Minimum Rationality for Minimum Wage

In an election year, legislators do irrational things, such as spend more money than the budget supports, fund pork projects for their districts, and raise the minimum wage.

There is an important principle in economics called the Law of Demand. It states that the higher the price of something, the less that will be bought. This applies to everything, including labor. When GM wants to sell more cars, it lowers prices. So why do politicians foolishly think that raising the price of labor won’t have an adverse impact on employment? They know better, so they only raise the minimum wage when the economy is strong and employment is growing. Thus they can claim (as many supporters do) that they raised the minimum wage and jobs went UP! However, when you raise the cost of labor, companies hire fewer workers.

What are the arguments in support of this government price setting?

“A family of four can’t live on a minimum wage job.” Naturally, yet few families are dependent on a single minimum wage job for their income. Families with a sole minimum wage worker receive some form of welfare benefits to supplement their income.

“This helps poor people.” Most minimum wage workers are from above median income families. The average family income of PA minimum wage earners is about $50,000. Almost 80% of the benefits of a higher minimum wage go to families that aren’t poor. Furthermore, most poor people don’t have a job to begin with. With a higher minimum wage, getting a job will become even harder in the future.

“The minimum wage has been eroded by inflation.” True, thus it is no surprise that we employ the highest percentage of the population in history. The lower the cost of labor, the more people businesses hire. This argument presumes that it makes sense for government to set a minimum at all. If there really is no adverse effect of raising the minimum wage, why settle? Why not $20 per hour, or even the Major League Baseball minimum salary of $327,000?

“It raises spending among low-wage earners and boosts the economy.” Unless businesses have a hidden pot of money not being used, every dollar a minimum wage worker gets from the increase must come from either (1) profits at the firm or (2) out of customers’ pockets through higher prices. Every dollar received comes from someone else, reducing their spending. The net gain is 0. And if employment falls, total spending will fall, not rise.

Suppose you own a pizza parlor. You employ 10 students at $5 per hour. You sell 60 pies a day at an average price of $15, for annual revenue of $250,000. Wages for 10 students for 2,000 hours at $5 per hour is $100,000. Rent, utilities, supplies, etc. cost $100,000, leaving a profit of $50,000 for you, the owner. Raising the minimum wage to $7 adds $40,000 to labor costs (for the same level of productivity) and reduces your salary to a meager $10,000. You can either (1) close your business, putting 11 people out of work, or (2) raise prices to cover the higher costs. But the Law of Demand says that at higher prices, less pizza is purchased—fewer than 10 workers are needed, and one will be fired. Those workers still having a job will get more money, but every dollar they earn comes out of the pockets of customers, you (the owner), or the unfortunate worker losing a job.

Raising the minimum wage is an inefficient way to help low-wage workers. Far preferable is an earned income tax credit that helps only low-wage workers and gives people an incentive to work. When you raise the minimum wage, owners will hire fewer unskilled workers, making it hard for new entrants to the labor force to get a good start.

Governor Rendell claims we were at a competitive disadvantage with New York and New Jersey because their minimum wages were higher than ours. Yet while the Governor thinks that higher labor costs (not higher quality workers, just more expensive ones) attract businesses, it is lower labor costs that make a state attractive. Raising the minimum wage is good politics if voters don’t think it through, but bad economics and bad for job creation, especially for unskilled workers and new entrants to the labor force.

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William C. Dunkelberg, PhD, is a professor of Economics at Temple University and a board member for the Commonwealth Foundation (, an independent public policy research and educational institute located in Harrisburg.