AS Economics Again
I’ve just been doing some economics past paper questions. Not wanting to exclude you from the fun, I’ve decided to type out one of my answers. If you think what I usually write is cobbler’s, just wait until you read this!
WJEC – EC2
b. Using a diagram, discuss the view that a significant rise in the national minimum wage would be good for the UK economy. (What is there to discuss?)
The National Minimum Wage is a price floor for labour. If the minimum wage is raised significantly, then the wage floor has risen significantly meaning nobody can be paid less than the floor. The effect is to raise some people’s wages as more low paid jobs are now illegal and firms must pay the minimum wage or more to their employees.
(Insert price floor diagram – drawn in pen and without a ruler – with ‘Labour Market‘ as a title. Imagine two different price floors, one a little bit higher than the market price ‘wage min’ and another significantly higher ‘wage min 2’.)
Raising the national minimum wage significantly from wage min to wage min 2 will significantly increase the supply of labour by Q3-Q1. This is because, at wage min 2, the producer surplus for labour has increased by a large amount, making it more profitable to supply in the labour market. Presumably, this addition of supply will come from some who had previously chosen not to work, perhaps living on benefits. Therefore, in terms of the UK economy, this rise in the minimum wage will reduce the numbers of people on benefits if they get jobs which will mean a reduced welfare budget thus allowing the government to meet its target on deficit reduction more easily (really, why didn’t the coalition just increase it to £100 per hour?).
In addition, due to the raising of the wage floor, this might help reduce poverty (of course, that old chestnut) as fewer of those in work would be in low-paid jobs. As a result, consumer spending could be expected to pick up as people may end up with more disposable income. As aggregate demand is largely made up of consumption, this move would thus potentially stimulate aggregate demand, thereby boosting output (I just took you from increasing the minimum wage to boosting output. I’m thoroughly ashamed of myself. I will, however, get a decent amount of marks for something like that in my exam next month.)
On the other hand (this is when whatever I must have been smoking evidently wore off), a significant increase in the minimum wage would worsen the disequilibrium caused by the wage floor. The disequilibrium ensues because the consumer surplus for employers is reduced thus reducing their quantity of labour demanded all the while the quantity supplied actually increases.
A significant fall in the quantity of labour demanded may (by which I mean “will”) result which may (by which I mean “will”) be measured by Q2-Q4. Therefore, unemployment may (by which I mean “will”) increase. If (by which I mean “when”) unemployment increases, those newly unemployed will have no income so therefore a fall in consumption is to be expected, thus reducing aggregate demand and thereby reducing output.
Furthermore, by reducing the amount of workers in the economy, the move may (by which I mean “will”) cause aggregate supply to shift to the left since with fewer workers one would expect less to be produced and hence supplied. The shift to the left in aggregate supply could potentially (by which I mean “would definitely”) lead to inflationary pressure as supply contracts and prices rise.
How a significant rise in the national minimum wage affects the economy would depend on how price elastic the demand for labour is. If it is perfectly inelastic, for example, then no reduction in quantity demanded would result and hence no reduction in aggregate demand or aggregate supply. However, as there clearly is unemployment in the economy and not all of it is ‘voluntary’, it is reasonable to assume that the demand for labour is wage elastic. Therefore, economic theory would predict an increase in unemployment, but without knowing the exact price elasticity, we cannot know how large the fall in quantity demanded, i.e. unemployment, would be. (Even in this very moderate concluding paragraph, I was probably a little bit too ‘one-sided’ for an exam. Of course, if my conclusion had been “A significant rise in the national minimum wage is likely to be good for the economy” then it wouldn’t have been one-sided at all…)