Unemployment: Minimum Wage Laws and Efficiency Wages - Online Tutor, Practice Problems & Exam Prep

Minimum wage laws, acting as price floors, can lead to unemployment by creating a surplus of labor. When a minimum wage is set above the equilibrium wage, demand for labor decreases while supply increases, resulting in more job seekers than available positions. Conversely, efficiency wages, which are higher than the equilibrium wage, incentivize employees to work harder, reduce turnover, and attract better talent. This model enhances productivity by motivating workers to maintain their jobs, as losing them would mean accepting lower-paying alternatives.

Unemployment: Minimum Wage Laws

Now, let's discuss how minimum wage laws and efficiency wages can affect the unemployment rate. We're going to talk about a topic here that's come up before, price floors, and if you want more detail, I'm going to provide an overview here. You'll want to refer back to a video about price floors and price ceilings where I go into a lot more detail on how these work. But let's use this discussion to describe minimum wages. A price floor is a legally determined minimum, right? It's the bottom. It's the floor. It's the legally determined minimum price for a good. So, let's go to the graph here and let's talk about how minimum wages can affect the labor market.

We've got a common graph that we've seen all the time here in economics, where we analyze the downward demand (D) and the upward supply (S). This D is the demand in the labor market, emanating from the firms. The firms are demanding labor, wanting people to work for them, while the workers supply the labor. Let's go ahead and analyze this graph as we usually would. We would see an equilibrium wage here in the middle. What does the equilibrium wage mean? Well, it means that if this market is left alone, the equilibrium quantity would be here at Q Star, and we would have an equilibrium wage. Let's say the equilibrium wage is $10, which is what this market would pay normally. The government then steps in and says, "Hey, $10 is just not enough for people to live on. We need to set a minimum wage that's higher than that." So, they set a minimum wage of $15, which is above the equilibrium to be effective.

Let's look at what happens when we have this higher minimum wage. With a minimum wage of $15, there's going to be less labor demanded because the price is higher, so firms will want less labor. This decrease in demand can be represented as quantity demanded. Conversely, workers think, "Hey, $15 an hour? I want a job." This leads to quantity supplied being much higher, as more workers are trying to enter the job market at this higher wage. But what do we find? Notably, the quantity supplied is much higher than the quantity demanded. This causes an oversupply of labor—a surplus—translating to few jobs available. Despite many people looking for jobs at this higher wage, firms are not willing to hire at that rate.

Examining the effects of a minimum wage law, for a price floor to be effective, it had to be set above equilibrium, right? For more information, I would definitely suggest going to the video where we discuss price floors and ceilings in more detail. If the minimum wage had been set at $5, it wouldn't impact the market since the prevailing wage is $10. Effective price floors lead to a surplus in the market. This surplus of supply leads to higher unemployment rates because there are people looking for jobs, but no jobs are available.

So, the topic here was the minimum wage law. What does this lead to? It results in a compromise. In theory, a minimum wage is seen as beneficial for workers, providing them with a living wage if they can find work. However, it also leads to higher unemployment for those unable to find jobs. So, that's how minimum wages affect unemployment in the market. In the next video, let's discuss efficiency wages.

Unemployment: Efficiency Wages

Alright. So now let's discuss efficiency wages a bit. Some employers pay a wage above equilibrium as an incentive to their employees. They might say, "I know this job should pay $10 an hour, but I'm going to pay you $12 an hour." Why would they do that? There are a few reasons. This wage above the equilibrium is called an efficiency wage, and it's supposed to increase the efficiency of the worker. So how does it do it?

First, it deals with decreased worker turnover. Decreasing worker turnover is beneficial because you don't have to retrain new workers if you can keep the same workers. That's going to improve your efficiency, right? And why does it decrease worker turnover? Well, in the workers' minds, they're making $12 an hour when similar people are making $10 an hour. If they lost this job, they would have to accept a lower-paying job. So the opportunity cost of losing this job is higher to them, right? Because they would have to take a lower-paying job. In this case, the worker wants to keep the job because of the higher wage.

Next is worker quality. If you're fired, you're likely going to have to accept a lower-paying job, right? The same idea. So, the quality of the workers that you can attract is higher, so you're going to get higher worker quality. So when you put out the job ad and you're saying, "Hey, I'm hiring for $12 an hour," you're going to get a lot more people applying to the job. So you can handpick who you think is going to be the best because you have more people applying to your job. You can get a better worker out of it.

Lastly, the worker effort. The workers are going to be motivated to perform well to avoid being fired. Right? They want to avoid being fired, so they are going to have higher worker effort because they don't want to be fired, so they want to make sure that you see that they're doing a great job and they're doing their best so that they would keep this higher paying job. So the efficiency wage, in essence, acts as an incentive to the employee to work harder. To be more efficient. Efficiency wage, higher wage, more efficient worker. That's about it here. Let's go ahead and pause and move on to the next video.

Here’s what students ask on this topic:

How do minimum wage laws affect unemployment rates?

Minimum wage laws act as price floors, setting a legally determined minimum price for labor. When the minimum wage is set above the equilibrium wage, it leads to a surplus of labor. This happens because the higher wage decreases the demand for labor from firms while increasing the supply of labor from workers. As a result, more people are looking for jobs than there are positions available, leading to higher unemployment rates. Essentially, while minimum wage laws aim to provide a living wage, they can inadvertently cause unemployment for those who cannot find jobs at the higher wage.

What is the concept of efficiency wages and how do they impact worker productivity?

Efficiency wages are wages set above the equilibrium level by employers to incentivize employees. These higher wages can lead to increased worker productivity through several mechanisms: reduced worker turnover, as employees are less likely to leave a higher-paying job; improved worker quality, as higher wages attract more qualified candidates; and enhanced worker effort, as employees are motivated to perform well to avoid losing their higher-paying job. Overall, efficiency wages can lead to a more efficient and productive workforce.

Why might a firm choose to pay efficiency wages?

Firms may choose to pay efficiency wages for several reasons. First, higher wages reduce worker turnover, saving costs associated with hiring and training new employees. Second, higher wages attract better-quality candidates, allowing firms to select the most qualified workers. Third, higher wages motivate employees to work harder and be more productive, as they want to avoid losing their well-paying job. These benefits can outweigh the additional cost of paying higher wages, leading to overall increased efficiency and productivity for the firm.

What are the potential drawbacks of setting a minimum wage above the equilibrium wage?

Setting a minimum wage above the equilibrium wage can lead to several drawbacks. The primary issue is increased unemployment, as the higher wage reduces the demand for labor while increasing the supply. This creates a surplus of labor, meaning more people are looking for jobs than there are positions available. Additionally, firms may pass on the higher labor costs to consumers through increased prices, potentially leading to inflation. Lastly, small businesses may struggle to afford the higher wages, which could result in reduced hiring or even business closures.

How do minimum wage laws and efficiency wages differ in their impact on the labor market?

Minimum wage laws and efficiency wages impact the labor market differently. Minimum wage laws, acting as price floors, can lead to unemployment by creating a surplus of labor when set above the equilibrium wage. This results in more job seekers than available positions. In contrast, efficiency wages are voluntarily set above the equilibrium wage by employers to incentivize employees. Efficiency wages can reduce worker turnover, attract better talent, and increase worker effort, leading to higher productivity. While minimum wage laws can cause unemployment, efficiency wages aim to enhance worker performance and overall firm efficiency.