The economist is watching the news on television. A reporter says: “The debate is heating up over the proposed increase in the minimum wage. We asked people at random if they thought a rise in the minimum wage would lower employment, profits, or both. Nine out of ten said profits. The argument we heard most often was that companies would not lay off people who earned the minimum wage just because it was increased. Instead, the companies would simply see their costs rise, and their profits decline.”
Hear what and how the economist thinks:
When it comes to proposals to raise the minimum wage, it seems as if you hear from two groups of people. First, there are those who claim an increase in the minimum wage will not affect the number of persons employed. In other words, if there are 400,000 employees earning a wage rate of \($10\) an hour, these same 400,000 will still be employed when the wage rate is raised to \($15\) an hour.
Then there are those who often claim that an increase in the minimum wage will reduce employment quite substantially. For instance, if there are 400,000 employees earning \($10\) an hour, and then the wage rate changes to \($15\) an hour, this increase will cause employment to fall precipitously, say, to 200,000.
What each of the two groups is predicting can be viewed in terms of the formula for the elasticity of labor demand, which is the percentage change in the quantity demanded of labor divided by the percentage change in the wage rate:
Elasticity of labor demand Percentage change in quantity demanded of labor Percentage change in wage rate/5 The first group we mentioned holds that as the denominator in the elasticity formula changes, the numerator does not. In other words, if there is a percentage rise in the wage rate, the percentage change in the quantity demanded of labor will be zero.
The second group we mentioned holds that, as the denominator changes, the numerator will change by a much greater percentage than the denominator. In other words, if the denominator rises by 10 percent, then the numerator will change by 40 percent.
In reality, how many people actually end up losing their minimum-wage jobs as the minimum wage rises depends upon the elasticity of demand for labor. If the demand for labor that is paid the minimum wage is inelastic, then the percentage change in the quantity demanded of labor will be less than the percentage rise in the wage rate. If it is elastic, then the percentage change in the quantity demanded of labor will be greater than the percentage rise in the wage rate. Simply put, it might be the case that as the minimum wage is increased, the cutback in the quantity demanded of labor is very small. But it might also be the case that as the minimum wage is increased, the cutback in the quantity demanded of labor is very large.
Again, whether there are large, small, or no reductions in the quantity demanded of labor depends upon the elasticity of labor demand.
Questions:
1. A person says, “Even if there is a little rain tomorrow, I still think there will be a lot of people going to the beach.” How is this similar to the person who says, “Even if the price of the good rises, I still think people will buy as much of the good as they bought before.”
2. Person 1 says, “A rise in the minimum wage will not lead to a cutback in the number of persons employed.” Person 2 says, “That is not true if the demand curve for labor is downward sloping.” Does person 2’s comment have any relevance to what person 1 says? Explain your answer.