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Labor Market Equilibrium and Surplus to Firms and Workers

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.

i) Consumer/firm surplus
ii) Producer/worker surplus
iii) Total surplus
iv) Resources lost in job search
v) Deadweight loss (2 marks)

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:

i) Firms are better off?
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:

i) Consumer/firm surplus
ii) Producer/worker surplus
iii) Total surplus
iv) Deadweight loss.

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? Explain.

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.

Labor Market Equilibrium and Surplus to Firms and Workers

Question 1 

Minimum wage refers to the price floor that government of a nation implements to ensure a minimum payment for the workers. Wages paid below the set minimum limit is considered as illegal.

A minimum wage is said to be binding when it is set above the equilibrium wage. Minimum wage set below the equilibrium wage does not have any impact on the labor market as workers in such a market are already receiving a higher wage.

Question 2 

The national minimum wage per hour in Australia for an adult worker is $18.93.

Question 3 

Demand and Supply curve of unskilled labors are given as

D = 1,500,000 – 60,000W

 S = 120,000W – 1,200,000

Question 4

i) D = 1,500,000 – 60,000W

The maximum wage that firm willing to pay is given as

ii) S = 120,000W – 1,200,000

The minimum wage cost for labor is

Question 5

Fair Work Commission imposes a minimum wage of $19.

At this wage,

Labor demand is obtained as Corresponding to minimum wage, Labor supply is obtained as

ii) At the minimum wage, supply of labor exceeds that of the demand. This creates a surplus of labor in the market.

Question 6

i) Given the minimum wage of $19

Consumer surplus is equivalent to the triangular area A

ii) Producer or worker surplus corresponding to set minimum wage is equivalent to the area (B + C)

Question 7 

i)

After the imposition of minimum wage, firms have to pay a higher wage to the workers.  This reduces surplus to firms from 3,000,000 to 1,000,000. The firms are thus worse off after the minimum wage.

ii)

Workers on the other hand get a higher wage per hour after the minimum wage. Surplus to workers thus increases from 1, 500,000 to 2,700,000.

iii)

The reduction in consumer surplus exceeds that of the increase in surplus to workers. As a result, there is a decline in overall surplus from 4,500,000 to 3,780,000.

Question 8

i)

There will be no change in consumer surplus. It remains to the earlier level of 1,080, 000.

ii)

If resources lost in the job search given to the producers, then surplus to workers increases to

(2,700,000 + 2880000) = 5,580,000

iii)

Total surplus increases to (1, 080, 000 + 5, 580, 000) = 6, 660, 000

iv)

There would be no deadweight loss under this condition.

Question 9 

After reallocation of resources, there is no change in welfare of firms. The workers however receive a higher surplus compared to the estimation in part (7). As there is a significant amount of resource lost because of minimum wage, this when adds to producers’ surplus offset both loss in consumer surplus and deadweight loss. Consequently, there is an increase in social welfare.

Consumer Surplus and Deadweight Loss

Question 10

Allocative efficiency refers to the situation where goods and services are distributed optimally among different members of the society. More precisely, allocative efficiency is achieved corresponding to the point where price is paid equivalent to the marginal cost of production. At this point, price reflecting willingness to pay of buyers match with the price at which sellers are willing to sell the product. The optimal distribution hence is determined from equality between marginal utility and marginal cost.

Minimum wage is a form of price intervention that set a legal minimum wage. Government intervention in the form of minimum wage fails to bring allocative efficiency. There is a mismatch between labor supply and labor demand. At higher wage, labor supply exceeds the labor demand at that wage. The marginal cost to workers in supplying labor is less than the marginal benefit enjoyed by them. Workers are benefitted at the cost of reduced surplus to firms. Workers receive more than marginal cost. Moreover, there is a welfare cost and a cost for lost resources in job search. Minimum wage thus fails to ensure allocative efficiency

Question 11

The minimum wage increases remuneration to the workers. As wage increases, workers are encouraged to supply more labor hours at the given wage. Employers on the other hand face a higher cost of workers. This reduces demand for labor hours from 600,000 to 360,000 hours. Supply of labor hour on the other hand increase from 600,000 to 1,080, 000 hours. Consequently, there is a surplus of unskilled labor hours amounting to 720,000 hours. The excess labor hours lead to unemployment in the economy. The unskilled laborers who get higher wage enjoys a higher standard of living. Workers who lost their jobs suffers a decrease in living standard. There is loss in resources resulted due to job searching by the unemployed workers.

The minimum wage thus increases living standard of only a fraction of unskilled laborers. Others on the other hand experiences a decrease in living standard from losing jobs. The practice of levying minimum wage to increase living standard of unskilled workers is not ethically right as instead of increasing welfare of all the unskilled workers it increase welfare of only a small fraction of workers.

Question 12 

From the previous discussion, welfare comparison of free market equilibrium and that of minimum wage suggest that after minimum wage, unskilled laborers remaining in the labor force get a higher surplus. Consumers or firms receive a lower surplus from the higher wage. There is a decline in total surplus in the economy. There is a resulted inefficiency from reallocation of resources. The cost from inefficiency is termed as dead weight loss. Resources are also lost from job searching of unemployed workers. Hence, from the welfare perspective, practice of minimum wage is socially inefficient.

The minimum wage legislation though intends to increase welfare but it often hurts those whom it targets to protect. Under free market condition, without any legislation, workers are given equilibrium wage. The binding minimum wage that sets the wage above equilibrium creates unemployment among the unskilled workers. The minimum wage thus though helps a fraction of workers but hurt others more by causing them to lose their current jobs.

References list 

"Welcome To The Fair Work Ombudsman Website." Fair Work Ombudsman. N.p., 2018. Web. 1 Oct. 2018.

Basu, Kaushik, et al. "Regulation, Minimum Wage and Informality: Introduction to Symposium." Review of Development Economics 21.4 (2017): 935-938.

Booth, Alison L. "Wage determination and imperfect competition." Labour Economics 30 (2014): 53-58.

Gerritsen, Aart. "Equity and efficiency in rationed labor markets." Journal of Public Economics 153 (2017): 56-68.

McCluskey, Martha T., Frank Pasquale, and Jennifer Taub. "Law and Economics: Contemporary Approaches." Yale Law & Policy Review 35.1 (2017): 10.

Meer, Jonathan, and Jeremy West. "Effects of the minimum wage on employment dynamics." Journal of Human Resources 51.2 (2016): 500-522.

Weiss, Andrew. Efficiency wages: Models of unemployment, layoffs, and wage dispersion. Vol. 1192. Princeton University Press, 2014.

Wood, Aaron D. "A model to teach non-rival and excludable goods in undergraduate microeconomics." International Review of Economics Education 24 (2017): 28-35.

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