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In a free market (where there is no trade union or government in intervention) the wage rate is determined by the interaction of market demand and market supply of labour, as also the number of workers employed. In Fig. 25.9 We is the equilibrium rate and Le is the number of hours demanded (or the number of workers employed) at this wage.
The two are determined simultaneously by the intersection of the market demand curve for labour (Ld) and this market supply curve (Ls). If the wage rate goes above the equilibrium level We, there will be excess supply of labour and if the wage rate is below We, then there will be an excess demand for labour.
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In equilibrium the wage rate We will be the same across all the industries among which labour is freely (completely) mobile. If one industry pays a higher wage rate, the workers from other industries will move to it. The process will continue until any wage discrepancy is eliminated.
In other words, if labour is completely mobile the forces of competition will lead to equalisation of marginal products of labour across industries and regions and thus the wage rates will also be equalised. This prediction of the marginal productivity theory of wages is based on the assumption that labour is a homogeneous factor. This means that workers are all alike in skill, ability and efficiency. Thus inter-individual and inter-sectoral wage differences are ruled out. This, however, is not found in the real world where labour markets are not perfectly competitive.
An increase in market demand for labour will lead to a rise in the wage rate and the level of employment. A fall in the market demand for labour will reduce the wage rate as also the level of employment. An increase is market supply of labour will lead to a fall in the wage rate. The converse is also true. A fall in market supply of labour will lead to a fall in the wage rate.
Effects of Minimum Wage Law:
Various government policies often affect the demand for labour, supply of labour, and the equilibrium in the labour market. One such thing is imposition of a minimum wage. The term minimum wage refers to various legal restrictions on the lowest wage rate payable by employers to workers. Its initial base is rooted in concern about the equity of market processes. It is usually in the context of the social criterion of poverty reduction that minimum wage legislation has to be judged.
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If the minimum wage law is to be effective, then it (W) has to be fixed above the market clearing (equilibrium) level (We). An effective minimum wage law will generate unemployment. In Fig. 25.10 the level of employment is 0L0 before the imposition of the minimum wage W.
As a result the level of employment falls from 0L0 to 0L1. But at this wage the number of job-seekers is larger (0L2). More workers will join the labour force, and those already working will want to work longer hours. Thus;
L1L0 = decline in employment hours and
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L0 L2 = increase in the quantity of labour supplied.
Therefore, L1L2 = L1L0 + L0L2 = magnitude of involuntary unemployment (in hours), which is higher than the fall in employment L1L0 induced by the minimum wage law.
Relative Effect of Minimum Wage Law:
Minimum wage laws are passed to ensure equity. Whether this can be achieved depends on the slopes of the demand and supply curves of labour. This point is illustrated in Fig. 25.11.
In case (a) the fall in employment L1L0 is very small, although the magnitude of unemployment L1L2 is high. Most of this unemployment comes from L0L2, the increase in the number of job-seekers In case (b) the fall in employment L0L1 is very large and accounts for most of the unemployment L1L2. In this case the social cost of minimum wage legislation is greater than that in the first case.
Segmented Labour Markets:
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However, the above analysis applies if all workers are covered by the law. If there is only partial coverage, there may not be any increase in unemployment. The reason is that the unemployed workers in the covered sector will switch sector and seek employment there. This will depress the wage rate in the uncovered sector. Thus, with effective minimum wage legislation, the wage rate in the covered sector goes up and that in the uncovered sector goes down. This point is illustrated in Fig. 25.12.
Initially, the wage rate is w0 in both the sectors. Employments Lc in the covered sector and Lu in the uncovered sector. With a minimum wage W in the covered sector, employment falls to L’c.The unemployed workers (Lc – L’c) try to find job in the uncovered sector. The wage rate in the uncovered sector falls to W1 so that the increase in employment (L’u – Lu) is less than (Lc – L’c).
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This is because some workers will leave the market as the wage rate falls. At the same time all the unemployed workers (Lc – L’c) cannot switch from Recovered sector and find employment in the uncovered sector. Thus there will be a certain amount of unemployment. But the unemployment will be less than that with total coverage.
The main objective of minimum wage laws is to promote a more of income by raising the wages of low-paid workers. But the wage rate in the covered sector rises and that in the uncovered sector falls, thus promoting a greater wage disparity.
The low-wage earners in the uncovered sector are likely to get still lower wages because of increased pressure in this market coming from the unemployed in the covered sector. Thus the cure may be worse than the disease and the neglect of indirect effects is the common source of all fallacies.
Alternatively stated, the income distribution consequences are likely to be the opposite of what were intended. Some workers will succeed in getting job in the covered sector at a higher wage but others will be either unemployed or employed in the uncovered sector at a lower wage.
Deficiencies of the Scheme:
George Stigler has pointed out that there are certain potential deficiencies of the minimum wage legislation as anti-poverty device.
The following three points may be noted in this context:
(i) Fall in Employment:
Employment may fall more than in proportion to the wage increase from the minimum, thereby reducing earnings. Wage rates in uncovered sectors may decrease more than those in the covered sector rise as the uncovered sector is forced to absorb the workers released by the covered sector.
(ii) Income Distribution:
The impact of the legislation on family income distribution may be perverse unless the fewer but better jobs are allocated to members of needy families rather than to low wage workers, most obviously teenagers, from wealthier families.
(iii) Opportunity Cost:
A crucial insight by economists is that minimum wage legislation alters the opportunity set of the least able but does not unambiguously expand it The legal restriction that employers cannot pay less than a specified wage is equivalent to the legal stipulation that workers cannot work at all in the protected sector unless they find employees willing to hire them at that wage.
Larger minimum wage restriction would presumably raise covered worker welfare and employer costs. An adjustment employers could make to an increase in the minimum wage would be an increase in effort demand or a reduction in the convenience (or number) of scheduled work hours. Perhaps the most serious concern about minimum wage law is the potential for a reduction in the provision of on-the-job training to the youth.
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