Deadweight loss in case of a price floor right or left? little, regarding, books, right, price

ShooterMcCFA

I am a little confused by looking at the graph in schweser/CFA books regarding price floors. They draw the deadweight loss left of equilibrium, while I thought the price floor would lead to overproduction, hence a deadweight loss right of equilibrium.

Any input on this?

btcapital

Yes, a price floor leads to underproduction in a similar way to minimum wages.

If the market efficient price and quantity is $50 and 100 units, and you set a price floor at $30, then producers are going to cut the quantity they supply to (roughly) 60 units because the cost of producing a quantity greater than 60 units is higher than the price floor of $30 and thus would be making losses if they produce any more than 60 units. Underproduction and a deadweight loss.

rgonzalez

I think the first part of your post is right -- because that is more like a subsidy, which does lead to overproduction.
Not sure on the second part, because I don't know if you can apply the same logic to all end products. hmm, will have to think on this

Bluetick1010

Allright, that makes sense!

But would this also be valid in case of a price floor for a normal good (E.g. price of corn minimum $10)? To me it seems that this would lead to overproduction?

Would it be correct to state that a price floor leads to underproduction in case of a minimum wage and to overproduction in case of an end product?

johnnyBuz

Kiakaha is correct about why there is underproduction. The people who were willing to work for less are no longer available to the producer at that lower price. If the producer wants to produce the same amount of good, they must use the same amount of workers (this is true as long as productivity doesn't change, but we always assume "all else equal" so we can assume productivity doesn't change). In order to hire the same amount of workers, the producer must now pay a higher per-unit cost to do so, because the workers who previously would work for only $7, $8, or $9 are now paid $10 instead. Therefore the per-unit cost of labor for the producer is higher. Because of the higher per unit cost, the producer will produce less output so that the total cost (unit cost * # of units) is the same as it was before the minimum wage. This results in underproduction.

bulosehi, I see your reasoning for why you think there would be overproduction, but try to think of the economics of it rather than the way you showed it.

MythosHF

This might be wrong -- so if someone has a better knowledge, please correct me -- but I don't think a minimum wage increases supply of labor at that level. Let's say it's $10. The people willing to supply labor at $10 will still supply it. The difference is, the people who were willing to supply labor at $9, $8, $7 etc, won't get the chance to, because producer demand will decrease. Therefore it causes underproduction..... Cheers

trogulj

Yeah but wages are an input into the supply process. Therefore if there is a price floor on wages, producers won't be as willing to hire workers because it is making production more expensive. Less workers = lower production, and therefore deadweight loss.
On the minimum wage supply/demand graph, demand refers to how many units of labor producers want, and what they will pay for them. Supply is what workers are willing to work for. Maybe this is what's tripping you up? Cheers

JPSem

Is it in the context of a minimum wage level? A minimum wage will mean employers are less willing to hire workers - ie it is like underproduction (hiring less workers than they would in a free market). Hope that helps