05 Feb 2014

My EconLib Article on the Minimum Wage Debate

Economics, Shameless Self-Promotion 25 Comments

Learn it, live it, love it. The key graph, with my commentary:

In Figure 1 below, for diagrammatic simplicity, I assume that the initial market-clearing wage for low-skilled labor is $7.25 per hour. At this $7.25 wage rate, two million workers have jobs. Then, the federal government imposes a wage floor of $10.10 per hour. Because the demand for low-skilled labor is (by stipulation) very inelastic, the quantity of labor demanded falls by only 2,000 workers, a negligible drop of 0.1 percent. Economists running regressions on this episode would conclude—correctly—that raising wages by 39 percent had little impact on the absolute level of employment.

However, in our example, the supply curve (by construction) is a more typical shape, such that the large increase in the wage rate leads to a large increase in the number of workers seeking employment—500,000 in our scenario. There is now a significant amount of involuntary unemployment in the market for low-skilled labor; the unemployment rate would skyrocket.4

Even though (by construction) our hypothetical minimum wage has not significantly reduced total employment, it has, nonetheless, drastically impaired the functioning of the labor market. The “glut” of workers on the market means that non-price allocation mechanisms must come into play. Since there are now multiple applicants for a given job opening, employers can rely on other criteria, including racial and class background, to choose which worker gets the job. It is much more likely that an applicant will need to “know somebody” to get hired, and that teenagers from “respectable” backgrounds will be the ones to work at fast food restaurants, displacing teenagers who might be in more desperate circumstances.

I also summarize some of the key issues in the econometric debates, but without declaring an unambiguous victor. My aim was more modest (in this article): I wanted to let the lay person (and indeed other economists) understand how it was possible to be arguing about this, when we supposedly have such a rich data set of minimum wage changes and employment responses.

25 Responses to “My EconLib Article on the Minimum Wage Debate”

  1. Steven Landsburg says:

    A terrific point and very well put.

    • Bob Murphy says:

      Thanks Steve! And hey, if there were a minimum wage for The Big Questions posts, would that elicit a greater supply?

      • Major_Freedom says:

        “However, in our example, the supply curve (by construction) is a more typical shape, such that the large increase in the wage rate leads to a large increase in the number of workers seeking employment—500,000 in our scenario.”

        Obviously that would mean there is insufficient aggregate demand to employ those workers.

        We need inflation to raise spending and prices.

        Then when it is noticed that the current $10.10 minimum wage is once again “below the poverty line”, it makes sense to raise the minimum wage once again, then in the face of the unemployment call for more aggregate demand.

        I just unlocked the mystery of Keynesianism.

  2. Beard Face says:

    “It is much more likely that an applicant will need to “know somebody” to get hired”

    That’s very true. I live in Australia, and I was only able to get my first job because my uncle knew the manager. Don’t get me wrong, I probably would have found a job eventually, but it would have taken longer.

  3. Tel says:

    Since there are now multiple applicants for a given job opening, employers can rely on other criteria, including racial and class background, to choose which worker gets the job.

    Like working conditions getting worse, just for example.

    Just in the interest of strengthening the theory here, what makes you think the hypothetical supply curve is not also stiff?

  4. Guillermo Sanchez says:

    An incredibly good article Bob, congratulations. Just to complement what you said, and I am sure you already knew it, Neumark and Wascher (2006) made an very long (155 pages) review of evidence and they said something similar to what you said: “[T]he oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect.” I recommend to people to see table 1 so they can see all negative elasticities tied to minimum wage increases. Bob, you are the man! 😀


  5. joe says:

    So the labor force participation rate would increase to 64.4% from 62.8% if the minimum wage was increased to 10.10/hour with a negligible drop in the employment participation rate. Seems like everyone complaining about the drop in the participation rate should support a minimum wage increase.

    • Matt M (Dude Where's My Freedom) says:

      Fewer total jobs are still demanded (just not that many fewer). There would be more people looking for work, since minimum-wage work is now more desirable, but still fewer people finding it. I don’t think anyone would really see that as a “solution” to the problem of a low labor force participation rate…

  6. Andrew' says:

    This basically explains in presentable terms the problem I had with the Krueger paper which seems from blog comment section debates to be the main source of support.

    He looked at McDonald’s where they increased minimum wage in one county while the neighboring county did not – or that’s a close enough summary.

    That is less of a natural experiment than it is obfuscating the supply and demand curves.

    By that, I mean, every worker in County B knows that County A just increased their pay rate, and thus the supply of workers to County A increases. This is NOT what happens when you increase the national rate- at least to the same degree.

    But one must also remember that just because the employment is not effective, where the money comes from might be. We are after all in an ongoing depression.

    • Andrew' says:

      And it also highlights the problems with the pure empiricists. Thanks Bob!

      • Andrew' says:

        Hey, I don’t mind being dumb, so a 101 question, is there a visual representation of how a market clears on a Supply/Demand chart when the intersection point is not allowed to be reached?

        Can we intuitively represent graphically the number of poor black kids who won’t be getting jobs?

        • Tel says:

          The curves are hypothetical.

          There is only one real measurement which is the exact place where supply meets demand. Think about it, every employed person also has a job, every person with a job is therefore employed. Thus the supply of jobs in any real economy exactly and precisely equals the demand for jobs.

          The hypothetical line indicates what might happen if something changed within the economy. We can’t measure that line, we can at best infer what it might be from past experience and perhaps survey questions, gut feel, etc.

          Should the economy really change for whatever reason, we end up with new hypothetical curves and moving to a new equilibrium point. Now, there’s something even more annoying for the empiricist… do we measure the equilibrium as a momentary sample of transactions, or as some sort of long term average? Actually we can do either, but we also need the hypothetical supply and demand curves to be compatible with our definition of equilibrium.

  7. Gamble says:

    Do these predictions account for tax and welfare implications?

  8. Cosmo Kramer says:

    -Most of the jobs are filled at my place of employment by word of mouth.
    -maybe this is why MMT has the job guarantee program.

  9. Cosmo Kramer says:

    *are filled by word of mouth*

  10. Neil says:

    Here’s the problem with the minimum wage debate in America today: When you combine all the various welfare related payment that an unemployed person can receive, it might take $10.10 or more just to give him enough incentive to get off the couch and start looking for a job. When my wife lost her job a few years ago, her unemployment benefits, if calculated based on a full time job scenario, came out to about 9 bucks an hour. With our kids being small at the time, she would have had to find a job making at least $13.50 an hour just to cover the added costs of day-care and gas, not to mention the loss of time with the kids and leisure time she was enjoying. With welfare, SNAP, WIC and countless other welfare programs available, it’s hard to accept a job making $7.25 an hour busting your hump when you can make the same amount or more while watching Jerry and Maury in your government subsidized apartment.

    • Gamble says:

      That is why I asked the above question, have tax and welfare implications been accounted for in these employment predictions?

      Not sure 10.10 will change their existing comfortable behavior all that much?

      Oh snap, what about tax free work and black market work. high school pot dealers will no be lining up for a 10.10 job anytime soon.

      Guess like most interventions you really don’t know what will happen till 10 years later and by then there will have been 1000 more interventions…

      • Andrew' says:

        “have tax and welfare implications been accounted for”

        Ha, y’er funny.

        • Gamble says:

          Workers seeking employment will not increase if 10.10 does not surpass freebie factor…

  11. Edward says:

    We’ll done, bob

  12. Edward says:

    Well done. (Sometimes I hate spellcheck)

  13. GabbyD says:

    How do we know what the shape of the supply curve is?

  14. Yancey Ward says:

    Very clearly demonstrated.

  15. Bharat says:

    Finally got around to reading this. Great article, Dr. Murphy.

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