Chapter Study Outline

  • The minimum wage controversy largely stems from disagreement on the positive consequences of raising the minimum wage.

8.1 From Perfect Competition to Monopsony

  • Model 8.1: The Competitive Full-Coverage Model
    • (a) The labor market is competitive and is populated by a large number of homogeneous workers and homogeneous profit-maximizing firms.
    • (b) All workers are covered by the minimum wage.
    • (c) All firms comply with the law.
      • After the imposition of a minimum wage, the equilibrium wage rises to Wm and the level of employment falls to Lm*.
      • (Lm S - LmD) workers are now unemployed as the minimum wage harms the workers it was designed to help.
  • This model does not hold in practice, since the coverage of the minimum wage is usually incomplete.
    • c = the covered sector
    • u = the uncovered sector
    • S0 workers are willing to work for any wage and their combined supply is completely inelastic.
      • If the two distinct sectors are economically independent, the minimum wage affects only the covered sector and the results of the full-coverage model are unchanged.
      • If the two sectors are linked, there may be spillover effects from economic interdependency.
        • Labor mobility: workers can migrate from one labor market to the other, thereby linking the sectors.
        • As a consequence of labor mobility, before the minimum wage both sectors offer the same wage.
    • After the imposition of a minimum wage, the wage rate in the covered sector rises to Wm and the level of employment in the covered sector falls to Lc*.
      • The wage in the uncovered sector falls to Wmu* and the level of employment rises by (L*c - Lmc), the number of workers who lost their jobs in the covered sector.
      • The total level of employment, S0, remains unchanged, but the minimum wage generates winners in the covered sector and losers in the uncovered sector.
  • For the monopsonist, a minimum wage law may either raise or lower the level of employment.
    • WC is governed by the intersection of the monopsonist’s marginal-revenue product schedule, MRPL, and its wage requirement’s schedule, W(L).
      • If the initial minimum wage, Wm0, is set below WC, then a marginal increase in the minimum wage raises the level of employment.
      • If the initial minimum wage, Wm0, is set above WC, then a marginal increase in the minimum wage lowers the level of unemployment.
    • In the presence of monopsony power, it is possible that an increase in the minimum wage can raise both the wage and the level of employment, contrary to the outcome predicted by the perfect competition model.

8.2 Offsets, Inequality, and Education

  • The Wessel’s effect: firms may attempt to undo the total compensation effects of an increase in the minimum wage by reducing worker benefits.
    • W* = the wage
    • ΔW = increase in the wage provided by the increase in the minimum wage, Wm
    • B* = the firm’s fringe benefits
      • According the Wessel’s effect, employers will respond to an increase in the wage, ΔW, by reducing benefits, B*, by ΔW.
      • W* + B* + ΔW - ΔW = W* + B*, so the value of the worker’s compensation is unchanged
  • Changes in the effort levels required of workers may actually exacerbate the employment consequences of a minimum wage.
    • eL= the effective level of employment
      • e = the agreed level of effort
      • L = the number of employees
      • The firm will respond to an increase in the wage by increasing the level of effort required, e.
    • MRPL(eL) = the marginal revenue product schedule
      • Because of diminishing marginal returns to labor, the increased effort level will shift the MRPL(eL) schedule downward, decreasing employment, L, and exacerbating the employment consequences of the minimum wage.
  • While a primary objective of raising the minimum wage is to reduce poverty, increasing the minimum wage may actually increase income inequality.
    • The view that the minimum wage reduces poverty assumes that the lowest wage earners correspond with those who actually live in poverty.
      • If those who live in poverty earn more than the minimum wage, while those who earn less than the minimum wage are a part of affluent families, and increase in the minimum wage will exacerbate inequality.
      • The empirical evidence is mixed.
  • Since the minimum wage has the greatest impact on the young, an increase could reduce education levels by making further education relatively less attractive as compared to work.

8.3 The Minimum Wage: The U.S. Experience

  • Over time, the nominal value of the minimum wage has increased along with its coverage.
    • The minimum wage was introduced at $0.25 per hour as part of the 1938 Fair Labor Standards Act.
    • Today it is $5.75 per hour and covers nearly 90% of workers.
    • The real value varies significantly due to inflation.
    • The wage changes at irregularly spaced intervals of time because of the political process.
  • Though the theory states that an increase in the minimum wage decreases employment, research has sometimes shown otherwise.
    • The principal finding of Card, Katz, and Krueger was that increases in the minimum wage may actually increase the level of employment.
    • Deere, Murphy, and Welch (1995) found that increases in the minimum wage reduce the employment levels of those who are most affected, in contrast to the new minimum wage literature.
    • Burkhauser, Couch, and Wittenburg (2000a) controlled for the macroeconomic environment and found disemployment effects from minimum wage increases.
    • Careful analysis of the data reveals that employment levels fall at small firms and rise at large employers, suggesting that larger firms may possess some monopsony power.
      • The general consensus is that the employment consequences of a slight increase in the minimum wage are small, while there is mixed evidence on the direction of the change.
      • Research is still very active, and economists continue to disagree on the effects of minimum wages.