Econ 101 and the War on Poverty

With the midterm elections approaching and the Democrat’s War on Poverty revving up there is no doubt that distinguished economists of all stripes will weigh in on how the war should be waged.  Expect a complete lack of consensus.

To the extent that a formalized canon of economics exists, supply and demand analysis rests comfortably at the top of the stack.  Many other more advanced economic models rely on this foundation and the explanatory power of supply and demand analysis, while imperfect, is powerful.  This simple model encompasses many important concepts including scarcity, elasticity (of supply and demand), substitution, competition and much more.

While the world’s most respected economists may orbit strata well beyond such elementary principles, the layperson can gain valuable insight from the application of these tools.  Most introductory Microeconomics texts include several common, noncontroversial examples of how to apply supply and demand analysis.  These examples typically include price controls, subsidies, minimum wages and various kinds of taxes, many of the same policies that Democrats are advocating as part of their war on poverty.

Despite some well-known limitations of supply and demand analysis, such as the assumption of perfect competition, conclusions drawn from such analysis often align closely with what is observed in real markets, especially when realistic estimates of elasticity can be made.  It would be a stretch to call the laws of supply and demand immutable, but given the near limitless diversity of theories, models and opinions in the field of economics, it is about as close as it gets.

Following are three common examples that would likely be encountered in the first 3-4 weeks of any freshman Microeconomics course, along with a generalized supply and demand graph that may be used with each example.  The demand curve slopes down and to the right because as the price of something drops, the quantity of the product demanded increases.  The supply curve slopes up and to the right because at higher prices, producers will want to supply more.

Minimum Wage:  As with any market there will be a price, P0, where supply and demand are in equilibrium.  If this price is arbitrarily raised to P2 however, through a minimum wage law, the quantity of unskilled labor demanded will be lower, and will correspond with d2.  Human substitutes such as self-service kiosks will be employed more frequently.  More people will also wish to work at this higher wage, represented by s2.  The difference between d2 and s2 represents a job shortage created by the minimum wage.

Personal Income Tax:  The creation of or an increase in personal income taxes will shift the entire supply curve for labor from supply to supply2.  This leads to a new (higher) equilibrium price for labor, E2.  The price for labor increases as workers and employers share the burden of the higher tax rate.  Employers will pay more and employees will earn less.  The higher labor costs will cause employers to seek alternatives to hiring, such as automation or outsourcing.  The reduced wages will also reduce incentives for some employees to work, particularly when the gap between government transfer payments and employment income becomes narrow.  Lower quantities of labor will be demanded because the price of labor is higher.

Price Controls:  Consider a price control for doctors performing knee replacements.  Assume that insurance companies are the payers and independent doctors are the providers.  If the government imposes a price ceiling below the current market price for this surgery, from p0 to p2 for example, the quantity of surgeries supplied will decrease from E to s1.  Doctors will choose to work less, retire early or pursue other types of work in response to the lower price.  Insurance companies will encourage more knee replacements instead of other treatments so the quantity of knee replacements demanded will increase.  A shortage of knee replacement services, between s1 and d1, is created.

Under the Affordable Care Act, the Independent Payment Advisory Board has power to set prices for Medicare payments.  Price controls are the board’s most powerful tool for accomplishing their mission of controlling medical spending growth.  Absurdly, IPAB is prohibited from making "any recommendation to ration health care”.  Markets are entirely capable of rationing themselves in response to price controls, and will restrict the quantity of any good or service supplied in response to an artificially low price.  Many lawmakers wish to take this a step further and remake the US healthcare system as a single payer system, where all prices are set by bureaucrats rather than by the market.  What happens in a single payer system is completely predictable.  Non-financial costs such as long delays for care, denial of care, lower quality of care and medical tourism emerge as a result of the shortages created by price controls.

Ingenuity and resourcefulness recede in the shadow of big government as the supply curves for labor, innovation and investment all get pushed to the left. The deceptive sense that the government will take care of everything can easily lead to complacency and a feeling that we will be ok whether we work hard or not, whether we plan for the future or not. This is easy to sell because we would like for this to be true, why not.  Such promises are as old as civilization itself however and the result is always the same. Power is centralized, promises are broken and freedom and prosperity are lost.