Economies

117CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

A Market with a Price Floor

Figure 4In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones.

(a) A Price Floor That Is Not Binding

$3

2

Quantity of Ice-Cream

Cones

0

Price of Ice-Cream

Cone

100 Equilibrium

quantity

(b) A Price Floor That Is Binding

$4

Quantity of Ice-Cream

Cones

0

Price of Ice-Cream

Cone

3 Price floor

Demand

Supply

Price floor

80 Quantity

demanded

120 Quantity supplied

Equilibrium price

Equilibrium price

Demand

Supply

Surplus

the floor, the price floor is a binding constraint on the market. The forces of sup- ply and demand tend to move the price toward the equilibrium price, but when the market price hits the floor, it can fall no further. The market price equals the price floor. At this floor, the quantity of ice cream supplied (120 cones) exceeds the quantity demanded (80 cones). Some people who want to sell ice cream at the going price are unable to. Thus, a binding price floor causes a surplus.

Just as the shortages resulting from price ceilings can lead to undesirable rationing mechanisms, so can the surpluses resulting from price floors. In the case of a price floor, some sellers are unable to sell all they want at the market price. The sellers who appeal to the personal biases of the buyers, perhaps due to racial or familial ties, are better able to sell their goods than those who do not. By contrast, in a free market, the price serves as the rationing mechanism, and sellers can sell all they want at the equilibrium price.

The Minimum Wage

An important example of a price floor is the minimum wage. Minimum-wage laws dictate the lowest price for labor that any employer may pay. The U.S. Congress first instituted a minimum wage with the Fair Labor Standards Act of 1938 to ensure workers a minimally adequate standard of living. In 2009, the minimum wage according to federal law was $7.25 per hour. (Some states

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118 PART II HOW MARKETS WORK

mandate minimum wages above the federal level.) Most European nations have minimum-wage laws as well; some, such as France and the United Kingdom, have significantly higher minimums than the United States.

To examine the effects of a minimum wage, we must consider the market for labor. Panel (a) of Figure 5 shows the labor market, which, like all markets, is sub- ject to the forces of supply and demand. Workers determine the supply of labor, and firms determine the demand. If the government doesn’t intervene, the wage normally adjusts to balance labor supply and labor demand.

Panel (b) of Figure 5 shows the labor market with a minimum wage. If the minimum wage is above the equilibrium level, as it is here, the quantity of labor supplied exceeds the quantity demanded. The result is unemployment. Thus, the minimum wage raises the incomes of those workers who have jobs, but it lowers the incomes of workers who cannot find jobs.

To fully understand the minimum wage, keep in mind that the economy contains not a single labor market but many labor markets for different types of workers. The impact of the minimum wage depends on the skill and experience of the worker. Highly skilled and experienced workers are not affected because their equilibrium wages are well above the minimum. For these workers, the minimum wage is not binding.

The minimum wage has its greatest impact on the market for teenage labor. The equilibrium wages of teenagers are low because teenagers are among the least skilled and least experienced members of the labor force. In addition, teenagers are often willing to accept a lower wage in exchange for on-the-job training. (Some teenagers are willing to work as “interns” for no pay at all. Because internships pay nothing, however, the minimum wage does not apply to them. If it did, these

Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.

How the Minimum Wage Affects the Labor Market

Figure 5

(a) A Free Labor Market

Quantity of Labor

0

Wage

Equilibrium employment

(b) A Labor Market with a Binding Minimum Wage

Quantity of Labor

0

Wage

Quantity demanded

Quantity supplied

Labor supply

Labor demand

Minimum wage

Labor surplus (unemployment)

Equilibrium wage

Labor demand

Labor supply

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119CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

jobs might not exist.) As a result, the minimum wage is more often binding for teenagers than for other members of the labor force.

Many economists have studied how minimum-wage laws affect the teenage labor market. These researchers compare the changes in the minimum wage over time with the changes in teenage employment. Although there is some debate about how much the minimum wage affects employment, the typical study finds that a 10 percent increase in the minimum wage depresses teenage employment between 1 and 3 percent. In interpreting this estimate, note that a 10 percent increase in the minimum wage does not raise the average wage of teenagers by 10 percent. A change in the law does not directly affect those teenagers who are already paid well above the minimum, and enforcement of minimum-wage laws is not perfect. Thus, the estimated drop in employment of 1 to 3 percent is significant.

In addition to altering the quantity of labor demanded, the minimum wage alters the quantity supplied. Because the minimum wage raises the wage that teenagers can earn, it increases the number of teenagers who choose to look for jobs. Studies have found that a higher minimum wage influences which teenagers are employed. When the minimum wage rises, some teenagers who are still attending high school choose to drop out and take jobs. These new dropouts displace other teenagers who had already dropped out of school and who now become unemployed.

The minimum wage is a frequent topic of debate. Economists are about evenly divided on the issue. In a 2006 survey of Ph.D. economists, 47 percent favored eliminating the minimum wage, while 14 percent would maintain it at its current level and 38 percent would increase it.

Advocates of the minimum wage view the policy as one way to raise the income of the working poor. They correctly point out that workers who earn the minimum wage can afford only a meager standard of living. In 2009, for instance, when the minimum wage was $7.25 per hour, two adults working 40 hours a week for every week of the year at minimum-wage jobs had a total annual income of only $30,160, which was less than two-thirds of the median family income in the United States. Many advocates of the minimum wage admit that it has some adverse effects, including unemployment, but they believe that these effects are small and that, all things considered, a higher minimum wage makes the poor better off.

Opponents of the minimum wage contend that it is not the best way to combat poverty. They note that a high minimum wage causes unemployment, encour- ages teenagers to drop out of school, and prevents some unskilled workers from getting the on-the-job training they need. Moreover, opponents of the minimum wage point out that it is a poorly targeted policy. Not all minimum-wage workers are heads of households trying to help their families escape poverty. In fact, fewer than a third of minimum-wage earners are in families with incomes below the poverty line. Many are teenagers from middle-class homes working at part-time jobs for extra spending money. ■

Evaluating Price Controls One of the Ten Principles of Economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity. This principle explains why economists usually oppose price ceilings and price floors. To economists, prices are not the outcome of some haphazard process. Prices, they contend, are the

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