Government policy, including national minimum wage (NMW) on wage determination

Micro‑economic Decision‑makers: Workers

1. Choice of Occupation (Syllabus 3.3.1)

When deciding on a career, workers weigh wage‑related and non‑wage factors.

• Expected earnings (wage factor) – the level of pay a job is likely to offer, both initially and in the future.
• Personal interests and abilities – enjoyment of the work and how well it matches one’s skills.
• Career prospects and advancement – chances of promotion, further training and higher future earnings.
• Location and commuting – proximity to home, transport costs and regional job availability.
• Health and safety – physical demands of the job and any medical restrictions.
• Family and cultural responsibilities – caring duties, gender expectations or cultural norms.

2. Wage Determination (Syllabus 3.3.2)

2.1 Market forces – supply and demand

• Labour demand – derived from the marginal revenue product of labour (MRP_L). Firms hire workers up to the point where wage = MRP_L.
• Labour supply – depends on the wage rate, population size, education, experience and the non‑wage factors listed above.
• Equilibrium wage (W*) – the wage at which the quantity of labour supplied equals the quantity demanded (where the supply and demand curves intersect).

2.2 Government policy – National Minimum Wage (NMW)

The NMW is a legally‑mandated price floor, usually quoted as an hourly rate and reviewed regularly to keep pace with inflation and productivity.

1. Purpose
   • Protect low‑paid workers from exploitation.
   • Reduce in‑work poverty.
   • Provide a baseline for fair pay across industries.
2. How it works
   • If the NMW is set above the market‑clearing wage (W_min > W*), it is a binding price floor.
   • If it is set below the market wage (W_min < W*), it is non‑binding and has no immediate effect on employment.
3. Other government tools that can affect wages
   • Tax credits (e.g., Working Tax Credit) that raise net pay.
   • Training subsidies that increase the productivity of workers, shifting the labour‑demand curve rightward.
   • Employment‑rights legislation (e.g., statutory sick pay) that alters the cost of employing staff.

2.3 Trade‑union influence (Syllabus 3.3.2)

• Collective bargaining – unions negotiate wages and conditions on behalf of members, often securing pay above the market equilibrium.
• Wage‑setting effect – a successful union can shift the effective labour‑demand curve to the right because firms are willing to pay more for a motivated, more productive workforce.
• Strike threat – the possibility of industrial action raises the cost of not meeting union demands, reinforcing bargaining power.
• Diagram tip – show the original demand curve (D) and a new right‑shifted curve (D′) after a union secures higher wages.

2.4 Interaction of NMW and unions

Both act as institutional floors on wages. When the NMW is binding, unions may concentrate on non‑wage benefits (e.g., holidays, training). When the NMW is non‑binding, unions are the primary driver of wage floors.

3. Reasons for Differences in Wages (Syllabus 3.3.3)

• Skill, education and experience – higher skill, more education and longer experience raise productivity and thus pay (e.g., doctors vs. retail assistants).
• Industry/sector – primary (agriculture) generally pays less than secondary (manufacturing) and tertiary (services) sectors.
• Geographic location – wages tend to be higher where the cost of living is higher (e.g., London vs. rural areas).
• Discrimination – wage differentials that are not justified by productivity (e.g., gender or ethnicity discrimination).
• Public vs. private sector – different pay structures, pension schemes and job security can lead to wage gaps.

4. Mobility of Labour (Syllabus 3.3.4)

• Occupational mobility – the ability of workers to move between different occupations or industries, often facilitated by training, education or transferable skills.
• Geographical mobility – the willingness and ability to relocate to another region or country for work, influenced by housing costs, family ties and transport links.
• Causes of high mobility – flexible labour markets, low moving costs, strong information networks.
• Impact on wage differentials – high mobility tends to reduce persistent wage gaps because workers can move to where their marginal product is highest; low mobility can reinforce regional or occupational wage disparities.

5. Division of Labour (Syllabus 3.3.5)

• Definition – the splitting of production processes into a series of specialised tasks performed by different workers.
• Advantages
  • Higher productivity through specialisation and skill development.
  • Lower per‑unit costs (economies of scale).
  • Faster production and the ability to use specialised equipment.
• Disadvantages
  • Monotony and reduced job satisfaction for workers.
  • Increased vulnerability to technological change or demand shocks (if a specialised task becomes obsolete).
  • Potential for greater income inequality if the gains from higher productivity are not shared.

6. Effects of a Binding National Minimum Wage

6.1 Immediate (short‑run) impact

1. Price floor – creates a gap between the quantity of labour supplied and demanded.
2. Labour supply ↑ – higher wages attract more workers, including those previously out of the labour force.
3. Labour demand ↓ – firms may cut hiring or reduce hours if the demand for their product is price‑elastic.
4. Resulting surplus = unemployment – the excess of labour supplied over demanded at W_min.

6.2 Longer‑run adjustments

• Firms invest in labour‑saving technology or automation.
• Production may shift to regions or countries with lower labour costs.
• Higher wages can increase consumer spending, potentially raising product demand and partially offsetting job losses.
• Workers may acquire further skills or experience, moving into higher‑paid occupations and reducing the surplus over time.

6.3 Elasticity considerations

The magnitude of the effects depends on the price‑elasticities of labour supply (ε_S) and demand (ε_D).

$$\varepsilon = \frac{\%\Delta Q_w}{\%\Delta W}$$

• If demand is highly elastic (|ε_D| large), a modest rise in wages leads to a large fall in employment.
• If supply is inelastic, the increase in workers willing to work is modest, limiting the unemployment created.

7. Summary Table of Effects

8. Suggested Diagrams for Exams

• Labour‑market with a binding NMW – supply (S) and demand (D) curves, equilibrium (W*), a horizontal line at W_min > W* and the resulting surplus of labour (unemployment).
• Effect of trade unions – original demand curve (D) and a right‑shifted curve (D′) after successful collective bargaining, showing a higher equilibrium wage.
• Elasticity impact – two demand curves: one relatively steep (inelastic) and one relatively flat (elastic) to compare employment outcomes after a minimum‑wage rise.

9. Evaluation Checklist (AO3)

1. Determine whether the NMW is binding or non‑binding in the given scenario.
2. Short‑run effects: unemployment, cost‑push inflation, changes in hours worked, impact on firm profitability.
3. Long‑run adjustments: automation, relocation of production, skill upgrading, possible reduction in the surplus.
4. Distributional analysis:
   • Winners – low‑paid workers, consumers (through higher disposable income), potentially higher productivity.
   • Losers – some low‑skill workers (unemployed or under‑employed), firms with thin profit margins, sectors that rely heavily on low‑wage labour.
5. Potential for growth of the informal sector or “under‑the‑table” work when the floor is binding.
6. Interaction with other institutions – trade unions, minimum‑wage boards, tax‑credit schemes.
7. Elasticity of demand and supply – assess how the size of the unemployment effect changes with different elasticities.
8. Macroeconomic feedback – higher household consumption may boost aggregate demand, offsetting some job losses.
9. Long‑run productivity gains – higher wages can improve morale, reduce turnover and encourage investment in training.

10. Real‑World Illustrations

• United Kingdom – National Minimum Wage introduced in 1999; the “Living Wage” (≈£10.42/hr in 2023) is higher than the statutory NMW. Studies show modest wage rises with limited job loss, attributed to relatively inelastic demand in many service sectors.
• United States – State‑level minimum wages (e.g., California $15/hr) illustrate varied impacts: higher wages in high‑cost areas with low unemployment, but some evidence of reduced employment for teenage and low‑skill workers.
• Australia – Fair Work Commission reviews the minimum wage annually; research indicates a small reduction in hours worked but an overall increase in household consumption.
• Germany – Introduction of a statutory minimum wage in 2015 (initially €8.50/hr). Early evaluations showed a slight rise in wages for low‑paid workers and a marginal increase in unemployment among the youngest workers.