Question

2. Graphically illustrate how minimum wage law causes unemployment. Be sure to label the axes.

Answer 1

Minimum wages law sets minimum legal price which the workers have to be paid. It is a price floor below which the employers cannot pay the workers. The model of demand and supply show that if we set the minimum wage above the equilibrium wage, it leads to a rise in unemployment.

To understand how, refer to the graph below.

From the graph, the demand and supply intersect at equilibrium E and there wage rate is Ew i.e equilibrium wage rate and labor supply is W_L i.e, equilibrium labor supply.

However when a price floor is set above the equilibrium wage rate, it acts as a price floor that is a binding constraint. It creates a surplus of unemployment from L₁ to L_2.

This is because at a higher wage, more people would be willing to work but there will not be so many jobs and thus the employer will choose based on his preferences creating an unemployment surplus. Usually the ones to suffer from minimum wages laws are unskilled labour and teenage workers.