When the minimum wage is raised, McDonalds has to either raise their price (which reduces demand), or find a way to do more with fewer workers.
Actually neither, according to standard economic theory. According to standard supply/demand ideas price is picked in order to maximized profit. This maximization of profit is the same point regardless of labor costs (or taxes or whatever). Similarly, a well run business has enough workers to meet demand. The first order effect to a minimum wage increase is a decrease in profit. Adjusting the price up will just result in even less profit.
The mechanism that drives up unemployment is that marginal businesses that WERE making a profit cannot make a profit under the new minimum wage law. This drives them out of business and reduces employment. So prices don’t go up, but marginal businesses fail.
The idea that price is related to cost is one of the first thing disabused by standard economic theory. Optimal price is market driven.
Isn’t this oversimplifying things? If McDonalds was previously making a 5% profit on its minimum wage workers, and the minimum wage increases by more than 5%, obviously they have to raise their price so they at least make a profit rather than a loss on each unit (of whatever they’re selling). But, raising the price reduces demand so they’ll probably have to reduce their production rate (number of units) by firing a few workers as well. Which I guess is in a way equivalent to marginal businesses failing.
The mechanism that drives up unemployment is that marginal businesses that WERE making a profit cannot make a profit under the new minimum wage law. This drives them out of business and reduces employment. So prices don’t go up, but marginal businesses fail.
That is one mechanism, sure. But you’ve done nothing to address the part where some businesses optimize productivity to remove positions, specifically in response to budget concerns brought about by wage increases.
According to standard supply/demand ideas price is picked in order to maximized profit. This maximization of profit is the same point regardless of labor costs (or taxes or whatever). … Adjusting the price up will just result in even less profit.
Yes, and spherical cows are frictionless in a vacuum, or something like that. The real world is non-spherical, with air resistance and friction.
In this context, the friction is that economists continuous functional curves are averaging out huge amounts of discrete behavior and ignoring time lag. They also tend to ignore things like real world prices not being infinitely adjustable. Consumer goods are priced according to numerology, or less flippantly, according to consumer psychology. If you were to graph sales according to price on a continuous curve, you would find all sorts of weird spikes, mostly where certain ending digits work better than others, but also where certain middle digits and starting digits are more popular as well.
This means that “adjusting the price up will just result in less profit” is not always true, because not every business has optimized its prices in the first place. It is a truism among consultants that the default recommendation to a small business in need of more income is to simply raise prices by 10-15% across the board, before looking for other ways to improve the bottom line. (Such as raising the prices of a few select products even further, e.g by 100-400%.)
Don’t the laws of economics say this condition shouldn’t exist? Why were these prices not optimized? Because the business owner is not a spherical cow any more than the consumer is. Market conditions changed but they didn’t notice or update their beliefs, for example.
If business owners were economic automatons, they would of course have already adjusted their prices to the optimum, and continuously improved their productivity so as to have already gotten rid of any people they could have gotten rid of. In practice, however, humans only pay attention to a few things at a time, and have their attention drawn to things that are causing them pain sooner than things that might potentially give them pleasure at a later date.
That is why they have not already raised their prices, nor optimized every potential ounce of productivity: the spectre of lost sales due to raised prices, or the likely pains involved in changing methods weigh more heavily on their minds than the theoretically improved profits that would come later.
However, when businesses are forced to increase wages, the pain of a reduced profit suddenly seizes their attention, and they become less risk averse about changes, whether the changes are to prices or procedures.
(And in many cases, the standby approach to increasing productivity is to just employ fewer people and leave it to the remaining people to figure out how to accomplish the same work they used to do with more people, “or else”.)
That is one mechanism, sure. But you’ve done nothing to address the part where some businesses optimize productivity to remove positions, specifically in response to budget concerns brought about by wage increases.
Sure, but those are secondary effects, and the ability to do this depends on the specifics of the market. As soon as you move away from econ 101, specifics matter and we can’t really say what will happen with any certainty.
Regardless, for your specific example of McDonalds there is an obvious third option (beyond making do with fewer workers or raising prices) that you were neglecting- making less profit. McDonalds, in particular, is fairly well run and has decently evidence based price points and labor guidelines. Would you really expect McDonalds has failed to optimize labor and productivity to the extent that a minimum wage hike won’t primarily come out of franchise and corporate profits?
What happens in reality with a minimum wage increase will depend on the mix of businesses in that area and how well they are run. If a small town’s local employers are a Walmart logistics center and an amazon warehouse, increasing minimum wage is unlikely to result in much reduced employment, both companies are very well run and focused on both productivity and pricing. A state wide minimum wage increase may even result in MORE employment from increased Walmart/Amazon demand.
If a local area’s primary employment is poorly run local restaurants, companies may well make do with fewer workers, and employment will drop.
It is a truism among consultants that the default recommendation to a small business in need of more income is to simply raise prices by 10-15% across the board, before looking for other ways to improve the bottom line.
And when a consultant works with big employers, (say Walmart), you don’t recommend what they are already doing (relentlessly optimizing prices). Many (most in many areas) minimum wage employees work for large chains (which are reasonably well managed), so its not obvious which effect will be larger and it probably varies area to area.
I hope we can agree that raising the minimum wage will have some mix of employment effects and (essentially) wealth transfer to low income workers. I hope we can agree that in the real world, this mix is going to be very much dependent on specific economic factors.
Actually neither, according to standard economic theory. According to standard supply/demand ideas price is picked in order to maximized profit. This maximization of profit is the same point regardless of labor costs (or taxes or whatever). Similarly, a well run business has enough workers to meet demand. The first order effect to a minimum wage increase is a decrease in profit. Adjusting the price up will just result in even less profit.
The mechanism that drives up unemployment is that marginal businesses that WERE making a profit cannot make a profit under the new minimum wage law. This drives them out of business and reduces employment. So prices don’t go up, but marginal businesses fail.
The idea that price is related to cost is one of the first thing disabused by standard economic theory. Optimal price is market driven.
Isn’t this oversimplifying things? If McDonalds was previously making a 5% profit on its minimum wage workers, and the minimum wage increases by more than 5%, obviously they have to raise their price so they at least make a profit rather than a loss on each unit (of whatever they’re selling). But, raising the price reduces demand so they’ll probably have to reduce their production rate (number of units) by firing a few workers as well. Which I guess is in a way equivalent to marginal businesses failing.
That is one mechanism, sure. But you’ve done nothing to address the part where some businesses optimize productivity to remove positions, specifically in response to budget concerns brought about by wage increases.
Yes, and spherical cows are frictionless in a vacuum, or something like that. The real world is non-spherical, with air resistance and friction.
In this context, the friction is that economists continuous functional curves are averaging out huge amounts of discrete behavior and ignoring time lag. They also tend to ignore things like real world prices not being infinitely adjustable. Consumer goods are priced according to numerology, or less flippantly, according to consumer psychology. If you were to graph sales according to price on a continuous curve, you would find all sorts of weird spikes, mostly where certain ending digits work better than others, but also where certain middle digits and starting digits are more popular as well.
This means that “adjusting the price up will just result in less profit” is not always true, because not every business has optimized its prices in the first place. It is a truism among consultants that the default recommendation to a small business in need of more income is to simply raise prices by 10-15% across the board, before looking for other ways to improve the bottom line. (Such as raising the prices of a few select products even further, e.g by 100-400%.)
Don’t the laws of economics say this condition shouldn’t exist? Why were these prices not optimized? Because the business owner is not a spherical cow any more than the consumer is. Market conditions changed but they didn’t notice or update their beliefs, for example.
If business owners were economic automatons, they would of course have already adjusted their prices to the optimum, and continuously improved their productivity so as to have already gotten rid of any people they could have gotten rid of. In practice, however, humans only pay attention to a few things at a time, and have their attention drawn to things that are causing them pain sooner than things that might potentially give them pleasure at a later date.
That is why they have not already raised their prices, nor optimized every potential ounce of productivity: the spectre of lost sales due to raised prices, or the likely pains involved in changing methods weigh more heavily on their minds than the theoretically improved profits that would come later.
However, when businesses are forced to increase wages, the pain of a reduced profit suddenly seizes their attention, and they become less risk averse about changes, whether the changes are to prices or procedures.
(And in many cases, the standby approach to increasing productivity is to just employ fewer people and leave it to the remaining people to figure out how to accomplish the same work they used to do with more people, “or else”.)
Sure, but those are secondary effects, and the ability to do this depends on the specifics of the market. As soon as you move away from econ 101, specifics matter and we can’t really say what will happen with any certainty.
Regardless, for your specific example of McDonalds there is an obvious third option (beyond making do with fewer workers or raising prices) that you were neglecting- making less profit. McDonalds, in particular, is fairly well run and has decently evidence based price points and labor guidelines. Would you really expect McDonalds has failed to optimize labor and productivity to the extent that a minimum wage hike won’t primarily come out of franchise and corporate profits?
What happens in reality with a minimum wage increase will depend on the mix of businesses in that area and how well they are run. If a small town’s local employers are a Walmart logistics center and an amazon warehouse, increasing minimum wage is unlikely to result in much reduced employment, both companies are very well run and focused on both productivity and pricing. A state wide minimum wage increase may even result in MORE employment from increased Walmart/Amazon demand.
If a local area’s primary employment is poorly run local restaurants, companies may well make do with fewer workers, and employment will drop.
And when a consultant works with big employers, (say Walmart), you don’t recommend what they are already doing (relentlessly optimizing prices). Many (most in many areas) minimum wage employees work for large chains (which are reasonably well managed), so its not obvious which effect will be larger and it probably varies area to area.
I hope we can agree that raising the minimum wage will have some mix of employment effects and (essentially) wealth transfer to low income workers. I hope we can agree that in the real world, this mix is going to be very much dependent on specific economic factors.