MINIMUM WAGES (GENERAL)
Ms I. P MOATSHE
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What is a minimum wage?
✓ It is a wage below which an employer is not
allowed to pay his/her workers or;
✓ Minimum wages refers to various legal restrictions
on the lowest wage rate payable by employers to
workers.
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Reasons for minimum wages
Reasons as to why a minimum wage may be
instituted include:
✓ Minimum wages are used to protect the welfare of
workers such that the employers do not take
advantage of them. So, they are an anti-poverty
instrument.
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✓ Minimum wage redistributes incomes with no
immediate consequences on public finances.
✓ Unlike other instruments that transfer income to the poor,
a minimum wage increase the incentive to work,
❖ in other words, it has no disincentives to work efforts
rather it encourages people to work harder
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✓ A minimum wage is administratively simple
compared to other instruments
❖ but it does have its problems such as non-
compliance which can be dealt with by the
Ministry of Labour and Home Affairs
Theoretical relationships between Minimum
Wage and Employment………..
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Generally imposition of minimum wage in
the labour market leads to reduction in
employment.
✓ We will use the static or the competitive model
to see how this comes about.
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The Static or Competitive Model
The simplest model of minimum wages effects on
employment and unemployment focuses on a single
competitive labour market.
The imposition of a minimum wage level above the
equilibrium level, say Wm, would lead to a drop in the
demand for labour, all things being equal.
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• Demand for labour is only Nm at Wm
wage rate, and yet labour supply is
increased to Nb, so there is bound to be
unemployment (as there is excess LS)
• Nc-Nm workers loose their jobs as a result
of the minimum wage and some Nb-Nc
workers are also attracted into the labour
market due to the minimum wage.
• Nc-Nm is called the disemployment
effect of a minimum wage.
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From the graph
Wm: minimum wage
- Wc: equilibrium wage
-Nm: demand for labour if the MW is set up above the equilibrium wage
-Nb: Supply of labour if the MW is set above the equilibrium wage
- Nc: demand for labour at the equilibrium wage
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The negative effects of a minimum wage
on employment result from the combination
of two elements:
(i) a Substitution Effect as well as
(ii) a Scale Effect.
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✓ The Substitution Effect: means that firms could decide
to use more capital than labour as the latter becomes
more expensive, and secondly, they could substitute
skilled-labour for unskilled-labour.
✓ The Scale Effect: results from the fall of sales due to
cost increases, leading to a reduction in the use of
factors, capital and labour, including low-skilled labour.
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❖ The overall minimum wage effects on total employment
also depends on the elasticity of demand for labour.
✓ If labour can be easily substituted with other FOP such
as capital, the demand for labour will be more elastic,
which means that, an increase in the minimum wage, will
decrease employment by an even greater proportion
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❖If minimum wage is wrongly placed or imposed
below the market clearing wage then there will be
excess demand for labour because labour will now be
cheaper.
❖ In this situation, forces of demand and supply will push
the wage back to equilibrium, hence minimum wage is
not effective if it is placed below the market clearing
wage.
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❖ No one would want to supply their labour at a
wage that is lower than the equilibrium wage
as it reduces their welfare.
❖ Wages are therefore forced to go back to
equilibrium to attract workers into the
labour market.
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The competitive model have the following
assumptions:
✓ ASSUMPTION 1: All the employers comply with
minimum wage legislation.
✓ ASSUMPTION 2: Employers operate in a
competitive labour market where they have little or
no influence in setting wages.
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✓ ASSUMPTION 3: Minimum Wage legislation covers
the whole economy(all sectors), that is, minimum
wages are comprehensive
✓ ASSUMPTION 4: All other things remain constant
or unchanged when minimum wages are
introduced.
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❖In reality the competitive model does not hold
because some of its assumptions do not hold.
❖ For example, minimum wages do not cover the
whole economy (all sectors) in most labour markets
and not all other things remain unchanged when
minimum wages are introduced.
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❖ Therefore, the theoretical analysis of the MW has
to incorporate such realities.
❖ Therefore we are going to relax assumption 3 and
assume that the minimum wage does not cover all
the sectors; and relax assumption 4 and assume
that not everything remain constant or unchanged
when minimum wages are introduced.
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Relaxing Assumption 3
Suppose that we have a two sector economy with
the formal sector (covered by the min wage) and
informal sector (uncovered by the min wage).
The setting up of a minimum wage, whose value is
higher than the equilibrium wage (Wm>Wc) would
lead to unemployment in the formal sector
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▪ Workers who are unemployed due to introduction
of min wage will then move to the informal or the
uncovered sector.
▪ This will shift the supply curve at the informal sector
to the right. This will in turn reduce the wage in the
informal sector to W1 as shown in the diagram
that follows
Uncovered informal sector
Covered formal sector
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✓ Some people may decide to stay at home after
they have lost their jobs in the formal sector due to
introduction of the min wage.
✓ These are usually people from well off families
and usually have family support. These people
can afford to be unemployed.
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✓In overall, an introduction of the min wage will
make people in the informal sector poorer and
poorer because of the reduction in wages,
✓ while those who remain in the formal sector will
get richer and richer as their welfare would have
improved.
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Relaxing Assumption 4
Here we assume that not everything remains unchanged when
the min wage is introduced;
✓ 1st scenario: We assume that when min wage is introduced the
economy is also growing at the same time
✓ 2nd scenario: We assume that an efficiency wage is introduced
at the same time the min wage is introduced,
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1st Scenario: Growing Economy
✓ When the government introduces a min wage at
the same time that the economy is growing,
employment will increase.
✓ This is because a growing economy increases the
demand for labour as there will be more job
opportunities.
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✓ This will shift the labour demand curve to
the right increasing employment from E0
to E1.
✓ Unemployment will reduce as shown in the
graph by the now smaller triangle.
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When the economy is growing
employment will increase to E1
offsetting the negative effects of the
minimum wage as shown in the diagram
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✓ Some people will see this as a puzzle if
employment increases after imposition of the
minimum wage.
✓ That is because they would have not realized that
the economy is growing at the same time.
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2nd Scenario: Efficiency wage
✓ Here we assume that an efficiency wage is
introduced at the same time the min wage is
introduced.
✓ An efficiency wage is a wage that is set above the
equilibrium wage.
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✓ When you pay people an efficiency wage you
give them an incentive to work harder.
✓ This will then increase their productivity (MPL) in the
workplace.
✓ If MPL increases, labour demand (MRPL) increases
and the labour demand curve will shift to the right.
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𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑤𝑎𝑔𝑒 →↑ 𝑀𝑃𝐿
↑ 𝑀𝑃𝐿 ∗ 𝑃 =↑ 𝑀𝑅𝑃𝐿 =↑ 𝐿𝑑
𝑠𝑜 𝑤ℎ𝑒𝑛 𝑀𝑃𝐿 ↑→↑ 𝐿𝑑
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Graphically:
Employment will no longer be at Eo but at
E1 which signifies an increase in
employment. Unemployment will reduce
as shown by the now smaller triangle in
the diagram.
Empirical Studies on Minimum Wages
and Employment (A Summary)……..
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✓ More studies have been done in the developed countries
covering countries like the USA, Canada, United Kingdom,
France, Greece, etc
✓ Fewer studies have been done for developing countries due to
lack of reliable data and the fact that Minimum wages do not
play an important role because of their low relative value,
limited coverage and the low level of compliance.
✓ The studies have also relied on different approaches and led to
different findings, often opposing.
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✓ Also, some empirical studies on minimum
wages have been found to be inconclusive,
i.e. not leading to firm conclusions.
✓ Findings of minimum wage therefore
include:
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✓A negative relationship between minimum wage
and employment which is usually expected
(especially on employment in low-pay sectors and
shops);
✓ A positive relationship between Min wage and
employment (which might be attributable to a
growing economy);
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✓ Some studies found the impact on min wage to be
harmful especially in some industries of the formal
sector; some found very small effects which made it
very difficult to validate the theory.
✓ So, in conclusion, the empirical studies are just
mixed up with regards to how min wage affects
employment.
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The results of MW are different because of the
following possible reasons:
✓ Researchers use different methods in their
studies.
✓ Some use econometrics to analyze their data
while others use simple data analysis.
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✓ Some use different time lags, some use time series
while others use cross sectional data (or they
interview firms);
✓ Furthermore, researchers investigate firms with
different elasticities of demand for labour and this
yield different results.
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❖If an employer’s demand for
labour is elastic the effect of min
wage is larger compared to the
one that is inelastic.
