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Are Minimum Wages Good? | The Law of Supply and Demand



What are the impacts of minimum wages on the economy? This is a discussion of the short and long term implications of minimum wage policy. I also discuss concepts such as the law of supply and demand as well as price elasticity.


Transcript


Hello ladies and gentleman welcome to the Elias Talks money v-log where I talk all things money and motivation. Today we're going to be talking about the law of supply and demand to help people understand the impact of government policy on the free market.


We've all heard the call from politicians like Bernie Sanders to increase the minimum wages, but what are the real impacts both short term and long term and how does this work from an economic standpoint.


In essence does increasing the mandatory minimum wage actually do more good than harm and are there any other considerations when we need to take into account when enacting such policies. Obviously, this is a political hot button, but I'm got to try and explain it simply from an economic theory perspective and not get into the politics of it.




So here is a supply and demand graph for labour let's just say this is for a generic good of "widgets". The blue line represents the demand for labour such that the lower the price of labour the greater the demand for it.


Meanwhile the green line represents the supply of labour such that the greater the price for labour the greater the supply of labour to make those widgets. Where the demand and supply curves intersect is considered the "equilibrium" price of labour such things are working efficiently, and there is no unemployment.


According to the law of supply and demand if you were to fix the minimum wage of labour above the equilibrium price then you would create unemployment. The greater you fix the wage rate above the equilibrium the great dislocation you create, and the more the resulting unemployment. This is represented by the different between the green line and the blue line up above the equilibrium price.


On the other hand if you believe the demand and supply are more inelastic the impact of a minimum wage above the equilibrium rate will be less as expressed by this graph. You can see that the lines are much more steep in this example.



Price elasticity of demand is the responsiveness of demand relative to the price. So if you believe the demand for labour is inelastic the demand of labour does not change too much with the price of labour. On the other hand if you believe if you have inelastic supply the supply of labour does not change much with price.


So what are the factors that impact the elasticity of the demand and supply curve. One thing could potentially could be substitutes. So if we are able to easily replace human workers with robots this would create dislocation in workers.


Also, if the job if it's hard to substitute workers due to special skill requirements and lengthy education the supply curve would be much more inelastic. Generally low skill jobs are considered to have more elastic supply curves.


For example, even if the wages increased drastically for doctors we would not see a massive increase in the supply of doctors especially in the short-run because of the education and extensive training required. If the wages for doctors increases substantially it could take years before people get the necessary skills and training to meaningfully increase their supply.


Generally over longer periods of time the supply curve of labour becomes more elastic. If you were to get a wage cut you would not leave your job tomorrow, as you would need time to look around for a job and give your two week notice etc. The more time you have the more you ability to find a new job.


Focusing back on the demand curve and the elasticity of it we've already mentioned replacing human labour with machines. Another factor is the elasticity of the final product that is being produced.


So for a product like bread that we purchase in similar quantity even if the price went up a bit, the demand for the labour would also be more inelastic because they could pass the price increase along to the consumer. From a theoretical standpoint this is one way that inflation is created.


Also for things that are more labour intensive, where labour is a very big portion of the total cost of producing a good or service the curve tends to be more elastic. The impact will be greater to the employer and more people will need to be laid off.


Lastly, similar to elasticity of the supply of labour the demand for labour tends to become more elastic the longer the time period.


The longer the time period the greater the ability of firms to adjust to increases in labour costs and find cheaper means of production, either through capital investment or the alteration of operating procedures to become more efficient.


In conclusion, we do know that minimum wages above the equilibrium price of labour can result in unemployment. The longer the time period we're looking at the more elastic the demand and supply curves necessary.


In the short term there may be little to no dislocation of labour, but the longer the time period we look at the more dislocation there is due to how elasticity of supply and demand works. So more similar to the first graph versus the second graph that I showed you.


In practicality how do we deal with this in the real world. We implement government policies such as additional funding for unemployment insurance to help pay for the dislocated works. These government policies would be funded by those who continue to produce widgets in this example via taxation. In theory if we set minimum wages below this equilibrium price to prevent the exploitation of the occasional vulnerable person which is a novel idea there shouldn't be any resulting unemployment in the long-run.


The challenge for policy makers comes from trying to determine the right minimum wage number as the equilibrium wage rate would differ between job category and industry. So that right number can be hard to determine, so there isn't a long-term detrimental impact to the economy.


The key here is long term as my point of emphasis as supply and demand curves are more elastic in the long-run. Thanks for watching my video and those are my thoughts on the subject. If you enjoyed my video please like and subscribe to the Elias Talks Money YouTube channel or follow me on the Elias Talks Money Facebook Page. Over and Out.


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