A price floor, also known as a minimum price, is a strategy by which the government imposes a minimum price for a certain good in a market. The purpose? To prevent the market price from falling too low, often to protect producers, especially in industries such as agriculture.

Real-World Example: In India, the government has set a minimum price for agricultural products like wheat, soybeans, paddy, and cotton.

There are several reasons a government might implement a price floor

Stability for Producers

Agricultural supply can be affected by unpredictable factors such as weather. Droughts or floods, for example, can decrease the supply, causing price volatility and unstable income for farmers. Price floors help stabilize this income.

Counteract Decreasing Agricultural Share of National Income

As economies grow, the demand for agricultural products often grows more slowly because these products have low income elasticity. Over time, farmers' incomes decrease relative to those earned in manufacturing and service sectors. Price floors can help counteract this trend.

Protecting Rural Employment

A price floor can prevent rural-to-urban migration by making farming more financially sustainable, thereby preserving rural employment and reducing pressure on urban infrastructure.

Consider the soybean market in India. Let's say the equilibrium price is Pe and the quantity is Qe. If the government sets a price floor (P') above Pe, producers offer more units (Qs), but consumers only want to buy less (Qd). This creates a surplus (Qs - Qd).

Real-World Example: If the Indian government then buys the surplus to maintain the price floor, it artificially increases demand. This is like the government saying, "we'll buy all the soybeans you can't sell."

The government has a few options to handle the surplus

• Store and release it in the future, which incurs storage costs.
• Destroy the surplus, which results in waste.
• Sell the surplus in foreign markets (a practice known as dumping), which may disrupt trade relations as local farmers in those markets suffer due to the lowered price.