Price control - Minimum wage

Minimum wage

A minimum price of labour (the 'wage') set by governments in the labour market, in order to ensure that low-skilled workers can earn a wage high enough to secure them with access to basic goods and services. It is a type of price fl oor.

Misallocation in product markets

Firms relying heavily on unskilled workers experience an increase in their costs of production, leading to a leftward shift in their product supply curve, resulting in smaller quantities of output produced. Therefore, the misallocation of labour resources leads also to misallocation in product markets.

Negative welfare impacts

In the free market, with no minimum wage, employer surplus consists of areas a + b + c, and worker surplus consists of areas d + e, making a total social surplus of a + b + c + d + e. After the imposition of the minimum wage, employer surplus is reduced to area a, and worker surplus becomes areas d + b, so that total social surplus is a + b + d. Therefore, the minimum wage has resulted in a loss of social surplus equal to c and e, representing welfare (deadweight) loss. The deadweight loss arises because there is an underallocation of labour resources (usually unskilled labour) relative to the social optimum, since Qd < Qe.

Misallocation of labour resources

It prevents the market from establishing a market-clearing price of labour. The wage acts as a signal and incentive to workers (the suppliers of labour) and firms (the demanders of labour) to determine the optimal allocation of labour resources. The imposition of a minimum wage changes these signals and incentives for unskilled labour, whose wage is affected by the price floor. Therefore, industries that rely heavily on unskilled workers are more likely to be affected, and will hire less unskilled labour.

Consequences of minimum wages for workers (suppliers of labour)

Some gain, as they receive a higher wage than previously (Wm > We), but some lose as they lose their job. Note that the workers who lose their job are those represented by Qe − Qd. This is not the full amount of unemployment created by the minimum wage, because the minimum wage leads to additional unemployment of Qs − Qe, since more workers supply their labour in the market when the wage increases. The mixed effects on workers are reflected in the gain in worker surplus of area b, and the loss of area e.

the equilibrium 'price' of labour and the quantity of labour demanded

The demand for labour shows the quantity of labour that firms are willing and able to hire at each wage, and the supply of labour curve shows the quantity of labour that workers supply at each wage.

Minimum wages in the real world

The effects are uncertain whether they produce an increase in unemployment to the extent that economic theory predicts. While the effects of minimum wages remain controversial, there is generally strong political support for their continued use on the grounds of greater equity in income distribution.

Labour surplus (excess supply) and unemployment

The imposition of a minimum wage in the labour market creates a surplus of labour equal to Qs − Qd, which is unemployment, as it corresponds to people who would like to work but are not employed. The unemployment is due partly to the decrease in quantity of labour demanded by firms (the difference between Qe and Qd) and partly to an increase in the quantity of labour supplied (the difference between Qs and Qe) which occurs because the higher wage makes work more attractive causing a movement up the labour supply curve. This unemployment is likely to involve unskilled workers.

Welfare analysis of product market vs resource market

The reason why the welfare analysis of the minimum wage differs from that of price floors for agricultural products with government purchases of the excess supply is that the government does not 'buy' the excess labour supply that results from the minimum wage by offering the excess workers jobs.

Consequences of minimum wages for firms (employers of labour)

Worse off as they face higher costs of production due to the higher labour costs. This is reflected in the loss of employer surplus.

Effects of minimum wage

if a minimum wage is set at a high level relative to the free market equilibrium wage, it is likely to create some unemployment. Some studies have shown that a minimum wage in some situations may have no effect or even a positive effect on total employment. Some firms respond to the minimum wage by maintaining the same number of workers but cutting non-wage benefits (such as paid holidays or sick leave); or they may hire fewer unskilled workers and more skilled workers. Also, it is possible that labour productivity (defined as the amount of output produced per worker) may increase due to the minimum wage, as workers feel motivated to work harder, with the result that some firms hire more unskilled labour in response to minimum wages.

Consequences of minimum wages for consumers

negatively affected, because the increase in labour costs leads to a decrease in supply of products (a leftward shift in firm supply curves) causing higher product prices and lower quantities.

Illegal workers at wages below the minimum wage

often involves illegal immigrants who may be willing to supply their labour at very low wages.

Price floors in the real world

strong political pressures exerted by farmers who claim to need these for income support.

Setting fixed prices

such as with ticket prices for theatres, movies and sports events, where prices are usually fixed ahead of time by the organising body (which may be private or public), and cannot increase or decrease according to supply and demand.

objective of minimum wage

to guarantee an adequate income to low-income workers, who tend to be mostly unskilled