Question

Explain your answer using isocost/isoquant diagrams.

Senator X claims that if the minimum wage increases firms will not reduce the amount of labor they hire. Firm YYY currently produces 100 widgets using labor paid the minimum wage and capital. The owner of this firm claims that he will reduce labor if the wage is increased. In the short run who is correct? What assumptions are you making? In the long run does your answer change? How?

Answer 1

In short run, the senator X is correct. Because in short run there is less unemployment effect of the hike in minimum wage. Here, the assumption we make is in short run labor demand is inelastic, firms need more time to respond to the price(wage) change and thus changing their demand for labor. Because of inelastic demand, an increase in minimum wage doesn't decrease the labor the firm is using in short run.

However, in long run, the unemployment will increase. Firms will reduce the amount of Labor they hire because in long run demand for Labor is wage elastic, firm has got much time to adjust to the price change and with increase in their cost they will decrease their labor demand by greater amount.