What Are Price Supports?
Price supports are a form of government intervention in markets designed to ensure that the market price of a good or service does not fall below a certain level. As a key tool in economic policy, price supports are typically implemented to protect producers, ensuring they receive a minimum income for their output. This mechanism sets a price floor above the natural market equilibrium price that would otherwise be determined by supply and demand. By keeping prices artificially high, price supports aim to stabilize incomes, prevent market collapse, and ensure the continued production of essential goods. While they can benefit producers, price supports often lead to unintended consequences, such as the creation of a surplus of the supported good.
History and Origin
The concept of price supports gained significant prominence during periods of economic instability, particularly in the agricultural sector. In the United States, a pivotal moment for price supports was the Great Depression. The Agricultural Adjustment Act (AAA) of 1933, a cornerstone of President Franklin D. Roosevelt's New Deal, was enacted to combat the severe decline in commodity prices that devastated farmers. This legislation sought to raise agricultural prices by reducing surpluses through measures such as government purchases of livestock and payments to farmers for not planting on a portion of their land. The AAA was designed to increase farmers' purchasing power and provide immediate economic relief during the Great Depression.9 The Act, and subsequent iterations like the 1938 Agricultural Adjustment Act, established the precedent for ongoing agricultural policy that included price support mechanisms to maintain fair pricing and ensure the stability of farm incomes.8
Key Takeaways
- Price supports establish a minimum price for a good or service, typically above the natural market equilibrium.
- Their primary goal is to protect producers' incomes and ensure the continued viability of a specific industry.
- While benefiting producers, price supports can lead to market inefficiencies such as overproduction and deadweight loss.
- Governments often implement price supports through direct purchases of surplus goods or by providing subsidies to producers.
- Historically, price supports have been most commonly applied in the agricultural sector.
Interpreting Price Supports
Interpreting price supports involves understanding their intended effects on producers and their broader implications for the economy and consumer prices. When a price support is implemented, it signifies that policymakers believe the free market price is too low to sustain producers. The supported price aims to ensure that producers cover their costs and earn a reasonable income, thereby encouraging continued production. However, this intervention also means that consumers typically pay more for the good than they would in a free market, and taxpayers may bear the cost of managing the resulting surplus. Evaluating a price support policy involves weighing the benefits to producers against the costs to consumers and the potential for reduced market efficiency.
Hypothetical Example
Consider a hypothetical scenario for a staple crop, "Agricorn," where the market equilibrium price is \($2.00\) per bushel, but farmers face rising costs, making this price unsustainable for many. To ensure economic stability and prevent widespread farm bankruptcies, the government implements a price support of \($2.50\) per bushel for Agricorn.
At \($2.00\) per bushel, farmers produce 100 million bushels, and consumers demand 100 million bushels. With the price support at \($2.50\) per bushel, farmers are incentivized to produce more, perhaps 120 million bushels, because of the guaranteed higher price. However, at this higher price, consumers might only demand 90 million bushels. This creates a surplus of 30 million bushels (120 million produced - 90 million demanded). The government, under the terms of the price support, would then typically purchase this 30 million bushel surplus to maintain the \($2.50\) price in the market. This action stabilizes farmer incomes but also incurs costs for taxpayers and potentially leads to storage issues for the excess Agricorn.
Practical Applications
Price supports are most commonly found in agricultural policy globally. Governments use them to stabilize farm incomes, ensure food security, and protect domestic producers from volatile international markets or adverse weather conditions. For instance, the European Union's Common Agricultural Policy (CAP) has historically used various market measures, including price supports, to manage agricultural markets and provide income support to farmers.7,6
Beyond agriculture, the principle of a price floor, which price supports exemplify, can be seen in other economic contexts. For example, minimum wage laws act as a price support for labor, setting a minimum price for hourly work. While not typically referred to as "price supports," these policies share the fundamental goal of establishing a minimum payment for a good or service in a specific market. The OECD regularly monitors and evaluates agricultural policies across numerous countries, providing insight into the prevalence and impact of various support measures, including those that influence market prices.5,4,3
Limitations and Criticisms
Despite their intentions, price supports face several limitations and criticisms. A significant drawback is the creation of artificial surplus. When the supported price is above the market equilibrium, producers supply more than consumers demand, leading to excess production that the government must purchase or manage. This often results in costly storage, waste, or the need for governments to find ways to dispose of the excess, such as through exports at subsidized prices, which can distort international trade.
Another criticism revolves around economic efficiency. Price supports can lead to a deadweight loss, representing a net loss of economic welfare because resources are not allocated efficiently. Farmers may continue to produce crops that are not in high demand simply because the price support guarantees profitability, rather than shifting to more economically viable alternatives. Furthermore, the benefits of price supports often disproportionately accrue to larger producers who can generate more output, while smaller farms may struggle to scale production sufficiently to benefit meaningfully. Critics also point to the financial burden on taxpayers, who fund the government's purchases of surplus goods or direct subsidies to maintain the supported price. The Federal Reserve Bank of San Francisco, in discussing minimum wages as a type of price floor for labor, highlights that while such policies aim to increase earnings for some workers, they can also lead to job losses, illustrating a common trade-off associated with price support mechanisms.2,1
Price Supports vs. Price Ceilings
Price supports and price ceilings are both forms of government intervention in markets, but they operate in opposite directions and serve different purposes. A price support, also known as a price floor, sets a minimum legal price for a good or service above the equilibrium price. Its goal is to protect producers by guaranteeing them a minimum income. This often results in a surplus of the good, as the quantity supplied at the higher price exceeds the quantity demanded.
Conversely, a price ceiling sets a maximum legal price for a good or service below the equilibrium price. Its purpose is to protect consumers by making essential goods more affordable, particularly during times of scarcity or high demand. The common consequence of a price ceiling is a shortage, as the quantity demanded at the lower price exceeds the quantity supplied. While price supports aim to bolster producer surplus, price ceilings aim to increase consumer surplus. Both policies interfere with the natural forces of supply and demand and can lead to market inefficiencies.
FAQs
Why do governments implement price supports?
Governments implement price supports primarily to protect producers from severe price drops, stabilize their incomes, and ensure the continued production of goods deemed essential, such as agricultural products. This type of government intervention aims to prevent market instability that could harm a critical sector of the economy.
What is the main downside of price supports?
The main downside of price supports is the creation of a surplus. Because the mandated price is set above the natural market equilibrium, producers supply more of the good than consumers are willing to buy at that price. This excess production often leads to costly storage, waste, or requires the government to purchase and manage the surplus, imposing a burden on taxpayers.
How do price supports affect consumers?
Price supports generally affect consumers by leading to higher consumer prices for the supported goods than would exist in a free market. Consumers pay more, and they may also indirectly bear costs through taxes that fund government programs to manage the resulting surpluses.
Are price supports common in industries other than agriculture?
While price supports are most famously associated with agricultural policy, the economic principle of a "price floor" applies more broadly. For example, minimum wage laws function as a price floor for labor, setting a minimum price for hourly work. However, the term "price supports" specifically typically refers to commodity markets.