Dr. Foldvary

Problem Set #11

The Living Wage

10 pts. max.

A "living wage" is a wage rate above the prevailing market wage for labor employed by a city or by companies contracting with the city. If the government-mandated wage is substantially above the market rate, then the taxpayers have to finance the difference.

The city of Econburgville is debating a living wage proposal. Three economists have provided analyses of the issue.

Professor Livwag said that the cost of living in Econburgville is very high, and the legal minimum wage cannot cover the expenses for housing. Even though only some workers are covered by the living wage, it's only fair and just to provide an adequate living for city workers. The taxpayers can afford it, since most of them earn more than the living wage.

Professor Suppledeman said that workers should be paid according to their marginal product, what they contribute to output. If we pay them more, then firms as well as city managers will hire those workers with the greater skills, having a market wage about the rate of the living wage, so those with lower skills may not be hired, and become even worse off. That's what happens when we distort market prices. If we want to help the poor, we should tax the rich and provide welfare subsidies to all the poor, not just to some.

Professor Georgius said that the problem is that workers are being taxed, reducing their take-home wages, and business taxes also reduce the demand for labor and therefore reduce wages. The city should abolish all taxes on labor and enterprise and all sales taxes. Instead, the city should tax the economic land rent, since that does not impose any added cost on businesses, and it would even raise wages by stimulating construction of underused sites to pay the land tax. All market wages would rise, workers would take home their full wage, and the rent left after paying city expenses would be distributed to the residents.

All members of the city council retire in one month, so they don't care about any political opposition. They only care about the economics. But the city council members are puzzled. They just don't know which proposal to adopt. Then someone tells them you are taking Prof. Foldvary's economics class in which you have learned to do awesome economic analysis. "Yes!" they all exclaim. You are summoned to the city council to make a recommendation.

Which policies do you recommend to raise the wages of the lowest-paid workers in Econburgville? You need to explain it well enough to convince the city council members to put your proposal into law. As a reward, they will name the law after you.