The Effect of the Minimum Wage Has on Unemployment

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David Metcalf has concluded that the implementation of the minimum wage appears to have had no negative impact upon Employment. Critically examine the possible explanations for this outcome.

The minimum wage was implemented and became law on the 1st April 1999 this helped prevent unfair low pay and “levelled the playing field” (http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1074402393) for employers as companies could compete on quality of goods rather than setting a reduced price based on low pay. It applies to most workers and sets hourly rates below where pay is not allowed to decrease; these rates are recommended by the Low Pay Commission (LPC). At first the adult rate was set at £3.60 per hour for adults in the first 6 months of their job with sufficient training, there was also a lower youth rate of £3.00 per hour for those aged 18 – 21.(Stuart p5) Presently the minimum wage stands at £5.52 per hour for ages 22 and over and £4.60 aged 18-21. (http://www.is4profit.com/business-advice/employment/minimum-wage-and-statutory-pay-obligations_2.html). Neo-classical economic analysis suggests that an individuals wage should equal their marginal product of labour, “as wages constitute the individuals reward for their personal contribution to output of a firm” which resembles that of perfect competition. ( Forth & O’Mahoney p4) The implementation of a minimum wage leads to a rise in wage rates for those that were previously paid unfairly which theoretically has a positive impact on employment. Therefore workers that previously got paid below the minimum wage will likely surpass their marginal product.

Figure 1 illustrates the impact of the implementation of a minimum wage, the model assumes a competitive market where homogenous workers earn W0 and then earn Wm after the minimum wage is introduced. If demand and supply measures were used to determine employment then the initial equilibrium would be at point E0 and after the implantation of the minimum wage it will be at point Em. It is clear from figure 1 that this would cause an excess supply of labour as shown by point Sm. Economically this could be caused by the substitution effect where a wage increase will decrease the hours worked due to an individuals specific level of utility or satisfaction. Therefore it is apparent that their will be an increase in unemployment as shown by Em to Sm. In theory a profit maximising firm would be likely to decrease the quantity of labour demanded especially those “whose marginal product is lower than the statutory minimum” (Forth & O’Mahoney p5). This is shown by Figure 2 where demand (D) is based on the Value of marginal product of labour (MVP). The market determined wage rate (Wo) is replaced by the minimum wage(Wm) causing a decrease in demand of quantity of labour (Lm-Lo) resulting in firms employing fewer workers.

The perfectively competitive model of labour assumes that each firm in the industry faces the same competitive price regardless of quantity of output sold and also that each firm pays all its workers an equal wage. However by using alternative market structures such as monopsonistic competition it is apparent that a fixed wage could increase both employment and wage itself. Monopsony is a firm that faces an upward sloping supply curve of labour and in order to hire workers it must pay higher wage to provide incentive. In figure 3 assuming perfect competition, equilibrium is shown by Wpc and Lpc where demand meets supply. However in a monopsonistic market if a minimum wage was proposed the employer must raise the wage rate from Wm in order to hire more workers. If a monopsonist charged a wage rate below Wpc workers would be more inclined to work at the rate of the minimum wage as it is higher. The monopsonist, therefore, must then raise its wage rate to Wm2 in order to provide the required amount of incentive for workers. As the monopsonist must increase the wage rate the marginal cost of labour curve...
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