Minimum Wages and Unemployment
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Last updated 8 Feb 2023
Why might a rise in the minimum wage help to reduce unemployment?
A rise in the minimum wage may reduce unemployment in a number of ways:
- Increased consumer spending: Workers with higher wages tend to spend more money, which can increase demand for goods and services and create new jobs. Workers on relatively low wages tend to have a high propensity to consume.
- Reduced poverty: A higher minimum wage can lift many workers out of poverty and reduce income inequality, which can lead to a more stable and robust economy.
- Improved worker productivity: When workers are paid a fair wage, they may be more motivated and productive, which can boost overall economic growth. Efficiency wage theory approaches the issue from this perspective.
- Reduced worker turnover: Higher wages can make it more attractive for workers to stay in their jobs, reducing the need for employers to constantly hire and train new employees.
- Improved work incentives: A higher minimum wage increases the hourly reward from working rather than remaining economically inactive.
However, it is important to note that too steep of a minimum wage increase can lead to inflation, reduced profits for businesses and potentially decreased job opportunities as companies look to reduce costs.
What is efficiency wage theory?
Efficiency wage theory is an economic concept that explains why firms may choose to pay their workers a wage higher than the market-clearing wage, which is the wage that would balance supply and demand in the labor market. The theory suggests that paying a higher wage can have several benefits for the firm, such as:
- Improved worker productivity: When workers are paid a higher wage, they may feel more valued and motivated, leading to increased effort and productivity.
- Reduced worker turnover: Higher wages can make it more difficult for workers to leave their jobs, reducing the need for employers to constantly train new employees.
- Better worker health: Higher wages may improve workers' health, as they are able to afford better nutrition and healthcare.
- Improved worker quality: By paying higher wages, firms may be able to attract and retain higher-quality workers.
In essence, the efficiency wage theory argues that paying higher wages can lead to greater efficiency in the workplace, which can offset the costs of the higher wages and lead to improved profits for the firm in the long run. However, this theory is controversial and has been the subject of debate among economists.
What happens when a minimum wage is enforced on a monopsony employer?
When a minimum wage is enforced on a monopsony employer, the employer's ability to set wages and hire workers is limited. A monopsony is a market structure in which there is only one buyer (in this case, the employer) and many sellers (workers).
In a monopsony, the employer has the ability to set wages lower than the market-clearing wage, which would result in a surplus of workers willing to take the job at that wage. By enforcing a minimum wage, the government limits the employer's ability to set wages too low, which can have several effects:
- Increased wages: Workers receive higher wages, which can improve their standard of living and reduce poverty.
- Increased employment: The higher wage increases the cost of labour, making it less profitable for the employer to hire as many workers. However, the minimum wage is still above the wage the employer would have set without the minimum wage law, so overall employment should still increase.
- Increased price of goods: The higher cost of labor may lead to higher prices for goods and services produced by the monopsony, as the employer passes on the higher labor costs to consumers.
In summary, enforcing a minimum wage on a monopsony employer can lead to higher wages, increased employment, and higher prices for goods and services. However, the magnitude of these effects depends on various factors, such as the level of the minimum wage and the elasticity of labor demand and supply.
Summarise the research of Card and Krueger on the economic effects of a minimum wage
Card and Krueger conducted a seminal study on the economic effects of a minimum wage, focusing on the fast food industry in New Jersey and Pennsylvania in the 1990s. They compared employment trends in fast food restaurants in New Jersey, which raised its minimum wage, to those in Pennsylvania, which did not.
They found that the increase in the minimum wage in New Jersey did not lead to a decrease in employment in the fast food industry, contrary to what many economists had predicted.
Instead, they found that employment in fast food restaurants actually increased slightly after the minimum wage was raised.
This study challenged the traditional textbook view that a rise in the minimum wage would lead to decreased employment, and suggested that the relationship between the minimum wage and employment may be more complex than previously thought.
However, it is important to note that the Card and Krueger study has been the subject of criticism and debate. Some researchers have questioned the validity of their findings, while others have conducted studies that support their conclusions.
The debate over the economic effects of the minimum wage continues to this day, and more research is needed to fully understand the relationship between the minimum wage and employment.