I contend that the following cartoon makes for a decent test of whether you understand economics (hat tip to econjeff.):
Get it? Let me walk you through it with some other (not as funny) pictures:
The U.S. minimum wage was raised to $7.25 per hour, effective 7/24/2009. (This is up from $6.55 per hour, in case you were curious. Here is an interesting chart of the history of the minimum wage. Also, to avoid potential confusion, it should be noted that states can set their own minimum wages about the federal level. Here is a handy graphic that shows state minimum wage levels as they compare to the federal level. I’m just a treasure trove of labor statistics today.) So let’s walk through the economics of this:
The minimum wage acts as a price floor on labor. In a lot of labor markets (read, occupations), the minimum wage is irrelevant since the equilibrium wage in the unregulated market would be about the minimum wage anyway. But let’s consider markets where the minimum wage is binding:
Nice picture, eh? But what does it all mean? Let’s go through the points:
- The amount of labor that a company wants to purchase decreases as the wage increases. This is a fancy way of saying that companies will hire fewer employees (and/or have them work fewer hours) if it has to pay them more. Therefore, the demand for labor slopes downward.
- The amount of labor that people want to supply slopes upwards, at least to a point. Think about it- isn’t it more worth it to you to get off of the couch for $100 per hour than it is for $10 per hour?
- In a free market, the wage that will prevail is the one where supply and demand intersect. In this equilibrium, the price is such that everyone that wants to work is working and companies get all of the labor they want to pay for.
- When you put a binding minimum wage in place, you encourage more people to go out and get jobs. Perhaps this is a good thing.
- When you put a binding minimum wage in place, you make companies want to hire fewer employees or have employees work fewer hours. This is not such a good thing, since it creates unemployment.
- There are winners and losers as far as employees are concerned- those that are still employed after the minimum wage is imposed are better off since their wage went up, but those that are now out of work (or have their hours cut) are worse off. (It could even be the case that some of the winners in the minimum wage game weren’t even looking for work before the minimum wage was imposed!)
- There are also winners and losers as far as firms are concerned. The firms that had been paying below the new minimum wage are worse off, since they have to reduce person-hours and pay the remaining people more. (Some companies that were already above the new minimum wage might even feel the need to increase wages if they pride themselves on paying a premium on top of the minimum wage. It is likely that this too will result in an eventual reduction in employment at those companies.) However, companies that had already been paying above the minimum wage benefit to a degree. Why? Because the minimum wage increase takes away a source of cost undercutting for the competition. (See here for more.)
Now that we’ve got that out of the way…why should *you* care about the minimum wage increase? Hopefully you haven’t said to yourself “gee, I make well above the minimum wage, this doesn’t apply to me” and stopped reading by now. Let’s say that one of the markets affected by the minimum wage increase is the market for Dunkin’ Donuts coffee. (I have noticed recently that my choice of examples is usually a reflection of my cravings at the moment. Must…have…caffeine…) What happens to the price of my delicious caffeinated beverage?
Again, let’s go through the relevant parts:
- The demand for coffee slopes downwards, since (all else being equal) people want more coffee when it’s cheaper.
- The supply of coffee slopes upwards, since more resources get devoted to making coffee if coffee commands a higher price.
- The price of coffee and the quantity of coffee sold are determined by where supply and demand intersect. This is true for both the old and new cases.
- Labor costs are a determinant of supply. More specifically, an increase in the cost of labor means that less coffee is supplied at any given price. (This makes sense since companies hire fewer people, and fewer people means less coffee is made.) The supply curve on the graph shifts to the left.
- I made the assumption that demand for coffee doesn’t change. Technically, those that benefit from the minimum wage hike would increased purchasing power, but those that lose from it would have less purchasing power. You also can’t tell in which direction purchasing power would affect Dunkin’ Donuts coffee- maybe people would buy more, but maybe that would “upgrade” (I use the term loosely here) to Starbucks. (In economic terms, it’s unclear whether Dunkin’ Donuts coffee is a normal or inferior good.) I chose to leave well enough alone rather than make an arbitrary guess.
- The shift in supply causes an increase in price and a decrease in the quantity of coffee sold.
Now, pretend that the cartoon above is of a Dunkin’ Donuts drive-thru, and everything should make sense. The additional subtlety in the cartoon is that it is stated that the person at the drive-thru is one who was “helped” by the minimum wage increase. If that minimum wage worker mainly shops at places that employ other minimum wage workers, then it’s likely that a lot of the benefit of his wage increase is being eaten away by higher prices.*
So there’s your econ lesson for the day. Hopefully I did not suck too much fun out of the joke.
* It’s interesting to note that one of the justifications Wal-Mart gives for paying low wages is that the low wages are partially offset by the fact that it is providing access to goods at a lower price than would otherwise be available.