How does minimum wage effect market equilibrium?

1 Answer
Sep 17, 2015

A binding minimum wage will create a surplus of labor supplied -- in other words, unemployment.


Here is a graph showing the supply-demand analysis.

From the graph, you can see that if we set a minimum wage that is binding (above the market equilibrium wage), we could create a gap between the quantity of labor that firms will demand (labor demanded) and the quantity of labor that workers will want to supply. This surplus is known as unemployment. At the high minimum wage, we would have more workers wanting to work than we would have firms wanting to employ them.

It's worth noting that empirical evidence about this tends to vary from study to study, and the biases of the authors are usually apparent to anyone who wants to investigate who funded the research, the other normative views of the authors, etc. However, the general conclusion is widely accepted in principle. Economists tend to disagree about whether a specific minimum wage will cause a problem.

For example, in the current U.S. economy, it's not clear that $7.25 is causing much unemployment. That's a pretty low minimum wage, compared to most labor markets. However, some people advocate for an increase to $15 per hour. This is more controversial, but just consider how firms with low-skill workers will respond. In the short run, maybe the just pay more. In the long-run, they can automate more and change the structure of their businesses in other ways to utilize less labor input.