Find your role and sit at the indicated seat. Don’t disturb the materials. Shane Seremet

The Players and the Goals In this experiment, there are WORKERS and FIRMS. WORKERS sell labor to the FIRMS. FIRMS make and sell stuff.

One thing makes you happy: Money The Players and the Goals Two types of worker Red workers Blue workers Each worker’s goal: Maximize happiness One thing makes you happy: Money

Profit = Ending $ – Starting $ The Players and the Goals One type of firm Firms hire Red Labor and Blue Labor to produce their products. Firms automatically sell everything they produce for $2 per unit. Each firm’s goal: Maximize profit Profit = Ending $ – Starting $

= 1 hour of Blue labor = 1 hour of Red labor = 1 dollar The Objects = 1 hour of Blue labor Labor = 1 hour of Red labor Labor = 1 dollar $ = $5 dollars (each)

Labor Market Red workers and Blue workers sell as much labor as they can to firms for $. Labor $ Labor $

Production and Goods Market Hired labor produces product. Product is automatically sold for $2 each. Red labor hired Blue labor hired Units of output produced

How much product does Firm 7 produce? Example: Labor Market Blue worker 1 Sells 6 to Firm 7 for $5 each. Red worker 2 Sells 8 to Firm 7 for $5 each. $40 $30 How much product does Firm 7 produce?

Example: Labor Market Firm 7 manufactures 87 units of product. The product will be automatically sold for $2 per unit. 87

Example: Labor Market and Goods Market Blue Worker 1 Ends the experiment with (6)($5) = $30. Money = $30. Red Worker 2 Ends the experiment with (8)($5) = $40. Money = $40. Firm 7 spent $70 on labor, and produced and sold 87 output at a price of $2 each.  Firm 7’s profit is $174 – $70 = $104.

Example: Cost/Benefit of Hiring More Labor Suppose you can hire 1 Red hour for $6 or 1 Blue hour for $7. So far, you have hired 1 Red hour and 3 Blue hours. 1. How much am I producing right now? 1 Red and 3 Blue  43 output 2. What happens if I hire 1 more Red worker? Output increases from 43 to 53  + 10 output 3. What does that do to my revenue? (10 output)($2) = + $20 revenue 4. What does it do to my costs? Cost of 1 Red worker = $6  + $6 cost 5. What does it do to my profit? + $20 revenue & + $6 cost  + $14 profit

Example: Cost/Benefit of Hiring More Labor Suppose you can hire 1 Red hour for $6 or 1 Blue hour for $7. So far, you have hired 1 Red hour and 3 Blue hours. 6. What happens if I hire 1 more Blue worker? Output increases from 43 to 45  + 2 output 7. What does that do to my revenue? (2 output)($2) = + $4 revenue 8. What does it do to my costs? Cost of 1 Blue worker = $7  + $7 cost 9. What does it do to my profit? + $4 revenue & + $7 cost  – $3 profit

Example: Cost/Benefit of Hiring More Labor Suppose you can hire 1 Red hour for $6 or 1 Blue hour for $7. So far, you have hired 1 Red hour and 3 Blue hours. Conclusion Hiring 1 more red hour increases profit by $14. Hiring 1 more blue hour decreases profit by $3  Hire 1 more red hour. 13

The Mechanics Firms Workers $5.00 Manager Buyer

The Mechanics Firms Workers Manager Buyer

The Mechanics Firms Workers $5.50 $4.50 Manager Buyer

Ready to begin…

Labor Market Red workers sell your labor to firms for $. Blue workers sell your labor to firms for $. Firms: Every unit of output you produce is automatically sold for $2.

Report 1. Red workers report unsold labor and ending money. 2. Blue workers report unsold labor and ending money. 3. Firms report labor hired and ending money.

New Rules The wage rate that some workers receive is too low. In the interest of assuring a minimum standard of living, we now impose a minimum wage. LAW: Henceforth, no firm may pay less than per hour.

Ready to begin…

Labor Market Red workers sell your labor to firms for $. Blue workers sell your labor to firms for $. Firms: Every unit of output you produce is automatically sold for $2. FIRMS MUST PAY NO LESS THAN PER HOUR.

Report 1. Red workers report unsold labor and ending money. 2. Blue workers report unsold labor and ending money. 3. Firms report labor hired and ending money.

Results…

Price Controls The intent of price controls is to provide relief to buyers (e.g., college tuition caps, interest rate caps) or support to sellers (e.g., minimum wage, retail milk prices). How do you cure a fever? Prices are not levers that set value, they are metrics that respond to value. Price controls fail on two counts: legislating price does not legislate value, legislating price prevents price from signaling value.

Prices Ration Goods All things are scarce. Scarce resources will be rationed. The question is, by what mechanism? In a free market, scarce resources are rationed by prices. With price controls, scarce resources are rationed by non-price factors. Capping interest rates rations credit away from risky borrowers. Capping tuition rations college away from less advantaged students. A minimum wage rations jobs away from less productive workers.

Minimum Wage When we force an employer to pay a worker more than the job is worth, the job disappears. 40 years ago: Telephone operators 30 years ago: Gas station attendants 10 years ago: Fast food servers Last year: Pizza deliverers What happens to workers whose jobs are eliminated? Those whose labor is worth more than minimum wage find new jobs. Those whose labor is worth less than minimum wage remain unemployed.

Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

Covered dots are for 1998 through 2000 Covered dots are for 1998 through 2000. Due to the dot-com bubble, unemployment for all sectors was at its lowest level since 1970. Source: Statistical Abstract of the United States, and Bureau of Labor Statistics

Minimum Wage as Percentage of Average Hourly Wage Unemployment Population Ratio for 16-19 Year Olds as a Percentage of Ratio for 20-64 Year Olds Source: Bureau of Labor Statistics

Source: Bureau of Labor Statistics

How to Pay for a Minimum Wage There are three ways in which a firm can find additional money to pay workers. Layoff some workers and shift their wages to the remaining workers. Keep all the workers and pay for the additional wages out of profits. Keep all the workers and pay for the additional wages by raising prices. 40

Source: Bureau of Labor Statistics, California Department of Finance

But, we have to do something about the distribution of income. The rich are getting richer while the poor get poorer! 42

% of Households in Each Income Bracket (2006$) Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.

% of Households in Each Income Bracket (2006$) From 1980 to 1990, the number of households with purchasing power of at least $75,000 grew while the number with purchasing power less than $75,000 declined. Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.

% of Households in Each Income Bracket (2006$) From 1990 to 2006, the number of households with purchasing power of at least $75,000 grew while the number with purchasing power less than $75,000 declined. Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2009, Table 668.

wtf? 46

In 1980, the lower 80% of households earned 56% of all income. By 2003, the lower 80% of households earned only 50% of all income. Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2008, Table 675.

In which world would each person rather live? In world #1, Person 10 earns 10% of all income. In world #2, Person 10 earns 15% of all income. (prices are the same in the two worlds)

In World #1, the lower 80% of households earned 80% of all income. In World #2, the lower 80% of households earned only 70% of all income. Yet each person would rather live in World #2!

In which world would each person rather live? World #3’s income distribution is the same as World #1’s. (prices are the same in the two worlds)

1. Everything is scarce and will be rationed. Conclusions 1. Everything is scarce and will be rationed. 2. Prices signal information about value. 3. Price controls both prevent prices from conveying value information and cause rationing to be based on some other (usually unanticipated) factor. 4. Despite no (real) increase in the minimum wage from 1980 to 2006, the poor got richer (in real terms).* Minimum wage increased (on average) by 2.2% annually from 1980 through 2003. That is slightly less than inflation. * Because the rich got richer by more than the poor got richer, the Gini-coefficient shows a growth in the disparity of income.

How Should Society Choose? To freely choose to purchase is to cast a vote. How is a free market vote different from a political vote? Political vote: One size fits all. Free market vote: Multiple sizes for multiple recipients. Political vote: Speed of change is driven by the election cycle. Free market vote: Speed of change is driven by the accounting cycle. Political vote: Signal is distorted because the vote is for a “bundle” of issues embodied by one candidate. Free market vote: Signal is clear because the vote is for a specific issue. Coca-Cola’s recipe for Coke had been unchanged since 1886. Coca-Cola spent two years and $5 million researching and developing New Coke. New Coke debuted on April 23, 1985. By June, entrepreneurs were selling original Coke for $30 per case. On July 11, Coca-Cola withdrew New Coke from the market. Elapsed time: 48 days.

Political freedom makes economic freedom possible. Economic freedom makes political freedom meaningful.