McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 33 Minimum Wage

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Outline TRADITIONAL ECONOMIC ANALYSIS OF A MINIMUM WAGE REBUTTAL TO THE TRADITIONAL ANALYSIS WHERE ARE ECONOMISTS NOW?

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Why Have a Minimum Wage The argument for a minimum wage is that people who work full time should not be in poverty. This combines two concepts: –Minimum Wage: the lowest wage that may legally be paid for an hour’s work –Living Wage: a wage sufficient to keep a family out of poverty

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Minimum Wage Increases The Federal minimum wage was originally set at 25 cents per hour. There have been 18 increases. In 2001 it was $5.15 per hour. To be equal to its 1968 high in inflation- adjusted terms it would need to have been close to $8 per hour in 2001.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Labor Market without a Minimum Wage Labor W Demand Supply A W* B C 0 L* Value to the firms: 0ACL* Firms pay workers: OW*CL* The opportunity cost to workers: OBCL* Surplus to firms: W*AC Surplus to workers: BW*C

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Minimum Wage Relevance A minimum wage is only relevant if it is above the market wage. A minimum wage below the market wage is irrelevant. –The company must pay the market wage to attract workers. –Paying below the market wage is not in its interests because such a wage would not attract sufficient workers to the company.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. What’s Wrong with the Minimum Wage The gain to the workers who keep their jobs is less than the loss to the losers who –lose their jobs and –are firms who have to pay higher wages.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Demonstrating the Case Against the Minimum Wage Labor Value to the firms: 0AEL min Firms pay workers: OW min EL min The opportunity cost to workers: OBFL min Surplus to firms: W min AE Surplus to workers: BW min EF Unemployed workers Who had jobs L*-L min Who are now looking L S -L* W Demand Supply A W* B C 0 L* W min L min LSLS E F

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Case Against (continued) An increase in the minimum wage by 10% decreases the number of jobs held by teens by 1% to 3%. A minimum wage increase negatively affects –small businesses more than larger firms. –minorities more than whites. A majority of minimum wage workers are young adults who are not supporting families. An increase in the minimum wage is an inefficient mechanism for helping poor working families.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The EITC Alternative to the Minimum Wage The earned income tax credit (EITC) –is a targeted tax credit to the working poor. –was, in 2000, as much as $3,888 for a working poor family with two children.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. The Rebuttals to the Traditional Analysis The Macroeconomic Argument –The money that is transferred from employers to employees in more likely to be spent than saved thereby increasing GDP. The Work Effort Argument –People who are paid more may work harder than people who are paid less. This may return some of the increased wage paid by employers back to them in terms of increased productivity. The Inelasticity of Labor Demand Argument –If the demand for labor is inelastic then there is less of a loss in employment and a smaller deadweight loss.

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Demonstrating the Inelasticity Argument Labor W Demand Supply W* B C 0 L* W min L min E F

McGraw-Hill/Irwin © 2002 The McGraw-Hill Companies, Inc., All Rights Reserved. Where are Economists Now Economists have long been against the minimum wage and for the EITC. Card and Kruger challenged many of the long-held conclusions in the 1990s with research verifying the Inelasticity Argument. For most labor economists, subsequent research has re-verified the original pro-EITC, anti-minimum wage argument.