A minimum price is a price floor set by the government
where the price is not allowed to fall below this set level (although it is
allowed to rise above it).
Reasons for setting a price floor:
To protect the earnings of producers in certain industries
prices are subject to great fluctuations. Minimum prices will guarantee producers income in periods
when prices would otherwise have been very low.
Examples include certain agricultural products.
To create a surplus in periods of glut surpluses can be
stored in preparation for possible future shortages.
To guarantee a certain level of earnings workers can be
given a minimum wage so that their earnings dont fall below a certain
The diagram below shows the effects of a minimum
The minimum price has created a surplus (excess
supply) of Qs Qd.
There are three ways in which the government can deal with this
The government purchases all the surplus to store it,
destroy it or sell it in other markets.
If the government seeks to do this then it has to buy up the excess (Qs
Qd) at the current minimum price.
This means the cost to the government and therefore taxpayer is the
shaded area QdabQs.
The government could artificially lower supply to Qd
by issuing quotas which limit production.
Demand could be raised by advertising, finding
alternative uses or by taxing substitutes.