Inefficiency of the Minimum Wage

Inefficiency of the Minimum Wage

The minimum wage was created to stop firms from paying their employees morally inadequate wages for the labor they provide and to allow individuals to obtain a wage that would be sufficient to sustain a decent standard of living.  However, when the government imposes a minimum wage, it creates a price floor for a firm that forces them to pay at least the minimum wage per hour.  When the government raises the minimum wage above the market equilibrium wage, supply exceeds demand. Raising the minimum wage above the market equilibrium wage makes it more expensive for firms to hire workers, especially if a firm requires a larger amount of unskilled labor where there is a low equilibrium wage rate (1).  In economic terms, inefficiency is created because some workers are in a market where the equilibrium price does not warrant the higher wage they are paid. Workers should be paid the price per hour that represents the market equilibrium value of the tasks that they are required to complete in order to reduce inefficiency. Thus, the minimum wage should not be raised despite the fact that inflation has eroded its value because it creates inefficiencies in the labor market that increases unemployment.  [pic 1]

A minimum wage creates a surplus of labor because it increases the price of labor above the equilibrium price, therefore, changing the quantities supplied and demanded. This is a movement along the supply curve, because at higher wages, more workers are willing to work. In the graph to the left, one can see the difference the minimum wage makes to the quantities supplied and demanded. Before, the equilibrium price ensured that businesses demanded the same amount of labor that the workers were willing to supply; now, however, businesses demand 21 million hours of labor per month while consumers are willing to supply 23 million hours of labor per month, therefore creating a surplus of 2 million hours per month. Because the quantity of labor demanded moved from 22 million hours of labor to 21 million hours of labor per month, we know that 1 of the 2 million hours of labor in surplus was caused by businesses demanding less labor. This occurs because labor is a cost for business, and an increase in the total average cost for a business would cause the marginal cost to exceed what the marginal revenue was before. Therefore, when a business sees their costs for labor increasing, they will try to reduce that cost by either reducing employee hours/benefits or by laying off employees. The rest of the 1 million hours of labor in surplus comes from the quantity supplied of labor rising from 22 million hours to 23 million hours of labor. This occurs because people who were not interested in obtaining a job when the wage level was at $5 are now interested when the minimum wage is set at $7.[pic 2]

Not only does a minimum wage create a surplus of workers searching for jobs, but it also creates a deadweight loss in a market. A deadweight loss is the cost to society that occurs when goods and services are not efficiently allocated. When goods and services are efficiently allocated, it is impossible to benefit someone without hurting someone else. Deadweight loss can be represented graphically through the triangle enclosed by the supply and demand lines as well as the vertical line going down from the quantity demanded at minimum wage to the origin. The deadweight loss changes based on the line going down from quantity demanded at minimum wage because the quantity demanded dictates how much labor is actually done in a month. Deadweight loss can be easily calculated by solving for the area of the red triangle, which is 2 million dollars per month. This means that 2 million dollars that could have benefited producers and consumers alike is now lost because of the set minimum wage.[pic 3]

     We can see that raising the federal minimum wage created inefficiency that resulted in deadweight lost by looking into the U.S. Census Bureau's data on the incomes earned by 15 to 24 year old Americans in 1994 and 2011.  The employment of individuals ages 15 to 24 has decreased from 1994 when the minimum wage was $4.25 compared to 2011 after the minimum wage was raised to $7.25.  The minimum wage was raised too far and prevented people from being able work in businesses that had jobs available at wages below the federal minimum. By using the data from the U.S. Census Bureau we can estimate that the deadweight loss to the U.S. economy as a result of the increase in the U.S. federal minimum wage from $4.25 per hour in 1994 to $7.25 per hour in 2011 is $485,430 per hour (2).  Individuals age 15 to 24 in the United States worked an average of 19.2 hours per week in 2011. Calculating this over a fifty-two week year span would estimate the deadweight loss of the minimum wage from $4.25 per hour in 1994 to $7.25 per hour in 2011 at $483,391,573 (2).  The deadweight loss from raising the minimum wage had cost the U.S. economy nearly half a billion dollars.[pic 4][pic 5][pic 6]

Even though millions of dollars per month are lost because of the minimum wage, people still support the enactment of it because of how it affects the employees of businesses. As said before, when wage is at equilibrium price, consumers and producers share surplus equally. However, when there is a minimum wage set on the labor market as shown on the graph to the left, the employees and the employers no longer equally share the surplus. Instead, the employees, whose surplus is shown in blue, enjoy a much larger surplus than the employers whose surplus is shown in green. However, while the employees have an advantage in this situation, only the workers lucky enough to have a job benefit. Thanks to the minimum wage, millions of people are now left without a job and searching for a way to make ends meet. While some people are now enjoying higher wages, they are doing so at the expense of other fellow unemployed workers.[pic 7]

In 2012,  there was 1.566 million hourly workers in the U.S. that earned the federal minimum wage of $7.25 and about 2 million that made less than the federal minimum wage because they under are one of many exemptions (i.e. tipped employees, full-time students, disabled workers).  This totals to about 3.55 million hourly workers that earn at or below the federal minimum wage (4).  People at or below the federal minimum wage are: mostly young adults 16 to 24 years old (50.6%), teenagers 16 to 19 years old (24%), and white women (50%).  Seventy-eight percent of these people are white and sixty-four percent are largely part-time workers.  They work in simple industries: 51% work in the leisure and hospitality industry, about 16% in retail, 9% in education and health services, nearly 44% are in food-preparation and serving-related occupations, 15% are in sales and related occupations, and others (4).  This shows that most people that work for minimum wage are indivduals that don’t need it and are individuals with work in simple industries that require less output from its workers than they are paid.  These  are mostly firms that require unskilled labor where there is a low equilibrium wage rate, and thus, find it diffult to manage when a minimum wage raise is mandated and ultimately causes firms to cut workers in order to meet the raise.  Also, data from the Bureau of Labor Statistics show that the workforce of individuals under the of age 25 constitute about 20% of those who earn hourly wages. These indidivuals, mostly teenagers and young adults, compose about half of all workers that earn the minimum wage or less (3).  This shows that although the minimum wage was created to decrease poverty it has created an inefficect labor market system that pays individuals that are well above the poverty line a wage that is well above the equalibrium wage rate for which they work for.[pic 8]