How a minimum wage changes the labour market, and the case for and against it

Equilibrium in the labour market. In the labour market the roles are the reverse of a goods market: households supply labour (hours of work) and firms demand it.

• Demand. A profit-maximising firm hires labour up to the point where the wage equals the value of the marginal product of labour. Because the marginal product diminishes, a higher wage means less labour is hired, so the demand curve for labour slopes downward.
• Supply. The market supply curve of labour slopes upward: at higher wages, more people are drawn to offer work.
• Equilibrium. The wage settles where the two curves cross, at which the hours households wish to work equal the hours firms wish to hire.

What a minimum wage does. A minimum wage law forbids paying less than a stated wage. It is a price floor on labour.

• If it is set at or below the equilibrium wage, it does not bind: the market wage is already at least that high, and nothing changes.
• If it is set above the equilibrium wage, which is how such laws are normally framed:
  • the wage paid rises to the legal minimum;
  • firms move up their demand curve and hire fewer hours than at equilibrium;
  • households move up their supply curve and offer more hours than at equilibrium;
  • the gap is an excess supply of labour at the minimum wage: people willing to work at that wage who cannot find the work.

Example: construction labour in Lucknow. Our own figures. Without the law, the daily wage settles at ₹450, where 10,000 worker-days a week are both offered and hired. A minimum wage of ₹550 a day is then fixed. At ₹550, workers offer 12,000 worker-days but builders hire only 8,500.

• Those still employed earn ₹100 a day more.
• Employment falls by 10,000 − 8,500 = 1,500 worker-days.
• Excess supply of labour = 12,000 − 8,500 = 3,500 worker-days a week offered at the legal wage but not hired.

Are economists in favour? Not without reservations. The demand-supply analysis above shows a gain for some workers and a loss for others, so the answer turns on how the two sides are weighed.

Arguments for.

• Higher pay for low earners. Workers who keep their jobs earn more. Low pay is one of the causes of poverty, since workers with little education can often find only low-paying jobs; a wage floor protects their income, much as support prices protect farmers.
• Equity as a goal of policy. Governments can sometimes improve market outcomes, and the government is needed to pursue equality as well as efficiency.

Arguments against.

• Fewer jobs. At a wage above equilibrium, firms hire less labour, and the excess supply means that some people who want work at the legal wage cannot get it. Those shut out may be the very low-paid workers the law meant to help.
• Prices lose their guiding role. Markets usually organise economic activity well, and controlling a price weakens the price signals that guide buyers and sellers.
• The efficiency–equality trade-off. Policies that redistribute income in favour of the poor tend to come at some cost in efficiency.

Conclusion. A minimum wage set above the equilibrium wage raises the wage of those who stay employed but reduces the labour hired and leaves an excess supply of labour; one set at or below equilibrium has no effect. Economists therefore give a qualified answer: they accept the aim of raising the incomes of the low-paid, but warn that a floor set well above the market wage costs jobs, and many weigh that loss against the gain to those who remain employed.