The employment effects of a minimum wage increase

One of the more hotly debated economic policy proposals in the past couple of years has been the proposal to raise the federal minimum wage. In his Feb. 2013 State of the Union, Obama proposed raising the federal minimum to $9.00/hour by 2015, and in March 2013, Congress went further with the Miller-Harkin Act (Fair Minimum Wage Act of 2013), which proposed raising it to $10.10/hour.

In Feb. 2014, the Congressional Budget Office produced a report assessing the likely impact of these proposals on employment and family income. The report, which was based largely on a synthesis of academic research, concluded that the employment effect of a $9 minimum wage could be anywhere from a small positive (i.e. a small increase in employment) to a moderate negative effect; and that the employment effect of a $10.10 minimum would likely be more negative than the effect of a $9 minimum.

Questions/guidelines:

First, based on what you have learned in the class, discuss and explain the possible reasons for (1) why the estimated employment effect of a U.S. federal minimum wage increase ranges from small and positive to moderately negative, and (2) why the employment effect is likely to be more negative at a higher value of the minimum wage. Your answer should draw on theoretical models of both competitive and imperfectly competitive (monopsonistic) labor markets. You should explain concepts verbally, but you may also sketch graphs to illustrate your points. In particular, you should address:

• What determines the size of the employment effect of a minimum wage increase in the model of perfect competition?

• What is meant by monopsony power and why might firms have it?

• Why might the minimum wage increase have a positive effect on employment if firms have significant monopsony power (as opposed to operating in very competitive labor markets)?

• In both competitive and monopsonistic markets, why and how does the employment effect depend on how high the minimum wage is set?