In last night’s GOP debate, Congressman Ron Paul was asked whether he believed that eliminating the minimum wage would improve the employment situation in the U.S. While his answer was weak–he called it a mandate, comparing it to the mandatory purchase of health insurance as required by the Patient Protection and Affordable Care Act of 2010 (Obamacare)–he was ultimately correct in his conclusion. As most viewers would clearly see a distinction between a requirement to purchase a product, and a restriction on the price of that product, I believe that Dr. Paul would have been better served by referring to the minimum wage as a price control.
The economic detriments of price controls are relatively simple as long as you grasp the law of supply and demand. In short, the law of supply and demand explains that as prices increase, a greater quantity of goods will be supplied and and a lesser quantity will be demanded (both serving to lower the price) and that prices on a free market will fluctuate to balance supply and demand at what is called the market-clearing price, that price which enables all willing suppliers and all willing demanders to fulfill their desired exchanges. Of course, it is very rare that an economy will ever actually reach the market-clearing price due to the constant changes and unlimited variables involved in human action, but prices on a free market will tend toward such an equilibrium.
When price controls are introduced into such a situation, the mechanism of supply and demand is prevented from working according to the explanation above. If the government places a maximum price on a good and therefore holds the price too low relative to the free market price, less will be supplied (as we saw above) and more will be demanded. These two factors would normally raise the price to ensure that everyone wishing to exchange could do so, but under a maximum price control, suppliers who realize that they are being prevented from earning what they could otherwise have earned will likely leave that market in order to supply some other good. On the flip side, consumers who realize that they are able to get the product more cheaply than they would otherwise be able will flock to this market. The inevitable result will be shortages as demand for that product exceeds the available supply.
A minimum price control (or a minimum wage) works the same way, only in reverse. If the government places a minimum on how much may be charged for labor and therefore holds the price too high relative to the free market price, labor suppliers (workers) will increase their supply of labor while employers will decrease their demand for labor. Some employers, now facing a choice of paying more for the same amount of labor, will now find increased automation to be worth the investment where a lower labor price had previously made it not worth the investment. On a free market, a greater supply of labor would lower wages to ensure that everyone desiring a job would be able to find it. Under a system of wage controls, involuntary unemployment is furthered as labor supply exceeds labor demand. The idea that a minimum wage will simply increase the amount of money in everyone’s pocket with no unpleasant side effects is just bad economics.
I certainly can’t blame the American people for not understanding the effects of price controls, as economics and logic were removed from most public school curricula long ago. In fact, most of the ideas coming out of Congress and our state legislatures these days would never be tolerated if the public was receiving sufficient education in these subjects. Until we get society trained in “the economic way of thinking“, we will continue to encounter the negative unintended consequences of all of our good intentions.
Oh, and just because it’s cool, click here for a picture of a nice supply-and-demand tattoo. I want one.