Question

Governments commonly uses price floors. One of the most classic examples of a price floor is a minimum wage policy in a labor market. Minimum wages laws date from 1894 in New Zealand, 1909 in the United Kingdom, and 1912 in Massachusetts. Minimum wage policies, however, often create unintended consequences. The original 1938 U.S. minimum wage law, for example, caused massive unemployment in Puerto Rico.

Suppose the following demand and supply curves describe the labor market in Puerto Rico before 1938:

Demand: P = 20 – Q              

Supply:   P = 2 + 0.5Q

where P is the wage per hour, and Q represents the number of workers hired, in thousands

(e.g. Q = 1 means that 1,000 workers have been hired).

a) Calculate the equilibrium wage and the number of workers hired before the 1938 minimum wage laws. Illustrate on a graph.

b) The 1938 U.S. minimum wage laws artificially required that all workers earned at least $10 per hour in Puerto Rico. So, how many workers would be employed under the minimum wage policy? Illustrate on a graph.

c) Using your graphs from (a), calculate the consumer surplus and producer surplus at the initial equilibrium price and quantity from part (a).          

d) Calculate the new consumer surplus and producer surplus with the minimum wage of $10 (part b).

e) How does the total consumer and producer surplus in part (c) compare to the total consumer and producer surplus in part (d)? What explains the difference in these two figures? Please explain intuitively.

PLEASE SHOW WORK; ESPECIALLY FOR QUESTION D STEP BY STEP.

Answer 1

a)

Equilibrium wage and workers before 1983 minimumwage laws:

In Equilibrium:

Demand = Supply

Equlibrium wages = $8 per hour

and 12000 workers were hired in equilibrium

b)

10,000 worker would be employed under minimum wage ploicy

c)

Consumer Surplus = Area ABD = (1/2)x(20-8)x(12) = 0.5x12x12 = 144/2 = 72

Producers Surplus = Area BCD =(1/2)x(8-2)x(12) = 0.5x6x12 = 36

d)

New Consumer surplus: Area ABF = (1/2)x(20-10)x(10) = 50

New Producer's Surplus: Area BCDEF = (1/2)x(7-2)x(10) + 3x10 = 25+30 = 55