Question

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

Short answer

In a market where a price floor is set above the equilibrium level, the quantity demanded decreases and the quantity supplied increases, leading to a surplus of goods and potential market inefficiencies. This situation benefits some producers who can sell at the higher price but disadvantages consumers who face higher prices and possibly reduced availability of goods, as well as producers unable to sell their surplus products.

Step-by-step solution

Understanding Price Floor

A price floor is a government-imposed minimum price that can be charged for a particular good or service. It is generally set to protect the interests of the producers or sellers, ensuring that they receive a specific minimum income from their production. However, if the price floor is set above the equilibrium level, it can create market distortions, since price floors interfere with the natural market forces of supply and demand.

Visualize the Market with Equilibrium Price and Quantity

In the absence of a price floor, the market reaches an equilibrium when the quantity demanded equals the quantity supplied. Using a supply and demand graph, we can illustrate this concept. Demand curve (D) is downward sloping, representing the inverse relation between price and quantity demanded, while the supply curve (S) slopes upwards, as price and quantity supplied are positively related. The point where D and S intersect represents the equilibrium price (P*) and quantity (Q*).

Introduce the Price Floor and Its Effects on Demand and Supply

Suppose that the government sets a price floor (Pf) above the equilibrium price (P*>Pf). At this new price level, the consumers' willingness to purchase the product decreases, leading to a decrease in the quantity demanded (Qd). On the other hand, producers will be more willing to supply at this higher price, thus increasing the quantity supplied (Qs).

Understand the Results in Excess Supply and Reduced Demand

As a result of setting a price floor above the equilibrium price, a surplus of goods is created, as the quantity supplied (Qs) exceeds the quantity demanded (Qd). Due to the reduced demand and increased supply, the market fails to clear, leaving some producers unable to sell their goods, which leads to inefficiencies and potentially waste.

Effects on the Market Participants

With a price floor set above the equilibrium level, it could benefit some producers who manage to sell their goods at the increased price. However, consumers generally experience disadvantages, as they face higher prices and possibly reduced availability of goods. Additionally, some producers might not be able to sell their surplus products, leading to potential loss and waste. In summary, when a price floor is set above the equilibrium level in a market, the quantity demanded decreases, while the quantity supplied increases, creating a surplus and potential market inefficiencies.