1 99:59:59,999 --> 99:59:59,999 - [Tyler] In the next two videos, we'll turn our attention to price floors 2 99:59:59,999 --> 99:59:59,999 and their effects. In this video, we'll look at the first two effects and cover 3 99:59:59,999 --> 99:59:59,999 one of the most well-known price floors, the minimum wage. Let's get started. 4 99:59:59,999 --> 99:59:59,999 A price floor is a minimum price allowed by law. That is, it is a 5 99:59:59,999 --> 99:59:59,999 price below which it is illegal to buy or sell, called a price floor because you 6 99:59:59,999 --> 99:59:59,999 cannot go below the floor. We're going to show that price floors create four 7 99:59:59,999 --> 99:59:59,999 significant effects: surpluses, lost gains from trade, wasteful increases in quality, 8 99:59:59,999 --> 99:59:59,999 and a misallocation of resources. We're going to go through these each in turn. 9 99:59:59,999 --> 99:59:59,999 Before we do so, however, it is worthwhile asking this question: price floors are 10 99:59:59,999 --> 99:59:59,999 less common than price ceilings - why is this? That is it's more common to see a 11 99:59:59,999 --> 99:59:59,999 price being held below the market price, than it is to see a price being held above 12 99:59:59,999 --> 99:59:59,999 the market price. Why? One reason may be political. That is, there are typically 13 99:59:59,999 --> 99:59:59,999 more buyers of goods than there are sellers of goods. So when you hold a price 14 99:59:59,999 --> 99:59:59,999 below the market price, you may benefit, or at least appear to benefit, more buyers, 15 99:59:59,999 --> 99:59:59,999 more people, more voters than when you hold a price above the market price, which 16 99:59:59,999 --> 99:59:59,999 would appear to harm buyers. Now interestingly, the paradigmatic, the 17 99:59:59,999 --> 99:59:59,999 classic case of a price floor is the exception which proves the rule. Because 18 99:59:59,999 --> 99:59:59,999 the classic case of a price floor is a good for which there are more sellers than 19 99:59:59,999 --> 99:59:59,999 there are buyers. So here's the case where the price is kept above the market price, 20 99:59:59,999 --> 99:59:59,999 and it make sense politically because there are lots of sellers compared to 21 99:59:59,999 --> 99:59:59,999 buyers. So, what is this good, for which price floor is common, and for which 22 99:59:59,999 --> 99:59:59,999 sellers exceed buyers? We'll get to that in just a moment. Think about it. So one 23 99:59:59,999 --> 99:59:59,999 of the things which a price floor does is it creates surpluses. Okay. Now, have 24 99:59:59,999 --> 99:59:59,999 you thought of the good which a price floor is common, and it's a good for which 25 99:59:59,999 --> 99:59:59,999 the number of suppliers exceeds the number of buyers? Well, the minimum wage is a 26 99:59:59,999 --> 99:59:59,999 price floor. The minimum wage is a price below which you cannot sell labor, and the 27 99:59:59,999 --> 99:59:59,999 suppliers of labor exceed the buyers of labor. So, it's not surprisingly that a 28 99:59:59,999 --> 99:59:59,999 minimum wage is often politically successful. Now, who will the minimum wage 29 99:59:59,999 --> 99:59:59,999 affect? Workers with very high productivity who already earning more than 30 99:59:59,999 --> 99:59:59,999 the minimum wage - they are not going to be affected by the minimum wage perhaps at 31 99:59:59,999 --> 99:59:59,999 all. Instead, it will affect the least experienced, least educated, least trained 32 99:59:59,999 --> 99:59:59,999 workers. Low-skilled teenagers, for example, are most likely to be affected by 33 99:59:59,999 --> 99:59:59,999 the minimum wage. Now, I said that a price floor creates surpluses. The minimum wage 34 99:59:59,999 --> 99:59:59,999 is a price floor, so it's going to create a surplus. A surplus of labor we call what? 35 99:59:59,999 --> 99:59:59,999 We say a gaggle of geese? Say pride of lions? A surplus of labor is called 36 99:59:59,999 --> 99:59:59,999 unemployment. So let's look with our model to understand how a minimum wage can 37 99:59:59,999 --> 99:59:59,999 create unemployment, particularly among the least skilled workers. Okay. Here's 38 99:59:59,999 --> 99:59:59,999 our standard diagram, except we're going to put the quantity of labor, especially 39 99:59:59,999 --> 99:59:59,999 unskilled labor, on the horizontal axis. The wage or the price of labor on the 40 99:59:59,999 --> 99:59:59,999 vertical axis. That's our supply curve. That's our demand curve with the market 41 99:59:59,999 --> 99:59:59,999 wage and the market employment level. Now we're going to add the minimum wage. This 42 99:59:59,999 --> 99:59:59,999 is a price floor below which it is illegal to buy or sell this good, labor. Now, we 43 99:59:59,999 --> 99:59:59,999 just read the consequences of the price floor of the diagram. So we read, for 44 99:59:59,999 --> 99:59:59,999 example, that at the minimum wage, the quantity of labor demanded is read off 45 99:59:59,999 --> 99:59:59,999 the demand curve. Remember, this is the demand for labor. So, this is the quantity 46 99:59:59,999 --> 99:59:59,999 of labor demanded, and at the minimum wage, the quantity of labor supplied is 47 99:59:59,999 --> 99:59:59,999 read off the supply curve. Let's put that point on, that's Qs. So we have Qs units 48 99:59:59,999 --> 99:59:59,999 of labor supplied, Qd units of labor demanded. Qs is bigger than Qd, so, the 49 99:59:59,999 --> 99:59:59,999 difference between them is a surplus of labor, also known as unemployment. Now 50 99:59:59,999 --> 99:59:59,999 the minimum wage is a controversy and hotly debated issue. Some academic results 51 99:59:59,999 --> 99:59:59,999 indicate that the unemployment effect of a modest increase in the minimum wage would 52 99:59:59,999 --> 99:59:59,999 not be substantial. At the same time, however, we also have to recognize that a 53 99:59:59,999 --> 99:59:59,999 modest increase in the minimum wage would not have big benefits either. First, only 54 99:59:59,999 --> 99:59:59,999 a small percentage of workers are going to be affected by the minimum wage. 97% 55 99:59:59,999 --> 99:59:59,999 or so of workers already earn more than the minimum wage. In fact, even among 56 99:59:59,999 --> 99:59:59,999 young workers, 94% or so less than 25 years of age, they already earn more than 57 99:59:59,999 --> 99:59:59,999 the minimum wage. At best, the minimum wage will raise the wages of some 58 99:59:59,999 --> 99:59:59,999 low-skilled and young workers, most of whose wages would have increased anyway as 59 99:59:59,999 --> 99:59:59,999 they became more skilled. At worst, the minimum wage will increase the price of a 60 99:59:59,999 --> 99:59:59,999 hamburger, create some unemployment and/or keep some teenagers in school for a bit 61 99:59:59,999 --> 99:59:59,999 longer. Not all necessarily bad things. What, however, about a larger increase in 62 99:59:59,999 --> 99:59:59,999 the minimum wage? Few economists doubt that a large increase in the minimum wage 63 99:59:59,999 --> 99:59:59,999 would cause serious unemployment. After all, we could not create prosperity by 64 99:59:59,999 --> 99:59:59,999 raising the minimum wage higher and higher. If a minimum wage of 10 dollars an 65 99:59:59,999 --> 99:59:59,999 hour is a good idea, what about 15? What about 20? 25? A hundred dollars? 66 99:59:59,999 --> 99:59:59,999 500 dollars an hour? Would we all be rich at that point? Would we all be 67 99:59:59,999 --> 99:59:59,999 receiving wages of 500 dollars an hour? Of course not. Most of us would be 68 99:59:59,999 --> 99:59:59,999 unemployed. So a large increase in the minimum wage is going to cause serious 69 99:59:59,999 --> 99:59:59,999 Unemployment, and the good example of this is Puerto Rico in 1938. Congress actually 70 99:59:59,999 --> 99:59:59,999 set the first minimum wage at this time at 25 cents an hour. Now, that may seem 71 99:59:59,999 --> 99:59:59,999 Low, but that's at the time when the average wage in the United States was 72 99:59:59,999 --> 99:59:59,999 still less than a dollar an hour, was 62 and a half cents an hour. Congress, 73 99:59:59,999 --> 99:59:59,999 however, forgot to exempt Puerto Rico. When the average wages in Puerto Rico at 74 99:59:59,999 --> 99:59:59,999 that time were much lower than in the rest of the United States, only three cents to 75 99:59:59,999 --> 99:59:59,999 four cents an hour. So this modest increase in the minimum wage for the 76 99:59:59,999 --> 99:59:59,999 continental United States was a huge increase in the minimum wage for Puerto 77 99:59:59,999 --> 99:59:59,999 Rico. And lots of Puerto Rican firms went Bankrupt, it created devastating 78 99:59:59,999 --> 99:59:59,999 unemployment. In fact, Puerto Rican politicians came to Washington to beg for 79 99:59:59,999 --> 99:59:59,999 an exemption to get them out of the minimum wage. So, a large increase in the 80 99:59:59,999 --> 99:59:59,999 minimum wage would certainly cause substantial and serious unemployment. We 81 99:59:59,999 --> 99:59:59,999 do see higher minimum wages in other countries. The minimum wage in France is 82 99:59:59,999 --> 99:59:59,999 higher than the U.S. relative to average wages in those two countries. In addition, 83 99:59:59,999 --> 99:59:59,999 labor laws in France make it very difficult to fire workers once they have 84 99:59:59,999 --> 99:59:59,999 been hired. As a result, firms in France are very reluctant to hire new workers. 85 99:59:59,999 --> 99:59:59,999 Younger workers are especially affected because they are less productive and also 86 99:59:59,999 --> 99:59:59,999 they are less known commodities. So, the risk of hiring them is greater. As a 87 99:59:59,999 --> 99:59:59,999 result, unemployment among young workers is very high in France. It was 23% in 2005, 88 99:59:59,999 --> 99:59:59,999 and that was long before at the economic crisis, the financial crisis affecting the 89 99:59:59,999 --> 99:59:59,999 entire world. So even during good times, unemployment in France among young workers 90 99:59:59,999 --> 99:59:59,999 is very high because the minimum wage is high, and because firms don't want to 91 99:59:59,999 --> 99:59:59,999 hire, given how difficult it is to fire workers. Okay. Let's also show that the 92 99:59:59,999 --> 99:59:59,999 minimum wage creates lost gains from trade - this ought to be fairly 93 99:59:59,999 --> 99:59:59,999 familiar by now. At the minimum wage, the quantity of labor demanded is given by 94 99:59:59,999 --> 99:59:59,999 Qd. That is less than the quantity of labor which would be traded given the 95 99:59:59,999 --> 99:59:59,999 market wage, this market employment. Key point is that there are buyers of 96 99:59:59,999 --> 99:59:59,999 labor who are willing to buy labor at a price below the minimum wage, and there are 97 99:59:59,999 --> 99:59:59,999 suppliers of labor, workers who are willing to work below the minimum wage. 98 99:59:59,999 --> 99:59:59,999 These deals would be mutually profitable, but they are illegal. So, there are buyers 99 99:59:59,999 --> 99:59:59,999 of labor who are willing to buy below the minimum wage, there are sellers willing to 100 99:59:59,999 --> 99:59:59,999 sell. These deals would be mutually profitable, but they are illegal, they are 101 99:59:59,999 --> 99:59:59,999 not made. Because of that, there are lost gains from trade or a deadweight loss. 102 99:59:59,999 --> 99:59:59,999 Okay. So, we have covered the first two effects of price floors, namely surpluses 103 99:59:59,999 --> 99:59:59,999 and lost grains from trade. In the next lecture, we will use a slightly different 104 99:59:59,999 --> 99:59:59,999 example to look at wasteful increases in quality and a misallocation of resources. 105 99:59:59,999 --> 99:59:59,999 - [Announcer] If you want to test yourself, click Practice Questions. Or, if you're 106 99:59:59,999 --> 99:59:59,999 ready to move on, just click Next Video.