Question

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

Minimum wages leads to higher payouts by firms and thus employees costs rise which leads to lower profitability. Hence to minimise costs companies restructure and layoff underperforming employees leading to higher structural unemployment.

Recession widens unemployment as structural unemployment rises duebto minimum wage rule which already plunges profitability and due to recession, companies layoff more causing cyclical unemployment and thus disposable incomes fall which leads to lower consumption and lower aggregate demand. Subsequently real GDP falls and so does inflation.

Low inflation and high unemployment are characteristics of Philips curve phenomenon.

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