Effects Of Minimum Wage On An Economy Economics Essay

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Wage is compensation in the form of financial payments made to employees for the exchange of their time and labor. It is given as salary for the amount of work done by employees or in return for their services. The wage rate is determined by the market forces as it is considered a perfectly competitive market. In a perfect competitive market, the assumption is that there are many firms which offer identical jobs to workers with the same set skills. The demand and supply of labor forces will set the equilibrium for the wage in the market which is at We. Firms are wage takers as workers will choose the wage offered to work.

Diagram of wage market:

1.2 Minimum wage

Minimum wage is defined as the lowest hourly, daily or monthly salary that employers may legally pay to workers. Minimum wage is the lowest amount where workers may sell their services which in term are known as the market floor for wage. Before minimum wage was proposed and enforced, employers would take advantage of women and young workers by underpaying them. Now employees are protected under the law to receive a certain lowest amount for their labor in low payment jobs.

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The first country that enforced the minimum wage law was New Zealand in 1894 and since then other countries have follow suit. Although the rate various among countries, it is up to the government to decide how much the minimum salary should be. A formal minimum wage is enforced by the law but there is another form of minimum wage; it is called informal minimum wage and it exists without legal bindings as some employees do not follow the law (Dube, Naidu, & Reich, 2007). Malaysia does not have a nation-wide minimum wage by law but there is a special exception for the plantation workers which get paid at least RM750 per month.

2.0 Effects of minimum wage

2.1.0 Benefits of minimum wage

2.1.1 Reduce poverty

By introducing the minimum wage, poverty levels may be reduced. According to Dube, Naidu, & Reich (2007), the introduction of minimum wage raised the bottom amount of salary for workers; which increases their income level and thus have more spending ability. When the income level increase, workers will be able to spend more money for goods.

2.1.2 Increase productivity

The implementation of minimum wage will increase workers productivity. This is in relation to the efficient wage theory that states higher wages will motivate workers to work harder and thus increasing labor productivity. Workers that are paid a higher amount will feel compelled to work and perform better in fear of losing the job.

2.1.3 Increase incentives

The minimum wage will be an additional incentive for the unemployed to find and accept a job. As the minimum wage will increase the difference between benefits from employment, it will help to increase the participation rate of employment. It will also encourage people to earn money legally and join the workforce as the minimum income is guaranteed.

2.1.4 Increase consumption

Minimum wage will increase the spending capability of workers which will increase the consumption level. As the low-income group of workers will have more money to spend on goods, they will spend more and increase the consumption in the country which will help the economy of the country (Bauer, Kluve, Schaffner, & Schmidt, 2009).

2.1.5 Decrease government spending

Minimum wage will effect government spending as it decreases government cost towards social welfare programs. Workers that get minimum salaries will be able to provide for their own needs and depend less on government aids. Government will be able to cut down on social spending and use the money for investment.

2.2.0 Disadvantages of minimum wage

2.2.1 Unemployment

In a perfectly competitive market, minimum wage will cause unemployment. When the minimum wage is above the market equilibrium, the demand and supply of labor is not balance as the supply will be more than the demand. As the extra supply of labor is not wanted by companies, it will cause unemployment when minimum wage is present. By introducing minimum wage laws, companies will react by lowering the number of employment and raising the price of goods which leads to unemployment (Lemos, 2007).

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The national minimum wage is at NMW where it is above the market equilibrium wage point of Q1 where wage is at W1. As the demand of labor is at Q2 and the supply of labor is at Q3, there is an excess of labor and thus unemployment occurs from Q2 to Q3.

Diagram of minimum wage market:

2.2.2 Inflation

Minimum wage may cause inflation of the price as the increase of money supply available to workers will cause price to increase. Businesses will try to increase the prices of goods as the available money supply for spending has increased through minimum wage. Because workers have more money to spend, businesses tend to take advantage of the situation to undo the wage increase by raising the price of goods. The worker will lose the wage gain to inflation because prices on the market are higher and require more money to buy the same amount of goods (Lemos, 2007).

2.2.3 Increase cost of investment

Minimum wage will increase the cost of investment for a company where it has to pay more to their workers and this will increase cost of production which increases the cost of investment. As the cost of investment increases, company need to spend more it decreases the revenue of the company. Due to the rising cost of investment, companies will then raise the price of the goods and services (Dube, Naidu, & Reich, 2007).

3.0 Conclusion

Minimum wage has both benefit and disadvantages to the country. Minimum wage stimulates the economic growth of a country by increasing the consumption. While it may improve the quality of life of low-income workers, it still depends on the structure of the labor market. Studies show that a moderate increase in minimum wage does not affect employment; however, a high increase may cause unemployment in the country. According to Fanti & Gori (2011), the gradual increase of minimum wage will ensure the stability of the economy as the unemployment rate and taxes will also increase gradually. This will not cause a huge unemployment rate and over inflation to occur in the country. Through balancing the minimum wage levels, it may help to stimulate economic growth and welfare of life.