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Impact of Minimum Wage on Unemployement Essay

“We cannot unambiguously conclude that a minimum wage increase will increase unemployment levels”. Discuss.

The essay is outline as follows. Firstly, I would define some of the key terms. Secondly, I would outline the reasons for the statement. Lastly, I would provide the concluding remarks.

Unemployment is when those members of the labour force who are willing and able to work cannot find a job. Minimum Wage

In a perfectly competitive labour market, the equilibrium wage should be W1, where labour supply = labour demand. Wages are artificially altered when the price floor is imposed. An increase in the wage rate encourages the economically inactive to enter the labour market, causing an expansion in the supply of labour. The minimum wage raises the marginal cost of employing workers, thereby causing a contraction of labour demand. From an excess supply of labour, only the workers who are skilled will be employed. The least skilled, thus least productive will be priced out of the market leaving them involuntarily unemployed. The change in employment levels is the product of the elasticity of labour demand multiplied by the proportional rise in the wage.

Any increase in the minimum wage will be passed on to consumer prices. If demand for the product is inelastic, the increased price will not effect consumption of the good to a great extent. So employment rates would remain relatively the same. The opposite effect would happen for elastic good. If labour costs make up a small proportion of total costs, then any increases in the wage rate would have little effect on employment, as total costs would have only increased by a small amount. Where labour and supply are both inelastic, employment costs are minimised. If they are both elastic, more jobs are lost.

Although according to classical theories, the reason that minimum wage increase will increase unemployment levels is because minimum wage would increase the cost of labour, which lead to an increase in the cost of production of the firm. Firms would have cut human resources (labour) in order for the firms to control their cost of production. As a result it would leads to a increase in unemployment rate. But in reality, it work differently.

In fact the experience of the UK is that a 67% increase in the National Minimum Wages has reduced unemployment and increased employment. It would have lead to a strong Economic Growth. In period of economic growth, firms employ more workers as there is more demand to produce goods. Economic growth in the UK has averaged 2.5% since 1999

In addition, the power of Monoposony should not be ignore. Classical theory assumes that the labour markets are competitive, but in practice workers often face employers with buying power. This means firms are able to pay workers less than the market wage. Therefore, when a government artificially raises wages, firms can actually afford to pay them. It is argued minimum wage legislation is similar to anti trust regulation.

Thus, it would lead to an increased productivity. A study by David Metcalf found that firms responded to increased wages by increasing the productivity of workers, especially in the service sector. This is important because it suggests that higher wages can actually help increase productivity in the economy.

Firms would lower working hours in respond to the increase in the minimum wage. Rather than make workers redundant, firms have reduced the average hours worked. This is related to part 3, firms try to get higher productivity in a shorter time, so they can afford the minimum wage.

Pass on Cost increases. Because the minimum wage affects all firms, it is easier for the cost increases to be passed onto consumers. e.g. because all cleaning firms have higher wage costs, they can all increase their prices. If the wage increase just affected one firm, they would become uncompetitive.

Firms would also think of different problems to avoided of Minimum Wage. It is uncertain to ascertain the extent of this problem, but some firms have circumvented the minimum wage legislation by employing immigrant labour and paying them lower wages. It also makes it more attractive to employ young workers.

To conclude, although an increase in minimum wage in theory would lead to an increase in unemployment, but in practical, it would not much negative impact on the employment rate. Therefore, we cannot unambiguously conclude that a minimum wage increase will increase unemployment levels.


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