The effects of “nonbinding” price floors

Governments often impose price floors to protect sellers against low prices in markets characterized by uncertainty. Hard floors arise in grain and currency markets whenever the government acquisitions at the support price are unconstrained. Soft floors arise whenever such acquisitions are subject to a binding constraint. An important special case of a soft floor arises in cap-and-trade programs when the permit auction has a reserve price. Such an auction is equivalent to one with no reserve price combined with a government program to acquire at the reserve price up to the amount auctioned. Using a unified approach, we investigate a novel characteristic of such floors. Although seemingly “nonbinding,” such floors can influence the new equilibrium price. Whether inserted below or above the laissez-faire price, they can result in a new price strictly exceeding the floor—a phenomenon we dub “action at a distance.” We explain it theoretically and illustrate with simulations.