Question

Some advocates of the minimum wage argue that any decrease in the employment of the unskilled will be slight. They assert that an increase in the minimum wage will actually increase the total amount paid to unskilled workers (i.e., wage \(\times\) number of unskilled workers employed). Discuss what assumptions they are making about the wage elasticity of labor demand.

Short answer

The advocates are making two main assumptions: first, that labor demand is relatively inelastic to changes in wages, and second, that the percentage increase in wages more than compensates for any small percentage decrease in workers hired. Both these assumptions imply that wage elasticity of labor demand is less than one in absolute value. Any such situation would result in an overall increase in total amount paid to unskilled workers.

Step-by-step solution

Understanding minimum wage effect

Firstly, advocates are implying that the increase in minimum wage does not significantly decrease the employment rate of unskilled workers. Thus, the first assumption they are making is that labor demand is relatively inelastic to changes in wages.

Understanding relationship between wage and employment

Secondly, they claim that the increase in minimum wage increases the total amount paid to unskilled workers, which is the product of wage and number of workers employed. This assumes that the percentage increase in wages more than compensates for any small percentage decrease in the number of workers hired. In other words, the income effect (wage \(\times\) employment) increases despite a potentially slight reduction in employment.

Understanding wage elasticity of labor demand

The assumption about wage elasticity of labor demand is that it is less than one in absolute value (i.e., demand is wage inelastic). Wage elasticity of labor demand measures the responsiveness of labor demand to changes in wages. If it's less than one in absolute value, it implies a 1% increase in wages leads to less than 1% decrease in employment. Thus, an increase in the minimum wage would result in a less than proportionate decrease in employment.

Key concepts

Wage Elasticity of Labor Demand

When discussing the effects of minimum wage, the concept of wage elasticity of labor demand plays a critical role. Economists use this to measure how sensitive the number of employees a business is willing to hire is to changes in wages. An inelastic labor demand, as the advocates of minimum wage suggest, would mean that employers are not significantly reducing the number of jobs when the wage goes up.

Think of it like a rubber band. If labor demand is inelastic, similar to a stiff rubber band, it doesn’t stretch much when pulled—or in economic terms, businesses don’t reduce their workforce considerably when wages rise. This implies that even with higher wages, unskilled workers may not face substantial unemployment risks. It suggests that the benefits of increased wages could potentially outweigh the costs of slightly reduced employment opportunities.

Unskilled Worker Employment

The term 'unskilled worker' refers to individuals who do not possess a specific skill set or higher educational qualifications that are often required for specialized jobs. Their employment nuances are particularly sensitive to policy changes like the adjustment of minimum wage.

The prevailing concern is that an elevation in minimum wage might lead to a reduced demand for unskilled labor, since employers may find the increased labor costs unsustainable. However, when the wage elasticity of labor demand is low, the fears may be overstated. Advocates argue that the total compensation (wages times the number of workers) for unskilled workers could increase, indicating that these workers could overall earn more even if there is a slight decline in employment.

Income Effect

The income effect is a key element when considering changes to the minimum wage. It encapsulates the change in an individual's or economy's income and how that change will affect the quantity of goods and services demanded.

In the context of raising minimum wages, if unskilled workers are earning more per hour, their overall income might increase, despite a potential slight dip in employment. This could lead to greater spending capacity for the workers who remain employed, possibly stimulating the economy. Conversely, for employers, the increased labor costs could reduce profit margins or increase costs for consumers if the costs are passed through prices, leading to diverse economic implications.