Examples of Price Floors
One modern example of a price floor is a minimum wage. A minimum wage may apply to a particular sector or all across the board. Normally, wages are determined by supply and demand in the labor market. In sectors where the equilibrium price determined by supply and demand of labor is below the minimum wage, the level of the minimum wage acts as a price floor and the effect is to artificially raise the price of labor. This may therefore serve to increase the potential supply of labor, because it will be worthwhile for more people to enter the job market at the minimum wage level. While this may combat exploitation of cheap labor, it can also distort the market and cause employers to reduce the number of people employed. While the potential supply of labor increases, the demand for labor by employers may therefore be reduced.
Certain industrialized countries and trading blocs such as the European Union have at times introduced price floors for agricultural goods, to protect their agricultural sector. Such price floors have had the effect of encouraging existing producers to increase their levels of production and attracting new firms to enter the market for certain agricultural goods. The effect of this policy when used in the EU was to create large stocks of some produce, which were purchased and stored by the EU, often referred to by the use of expressions such as butter mountains and wine lakes.
The problem of over-production resulting from the imposition of price floors for agricultural produce was dealt with in the EU by measures such as payments to farmers to leave some fields fallow, effectively paying farmers not to produce. The introduction of quotas for crops such as potatoes ensured that producers kept their production levels within the required limit to avoid paying a fine imposed by the EU.
An alternative approach is to set an intervention price for a certain good, a level at which a government or trading bloc will intervene in the market to purchase the goods and ensure that the price does not fall below that level. A similar mechanism can be seen on currency markets where a government may intervene to buy its own currency and keep the exchange rate above a certain level.
Another strategy used by governments is a price floor for products such as alcoholic drinks, to ensure that the price does not fall low enough to encourage excess consumption. This may reduce demand but may also encourage an increase in the supply of these goods. Governments may achieve the same effect on the price by the imposition of so-called sin taxes such as alcohol or tobacco duty.