Question

a. What are the likely employment impact of minimum wages in a competitive labor market? What happens when the labor market is monopsonistic?

b. Discuss the empirical evidence on the various effects of the minimum wage.

c. What are pro’s and con’s of using a higher minimum wage to reduce income inequality?

Answer 1

a.

The imposition of a minimum wage on a competitive labor market will likely create unemployment as some people enter the labor market while some firms reduce the quantity of labor they are willing to employ due to the increased wage.

In a competitive labor market, the imposition of a minimum wage above the prevailing (equilibrium)wage will unambiguously reduce employment, as long as the labor demand curve is downward sloping. On the other hand, a minimum wage set between the monopsony and competitive wage will increase employment in a monopsonistic labour market.

b. The empirical evidence say about the minimum wage with respect to employment and unemployment is:

A higher minimum wage reduces the employment of teenagers.

The empirical evidence say about the minimum wage with respect to human capital is

- a higher minimum wage will likely reduce on-the-job training as firms seeks to cover the increased wage cost
- a higher minimum wage results in an increase in the dropout rate from high school.

The empirical evidence say about the minimum wage with respect to poverty is

The minimum wage has little effect on the poverty rate because most people making the minimum wage are above the poverty line.

c. Pros

• Higher minimum wage will have positive economic effects above and beyond lowering the poverty rate. Economic research points to the conclusion that a higher minimum wage does not cause greater unemployment, boosts productivity, and addresses the growing problem of rising income inequality.

Cons

• Basic economic theory shows that in a perfectly competitive labor market, the minimum wage acts as a price floor, thereby creating unemployment. 5 Some low-wage workers are paying for the minimum wage increase. Using this mechanism, increases to the minimum wage decrease the wages of low-wage workers due to the unemployment, and income inequality would become larger.