MINIMUM WAGE AND ITS EFFECT ON EMPLOYMENT

 

If Alice has a cake business, she will need to hire people to help her bake, decorate and deliver her cakes to her clients. In the resource market, Alice becomes the demander and her workers become the suppliers. When the supply of labour is equal to the demand for labour, the market can be said to be at equilibrium at the intersection between supply and demand curves. This is the stage when wages are at the current market rate. In other words, the person hiring is willing to pay what is agreeable to the worker.

Let us assume that is £7 pounds an hour. The government then passes a law that says that there has to be minimum £8.72 an hour for these workers, as anything less than that is not sufficient to give them a good life. Minimum wage is also called the price floor in the market. One would think that having a fixed minimum wage would bring clarity in the market. Surprisingly, it doesn’t happen that way. If the minimum wage /price floor is higher than the actual clearing price, it will end up distorting the market. Employers will have to reduce the number of hours that it can hire labour as they have a fixed amount of money that they can spend on their workers.

However, the workers see the increased rate at which they can be hired and thus more of them will be willing to work. A worker who made £7 an hour and worked 40 hours a week will now feel that he is eager to work more hours, say 45 , as he will now earn nearly £9 an hour. The supply of labour will increase. What will happen now is that the demand is limited. Thus, there will be an over supply of labour. Hence, we see that before the introduction of minimum wage, there was a surplus below the demand curve and above the supply curve. The producer surplus was the benefit of the individual workers, which was above and beyond the benefit they would now get after the minimum wage. The consumer surplus was the advantage that the employer was getting before the minimum wage. Overall, the market gets dead weight loss. Minimum wage works to the advantage of those who have employment in hand. However, it works to the detriment of the employer for the labour he has employed already.

Minimum wage affects unskilled labour markets where the workers do not have specific training or relevant experience for the work they are applying for. In the labour market, demand comes from employers and not from individual consumers. Similarly, the supply is not coming from big corporations, it is coming from individual workers.

Milton Friedman, Free market economist,  had argued ,’A minimum-wage law is, in reality, a law that makes it illegal for an employer to hire a person with limited skills’. His argument was that if you were willing to hire a teenager for a dollar fifty an hour, the law won’t let you as it would be illegal to hire someone for less than minimum wage. The law would say that you must hire him at a dollar sixty. If you didn’t want to pay that, or couldn’t afford to pay that, you would just end up not hiring him. As a result, this would produce unemployment among people with low skills.

The National minimum wage rate is currently £8.72 for workers over 25 (from April 2020). The minimum wage was introduced in April 1999 (at £3.60) and is the legal minimum that employers can pay.