Thursday, November 26, 2015

The minimum wage in Info Econ 101

I added an update to this post about using supply and demand diagrams for the minimum wage, but thought it would be good to do a post on its own. The traditional Econ 101 use of supply and demand diagrams looks like this:


If you set a price above the equilibrium price P* then the new equilibrium market solution becomes the intersection of the demand curve and the minimum wage and the difference between the intersection of the demand curve and the supply curve with the minimum wage value is the amount of unemployment.

Some questions arise:

Why the demand curve intersection point? Why not the supply curve intersection point? This basically assumes that employers are at their limits, rather than say people are staying out of the labor force because a minimum wage job at a lower minimum wage isn't worth it.

What do the curves below the minimum mean? These represent the "illegal" supply and demand for labor -- the desire to employ people at less than the legal minimum wage. I personally would like to drive well over the speed limit, but that piece of the solution space doesn't necessarily enter into my speed decisions that are more based on traffic and road conditions. I'd really like to go a speed that is impossible for my car to attain ... but that should have even less impact.

Anyway, the Info Econ 101 (or Info Econ 1100101, ha! there's a nerd joke for you) picture is different:


The original solution to the information equilibrium condition is no longer a solution in the case of a minimum wage. The intersection point with the minimum wage and the original demand curve (or supply curve) is no longer a meaningful point. The general information equilibrium solution just says both supply and demand go up ... at least in the simplified presentation. There could be all kinds of more complex factors going on.

However that is the point. The Econ 101 analysis is not just oversimplified but wrong according to data. The Econ 101 view above is also wrong in the Info Econ 101 view which is itself simplified, but isn't inconsistent with data.
Econ 101: simple but inconsistent with data
Info Econ 101: simple and consistent with data

4 comments:

  1. "This basically assumes that employers are at their limits"

    Yes, it seems to me that economists typically take the point of view of employers.

    "The general information equilibrium solution just says both supply and demand go up ... at least in the simplified presentation. There could be all kinds of more complex factors going on."

    It was a shock to me to find the economics arguments against a minimum wage not taking a systemic approach. Why should the original curves remain the same?

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    Replies
    1. I think this was part of the original Marshall versions of the diagrams -- and it just stuck around.

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  2. That's a PRIME time nerd joke!

    ReplyDelete

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