Question

4. (10%) Consider a competitive market for labor where the supply of labor are workers and the demand for labor comes from firms. The local government sets a minimum wage above the current equilibrium wage. What effect does this have on employment? What are its effects on consumer surplus, producer surplus, and total surplus? Support your answer with a graph. (hint: if you need to, revisit the content on price controls from earlier in the semester)

Answer 1

Minimum wage decrease the quantity of labor demanded (Qd) and increases quantity of labor supplied (Qs). Since workers will get jobs only to the extent firms hire, market employment will be Qd, causing unemployment of (Qs - Qd).

This decreases consumer surplus (CS), and may or may not increase producer surplus (PS). However, total surplus (TS = CS + PS) falls, causing a deadweight loss.

In following graph, D0 and S0 are labor demand and supply curves intersecting at point E with equilibrium wage rate P0 and employment Q0.

CS = area AEP0

PS = area BEP0

TS = area AEB

At higher minimum wage Pf, quantity of labor demanded falls to Qd, quantity of labor supplied rises to Qs, unemployment is (Qs - Qd).

CS = area AFPf [decrease in CS = area P0EFPf]

PS = area BGFPf

TS = area AFGB

Deadweight loss = area EFG