The Problems with a Minimum Wage (Economics 101)

[Imran Siddiqui]

Following an outside external change, the demand curve for labour shifted left creating an increase in unemployment. Employers responded by reducing the number of workers and by cutting salaries. Both of these factors led to a decrease in consumption which then leads to deflationary pressure which in turn shifts the demand curve for labour further left. That sets up a new round for of layoffs and wage cuts and the cycle begins again.

Equilibrium is never reached.

If the demand curve for labor shifts to the left, the equilibirum shifts to a new level. One where quantity and price falls to the new level. There is a decrease in consumption due to external shocks, which is simply result of the bust cycle. As you are aware after the bust comes a boom. There is less consumption, but the less cost in labor creates an equilibrium, where there is no need for further cuts. Less consumption doesn't necessary lead to deflation. Remember, inflation and unemployment are inversely related based on the Phillips-curve. Therefore, with the increase in unemployment, inflation is naturally supposed to fall.... which shouldn't lead to any kind of slippery slope cycle.

If what you say is true, then every bust of the business cycle would result in a lack of equilibrium. However, this does not occur, even in areas without as many checks as the US has.

Basically, when inflation falls, interest rates rise, and there is greater incentive for investment. This is the natural market force that pulls economies out of busts. More investment eventually leads to more jobs in the recovery period.

and this situation would show that your initial statement that eliminating the minimum wage leads to full employment is not true all of the time.

No, perhaps not, but it is most of the time.... during the regular business activity periods and non-bust times.. the full employment is reached. During bust times you might stray from that, but usually (problems involving government like Japan or Great Depression withstanding) busts are short lived.

edit: Phillips Curve, not J-curve

[Tingkai]

Originally posted by Imran Siddiqui

If the demand curve for labor shifts to the left, the equilibirum shifts to a new level. One where quantity and price falls to the new level. There is a decrease in consumption due to external shocks, which is simply result of the bust cycle. As you are aware after the bust comes a boom. There is less consumption, but the less cost in labor creates an equilibrium, where there is no need for further cuts. Less consumption doesn't necessary lead to deflation. Remember, inflation and unemployment are inversely related based on the J-curve. Therefore, with the increase in unemployment, inflation is naturally supposed to fall.... which shouldn't lead to any kind of slippery slope cycle.

You lost me on here. You're saying that less consumption doesn't necessarily lead to deflation, but everything you say after that results in lower prices (or at least a slowing of inflation)

Originally posted by Imran Siddiqui

If what you say is true, then every bust of the business cycle would result in a lack of equilibrium. However, this does not occur, even in areas without as many checks as the US has.

Good point, and my repsonse is, uhm, I don't know.

Originally posted by Imran Siddiqui
Basically, when inflation falls, interest rates rise, and there is greater incentive for investment.

Don't you mean interest rates fall?

Originally posted by Imran Siddiqui
This is the natural market force that pulls economies out of busts. More investment eventually leads to more jobs in the recovery period.

Doesn't Keynes' general theory showed that there can be situations where declining interest rates will not lead to increased investments.

[Imran Siddiqui]

You lost me on here. You're saying that less consumption doesn't necessarily lead to deflation, but everything you say after that results in lower prices (or at least a slowing of inflation)

Deflation refers to going beyond 0 (negative). Because a lessening of inflation isn't going to lead to anyone cutting more people. Though falling below 0 just might.

Don't you mean interest rates fall?

Yes... sorry, misposted. Interest rates are there to account for inflation, so they would fall if inflation did.

Though, for some reason that sounds wrong. I mean, Greenspan raised rates to decrease inflation. Hmm... I think I've confused myself .

Well, I guess if you raise rates, then there is less investment, which means the money supply is low, which leads to less inflation? That sounds right . Fiddling with interest rates messes with investment, which then changes inflation.

Ah... bugger.

Doesn't Keynes' general theory showed that there can be situations where declining interest rates will not lead to increased investments.

I'm not entirely sure. I have to get my brain straight for one now .

[Tingkai]

Yeah, I did a BA in economics 12 years ago and I've forgotten far too much. Time to get a basic economic theory book and awake my mind.

[Imran Siddiqui]

LOL, I don't even want to touch my old micro books .

I'm too busy writing papers for my Poly Sci seminar (about injustice in the legal system to rape victims... look, I'm becoming a leftist ), and reading about 'Public Policy Towards Business' (mostly anti-trust stuff), Greenhouse Effect (told you I was becoming a liberal ), Economics of India (development economics is something I'm interested in), and Medieval Italy.

I don't have time to get my mind bent out of shape just yet .

[Lawrence of Arabia]

Well, I guess if you raise rates, then there is less investment, which means the money supply is low, which leads to less inflation? That sounds right

Ya thats correct.

[Lawrence of Arabia]

And BTW it's Macro, not micro

[Imran Siddiqui]

And BTW it's Macro, not micro

DOH! I sit corrected .

[Asher]

I've e-mailed blackice and told him to join the fray.

[Tingkai]

Originally posted by Asher
I've e-mailed blackice and told him to join the fray.

You should be banned for a month.

[Imran Siddiqui]

He should be banned for a month for more things than that .

[Asher]

I should get Wiggy too.

[Adam Smith]

A few quick comments.

First, the quality of the debate on this thread is much better than usual. There are some posters I have not seen before, and some people actually appear to be familiar with facts to back their positions.

Question: If raising the minimum wage is ecnomically beneficial, why not raise it to $50 per hour as Asher suggested? Answer: because, overall, it is not economically beneficial. We have now established the direciton of the trend. The only issue is the magnitude. (See below)

Why did Henry Ford pay $5 per day wages, which were unheard of at that time? Because his huge new plant at River Rouge exhausted the local supply of skilled and unskilled labor, and he had to attract workers from other parts of the country. This was the start of the Black migration to big northern cities in the 1920's. (People like A. Philip Randolph also had something to do with it.)

Imran:
Reducing the minimum wage will NOT get us to zero unemployment. Even if the wage went to zero, some people would still be unemployed because they do not have needed skills, or it is not in their economic interest to pay transport costs to get to distant jobs.

Moral Hazard:
Kudos for knowing about the Card/Kruger study. The problem with the Card/Kruger study was that they interviewed fast food managers and asked them how they expected the number of hours would change if the minimum wage increased. Kevin Murphy reran the Card/Kruger study using the actual employment records before and after the minimum wage increased. Using the actual data reversed Card and Kruger's findings, and showed pretty much what the vast majority of other studies on the minimum wage in the US showed: a ten percent increase in and effective minimum wage reduces employment by about three percent.

Spiffor:
The perfectly competitive model is a polar position from which to start analysis of a market. (Monopoly or monopsony is the other pole.) Every single last assumption does not need to hold in order for economic predictions to be valid. If one assumption does not hold, you don't throw out the entire model and economics with it. You make adjustments. And in this case the necessary adjustments make little if any difference to the conclusions.

Its late. I'm going to bed. Good night.

Adam Smith
Old posters never die,
they j.u.s.t..f...a...d...e...a....w....a....y....

[Spiffor]

Adam Smith :
Basically, my main concern is the true economy rather than pure theory. Of course all liberals are not blindly supporting their perfect model, but the tries to connect the model to the real world (such as expressed in the new classical macroeconomy) tends to weaken the model, as plenty of exceptions are found. The perfect equilibrium is hurt.
My main problem with the liberal economics is that it's only concerned by a purely financial logic, whil economy is much more than just figures : it has to do with the human being, someone prone to mistakes, someone who acts with his heart, or who acts like society learned him to do. As long as economy thinks with the homo oeconomicus rather than with the human being, as simperfectly studied by psychology and sociology, it cannot understand the deep causes of economy.

There are 2 reasons I'm rather keynesian : I fundamentally think a company will produce only if it's incited to do so (demand oriented theory), but alos because there is a modesty in the keynesian theory, an opening to mistakes. There aren't many "perfect" things in the keynesian economy, and the "perfect" mechanisms seem dull to me (like the accelerator). Although I should be oriented towards a marxist approach, I truly dislike Marxist economics, as it is purely theoretical, perfect and disconnected from the real world (saying that profit only comes from the labour and not from the investment, thus reducing the impact of technological progress). In this way, marxist and liberal approaches resemble to each other.

[Imran Siddiqui]

Even if the wage went to zero, some people would still be unemployed because they do not have needed skills, or it is not in their economic interest to pay transport costs to get to distant jobs.

Basically zero. If people don't have the needed skills they couldn't be used as surplus labor, and the ones with transport costs wouldn't be in the pool either.

I didn't mean zero as in everyone in the whole country has a job, but rather there is so much employment that those who are left will probably not be employed by anyone, basically making them usless in the suplus labor pool.