What will be the consequences of setting up a price floor above the equilibrium price?

Consequences of Setting a Price Floor Above the Equilibrium Price

A price floor set above the equilibrium price can lead to several significant market distortions and economic inefficiencies. This intervention typically aims to protect producers by ensuring that prices do not fall below a certain level, but it can have unintended consequences.

1. Creation of Surplus

The most immediate effect of a price floor set above the equilibrium price is the creation of a surplus in the market. At this artificially high price, the quantity supplied by producers exceeds the quantity demanded by consumers. Producers are willing to supply more because the higher price increases potential profits, but consumers are less willing to buy the product at this inflated price, leading to excess supply.

2. Inefficiency in Resource Allocation

The surplus created by the price floor indicates an inefficient allocation of resources. Resources that could be used more efficiently elsewhere in the economy are instead tied up in producing goods that are not in demand. This inefficiency can lead to a deadweight loss in the economy, where the total surplus (consumer and producer surplus) is reduced compared to the equilibrium condition.

3. Burden on Consumers

A price floor above equilibrium raises the price of the commodity for consumers. This can be particularly burdensome for lower-income consumers if the commodity is a necessity. The higher price may force consumers to either reduce consumption or reallocate spending from other goods, potentially affecting their overall welfare.

4. Government Intervention to Manage Surplus

Governments may have to intervene to manage the surplus created by the price floor. This can involve purchasing the excess supply or subsidizing producers, which can be costly and lead to increased government expenditure. These costs are ultimately borne by taxpayers.

Conclusion

Setting a price floor above the equilibrium price can lead to market inefficiencies, including surplus creation, inefficient resource allocation, increased consumer prices, and the need for costly government intervention. While intended to benefit producers, such measures can have broader negative implications for the economy and consumers.