A price floor is a legal minimum on the price at which a good can be sold. When you think of a floor, you think low, so of course one would automatically assume that a price floor would be below the equilibrium price. However, that is incorrect. A binding price floor keeps the market price high; not allowing it to drop to the equilibrium, therefore it is kept above the equilibrium price. Because of this, the amount of a good that is supplied will exceed the amount that is demanded, causing a surplus in the market. That’s the basics of Economics.
The most common example of a price floor are minimum wage laws which enforce the lowest price for labor that any employer may pay. This law was first instituted by the U.S. Congress with the Fair Labor Standards Act of 1938, done in effort to safeguard workers with a minimally suitable standard of living.
According to federal law, the minimum wage was $7.25 per hour in 2015, however some states ordered minimum wages above the federal level. (Mankiw, 2018) In order to consider and understand the outcomes of a minimum wage, one must first take into account the market for labor. The labor market is not exempt from the forces of supply and demand. Labor is supplied by the workers in the market and demand for that labor is established by the firms. In a balanced market where the demand and supply for labor are equal, the wage will normally adjust on its own as long as the government does not intervene. (Mankiw, 2018)
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As mentioned above, economics teaches us that one negative effect of a binding price floor such as minimum wage will be unemployment. The expectations would be an excess of the quantity of labor supplied from workers in comparison to the quantity of labor demanded by firms. It’s a given fact that individuals purchase less of a good or service when the price rises. Again, labor is not exempt. Writing for Forbes, Tim Worstall offered a mathematical proof: “A reduction in wage costs of some few thousand dollars increases employment. Obviously therefore a rise in wage costs of four or five times that is going to have significant unemployment effects.” (Kwak, 2017)
The truth of the matter is that after considering past experiences, there is no obvious correlation between unemployment and the minimum wage. (Kwak, 2017) The United States Department of Labor researched 64 studies on the effects of minimum wage increases and unemployment. Contrary to economic belief, the findings from these studies suggested more benefits than costs. Instead of an increase in unemployment, the studies found that there was a decrease in employee turnover in addition to a decrease in the expenses affiliated with hiring and training new employees. (Waldrop, 2015)
This notion that an increased minimum wage may possible contradict the basic lessons of economics was even shocking for me. At start of my research, I just knew that I would find an excessive amount of support backing the fact that unemployment would increase.
According to the textbook, if labor becomes more expensive, firms will buy less of it, but there are several reasons why the real world doesn’t behave as expected. There’s a saying, “You have to spend money in order to make money.” Well, companies that are willing to pay more, often find themselves benefitting from higher employee productivity. In turn, the increase of labor costs is offset. These higher wages are rather motivating; encouraging people to work harder while attracting higher skilled workers at the same time. The end result being an increase in employment and output. (Kwak, 2017)This fact was proven in the UK. The British minimum wage has doubled over the last 17 years.
Research of this data compared to unemployment levels has shown that there is no apparent correlation between the two. The UK currently has the lowest ever unemployment and the highest ever minimum wage. (Edwards, 2017) Earlier studies at the national level have found that a 10% increase in the minimum wage would reduce employment by 1%, if anything at all. A tradeoff that minimal suggests that the benefits of raising the wage outweigh the relatively insignificant job losses it might create.(Edwards, 2017)
The bottom line is that job loss due to a minimum wage price floor is inevitable, however the loss will be caused by several reasons. The percentage level of unemployment will have many factors. For starters, there will be a reduction in demand from firms. At the same time, many small businesses who cannot afford the increased labor costs will be forced to close, causing workers to lose their jobs. Some firms may even choose to shift their labor costs toward technological development in place of skilled workers. The minimum wage price floor has its pros and cons, with many arguments supporting both, however there is no true evidence proving any correlation. Either way the coin is flipped, there will be job loss and job gain; it all depends on the independent labor market.
References
- Edwards, J. (2017, Oct 29). Britain has doubled its minimum wage since 2000 — with no observable effect on unemployment. Retrieved from Business Insider: https://www.businessinsider.com/britain-doubled-minimum-wage-with-no-effect-on-unemployment-2017-10
- Kwak, J. (2017, Jan 14). The Curse of Econ 101: When it comes to basic policy questions such as the minimum wage, introductory economics can be more misleading than it is helpful. Retrieved from The Atlantic: https://www.theatlantic.com/business/archive/2017/01/economism-and-the-minimum-wage/513155/
- Mankiw, N. G. (2018). Chapter 6: Supply, Demand, and Government Policies. In Principles of Economics (Eighth ed., pp. 116-120). Boston, MA: Cengage Learning.
- Waldrop, S. A. (2015, Jan 30). How Minimum Wage Impacts Unemployment. Retrieved from Investopedia: https://www.investopedia.com/articles/personal-finance/013015/how-minimum-wage-impacts-unemployment.asp
