Minimum Wages


(A) With the use of diagrams illustrate and explain the likely effect of the introduction of minimum wage legislation on labor markets over time. 3 (B) Discuss the extent to minimum wage legislation has a positive or negative impact on the well-being of people living in poverty. 6


The different types of labor markets are skilled, semi skilled and unskilled markets. The workers skilled in a certain job are categorized in the skilled market while the unskilled workers fall under unskilled market. The workers who are having relatively more expertise in a certain job than the unskilled ones are categorized in semi skilled market.

(A) With the use of diagrams illustrate and explain the likely effect of the introduction of minimum wage legislation on labor markets over time.


The rates of minimum wage can vary across jurisdictions. The concerned authorities are entitled to set the minimum amount of wage for the workers. The indicators that minimizes the loss of jobs as well as maintains international competitiveness is used to set the initial minimum wage. The general economic conditions like real and nominal rates of gross domestic product, the supply and demand of labor force, and the level of inflation existing within the economy, the different terms of employment and costs of labor and business operation, the standard of living are taken into consideration as well.

In a perfectly competitive labor market many firms are in competition in hiring workers. The firms lack the power to set wages and the wage rate is determined by the market. If a firm deviated from that wage it losses by paying higher and gains if it pays lesser. In employer dominated labor markets there is a collection of some small local markets. Some firms enjoy the dominant position and a major employer has the capability to set the wage rate for the workers without the fear of competition from other firms (Flinn, 2010, p. 3).. In both the cases there are large numbers of workers and each of them has a reservation wage. The worker may not work if the wage rate is below his reservation wage. The relationship between the participants in the labor market and the market wage is regarded as labor supply and denoted by the upward sloping curve.

The effect of the introduction of minimum wage legislation depends on the type of labor market. The employers’ power on wage decisions is dependent on whether the market is competitive or not. Two scenarios can be taken under consideration. The diagram below shows two market structures. Bothe panels have the supply and the demand curve for labor. The wage rate is depicted on the X-axis while total labor force N is depicted on the Y-axis. The minimum wage is denoted by ?. The market wage rate is denoted by w*. N1, N2 and N3 depict different labor forces. In the next panel, monopolistic market is shown. Marginal cost of labor as well as marginal product of labor is depicted in this panel. In the first case there are many employers competing to attract labor. In this case wage rate is equal to marginal product of labor.

The market wage should be equal to the reservation wage of workersThe market wage should be equal to the reservation wage of workers. Suppose a worker can provide services of 5 dollars an hour. In this case firms can bid anything less than the arte and earn a profit. If the market wage rises, firms will act by cutting the payrolls and return on the profitable track. Now suppose a mandatory minimum wage of 6 dollars per hour exists which is denoted with line. The minimum wage in this case is binding as the market wage rate is lower than the minimum wage. In this case the demand for workers by the firms decreases from N* to N1.  On the other hand the number of people willing to participate in the market for labor as a result of higher wages rises from N* to N2. The market for labor returns at the state of disequilibrium. In this case some workers who are willing to work at lower wages suffers from the problem of finding a job while the employers willing to hire workers at lower wage cannot do so as the law forbids. So it can be said that in a competitive labor market the effect of minimum wage legislation is to reduce the level of employment and accelerate involuntary unemployment. Now in the second case the labor market is dominated by employers. In this case the firm will carry on in hiring workers as long as the marginal cost of hiring additional workers equals the value of service provided by the additional worker. The intersection of the curves namely marginal product of labor and marginal cost of labor denotes the employment level for the firm. It is not surprising that employment level is lower than it was in competitive markets. The wage rate wM in this market is lower than that in competitive market. A monopsonistic firm employs fewer employees and pays them less than marginal product. Now suppose the minimum wage is set at higher the monopsony’s wage but below the wage in competitive markets. In that case the marginal cost of labor curve becomes flatter until it cuts the supply curve of labor. As long as the firm is not looking to hire more workers than the number of workers in labor force, the cost of additional labor equals to that of minimum wage. Therefore in this case the introduction of minimum wage increases the level of employment by eliminating the negative effects of monopsony power. The introduction of minimum wage is fruitful for the workers where the labor market is dominated by more employers. The workers are receiving higher wages than the employers would have offered and they have a job. On the other hand the introduction of minimum wage legislation is not fruitful from the point of view of the employers. They have to offer higher wage to match the minimum wage bar which in turn reduces the profit levels of them. It can be stated that optimal level of minimum wage is the competitive wage which maximizes the level of employment.

(B) Discuss the extent to minimum wage legislation has a positive or negative impact on the well-being of people living in poverty.


Economic growth can induce the well being of the people living in poverty. With the aim to improve the well being of the people many governments introduced the idea of minimum wage below which no employer will be able to hire workers. The central idea was to resist worker exploitation. The effect of the minimum wage was different in two market structures. Then came the concept of raising the minimum wage. It was expected that raising the minimum wage will act as the toll to reduce poverty. The justification behind the minimum wage legislation was to redistribute income to the low wage earners. It was thought that the inequality can be reduced with minimum wage legislation (Taylor and Mankiw, 2006).

Supporters of the minimum wage legislation argue that introduction of minimum wage bar will reduce poverty. It apparently seems that raising the minimum wage will raise the income level of the households and they can move out of the vicious circle of poverty. But real world scenarios pose a different picture. It has been observed minimum wages fail to reduce poverty mainly for three below mentioned reasons. The higher minimum wage is effective only for those workers who actually earn that high amount of wage. Raising the minimum wage bar can also lead to loss of job opportunities to some. A smaller amount of people who earn higher minimum wage actually belong to poor households. It may be a case that some amount of people is not willing to work at all at any wage and therefore raising the minimum wage has no effect on them. Higher minimum wage does not serve the purpose of anti poverty tool. The evidence on income distribution states that minimum wages raises the income of the poor families but the net effect is to increase the proportion of families that are below poverty. Raising the minimum wages causes the firms to reduce the profits which are against their aim and therefore they move on to the policy of retrenchment (Wascher and Neumark, 2008, p. 274-277). Therefore some amount of job opportunity is lost for the labor force. The workers whose wage initially was near to the minimum wage gains but the amount of hours served as well as employment declines. The combined effect seems to have adverse consequences for the low wage earners. Estimates suggest that a increase in the minimum wage by 10% leads to 2% increase in the level of unemployment. The raising of the minimum wage leaves the poor families in a worse off situation as they lose employment opportunities and the income of the families is affected. In the era of globalization some strategists argue for reduction in the amount of minimum wages. They put forward the view that such an action will increase the job opportunities and the families living below poverty will be able to earn their livelihood. But some provide their arguments that in pace of global competition the wage standards and global competition will force the wages to such a level which will not be sufficient enough to maintain livelihood.


The labor market provides the opportunity for the employers to find their workers. They can select the worker of their choice. The labor markets are often characterized by labor market unions. The impacts of labor markets are different in different parts of the world. It cannot be argued that a positive effect of labor market of one part of the globe will incur the same positive effect on any other parts.  In order to arrive to such conclusions it is necessary to take the socio economic conditions into account.


Flinn, C. 2010. “The minimum wage and labor market outcomes”. [online]. MIT Press.

Taylor M. and Mankiw, N. 2006. “Economics”. [online]. Cengage Learning EMEA.

Wascher W. and Neumark, D. 2008. “Minimum Wages”. [online]. MIT Press.

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