WEBVTT 00:00:09.139 --> 00:00:12.220 - In the next two videos, we'll turn our attention to price floors 00:00:12.400 --> 00:00:16.190 and their effects. In this video, we'll look at the first two effects and cover 00:00:16.370 --> 00:00:20.822 one of the most well known price floors, the minimum wage. Let's get started. 00:00:25.051 --> 00:00:29.930 A price floor is a minimum price allowed by law. That is, it is a 00:00:30.110 --> 00:00:35.280 price below which it is a legal to buy or sell, called the price floor because you 00:00:35.460 --> 00:00:41.200 cannot go below the floor. We're going to show that price floors create four 00:00:41.380 --> 00:00:49.500 significant effects; surpluses, lost gains from trade, wasteful increases in quality 00:00:49.680 --> 00:00:52.890 and a misallocation of resources. We're going to go through these each in turn 00:00:53.070 --> 00:00:58.380 before we do so however, is worthwhile asking this question. Price floors are 00:00:58.560 --> 00:01:04.400 less common than price ceilings. Why is this? That is it's more common to see a 00:01:04.580 --> 00:01:13.010 price being held below the market price, than it is to see a price being held above 00:01:13.190 --> 00:01:21.150 the market price. Why? One reason may be political, that is, there are typically 00:01:21.330 --> 00:01:28.650 more buyers of goods than there are sellers of goods. So when you hold a price 00:01:28.830 --> 00:01:34.850 below the market price, you may benefit or at least appear to benefit more buyers, 00:01:35.030 --> 00:01:42.250 more people, more voters than when you hold a price above the market price which 00:01:42.430 --> 00:01:47.780 would appear to harm our buyers. Now interestingly, the paradigmatic, the 00:01:47.960 --> 00:01:53.570 classic case of a price floor is the exception which proves the rule because 00:01:53.750 --> 00:01:59.690 the classic case of a price floor is a good for which there are more sellers than 00:01:59.870 --> 00:02:06.400 there are buyers. So here's the case where the price is kept above the market price 00:02:06.580 --> 00:02:10.810 and it make sense politically because there are lots of sellers compared to 00:02:10.990 --> 00:02:16.640 buyers. So, what is this good for which price floor is common and for which 00:02:16.820 --> 00:02:22.790 sellers exceed buyers? We'll get to that in just a moment. Think about it. So one 00:02:22.970 --> 00:02:27.190 of the things which a price floor does is it creates surpluses. Okay. Now, how do 00:02:27.370 --> 00:02:31.380 you thought of the good which a price floor is common and it's a good for which 00:02:31.560 --> 00:02:37.380 the number of suppliers exceeds the number of buyers? Well, the minimum wage is a 00:02:37.560 --> 00:02:44.380 price floor. The minimum wage is a price below which you cannot sell labor, and the 00:02:44.560 --> 00:02:49.210 suppliers of labor exceed the buyers of labor. So, it's not surprisingly that a 00:02:49.390 --> 00:02:53.970 minimum wage is often politically successful. Now, who will the minimum wage 00:02:54.150 --> 00:02:58.030 affect? Workers were very high productivity who already earning more than 00:02:58.210 --> 00:03:01.300 the minimum wage, they are not going to be affected by the minimum wage perhaps at 00:03:01.480 --> 00:03:06.440 all. Instead, it will affect the least experience, least educated, least trained 00:03:06.620 --> 00:03:11.260 workers. Low-skilled teenagers, for example, are most likely to be affected by 00:03:11.440 --> 00:03:17.350 the minimum wage. Now, I said that a price floor creates surpluses. The minimum wage 00:03:17.530 --> 00:03:23.150 is a price floor so it's going to create a surplus. A surplus of labor we call what? 00:03:23.330 --> 00:03:29.070 We say a gaggle of geese? Say pride of lions? A surplus of labor is called 00:03:29.250 --> 00:03:34.560 unemployment. So let's look with our model to understand how a minimum wage can 00:03:34.740 --> 00:03:39.900 create unemployment, particularly among the least skilled workers. Okay. Here's 00:03:40.080 --> 00:03:43.340 our standard diagram, accept we're going to put the quantity of labor, especially 00:03:43.520 --> 00:03:47.930 unskilled labor on the horizontal axis. The wage or the price of labor on the 00:03:48.110 --> 00:03:52.770 vertical axis. That's our supply curve. That's our demand curve with the market 00:03:52.950 --> 00:03:56.910 wage and the market employment level. Now, we're going to add the minimum wage. This 00:03:57.090 --> 00:04:03.650 is a price floor below which it is illegal to buy or sell this good labor. Now, we 00:04:03.830 --> 00:04:07.950 just read the consequences of the price floor of the diagram. So we read for 00:04:08.130 --> 00:04:14.030 example, that at the minimum wage, the quantity of labor demanded is right off 00:04:14.210 --> 00:04:18.600 the demand curve. Remember, this is the demand for labor. So, this is the quantity 00:04:18.779 --> 00:04:23.590 of labor demanded, and at the minimum wage, the quantity of labor supplied is 00:04:23.770 --> 00:04:30.230 right off the supply curve. Let's put that point on, that's QS. So we have QS units 00:04:30.410 --> 00:04:37.840 of labor supplied, QD units of labor demanded. QS is bigger than QD, so, the 00:04:38.020 --> 00:04:46.930 difference between them is a surplus of labor, also known as unemployment. Now, 00:04:47.110 --> 00:04:52.600 the minimum wage is a controversy and hotly debated issue. Some academic results 00:04:52.780 --> 00:04:57.600 indicate that the unemployment effect of a modest increase in the minimum wage would 00:04:57.780 --> 00:05:02.810 not be substantial. At the same time, however, we also have to recognize that a 00:05:02.990 --> 00:05:08.070 modest increase in the minimum wage would not have big benefits either. First, only 00:05:08.250 --> 00:05:12.780 a small percentage of workers are going to be affected by the minimum wage. Not any 00:05:12.960 --> 00:05:17.880 7% or so of workers already earn more than the minimum wage. In fact, even among 00:05:18.060 --> 00:05:23.600 young workers, 94% or so are less than 25 years of age, they already earn more than 00:05:23.780 --> 00:05:28.500 the minimum wage. At best, the minimum wage will raise the wages of some 00:05:28.680 --> 00:05:33.760 low-skilled and young workers, most of whose wages would have increase anyway as 00:05:33.940 --> 00:05:38.390 they became more skilled. At worst, the minimum wage will increase the price of 00:05:38.570 --> 00:05:44.670 hamburger, create some unemployment and/or keep some teenagers in school for a bit 00:05:44.850 --> 00:05:51.000 longer. Not all necessarily bad things. What, however, about a larger increase in 00:05:51.180 --> 00:05:56.270 the minimum wage? Few economists doubt that a large increase in the minimum wage 00:05:56.450 --> 00:06:03.360 would cause serious unemployment. After all, we could not create prosperity by 00:06:03.540 --> 00:06:07.360 raising the minimum wage higher and higher. If a minimum wage of 10 dollars an 00:06:07.540 --> 00:06:11.640 hour is a good idea, what about 15? What about 20? 25? A hundred dollars? 00:06:11.820 --> 00:06:16.350 500 dollars an hour? Would we all be rich at that point? Would we all be 00:06:16.530 --> 00:06:20.920 receiving wages of 500 dollars an hour? Of course not. Most of us would be 00:06:21.100 --> 00:06:25.390 unemployed. So a large increase in the minimum wage is going to cause serious 00:06:25.570 --> 00:06:30.620 unemployment and the good example of this is Puerto Rico in 1938. Congress actually 00:06:30.800 --> 00:06:35.920 set the first minimum wage at this time at 25 cents an hour. Now, that may seem 00:06:36.100 --> 00:06:39.690 low but that's at the time when the average wage in the United States was 00:06:39.870 --> 00:06:44.600 still lesser than a dollar an hour, with 62 and a half cents an hour. Congress, 00:06:44.780 --> 00:06:49.910 however, forgot to exempt Puerto Rico. When the average wages in Puerto Rico at 00:06:50.090 --> 00:06:54.720 that time were much lower than in the rest of the United States, only three cents to 00:06:54.900 --> 00:06:59.880 four cents an hour. So this modest increase in the minimum wage for the 00:07:00.060 --> 00:07:04.720 continental United States was a huge increase in the minimum wage for Puerto 00:07:04.900 --> 00:07:09.610 Rico, and lots of Puerto Rican firms went bankrupt. It created devastating 00:07:09.790 --> 00:07:15.010 unemployment. In fact, Puerto Rican politicians came to Washington to beg for 00:07:15.190 --> 00:07:20.510 an exemption to get them out of the minimum wage. So, a large increase in the 00:07:20.690 --> 00:07:25.820 minimum wage would certainly cause substantial and serious unemployment. We 00:07:26.000 --> 00:07:30.190 do see higher minimum wages in other countries. The minimum wage in France is 00:07:30.370 --> 00:07:34.730 higher than the U.S. relative to average wages in those two countries. In addition, 00:07:34.910 --> 00:07:39.240 labor laws in France make it very difficult to fire workers once they have 00:07:39.420 --> 00:07:46.050 been hired. As a result, firms in France are very reluctant to hire new workers. 00:07:46.230 --> 00:07:50.820 Younger workers are especially affected because they are less productive and also 00:07:51.000 --> 00:07:56.160 they are less known commodities. So, the risk of hiring them is greater. As a 00:07:56.340 --> 00:08:01.870 result, unemployment among young workers is very high in France. It was 23% in 2005 00:08:02.050 --> 00:08:08.460 and that was long before at the economic crisis, the financial crisis affecting the 00:08:08.640 --> 00:08:14.420 entire world. So even during good times, unemployment in France among young workers 00:08:14.600 --> 00:08:19.310 is very high because the minimum wage is high, and because firms don't want to 00:08:19.490 --> 00:08:24.500 hire, given how difficult it is to fire workers. Okay. Let's also show that the 00:08:24.680 --> 00:08:28.040 minimum wage creates lost gains from trade, that this ought to be fairly 00:08:28.220 --> 00:08:32.850 familiar by now. At the minimum wage, the quantity of labor demanded is given by a 00:08:33.030 --> 00:08:38.919 QD, that is less than the quantity of labor which would be traded given the 00:08:39.100 --> 00:08:45.800 market wage this market employment. The key point is that there are buyers of 00:08:45.980 --> 00:08:51.770 labor who are willing to buy labor at a price below the minimum wage, and they are 00:08:51.950 --> 00:08:57.790 suppliers of labor, workers who are willing to work below the minimum wage. 00:08:57.970 --> 00:09:05.070 These deals would be mutually profitable but they are illegal. So, there are buyers 00:09:05.250 --> 00:09:08.710 of labor who are willing to buy below the minimum wage, there are sellers willing to 00:09:08.890 --> 00:09:12.790 sell. These deals would be mutually profitable, but they are illegal, they are 00:09:12.970 --> 00:09:18.590 not made. Because of that, they are lost gains from trade or a deadweight loss. 00:09:18.770 --> 00:09:23.160 Okay. So, we have covered the first two effects of price floors, namely surpluses 00:09:23.340 --> 00:09:27.380 and lost grains from trade. In the next lecture, we will use a slightly different 00:09:27.560 --> 00:09:32.284 example to look at wasteful increases in quality and a misallocation of resources. 00:09:33.940 --> 00:09:38.110 - If you want to test yourself, click Practice Questions or if you're 00:09:38.290 --> 00:09:40.648 ready to move on, just click Next Video.