Minimal price

The minimum price is a measure commonly adopted by the Government, by which a rate is established below which a product or service cannot be sold on the market.

Minimal price

In other words, this type of policy sets a floor for the price of certain merchandise. This, with the aim of benefiting the bidders.

By setting a minimum price, producers will receive a price for their product that the authorities consider "fairer" than they would receive without state intervention.

In this sense, we must point out that the implementation of a minimum price is relevant as long as it is above the equilibrium price.

On the other hand, if the minimum price were lower than the equilibrium price, the latter would be the amount agreed between buyers and sellers. For example, if the minimum price were 15 euros and the equilibrium price 20, the latter would be the one that would finally be set in the market.

As we mentioned earlier, this type of measure seeks to benefit producers. However, what occurs is that, on the one hand, the bidders will be willing to sell a quantity greater than the equilibrium quantity. In turn, buyers will reduce their quantity demanded by seeing that artificially high price.

A classic example of a minimum price is the interprofessional minimum wage, which aims for workers to receive a minimum wage that allows them to cover their basic needs. However, this has some drawbacks, as we will develop later.

Minimum price in chart

In the following graph we can see that, when setting a minimum price (Pm) above the equilibrium price (Pe), the quantity supplied is Q2, greater than that of equilibrium (Qe). Meanwhile, the quantity demanded is Q1, less than that of equilibrium.

This implies that there has been an excess supply, represented by the difference between Q2 and Q1.

Minimal price

Minimum price example

As we mentioned previously, a clear example of the concept that concerns us here is the minimum remuneration established by a State or what we know as "minimum interprofessional wage" (It depends on the name assigned to it in each country). This refers to a base salary, regulated by law, which establishes the minimum amount that a worker must earn.

This policy has some advantages, such as that low-income workers receive a minimum that allows them to afford a standard of living considered decent. Similarly, labor exploitation is avoided. That is, a situation in which many workers receive very low incomes under unfair conditions.

However, the disadvantage of establishing a minimum price for wages is that a group of people will be left out of the labor market. These individuals may be willing to receive less than the minimum remuneration, but since regulation does not allow it, they end up unemployed or working informally. This brings, consequently, the increase of the underground economy.

Now let’s look at a numerical example. Suppose the following are the supply and demand functions:

O: p = 0.04q + 1.8

D: p = -0.05q + 9

So, we first equalize to calculate the equilibrium quantity:

0.04q + 1.8 = -0.05q + 9

0.09q = 7.2

q = 80

p = (0.04 * 80) + 1.8 = 5 (can also be replaced in the demand function).

That is, the equilibrium quantity is 80 and the equilibrium price, 5 monetary units (cu).

Now, if a floor price of CU6 were imposed, the quantity supplied would be:

6 = 0.04q + 1.8

4.2 = 0.04q

q = 105

Meanwhile, the quantity demanded would be:

6 = -0.05q + 9

-3 = -0.05q

q = 60

That is, as we had previously explained, when establishing a minimum price, the quantity supplied (105), will be higher than the equilibrium quantity (80), and this, in turn, will be greater than the quantity demanded (60).