Price floor is a price control mechanism employed by the government, institutions or companies on how low the price of a product or service can be. Simply put, the lowest price in the price band is called the price floor.
The opposite of this economic jargon is cap price (price ceiling) which is the highest price in the price band; the maximum price that can legally be charged for a commodity or item.
We can address this concept in a separate article.
Simplifying The Concept Of price floor
If a government says the price of a product or commodity shouldn’t be sold below a certain price, it means the government is setting a limit so as to create a healthy competition in the market.
For the price floor to be effective, it must be higher than the equilibrium price (the price where supply and demand are balanced).
It must be noted that to have an equilibrium price, there must not be government or external influence. In a perfectly competitive market, the quantity demanded and quantity supplied will be equal.
Reasons for Price Floor
1) The government uses the price floor to protect the interest of the manufacturing sector of its economy so that the financial existence of producers of the commodity is not threatened.
2) Price floor is majorly used to prevent certain prices from going too low.
Examples of Price floor
All over the world, the government intervenes in certain situations to create fair competition among major players
For instance, the Nigeria Government in the area of wage laws set a minimum wage at NGN30,000 ($51.7 at NGN580 parallel market exchange rate which is the true reflection of the value of Nigerian Naira) per month across the board for civil servants.
Although some of the 36 state governments in Nigeria claimed they don’t have enough resources to pay $51.7 per month, some submitted that state governments should have a say over how much they can a worker in their state.
To complicate the minimum wage law, some of the state governors claimed that the resources and the economic viability of a state should be the determinant.
In Canada, on the other hand, the two common price floors are 1) minimum wage laws and 2) supply management in Canadian agriculture.
In the United States of America (USA) before 1978, there were price floors that regulated the US airfares and minimum price per-drink laws for alcohol.
The National Football League (NFL) used to set a price floor on tickets that were sold on league websites, until November 2016 when a court ruled that it was in violation of US antitrust laws.
Still in the United States, specifically in 2013, the New York Yankees and Los Angeles Angels of Anaheim declined to participate in Major League Baseball ticket sales.
Why?
The action of teams was as a result of StubHub (an online ticket resale website) did not allow teams to put a price floor in place.
Can Private Organisation Use price floor?
Of course yes. It is also common among beverage companies. They imprint the price on the cap of bottles, most especially in Nigeria. Distributors can’t sell below the price.
The price they sell or the margin may, however, be determined by many factors: location, the standard of a selling point (for instance beverages are more expensive at exquisite bars and hotels than on the street).
So, non-governmental organisations and entities use the price control mechanism.
Economic Effect Of Price Floor On The Market
There may be consequences for a price floor set above the market equilibrium price.
1) Consumers may pay a higher price for the same product.
If this happens, the buyers will most likely reduce their purchases or switch to substitutes e.g hundreds of Nigerian switched from cooking gas to charcoal. While some of them resorted to firewood.
2) While prospective buyers are switching, suppliers see it as a guaranteed new way of charging more to up their profit, the willing buyers continue to reduce.
3) When this continues, supply will be more than demand, thereby creating a surplus in the market to maintain the price floor over the long term.
4) Price floor may lead to market failure if the market is not able to allocate scarce resources in an efficient manner.
5) If the price floor is not properly checked most especially in the minimum wage, it may trigger unemployment as can be seen in Nigeria.
Governments reduce employment or place embargo on employment, they increase the workload of existing workers instead of employing more workers for efficiency.
6) It may also lead to poor efficiency as a result of increasing the workload or unofficially increasing work hours of workers, they perform below expectation. It causes poor output.