Tuesday, February 16, 2016

Thoughts on the Minimum Wage

Most people who argue against the minimum wage assume labor demand is elastic, meaning the amount demanded will disproportionately change relative to price changes.  Here's a simply supply and demand chart to illustrate:

In the above chart, the government increases wages from P to P1 and demand drops from Q1-Q2.  In this example, the line Q1-Q2 is longer than P-P1, meaning the increase in price had a large impact on demand.

However, what if demand is inelastic?  In that case, we'd be looking at the following chart:

Above we see the quantity demanded decrease slightly relative to the larger increase in price.  This means that even if wages increase, we still demand a certain amount of labor.

The second chart is actually far more realistic.  Consider the following fact pattern: a store currently has 100 employees.  Because they're a profit maximizing entity, they are already using the optimal amount of labor (give or take say 5-7 employees).  Let's assume they cut their workforce by 25% because of the increased wages they must now charge.  At this level of cuts they'll see shelves stocked less frequently, fewer employees helping customers finding items and longer check-out lines. This will actually decrease their sales; customers will get tired of not being helped and will become frustrated with the longer lines.

The underlying reasoning is based on the production function, another basic micro-econ concept:

The horizontal line shows the total amount of labor while the vertical lines shows total output.  Notice that as L decreases, so does output.

Anyway, food for thought.

Thanks to Jared Bernstein for first pointing this out awhile ago.

[UPDATE]: Alan Kreuger's research confirms.