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The Big Question ♦ Introduction ♦ Lec 1 Price Ceilings ♦ Lec 2 Examples of Price ♦ Ceilings ♦ Lec 3 More on Rent Controls ♦ Lec 4 Price Floors ♦ Lec 5 An Example of a Price Floor ♦ Lec 6 Are Minimum Wage Laws Good?

The Big Question for L12b Price Controls: “Why did an economist call rent control ‘the best way to destroy a city, other than bombing?”

The economist stated that rent controls are a great way to destroy a city because he forecast that the result would be a city with low quality, poorly maintained apartments and a deteriorating and diminishing housing stock. Few things unite economists as strongly as the conclusion that rent controls are bad policies. In 2012 81% of the IGM Economic Experts Panel disagreed with the statement, “LocaL ordinances that limit rent increases for some rental housing units, such as in New York and San Francisco, have had a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them.”

Supply and demand analysis shows that binding rent controls reduce price and the quantity traded. In Figure 1, the equilibrium price is $600.Imposing a price ceiling of $400 drives the price down to $400. Yea for the price ceiling! However, the decrease in price decreases the quantity supplied. Instead of wanting to provide 300 apartments or homes as they do in equilibrium, the landlands want to provide only 200 apartments even though the quantity demanded  is 400. The shortage means that the quantity supplied determines the quantity traded. Presuming that landlords are not coerced to provide more apartments than they want, consumers cannot purchase more than 200 apartments. Boo for the price ceiling!

The supply and demand graph does not show all of the effects of the shortage. Here is a quick list.

1. The shortage means that finding a vacant apartment is more difficult. People looking for housing must spend more time searching. Boo for the price ceiling!
2. Landlords are more picky about their tenants, The shortage means that landlords have little trouble renting a vacant apartment and don’t need to wait long for another applicant when they reject another applicant. The ability to be picky means that the decrease in quantity consumed from 300 to 200 falls particularly hard on tenants landlords view as less desirable. For example, landlords may view people who own dogs, have children, or are college-aged males as less desirable tenants because the average cost of repairing the apartment after they terminate their lease is higher than other people. When the shortage exists, therefore, people who own dogs, have children, or are college-aged males have a particularly difficult time getting a lease. Landlords who dislike particular types of people may view them as less desirable tenants. Therefore, when the shortage exists homosexuals, transgender people, Asians, or African Americans have particulary difficult times getting leases when landlords are homophobic, transphobic, xenophobic, or racist. Boo for the price ceiling!
3. Landlords increase the real price of the apartment without increasing the nominal price.They reduce the quality of the apartment by letting it deteriorate and responding less quickly to requests for maintenance. They increase the deposits required for the lease. They increase the requirement for supplemental contracts, such as furnishings for the apartment, and increase the prices for the supplemental contracts. Boo for the price ceiling!

Many economists are also concerned about the unintended consequences of minimum wage laws. Supply and demand analysis shows that binding minimum wages increase price but decrease the quantity traded. The figure below shows that when a minimum wage law pushes up wages from $10 per hour to $12 per hour, the quantity demanded decreases from 1,200 to 700 and the quantity supplied increases from 1,200 to 1,600. The surplus hurts low-wage workers in many ways.

1. The surplus means that the quantity demanded determines the quantity traded. Presuming that employers are not coerced to employ more workers than they want, employees cannot find more than 700 jobs. Therefore, the number of jobs available decreases from 1,200 to 700 and the cost employees pay to find a vacancy increases. Boo for the minimum wage!
2. The surplus means that employers can be more picky. The extra pickiness is bad news for the least skilled workers who are perhaps the main group the people passing the law intend to help. The least skilled workers are the group most likely to lose a job when the number decreases from 1,200 to 700. Boo for the minimum wage!
3. The extra pickiness is also bad news for workers that the employers view as less desirable despite their productivity. Employers who are homophobic, transphobic, xenophobic, and racist may view homosexuals, transgender people, Asians, and African Americans as less desirable and hire fewer of them because the employer can easily replace them with the types of workers they prefer. Boo for the minimum wage!
4. Employers decrease the real wage without decreasing the nominal wage. They reduce benefits, training, promotions, scheduling flexibility, and overtime. Boo for the minimum wage!

1. Introduction

Where is this lesson heading?

The lesson explores the effects of price ceilings and price floors on market outcomes. The lesson makes four key points.

1. When a price ceiling prevents price from reaching equilibrium, then shortages persist and price cannot function as a rationing device.
2. When a price floor prevents price from reaching equilibrium, then surpluses persist and price cannot function as a rationing device.
3. Rationing by something other than price helps some people and hurts others.
4. The analysis provides answers to many questions.

1. Why is finding a vacant rent-stabilized apartments in New York City so much harder than finding one that does not have laws restricting the price that landlords may charge?
2. Why are waiting times long in Canadian and VA hospitals?
3. Why is the unemployment rate for 16-19 blacks 38.8% while the national average is only 7.4%.

All three situations share a common attribute - government regulations prevent price from reaching equilibrium.

Why would a student care?

This lesson answers a question raised in the trailer (2:44) for the course: “who wins and who loses when the minimum wage increases?” The analysis can help you be a more informed citizen and voter: politicians and political activists often advocate that the government should impose more price controls on the economy to prevent “price gouging” or “unfair competition”.

What are the main points?

1. Price ceiling and floors are maximum and minimum legal prices.
2. Supply and demand analysis predicts that a price ceiling that is less than the equilibrium price has seven effects.
3. The markets for apartments and medical care are two good examples of the effects of a price ceiling.
4. Rent control creates winners and losers.
5. Supply and demand analysis predicts that a price floor that is greater than the equilibrium price has seven effects.
6. Minimum wage is a good example of the effects of a price floor.
7. An increase in the minimum wage creates winners and losers.
8. Economists generally agree that price controls adversely affect many of the people that they are intended to help and that more efficient ways may exist to achieve the desired goals.

What are the takeaways?
A successful student can

1. define price ceilings and price floors.
2. state the effects of a price ceiling that is below the equilibrium price
3. state the effects of a price floor that is above the equilibrium price.
4. use a supply and demand graph to illustrate some of the effects of ceilings and floors.

2. Lec 1 Price Ceilings

Watch for

1. The definition of a price ceiling,
2. The seven predictable effects of a binding price ceiling,
3. Why a price ceiling has no effect when it is greater than the equilibrium price.

A customer searches for groceries at a supermarket in Caracas, Venezuela, July 25, 2017. Photo: Carlos Becerra/Bloomberg News

Why are the shelves so empty?

What is a price ceiling?

A price ceiling is a maximum legal price at which a good can be sold. Examples of price ceilings are rent controls and laws against “price gouging”.

What are the effects of a price ceiling?

Supply and demand analysis predicts that a price ceiling that is less than the equilibrium price has seven effects.The predictable effects are:

1. The market price is less than the equilibrium price. The price ceiling is the market price when it is less than the equilibrium price.
2. Shortages occur and persist. Shortages occur when the market price is less than the equilibrium price. In the market system the shortage would cause the market price to increase. However, the price ceiling prevents the market price from rising. Therefore, the shortage persists.
3. The quantity traded equals the quantity supplied when the market price equals the price ceiling. Since the ceiling creates a shortage, the quantity supplied is less than the quantity demanded. When the quantity supplied is less than the quantity demanded, every buyer willing to buy cannot find a seller willing to sell. Since buyers cannot force sellers to sell more than they want to sell, buyers purchase only the quantity supplied.
4. The quantity traded is less than the quantity traded in the market system.

1. The quantity traded is the quantity supplied when price equals the price ceiling.
2. The quantity traded in the market system is the quantity supplied when price equals the equilibrium price.
3. Since the quantity supplied decreases as price decreases, the quantity supplied is less than the quantity supplied when price equals the equilibrium price.

The table below is an example.

1. Row 1 shows what happens when the market is in equilibrium. When market price = 10, the quantity supplied, quantity demanded, and quantity traded  all equal 5.
2. Row 2 shows what happens when a price ceiling makes the market price = 8. Quantity demanded = 7,  quantity supplied is only 3, and the quantity traded also equals 3.
3. Since the quantity supplied decreases from 5 to 3 as price decreases from 10 to 8, the quantity traded decreases from 5 to 3 when the government imposes the price ceiling.

5. Alternative rationing devices emerge to ration the quantity traded among buyers. A price ceiling means that price cannot ration the quantity traded. Since quantity demanded is greater than the quantity supplied, sellers have greater discretion to pick the buyers to whom to sell and to whom not to sell. Not selling to a buyer is not costly because a shortage exists. When the shortage exists, a seller can easily find other buyers sufficient to buy all of the quantity the seller wants to sell. Alternative rationing devices may include:

1. Waiting lists and first come, first served
2. Showing favoritism to friends, families, and people of influence
3. Avoiding selling to people with characteristics the seller finds undesirable.

6. A gray market emerges in which price is above its legal price. Buyers are willing to pay more than the price when the quantity demanded is greater than the quantity supplied. By selling illegally at higher prices, sellers can increase the quantity sold and profit.
7. Producers develop and use tactics that increase the “real” price without increasing the posted price. Here are two examples:

1. Reducing the quality of the good
2. Requiring the buyer to purchase additional items from the seller

What happens if the price ceiling is greater than the equilibrium price?

Supply and demand analysis predicts that a price ceiling has no effect on market outcomes if it is greater than the equilibrium price. The market tends to move towards the equilibrium price. A price ceiling greater than the equilibrium does not prevent price from moving towards equilibrium and, therefore, has no effect.

An example may help. What would happen if the government passed a law making prices for hot dogs greater than $1,000 illegal? The answer is, nothing. The equilibrium price for hot dogs is under $1,000. Since the equilibrium price is legal, the law would have no effect.

3. Lec 2 Examples of Price Ceilings

Watch for how rent control in NYC and price controls in medical care in the US illustrate the effects of binding price ceilings.

What are some examples of the effects of price ceilings?

The markets for apartments and medical care are two good examples of the effect of a binding price ceiling.

Rent control

New York City has a myriad of laws that restrict the ability of landlords from raising rents. The restrictions generally fall into two categories: Rent Control and Rent Stabilization.

Rent-Controlled apartments in NYC are governed by price controls imposed in World War II. Rents are very low and are set to cover the cost of building maintenance and improvements. One interesting caveat is that Rent-Controlled apartments convert to Rent-Stabilized apartments when they become vacant. Therefore, the vacancy rate is always 0%. Since the rents are so low, tenants designate in their will who inherits the apartment to insure an heir will enjoy the benefits of the low rents. The optional readings have great stories. Also, Doonesbury ran a series of cartoons about the difficulty of finding a Rent-Controlled apartment.

Rent-Stabilized apartments are governed by a series of laws passed by the New York City Council. Rents are low and a government board determines the maximum amount by which landlords may increase rents each year. Rent stabilization often prevents rents from rising to the equilibrium price. Therefore, the quantity demanded is higher and the quantity supplied is lower than they would be at equilibrium. The result is a shortage of apartments. The shortage means people have a harder time finding low-rent Rent-Stabilized apartments than high-rent unregulated apartments. The data on vacancy rates confirm that finding a Rent-Stabilized apartment is difficult.

Vacancy Rates in NYC, 2008, http://www.nyc.gov/html/hpd/downloads/pdf/HVS-Chapter-5.pdf

Price controls on health care

Rates for the single-payer health care system in Canada are set by the national government at prices that are below the rates charged in the private market sector in the US. Similarly, the US government sets rates at VA hospitals in the US that are below the rates charged in the private sector.

Supply and demand predicts that the quantity demanded is greater than the quantity supplied when the government sets prices for health care below the equilibrium price. One signal that the quantity demanded is greater than the quantity supplied for a hospital is a long waiting time for patients who want to use the hospital. As predicted, waiting times in Canada and at VA hospitals are long.

Who wins and who loses when rents are controlled?

Rent control creates winners and losers.

1. The big winners are people who live in rent-controlled apartments and pay less than the going rate.

1. However, their gain is diminished when landlords allow the housing stock to deteriorate. Letting the housing stock deteriorate with less service and fewer repairs allows landlords to increase legally the quality-adjusted price. The rent control laws in NYC have provisions to punish landlords who let the stock deteriorate too much.
2. Their gains are also diminished when landlords require tenants to pay additional fees or costs that are abnormal. For example, the landlord for a rent-controlled apartment may require security deposits and pre-paid rent that are higher than what landlords require for apartments not subject to rent control. Landlords may require tenants to rent the apartment only if the landlord furnishes the apartment and charge more for the furniture than the tenant would pay if he or she rented furniture directly from a home furnishing store. Studies of NYC show that rent-controlled apartments require tenants to rent furniture more frequently than apartments that are not subject to rent control.  

2. The big losers are people who cannot find an apartment because of the reduction in the quantity supplied. Some localities try to stop the decrease in the quantity supplied by restricting the ability of landlords to convert apartments into condominiums.

Exactly who wins and who loses depends on the allocation mechanism that replaces price as the rationing device.

1. First come, first served hurts people with busy schedules and helps those with time on their hands or who can afford to employ people to stand in line.
2. Rationing by “connections” hurts people who are not connected and helps those who are connected.
3. Rationing by how the prospective tenant looks probably hurts people who do not look like the landlord and helps those who are members of groups for which the landlord has an affinity.

Are Rent Controls Good?

• Economists generally agree that rent controls adversely affect many of the people that they are intended to help. In 2012 81% of the IGM Economic Experts Panel disagreed with the statement that, “LocaL ordinances that limit rent increases for some rental housing units, such as in New York and San Francisco, have had a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them. A reduction in the quantity and quality of affordable rental housing available is contrary to the goal of helping people with low incomes find housing. “ Since the impact on the housing stock increases the longer the rents are controlled, the reduction in the amount and quality of rental housing increases with time. One economist called rent control ‘the best way to destroy a city, other than bombing.’” (Mankiw, Principles of Economics 8e, p. 115).

The negative impact on people who have low incomes tends to be more severe the more landlords rely on rationing by “connections” and by how the prospective tenants look. People with low incomes tend to lack connections to landlords and to look different than landlords.

Economists also generally agree that more efficient ways exist to help people with low incomes find housing. Most economists agree that subsidies to low-income households is a better way to help them find affordable housing than rent controls.

A definitive judgement of the merits of rent controls requires knowledge of the size of the impact. Unfortunately, measuring the impact of rent controls on housing stock varies and large differences exist between what happens soon after the government imposes controls and what happens as the years pass. Therefore, one person may favor a law limiting how much rents can increase because he believes that the impact on the housing stock is small while another person may oppose the law because she believes that the impact is large.

4. Lec 3 More on Rent Controls

Watch for how rent controls can increase “going condo” and discrimination.

Let’s look a little more closely at rent control and highlight two unintended consequences. The first unintended consequence is that rent controls encourage converting apartments into condominiums.. The second unintended consequence is that rent controls may exacerbate discrimination.

When someone owns a living space in a building, they have several options about how to use it. One option is to use the space as an apartment and rent it to renters. When rented, the landlord’s revenue equals the rent the renter pays the landlord each month. The present value of these rents, less maintenance expenses, taxes, etc., equals the total monetary benefit to the owner when she decides to use the space as an apartment. Another option for the space is to sell it as a condominium. When she sells the space as a condominium, the buyer pays the purchase price but does not pay rent. The total monetary benefit to the owner when she sells a condominium is the purchase price less any transactions costs, taxes, etc.

When the market sets the rent paid for an apartment, the monetary benefit to the landlord of using the space as an apartment will be close to the purchase price the market sets for condos. However, rent controls drive a wedge between the monetary benefits. Since rents decrease, the monetary benefit of keeping the space as an apartment decreases. However, people are willing to pay more than the ceiling set by rent controls and are having a difficult time finding vacant apartments because of the shortage. Therefore, the willingness to pay for a condo is at least as high as it is without rent controls. Therefore, the monetary benefit of using the space as a condo does not decrease, and may increase. Since the monetary benefit of using the space as an apartment decreases and the benefit of using it as a condo does not, rent controls increase the incentive to convert apartments to condos.

Politicians and advocates of rent controls recognize that rent controls increase the incentive to “go condo”. As a result, several cities with rent controls include provisions in the law that limit the ability of landlords to sell apartments as condominiums. Despite these restrictions, a recent study finds that landlords are 8% points more likely to convert rent-controlled apartments to condos that the control group (https://cepr.org/sites/default/files/McQuade,%20Tim%20DMQ_Paris.pdf).

The earlier notes also point out that rent controls lead landlords to use something other than price to allocate apartments among potential renters. One way to allocate apartments besides price is for landlords to rent to “preferred” groups of people and not to rent to people they don’t prefer. Therefore, rent controls may exacerbate discrimination.

Let’s consider the cost of rejecting a qualified prospective tenant with and without rent controls. The cost of rejecting a qualified tenant equals the expected loss of revenue caused by the delay in renting the apartment. This expected loss is small when rent controls depress rents because the resulting shortage decreases vacancy rates. Lower vacancy rates mean that more prospective tenants are looking for a smaller number of vacant apartments and, therefore, that the waiting time for another qualified applicant decreases. With a shortage, a landlord may be able to fill the apartment immediately after it becomes vacant by selecting an applicant from a waiting list.

The lower cost of rejecting a qualified applicant reduces the opportunity cost of exercising personal preferences about the types of applicants to reject. Rejecting someone because of characteristics unrelated to being a good tenant is less costly because the expected extra time needed to find the “right kind” of tenant is shorter. Therefore, the opportunity cost of rejecting someone because of their gender identify, sex, race, ethnicity, or religious and political beliefs is lower when rent controls create shortages of apartments.Since the opportunity cost is lower, economics predicts that landlords with preferences against these types of people would discriminate more against them when rent controls create shortages, all else constant..

Laws against discrimination increase the opportunity cost of rejecting a propsective tenant because of their gender identify, sex, race, ethnicity, or religious and political beliefs. Therefore, these laws tend to reduce the extent to which landlords discriminate. However, not everyone follows the law. The book points out that laws against discrimination are difficult to enforce. The opportunity cost of discrimination decreases as the probability of legal punishmnet decreases. Moreover, clever landlords can increase the cost of discovering their misdeeds. For example, rather than telling a couple they can’t rent because they are black, the landlord might ask the couple to add their name to a waiting list and promise to call them when something becomes available. Few people are going to report the landlord when she never calls.

5. Lec 4 Price Floors

Watch for

1. The definition of a price floor,
2. The seven predictable effects of a binding price floor,
3. Why a price ceiling has no effect when it is less than the equilibrium price.

What is a price floor?

A price floor is a minimum legal price at which a good can be sold. Minimum wage is an example. Wages below the minimum wage are illegal for the occupations covered by minimum wage legislation.

What are the effects of price floors?

Supply and demand analysis predicts that a price floor that is greater than the equilibrium price has seven effects. The predictable effects are:

1. The market price is greater than the equilibrium price. The price floor sets the price when it is greater than the equilibrium price.
2. Surpluses occur and persist. Surpluses occur when price is greater than the equilibrium price. In the market system the surplus would cause price to decrease. However, the price floor prevents price from falling. Therefore, the surplus persists.
3. The quantity traded equals the quantity demanded when price equals the price floor. Since the floor creates a surplus, the quantity demanded is less than the quantity supplied. When the quantity supplied is greater than the quantity demanded, every seller willing to sell cannot find a buyer willing to buy. Since sellers cannot force buyers to buy more than they want to buy, the sellers sell only the quantity demanded.
4. The quantity traded with the price floor is less than the quantity traded at the equilibrium price.

1. The quantity traded with the price floor equals the quantity demanded when price equals the price floor.
2. The quantity traded at the equilibrium price equals the quantity demanded when price equals the equilibrium price.
3. Since the quantity demanded decreases as price increases, the quantity demanded is lower when price equals the price floor than when price equals the equilibrium price.

The table below is an example.

1. Row 1 shows what happens when the market is in equilibrium. When price = 10, quantity supplied, quantity demanded, and quantity traded  all equal 5.
2. Row 2 shows what happens when a price floor makes price = 13. The quantity supplied = 8, quantity demanded is only 2, and the quantity traded also equals 2.
3. Since quantity demanded decreases from 5 to 2 as price increases from 10 to 13, the quantity traded decreases from 5 to 2, the quantity traded decreases from 5 to 2 when the government imposes the price floor.

5. Alternative rationing devices emerge to ration the quantity traded among sellers. A price floor means that price cannot ration the quantity traded. Since the quantity demanded is less than the quantity supplied, buyers have greater discretion to pick the sellers from whom to buy and from whom not to buy. Not buying from a seller is not costly because a surplus exists. When the surplus exists, a buyer can easily find other sellers sufficient to sell all of the quantity the buyer wants to buy. Alternative rationing devices may include:

1. Showing favoritism to friends, family, and people of influence
2. Avoiding buying from people with characteristics the buyer finds undesirable.

6. A gray market emerges in which price is below its legal price. By selling illegally at lower prices, sellers can increase the quantity sold and profit.
7. Producers develop and use tactics that reduce the “real” price without reducing the posted price. The tactics may include:

1. Increasing the quality of the good. For example, when federal regulations created price floors for airlines, airlines competed by offering frequent flights, great meals, and attractive stewardesses (the term “flight attendant” did not exist) in designer uniforms.
2. Giving the buyer discounts or easier access to other items not subject to price controls.

What happens if the price floor is below the equilibrium price?

Supply and demand analysis predicts that a price floor has no effect on market outcomes if the floor is less than the equilibrium price. In this case the price floor does not prevent price from moving towards equilibrium and, therefore, surpluses and shortages tend to push price and quantity traded towards their equilibrium values.

An example may help. What would happen if the government passed a law making prices for hot dogs less than $0.02 illegal? The answer is, nothing. The equilibrium price for hot dogs is above $0.02. Since the equilibrium price is legal, the law would have no effect.

6. Lec 5 An example a price floor

Watch for evidence that minimum wage has the predicted effects of a binding price floor.

Minimum wage is one of the few examples of a price floor in the US today. Minimum price legislation and laws against price gouging also make low prices illegal. See the optional URLs for examples of minimum price legislation.

What are the effects of the minimum wage?

Evidence exists that minimum wage has the effects predicted by supply and demand analysis.

1. One predicted effect is that the floor sets the market price. Many people receive increases in their wages when the minimum wage increases. These increases in wages suggest that the minimum wage sets the wage, not a market equilibrium.
2. A second predicted effect is that a surplus exists and persists. A surplus in the labor market means that the quantity demanded is less than the quantity supplied and that, therefore, the unemployment rate is high.
   
   Since the minimum wage is binding only if the equilibrium wage is less than the legal minimum, the effects are concentrated on low-wage workers who would otherwise earn less than the minimum wage. Here is some evidence that the unemployment rate is higher for low income groups.
   
   One low Income group is young people. The  median income in 2011 for all workers was $50,054. For people aged 15-24, the median was only $30,460.
   
   As predicted, the unemployment rate for young people is high. In 2013 the unemployment rate in the US for the general population was 7.4%. For people aged 16-19, it was 22.9%.
   
   Another low income group is African Americans. The median income in 2011 for white workers was $52,214. For black workers, the median was only $32,299.
   
   Again as predicted the unemployment rate for black people is higher than for white people. In 2013, the unemployment rate in the US for the white people was 6.5%. For black people, it was 13.1%.
   
   Combining our analysis of the labor market for young people and black people suggests that the wages for people who are both young and black is low and their unemployment rate is high. The evidence is consistent with the suggestion.
   The median income in 2011 for black workers aged 15-24 was only $20,546.
   The unemployment rate in 2013 for black people aged 15-19 was 38.8%.
3. Another predicted effect is the emergence of a grey market. Employers often break the law and pay less than the legal minimum. Sweatshops exist. The employees are often people who are reluctant to notify officials because they are working here without proper documentation.
4. A fourth predicted effect is that employers will find ways to reduce the “real” wage without reducing the nominal wage. One way to reduce the real wage when the minimum wage increases is to reduce benefits.
   

7. Lec 6 Are minimum wage laws good?

Watch for

1. Who wins and who loses when the minimum wage increases,
2. Why the minimum wage may increase discrimination,
3. Why economists are softening their opposition to minimum wage legislation, and
4. What most economists think is a better way to help low-income workers than minimum wage legislation.

Who wins and who loses when the minimum wage increases?

An increase in the minimum wage creates winners and losers.

1. The big winners are the workers whose wages increase to the new minimum. Of course, their gain may be reduced by employers who reduce benefits. Reducing benefits (less vacation, greater share of health insurance paid by employee, etc.) allows employers to decrease legally the net compensation to workers.
2. Another winner are workers who earn more than minimum wage and compete with minimum wage workers. Milton Friedman argued that self-interest motivates the support by labor and trade unions for increases in the minimum wage. The wages at these unions are well above the minimum wage. However, as the minimum wage increases, the wage paid to low-skilled workers increases, thereby increasing the demand for and wages paid to highly skilled workers.
3. The big losers are people who would find employment at the equilibrium wage and cannot find employment at the minimum wage. Economists at the Federal Reserve Bank of San Francisco attempted to measure the impact of minimum wages on employment and concluded that “... a reasonable estimate based on the evidence is that current minimum wages have directly reduced the number of jobs nationally by about 100,000 to 200,000”.
   

Milton Friedman argued that minimum wage often hurts the very groups that people with good intentions are trying to help. Since the minimum wage affects most directly groups that tend to earn wages at or near the minimum wage, they are affected most directly by increases in the minimum wage. The people affected most directly are the least skilled workers.  

As noted above, Black workers are more likely to be directly affected by increases in the minimum wage because they earn less on average than White workers.  A crucial question is, “Why are wages for Black workers, on average, lower than wages for White workers?” One possible answer is that Black workers face discrimination in the labor market. When employers “prefer” to hire a White person over a more qualified Black person the demand for White employees increases and the demand for Black employees decreases. As a result of these changes in demand, the equilibrium wage for Whites is higher than the equilibrium wage for Blacks. Few economists doubt that that discrimination contributes to the average income disparity between Whites and Blacks.

A possible contributing factor to the average income disparity is that Black people receive, on average, less and worse education than White people.  The demand for an employee increases as the employee’s skills increase. Therefore, if education increases an employee’s skills, highly educated employees would be in greater demand and would earn higher wages in equilibrium than less educated employees. If White students, on average, receive more and better education than Black students, their equilibrium wage would be higher. A recent study by the National School Board Association unfortunately confirms that education disparities exist, on average, between White and Black students. Figure 3 shows that proficiency rates for Black students are substantially lower than the rates for White students.

The Association also writes that

• “The achievement gap between Black and white students has not been closed.
• “School dropout rate keeps high among Black students.
• “Graduation rates and college enrollment rates remain low among Black students.”

A related crucial question is, “Why are unemployment rates higher for Black people than for White people?”  As noted above, one possible answer is that, since Black people are more likely to be working for or near the minimum wage, the surplus of labor created by the minimum wage falls disproportionately on them. A second answer is that employers discriminate against Black employees in favor of White employees. As the demand for White labor increases and the demand for Black labor decreases, the equilibrium quantity of employment for White workers increases and the equilibrium quantity of employment for Black workers decreases.

Gary Becker argued that the minimum wage exacerbates the employment disparity between White and Black workers when employees discriminate against Black employees in favor of White employees. Becker argued that a binding minimum wage decreases the extra cost employers pay when they discriminate against Black workers and that the decrease in the extra cost means that employers will hire more White workers and fewer Black workers than they would if wage differentials were possible. Suppose that employers prefer employees who are White and discriminate against employees who are Black. As noted earlier, this discrimination would make the equilibrium wage for White employees be greater than for Black employees even when both are equally productive. Therefore, in the market system employers can discriminate against Black workers  only if they are willing to pay higher wages to White workers. If the extra cost > the extra amount that the employer is willing to pay, the employer would hire Black workers despite her preference for White workers. However, when the wages for both White and Black workers = minimum wage, employers can discriminate against Black workers without having to pay higher wages to White workers. Moreover, the surplus of labor created by the binding minimum wage allows employers to pick employees from a surplus of job applicants. Therefore, the minimum wage reduces the extra cost paid by employers who discriminate. Since the extra cost of hiring a White worker instead of a Black worker decreases, Becker’s model suggests that employers will hire more White workers and fewer Black workers when the minimum wage is binding.

Jason Riley writes that the origin of minimum wage legislation is, in fact, racist (WSJ, Feb. 2021). “The federal government got involved in setting wage levels in the 1930s and did so at the urging of unions that excluded blacks as members. During debates in Congress, lawmakers complained openly about the ‘superabundance’ and ‘large aggregation of Negro labor’ and cited complaints by whites of black Southerners moving north to take jobs.

“As Congress increased the minimum wage periodically over the decades, these same arguments were put forward as a justification. When he was a U.S. senator from Massachusetts, John F. Kennedy backed minimum-wage hikes as a way of protecting New England industry. ‘Having on the market a rather large source of cheap labor depresses wages outside of that group, too—the wages of the white worker who has to compete,’ he lectured an NAACP official at a hearing in 1957. ‘And when an employer can substitute a colored worker at a lower wage—and there are, as you pointed out, these hundreds of thousands looking for decent work—it affects the whole wage structure of an area, doesn’t it?’”

Historically economists generally agree that minimum wages adversely affect many of the people that they are intended to help.  For example, around 1995 79% of the economists polled agree that “A minimum wage increases unemployment among young and unskilled workers” (Mankiw, Chapter 1, Table 1). Increasing unemployment among unskilled workers is contrary to the goal of helping them achieve a high standard of living.  

Recently however, some researchers have questioned whether supply and demand analysis of the labor market is accurate. Supply and demand analysis tends to be accurate when the market is competitive. These researchers argue that the labor market is not competitive because employers have “buyer” power. The researchers show that the quantity of labor traded does not always decrease when the minimum wage increases and employers have buyer power. They also present evidence that increases in the minimum wage has small or negligible effects on employment.

The recent research has led to a softening of economists’ opinions about the minimum wage. In 2015, the Booth School of Business asked the IGM Economic Experts Panel, “If the federal minimum wage is raised gradually to $15-per-hour by 2020, the employment rate for low-wage US workers will be substantially lower than it would be under the status quo.” 26% of the experts either strongly agreed or agreed, 38% were uncertain, and 24% disagree. Economists may be unable to agree on whether minimum wage helps low-wage workers or not; but, they are able to agree that better ways exist to help them.

Economists tend to agree that the Federal Earned Income Tax credit is a better way than the minimum wage to raise the standard of living for low-wage workers. The Earned Income Tax Credit affects only people with low incomes. According to the best CBO estimate,  just 19 percent of the $31 billion increase in wages paid if the minimum wage increases from $7.25 to $10.10 would accrue to families with earnings below the poverty threshold, whereas 29 percent would accrue to families earning more than three times the poverty threshold.