[1.2.6c] Labour market intervention
The National Minimum Wage
A minimum wage is a legal price floor in the labour market — a minimum hourly rate below which it is illegal for an employer to pay a worker. By law, every eligible worker must receive at least this amount regardless of what the market equilibrium wage would otherwise be.
In the United Kingdom, the minimum wage has existed since 1999. Most developed economies operate some form of statutory minimum wage, though the level and coverage vary considerably.
Reasons for a Minimum Wage
- Reduce poverty: workers in low-paid jobs earn more, helping them meet basic living costs and reducing in-work poverty.
- Reduce inequality: by raising the wages of the lowest earners, the minimum wage compresses the wage distribution and narrows the gap between high and low earners.
- Increase worker motivation and productivity: higher wages may reduce labour turnover, increase effort and improve morale — potentially partially offsetting the cost to employers.
- Reduce exploitation: without a minimum wage, workers with limited bargaining power (especially in monopsonistic labour markets dominated by a single large employer) may be paid below the competitive equilibrium. A minimum wage provides a floor of protection.
- Reduce government spending: if workers earn more, they depend less on government welfare payments (tax credits, housing benefit), reducing the public spending burden.
Effect on the Labour Market
The impact of a minimum wage depends critically on where it is set relative to the free market equilibrium wage W*.
When a minimum wage is introduced at Wmin above the free market equilibrium W*, it creates a labour surplus. At the higher wage, more workers are willing to supply their labour (QS) but employers demand fewer workers (QD). The gap between QS and QD represents potential unemployment.
When the minimum wage is increased, the same diagram applies at a higher wage floor. The labour surplus (unemployment) widens if the minimum wage is pushed further above the equilibrium. However, those who remain employed earn a higher wage. The key question is the size of the resulting job losses relative to the wage gain for those still employed.
Empirical evidence from many countries suggests that modest increases in the minimum wage (keeping it reasonably close to the market equilibrium) cause smaller unemployment effects than simple theory predicts — partly because of monopsony power by employers, efficiency wages and reduced labour turnover offsetting some of the cost.
If the minimum wage is set below the free market equilibrium wage W*, it has no effect — the market already pays above the floor, so the legal minimum is irrelevant. For a minimum wage to affect the market, it must be set above W*. This is why minimum wages in high-wage regions (e.g. London) are sometimes set higher than the national level.
Advantages and Disadvantages of a Minimum Wage
| Advantages | Disadvantages |
|---|---|
| Reduces in-work poverty and increases living standards for lowest earners | May cause unemployment if set significantly above the equilibrium wage |
| Reduces inequality by raising the wage floor relative to higher earners | May increase costs for businesses, particularly small firms with thin margins, potentially reducing investment |
| May increase worker motivation, reducing absenteeism and staff turnover | May cause some firms to reduce hours rather than laying off workers — same headcount but less income |
| Reduces dependency on government benefits, saving public expenditure | A uniform national rate may be too high for low-wage regions but too low for high-wage cities |
Key Takeaways
- A minimum wage is a legal price floor — the lowest hourly rate an employer may legally pay.
- Set above the market equilibrium, it raises wages for those employed but creates a potential labour surplus (unemployment).
- Set below the market equilibrium, it has no effect on wages or employment.
- Reasons include: reducing poverty, reducing inequality, protecting workers from exploitation and reducing welfare spending.
- The unemployment effect depends on how far above equilibrium the minimum wage is set and the elasticity of labour demand and supply.