If we are interested in the effect on unemployment, however, we must look at both demand and supply. A worker is counted as unemployed if he or she is looking for a job but does not currently have a job. The labor supply curve tells us how many workers are willing to work at a given wage; those who are not employed are looking for a job. To understand the effects of the minimum wage on unemployment, we need to look at the mismatch between supply and demand at the minimum wage, so we must look at the supply of labor as well as the demand for labor. The price elasticity of supply measures the responsiveness of the quantity supplied to a change in the price: in the case of the labor market, we obtain the wage elasticity of labor supply:we can see that the wage elasticity of labor demand tells us everything we need to know about the effects of a change in the wage on employment. If the demand curve is relatively elastic, then a change in the minimum wage will lead to a relatively large change in employment. If the demand curve is relatively inelastic, then a change in the minimum wage will lead to a relatively small change in employment. This is intuitive because the elasticity of labor demand tells us how sensitive firms’ hiring decisions are to changes in the wage. An elastic demand for labor means that firms will respond to a small change in the wage by laying off a large number of workers, so the employment effect will be large. The elasticity of labor supply is not relevant if we are concerned only with employment effectsOur model generates a qualitative prediction: an increase in the minimum wage will decrease employment and increase unemployment. At the same time, the wage increase will ensure that those with jobs will earn a higher wage. So we can see that there may be both advantages and disadvantages of increasing the minimum wage. To go further, we have to know how big an effect such a change would have on employment and unemployment—that is, we need the quantitative effects of a higher minimum wage
Sample Solution