Minimum Wage and Unemployment in Microeconomics

This article discusses the concept of minimum wage and its impact on unemployment in microeconomics. It explains how the government sets a price floor and how it affects the labor market. The article also includes a demand and supply model to explain the labor surplus resulted from minimum wage.

Running head: MICROECONOMICS
Microeconomics
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1MICROECONOMICS
Table of Contents
Minimum wage and unemployment................................................................................................2
References........................................................................................................................................5

2MICROECONOMICS
Minimum wage and unemployment
Government takes price control measures such as price ceiling or price floor when free
market price fails to ensure maximum social welfare. Price floor refers to the legal minimum
price set by the government. Government restricts exchange of the good below the set minimum
price. Buyers causing buying the good at less than the floor price are subject to punishment
(Cowell, 2018). The justification given in supporting the policy is that sellers deserve a higher
price than that determined under the free market.
One practical application of price floor is the minimum wage in the labor market.
Minimum wage refers to the price floor set in the labor market. The minimum wage aims to
increase minimum wages for workers. Immediate effect of minimum wage is to create a labor
surplus in the economy and hence, unemployment. The size of surplus labor however depends on
the elasticity of labor demand. In case demand for labor is relatively inelastic meaning not much
price sensitive, an increase in wage does not reduce the labor demand much (Baumol & Blinder,
2015). Size of labor surplus is relatively small in this case. In case demand is relatively inelastic
in elastic in nature implying high price sensitive then there is significant reduction in labor
demand creating huge labor surplus and unemployment. The resulted labor surplus from
minimum wage can be explained with the economic model of demand and supply in the labor
market.

3MICROECONOMICS
Figure 1: Labor market surplus resulted from minimum wage
(Source:
The figure above depicts demand and supply in the labor market. Cost a firm is an
increasing function of rate of wage. Higher is the wage rate, fewer labor hours an employer
demand. This is for the simple reason that it becomes more expensive for employers to hire
workers because of the high wage cost. The labor demand curve therefore slopes downward as
shown by the curve DD. On the other hand, high wage means higher return for workers. Supply
of labor therefore is an increasing function of wage as shown by the upward sloping curve SS
(Cowen & Tabarrok, 2017). The market clearing wage is at W* obtained corresponding to labor
market equilibrium at E. The equilibrium level of employment is L*. Now if government sets the
minimum wage at W1 which is above the equilibrium wage both supply and demand of labor
changes from the equilibrium position.

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Following a higher wage, firms cut their demand for labor and looks for cheaper
alternatives. This reduces demand for labor L* to L1. The higher return in contrast encourages
more workers to join the labor force resulting in an increase in quantity supplied of labor.
Correspondingly supply of labor increases from L* to L2. As the demand for labor falls short of
available supply, there creates a shortage of labor of the amount (L2 – L1) in the labor market
(Meer & West, 2016). Therefore, from the demand and supply model it is clear that minimum
wage set above the equilibrium wage creates labor surplus in the economy resulting in
unemployment.

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References
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Macroeconomics in
context. Routledge.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Meer, J., & West, J. (2016). Effects of the minimum wage on employment dynamics. Journal of
Human Resources, 51(2), 500-522.
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.