Sometimes governments intervene to push market prices up instead of down. Price floors have been widely legislated for agricultural products, such as wheat and milk, as a way to support the incomes of farmers. (In 2012, the federal government ended the monopoly position of the Canadian Wheat Board (CWB), which used government subsidies to guarantee farmers a minimum price for wheat and barley.²) Historically, there were also price floors on such services as trucking and air travel, although these were phased out by the government of Canada in the 1970s and 1980s. If you have ever worked in a fast-food restaurant, you are likely to have encountered a price floor: governments in Canada, the United States, and many other countries maintain a lower limit on the hourly wage rate of a worker’s labour; that is, a floor on the price of labour—called the minimum wage.

Just like price ceilings, price floors are intended to help some people but generate predictable and undesirable side effects. Figure 4-4 shows hypothetical supply and demand curves for butter. Left to itself, the market would move to equilibrium at point E, with 10 million kilograms of butter bought and sold at a price of $1 per kilogram.

Now suppose that the government, in order to help dairy farmers, imposes a price floor on butter of $1.20 per kilogram. Its effects are shown in Figure 4-5, where the line at $1.20 represents the price floor. At a price of $1.20 per kilogram, producers would want to supply 12 million kilograms (point B on the supply curve) but consumers would want to buy only 9 million kilograms (point A on the demand curve). So the price floor leads to a persistent surplus of 3 million kilograms of butter.

Does a price floor always lead to an unwanted surplus? No. Just as in the case of a price ceiling, the floor may not be binding—that is, it may be irrelevant. If the equilibrium price of butter is $1 per kilogram but the floor is set at only $0.80, the floor has no effect. And sometimes, a surplus can be saved in order to maintain the price floor in later years. For example, the Federation of Quebec Maple Syrup Producers regulates the production and marketing of maple syrup in Quebec, the source of more than 75% of the world’s supply. Besides setting production limits and quality, it holds a strategic reserve of maple syrup equal to about 42% of the world’s 2011 production. During high production years the reserve grows in order to limit sales and maintain higher prices, and during years of lower production reserves are sold off at higher prices.

But suppose that a price floor is binding and the surplus is unwanted: what happens to it? The answer depends on government policy. In the case of agricultural price floors, governments buy up unwanted surplus. (The European Commission, which administers price floors for a number of European countries, once found itself the owner of a so-called butter mountain, equal in weight to the entire population of Austria.) The government then has to find a way to dispose of these unwanted goods.

Some countries pay exporters to sell products at a loss overseas; this is standard procedure for the European Union. Sometimes Canada gives surplus food away as foreign aid to less developed countries. In some cases, governments have actually destroyed the surplus production. For example, in 1975 about 90 million surplus eggs were destroyed in Canada. To avoid the problem of dealing with the unwanted surplus, the Canadian government typically either pays farmers not to produce the products at all or limits their ability to produce more output.

When the government is not prepared to purchase the unwanted surplus, a price floor means that would-be sellers cannot find buyers. This is what happens when there is a price floor on the wage rate paid for an hour of labour, the minimum wage: when the minimum wage is above the equilibrium wage rate, some people who are willing to work—that is, sell labour—cannot find buyers—that is, employers—willing to give them jobs. These people are unemployed thanks in part to the binding minimum wage constraint.

As we said earlier, price floors don’t always create a surplus: if a price floor is set below the equilibrium price, it is non-binding and won’t have any effect. However, a binding price floor can become non-binding if shifts in the demand and/or supply curves cause the equilibrium price to be greater than or equal to the price floor. In our butter example, the price floor of $1.20 per kilogram may no longer be a binding price floor if there is an increase in the demand for butter due to a change in consumers’ preferences. If the demand curve in Figure 4-5 shifts far enough to the right to raise the equilibrium price to $1.20 per kilogram or more, then the price floor is no longer binding. Similarly, if the supply of butter decreases, causing the equilibrium price to increase to $1.20 per kilogram or more, then the price floor will be non-binding.

The persistent surplus that results from a price floor creates missed opportunities—inefficiencies—that resemble those created by the shortage that results from a price ceiling. These include an inefficiently low quantity transacted, inefficient allocation of sales among sellers, wasted resources, inefficiently high quality, and the temptation to break the law by selling below the legal price.

Inefficiently Low Quantity Because a price floor raises the price of a good to consumers, it reduces the quantity of that good demanded; because sellers can’t sell more units of a good than buyers are willing to buy, a price floor reduces the quantity of a good bought and sold below the market equilibrium quantity. Notice that this is the same effect as a price ceiling. You might be tempted to think that a price floor and a price ceiling have opposite effects, but both have the effect of reducing the quantity of a good bought and sold (see Pitfalls above).

As in the case of a price ceiling, the low quantity sold is an inefficiency due to missed opportunities: price floors prevent mutually beneficial transactions from occurring, transactions that would benefit both buyers and sellers. Figure 4-6 shows the inefficiently low quantity of butter sold with a price floor on the price of butter.

Inefficient Allocation of Sales Among Sellers Like a price ceiling, a price floor can lead to inefficient allocation—but in this case inefficient allocation of sales among sellers rather than inefficient allocation to consumers.

An episode from the Belgian movie Rosetta, a realistic fictional story, illustrates the problem of inefficient allocation of selling opportunities quite well. Like many European countries, Belgium has a high minimum wage, and jobs for young people are scarce. At one point Rosetta, a young woman who is very anxious to work, loses her job at a fast-food stand because the owner of the stand replaces her with his son—a very reluctant worker. Rosetta would be willing to work for less money, and with the money he would save, the owner could give his son an allowance and let him do something else. But to hire Rosetta for less than the minimum wage would be illegal.

Wasted Resources Also like a price ceiling, a price floor generates inefficiency by wasting resources. The most graphic examples involve government purchases of the unwanted surpluses of agricultural products caused by price floors. The surplus production is sometimes destroyed, which is pure waste; in other cases the stored produce goes, as officials euphemistically put it, “out of condition” and must be thrown away.

Price floors also lead to wasted time and effort. Consider the minimum wage. Would-be workers who spend many hours searching for jobs, or waiting in line in the hope of getting jobs, play the same role in the case of price floors as hapless families searching for apartments in the case of price ceilings.

Inefficiently High Quality Again like price ceilings, price floors lead to inefficiency in the quality of goods produced.

We saw that when there is a price ceiling, suppliers produce products that are of inefficiently low quality: some buyers prefer higher-quality products and are willing to pay for them, but sellers refuse to improve the quality of their products because the price ceiling prevents their being compensated for doing so. Of course, a binding price ceiling means excess demand is created, so some sellers are able to sell all their low-quality units. This same logic applies to price floors, but in reverse: suppliers offer goods of inefficiently high quality. A binding price floor creates excess supply, so some sellers must offer higher quality to avoid being shut out of the market.

How can this be? Isn’t high quality a good thing? Yes, but only if it is worth the cost. Suppose that some suppliers spend a lot to make goods of very high quality but that this quality isn’t worth much to some consumers, who would rather receive the money spent on that quality in the form of a lower price. This represents a missed opportunity: suppliers and buyers could make a mutually beneficial deal in which buyers got goods of lower quality for a much lower price.

A good example of the inefficiency of excessive quality comes from the days when transatlantic airfares were set artificially high by international treaty. Forbidden to compete for customers by offering lower ticket prices, airlines instead offered expensive services, like lavish in-flight meals that went largely uneaten. At one point the regulators tried to restrict this practice by defining maximum service standards—for example, that snack service should consist of no more than a sandwich. One airline then introduced what it called a “Scandinavian Sandwich,” a towering affair that forced the convening of another conference to define sandwich. All of this was wasteful, especially considering that what passengers really wanted was less food and lower airfares.

Since the deregulation of North American airlines in the 1970s and 1980s, Canadian passengers have experienced a large decrease in ticket prices accompanied by a decrease in the quality of in-flight service—smaller seats, lower-quality food, and so on. Everyone complains about the service—but thanks to lower fares, the number of people flying on Canadian carriers has grown several hundred percent since airline deregulation.

Illegal Activity Finally, like price ceilings, price floors provide incentives for illegal activity. For example, in countries where the minimum wage is far above the equilibrium wage rate, workers desperate for jobs sometimes agree to work off the books for employers who conceal their employment from the government—or bribe the government inspectors. This practice, known in Europe as “black labour,” is especially common in southern European countries such as Italy and Spain (see the upcoming Economics in Action).

To sum up, a price floor creates various negative side effects:

So why do governments impose price floors when they have so many negative side effects? The reasons are similar to those for imposing price ceilings. Government officials often disregard warnings about the consequences of price floors either because they believe that the relevant market is poorly described by the supply and demand model or, more often, because they do not understand the model. Above all, just as price ceilings are often imposed because they benefit some influential buyers of a good, price floors are often imposed because they benefit some influential sellers.