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Minimum wage and price floors

Another type of price control is a price floor, which is a minimum legal price. A real world example of a price floor is a minimum wage. In this video we explore how a minimum wage might affect a perfectly competitive labor market. Created by Sal Khan.

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  • spunky sam blue style avatar for user maurice.cpa
    Why didn't the entire supply curve shift to the left? I think I am misunderstanding that in the dead weight loss videos.
    (30 votes)
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    • blobby green style avatar for user milliehandshrimp
      The supply curve did not shift because all we changed was price. We didn't change technological improvements or lower the cost of living or anything like that. The supply curve represents the entire relationship between supply and price, and a point on the supply curve represents the quantity supplied at that price. Make sense?
      (71 votes)
  • blobby green style avatar for user Danny Courtney
    This is all based on the assumption that lower wages will mean people want to work less, but isn't that assumption a bit strange? People don't just work because it would be nice to be able to go out more at the weekend, people need a certain amount of money to survive. Therefore couldn't lower wages force people to work longer hours out of necessity?
    (25 votes)
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    • leafers ultimate style avatar for user Andris
      You got this very right, but note that the model also (and mainly) implies that at lower wages fewer people will work. Those, who have savings, or other income (interest payments, government support, unemployment benefit, etc...) may not want to work for less than a given wage. In fact ,everybody has a minimum wage like that (in economics it's called the reservation wage) - I'm sure you wouldn't work for 0.01 dollar / hour, even if it was the market equilibrium price for work. You would be much happier with a few hundred dollar unemployment benefit.

      What I mean you were very right about is that the forces you mention actually work the way you described them, and they are used in more sophisiticated economic models. It might happen, that lower wages force people to work more. If you are interested, check out the Wikipedia page about the backward bending labour supply (http://en.wikipedia.org/wiki/Backward_bending_supply_curve_of_labour).
      (32 votes)
  • piceratops ultimate style avatar for user Mathuss
    Why is Sal using Millions of hours/month and Millions of jobs interchangeably?
    (21 votes)
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    • blobby green style avatar for user Elizabeth Sholler
      Because they CAN, and should, for purposes of this discussion, be used interchangeably. They're directly proportional. From an employer's perspective that axis reflects number of labor hours that must be paid for. But from an employee's perspective, it's more about the availability of work...more hours of labor simply means more jobs. The entire point was to give you a feel for how the economy is affected by minimum wage...the actual numbers aren't important.
      (7 votes)
  • blobby green style avatar for user shacktoms
    I think the supplier surplus analysis is flawed. We only know the employed workers are somewhere to the left of intersect of the price and the supply curve. There is no reason for them to all be to the left of the intersect with the demand curve. Employers will more likely hire the workers who are more ambivalent over the ones who are more desperate. You assumed the employers prefer those workers with the worst alternatives (e.g. who nobody else will hire), who would freely accept a low wage.
    (3 votes)
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    • blobby green style avatar for user jimdetry
      If you remember, when he started these microeconomics videos, Sal stated several times that the analysis assumes "Everything else being equal." This is, as he said, a simplified version to teach how, in general, economics works. You are adding in details the analysis is not meant to take into account. The general results are still correct--putting a minimum wage in place will reduce total employment, and redistribute some of the surplus benefit from the (remaining) employers to the (remaining) employees. There are all kinds of additional effects not included, such as some employers may go out of business (can't afford to compete with higher labor costs), prices will go up (higher labor costs are passed on to the customers), demand will go down (as usual when prices go up), etc. That does not change the general idea.
      (19 votes)
  • spunky sam blue style avatar for user zeyili0926
    Can anyone give me a definition of "surplus" in this video, I don't quiet understand it. It would help me a lot if it was in your own words :)
    (6 votes)
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    • leaf green style avatar for user Allie
      Think of total surplus as a measure of the gains to buyers and sellers generated by exchanging goods.

      Consumer surplus is the difference between a buyer's willingness to pay for a good and the actual price paid by the buyer for that good. When this difference is greater than zero, the buyer has surplus. That is, the buyer paid less for the good than they were willing to pay and hence has been made better off from the purchase. Consumer surplus is a measure of how much the consumer is made better off, i.e. the gain incurred by the consumer from buying the good.

      Producer surplus is a measure of the gain from selling a good. It's the difference between how much the seller is willing to sell the good for and the price at which the good is sold. When this difference is greater than zero, the seller receives surplus, i.e. gains from selling the good.

      Total surplus (consumer surplus + producer surplus) describes the benefits to both buyers and sellers from exchanging goods.
      (12 votes)
  • leaf green style avatar for user Mohammed Ibrahim
    what is oppurtunity cost? can anyone explain this with an example if possible.?
    (3 votes)
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    • blobby green style avatar for user brandonkleine
      Opportunity Cost is the value of the best alternative to a given choice. That sounds pretty vague, so here is a good example:
      A farmer has a plot of land on which he can either grow wheat or barley. He chooses to grow wheat. His opportunity cost is what he would have made if he had chosen to grow barley. I hope that helps.
      (12 votes)
  • piceratops ultimate style avatar for user Isaac McQuown

    wouldn't the increase in wages cause people to want to work less hours if they can make the same amount of money for less work?
    (4 votes)
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    • male robot hal style avatar for user Andrew M
      It might! Different people might respond in different ways, depending on what they want from life. Some people are happy with a certain amount of money and would work fewer hours if they got paid more per hour. Other people would say, wow, if you are going to pay me more, then it's worth it to me to give up more of my time to make even more money.

      There is evidence that many cab drivers behave the way you are suggesting, for example. They want to make a certain amount of money per week, and when they hit their target, they stop. This is a different behavior than the behavior that's built into our "typical" law of supply, right? Economists will want to explore what the impact is if they change that assumption in their model.

      This is a good observation and it's good to question the models in this way by asking whether the underlying assumptions are correct.
      (6 votes)
  • blobby green style avatar for user Aayushman Singh
    Sir, what happens to the surplus labour? Won't they try to go even below the earlier equilibrium illegally just to survive as the demand has contracted?
    (2 votes)
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  • blobby green style avatar for user KennTakara
    Doesn't this model ignore feedback effects? It seems to me, that the linkage between the supply and demand for labor is indirect. There's a demand for labor if and only if there's a demand for the goods/services that the labor provides. So this graph only works if there are no feedback effects from the wage floor. Before the wage floor there $132M in wages is paid out, after the wage floor $142M in wages is paid out. Wouldn't that affect the demand curve?
    (3 votes)
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  • blobby green style avatar for user costasmanolas3
    How can you explain the impacts on consumers, producers, the government and workers following government's price floor imposition by using an appropriate diagram?
    (3 votes)
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Video transcript

Voiceover: Let's think a little bit about the labor market. In all of these videos, whether we're talking about renting units or hiring people, these are huge oversimplifications, but we're doing it in this way so we can apply some of these basic ideas that we're being exposed to in this survey of microeconomics, so that we can apply those basic ideas to real world things. It's important to realize we're making huge oversimplifications and often times the real context can be more complicated or a little bit nuanced, but it gives us a way of thinking about things. This is the unskilled labor market, so people who don't have any specific training or experience for a given job. The vertical axis is their wage rate per hour. It's essentially the price of labor. This little gap here shows I started at zero, but then I jumped up to five, six, seven. This right here is a quantity of labor. We're measuring that in terms of millions of hours per month. Once again, we have this little gap here, so we can jump to 20 million hours, 21 million hours. It's important to realize, when we think about demand in the labor market, we're not talking about individual consumers, we're talking about employers. In most cases, demand comes from individual consumers, but now the demand is coming from employers. These are the people who are essentially buying labor. The supply is not coming from corporations. The supply is coming from the people who provide labor, so now it's coming from individual workers. Now it is coming from workers. Let's just say that this market starts off completely unregulated, so it has a natural equilibrium price or equilibrium wage at $6 an hour and an equilibrium quantity of labor supplied, which is 22 millions of hours per month. Let's say the government in this hypothetical city or country says, "You know what? "$6 is a really low wage. "We have trouble imagining how people live well "off of a $6 an hour wage." They say this right over here is too low. The government does not like it and maybe many of their voters are people making that wage, so they say, "Hey, you know what? "We are going pass some well-intentioned legislation. "We are going to pass a minimum wage. "We are going to pass a law, minimum wage, "that says any employer has to pay at least $7 an hour." $7 an hour. It has to be at least $7 an hour, so this right over here is a price floor. This is a minimum price in the market. When we talked about rent control, that was a price ceiling. That was a maximum price for rent, now this is a minimum price for labor. Since the price floor, this minimum price, is higher than the actual clearing price, it's going to distort the market. Our price floor is right over here, $7. This right over here is our minimum wage. What's going to happen here? If you look at the demand side of things, the employers are going to say, "Wow! "If I have to pay $7 an hour now, I can only afford "21 million hours of labor." They're going to say, "I can only afford now "21 million hours of labor," but if you look at the workers they're going to say, "Gee, if I can make $7 an hour, "more people are going to be willing to work." Either an individual might say, "If I was working 40 hours a week making $6 an hour. "If I'm making $7 an hour, I'm willing to work "45 hours a week." Or there might be a student who's on the fence, who says, "Wow! "Now wages have gone up enough that it makes sense "for me to work." There might be someone who's retired and now, at $6 wasn't enough for them to come out of retirement, but $7 is. Maybe a stay at home parent now says $7 is enough for them to come out of retirement or not stay at home anymore. The labor, the quantity supplied of labor, in terms of hours, will increase. At $7 an hour, people will be willing to supply that much labor, but what's going to happen in this situation right over here? In this situation you have all of these people who want to work, but there's only demand for this much work. Right here, this is going to be an oversupply of labor. Another way to think about it, there's only jobs for 21 million people now and now 23 million people want to work. You're going to have 2 million people who are, by the classical definition of unemployed, people who are looking for work who can't find work now. Once again, this is completely oversimplified, because at this point right over here, based on the way I just viewed that, you would have no unemployment and we all know even when the economy is humming maximumly and there's no regulation, there is some unemployment, just due to frictions in the market, people just randomly quitting jobs or looking for a new job, so you could almost view this as excess unemployment. Or you could view this as just a very oversimplified model and in the ideal world you'd get close to zero unemployment. Now you have more people looking for jobs, because the wages have gone, but fewer jobs, because the employers are forced to pay more. If we make all of these assumptions in the model and you just want to say how many fewer jobs are there, because this, obviously, we're talking about more people even looking for jobs because the perceived wages have gone up. In the absolute level, based on these linear supply and demand curves, before there was demand for 22 million jobs and that was what the quantity demanded was and that's also where the quantity supplied was, but now its only 21 million. Based on this model, you're going to have 1 million fewer jobs. When you think about it in terms of surplus. Before the minimum wage, the entire surplus was this entire area over here. This entire area that's below the demand curve and above the supply curve. This entire area was the total surplus and it was being divided between the consumer surplus and the producer surplus. This right over here, between the price and the supply curve was the producer surplus. The producer surplus, remember the producers of labor are the individual workers. This was the benefit above and beyond the opportunity cost that the workers were getting was this area right over here that I'm doing in dark white or filled in white and the consumer surplus or the employer surplus here was the value that the employers were getting above and beyond the price that they had to pay. Now, in this situation of a minimum wage, now this is the set price, this is the quantity of labor that is demanded. What you lose now, the surplus that we lose is this quantity right over here. We could figure out that area quite easily. Let's see, this height right over here is 1 million hours per month, so it's going to be 1 million. I'll just write 1, we'll just remember it's on millions. Times this height right over here, which is $2 per hour. Times one half. If we just multiply these, we get this whole rectangle for the area of the triangle, we multiply it times one half. That gives us exactly 1 and the units are dollars per hour times millions of hours per month, gives us millions of dollars per month. It becomes $1 million per month of surplus, of benefit above and beyond, of total benefit that is lost to this market because of this regulation, if you assume all of the things in this model. Just like we talked about in the last video, we have a $1 million per month dead weight loss. Now, not everyone loses here. Because the price is set up over here, for the people who are working those first 21 million hours per month, their producer surplus has now increased, because the space between what they're getting and their opportunity cost has now increased. For those lucky enough to actually have a job, those workers now do have a higher surplus, but for those employers, which is on the demand side right now, who are employing those first 21 million hours of labor, they now have a smaller consumer surplus or demand surplus or employer surplus right there. For the first 21 million units of labor, it's redistributing the pie between the employers and the workers, but then because you are making the wage higher, it's reducing the overall demand, so there is, if you believe this model, some job destruction taking place.