Question

How does a price floor set above the equilibrium level affect quantity demanded and quantity supplied?

Short answer

A price floor set above the equilibrium level causes the quantity demanded to decrease and the quantity supplied to increase, resulting in a surplus of the product in the market and market inefficiencies. This is due to the higher price imposed by the price floor, which in turn affects consumer demand and producer supply.

Step-by-step solution

Understanding the equilibrium level

The equilibrium level is the point where the market demand and supply curves intersect. It represents the market price at which the quantity demanded equals the quantity supplied. In other words, the equilibrium level is the market clearing price where there is no excess demand or supply.

Understanding the price floor

A price floor is a government-imposed minimum price on a good or service, which is set above the equilibrium level. It prevents the price of a good or service from falling below the specified limit. The purpose of implementing a price floor is usually to protect producers and ensure them a minimum income.

Analyzing the effect of the price floor on quantity demanded

When a price floor is set above the equilibrium price, the price of the good or service increases. As the law of demand states, all things being equal, when the price of a good or service increases, the quantity demanded decreases. So, the quantity demanded by consumers will fall in response to the higher price imposed by the price floor.

Analyzing the effect of the price floor on quantity supplied

As mentioned above, a price floor is designed to support the income of producers by setting a minimum price. When the price floor is above the equilibrium price, the price of the good or service increases. According to the law of supply, all things being equal, when the price of a good or service increases, the quantity supplied increases. Therefore, the quantity supplied by producers will rise in response to the higher price caused by the price floor.

Examining the overall effects of the price floor on the market

The price floor set above the equilibrium level creates a situation where the quantity supplied exceeds the quantity demanded. This results in a surplus of the product in the market. Producers may have unsold stock, and consumers may struggle to find the product at a price they can afford. This also creates inefficiencies in the market, as resources are not allocated optimally due to the intervention. In conclusion, a price floor set above the equilibrium level leads to a decrease in quantity demanded and an increase in quantity supplied, causing market inefficiencies and a surplus of the product in the market.