No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Six: Applications in Markets 130 INTRODUCTION Supply and demand analysis is the cornerstone of economics as it allows us to model the heart of markets: mutually beneficial voluntary exchange. In the last chapter we explored how changes in supply or demand would result in new price/quantity combinations. As useful as this framework may be, it has some limitations. In this chapter we’ll review how government regulations often hinder the plan coordination function of markets, how lack of information and other transaction costs reduce the number of mutually beneficial exchanges, and finally how markets work to overcome those transaction costs. MARKET PROCESS APPLICATION: MINIMUM WAGE LEGISLATION AND PRICE FLOORS You now have the tools to apply economic analysis to the real world. You can assess whether given means are likely to lead to a stated end. Consider the ongoing political issue of the minimum wage. President Obama supported the minimum wage (as do many republicans); while running for President in 2008 he said: “It’s time to turn the page for all those Americans who want nothing more than to have a job that can pay the bills and raise a family. Let’s finally make the minimum wage a living wage. Let’s tie it to the cost of living so we don’t have to wait another 10 years to see it rise.” In 2009, the United States was in the middle of what many were calling the worst financial crisis since the Great Depression. Unemployment rose to over 10% of the workforce during 2009 from under 5% in early 2008. During this time of significantly rising unemployment, the minimum wage was increased twice, to the current level of $7.25/hr. Many of you readers may be paid minimum wage, if you are able to find a job. So perhaps you think a hike in the minimum wage is a good thing? Raising the minimum wage is often politically popular; who can risk a vote against the “little guy” while Wall Street titans are making millions? And everybody knows one can’t support a family on minimum wage. We will leave aside many of the substantive issues such as the length of time workers actually make the minimum wage and what type worker makes the minimum wage, or what lifestyle a minimum wage actually could support. We’ll simply use our economic tools to assess the likely result of an increase in the minimum wage to the number of people who will actually receive such a wage increase. First, we will assume that the reason politicians are voting to raise the minimum wage is that it will actually raise minimum wages. To the extent that market wages already exceed any proposed minimum wage, there is no impact. Think about it: if the minimum wage were $1/hr., and politicians were proposing to raise it to $2/hr., yet the real market wage is already $5/hr., there will be no effect. Yes—now we can’t pay $1/ hr., but the market-clearing price was well above that anyway. Further, the politicians wouldn’t actually be able to credit themselves; they would likely hear “thanks for nothing” from their constituents. Market wage: the wage rate for labor that prevails in competitive markets without government interference.