Welcome back to Pros and (E)cons! I have realized over time as I have taken economics classes that there are many misconceptions about economic issues. Whether they came from childhood upbringings or politicians’ misleading claims, millions of Americans lack a basic understanding of many economics concepts, to no fault of their own. With this post I would like to look into the current debates surrounding the minimum wage and explain what it can mean for Americans and the United States economy. So without further ado, let’s learn a thing or two from economics!
As we learned last week, millions of Americans are on welfare and millions more are struggling to remain in the middle class. Wage stagnation is a major cause of this. If wages don’t rise to meet or outgrow inflation, then our standards of living will continually decrease. In a capitalist economy, the government cannot force companies to pay all employees certain pre-approved amounts. This is obvious as each firm’s labor costs and needs are different and the government simply does not have the right to do so. What the government can do, however, is enforce a living wage that can afford the most basic lifestyle. This is the minimum wage. This wage marks the bare minimum an employer can pay so that the worker can buy food, clothes, and pay rent among other necessities. Currently, our minimum wage is $7.25/hour. It’s determined by a relatively complicated process so for our purposes we won’t be delving into how it is determined.
To find a solution for the wage stagnation problem, many liberal politicians have been pointing the finger at minimum wage. They claim that it is too low to help any family to survive and that greedy corporations are trying to keep wages low so that they can continue to reap massive profit margins. (Both of these things may or may not be true, but neither of these claims affect what we will be discussing today so we won’t consider them any farther.) These politicians also claim that a higher minimum wage would benefit the everyday American. Is this claim true? The Fight for Fifteen, a movement protesting for a $15.00/hour minimum wage, and political idols such as Senator Bernie Sanders and Secretary Hillary Clinton have championed raising minimum wage so it must be a verifiable solution, right? Well it depends….
Higher wages for Americans sounds like a great way to tackle the wage stagnation problem. Millions will receive a raise, they will have more disposable income to consume or save, and they will be better off in the present and potentially the future. As you begin to think of this, you wonder why politicians haven’t raised the minimum wage. Though it may sound like a wonderful and easy-to-implement solution, there are two main problems with raising the minimum wage: inflation and unemployment. With the first issue, inflation (prices rising), there are two aspects. One, imagine that the government mandates a minimum wage so employers, many of whom are small business owners, must raise wages for their employees. In order to remain in business, the employers must then also raise the prices of their products or services in order to make up for the greater wage expense. Then, prices are higher for goods and services so the employees’ increase to disposable income becomes negligible as they must pay more for their current goods basket. Two, employers are forced to increase their employees’ wages. Now employees demand more goods and services from the markets due to the increase in income. Maybe you can finally afford that new car or the nicer deli meat. Because of an increase to demand, prices rise, once again minimizing the effects of increasing minimum wage.
Another one of minimum wage’s problems is unemployment. In business, it is important to make a profit. This is how businesses stay afloat and are able to provide secure jobs for American workers. When starting the business, the leaders must figure out their maximum production and how many workers they should hire. So, a firm with a certain amount of resources must find out how to best allocate them among workers to maximize production and profit. The marginal product of labor (MPN) refers to how many additional units of output you get from each additional worker. So in the table above, we found that the third worker’s MPN=3, right? For hiring the third worker, we get 3 additional toys. But, where does minimum wage come into this? Well, we want to make a profit, so we need to make sure that we aren’t paying our worker more than what they are making us in product. So if we pay them $7.25/hour, let’s just say that this is the same value as 2 toys. If they make us 3 toys and we are only paying them 2 toys, that’s a marginal profit of 1 toy! This tells us that we will keep hiring until MPN=w (w is wage). If wage becomes higher than MPN, then we are paying them more than they make us so they should be fired. Why does MPN continually decrease with each worker we add though? Well, we assume that each worker has the same level of skill and education so it isn’t because they aren’t as good at making toys. It’s simply because as we try to spread more and more workers over the same limited resources they are able to contribute less and things get crowded and complicated (this is called the decreasing returns to labor). So in the graph way above, MPN=w. If the government suddenly forces us to raise w, the quantity of labor demanded will decrease dramatically. This is because maybe now we need to pay the value of 5 toys to each worker. If that second worker only makes us 3 toys but we pay them 5, they will need to be fired in order for the company to continue making a profit and providing jobs for other workers. This brings us to the cartoon below. That third worker makes 3 toys and helps us fulfill the profit-maximizing condition but as soon as we must pay 5 toys instead of 2, we must fire them. This of course makes the two other workers better off but it makes the one worse off. In the real world, hundreds of employees could be fired because of a huge raise in minimum wage, making companies and Americans worse off than before. Now, instead of a low wage, some Americans would have no job.
Thanks for reading this post! I really appreciate you sticking through all of that especially my rough explanation of the MPN chart and graph. I hope that you learned more about the minimum wage and why it isn’t as simple as forcing businesses to pay out more. Instead, we need to focus on more permanent shifters such as increasing human capital (K) through education or increasing technology (A) through investment. Well, see you next time on Pros and (E)cons!
Image Credits:
Figure 1: Image 1
Figure 2: Image 2
Figure 3: Image 3
Figure 4: Image 4
I’ve been telling people this for almost five years now and the concept just doesn’t get through, I’m made out to be a Mr. Mc Scruge especially by my union brothern. Thanks for presenting it so clearly, perhaps people will now listen. You can’t mandate wages without looking at productivity and the inflationary influences. Otherwise people will end up worse off because don’t forget the profit aspect too, as wages increase people just north of the new wage minimum will want an increase too due to their seniority as will their bosses too. In the long run minimum wage workers can end up even worse off as the price of the hamburger that the worker makes increases proportionally more than their wage increase and everyone pays more and gets less….. But no one listens.
So what’s the answer. Smaller increase, because$7.25 is pretty bad.