Lecture Issues in economics today - Chapter 33

The following will be discussed in this chapter: Derived demand, productivity, marginal revenue product, changes in resource demand, the substitution and output effects, optimum resource mix for the firm.

Chapter 33

Minimum Wage

Chapter Outline

• TRADITIONAL ECONOMIC ANALYSIS

OF A MINIMUM WAGE

• REBUTTAL TO THE TRADITIONAL

ANALYSIS

• WHERE ARE ECONOMISTS NOW?

Why Have a Minimum Wage

• The argument for a minimum wage is

that people who work full time should not be in poverty This combines two concepts:

– Minimum Wage: the lowest wage that may legally be paid for an hour’s work

– Living Wage: a wage sufficient to keep a

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998

Year

Full-Time Minimum Wage/Poverty Line

by family size

0

2

4

6

8

1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998

Year

Nominal and Real Minimum Wage

Minimum Wage Increases

• The Federal minimum wage was

originally set at 25 cents per hour

• There have been 18 increases.

• In 2001 it was $5.15 per hour.

• To be equal to its 1968 high in inflation-adjusted terms it would need to have been close to $8 per hour in 2001.

The Labor Market without a

Minimum Wage

Labor

W

Demand

Supply

A

W*

B

C

0 L*

• Value to the firms:

• 0ACL*

• Firms pay workers:

• OW*CL*

• The opportunity cost to workers:

• OBCL*

• Surplus to firms:

• W*AC

• Surplus to workers:

• BW*C

Minimum Wage Relevance

• A minimum wage is only relevant if it is above the market wage.

• A minimum wage below the market

wage is irrelevant.

– The company must pay the market wage to attract workers

– Paying below the market wage is not in its interests because such a wage would not attract sufficient workers to the company

What’s Wrong with the

Minimum Wage

• The gain to the workers who keep their jobs is less than the loss to the losers who

– lose their jobs and – are firms who have to pay higher wages

Demonstrating the Case Against the Minimum Wage

Labor

• Value to the firms:

• 0AELmin

• Firms pay workers:

• OWminELmin

• The opportunity cost to workers:

• OBFLmin

• Surplus to firms:

• WminAE

• Surplus to workers:

• BWminEF

• Unemployed workers

• Who had jobs

• L*-L

W

Demand

Supply

A

W*

B

C

0 L*

E F

The Case Against (continued)

• An increase in the minimum wage by 10%

decreases the number of jobs held by teens

by 1% to 3%

• A minimum wage increase negatively affects

– small businesses more than larger firms

– minorities more than whites.

• A majority of minimum wage workers are

young adults who are not supporting families

An increase in the minimum wage is an

The EITC Alternative to the

Minimum Wage

• The earned income tax credit (EITC)

– is a targeted tax credit to the working poor – was, in 2000, as much as $3,888 for a

working poor family with two children

The Rebuttals to the Traditional Analysis

• The Macroeconomic Argument

– The money that is transferred from employers to employees in more likely to be spent than saved thereby increasing GDP

• The Work Effort Argument

– People who are paid more may work harder than people who are paid less This may return some of the increased wage paid by employers back to

them in terms of increased productivity.

• The Inelasticity of Labor Demand Argument

– If the demand for labor is inelastic then there is

Demonstrating the Inelasticity

Argument

Labor

W

Demand

Supply

W*

B

C

0 L*

E F

Where are Economists Now

• Economists have long been against the

minimum wage and for the EITC

• Card and Kruger challenged many of the

long-held conclusions in the 1990s with research verifying the Inelasticity Argument

• For most labor economists, subsequent

research has re-verified the original pro-EITC, anti-minimum wage argument