Topic 1: The employment effects of a minimum wage increase

One of the more hotly debated economic policy proposals in the past couple of years has been the proposal to raise the federal minimum wage. In his Feb. 2013 State of the Union, Obama proposed raising the federal minimum to $9.00/hour by 2015, and in March 2013, Congress went further with the Miller-Harkin Act (Fair Minimum Wage Act of 2013), which proposed raising it to $10.10/hour.

In Feb. 2014, the Congressional Budget Office produced a report assessing the likely impact of these proposals on employment and family income. The report, which was based largely on a synthesis of academic research, concluded that the employment effect of a $9 minimum wage could be anywhere from a small positive (i.e. a small increase in employment) to a moderate negative effect; and that the employment effect of a $10.10 minimum would likely be more negative than the effect of a $9 minimum.

Questions/guidelines:

Fist, based on what you have learned in the class, discuss and explain the possible reasons for (1) why the estimated employment effect of a U.S. federal minimum wage increase ranges from small and positive to moderately negative, and (2) why the employment effect is likely to be more negative at a higher value of the minimum wage. Your answer should draw on theoretical models of both competitive and imperfectly competitive (monopsonistic) labor markets. You should explain concepts verbally, but you may also sketch graphs to illustrate your points. In particular, you should address:

- What determines the size of the employment effect of a minimum wage increase in the model of perfect competition?

- What is meant by monopsony power and why might firms have it?

- Why might the minimum wage increase have a positive effect on employment if firms have significant rnonopsony power (as opposedto operating in very competitive labor markets)?

- In both cornpetitive and monopsonistic markets, why and how does the employment effect depend on how high the minimum wage is set?

Briefly discuss what you know about the empirical methodology that has been used to measure the causal effect of a minimum wage increase on employment. In particular, explain why the range of estimates that have been produced by various studies may be due partly to:

- a lack of internal validity in some studies. (i.e. Why might studies lack internal validity? What are the key challenges to estimating the causal effects of a minimum wage increase?)

- a lack of external validity of studies that focus on particular market locations or narrowly defined groups workers. (i.e. Why might the true effects of a minimum 9955 9615555 differ in different markets and for different groups of workers? You may refer back to your discussion of the theory here.)

- You may refer to specific studies such as Card & Krueger (1994) if you wish to use exarnples. Firally, briefly explain at least one of the following arguments for raising the minimum wage, even if a higher minimum wage were to result in lower employment:

1. In the absence of a substantial minimum wage, the Earned Income Tax Credit (EITC) may drive down the market wage and effectively subsidize low-wage employers instead of helping low-income workers.

2. Two-earner families may be better off with a higher minimum wage even if one or both earners end up working less. (Explain the conditions under which this would be true; consider the income/substitution effects of a wage increase on the labor supply decision of the family as a whole.)

Part 2- The return to investment in education

Regarding U.S. government policy toward higher education, the Obama administration has pursued several policies aimed at expanding investrnent in post-high school education.

- Early on, Obama proposed that every American should pursue at least one year of education beyond high-school and argued that the U.S. should aim to regain its status as the world's leader in the proportion of college graduates by 2020.

- He has increased government financing by expanding the Pell Grant program (which provides need-based grants to low-income undergraduates) and by expanding tax credits for college tuition (the American Opportunity Tax Credit).

- More recently, Obama has directed the Department of Education to develop a new college ratings system that would rate colleges based on their value. In response, some news organizations and websites such as Payscale.com have begun reporting "return on investment" measures that claim to measure the average return to graduating from a particular college or university, and have produced rankings based on these measures.

Question/guidelines:

Based on what you have learned in the class, (1) discuss/explain how one would evaluate the policies aimed at expanding investment in higher education, and (2) discuss some of the challenges involved in estimating the return to education and ranking colleges by their return on investrnent (ROI).

YOU should explain concepts verbally, but you may also sketch graphs and/or use mathematical expressions to illustrate your points. In particular, you should address the following:

- First: suppose that the government has good estimates of the internal rate of return (i.e. the net return on the marginal dollar invested in education) for all groups of potential college students, and is able to direct subsidies toward those with the highest returns to education. Describe the key factors that determine an individual, internal rate of return in equilibrium and hence should help determine how subsidies are directed. You may wish to illustrate using a supply and demand diagram. A good answer will explain (at least briefly): o why individuals are likely to have downward-sloping demand curves for educational investments o why individuals are likely to face upward-sloping supply curves for educational loans

What factors determine location (shifts) in the supply and demand curves for educational investments, and thus also determine how the equilibrium rate of return varies across individuals.

Next: Explain why it is difficult to obtain good estimates of the caused effect of attending college on earnings? Similarly, why is it difficult to obtain good estimates of the causal effect of attending one particular college vs. another so that colleges can be ranked on ROI?

Good answers will explain the problem of selection bias (especially ability bias) and how it may affect the internal validity of the estimates. You may refer to specific empirical studies or specific approaches to dealing with selection bias if you wish to use exarnples.

Briefly explain at least one of the following arguments, based on factors that are ignored in the standard "human capital" model of educational investment:

1. If the return to a college degree is explained entirely by its "signaling" value rather than by the accurnulation of human capital, then it might be inefficient to encourage everyone to attend college. (Your answer should include an explanation of what is meant by the "signaling" value of education.)

2. If some groups have lower returns to education because of labor market discrimination, then it may be efficient for governments to subsidize education for these groups, even though their returns (under the current market conditions) are relatively low. (Hint: consider the role of self-fulfilling expectations in a model of statistical discrimination and the possibility that education policy could help break stereotypes.)