What are minimum prices and what are the effects of minimum prices?

Minimum prices or price floors are the minimum legally allowed prices for a good set by the govenement. They are established for the benefit of producers/suppliers of essential goods such as wheat and milk. Another good example are minimum wages set in the labour market. (Diagram of wheat market) Before the the minimum price is set, equilibrium exists at Pe Qe at intersection between producers and suppliers. At this price the govenement has decided the price is too low for wheat producers to recieve, so a higher price is set Pmin. At this price, less wheat is demanded (Q2) and more is supplied (Q3) causing an excess supply equal to Q3-Q2. Exess supply is particularly a problem in the agricultural sector because there is continually unsold wheat. Food needs to be used before it goes out of date, so the buffer stock scheme is sometimes used to reduce this problem. It involves two poicies that accompany a minimum price: First, government is required to clear the market by purchasing the excess supply, and for non perishable goods store until required. Second, the supplier will be taxed to restrict supply if there is an overproction. What are the effects of minimum prices? 1. Surplus occurs the law of supply shows quanitity supplied is far greater than quanitity demanded. 2. Reduced market size occurs because the price rise is a sigmal to consumers to reduce demand according to the law of demand. Only quantity demanded above the higher price is purchased which redueces consumer surplus. Producer surplus increases. 3. Cost inefficiencies occur becasue higher prices incentivice an increase in production that is not met with demand. High cost production ensues becasue it uses resources that could otherwise be devoted to other production techniques. 4. Informal markets occur becasue firms may choose to sell below the set price (illegally).