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

Answer 1

We have the demand and supply curves describing the labor market in Puerto Rico before 1938:

Demand: P = 20 – Q Supply: P = 2 + 0.5Q

Market is in equilibrium when demand are supply are equal

20 - Q = 2 + 0.5Q

18 = 1.5Q

Q = 12

P = 8

Hence, the equilibrium wage is $8 per unit and the number of workers hired before the 1938 minimum wage laws is 12000 units.

The 1938 U.S. minimum wage laws had a wage rate of least $10 per hour in Puerto Rico. At this wage rate, total employment was 20 - 10 = 10000 workers but total available labor units were (10 - 2)/0.5 = 16000 units. Hence there was an unemployment of 6000 units of labor.