Question

Suppose there is a discussion about the minimum wage policy. A group of people argue that the wages are currently too low for unskilled labor. They advise government to increase the minimum wage:

a. What would this probably mean for the labor market for the college-educated skilled workers? Will that market be affected? Will the equilibrium wage change for the skilled workers?

b. What about unskilled labor? How are they going to be affected if a new minimum wage law is implemented? What would happen in the labor market for unskilled workers?

c. Opponents of the proposed minimum wage policy argue that demand for unskilled labor is not as inelastic as proponents of the policy believe. Now, suppose you do not know whether the demand curve is relatively elastic or inelastic. Using two different demand curves on a single graph (one relatively inelastic and the other relatively elastic), show the effects of a minimum wage policy in both cases. Which case had more detrimental effects on efficiency and employment? Compare results on the graph. If the opponents’ belief about demand is correct, should the government re-consider the proposed minimum wage policy?

Answer 1

a.

The above figure represents the labour market for the skilled labour force. With an introduction of the higher minimum wage in the unskilled labour market, we can notice a small dip in the supply of skilled labour represented by a leftward shift in the supply curve. This is because an individual would find unskilled labour market more alluring with new wages in place and might even choose over skilled labour market considering the investment he has to make in terms of education and experience to get into the skilled labour market. This fall in supply would create upward pressure on equilibrium wages in the skilled labour market causing them to rise to .

b.

The above figure represents the unskilled labour market. With an introduction of the minimum wage () we can notice an increase in labour supply to and a decrease in labour demand to . This surplus in labour supply would translate to a fall in the equilibrium quantity of labour traded from to , creating   unemployment in the market. Thus we can conclude that higher minimum wages leads to fewer jobs.

Job loss is not the only adverse outcome of minimum wages. The society would also experience a deadweight loss and fall in consumer surplus. Consumer surplus falls from to with the introduction of minimum wages. This is because higher wages are translated to higher prices for the final products.

The deadweight loss is represented by the  triangle .

Thus benefit attributed by earings gain tends to be outweighed by the loss in jobs and inflation.

c.

1. Case 1: Inelastic demand curve ()

• Deadweight loss: Triangle
• Consumer surplus: fall in consumer surplus from   to
• unemployment :

1. Case 2: Elastic Demand Curve ()

• Deadweight loss: Triangle
• Consumer surplus: Fall in consumer surplus from to
• unemployment:

1. Comparing case 1 and case 2

• Deadweight loss in case 2 is more than case 1
• Unemployment is higher in case 2 than case 1.

Thus we can conclude case 2 is more detrimental than case 1.

Yes, considering the demand curve to be elastic the government should; reconsider the proposed minimum wage policy. The above analysis leads one to believe that minimum wage is not an effective tool in achieving its intended goals of improving the condition of poor as with increased unemployment in the unskilled labour market and higher product prices outweighs the positive impact relayed by higher minimum wages. Thus alternative tools such as targeted tax credit do a better job in reaching the targeted audience. In the US most evidence supports the above argument.