Price Floor Explained: A complete guide

We often don’t realize how much we rely on electricity until the lights go out during an important Zoom call. Similarly, the role of price fluctuations in our daily lives often goes unnoticed—until the government steps in to regulate them.

One such intervention is the price floor, a control mechanism that sets a minimum price above the natural market equilibrium, often to protect producers or workers. While this might sound straightforward, its short- and long-term impacts are anything but simple.

Unfortunately, discussions about price floors often get oversimplified or misinterpreted, polarizing public opinion. To make informed decisions, we need to understand this economic tool thoroughly—its definition, advantages, and real-world impacts. As economist Thomas Sowell wisely said, “Economics is not simply a topic on which to express opinions or vent emotions. It is a systematic study of cause and effect.”

Stick around, and we’ll dive into everything you need to know about price floors—from what they are and why they exist to their benefits and potential drawbacks. By the end, you might even find yourself rethinking debates about policies like minimum wage increases or agricultural subsidies!

What are price controls?

The price ‘floor’ is simply a consequence of price control. So let’s first understand how prices fluctuate in a free market.

Prices rise because the amount demanded exceeds the amount supplied at existing prices. Prices fall because the amount supplied exceeds the amount demanded at existing prices.

The first phenomenon is called a ‘shortage’ and the second phenomenon is called a ‘surplus’

There’s nothing really complex about this idea. But we often overlook the fact that both of these concepts depend on ‘existing prices’.

What is a price floor in economics?

A price floor is a legally set minimum price above the free market¹

When a price for a product or service is set above the free market level tends to cause more to be supplied than demanded. Now that the consumer sees the price has gone up, the demand for that product or service goes down.The result of this lower demand from the consumer (or buyer) is that it creates a ‘surplus’ of the product or the service.

But why would the government(or legal entity) want to set a minimum price about the free market price?

To producers or workers from unreasonably low prices.

Real-world examples of price floor and its consequences

Let’s take an examples to see understand this better.

During the great depression of the 1930s, American farmers were among the most troubled workers because the farm products fell into unprecedented low numbers. The money they gained from selling the farming products was way less than the money they needed to maintain their livelihood².(The income of an average American farmer fell from 6 billion to around 2 billion in just 3 years).

**“Unloading dry farm wheat“** (By George W. Ackerman, Washington, 1925)

The price of corn fell so low—sometimes as little as eight or ten cents a bushel—that farmers found it cheaper to burn corn as fuel than to buy coal for their stoves. In some rural areas, the countryside even took on the smell of popcorn as families burnt their harvest to heat their homes³.

This eventually led to farmers selling their property and eventually quitting farming.

This is where the federal government intervened to save agriculture by keeping farm prices falling so sharply.

One approach was to legally reduce the production of some specific types of crops (peanuts, cotton, citrus fruit etc). Producing and selling these types of crops, more than the secretary of agriculture decided on was prohibited by law.

Now that the supply went down for certain products, demand for those products went up.

That means people are willing to pay more for crops now.

Consequentially, the price went up to what the government official decided upon.

One of the more recent examples of a price floor in action is the federal minimum wage in the United states⁴ . It was initiated in 1938 as a part of the Fair Labor Standards Act (FLSA) at 0.25 US dollars per hour⁵. This is a classic example of a government intervention for ensuring a minimum standard of living.

Over the years, the minimum wage has been adjusted to account for inflation and changing economic conditions, with the current federal rate set at $7.25 per hour since 2009. Some states, like California and Washington, have gone further, setting significantly higher minimum wages to reflect their higher costs of living—for example, California’s minimum wage reached $15.50 per hour in 2023⁶.

Benefits of price floor

As obvious from these examples, price floors can be immensely beneficial.

In the case of agricultural price floor controls, they provide income stability for farmers and isolate them from market instability. As seen above, farmers benefit from agricultural price floors when market prices drop significantly due to oversupply, ensuring they can cover production costs and remain in business⁷.

Likewise, minimum wage laws guarantee a baseline income for workers, reducing poverty and promoting a better standard of living for low-income families⁸.

woman in white crew neck t-shirt holding white and black quote board — Photo by Ehimetalor Akhere Unuabona on Unsplash

Another key advantage of price floors is their ability to reduce income inequality. By setting a legal minimum for wages or product prices, these controls can help address inequalities, especially in industries where labour or goods are not precisely valued. As an example, studies show that higher minimum wages are associated with reduced wage gaps among workers⁹.

Also, price floors also contribute to economic stability by preventing extreme market fluctuations, which can create uncertainty for both producers and consumers.

In addition, price floors can act as a tool for promoting ethical standards. In agriculture, for example, fair trade initiatives often include price floors to ensure small-scale farmers in developing countries receive a sustainable income, igniting long-term growth and resilience¹⁰.

Drawbacks of price floors

A big problem with price floors is figuring out what to do with the ‘surplus’ when there’s more supply than people want to buy.

As long as the price stays above the level the government has decided upon, the product is sold with a fair equilibrium between supply and demand.

But, the government has to intervene again if this equilibrium is challenged.

For instance, if the supply exceeds the demand, the government has to buy the excess supply that consumers are not willing to buy.

As an example, when the price of powdered milk fell from 2.20 dollars to 80 cents in 2008 in America, the government had to buy 112 million pounds of powdered milk¹¹.

This cost more than 90 million US dollars.

price floor explained. The government has to store the surplus — Photo by Radowan Nakif Rehan on Unsplash

In addition, if the products are not consumed, the government has to store them somewhere after buying them. One of the examples of this is, in 2001, American sugar consumers were paying an extra 1.9 billion US dollars per year for artificially set prices by the government. And the government was paying 1.4 million US dollars per month just to ‘store’ the excess sugar¹².

So the government is directly in payments to storage companies and the wealthiest 10% of farmers.

The long-term beneficiaries of price floors are these wealthy farmers and other third-party companies.

Therefore the original plan of helping the farmers in need can take a completely wrong turn in the wrong run.

Although the media ‘promotes’ these situations as “bipartisan support” in that, sugar producers are big donors to both Republicans and Democrats¹³ (Two major political parties in the United States of America)

In the case of minimum wage laws, while the minimum wage has helped many workers in their personal lives, it can turn on them.

Now that the labour costs are higher, it makes sense for some businesses to reduce hiring, cut hours, or invest in automation to manage expenses.

The politics of price control

This is why we should always keep an eye on the ‘big picture’ of these types of price controls.

As once the economist Thomas Sowell said, “Politically, price controls are always a tempting ‘quick fix’ for inflation, and certainly easier than getting the government to cut back on its spending that is often behind the inflation”

In the long run, the greater the difference between free market prices and the prices decreed by price control laws, the more severe the consequences of price control.

When governments implement price floor controls, in the form of agricultural price supports or minimum wage, they can unintentionally “disturb” the balance of the free market.

This unbalance can lead to long-term consequences like market inefficiencies and resource misallocation¹⁴.

These examples demonstrate that while price floors serve important social and economic goals, their long-term impacts often require careful balancing with other policies to mitigate adverse effects.

Conclusions

A price floor is a tool used by governments to make sure prices don’t drop too low, helping producers and workers stay afloat. It has some great benefits, such as stabilizing incomes and reducing poverty, but it can also cause issues, such as creating surpluses that are tough to manage. By understanding both the pros and cons of price floors, we can better navigate these policies and make smarter decisions about how they affect our economy and daily lives!

Price Floor Explained: A complete guide

What are price controls?

What is a price floor in economics?

Real-world examples of price floor and its consequences

Benefits of price floor

Drawbacks of price floors

The politics of price control

Conclusions

Further readings

Aruna Kumarasiri

The Rational Optimist by Matt Ridley

The Rise and Fall of the Great Powers by Paul Kennedy

Nudge by Thaler and Sunstein

Basic Economics by Thomas Sowell