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♪ [music] ♪

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- [Alex] In the next two videos,

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we'll turn our attention 
to price floors and their effects.

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In this video, we'll look at 
the first two effects

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and cover one of the most 
well-known price floors:

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the minimum wage.

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Let's get started.

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A price floor is a minimum price 
allowed by law.

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That is, it is a price 
below which it is illegal

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to buy or sell,

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called a price floor

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because you cannot go
below the floor.

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We're going to show 
that price floors

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create four significant effects:

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surpluses, lost gains from trade, 
wasteful increases in quality,

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and a misallocation of resources.

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We're going to go through 
these each in turn.

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Before we do so, however,

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it's worthwhile
asking this question:

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price floors are less common 
than price ceilings --

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why is this?

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That is, it's more common 
to see a price being held

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below the market price,

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than it is to see a price 
being held above the market price.

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Why?

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One reason may be political.

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That is, there are typically
more buyers of goods

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than there are sellers of goods.

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So when you hold a price 
below the market price,

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you may benefit, or at least 
appear to benefit,

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more buyers,
more people, more voters

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than when you hold a price 
above the market price,

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which would appear to harm buyers.

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Now interestingly,
the paradigmatic,

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the classic case of a price floor

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is the exception
which proves the rule.

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Because the classic case 
of a price floor is a good

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for which there are more sellers 
than there are buyers.

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So here's the case where the price 
is kept above the market price,

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and it make sense politically 
because there are lots of sellers

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compared to buyers.

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So, what is this good,
for which price floor is common

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and for which sellers exceed buyers?

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We'll get to that in just a moment.

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Think about it.

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So one of the things 
which a price floor does

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is it creates surpluses.

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Okay. Have you thought of the good
which a price floor is common,

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and it's a good for which 
the number of suppliers

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exceeds the number of buyers?

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Well, the minimum wage 
is a price floor.

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The minimum wage is a price 
below which you cannot sell labor,

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and the suppliers of labor 
exceed the buyers of labor.

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So it's not surprising
that a minimum wage

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is often politically successful.

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Now, who will
the minimum wage affect?

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Workers with very high productivity

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who are already earning
more than the minimum wage –

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they are not going to be affected 
by the minimum wage perhaps at all.

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Instead, it will affect 
the least experienced,

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least educated, least trained workers.

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Low-skilled teenagers, for example, 
are most likely to be affected

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by the minimum wage.

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Now, I said that a price floor
creates surpluses.

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The minimum wage is a price floor,
so it's going to create a surplus.

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A surplus of labor, we call what?

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We say a gaggle of geese?

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Say pride of lions?

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A surplus of labor
is called unemployment.

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So let's look with our model

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to understand how a minimum wage
can create unemployment,

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particularly among
the least skilled workers.

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Okay. Here's our standard diagram,

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except we're going to put 
the quantity of labor,

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especially unskilled labor,
on the horizontal axis.

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The wage or the price of labor 
on the vertical axis --

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there's our supply curve.

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There's our demand curve
with the market wage

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and the market employment level.

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Now we're going to add
the minimum wage.

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This is a price floor

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below which it is illegal to buy 
or sell this good: labor.

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Now we just read the consequences 
of the price floor of the diagram.

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So we read, for example,

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that at the minimum wage, 
the quantity of labor demanded

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is read off the demand curve.

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Remember, this is
the demand for labor.

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So this is the quantity
of labor demanded,

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and at the minimum wage, 
the quantity of labor supplied

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is read off the supply curve.

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Let's put that point on,
that's "Qs."

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So we have Qs units
of labor supplied,

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"Qd" units of labor demanded.

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Qs is bigger than Qd,

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so the difference between them 
is a surplus of labor,

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also known as unemployment.

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Now the minimum wage
is a controversial

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and hotly debated issue.

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Some academic results indicate

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that the unemployment effect 
of a modest increase

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in the minimum wage

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would not be substantial.

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At the same time, however, 
we also have to recognize

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that a modest increase
in the minimum wage

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would not have big benefits either.

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First, only a small percentage
of workers

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are going to be affected
by the minimum wage.

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97% or so of workers already earn 
more than the minimum wage.

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In fact, even among young workers,

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94% or so less than 25 years of age,

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they already earn
more than the minimum wage.

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At best, the minimum wage 
will raise the wages

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of some low-skilled
and young workers,

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most of whose wages 
would have increased anyway

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as they became more skilled.

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At worst, the minimum wage

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will increase the price
of a hamburger,

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create some unemployment,

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and/or keep some teenagers 
in school for a bit longer --

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not all necessarily bad things.

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What, however,

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about a larger increase 
in the minimum wage?

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Few economists doubt

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that a large increase
in the minimum wage

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would cause serious unemployment.

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After all, we could
not create prosperity

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by raising the minimum wage 
higher and higher.

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If a minimum wage of $10
an hour is a good idea,

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what about 15?

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What about 20, 25, $100?

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$500 an hour?

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Would we all be rich at that point?

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Would we all be receiving wages 
of $500 an hour?

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Of course not.

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Most of us would be unemployed.

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So a large increase
in the minimum wage

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is going to cause
serious unemployment,

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and the good example of this 
is Puerto Rico in 1938.

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Congress actually set 
the first minimum wage at this time

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at 25 cents an hour.

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Now that may seem low,
but that's at a time

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when the average wage
in the United States

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was still less than
a dollar an hour,

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was 62 and a half cents an hour.

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Congress, however,
forgot to exempt Puerto Rico,

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when the average wages 
in Puerto Rico at that time

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were much lower than in the rest 
of the United States,

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only three cents
to four cents an hour.

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So this modest increase 
in the minimum wage

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for the continental United States

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was a huge increase
in the minimum wage for Puerto Rico.

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And lots of Puerto Rican firms
went bankrupt,

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it created devastating unemployment.

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In fact, Puerto Rican politicians 
came to Washington

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to beg for an exemption 
to get them out of the minimum wage.

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So, a large increase
in the minimum wage

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would certainly cause substantial 
and serious unemployment.

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We do see higher minimum wages 
in other countries.

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The minimum wage in France 
is higher than the U.S.,

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relative to average wages 
in those two countries.

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In addition, labor laws in France

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make it very difficult
to fire workers

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once they have been hired.

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As a result, firms in France

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are very reluctant
to hire new workers.

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Younger workers
are especially affected

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because they are less productive,

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and also they are
less known commodities.

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So, the risk
of hiring them is greater.

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As a result, unemployment
among young workers

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is very high in France.

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It was 23% in 2005,

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and that was long before 
the economic crisis,

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the financial crisis 
affecting the entire world.

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So even during good times,

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unemployment in France 
among young workers is very high,

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because the minimum wage is high,

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and because firms
don't want to hire,

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given how difficult it is 
to fire workers.

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Okay. Let's also show
that the minimum wage

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creates lost gains from trade --

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this ought to be
fairly familiar by now.

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At the minimum wage, 
the quantity of labor demanded

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is given by Qd.

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That is less than the quantity 
of labor which would be traded,

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given the market wage,
this market employment.

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Key point is that 
there are buyers of labor

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who are willing to buy labor 
at a price below the minimum wage,

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and there are suppliers of labor,

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workers who are willing 
to work below the minimum wage.

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These deals would be
mutually profitable,

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but they are illegal.

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So there are buyers of labor

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who are willing to buy below 
the minimum wage,

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there are sellers willing to sell.

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These deals would be
mutually profitable,

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but they are illegal,
they are not made.

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Because of that,
there are lost gains from trade,

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or a deadweight loss.

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Okay. So, we have covered 
the first two effects of price floors,

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namely surpluses 
and lost gains from trade.

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In the next lecture, we will use 
a slightly different example

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to look at wasteful
increases in quality

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and a misallocation of resources.

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- [Narrator] If you want
to test yourself,

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click "Practice Questions."

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Or, if you're ready to move on, 
just click "Next Video."

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♪ [music] ♪