Chapter 31

Minimum
Wage

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 Chapter Outline
• Traditional Economic Analysis Of A
Minimum Wage
• Rebuttal To The Traditional Analysis
• Where Are Economists Now?
• Kick It Up A Notch

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 Why Have a Minimum Wage
• The argument for a minimum wage is
that people who work full time
should not be in poverty. This
combines two concepts:
• Minimum Wage: the lowest wage that
may legally be paid for an hour’s work
• Living Wage: a wage sufficient to keep a
family out of poverty

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 Minimum Wage
Relative to the Poverty Line

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Nominal and Real Minimum Wage
(1999 dollars)

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 Minimum Wage Increases
• The Federal minimum wage was
originally set at 25 cents per hour.
• There have been 21 increases.
• July 2011 it was $7.25 per hour.
• To be equal to its 1968 high in
inflation-adjusted terms it would
need to be $11 per hour in 2009.

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 Minimum Wages
in States and Cities
• 15 states have minimum wages laws
• Many cities have their own
minimum wages laws
• 7 states index their minimum wages
for inflation

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 The Labor Market without a Minimum
Wage
• Value to the firms:
W • 0ACL*
A
Supply • Firms pay workers:
• OW*CL*
W* • The opportunity cost to workers:
C
• OBCL*
• Surplus to firms:
B
• W*AC
Demand • Surplus to workers:
0 L* Labor • BW*C

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 Minimum Wage Relevance
• A minimum wage is only relevant if it
is above the market wage.
• A minimum wage below the market
wage is irrelevant.
• The company must pay the market
wage to attract workers.
• Paying below the market wage is not in
its interests because such a wage would
not attract sufficient workers to the
company.
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 What’s Wrong with the
Minimum Wage
• The gain to the workers who keep
their jobs is less than the loss to the
losers who
• lose their jobs and
• are firms who have to pay higher wages.

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 The Case Against
(continued)

• An increase in the minimum wage by 10%

decreases the number of jobs held by teens by
1% to 3%.
• A minimum wage increase negatively affects
• small businesses more than larger firms.
• minorities more than whites.
• A majority of minimum wage workers are young
adults who are not supporting families. An
increase in the minimum wage is an inefficient
mechanism for helping poor working families.

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 The EITC Alternative
to the Minimum Wage
• The earned income tax credit (EITC)
• is a targeted tax credit to the working
poor.
• was, in 2011, as much as $4,824 for a
working poor family with two children.
• 70% of benefits go to households in
poverty
• 70% of minimum wage benefits go to
households not in poverty
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 The Rebuttals to the Traditional
Analysis
• The Macroeconomic Argument
• The money that is transferred from employers to
employees in more likely to be spent than saved
thereby increasing GDP.
• The Work Effort Argument
• People who are paid more may work harder than
people who are paid less. This may return some of
the increased wage paid by employers back to them
in terms of increased productivity.
• The Inelasticity of Labor Demand Argument
• If the demand for labor is inelastic then there is less
of a loss in employment and a smaller deadweight
loss.

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 Where are Economists Now
• Economists have long been against the
minimum wage and for the EITC.
• Card and Kruger challenged many of
the long-held conclusions in the 1990s
with research verifying the Inelasticity
Argument.
• For most labor economists, subsequent
research has re-verified the original
pro-EITC, anti-minimum wage
argument.
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 Kicking it Up a Notch: Demonstrating the Case
Against the Minimum Wage
• Value to the firms:
W • 0AELmin
Supply • Firms pay workers:
A
• 0WminELmin
E
Wmin • The opportunity cost to workers:
W* C • 0BFLmin
F • Surplus to firms:
• WminAE
B
• Surplus to workers:
Demand • BWminEF
0 Lmin L* LS • Unemployed workers
Labor • Who had jobs
• L*-Lmin
• Who are now looking
• LS-L*

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Demonstrating the Inelasticity Argument

W
Supply
E
Wmin
W* C Low level of DWL
F

B
Demand
0 Lmin L* Labor
Small number of displaced workers

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