Markets thrive on the law of demand and supply, which indicates that there is always a negative relationship between the price of a good/service and quantity demanded, and a positive relationship between the price of a good/service and the quantity supplied.
There are several types of markets differentiated on various factors such as level of competition, number of firms, types of products, and services offered among others. One most common type of market is the perfectly competitive market in which there a large number of buyers and sellers with free exit and entry of new firms.
The price floor refers to the minimum price set by the governing authority, which keeps prices from going lower. For the price floor to be effective, it is set above the market equilibrium price – at which quantity demanded and quantity supplied are equal. This gives the suppliers more revenue as the consumer is forced to pay higher than they would have paid without the price control. Less of the good is demanded than before, with the producers supplying more of the good, which creates a condition described as a surplus.
The price floor on wages dictates the minimum wages a firm should pay its workers. This increases the number of wages that a worker receives at a particular time while increasing the cost of paying wages by the firms.
The price ceiling keeps prices from getting higher and is usually set below the market equilibrium price. This benefits the consumer as the products cost less than what the market price would be if there were no limits. The producer gets less revenue from the products because the cost of production remains the same while the price decreases. When producers are supplying fewer products while demand increases due to the price ceiling, a shortage occurs.
Negative consequences of a price floor in the labor market
There will be increases in the supply of labor
Workers receive high wages when there is a price floor. As the supply curve indicates with the upward sloping shape, as wages increases, more workers are willing and able to offer labor than before. For example, if the price floor for nurses’ wages was to be raised today, there will be an increase in the number of students enrolling in a nursing course, which will raise the number of nurses seeking employment.
There will be a decrease in the demand for labor
With an increase in wages, the firms will experience a rise in the cost of production. There are four main factors of production; land, labor, capital, and entrepreneurship. Cost of production changes when either of these four factors changes. The amount of goods produced at any given time depends on the cost of producing among other factors such as technology, etc. If the cost of labor increases due to price floor, less is demanded by firms and this will cause a surplus of labor in the market
Reduced market size
The price floor shrinks the market because of the decrease in quantity demanded. Less quantity demand discourages more production of goods in the market which results in its eventual shrinkage.
Negative welfare impacts
The government will have to spend money to buy off the surplus labor in the market to maintain balance
The cost of goods and services will increase
When it becomes costlier to produce goods and services, less is produced. There is less incentive to hire more workers when wages increase. The decrease in cots of labor will translate to an increase in the price of goods and services to cover for the cost.
Reasons why the government impose price floor for goods and services
- Price floors are used by the government as a way of providing the sellers with income support by increasing the prices of goods. This is commonly done when the government wants to encourage growth in specific sectors of the economy
- To provide low-skilled, low wage workers by offering them a wage that is above the equilibrium wage. If there is less supply of labor in a sector of the economy, a price floor may be used to encourage more supply of labor.
- The government may use the price floor on goods that provide social benefits. By raising the price floor of the good, it encourages more production.
Price floor and price ceiling on consumer surplus and producer surplus
Consumer surplus refers to the difference between the actual price that a consumer pays and the maximum they are willing to pay.
Producer surplus refers to the difference between the actual price that a producer charges on goods, and the minimum they are willing to accept.
Price affects both consumer surplus and producer surplus. With a price floor that sets the minimum, a producer can charge on goods, the consumer surplus increases as he/she receives higher prices. The consumer pays the much higher price; near the maximum, they are willing to pay for the goods which decrease consumer surplus
A price ceiling sets the maximum price a producer can charge on goods, which decreases the producer surplus while the consumer pays much less price than without the price ceiling hence decreasing consumer surplus.