Question

Show graphically how an increase in the minimum wage might affect unemployment in (i) a perfectly competetive market and (ii) a labor market characterized by monopsony.

Answer 1

Wages and labor supply have a negative relationship, from producer's point of view. Suppose, at the wage rate of 10$, the producer hires 2 units of labor. As the minimum wage reduces to , say, $5 , the producer will be able to hire 4 units of labor. This is because now he can afford more due to low wage rates. This has been explained in diagram 1.

In case of Perfectly Competitive Markets:

Key assumptions with respect to labor markets:

1. labor is homogenous (identical in terms of their productivity)
2. perfect information (all employees would know how much the other employee is being paid etc)
3. perfect labor mobility
4. workers and firms are price takers
5. no barriers to entry or exit

So, labor market equilibrium will be achieved as shown in diagram 2. In perfect competition, a firm faces perfectly elastic supply curve and is equal to marginal cost (MC) and downward sloping demand curve. An increase in the minimum wage (shown in diagram 3) will reduce the amount of labor a producer is willing to employ. This will cause a leftward shift in the supply curve. Because, producer will have to pay higher wage rate, so he will lay off some units of labor to cut down his cost of production.

In case of labor market characterized by monopsony:

A special case of monopsony, where monopsonist is a single buyer of labor. They are able to influence wage rates in more competitive markets. The marginal wage rate is more when he has to attract more laborers and in such case the wager ate paid to new ones along with older ones increases. In this case marginal cost of labor will be more than the average cost of labor.

In diagram 4, intersection of supply curve and MRP curve shows the competitive equilibrium which brings us to minimum wage equilibrium. In diagram 5 , if minimum wage rate increases, the demand for labor will contract , wage rates will shoot up. The impact of this incerease also depends on the elasticity of demand curve and supply curve. For instance, if the demand curve is relatively inelastic, the number of people losing jobs will be a thinner number. On the other hand, if the supply curve is relatively inelastic, the change in minimum wage rates will not cause significant changes in the employment rates.