1 00:00:09,139 --> 00:00:12,220 - In the next two videos, we'll turn our attention to price floors 2 00:00:12,400 --> 00:00:16,190 and their effects. In this video, we'll look at the first two effects and cover 3 00:00:16,370 --> 00:00:20,822 one of the most well known price floors, the minimum wage. Let's get started. 4 00:00:25,051 --> 00:00:29,930 A price floor is a minimum price allowed by law. That is, it is a 5 00:00:30,110 --> 00:00:35,280 price below which it is illegal to buy or sell, called the price floor because you 6 00:00:35,460 --> 00:00:41,200 cannot go below the floor. We're going to show that price floors create four 7 00:00:41,380 --> 00:00:49,500 significant effects; surpluses, lost gains from trade, wasteful increases in quality 8 00:00:49,680 --> 00:00:52,890 and a misallocation of resources. We're going to go through these each in turn 9 00:00:53,070 --> 00:00:58,380 before we do so however, is worthwhile asking this question. Price floors are 10 00:00:58,560 --> 00:01:04,400 less common than price ceilings. Why is this? That is it's more common to see a 11 00:01:04,580 --> 00:01:13,010 price being held below the market price, than it is to see a price being held above 12 00:01:13,190 --> 00:01:21,150 the market price. Why? One reason may be political, that is, there are typically 13 00:01:21,330 --> 00:01:28,650 more buyers of goods than there are sellers of goods. So when you hold a price 14 00:01:28,830 --> 00:01:34,850 below the market price, you may benefit or at least appear to benefit more buyers, 15 00:01:35,030 --> 00:01:42,250 more people, more voters than when you hold a price above the market price which 16 00:01:42,430 --> 00:01:47,780 would appear to harm our buyers. Now interestingly, the paradigmatic, the 17 00:01:47,960 --> 00:01:53,570 classic case of a price floor is the exception which proves the rule because 18 00:01:53,750 --> 00:01:59,690 the classic case of a price floor is a good for which there are more sellers than 19 00:01:59,870 --> 00:02:06,400 there are buyers. So here's the case where the price is kept above the market price 20 00:02:06,580 --> 00:02:10,810 and it make sense politically because there are lots of sellers compared to 21 00:02:10,990 --> 00:02:16,640 buyers. So, what is this good, for which price floor is common, and for which 22 00:02:16,820 --> 00:02:22,790 sellers exceed buyers? We'll get to that in just a moment. Think about it. So one 23 00:02:22,970 --> 00:02:27,190 of the things which a price floor does is it creates surpluses. Okay. Now, how do 24 00:02:27,370 --> 00:02:31,380 you thought of the good which a price floor is common and it's a good for which 25 00:02:31,560 --> 00:02:37,380 the number of suppliers exceeds the number of buyers? Well, the minimum wage is a 26 00:02:37,560 --> 00:02:44,380 price floor. The minimum wage is a price below which you cannot sell labor, and the 27 00:02:44,560 --> 00:02:49,210 suppliers of labor exceed the buyers of labor. So, it's not surprisingly that a 28 00:02:49,390 --> 00:02:53,970 minimum wage is often politically successful. Now, who will the minimum wage 29 00:02:54,150 --> 00:02:58,030 affect? Workers were very high productivity who already earning more than 30 00:02:58,210 --> 00:03:01,300 the minimum wage, they are not going to be affected by the minimum wage perhaps at 31 00:03:01,480 --> 00:03:06,440 all. Instead, it will affect the least experience, least educated, least trained 32 00:03:06,620 --> 00:03:11,260 workers. Low-skilled teenagers, for example, are most likely to be affected by 33 00:03:11,440 --> 00:03:17,350 the minimum wage. Now, I said that a price floor creates surpluses. The minimum wage 34 00:03:17,530 --> 00:03:23,150 is a price floor so it's going to create a surplus. A surplus of labor we call what? 35 00:03:23,330 --> 00:03:29,070 We say a gaggle of geese? Say pride of lions? A surplus of labor is called 36 00:03:29,250 --> 00:03:34,560 unemployment. So let's look with our model to understand how a minimum wage can 37 00:03:34,740 --> 00:03:39,900 create unemployment, particularly among the least skilled workers. Okay. Here's 38 00:03:40,080 --> 00:03:43,340 our standard diagram, accept we're going to put the quantity of labor, especially 39 00:03:43,520 --> 00:03:47,930 unskilled labor on the horizontal axis. The wage or the price of labor on the 40 00:03:48,110 --> 00:03:52,770 vertical axis. That's our supply curve. That's our demand curve with the market 41 00:03:52,950 --> 00:03:56,910 wage and the market employment level. Now, we're going to add the minimum wage. This 42 00:03:57,090 --> 00:04:03,650 is a price floor below which it is illegal to buy or sell this good labor. Now, we 43 00:04:03,830 --> 00:04:07,950 just read the consequences of the price floor of the diagram. So we read for 44 00:04:08,130 --> 00:04:14,030 example, that at the minimum wage, the quantity of labor demanded is right off 45 00:04:14,210 --> 00:04:18,600 the demand curve. Remember, this is the demand for labor. So, this is the quantity 46 00:04:18,779 --> 00:04:23,590 of labor demanded, and at the minimum wage, the quantity of labor supplied is 47 00:04:23,770 --> 00:04:30,230 right off the supply curve. Let's put that point on, that's QS. So we have QS units 48 00:04:30,410 --> 00:04:37,840 of labor supplied, QD units of labor demanded. QS is bigger than QD, so, the 49 00:04:38,020 --> 00:04:46,930 difference between them is a surplus of labor, also known as unemployment. Now, 50 00:04:47,110 --> 00:04:52,600 the minimum wage is a controversy and hotly debated issue. Some academic results 51 00:04:52,780 --> 00:04:57,600 indicate that the unemployment effect of a modest increase in the minimum wage would 52 00:04:57,780 --> 00:05:02,810 not be substantial. At the same time, however, we also have to recognize that a 53 00:05:02,990 --> 00:05:08,070 modest increase in the minimum wage would not have big benefits either. First, only 54 00:05:08,250 --> 00:05:12,780 a small percentage of workers are going to be affected by the minimum wage. Not any 55 00:05:12,960 --> 00:05:17,880 7% or so of workers already earn more than the minimum wage. In fact, even among 56 00:05:18,060 --> 00:05:23,600 young workers, 94% or so are less than 25 years of age, they already earn more than 57 00:05:23,780 --> 00:05:28,500 the minimum wage. At best, the minimum wage will raise the wages of some 58 00:05:28,680 --> 00:05:33,760 low-skilled and young workers, most of whose wages would have increase anyway as 59 00:05:33,940 --> 00:05:38,390 they became more skilled. At worst, the minimum wage will increase the price of 60 00:05:38,570 --> 00:05:44,670 hamburger, create some unemployment and/or keep some teenagers in school for a bit 61 00:05:44,850 --> 00:05:51,000 longer. Not all necessarily bad things. What, however, about a larger increase in 62 00:05:51,180 --> 00:05:56,270 the minimum wage? Few economists doubt that a large increase in the minimum wage 63 00:05:56,450 --> 00:06:03,360 would cause serious unemployment. After all, we could not create prosperity by 64 00:06:03,540 --> 00:06:07,360 raising the minimum wage higher and higher. If a minimum wage of 10 dollars an 65 00:06:07,540 --> 00:06:11,640 hour is a good idea, what about 15? What about 20? 25? A hundred dollars? 66 00:06:11,820 --> 00:06:16,350 500 dollars an hour? Would we all be rich at that point? Would we all be 67 00:06:16,530 --> 00:06:20,920 receiving wages of 500 dollars an hour? Of course not. Most of us would be 68 00:06:21,100 --> 00:06:25,390 unemployed. So a large increase in the minimum wage is going to cause serious 69 00:06:25,570 --> 00:06:30,620 unemployment and the good example of this is Puerto Rico in 1938. Congress actually 70 00:06:30,800 --> 00:06:35,920 set the first minimum wage at this time at 25 cents an hour. Now, that may seem 71 00:06:36,100 --> 00:06:39,690 low but that's at the time when the average wage in the United States was 72 00:06:39,870 --> 00:06:44,600 still lesser than a dollar an hour, with 62 and a half cents an hour. Congress, 73 00:06:44,780 --> 00:06:49,910 however, forgot to exempt Puerto Rico. When the average wages in Puerto Rico at 74 00:06:50,090 --> 00:06:54,720 that time were much lower than in the rest of the United States, only three cents to 75 00:06:54,900 --> 00:06:59,880 four cents an hour. So this modest increase in the minimum wage for the 76 00:07:00,060 --> 00:07:04,720 continental United States was a huge increase in the minimum wage for Puerto 77 00:07:04,900 --> 00:07:09,610 Rico, and lots of Puerto Rican firms went bankrupt. It created devastating 78 00:07:09,790 --> 00:07:15,010 unemployment. In fact, Puerto Rican politicians came to Washington to beg for 79 00:07:15,190 --> 00:07:20,510 an exemption to get them out of the minimum wage. So, a large increase in the 80 00:07:20,690 --> 00:07:25,820 minimum wage would certainly cause substantial and serious unemployment. We 81 00:07:26,000 --> 00:07:30,190 do see higher minimum wages in other countries. The minimum wage in France is 82 00:07:30,370 --> 00:07:34,730 higher than the U.S. relative to average wages in those two countries. In addition, 83 00:07:34,910 --> 00:07:39,240 labor laws in France make it very difficult to fire workers once they have 84 00:07:39,420 --> 00:07:46,050 been hired. As a result, firms in France are very reluctant to hire new workers. 85 00:07:46,230 --> 00:07:50,820 Younger workers are especially affected because they are less productive and also 86 00:07:51,000 --> 00:07:56,160 they are less known commodities. So, the risk of hiring them is greater. As a 87 00:07:56,340 --> 00:08:01,870 result, unemployment among young workers is very high in France. It was 23% in 2005 88 00:08:02,050 --> 00:08:08,460 and that was long before at the economic crisis, the financial crisis affecting the 89 00:08:08,640 --> 00:08:14,420 entire world. So even during good times, unemployment in France among young workers 90 00:08:14,600 --> 00:08:19,310 is very high because the minimum wage is high, and because firms don't want to 91 00:08:19,490 --> 00:08:24,500 hire, given how difficult it is to fire workers. Okay. Let's also show that the 92 00:08:24,680 --> 00:08:28,040 minimum wage creates lost gains from trade, that this ought to be fairly 93 00:08:28,220 --> 00:08:32,850 familiar by now. At the minimum wage, the quantity of labor demanded is given by a 94 00:08:33,030 --> 00:08:38,919 QD, that is less than the quantity of labor which would be traded given the 95 00:08:39,100 --> 00:08:45,800 market wage this market employment. The key point is that there are buyers of 96 00:08:45,980 --> 00:08:51,770 labor who are willing to buy labor at a price below the minimum wage, and they are 97 00:08:51,950 --> 00:08:57,790 suppliers of labor, workers who are willing to work below the minimum wage. 98 00:08:57,970 --> 00:09:05,070 These deals would be mutually profitable but they are illegal. So, there are buyers 99 00:09:05,250 --> 00:09:08,710 of labor who are willing to buy below the minimum wage, there are sellers willing to 100 00:09:08,890 --> 00:09:12,790 sell. These deals would be mutually profitable, but they are illegal, they are 101 00:09:12,970 --> 00:09:18,590 not made. Because of that, they are lost gains from trade or a deadweight loss. 102 00:09:18,770 --> 00:09:23,160 Okay. So, we have covered the first two effects of price floors, namely surpluses 103 00:09:23,340 --> 00:09:27,380 and lost grains from trade. In the next lecture, we will use a slightly different 104 00:09:27,560 --> 00:09:32,284 example to look at wasteful increases in quality and a misallocation of resources. 105 00:09:33,940 --> 00:09:38,110 - If you want to test yourself, click Practice Questions or if you're 106 00:09:38,290 --> 00:09:40,648 ready to move on, just click Next Video.