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- In the next two videos,[br]we'll turn our attention to price floors

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and their effects. In this video, we'll[br]look at the first two effects and cover

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one of the most well known price floors,[br]the minimum wage. Let's get started.

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A price floor is a minimum[br]price allowed by law. That is, it is a

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price below which it is illegal to buy or[br]sell, called the price floor because you

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cannot go below the floor. We're going to[br]show that price floors create four

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significant effects; surpluses, lost gains[br]from trade, wasteful increases in quality

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and a misallocation of resources. We're[br]going to go through these each in turn

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before we do so however, is worthwhile[br]asking this question. Price floors are

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less common than price ceilings. Why is[br]this? That is it's more common to see a

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price being held below the market price,[br]than it is to see a price being held above

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the market price. Why? One reason may be[br]political, that is, there are typically

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more buyers of goods than there are[br]sellers of goods. So when you hold a price

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below the market price, you may benefit or[br]at least appear to benefit more buyers,

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more people, more voters than when you[br]hold a price above the market price which

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would appear to harm our buyers. Now[br]interestingly, the paradigmatic, the

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classic case of a price floor is the[br]exception which proves the rule because

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the classic case of a price floor is a[br]good for which there are more sellers than

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there are buyers. So here's the case where[br]the price is kept above the market price

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and it make sense politically because[br]there are lots of sellers compared to

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buyers. So, what is this good, for which[br]price floor is common, and for which

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sellers exceed buyers? We'll get to that[br]in just a moment. Think about it. So one

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of the things which a price floor does is[br]it creates surpluses. Okay. Now, how do

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you thought of the good which a price[br]floor is common and it's a good for which

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the number of suppliers exceeds the number[br]of buyers? Well, the minimum wage is a

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price floor. The minimum wage is a price[br]below which you cannot sell labor, and the

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suppliers of labor exceed the buyers of[br]labor. So, it's not surprisingly that a

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minimum wage is often politically[br]successful. Now, who will the minimum wage

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affect? Workers were very high[br]productivity who already earning more than

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the minimum wage, they are not going to be[br]affected by the minimum wage perhaps at

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all. Instead, it will affect the least[br]experience, least educated, least trained

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workers. Low-skilled teenagers, for[br]example, are most likely to be affected by

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the minimum wage. Now, I said that a price[br]floor creates surpluses. The minimum wage

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is a price floor so it's going to create a[br]surplus. A surplus of labor we call what?

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We say a gaggle of geese? Say pride of[br]lions? A surplus of labor is called

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unemployment. So let's look with our model[br]to understand how a minimum wage can

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create unemployment, particularly among[br]the least skilled workers. Okay. Here's

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our standard diagram, accept we're going[br]to put the quantity of labor, especially

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unskilled labor on the horizontal axis.[br]The wage or the price of labor on the

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vertical axis. That's our supply curve.[br]That's our demand curve with the market

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wage and the market employment level. Now,[br]we're going to add the minimum wage. This

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is a price floor below which it is illegal[br]to buy or sell this good labor. Now, we

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just read the consequences of the price[br]floor of the diagram. So we read for

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example, that at the minimum wage, the[br]quantity of labor demanded is right off

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the demand curve. Remember, this is the[br]demand for labor. So, this is the quantity

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of labor demanded, and at the minimum[br]wage, the quantity of labor supplied is

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right off the supply curve. Let's put that[br]point on, that's QS. So we have QS units

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of labor supplied, QD units of labor[br]demanded. QS is bigger than QD, so, the

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difference between them is a surplus of[br]labor, also known as unemployment. Now,

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the minimum wage is a controversy and[br]hotly debated issue. Some academic results

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indicate that the unemployment effect of a[br]modest increase in the minimum wage would

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not be substantial. At the same time,[br]however, we also have to recognize that a

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modest increase in the minimum wage would[br]not have big benefits either. First, only

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a small percentage of workers are going to[br]be affected by the minimum wage. Not any

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7% or so of workers already earn more than[br]the minimum wage. In fact, even among

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young workers, 94% or so are less than 25[br]years of age, they already earn more than

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the minimum wage. At best, the minimum[br]wage will raise the wages of some

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low-skilled and young workers, most of[br]whose wages would have increase anyway as

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they became more skilled. At worst, the[br]minimum wage will increase the price of

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hamburger, create some unemployment and/or[br]keep some teenagers in school for a bit

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longer. Not all necessarily bad things.[br]What, however, about a larger increase in

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the minimum wage? Few economists doubt[br]that a large increase in the minimum wage

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would cause serious unemployment. After[br]all, we could not create prosperity by

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raising the minimum wage higher and[br]higher. If a minimum wage of 10 dollars an

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hour is a good idea, what about 15? What[br]about 20? 25? A hundred dollars?

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500 dollars an hour? Would we all be[br]rich at that point? Would we all be

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receiving wages of 500 dollars an[br]hour? Of course not. Most of us would be

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unemployed. So a large increase in the[br]minimum wage is going to cause serious

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unemployment and the good example of this[br]is Puerto Rico in 1938. Congress actually

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set the first minimum wage at this time[br]at 25 cents an hour. Now, that may seem

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low but that's at the time when the[br]average wage in the United States was

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still lesser than a dollar an hour, with[br]62 and a half cents an hour. Congress,

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however, forgot to exempt Puerto Rico.[br]When the average wages in Puerto Rico at

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that time were much lower than in the rest[br]of the United States, only three cents to

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four cents an hour. So this modest[br]increase in the minimum wage for the

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continental United States was a huge[br]increase in the minimum wage for Puerto

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Rico, and lots of Puerto Rican firms went[br]bankrupt. It created devastating

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unemployment. In fact, Puerto Rican[br]politicians came to Washington to beg for

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an exemption to get them out of the[br]minimum wage. So, a large increase in the

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minimum wage would certainly cause[br]substantial and serious unemployment. We

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do see higher minimum wages in other[br]countries. The minimum wage in France is

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higher than the U.S. relative to average[br]wages in those two countries. In addition,

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labor laws in France make it very[br]difficult to fire workers once they have

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been hired. As a result, firms in France[br]are very reluctant to hire new workers.

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Younger workers are especially affected[br]because they are less productive and also

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they are less known commodities. So, the[br]risk of hiring them is greater. As a

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result, unemployment among young workers[br]is very high in France. It was 23% in 2005

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and that was long before at the economic[br]crisis, the financial crisis affecting the

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entire world. So even during good times,[br]unemployment in France among young workers

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is very high because the minimum wage is[br]high, and because firms don't want to

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hire, given how difficult it is to fire[br]workers. Okay. Let's also show that the

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minimum wage creates lost gains from[br]trade, that this ought to be fairly

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familiar by now. At the minimum wage, the[br]quantity of labor demanded is given by a

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QD, that is less than the quantity of[br]labor which would be traded given the

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market wage this market employment. The[br]key point is that there are buyers of

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labor who are willing to buy labor at a[br]price below the minimum wage, and they are

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suppliers of labor, workers who are[br]willing to work below the minimum wage.

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These deals would be mutually profitable[br]but they are illegal. So, there are buyers

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of labor who are willing to buy below the[br]minimum wage, there are sellers willing to

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sell. These deals would be mutually[br]profitable, but they are illegal, they are

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not made. Because of that, they are lost[br]gains from trade or a deadweight loss.

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Okay. So, we have covered the first two[br]effects of price floors, namely surpluses

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and lost grains from trade. In the next[br]lecture, we will use a slightly different

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example to look at wasteful increases in[br]quality and a misallocation of resources.

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- If you want to test yourself,[br]click Practice Questions or if you're

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ready to move on, just click Next Video.