Price Floor and Welfare LossSL
MicroeconomicsA diagram showing the effects of a price floor set above equilibrium, resulting in excess supply and welfare loss in the market.
Curves and elements
- demand
- Demand Curve: Slopes downward, indicating an inverse relationship between price and quantity demanded.
- supply
- Supply Curve: Slopes upward, indicating a direct relationship between price and quantity supplied.
- price floor
- Price Floor (Pf): A legally imposed minimum price above equilibrium, leading to market distortion.
- excess supply
- Excess Supply: The difference between Qs and Qd — the amount of unsold goods resulting from the price floor.
- welfare loss
- Welfare Loss: The loss of total surplus due to reduced market efficiency — shown as a shaded triangle.
Key explanations
- 1
A price floor is a minimum legal price set by the government, typically above the market equilibrium price.
- 2
At the floor price (Pf), quantity supplied (Qs) exceeds quantity demanded (Qd), creating excess supply (surplus).
- 3
Firms are willing to supply more, but consumers demand less due to the higher price.
- 4
The shaded area represents welfare loss — the loss of allocative efficiency as mutually beneficial trades between Qd and Qe do not occur.
- 5
Price floors are commonly used in agricultural markets and labor markets (minimum wage) to protect producers or workers, but can lead to inefficient outcomes.
Example exam question
Using a diagram, explain the effects of a price floor on market outcomes, including reference to excess supply and welfare loss.
Show example answer
When a price floor is set above the equilibrium price, it leads to excess supply, as shown by the gap between Qs and Qd. At the higher price Pf, consumers reduce their quantity demanded while producers increase quantity supplied. This causes a market surplus and leads to allocative inefficiency. The shaded triangle represents the welfare loss — the value of trades that would have benefited both buyers and sellers but now no longer occur. Governments often use price floors in agriculture to support farmers, but they must manage the resulting surplus.
