A minimum wage

A national minimum wage aims to reduce ‘poverty pay’ and reduce the income gap between the low paid and other workers. Most countries have a national or local minimum wage.

What causes low pay?

Low pay can result from a number of labour market failures, including:

  1. A lack of access to the labour market for particular groups, caused by barriers to entry, such as discrimination against race, gender or age.
  2. Low pay is also possible in markets which are dominated by a single employer - a monopsonist – average wages may be below the competitive market rate, with individuals unable to bargain for wage increases. In this sense, the monopsonist exploits its monopsony power to suppress all costs - including labour costs.
  3. Low pay can also result from inward migration from ‘low-pay’ countries which drives down the wages for domestic employees.
  4. Low pay often reflects a lack of skills and a very elastic demand for labour, as firms have a large pool of workers to choose from.
    Low pay may be common in countries where labour unions are banned, or strictly controlled, including the Gulf States, and across Latin America1.

The benefits of a minimum wage

There are several potential benefits of a minimum wage.

  1. Firstly, greater equity can be achieved, and the distribution of income between the high paid and low paid may be narrowed.
  2. Poverty may be reduced as the low paid gain more income and the unemployed may be encouraged to join the labour market.
  3. Exploitation by powerful monopsonists may also be restricted.
  4. A minimum wage can also save government spending in terms of having to pay lower in-work benefits and tax credits.
  5. Finally, a higher minimum wage provides a boost to earnings, which can increase national income, and create jobs. A country’s official level of development, as measured by the HDI, may also increase.

Video on the minimum wage

The costs of a minimum wage

Set against the benefits are several potential costs of a minimum wage, including:

  1. The classical, free-market, argument against a national minimum wage is that it can create unemployment by distorting labour markets. Assuming the minimum wage is higher than market clearing wage, demand will contract and supply extend.
    Minimum wage
    The contraction of demand is the result of a combined income and substitution effect in response to the higher wage rate. For example, a minimum wage of £10.00 per hour would create a contraction in demand to e1, but supply would extend to e2 as more low skilled workers are encouraged to look for work, creating classical unemployment of e1 – e2.
  2. In addition, critics argue that a high minimum wage can cause price inflation as firms pass on the higher wages in higher prices. The competitiveness of goods abroad can also suffer compared with low wage economies, such as China and India.
  3. This can worsen the balance of payments. Similarly, inward investment may be deterred, as foreign investors will look to avoid high wage economies. The labour market may also become inflexible in response to changes in the rest of the economy. Finally, workers and employers may be driven into the ‘unofficial’ labour market.

The full impact of a minimum wage depends upon the level of the minimum wage, and the elasticity of demand for, and supply of, labour.


What determines monopsony power?

Demerit goods

What are the remedies for demerit goods?

Demerit goods

How does equilibrium create welfare?


1. According to The International Trade Union Confederation (ITUC), Viewed March 2 2021; https://www.ituc-csi.org/ituc-global-rights-index-names

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