Which of the following statements is true about a price floor imposed in a perfectly competitive market without a market failure? (assume that both supply and demand are neither perfectly elastic nor perfectly inelastic)

I. The price floor always leads to excess supply.
II. The price floor always leads to deadweight loss.
III. The price floor always generates larger producer surplus.

Question

Which of the following statements is true about a price floor imposed in a perfectly competitive market without a market failure? (assume that both supply and demand are neither perfectly elastic nor perfectly inelastic)
 
I. The price floor always leads to excess supply.
II. The price floor always leads to deadweight loss.
III. The price floor always generates larger producer surplus.

BlackTom AI · Accepted Answer

Let’s break down what a price floor does in a perfectly competitive market without market failures, noting that the binding nature of the floor matters.
Option I: 'The price floor always leads to excess supply.' If the floor is above the market-clearing price (a binding floor), excess supply (a surplus) indeed arises. However, if the floor is set below the equilibrium price (a non-binding floor), it has no effect and does not create excess supply. Therefore, because the word 'always' makes this statement false in the non-binding case, this option is not universally correct.
Option II: 'The price floor always leads to deadweight loss.' A binding price floor above equilibrium does cause deadweight loss due to the reduction in traded quantity. Yet, if the floor is non-binding (below or at equilibrium), no DWL is generated. Consequently, the claim that it always leads to DWL is incorrect in the non-binding scenario.
Option III: 'The price floor always generates larger producer surplus.' When a binding floor raises the price, producers receive a higher price for each unit sold, which tends to increase producer surplus for the units that are actually sold. However, the quantity sold falls due to the surplus and the limited demand at the higher price, and there is a portion of output that remains unsold. Whether the overall producer surplus always grows depends on the relative magnitudes of the higher price versus the reduction in quantity sold, and in some cases the net effect on producer surplus may not be strictly larger. Thus, describing it as ‘always’ larger is not strictly accurate in all scenarios.
Because each option contains qualifiers (such as 'always') that render them incorrect in at least one plausible scenario, none of the provided combinations strictly holds in all cases. In other words, the statements as a group do not cleanly map to a universally true description of price floors in a perfectly competitive market without a market failure. This analysis shows why the listed answer choices may not be fully correct as stated.

ECON1001 (ND) Quiz 4

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