Question

Consider the market for unskilled labour where the equilibrium wage rate is $6 per hour.

A. Suppose the government introduces a price floor of $5 on the market wage. Is price floor binding in this case? What effects will this have on the market outcome and welfare?

B. Now suppose the government introduces a price floor of $7 on the market wage. Is price floor binding in this case? What effects will this have on the market outcome and welfare?

C. Will price floor on the unskilled workers affect the market for skilled labour? Why or why not?

Answer 1

Equilibrium wage rate in the market for unskilled labours = $6 per hour

A. When the government introduces the price floor of $5 which is less than the equilibrium wage, it is not binding. This is because a price floor which is less than the equilibrium price is not binding in the market as it will not affect the economy in any way. A non-binding price floor brings back the wage to the equilibrium wage (or increases the wage back the equilibrium wage and will have no effect in the market for unskilled labours.

B. When the government introduces a price floor of $7 which is more than the equilibrium wage rate, it will be binding. This is because a price floor which is more than the equilibrium price binds the market for that good as it does not fall below that price. Here the wages above the equilibrium wage will be binding and will stick in the market for labours. A wage higher than the equilibrium wage will lead to a greater supply of unskilled labours than their demand and will cause a surplus of unskilled labours in the market.

C. No, the price floor of unskilled workers will not affect the market for skilled labours. The price floor will cause the wages to increase above the equilibrium wage and the supply of unskilled workers will be more than their demand. This will create a surplus in the market for unskilled workers. They will leave the market and will be unemployed. But they cannot join the market for skilled laborers because they do not have the skills to compete with them and enter their market. Thus they will not affect the market for skilled laborers.