The economics of Minimum Wage
minimum wage economics explained in simple terms
Resources such as oil, water, and land are scarce. In order to determine how society should distribute scarce resources, society needs a way to determine their value.
Value is the monetary, material, or perceived worth of a good or service.
Prices enable us to allocate resources because prices represent value. Human beings determine value based on how that good or service will benefit them, and this desire creates demand.
Demand helps producers decide how much supply there will be. In essence, supply and demand, prices, and value work together to ensure the economy runs efficiently.
Price Controls
Prices are determined by the market forces of supply and demand and work best without government tampering. Price controls limit the price producers and consumers can buy or sell at.
Minimum wage is a price floor. Price floors are a government limit or how low a buyer or seller may bid for a good or service. Minimum wage is a price floor that dictates the lowest an employer may pay. On the flip side, it prevents workers from contracting their labor at a wage lower than minimum wage.
Price floors create surpluses.
The point where the demand and supply meet is the market equilbrium. As you can see from the graph all prices below PF are illegal. Because these goods and services can not be sold they create a surplus.
A surplus of labor is called unemployment. If the natural wage for a job is $5.25, and the minimum wage is $7.25, the worker will either be unemployed or the employer will eat the added cost and pass it on to the consumers. Alternatively, the employer may hire fewer workers or give the workers fewer hours. Regardless, note how that $2 cost, has to be recouped.
Consider a thought experiment. If the government mandated that all cars, used and new, couldn’t be sold for less than $20,000, what would happen? People who can’t afford to buy a car for that amount would be forced to use alternatives. This mandate means any car, even my 1999 Ford Explorer with 314k miles on it, couldn’t be sold for less than 20k. Cars that have a value of less than 20k would not be sold, creating a surplus. This mandate would also force the prices of cars already above the floor to increase.
Apply this scenario to wages, and you can begin to see the effects of minimum wage.
Remember people are willing to buy a car for less than 20k, similar to how people are willing to work for less than the minimum wage. Sellers want to sell for less than the price floor, just like employers want to contract labor for less than the minimum wage. However, these voluntary exchanges have now been banned.
In summary, price floors distort the market. They create surpluses were surpluses do not naturally exist. In the case of minimum wage, they create unemployment. In part two we will look at how the first minimum wage laws were first devised to price black workers out of the market.
