Price Floors

Consumers are not the only ones who ignore the basics of supply and demand. Producers have at times called for price floors. A price floor is a legal minimum price for a good, service, or resource. Probably the best-known price floor is minimum wage. In the market for resources like labor, households supply and businesses demand. Politicians representing areas with large populations of unskilled labor are often pressured by voters to increase the minimum wage. It's believed that an increase in the minimum wage is justified because employers will pay the higher wage and maintain the same number of workers. However, that works only if you assume that people do not behave like people.

For example, suppose that the city council of a major city, under pressure from voters, raises the minimum wage from the federal minimum to a city minimum of $10 an hour. Further assume that the equilibrium wage in the inner-city area was already $8 an hour and that in the suburbs it was $11 an hour. What will happen in the inner city and what will happen in the suburbs? In the inner city more producers (workers) will be willing to supply their labor at the higher price, but fewer consumers (employers) will be willing to employ that labor at the higher price. As a result, a surplus of unskilled labor develops, better known as unemployment. In the suburbs, the increase in the minimum wage has no effect, as the equilibrium wage was already $11. In the end, the policy meant to help the poor helped those who maintained their job but resulted in unemployment for those who were laid off and those who entered the job market looking for work at $10 an hour.

How important is minimum wage?

For all the attention it receives, it is not very important. In 2007, the Bureau of Labor Statistics estimated that only about 2.5% of wage earners made minimum wage.

Interestingly enough, those most in favor of increasing the minimum wage are often the same people who would be most harmed by the increase. Politicians know this now and will often pass increases in the minimum wage that keep it less than the average equilibrium wage for unskilled labor. For example, if the average market equilibrium unskilled labor wage is $8 an hour, then politicians will gladly increase the minimum wage from $6 to $7.50 knowing that it will have little economic effect. Yet, they can still put a feather in their cap for “raising” the minimum wage.

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