When a government sets a price floor, what is the expected outcome?

Question

BlackTom AI · Accepted Answer

In analyzing what a government-imposed price floor does, we must consider how it interacts with the market equilibrium price.
Option 1: 'There is no effect on the market.' This is incorrect in general. A binding price floor (set above the equilibrium price) prevents prices from falling to the equilibrium level, changing quantity demanded and supplied and creating excess supply. Only a non-binding floor (below or equal to equilibrium) would have little or no effect.
Option 2: 'Price will always fall.' This misstates the mechanism. A price floor acts as a lower bound on price; it does not push prices downward. If anything, a binding floor keeps prices elevated relative to equilibrium, not lowered. The statement is therefore false.
Option 3: 'A surplus occurs if the floor is above equilibrium.' This aligns with standard microeconomic theory. When the floor is above the equilibrium price, the quantity supplied exceeds the quantity demanded, producing a surplus. This is the classic outcome of a binding price floor.
Option 4: 'A shortage occurs at all times.' This would be the case for a price ceiling set below equilibrium, not for a price floor. A price floor above equilibrium leads to surplus, while a ceiling below equilibrium leads to shortage. Hence this option is incorrect.

When a government sets a price floor, what is the expected outcome?

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