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 don’t fall below a certain (unacceptable) level.

The diagram below shows the effects of a minimum price:

The minimum price has created a surplus (excess supply) of Q_s – Q_d.  There are three ways in which the government can deal with this surplus:

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 (Q_s – Q_d) at the current minimum price.  This means the cost to the government and therefore taxpayer is the shaded area Q_dabQ_s.

The government could artificially lower supply to Q_d by issuing quotas which limit production.

Demand could be raised by advertising, finding alternative uses or by taxing substitutes.