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A living wage: example of a price floor

The graph shows how a price floor results from an excess supply of labor.
The original equilibrium in this labor market is a wage of $10/hour and a quantity of 1,200 workers, shown at point E. Imposing a wage floor at $12/hour leads to an excess supply of labor. At that wage, the quantity of labor supplied is 1,600 and the quantity of labor demanded is only 700.
Living wage: example of a price floor
Wage Quantity Labor Demanded Quantity Labor Supplied
$8/hr 1,900 500
$9/hr 1,500 900
$10/hr 1,200 1,200
$11/hr 900 1,400
$12/hr 700 1,600
$13/hr 500 1,800
$14/hr 400 1,900

The minimum wage as an example of a price floor

The U.S. minimum wage is a price floor that is set either very close to the equilibrium wage or even slightly below it. About 1% of American workers are actually paid the minimum wage. In other words, the vast majority of the U.S. labor force has its wages determined in the labor market, not as a result of the government price floor. But for workers with low skills and little experience, like those without a high school diploma or teenagers, the minimum wage is quite important. In many cities, the federal minimum wage is apparently below the market price for unskilled labor, because employers offer more than the minimum wage to checkout clerks and other low-skill workers without any government prodding.

Economists have attempted to estimate how much the minimum wage reduces the quantity demanded of low-skill labor. A typical result of such studies is that a 10% increase in the minimum wage would decrease the hiring of unskilled workers by 1 to 2%, which seems a relatively small reduction. In fact, some studies have even found no effect of a higher minimum wage on employment at certain times and places—although these studies are controversial.

Let’s suppose that the minimum wage lies just slightly below the equilibrium wage level. Wages could fluctuate according to market forces above this price floor, but they would not be allowed to move beneath the floor. In this situation, the price floor minimum wage is said to be nonbinding —that is, the price floor is not determining the market outcome. Even if the minimum wage moves just a little higher, it will still have no effect on the quantity of employment in the economy, as long as it remains below the equilibrium wage. Even if the minimum wage is increased by enough so that it rises slightly above the equilibrium wage and becomes binding, there will be only a small excess supply gap between the quantity demanded and quantity supplied.

These insights help to explain why U.S. minimum wage laws have historically had only a small impact on employment. Since the minimum wage has typically been set close to the equilibrium wage for low-skill labor and sometimes even below it, it has not had a large effect in creating an excess supply of labor. However, if the minimum wage were increased dramatically—say, if it were doubled to match the living wages that some U.S. cities have considered—then its impact on reducing the quantity demanded of employment would be far greater. The following Clear It Up feature describes in greater detail some of the arguments for and against changes to minimum wage.

What’s the harm in raising the minimum wage?

Because of the law of demand, a higher required wage will reduce the amount of low-skill employment either in terms of employees or in terms of work hours. Although there is controversy over the numbers, let’s say for the sake of the argument that a 10% rise in the minimum wage will reduce the employment of low-skill workers by 2%. Does this outcome mean that raising the minimum wage by 10% is bad public policy? Not necessarily.

If 98% of those receiving the minimum wage have a pay increase of 10%, but 2% of those receiving the minimum wage lose their jobs, are the gains for society as a whole greater than the losses? The answer is not clear, because job losses, even for a small group, may cause more pain than modest income gains for others. For one thing, we need to consider which minimum wage workers are losing their jobs. If the 2% of minimum wage workers who lose their jobs are struggling to support families, that is one thing. If those who lose their job are high school students picking up spending money over summer vacation, that is something else.

Another complexity is that many minimum wage workers do not work full-time for an entire year. Imagine a minimum wage worker who holds different part-time jobs for a few months at a time, with bouts of unemployment in between. The worker in this situation receives the 10% raise in the minimum wage when working, but also ends up working 2% fewer hours during the year because the higher minimum wage reduces how much employers want people to work. Overall, this worker’s income would rise because the 10% pay raise would more than offset the 2% fewer hours worked.

Of course, these arguments do not prove that raising the minimum wage is necessarily a good idea either. There may well be other, better public policy options for helping low-wage workers. (The Poverty and Economic Inequality chapter discusses some possibilities.) The lesson from this maze of minimum wage arguments is that complex social problems rarely have simple answers. Even those who agree on how a proposed economic policy affects quantity demanded and quantity supplied may still disagree on whether the policy is a good idea.

Concepts and summary

In the labor market, households are on the supply side of the market and firms are on the demand side. In the market for financial capital, households and firms can be on either side of the market: they are suppliers of financial capital when they save or make financial investments, and demanders of financial capital when they borrow or receive financial investments.

In the demand and supply analysis of labor markets, the price can be measured by the annual salary or hourly wage received. The quantity of labor can be measured in various ways, like number of workers or the number of hours worked.

Factors that can shift the demand curve for labor include: a change in the quantity demanded of the product that the labor produces; a change in the production process that uses more or less labor; and a change in government policy that affects the quantity of labor that firms wish to hire at a given wage. Demand can also increase or decrease (shift) in response to: workers’ level of education and training, technology, the number of companies, and availability and price of other inputs.

The main factors that can shift the supply curve for labor are: how desirable a job appears to workers relative to the alternatives, government policy that either restricts or encourages the quantity of workers trained for the job, the number of workers in the economy, and required education.

Problems

Identify each of the following as involving either demand or supply. Draw a circular flow diagram and label the flows A through F. (Some choices can be on both sides of the goods market.)

  1. Households in the labor market
  2. Firms in the goods market
  3. Firms in the financial market
  4. Households in the goods market
  5. Firms in the labor market
  6. Households in the financial market
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Predict how each of the following events will raise or lower the equilibrium wage and quantity of coal miners in West Virginia. In each case, sketch a demand and supply diagram to illustrate your answer.

  1. The price of oil rises.
  2. New coal-mining equipment is invented that is cheap and requires few workers to run.
  3. Several major companies that do not mine coal open factories in West Virginia, offering a lot of well-paid jobs.
  4. Government imposes costly new regulations to make coal-mining a safer job.
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References

American Community Survey. 2012. "School Enrollment and Work Status: 2011." Accessed April 13, 2015. http://www.census.gov/prod/2013pubs/acsbr11-14.pdf.

National Center for Educational Statistics. “Digest of Education Statistics.” (2008 and 2010). Accessed December 11, 2013. nces.ed.gov.

Questions & Answers

what is scarcity
Bonny Reply
what is demand
Sophia Reply
demand means that's good demand according to your needs is called demand
Bonny
needs of people ar called demand
Francis
what's the difference between opportunity cost and production possibility curve?
Francis
apportunity cost means a goods which can be replace by other goods without any ease of saticfaction
Bonny
what is economocs
Bonny Reply
Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.
Abubakari
It deals with making choices in the face of scarcity
Abu
what is perfect complements?
Bilal Reply
explain the return to scale with the help of mathematical expression
Bilal
what is scarcity
Bonny
difference between fixed policy and monetary policies
Doris Reply
explain why the ppc curve slopes downward?
Osei Reply
As you shift you attention to producing more of one good the graph will represent the trade-off of of the limitations of time or resources producing one verses the other good. The first 2 end points represent that you are using all your resources to only produce one good.
Sean
what is perfect complements?
Bilal
determination of perfect competition
Mumbere Reply
How can economics be important to us
Obed Reply
how can economics be important to us
Winny
economics is important on expenditure analysis
Umar
because it is to make choice
Puosour
Economics also provide the individuals the opportunity to make significant contributions to make social and economic development in their country
Sarah
Economic is important because of the fact of scarcity and desire for efficiency...
Ernest
it enable us to make rational choice
Osman
what is unemployment
scor
unemployment occurs when a person is actively searching for employment is unable to find work .....
Fatema
unemployment occurs when an individual is willing and capable to work but is unable to attain a job.
Lintoya
It is important because economics provide solutions about scarcity.
Pobreng
which of the following measures will the government take during inflation?
Ally
Price falls and demand is inelastic Please define it with an example and diagram.
Muhammad Reply
difference between nominal gdp and real gdp
Sakshi Reply
main is adjustment for inflation
cleophas
what are the factors of production
Sheku Reply
capital, labor, technology
Lucas
is economic a science
Emmanuel Reply
as economic a science
Emmanuel
yes because it study human behavior
Ahmed
yes it deal with human activity and the welfare of people in the country
Nsobila
yes because it uses scientific methods of solving problems
Osman
yes
Sarah
yes because it uses scientific methods in solving problems
Sarah
pls can I ask a question
Sarah
yes
Nyakeh
Pls what are the characteristics of opportunity costs
Sarah
identify the type of price elasticity of demand
Mamie
economic is a science
Azeez
what is monopoly
Issah
Is Economics a Science
Albert Reply
what is scarcity
Edmore Reply
Scarcity is the limitedness of resources relative to human wants. In economic sense means that the available resources are not sufficient to satisfy all human wants.
Innocent
Moreover, Fiscal policy deal with government revenue and expenditure. Government expenditure puts money in public hands while government revenue withdraws the money. Role of fiscal policy is to reduces money circulation as a means of reducing demand.
Innocent
What is an inflationary spiral?
Innocent
Suppose that you 're nominated as a Minister of Finance in your country's. How can you finance a deficit budget?
Innocent
is economic a science
Emmanuel
yes because we studying human behaviour
Umar
what are the factors of production
Sheku
pls Emmanuel adjei do we know each other
Hawa
Emmanuel adjei pls did u attend living God school
Hawa
Can you explain the terms 'fiscal deficit' and 'fiscal policy'?
Brahmani Reply
fiscal deficit refers to the government expenditure exceed expected to the government revenue
Innocent
fiscal deficit is like budget deficit
Innocent
fiscal policy it occurs when the government takes and maintain the strategic to resolve the inflation.
Innocent

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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