Question

1. Consider two states, New York and California. Currently, in NY the equilibrium wage for low skilled labor (Fast food workers, dishwashers, etc.) is $7.50 an hour. In California, the equilibrium wage for low skilled labor is $9.00 an hour. Now suppose President Obama passes legislation that increases the federal minimum wage from $6.55 per hour to $8.00 per hour.

1a) What is the effect of the current minimum wage of $6.55 per hour in each state? Support your answer with graphs that illustrate the demand and supply for low skilled labor in NY and CA prior to the increase in the minimum wage in each state. Illustrate the current minimum wage in your diagrams.

1b) What is the effect of the increase in the minimum wage on the wage rate and the number of worker hired in each state? Be specific and support your answer using supply and demand diagrams.

1c) Is there an excess supply or demand for labor in either state? Why or why not.

Answer 1

a)

Given that the equilibrium wage rate in New York is 7.50 and that in California is 9. We know that the minimum wage rate prior to the increased wage rate was 6.55. Let w be the wage rate and q be the quantity of labour. The followig graph shows us the situation in the labor market of New York and California respectively.

In both the states, equilibrium level is given by E where the corresponding price level is marked and the equilibrium quantity is q.

When minimum wages are at 6.55 which is lower than the equilibrium wage rate in both the states then the quantity demanded for labor is less than the quantity demanded for labor. However since the market prices are already above the minimum wages therefore, there will not be a change in the labor market and the market will continue at the equilibrium level.

b)

When minimum wages rise to 8.

Case in New York-

Now the minimum wages have risen above the equilibrium wage rate at point E where wages = 7.5. Since wages rise therefore, the producers have to now necessarily pay the wage rate of 8 and therefore, the quantity demanded of labour falls and the quantity supplied rises. This is shown in the diagram as Q_D (Quantity demanded) and Q_S (Quantity supplied). We can clearly see from the diagram that when wages rise due to increase in the minimum wage rate above the equilibrium wage rate then there is an excess of labor in the market.

Case in California-

The rise in minimum wages has still not risen above the equilibrium wage rate. At the new minimum wage rate the quantity demanded is greater than the quantity supplied and therefore, there would be a shortage of labor at this level. However since the wage rate is already above the minimum wage rate at 9 therefore, there would not be a change in the quantity demanded or supplied and the market will continue at equilibrium.

c)

There is an excess supply of labor in New York as the wages are above the equilibrium rate and therefore, it would be beneficial for the labor to work at this wage rate however the producers who would hire them would feel that it is an additional cost and would want to reduce their intake leading to a fall in the quantity of labor demanded.

There would be a shortage of labor in California if the minimum wage rate is followed as less labor would want to work at wage rates lower than the equilibrium wage rate whereas more employers would be attracted to hire them leading to a greater demand in the quantity of labor. Howver since the wage rates are already higher in California the market would want to function at the equilibrium level.