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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- 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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