A minimum wage is the practical implementation of what is known in economic theory as a price floor: a set point below which prices are not allowed to fall for a given unit of supply. A price floor imposes an artificial price set above market equilibrium which, all things equal, creates a surplus. Rather than a surplus created by workers added to the market’s existing labor supply, the surplus is the direct result of a price phenomenon*.
*At existing prices, employers are unwilling or unable to pay more per hour for the same number of labor hours the current number of workers are willing to perform with the same productive capacity, i.e. higher labor prices reduces demand for such labor.
This arbitrary price floor creates a gap between supply and demand where more work is sought out by workers than is demanded by employers. This concept is illustrated in the graphic below:
Picture credit: studyblue.com
The shaded surplus represents the labor hours (a common unit of measurement for labor required) which, under the imposed price floor, is supplied but no longer in demand. In practical terms, this means a reduction of hours and/or full termination of employment for workers who are willing and able to work those hours.
It is critical to understand that a free-market, price-coordinated economy leverages prices as a mechanism to convey the value society places on goods and services. Exceptionally rare cases aside (looking at you Shkreli), prices are dictated by the competing interests of 7.8+ billion individuals making trillions upon trillions of purchasing decisions each day—impacting the cost of goods from toilet paper to steel beams. In the same way that no individual intends for the stock market to close at a certain price, prices of goods and services are based on the price that billions of individual consumers are willing to pay for various goods and services (read: raw inputs and finished outputs).
Applying this concept to the current calls for an increased minimum wage in Washington D.C., it should be concluded that labor costing $15/hr is no more valuable than labor costing $7.25/hr for the same position. According to basic principles of managerial accounting, the artificially expensive labor is mathematically less valuable. Consider this simple scenario:
Jane owns Jane’s Smoothie Shop and employs two workers (Tom and Patrick) paid $8/hr each. Tom and Patrick can produce 12 smoothies each, per hour. Jane sells a smoothie for $1 and brings in $24 in revenue per hour. This means each employee brings in $12 in revenue per hour ($24/2 employees = $12) earning Jane an $8 profit—$24-$16 (revenue - cost).
Now consider that a minimum wage is imposed which increases Tom's and Patrick’s wages to $15/hr. All things equal, Tom and Patrick can still only produce 12 smoothies per hour and still bring in $24 in total revenue per hour. Although the revenue per employee is still $12 per hour, they now cost Jane $30 per hour. This results in Jane losing $6 per hour—24$ - $30. Tom and Patrick have gone from earning the smoothie shop $4 in profit per hour to costing the shop $3 per hour—a difference of the exact amount of the wage increase, $7.
Since Tom and Patrick are paid nearly double their previous wage with no increase in productive capacity, Jane’s cost per smoothie has risen from $.66 to $.80 per smoothie. The added cost from the wage increase for the same amount of output makes both employees less valuable to Jane and the shop. If Jane were to perform a simple cost-benefit analysis, she would be forced to conclude that she could not afford to employ both workers at $15/hr, full-time if she desires to stay in business.
Minimum wage laws do not increase the value of the labor, they just force employers to pay arbitrarily higher prices for the same amount of production. This type of law is a prime example of legislating by goal rather than incentive. Incentives created by minimum wage laws include, but are not limited to:
Price increases.
Would you pay $7.90 for the same Big Mac that cost you $5 yesterday? To offset increased labor costs, employers necessarily pass the increased cost of production to consumers despite providing no additional value than before the wage increase. After the price floor imposed in the example above, Jane would have had to sell smoothies for $1.58 to achieve the same $8 profit (assuming the same demand).
This is a 58% increase in price that may seem negligible, but consider a 58% increase on the price of products and services you purchase every day. Now consider this type of price increase on more expensive items. Over time, the increases add up and disproportionately impact those with less money to pay for such price increases. Additionally, consider the alternative uses of an extra $50, $100, or more spent per month on such price increases.
Reduction of labor hours for and/or termination of employees.
If the business cannot raise its prices due to customers’ unwillingness or inability to pay more for the same product or service, it must lower costs to a point that it—at a minimum—is not losing money. In the example above, Jane would have to either reduce the number of hours each employee receives or terminate one of her loyal employees.
Multiple studies have been conducted indicating the economic cost of minimum wage laws including the 2021 Congressional Budget Office study reported by the media which claims that 1.4 million Americans would be reduced to a minimum wage of $0/hr (read: unemployed) while only 900,000 would be lifted out of poverty. If the goal is to raise as many individuals as possible out of poverty, this legislation does not appear to meet that goal. Even workers who are retained but have their hours cut tend to earn less overall as the increased wages do not offset the loss of hours.
Businesses may opt for automation of previously human roles.
Businesses already recognize the cost savings of automating roles previously held by humans. Robots and software replace people who could have received an income doing the same work. Since this cost savings is applicable at the current minimum wage of $7.25/hr it logically follows that the cost savings would be even higher at $15/hr and could drive increased adoption of technologies that would replace low-wage workers.
Big businesses would benefit at the expense of smaller businesses.
Many large businesses would likely welcome a minimum wage increase because it would drive out businesses—reducing competition—that cannot afford the additional labor costs. A higher minimum wage also serves as a barrier to entry for new competition in the market. In contrast, larger companies can more easily bear the increased cost of labor though they would have less money available for donations, new initiatives, research and development, and investment in new ventures.
The ramifications of minimum wage laws can be predictably identified through a fundamental understanding of economic theory and analysis of empirical data. Despite any study indicating alternative outcomes based on hand-picked data and/or different success criteria, the underlying reality exists that an artificial price increase on a product or service (in this case labor) does not increase its value to society or society’s perceived value of it. Until market forces are corrected back to equilibrium, labor, among other scarce resources, will be directed away from their most valued, efficient uses.
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