Topic 3.2a Minimum Wages. Professor H.J. Schuetze Economics 370

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1 Topic 3.2a Minimum Wages Professor H.J. Schuetze Economics 370 Minimum Wages Canada: Each province sets its own minimum wage. Interprovincial/international industries are under federal jurisdiction Reason for minimum wages? No clear answer to this. Curbing poverty among the working poor Preventing exploitation of the non-union sector Discouraging the development of low wage sectors Professor Schuetze - Econ

2 Professor Schuetze - Econ Minimum Wage Theory The theory predicts that the inclusion of a minimum wage under perfect competition leads to a reduction in employment. Employment is reduced from N C to N M W S Total unemployment is the difference between the supply of labour (N S ) and the number employed (N M ) N C N M is the number of D workers laid off as firms substitute for cheaper inputs and reduce output because of increased costs. N W M W C N M N C N S N S N C is the number of new labour force participants because of the minimum wage. Professor Schuetze - Econ

3 Long-Run Effects The long-term effects need not mean an increase in unemployment. Those who lose jobs could: i. Move to sectors not covered by minimum wage. ii. Drop out of the labour force. The magnitude of the reduction in employment depends upon the elasticity of demand elastic minimum wage has big effect inelastic minimum wage has small effect Professor Schuetze - Econ Elasticity of Demand Would you expect the elasticity in industries affected by the minimum wage to be elastic or inelastic? Likely to be elastic in low wage industries (e.g., textiles) Why? Availability of substitutes no special skills could be automated Wages are a large proportion of total costs. very little capital invested Professor Schuetze - Econ

4 Offsetting Factors One factor which could offset the effect of the minimum wage is a shock effect Employment could increase because the cost pressure caused by the minimum wage could force firms to use cost-saving devices. Minimum wage is a catalyst for the use of devices that should have already been used. Labour may be forced to become more productive because of the higher wage or because of the large number of applicants waiting for their jobs. Problem: these shock effects mean that the firm must not have been minimizing costs Professor Schuetze - Econ Offsetting Factors Some firms may be able to absorb the costs of the increase in wage. e.g. Oligopolist can raise the price with little effect on demand. This is unlikely given that most low wage industries are highly competitive. Therefore, it is likely that minimum wages will reduce employment, particularly for unskilled workers (e.g. younger workers) Those who require experience the most. Professor Schuetze - Econ

5 Empirical Evidence Numerous studies to determine the impact of minimum wages on employment. Difficult to get the actual impact since other things are also changing over time. Typically look at teenage workers (16-19) but some have looked at older workers. Probably the most well known research is by Card and Krueger New Jersey raised it s minimum wage above the federal level of $4.25 to $5.05 Professor Schuetze - Econ Card and Krueger Paper Basic idea is to compare the New Jersey experience with Pennsylvania which did not change its minimum wage. Pennsylvania is geographically close to New Jersey and therefore is similar in many respects. One method would be to run a regression of the change in employment at a fast food restaurant on a firm specific variable for New Jersey employment = + stuff + Jersey Firm + Professor Schuetze - Econ

6 Methodology A more precise approach recognizes that some firms are already paying above the minimum wage. So the key variable is GAP = min (o, minimum wage - initial wage at firm) note: this is 0 for firms in Pennsylvania and New Jersey firms paying above minimum wage. Measures amount of wage change due to minimum wage in New Jersey. employment = + stuff + GAP + Professor Schuetze - Econ Results Unlike what the model predicts, don t get a negative effect! Most specifications get a positive effect. Does this tell us that the demand elasticity is positive? More likely that it is telling us something else is going on. not testing what we think model is wrong Professor Schuetze - Econ

7 Previous Studies on US Teens Time Series Data: 10% increase in minimum wage = 1-3% reduction in teen employment. Cross-Section Data: 10% increase = 0-3% decline. Professor Schuetze - Econ Monopsony minimum wage might help w Recall the equilibrium under monopsony MC N S Hire up to the point where MC N equals MRP N (N M ) w min w M Read the wage off of the supply curve (w M ) N min MRP N N M N Suppose the minimum wage is set above w M (w min ) Now the labour supply curve faced by the firm is horizontal at w min (up to the point where it intersects the industry supply curve) To the right of this point the labour supply curve is the industry supply curve Professor Schuetze - Econ

8 Monopsony minimum wage might help What does this imply about the firms MC curve? w MC N Along the horizontal portion S of the supply curve MC=w min w min To the right of N min MC w M jumps up to the old MC MRP N curve N M N min N Why? To the right of N min on upward sloping supply curve Thus, to hire more workers the firm must raise the wage This means raising the wage for all (N min ) workers as well!! Professor Schuetze - Econ Optimal Choice of Labour? w w min w M MC N S The firm will still hire up to the point where MRP N =MC N M N min MRP N N At N min, marginal cost is still below MRP N Just to the right of N min, marginal cost is above MRP N Therefore, the firm will hire N min units of labour So in this case an increase in the wage actually leads to an increase in the number of workers demanded! Professor Schuetze - Econ

9 Notes on Monopsony 1. Notice that policy makers could potentially get the perfectly competitive outcome (efficient) 2. A high enough minimum wage could also potentially reduce employment if the minimum wage is set above MRP N in the monopsony equilibrium 3. Not likely that increases in the minimum wage will increase employment Why? Most sectors of the economy for which minimum wages matter are not characterized by monopsony Professor Schuetze - Econ Final Analysis Is the minimum wage an effective antipoverty program? Many of the poor don t work can t help these For those who do work, it increases the wage for workers at the bottom of the distribution However, it may also reduce employment opportunities for some of these workers Trade off might be worthwhile if employment losses are small and benefits accrue mainly to the working poor Research suggests that many beneficiaries of the minimum wage are workers in better off households (e.g. young students) Professor Schuetze - Econ