Price Floor & Legal Minimum Wage: Market Consequences & Economic Implications
The market consequence of a price floor is a reduction in the elasticity of price. Lower elasticity of price can decrease the buying capacity of consumers. When demand increases, the supply of non-scarce goods usually increases because of an increase in production. At the same time, the prices of these goods decrease along with the decrease in the variable costs per unit produced. However, because of the price floor, these prices cannot decrease below the set minimum price level. As a result, prices can increase but not decrease below the price floor level. Because of the price floor, prices remain at the price floor even when a lower price might be needed to compensate for market changes. In this condition, the consumer could buy less than what they could if there was no price floor.
The minimum wage law has a similar effect in the labor market. The economic implications of a legal minimum wage are based on the resulting inflexibility of wages relative to prices. When commodity prices decrease, lower profits could drive firms to reduce wages. However, because of the legal minimum wage, actual wages cannot decrease below the minimum wage level, even when prices continue to decrease and the firm takes some of the negative effects of this deflationary market change. Thus, a benefit of the minimum wage law is that it helps prevent deflation through the interactions among wages, demand, and prices. Deflation is prevented because prices could not easily fall when wages are maintained at or above the minimum wage level, as workers would remain capable of buying goods they need. Without the legal minimum wage, wages could decrease to the point where people would need to reduce their consumption, which leads to the downward spiral of deflation.
Should We Raise the Minimum Wage to Improve Workers’ Standard of Living?
The minimum wage does not need to be raised to provide workers with a better standard of living. The standard of living is mainly based on the buying capacity of workers and the quality of goods and services. Assuming that goods and services remain constant, if prices do not change, an increase in wages means that the workers would have higher buying capacity. A decrease in wages means that the workers would have reduced buying capacity. In this regard, if prices do not change, an increase in wages can improve the standard of living of workers, and a decrease in wages can decrease their standard of living.
However, in the real world, prices change according to market conditions and consumers’ buying behaviors. Realistically, an increase in wages does not necessarily mean an increase in workers’ standard of living. Also, a decrease in wages does not necessarily mean a decrease in workers’ standard of living. With inflation, prices increase continually, and higher wages would not necessarily give workers higher buying capacity and a better standard of living, because they could still face difficulties buying the things they need. With high inflation, prices could become so high that wages would not be sufficient to compensate for the high prices. A higher minimum wage is not the solution for a better standard of living for workers.
Effect of Minimum Wage Increase on Firms: Supply and Demand
In terms of supply and demand, increasing the minimum wage affects firms by increasing the demand for goods or services. An increase in wages leads to an increase in the buying capacity of workers. With more wages, workers tend to buy more goods and services. When workers buy more goods or services, firms’ profits are more likely to increase. Thus, firms benefit from an increase in the minimum wage because their revenues increase as a result.
However, when considering the employment aspect, firms need to spend more for wages if the minimum wage is increased. Initially, firms experience reduced net profit because their expenses for wages increase. Nonetheless, the situation eventually balances out and allows firms to adjust to a higher minimum wage. For instance, with higher minimum wages, workers have more money to buy goods and services, creating an increase in demand, which leads to an increase in firms’ revenues. The increased revenues compensate for the firms’ higher spending on wages. Still, these changes take time. There is a lag between wage increase and consumption increase. Thus, when the minimum wage is increased, firms initially experience a decrease in profits, but eventually adjust when workers’ consumption and spending increase according to their higher wages.
Minimum Wage Law as Poverty-Fighting Measure, Alternative Policies
The minimum wage law can be an effective poverty-fighting measure, perhaps as preventive measure for the short term, but not for the long term. For the short term, the legal minimum wage can help prevent wages from decreasing to a point where workers are unable to buy important goods and services. However, poverty is highly linked to the inability of the poor to pay for goods and services, and not necessarily the level of their wages. If the legal minimum wage is increased but prices also increase, the poor would still have low buying capacity.
The focus of efforts for fighting poverty should not be on increasing the minimum wage, but increasing the buying capacity of the people. An alternative policy to fight poverty is to decrease the dependence of the poor on minimum wages, and increase their incomes by engaging them in livelihood projects, such as cottage industries or home-based businesses. Shifting the source of revenues away from employment toward entrepreneurship can help increase the buying capacity of the poor and consequently empower them to improve their quality of life.
- United States Department of Labor (2015). Minimum Wage Laws in the State [Opens in New Window].
- Wilson, Mark. (2012). The negative effects of minimum wage laws [Opens in New Window]. Cato Institute.
- American Legislative Exchange Council (2014). Raising the minimum wage: The effects on employment, businesses and consumers [Opens in New Window].
- Lammam, Charles. (2014). The economic effects of living wage laws [Opens in New Window]. Fraser Institute.
- Reich, Michael, Ken Jacobs, and Annette Bernhardt (2014). Local minimum wage laws: Impact on workers, families and businesses [Opens in New Window]. Institute for Research on Labor and Employment.