Question

What does theory predict will be the main impact of the minimum wage on labor demand and labor supply? Graph this scenario for inelastic and elastic labor demand in a labor market graph.

Answer 1

In theory a minimum wage is imposed by the authorities to increase the ongoing wage in the market. In doing so they impose a minimum wage (a type of price floor) below which wages cannot be charged. This minimum wage is imposed generally above the ongoing equilibrium price in order to raise the market wage rate. The theoritical outcome of this is a binding minimum wage which does not let market forces bring market to equilibrium. At a higher minimum wage, quantity supplied is more while quantity demanded is less. This leads to a surplus situation in labor market. The surplus labor indicates the number of laborers who are unemployed Hence a minimum wage causes unemployment.

Lets graph the scenario - When demand is elastic then it is flatter in nature (high responsiveness) while an inelastic demand (low responsivess) is steeper in nature. The x-axis represents quantity of labor while y-axis is the wage rate. In both diagram initial equilibrium is at e where demand equals supply. Then a minimum wage Mw is imposed in the market. This causes Qs>Qd and a resulting surplus equal to Qs-Qd. This surplus denotes the level of unemployment due to minimum wage. For the elastic demand the amount of surplus is more as compared to the inelastic demand. The reason is that in case of elastic demand, demanders (firms) have other substitute options available and so Qd falls more due to wage rise and so Qs-Qd is more. While for inelastic demand, firms dont have much choice available and so responsivess to wage rise is less and hence Qd responds less and so Qs-Qd is less.

So in case of elastic demand - unemployment is more as compared to inelastic demand after a minimum wage is imposed. .