Minimum Wage Employment Economics - It's Just a Monopsonistic Labor Market

Minimum wage employment economics can easily be confused. I'm a free market enthusiast, but even I'm getting annoyed by "free market" minimum wage arguments. I've heard the cliché economics argument too many times now.

"It's simple supply & demand. If you impose a minimum wage, you artificially raise the price of labor. With a higher price, businesses will demand less labor. Therefore, minimum wage causes more unemployment."

Many people use this argument to combat minimum wage laws. I can almost picture them smugly thumbing through an Econ 101 textbook for 10 minutes, then using this simplistic supply & demand argument to oppose something they already didn't like.

It takes more than superficial supply and demand knowledge to explain something as complex as minimum wage laws. I read the Econ textbook for 11 or 12 minutes, so I can tell you there is little to no basis for this economic argument against minimum wage. (To please the CSO requirements, I should tell you that I've really taken 5 economics classes, most graduate level. That's what "makes me an authority on the subject". I may even have read each textbook for more than 12 minutes.)

In the front of that Econ book, there are some important assumptions to be made before describing basic supply & demand. These are:

1) There are many buyers & sellers

2) There is perfect mobility (both buyers and sellers can freely enter and exit)

3) There is perfect information (everybody knows everyone else's prices)

In a market with these conditions, a minimum wage (or any minimum price) will indeed lower labor demand and increasing unemployment.

But does the labor market fit these conditions? I argue that the labor market doesn't meet ANY of these conditions.

1) I can attest that there are very few buyers of my particular labor.

2) There is almost no mobility. If I find that Google would offer me $100 more salary, I can't join Google and then later return to my original job when they offer me $200 more. Mobility is very low.

3) Information is nowhere near to perfect. Often, I don't know much a company is paying for labor until AFTER I've interviewed.

The Supply & Demand model does not describe the labor market very well. So we have to delve a little deeper, maybe even into the Econ 102 book.

We can describe minimum wage laws better with a monopsony model. The word monopsony might sound foreign to you, but it's just like a monopoly, which shouldn't be foreign at all.

In a monopoly there is only one seller. Since the monopolist doesn't face competition, it can set the price. Buyers then choose whether to purchase or not. Buyers can't choose to shop around for a better price. In most monopolistic markets, the seller will set an artificially high price to maximize its profit.

In a monopsony, there is only one buyer. That buyer sets the price, and then sellers can choose to sell or not. In a monopsonistic market, the buyer will set an artificially low price to maximize its utility (in other words, get more stuff for less money).

The labor market displays something closer to monopsonistic competition. This means there are multiple buyers who set their own prices. When was the last time you went to a job interview and said "I'm selling my labor for $50,000. Would you like to purchase?" In reality, the buyer sets the price (Executive Assistant needed, $35,000 salary). There is a little room to negotiate, but for the most part the seller can choose to take the job at the price offered, or not. The business (the buyer) sets the price of labor.

Monopsonistic labor purchasers set artificially low prices, which is economically inefficient. Essentially there is waste which makes society as a whole worse off. A minimum wage will bring the supply and demand equilibrium closer to its most efficient levels. In a monopsonistic market, a minimum wage will often actually INCREASE employment (or reduce unemployment). So if the labor market is monopsonistic, then rejecting a minimum wage law will increase unemployment.

Is the labor market monopsonistic? Economists are divided on the issue. However, there is little question that the monopsony argument better explains labor markets than the simple supply & demand argument.

So next time someone uses superficial economic reasoning, you will know better. It's not nearly that simple. At some point, we'll have to stop trying to logicize our way through the issue. The only way we'll get a clear answer is by testing minimum wage laws empirically, and then observing what truly happens.

Photo Credit: Sanja Gjenero