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A Student’s Question About the Minimum Wage

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UnknownLast night in my Principles of Microeconomics class at George Mason University (ECON 103) my students and I discussed the economics of the minimum wage.  Here’s a letter to one of my students who e-mailed me with a question:

Dear Mohammed:

You ask: “What if prices go up by the whole amount of the minimum wage? Won’t that let businesses afford to pay workers more and not fire any of them? For example what if the [minimum] wage goes up by 25% and all prices go up by 25%?”

Your question is a good one, and I apologize for rushing too quickly last night pass this possibility.

First a small point: because labor costs are only part of producers’ costs, a better way to word your example is “What if a 25 percent rise in the minimum wage causes employers’ costs to rise by 10 percent, and what if, then, all prices rise by 10 percent?”

A deeper understanding of the answer to your question requires that we first cover in more detail the nuances of demand and supply elasticities (which we’ll do in a later lecture).

But for now think of the matter this way: If all prices rise – as a result of a hike in the minimum wage – by enough to ensure that employers’ profits are not reduced at all by the higher minimum wage, then the amount of output that consumers buy will be less than they bought before the minimum wage rose.  That is, the rise in the prices of those consumer goods and services that are produced using lots of low-skilled workers will cause consumers to buy fewer of those goods and services.  Consumers will buy, for example, fewer meals at fast-food restaurants, fewer lawn-mowings, and fewer stays at motels.  And as consumers buy fewer of these goods and services, the amounts of these goods and services that employers produce will therefore fall – meaning that the demand for low-skilled workers will also fall. The final result is fewer jobs for low-skilled workers.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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