A price control is a legal price established by the government that forbids the selling of a good or service above some maximum or below some minimum price. It is an example of triangular intervention—the state coerces two parties to exchange at a certain price. The direct consequence of the effective maximum price control is for a shortage to emerge as quantity demanded exceeds quantity supplied. Secondary effects will include a queue of buyers, non-price rationing by the sellers, misallocation of resources, and malinvestment. This article, however, will focus on a minimum price control.
There are two types of minimum price controls: effective and ineffective.
An ineffective minimum price control will occur when the state legislates a minimum price which is below the equilibrium price. In this case, there will be no effects attributable to the legislation because the good or service is already trading above where the government mandates it must. Thus, there is very little analysis for the economist in this situation.
On the other hand, an effective minimum price control establishes a mandatory minimum price above the equilibrium price. This scenario distorts market processes not only for that particular good, but also for related markets.
The direct effect of an effective minimum price control is for a surplus to emerge. Because the price is higher than what it would be on the market, this induces more suppliers to enter the market. At the same time, the marginal buyers will exit the market in search of substitutes once the higher (non-market) price goes into effect. As a result, the quantity traded of this good will fall in response to the higher price. If the good in question is labor, say in the case of an effective minimum wage law, a surplus of labor will emerge. Consequently, only the most productive workers that earn the minimum wage will retain their positions. The rest would be forced into unemployment or illegal compensation.
There are numerous secondary effects that would likely emerge from an effective minimum wage law. The New York Times recently highlighted some concerns of business-owners about a minimum wage hike–an idea being pushed by Mayor Bloomberg. But there is a deeper economic analysis of this issue that should accompany any discussion of a minimum wage.
First, sellers will misallocate themselves into the market with the minimum wage law. If the law is universal, those that were voluntarily unemployed will experience a rise in the opportunity cost of leisure. In our current system, there is a minimum wage on all industries except agriculture. The short-run effect is to have labor leave agriculture for the mandated higher wage industries.
However, due to the surplus of labor in all other industries, many workers will opt for employment at the lower wage that agriculture offers. Some workers will view this as preferable to being unemployed. Thus, the long-run affect is to further reduce the wages in agriculture because of the increased supply of labor. The minimum wage law has affectively reduced all non-minimum wage industries.
The surplus which emerges in response to minimum wage leads to further secondary effects: queuing and non-price rationing schemes. Queuing implies that labor is literally “lining up” to apply for a job. For instance, a company might have two openings for which they have 100 applicants, and of these 40 might satisfy the marginal revenue product requirement. On the market, this problem would be solved as workers find wage rates that match their respective marginal revenue products.
Without the ability of wages to fall to match these marginal revenue products, employers can exercise non-price rationing in determining who to employ. Racist employers might now select employees on the basis of skin color, sexist employers on the basis of gender, etc. On the market, this discriminatory behavior would be punished by falling revenue if an employer chose to entertain his prejudices more strongly than considerations of profit and loss.
An additional secondary effect that is likely to emerge is the black market. Rather than accept unemployment, many workers will opt to receive lower wages “under the table.” An unfortunate side-effect of this situation is for sweatshops and other substandard work environments to emerge. In order to increase profit, employers can cut on costs, and this includes amenities and safety precautions that are commonplace on the legal market. Furthermore, sweatshops and unsafe working conditions are likely to persist because there is no legal redress for the workers. After all, there very labor has been criminalized. Many workers are willing to work in these conditions because they perceive them as superior to the alternative of unemployment. In short, minimum wage laws allow for property to go undefended.
Undesirable cultural effects may also arise out of minimum wage legislation. Empirically, young, uneducated males are those that have the lowest marginal revenue products. As a result, this demographic is most likely to experience higher than average unemployment rates in the face of minimum wage legislation. There is a tendency for these young, unemployed, restless individuals to form gangs and earn an income through plunder and theft instead of production. Racial discrimination by employers only heightens the tendency for gang formation. While this observation is not derived praxeologically, it has strong empirical backing. The rise of gangs in the United States is strongly correlated with minimum wage laws.
In industries subject to minimum wage laws, there will tend to be a form of malinvestment of scarce, societal resources. This will come in the form of over-capitalization. In the face of minimum wage legislation, firms will increase their investment in capital goods in order to raise the productivity of their workers so that the higher wage rate may be justified. The hope is that the capital goods will raise the discounted marginal revenue product of each worker by enough to justify the higher wage.
In fact, unions employ this argument to lobby for higher wages. On the surface, it seems plausible that minimum wage legislation has positive effects because it increases productivity and therefore increases the number of goods and services available to all members in society.
However, this analysis ignores what is unseen. The capitalization argument does not account for what investment would have occurred in the absence of minimum wage legislation. This foregone investment would have been more productive to society, by definition, because it would have occurred at the dictates of consumer demand instead of the dictates of politicians wielding coercive force. If the government forces a shift in investment, on net, wealth is being destroyed. The goods that would have been produced are more valuable the goods that are being produced.
Every intervention includes both winners and losers. Otherwise, there would be no intervention at all. Workers with a higher marginal productivity that are thus able to retain their jobs will gain in wealth because they now earn a higher wage. Those that are unemployed, find lower wages, or worse working conditions will be harmed in wealth. Producers will be harmed in wealth because there costs have increased. They are also harmed in utility because they have been coerced into exchange. Consumers will also be harmed in utility because the supply of goods will shrink due to additional costs for producers.