Synoptic Economics: Impact of Higher Minimum Wage

Minimum wages are a favourite topic for synoptic questions because changes in pay floors affect individual people, businesses and industries whilst also have an impact on aggregate demand and supply.

This short revision video distinguishes between some of the possible micro and macro impacts and give four evaluation arguments to support the analysis.

Here are three microeconomic and three macroeconomic effects of a rise in a country's minimum wage, along with an evaluation of each.

Microeconomic Effects

Increased Income for Low-Wage Workers

The most direct effect of a rise in the minimum wage is an increase in the disposable income of low-wage workers. This can help to reduce relative poverty as well as increase consumer spending, which can have a positive impact on the economy.

Evaluation: On the other hand, the increased labour costs for firms could lead to reduced profits and investment, which could negatively impact economic growth.

Changes in Employment

A rise in the minimum wage can lead to changes in employment, as firms such as hospitality businesses may choose to reduce the number of low-wage workers they employ in order to offset the increased labour costs. This can result in job losses for some workers, particularly those with lower skill levels.

Evaluation: The effect of a rise in the minimum wage on employment is a highly debated issue among economists. While some argue that it leads to job losses, others argue that it leads to increased demand for labour, as low-wage workers have more disposable income to spend. The net effect on employment is likely to depend on the size of the increase in the minimum wage and the wage elasticity of demand for labour.

Price Increases

A rise in the minimum wage can also lead to price increases for goods and services produced by firms that employ low-wage workers, as they pass on the increased labour costs to consumers.

Evaluation: The impact of a rise in the minimum wage on consumer prices is likely to depend on the extent to which firms are able to pass on the increased labor costs. In competitive industries, where firms have limited ability to increase prices, they may absorb the increased labour costs, while in less competitive industries where businesses have monopoly power, they may pass on the costs to consumers.

Macroeconomic Effects

Increased Consumer Spending

The increased income for low-wage workers resulting from the rise in the minimum wage can lead to an increase in consumer spending, which can boost economic growth and create jobs.

Evaluation: The increase in consumer spending can provide a short-term boost to economic growth, but it could also lead to higher inflation, as firms pass on the increased labor costs in the form of higher prices.

Impact on Businesses

A rise in the minimum wage can have a negative impact on businesses that employ low-wage workers, as they will face higher labor costs. This can lead to reduced profits and investment, which can negatively impact economic growth.

Evaluation: The impact of a rise in the minimum wage on businesses is likely to depend on the size of the increase and the competitiveness of the industry. In industries with high levels of competition, businesses may have limited ability to pass on the increased labor costs, which could lead to reduced profits and investment. In more concentrated industries, businesses may be able to pass on the costs to consumers, which could limit the negative impact on profits and investment.

Effects on Inflation

A rise in the minimum wage can also have an effect on inflation, as the increase in labor costs is passed on to consumers in the form of higher prices. This can lead to a rise in overall inflation, which can have a negative impact on the economy if not properly managed by the central bank.