After reading my last post on minimum wage policy, a friend
of mine asked: “does increasing
the minimum wage actually increase the overall supply of goods, or does it
simply redistribute that existing fixed quantity?” This is a very cool
question, and to answer it, we first have to understand what makes up gross
domestic product (GDP).
What is
GDP?
GDP is the total amount of value produced by a
country in a calendar year. It is the sum of what everyone spends, what
everyone invests, what the government spends and what the country sends to and
receives from other countries. The equation looks like this:
GDP =
So, let’s say that six squirrels live in the same
tree and each squirrel can gather 100 nuts in a year. The government then taxes
each squirrel 10 nuts, and spends those 60 nuts fixing up the tree. A
squirrel-preneur, whom we will call Richard spends 50 of his nuts building a
store to sell peanut butter, and Jim (the really excited guy on the right) exports
10 nuts to a neighboring tree and all other nuts are consumed. The GDP here is:
Consumer: Production: (100 x 6) – Taxes: (10 x 6)
– Savings: (50 + 10) = 480
Government: 60
Investment: 50
Exports: 10
Imports: 0
GDP = 600.
What makes
GDP grow?
Because GDP is the main measure of prosperity in
our world, we are often obsessed with making it grow. So how could we increase
the GDP of this tree?
The first way of increasing the output of the tree
would be to add more squirrels. As
population grows, so does GDP, because each additional squirrel can harvest 100
more nuts per year.
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| Squirrel Babies! |
The second major influence on GDP is technology. If the squirrels are given
reacher-grabbers, they can gather more nuts, increasing their production and
the tree’s GDP.
 |
The internet does not yet have a picture of squirrels using reacher-grabbers,
it’s never let me down like this before. |
These three things: population growth, technology
and capital are the only methods of increasing total economic output in the
long run. If the population doesn’t grow, and investment and technology remains
the same, GDP does not grow.
But GDP
changes all the time!
Yes, GDP changes all the time for a variety of
reasons: first, the human population continues to grow.
Second, technology is making us more productive:
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| This is okay, but my dream is to be an automatic teller. |
Third, since 2006, Canada has invested
an average of 23.5% of its GDP into fixed capital (stores, factories, oil
rigs, etc.). This money continues to improve the efficiency of works and
develop new products like the iPhone 6S.
Last, there are many methods of adjusting when
certain transactions are realized. For example, if you raise interest rates,
people are more likely to save their money, deferring the production and
purchase of things like cars and houses. This means GDP this year will decrease, but the total economic output of the system is not necessarily impacted, as that money might be spent next year instead. This gets at the concept of long-run equilibrium, which you can read about here.
So back to
the original question: would increasing minimum wage raise total economic
output?
The answer is: not necessarily. This is because
when you raise minimum wage, you are mostly diverting money that would have
otherwise been saved or spent elsewhere into increased labour costs. Thus, you are not changing the total economic value of the system, but just adjusting when that value is realized.
For example, McDonald’s will be required to pay its employees
more money, meaning they will charge more for cheeseburgers, so families dining
there will have less disposable income to save or spend elsewhere. Therefore,
money that would have been spent later (perhaps after retirement?) is being spent now on a more
expensive Big Mac.
However, the additional money that is being earned by
minimum wage employees is then spent, and spent again, and again (according to
the multiplier effect – see my last blog post), which
could produce more economic value this year than would have been created if
that money had been saved or spent elsewhere. This additional economic value
might then be invested (in technology or factories), or used to afford more
children, increasing long-run economic output.
Thanks for reading
Let me know if you have any questions about minimum wage policy, or if you would like me to cover a particular economic topic in the future. For my next post, I am going to look at murder rates and gun policy.
Thanks for reading
Let me know if you have any questions about minimum wage policy, or if you would like me to cover a particular economic topic in the future. For my next post, I am going to look at murder rates and gun policy.
