Elasticity Analysis of Minimum Wage

This activity is a 20-30 minute activity that is appropriate for principles of microeconomics or microeconomic theory. Students should have familiarity with supply and demand curves, labor markets, and elasticities before approaching this exercise. Student should understand a broader definition of elasticity that includes: elasticity of [dependent variable] with respect to [independent variable]. They should also have a sense that elasticities can be measured empirically to resolve disputes about the magnitude of these relationships.

Overview

This exercise has students thinking about the source of disagreement between people who want a raise in the minimum wage and those who want to keep it the same.

Expected Student Learning Outcomes

1) Students will be able to understand the importance of elasticities in policy analysis.
2) Students will be able to show how supply and demand curves can be used to analyze a minimum wage debate.

Information Given to Students

Two friends disagree about whether the U.S. should raise the minimum wage. Which of the following elasticities are these two most likely to disagree about?
A. Elasticity of labor demand.
B. Elasticity of labor supply.
C. Elasticity of jobs offshored w.r.t. minimum wage.
D. Elasticity of work effort w.r.t. minimum wage.

(w.r.t. = "with respect to")

***In discussing your answer, be sure to consult a labor supply & demand diagram.

Leading discussion:

In leading a discussion after teams have revealed answers, the first order of business is to have a team put their supply and demand diagram on the board. If their supply and demand analysis is incorrect, other teams can correct the analysis.

After that, it can be useful to discuss the elasticity of supply and the elasticity of demand. At least one team is likely to identify the elasticity of labor demand as an important factor. These teams can articulate the fact that the firms have substitutes for labor (machines, wait times, etc).

If any team identifies labor supply as the most important factor, it is worth first making sure that they are not mixing up labor supply with labor demand, since these are the reverse of the "normal" supply and demand graph (people = labor supply / people = product demand). If they have that correct, it is worth exploring what substitutes low-wage workers have for supplying their labor (black market labor, etc).

If teams identify the elasticity of jobs offshored w.r.t minimum wage as the most important elasticity in the debate, it is worth exploring how important offshoring is compared to automation in terms of the source of job loss among low wage workers. This may also be a good time to bring up the concept of measured elasticities, and to ask the class how they may go about measuring any one of these particular elasticities, if they had the resources to study the matter.

If teams choose the elasticity of work effort w.r.t. minimum wage, it can be a good time to bring up shirking and motivation for work.

Tailoring for microeconomic theory:

In microeconomic theory, this conversation could be deepened by considering what kind of utility function workers are maximizing. Are they simply maximizing wages? What s the opportunity cost to their work? How would that opportunity cost be built into their utility maximization model?

A microeconomic theory class could also potentially build a profit maximization function with workers (w) as a choice variable, or with workers and capital (w & k) as choice variables. They could identify what about the function makes the labor demand curve that results from the model (w*). Is it the opportunity cost of capital that matters most? The substitutability of capital and labor?

You could also prod a class that is reporting out their answers to this exercise about how the possibilities of monopsony power and/or backward-bending supply curves would change the answer.

The main way of assessing teams is to ensure that their labor supply & demand curves accurately portray the minimum wage debate, and that the nuance of forces behind the magnitude of elasticities comes out through the discussion.