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National Minimum Wage for the UK

April 1999 saw the introduction of a National Minimum Wage for the UK. Set by the LPC at 3.60 pounds for workers over 22 and 3.00 pounds for workers between 18 & 21, it was the first time a floor minimum wage had been applied nationally. The LPC said their aim was �to have a minimum wage that helps as many low paid workers as possible without any significant adverse impact on inflation and employment� (LPC 2005). While supported by the Labour Government and the workers unions, it was met with criticism from the conservatives, economists and businesses.

This was because classical theory states that the introduction of a minimum wage raises unemployment. We will look at the impact of the NMW and examine whether it has had an adverse effect on the lowest paid workers and employment levels.

The standard model of a competitive labour market uses assumes demand to be downward sloping, workers homogeneity and perfect knowledge of market conditions and wages.

Before the imposition of the minimum wage, employment in equilibrium is E* and wages W*. A minimum wage above the market equilibrium (W�) causes unemployment equal to Ed-Es, as a higher wage reduces the firms demand for workers who are now more expensive. The higher minimum wage also increases the supply of labour as more workers have their Reservation wage satisfied by the higher wage. The effect on the unemployed workers is reduced if there is unemployment benefit set below the level of the equilibrium competitive wage. Then the loss to these workers is not W* but W* - b, where b is the benefit level. The workers who do remain in employment however, gain from the higher wages of (W� � W*).

The number of workers that will be unemployed depends on the elasticity of labour demand and the level that the minimum wage has been set at compared to the equilibrium competitive wage. The imposition of a higher that equilibrium minimum wage on a firm with elastic demand for labour will lead to some workers becoming unemployed.

The more elastic the demand curve the higher will be the involuntary unemployment level. The graphs show the imposition of an above equilibrium minimum on three different firms with demand curves of varying elasticities. The imposition of the minimum wage W� on Firm 1 with a relatively elastic labour demand curve D1 leads to a much higher unemployment level U1 compared to the imposition of the minimum wage on firm 3 with a more inelastic demand curve. The group of workers this hurts the most is assumed to be those at the lowest part of the wage distribution, mainly those who are low skilled and low paid. One of Marshall�s rules of derived demand states that the more elastic demand is the greater the elasticity of substitution between labour and capital, so as wages increase firms are assumed to substitute the low skilled low paid with capital further raising the unemployment effect of firms with more elastic labour demand.

The second factor that affects the unemployment level is the size of the minimum wage above the equilibrium competitive wage.

Initially at a minimum wage of W� the total unemployment effect is only U�. As the minimum wage is further increased more workers offer themselves up for employment as their reservation wages are met. However labour demand falls with minimum wage increases. So as the minimum wage rises from a lower level of W� to W��� the unemployment effect rises too, from U� to U���.

One concern prior to the implementation of the minimum wage was the potential spillover effect. With workers below the minimum wage entitled to a wage increase, workers earning just above the minimum wage would look to restore pay differentials against the lower wage workers. This could create cost push inflation because as workers demand higher wages, these are passed on to the firms as higher costs and then these costs are then passed on to consumers in the form of higher prices.

In a monopsonistic market a minimum wage can be beneficial to both wages and employment. A monopsony is a market in which there exists only one firm but many workers.

A monopsonistic firm is a firm which must pay all workers the same wage regardless of their reservation wage. As a result, we can see that the individual firm faces an upward sloping supply curve and an upward sloping marginal cost curve (MC). MC is rising because as the wage increases it has to pay all its workers the higher wage irrespective of their RW and also in order to attract more labour in the workforce the monopsonist has to raise the wage. However, by having a monopsony power it means that the employer charges its workers a wage below their VMP. From the graph we can see that the monopsonistic equilibrium point is where marginal cost curve equals the value marginal product curve, that is MC=VMP, at point A. However, at point A workers produce at a wage of WVMP but they are only paid a wage of WM. As a result the workers are exploited in a monopsonistic market and this is illustrated by the area MVMP-WM.

By the imposition of the minimum wage W� the employer will now face a perfectly elastic and thus constant MC curve as it has to pay all his workers the same wage irrespective of their VMP. However, this can only be the case up to the point where the minimum wage intersects the labour supply curve at point E�. This is because up to point E� workers were willing to work and get paid a wage less or equal than the minimum wage before the imposition of the minimum wage.

However if the firm tries to employ one extra worker above E� then the marginal cost of an additional worker increases as the wage becomes larger than the minimum wage. As a result the MC curve is perfectly inelastic at that additional worker and then moves back to its original level. In the monopsonistic model the employment level increases from EM to E� and wages from W�M to W�. In addition, with a monopsonistic market there is no unemployment, as every worker can find a job at their reservation wage.

Additionally the government can raise the minimum wage up to the perfectly competitive equilibrium wage (W*). By doing this it can further increase wages and employment. In this case we would employ the same number of workers and pay them the same wage as in a perfectly competitive market. Thus, good level of minimum wage can bring into the market the same number of workers as would be present in a competitive market.

This eliminates the monopsonistic power of the single firm and reduces the exploitation of workers. But the government doesn�t know exactly where the perfectly competitive level is thus it is difficult to determine the ideal level of the minimum wage!

One of the main purposes of the NMW was to reduce the inequality of wages; by the way of reducing the pay gap between the lowest paid workers and the average worker and reducing the gender pay gap for those on low pay. In order to evaluate its success, it is useful to make before and after comparisons.

Prior to the introduction, wages were increasing fastest for the highest paid and slowest for the lowest paid.

How hourly earnings growth for each percentile differs from the growth in the middle (fiftieth) percentile for male and female employees. From s 2 and 3, the 1992-1997 monotonic positive relationship is replaced by a U � shaped relationship for 1998 � 2003, which shows hourly earnings growth was above the median for the lowest paid third of the hourly earnings distribution, with these increases being greater for those who were lowest paid. The introduction however led to little differences in the higher paid workers.

Part time male and part time female employees, show the same correlation, but an even greater increase in relative hourly earnings for the lower percentiles. A 2005 report estimated that nearly half of all low paid employees were women working part � time so 10 could show the clearest evidence of changes of earnings since the NMW introduction. From this data we can see that the NMW does appear to have produced desired effect in increased growth in low paid wages and reduction of the gender gap, but it is important to note this data does not take into account the effects it has on the labour force, i.e. whether it leads to more unemployment or, because of the likely higher competition of the lower paid jobs, people to leave the workforce into retirement or to accept benefits.