Robert Reich’s Econ 101 Mistake

Recently, Robert Reich released a video promoting the idea of a $15/hr minimum wage.  There are many, many issues in this video, from incorrect information, to poor reasoning, to cherry-picking data.  To quote Dr. Don Boudreaux, “Nearly every sentence out of Reich’s mouth in this video is flawed.”

But Reich makes a more basic, fundamental error.  It’s an error that Econ 101 students are taught, usually in the first week, not to make.  Reich confuses a shift of the demand curve with a movement along the demand curve.

In his video, he claims businesses recently raised wages and that it proves minimum wage can rise without the need to harm workers.  But there are two separate things going on here.  Let’s start with a quick lesson:

Here we have a simple supply and demand chart.  This is just a graphical representation of the Laws of Supply and Demand.  Where the supply and demand lines meet is called equilibrium.*  If the demand curve is shifted to the right (representing an increase of demand, such as companies wanting to hire more), we can see that, in the new equilibrium, price rises, and so does quantity (in labor terms, prices are wages).  This is what is going on now in the labor market.  Wal-Mart et al are facing a generally improving economy.  Their demand for employees are rising, and employees are thus able to command a higher price.

But what happens when a price floor, such as minimum wage, is imposed?  Take a look at this chart.  With a price floor, there is no change in demand or supply, as the factors of demand or supply did not change (unlike the first example).  But what does change is the quantity demanded and the quantity supplied.  You can see the quantity demanded is considerably lower than the quantity supplied, creating excess supply.

Reich is seeing a price change from normal supply and demand movement and basing conclusions off that.  To quote Scott Sumner, he is reasoning from a price change, but this gets the reasoning backwards.  In other words, he is ascribing a cause to the effect, and an effect to the cause.

To be sure, if the demand curve is shifting to the right at the same time a price floor is passed, it is very possible that the minimum wage would have no effect on employment, but this is merely an illusion.

*Realistically, equilibrium is impossible to know as there really isn’t a single price point and quantity point for everything in a market, but this is a simple demonstration to show the mistake Reich, and many econ and business students make too, when they first start out, including myself.