1.6.6 The National Minimum Wage

Specification Coverage: AQA unit 1.6.6 - The National Minimum Wage. Students should be able to explain how the government sets the national minimum wage, and the impact it has on workers and employers in different labour markets.

National Minimum Wage

The national minimum wage (NMW) is a legally enforced price floor set above the market equilibrium wage.

Labour market diagram showing a minimum wage above equilibrium creating excess supply of labour and unemployment
Figure 1: The introduction of a national minimum wage (Wmin) above the equilibrium wage (W1) creates a surplus of labour (unemployment) equal to the difference between the quantity of labour supplied (Qs) and the quantity of labour demanded (Qd).

The minimum wage creates a rigid wage floor at Wmin, increasing the wages of lower income earners from W1 to Wmin. This helps to reduce income inequality.

However, minimum wages increase the costs of employing labour for businesses, and as a result the demand for labour contracts from Q1 to Qd, resulting in a lower level of employment for lower income workers. This is known as Real Wage Unemployment.

Evaluations for the impact of a minimum wage include:

  • Depends on the size of the minimum wage: if the minimum wage is significantly above the equilibrium, this significantly increases incomes but creates a substantial level of real wage unemployment.
  • Depends on the Wage Elasticity of Demand for Labour: if the demand for labour is wage elastic, then the unemployment created will be more significant. Minimum wages are more effective in markets with wage inelastic demand.
  • Depends on improvements to worker motivation: if the higher wages cause workers to become more motivated, this may increase their productivity. As a result this offsets the rise in ATC for firms, reducing the size of the unemployment created.

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