Effect Of An Increase In Minimum Wage

Effect of an Increase in Minimum Wage:

Introduction:

Minimum wage is a policy measure that ensures that workers are paid a certain wage rate; a rise in minimum wage will benefit the workers but will have other benefits and costs in an economy. Minimum wage laws have already been adopted by many countries and many studies have been undertaken by scholars to check the effects of a change in minimum wage on the economy.

Economists argue that minimum wage is a form of government interference with the free market and this only causes inefficiency in the market, however other scholars argue that market failure may justify government interference with the free market. Therefore there is need to interfere with the free market but at thee same time taking into consideration the consequences of the policy measures in an economy.

This paper focuses on the costs of a rise in minimum wage, the benefits of a rise in minimum wage and finally the effect of a rise in the minimum wage when the labor market is monopsonistic. The paper discusses the effect of this rise on the supply and demand curve on labor, effect on price, effect on the standard of living and how this increase will lead to unemployment and increased outsourcing in other lower minimum wage countries.

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Effect of an increase in minimum wage

Supply and the demand for labor:

We first analyze the effect of an increase in minimum wage rates on the supply and the demand for labor in a competitive market, in a competitive market demand increases when wages decline and demand declines when wage rates increase. Supply of labor increases when the wage rates rise, and that supply of labor decline when wage rates are reduced, therefore an increase in minimum wage rates will increase supply and reduce demand.

The demand and supply of labor:

Labor has its own demand and supply in the economy; we first derive the supply curve of labor in an economy and the effect of an increase in the minimum wage on the supply:

From the above chart an increase in the minimum wage will lead to an increase in the supply of labor, the rationale behind this increase is because as minimum wage increase then more workers will be willing and also encouraged to work more labor hours and therefore supply of

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Effect of an increase in minimum wage

labor will increase.

Demand for labor:

Considering that labor is factor of production and that firms will consider labor as a production cost then if the cost of labor increases then firms will demand less of labor, this can also be explained by the fact that firms will determine the optimal production point using the budget line and the isoquants, therefore an increase in cost of labor will lead to substitution of labor for capital and therefore less labor will be demanded, the diagram below demonstrates the effect of this increase on labor demand:

From the above diagram it is evident that an increase in minimum wage will lead to a decline in the demand for labor, therefore this will result into less employment in an economy.

Benefits of increased minimum wage:

Standard of living:

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Effect of an increase in minimum wage

An increase in minimum wage will result into an increase in living standards, workers will now be paid higher wage rates and for this reason there will be a rise in living standards, this will be realized because workers will now have a larger disposable income and therefore can afford more in the economy.

Motivation of workers:

Workers in the economy will be more motivated, according to various studies increased wages result into increased motivation and therefore increased productivity of labor, when productivity of labor increases then the firm will benefit because the firm becomes more productive.

Economic growth will also be realized due to increased productivity of laborers in the economy and therefore higher growth.

Increased consumption:

When minimum wage is increased consumers will experience a rise in their income, a rise in the income level also signifies a rise in the consumer disposable income, therefore as disposable income increases there will be a rise in the consumption levels in an economy. This will benefit the economy because increased consumption will mean an increase in the demand for goods and services in the economy and this will positively affect the economy as more goods are demanded more firms emerge to fulfill the demand levels in the economy.

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Effect of an increase in minimum wage

Decreased government spending:

Governments spend a lot in areas where poverty levels are high, inn these regions the government spend in funds to provide social amenities and aid, when the minimum wage is increased this means that the poor individuals in the economy will also experience a rise in their income and therefore they will be in a position to provide certain goods and services provided by the government. A decline in government spending will benefits an economy because the amount previously spent in these areas will now be spent on other developmental programs, this also means that the government will reduce taxes.

Growth in employment:

As earlier discussed a rise in minimum wage will lead to an increase in the demand for goods and services in an economy, as the demand increase firms will emerge to offset the supply deficit. As firms increase in an economy this means that there will be a rise in employment in the economy, therefore a rise in the minimum wage may result into an increase in employment if the increased wage rate increases consumption of goods and services.

Economic costs of an increase in minimum wage:

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Effect of an increase in minimum wage

Reduced demand for workers:

As minimum wage increases the firms experience an increase in the cost of production and therefore demand less labor in the production process, this reduced demand for labor in the economy will therefore lead to a decline in employment in the economy which will negatively affect the economy negatively.

Reduced profits:

Firms will experience a decline in profits, a firms profit is calculated by subtracting costs from revenue, an increase in cost will therefore mean that the profit levels will decline. As the profits decline the government may also experience a decline in revenue collected, this is because most firms will pay taxes from their earning and if the profits by firms decrease then there will be a decline in government revenue. As profits decrease firms will tend to lay off workers as a way of cutting down on cost and some may even exit industries and this will contribute to increased unemployment in the economy.

Increased prices:

As the cost of production increase due to the rise in minimum wage rates firms will tend to increase the final prices of goods in the economy as a way to maintain high profit levels, as the final price increase the consumers in the economy will experience a decline in their real income

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Effect of an increase in minimum wage

and therefore this will negatively affect the economy. Also the rise in price may lead to high inflation levels in an economy resulting to problems in an economy.

Increased unemployment:

Unemployment will rise in the economy when the minimum wage is increased, this is due to the fact that the demand for workers by firms will reduce as the cost of labor increase, and therefore the minimum wage will affect the labor market where there will be an increase in unemployment. This is evident from the study by Card and Krueger in 1992 when minimum wages were increased, this study was undertaken on fast food restaurants and showed that an increase in minimum wage reduced employment.

Outsourcing:

When the cost of production increases firms will now prefer to produce in other countries where the cost of labor is lower, as firms invest in low production cost countries then there will be a reduction in the employment opportunities in a country. Therefore an increase in minimum wage will encourage outsourcing which will in turn lead to reduced employment opportunity in a country

Reduced human capital:

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Effect of an increase in minimum wage

Human capital is increased through education, human capital is an important factor in the development of an economy, when minimum wage rates are increased this causes a pull effect into the labor market, when this happens more individuals in the economy will tend to work rather than continue with their studies, therefore in the long run there will be a decline in human capital in the economy resulting to less economic development potential in the future.

Economic growth:

Economic growth is realized when an economy produces at the most optimal point, this means that firms in the economy must allocate resources in the most optimal way. The increase in minimum wage will result into an increase in the cost of labor and will affect optimal allocation of resources and therefore this will affect economic growth.

International trade:

As the cost of production in a country increases then the final price of its goods in the international market will be high, higher prices means that there will be lower demand. Therefore a country may experience a decline in the demand for its exports and this will contribute to problems of balance of payment and terms of trade in the international market. This problem will be as a result of the increase in the cost of production caused by an increase in the minimum wage.

Monopsonistic labor market:

The above analysis was concerned with a competitive labor market, however if we were to analyze a case where the labor was monopsonistic in nature the effects will be different,

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Effect of an increase in minimum wage

according to economist in a monopsonistic labor market a rise in minimum wage will increase the wage rate and at the same time increase employment, in the monopsonistic market the buyers have more power over the sellers, in this case therefore firms will be buyers while the workers are the sellers, thereof there will be different results:

The monopsonistic market will have a steeper demand curve meaning that workers are paid less by firms because the firm has more power in the market, for this reason therefore an increase in the minimum wage will result into less decline in the demand for labor, the following diagram summarizes the effect of an increase in minimum wage in a monopsonistic labor market:

From the above diagram it is evident that an increase in minimum wage will only reduce the market demand for labor in the market by a smaller margin than in the case of competitive market, for this reason therefore it is evident that in monopsonistic market the increase in minimum wage will increase employment and also the wage rate. Therefore in this market the increase will have more benefits than in the competitive market.

Conclusion:

From the above discussion it is evident that an increase in minimum wage will have benefits and costs to the economy, scholars argue for a free market economy where the government should not interfere with the free market, minimum wage is a policy that interferes with the free market and therefore there should be no regulations in the labor market.

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Effect of an increase in minimum wage

Other economists argue that there is need to regulate the economy to improve on market failure, the government should only interfere with the free market when there is need, therefore there is need to increase or decrease the minimum wage taking into consideration the effects of this increase ort decrease.

From the paper it is evident that the increase in minimum wage will result into economic benefits such as improved standards of living, motivation of workers, increased consumption, decreased government spending and increased investment and employment opportunities. It is also evident that the increase will result into some economic costs such as reduced labor demand, increase unemployment, increased prices and therefore inflation and reduced economic growth.

Various studies have been undertaken by economists to determine the effect of an increase in minimum wage example the Card and Krueger study on fast food restaurant in 1992, in this study it was evident that increased minimum wages resulted into reduced employment in an economy.

References:

Card and Krueger (1994) “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” American Economic Review, 84, 4, page 772 to 793

Neumark, and Wascher (2000) “Minimum Wages and Employment: A Case Study of the Fast Food Industry in New Jersey and Pennsylvania: Comment” American Economic Review, 90, 5, page 1362 to 1396

Philip Hardwick (2004) Introduction to Modern Economics, Pearson Press, New York

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Effect of an increase in minimum wage

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