Question

Governments commonly uses price floors. One of the most classic examples of a price floor is a minimum wage policy in a labor market. Minimum wages laws date from 1894 in New Zealand, 1909 in the United Kingdom, and 1912 in Massachusetts. Minimum wage policies, however, often create unintended consequences. The original 1938 U.S. minimum wage law, for example, caused massive unemployment in Puerto Rico.

Suppose the following demand and supply curves describe the labor market in Puerto Rico before 1938: Demand: P = 20 – Q Supply: P = 2 + 0.5Q where P is the wage per hour, and Q represents the number of workers hired, in thousands (e.g. Q = 1 means that 1,000 workers have been hired).

The 1938 U.S. minimum wage laws artificially required that all workers earned at least $10 per hour in Puerto Rico. So, how many workers would be employed under the minimum wage policy? Illustrate on a graph. Calculate the equilibrium wage and the number of workers hired before the 1938 minimum wage laws. Illustrate on a graph.

Answer 1

Before the law in 1938, at equilibrium

Demand = Supply

20 - P =(P - 2)/0.5

10 - P/2 = P - 2

3/2P = 12

P = 8

At P = 8, Q = 12 which means 12,000 workers are hired

After the law, P is set equal to 10

Hence, Q = 20- 10 = 10 means 10,000 workers are hired which is lesser than the number of employed persons before minimum wage law was implemented. This happens because at a wage rate higher than the equilibrium wage, less firms will demand labor. Hence , the wage law is binding and the quantity of labor demanded is less than quantity of labor supplied