Minimum Wage
What is Minimum Wage?
A minimum wage is a legal price floor on wages, the lowest amount employers may legally pay workers.
Set above the market wage, it can raise pay for some workers but may cause a surplus of labor (unemployment) by reducing hiring. Its real-world employment effects are debated and depend on how high it is set.
Minimum Wage: a worked example
Let labor demand be Qd = 120 - 5W and labor supply be Qs = 20 + 5W, with Q in thousands of workers and W the hourly wage. Setting them equal, 120 - 5W = 20 + 5W gives 10W = 100, so W = $10 and Q = 70 thousand workers. Now impose a minimum wage of $12. Quantity demanded falls to 120 - 5(12) = 60 thousand while quantity supplied rises to 20 + 5(12) = 80 thousand, leaving a surplus of 20 thousand workers, which is the unemployment the floor creates. Employment itself drops by 10 thousand. Check who gains: the 60 thousand still working earn 60,000 × $12 = $720,000 an hour between them, against 70,000 × $10 = $700,000 before, so total earnings rise $20,000 even with fewer people employed. Set the floor at $8 instead and nothing happens, since $8 is below equilibrium.
The mistake students make with minimum wage
The specific slip is reporting the fall in employment as the whole surplus. Two things happen at once at a binding floor. Employers cut hiring, and workers who were not interested at the old wage now want jobs. The surplus is the horizontal gap between quantity supplied and quantity demanded at the floor, which is wider than the drop in employment measured from the old equilibrium, so read both distances off the graph. The second slip is generalizing the earnings result. Total pay for those still working rises only where labor demand is wage inelastic, and falls where it is elastic.
Minimum Wage questions
Does a minimum wage always cause unemployment?
A minimum wage set below the market clearing wage changes nothing, because employers already pay more than the law requires. Only a binding floor, one above the equilibrium wage, creates a surplus of labor. How large that surplus grows depends on how far above equilibrium the floor sits and on how sensitive labor demand and supply are to the wage, so a small increase in an industry with few substitutes for workers can cost very few jobs, while a large one where tasks are easy to automate costs many.
Why is the minimum wage a price floor rather than a price ceiling?
A price floor sets a legal minimum price and binds only when it sits above the market price, which is exactly what a minimum wage does in the market for labor. Rent control is the mirror image, a ceiling that sets a legal maximum and binds only below the market price. Floors above equilibrium generate surpluses, so a binding minimum wage produces surplus labor, the unemployment you read as a horizontal gap on the graph, while binding ceilings generate shortages instead.
Can a minimum wage ever increase employment?
Monopsony is the standard exception taught in AP microeconomics. A single dominant employer restricts hiring in order to hold the wage down, so it employs fewer workers than a competitive market would. A minimum wage set between the monopsony wage and the competitive wage removes that incentive to restrict hiring, and employment can rise alongside the wage. Push the floor well above the competitive wage and job losses return.
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