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Economics For Beginners: Top 5 Economic Myths

Updated on January 23, 2014

Myth 5: Raising The Minimum Wage Boosts The Economy.

The Argument: When you raise the minimum wage, it gives workers more money to spend, thereby boosting the economy.

Why People Believe It: At face value, this seems like a no-brainer: the more money a person makes, the more they have to spend, and since spending is good for the economy, it only makes sense that this should work.

Why It’s A Myth: While it may seem like this one makes sense, it ignores one crucial detail: the employers paying those higher wages are part of the same economy, so nothing is actually being “added”, only redistributed; it’s called the “Glazier’s Fallacy”, and it’s been around for over 160 years..

The Glazier’s Fallacy was first postulated by Frédéric Bastiat in 1850, and it’s the great-grandfather of what we now call Keynesian Theory. The Glazier’s Fallacy tells the parable of the broken window:

A child throws a rock through the window of a bakery. The baker is then forced to employ the glazier to fix the window, which costs $200. So now, the glazier has the $200 he made from fixing the window to spend on other goods and services around town. So he buys some vegetables from the farmer, and some meat from the butcher, and toys from the toy maker, and with the remainder he buys a new dress for his wife.

Source: Roberto Verzo, CC: BY, via Flickr
Source: Roberto Verzo, CC: BY, via Flickr

At face value, it might seem that, although it was unfortunate for the baker, that broken window actually did some good. You hear this theory all the time after any particularly destructive event. There were people talking about the “silver lining” with 9/11, the Tsunami in 04, the Japan Earthquake, and Hurricane Sandy.

As Bastiat pointed out though, this thinking only takes into account what is seen, while completely ignoring what is unseen. See, now that the baker had to pay to replace his window, he no longer has that $200 to spend on a new suit, or a new wheel for his wagon, or to hire a new helper, or to take his family out to dinner. The broken window didn't actually create anything, it simply redistributed the $200 and how it was spent.

The same is true with higher wages. Say a business has 10 employees working 40 hours a week, all making the current federal minimum wage of $7.25, that’s $2,900 a week in wages (7.25 X 40 = $290 X 10 = $2,900). Now let’s say that you raise the minimum wage to $10. That brings the weekly wages up to $4,000 ($10 X 40 = $400 X 10 = $4,000). That’s an increase of $1,100. That means that that business has $1,100 less to spend on goods and services. It also means that the workers have an additional $110 a week each to spend ($1,100 ÷ 10 = $110).

So it breaks down like this:

 
 
The Business Loses:
$1,100
The Workers Gain:
$1,100
Net Gain:
$0
Not exactly what I would call a "boost" to the economy.

The Broken Window Fallacy

Source: kenteegardin, CC: BY-SA, via Flickr
Source: kenteegardin, CC: BY-SA, via Flickr

Myth 4 : The Poor Don’t Pay Taxes.

The Argument: The poor in this country don’t earn enough to pay Income Tax, yet they consume government services.

Why People Believe It: Again, at face value, this one appears to be true also: people who make under a certain amount per year (the amount changes year to year) do not have to pay Federal Income Tax.

Why It’s A Myth: Income Tax is not the only way people are taxed. If you have a job you pay Payroll Taxes every week, in addition to whatever taxes are required in your State. If you buy things, you pay sales tax. Do some people pay more than others, yes, of course they do, but everyone pays something.

The Progressive Tax System (which is what we use here in America) was established by President Lincoln, and essentially works on the “the more you make, the more you pay” philosophy. Most of the time you hear people bust out the “the poor don’t pay taxes” argument, it’s because they’re in favor of a Flat Tax system where everyone is charged the same rate, regardless of income level.

Now while you can debate that taxes are too high (which I certainly agree with), a flat tax is most definitely not the answer. It’s regressive to say the least, and would devastate the poor. This is to say nothing of the fact that any “gains” in revenue would almost certainly be eaten up by the increase in welfare expenditures resulting from the economic impact to the poor. How would it hurt the poor if we all paid the same rate? Let me explain:

Assume there are three families, with the following income levels:

Family 1: $10,000 a year

Family 2: $100,000 a year

Family 3: $500,000 a year

Assuming a 10% flat tax, their tax burden would break down as follows:

Family 1: $1,000

Family 2: $10,000

Family 3: $50,000

Now while they’re all paying the same percentage of their income in taxes, the economic impact on Family 1 is much greater than it is on Family 2, even though Family 2 is paying 10 times as much in taxes as family 1. Likewise, the economic impact on Family 2 is greater than the impact on Family 3, even though Family 3 is paying 5 times as much in taxes, as Family 2.

Myth 3: CEOs Make Too Much Money.

The Argument: Corporate CEOs are paid many times that of the workers at their companies, sometimes hundreds or thousands of times more, and it’s not fair.

Why People Believe It: Once you start talking about income levels over $30 million a year, most people lose the ability to comprehend how anyone could be worth that much money each year.

Why It’s A Myth: There are two big factors at work on this one, first of which is the market value of their skillset, and the second is their economic impact on the company they work for. To better explain this, I’ll use an example that most people can understand… sports.

Take LeBron James for example. He has a very specific, very rare skillset. Even among other professional basketball players, he is a rare commodity. His abilities alone have a market value, but in determining his worth to a team, you also need to consider his ability to impact things like ticket sales, merchandising, and other peripheral benefits. With all of those things considered, the market places a value on him, and that’s what he makes; in his case, it’s a little over $19 million a year.

The same is true for CEOs. Successful CEOs have a very rare skillset, not just anyone could do what they do, and as with sports superstars, they also have the ability to impact a company simply by taking the job. The market places a value on these skills, and that’s what the CEO earns.

Now a lot of people make the argument that it’s not fair for CEOs to earn so much more than the average employee at their company. This is an understandable point of view, but it’s simply ridiculous to suggest that the two are even close to analogous. Every profession has top and bottom wage earners, and the range in-between is determined by their market value, as it should be.

Source: The All-Nite Images, CC: BY-SA, via Flickr
Source: The All-Nite Images, CC: BY-SA, via Flickr

Myth 2: All Jobs Should Pay A “Living Wage”.

The Argument: Every job should have to pay enough for the employee to live on.

Why People Believe It: This is another one of those “that sounds like a good idea” ones that more and more people are starting to latch on to.

Why It’s A Myth: This is one of those economic truths that no one likes to talk about, but the simple fact is, not every job is worth a “living wage”.

First of all, “living wage” is a ridiculously subjective and fluid number; it changes from place to place, and sometimes month to month. For where I live (Orlando, Florida), the current “living wage” is calculated at $10.57 an hour. Assuming a 40 hour work week, that would be a little under $425 a week ($422.80 to be exact). As a business owner myself, I can tell you first hand that not every job at my company is worth $425 to me. For example:

I have three receptionists working for me. At $10.57 a week, that’s over $5,500 a month in wages alone, not to mention the ancillary costs. At that amount, it’s much more cost effective to go with a virtual receptionist service.

You see, every job at a company, no matter how big or small, has both a value and a cost to the business. As long as the value is equal to or greater than the cost, then it makes sense to keep the employee. However, when that balance shifts, and the costs outweigh the value, then it makes sense to replace the employee with automation if possible, or if not, to just eliminate the position all together.

Now while that may sound harsh, it’s a simple fact: companies have a larger responsible than to just any one individual. My company has a little over 100 employees, not counting me. That’s 100 families that are counting on me to keep things running smoothly; 100 families whose livelihood is predicated on my running a successful business. When I make decisions, I have to make them as they pertain to the overall success of the company, and not based on how they might impact any one person.

Keynes Vs. Hayek: Round Two

Myth 1: The Government Can Fix The Economy.

The Argument: The President/Congress could do more to fix the economy, but it’s the Republican’s/Democrat’s fault that they’re not getting anything done.

Why People Believe it: Most people don’t understand what Congress and the President can actually do, and the certainly don’t understand the Economy and how it works, so they end up with a lot of misconceptions about just what kind of impact the Government can have on the economy.

Why It’s A Myth: To quote one of my favorite videos:

“The economy's not a car, there's no engine to stall
No expert can fix it, there's no "it" at all
The economy's us, we don't need a mechanic
Put away the wrenches, the economy's organic”

As with any other science, there are basic rules and laws that govern Economics; chief among them being the Laws of Supply and Demand. Oftentimes politicians think that they can circumvent these laws in order to accomplish their objectives; sooner or later, they all find out how wrong they are.

As I wrote in one of my previous articles, Economics is simply the study of how people make decisions: no more, no less. Yes, there are things that the Government can do to try and manipulate the Economy, with the key word there being “try”. In the end, the people are the ones that drive Economy, the most that Government can do is give it a little nudge now and then.

© 2014 Shawn McIntyre

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  • profile image

    retief2000 3 years ago

    Pearls before swine, son, pearls before swine - Economics is the most misunderstood and undertaught science. No one who thinks that the minimum wage is a good idea should ever be allowed to graduate until their mind is put right.

  • heidithorne profile image

    Heidi Thorne 3 years ago from Chicago Area

    Shawn, another amazing article on economic realities! I don't know which myth is my favorite, but I think No. 1 that the government can fix the economy ranks close to the top for me, too. What always makes me laugh is that people think an elected official can actually change economic conditions in the timeframe of their terms. The wheels of economic progress can turn slowly indeed in complex societies like ours. The impact of economic decisions by one administration may not be felt for decades.

    And Myth No. 3 that CEOs make too much? Laughable! Those folks do not realize the incredible level of responsibility that CEOs accept. They're just jealous.

    I better get off the soapbox. Thanks for letting me rant!

  • Paul Maplesden profile image

    Paul Maplesden 3 years ago from Asheville, NC

    Excellent article; although I may not 'emotionally' agree with what you say, I can't fault your logic, and your arguments are well made. Definitely food for thought. Voted up.

  • Shawn McIntyre profile image
    Author

    Shawn McIntyre 3 years ago from Orlando, FL.

    @retief2000 Thanks for stopping by,

    The problem is that colleges have been dominated by a devotion to Keynesian theory for so long. Spending is the default position for generations of college students... the same ones that are running the country now.

  • kschimmel profile image

    Kimberly Schimmel 3 years ago from North Carolina, USA

    Excellent hub that summarizes arguments effectively. If only people would learn a little basic economics instead of just listening to sound bites on TV from politicians!

  • Shawn McIntyre profile image
    Author

    Shawn McIntyre 3 years ago from Orlando, FL.

    @heidithorne I'm glad you enjoyed the article,

    It amazes me how many people expect a group of lawyers to be qualified to fix the economy, or education, or health care, it's ridiculous. When I broke my foot a few weeks ago, I didn't go to a lawyer, I went to a doctor.

  • Shawn McIntyre profile image
    Author

    Shawn McIntyre 3 years ago from Orlando, FL.

    @Paul Maplesden, Thanks for taking time to read the article,

    Always nice to hear views from all sides, especially those who disagree with me.

  • Shawn McIntyre profile image
    Author

    Shawn McIntyre 3 years ago from Orlando, FL.

    @kschimmel Thanks for taking time to read the article,

    Economics is actually really very simple to understand, economists (and I'm guilty of this as well sometimes) just make it seem harder than it is.

  • savvydating profile image

    savvydating 3 years ago

    I appreciate your breaking down these myths in a way that regular people (such as myself) can understand. That being said, I've worked as a receptionist. Do real people not contribute something more and are they not more valuable than a virtual receptionist, if they actually represent the Company well and bring a good measure of positive personality? Not arguing with your economics. Just wondering...since I thought I was Amazing at my job, when I worked the front desk.

    Up, interesting, useful.

  • Shawn McIntyre profile image
    Author

    Shawn McIntyre 3 years ago from Orlando, FL.

    @savvydating Thanks for stopping by, I'm glad you enjoyed the article.

    Yes, real people are preferable to automation, but at a certain point, the benefits of having a real person are outweighed by the increased costs.

    The current Federal Minimum Wage is $7.25 and there is a push by the President and Democrats in Congress to raise it to $10.10, that's a roughly 40% increase. Now imagine the price of the things you buy every week went up by 40%, but your income stayed the same. You would have to start making some adjustments in your spending habits to compensate. It's the same for businesses.

    Labor costs are like a company's grocery bill: when things start getting more expensive, they have to start cutting back. One of the ways they cut back is by buying the generic brand (automation) instead of the name brand (real people). Some things that are luxuries (like extra receptionists, landscapers, maintenance staff, etc) you just have to stop buying altogether (layoffs).

  • savvydating profile image

    savvydating 3 years ago

    Hi Shawn. That makes sense! I appreciate your taking the time to answer my question.

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