A $9 Minimum Wage and a Lesson in Price Floors

Feb 28, 2013

Since President Obama proposed last month in his State of the Union address to increase the federal minimum wage to $9 per hour, analysts have been theorizing about what this will mean for the American public. At Edgeworth, we think about the President’s proposal from an economic perspective in terms of how it impacts both the US economy and the labor market. 

The minimum wage is an example of a price floor in economics. A price floor is the absolute minimum price at which a good or service (labor in this case) can be sold and it is usually set by the government.

Price floors are set above the market equilibrium price of a good or service. The market equilibrium price is where the supply of a good or service meets the demand for it in the marketplace. The minimum wage price floor is enacted so that the suppliers (current or potential employees in this case) will not sell their labor below the designated price even if the demanders (employers) are willing to hire them for less.

In economic theory, a price floor creates a surplus in the market place because there is more supply than demand at the set price. This theory applies to the market for labor as well. Some argue that when the minimum wage is raised, more people want jobs because now they are more lucrative. However new jobs are not necessarily created. Based on this standard economic model, when demand for labor is greater than the supply, a labor surplus results, creating unemployment.

However, this supply and demand model may not fully depict the dynamic nature of the labor market, leading to a serious debate on the precise implications of raising the minimum wage. While some economists adhere to the tenet of increased unemployment, others argue that when the minimum wage is modestly increased, this increase in labor costs is small compared to a company’s overall cost and may be more easily absorbed into existing cost structures. Instead of laying off workers, companies frequently decide to lower costs through a variety of other techniques such as restricting hours, lowering non-wage benefits, reducing training, limiting the salaries of higher-skilled works or increasing prices paid by consumers.

No matter which side of the debate economists are on, most can agree that the implications of increasing the minimum wage are multifaceted and may vary by company and industry.  Until further congressional action occurs, economists will continue to debate the potential effects of increasing the minimum wage.

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