What is a Price Floor?

Mary McMahon
Mary McMahon

A price floor is a government limit on the lowest sales price of a good. Such limits are usually part of a program to protect a given industry and keep the domestic economy strong, but they can have unintended consequences. Not all goods and commodities have a price floor, as many governments prefer to let the market determine prices, rather than controlling them through regulations. Markets tend to be self-correcting, and problems with pricing often resolve on their own before the government needs to intervene.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

In order to work well, a price floor must be above the equilibrium price. This price is the point the market naturally reaches, reflecting a balance between supply, demand, and willingness to pay. If the price floor is lower, prices will not dip that low, and thus it serves no real function. When the price floor is higher, it keeps prices from falling below that point.

The ostensible purpose of a price floor is to protect suppliers of a given good, making sure they receive enough from buyers to compensate for the costs of production. One example is the minimum wage, a standard to keeps worker compensation at a reasonable level, allowing people to make enough to live. Agricultural commodities are also subject to a price floor in many regions, to prevent situations like farmers plowing crops back into the ground because they cannot get enough to compensate for the cost of bringing them to market.

One problem with this is the tendency to create a surplus. When regulators set a price higher than the equilibrium, some people will stop buying either because they cannot afford it, or they are unwilling to pay that much. With things like minimum wages, this can result in unemployment. Unsold goods and unused labor can harm an economy and create a ripple effect. When producers cannot sell all their goods or labor, they have less money available for buying things in turn, and the market can start to fall due to reductions in economic activity.

Governments can also set a price ceiling, preventing a price from spiking too high. Like a price floor, the intent is to control costs, but in this case to make them more accessible to consumers, rather than for the benefit of producers. Ceilings can also create problems, as producers may not be able to keep production costs below the limit, and thus take a loss in sales revenue.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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