A Note On Minimum Wages and Output Prices

by Don Boudreaux on July 29, 2016

in Myths and Fallacies, Work

Warning: wonky

A common argument offered by people who grasp for reasons to believe that minimum wages do not price some low-skilled workers out of jobs is that employers of low-skilled workers will raise the prices of their outputs in order to reap the additional revenues needed to cover those employers’ higher labor costs.

One correct and dominant response to this argument is that higher prices for goods and services produced with disproportionate amounts of low-skilled workers will reduce the quantities of such goods and services demanded by consumers and, thus, cause employers of low-skilled workers to employ fewer such workers.

Another response to this “they’ll-just-raise-their-prices” argument, however, is not correct – namely, it is not correct to ask rhetorically “If raising prices on outputs is such a good idea, why do employers wait for the minimum wage to rise before raising their output prices?”  The minimum-wage advocate has a good answer to this question.  That good answer is that, without a hike in the minimum wage, any firm that raises its prices will continue to be profitably underpriced by its competitors because those competitors’ costs of production have not risen.  The sustained rise in output prices that follows a hike in the minimum wage is possible only because all firms that employ low-skilled workers have higher costs because of the rise in the minimum wage.

Put differently, the reason firms’ output prices rise after the minimum wage is raised is that only after the minimum wage is raised do all of these firms have higher costs of production.  It’s this minimum-wage-induced rise in the production costs of all firms that employ minimum-wage workers that is responsible for the rise in output prices.

Notice, though, that the above correct reasoning implies that output prices are set competitively.  Firms cannot willy-nilly raise output prices whenever they wish because any firm that does so will lose too many customers to rivals that keep output prices lower and closer to costs.

This reasoning surely does square with American reality.  Food service, retailing, lawn-care and yard-maintenance services, and most other industries that employ disproportionately large numbers of low-skilled workers are among the most competitive in America.

Yet if output markets are competitive, firms operating in these markets have no excess profits into which they can dip to cover the higher labor costs brought on by the minimum wage.  If the minimum wage rises, some low-skilled workers must lose their jobs (or suffer some combination of reduced fringe benefits and worsened work conditions).

Indeed, the case is more general: even an employer with a genuine monopoly in the output market would still raise its output price in response to a hike in the minimum wage, for before that hike this firm presumably charged a profit-maximizing price and sold a profit-maximizing quantity of output.  The hike in the minimum wage raises this employer’s costs and, thus, reduces its profit-maximizing quantity of output.  (While such a monopolist might have excess profits into which it can dip to fully fund the higher labor costs brought on by the minimum wage, it will not do any such dipping, for such dipping is neither necessary nor desirable for the monopolist.)

Raising the minimum wage, therefore, while it causes output prices to rise, also inevitably causes the quantities of outputs supplied and sold by employers of minimum-wage workers to fall.  This reality holds true for employers that sell in competitive output markets as well as for employers that are monopoly sellers in their output markets.

It remains the case, therefore, that the only theoretically plausible situation under which a minimum wage will not destroy jobs is the situation of monopsony power in the market for low-skilled workers.  But theoretically plausible does not imply realistically plausible: it is ridiculous to believe that the market for low-skilled labor in the U.S. – or any localized market for low-skilled workers – is infected by such a quantity of monopsony power as to justify minimum-wage legislation.


I can’t resist reminding readers of Robert Reich’s especially absurd take on the argument that higher minimum wages are followed by higher output prices.


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