Income
inequality is a huge hot button issue in the United States right now,
and a proposed solution or reform to battle this issue is a hike in
the minimum wage to a "livable level" of $15 an hour. It is
justified with comments like, "Wal-Mart made X billion dollars last
year, they can afford it!" or, "CostCo or [insert company here]
pay above minimum wage already, so it clearly isn't an issue!"
In
this article, I will demonstrate two things:
This
policy would harm those it is intended to help
Supporters
do not understand profit margins or basic economics
I'm
going to skip all the economics for now and just boil it down to a
dollars and cents problem.
Suppose
Dan owns a burger joint, "Dan's Delicious Burgers." The
following are his costs, prices, and sales per month of menu items:
Burgers:
$2.00 Fries: $1.00 Drink: $1.00
bun:
$0.15 potatoes: $0.08 soda: $0.10
patty:
$0.85 oil: $0.12 cup: $0.05
cheese:
$0.25
TC(B):
$1.25 TC(F): $0.20 TC(D): $0.15
In a
given month, Dan sells...
1000
burgers x 2.00 = $2,000 1000 x TC(B) = $1,250
800
fries x 1.00 = $800 800 x TC(F) = $160
900
drinks x 1.00 = $900 900 x TC(D) = $135
Revenue
R = $3,700 Costs C = $1545
Profit
P = R-C = 3700-1545 = $2155
Profit
margin (P/R) = 2155/3700 = $58.24%
This
assumes that Dan employs 0 people. Now, let's say Dan hires Jimmy at
a rate of $7.50 an hour, the minimum wage. Let's also say that Jimmy
works full time or 40 hours a week.
Jimmy's
monthly wage cost = 4(40 x 7.50) = $1,200
Total
Cost = 1545+1200 = 2745
Profit
= $955, P/R = 25.8%
Those
are pretty cushy margins for any business, but we also didn't account
for rent, tax, etc.
A few
months later, the protestors get their way, and the minimum wage is
increased to $15 per hour, doubling Jimmy's wage cost. Let's pretend
for now that the cost of all other inputs remain the same and that
Dan achieves equal sales figures.
R =
3700, C= 1545+2400 = 3945, P = -245, P/R = -6.62%
Dan
rationally decides that losing money is bad for his business, duh!
Let's now assume that Dan can't fire Jimmy. How much would Dan have
to raise prices by to achieve like profit, $955?
Dan
would need to raise $1200 in revenue. In order to do that, he would
have to raise prices by ΔC/R...
1200/3700 = 0.324 or 32%.
A burger would now
cost $2.64 and fries and drinks would cost $1.32. Assuming like sales
figures and all other costs, R = $4884.
4884-3945
= $939, lower due to the rounding down.
It's
important to note that Dan's margins have declined substantially.
939/4884 = 19.2%
Now
I'm going to demonstrate that the two assumptions regarding sales and
other costs are bunk in the real world. I will still use the
inability to fire workers assumption for now, though.
Dan's
cost of other inputs will also rise substantially because other firms
will have to increase prices by ΔC/R. Let's make the assumption (for
simplicity) that ΔC/R = 32% for all firms in Dan's supply chain,
that is, the companies who make the things Dan buys in order to make
burgers, fries, and drinks. So the cost of Dan's inputs rise by 32%
TC(B)
= 2.00 x 1.32 = 1.65
TC(F)
= 0.20 x 1.32 = 0.26
TC(D)
= 0.15 x 1.32 = 0.20
To
maintain like P of $955, Dan would have to hike prices even higher.
Still assume like sales figures...
$1.65
x 1000 = 1650
$0.26
x 800 = 208
$0.20
x 900 = 180
Costs
= $2,038
Total
Costs = 2038+2400 = 4438.
ΔC
= 1693
Dan
now needs to raise $1693 in revenue. 1693/3700 = 46%.
Now, the cost of Dan's
burger would be $2.92, and fries and drinks would be $1.46.
Dan's
profit margins have once again dropped.
R
= 3700(1.46) = 5402
P
= 5402-4438 = $964
P/R
= 964/5402 = 17.8%
As
mentioned before, this assumes that Dan can actually maintain like
sales figures while hiking prices by 46%. As you all know, that isn't
going to happen! If you increase the price of anything, people will
buy less of it, that's a Law
of Demand.
Once
again, for the sake of simplicity (I really don't want to throw
calculus in the mix here), let's assume the relationship between the
price and quantity demanded for Dan's menu items are 1-for-1. In
other words, an increase in price of 46% would mean a decrease in
quantity demanded (or sales) of 46%.
Dan
would bring in substantially less revenue.
540
x 2.92 = $1576.80
432
x 1.46 = $630.72
486
x 1.46 = $709.56
Revenue
= $2917.08
540
x 1.65 = $891
432
x 0.26 = $112.32
486
x 0.20 = $97.20
Costs
= 1100.52+2400 = 3500.52
Profit
= -$583.44
This
leads to the disqualification of our other assumption. Dan would
absolutely have to cut
hours of his employees or lay them off to save costs. There
are two sides to the profit equation! Cutting costs is substantially
easier. But, Dan would
have to fire Jimmy, and in the end would most likely run out of
business.
Which
brings us to the conclusion that raising
the minimum wage causes an increase in unemployment.
When
the minimum wage is raised, more people would like to "sell their
labor" for that wage, i.e., more people want to enter the labor
force. The red line, supply of labor, reflects that relationship.
However, when the minimum wage is raised, as shown extensively above,
employers are less willing to hire workers at that rate. The blue
line, demand of labor, reflects that relationship. When you place the
minimum wage above the market clearing wage, denoted as W*, you get
unemployment. Period.
The
workers who are not let go or do not receive hour cuts will only
benefit marginally and only in the very short run. As the effects of
labor cost increases work their way into the economy, the prices of
the things that these employees buy will rise. The costs of
necessities as a percentage of the poor's wages are already
disproportionately higher compared to the middle class or the
wealthy. It isn't as if the price of only burgers will increase!
Those who lose their jobs due to this policy will be greatly affected
because of this. In addition, many new workers will be priced
out of the market. This
means that their productivity does not justify a wage of $15 an hour,
so they are never hired in the first place. Many of these potential
workers would be teens in need of that first job experience. A hike
in the minimum wage will actually put
less money in the pockets of the poor.
Now,
recall what I said about profit margins. A common argument for an
increase in the minimum wage is that "big corporations" can
afford this hike because they make billions in profits. It
doesn't matter if you make $1 billion if it cost you $999,999,999 to make
that billion! In other
words, what matters is...
PROFIT
MARGINS
Corporations
like Wal-Mart and McDonald's operate under very thin profit margins,
i.e., they make very little on each individual sale. Therefore, the
way to make more nominal profit, the end number (in the example,
$955), is to increase total sales. That's why you see so many
Wal-Marts and McDonald's restaurants! They make a tiny profit on each
sale but make many millions of sales.
Wages
are the most immediate and highest cost to any business. You can't
pay for anything until you've paid your workers. In the example, the
cost of labor, even at $7.50, was the highest cost.
A
hike to $15 would put huge pressure on Wal-Mart and McDonald's to cut
hours, lay off workers, and increase prices. They simply would have
to do so to stay alive. In the example, Dan didn't really have the
choice to fire Jimmy because Jimmy was his only employee.
Wal-Mart
has an average
quarterly profit margin of around 3.5%. On every $1.00 of
revenue, they take home $0.035. An increase to $15/hour would
absolutely hammer that. Is it better for those workers to have jobs
or not? Plus, do you really think that McDonald's is going to pay its
workers $15 an hour? Not
in the long term!
So,
what about CostCo? Why would they support a hike in the minimum wage?
Think
about this; who is CostCo's biggest competitor... WAL-MART! CostCo
would no doubt like to see it's biggest competitor take a hit. If
prices rise at Wal-Mart, the incentive to go to CostCo becomes much
higher, because the difference in prices between the two gets
smaller.
I'm
not saying that Wal-Mart and McDonald's are the best corporations in
terms of ethics. I don't buy things from either. (The Wal-Mart in my
area is filthy dirty and is always busy, plus, there's only ONE
register open. Gee, doesn't that prove the point!) I only used them
because they are common targets of outrage.
The
concepts I want readers to takeaway from this article are:
Think
on the margin.
Do
cost/benefit analysis.
You
can't mandate your way to a better life.
People
respond to incentives.
Do
your own research. Don't listen to the "talking heads."
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