Case study: The minimum wage

The minimum wage:

An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price for labor that any employer must pay. The US congress first instituted a minimum wage with the Fair Standards Act of 1938 to ensure workers a minimally adequate standard of living. In 2005, the minimum wage according to federal law was $ 5.15 per hour and some state laws imposed higher minimum wages.

To examine the effects of a minimum wage, we must consider the market for labor. The labor market which, like all markets is subject to the forces of supply and demand. Workers determining the supply of labor, and firms determine the demand. If the government doesn’t intervene the wage normally adjusts to balance labor supply and labor demand.

Labor market with a minimum wage: If the minimum wage is above the equilibrium level, the quantity of labor supplied exceeds the quantity demanded. The result is unemployment. Thus, the minimum wage raises the incomes of those workers who have jobs, but it lowers the incomes of workers who cannot find jobs.

To fully understand the minimum wage, keep in mind that the economy contains not a single labor market but many labor markets for different types of workers. The impact of the minimum wage depends on the skill and experience of the worker. Workers with high skills and much experience are not affected because their equilibrium wages are well above the minimum. For these workers, the minimum wage is not binding.

The minimum wage has its greatest impact on the market for teenage labor. The equilibrium wages of teenagers are low because teenagers are among the least skilled and least experienced members of the labor force. In addition, teenagers are often willing to accept a lower wage in exchange for on the job training (some teenagers are wiling to work as interns for no pay at all). Because internships pay nothing, however the minimum wage does not apply to them. If it did, these jobs might not exist. As a result the minimum wages is more often binding for teenagers than for other members of the labor force.

Many economists have studied how minimum wage laws affect the teenage labor market. These researchers compare the changes in the minimum wage over time with the changes in teenage employment. Although there is some debate about how much the minimum wage affects employment, the typical study finds that a 10 percent increase in the minimum wage depresses teenage employment between 1 and 3 percent. In interpreting this estimate a 10 percent increase in the minimum wage does not raise the average wage of teenagers by 10 percent. A change in the law does not directly affect those teenagers who are already paid well above the minimum, and enforcement of minimum wage laws is not perfect. Thus, the estimated drop in employment of 1 to 3 percent is significant.

In addition to altering the quantity of labor demanded, the minimum wage also alters the quantity supplied. Because the minimum wage raises the wage that teenagers can earn, it increases the number of teenagers who choose to look for jobs. Studies have found that a higher minimum wage influences which teenagers are employed. When the minimum wage rises, some teenagers who are still attending school choose to drop out and take jobs. These new dropouts displace other teenagers who had already dropped out of school and who now become employed.

The minimum wage is a frequent topic of political debate. Advocates of the minimum wage view he policy as one way to raise the income of the working poor. They correctly point out that workers who earn the minimum wage can afford only a meager standard of living. In 2005, for instance, when the minimum wage was $ 5.15 per hour, two adults working 40 hours a week for every week of the year at minimum wage jobs had a total annual income of only $21,424 which was less than half of the median family income. Many advocates of the minimum wage admit that it has some adverse effects, including unemployment, but they believe that these effects are small and that, all things considered, a higher minimum wage makes the poor better off.

Opponents of the minimum wage contend that it is not the best way to combat poverty. They note that a high minimum wage causes unemployment, encourages teenagers to drop out of school and prevents some unskilled of the minimum wage point out that he minimum wage is a poorly targeted policy. Not all minimum wage workers are heads of households trying to help heir families escape poverty. In fact fewer than a third of minimum wage earners are in families with incomes below the poverty line. Many are teenagers from middle class homes working at part time jobs for extra spending money.

Evaluating Price controls>>

Markets are usually a good way to organize economic activity. This principle explains why economists usually oppose price ceilings and price floors. To economists, prices are not the outcome of some haphazard process. Prices, they contend are the result of the millions of business and consumer decisions that lie behind the supply and demand curves. Prices have the crucial job of balancing supply and demand and, thereby coordinating economic activity. When policy makers set prices by legal decree, they obscure the signals that normally guide the allocation of society’s resources.

Governments can sometimes improve market outcomes. Indeed, policymakers are led to control prices because they view the market outcome as unfair. Price controls are often aimed at helping the poor. For instance, rent control laws try to make housing affordable for everyone, and minimum wage laws try to help people escape poverty.

Yet price controls often hurt those they are trying to help. Rent control may keep rents low, but it also discourages landlords from maintaining their buildings and makes housing hard to find. Minimum wage laws may raise the incomes of some workers, but they also cause other workers to be unemployed.

Helping those in need can be accomplished in ways other than controlling prices. For instance, the government can make housing more affordable by paying a fraction of the rent for poor families. Unlike rent control, such rent subsidies do not reduce the quantity of housing supplied and, therefore do not lead to housing shortage. Similarly, wage subsidies raise the living standards of the working poor without discouraging firms from hiring them. An example of a wage subsidy is the earned income tax credit, a government program that supplements the incomes of low wage workers.

Although these alternative policies are often better than price controls, they are not perfect. Rent and wage subsidies cost the government money and, therefore, require higher taxes.