Answer to Question #186663 in Microeconomics for Haider Ali

Question

Illustrate when a government intervenes in a competitive labor market to change the unfair outcome of the market determined wages by taking the policy of price Floor under binding constraint. Also evaluate the adverse effects for labor market of this policy.

Answer 1

When the government intervenes it introduces Minimum (floor) price policy.

Here prices are set above the equilibrium price, the reason being that the government might consider the equilibrium price to be a very low to motivate producers to continue production effectively. Done in order to encourage producers to produce more. The government sets a minimum price. This happens for example for agricultural goods and wages/labor.

In the diagram it can be seen that a result of fixing a minimum price $P_1$ above the equilibrium price $P$ excess supply $Q_2-Q_1$ is created since consumers are willing to be buy $Q_1$, while suppliers are willing to supply $Q_2.$ In this case the government has to purchase the excess supply and either store it so that it can be re-supplied during the period of shortage or export to the outside market on order to earn the country foreign exchange.