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Ur all $h1t (2)
Thursday, April 09, 2009

Minimum wages - theory and evidence

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Comments: 8

Traditional labour market models suggest that when the price of labour increases the number of people employed will fall. Using these models many economists have argued that mechanisms such as a minimum wage have the perverse effect of reducing employment. A minimum wage, set above the market clearing equilibrium can only reduce employment. Their conclusion is then that minimum wages hurt the very people they seek to help. However, such claims have been contradicted by empirical findings showing that the introduction of minimum wages either increase employment or allow it to remain stable, while granting a higher wage.


More recent models suggest many individual firms face monopsony in the labour market – implying that many individual firms face an upward sloping labour supply curve in the short run and have control of the wage rate (a monopsony is where a single buyer, i.e. the firm, faces many sellers, i.e. prospective workers. Like a monopoly, but for a single buyer rather than a single seller). The monopsonist maximizes profit where the marginal expense of labour is equal to the value of the marginal product of labour. What are the consequences of this? With an upward sloping labour supply curve and imperfect competition an increase in a minimum wage can result in an increase in employment.



 

As we can see from the graph, the monopsony wage is lower than the competitive wage and at this wage there is an under supply of labour. As the market is operating at the monopsony wage, efficient increases can be made in wages and employment. If the government imposes a minimum wage at ‘minimum wage 1’, below the competitive wage but above the monopsony wage, we can see that the wage has increased from the monopsony level and employment has increased from E1 to E*. There is still some under supply of labour relative to the competitive outcome, however, this is still a greater level of employment than under a monopsony.

 

There is an interesting anomaly presented by a monopsony model for labour. If the government were to set a minimum wage above the competitive wage (‘minimum wage 2’;) employment would increase (from E1 to E**) but unemployment would also increase (there distance between A and B), as more people would be willing to work at this wage than the employers seek to employ - however, more people will still be employed at a higher wage, generating a greater net surplus than a monopsony.

 

So we have shown that we can model scenarios where a minimum wage can both increase wage and employment, contrary to traditional expections. Let us now have a look at some empirics. In New Zealand, pre-2001, there was an adult minimum wage (for persons over 20 years old) and a youth minimum wage (for persons 16-19 years old) which was set at 60% of the adult minimum wage. In 2001 the government extended the adult minimum wage to cover people over 18, while the youth wage, which remained for 16-17 year olds, was increased to 80% of the adult minimum wage. This had the effect of increasing the wage for 18-19 year olds by 85% and for 16-17 by 50%. Traditional models of labour market supply would have predicted this wage increase to result in a reduction in employment for the two treatment groups (18-20 year olds and 16-17 year olds). In fact, quite the opposite resulted. The employment rate for 18-20 increased by 0.12% and by 0.11% for 16-17 year olds, both groups increased by 0.12% relative to the control group (20-25 year olds).  While these are only small increases, the important point is that they are not decreases as the traditional model would have expected. Furthermore, 16-17 year olds increased their hours worked by 10% while 18-19 year olds increased their hours worked by 5% (Hyslop and Stillman 2004). These are quite substantial increases, and again, they are inconsistent with traditional model predictions of a reduction in employment from increasing a minimum wage.

 

I should also add that there are also very sound social reasons for minimum wages, but it helps to have economic theory and evidence supporting the argument too!

9:10 am - 8 comments - 2 Kudos - Report!
Comments
Ur all $h1t wrote on Apr 10th, 2009 10:57pm

:D
I usually try to keep clear of economic arguments on minimum wage because I don't know enough about economics and am likely to get myself pwned, but it's good to know that they exist.

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captaincrunk wrote on Apr 21st, 2009 3:40pm

WEll New Zealand is the exception. So few children wanted to work for 60% of what they deserve. In most countries minimum wage applies to all those who work

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Kiwi Acea wrote on Apr 21st, 2009 11:22pm

On the contrary, this policy change provided a very good opportunity to test traditional economic models - an opportunity that may not have existed elsewhere in the world. There is no reason why New Zealand's labour market should behave fundamentally differently to any other first world country. You can't just say 'it's an exception' because the result is unexpected. The results stack up, and are consistent with theory, just not traditional models.

"So few children wanted to work for 60% of what they deserve." - this may be true, but it ignores the demand side of the model, arguably the key consideration here. It goes without saying that when wages increase more people will want to work. What was surprising here was that labour demand also increased - employers were willing to employ more people at a higher wage. This was very unexpected. That wages went up 85% and employment increased by 5% is a huge result.

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scheck006 wrote on May 2nd, 2009 7:01am

When you give people on the bottom level of the social ladder more money, they spend it. Meaning more demand for products and the people who create, ship, and stock, them.

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scheck006 wrote on May 2nd, 2009 7:01am

When you give people on the bottom level of the social ladder more money, they spend it. Meaning more demand for products and the people who create, ship, and stock, them.

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captaincrunk wrote on Jun 8th, 2009 9:34pm

Kiwi Ace wrote on Apr 21st, 2009 at 4:22pm :
"So few children wanted to work for 60% of what they deserve." - this may be true, but it ignores the demand side of the model, arguably the key consideration here. It goes without saying that when wages increase more people will want to work. What was surprising here was that labour demand also increased - employers were willing to employ more people at a higher wage. This was very unexpected. That wages went up 85% and employment increased by 5% is a huge result.


The point I made is where the increase in employees came from, what groups tehy came from. You can strategically place laws making 16 year olds very good hiring, cause 20 year olds to lose their jobs, but have more 16 year olds than 20 year olds.

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mamosa wrote on Jun 13th, 2009 9:22pm

lolwut?

No, but seriously, that's commonly known, isn't it? After all, that's why FDR gave the people money instead of the companies.

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kolby.patrick wrote on Apr 21st, 2011 9:22pm

Just because employment increased for a percentage of the population during the time of a great economic expansion for New Zealand, does not necessarily mean that we can attribute it solely on this new policy.

In the period from 2001-2005, the New Zealand economy nearly DOUBLED. When I skimmed through the paper, I did not find any reference to GDP. Especially when dealing with Labor, it would be smart of the authors to mention GDP, as the employment lags behind GDP, and should be of great predictive value.

My question is this: "If you owned a McDonald's and typically hired young adults, would you hire more because it now costs you more?"

Regardless of what I believe in your viewpoint, I respect you for being engaged in this wonderful "dismal science"! It is nice to be able to have an exchange of ideas with somebody that is not apathetic to the world around them!

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