consumers demands and clear off the stock.
When government laws regulate prices instead of letting market forces determine prices it is known as price control.
Price helps define consumer surplus but overall surplus is maximized when the price is pareto optimal or at equilibrium.
