Econ 101: Example Issue – Minimum Wage

Posted: May 2, 2013 by davishipps in Economics

The first example issue I wanted to discuss, since it has come up somewhat recently, is the idea of a minimum wage. It can be a controversial topic, so I will simply discuss the economics involved and not attempt to say whether it is good or bad to have such a wage.

President Obama announced his support for an increase in the Federal Minimum Wage – from the current $7.25/hour rate to $9/hour – during the first State of the Union address of his second term. House Minority Leader Nancy Pelosi favors a plan that would see it raised to $10/hour, and Senator Elizabeth Warren has suggested that it should be as much as $22/hour. To see what the effects of such an increase might be, we need to look at this with the Laws of Supply and Demand in mind. We’ll use the President’s suggestion for our example.

In this case, the Supplier is the worker and the Buyer is the employer. The Buyer, as ever, has only so much money to spend on his purchases, and he would generally prefer to spend as little money as needed. The Supplier, as ever, would generally like to receive as much money as possible for his services. These two must come to an agreement known as the “price” for the services to be exchanged. In the recent past, the Buyer has purchased the Supplier’s services for the price of $7.25/hour, and the Supplier has been willing to accept this arrangement. If the Federal Minimum Wage has just been raised as proposed above, the Supplier is now legally prevented from selling his services for anything less than $9/hour, and the Buyer must make a decision.

The Buyer may decide one of three things: A) He may decide to forgo the Supplier’s services altogether based on his belief that those services are not worth the new rate in any quantity, B) he may decide to cut back on the quantity of the Supplier’s services that he will purchase, or C) he may decide to continue to purchase the full previous amount of the Supplier’s services and cut back in other areas. There can be no other option for the Buyer because, as has already been mentioned, he has only so much money to spend. And, in fact, if we look closely at option C, we find that it also eventually results in option A or B.

If we suppose that the Buyer determines the full amount of the Supplier’s services to be absolutely required in order to meet the Buyer’s needs, then other areas will necessarily be cut back. Remember, though, that the Buyer is the employer, and the reason for the employment is to assist in the production of a good or the offering of a service. In this case, “cutting back in other areas” means that less money is spent on other components that are needed to produce the good or service, and ultimately less of the good or service is offered for sale. Alternatively, the price of the good or service could be raised to try and offset the increased cost of production. Remembering our Laws of Supply and Demand, however, we find that either of these options necessarily reduces the amount of total revenue for the employer, since either less is offered for sale at the same price (the supply is lower) or the price is increased (which tends to lower demand). Lower revenues, in turn, mean that there is less of the “only so much money” to spend on paying employees, and ultimately there will be less employment as a result.

So we see that, really, the Buyer has only option A or B from which to choose. An increase in the price of the Supplier’s services will result in the Buyer purchasing less of those services, other things being equal. Employment is subject to the Law of Demand just like any other service offered for sale. As this is the case, it may be worth noting that a decrease in the price of the Supplier’s services would likely result in the Buyer purchasing more of those services, other things being equal.

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