Economic Fluctuations: Unemployment and Inflation Causes of Unemployment Minimum Wage Laws Page 1 of 2

If you’re concerned about the predicament of working poor people, it might seem a good idea to impose a minimum wage; that is, guarantee that everyone who works earns at least a certain amount of money per hour that they work – enough to pay for food, clothing, and other necessities. There’s a lot of discussion these days about what a living wage is; and many cities across the United States are establishing living wages that must be paid by people who have contracts with the cities. The question is, does a living wage – does a minimum wage law – actually help the people that it’s designed to help? And there’s a fair bit of controversy about this proposition. Do minimum wages play a role in creating unemployment? Let’s see how this would work.

Let’s begin with an analysis of the market for labor. Here’s the demand curve for labor, which represents the behavior of firms. As the wage increases, firms hire fewer workers and substitute instead with machines, or else they simply don’t do the business at all. So the downward slop in demand curve means that if the wage rises, firms demand less labor. As the wage falls, the demand for labor increases. The supply curve for labor shows the behavior of households. When wages are higher, households will supply a larger quantity of labor in the market, because it’s more rewarding to work when the wage is higher. Whenever the wage is lower the quantity of labor supply falls.

The interaction of supply and demand would automatically determine an equilibrium wage in the market, and an equilibrium level of employment. So at this wage – W* – we get L* jobs. However, W* might be too low in__ the view of people who are in favor of a living wage; and, therefore, they mandate that the wage __must be higher – W – at this legally restricted level, the minimum wage. But the wage is not allowed to fall below W down to this point of equilibrium. Instead what we get is a quantity__ supply that’s greater than the quantity demanded. That is, the number of people who are willing and able to work at W is larger than the number of jobs that firms are offering. __ The difference between the number of people who want to find work at W and the number of jobs offered is a surplus of labor – or unemployment. So we get unemployment from the minimum wage, because more people are willing to work at this high wage than there are jobs for them. After all, if the minimum wage were taken away, we would have an equilibrium in the labor market; there would be fewer people looking for work, but firms would want to hire more of them, so the job market would clear. But because the price mechanism is not allowed to operate and the wage is held above its equilibrium level, we get this unemployment. And this is the argument of people who are opposed to the minimum wage as a tool for helping the working poor. They believe, in fact, that it hurts them by limiting the number of jobs.

Well, there’s another argument that can be made about the minimum wage, and that is that the minimum wage is especially harmful to workers who have lower productivity – unskilled workers. Suppose that a company can produce its product by hiring either one highly skilled worker or two less skilled workers; these less skilled, or unskilled, workers would typically earn a lower wage. And let’s suppose that the wage that’s paid to the unskilled workers is $5.00 an hour. If each of these workers earns $5.00 an hour, and it takes two of them to make your product, that’s $10.00 worth of labor costs. Suppose now the skilled worker wants to take the job away from these unskilled workers. He’s got to offer to work for $10.00 an hour or less. However, if this skilled worker wants to earn a higher wage, then he can cause these workers to become uncompetitive by urging the imposition of a minimum wage. That is, if the minimum wage were $8.00 an hour, these two workers would cause you $16.00. That means that our skilled worker is now competitive at a wage of $13.00, or $14.00, or $15.00.

Look at it another way. If this worker continued to earn $10.00 an hour, and the minimum wage goes up to $6.00 an hour – 6 times 2 is 12 – these workers are no longer going to be hired. The skilled worker will be hired instead, because his $10.00 labor charge is less than the $12.00 labor charge that results when the unskilled workers are subjected to a minimum wage. Therefore, the argument is that politically the unskilled workers find themselves doing less well when a minimum wage is imposed, because they can’t offer themselves willing to work at a wage that makes their labor competitive with the labor of more skilled workers.

Economic Fluctuations: Unemployment and Inflation Causes of Unemployment Minimum Wage Laws Page 2 of 2

Now there’s a fair bit of research about the minimum wage, and it’s mixed; that is, there’s no clear indication that the minimum wage actually hurts the working poor. For one thing, of all those workers 25 years old and older, less than 2% of them are working at the minimum wage. Those people who are most frequently profiting from the minimum wage are teenage workers, and teenage workers in middle-class households. Therefore, increases in the minimum wage may create unemployment, but largely among middle-class teenagers, the argument goes, not among the people that we are really concerned about helping – that is, workers who are breadwinners for families.

During an expansion, the minimum wage probably causes minimal problems. One piece of research showed that the 1997 minimum wage law, the increase in the minimum wage probably resulted in only about 200,000 jobs being lost, and these predominantly for teenagers. The conclusion that we come up with is that although the minimum wage probably does cause employers to hire less labor, and although the workers that they don’t hire are younger workers, as they switch to machines instead, or as they cut back their business activities, that, for the most part, the working poor are not hurt by an increase in the minimum wage. It is middle-class teenagers whose jobs are probably the first to go whenever minimum-wage hikes are enacted.

So here’s a little bit of microeconomics applied to macroeconomics. The minimum wage law shows you how an imposition of a price floor on wages can create unemployment. But that’s not a reason to scrap the minimum wage altogether. We need to look deeper into the story and ask who’s benefited and who’s hurt, because there is no one single labor market; there are all kinds of players in the labor market, and it turns out that the minimum wage influences them differently. But probably the minimum wage does create some unemployment. The only question is what is the real cost to society of the particular kind of unemployment that it creates.