A Thought Experiment
Published on May 16, 2005 By stutefish In Blogging
Let's say I own a small factory. The factory produces about $100[1] worth of widgets every day, and requires a crew of seven people to operate at full efficiency.

Let's also say that this factory operates in a country where it is customary to pay workers by the day, and that $10 per day is a low but acceptable wage.

Now, I could pay my seven workers up to $14 per day, and still make a $2 profit. Very tight margin, but at least there's some money left over for my investors, or for capital improvements, or for the company Christmas party, or whatever.

Now, let's say the government passes a law, requiring that all workers be paid a minimum of $15 per day. What happens?

The first thing that happens, the day I begin complying with the new minimum wage, is that my factory loses money: $5 per day, in fact. Not much, but it will add up quickly.

Why I Hate, #1: The minimum wage hurts the economy, creating deficits instead of surpluses for any employer on a tight profit margin. It punishes employers for being competitive or generous in their hiring and employee compensation practices. Thus, it is bad for both employers and employees.

Of course, I can't keep operating my factory at a loss each day. I need to make some adjustments.

One thing I could do is raise the price of my widgets, to cover the increase in my payroll costs. Of course, this would tend to nullify the value of the minimum wage in the first place. Sure, my workers get paid more, but--surprise!--their cost of living just went up, too.

Why I Hate, #2: The minimum wage promotes inflation. By increasing the operating costs for employers, it drives increases in the costs consumers must pay for goods and services. Pay raises are offset by price increases. Instead of a Better Tomorrow for my employees, they get inflation. And inflation is bad for the economy.

But as bad as inflation is, a price increase may be my best option. Let's see what else I can do...

Well, I can fire one of my employees. This brings my factory back into profitability--improves it, even, since I go from a $2 profit to a $10 profit.

Why I Hate, #3: The minimum wage promotes unemployment.

Of course, my profit margin just improved dramatically, from $2 before the minimum wage law to $10 after the minimum wage law. And my employees even got a raise (the ones I didn't have to lay off got a raise, anyway)! On the other hand, that profit increase isn't real, because the factory's efficiency just went down. Now, instead of having 7 workers producing $100 worth of widgets, I have six workers producing about $85 worth of widgets. In fact, at $15 per day, my workers cost me more than the value of the widgets they produce.

Why I Hate, #4: The minimum wage promotes massive unemployment by driving companies out of business. It also hurts the economy by making whole sectors unprofitable.

But maybe I can keep my factory in the black. Let's say I lay off my least efficient worker. Instead of a 14% efficiency loss, maybe I only have a 9% efficiency loss--that's the maximum I can afford, anyway. Now my factory is making $91 of widgets every day, but at least that's better than my payroll costs of $90 per day for my remaining 6 employees. I'm down to a $1 profit from a $2 profit before the minimum wage, but it's better than going out of business, laying off more employees, or driving inflation, isn't it?

Why I Hate, #5: The minimum wage harms the economy by reducing profits.

Summary:
1 The minimum wage increases deficits and decreases surpluses.
2 The minimum wage accelerates inflation.
3 The minimum wage increases unemployment.
4 The minimum wage puts employers out of business, hurting the economy and increasing unemployment at the same time.
5 The minimum wage makes employers less profitable, without improving the economy or the lives of employees (who must now work harder to keep their employer profitable; sure, they get paid more, but they have to work more, too. You could call this another kind of inflation.)

Question: What do I not understand about the minimum wage, that makes it such a great idea?




[1] After accounting for the cost of raw materials and support services like water and power, but not payroll expenses.

Comments (Page 1)
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on May 16, 2005

Excellent post! I do a sort of dollar cost averaging of my (self employed) endeavours, and my "wages" range from about $1 (yes, you read that right) to $10 an hour. The $1 is my "typical" can rate (when I don't hit the mother lode somewhere), and I will always swap it for more lucrative employment (mowing lawns, odd jobs, etc), which I figure at $4-10 an hour, depending on how able the person is to pay me (after all, basic economics says $4 an hour's better than $1).

When I lived in Nevada, because of the time and expense of the drive to Vegas, I often made less than minimum. I would have gladly traded it for subminimum wage there in Pahrump had it been legal and offered.

Say what you want about my work ethic, but I'm doing what I have to do. Far too many people don't understand this.

on May 16, 2005
Simple, yet very accurate and illustrating.  But half the people here will not understand it and will argue with you that you are just plain wrong, even tho this is a demonstrable fact of life.
on May 16, 2005
I agree that hikes in the minimum wage impacts the employers ability to operate effeciently and keep on employees. Increases have to be carefully measured against inflation and average cost of living, hikes recently have sort of leapfrogged.

That said, we have the minimum wage for a reason. To prevent employers from exploiting workers for a pittance. There are many places where a town still has one, maybe two primary employers. In an employment environment like that, the businesses have the power to fix wages extremely low if they want to. In one-company towns they control it completely. The wage limits are there to ensure companies with that sort of power can only abuse it to a certain degree.

Yes, you can move, but there are practical limits to that suggestion. Saying someone can just uproot their family and haul across the country isn't a very good argument against the idea that companies shouldn't abuse their position of power in such places.

I don't agree with the notion that raising the wage makes life better for people or that it helps fuel the economy, I know it leads to layoffs. What I do agree with is the need to have some sort of minimum wage set that is adjusted with time to prevent businesses with an unfair market advantage to pay slave wages.
on May 16, 2005
That said, we have the minimum wage for a reason. To prevent employers from exploiting workers for a pittance.


Funny...what YOU call "exploitation", I call "employment".
on May 16, 2005
Paying someone $2/day to sew garments is definitely exploitation. Companies will get away with the absolute minimum if they can. There is a line between employment and exploitation, and the minimum wage should be used to set that line. I'm not saying the line should be outrageously high, but it needs to be set to prevent such behavior.
on May 16, 2005

That said, we have the minimum wage for a reason. To prevent employers from exploiting workers for a pittance. There are many places where a town still has one, maybe two primary employers. In an employment environment like that, the businesses have the power to fix wages extremely low if they want to. In one-company towns they control it completely. The wage limits are there to ensure companies with that sort of power can only abuse it to a certain degree.

That is the only reason I have ever heard of where the Minimum wage has any good to it.  But, that is not why it was and is in effect.  It is in effect to drive out unskilled labor so they cannot compete with Unions.

And in the end, raising the minimum wage will only drive that one horse village out of business itself.  We live in a global economy, and you raise the wages on that company, they move offshore and then there is no jobs in that town.

on May 16, 2005
Paying someone $2/day to sew garments is definitely exploitation. Companies will get away with the absolute minimum if they can. There is a line between employment and exploitation, and the minimum wage should be used to set that line


If people were equitable and fair, we wouldn't NEED a minimum wage. Unfortunately, people can't always be relied on to be fair and equitable, and that's where the minimum wage comes in.

I can understand how minimum wage can hurt companies.....but I can also see where some companies would hurt their employees in the name of profit if they were allowed to.
on May 16, 2005
zoomba,

For many many years I agreed with you. But then, for some reason I still don't understand, I found myself virtually unemployable, despite having had a very solid resume only recently. This led me to realize, I'll take what I can get, even the subminimum wage that I make in most of my undertakings...I have a family to care for, you know
on May 16, 2005
And in the end, raising the minimum wage will only drive that one horse village out of business itself. We live in a global economy, and you raise the wages on that company, they move offshore and then there is no jobs in that town.


The only claim I make about increasing the minimum wage is that it should be adjusted to reflect inflation rates. $2 20 years ago is a lot different than $2 today. But increasing it in the name of eliminating the poor, is just plain stupid since the minimum wage should not be the vehicle we use to help the lower classes. Subsidized education, work programs yeah... jacking up the min wage? no way.

I think the min wage is a great thing that's being itself exploited for political means, and thus ruining it for everyone.
on May 16, 2005
Minimum wages are usually used as a price floor by the government. Likewise, it stabilizes the global economy, especially in a time of crisis. A rise in unemployment is much better than a substantial deflation of the lower wages when there's a crisis. It’s an essential tool, in developed countries, to stabilize the demand and the consumption.
on May 16, 2005
Thank you all for your replies. I'm relieved to discover that so far, Gideon's pessimistic prediction has proven false, and nobody is telling me how stupid I am.

Now, could somebody please explain to me how this "price floor" thing works, and how its benefits more than offset the inflation, unemployment, and failing economies created by the minimum wage?

Thanks again, everybody!
on May 16, 2005
The only claim I make about increasing the minimum wage is that it should be adjusted to reflect inflation rates. $2 20 years ago is a lot different than $2 today. But increasing it in the name of eliminating the poor, is just plain stupid since the minimum wage should not be the vehicle we use to help the lower classes. Subsidized education, work programs yeah... jacking up the min wage? no way.


You will get no argument from me. Once the floor has been set, leave it. Withdrawing it will have no visible effect, and the damage has already been done. let the Economy catch up to the minimum wage and then digest it.
on May 16, 2005
Zoomba:

I'm not sure you read my article. You say "The only claim I make about increasing the minimum wage is that it should be adjusted to reflect inflation rates."

But you make no attemp to acknowledge or refute my argument that the minimum wage is a cause of inflation.

In effect, you're saying we should solve the problem by causing the problem. What's up with that?
on May 16, 2005
You've summarised in a couple sentences what people study for a lifetime !!

Are you an Economicist, or just naturally intelligent ?
on May 16, 2005
Dr. Guy:

How can you say that "withdrawing [the minimum wage floor] will have no visible effect"?

It seems to me that it would have the immediate effect of increasing profits, productivity, and employment. If you agree that the minimum wage causes the problems I listed, what makes you think that eliminating the minimum wage won't eliminate the problems it causes?

Also, could somebody please explain to me how the "price floor" works, and why I would ever want to sign up for inflation, unemployment, and economic collapse, in order to get one?

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