- 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 a legal to buy or sell, called the 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, is 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 our 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. Now, how do
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 surprisingly that a
minimum wage is often politically successful. Now, who will the minimum wage
affect? Workers were very high productivity who 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 experience, 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, accept 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. That's our supply curve. That'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 right 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
right 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 controversy 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. Not any
7% or so of workers already earn more than the minimum wage. In fact, even among
young workers, 94% or so are 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 increase anyway as
they became more skilled. At worst, the minimum wage will increase the price of
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 dollars an
hour is a good idea, what about 15? What about 20? 25? A hundred dollars?
500 dollars an hour? Would we all be rich at that point? Would we all be
receiving wages of 500 dollars 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 the time when the average wage in the United States was
still lesser than a dollar an hour, with 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 at 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, that this ought to be fairly
familiar by now. At the minimum wage, the quantity of labor demanded is given by a
QD, that is less than the quantity of labor which would be traded given the
market wage this market employment. The key point is that there are buyers of
labor who are willing to buy labor at a price below the minimum wage, and they 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, they 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 grains 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.
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