Question 3 (b)
A price floor set below the equilibrium price
4 marks
- Time to write
- About 8 minutes
Question
Question 3 (b) · 4 marksWhat is a price floor? What will the effect be on the market outcome if the government sets a price floor on a commodity at a price that is below its equilibrium price?
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- What…?Two asks in one question: answer both.
What the paper leaves open
As printed, the question asks about a price floor set below the equilibrium price.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Meaning of a price floor 1½ marks 1 min
- 2 Effect of a floor below equilibrium: none, with the reason 2 marks 5 min
- 3 When it would bind ½ mark 1 min
Easy marks
- Meaning of a price floor (step 1, 1½ marks): a clear definition and a line on what it covers. It opens the answer, so it takes a minute or two.
Short on time? Step 2 carries 2 of the 4 marks: guard its minutes.
Try it first. About 8 minutes for 4 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
What a price floor is. A price floor is a minimum price fixed by the government: by law the good may not be sold for less. Governments use it to stop a price from falling too low, usually to protect sellers. Support prices for crops and the minimum wage are examples.
Effect of a floor below equilibrium. A floor set below the equilibrium price is not binding, and the market outcome does not change.
- The floor only forbids prices under its level. The equilibrium price is above that level, so it is still allowed.
- At the equilibrium price, quantity demanded equals quantity supplied, so no buyer or seller has any reason to change the price, and the floor never comes into play.
- Equilibrium price and quantity therefore stay as they were, with no surplus and no shortage.
Example (our figures): if the market price of mustard is ₹5,500 a quintal and the government sets a floor of ₹5,000, trade carries on at ₹5,500. The law has no effect, because nobody wanted to sell at ₹5,000 in the first place.
When a floor would bind. Only a floor set above the equilibrium price restricts the market: the price is held up, quantity supplied exceeds quantity demanded, and a surplus appears. A floor now below equilibrium could become binding later, if a fall in demand or a rise in supply pushed the equilibrium price below it.
Conclusion. A price floor below the equilibrium price has no effect: the market stays at its equilibrium price and quantity, and there is no surplus.
Where the 4 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Meaning of a price floor | 1.5 |
| 2 | Effect of a floor below equilibrium: none, with the reason | 2 |
| 3 | When it would bind | 0.5 |
| Total | 4 |
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