An Economic Analysis of Price Floors

Inn the last post, we talked about Crusoe Economics, which helps to explain the phenomenon of marginal utility in the market among both producers and consumers. Producers will produce as much of a product as it can while it continues to yield a profit, while consumers will consume a product as long as it remains beneficial to them. Producers will not supply more than demand calls for, just like (most) consumers will not buy two pairs of shoes for themselves on any given day. This is a universal economic truth, and unfortunately it is not recognized and oftentimes dismissed among bureaucrats who claim they know more than you.

The next principle that ought to be covered is what happens when the government encroaches on market prices. The government can do this in many ways; they can set price floors, they can set price ceilings, they can set wage laws, or what have you. While all of these principles will be covered in time, we need only to concern ourselves with price floors for the time being.

So, what is a price floor? A price floor is a price set by the government in which businesses are not allowed to accept any less than the said price for the good or service in question. For example, you live in an area that grows apples, and your local government has set a price floor of fifty cents per apple in your community. Let’s say you are selling apples for fifty cents apiece, but demand falls off tremendously, leading you to drop your prices to meet the new level of market equilibrium. With the local government’s price floor, you will be barred from doing so. Price floors are simply a government’s way of limiting demand, while inadvertently restricting supply.

The common excuse for a price floor is this: “the price of apples is too low,” says the local businessman, “that I can’t make a steady profit. Therefore, a price floor is needed to stop prices from going down and putting me out of business.” This grabs the attention of the community, as putting a poor businessman and fellow townsman out of work is not their intention. They grasp at their hearts as they all vote for elected officials who say they will help the downtrodden businessmen who are affected by the low price of apples, and soon a price floor is enforced by legislative authority. “Now,” says the elected official, “the apple business will continue to thrive and everyone will benefit.” The businessman will benefit from selling apples at a “reasonable” price, the community will benefit from jobs that the businessman will provide, and the consumer will benefit by knowing that they are keeping the apple business afloat in their community.

            There are many things wrong with price floors, and many of them can be explained from this one example. First of all, a price floor does nothing more than limit supply and stifle demand of any given product. If prices continued to decrease over time, it would not have been the fault of the consumers. If it would have been anyone’s “fault,” it would be the overcrowded apple market that continued to outpace demand. Now that the price floor has been enforced, aggregate supply of apples has been stopped in its tracks. Price increases will inevitably follow, as marginal producers of apples who are less efficient in their production will soon cease to exist. While local businesses will be artificially propped up by government intervention, their gain is comparable to another businessman’s losses. This could also go the other way as well; if the local businessman is not as efficient in producing apples as, say, the local Wal-Mart, then he will go out of business, which was never his intention or the community’s.

Price floors are almost always followed by a consumer base turning to substitutes, or a product very similar to the product in question and offering similar levels of utility as the original. The public turning to a substitute will do several things, all of which will lead us away from the primary subject of this writing, but the main effect will be to encourage marginal apple producers to focus their attention on producing pears, leaving only the most efficient apple producers to supply the community with apples. This will almost certainly create a monopoly in the apple market and killing a once great communal industry. Soon, the government will notice that the price of pears is decreasing because of the market’s newfound demand, leading the elected officials to enforce further price floors on more and more products until only monopolies can afford to exist in each industry.

The consumer is hurt by price floors because now they do not have the option to buy apples for a lower market price. Had the market been left to its own devices, the prices of apples would have decreased. Furthermore, the elected official does not understand that no one is forcing the producer’s hand into producing more apples. The producer is doing this by his own volition. He knows that he will make less money per apple than he used to, but he’s okay with that, as long as he sells more apples, which the law of demand says will happen. No one is being forced to do business with the other; the producer is willing and able to produce at a lower price, and the consumer is willing and able to buy at a lower price. But the bureaucrats and elected officials aren’t concerned with the forest; they want to fixate on the tree, not knowing or caring that the tree sits on poor soil and will cease to grow with or without external help.

Let’s analyze a specific example of price floors in American history.

The Great Depression is always a good place to find nonsensical policies that were passed with good intentions in mind, but led to poor results. Here, we can focus our attention to the parity prices of the 1930s. This was a price floor that concerned agricultural products, such as wheat. FDR’s argument was similar to the argument of the apple salesman that we just discussed: “agriculture is the bedrock of our society,” Roosevelt said. “We must be able to eat. However, due to the depression, farmers are struggling to make ends meet, and the reason for this is the very low price of wheat. Therefore, we need a price floor that returns the price of wheat to that of the late 1910s, when agriculture was most successful.” This policy was thought to help everyone involved; the farmer was now able to make a decent living for himself, the community would be enriched by the purchases made by the now-wealthy farmer, and the consumer will see the benefits of an enriched economy and plentiful food.

The real picture of what happened after parity prices were enforced and the picture painted by politicians at the time seemed to be of two completely different events. Americans were promised a better economy if price floors were enforced by the federal government; what they got was a prolonged depression, strengthened by a lack of wheat available to the market. The only people who were getting wheat were the people who had the greatest purchasing power, but even they were barred from buying the normal amount that they used to due to the higher prices. Furthermore, the farmer was promised a greater amount of wages due to the price floor. This is the one category in which the federal government might have fulfilled their promise, because to pay the farmer for keeping his goods off of the market, the government sent out subsidies to aid the continuation of their policy. However, what the farmer gained is precisely what the consumer has lost, because the subsidies have to be paid by someone. No matter if the government prints the money themselves or taxes its citizens, it ultimately has the same effect: citizens now have less purchasing power, and the farmer has gained that exact amount in purchasing power. The government promised a better life for everyone with price floors for crops, and ended up continuing the greatest economic downturn in American history.

Setting a price floor is never a good idea. No matter who the government says they intend to help, they always end up hurting someone else by that same amount. The free market is beautiful; it allows products to be offered to consumers for as low a price as producers can afford, and thus encourages efficiency. Price floors discourage efficiency, allowing inefficient producers to stay open using legislative authority. Everyone is worse off, leading them to ask the question of how they were able to be convinced that the price floor was a good idea. The fallacies of price floors are clear and blatantly evident, and it fascinates me that governments around the world continue to make the same mistakes over and over again.

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