Price Floor Effect Producer Surplus

Price helps define consumer surplus but overall surplus is maximized when the price is pareto optimal or at equilibrium.

Price floor effect producer surplus.

In the price floor graph below the government establishes the price floor at price pmin which is above the market equilibrium. An effective binding price floor causing a surplus supply exceeds demand. In case of producer surplus producers would have reduced the price to increase consumers demands and clear off the stock. Producers may be better off no different or worse off as a result of the measure.

The effect of a price floor on consumers is more straightforward. Suppliers can be worse off. It ensures prices stay high causing a surplus in the market. In effect the price floor causes the area h to be transferred from consumer to producer surplus but also causes a deadweight loss of j k.

Consumer surplus always decreases when a binding price floor is instituted in a market above the equilibrium price. The result is that the quantity supplied qs far exceeds the quantity demanded qd which leads to a surplus of the product in the market. But the price floor p f blocks that communication between suppliers and consumers preventing them from responding to the surplus in a mutually appropriate way. The total economic surplus equals the sum of the consumer and producer surpluses.

A mandated minimum price for a product in a market. They may be worse off or no different. This analysis shows that a price ceiling like a law establishing rent controls will transfer some producer surplus to consumers which helps to explain why consumers often favor them. Consumers never gain from the measure.

So government has to intervene and buy the surplus inventories. When a price floor is set above the equilibrium price quantity supplied will exceed quantity demanded and excess supply or surpluses will result. The deadweight welfare loss is the loss of consumer and producer surplus. Price floors cause a deadweight welfare loss.

By contrast in the second graph the dashed green line represents a price floor set above the free market price. But since it is illegal to do so producers cannot do anything. The effect of a price floor on producers is ambiguous. A deadweight welfare loss occurs whenever there is a difference between the price the marginal demander is willing to pay and the equilibrium price.

Reasons for setting up price floors. This mutual adjustment continues until the price reaches p where producer and consumer decisions are perfectly coordinated.