Labor equilibrium?

Question

If there were to be an increase of 2 dollars to the minimum wage, how would the labor market equilibrium change? I am really struggling with this and would really appreciate help!

thanks

Answer 1

Depends on what sort of increase are these 2 dollars - if nominal then you should adjust to inflation - to calculate real change.

In most cases if real wage increases (without increase in productivity) then this will lead to jobs reduction.

But at the same time you should consider changes in capital markets - if real interest for capital increases faster than real wage then there could be increase in demand for labor and vice versa - if capital becomes cheaper then negative effect on labor-market will be doubled.

Another factors can affect too - level of business activity / demand for goods and services, etc.

Just remember general equilibrium condition:

MPK/r=MPL/w

there:

MPK - marginal product of capital

MPL - marginal product of labor

r - price for capital (interest rate)

w - price for labor (wage)

So if "w" increases then to compensate effect producer should increase MPK by reducing quantity of labor (due to decreasing marginal returns) or decrease MPK by using more capital.

Here how it will look like on graph:

- Since minimal wage is fixed above market equilibrium (effective price-floor) excess of labor will arise.

Other reactions are possible too.

Answer 2

Start with an X and Y axis, with an "X" shaped graph in the middle.  Label the upward sloped part of the "X" supply, and the downward sloped part as demand.  Label the X axis as quantity; label the Y axis as price.  Draw a dotted line from the intersection of the supply and demand curves to each axis.  Now you have P0 and Q0 which are the starting price and quantity of labor.

Think of the minimum wage as a price floor.  Wages cannot be below the minimum wage.  Draw a dotted line at P1, the new minimum wage $2 higher than P0.  If you want you can also draw lines from where P1 intersects with the supply and demand curves, maybe at Qs and Qd.  Now you can see that the labor supply will be higher than the labor demand.  This is the effect that you are probably looking for for the purposes of this problem.  

In the long term, what will eventually happen is the market will "adjust" and the new minimum wage will become P0, and a new quantity of labor will become Q0.  However, you do not have enough information to determine these effects.