Why do binding price floors cause a deadweight loss?
A. A binding price floor prevents some mutually beneficial exchanges from happening.
B. Binding price floors do not cause a deadweight loss. By keeping prices higher than the market equilibrium price, consumer and producer surplus increase.
C. A binding price floor increases producer surplus and increases producer surplus by an equal amount, leaving total surplus unchanged.
D. A binding price floor increases consumer surplus and decreases producer surplus by an equal amount, leaving total surplus unchanged.
The correct answer and explanation is :
Correct Answer: A. A binding price floor prevents some mutually beneficial exchanges from happening.
Explanation (300 words):
A binding price floor is a government-imposed minimum price that is set above the market equilibrium price. It is termed “binding” because it actually affects the market outcome—unlike a non-binding floor set below the equilibrium, which has no impact.
At the market equilibrium price, supply equals demand, and total surplus (the sum of consumer and producer surplus) is maximized. This means resources are being allocated efficiently, and all mutually beneficial trades are occurring. However, when a binding price floor is imposed, the price is artificially kept higher than what the market would naturally determine.
This higher price causes two main distortions:
- Excess Supply (Surplus): At the higher price, producers are willing to supply more of the good than consumers are willing to buy. This leads to unsold goods—wasted resources that could have been used elsewhere in the economy.
- Reduced Quantity Exchanged: Because fewer consumers are willing to buy at the higher price, the actual quantity sold in the market falls. That means some buyers and sellers who would have made trades at the equilibrium price can no longer do so.
The loss of these mutually beneficial trades results in a deadweight loss—a reduction in total surplus that neither the consumer nor the producer receives. Essentially, potential value is left “on the table” because the market is prevented from reaching its most efficient outcome.
While producers may benefit from higher prices in the short run (producer surplus might rise for some), the decrease in quantity sold and the exclusion of some market participants make the economy worse off overall. That’s why binding price floors, like those on minimum wages or agricultural goods, are often debated in policy discussions.