The Concept of the Minimum Wage - Essay Example

Minimum Wages The purpose of this essay is to critically evaluate the fact that an increase in the minimum wage causes a reduction of the employment by the firms. The generally accepted principle is that this is true. However there are some theories and facts that stated otherwise. Considering both the statement and the alternate theories, the paper tries to evaluate the applicability of this notion in the real world. The Concept of the Minimum Wage According to Waltman (2000), minimum wage is the lowest hourly wage that can be paid to a worker by a firm. In order to ensure that the rights of the workers are safeguarded, usually the governments focus on the increases in the minimum wage. Kosters (1996) states, that the increase in the minimum wages has varied implications on the firms and on the employment of the workers, especially the unskilled and the teen workers. The reason for this is explained by economic theory. Economic theory argues that as the minimum wage is increases; the least wage that is paid by the firm to the worker is increased. As a consequence, the cost of the production of the firm increases and, as Kosters (1996) points out (see chart 1 and chart 2 in Appendix). Since profit maximization and cost minimization are two objectives that the firms want to achieve, the firms concentrate on reducing their costs because of the increase in the minimum wages. The easiest way of the firms in such a case is to fire some of its workers and, as a result, the employment falls. The firms may also not be keen to hire more workers because of the cost constraints they face. The theory about the increases in the minimum wage and the adverse effects on the labor markets has been substantiated by the evidence from many nations. Usually, it is observed that the countries with the highest minimum wages have the highest unemployment rates. According to Chapman (2004), the three states in the US namely Washington, Alaska and Oregon have the highest implemented minimum wages and so the highest unemployment rates. The research director of the employment polices, Craig Garthwaite, has been noted as saying the following. ‘It is perhaps no coincidence that the three states with the highest minimum wages in the nation—Oregon, Washington, and Alaska—are among the five states with the highest unemployment rates in the nation’ The relation of the employment and the minimum wages may be true to some extent. However, economists now argue that the theory is based on oversimplifications and that the increases in the minimum wages. The paper will now focus on why the minimum wage hikes may not decrease the employment. Findings and Analysis Recently different studies have shown that increases in the minimum wages may not increase the unemployment rates. This is what President Clinton also said in one of his speeches in 1996, as Zavodny (1998) relates. Studies like that of Neumark and Wascher (1995), Wellington (1991); Card, Katz, and Krueger (1994) have shown that the minimum wages may not necessarily have affects on the employment level in the country or state. According to Card (1994), in 1988 as the minimum wage was increased, the employment did not fall in the US. The same trend was observed as he studied the era from the 1950s to the 1980s. Chapman (2004) also argues that the effect of the minimum wages on the employment may not necessarily be negative. He substantiates this fact by stating that there has been a weak connection between the unemployment and the minimum wage on the national level and the states (see chart 3 in Appendix). According to him (2004), many states in the US in 2003 were observed to have very high unemployment rates despite the fact that the minimum wages were not altered. Also, some of the states of the US that increased the minimum wages had very small effects on the employment level that is around 5 %. The recent data, therefore, suggests that the model that relates the higher national minimum wages to the higher unemployment rates is an oversimplified one. Chapman (2004) argues that the effect of the minimum wages on the employment is not properly studied because the economists have assumed many things. The first and the most important assumption is that the labour market is taken as a competitive market. The competitive market, according to Zavodny (1998), comprises of homogenous workers and perfectly competitive identical firms. This model assumes that the workers will have to be paid more so that they can be motivated to work more. The wages have to be increased so that the marginal product of labour or the additional labour is increased. This assumption leads to the firms having upward sloping supply curves, and downward sloping demand curves that are both responsible for the determination of the equilibrium wages. Since this model is employed, it can be shown graphically that the increase of the minimum wages disturb the equilibrium. Wages that are greater than the equilibrium, under this model, pertain to less labour demand by the firms and an increased labour supply. The result of this is that unemployment is increased in the economy. This is not what happens in the true world. In reality, the firms are not identical and the workers not homogenous. Chapman (2004) argues that the firms in the real world have greater powers over the determination of the prices and the wages, Hence they are not just price takers. The firms, this way, have more power over their wage policies and the equilibrium wages. Also, the determination of the wages may not just depend on the market forces as in the competitive model. It is likely that the employers and the firms themselves alter the wages without giving any weight-age to the market forces. As a result, the assumption is invalid. Chapman (2004) also argues that the low wages should be actually better for the firms and the workers. Even with lower wages, the firms may expect to have a high turnover. Since the firms may pay lower wages, there is a chance that the firms invest in the workers and are more ready to incur the costs associated with the training and the recruitment of the workers (because of the lesser costs incurred already). As a result, the firms and the workers may both be satisfied even with the lower wages. Therefore Chapman (2004) believes that the minimum wages need not to be increased. Alternative Economic Models The contradictory relationship of the wages and the employment can be explained by some economic models in detail as Zavodny (1998) explains. The first model that needs to be considered is the price effects model. According to Zavodny the minimum wage unemployment model does not consider the effects on the prices. The increases in the minimum wages that reduce employment have direct effects on the output of the firms. As the labour falls, the total output of the firms decrease. In such a model if the demand curve is inelastic or is vertical, the effect of the price change does not let the employment to fall. Hence, if the prices are taken into account and the demand for the labour is considered, the employment may actually not fall due to a change in the minimum wage. Some of the theories actually propose that the minimum wages have positive effects on the employment levels in the countries. The model explained below is one. The ‘hungry teenager’ theory also explains why the minimum wages may not affect the employment negatively. According to Card and Krueger (1995), the increase in the minimum wages may increase the incomes of some of the workers. These workers may increase their consumption by spending on certain goods. Because of an increase in the consumption, the demand for the goods may rise. The direct result of this is that the firms would need to produce more so that the higher demand can be met and higher revenues are earned. As a consequence, the firms may be motivated to hire more workers despite the rise in the minimum wages and so the employment may actually rise. Conclusion To conclude, the statement that an increase in the minimum wage causes a reduction of the employment by the firms may be valid to some extent and may apply to some cases, however the reliability of this statement is questionable. Various studies have shown that the minimum wages may not have any or very little negative effects on the employment. Also, the assumptions regarding the model that relate the two are not practical. The notion of the labour market being a competitive one is a myth according to Card and Krueger (1995). Models like the price effects model and the hungry teenager model are more reliable and practical in determining the relation between the two economic variables. Since the employment level is very important for an economy, a lot of research needs to be done to find the ‘true’ relation between the minimum wages and the employment by the firms. Appendix Chart 3 References Card, D and Kruger, A. (1995) Myth and measurement: the new economics of the minimum wage. UK. Princeton Press Chapman J. (2004). Employment and the Minimum Wage—Evidence from Recent State Labor Market Trends. USA. EPI Kosters, M. (1996).The Effects of the Minimum Wage on Employment. USA. AEI. Neumark D, and Wascher, W. (2003). Minimum Wages, Labor Market Institutions, and Youth E,ployment: A cross-National Analysis. USA. Federal Pulications. Partridge,M and Partridge,J. (1999).Do minimum wage hikes reduce employment? State-level evidence from the low-wage retail sector. USA. Springer New York. Waltman, J. (2000). The Politics of Minimum Wage. USA. University of Illiniois Press.  Zavodny, M. (1998). Why MinimumWage Hikes May Not Reduce Employment. USA. Federal Reserve Bank of Atlanta Read More