Saturday, February 16, 2013

My defense for an increase in the Minimum Wage to $9.00. I speak of one element of the labor market I don't hear ANYONE refer to and I think it is important to understand...

There is lots of talk, for and against, regarding the recent proposal by the President to increase the minimum wage from $7.25 to $9.00 per hour.

Economic theory suggest that when you increase the price of something (wages) the quantity demanded (workers) decreases, hence unemployment increases and if the price (wages) decreases the quantity demanded (workers) increases, hence unemployment decreases. 

Even with an increase in the minimum wage I believe I can make the case that employment will INCREASE rather than decrease using the principles of Price Elasticity of Demand and the Total Revenue (Income) Test for Elasticity of Demand.

It might be a "stretch" but I think Elasticity of Demand for Labor factors into the equation.
I will use a series of graphs to illustrate my case.
The first graph shows a labor market in equilibrium at an hourly wage of $7.25 and the current level of employment at that wage 100 workers (obviously a made up number for simplicity).  $7.25 is the current minimum wage in the US. I will use this wage rate as my base and compare it to the new minimum wage of $9.00 proposed by President Obama in his State of the Union Address.  It also shows the TOTAL amount of income earned by these workers at that wage rate--$725.00 PER HOUR
Graph #2 shows the imposition of a new $9.00 per hour minimum wage ABOVE the current wage.  This would establish a new PRICE FLOOR. This is a 24% increase in the wage rate. The quantity demanded for labor DECREASED to 75 workers. This is a 25% decrease in Quantity Demand for Labor.  Using our formula for Price Elasticity of Demand (%chg in Qd/%chg in P) this suggests the Demand for Labor in this market is slightly ELASTIC, just over 1.  If we apply the Total Revenue Test (in this case Total Income), we find that as the wage increased the Total Revenue (Income) DECREASED to $675.00. This suggests the Elasticity of Demand is ELASTIC—as the price increases the Quantity Demanded decreases by a greater amount.

The policy implication of this increase in the minimum wage is we have REDUCED the income of these workers overall.  Less income, less spending in the economy overall, less GDP, hence less employment.
However, I think we have to look closer at the Elasticity of Demand (even for low income workers) in the SHORT RUN. The Short Run is the operative 2 words.  
I don’t believe businesses will significantly change their hiring or lay-off decisions in the immediate after-math of the increase in the minimum wage.  They must serve current customers and fill current and future orders.
Given this condition, In Graph #3 I suggest the Demand for Labor is relatively INELASTIC.  Business will NOT reduce their Quantity Demanded for Labor by more than the Increase in the Price of Labor. 

If Demand for Labor is relatively INELASTIC, then an increase in the Minimum Wage (+24%) will reduce employment to 90 workers from 100, or 10% LESS than before.  Using the formula for Price Elasticity of Demand (%chgQd/%chgP)  will yield a number LESS than 1 (-10%/+24%= -.41).  Performing the Total Revenue (Income) test, we find total income earned by these workers is $810.00, $85.00 MORE than before.  Fewer workers, higher overall income, in spite of the decrease in employment.

Assuming Demand for Labor is relatively INELASTIC, even for low skilled workers in the short run, by increasing the minimum wage will increase total income earned by these workers.

If total income increases these workers have more money to spend.  An increase in income will tend to move them to buy more “normal” goods and fewer “inferior” goods.  Normal goods tend to be higher value goods purchased as income increases.  Spending more money will create an increase in demand for new “normal” goods and services.  Hence, businesses will sell and produce more goods and services.  They will likely need to hire additional workers (at the margins) to produce and sell those additional goods and services.

As illustrated in the graph below, the Demand for Labor will INCREASE. The Demand Curve (D2 for Labor) will shift to the RIGHT.  As represented by Point “D”, at $9.00 the Quantity Demanded for Labor is 110 workers, a level of employment HIGHER than before.

Elasticity of Demand for low-skilled minimum wage workers seems to me mirrors the condition of the economy.  If the economy is doing well and unemployment is relatively low, then an increase in the minimum wage may actually be productive for the economy, as the demand for that labor will be relatively inelastic.

However, in an economic downturn it seems to me the demand for low-skilled labor becomes relatively elastic and an increase in the wage rate will have a higher negative impact on employment.

Bottom line for me:  Gotta pay attention to Elasticities and less to politics when it comes to this issue.

Friday, February 15, 2013

Price Floor Powerpoint---You can bet the Farm on this one!!!

Price Floors are another example of government intervention into the "free" market. It is an effort to set a price for a good or service ABOVE what the marketplace dictates/suggests the price should be.

The two prominent examples are the Minimum Wage and prices received by farmers for their commodity in the market. 

Here is my Powerpoint presentation trying to illustrate this concept in the simplest terms possible.

I use an agricultural commodity as an example---Corn.

Let me know what you think, and more importantly, any egregious errors I might have made. THANKS!

Price Ceilings explained as simply as possible. Must know info for when the Mayhem Guy from AllState comes to visit your community...

When disaster looms or when it strikes there can be a significant disruption in the delivery of goods to that area.  We have learned about this from the recent natural disasters in the Northeast US (Hurricane in the Summer and Snow just recently).

When this happens there are usually price increases on vital goods, such as water, basic food staples, gasoline, batteries, etc.  When the prices rise there is the inevitable cry of "PRICE GOUGING!!" and people demand the government do something about it.

The obvious action would be for the government to impose Price Ceilings.  A Price Ceiling prevents sellers of goods from raising prices above "reasonable" levels---whatever that means exactly.

The imposition of Price Ceilings do have consequences.  I put this powerpoint presentation to help you (or your students) understand how they work to serve AND under serve the marketplace.

Let me know what you think. Thanks!

Thursday, February 14, 2013

My Powerpoints to teach the Foreign Exchange Market in AP Macroeconomics.

My Powerpoints to teach the Foreign Exchange Market in AP Macroeconomics.

The first one is a long version to teach the "nuts and bolts". The second is a quick(er) review of the first.  The third is an explanation of the Interest Rate Effect on in the FOREX (very important for the AP Macroeconomics test).

Tuesday, February 12, 2013

Can you see me (Powerpoint) now?

My detailed powerpoint on curve shifting in a Basic Supply and Demand graph.  This is a test to see if it embeds properly and people can see it without having to sign up at the site where it is posted.

Let me know in the comments if you can view it freely. Thanks!

Sunday, February 10, 2013

Nice Infographic showing why Chinese consumers pay more for imports of certain foreign goods. See here how I link it to the Foreign Exchange Market. Gives an interesting perspective.

Here is a comparison of the price differential of certain "luxury goods" sold in China and the US.

The items below give the prices in the Chinese currency Yuan.  This shows, at the prevailing exchange rate (more on that a minute) how much the good is locally in China and how much that same good would cost the Chinese if they could exchange their currency and buy it in the US. In other words, how much Yuan are they giving up to buy the good in each place.

The current exchange rate between the US Dollar and the Yuan (CNY) is $1.00 = 6.23 CNY or the reciprocal 1 CNY = $.16.  ($1.00 "buys" 6.23 CNY or 1 CNY "buys" $.16).

To put each of the CNY numbers below in perspective, divided each of the numbers you see below by 6.23 CNY. This will give you the US Dollar equivalent.   Note: you can also multiply 22 CNY by $.16 and get the same result.

Example: In China 22 CNY for a Starbucks coffee would be (22CNY/6.23CNY) $3.53. In the US it would be (12 CNY/6.23 CNY)  $1.95.

Do the same math for the other goods to get a dollar to dollar comparison.  This is too much fun not to share! Hope you liked it.  :)
Infographic: Why are prices for Western consumer prices so high in China?
[Infographic by] [Original Chinese version by]
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