Most of the time in a free market economy, an equilibrium price occurs naturally based on the supply and demand of the product, which leads to the greatest total welfare possible for producers and consumers. Supply is the willingness and ability of producers to produce a quantity of a good at a given price in a given time period. Demand is the quantity of a good that consumers are willing and able to purchase at a given price in a given time period. Equilibrium is where the supply and demand curve meet on a graph. The free market does not always, however, lead to the most optimal outcomes for society in general. If that is the case, the government will often intervene in the market by controlling the price of the product to adjust the outcome.
One way of controlling price is by setting a minimum price, known as a price floor, which is set above the equilibrium price. This forbids producers from selling their product at a price lower than the minimum price implemented by the government. In an article about a situation in Australia, the Government's National Preventative Health Taskforce is putting a price floor on alcoholic beverages. There are different reasons why the government might consider implementing price floors; it could for instance be to try to raise incomes for producers of goods and services that are important for society. In this case, though, the government is controlling the price due to health reasons. Because the price of alcoholic beverages in Australia is so low, the quantity demanded is very high, since according to the law of demand, there exists an inverse relationship between quantity demanded and price. Since the price of alcohol was incredibly low, it created a culture in which being drunk was considered normal, which is obviously not healthy for society.
At Pe the total economic welfare is maximized, meaning there is no inefficiency. However, the social welfare is not maximized, considering that there is lots of alcoholism. The price floor will indeed decrease the quantity demanded, but this does not happen without consequences. If the price of a good is forced above equilibrium price, then the quantity supplied increases according to the law of supply, which states that there exists a direct relationship between quantity supplied and price. So, the quantity demanded decreases and the quantity supplied increases, meaning that there is excess supply, known as a surplus.
If there is a surplus of a product, then that means that the market is inefficient, because resources will be over-allocated to alcohol, so society is not getting the most out of its resources. Another problem with a price floor is that it may lead to a "black market" for booze where it is sold at illegal, low prices, since the market price is below the legal price. For this reason, a price floor may make matters worse. A better solution to this problem would be for the government to intervene by placing a specific tax on all alcoholic beverages. On Graph 2, one can see that a tax causes the supply curve to shift to the left, which creates a new equilibrium. Because the quantity supplied and the quantity demanded decreases, the market falls in size from one producing Qe units to one producing Q1 units. A tax will always result in a dead weight loss (the purple triangle on the graph), which is the net loss of consumer and producer surplus that occurs when a market is in disequilibrium. However, the amount of dead weight loss that would occur if the government placed a tax on alcoholic beverages would be relatively small, considering that the price elasticity of demand for alcohol is relatively inelastic.
Price elasticity of demand is a measure of how much the demand for a product changes when there is a change in the consumer's income. If PED is inelastic, it means that consumers are relatively unresponsive to a change in price. In this case, the consumption of alcoholic beverages will decrease by a proportionally smaller amount than the change in price, because it is a good that is relatively addictive and it does not have any substitutes that consumers can replace it with. For this reason, the dead weight loss would be relatively small, so the total welfare for the community would increase since there will be fewer drunks.
Although the tax creates dead weight loss, it might actually benefit society because the total revenue gained by the government (illustrated on the graph as the turquoise rectangle) can be used to, for instance, fund campaigns against drinking alcohol. If the government spends the revenue from the tax on increasing the awareness of the dangers of alcohol, then that would be a more effective way of reducing the consumption of alcohol, as opposed to setting a price floor.
