Minimum-Wage Theories of Unemployment

Efficiency-Wage Theories:

1. The theory holds true only for poor countries. Wages influence nutrition.

Better-paid workers can afford a more nutritious diet and therefore, they are more healthy and productive than a low paid worker.

The firm therefore decides to pay a wage above the equilibrium level. But this does not hold true for rich countries because wages in these countries are above the minimum level.

2. Due to high wage, workers are reluctant to quit the job. As a result the frequency of quits reduces.

This in turn decreases the time and cost incurred on hiring and training new workers. This is applicable more for developed countries.

3. By paying high wage the firm will get the best and most experienced employees who once employed will not leave the firm.

This reduces adverse selection, improves the average quality of work force and thus increases the productivity.

4. Due to high wage not only the productivity of labour increases but also the problem of moral hazard is reduced. High wages induces the worker not to leave the job and give their best in performing the job. Thus, the productivity increases.

Thus, we find that all these four efficiency-wage theories share a common theme that is, if wages are fixed above the equilibrium wage, the rate of job finding will decrease and wait unemployment will increase.

Impact of Minimum Wage:

1. The greatest impact of minimum wage is on teenage unemployment than for others in the labour force.

The equilibrium wages of teenagers tend to be low because of 2 reasons:

(i) Teenagers are usually unskilled with least experience. Their marginal productivity is low, therefore, their wages are low.

(ii) Teenagers often take some of their “compensation” in the form of on-the- job training rather than direct payment, for example: apprenticeship, and, therefore, have low a wage.

Therefore, any attempt to increase the minimum wage will lead to unemployment among the teenage.

Solutions to Minimum Wage:

I. To remove the effect of teenage unemployment

(i) Exempt young workers from regular minimum wage:

This permits a lower wage for teenagers, which will reduce their unemployment and enable them to get training and job experience.

But some economics argue that by doing so, firms will substitute teenagers for unskilled adults their by raising unemployment among that group.

(ii) Another solution to minimum wage is Earned Income-tax Credit:

This is a better way to increase the income of the working poor. The earned income-tax credit is given to the poor families with very low income. The payment is given directly against a tax by the Government because the tax credit of these families exceeds their tax liabilities. That is why the taxes are reduced by the amount of credit they owe.

Advantage:

Since the tax does not increase the labour cost to firms like minimum wage, the demand for labour by the firm does not fall.

Disadvantage:

It decreases the Government tax revenue.

According to Mankiw:

“Advantages of minimum wage are:

1. It prevents monopsony firms from giving low wage.

2. Minimum wage although causes unemployment but by increasing the income of working poor, it brings others out of poverty.