Price and Quantity controls: Price Floor

After exploring the concept of a price ceiling in a previous post. It is time define the term "price floor". A price floor can be thought as the opposite definition of a price ceiling, where the latter can be described as setting a maximum price that must be smaller than the current equilibrium price. The former is a minimum price that must be greater than the equilibrium price.

If a government finds the that the market equilibrium price for a good to be too low, it may impose a minimum price that is greater than the current market price. The quantity demanded is lower than the quantity supplied. The market produces more than the consumers are willing to buy at that price. This results in a surplus which can be represented by the distance between the quantity consumed and the quantity supplied at the new imposed price in the market.

Real life examples of price floors can be found in the agriculture and energy industries, or in the labor market (minimum wage). Recently, the Federal Energy Regulatory Commission imposed a price floor on the renewable power resource providers in New York's capacity market.

Example:

The government decides to put in place a minimum price on corn crops. Assuming that this market is competitive, then the new binding price (PC) causes the quantity demanded to be less than the quantity produced. This results in a surplus in the market. The amount of people willing to buy corn crops (QD) at the new given price is smaller than the amount supplied by the producers (QS). The new amount of corn crops consumed in the market is now lower than it was before the price floor (QE>QD).

Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 64.

Comments

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP). Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...

Exercise: maximizing profit

Assume that you are the owner of a small business that produces T-shirts. Your the total revenue for your business can be modeled by the following equation: and your total cost corresponds to this function: Find the point at which your firm maximizes its profit. Then, find how much profit the firm if able to earn at that point. Using the total cost and total revenue functions we can set up the profit function: Then, realize that if you want to find the maximum profit, take the derivative of the function and set it up equal to zero, and solve for Q. This is equivalent of taking the derivative of the total cost and total revenue functions and setting them equal to each other. In this problem, I chose the latter option as it was explained in the previous lessons. Notice that profit is often denoted by a capital pi. We are assuming that the TR>TC for some positive value, you can check for yourself. However, if we did not know that, we would first take the first ...

A short interlude...

Hello all, it's been quite some time since I have made any major announcements since the creation of this blog about a year and a half ago. I am currently in graduate school and will soon take a portion of my comprehensive examination (i.e exams in Micro, Macro, and Metrics that will allow me to continue my studies in my graduate program), wish me luck! Thus, I will not be able to post consistently until at least mid-June. The roadmap is as such, if I pass, I will start introductory lessons in Econometrics and Statistics (if not, then I'll have to study until I can retake the comps in August). I hope that once I am done, I will be able to add more advance materials to the blog, such as general equilibrium, indirect utility functions, and game theory/mechanism design for Micro. The Solow, Ramsey, RBC, New Keynesian models, permanent income hypothesis (PIH) and more for Macro. By the way I think I still need to add notes on the IS-LM curves, so I will do that before jumping to t...

Economics and Statistics

Search This Blog