San José State University
Thayer Watkins
Silicon Valley,
Tornado Alley
& the Gateway
to the Rockies

The Minimum Wage Rate
and the Real Wage Rate

At election times politicians on the political left vie with each other in the amount of their calls for an increase in the minimum wage rate. They presume and some of the electorate believes that such increases will increase the standard of living of workers, either directly or as a result of the corresponding general increase in wage rates due to collective bargaining by organized labor. Politicians of a more cautious persuasion fear that an increase in the minimum wage will result in the loss of some jobs.

What neither group realizes is that neither hopes of those on left nor the fears of those on the right in practice come to pass. Here is the record of the Federal minimum wage going up and up and up.

On the other hand here is the record of the average wage rate relative to the consumer price level, the appropriately termed real wage rate. The real wage rate, despite the increases in the minimum wage rate, has remained roughly constant over the past thirty years,

The explanation for this constancy is that prices increase for two basic reasons: 1. Increases in the marginal cost of production, 2. Increases in what consumers are able and willing to pay. Thus if the minimum wage is increased x percent and that leads to wage rates generally increasing x percent then the unit cost of production will increase by x percent, But consumer incomes also increase x percent and the price they are willing to pay by x percent. There is a remarkable general theorem that says that in a market of profit-maximizing enterprises market prices changes are a weighted average of the price changes due to shifts in the demand functions and shifts in the marginal cost functions. The weights depend upon the degree of competition in the market; i.e., whether the market is a monopoly or an oligopoly of n competitors, and whether their products are uniform or differentiated.

Thus in the case of an increase in the minimum wage of x percent marginal costs go up by x percent and the prices consumers are able to pay go up by x percent. The weighted average of x percent and x percent is x percent no matter what the weights are.

Thus theory says that an increase in the minimum wage will induce an increase in the price level that exactly offsets it leaving the real wage rate unaffected. And that is just what we see has happened in practice.

But if real wage rates remain constant it not just consumers' standard of living that is unaffected; employers' decisions about employing labor are also unaffected. Barack Obama at one point argued for an increase in the minimum wage on the basis that there was no evidence that the last such increase had hurt the economy in terms of jobs.

More details of the analysis are given in Prices and Wages in an Economy of Oligopolistic Market Structures .

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