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Chapter 33

Minimum Wage

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved.

Chapter Outline

• TRADITIONAL ECONOMIC ANALYSIS OF A MINIMUM WAGE

• REBUTTAL TO THE TRADITIONAL ANALYSIS

• WHERE ARE ECONOMISTS NOW?

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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

family out of poverty

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0.4 0.6 0.8

1 1.2 1.4 1.6 1.8

2

F-T

M

in W

/P

overty Lin

e

19591962196519681971197419771980198319861989199219951998Year

One Two ThreeFour

Full-Time Minimum Wage/Poverty Lineby family size

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0

2

4

6

8

Wage

1938194319481953195819631968197319781983198819931998Year

NominalReal

Nominal and Real Minimum Wage

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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.

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The Labor Market without a Minimum Wage

Labor

W

Demand

SupplyA

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

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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.

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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.

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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*-Lmin

• Who are now looking

• LS-L*

W

Demand

SupplyA

W*

B

C

0 L*

Wmin

Lmin LS

E

F

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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 inefficient mechanism for helping poor working families.

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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.

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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 less of a

loss in employment and a smaller deadweight loss.

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Demonstrating the Inelasticity Argument

Labor

W

Demand

Supply

W*

B

C

0 L*

Wmin

Lmin

E

F

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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.