Question

Suppose that Malaysian government is considering to raise the minimum wage. Some people suggested that a government subsidy could help employers finance the higher wage. This exercise examines the economics of a minimum wage and wage subsidies. Suppose the supply of low-skilled labor is given by L S = 10w, where L S is the quantity of low-skilled labor (in millions of persons employed each year), and w is the wage rate (in Malaysian Ringgit per hour). The demand for labor is given by L D = 80 - 10w. i. What will be the free-market wage rate and what will be employment level? ii. Suppose the government sets a minimum wage of RM5 per hour. How many people would then be employed? iii. Draw the graph to illustrate your answer and explain. b) Suppose that instead of a minimum wage, the government pays a subsidy of RM1 per hour for each employee. i. What will the total level of employment be now? 5 ii. What will the equilibrium wage rate be? iii. Draw graph to illustrate the effect of subsidy and explain

Answer 1

Supply of low-skilled labor is given by L S = 10w and demand for labor is given by L D = 80 - 10w.

i. At the free-market equilibrium we have

Ls = Ld

10w = 80 - 10w

20w = 80

w = 4 Ringgit per hour

L = 40 millions persons employed each year

ii. Suppose the government sets a minimum wage of RM5 per hour.

Now Ls = 10*5 = 50 and Ld = 80 - 10*5 = 30

Hence employment = 30  millions persons and unemployment = 20  millions persons

iii. Below is the graph to illustrate your answer. Labor demand and labor supply meet at w = 4 and L = 40. Minimum wage makes market wage w = 5 fixed. This implies that now there is an unemployment of 20 million persons.

b) Instead of a minimum wage, the government pays a subsidy of RM1 per hour for each employee.

i. New supply is Ls = 10(w + 1) or Ls = 10w + 10

New equilibrium has Ls = Ld

10w + 10 = 80 - 10w

20w = 70

w = 3.5 (paid by employers)

w = 4.5 (received by empoyers)

L = 45 million persons.

Total level of employment = 45 million persons

ii. The equilibrium wage rate is 3.5 Ringgit per hour

iii. Subsidy reduces the wage rate paid by employers, raises the wage rate received by employees and thereby raises employment