Price Floors: The Minimum Wage

Price floors, when prices are kept artificially high, lead to several consequences that hurt the consumer. In this video, we take a look at the minimum wage as an example of a price floor. Using the supply and demand curve and real world examples, we show how price floors create surpluses (such as a surplus in labor, or unemployment) as well as deadweight loss.

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- [Alex] In the next two videos,

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

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

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

the minimum wage.

Let's get started.

A price floor is a minimum price
allowed by law.

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

to buy or sell,

called a price floor

because you cannot go
below the floor.

We're going to show
that price floors

create four significant effects:

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

and a misallocation of resources.

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

Before we do so, however,

it's worthwhile
asking this question:

price floors are less common
than price ceilings --

why is this?

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

below the market price,

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

Why?

One reason may be political.

That is, there are typically
more buyers of goods

than there are sellers of goods.

So when you hold a price
below the market price,

you may benefit, or at least
appear to benefit,

more buyers,
more people, more voters

than when you hold a price
above the market price,

which would appear to harm buyers.

Now interestingly,
the paradigmatic,

the classic case of a price floor

is the exception
which proves the rule.

Because the classic case
of a price floor is a good

for which there are more sellers
than there are buyers.

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

and it make sense politically
because there are lots of sellers

compared to buyers.

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

and for which sellers exceed buyers?

We'll get to that in just a moment.

Think about it.

So one of the things
which a price floor does

is it creates surpluses.

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

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

exceeds the number of buyers?

Well, the minimum wage
is a price floor.

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

and the suppliers of labor
exceed the buyers of labor.

So it's not surprising
that a minimum wage

is often politically successful.

Now, who will
the minimum wage affect?

Workers with very high productivity

who are already earning
more than the minimum wage –

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

Instead, it will affect
the least experienced,

least educated, least trained workers.

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

by the minimum wage.

Now, I said that a price floor
creates surpluses.

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

A surplus of labor, we call what?

We say a gaggle of geese?

Say pride of lions?

A surplus of labor
is called unemployment.

So let's look with our model

to understand how a minimum wage
can create unemployment,

particularly among
the least skilled workers.

Okay. Here's our standard diagram,

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

especially unskilled labor,
on the horizontal axis.

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

there's our supply curve.

There's our demand curve
with the market wage

and the market employment level.

Now we're going to add
the minimum wage.

This is a price floor

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

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

So we read, for example,

that at the minimum wage,
the quantity of labor demanded

is read off the demand curve.

Remember, this is
the demand for labor.

So this is the quantity
of labor demanded,

and at the minimum wage,
the quantity of labor supplied

is read off the supply curve.

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

So we have Qs units
of labor supplied,

"Qd" units of labor demanded.

Qs is bigger than Qd,

so the difference between them
is a surplus of labor,

also known as unemployment.

Now the minimum wage
is a controversial

and hotly debated issue.

Some academic results indicate

that the unemployment effect
of a modest increase

in the minimum wage

would not be substantial.

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

that a modest increase
in the minimum wage

would not have big benefits either.

First, only a small percentage
of workers

are going to be affected
by the minimum wage.

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

In fact, even among young workers,

94% or so less than 25 years of age,

they already earn
more than the minimum wage.

At best, the minimum wage
will raise the wages

of some low-skilled
and young workers,

most of whose wages
would have increased anyway

as they became more skilled.

At worst, the minimum wage

will increase the price
of a hamburger,

create some unemployment,

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

not all necessarily bad things.

What, however,

about a larger increase
in the minimum wage?

Few economists doubt

that a large increase
in the minimum wage

would cause serious unemployment.

After all, we could
not create prosperity

by raising the minimum wage
higher and higher.

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

what about 15?

What about 20, 25, $100?

$500 an hour?

Would we all be rich at that point?

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

Of course not.

Most of us would be unemployed.

So a large increase
in the minimum wage

is going to cause
serious unemployment,

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

Congress actually set
the first minimum wage at this time

at 25 cents an hour.

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

when the average wage
in the United States

was still less than
a dollar an hour,

was 62 and a half cents an hour.

Congress, however,
forgot to exempt Puerto Rico,

when the average wages
in Puerto Rico at that time

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

only three cents
to four cents an hour.

So this modest increase
in the minimum wage

for the continental United States

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

And lots of Puerto Rican firms
went bankrupt,

it created devastating unemployment.

In fact, Puerto Rican politicians
came to Washington

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

So, a large increase
in the minimum wage

would certainly cause substantial
and serious unemployment.

We do see higher minimum wages
in other countries.

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

relative to average wages
in those two countries.

In addition, labor laws in France

make it very difficult
to fire workers

once they have been hired.

As a result, firms in France

are very reluctant
to hire new workers.

Younger workers
are especially affected

because they are less productive,

and also they are
less known commodities.

So, the risk
of hiring them is greater.

As a result, unemployment
among young workers

is very high in France.

It was 23% in 2005,

and that was long before
the economic crisis,

the financial crisis
affecting the entire world.

So even during good times,

unemployment in France
among young workers is very high,

because the minimum wage is high,

and because firms
don't want to hire,

given how difficult it is
to fire workers.

Okay. Let's also show
that the minimum wage

creates lost gains from trade --

this ought to be
fairly familiar by now.

At the minimum wage,
the quantity of labor demanded

is given by Qd.

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

given the market wage,
this market employment.

Key point is that
there are buyers of labor

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

and there are suppliers of labor,

workers who are willing
to work below the minimum wage.

These deals would be
mutually profitable,

but they are illegal.

So there are buyers of labor

who are willing to buy below
the minimum wage,

there are sellers willing to sell.

These deals would be
mutually profitable,

but they are illegal,
they are not made.

Because of that,
there are lost gains from trade,

or a deadweight loss.

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

namely surpluses
and lost gains from trade.

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

to look at wasteful
increases in quality

and a misallocation of resources.

- [Narrator] If you want
to test yourself,

click "Practice Questions."

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

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