Question

There has been a great deal of discussion in the news over the past few years about raising the minimum wage. Some cities and states have increased minimum wages in their locality above the federal minimum wage, which has brought demands for the federal minimum wage to be increased. Some argue that the federal minimum wage should be increased to $10.10 while others argue for the $15 level. From a microeconomics perspective, who is hurt and who is helped by an increase in the legal minimum wage? Why might a higher minimum wage increase unemployment? Under what circumstances might a higher minimum not impact unemployment?

In considering increasing minimum wage, it is often claimed that businesses are greedy and that increasing minimum wage just means less profit for a company. How might "profit" reflect a cost of doing business? How is profit differentiated in economics and what impact might economic profit have on entry into the industry, ultimately benefiting consumers?

Answer 1

On a microeconomic level, increasing the legal minimum wage makes the employees or workers better off as their incomes increase thereby leading to an increase in the standard of living. Meanwhile when the legal minimum wage is increased, the firms are made worse off. This is because the firms will now have to pay more if they were previously paying less to the workers and keeping all of the profits to themselves.

Higher minimum wages may increase unemployment when the minimum wages are above the natural rate. Increase in minimum wages essentially leads to an increase in unemployment because it reduces the employers incentive to hire more workers. When the minimum wages rise, the employers would want to automate the production process to reduce costs. This will lead to an increase in unemployment. Minimum wages leads to employers hiring less workers as their profits get affected thereby leading to a rise in unemployment. In the US it was seen that when the minimum wages were kept at a minimum of $10, there was a supposed increase in worker earnings but it did not contribute to unemployment. This would mean as long as the minimum wages are set below natural rate, there will not be an increase in unemployment.

Profit reflects the cost of doing a business and firms operate with the motive of making highest profits. Profits would make it easy for them to survive in the industry and when they are reinvested in research, it will increase long term profitability. Economic profits are the difference between total cost and total revenue of a firm. When firms in an industry are earning economic profits, it provides an incentive for new firms to enter or for the existing ones to expand production. Economic profits induce firms to enter into the industry.