Friday, February 26, 2016

The Case Against Raising the Minimum Wage

A focal point of Presidential Candidate Bernie Sanders’ revolutionary economic plan is raising the federal minimum wage from $7.25 an hour to $15.00 an hour. This means that the wages of any entry level labor job will more than double. On the surface, this change is appealing. Young people can save more money for their education, and those who work minimum wage jobs to support their family will earn more than twice of what they earned before, right?

Wrong. The jump might have some immediate positive effects, but in the long run, the workers suffer.

To explain the damaging effects of raising the minimum wage, allow me to dust off one of my favorite high school textbooks and present a simple equation I learned in AP Macroeconomics, the Quantity Theory of Money (also referred to as the Equation of Exchange):

M V = P * Y

Now, before anyone has a flashback to math class with numberless and confusing equations, let’s identify each variable:
  • M = amount of money in a given economy
  • V = velocity of money (the rate at which money circulates throughout a given economy in a given unit of time)
  • P = price level of goods and services in a given economy
  • Y = output of goods and services in a given economy
Essentially, this equation states that the amount of money in an economy is directly related to the price level of goods and services, given that velocity and output remain constant. So, when the amount of money increases, price will increase in proportion. Here’s a simplified model to explain what I’m getting at:

M * V = P * Y

  • The Amount of Money in this example economy will equal the current minimum wage, $7.25.
  • For friendly numbers sake, the Velocity of the money of this economy will equal 100. This means that a given dollar is spent 100 times in this economy in a given unit of time.
  • The Price Level of Goods and Services in this economy will equal $25.
  • Finally, the Output of this economy will be 29 units of Goods and Services.

Now we plug in our variables
($7.25) * (100) = ($25) * (29)
$725 = $725
  • Now let’s implement the higher minimum wage, and solve for the new price level. (Remember, Velocity and Output remain constant)

($15) * (100) = (P) * (29)
$1500 = (P) * (29)
P = ($1500) / (29)
P= $51.724 (rounded to three decimal places)
  • From this, we can conclude that increasing the amount of money in an economy will also increase the Price Level of Goods and Services in an economy.
Simply put, inflation will be the result of doubling the federal minimum wage. However, some might be scratching their heads at my explanation. After all, it’s just an economic theory, and there are some economists who refute it. Perhaps that criticism is fair, but real world occurrences of this phenomena exist in extreme examples. Take Venezuela, a lush South American country rich with oil has developed into a poverty-stricken nation with an almost worthless unit of currency. I pray the United States does not follow suit and give in to short term success with the consequence of diminishing our currency and damning the economy.

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