Question

Assume the federal government were to step in and increase the minimum wage to $15/hour. What would happen, according to a supply and demand model. Include a graph.

Answer 1

Higher minimum wage will decrease the quantity of labor demanded (Qd) and increase quantity of labor supplied (Qs). Because the workers will obtain employment to the extent firms will hire, market quantity of labor (employment) is Qd, so unemployment will be (Qs - Qd).

This will decrease firms' consumer surplus (CS), and effect on producer surplus (PS) of workers is uncertain. Total surplus (TS = CS + PS) will decrease, giving rise to a deadweight loss.

In following graph, D0 and S0 are labor demand and supply curves intersecting at point E with equilibrium wage rate P0 and employment Q0.

In equilibrium,

CS = area AEP0

PS = area BEP0

TS = area AEB

When minimum wage is higher at Pf, quantity of labor demanded is Qd (< Q0), quantity of labor supplied is Qs (> Q0) and unemployment is (Qs - Qd).

CS = area AFPf [Loss in CS = area P0EFPf]

PS = area BGFPf

TS = area AFGB

Deadweight loss = area EFG