Impact of Minimum Wage on Labor Markets
Minimum wage is the price floor imposed in the labor market to ensure that firms don’t exploit workers. Usually, the minimum wage is set above the equilibrium wage. The minimum wage ensures workers get adequate income that can enable them to live a decent lifestyle. This price floor is revised from time to time as per changes in the cost of living. Therefore, it disrupts the supply and demand of labor in the economy. Economists who advocate for this policy argue that it supports the low-skilled workers who are easily exploited due to their low bargaining power (David, 2015).
Impact of Minimum Wages on Labor Supply
The imposition of the minimum wage in the labor market increases the labor supply. Normally, there are some people in the economy who are unemployed and are not looking for work because they consider the equilibrium wage to be lower than the amount they expect to be paid. If these people join the labor market the labor supply curve shifts to the right. On the other hand, there is a direct relationship between wages and supply for labor in the economy. Thus, when wages are increased workers are willing to work for many hours. This is a movement along the supply curve (Hubbard, 2009).
Impact of minimum wage on demand for labor
In the labor market, wages paid to workers and labor demands have an inverse relationship. This means that when the wages are decreased demand for labor increases but when wages are increased demand for labor falls. Setting minimum wage increases the cost of labor because the wage level is put above the equilibrium wage. Thus, this policy leads to decline in demand for labor (Walter, 2001).
There are other factors that will affect the demand for labor in the long term. The first one is that labor costs form a significant proportion of the cost of production. Therefore, if the minimum wage is imposed above equilibrium wage the cost of labor increases as well as the total cost of production. The firms will either pass the increased cost of production to customers or absorb it and suffer from reduced contribution margin. In many cases, the cost is passed to the consumer by increasing output prices. The consumers reduce their demand for theses product and aggregate demand in the economy falls. The fall in aggregate demand leads to a reduction of demand for labor because production will be reduced. The imposition of minimum wage also affects the demand for labor in the long run because firms replace workers with machines to evade the high labor costs (David, 2015).
The minimum wage for unskilled workers will also force employers to replace low-skilled workers with workers with more skills. This is referred to as labor-labor substitution. In many cases, workers with high skills will be able to perform various functions performed by several unskilled workers. Thus, the overall demand for labor falls (Hubbard, 2009).
Supply and demand for labor in a competitive market are based on the invisible hand theory. Thus, the market will be in equilibrium at the point where supply for labor equals its demand (Walter, 2001).
Introducing minimum wage affects both the demand and supply for labor. The labor market does not clear, and the demand for labor falls below supply for labor. This means that there will be people looking for job, but they cannot get any job because firms are not willing and able to pay the minimum wage imposed (Hubbard, 2009).
(David, 2015).
The above graph shows that fifty thousand quantities of unskilled labor hours are available in the market if the minimum wage is imposed at five dollars per hour. However, only thirty-three thousand are engaged. The graph also shows that when the minimum wage is imposed the number of people willing to work increases but the demand for labor decreases (David, 2015).
The increase in the rate of unemployment is caused by the layoff of unskilled workers and the increased number of people willing to work.
Minimum wage and elasticity concept
The imposition of the minimum wage should not increase unemployment in the economy because the additional income to households increases demand for output and this leads to increase in demand for labor. However, this is not the case because the price elasticity of labor supply is different from the price elasticity of demand for labor. The imposition of minimum wage increases cost for labor without necessary increasing its productivity. Therefore, the price for output may increase due to inefficiency and high wages at a rate that cannot be compensated by the increase in aggregate demand (David, 2015).
Conclusion
Minimum wage disrupts the labor market and leads to increased unemployment. This is caused by increased supply for labor as more workers will be willing to work for more hours than they could when the wage was low. Fall in for demand also causes the increase in unemployment. Firms reduce the number of unskilled workers by either employing high-skilled workers or using machines instead of workers.
References
David, N. (2015, December 21). The Effects of Minimum Wages on Employment. Retrieved
April 18, 2016, from http://www.frbsf.org/economic-research/publications/economic-letter/2015/december/effects-of-minimum-wage-on-employment/
Hubbard, R. G. (2009). Macro economics. Frenchs Forest, N.S.W.: Pearson Prentice Hall.
Walter, W. (2001, June). Employment Policies Institute | The Effect of Minimum Wages on the
Labor Force Participation Rates of Teenagers. Retrieved April 18, 2016, from https://www.epionline.org/studies/r32/
