Unit 6 The firm and its employees
6.13 Application: The minimum wage
Governments in many countries set a legal minimum hourly wage, in order to protect the living standards of low-paid workers. In some cases, the same minimum wage applies to all workers; elsewhere it may vary according to the type of work. In India, minimum wages vary by state and industry. In the United States, many individual states set their own minimum wage above the federal minimum, according to local conditions and preferences.
- minimum wage
- A minimum level of pay laid down by law or regulation, for workers in general or of some specified type. The intention of a minimum wage is to guarantee living standards for the low-paid. Many countries, including the UK and the US, enforce this with legislation.
It is often argued that if employers have to pay higher wages, they will employ fewer workers—which leads to unemployment of low-skilled workers. So while some will benefit from higher pay, others will be unable to find jobs. But economists who have studied the effect of rises in the minimum wage have found that the effect on wages is much bigger than the effect on jobs. Some studies have found a modest decrease in employment; others estimate that the number of jobs has increased. In our video, Arin Dube explains how he and his co-authors measured the effects of the minimum wage, and what they found.
Question 6.12 Choose the correct answer(s)
Watch the video of Arin Dube’s study on the minimum wage in the US, read the following statements, and choose the correct option(s).
- This method is known as a natural experiment—the side of the border that did not experience a minimum wage increase was the ‘control’ group; the side that did experience a minimum wage increase was the ‘treatment’ group.
- The study found the opposite—that the minimum wage could improve the functioning of the labour market by reducing labour turnover.
- Inequality decreased because the minimum wage benefited low-wage workers especially, raising their overall take-home pay.
- The study found that employers passed on the increase in wage costs to the consumers, so there was a minimal negative impact on employment.
We can use our wage-setting model to show that when employers have labour market power, a minimum wage can lead the firm to raise both employment and wages. This happens because the minimum wage limits the firm’s ability to hold wages down by keeping employment low.
Figure 6.19 shows the no-shirking wage curve for a firm that maximizes profit by employing 50 workers at a wage, w0. Work through the steps to analyse the effect of a minimum wage.
The minimum wage alters the firm’s feasible set. If N is low, the lower boundary of the feasible set is horizontal at the minimum wage. As N rises, this remains true until it hits the reservation wage curve.
If the introduction of a minimum wage makes the firm’s previous profit-maximizing point infeasible, its choices of wage and employment will change, from E to F in the figure. Make sure you understand why it maximizes profit at point F, by imagining yourself moving along the lower edge of the feasible set (as in Section 6.10), and using the isoprofit curves to determine whether profit is rising or falling.
This analysis shows that a minimum wage can benefit workers in this firm. If it is high enough to affect the firm’s decision, then more workers are employed—and at a higher wage than before. But the firm makes less profit: profit is lower at F than at E.
This model shows how minimum wages could have positive effects on both wages and employment, consistent with evidence from several studies of how it works in practice. But be careful how you interpret this: if the minimum wage were raised further, it could exceed the workers’ productivity. Then the firm would make negative profits and have to shut down or fire workers. For this reason, policymakers tend to be cautious in setting the level of the minimum wage, and in many countries the standard of living of those in minimum wage jobs remains low.