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Equilibrium Wage Rate and Labour Market Analysis

Q1. From the perspective of economic theory, what is a minimum wage and when is it binding?

Q2. According to the Fair Work Commission’s National Minimum Wage Order for 2018 (available on it’s website), what is the national minimum wage per hour in Australia for an adult worker?

The following information will be used for the remaining 10 questions. Assume that the market for unskilled labour in Australia is a competitive market and can be described by the following demand and supply curves:

D = 1,500,000 – 60,000W

S = 120,000W – 1,200,000

Where W = wage rate per hour for labour, D is hours of labour demanded and S is hours of labour supplied.

Q3. Calculate the equilibrium wage rate and quantity of unskilled labour employed. Draw a diagram to illustrate your answer.

Q 4. Show on your diagram and calculate the size of the:

(i) Consumer/firm surplus

(ii) Producer/worker surplus

(iii) Total Surplus

Q5. Suppose that the Fair Work Commission imposes a minimum wage of \$19 per hour.

(i) How many hours of employment are exchanged in the market?

(ii) Calculate the size of the surplus or shortage of hours created by the imposition of the minimum wage.

Q6. Assume that a minimum wage of \$19.00 per hour is introduced. However, there is no change in either the Supply or Demand equations used in Question 3. Draw a new diagram and label the minimum wage. This diagram should be at least ½ A4 page in size.

Calculate and show on the diagram:

1. i) Consumer/firm surplus
2. ii) Producer/worker surplus

iii) Total surplus

1. iv) Resources lost in job search

Q7. In answering the following questions, base your responses on what has happened to the relevant surplus.

Following the introduction of the minimum wage explain if:

1. i) Firms are better off?
2. ii) Workers are better off?

iii) Society is better off?

Q8. Now assume that the resources lost in job search calculated in Q6 are actually captured by producers (workers). In other words, now assume that no resources at all are lost in job search activity.

Re-calculate the following:

1. i) Consumer/firm surplus
2. ii) Producer/worker surplus

iii) Total surplus

Q9. Based on your re-calculations in Q8, do your conclusions reported in Q7 change?

Q10. Consider your responses in Q7 and Q9. From a consequentialist perspective that has as its objective allocative efficiency, is the introduction of a minimum wage ethically justified?

Q11. Consider your responses in Q7 and Q9. From a consequentialist perspective that has as its objective improving the standard of living of unskilled workers, is the introduction of a minimum wage ethically justified?

Q12. From a deontological ethical framework, construct an argument either in favour of a minimum wage or against it.

Equilibrium Wage Rate and Labour Market Analysis

A minimum wage is the lowest amount of payment that the employer needs to pay to the employee (i.e. the wage earners) for a set period of time which cannot further reduced by an set of contract or agreement (Jardim et al. 2017). Binding minimum wage is set above the wage equilibrium level where the firms are forced to pay and are not willing to hire at this particular wage.

As per Australia’s national workplace relations tribunal (“Fair Work Commission”), the minimum wage rate for an adult is \$18.93 per hour and if calculated based on a week of 38 hours, then it would be \$719.20 per week (FWC 2018).

To calculate equilibrium wage rate, labour demand and labour supply should be equal for hours of labour.

Here, Labour demand = Labour supply

è1,500,000 – 60,000W = 120,000W – 1,200,000

è 120,000W + 60,000W = 1,500,000 + 1,200,000

è180,000 = 2,700,000

èW = 2,700,000/180,000 = 15

Unskilled labour at the existing wage rate can be given as

=1,500,000 – 60,000W

= 1,500,000 – 60,000 * 15

= 1,500,000 – 900,000

= 600,000

Hence, equilibrium wage rate = \$15 with 600,000 as quantity of unskilled labourers

Diagrammatically, it can be presented as given below.

D = 1,500,000 – 60,000W

The maximum a firm is prepared to pay to its workers is given by W1

èW1 =  1,500,000/ 60,000 = 25

S = 120,000W – 1,200,000

The minimum a firm is supposed to pay as cost for labour is given by W2

èW2 =  1,200,000/ 120,000 = 10

Part 4i)

Consumer Surplus or Firm’s Surplus = ½ * base * height

è Consumer Surplus = ½ * 600,000 * (25-15)

è Consumer Surplus = ½ * 600,000 * 10

èConsumer Surplus or Firm’s Surplus = ½ * 6,000,000 = 3,000,000

Part 4ii)

Producer Surplus or worker’s Surplus = ½ * base * height

è Producer Surplus = ½ * 600,000 * (15-10)

è Producer Surplus = ½ * 600,000 * 5

è Producer Surplus or Worker’s Surplus = ½ * 3,000,000 = 1,500,000

Part 4iii)

Total Surplus = Firm’s Surplus + Worker’s Surplus

è Total Surplus = 3,000,000 + 1,500,000

èTotal Surplus = 4,500,000

Part 5i)

When the FWC puts forward a minimum wage of \$19, the hours of labour exchanged in the market can be given as

Hours of Labour demand  = 1,500,000 – 60,000W = 1,500,000 – 60,000 * 19 = 1,500,000 – 1,140,000 = 360,000

Hours of Labour Supply = 120,000W – 1,200,000 = 120,000 * 19 – 1,200,000 = 2,280,000 – 1,200,000 = 1,080,000

Part 5ii)

Surplus Calculation and Analysis

At \$19, minimum wage, hours of supply labour exceeds demand.

The difference of Hours of Labour Supply – Hours of Labour demand = 1,080,000 – 360,000 = 720,000

Calculation when minimum wage = \$19

Part 6i)

Consumer surplus = A = ½ * base * height

è Consumer Surplus = ½ * 360,000 * (25 - 19)

è Consumer Surplus = ½ * 600,000 * 6

èConsumer Surplus or Firm’s Surplus = A = ½ * 3,600,000 = 1,080,000

Part 6ii)

Producer Surplus or worker’s Surplus = B + C

è B = 360,000 * (19 - 15) = 360,000 * 4

è B = 1,440,000

C = {(C + D) – D}

èC = {( ½  * 600,000 * (15 - 10)) – ( ½ * (600,000- 360,000) * (15 - 13))}

èC = ( ½ * 600,000 * 5) – ( ½ * 240,000 * 2)

èC = (½ * 3,000,000) – (1* 240,000)

èC = 1,500,000 – 240,000

èC = 1,260,000

Producer Surplus or worker’s Surplus = B + C = 1,440,000 + 1,260,000 = 2,700,000

Part 6iii)

Total Surplus = Firm’s Surplus + Worker’s Surplus

è Total Surplus = 1,080,000 + 2,700,000

èTotal Surplus = 3,780,000

Part 6iv)

F = Resource Cost

Resource Cost = (E + F + G) – E – G

E + F + G= Length * breadth

èE + F + G = (1,080,000- 360,000) * (19 - 15) = (720,000 * 4) = 2,880,000

E = ½ * base * height

èE = 0.5* (600,000 - 360,000) * (19 - 15) = ( ½ * 240,000 * 4) = 480,000

G = ½ * base * height

èG =  0.5* (1,080,000 – 600,000) * (19 - 15) =( ½ * 480,000 * 4) = 960,000

Resource Cost = (E + F + G) – G – E = 2,880,000– 960,000 – 480,000 = 1,440,000

Part  6v)

D + E = Dead Weight Loss

èE = 0.5* (600,000 - 360,000) * (19 - 15) = ( ½ * 240,000 * 4) = 480,000

èD = 0.5* (600,000 - 360,000) * (15 - 13) = ( ½ * 240,000 * 2) = 240,000

Dead Weight Loss = E + D= 480,000 + 240,000 = 720,000

Firms better off position can be analysed from consumer’s surplus. After the imposition of minimum wage, the surplus has decreased to a greater amount by (3,000,000 – 1,080,000) = 1,920,000 stating the firm is in a worse off condition after the minimum wage.

Part 7ii)

Impact of Minimum Wage on Firms, Workers, and Society

The worker’s have been enjoying the additional surplus after the imposition of minimum wage. The surplus after \$19 imposition has increased by (2,700,000 – 1,500,000) = 1,200,000 receiving a high wage per hour.

Part 7iii)

The society has been facing a dead weight loss situation with resource lost. Earlier before minimum wage, the wage rate (\$15) was at equilibrium with no welfare loss. However, after imposition of minimum wage, there is dead weight loss of 720,000. Also, with the decline in firm’s surplus, the worker’s surplus has increased but shows a total decline in total surplus from 4,500,000 (\$15 wage rate) to 3,780,000 (\$19 minimum wage rate).

Resource cost captured by the workers

Part 8i)

Consumer surplus = A = ½ * base * height

è Consumer Surplus = ½ * 360,000 * (25 - 19)

è Consumer Surplus = ½ * 600,000 * 6

èConsumer Surplus or Firm’s Surplus = A = 1,080,000 (it remains the same as it is)

Part 8ii)

Earlier Producer Surplus or worker’s Surplus = B + C = 1,440,000 + 1,260,000 = 2,700,000

Resource Cost = (E + F + G) – F – E= 2,880,000– 960,000 – 480,000 = 1,440,000

DWL = E + D = 480,000 + 240,000 = 720,000

Total Worker’s Surplus = B + C + (E + F + G) – F – E + E + D = B + C + G + D = 2,700,00 + 1,440,000 + 720,000 = 4,860,000

Part 8iii)

Total Surplus = Firm’s Surplus + Worker’s Surplus

è Total Surplus = 1,080,000 + 4,860,000

èTotal Surplus = 5,940,000

Part 8iv)

No DWL as it is considered under the worker’s surplus

The calculation done in part 7 change from part 8. This is because as the resource cost in job is considered to be under worker’s surplus. It creates an additional surplus for the workers with no change in firm’s surplus. Moreover, the total surplus increases by increasing social welfare in the economy.

Ethically, setting up of higher minimum wage was the means to reduce unemployment and to fire the unproductive workers. As  a result, it started creating allocative inefficiencies by not distributing the equality of marginal benefit and marginal cost such that the employers paying the wage should be willingly accepted by the workers for a fixed period (Cothren and Radhakrishnan 2018). However, this willingness was lost for the skilled labourers creating a disparity in labour demand and supply (Altman 2016). The marginal cost of labour supply was less than the marginal benefit received by workers. In addition, it not only hampered the welfare of the economy but also created inequality in wages.

The workers receive extra benefit when the minimum wage rate is imposed by the government. As there is increase in wage, the workers supply with more hours of labour and the firm is directed to hire for labour with a higher level of cost (Atkinson and Storey 2016). However, creating excess labour supply in the market further leading to unemployment. Although, the worker’s standard of living improves at the minimum wage rate but due to hiring restriction by the firms; the workers who get unemployed or remain unemployed suffer dearly by creating additional reserve of job resource cost (Ehrenberg and Smith 2016). It is not ethically justified, that the existing unskilled labourers have higher standard of living by neglecting the social welfare in the economy only by a portion of workers.

Minimum wage that is binding in nature leads to disequilibrium as the market is diminished by demand followed by excess supply of labour creating allocating inefficiencies. Moreover, it is not considered to be an appropriate tool for redistribution (Gerritsen and Jacobs 2016). The minimum wage set by the government is to maintain standard of living but it oversimplifies not only the unskilled labour market but marks to generate equivalent productivity (Jardim 2017). However, for unskilled workers the binding wage rate can be considered as a boon but for skilled labourers is the restriction imposed on their capabilities.

Without the minimum wage rate, when the economy is operating with the forces of demand and supply, the equilibrium doesn’t distinguishes between skilled and unskilled labourers. Also, it creates unemployment in the economy as the firm is not ready to hire more unskilled labourers at this binding rate. As a result, the skilled labourers might lose their job further creating a decline in surplus for the economy.

References

"National Minimum Wage Orders". 2018. FWC. https://www.fwc.gov.au/awards-and-agreements/minimum-wages-conditions/national-minimum-wage-orders.

Altman, Morris. "The living wage, economic efficiency, and socio-economic wellbeing in a competitive market economy." In Forum for Social Economics, vol. 41, no. 2-3, pp. 166-186. Routledge, 2012.

Atkinson, John, and David J. Storey. Employment, the small firm and the labour market. Routledge, 2016.

Cothren, Richard, and Ravi Radhakrishnan. "Productivity growth and welfare in a model of allocative inefficiency." Journal of Economics 123, no. 3 (2018): 277-298.

Ehrenberg, Ronald G., and Robert S. Smith. Modern labor economics: Theory and public policy. Routledge, 2016.

Gerritsen, Aart, and Bas Jacobs. "Is a minimum wage an appropriate instrument for redistribution?." (2016).

Jardim, Ekaterina, Mark C. Long, Robert Plotnick, Emma Van Inwegen, Jacob Vigdor, and Hilary Wething. Minimum wage increases, wages, and low-wage employment: Evidence from Seattle. No. w23532. National Bureau of Economic Research, 2017.

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