Price Theory Research Paper

In many countries there is a national minimum wage which employers are required to pay. In the UK, this minimum has never existed in its pure idea; however, the Labor government has committed itself to determine it. Nevertheless, the debate regarding the acceptable minimum payments is still in progress. Nowadays, the rate of the national minimum wage was close to the level set by the Committee on wages, which was formed at the beginning of the twentieth century. The institutions that are responsible for the salary have the right to establish the limits of the minimum wage for workers in those industries where wages are usually low, such as in agriculture, in services (hairdressing), and in foodstuffs and supplies. In 2006, there were 26 committees on wages, which covered 2.3 million workers. The example of the UK shows the way the minimum wage impacts the employment rates.

The Committees on wage were abolished by the Conservative Government in 2007, since the Conservatives were opposed to interference in the functioning of the labor market, giving preference to the forces of a competitive market in which wages are set based on supply and demand. The abolition of the wage committees enabled to resume the debate over the legislation relating to the minimum wage. Therefore, it is necessary to examine the traditional arguments for and against a minimum wage and also consider the results of some recent studies on the problems of the expected decline in employment caused by introducing the minimum wage.

The overall income from wages and salaries is more than 80% of total revenue (Neumark and Wascher 37). For this reason, the price the firm pays for labor as a factor of production is the most controversial in comparison with all the other expenses of the company. It is not surprising that people are extremely concerned about the establishment of wage rates. To reduce poverty, it is necessary to set some minimum wage level (“More on Recent Evidence”). However, the traditional response of economists and some politicians to the proposal to introduce a national minimum wage is to indicate the unintended consequences of this step (Neumark and Wascher 37). Since the establishment of minimum prices tends to reduce the magnitude of demand, opponents of the introduction of the minimum wage argue that it increases the income of a small number of people while depriving many people of almost the entire income.

Supply and demand for labor determine the equilibrium wage rate and total employment in the competitive markets. The market of labor supply and demand of labor (SL and DL) establishes the equilibrium wage rate equal to eight monetary units per hour. At this level of wages in this competitive labor market, all firms hired 40,000 workers (Fig. 1, Part a). It should be noted that more than 40,000 employees are ready to offer their labor, but only if the wage rate will exceed eight pounds at one hour. On the other hand, thousands of people are willing to work at a rate of less than eight monetary units per hour, although they receive a salary equal to the above-mentioned sum. This is for a reason that every employee receives equal pay for equal work, and eight monetary units per hour is a bet that a firm must pay to attract marginal or “last” employee (Neumark and Wascher 37). Thus, each employee receives a salary limit.

To understand the essence of the minimum wage better, it is significant to refer to some special cases. For example, the question relates to the number of employees the Steely Dan & Co Company hires and the wages it pays them. As Steely Dan & Co is the only company operating in a competitive market, its supply curve of labor will be a horizontal line (the SL), at current rates of wages of eight monetary units per hour (see Part b of the Figure 1) (“Revisiting the Minimum Wage”). Steely Dan & Co as a company that takes the existing level of prices (wages) may increase the number of employees (employment level) from one to ten workers without affecting the equilibrium price level (wage rate) of eight monetary units (“More on Recent Evidence”).

Figure 1. The equilibrium wage rate and employment: the market and the individual firm

The decision taken by the number of employees closely resembles the decision on the volume of products. That is why, the company Steely Dan & Co hires equilibrium level of seven workers at the market rate of wages, which is equal to eight monetary units (Card and Krueger 772). Every employee, including the seventh, adds more to the company’s income rather than to it costs (MRPL> We) thus increasing its profits (“Revisiting the Minimum Wage”). If the company hired eight thousand workers, its profit would have been reduced because the additional income generated by this employee would be less than his wage rate.

It is necessary to note that under the conditions of equilibrium each firm pays a wage rate in a competitive market, which is equal to the marginal productivity index of labor profitability (Neumark and Wascher 37). This means that each employee receives the value of his/her contribution to the company – no more and no less. Distribution of workers under conditions of perfect competition is effective as long as distribution of its products is effective.

Nevertheless, the question as to what is the traditional argument presented against the introduction of a national minimum wage remains. Determining the level of wages and employment in the perfect competition market is represented in Fig. 2. The intersection of the supply and demand for labor curve sets the equilibrium wage and employment market as well as equal We Qe respectively. The effect of a minimum wage will cause Wm imbalance (“More on Recent Evidence”).. At the level of wages, given that Wm is equal, the number of low-skilled workers who are willing to hire an entrepreneur (Qm) is less than the number of people willing to sell their labor (Qs). Since the labor force customers (firms) cannot be forced to buy what they do not want, employment declines to the level of Qm (“Revisiting the Minimum Wage”). That is the reason why the minimum wage reduces employment with Qe to Qm. In this sense, the flatter is the curve indicating the demand for labor, the greater it effects employment.
Despite the fact that the impact on employment has always been a central issue in any discussion concerning the establishment of a minimum wage, there is another aspect that is no less important, and namely, the impact of the minimum wage on the total income of workers.

Figure 2. The effect of a minimum wage on a competitive labor market

The minimum wage reduces the number of employees. In this way, it is bought and sold to the level of Qm. In perfect competition, the total labor income will be equal to the value of We • Qe. While determining the minimum wage total income of workers, one may conclude that it is equal to Wm • Qm. The amount Qm workforce keeps their jobs and generates revenue (presented on a rectangular area), while the other (Qe – Qm) lose their jobs at a higher level of wages, which means lost revenue. It is the slope of the demand curve for labor that determines whether the total income of workers after the establishment of the minimum wage was more or less We • Qe (“Revisiting the Minimum Wage”). One must understand that the flatter (more elastic) is the demand curve for labor, the more likely that the total income of workers will decrease with the introduction of the minimum wage.

Labor market model of perfect competition suggests that the minimum wage reduces employment, and that it can also reduce the total income of workers. It indicates that depending on the elasticity of the demand curve for labor, the effects of the minimum wage would be more or less detrimental. Based on this, economists have shifted their attention to the measurement of the elasticity of demand for labor in the assessment of the possible impact of the minimum wage. From this perspective, a national minimum wage level appears to be ineffective way to enhance the welfare of the poorest members of society (“Revisiting the Minimum Wage”). Most researchers confirm that the low-skilled labor demand is elastic with respect to the wages (the demand curve for labor is completely flat). In other words, a slight increase in wages will cause a more than proportional reduction in employment (“More on Recent Evidence”).. Thus, the effect of minimum wages on employment is very significant.

Recently, however, the research into the effect of minimum wages on employment and on the other positions was started. If labor markets are not perfectly competitive, the conditions of perfect competition model may be incorrect. The angle of slope of the demand for labor (the elasticity of demand for labor) may not always be the best indicator of the most likely impact of minimum wages on employment. To investigate this problem, we need to examine how firms reaching maximum profit choose a combination of salary, in particular, employment conditions different from perfect competition market conditions.

Aiming to maximize its profits, the firm will hire a number of employees so that the marginal cost of labor (MCL) will be equal to the marginal labor yields (MRPL). In other words, the company employs a number of workers, while the additional costs of hiring each additional worker can create extra profits. If the firm hires people under conditions of perfect competition market, marginal cost of labor will simply match the constant wage rate. This means that the individual firm has a horizontal labor supply curve (SL = MCL at Fig. 1) (“Revisiting the Minimum Wage”). If the wage offered by the firm will slowly fall below the equilibrium value of wages, no one would want to be hired for this company.

However, employers are not entirely accurate in this description of the situation faced by low-skilled workers, because people do not just change jobs in response to small fluctuations of wages. Finding a new job can be very costly in terms of time and efforts spent, and individuals may not have complete information about the likelihood of alternative job offers (Meer and West). As a direct consequence of the company’s ability to change the amount of wages without losing all its employees, the company will have a curve which is worse than the demand curve for labor. Due to the fact that it gives the company a certain power on the market (it can affect the salary), the labor market cannot be perfectly competitive (Card and Krueger 772). In this situation, the company has some monopsony power. In essence, if a monopolist is the only supplier of goods and services, then a monopsonist is the only buyer of goods and services. Therefore, a monopsonist firm can affect their value more than the current level of wages.

The next issue that arises is how a monopsonist determines the equilibrium quantity for hiring employees. When the firm with monopsony power makes a decision about hiring more workers, it should be against the payment of higher wages. This increased rate of wages is paid not only to the last hired employee but also to the rest of employees. This means that the curve of marginal costs of labor (MCL) is different from the labor supply curve. To maximize the company’s profits, a monopsonist hires workers up to the level at which the MCL equals to MRPL. The equilibrium is reached in a case where the curve intersects the curve MCL and MRPL. Hence, a monopsonist firm hires Qj the number of workers and pays them a salary W1.

Figure 3. Establishment of employment and wages of firm-monopsonist

The determining factor here is that the company-monopsonist pays wages below marginal productivity of labor yields (compared with W1 We). The greater is the gap between the marginal cost of labor (W1) and the marginal productivity of labor yield (We), the more profit the firm will receive by limiting employee. If in such a case the firm sets the level of the minimum wage, it is forced to pay higher wages; while due to the gap between W1 and We increased salaries, this rate does not necessarily hires non-profit workers. Picture 1.5 shows that in the case of setting the minimum rate at Wm, nobody will offer their work below this level. Thus, the company will hire workers in the labor supply curve at the intersection of WMX and MRPL curve. This will indicate an increase in employment (from Q1 to Q2) and an increase in wages. Consequently, the total income of workers will become larger too.
This statement is a matter of the utmost importance. If the firm has monopsony power, according to economic theory, the minimum wage could lead to an increase rather than a decrease in employment. For economists, it is very difficult to determine how many firms have monopsony power in the labor force with low-wage markets. A recent research has set a goal to measure the magnitude of the gap between the marginal cost of labor and the marginal product of labor.

Economists in the UK and the United States are now actively studying the problem of how wages of unskilled workers falls below the level of the marginal profitability of labor. Typically, these studies are based on a review of the information that contains certain evidence and necessary conclusions. According to the recent studies in the US, the growth of the minimum wage in the state of New Jersey by 18% in 2006 led to an increase in employment. Critics of the study objected to this question, although it there were no proos that the increase in the minimum wage had a negative impact on employment (Card and Krueger 772). Multiple researches in the UK does not support any increase in employment following the abolition of the wage committees. One of the reports about the effect of the minimum wage in the agricultural sector (until the abolition of the wage committees in 2007) stated that the introduction of the minimum wage has increased the salaries of low-paid workers, which did not have a negative impact on their employment prospects.

Another study in the UK concerns traditionally low paid sectors such as, for example, homes for the elderly care. 90% of workers earn about 3.50 monetary units per hour, while the normal rate is 3 monetary units for one hour. On this basis, the Labor government now expects a minimum level of wages in the amount of 3 to 4 monetary units (“Revisiting the Minimum Wage”). The study estimated that the wages in the care sector by an average of 15% is lower than the marginal profit. However, this average value does not mean that if the minimum salary will be set in the amount of 3.20 monetary units, it will not reduce the employment rate (Card and Krueger 772). If firms pay wages close to the marginal productivity of labor yields, it has the opposite effect on employment but most companies are not affected. Nevertheless, studies have shown that about 70% of workers do not change their employment preferences after the establishment of the national minimum wage equal to 3.40 monetary units (“Revisiting the Minimum Wage”). Owing to the fact that these studies are typical for markets with low-wage labor, concerns about the introduction of a legislative minimum wage are groundless.

The debates over the national minimum wage often do not have clear information base, since they rely on the economic analysis given in most textbooks. With this approach, the introduction of the minimum wage on a perfectly competitive market leads to an imbalance; the minimum wage acts as a price ceiling, and hence, to a decrease in the quality of products sold. The result is a reduction in overall unemployment and workers’ incomes, which is a negative situation (Meer and West). From this perspective, the minimum wage will bring the greatest harm if the demand for labor will be highly elastic. However, this may be unacceptable for markets with low-wage labor model of perfect competition. For a firm-monopsonist, the introduction of the national minimum wage will mean an increase in employment, and consequently, an increase in the income of low-paid workers. Recent studies in the UK and other countries have confirmed this fact to the monopsonist firms. As a result, it can be stated that the introduction of a minimum wage may help to improve the well-being of the poorest workers.

In conclusion, individuals receive income by selling their labor to firms. The forces of supply and demand in competitive markets combined with production factors determine the price of the factors of production and the amount of supply and demand. Demand factors (labor) are calculated from the demand for the products of the company (or industry). The curve of labor demand reflects the value of the firm where more products manufactured correspond to the unit of labor: MRPL = MPL • MR. In competitive markets, the marginal revenue is equal to (constant) the price of goods, so the demand curve for labor is descending as marginal product of labor decreases due to hiring additional workers in the short-term period. An averagely competitive firm hires a very small number of employees compared to the conditions of perfect competition. Aiming to maximize profits, the firm will increase the number of employees up to the point at which the marginal cost of labor (MCL) will be equal to the marginal labor yields (MRPL). In perfectly competitive markets, labor marginal costs are constant wage rate. Consequently, the individual firm has a horizontal supply curve labor (SL = MCL). The company takes the market wage rate. In that case, if the firms have some market power, the labor supply curve for the firm would be rising.

In such a situation, the firm is called monopsony, and monopsonists can influence their own wages. If the monopsonist pays higher wages, it is paid not only to the last hired employee but also to all other workers. This means that the curve of marginal costs of labor (MCL) is located above the curve that the firm offers. To maximize profits, the monopsonist hires workers up to the level at which the MCL becomes equal to MRPL. The labor market model of perfect competition suggests that the national minimum wage will reduce employment and may result in a decrease in the total income workers. The more elastic (flatter) is the demand for labor, the worse are the repercussions for the minimum wage. Anyway, it is not that markets with low-skilled labor can be better described by a monopsony model. In this case, as suggested by economic theory, the establishment of the minimum wage can increase employment and income of low-paid workers. Recent studies have confirmed the presence of monopsony power, formulating the hypothesis that the minimum wage can improve the financial situation of the poorest workers.