Question

Labour costs have a bearing on the demand and supply of so many goods in the economy. Illustrate with well labelled graphs, how the minimum wage affects demand, supply and equilibrium

Answer 1

A minimum wage creates the same impact as a price floor.

It sets the minimum level of wages that workers in a certain market will receive. Thus, it serves to protect the interests of the workers.

Suppose there is a certain labour market, say for unskilled labourers in construction. The government feels that these labourers are being exploited due to very low wages. Thus, the government sets a minimum wage rate that has to be paid to these workers.

In any labour market, the demand for labour comes from businesses, mainly. There is also some demand for labour from the government. Businesses produce goods and services from the factors of production. Thus in our example, the demand for unskilled labourers will come from the construction business.

The supply of unskilled labourers comes from the population at large. In every country, there will be a large number of workers, who may not have technical skills. But their labour is still required in various sectors.

Firms offer them a wage rate, and they respond by supplying their labour. If a higher wage rate is offered, they supply more. However, it is seen that firms may deliberately offer a very low wage rate. This is where some level of government regulation is needed.

This can be shown in the graph below:

A minimum wage set above the equilibrium wage rate is said to be binding. This means that the firm is legally bound to pay this wage rate.

In the diagram, we can see the equilibrium wage rate and the minimum wage, set above it. The government feels that the equilibrium wage was too low.

Due to the minimum wage, the firm reduces its demand for labour, but the unskilled workers are now ready to supply more labour. Thus, there are movements along the demand and supply curves, respectively.

This distortion can be seen on the X-axis quantities

This excess labour supply results into Unemployment.

Equilibrium quantity becomes distorted due to the minimum wage.

Wage rate rises from equilibrium to the minimum wage - any other wage rate is not allowed by the government.