Reasons for differences in wages: government policy

Published by Patrick Mutisya · 14 days ago

Cambridge IGCSE Economics 0455 – Workers: Government Policy and Wage Differentials

Microeconomic Decision‑Makers: Workers

Objective

Understand why wages differ between workers and how government policy can influence those differences.

Key Concepts

  • Wage – the monetary remuneration paid to a worker for a unit of labour (hour, day, week, etc.).

  • Wage differentials – variations in wages between workers with different skills, locations, or occupations.

  • Government policy – actions taken by the state that affect the labour market, such as legislation, taxes, and subsidies.

How Government Policy Affects Wages

Governments intervene in the labour market for three main reasons:

  1. To protect workers from exploitation.

  2. To correct market failures (e.g., information asymmetry, externalities).

  3. To achieve broader social and economic objectives (e.g., reducing inequality, encouraging employment).

Major Policy Instruments

Policy InstrumentPurposeTypical Effect on WagesPotential Unintended Consequences
Minimum Wage LegislationSet a legal floor for wages to protect low‑paid workers.Raises wages for workers earning below the floor; may compress wage differentials.Possible reduction in employment if firms cut jobs or hours; informal employment may rise.
Payroll Taxes (e.g., Social Security, National Insurance)Finance public benefits and pensions.Increases the cost of labour; employers may lower gross wages or shift costs to consumers.May discourage hiring, especially of low‑skill workers.
Subsidies to EmployersEncourage hiring of specific groups (e.g., youth, disabled).Can raise net wages for targeted workers without raising employer costs.Risk of dependency; may distort labour allocation.
Training and Education GrantsImprove worker productivity and skill levels.Higher skill leads to higher wages; reduces wage gaps between skilled and unskilled.Benefit may accrue to those already better positioned to access training.
Collective Bargaining Rights / Trade Union LegislationStrengthen workers’ negotiating power.Can raise wages for unionised sectors; may widen wage differentials between union and non‑union jobs.Potential for wage rigidity; may affect competitiveness.
Regional Wage Policies (e.g., higher minimums in high‑cost areas)Address cost‑of‑living differences.Align wages with local price levels; reduces regional wage gaps.May encourage migration to higher‑wage regions, affecting local labour supply.

Illustrative Example: Minimum Wage Impact

Consider a simple labour market where the equilibrium wage is \$8 per hour. The government introduces a minimum wage of \$10 per hour.

\$\$

\begin{aligned}

\text{Supply of labour (workers)} &: Q_S = 2W \\

\text{Demand for labour (employers)} &: Q_D = 20 - W \\

\text{Equilibrium} &: 2W = 20 - W \Rightarrow W^* = \frac{20}{3} \approx 6.67 \\

\text{With } W{\min}=10 &: QS = 20,\; Q_D = 10 \\

\text{Result: Surplus of labour (unemployment)} = QS - QD = 10

\end{aligned}

\$\$

Key points from the diagram:

  • Workers earning below $10 receive a higher wage.

  • Employers demand fewer workers at the higher wage, creating unemployment.

  • The policy reduces wage inequality but may increase joblessness among low‑skill workers.

Suggested diagram: Labour market graph showing supply and demand curves, equilibrium, and the effect of a minimum wage set above equilibrium.

Evaluation of Government Intervention

When assessing whether a policy is desirable, consider both efficiency and equity.

  • Equity benefits: Higher wages for low‑paid workers, reduced poverty, improved living standards.

  • Efficiency costs: Potential unemployment, reduced incentives for skill acquisition, higher production costs passed to consumers.

  • Distributional effects: Policies may benefit certain groups (e.g., union members) more than others, altering wage differentials.

  • Long‑run considerations: Investment in training can raise productivity, mitigating short‑run wage distortions.

Summary Checklist

  1. Identify the main government tools that affect wages.

  2. Explain how each tool changes the gross and net wage received by workers.

  3. Analyse possible unintended effects on employment and wage differentials.

  4. Weigh equity gains against efficiency losses when evaluating a policy.

Typical Exam Question

“Explain two ways in which government policy can affect wage differentials between skilled and unskilled workers. Use diagrams where appropriate.”

Answer structure:

  • Define wage differentials.

  • Discuss a policy (e.g., minimum wage, training subsidies) and its impact on each group.

  • Show a diagram (labour market or supply‑skill curve) to illustrate the effect.

  • Evaluate the policy’s advantages and disadvantages.