AQA Specification focus:
‘The effects of a national minimum wage upon labour markets; the advantages and disadvantages of a national minimum wage.’
Introduction
The national minimum wage is a legal wage floor that directly influences labour markets, shaping wage levels, employment opportunities, and economic efficiency while presenting both benefits and drawbacks.
Minimum Wage: Key Concepts
Definition of Minimum Wage
Minimum Wage: The lowest legal hourly, daily, or monthly wage rate that employers can pay their workers, set by government regulation.
A national minimum wage establishes a baseline wage across the economy, preventing wages from falling below a socially or politically acceptable threshold. Its introduction alters the dynamics of wage determination and labour market equilibrium.
Effects of a National Minimum Wage
Labour Market Impact
The imposition of a minimum wage creates a wage floor.
A wage floor set above the competitive equilibrium raises the wage but creates excess supply of labour. The surplus visually represents unemployment among low-wage workers. Source
If set above the equilibrium wage, it can alter employment patterns:
Excess supply of labour (unemployment): Higher wages encourage more workers to enter the market, but firms may demand fewer workers at that wage level.
Wage rigidity: Wages cannot adjust downwards in response to falling demand for labour.
Increased earnings for low-paid workers: Those who remain employed benefit from higher income.
Distributional Effects
Reduces in-work poverty: By lifting the lowest wages, it can enhance living standards for low-income households.
Income redistribution: Narrowing wage inequality between the lowest-paid and higher earners.
Regional impacts: In lower-cost regions, the minimum wage may bind more strongly, affecting employment patterns differently compared to high-cost areas.
Business Costs and Competitiveness
Increased labour costs: Firms face higher wage bills, which may reduce profitability.
Price effects: Businesses may raise prices to cover higher costs, fuelling inflation.
Productivity incentives: Firms may invest more in training, technology, or efficiency improvements to justify higher wages.
Advantages of a National Minimum Wage
Social and Economic Benefits
Reduces exploitation: Protects workers from being paid unreasonably low wages by employers with greater bargaining power.
Improves living standards: Ensures a basic income, reducing reliance on welfare benefits.
Promotes fairness: Creates a sense of equity in the labour market.
Stimulates aggregate demand: Higher incomes for low-wage workers increase consumer spending, benefiting the wider economy.
Labour Market Dynamics
Encourages labour participation: Higher wages may attract more people into the workforce.
Efficiency wage effects: Better pay can reduce absenteeism and turnover while increasing worker effort and morale.
Disadvantages of a National Minimum Wage
Employment Concerns
Unemployment risk: If set too high, firms may reduce staff numbers, increase automation, or outsource jobs abroad.
Youth and unskilled workers most affected: These groups face higher risks of exclusion from employment, as employers may prefer more skilled workers at higher wage costs.
Economic Drawbacks
Cost-push inflation: Higher labour costs can raise overall production costs, contributing to inflation.
Business competitiveness: Export-oriented industries may suffer if domestic wage floors raise costs compared to international rivals.
Informal economy growth: Employers may evade regulation by paying “off the books,” undermining legal protections for workers.
Factors Influencing Impact
Level of Minimum Wage
The magnitude of the impact depends on where the wage is set relative to the equilibrium wage:
Below equilibrium: No real effect.
At equilibrium: Limited influence.
Above equilibrium: Significant changes in employment and wage distribution.
Labour Demand Elasticity
Elasticity of Labour Demand: The responsiveness of the quantity of labour demanded to changes in the wage rate.
If elastic, a small wage rise leads to a large fall in employment.
If inelastic, firms absorb higher costs with limited job losses.
Economic Conditions
During booms, minimum wages may have little negative effect as demand for labour is strong.
During recessions, higher wage floors can exacerbate unemployment pressures.
Evaluation of Advantages and Disadvantages
Situations Where Benefits Outweigh Costs
When set at a moderate level, the minimum wage improves incomes without major job losses.
In industries with monopsony power, it can increase both wages and employment.
In a monopsony, a minimum wage can both increase pay and expand employment by flattening the marginal factor cost curve, moving outcomes closer to competitive levels. Source
Situations Where Costs Outweigh Benefits
If set too high, especially in low-skilled sectors, it risks unemployment and business closures.
In highly competitive global markets, it may undermine cost competitiveness.
FAQ
Governments usually set the level of the minimum wage after considering advice from independent bodies such as the UK’s Low Pay Commission.
Key factors include:
Cost of living and inflation rates
Productivity levels in the economy
Impact on employment and business competitiveness
Balancing worker welfare with firm sustainability
The aim is to protect low-paid workers without causing widespread job losses.
The groups most affected are typically:
Young workers, who often have lower skills and experience
Low-skilled and entry-level workers in industries like retail, hospitality, and care
Workers in lower-cost regions, where equilibrium wages may fall closer to the legal minimum
These groups feel both the benefits of higher pay and the risks of reduced job opportunities.
Over time, firms adapt to higher wage costs by:
Investing in automation and technology
Reducing reliance on low-skilled labour
Focusing on efficiency improvements
Training workers to increase productivity
These adjustments can raise overall efficiency but may reduce the number of low-skilled roles available.
Regional differences in wages, living costs, and economic activity affect how binding the minimum wage is.
In London and the South East, wages are generally higher, so fewer workers are directly impacted.
In lower-wage regions, like parts of the North East, more workers are lifted by the minimum wage, increasing both benefits and risks.
This means the same national policy can have very different local effects.
The minimum wage can help narrow wage gaps by lifting the pay of the lowest earners.
It is particularly effective in reducing inequality between full-time low-wage workers and those on average wages. However, it is less effective in addressing inequality caused by very high salaries or wealth ownership, which are outside its scope.
Thus, while useful, it is often combined with other policies such as tax credits and progressive taxation.
Practice Questions
Define a national minimum wage and state one potential effect it may have on the labour market. (2 marks)
1 mark for a correct definition: The lowest legal wage that employers can pay, set by the government.
1 mark for one valid effect, e.g. can create excess supply of labour/unemployment if set above equilibrium or raises income for the lowest-paid workers.
Using a diagram, explain how the introduction of a minimum wage above the equilibrium wage may affect employment levels and worker incomes in a competitive labour market. (6 marks)
1 mark for correctly drawing and labelling a supply and demand diagram for labour with equilibrium wage and employment identified.
1 mark for showing the minimum wage line above equilibrium.
1 mark for correctly identifying excess supply of labour (unemployment).
1 mark for explaining that employment falls as firms reduce demand for labour.
1 mark for explaining that those still employed benefit from higher wages.
1 mark for overall clarity and accurate link between diagram and explanation.
