Question

Notes: Draw separate diagrams for answers to each part of different questions and label graphs according to question (a, b, c, d, & e). Do not combine all your answers on one graph. All of your answers should be based on your graphical analyses. Your written explanations should complement what you draw on your graphs.

Thank you!!

3- [Minimum Wage – 50 points]

The purpose of a minimum wage is to increase the standard of living of workers who are employed in sectors which generally employ low-skill workers. Assume that the minimum wage is binding.
a- Using labor supply and demand diagram, show the effect of a minimum wage on wage and employment. No explanation is required. (5 p)

b- Use supply and demand diagram to determine the change in firms’ surplus, workers’ surplus, and social (or total) surplus as a result of the minimum wage. (15 p)
c- Assume that labor market is characterized by the absence of labor unions and the presence of relatively cheap robots. Does a minimum wage policy is successful in increasing the surplus of the workers in this situation? (10 p)

d- Assume that labor market is characterized by the presence of strong labor unions as well as relatively expensive robots. Does a minimum wage policy is successful in increasing the total earning of the workers in this situation? (10 p)
e- How does a labor-saving technological innovation affect the surplus of the workers in the presence of a minimum wage policy? (10 p)

Answer 1

a. If labour supply is binding it is placed above equilibrium wage and is shown as follows:

Wo =Minimum Wage

We =Equilibrium wage

Le =Equilibrium Labour recruited

LE= Labour hired by Firm

LU = Labour supplied

b. The following diagram shows supply and demand diagram to determine the change in firms’ surplus, workers’ surplus, and social (or total) surplus as a result of the minimum wage.

At Market Equilibrium (Le, We),

Firm’s Surplus : ΔAFE

Worker’s Surplus : ΔBFE

Total Surplus: ΔABE

At minimum wage (Le, Wo),

Firm’s Surplus : ΔAHC

Worker’s Surplus : ΔBGD

Total Surplus: ΔAHC + ΔBGD

The Total Loss in Welfare : HGCD+ ΔCDE

Here, HGCD= Loss due to job search

ΔCDE = Deadweight loss

c. As the market is characterised by absence of labour union and cheap robot, it is more likely for the firm to employ minimum human labour at minimum wage.

In such case the situation is similar to that of (b) and thus the workers surplus is reduced drastically. The firm’s surplus is however though reduced is somewhat made up by the cheap robot labour employment.

d. Now if there is labour union and robot labour is rather expensive then labour union will force to employ ‘LU’ amount of labour and due expensive alternative, the firm will employ ‘LU’ labour.

The Firm’s Surplus : ΔAHC

The Worker’s Surplus : ΔBHI

Total Surplus: ΔAHC + ΔBHI

e. The Labour-saving technological innovation affect the surplus negatively as the firm can now employ less labourers.

The minimum wage policy in the presence of such innovation will reduce the amount of labour employed and reduce the workers surplus significantly