Right in the Short Run

I do not know a lot about labor economics, but I have been playing around with this idea for quite sometime now. Can we raise the minimum wage (or institute a minimum wage) and still see an uptake (or a non-decrease) in labor? Well, the standard response seems to be “yes” via a monopsony model, which is great, but not the viewpoint I was going for.

The vantage point I wanted to consider was a little more general. What if the industry is not monopsonistic? My idea stemmed from a discussion in which Steven Levitt was explaining his research about how most firms may not be profit maximizing though this seems to be a common assumption in economics.

The reason we say that increases in wage correspond to a decline in labor uptake and a substitution towards capital is because we assume profit maximization on the part of firms. Essentially, if data (such as Card’s research) points to the fact that labor does not decrease despite these increases in wages, then the change in slope of the hyperplane did not affect its tangency point! This means that capital and labor are perfect complements since the the only way a hyperplane can still be tangent to an isoquant manifold after changing slope is if it has met the manifold at a cusp/kink. Of course, perfect complementarity between capital and labor is probably not the case. What else can be the explanation?

Well, if firms weren’t profit maximizing in the first place, then certainly this could be explained. Differential changes in wage rates would not correspond to substitution away from labor since the firm would not even be at the tangency condition in the first place! Consider a situation in which firms only seek to profit “satisfice” as opposed to maximize. Threshold satisficing could mean that firms don’t respond to increases in wages by firing en masse. (This isn’t to say that one can make large increases in wage rate and still have the firms employing everybody.)

Ultimately, my discussion here is a general comment that when we institute policies based on assumptions such as profit maximization, some of the results may be contingent on that fact. These are not general results, but are rather specific implications of our particular assumptions. Remove those assumptions (perhaps they do not actually happen in real life) and many policy implications may change. Of course, the framework I have discussed makes no claim to understanding how firms decide to target profits … we can discuss further theories about that