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Minimum Wage, part 1

May 27, 2011

Of all the injustices in the world, the minimum wage is a minor one. It preys on the weak, the ignorant and the vulnerable members of society. The minimum wage’s defenders are self righteous and claim to be motivated by a love for the poor, but hoping something is true does not make it so.

The economic case against the minimum wage is simple. The minimum wage is a price ceiling for labor, and since demand curves slope downward, the minimum wage will cause unemployment. Depending on the slope of the demand curve, total wages could either rise or fall. If the demand curve is steep, total wages will increase because the number of unemployed workers will be small. If the demand curve is flat, so many workers will lose their jobs entirely that the increased wages to those remaining in jobs will not make up for the losses. The higher the minimum wage, the more people become unemployed because of it. This is why a high minimum wage would be foolish. While it would end poverty for the employed, it would making finding jobs nearly impossible for the low skilled.

The slope of the demand curve is determined by the opportunity cost an employer faces when hiring low skilled workers. In other words, what alternatives do employers have to paying the higher wage? If the wage is so high that they can no longer profitably remain in business, the firm will declare bankruptcy. If there are capital investments the firm can make, they will replace a large number of workers with a smaller number of workers with better tools to do the job. In an extreme scenario, the workers will be replaced by robots. A high minimum wage will make low skilled workers less attractive to employers relative to high skilled workers. Employers who have to pay a higher price regardless of quality will respond by substituting towards higher skilled workers.  Finally, firms can substitute to jurisdictions with lower minumum wages, both overseas and in other states.

The wages of workers can never exceed the productivity of the firm. If a company makes $10,000 worth of goods a day and employs 100 workers, it can only pay them on average $100 a day. If it tried to pay them more, its wage bill would exceed its earnings and it would go bankrupt. Likewise, we can go worker by worker and, although productivity is hard to measure individually, wages cannot exceed productivity for a worker, unless there is another worker whose wages are less than productivity by the same amount. But what about capital, you ask? The returns from capital simply go to compensate those who produce it, whose wages in turn are in proportion to their productivity. The more competitive the labor market is, the more a minimum wage will simply translate into a higher unemployment for low productivity workers. The only market structure where a minimum wage does not result in higher unemployment is a monopsony – one employer of minimum waged workers. However, that market structure does not correspond to any real world markets. There are thousands of firms who use low skilled workers and they all compete for the same labor pool.

Source: New York Times

I believe that the minimum wage results in sufficient unemployment that the total wage income to the poor is lower than it would be without a minimum wage.  In my next post, I will discuss further damaging factors of minimum wage to society, beyond the income effects.

Part 2 here.


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