Question

5.
Statutory Minimum Wage (SMW) has come into force since 1 May 2011 in Hong Kong. The current SMW rate is $37.5 per hour.
a. Briefly explain how an effective minimum wage causes a structural unemployment.
b. With the aid of a demand-and-supply diagram, illustrate the effect of an economic recession on a labour market with an effective minimum wage.

Answer 1

5.a)

The effective minimum wage is price control placed on the labor market and generally set above the market-clearing rate. Let initially the market was at equilibrium with wage rate w*. After this, the government established the minimum wage at w_. The demand for labor at this wage is at a and the supply of labor is at b. The demand falls due to the fact that there is not enough skill to match the wage rate as high as w_. This increases structural unemployment to ab.

b)

As the recession hit the economy at this stage the demand for labor falls to Ld'. The fall in demand decreases firms' demand for matched killed labor from a to c. Hence the unemployment rises by ac. This is cyclical unemployment due to a lack of demand. the structural unemployment remains unchanged at ab. The total unemployment rises to cb due to recession.