Price floor may be defined as the lowest legal price of a commodity at which it can be sold. Price floor is a system initiated by the government under which a floor is laid on the price of a commodity as a result of which sellers need not sell at a price lower than the price fixed by the government. Floor price is higher than the equilibrium price.
The common purpose of fixation of floor price by the government is to protect the interests of producers generally farmers and unskilled labourers who are assured of a minimum price. For example, minimum wages are fixed by the government for the welfare of the labourers and minimum support prices are fixed to protect the farmers.
Adjoining diagram shows the consequence of minimum support price.
In the diagram, OP is equilibrium price. The government fixes the floor price at OC. As a result of price floor, price is increased from OP to OC. At this price supply increases to CN i.e., OV. But the demand of the commodity is only CM i.e., OU. As a result, there is a surplus of commodity equal to MN or UV. To avoid the problem of surplus, the government may purchase the commodity and build buffer stocks which are released in case of shortage of commodities.
