$10 > $5 (Although Sometimes Some People Believe That $10 = $5)

(Don Boudreaux)

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Earlier today I reconnected in Dallas with my old friend Charlie Steen.  Charlie was a year ahead of me in law school at UVA.  He also has a PhD in economics from UVA.  Charlie has practiced law in Dallas for the past twenty or so years.

Charlie reminded me of a mental experiment offered either by Thomas Sowell or by my colleague Walter Williams.  The mental experiment is designed to show the job-destroying impact of minimum wages.  Here it is (in my words).

Imagine that you’re given the option of buying ten-dollar bills for $5 a piece.  How many will you buy?  The answer is obvious: as many as the sellers of these discount-priced ten-dollar bills will sell to you.  Of course, in reality $10 bills are never available for sale at $5 a piece.  Or are they?!  In a very real way, reality does indeed sometimes offer such deals.  If a worker that can produce $10 per hour worth of output is currently paid by his or her employer only $5 per hour, a competing employer can profit by hiring, at some wage higher than $5 per hour, that worker away from his or her current employer.  Indeed, employers will compete for this worker until this worker’s hourly wage is bid up to $10.  (If you doubt this outcome, the burden is on you to explain why this worker’s wage will stop rising at some amount less than $10 per hour.  It’s a surprisingly difficult burden to meet.)

Now imagine that you’re offered the prospect of buying five-dollar bills for $10 a piece.  How many $5 bills will you buy?  The answer again is obvious: none.  Even if you’re a billionaire, you have no incentive to spend $10 to buy a $5 bill.  The fact that you can “afford” to do so is irrelevant.  If someone is asked to predict how many $5 bills, say, billionaire Nick Hanauer will buy if each of these bills is priced at $10, that someone would surely say “none.”  And that someone would surely be correct.

The minimum wage is economically identical to a scenario in which government prohibits the sale of Federal Reserve notes at any price below $10 each.  No bill worth less than $10 will be purchased.  No one will knowingly buy something worth only $5 for a price higher than $5.

The above example involving Federal Reserve notes is easy to grasp.  Yet change the item for sale from “five-dollar bill” to “low-skilled worker who can produce on average no more than $5 worth of output per hour,” and many people – including even some economists – somehow mysteriously find reason to believe that people will pay for $5 bills some price greater than $5.

Mysterious.