What's the real impact of the minimum wage?

Economists often disagree on things. One of those ‘things’ is the minimum wage.

Let’s think about minimum wages. A minimum wage is a form of price intervention by governments. They intervene in the free market, they get their hands dirty, to ‘fix’ the equilibrium wage in the market.

You see, by imposing a minimum wage, the government is saying that the equilibrium wage (represented by point A) in the market is too low. It needs to be higher. So, the government sets it higher.

The whole process is laid out in the graph below. The government’s minimum wage (WMIN) is above the equilibrium wage and leads to the quantity of labour supplied (people looking for work, point C) exceeding the quantity of labour required by firms (point B). The result is the excess supply of labour and unemployment.

Some annotated class work about the economic impact of a minimum wage.

But! It’s important to note that this is what economic theory suggests. The reality is far more contested. Economists have a range of views on what actually happens when a minimum wage is imposed, or increased. 

Many economists do not believe that a rise in minimum wages will increase unemployment. Some economists have found that minimum wages may increase unemployment for some groups, such as young workers, but not all workers. And other economists have found that if minimum wages are imposed, employers will look to save money in other areas, such as by reducing the quality of working conditions.

I did a quick look at some of these different views and you can see the video below.

The point is that, in Economics, we need to be able to distinguish between the economic theory and the real world. Sometimes they don’t precisely match up and it’s important for us to point this out.