The federal minimum wage was established in 1938 by the Fair Labor Standards Act. Initially set at 25 cents an hour, the wage has been raised periodically to reflect changes in inflation and productivity.
From September 1997 to the beginning of 2007, the minimum wage stood at $5.15 an hour, but its real value declined steadily from about 40 percent of the average private nonsupervisory wage to a mere 30 percent. Adjusted for inflation, the minimum wage was lower at the beginning of 2007 than at any time since 1955 (see figure 1). Meanwhile, the wage affected fewer people, as the fraction of hourly workers who earned no more than the minimum dropped from around 15 percent in 1980 to just 2.2 percent in 2006. On May 24, 2007, Congress passed a bill raising the federal minimum wage to $7.25 in three phases over two years.
To assess whether the recent increase in the minimum wage is excessive or not, one must know what it is intended to achieve. The wage's proponents have argued that it exerts positive effects on labor market outcomes by reducing employers' excessive market power. Its opponents, however, believe that labor markets are competitive and any wage regulation is bound to reduce employment, especially among lowskilled workers.
This debate can be clarified with the aid of economic theories that analyze the effects of the minimum wage on the labor market. These theories can help us answer questions such as: Does a minimum wage necessarily increase unemployment? Does it expand the number of people participating in the labor force? Does it improve social welfare?
* Competitive and Noncompetitive Labor Markets
The effect of a minimum wage depends, in part, on whether the labor market is competitive-or not, in which case employers exert significant power over wage decisions. We review the employment effects of the minimum wage under two extreme assumptions: In the first case, there are a lot of... [continues]
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