Question

Critically evaluate how labour market policy through the use of minimum wages can be used to reduce income inequality.

Answer 1

In a minimum wage policy, the wage rate for a particular market is legally set above the equilibrium price. This is generally done when the prevailing market rate is deemed to be too low. This is done with the intention to enhance the welfare of the labourers in that market.

For instance, suppose that there is a market for plumbers. There is a certain demand and supply of plumbers, and this leads to an equilibrium wage rate. The government feels that this wage rate is too low, considering the efforts that plumbers exert, and that they need to brought out of poverty. Thus, the government sets a law, which sets a price floor for this market.

This can be illustrated by the diagram below:

The minimum wage thus raises the wage rate in the market for plumbers.

However, it now creates a surplus of plumbers in the market, and some of them may end up unemployed.

Critical evaluation

• Advantages
  • Income inequality will be reduced, and pay rates in that market will improve
  • More labourers will be encouraged to participate in the market, and this will improve their economic position.
  • Large firms will not be able to exploit labourers; the law will protect the wages of labourers

• Disadvantages
  • Higher wages result in higher cost of production, and higher prices for consumers
  • Minimum wage laws can lead to unemployment, as shown in the graph above
  • Higher wages make products costlier, and our exports become less attractive
  • It may encourage labour markets that are unaccounted in nature (black markets)
  • For foreign direct investors, the home country becomes an expensive destination