Question

Now suppose that the labour market is perfectly competitive (i.e. there are many firms in the labour market and they take the market wage as given). Explain using a graph or in clear words how introducing a minimum wage can decrease employment.

Answer 1

As per the above perfectly competitive labor market diagram, at market equilibrium, the wage rate is W and at firm level the workers employed are Q1 and at the industry level, the workers employed are Q'. Once, the minimum wage is applied as Wm, then industry level demand of workers decreases to the level of Q'' and at firm level, it comes down to Q2. It means that minimum wage is going to create unemployment at the firm level by (Q1-Q2) and at industry level by (Q'-Q''). It is due to the reason that industry makes decrease in quantity demanded to offset the increased level of cost due to the higher minimum wage. It leads to increase in unemployment or decrease employment.