Garrett M. Petersen

Opaque Facts

Welcome to Night Vale

“Some mysteries aren’t questions to be answered, but just a kind of opaque fact—a thing which exists to be not known.” – Welcome to Night Vale: A Story About You

The above quote was in an episode of the excellent podcast Welcome to Night Vale. I love the term “opaque fact,” and it strikes me that economics is full of opaque facts, and that our distinctions between opaque facts and mysteries largely determine our views of markets.

People’s preferences are opaque facts. We can’t know other people’s preferences; the best we can do is observe their past actions to infer something about their past preferences.

Supply and demand curves are also opaque facts. We know that for some definite price of a good, sellers will attempt to sell and buyers will attempt to buy some quantity of the good in question. If we were all-knowing, we could draw curves representing every hypothetical amount of goods buyers and sellers would want to buy and sell if confronted with each possible price, and these would be the demand and supply curves. However, only one price and quantity are actually observed, and the curves themselves are not constant over time. Thus, we never see more than one data point of our supply and demand curves, so we can never derive their shape. Supply and demand curves are opaque facts, not mysteries we can solve with clever statistical analyses.

In my view, it is the people who have failed to recognize the opaqueness in all economic phenomena that have created the most harm. The Phillips curve is the most famous example: economists discovered a negative relationship between inflation and unemployment, assumed that this could be exploited, and encouraged governments to combat unemployment with inflation. They viewed the relationship between inflation and unemployment as a mystery, one that could be solved by sufficiently determined researchers and then added to human knowledge like Pythagoras’ theorem or the Earth’s gravitational constant. If they had exercised some humility, they might have realized that the relationship between inflation and employment is not a fixed, discoverable constant, but an opaque fact that can change with people’s beliefs.

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Opaque Facts

Welcome to Night Vale

“Some mysteries aren’t questions to be answered, but just a kind of opaque fact—a thing which exists to be not known.” – Welcome to Night Vale: A Story About You

People’s preferences are opaque facts. We can’t know other people’s preferences; the best we can do is observe their past actions to infer something about their past preferences. (more…)

The post Opaque Facts appeared first on The Economics Detective.

Monopsony and the Minimum Wage

Suppose it is entirely true that the employers of low-skilled workers have monopsony power over those workers. Maybe low-skilled workers aren’t informed about their other options.

Standard economic analysis would indicate that under such conditions, the minimum wage could increase employment. However, this standard analysis simplifies the labour contract down to two elements: price and quantity. In a more realistic setting, where labour contracts involve more than just the exchange of some quantity of homogeneous labour for some quantity of money, we would expect other elements of the contract to be adjusted in response to a binding minimum wage.

So what does this mean? Well, without the minimum wage, the employer would compensate his workers so as to minimize his costs for any given level of compensation. He would offer a total compensation package such that the marginal cost of adjusting any element of the package would be equal to the marginal benefit to the employee of adjusting that element of the package. This would minimize the employer’s costs. With a binding minimum wage, the employer is obligated to offer a greater proportion of compensation in cash, so the marginal value of adjusting some other elements of the total compensation package must be higher than the marginal cost of doing so (e.g. the employee would forego $1.50 for $1.00 of additional on-the-job training from his employer). Thus it is more costly to offer any given amount of compensation to employees under a binding minimum wage, and even a monopsonist would reduce his employment of low-skilled labourers!

If we suppose that the other elements of total compensation can only adjust a limited amount, then once they have adjusted to the fullest extent possible (i.e. there is no on-the-job training, workers are worked as hard as they possibly can be, there are no employee benefits, etc.) further increases in the minimum wage will indeed increase total compensation and therefore employment. However, it is ambiguous at this point whether this increase can increase employment above where it would have been with no minimum whatsoever, as the costs of compensating workers are higher than they were before. To be sure, the government could regulate all elements of employee compensation to counteract this effect, but such regulations are costly to administer, so the costs of administration and compliance could easily exceed the benefits of correcting the market failure generated by a monopsony in the market for low-skilled labour.

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