The Fundamentals: Tariffs or Minimum Wage - Which Causes Inflation?

Photo by David Everett Strickler on Unsplash

By now my regular readers know that there is a huge overlap between sections of my posts. The last post in the Business Section was about the difference between cost and price and how that affects supply and demand. I encouraged you to apply the knowledge to your life. This time we will look at government intervention in the market - specifically, tariffs and minimum wage.

To review, if buyers have enough money and value a product or service more than the price, they will buy. If buyers have limited money, or the price is higher than the value to the buyer, they will not buy.

More buyers mean competition for goods and services and higher prices. Take money away from buyers and demand drops. They cannot pay as much. Give money to buyers and demand goes up. Government can reduce demand by increasing taxes – taking money away from buyers. Or government can increase demand, by investment in businesses (increasing employment) and by lowering taxes.

If suppliers are making money, they will expand, and more suppliers will enter the market. More suppliers mean more competition to supply goods and services and lower prices. Take money away from suppliers and supply drops. They cannot expand and less money is available for competitors to enter the market. Government can take money away from suppliers by increasing tax on business. Conversely, reducing taxes increases money available for expansion.

What happens if government increases minimum wage? The cost of goods and services goes up. As we saw in the last post, that may not result in higher prices. Cost and price are not necessarily related. Demand does go up.

When minimum wage increases, not only do those making minimum wage have more money to spend, but everyone else also ultimately has more money due to wage compression. For example, I hired a company to move my belongings from one house to another. I was talking with the two movers. They were opposed to increasing minimum wage because they worked hard for their $20/hour and thought that those who did not work as hard should not be making nearly what they made.

The point is that when minimum wage increases, everybody above minimum wage wants more too. The result is not just an increase in costs to business. The result is an increase in demand. Prices go up – not just because costs go up – because demand goes up. We have inflation.

When tariffs go up, the cost of the goods that have the tariff applied goes up. Again, as we saw in the last post, prices may or may not go up. Supply might stay the same. Demand will not go up. Buyers still have the same amount of money. The supply and demand curves are not shifted. If sellers try to raise prices to cover costs, demand will go down. When buyers see prices higher than the value they place on the goods, they will not buy.

The result of tariffs might be inflation. However, the inflation will be short lived. Unless workers can demand higher wages, demand will go down. Inventories will increase and prices will be lowered to sell off the inventories.

Those are the fundamentals. When buyers have no money, they cannot buy. While both tariffs and minimum wage increase costs, they may have opposite effects on the economy.