“Minimum wage is a basic government-imposed price control. Price controls set a floor indicating what minimum price must be paid for certain goods or services. Governments set price controls to ensure individuals receive a fair wage at various jobs” (Osmond Vitez, 2016). To receive the national minimum wage, workers must at least be of the age to leave school and they must be at least 25 or over to receive the National Living Wage (NMW) on top.
Since October 2015 the NMW has increased by 25p for over 21 year olds and a National Living Wage was introduced in April 2016 for 25 and over, with a combined wage of £7.20. In October 2016 the minimum wage also increased by 25p for 18-20 year olds and by 13p for under 18’s (Figure 1) (GOV.UK, 2016). The purpose of the NMW in the long run is to remove the issue of poverty pay.
Therefore, an increase in the NMW would see a decrease in the demand for labour and a decrease would lead to an increase in the demand of labour. The demand for labour in relation to the NMW is inelastic. (Figure 2) At W1 there is lower demand for labour due to the minimum wage, but at W2, the demand for labour increases due to the NMW being lowered/ removed. This is because costs are lower for firms, which means they can look to expand their workforce whilst minimising costs. At W1 the supply of labour is also higher because people want to be earning the NMW and this shows a lower supply at W2, due to changes in the NMW meaning there is less incentive to work. If the supply changes but the demand for labour remains the same then employment will be lower due to the trade-off firm’s face, having less/more workers for cheaper/dearer costs. Although, if the demand curve shifts to the right there will be a new equilibrium where W1-Q1 meet (Figure 5). Once the NMW has increased, the supply of labour will increase which means if the NMW was lowered or if it didn’t exist then supply would shift to the right of the equilibrium point where W1 meets Q1 (Figure 6) and firms would employ more people due to the costs decreasing. Having said this, the supply curve can also shift because of other reasons, such as the legal age to start work, the hours of each working contract and changes to the qualifications/ skills required.
Productivity would potentially increase with the NMW and would be highest where demand is greater for labour than supply. This is because workers would become more motivated due to a higher income, which would increase their standard of living. In comparison, if the NMW decreased in October 2016 then it could lead to workers becoming less motivated and the quality of work being affected which could have consequences on the sales of firms, both short-term with refunds and long-term with customer loyalty. Therefore, an increase in the minimum wage from £6.70 – £6.95 (Figure 1) for 21-24 year olds would produce a concentrate in demand at Q1, but the supply would extent to Q2, this creates unemployment between Q1-Q2, since there is excess supply of labour (Figure 2).
One positive effect of the NMW is that it enables the substitution effect to be reduced by having a minimum wage rate which stays fixed. The substitution effect is where firms paying higher wages will look to substitute workers for capital or other means. This is because higher rates mean firms have higher costs and they look for ways to reduce them.
The law of diminishing returns must be considered when looking at how the demand of labour varies inversely with wage rates. An increase in the NMW means that individual firms can be analysed to see the number of workers profit maximisation firms employ. They will employ workers up to the point where Marginal Revenue (MR) = Marginal Cost (MC), at this point profit can be maximised and if MR is higher than MC then output will be increased, whereas if MC is higher than MR, then output will be decreased. This will enable UK firms to strengthen and make it harder for new competition to enter their market.
Furthermore, in a labour market which has perfect competition, firms and workers become wage takers “since neither can exert any control over the market wage rate” (McConnell et al, 2008, p273) , this leads to the supply of labour becoming perfectly elastic to the market rate. (Figures 3 & 4). The perfectly competitive market is most likely to be impacted when the NMW is lower since people have less disposable income and therefore will look to buy cheaper products such as ‘supermarket own products’. However with the increase in the NMW, monopolistic markets could be affected more since there will now be a rise in disposable income and consumers will be purchasing a higher amount of normal and luxury goods from many firms in a market, who all have differentiated products which will have a positive income-elasticity coefficient, meaning that more of these goods are demand as the income for consumers rises (McConnell et al, 2008). The large variety means that productivity of firms needs to be increased which “enables the economy to obtain more real output from its limited resources” (McConnell et al, 2008, p593) and it also allows firms to maximise their profit margins, this can be achieved when π=TR-TC (Figure 8) (McConnell et al, 2008). Although, monopolies in the market will have more control over consumer spending by being able to set prices where there are little substitutes due to less competition in the market, which leads to families being affected, because the NMW will only cover an individual’s cost of living with raised prices.
An advantage from the increase in the NMW is that it provides employment incentives which can lead to short term motivation for workers, boosting productivity for firms. But the productivity of workers will vary depending on what the wage rate is (Root III, 2016). However, it can be argued that unemployment levels will rise with an increase in the NMW, because it means that the less skilled workforce are unable to find employment and that the poverty levels remain the same as before due to having excess supply in the market (Gillikin, 2016). This creates a deadweight loss which can be shown by points below the supply line and above the demand line before and after the equilibrium point (Figure 9).
Another advantage that the UK would benefit from with the October 2016 NMW increase is that it reduces the worker exploitation by labour market monopsonists, where a single employer is able to pay below the labour market equilibrium, this allows the average standard of living to increase for the UK and other markets could be benefited in the long-run, such as the NHS. Since consumer income will increase it means consumers could purchase appropriate healthcare when needed which boosts sales and demand for the market. On the other hand, a high minimum wage can cause price inflation, as firms cover the higher wage costs with higher prices for consumers, which leads to a decrease in consumer spending. The NMW change would have little effect on the housing market, because even with a rise in consumer income, deposits are still a high amount to save, especially with the rising house prices. But there would still be an increase in the number of houses being rented/ sold (Figure 7) as shown when W1 and Q1 meet to create a new equilibrium in the housing market because of higher demand. Furthermore, monopolistic competition markets such as the ‘clothing industry’ will be impacted favourably, this is because there are a large number of firms whose products are differentiated through; product attributes, location, brand names and price (McConnell et al, 2008), which leads to consumers having a range of fashion to choose from, with quality and price at both high and low ends. The increase in sales is good for the UK because it means that small local businesses can expand and look to grow into foreign markets. Not only this, but with businesses performing better there will be a rise in the UK’s GDP.
Having discussed the increase of the NMW, the UK should also consider other policies in regards to its introduction. For example, one policy they could consider is providing education for the unemployed/low-skilled workers to gain some qualifications. As a result it would benefit the UK because it would reduce the unemployment rate and as people work their way up the ‘work ladder’ mean that more people are paying tax which will enable the government to spend more on the education system and to help build a strong economy. However, the costs could be too much for the government, especially in the short-run.
Furthermore, instead of increasing the NMW the government could instead introduce an economic policy to subsidise wages. This which would help to reduce unemployment because of lower costs, meaning firms would employ more low-income workers due to the opportunity cost being much lower than before. Not only would it pull people off the streets, but the UK poverty level would decrease, workers would gain experience, and higher employment means that there would be higher payroll taxes, which can be used as one way to help fund the subsidies.
Lastly, a third policy which could be considered is having no NMW, it would mean firms motivate workers through other ways such as piece-rate and this would lead to increased production, opening the opportunity to adopt economies of scale. Having no NMW could lead to less income for individuals which also limits financial support towards families, but it would also reduce the unemployment rate and it would allow both small and large businesses in the UK to flourish from the low costs. Equally important, the UK would become an attractive market for foreign businesses who wish to outsource/relocate for cheap labour brining more investment into the UK’s infrastructure.
Overall, the NMW is more important for teenagers and the unemployed, since the highly skilled/experienced workers have a higher wage equilibrium. Also the NMW raises the standard of living, stops businesses from significantly underpaying staff and reduces tax burden. Moreover, it rewards workers for their effort and it is more likely to motivate individuals, whilst making them feel more confident which could lead to improved performance. But it can also lead to higher unemployment and slow job growth. Therefore, increasing the NMW has both positive and negatives and I believe the increase is necessary in the UK, but the government should be more open to introducing other policies alongside the NMW, such as educating low-waged workers so that they can obtain better jobs and other low-income workers should have policies such as subsidies to look after them.