Hi everyone, my first post here and before I explain my probably easy question I just want to offer preemptive thanks for any help. I'm your average young adult libertarian with a recently developed interest in economics and I've been trying to learn as much as I can lately (Probably too much even! This science is soo expansive I can hardly even integrate and remember it all!). Now, I'm currently in an email debate about the minimum wage with a particularly intelligent liberal friend of mine, and while acknowledging that minimum wages will usually increase unemployment in the lesser skilled, he maintains it isn't proper to assert such in any blanket statement kind of way. Namely, he mentions a situation in which a minimum wage will actually increase demand for labor to such an extent it offsets any decrease in hiring. He says there are certain factors which can lead to the "natural" wage (his quotations, I'm guessing this is the wage at the natural rate of unemployment?) being unable to reach equilibrium. This in turn leads to aggregate demand being unable to reach equilibrium, which in turn messes with the whole employment-demand-inflation balance. He says a raise in minimum wage can increase aggregate demand because the marginal propensity to spend is higher for lower income workers.
Now, I understand what all this means (except how inflation really ties in) and his argument seems to make sense on the surface... but it also seems (thinking with my gut unfortunately because I couldn't find anything with the site search, which is why I'm here) like he's missing parts of the bigger picture which, like I said above, I haven't really been able to fully integrate yet. Could a minimum wage really increase overall employment in a situation like this? Would it increase employment in some areas while decreasing it in others so that as an aggregate there is hardly any affect? Or, would it increase employment in some select few areas while still overall decreasing employment? If there is an employment increase, how long term could it be?
He says he got this from an empirical study that analyzed minimum wage increases in certain cities, but doesn't remember where he read it. Sorry, I know that makes it more difficult to address the study's methodology. Any help in understanding the theoretical aspects would be greatly appreciated.
Also, I'm aware this is some kind of Keynesianism despite being an argument I've never heard before. Is there a particular kind of Keynesiansim this would be attributed to (new, neo, post)?
EDIT: Sorry if I put this in the wrong forum.
Oh, and to briefly mention what I do understand about inflation in this issue, wouldn't the prices of consumer goods be raised in businesses with many minwage workers? I know inflation is actually defined as an increase in the money supply with rising prices just being an effect, and I don't see how raising the minwage could increase the money supply. One site I found via google briefly mentioned rising prices in this situation come out of what people would otherwise save. What do you guys think would be the effect of higher prices resulting from all this?
Get your hands on Economics in One Lesson
Read it and encourage your friend to read it too.
A minimum wage is a price control, it fixes the price for labor above the market price, resulting in unemployment. There is no way around this fact.
JackW: He says there are certain factors which can lead to the "natural" wage (his quotations, I'm guessing this is the wage at the natural rate of unemployment?) being unable to reach equilibrium. This in turn leads to aggregate demand being unable to reach equilibrium, which in turn messes with the whole employment-demand-inflation balance.
He says there are certain factors which can lead to the "natural" wage (his quotations, I'm guessing this is the wage at the natural rate of unemployment?) being unable to reach equilibrium. This in turn leads to aggregate demand being unable to reach equilibrium, which in turn messes with the whole employment-demand-inflation balance.
By definition, this is not equilibrium. If it requires outside influence to force a balance then it is not balanced. This is like saying two sides of a scale are balanced as long as you put some pressure on the right side.
JackW: He says a raise in minimum wage can increase aggregate demand because the marginal propensity to spend is higher for lower income workers.
He says a raise in minimum wage can increase aggregate demand because the marginal propensity to spend is higher for lower income workers.
If a company has $100 to spend on employment and minimum wage is $10 but people will work the job for $5 there is still $100 going from the company back into the market through employment. In the minimum wage case, 10 people will get $10/month and pay for food, clothing, shelter and some luxury goods. In the no minimum wage case 20 people will get $5/month and pay for food, clothing, shelter and nothing else.
So in the minimum wage case you have more luxury goods being purchased and less food/clothing/shelter being purchased along with 5 people starving to death or living off the state. In the no minimum wage case you have less luxury goods being purchased and more food/clothing/shelter and no one starving to death.
In your opinion, which of these is the true equilibrium? Is it better for the economy to have more luxury goods purchased and less necessities purchased? Does the market care whether it's luxury goods or necessities that are being purchased or just that voluntary exchanges are occuring? Is it better that some people starve while others have luxury goods?
Also consider that in the case where there is no minimum wage in our above example the company can get twice as much labor for the same cost which means they will produce more for the same amount of cost which will result in lowering the prices of their goods which will result in more purchasing power of those 20 employees.
JackW: He says he got this from an empirical study that analyzed minimum wage increases in certain cities, but doesn't remember where he read it. Sorry, I know that makes it more difficult to address the study's methodology. Any help in understanding the theoretical aspects would be greatly appreciated.
Most economic studies are correlational which is not grounds for acting on. Correlational studies are a great first step in the discovery process in science but only as a guide for future causational studies.
What he is saying in simple English is that sure, many workers will be left to starve in the streets because of minimum wage, but don't you worry.
1. Somehow, somewhere, somebody else will get more money than before due to the minimum wage law. More in fact, than he would have gotten by that tired scheme of supply and demand. And that somebody will get all the money that the fired suckers used to get, and more.
2. He will spend it all
3. And the economy will thrive.
****
That 1. is a big mistake should be obvious. In the long run, someone who gets more than supply and demand determines will either lose his job by getting fired, or lose his job by the company going out of business.
[Not to mention that a law that takes money away from anyone to give to the next guy, causing the first one to lose his job, is an outrage].
3. is a big mistake also, although it is the standard Keynesian fairy tale.
At least he got 2. right.
Like the other posters said, Eco in One Lesson is a good place to start.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
Hmm, that does make sense. But isn't his argument essentially that given a company with $100 to spend on labor, it won't hire all 20 workers at $5 because there are outside factors preventing equilibrium? How do we reconcile that?
What outside factors are preventing equilibrium, besides government regulations?
Mindblowing! It makes one wonder if a Minimum Underwear Price Law would also increase aggregate demand under certain conditions. Yes, some people may not be able to afford underwear, but the profits made from the ones that are able to afford it would be so huge that everything would turn out for the better for everyone in the end.
The guy is fan of Stiglitz, so he'd probalby mention instances of imperfect information et al.
I summarized your example by saying "That is a pretty interesting take on Keynes and price floors. I tried to find a study but couldn't find one quite like this so its hard to judge the methodology. Anyway, say a hypothetical company has $100 to spend on labor. If a minimum wage of $10 is put in place, that company can hire ten workers for labor. Without the minimum wage say that company would instead have hired 20 workers for $5. The same amount of $100 is being paid out in wages either way and by your own reasoning the example without a minimum wage will produce a higher aggregate demand(though probably not by much as this is obviously an exaggerated example). Not to mention, the latter example's company will also be more productive in turn enabling it to sell its goods for less and over time raise wages on its own."
He replied with, "that's a misleading example. it fails to answer quite a few things. 1) 20 workers working for 5 produces higher demand only if paying 10 10 leads to greater unemployment. 2) we're not talking about a wage floor in a system already at equilibrium, which is what your company is in. 3) it assumes absolute rationality on part of the employer "
Sorry if it seems like I'm trying to get you guys to do the hard work for me. I've read Econ in One Lesson before but it has been a while and I don't remember it addressing these particular issues. I'll definitely read it again now. I guess I've just gotten in over my head and don't know how to address all these issues at once.
Jack - welcome to the forums. My advice is to bring him back to the basics. Ask him to explain what would happen if there was a minimum price control on some other commodity, like oil or bread. If he knows a bit about economics, he should know that this would cause a surplus of the oil or bread. Then get him to acknowledge that 1) labor is a commodity, 2) wages are the price of labor, and 3) minimum wage legislation is a minimum price control. He would then have to somehow argue that labor is some exception to the rule... and he won't have any good reason why.
Or for another approach: get him to acknowledge that if the minimum wage was $500/hr, almost everyone would be out of work, because most people's labor is simply not worth that much, so no employer would want them. The same logic applies at any minimum wage, except that fewer people will be affected the lower it is set. Anyone whose labor is currently worth less than the minimum wage is unable to get onto the job ladder... because the bottom rungs have been removed.
He can't wriggle out of this logical approach by pointing to some real-world study. If someone claimed to have found a triangle that violates and disproves Pythagoras' Theorem, we would laugh at him: clearly something has gone wrong with his measurements or calculations somewhere, because that theorem is logically derived. If there is a lack of correlation between minimum wage rates and unemployment, then clearly other factors are at work: it is not that the theory is disproved.
Anyway, this may interest you: Economics in One Lesson: Wars, Governments, Price Controls and the Boom-Bust Cycle.
Government Explained 2: The Special Piece of Paper
Law without Government
JackW: He replied with, "that's a misleading example. it fails to answer quite a few things. 1) 20 workers working for 5 produces higher demand only if paying 10 10 leads to greater unemployment.
He replied with, "that's a misleading example. it fails to answer quite a few things. 1) 20 workers working for 5 produces higher demand only if paying 10 10 leads to greater unemployment.
Which it necessarily will. Companies have a finite budget to work with. If they are required by law to pay people more ($10) than those people would work for given an unregulated labor market ($5) then the company necessarily must hire fewer employees. If any company hires fewer employees in a regulated labor market than they would in an unregulated labor market then we can conclude that there are more people unemployed in the regulated market compared to an unregulated market.
I'm guessing the (flawed) logic he is using that those people will go get jobs elsewhere. However, all companies are limited by these restrictions and we have already established that those individuals have $5 skills meaning the other companies are going to be in the same boat and hiring half as many people for that type of work.
If you break it all the way down eventually you are lead to the conclusion that involuntary unemployment doesn't exist in an unregulated market. Market regulation is what leads to unemployment. When the market determines the skillset of the laborer is valued below minumum wage then that laborer becomes unemployable.
JackW: 2) we're not talking about a wage floor in a system already at equilibrium, which is what your company is in.
2) we're not talking about a wage floor in a system already at equilibrium, which is what your company is in.
Can you clarify this statement? I don't understand what equilibrium he is referring to. As I mentioned before, it's not equilibrium if it requires intervention to be achieved.
JackW: 3) it assumes absolute rationality on part of the employer
3) it assumes absolute rationality on part of the employer
No it doesn't. Employers will hire and fire as they see fit and the market will weed out the successful ones over time. Individual businesses do not need to function rationally for the market as a whole to succeed. In fact, market regulation results in otherwise good businesses failing and bad businesses succeeding which is the opposite of the desired effect.
TANSTAAFL: Get your hands on Economics in One Lesson Read it and encourage your friend to read it too.
I think this should get its own sticky since it is linked to so often:
http://fee.org/library/books/economics-in-one-lesson/
What are some of these "outside factors" which he's talking about? That's incredibly vague so I don't know how anyone can address it. That's like me saying "because of some destabilizing factors caused by the market which leads to under farming and famine, we have to have the government give huge amounts to farmers" it's nonsense.
An increase in the price of a good, all else equal, will lead to a decrease in the amount sold. In terms of the minimum wage this means an increase in unemployment, and of the lowest income levels of society. It doesn't end here however, an increase in the cost of production leads to an increase in the price of the consumer's goods. This means you've increased prices, you've decreased amount of labor consumed and you've decreased the amount that people will consume, decreased the size of the pie and decreased the number of people who have access to the pie.
In some cases benefits won't even be derived from people who can receive the higher wages as minimum wage labor with lower output might be replaced by higher wage labor with higher output.
There really is no way that one can get around this, and reffering to vague excuses cannot change the fact that minimum wages are likely to hurt everyone involved. Even if he was correct his thesis would imply that the minimum wage could only increase employment under certain conditions and it would be difficult and dangerous to indentify them and it would still mean that the minimum wage should be repealed upon a federal level.
If there's any other way that I could you with the debate then just say the word.
Like time, rationality is relative.
Pardon my vulgarity, but this is the best example I know. Ask him if he thinks it would be rational for a "straight" man to suck c$%k for money. He is gonna say no, that is crazy. Then get him to look at it from the perspective of the crack head. The crack head has no means, but his body is screaming for a fix. Desparate times call for desparate measures and in the worst of times men will act in ways that otherwise would be considered "irrational."
One could easily say it is "irrational" for the billionaire who already owns three yachts to purchase a fourth. He has no real "need" for the fourth yacht. Whenever anyone is accusing someone else of acting irrationally they are simply projecting their own value judgment onto others.
And if that is not enough ammunition we can go back to the basics. Whether a person acts rationally or irrationally does not matter. Motivation and the psychology of why someone acts is unimportant to economics. The salient point as far as economic study is concerned is that he acts.
Micah I get what you're saying about his points 1 and 3, but I'm not sure I follow you when you say something can't be equilibrium if it requires intervention? Isn't equilibrium just when supply and demand for a good are equal? From what I gather he is talking about a situation where wages are stuck at something lower than equilibrium would put them at, (an excess supply of labor?) and then raising the minimum wage so those workers with jobs could spend more and increase aggregate demand. And then the demand for that low skill labor market will increase I guess. There seems to be tons wrong with this, like it forgets the rise in consumer good prices caused by initial decrease in productivity Neodoxy brought up.. but I don't know how that ties in with this particular abnormal example. I've also read about imputation, where it can happen the other way around and cost of production is determined by the cost of goods, though I don't truly understand how that works even outside a strange example as this.
Also, could any of this have an effect on capital structure? Say if a business has to decrease investment to cover the extra costs?
Also, I'll ask him about what outside factors he's talking about.