Free market economists often predict job losses from a higher minimum wage, while progressives say poverty will be reduced with no loss of employment. The truth is some people will benefit, some will lose, and most of us will be unaffected. My recent article on how business can respond to a higher minimum wage ignored the theory behind the minimum wage. We turn to that here.

Many arguments for raising the minimum wage are foolish, centered on what we would like to see rather than how the economy really works. The only good argument for raising the minimum wage is that labor markets do not operate perfectly efficiently. The most notable problem is lack of information. A first-time job seeker usually applies for work without considering wage rates. Local stores and restaurants are likely targets for an application, as are places where friends already work. That means that employers can offer lower wages than if everyone had full information about wage rates. We call that “monopsony power,” similar to monopoly power but on the buy side of the market.

With monopsony power, companies not only pay lower wages than in perfect competition, but they employ fewer people. Let’s say a store is paying $10 an hour (all-in, counting mandatory non-wage payments as well as wages). If an additional worker would make an $11 contribution to the business, then an additional worker would be hired by a competitive employer. With monopsony power, though, the company is already hiring every qualified applicant who walks in. To get more workers, the company would have to raise the wage offer. (Practically, that means wages would have to be raised for existing workers, too. Even if not legally required, morale would go down if new workers earned more than their experienced colleagues.) The cost of adding an additional worker is not just the employee’s earnings; add to that the cost of raising all similar workers’ wages and the total is prohibitive. So employment does not expand as much as in a perfectly competitive market.

If a minimum wage were increased to the right level, then no jobs would be lost. In fact, there might be even more people hired. This is an elementary conclusion taught in Principles of Economics, even by conservative professors; pull out your old textbook and review the chapter on monopolies.

Now let’s return to reality. The statement above was that “if a minimum wage were increased to the right level.” What’s the right level?

If the most common entry wage is $10 an hour, is it likely that the ideal wage is $15? That implies that workers could earn substantially higher pay today by shopping around. They could consult with friends, check web sites, ask about wages when applying for jobs. The market does not require that everyone behave fully rationally, but enough that the rational people make a difference. I can easily believe that entry-level workers are failing to find an extra 50 cents an hour when they take the first offer they receive; I can’t believe they would leave $5 an hour on the table. Published estimates of the size of monopsony power are in the neighborhood of five to ten percent, which would be 38 to 73 cents per hour relative to the federal minimum wage of $7.25. (See this survey. Note that monopsony power is likely to be higher in more specialized occupations with few employers, and should be smaller where workers are less specialized and have more employers to choose from.)

Further, we’re not looking at market wages right now, but rather wages with the existing minimum. The true market wage could be a couple of dollars lower, depending on local conditions.

Note that a minimum wage meant to counteract monopsony power will be different from one location to another. A $15 minimum would do less damage in Seattle than in rural Mississippi. Market wage rates vary substantially from place to place. Market efficiency is also likely to vary. A city with good Internet usage and good transportation infrastructure is likely to have employers with less monopsony power, and thus the minimum wage need not be as high.

In practical terms, it is highly likely that any of the current minimum wage proposals will reduce employment.

One issue to consider is how the impact of a high minimum wage varies across low-skilled job applicants. The middle class teenager whose parents provide job-interview coaching will do well. The young person from a disadvantaged family, whose parents have not had positive job experiences, is likely to do much worse. Thus, raising the minimum wage helps middle-class teenagers at the expense of the poorest members of our society.

The moral issue that most concerns me is that the minimum wage uses the force of law—force that is backed up by the government’s willingness to use guns and violence—to prohibit an employer and prospective employee from striking a bargain to which they both agree. The threat of violence against the employer keeps the job-seeker from competing on price. Those concerned with violence in our society should be ill at ease with minimum wage laws.