Question

Discuss the theoretically expected impact of minimum wage legislation on each of the following:
(a) Employment under neoclassical labour market model vs. monospoly labour market model.
(b) Education Enrolment
(c) Use a well-labelled diagram to depict the situation of monopsony in the labour market and briefly describe the components of the diagram.

(d) Depict the equilibrium wage and level of employment in such a situation. Imagine you are a legislator setting a minimum wage in such an environment and it would be above the equilibrium wage.

(e) Show the minimum wage that would maximize employment. (f) Show the minimum wage that would be the highest minimum wage consistent with there not being an adverse employment effect.

(g) Why can legislative wage increases also increase employment in such an environment?

Answer 1

1. In contrast to goods and services markets, price ceilings are rare in labor markets, because rules that prevent people from earning income are not politically popular. There is one exception: sometimes limits are proposed on the high incomes of top business executives. The labor market, however, presents some prominent examples of price floors, which are often used as an attempt to increase the wages of low-paid workers. The U.S. government sets a minimum wage, a price floor that makes it illegal for an employer to pay employees less than a certain hourly rate. About 1% of American workers are actually paid the minimum wage. In other words, the vast majority of the U.S. labor force has its wages determined in the labor market, not as a result of the government price floor. But for workers with low skills and little experience, like those without a high school diploma or teenagers, the minimum wage is quite important

On the one hand, by raising wages for the unskilled and reducing the wage differentials between skilled and unskilled labour, wage floors reduce the incentives to invest in further education or training. It has been suggested that “reduced training opportunities or lowered educational attainment could be much more widespread than unemployment effects, and could – by lowering skill acquisition at young ages – have longer lasting consequences for the affected individuals”. Others argue that by increasing the relative demand for higher skilled workers, minimum wages may actually increase the incentives to invest in education and training in order to compete effectively for more skilled jobs

2. Understanding how the minimum wage affects enrollment is important because a minimum wage increase has the potential to reduce community college enrollment. As the existing evidence suggests that community college graduates earn higher wages, reduced enrollment increases the number of workers in the lower tail of the wage distribution. This unintended consequence of a minimum wage increase counteracts efforts to increase postsecondary enrollment and reduces the skill level of many workers. It also has the potential to work against recent efforts to provide free community college education for low income groups.

3. For a monopsony employer, the supply curve of labour equals the average cost of labour. The monopsony employer will have to bid up wages in order to attract new workers.

Profit maximising employment level is where MCL=MRPL i.e. E2 number of people are employed
Their marginal revenue product is valued at W2
Monopsony power of the employer allows them to pay a wage rate W3.

Monopsony employer can use their buying power to pay a wage lower than the value of the marginal revenue product of workers employed at E2

4. Equilibrium wage

In a competitive market, workers receive wages equal to their MRPs. Workers employed by monopsony firms receive wages that are less than their MRPs. This fact suggests sharply different conclusions for the analysis of minimum wages in competitive versus monopsony conditions.

In a competitive market, the imposition of a minimum wage above the equilibrium wage necessarily reduces employment, as we learned in the module on perfectly competitive labor markets. In a monopsony market, however, a minimum wage above the equilibrium wage could increase employment at the same time as it boosts wages!