Question

Big is a monopoly with demand pH(q), employing skilled workers at market wage wH. Little is a monopoly with demand pL(q), employing unskilled workers at market wage wL. A minimum wage, wM, is introduced, wL < wM < wH. There is a profit tax.

a) What happens to employment in Big and Little? Why?

b) What happens to Big and Little’s profits and to profit tax collected?

c) Suppose instead of introducing a minimum wage, the government decides to give a subsidy of wM – wL to each unskilled worker. The subsidy is funded from an increase in profit tax. What happens to output, employment and profits?

Answer 1

a) You can think of Big and Small almost as dividing the economy into two sectors: the skilled sector and the unskilled sector.

Because each sector is ruled by a monopolist overlord, it is fair to assume that the initial wages are the respective profit maximization wages. If labor is the only unit of input of production then the wage rates are the respective MCs.

If minimum wage is less than monopolist optimal wage, the monopolist isn't affected in their decisions. So employment at Big isn't affected.

On the other hand if minimum wage is is greater than optimal wage, that increases the MC for the monopolist. So in case of Little, the firm now faces a higher (horizontal) MC curve. For a regular downward sloping demand curve, the MR curve is also downward sloping.

Setting MR (q) = MC to decide output (monopolist's profit maximization criteria) means that for higher marginal cost output and (thus necessarily employment) contracts.

b) Assuming a constant rate of profit tax as a fraction of profit, profit tax is directly proportional to profit,

Big isn't affected. Their profit and profit tax is constant.

For Little since the wage has deviated from monopolist's optimal wage factor employment isn't optimal. The implication is that at this suboptimal output-employment level profit is lesser, so profit tax is also lesser.

c) Again, only Little i.e. the unskilled sector is affected. Big remains unaffected.

Imposition of lump sum tax and profit tax simply reduces excess profits of the monopolist since these two taxes are an addition to the total fixed cost.

As fixed cost is independent of the level of output, imposition of such taxes will not alter MC of the monopolist. Hence the equilibrium in the monopoly market will remain the same and, consequently, output and price will remain unchanged. The only change that will occur is the reduction of profit of the monopolist.

So this measure is better in that it has the presumably intended redistributive effect on wealth. A chunk out of monopolist profit is redistributed between the unskilled labor force which is generally the most vulnerable economic group.