I was discussing the tragedy of the minimum wage over the weekend with a friend, explaining that economists of pretty much all political affiliations agree that a minimum wage set above a competitive market wage hurts the poorest members of society.
Even after viewing this video, he proposed a model: imagine that an employer makes $1 million in profit, and needs workers to produce the product. Raising the minimum wage will be simply redistributive, and that firm will simply hire the same workers that they would have hired, but pay them more.
That’s the wrong model. The mechanism at work here is not just simple redistribution. Governments might accomplish simple redistribution by cash transfers, but not by just raising the minimum wage. Employers make hiring decisions at the margin. This means that they weigh the costs and benefits of hiring that next worker. If the worker only produces $5.00 of value per hour, it doesn’t make sense for a profit-maximizing firm to pay $6.00 per hour for that labor. In a competitive market, we would expect that a wage for a worker would be competed up to how much value that worker can actually produce.
People make decisions at the margin. Imagine you’re selling hot chocolate, and you’re going to donate the proceeds to your favorite charity. Assume that all customers won’t pay more than $1.00. If you find that you require $1.50 to make a cup, it doesn’t make sense to even make it. If you’re selling each unit at a loss, you can’t turn a profit by increasing the volume you sell.