Figure 5-2 A Binding Price Floor
Price Floors
Governments sometimes establish a price floor, which is the minimum
permissible price that can be charged for a particular good or service. A
price floor that is set at or below the equilibrium price has no effect
because the free-market equilibrium remains attainable. If, however, the
price floor is set above the equilibrium, it will raise the price, in which
case it is said to be binding.
Price floors may be established by rules that make it illegal to sell the
product below the prescribed price, as in the case of a legislated
minimum wage. Or the government may establish a price floor by
announcing that it will guarantee a certain price by buying any excess
supply. Such guarantees are a feature of many agricultural income-
support policies.
The effects of a binding price floor are illustrated in Figure 5-2 , which
establishes the following key result: