Understanding Minimum Wage: Economic Theory And Labor Market Dynamics

Definition of Minimum Wage from Economic Theory

A minimum wage is an example of a price floor, it is a government regulation that makes hiring labour services for less than a specified wage illegal such that an employee cannot give a wage lower to the level defined.  A minimum wage is not binding if set at an equilibrium position but is considered to be binding if it is set above the “equilibrium wage”. The uncertainty is only driven by the minimum wage policy undertaken (Sorkin 2015).

Question 2

The minimum wage as per Fair Work Commission’s “National Minimum Wage Order” is $719.20 per week for an adult such that calculated for 38 hours in a week is $18.93 per hour (employsure.com.au 2018).

Question 3

Equilibrium Wage Rate

D = 1,500,000 – 60,000W; S = 120,000W – 1,200,000

èDemand = Supply at the equilibrium for labour market

è1,500,000 – 60,000W = 120,000W – 1,200,000

è180,000W = 2,700,000

èW = 15

The diagram of the minimum wage and unskilled labour employed is given as:

The number of unskilled labour employed = 1,500,000 – 60,000W = 1,500,000 – 60,000(15)

= 1,500,000 – 900,000 = 600,000 unskilled employed labourers

Question 4

4 (i) Consumer Surplus

Maximum wage rate = 1,500,000/ 60,000 = 25 (From D = 1,500,000 – 60,000W)

Consumer surplus = 0.5* (A – 15)* 600,000 = 0.5* (25 – 15)* 600,000 = 3,000,000

4 (ii) Producer Surplus

Minimum wage rate = 1,200,000/ 1,200,000 = 10 (From S = 120,000W – 1,200,000)

Producer surplus = 0.5* (15 – B)* 600,000 = 0.5* (15 – 10)* 600,000 = 1,500,000

4 (iii) Total Surplus = Consumer Surplus + Producer Surplus = 3,000,000 + 1,500,000 = 4,500,000

Question 5

5 (i) If minimum wage of $19 is imposed, then hours of employment would be

Labour demand hours = 1,500,000 – 60,000*(19) = 360,000

Labour supply hours = 120,000*(19) – 1,200,000 = 1,080,000

5 (ii) At this point of minimum wage, labour supply increases the demand. Hence, the exceeded surplus of labour in this scenario = 1,080,000 – 360,000 = 720,000

Question 6

6 (i) Minimum wage = $19

Consumer surplus = “I. CS” triangle

Therefore, Consumer surplus = 0.5* (25-19)* 360,000 = 0.5* (25 – 19)* 360,000 = 1,080,000

6 (ii) Producer Surplus

Producer surplus = “II. PS” rectangle + “III. PS”

1. PS = (19-15)*360,000 = 1,440,000

III. PS = (0.5 * (15-10)*360,000) – (0.5* (15-13)* (600,000- 360,000))

= (0.5*5*360,000) – (0.5*2*240,000) = 1,500,000 – 240,000 = 1,260,000

National Minimum Wage Regulations in Australia

Therefore, Producer Surplus = “II. PS” rectangle + “III. PS” = 1,440,000 + 1,260,000 = 2,700,000

6 (iii) Total Surplus

Total Surplus = CS + PS = 1,080,000 + 2,700,000 = 3,780,000

6 (iv) Resource Cost

Resource Cost = ((19-15)* (1,080,000- 360,000)) – 0.5* (19-15)*(600,000 – 360,000) – 0.5* (19-15)* (1,080,000 – 600,000)

= (4* 720,000) – (0.5*4*240,000) – (0.5*4*480,000)

= 2,880,000 – 480,000 – 960,000 = 1,440,000

6 (v) Dead Weight Loss

DWL = “IV. DWL” triangle + “V. DWL” triangle

= 0.5* (19-15)*(600,000 – 360,000) + (0.5* (15-13)* (600,000- 360,000))

= 480,000 + 240,000 = 720,000

Question 7

7 (i) With the introduction minimum wage, the firm surplus has decreased from 3,000,000 to 1,080,000 because, the wage rate has been increased from $15 to $19. The firms are experiencing loss is surplus than the previous state.

7 (ii) The workers have been in a better off stage because not only the wage has increased from $15 to $19 but it has even increased the surplus from 1,500,000 to 2,700,000.

7 (iii) The total surplus has decreased when the wage rate increased to a higher minimum wage. Moreover, there has been considerable dead weight loss in the society worsening the situation with a decline of 72,000.

Question 8

Being minimum wage rate same as $19, with resource lost acquired by workers then,

8 (i) Consumer surplus will experience no change, it will be same.

=0.5* (25-19)* 360,000 = 0.5* (25 – 15)* 600,000 = 1,080,000

8 (ii) Earlier Producer surplus was 2,700,000, now with resources lost, it will be resource lost + earlier dead weight loss even considered in producer surplus

Producer surplus = 2,700,000 + 1,440,000 + 720,000 = 2,700,000 + 2,160,000 = 4,860,000

8 (iii) Total Surplus = 1,080,000 + 4,860,000 = 5,940,000

8 (iv) There will be no dead weight loss in this situation as all have been consumed by the producer’s surplus.

Question 9

The conclusions have considerably increased from question 7. This is because with addition of resource cost, the producer surplus has increased and surpassed the amount for dead weight loss and firm’s surplus. However, there is no change in firm’s surplus but socially, the surplus has increased for a greater good.

Question 10

Allocative efficiency is the point where every last unit of marginal benefit to the workers is equal to marginal cost. However, where this position is met, there is no dead weight loss in the market. This is the main welfare tool where marginal utility is equal to marginal cost. Nonetheless, when the same situation is analysed based on minimum wage, then this intervention by the government does not create allocative efficiency as the price set by the government does create the equilibrium position (Booth 2014). The firms experience loss due to unequal condition between labour supply and labour demand such that the marginal cost of labour supply is fewer than the reimbursements enjoyed by the workers (LeBaron and Howard 2015). Hence, adding dead weight loss and job resource cost to welfare loss in the society.

Employment Dynamics of Unskilled Labor Market

Question 11

The workers at equilibrium had been allowed with a wage of $15 with 600,000 hours of labour. The argument for standard of living is drastically improved at $19 minimum wage but earlier as in question 7, the excessive labour surplus created in market leads to resource lost. The unemployment (labour surplus) searching for employment are losing on the benefits shared by the workers at $19. On the other hand, when the worker’s surplus with the resource cost is added as producer surplus,

all the employed yet unskilled labourers enjoying wages with a substantial higher standard of living (Ehrenberg and Smith 2016). Hence, the government has set the standard of minimum wage at a considerable standard of living but it is not justified for the unskilled workers who are disguisedly employed. This in turn increases only a part of skilled workers whereas this welfare cannot be implied with ethically justified welfare for the unskilled workers (FitzRoy and Jin 2015).

Question 12

Minimum wage in a scenario where it is considering both skilled and unskilled for employment can create a diversion in the system. The minimum wage theory can cause a ripple effect because the unskilled labourers at the same level are getting a higher surplus then the labourers who deserve in the economy. Moreover, the minimum wage is decreasing the firm surplus in all, creating allocative inefficiency in the market which further creates the situation of dead weight loss and social inefficiencies in the economy (Rakhmatullina 2014).

This binding wage freezes the opportunity of getting the skilled labourers and generating a situation of unemployment for skilled labourers. Moreover, this would further escalate to the issue of raising the cost of living because of price increases and would initiate an increase further for minimum wage (MaCurdy 2015).

References

“Minimum Wage And Award Rates In Australia | Employsure”. 2018.

Booth, Alison L. “Wage determination and imperfect competition.” Labour Economics 30 (2014): 53-58.

Ehrenberg, Ronald G., and Robert S. Smith. Modern labor economics: Theory and public policy. Routledge, (2016).

FitzRoy, Felix R., and Jim Yongtao Jin. “A basic income can raise employment and welfare for a majority.” (2015).

LeBaron, Genevieve, and Neil Howard. “Forced labour in the global economy.” (2015).

MaCurdy, Thomas. “How effective is the minimum wage at supporting the poor?.” Journal of Political Economy 123, no. 2 (2015): 497-545.

Rakhmatullina, Altynay. “Overeducation and mismatch in labor market.” PhD diss., Masarykova univerzita, P?írodov?decká fakulta, 2014.

Sorkin, Isaac. “Are there long-run effects of the minimum wage?.” Review of economic dynamics 18, no. 2 (2015): 306-333.