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Benefits and Drawbacks of a National Minimum Wage

Discuss the view that a national minimum wage is beneficial for an economy. [25 marks]


Labor Market and Income Distribution




Tip: Use relevant diagrams to support your analysis. Including some facts and figures about the national minimum wage will enhance your essay. Provide a sound conclusion to your essay.

🠊 Step 1: Define 'national minimum wage' in the introduction

Is a national minimum wage beneficial to an economy? There has been fierce debate around the topic. A national minimum wage is the lowest level of pay that is legally allowable. In this essay, we will discuss whether the overall impact of a national minimum wage on an economy is beneficial. In order to make a more in-depth analysis, we will take the UK economy as an example.

Before diving into the economic impacts of the national minimum wage(NMW), it is important to distinguish it from the National living wage. The following definitions are taken from the UK government website (GOV.UK):

➤ The National Minimum Wage is the minimum pay per hour to which most workers aged 16 to 24 are entitled.

➤ The National Living Wage is the legally binding hourly rate for workers aged 25 and over.

The national living was set at £8.91 an hour in April 2021 and is reviewed every year just like the National Minimum Wage.

🠊 Step 2 : Analyse how a national minimum wage works in a competitive market, and the consequent theoretical impact

Let us begin our discussion with the impact of a national minimum wage in a competitive market. We will also assess whether the outcome will be beneficial for workers.

➤2.1 In a competitive labour market, a government is able to secure a minimum wage above the equilibrium wage rate at Wu. This is shown in Figure 1.

Figure 1:


At the equilibrium wage (W) , the quantity of labour employed is L. When the government imposes a national minimum wage, the wage rate rises from W to Wu. This wage increase has several benefits to workers. They will enjoy a higher income and more purchasing power. This will also increase their incentive to work harder and improve their labour productivity.

➤ 2.2 However, there are also drawbacks to the national minimum wage to workers.

In Figure 1, the national minimum wage Wu is above the equilibrium. As a result, the number of workers who are offered jobs by employers falls to Lu. At this wage the number of people who would like to work is higher, this is shown by Lc. Consequently, there is a shortfall between those who want to work and those who can actually work. This is shown in figure 1 as the difference between Lc and Lu

🠊Step 3 : Analyse how a national minimum wage works in a monopsonistic labour market, and the consequent theoretical impact

Let us analyse how a national minimum wage works in a monopsonistic labour market. In this situation, we are now dealing with an imperfect rather than a competitive market. We will also discuss its overall benefit to workers.

➤3.1 A monopsony occurs when there is a single or dominant buyer, in this case of labour. The power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power. Monopsonists often exist in local labour market situations, for example where there is just one major employer in a town.

Figure 2 :


Figure 2 shows how the monopsonist can affect the market equilibrium. The monopsonist will hire workers by equating the marginal cost paid to employ a worker with the marginal revenue product gained from this employment. This is the profit-maximising position. The wage that the monopsonist pays to hire labour is Wm. This is actually below the wage that should be paid if they were paying the full value of their marginal revenue product, that is Wmrp. The level of employment is Lm.

The government could impose a national minimum wage of Wmrp, it is illegal for the firm to pay less. This minimum wage would be a counterbalance to the effect of monopsony employers. Worker wage rates would increase from Wm to Wmrp. This would be clearly beneficial for workers.

🠊 Step 4: Discuss arguments in favour of a national minimum wage

We have previously discussed the impact of a national minimum wage on workers. We will now discuss its wider benefits on the economy.

➤ 4.1 A national minimum wage can help to reduce poverty. It leads to an increase in the wage of the lowest paid in a country. This will motivate workers to work harder, enhancing productivity and efficiency. Firms consequently benefit from reduced costs and greater output.

➤ 4.2 Moreover, a national minimum wage will increase the incentives for the unemployed to accept a job. This is because they will be able to earn more by working compared to claiming unemployment benefits.

➤ 4.3 There here will be also a knock-on effect on those earning higher wages. If the minimum wage floor rises, firms may need to increase wages for those just above the minimum wage floor – to maintain a pay premium for experienced workers.

➤4.4 In the free labour market, market failures may occur such as discrimination, inequality and exploitation from monopsonist employers, who are able to pay below the market equilibrium. With a national minimum wage, the distribution of income between the high paid and the low pay will be narrowed. There would be less worker exploitation by labour market monopsonists.

🠊 Step 5: Discuss arguments against a national minimum wage

A national minimum wage has several drawbacks on a macroeconomic level.

➤ 5.1 A national minimum wage can cause unemployment.

This was seen in Figure 1 as the difference between Lc and Lu, where there there is a shortfall between those who want to work and those who can actually work. Unemployment comes with its own set of problems such as social unrest, the burden on taxpayers and a fall in economic growth. Furthermore, unemployment may be concentrated amongst low-skilled workers from disadvantaged backgrounds thus reinforcing existing inequality.

Because of unemployment, a national minimum wage can also create incentives for workers to join the black market. Firms may be more attracted to hire workers from the underground economy and offer cash-in-hand salaries, this also avoids the need to declare wages to the government. This in turn can lead to the exploitation of workers, especially in industries with high rates of migrant labour.

➤ 5.2 Furthermore, the cost to firms of paying higher wages may be passed on to consumers.

There will be a regressive effect as the price rise hits those with a proportionally lower income first. This price increase can in turn demotivate consumers to buy certain goods or services.

When firms increase their price to cover additional wage costs, this may cause cost-push inflation. Inflation can make an economy internationally uncompetitive.

➤5.3 Government intervention to impose a national minimum wage may in fact create further inefficiencies and so not improve the use of scarce resources in a society. This is known as government failure.

It has been seen that the imposition of a national minimum wage may cause unemployment and encourage the underground economy. Furthermore, politicians may be motivated by political power rather than economic imperatives. Economic policies may be designed by governments to retain power rather than to ensure maximum efficiency in the economy. For example, a government may promise to raise the national minimum wage just before an election.

🠊 Step 6: Conclude

To conclude, while minimum wages raise pay at the bottom, this benefit needs to be traded off against the possible costs of imposing such a standard. It has been seen that the imposition of a national minimum wage can be beneficial in theory. It reduces inequality, prevents exploitation by monopsonists, motivates workers and increases purchasing power. However, a national minimum wage also has many drawbacks. It can create employment, cause inflation and even encourage the black market.

In the UK, research on the impact of the National Minimum Wage concluded that in general there was little effect on employment but found some evidence that the NMW had led to small reductions in hours. The NMW was introduced in the UK on 1 April 1999. Since then, it has risen faster than average earnings and inflation without damaging jobs.

🠊 Marking scheme
Areas for discussion include:
• discussion of national minimum wages including why they have been introduced
• discussion of the distinction between the NMW and National Living Wage in the UK
• analysis of how a national minimum wage works in an otherwise competitive market, and the
consequent theoretical impact
• analysis of how a national minimum wage works in a monopsonistic labour market, and the
consequent theoretical impact
• arguments for a NMW
o prevents exploitation
o reduces in-work poverty and inequality
o incentivises firms to invest in labour productivity-enhancing capital
o boosts motivation amongst workers leading to enhanced productivity
o can remove the ability of immigrants to undercut existing workers’ wages, which brings costs
and benefits
• arguments against a NMW
o can create unemployment by setting a wage higher than the marginal revenue product of some
o unemployment may be concentrated amongst low-skilled workers from disadvantaged
backgrounds thus reinforcing existing inequality
o certain sectors affected more than others (e.g. careworkers, hospitality, retail). Higher wage
costs may lead to falling profits and business failure
o where firms pass on higher labour costs to consumers via product prices, this may be
o administrative costs of introducing and uprating the minimum wage, along with policing and
prosecuting firms that break the rules
• labour market flexibility and supply-side considerations
• impact on the economy as a whole e.g. cost-push inflation, international competitiveness
• evidence from the UK or elsewhere about the impact on the labour market and wider economy
• consideration of the level or ‘bite’ of the NMW
• market failure arguments
• government failure arguments.
The use of relevant diagrams to support the analysis should be taken into account when assessing
the quality of the student’s response to the question.
Use the level mark scheme on page 4 to award student marks for this question.




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