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Apparently The Minimum Wage Is A Laughing Matter…

July 28th, 2009 · 22 Comments
Econ 101 · Just For Fun · Policy

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.

Tags: Econ 101 · Just For Fun · Policy

22 responses so far ↓

  • 1 Colin // Jul 28, 2009 at 6:56 pm

    What, no mention of a backward-bending labor supply curve?

    Not that it is particularly relevant for fast food workers, though. Something tells me they’re on the positive-slope part of any curve…

  • 2 M C Markman // Jul 28, 2009 at 7:08 pm

    Minimum wage is a socialist ideal that requires price caps in certain areas to function (i.e. cost of certain basic nessecary food items, rent/ housing, and clothing)….
    Actually it’s amusing to me that most companies don’t actually study how much they would need to lower their prices to increase their profit… (although then they have to be careful not to lower their prices so much that they create a glut on the market and kill their own business that way…)
    MCM

  • 3 Tony // Jul 28, 2009 at 8:20 pm

    Interesting graphs and discussion.

    But, on your first graph, I have a nitpick. The quantity of labor you label as “increase in unemployment” is actually just the “decrease in employment.”

    That sounds like two sides of the same coin, but there’s a concept in there. Unemployment is the difference between quantity supplied (people looking for work) and quantity demanded (people actually employed). In the first graph, it’s the entire amount of the shortage.

    With that in mind, the price floor graph illustrates two reasons for unemployment to increase on account of a minimum wage:

    1. Employment decreases (the downward sloping labor demand)
    2. Number of people looking for work increases (due to a likely upward sloping labor supply).

    That shows up in your discussion (“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!”), but it should also show up in the graph.

  • 4 LL Cool A // Jul 28, 2009 at 8:54 pm

    This is a very interesting follow-up post to your last, since the last one covered problems in economics teaching and perhaps the discipline overall give that (empirically speaking) minimum wage laws mean absolutely nothing. They tend to benefit two groups: Poor mothers and high school students [citation needed].

    Anyway, since I am currently writing jokes, I am in a jokey kind of mood, so take it away, The Onion:
    http://www.theonion.com/content/news/minimum_wage_hike_celebrated_with

  • 5 Samuel Meyer // Jul 28, 2009 at 9:21 pm

    Theoretically, yes, minimum wage should act as a price floor for labor, causing a decrease in employment. However, empirically, Card and Krueger http://press.princeton.edu/titles/5632.html observed that an increase in minimum wage does not cause a decrease in employment.

  • 6 Dan L // Jul 28, 2009 at 9:35 pm

    The cartoon is bullshit. The unstated implication (which is the source of the “humor”) is that even those who receive an actual increase in the minimum wage (e.g. Bob) end up worse off. This is complete nonsense, of course.

    But I have to admit that I’m not an economist, so perhaps I’m too simple to understand all of the subtleties.

  • 7 Marshall // Jul 28, 2009 at 10:28 pm

    So, you are saying that the economics of a single-variable model accurately describe the labor market?

    i.e. Do you actually support the idea of a minimum wage-employment rate correlation? Or are you just relating the cartoon to the standard idealised model of introductory economics?

    My understanding is that the effects of minimum wage on large economies are notoriously difficult to establish, and that most serious analyses suggest that it’s below noise levels.

  • 8 Lawrence M // Jul 29, 2009 at 12:24 am

    Well if we’re increasing the price of coffee, shouldn’t the level of unemployment remain constant? I mean all we’re doing is creating inflation and if I remember my econ 100, that should mean lower unemployment.

    Then what happens in the market for illegal labor? Do their wages go up to match inflation or does the increase in unemployment make more people accept jobs paying below min wage?

    Ugh, I shouldn’t be thinking…it’s past midnight.

  • 9 Ben Kunz // Jul 29, 2009 at 8:59 am

    This is a beautiful, clear analysis.

    However, it misses a point — the flexibility of labor and coffee supply and demand curves is not so fluid at the low end of the payment spectrum. First, minimum wage is already *so* low that minor increases will not dramatically shift how many hours people want to be employed, or how many hours people are employed — so the supply and demand curves in your first graph are very “flat,” leading to minor increases in unemployment. There is already an oversupply of young workers willing to sell coffee for pennies an hour, and a few more pennies won’t get many more to leap off the couch to influence labor demand or unemployment.

    Second, companies such as Dunkin’ Donuts (which I too love!) have sales targets. If costs go up slightly in one area such as labor, they don’t pass costs seamlessly on to consumers in a way that would depress sales. A 10.7% increase in minimum wage at the very low end of the employment pool may really be a 2-3% payroll increase (if only a fraction of workers make minimum wage). The company, structured to handle various swings in costs — coffee beans fly up and down in price, too — can cut corners elsewhere, using cheaper coffee, reducing product sizes, turning down the A/C, etc. In such a firm’s marketing meetings I’m sure there’s a whiteboard saying they have to achieve X sales every quarter, so X sales will be achieved by rejiggering every operational cost possible.

    So my point is at the *low end* of the labor cost market, supply and demand curves don’t act like theoretical lines on a chart. The labor costs are already below the threshold of most workers caring; the increases in costs are so negligible that they can be absorbed by company operations elsewhere; and for many products the supply constraints of hitting targets and the demand consistency of we-want-it-anyway means the curves are flatter than we might think.

    The guy’s burger in the cartoon above just went from $0.99 to $1.00. I’d say the conservative cartoonist better brush up on econ.

    Great analysis, and wonderful blog. If I’m wrong, please let me know 😉

  • 10 BradyDale // Jul 29, 2009 at 10:09 am

    This is all very nice theory but it’s not how it plays out. At all.
    I was central to the work to raise the Minimum Wage here in Pennsylvania. We studied the actual numbers around minimum wage hikes here closely and found that they always corresponded to a subsequent flat rate of employment or an increase. Jobs weren’t lost.
    If anything, they went up.

    The graphs are cute, but they are too simplistic. Here’s how it actually plays out:

    Small businesses that say that they can’t afford to raise the minimum wage really are so small that they can’t afford to lose the workers, because they cut it so close to the bone. So they don’t lose them and, in fact, for businesses with margins that tight, they usually don’t even pay minimum wages at all, because they can’t afford the turnover.

    The companies that do pay minimum wage, ironically, are the ones with more money. Why, because they can afford the turnover. The Dunkin’ Donuts and McDonalds are the ones who pay the bare minimum and they can more than handle it when the wages go up.

    What I’d really like to see is any data that shows a price spike at fast food places following minimum wage increases, because I don’t buy that for a second. That strikes me as completely ridiculous.

    And, by the way, as a person who worked his share of crappy jobs through high school and college, even if there were a price spike it wouldn’t hurt the actual workers because, at food joints, you get a pretty huge discount if you work there.

    I’m generally down with economic theory, especially in a micro context, but the theory gets it all wrong with the minimum wage. In fact, the only thing I find really compelling here is the first chart that shows the way that the real and nominal values of the wage have come together. This, of course, is too bad. We ought to guarantee a better wage for workers rather than let that money sit idly in the savings accounts of the very rich.

  • 11 econgirl // Jul 29, 2009 at 2:31 pm

    @ Colin: Exactly. I even considered putting my hypothesis out there that the labor supply curve bends around at the low end too. My reasoning is that if you have someone who needs to make enough money for himself in order to consume necessities like food and shelter, then a decrease in the wage could result in an increase in person-hours supplied since those low-wage workers now need to work more in order to make ends meet.

    After some reflection, however, I had decided to leave that point for a separate post. But now you know. 🙂

  • 12 econgirl // Jul 29, 2009 at 4:02 pm

    @ Tony: You are also correct. I was well-aware in the course of writing this that I was taking a bit of liberty with the (governmental) definition of unemployment, which is “the proportion of people seeking employment that have jobs.” In this case, there are two reasons why I didn’t want to use that specific concept in this context:

    1. The labor supply and demand model suggests that unemployment is zero at equilibrium in a free market. I find this misleading, since even in this type of market is some sort of frictional unemployment just from people switching jobs and moving and whatnot.

    2. From a policy perspective, I’m not sure that I care about those people who are only in the market after the minimum wage is increased, since they are the lazy asses who were sitting on their couches in the free market scenario. Therefore, I chose not to include them in my “increase in unemployment,” since I deemed their lack of jobs to be mostly irrelevant. (In other words, it’s hard to claim that they are hurt by a policy that takes them from not wanting a job to wanting a job but not having one. *breaks out the world’s smallest violin*) I do think, given this, that your terminology of “fall in employment” sounds better. I am going to use that from now on to avoid confusion.

  • 13 fenzel // Jul 29, 2009 at 8:35 pm

    @econgirl

    So, people should trade things for less than they believe they are worth to avoid your moral condemnation and satisfy a Protestant Price Principal?

    That hardly sounds like the talk of an economist.

  • 14 Dan L // Jul 30, 2009 at 12:28 pm

    Econgirl, this discussion is an excellent example of what I dislike about Econ 101. Econ 101 sells itself as a useful framework for making intelligent decisions in the real world. So let’s use it to analyze the following question: Should we support a minimum wage (and if so, what should it be)? Your post seems to be saying “NO” although you do not explicitly say so. But let’s review your main economic conclusions about an increase in the minimum wage: (1) Some people will lose their jobs. (2) Some prices will increase. Congratulations, Econ 101 students, your expensive textbook and fancy graphs just told you what you already knew if you had half a brain!

    But you haven’t touched the actual difficult question: Do the benefits of an increased minimum wage outweigh the costs? In order to answer this question, a reasonable person (with his or her own set of normative values) would want to know *how many* people will lose their jobs, *how much* prices will increase, and *how many* people’s wages will increase and by *how much* (among other things). In all fairness to microeconomics, it does give a framework for answering these questions, IF you know all the supply and demand curves and whatnot (which is essentially never the case), AND the basic supply and demand model is robust enough that its quantitative findings translate to the real world (a question open for debate but rarely mentioned in Econ 101).

    So my basic point is that while I do find Econ 101 to be interesting and worthwhile subject, I do not believe that it helps ordinary Americans to make policy decisions. It just dupes people into thinking they know more than they do, as in, “I took economics, so I know that the minimum wage is bad. Those clueless liberals are just ignorant of the basic facts.” Or worse, you have morons like the cartoonist trying to imply that a minimum wage increase helps no one at all.

    P.S. Your last comment calls out people who would look for a job at a certain wage but not at a lower wage as “lazy asses,” but of course, that description applies to EVERYONE. Surely an economist, of all people, realizes this. (Of course, you are correct that a minimum wage increase does not harm such people.)

  • 15 Tony // Jul 30, 2009 at 1:18 pm

    @econgirl

    1a. I agree that the “no unemployment” prediction is unrealistic. To get the model right, you’d really want to model that with a search model for the laborers. For some flair, you might want to account for menu costs on the employer side.

    But, the supply and demand model you put up assumes that there are no frictions. I’m just saying that for the purpose of the exercise, I’d stick with the standard story (and then caveat it up).

    1b. Dan is right that it doesn’t tell us how much to care about the problem. The Card and Krueger research tells us quite a bit in this regard.

    2. You said:

    “From a policy perspective, I’m not sure that I care about those people who are only in the market after the minimum wage is increased, since they are the lazy asses who were sitting on their couches in the free market scenario.”

    Suppose that your lazy asses (i.e., “teenagers who should be studying for the SATs instead of flipping burgers”) are induced into the minimum wage market on account of an increase in the minimum wage. If the lazy asses end up with any jobs at all, more of the people we care about (i.e., non-lazy asses) lose their job than what is indicated in your graph.

    That is, lazy-ass employment in this story will translate into additional non-lazy-ass unemployment. In this story, not only do the people we care about lose jobs due to a fall in employment, but they stand a chance of being displaced by someone with a higher reservation wage.

    I’m willing to “play the smallest violin” for the lazy asses, but someone who is replaced by a lazy ass might actually get my sympathy.

  • 16 econgirl // Jul 30, 2009 at 1:18 pm

    @ Dan L: Stay tuned for a follow up post…though you seem to have done a decent amount of the work for me here. 🙂

    For the record, I was merely being facetious with my lazy asses comment. I, for one, would not get off of the couch for $7 an hour either.

  • 17 Luke Alan // Jul 30, 2009 at 10:33 pm

    Wow, lots of comments here already.

    I just want to note that in some circumstances, an increase in the minimum wage can actually INCREASE employment.

    This, while counterintuitive, is a result under monopsonistic conditions (employer has some ability to set the wage) over a certain wage range.

    See pgs. 138 – 140 In Modern Labor Economics, 10th Edition, by Ehrenberg and Smith.

  • 18 spencer // Jul 31, 2009 at 5:10 pm

    Well at least you did not try to argue that the people receiving the minimum wage increase would be worse off.

    Even the employment elasticities found by the strongest opponents of the minimum wage are so small that it is obvious that the income impact of higher minimum wages are much greater than the negative employment impact.

    In general, you seem to be pushing a theory, or two theories, desperately in need of any evidence to support it or them.

  • 19 spencer // Jul 31, 2009 at 5:13 pm

    It is going to be an interesting economic experiment to compare the impact of this minimum wage increase in the about 30 states where it goes up with the change in the about 20 states with no change.

    Anyone want to bet there is no significant difference?

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