How Does Minimum Wage Affect Market Equilibrium Essay

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Introduction

A minimum wage is essentially the lowest remuneration that employers pay their workers legally. It thus acts as a price floor below which workers do not sell their labor. Most countries introduced laws related to minimum wages by the end of the 20th century and New Zealand in fact, became the first country to enact minimum wage laws as early as 1894. The current minimum wage rate is $17.70 per hour in New Zealand and the Coalition Agreement between the New Zealand Labour Party and New Zealand First Party is to progressively increase the minimum wage to $20 by 2020.

There is no denying the fact that an increase in the minimum wage leads to an increase in the standard of living and in a way reduces poverty and encourages people to work. In contrast, this can also lead to mass unemployment (particularly amongst low skilled persons), increase poverty, and can also damage businesses as excessively high minimum wages require businesses to raise the prices of their products to accommodate the expense of higher wages.

The job market is like any other market and markets work best when wages are set by supply and demand, not by any other factor, like government rules. Economics tells us that minimum wage is a bad idea and increasing it can lead to slow economic growth and unemployment, yet there have been many researches and studies that point that there has been little impact on unemployment due to minimum wage policies. According to the minimum wage review of November 2018 by the Ministry of Business, Innovation and Employment, the unemployment rate in New Zealand fell to 3.9 percent and employment increased to 2.8 percent indicating a positive sign for the labour market. (MBIE, 2018)

Economic Analysis of the Labour Market

A firm requires a few inputs like labor, land, and capital to produce some output. The demand for these inputs is not direct or final demand, but a derived demand, reflecting demand for the firm’s output. Each firm simultaneously decides how much output to supply and how much input to demand. The two are closely linked. (Begg, 2003)

The firms always think about producing outputs at the lowest cost possible and then select output that maximizes profit. To produce any output with the cheapest available technique, a rise in the price of labor due to the minimum wage will lead to firms switching towards the more capital-intensive techniques. Conversely, if capital becomes expensive, the least-cost technique for a given output is now more labor-intensive. The firms are away from the factors of production that have relatively become more expensive. This principle helps explain differences in capital-labour ratios in the same industries across different countries. A higher wage will lead to firms substituting capital for labour in making an output which will also lead to an increase in the total cost of producing the output. Firms still use the same labor but are now paying more than before. With higher marginal costs, but unchanged demand and marginal revenue curves, the firm chooses to make less output.

Hence, a simple analysis using the basic supply and demand model tells us that in the long run, the minimum wage will reduce the quantity of labor demanded. The substitution effect leads to the labor demanded getting low for each output, and this, in turn, reduces the demand for all inputs. The following graph shows us the basic supply and demand model in the labor markets.

Graph showing basic supply demand in labor markets

If there was no minimum wage in place the wages would adjust reaching equilibrium, where the demand equals supply and curves intersect. The minimum wage acts as a price floor and economics suggests that if the minimum wage is set above the equilibrium price, more labor would be willing to work than will be demanded by employers, thereby creating unemployment.

Thus, as far as the basic economic model of demand and supply goes, increasing the minimum wage to $20 seems to be a bad idea according to me as it pushes people towards unemployment by creating a surplus. This is an increase of almost 15.25% from the current minimum wage of $17.70. This would also push employers increasingly towards automation and can also lead to businesses getting shut down because they cannot keep up.

The service sector industry of New Zealand accounts for almost 64% of its GDP. There are many small and medium-scale industries operating in and around New Zealand. The country also depends greatly on international trade. An increase in the minimum wage would encourage the youth to work but this may discourage youths from getting education and training leading to the formation of a youth population who are low on productivity, thereby discouraging employers from hiring them. Another major impact of the increase in minimum wage can be the outsourcing of operations by companies. Many companies would prefer outsourcing their functions to countries where there is cheap labor available. This increase can also lead to a decrease in the number of working hours for workers.

There can be some other impacts of this rise in minimum wage like employers cutting down on the benefits that they can provide to their employees like healthcare, training, etc. In small and medium enterprises, the margins are very small, and an increase in wages can lead to negative employment impacts in industries that are labor-intensive like the hospitality and tourism industry. There is also an uncertainty that surrounds businesses that are already burdened by the impacts of environmental laws, government barriers, and industrial relations. A certainty allows businesses to build for the future and respond effectively to increased costs, including the cost of labor.

Conclusion

To achieve the goal of a higher wage economy it is recommended that the government concentrates on making people more productive by providing training rather than relying on increasing wages alone. The youth will be the most affected due to increased minimum wage as this might increase unemployment among them as the employers will look for more experienced workers due to higher minimum wage. It is also recommended that the government provides support to small and medium enterprises by training and coaching them or by providing subsidies and tax rebates so that they can cope if there is an increase in the minimum wage.

To conclude, I believe that the increase in minimum wage can lead to massive unemployment among the youth and can lead to a rise in inflation. There will be people earning the minimum wage rather than a higher wage and increasing it to $20 means that it will be a long time before parity can be achieved. This increase can have a significant impact and can lead to many companies switching their operations overseas, while small and medium-scale enterprises will be the ones suffering the most.

So far no data is backing up the fact that there has been a negative effect of increased minimum wage. According to the review report published by the Ministry of Business, Innovation, and Employment, there has been no significant impact due to increased wages as of now but still increasing the wage by such a huge margin in a short time can have an impact and it is recommended to have a skilled population rather than unskilled population. For now, the wages should remain the same and the focus should shift towards making the youth skilled.

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How Does Minimum Wage Affect Market Equilibrium Essay

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