10/24/2018 E-Player App Is the Competitive Market Fair? 5.4 Explain the main ideas about fairness and evaluate claims that markets result in unfair outcomes When a natural disaster strikes, such as a severe winter storm or a hurricane, the prices of many essential items jump. The reason prices jump is that the demand tio n and willingness to pay for these items has increased, but the supply has not changed. So the higher prices achieve an efficient allocation of scarce resources. News reports of these price hikes almost never talk about efficiency. Instead, they talk about equity or fairness. The claim that is often made is that it is unfair for ib u profit-seeking dealers to cheat the victims of natural disaster. Similarly, when low-skilled people work for a wage that is below what most ist r would regard as a “living wage,” the media and politicians talk of employers taking unfair advantage of their workers. D How do we decide whether something is fair or unfair? You know when you think or something is unfair, but how do you know? What are the principles of fairness? Philosophers have tried for centuries to answer this question. Economists have ot f offered their answers too. But before we look at the proposed answers, you N should know that there is no universally agreed upon answer. Economists agree about efficiency. That is, they agree that it makes sense to make the economic pie as large as possible and to produce it at the lowest possible cost. But they do not agree about equity. That is, they do not agree about what are fair shares of the economic pie for all the people who make it. The reason is that ideas about fairness are not exclusively economic ideas. They touch on politics, ethics, and religion. Nevertheless, economists have thought about these issues and have a contribution to make. Let’s examine the views of economists on this topic. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 1/19 10/24/2018 E-Player App To think about fairness, think of economic life as a game—a serious game. All ideas about fairness can be divided into two broad groups. They are It’s not fair if the result isn’t fair. It’s not fair if the rules aren’t fair. It’s Not Fair if the Result Isn’t Fair The earliest efforts to establish a principle of fairness were based on the view that the result is what matters. The general idea was that it is unfair if people’s tio n incomes are too unequal. For example, it is unfair that a bank president earns millions of dollars a year while a bank teller earns only thousands of dollars. It is unfair that a store owner makes a larger profit and her customers pay higher ib u prices in the aftermath of a winter storm. During the nineteenth century, economists thought they had made an incredible discovery: Efficiency requires equality of incomes. To make the economic pie as ist r large as possible, it must be cut into equal pieces, one for each person. This idea turns out to be wrong. But there is a lesson in the reason that it is wrong, so this or Utilitarianism D idea is worth a closer look. The nineteenth-century idea that only equality brings efficiency is called ot f utilitarianism. Utilitarianism is a principle that states that we should strive to achieve “the greatest happiness for the greatest number.” The people who developed this idea were known as utilitarians. They included the most eminent N thinkers, such as Jeremy Bentham and John Stuart Mill. Utilitarians argued that to achieve “the greatest happiness for the greatest number,” income must be transferred from the rich to the poor up to the point of complete equality—to the point at which there are no rich and no poor. They reasoned in the following way: First, everyone has the same basic wants and a similar capacity to enjoy life. Second, the greater a person’s income, the smaller is the marginal benefit of a dollar. The millionth dollar spent by a rich https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 2/19 10/24/2018 E-Player App person brings a smaller marginal benefit to that person than the marginal benefit that the thousandth dollar spent brings to a poorer person. So by transferring a dollar from the millionaire to the poorer person, more is gained than is lost. The two people added together are better off. Figure 5.7 illustrates this utilitarian idea. Tom and Jerry have the same marginal benefit curve, MB. (Marginal benefit is measured on the same scale of 1 to 3 for both Tom and Jerry.) Tom is at point A. He earns $5,000 a year, and his marginal benefit from a dollar is 3 units. Jerry is at point B. He earns $45,000 a year, and his marginal benefit from a dollar is 1 unit. If a dollar is transferred from Jerry to Tom, Jerry loses 1 unit of marginal benefit and Tom gains 3 units. So together, tio n Tom and Jerry are better off—they are sharing the economic pie more efficiently. If a second dollar is transferred, the same thing happens: Tom gains more than Jerry loses. And the same is true for every dollar transferred until they both reach point C. At point C, Tom and Jerry have $25,000 each and a marginal benefit of 2 Utilitarian Fairness N ot f or D Figure 5.7 ist r the greatest happiness to Tom and Jerry. ib u units. Now they are sharing the economic pie in the most efficient way. It brings Tom earns $5,000 and has 3 units of marginal benefit at point A. Jerry earns $45,000 and has 1 unit of marginal benefit at point B. If income is transferred from Jerry to Tom, Jerry’s loss is less than Tom’s gain. Only when each of them h $25 000 d2 it f i lb fit ( t i t C) th f th i t t l https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 3/19 10/24/2018 E-Player App has $25,000 and 2 units of marginal benefit (at point C) can the sum of their total benefit increase no further. Watch Utilitarian Fairness The Big Tradeoff One big problem with the utilitarian ideal of complete equality is that it ignores the costs of making income transfers. Recognizing the costs of making income transfers leads to what is called the big tradeoff , which is a tradeoff between tio n efficiency and fairness. The big tradeoff is based on the following facts. Income can be transferred from people with high incomes to people with low incomes only by taxing the high incomes. Taxing people’s income from employment makes them work less. It ib u results in the quantity of labor being less than the efficient quantity. Taxing people’s income from capital makes them save less. It results in the quantity of capital being less than the efficient quantity. With smaller quantities of both labor ist r and capital, the quantity of goods and services produced is less than the efficient D quantity. The economic pie shrinks. The tradeoff is between the size of the economic pie and the degree of equality with which it is shared. The greater the amount of income redistribution through ot f or income taxes, the greater is the inefficiency— the smaller is the economic pie. There is a second source of inefficiency. A dollar taken from a rich person does not end up as a dollar in the hands of a poorer person. Some of the dollar is spent N on administration of the tax and transfer system. The cost of tax-collecting agencies, such as the Internal Revenue Service (IRS), and welfare-administering agencies, such as the Centers for Medicare & Medicaid Services (CMS), must be paid with some of the taxes collected. Also, taxpayers hire accountants, auditors, and lawyers to help them ensure that they pay the correct amount of taxes. These activities use skilled labor and capital resources that could otherwise be used to produce goods and services that people value. When all these costs are taken into account, taking a dollar from a rich person does not give a dollar to a poor person. It is possible that with high taxes, people https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 4/19 10/24/2018 E-Player App with low incomes might end up being worse off. Suppose, for example, that highly taxed entrepreneurs decide to work less hard and shut down some of their businesses. Low-income workers get fired and must seek other, perhaps even lower-paid, work. Today, because of the big tradeoff, no one says that fairness requires complete equality of incomes. Make the Poorest as Well Off as Possible A new solution to the big-tradeoff problem was proposed by philosopher John tio n Rawls in a classic book entitled A Theory of Justice, published in 1971. Rawls says that, taking all the costs of income transfers into account, the fair distribution of the economic pie is the one that makes the poorest person as well off as possible. The incomes of rich people should be taxed, and after paying the costs of ib u administering the tax and transfer system, what is left should be transferred to the poor. But the taxes must not be so high that they make the economic pie shrink to the point at which the poorest person ends up with a smaller piece. A bigger ist r share of a smaller pie can be less than a smaller share of a bigger pie. The goal is to make the piece enjoyed by the poorest person as big as possible. Most likely, D this piece will not be an equal share. The “fair results” idea requires a change in the results after the game is over. or Some economists say that these changes are themselves unfair and propose a ot f different way of thinking about fairness. N It’s Not Fair if the Rules Aren’t Fair The idea that it’s not fair if the rules aren’t fair is based on a fundamental principle that seems to be hardwired into the human brain: the symmetry principle. The symmetry principle is the requirement that people in similar situations be treated similarly. It is the moral principle that lies at the center of all the big religions and that says, in some form or other, “Behave toward other people in the way you expect them to behave toward you.” In economic life, this principle translates into equality of opportunity. But equality https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 5/19 10/24/2018 E-Player App of opportunity to do what? This question is answered by the philosopher Robert Nozick in a book entitled Anarchy, State, and Utopia, published in 1974. Nozick argues that the idea of fairness as an outcome or result cannot work and that fairness must be based on the fairness of the rules. He suggests that fairness obeys two rules: 1. The state must enforce laws that establish and protect private property. 2. Private property may be transferred from one person to another only by voluntary exchange. tio n The first rule says that everything that is valuable must be owned by individuals and that the state must ensure that theft is prevented. The second rule says that the only legitimate way a person can acquire property is to buy it in exchange for something else that the person owns. If these rules, which are the only fair rules, ib u are followed, then the result is fair. It doesn’t matter how unequally the economic pie is shared, provided that the pie is made by people, each one of whom ist r voluntarily provides services in exchange for the share of the pie offered in compensation. rD These rules satisfy the symmetry principle. If these rules are not followed, the symmetry principle is broken. You can see these facts by imagining a world in fo which the laws are not followed. First, suppose that some resources or goods are not owned. They are common ot property. Then everyone is free to participate in a grab to use them. The strongest will prevail. But when the strongest prevails, the strongest effectively owns the N resources or goods in question and prevents others from enjoying them. Second, suppose that we do not insist on voluntary exchange for transferring ownership of resources from one person to another. The alternative is involuntary transfer. In simple language, the alternative is theft. Both of these situations violate the symmetry principle. Only the strong acquire what they want. The weak end up with only the resources and goods that the strong don’t want. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 6/19 10/24/2018 E-Player App In a majority-rule political system, the strong are those in the majority or those with enough resources to influence opinion and achieve a majority. In contrast, if the two rules of fairness are followed, everyone, strong and weak, is treated in a similar way. All individuals are free to use their resources and human skills to create things that are valued by themselves and others and to exchange the fruits of their efforts with all others. This set of arrangements is the only one that obeys the symmetry principle. Fair Rules and Efficiency tio n If private property rights are enforced and if voluntary exchange takes place in a competitive market with none of the obstacles described above (here ), ib u resources will be allocated efficiently. According to the Nozick fair-rules view, no matter how unequal is the resulting ist r distribution of income and wealth, it will be fair. It would be better if everyone were as well off as those with the highest incomes, but scarcity prevents that outcome and the best attainable outcome is the efficient D one. ot f or Case Study: A Generator Shortage in a Natural Disaster Hurricane Katrina shut down electricity supplies over a wide area and increased N the demand for portable generators. What is the fair way to allocate the available generators? If the market price is used, the outcome is efficient. Sellers and buyers are better off and no one is worse off. But people who own generators make a larger profit and the generators go to those who want them most and can afford them. Is that fair? On the Nozick rules view, the outcome is fair. On the fair outcome view, the t i ht b id d f i B t h t th lt ti ? Th https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 7/19 10/24/2018 E-Player App outcome might be considered unfair. But what are the alternatives? They are command; majority rule; contest; first-come, first-served; lottery; personal characteristics; and force. Except by chance, none of these methods delivers an allocation of generators that is either fair or efficient. It is unfair in the rules view because the distribution involves involuntary transfers of resources among citizens. It is unfair in the results view because the poorest don’t end up being made as well off as possible. At Issue tio n Price Gouging Price gouging is the practice of offering an essential item for sale following a natural disaster at a price much higher than its normal ib u price. In the aftermath of Hurricane Katrina, John Shepperson bought 19 ist r generators and rented a U-Haul truck to transport them from his Kentucky home to a town in Mississippi that had lost its electricity supply. He offered the generators to eager buyers at twice the price he D had paid for them. But before Mr. Shepperson had made a sale, the Mississippi police confiscated the generators and put him in jail for or four days for price gouging. ot f In Favor of a Law Against Price Gouging Supporters of laws against price gouging say N It unfairly exploits vulnerable needy buyers. It unfairly rewards unscrupulous sellers. In situations of extraordinary shortage, prices should be regulated to prevent these abuses and scarce resources should be allocated by one of the non-market mechanisms such as majority vote or equal shares for all. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 8/19 10/24/2018 E-Player App Should the price that this seller of generators may charge be regulated? tio n The Economist’s Response Economists say that preventing a voluntary market transaction leads to inefficiency—it makes some people worse off without making ib u anyone better off. In the figure below, when the demand for generators increases from D0 to D1, the equilibrium price rises from $200 to $600. ist r Calling the price rise “gouging” and blocking it with a law prevents additional units from being made available and creates N ot fo rD a deadweight loss. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13e… 9/19 10/24/2018 E-Player App Review Quiz 1. What are the two big approaches to thinking about fairness? 2. What is the utilitarian idea of fairness and what is wrong with it? 3. Explain the big tradeoff. What idea of fairness has been developed to deal with it? ib u tio n 4. What is the idea of fairness based on fair rules? ist r This content is unavailable when printing rD . You’ve now studied efficiency and equity (fairness), the two biggest issues that looks at an example fo run through the whole of economics. Economics in the News of an inefficiency in our economy today. At many points throughout this book— and in your life—you will return to and use the ideas you’ve learned in this ot chapter. We start to apply these ideas in the next chapter where we study some N sources of inefficiency and unfairness. Economics in the News Making Traffic Flow Efficiently La La Land Has the World’s Worst Traffic Congestion A di t th INRIX T ffi S d th l t t d f https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 10/19 10/24/2018 E-Player App According to the INRIX Traffic Scorecard, the largest-ever study of traffic congestion, the United States has the most traffic congestion of any developed country in the world. The study looked at 1,064 cities across 5 continents and 38 countries. Traffic congestion costs U.S. drivers close to $300 billion in 2016, or $1,400 per driver. Five U.S. cities made the global top 10, with Los Angeles coming in first place. The study found that drivers in L.A. spend an average of 104 hours a year sitting in traffic, at a cost of $2,048 per driver. For the city as a whole, INRIX reported that the congestion costs Los Angeles $9.6 billion in direct and indirect costs. Direct costs include wasted time and fuel; indirect costs include freight and business fees from tio n company vehicles being stuck in traffic. Those indirect costs are ultimately passed along to consumers in the form of higher prices. The most congested U.S. cities are taking steps to break the gridlock. ib u In 2016, Los Angeles passed Measure M, which is a $120 billion plan to update the city’s transit infrastructure. New York—which ranked as the third most congested city—is focusing on subway expansion to ist r keep cars off its roads; and San Francisco, which came fourth in the study, has implemented its Smart I-80 Corridor, which uses technology D including ramp meters, overhead lane marker signs, and traffic information boards to keep the interstate traffic moving smoothly. ot f or Sources: USA TODAY, February 20, 2017; INRIX; theplan.metro.net; and California Department of Transportation, I-80 Smart Corridor. Essence of the Story N Transportation analytics firm INRIX studied traffic flows in 1,064 cities around the world. U.S. motorists wasted almost $300 billion in time and fuel in 2016. Los Angeles had the worst congestion. The average LA driver wasted 104 hours and $2,408 of fuel. Los Angeles plans a $120 billion transit upgrade. San Francisco has created the Smart I-80 corridor. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 11/19 10/24/2018 E-Player App This content is unavailable when printing tio n Economic Analysis Let’s see how a congestion price works by looking at an economic model of a highway. ib u The highway has the marginal social cost curve MSC in the figures. It can carry only 10,000 vehicles per hour with no congestion. Figure 1 ist r At the peak time, the demand curve and marginal benefit curve is illustrates inefficient road use. At the peak demand time, D at a zero price, 40,000 vehicles per hour enter the road. The marginal social cost is $6 per vehicle-hour and there is a ot f or deadweight loss (of time and gasoline) shown by the gray triangle. Inefficient Rush-Hour Road Use N Figure 1 https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 12/19 10/24/2018 E-Player App Figure 2 illustrates efficient road use at the peak period. Imposing a congestion charge of $3 per vehicle-hour brings an equilibrium at 25,000 vehicles per hour, which is the efficient quantity. Total surplus, the sum of consumer surplus (green) plus producer surplus (blue), is maximized. tio n Efficent Rush-Hour Road Use N ot f or D ist r ib u Figure 2 Congestion charges would be paid by all road users, regardless of whether they are rich or poor, but they don’t have to leave the poor worse off. Revenue raised from congestion charges can be redistributed to low-income households if there is a fairness problem. So long as road users pay the marginal social cost of their decision, road use is efficient. San Francisco has introduced a system of congestion pricing on a ti f I 80 th t i ti i h h hi l https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 13/19 10/24/2018 E-Player App section of I-80 that imposes a time-varying charge when a vehicle tio n enters an on-ramp. While traffic grinds to a halt on many U.S. freeways, Electronic Road ib u Pricing (ERP) keeps vehicles moving in Singapore. Singapore has the world’s most sophisticated congestion pricing ist r with the price displayed on gantries (see photo). The price rises as congestion increases and falls as congestion eases. Advances in information technology make congestion pricing an D attractive tool for achieving an efficient use of the road ot f or transportation system. N Worked Problem This content is unavailable when printing . https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 14/19 10/24/2018 E-Player App ist r ib u tio n The figure illustrates the market for sunscreen. D Questions 1. At the market equilibrium, calculate or (a) consumer surplus and (b) producer surplus. 2. Is the market for sunscreen efficient? Why? ot f 3. What is deadweight loss? Calculate it if factories produce only 50 bottles of sunscreen. N Solutions 1. (a) Consumer surplus is the excess of the benefit received over the amount buyers paid for it. The demand curve tells us the benefit, so consumer surplus equals the area under the demand curve above the market price, summed over the quantity bought. The price paid is $10 a bottle, the quantity bought is 100 bottles, so consumer surplus equals the area of the green triangle in the figure below. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 15/19 E-Player App tio n 10/24/2018 The base is the quantity ib u bought (100 bottles) and the height the maximum price ($20 a bottle) ist r minus the market price ($10 a bottle). Consumer surplus equals Key Point: Consumer surplus equals the area under the demand curve above the D market price. or 1. (b) Producer surplus is the excess of the amount received by sellers over the cost of production. The supply curve tells us the cost of producing the ot f good, so producer surplus is equal to the area under the market price above the supply curve, summed over the quantity. Producer surplus is N equal to the area of the blue triangle in the following figure. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 16/19 10/24/2018 E-Player App In this triangle, the base is the quantity sold (100 bottles), the height is the market price ($10 a bottle) minus the minimum cost ($5 a bottle), so producer surplus is or $250. Key Point: Producer surplus equals the area under the market price above the tio n supply curve. 2. Total surplus (consumer surplus plus producer surplus) is a maximum, so ib u the market is efficient. ist r Key Point: A competitive market is always efficient. 3. When factories produce less than the efficient quantity (100 bottles), some total surplus is lost. This loss is called the deadweight loss and it is N ot f or D equal to the area of the gray triangle in the following figure. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 17/19 10/24/2018 E-Player App This content is unavailable when printing tio n The base is the benefit of the 50th bottle minus the cost of producing it ($7.50), the height is quantity not produced (50 bottles), so deadweight ib u loss equals N ot f or D ist r Key Point: Underproduction creates a deadweight loss. https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 18/19 E-Player App N ot f or D ist r ib u tio n 10/24/2018 https://etext.pearson.com/eplayer/print?url=https://etext.pearson.com/eps/pearson-reader/api/item/af05b5ec-1aba-4385-bfb8-99444ec9a33c/1/file/parkin-microe-13… 19/19 A Labor Market with a Minimum Wage 6.2 Explain how a minimum wage law creates unemployment For each one of us, the labor market is the market that influences the jobs we get and the wages we earn. Firms decide how much labor to demand, and the lower tio n the wage rate, the greater is the quantity of labor demanded. Households decide how much labor to supply, and the higher the wage rate, the greater is the quantity of labor supplied. The wage rate adjusts to make the quantity of labor ib u demanded equal to the quantity supplied. When wage rates are low, or when they fail to keep up with rising prices, labor ist r unions might turn to governments and lobby for a higher wage rate. A government regulation that makes it illegal to charge a price lower than a rD specified level is called a price floor . The effects of a price floor on a market depend crucially on whether the floor is fo imposed at a level that is above or below the equilibrium price. ot A price floor set below the equilibrium price has no effect. The reason is that the price floor does not constrain the market forces. The force of the law and the N market forces are not in conflict. But a price floor set above the equilibrium price has powerful effects on a market. The reason is that the price floor attempts to prevent the price from regulating the quantities demanded and supplied. The force of the law and the market forces are in conflict. When a price floor is applied to a labor market, it is called a minimum wage . A minimum wage imposed at a level that is above the equilibrium wage creates unemployment. Let’s look at the effects of a minimum wage. Minimum Wage Brings Unemployment At the equilibrium price, the quantity demanded equals the quantity supplied. In a labor market, when the wage rate is at the equilibrium level, the quantity of labor supplied equals the quantity of labor demanded: There is neither a shortage of labor nor a surplus of labor. But at a wage rate above the equilibrium wage, the quantity of labor supplied exceeds the quantity of labor demanded—there is a surplus of labor. So when a minimum wage is set above the equilibrium wage, there is a surplus of labor. The tio n demand for labor determines the level of employment, and the surplus of labor is unemployed. Figure 6.3 illustrates the effect of the minimum wage on unemployment. The ib u demand for labor curve is D and the supply of labor curve is S. The horizontal red line shows the minimum wage set at $10 an hour. A wage rate below this level is illegal, in the gray-shaded illegal region of the figure. At the minimum wage rate, ist r 20 million hours of labor are demanded (point A) and 22 million hours of labor Minimum Wage and Unemployment N ot fo Figure 6.3 rD are supplied (point B), so 2 million hours of available labor are unemployed. The minimum wage rate is set at $10 an hour. Any wage rate below $10 an hour is illegal (in the gray-shaded illegal region). At the minimum wage of $10 an hour, businesses hire 20 million hours of labor, but 22 million hours are available. Unemployment—AB—of 2 million hours a year is created. With only 20 million hours demanded, someone is willing to supply the 20 millionth hour for $8. Minimum Wage and Unemployment tio n Watch ib u This content is unavailable when printing ist r With only 20 million hours demanded, someone is willing to supply that 20 millionth hour for $8. Frustrated unemployed workers spend time and other rD resources searching for hard-to-find jobs. fo Is the Minimum Wage Fair? The minimum wage is unfair on both views of fairness: It delivers an unfair result ot and imposes an unfair rule. N The result is unfair because only those people who have jobs and keep them benefit from the minimum wage. The unemployed end up worse off than they would be with no minimum wage. Some of those who search for jobs and find them end up worse off because of the increased cost of job search they incur. Also those who search and find jobs aren’t always the least well off. When the wage rate doesn’t allocate labor, other mechanisms determine who finds a job. One such mechanism is discrimination, which is yet another source of unfairness. The minimum wage imposes an unfair rule because it blocks voluntary exchange. Firms are willing to hire more labor and people are willing to work more, but they are not permitted by the minimum wage law to do so. Inefficiency of a Minimum Wage In the labor market, the supply curve measures the marginal social cost of labor to workers. This cost is leisure forgone. The demand curve measures the marginal social benefit from labor. This benefit is the value of the goods and services produced. An unregulated labor market allocates the economy’s scarce labor resources to the jobs in which they are valued most highly. The market is tio n efficient. The minimum wage frustrates the market mechanism and results in unemployment and increased job search. At the quantity of labor employed, the ib u marginal social benefit of labor exceeds its marginal social cost and a deadweight loss shrinks the firms’ surplus and the workers’ surplus. shows this inefficiency. The minimum wage ($10 an hour) is above ist r Figure 6.4 the equilibrium wage ($9 an hour) and the quantity of labor demanded and The Inefficiency of a Minimum Wage N ot fo Figure 6.4 rD employed (20 million hours) is less than the efficient quantity (21 million hours). A minimum wage decreases employment. Firms’ surplus (blue area) and workers’ surplus (green area) shrink and a deadweight loss (gray area) arises. Job search increases and the red area shows the loss from this activity. Watch The Inefficiency of a Minimum Wage Because the quantity of labor employed is less than the efficient quantity, there is a deadweight loss, shown by the gray triangle. The firms’ surplus shrinks to the blue triangle and the workers’ surplus shrinks to the green triangle. The red tio n rectangle shows the potential loss from increased job search borne by workers. The full loss from the minimum wage is the sum of the deadweight loss and the ib u increased cost of job search. ist r At Issue Does the Minimum Wage Cause Unemployment? rD In the United States, the federal government’s Fair Labor Standards Act sets the federal minimum wage. In 2017, it was $7.25 an hour, a level set in 2009. Most states have a minimum wage that exceeds the fo federal minimum. Does the minimum wage result in unemployment? And if so, how much ot unemployment does it create? N No, It Doesn’t David Card of the University of California at Berkeley and Alan Krueger of Princeton University conducted a very large and carefully designed telephone survey of more than 400 employers of workers who earn the minimum wage. They say: An increase in the minimum wage increases teenage employment and decreases unemployment. Their study of minimum wages in California, New Jersey, and T f d th t th l t t fl i k Texas found that the employment rate of low-income workers increased following an increase in the minimum wage. A higher wage increases employment by making workers more conscientious and productive as well as less likely to quit, which lowers unproductive labor turnover. A higher wage rate also encourages managers to seek ways to increase labor productivity. Yes, It Does David Neumark of the University of California, Irvine combined all the most recent studies and says they show that a 10 percent tio n rise in the minimum wage decreases teenage employment by between 1 and 3 percent. Daniel Hamermesh of the University of Texas, at Austin says that minimum wage goes up. ib u firms anticipated the rise and cut employment before the Finis Welch of Texas A&M University and Kevin Murphy of the University of Chicago say regional differences in economic ist r growth caused the employment effects that Card and Krueger found. rD Michael Luca of the Stanford Institute for Economic Policy Research used a huge dataset from online review resource Yelp and found that a higher minimum wage rate increases the ot fo business failure rate. N Review Quiz 1. What is a minimum wage and what are its effects if it is set above the equilibrium wage? 2. What are the effects of a minimum wage set below the equilibrium wage? 3. Explain how scarce jobs are allocated when a minimum wage is in place. 4. Explain why a minimum wage creates an inefficient allocation of labor resources. 5. Explain why a minimum wage is unfair. This content is unavailable when printing . tio n Next we’re going to study a more widespread government action in markets: taxes. We’ll see how taxes change prices and quantities. You will discover the surprising fact that while the government can impose a tax, it can’t decide who N ot fo rD ist r ib u will pay the tax! You will also see that a tax creates a deadweight loss. N ot rD fo ist r ib u tio n Extra Credit 3 (due on Tuesday) Many politicians are advocating for a higher minimum wage. But others have argued against raising the minimum wage. a) Is the minimum wage fair? Evaluate the fairness of the minimum wage based on both the "results" and "rules" of a minimum wage (see the section "Is the Competitive Market Fair?" in Chapter 5 for the two broad ideas of fairness). b) Read an article from one side of the debate (either for or against the higher minimum wage). Argue your own position based on what you've learned in Chapters 5 and 6 and the article you've read. Make sure you cite your article.
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