Question

Illustrate the floor price diagrammatically.

Answer 1

In the diagram, point E is where the demand and supply curves meet; this is the equilibrium point. The price at this point is OP₀, and the quantity is OQ₀. If the government sets a minimum price (floor price) at OP₁, which is below the equilibrium price OP₀, it won’t affect the market. This is because, at that lower price, more people want to buy than suppliers want to sell this creates excess demand (shortage). The shortage will naturally push the price back up to OP₀, so there's no need for the floor price at OP₁. For a floor price to have any effect, it must be set above the equilibrium price. Let’s say the government sets it at OP₂ (above OP₀). At this higher price, producers want to sell more OQ₂, but buyers only want to buy OQ₁. This creates a surplus or excess supply equal to Q₁Q₂.