Sunday, 23 April 2017

Mental experiment on the effects of minimum wages

This thought experiment is from Don Boudreaux at Cafe Hayek.
Imagine that you’re given the option of buying ten-dollar bills for $5 a piece. How many will you buy? The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you. Of course, in reality $10 bills are never available for sale at $5 a piece. Or are they?! In a very real way, reality does indeed sometimes offer such deals. If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer. Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10. (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour. It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece. How many $5 bills will you buy? The answer again is obvious: none. Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill. The fact that you can “afford” to do so is irrelevant. If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.” And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each. No bill worth less than $10 would be purchased. No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp. Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

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