6.2.3 Fixing a minimum price

In contrast to the fixing of a maximum price, one objective of setting a minimum price may be to improve the position of suppliers and to stimulate production. Consequently, the minimum price must be higher than the equilibrium price (see above figure). If the sale of the good is guaranteed, for example through government purchases, this price leads to a secure income for an industry. On the other hand, a minimum price can also be used to reduce consumption of a particular good, since an increase in price reduces demand.
As the figure above shows, by fixing a minimum price, supply increases and demand decreases. Therefore, an excess supply is created: the difference between the quantityofsupply and quantityofdemand.
In the case of a purchase guarantee, this fixed minimum price means higher costs for the state, since it may have to buy and store the excess of the produced quantity (for example, the – by now abolished – price guarantees for agricultural goods within the European Union in the 1990s). However, if the state is more concerned with the reduction of demand, a tax would probably be the more efficient way.
It is difficult to implement the minimum price without a state purchase guarantee, as the excess supply tempts producers to engage in (hidden) discount campaigns. For example, instead of the prohibited lower price, other goods or service vouchers can be offered.
Without state purchase guarantees, the producer surplus of the producers remaining in the market increases at the expense of the remaining consumers and the consumers and producers leaving the market. If state purchase guarantees are given, new producers will enter the market. The producer surplus increases at the expense of the consumers and the state, which can resell the excess quantity it purchased only at a loss.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de