Show in a supply and demand diagram how minimum wage can increase unemployment

In our supply and demand analysis, a minimum wage is a simple application of a binding price floor.

In this case, the "price" which is typically on the y-axis is the wage which gets paid to workers. In this simplistic model, it is best to think of the wage as how much a firm pays to get one worker. This means that workers are either employed or unemployed.

The demand curve represents the amount of workers all the firms in an economy will demand. The higher the price a firm must pay for a worker, the less workers that they wish to hire. Therefore, the demand curve slopes downwards as per usual.

The supply curve represents the amount of workers who are willing to provide their labor in exchange for the wage on offer. The higher the wages, the more people within an economy are willing to work. A logical question might be where do these workers come from? Well, they may decide to work instead of retiring, going on holiday or going to school (since we are assuming that current workers cannot work longer).

The effects of a minimum wage in a supply-and-demand framework

In this diagram, we can see that in equilibrium, at point A, the amount of workers willing to work corresponds to the amount that firms wish to hire. Therefore, there is no unemployment. However, when we add a minimum wage, the wage is higher than the market-clearing level. This causes firms to desire fewer workers and increases the amount of workers willing to work. This creates unemployment of the distance between Wd - Ws.

Note: This is a very simplistic description of an economy. Real world economies are much more complex so in reality minimal adjustments to minimum wages may not have the effects on unemployment as described above. However, this also paints an important picture about economies: If you increase the price of a resource too far above the market-clearing price you may create shortages.

 

 

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