Lemonade, Minimum Wage and Daddy’s Tough Decision

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[This Commentary originally appeared in the May 4, 1989 issue of The Mendon-Honeoye Falls-Lima Sentinel.]

CarosaCommentaryNewLogo_259Many people in the Mendon, Honeoye Falls and Lima area have been reading in the national news about the minimum wage. Like most of the people in our country, they are sympathetic with increasing the minimum wage, but remain anxious about the impact the boost will have. The threat of an increasing wage-price spiral worries everyday folks the most. Unfortunately, we see Democrats saying one thing and Republicans saying another, with no one trying to take the time to explain what the real effect will be.

Being trained as a scientist, I never took economists seriously. Still, the issue of minimum wage and inflation provided too much confusion to go unanswered. “Sure,” I said to myself, “it seems fair to up the level given the increased cost of living over the past eight years. If it appears so fair, then why do so many people say it will actually hurt the poor, not help them?”

Last summer, in search of the answers, I spoke to an economics professor at the University of Rochester’s Simon School. After several hours of calculus, supply and demand curves and strained analogies, I finally began to understand. Yet, I wondered why he couldn’t explain it in simple terms. The following allegory attempts to remove the curtain of mystery from the minimum wage and its repercussions.

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Daddy just won the lottery. He and mommy have eight young children and a hefty mortgage of $44,000 a year. Daddy decides to quit his current job. Though the new job requires him to sign a life-time contract, he really likes it and knows it will satisfy him because he always wanted to have this job. Unfortunately, Daddy’s new salary will only pay for the barest of living expenses. He needs to find a way to pay the mortgage and allow his children some playtime toys.

Daddy decides to finance, with all his lottery winning, a Lemonade Stand which his children can operate. Being an astute entrepreneur, he knows he can maximize his profits (and his children’s salaries) by producing at capacity. Given his children’s abilities, Daddy’s Lemonade Stand therefore makes as much lemonade as it could. In his first year, the stand sells $115,000 worth of lemonade. With $15,000 in operating expense, the resulting profit can pay the mortgage ($44,000) and pay each child $7,000 (for a total of $56,000).

Each child spends his or her $7,000 at the local toy store. This merchant has a large inventory of amusing trinkets which he handcrafts from the natural things he finds on the many acres he owns (the children like the 100% All-Natural Nintendo games the best). The storekeeper, a rather strange fellow, lives only on the lemonade he buys from the kids. It so happens he consumes exactly $56,000 worth of lemonade in a year (precisely equal to the amount of toys he sells to the children – his only customers).

Grandpa lives on a fixed income. He purchases only lemonade (form Daddy’s Lemonade Stand). He quite happily spends all his $15,000 of annual income on lemonade.

Now comes the hard part. The government, in response to various concerns, decides to raise the minimum wage from $7,000 a year to $8,000 a year. This makes all the kids and the storekeeper very happy. Each child will receive $1,000 more; thus, the toy seller can expect to get $8,000 in new business. Grandpa, who always favors giving the children more, likes the whole idea and agrees with his congressman’s vote affirming the increase.

Poor Daddy. He’s stuck in the middle and he’s got to make a decision. In order to pay the new minimum wage, he will have to give his children $8,000 each for a total of $64,000. The Lemonade Stand, which makes $100,000 a year, (after expenses), will thus only have $36,000 left over, $8,000 short of his mortgage commitment ($44,000). Daddy had three choices. (Remember, he signed a life-time contract so he can’t change jobs and since the Lemonade Stand already runs at peak capacity, it can’t produce any more lemonade.)

Daddy can sell the Lemonade Stand and put his money into something else which will yield $44,000. This choice, though, will leave his children no income and that will make them sad. Daddy assumes the buyer will operate the Lemonade Stand so Grandpa and the storekeeper can continue to buy the delicious drink (until he realizes that, unless his children have money to spend, the storekeeper will have no income himself). Clearly, too many people would be hurt if Daddy sold the Lemonade Stand.

Daddy’s second choice involves laying off one of his kids. Daddy really feels uncomfortable doing this because he thinks it would be unfair no matter which of his offspring he picks. Besides, if he did this, he would then have to contend with the wrath of Mommy. This is not a viable option.

Suddenly, Daddy comes to the third option. Since he needs to $8,000 more, why doesn’t he raise the price of a glass of lemonade so he can get that much more money? Daddy, Mommy and the kids think this is a great idea. But then, Mommy, ever the rational woman, points out something. “If we raise our prices, then Mr. Storekeeper and Grandpa will have to pay us more money. In order to pay us more money and still receive the same amount of lemonade he is accustomed to, Mr. Storekeeper will have to raise his prices by very nearly the same amount we raised ours. The children will then only be able to purchase the same amount of toys they bought before.” Finding out they would not gain anything as a result of the wage increase made the kids unhappy. “Why did they even bother raising it in the first place?” asks little Cindi-Lu. Everyone decided this offered the best option since at least nobody gets hurt.

Grandpa just then dropped in to visit. Upon hearing the news, he became very upset. “My income is fixed! If you raise your prices, then I will have to be satisfied with less lemonade than I’m used to! Is that fair?!” asserted Grandpa, who began to have second thoughts about his congressman.

Daddy sat grief stricken. He wanted to act fairly, but whatever he did hurt somebody. He thought and thought and thought, but could come up with nothing…

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The above story is not meant to comment on the ethics of raising the minimum wage. Some may claim it’s too simple-minded to accurately reflect reality. Indeed, using a more true-to-life model, while more complex, will show how raising the minimum wage can negatively affect many other innocent people. Someone else may say I have failed to take into account international competition (which is true). We can add the concept of the World Economy by supposing South Korea produces lemonade of equal quality. The Storekeeper can buy South Korean lemonade at the same price as Daddy’s Lemonade Stand (albeit, through mail order). If this were the case, then Daddy cannot consider raising his prices because then he would have no sales at all (and none of his children would get any spending money). He is therefore forced to sell out or lay off.

Taking into consideration every possible scenario is not the point of the story. Rather, the intent is to show why the issue of raising the minimum wage is not as black and white as it appears. I hope this story shows just why so many people have difficulty with raising the minimum wage. It really is hard to think of a way in which no one gets hurt. Unfortunately, most businessmen opt for the second or third option (or a combination of both). In preparing for a minimum wage increase (by either hiring fewer workers or charging higher prices), businesses show the anticipation of a minimum wage increase can result in the same outcome whether or not the law is actually passed.

Before you judge your congressman too quickly (like Grandpa), consider all the elements that go into the minimum wage issue. The answer is not always clear.

Last Week #5: An Open Letter to Governor Cuomo (originally published April 27, 1989)

Next Week #7: Coke vs. Pepsi (originally published May 11, 1989)

[What is this and why is here? See Interested in Discovering My Time Machine? for more details.]

Comments

  1. Chris Carosa says:

    Author’s Comment: This article took up so much space we had to reduce the font size in order to get it to fit. It represents my first attempt to offer a common sense economic lesson. It proved a difficult task to achieve in the limited space I had.

    Oddly enough, within ten years of publishing this, I would teach economics and finance at the college level. My favorite lesson involved reading Thidwick the Big-Hearted Moose (a Dr. Seuss story) to an Econ 101 class. It’s a great book. It teaches you all about the free-rider (a.k.a. “free-loader”) problem.

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