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Government Intervention » The Minimum Wage

What you'll learn this session

Study time: 30 minutes

Edexcel spec: 1.2.6 (d)

What a minimum wage is and why governments use one
The advantages and disadvantages of a minimum wage
How to draw a minimum wage above equilibrium and show excess supply of labour
How to show an increase in the minimum wage

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What is a minimum wage?

In the lesson on wage diagrams and trade unions you saw that wages are set by the demand for and supply of labour. Sometimes the government steps in to change the result. This is government intervention in the labour market. It is examined on Paper 1 (Microeconomics and Business Economics).

Key terms:

Minimum wage: the lowest hourly pay that an employer is allowed by law to pay a worker.
Excess supply of labour: when, at a given wage, more people want to work than firms want to employ.

A minimum wage only matters if it is set above the equilibrium wage. If it is set below it, firms already pay more than the minimum and nothing changes. So in exam diagrams, always draw the minimum wage above the equilibrium wage.

Reasons for a minimum wage

A minimum wage aims to give low-paid workers, like many in cafes and shops, a fairer income

💪 Protect low-paid workers

Some workers have little bargaining power, for example workers with few skills or no trade union. A minimum wage stops employers paying very low wages.

📈 Reduce poverty and inequality

Higher pay at the bottom gives low-paid workers more income, so the gap between the richest and poorest is smaller.

💼 Encourage people to work

If pay is higher, it is more worthwhile to take a job rather than rely on benefits.

💰 Raise spending

Workers with more pay can spend more. The government may also pay less in benefits to people in work.

Showing a minimum wage on a diagram

Here is a labour market for cleaners in the town of Brelda. The numbers are made up. Quantity of labour is in thousands of workers.

Wage per hour	Demand for labour	Supply of labour
£6	60	20
£7	50	30
£8	40	40
£9	30	50
£10	20	60

The equilibrium wage is £8, where demand equals supply at 40 thousand workers. Now the government sets a minimum wage of £9.

How to draw it:

Label the vertical axis "Wage rate" and the horizontal axis "Quantity of labour".
Draw a downward-sloping demand curve (D) and an upward-sloping supply curve (S). Where they cross is equilibrium, wage W and quantity Q (£8 and 40 thousand).
Draw a horizontal line across the diagram above W. Label it "Minimum wage" (£9).
Where the minimum wage line meets the demand curve, drop a line down to the horizontal axis. This is the number of workers firms will employ, Q1 (30 thousand). It is lower than Q.
Where the line meets the supply curve, drop a line down to the axis. This is the number of people who want to work, Q2 (50 thousand).
The gap between Q1 and Q2 is the excess supply of labour (20 thousand).

The results are two-sided. Workers who keep their jobs now earn £9 instead of £8. But firms now employ only 30 thousand, so 10 thousand lose their jobs. In total, 20 thousand people want a job at £9 and cannot get one, which is the excess supply.

An increase in the minimum wage

Suppose the government later raises the minimum wage from £9 to £10. On your diagram, draw a second horizontal line higher up and label it "New minimum wage". Use the same steps again. Firms now want only 20 thousand workers, but 60 thousand want to work. The excess supply of labour grows from 20 thousand to 40 thousand. Employment has fallen again, from 30 thousand to 20 thousand.

Notice that the demand and supply curves do not move. The minimum wage is a line placed above equilibrium. You are showing a movement up the demand curve (contraction) and up the supply curve (extension).

Worked example

Using the table, the minimum wage rises from £9 to £10. Excess supply at £9 = 50 − 30 = 20 thousand. Excess supply at £10 = 60 − 20 = 40 thousand. Employment falls by 10 thousand (30 to 20). The excess supply of labour doubles.

Advantages and disadvantages

A higher minimum wage raises staff costs, so some small firms may hire fewer workers

✅ Advantages

Workers who keep their jobs earn more. Poverty and inequality fall. Pay is fairer for low-paid workers. Workers may be more motivated and leave less often, which helps firms. The government may pay less in benefits.

❌ Disadvantages

Firms hire fewer workers, so unemployment may rise, as the diagram shows. Wage costs go up, which can raise prices or cut profit. Small firms may struggle to pay. Firms may use machines instead of workers. Some employers may break the law and pay less in secret.

How big the job losses are depends on how much firms cut back when wages rise. If demand for labour is steep, firms cut few jobs and the minimum wage works well. If demand is shallow, many jobs may be lost.

Common mistakes

Drawing the minimum wage below equilibrium. It has no effect there.
Shifting the demand or supply curve. Leave them alone and draw a horizontal line.
Labelling the gap as excess demand. Above equilibrium there is excess supply of labour.
Giving only advantages. For evaluation, give both sides and then a judgement.

Exam-style question

The table shows the labour market for shop workers in Teska. Quantities are in hundreds of workers.

Wage per hour	Demand for labour	Supply of labour
£5	80	20
£6	70	40
£7	60	60
£8	50	80

The government sets a minimum wage of £8 per hour.

(a) Define "minimum wage". [2 marks]

(b) Calculate the excess supply of labour at a wage of £8. [2 marks]

(d) Evaluate whether a minimum wage of £8 is good for Teska. [6 marks]

Model answer

(a) The lowest hourly pay (1) that an employer is allowed by law to pay a worker (1).

(b) Supply 80 − demand 50 (1) = 30 hundred, which is 3,000 workers (1).

(d) Advantage: the equilibrium wage is £7, so £8 raises pay for the 5,000 workers who keep their jobs (1), which may reduce poverty and make work more worthwhile (1). Disadvantage: firms now want only 5,000 workers instead of 6,000, so 1,000 lose their jobs (1), and in total 3,000 people want work but cannot find it (1). Higher wage costs may also push up prices or hurt small shops (1). Judgement: it depends on how many jobs are lost compared with how many workers gain, so it is good if most workers keep their jobs on higher pay, but harmful if unemployment rises sharply (1).

Exam tip

In part (b), subtract demand from supply at the minimum wage, and remember the table is in hundreds, so write 3,000, not 30.

Recap

A minimum wage is the lowest hourly pay allowed by law. It must be above equilibrium to have an effect.
Reasons: protect low-paid workers, reduce poverty and inequality, encourage work, raise spending.
On a diagram, draw a horizontal line above equilibrium. The gap between demand and supply is the excess supply of labour.
Raising the minimum wage again widens the gap and cuts employment further.
Advantages: higher pay for those in work, less poverty. Disadvantages: possible unemployment, higher costs for firms.

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