Minimum Wage: The Legal Price of Labor
What Is the Minimum Wage and Why Was It Created?
Imagine you are hired to help at a local grocery store, stocking shelves for a few hours after school. Without a minimum wage law, the store owner could offer to pay you any amount, perhaps just $2 per hour. A minimum wage law sets a legal limit below which that payment cannot go. In the United States, the federal minimum wage is currently $7.25 per hour. This means our grocery store must pay at least that rate.
The primary goal is to protect workers from exploitation—being paid unfairly low wages—and to ensure a basic standard of living. The idea gained major traction during the Great Depression of the 1930s. With massive unemployment, companies could pay desperately low wages. The U.S. government passed the Fair Labor Standards Act (FLSA) in 1938, establishing the first national minimum wage at $0.25 per hour. The goal was to boost consumer spending: if workers earn more, they can buy more goods, which helps the entire economy.
How the Minimum Wage Works: Federal vs. State Rules
In many countries, including the U.S., there isn't just one single minimum wage. There is a hierarchy of rules:
- Federal Minimum Wage: This is the nationwide floor set by the federal government. No state can set a minimum wage lower than this.
- State Minimum Wage: Individual states (and some cities) can set their own minimum wage that is higher than the federal rate. For example, the state minimum wage in Washington is much higher than the federal one.
- Local/City Minimum Wage: Some major cities like Seattle and New York City have even higher minimum wages to account for a much higher cost of living.
The rule is simple: workers are entitled to the highest minimum wage that applies to them—federal, state, or local. This system allows for differences in economic conditions across the country.
| Jurisdiction | Minimum Wage (per hour) | Notes |
|---|---|---|
| U.S. Federal | $7.25 | Last increased in 2009 |
| California | $16.00 | Applies to all employers |
| Texas | $7.25 | Follows federal rate |
| Washington | $16.28 | Adjusted annually for inflation[1] |
| Seattle, WA (City) | $19.97 (large employers) | One of the highest city-level wages |
The Economic Model: Supply, Demand, and the Wage Floor
Economists use supply and demand models to predict the effects of a minimum wage. Let's visualize the market for low-skilled labor, like fast-food workers or retail assistants.
- Labor Demand (D): This represents businesses that want to hire workers. The demand curve slopes downward. Why? If wages are high, businesses might hire fewer workers or invest in automation (like self-checkout kiosks).
- Labor Supply (S): This represents people willing to work at different wage levels. The supply curve slopes upward. Higher wages attract more people to seek jobs.
In a free market without a minimum wage, the wage ($W_e$) and the number of workers hired ($Q_e$) are determined where supply and demand meet—this is the equilibrium.
Now, introduce a minimum wage ($W_m$) that is set above the equilibrium wage ($W_e$). On a graph:
1. At the higher wage $W_m$, the quantity of labor supplied (people wanting jobs) increases along the supply curve to $Q_s$.
2. However, the quantity of labor demanded (jobs available) decreases along the demand curve to $Q_d$.
The result is a surplus of labor, which we call unemployment. The size of this unemployment is $Q_s - Q_d$.
This model predicts job loss, which is the classic argument against raising the minimum wage. But real-world outcomes can be more complex, as we'll see next.
The Great Debate: Arguments For and Against
The minimum wage is one of the most debated topics in economics. Here are the main points from both sides.
Arguments For Raising the Minimum Wage:
- Reduces Poverty and Inequality: It directly increases the income of the lowest-paid workers, helping them afford basic necessities like food, housing, and healthcare.
- Boosts Consumer Spending: Low-wage workers are likely to spend any extra income immediately in their local economies, stimulating business.
- Increases Productivity and Reduces Turnover: Better-paid workers may be happier, more motivated, and less likely to quit, saving businesses money on hiring and training.
- Reduces Government Spending: With higher wages, fewer workers need government assistance programs like food stamps (SNAP[2]), potentially reducing taxpayer costs.
Arguments Against Raising the Minimum Wage:
- Increases Unemployment: As the simple model shows, if labor becomes more expensive, employers may hire fewer people, especially young and low-skilled workers.
- Raises Costs for Businesses: Small businesses with thin profit margins may struggle to pay higher wages. They might raise prices, cut workers' hours, or even close.
- Could Lead to Automation: Businesses might replace workers with machines. For example, a fast-food restaurant might install ordering kiosks instead of hiring more cashiers.
- May Hurt the Very People It Aims to Help: If a teenager loses a job because the minimum wage rose, they lose income and valuable work experience.
A Real-World Case Study: The Fast-Food Restaurant
Let's apply these concepts to a concrete example: "Burger Barn," a local fast-food restaurant.
Scenario 1 (Before a Minimum Wage Increase):
Burger Barn employs 10 crew members at the state minimum wage of $12 per hour. Business is steady, and the owner, Maria, finds this wage sustainable. The crew's total hourly wage cost is $120 (10 x $12).
Scenario 2 (After a Minimum Wage Increase to $15):
The state raises the minimum wage to $15. Maria now faces a 25% increase in her hourly labor costs. She has several options, each reflecting different economic theories:
1. Raise Prices: She increases the price of a burger from $5 to $5.50. This may reduce the number of burgers sold if customers are sensitive to price.
2. Reduce Staff/Hours: She cuts her staff to 8 workers. The 2 laid-off workers are now unemployed. The hourly wage cost is now also $120 (8 x $15), but with less work being done.
3. Invest in Automation: She installs two self-order kiosks for $8,000. This allows her to reduce staff by 2 permanently. The upfront cost is high, but it saves money long-term.
4. Absorb the Cost: If Maria's business is very profitable, she might simply accept lower profits for a while, hoping that her more motivated and stable staff will improve service and attract more customers.
In reality, Maria will likely use a combination of these strategies. This example shows that the outcome isn't just "job loss" or "no job loss." It's a mix of effects on employment, prices, technology, and business investment.
Important Questions
A: This is a major criticism of the current federal minimum wage in the U.S. A full-time worker earning $7.25/hour earns about $15,080 per year, which is below the federal poverty line for a single-person household. The point of having it is to establish an absolute legal minimum, but many argue it needs to be a "living wage"[3]—a wage high enough to meet basic needs. This debate drives movements to raise it to $15 or more.
A: No, there are important exceptions written into the law. For example, "tipped workers" like waiters and waitresses can be paid a lower "cash wage" (as low as $2.13 per hour federally) as long as their tips bring their total earnings up to at least the standard minimum wage. If tips don't cover the difference, the employer must pay it. Other exceptions can include some student workers, workers with disabilities, and young workers under 20 in their first 90 days of employment.
A: It can contribute to inflation, but it's not a simple one-to-one relationship. If many businesses raise prices to cover higher wage costs across the economy, overall price levels can rise. However, this effect is usually considered small for moderate increases. Other factors, like the cost of raw materials and energy, have a much larger impact on inflation.
The minimum wage is a powerful policy tool with clear goals—protecting workers and ensuring a baseline for earnings—but complex economic consequences. The basic supply and demand model provides a crucial framework for understanding the risk of unemployment, yet real-world studies often show that modest, well-planned increases have minimal negative effects on jobs while significantly helping low-income families. The key takeaway is that the impact depends on how much it is raised, where it is raised, and the overall health of the economy. As students of economics, observing the ongoing experiments in different states and cities provides valuable insights into how societies balance the goals of fairness, opportunity, and economic growth.
Footnote
[1] Indexation/CPI: Consumer Price Index (CPI). A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Many states index their minimum wage to the CPI, meaning it automatically increases each year with inflation to maintain its purchasing power.
[2] SNAP: Supplemental Nutrition Assistance Program. A U.S. federal program that provides food-purchasing assistance for low- and no-income people.
[3] Living Wage: An hourly wage that is high enough for a person to meet their basic needs (food, housing, healthcare, transportation) without needing government assistance or secondary employment. It is often calculated locally and is usually higher than the minimum wage.