Wednesday, May 26, 2021

Minimum Wage Economics and Fallacies: Marginal Revenue Product (Part 2 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff continues with minimum wage as the low-skilled worker’s hurdle—not ladder—to a career.

As we discussed in Part 1, the concept of Marginal Revenue Product (MRP) is a useful tool for analyzing the potential impact of raising wage floors such as proposals for a national $15-per-hour minimum wage.

Marginal Revenue Product, or MRP, is the additional (marginal) revenue a firm can secure with the labor of one more hired or retained (ie. “marginal” or “the last”) employee. 

To go back and read MRP basics visit:


The Economics Correspondent credits Loyola University Economics Professor Walter Block for the ladder-hurdle illustration.

Progressives who laud a higher minimum wage depict it as a “ladder” that helps employees climb up to a better lifestyle.

But Professor Block argues that since low-skilled employees first have to produce the additional MRP required to exceed the higher minimum wage, it actually serves as a taller hurdle they must first jump over to get a job.

If a young worker with no skills can only produce $10 in MRP, he will probably be hired at $7.25 per hour. And once employed inexperienced workers doing low-skilled labor, even in fast food or basic office work, do learn valuable job skills.

For example, just having to deal with angry customers teaches novice workers a lot about the importance of serving others in the marketplace or standing in the shoes of the consumer. They may not realize the importance of showing up to work on time—until they’re late and get an earful from the boss. And they have to sharpen their communication and listening skills even when doing something as simple as taking orders.

Young, unskilled workers learn none of this while sitting idle at home playing video games every day for years, or loitering on streetcorners waiting to get in trouble with the law.

And over time inexperienced workers' MRP can rise above $10 as they gain experience and pick up more skills, allowing them to find work elsewhere for higher pay. Hence the real first rung of the “ladder” is a job that can teach young workers skills that better position them for advancement to better jobs.

However if the minimum wage is forced up to $15, now the proverbial hurdle they must jump over is raised. 

Still producing an MRP of $10 per hour, they don’t get the starting job to begin with.

Far from giving them the “ladder” to climb to better opportunities, the higher wage floor has robbed them of a starting job and instead presented a higher “hurdle” they must scale to get that critical start in the workplace.

The Economics Correspondent himself started with a very low-paying job ($5.77 per hour, barely over the minimum wage at the time) answering phones at a major airline’s newly built reservations office. Over time he picked up skills that led him into operations, then transferred to other companies in financial services and corporate travel as an analyst learning new telephone systems and operational skills. Eventually the Correspondent's MRP rose enough to qualify for a six-figure professional services career in telecom consulting which financed a comfortable retirement nest egg. 

His MRP rose as he gained more skills in multiple jobs over the years.

And it all started with no marketable skills and $5.77 an hour.

But if at the beginning the local government had forced a “living wage” on the airline and demanded $10 an hour for all new hires—which would have increased the office’s operating budget by at least $18 million a year—the facility would have been built in another city or state, or the added $18 million in annual cost would have been diverted to expensive automated telephone systems to replace new hires. 

Under a mandated “living wage,” the Correspondent’s career ladder would have turned out very differently or perhaps not at all.


When confronted with MRP, a common retort from Fight for $15 advocates is:

“Just raise prices which in turn will raise the worker’s MRP.”

After all, MRP is expressed in dollar terms so just demand more dollars. With more dollars coming in, the new minimum wage is now lower than the new MRP. How could that not work, right?

Most opponents of higher wage floors instinctively see the problem with this solution right away—rooted in the Law of Demand.

All things being equal, the higher the price of a product the lower the quantity demanded.

So if Subway arbitrarily raises its sandwich prices by two or three dollars, the Law of Demand states customers will make fewer purchases, a phenomenon that’s been proven out by four thousand years of historical evidence.

Even if consumers’ attitudes are magically unfazed by the increase (and 99% of consumers are not, they notice) higher prices alone will simply eat away that much more of their discretionary income and limit their purchases as a matter of simple arithmetic.

Which leads us to another critical concept that applies worker MRP:

The decision to hire or retain a worker after a minimum wage increase and price hikes is made less by the employer than by the consumer. After all, the “revenue” in Marginal Revenue Product comes from consumers, not from bosses.

Fight for $15 proponents like to think it’s easy for firms to give legions of low-skilled workers big pay raises and the only problem is that bosses are just too stingy. 

But in reality it’s the consumer’s stinginess that plays the larger role in prohibiting higher pay, not the employer’s.

Not only that, but it’s neither the employee, the employer, nor the progressive activist who determines the worker’s subjective marketplace “worth.” Ultimately the final arbiter of worth is the consumer by decision to pay or abstain from paying.

Simply declaring “I want MRP for a new sandwich artist to be $100 per hour” and raising the price of a sandwich by $25 in order to generate that MRP will quickly be canceled out by reality when consumers balk and stop buying. Thus the sandwich artist’s MRP will fall far, far short of the $100 per hour dream no matter how badly minimum wage proponents want to believe it won’t.

Of course the employer is the easier political target to bash since he/she can be portrayed as the greedy fat cat holding large bags of money with dollar signs. But in a market economy the employee’s—even the employer’s—whims and wishes are subject to the consumer’s final veto power.


The Fight for $15 proponent then often says “Well we’re not talking about $100 an hour. We want a modest increase which won’t generate the negative consequences in your extreme example.”

There is a real kernel of truth in this. There can be nuanced “room to wiggle” with modest wage and price increases, so long as one accepts there is virtually always a negative cost to some worker somewhere.

Fight for $15 proponents might say “Just raise the minimum wage to $15 and you only have to raise the price of sandwiches by $4, not $25.” 

That’s probably true. A $4 price increase will also cause demand to decline, but more modestly. So if a typical Subway store employs a dozen people, perhaps only two or three might watch their wage fall to zero (ie. lose their jobs) along with reduced store hours. And perhaps one full-time employee will be reduced to part-time.

The part-time worker’s total take home pay might be reduced (depending on how many hours are cut and the size of the raise) although he can get a second part-time job to make up the difference. But low-skilled jobs are going to be harder to find when hours are being reduced everywhere with even many fulltime workers being let go, including two or three of his former colleagues who are now job market competitors.

And even if he’s lucky enough to find another job, he then becomes the poster boy for politicians like AOC who lament “more people than ever have to work two jobs to make ends meet,” and go on to demand an even higher minimum wage creating another round of layoffs and reduced hours.

And the job losses won’t stop there. 

The Congressional Budget Office has estimated (conservatively) that a net 1.5 million U.S. workers would immediately lose their jobs due to a nationwide $15/hour minimum wage. But what doesn’t make CBO headlines is that additional jobs will be lost over ensuing years as companies replace labor with automation/capital, a process that takes time and will eliminate more jobs long after the initial headlines have faded.


More heartening to "living-wage" proponents is this: Some firms might reduce staff to a level where the remaining staff’s MRP actually does rise from $10 to $15 an hour, and the pay raise really is justified.

Setting aside that other workers still got a pay cut to zero, how can the surviving low-skilled worker’s MRP magically rise from $10 to $15 per hour?

By reducing staff to the point that constant customer queues (bad for the consumer) fully occupy workers who never get a chance to catch their breath. Even with low skills, if their on-the-job occupancy is raised from 65% to 95% they technically can raise their MRP. Both their productivity in terms of units produced per labor-hour and revenue per unit rise, and some employees might even prefer this tradeoff: earning more but working nonstop.

But many will also “burn out,” and politicians will again blame capitalism for “imposing slavery-like workloads on employees.” Never mind it wasn’t capitalism at all but rather politicians forcing mandates on employers that reduced the worker’s options to two: work like a dog or be fired.

So it becomes a value judgment: Is it worth laying off some employees so the surviving ones can be overworked to generate higher MRP, but imposing an unsustainable workload on them to do it?


Incidentally the Correspondent witnessed this exact “Subway phenomenon” after San Francisco raised its minimum wage to $15 per hour in 2018. Prices at local Subways rose considerably, many employees were fired, several stores reduced business hours or closed.

And even the diminished number of customers found themselves waiting in longer lines (much longer, until the pandemic) as there was only one employee behind the counter working frantically while looking miserable and burned out. 

Yes indeed, the surviving worker’s higher MRP now justified a $15 per hour wage—the only way he was going to keep his job anyway—but at the cost of another employee’s job, higher prices, lower consumer demand, reduced customer service/well-being, and his own mental health.

The Correspondent has also seen customers walk in, survey the queue, then turn around and walk out, another form of reduced demand and negative consumer well-being since the consumer chooses to abandon an exchange he was previously willing to enter into, even at the higher price.

And most ironically the Correspondent has heard plenty of grumbling by angry customers waiting in those lines. In San Francisco you can bet most of them voted to raise the minimum wage to begin with and now have no clue that they are being inconvenienced/frustrated by the consequences of their own political decisions. But instead they blame “greed” and “free market capitalism” while opining that “if only the government regulated these companies more.”

We’ll discuss the concept of Marginal Factor Cost (MFC) in the next column.

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