Tag Archives: Minimum Wage

Does a higher minimum wage mean higher unemployment?

In most economics textbooks the labour market is shown with a simple graph of the supply of labour and the demand for labour and where they intersect the wage that employees receive for their service and the amount employed. The theory is based on the following:

Demand for Labour
In this context the demand for labour is determined by the marginal revenue product where workers are paid the value of their marginal revenue product to the firm. The demand for labour is downward sloping as when there is a fall in the wage rate the firm will expand employment as the labour input has become relatively cheaper for a given level of productivity, compared to other inputs. A rise in the wage rate will causes a contraction of labour demand.

Supply of Labour
Economic theory would suggest that the real wage (adjusted for inflation) is a key determinant of the number of hours. Therefore the supply curve for labour slopes upward because people want to work more hours if you pay them more, at least in theory. An increase in the real wage on offer in a job should lead to someone supplying more hours of work over a given period of time, although there is the possibility that further increases in the going wage rate might have little effect on an individual’s labour supply.

The Minimum Wage

The minimum wage distorts the market equilibrium as there is now a wage floor – a level which the wage cannot fall below. If the minimum wage is below the equilibrium wage then there is no impact as the market will ensure that is reaches equilibrium. However a minimum wage above the equilibrium means that companies will hire fewer workers and therefore result in more unemployment. On the graph below a minimum wage of W1 means that the level of employment has fallen but those prepared to work but are involuntary unemployed has increased. However the people still employed are better off as they are paid more for the same work; their gain is exactly balanced by their employers’ loss. The jobs that someone would have been willing to do at less than the wage of We and for which some company would have been willing to pay more than We. Those jobs are now gone, as well as the goods and services they would have produced.

Real Impact of the Minimum Wage.

In reality the theory of the minimum wage explained above is not as simple as it is made out to be. From records in the USA there is no obvious relationship between the minimum wage and unemployment: adjusted for inflation, the federal minimum wage was highest from 1967 through 1969, when the unemployment rate was below 4%. One study in 1994 by David Card and Alan Krueger evaluated an increase in New Jersey’s minimum wage by comparing fast-food restaurants on both sides of the New Jersey – Pennsylvania border. They concluded, “contrary to the central prediction of the textbook model … we find no evidence that the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”

The idea that a higher minimum wage might not increase unemployment goes against the the theory in textbooks as if labour becomes more expensive firms will take on less employees. But there are several reason why this might not be the case:

  • The standard model states that firms will replace labour with machines if wages increase, but what happens if labour saving technologies are not available at a reasonable cost.
  • Some employers may not be able to maintain their business with fewer workers especially in service based industries. Therefore, some companies can’t lay off employees if the minimum wage is increased.
  • Small firms are traditionally labour intensive and can’t afford large capital investment. Therefore the minimum wage doesn’t have the impact of laying off workers.
  • If employers have significant market power that the theory of the supply and demand for labour doesn’t exist, then they can reduce the wage level by hiring fewer workers (only those willing to work for low pay), just as a monopolist can boost prices by cutting production (think of an oil cartel, for example, see graph Monopsony Labour Market). A minimum wage forces them to pay more, which eliminates the incentive to minimize their workforce.
  • Even though a higher minimum wage will raise labour costs many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.
  • Higher wages boost productivity as they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better. A higher minimum wage motivates more people to enter the labor force, raising both employment and output.
  • Higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs.
Monopsony Labour Market

All the above add a range of variables that are not considered in the simple supply and demand model for labour. It maybe useful as a starting point in discussing the minimum wage but has its limitations in the more complex real world

Source: Economism by James Kwak

Monopsony power in the labour market and the minimum wage

Min Wage 2011In 1894 New Zealand made history by being the first developed nation to introduce a minimum wage. The Economist had an article on minimum wages and the fact that they might in fact be good for an economy. Most economists believe that a higher minimum wages = the artificial increase in labour costs and therefore lower demand for labour.

Some economists have suggested that minimum wages can increase employment and obviously pay. However if employees have monopsony power as buyers of labour and are able to influence wages they can keep the wages lower below its competitive rate – see graph below.

Two economists (David Carr & Kruegger) found out in New Jersey that when the minimum wage was raised employment in fast-food restaurants actually increased. The Economist suggests that if firms are not reducing the number of their employees with higher minimum wages they must be employing a number of strategies such as raising prices of their goods/services or saving money from reduced revenue. The IMF state that a moderate minimum wage (30-40% of the median wage – see graph) doesn’t have a significant negative effect on employment numbers and may do some good.

Monopsony in the Labour Market

Monopsony Lab

A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.

If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.

Paying your citizens to be alive – The Swiss Proposal

Truck dumps five cent coins in the centre of the Federal Square during event organised by Committee for initiative Grundeinkommen in BernI was directed to this article on the New York Times website by A2 student Annie Huang. In October this year, a truck dumped 8 million coins (see photo) in front of the Swiss Parliament along with 125,000 signatures in support of a minimum monthly wage. The coins represented the citizens of Switzerland, and the petition was enough to trigger a referendum, voting on whether Swiss citizens should receive a monthly minimum income of $2,800, no questions asked. Each Swiss person would recieve this money from the government no matter what age they are, if employed or unemployed.

Although this seems rather radical there are some interesting points made as to why it has been proposed. The proposal is the work of German Enno Schmidt who is a leader of the basic-income movement. Here are some of the reasons:

* Basic income would provide dignity and security to those underemployed and unemployed
* Empower the labour force to work they want to, rather than just getting by
* Basic income through the tax code would be fairer than band aid programmes such as benefits, housing allowances, child benefits etc.
* The one basic income would replace and reduce welfare bureaucracy that is apparent with numerous welfare schemes
* Reduce poverty and increases social mobility

Research has shown that where the basic income has been implemented not only did poverty disappear but secondary school completion rates increases, hospitalisation went down and the community values started to change.

However there are some strong arguments against:

* The cost is too great
* It creates a disincentive to work
* The basic income might be enough to live on but at a very low standard

Deeper Arguments

With the record earnings in the corporate sector but still no increase in the living standards of many, guaranteed incomes have resurfaced. Millions of workers have had no real increase in earnings since the late 1980’s. Below is an extract from the article:

The advocacy group Low Pay Is Not OK posted a phone call, recorded by a 10-year McDonald’s veteran, Nancy Salgado, when she contacted the company’s “McResource” help line. The operator told Salgado that she could qualify for food stamps and home heating assistance, while also suggesting some area food banks — impressively, she knew to recommend these services without even asking about Salgado’s wage ($8.25 an hour), though she was aware Salgado worked full time. The company earned $5.5 billion in net profits last year, and appears to take for granted that many of its employees will be on the dole. New York Times – 12th November 2013

Increase in minimum wage = Positive outcomes for economy?

Recently the minimum wage in New Zealand increased from $13.50 to $13.75 per hour. What are the arguments for an increase in this and what affect does it have?

An argument for the minimum wage is the fact that sometimes in labour markets there isn’t enough competition between employers and a monopsony situation occurs – see graph below. Here the minimum wage would protect the employee. However, is raising the minimum wage based more on reducing inequality as people are still struggling with the purchasing power of their incomes. In the US President Obama spoke in his State of the Union address about increasing the minimum wage from US$7.25 to US$9 – seems to be well targeted with regard to its impact. But ultimately how many people are affected by the increase in the minimum wage?

With the increase in minimum wage there is the belief that employers will lay-off workers. Evidence suggests the following:

1. Employment doesn’t fall much as the increase in wages lowers labour turnover, which raises productivity and the demand for labour.
2. The increase in costs for the employer will be passed onto the consumer in higher prices for goods and services

There is also the argument that wage increases will boost aggregate demand and therefore growth and employment. But in the USA this is estimated to increase consumer purchases by approximately US$15bn and when you think that the US economy is worth US$15 trillion is quite small in the scheme of things.

Economist Christina Romer stated in The New York Times that a more generous earned-income tax credit would provide more support for the working poor and would be more pro business at the same time.

Monopsony Labour Market
A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.

Monopsony Lab