The question of minimum wage introduction for low-skilled workers offers conflicting research findings. Some theorists suggest that the introduction of minimum pay for low-skilled labor may affect the whole employment. However, the general model of competitive market for labor assumes that the introduction of minimum wage will cause job loss among the low-skilled employees. This report is dedicated to the economic analysis of this model.
What Economic Theory Predicts Will Happen
The simplest approach includes the analysis of one separate labor type. In such market, the minimum wage that overshoots the competitive equilibrium in the market causes harm to employment from two standpoints. First of all, employers will be looking for substitute for low-skilled labor, which now makes their output more expensive (Federal Reserve Bank of San Francisco). They will be looking for new equipment or other forms of capital. Secondly, higher prices of products caused by more expensive labor will reduce the demand for product and labor (Federal Reserve Bank of San Francisco). However, with regard to labor market, after minimum wage introduction for low-skilled segment, employers may also begin employing more high-skilled labor, which is now comparatively less expensive (Federal Reserve Bank of San Francisco).
In a monopsony model, where workers are not mobile, employers can still be dictating wages. In such economic setting, there is more ambiguous effect of a minimum pay introduction. Although, this form of labor market does not apply directly to unskilled labor force, because there is only a particular demand for labor and extensive employee turnover (Federal Reserve Bank of San Francisco).
Economically, it is believed that companies “absorb” the negative effects of minimum wages and suffer lower revenues (Wilson, 2012). However, in reality, they react by reducing work hours, cutting costs and benefits, and hiring less employees (Wilson, 2012). In effect, while policymakers are trying to help low-skilled workers, they are in essence hurting them, as companies resort to more layoffs and less hiring in order to minimize the negative impact on their profits.
Supply and Demand Graph: The Effect of Minimum Wage
The supply and demand graph is applicable to the labor market in order to analyze the effect of minimum wage (Mankiw, 2015, p. 118). Demand and supply curves represent demand and supply for labor in this market. Equilibrium is marked as E, and thus Wc is the competitive wage in the market. Ec is optimal employment in the competitive market for labor. In case minimum wage increases to Wm, employment has to reduce to Em. However, the decrease in employment is smaller than excess labor supply AC. Distance AB represents the workers who suffer from employment reduction because of less job opportunities and working hours. Distance BC represents the workers who are drawn into the market by the promise of higher wage but are still unemployed. Even if employees with more skills manage to find jobs in the low-skilled labor market, they push the low-skilled workers out of the employment segment.
Elasticity Conditions
In order for the employment not to be affected by minimum wage, labor demand has to be inelastic, as the following figure shows. In essence, it means that employers do not alter the number of employees with the introduction of a minimum wage. As the wage Wm increases from the equilibrium value of Wc, the employment stays at the same point Ec.
In case the labor demand is perfectly elastic, employers will not hire at the wage higher that equilibrium (Ozimek, 2013). Therefore, there will be excessive supply of labor at the higher wage, and employment will stay the same. The triangle in the middle of the graph represent excess supply of labor.
As a result, it may be concluded that minimum wage affects low-skilled workers positively in case of higher elasticities and negatively in case of lower elasticities. According to Danziger (2007, p. 2), elasticity of labor demand decreases with unemployment benefits and expands with the risk aversion of workers. For the most optimal outcome for low-pay workers, the elasticity of labor demand should be lower than the social optimum (Danziger, 2007, p. 16) in order to balance the benefit of higher wage with the loss in employment.
All in all, minimum wage for low-skilled workers has ambiguous effects. Theory predicts that this policy would affect the whole labor market. Depending on the elasticity of the demand for labor market, low-pay employees benefit or suffer from the introduction of minimum wage. However, in any case, the economy has to balance itself, which means that the benefit gained by low-skilled workers from higher salary has to be offset by a decrease in employment. The extent to which employment changes depends on the elasticity of demand in the labor market.
References
Danziger, L. (2003). The elasticity of labor demand and the minimum wage. Discussion Paper No. 3150. Bonn: The Institute for the Study of Labor.
Federal Reserve Bank of San Francisco. (2015, December 21). Three effects of minimum wages on employment. Retrieved from http://www.frbsf.org/economic-research/publications/economic-letter/2015/december/effects-of-minimum-wage-on-employment/
Mankiw, G. N. (2015). Principles of economics (7th ed.). Stamford, CT: Cengage Learning.
Ozimek, A. (2013, March 16). Bryan Caplan on the minimum wage. Forbes. Retrieved from http://www.forbes.com/sites/modeledbehavior/2013/03/16/bryan-caplan-on-the-minimum-wage/#4cb757496507
