Derived Demand and Fair Wages

Earlier in the course, we discussed the collapse of oil prices in the mid-2010s due to a combination of increased supply and decreased demand. Another major consequence of this that we didn't mention was the loss of 195,000 jobs in the oil and gas industry. This huge job loss occurred because, when supply and demand for a particular product shifts, it affects the income of the workers who are involved in the production of that product. If demand goes down enough, many workers won't be needed any longer, and they'll lose their jobs.

Derived Demand

The demand for factors of production, such as labor, is derived from the demand for the goods and services produced by those resources. This concept is called derived demand—demand for a good, service, or resource that is a consequence of demand for something else.

For example, an increase in demand for new homes will increase the demand for carpenters. This will likely lead to increased income for carpenters. If demand for new houses goes down, then there will be less demand for carpenters, and their incomes will decrease. When there is a surplus (excess supply) of a particular good, that will reduce demand for the resources (including labor) used in that good's production.

Derived demand is an important concept to understand when trying to explain changes in the labor market. For instance, the rise of online shopping has decreased demand for retail stores. This, in turn, has decreased the demand for cashiers. Demand for cashiers is derived from the demand for retail stores. As long as demand for retail stores continues to decline, then demand for cashiers will also continue to decline.

Enough to Buy Back the Product

So far in the course, we've discussed a couple of methods that Americans have used to artificially raise wages (i.e., raising wages above the market value established by supply and demand). One of these methods is instituting a government-enforced minimum wage. The other is using labor unions to bargain for increased wages through methods like strikes and boycotts. Proponents of these measures argue that they're necessary to ensure workers receive a fair wage or a living wage. But what level of income is fair? How much does a worker need to make to earn a living wage? Today's reading will discuss one popular definition of a fair wage: enough income to buy back the product that the worker produces. As you read the chapter, think about how short-term and narrow thinking might lead to the fallacies that Hazlitt writes about.

READ: Hazlitt, Economics in One Lesson, Chapter 20: "'Enough to Buy Back the Product.'" [This may be Chapter 21 in some newer editions.] When you've finished, click below to continue with the rest of the lesson.

It doesn't take much thought to realize that there are serious problems with the idea that workers should be paid a wage that's based on the value of the product they create. First, the skills and experience that are required to manufacture a product aren't necessarily related to the cost of that product. It costs $1,000 to buy an iPhone because of the technology and engineering that went into designing it, not because it's difficult to put together in the factory. Second, manufactured products can have extremely different values. Two people could work a very similar job, but one person helps manufacture ten-dollar t-shirts, while the other helps manufacture hundred-dollar suits. Why should the person who makes the hundred-dollar suits earn more than the person who makes ten-dollar t-shirts when they are essentially performing the same job?

However, liberal economists and politicians continue to push this definition of a fair wage. In 2014, President Obama made these remarks when discussing the need to increase the minimum wage:

A hundred years ago, Henry Ford started Ford Motor Company. Model T—you remember all that? Henry Ford realized he could sell more cars if his workers made enough money to buy the cars. He had started this—factories and mass production and all that, but then he realized, if my workers aren't getting paid, they won't be able to buy the cars. And then I can't make a profit and reinvest to hire more workers. But if I pay my workers a good wage, they can buy my product, I make more cars. Ultimately, I'll make more money, they've got more money in their pockets—so it's a win-win for everybody.

Barack Obama, Jan. 29, 2014 [emphasis added]

In this quote, Obama implies that when workers make enough money to buy back the product they create, it's a win-win for everybody. But Ford didn't raise the wages of his workers so that they could buy the cars that they helped manufacture. Ford increased the wages of his workers because working on his assembly line was a demanding job that required competent employees. Ford was willing to pay higher wages to keep these productive employees at his company. In other words, the workers earned more income because they were more productive. The fact that they could potentially afford to buy the cars that Ford manufactured was an unintentional byproduct—one that occurred largely because Ford reduced the price of cars, not because his workers made more money.

It wouldn't make sense for any company to raise their employees' wages in the hopes that those employees would spend the extra money on their company's products. If the employees spent every extra dollar they made on their own company's products, this would still result in zero extra profit for the company (because the extra profit on sales would be completely offset by the extra wages paid out to workers). That is an extremely unlikely result, however. Instead, the employees would almost certainly spend the majority of their additional income elsewhere, spending only a small percentage of it at their own company. Therefore, the result is much less profit for the company. The only economic reason for a company to pay its workers higher wages is if they expect that investment to yield higher productivity. Any artificial measures created by minimum wage laws or labor union bargaining might help workers in the short term, but they will damage the economy as a whole, and those same workers will be no better off (and possibly worse off) in the long run.

Over the last few lessons, we've spent a lot of time talking about the income of workers. It is, of course, natural for an economics course to focus on money. But income is not the only factor workers should consider when looking for employment or performing work. There are many other factors, such as work-life balance, the work environment, whether there are opportunities for growth, and most importantly, whether it fits in with God's plan for your life.