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The Myth of Manipulation

The Economics of Minimum Wage

Andrew Joliet
University of Rochester

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ABSTRACT

Myth of Manipulation
The Economics of Minimum Wage

Traditional research on minimum wage has largely focused on its possible employment
effects. The negative impact of minimum wages appeared to be empirically and theoretically
obvious through most of the 20th century. In 1992 that economist David Card shifted the focus
of labor market analysis from competitive to monopsonistic settings. If wages are set
monopsonistically it is theoretically possible for mandated wage increases to increase
employment. My paper will examine the verity of this possibility as well as provide an
exhaustive review of the impact of minimum wages on other outcomes including on-the-job
training, school enrollment, prices, and poverty.

I. INTRODUCTION
Minimum wage legislation is a highly controversial topic that is and has been debated in
the public, political, and economics communities throughout the 20th and 21 centuries. The
questions of minimum wage and its impact are really questions about labor markets and what
we actually know about labor markets and how they operate. The main focus of this paper will
be on what theory says labor markets look like, whether or not labor markets actually look like
this, and what these labor market theories mean for minimum wage legislation.
I will first discuss the two general theories explaining labor markets. An in-depth
overview of competitive labor markets will be given. There will be a focus on the impact of
minimum wage in this type of market. Special attention will be paid to employment effects,
unemployment effects, on-the-job training, schooling, and prices. The specific effects will be
discussed through theory and survey research. We will look at the results of over 150 empirical
research papers from 1957 to 2011.
Monopsony theory will also be discussed. There will be a specific focus on the theory
and whether or not labor markets look like this. As the reader will discover later in this paper,
monopsony theory is used as a justification of minimum wage legislation on the basis that such
legislation can increase employment. The relationship between monopsonistic labor markets
and minimum wage will be analyzed with a focus on employment. There will be a special focus
on labor demand elasticity, size of labor demand, size of labor supply, and the implications of
these factors on minimum wage legislation. Once again, these topics will be discussed with an
overview of the results of over 150 research papers. In addition, data from the Current
Population Survey will be used to take a deeper look at labor markets.
After the differing theories have been discussed, will find that we do not know exactly
what labor markets look like. Despite this lack of definitiveness, we will still be able to draw
some conclusions about minimum wage legislation. We will come to these conclusions partly
by taking a look at what the minimum wage labor force looks like. We will discover that the
minimum wage labor force is very small and that even though we don’t have a definitive
conclusion on what labor markets look like, minimum wages impact whether positive or negative
is likely small and insignificant.

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Many people believe that markets can simply be manipulated to produce beneficial
outcomes, especially if markets are shown to have frictions. I hope that those who read this
paper are able to see that even if there are labor market frictions; minimum wage legislation
must be structured in a particular fashion to produce optimal outcomes and even then the
legislation still has serious implications on the cost structures that firms face. Moreover, I hope
readers will see that prices are extremely important in that they send signals to firms and
laborers and that a binding minimum wage has serious implications on these signals.
History
Minimum wage legislation in the United States dates back to 1912 with Massachusetts
organizing a commission to establish wage regulation for women and children. Over the next
eight years thirteen other states passed similar legislation, usually with a legal emphasis on
women and children. Very quickly these state level minimum wage laws began to be
challenged in the courts. The first case dealing with minimum wage ruled on by the Supreme
Court was Adkins v. Children's Hospital in 1923. The Court ruled 5-3 that a minimum wage was
unconstitutional on the grounds that it violated the Due Process Clause of the Fifth
Amendment(PBS).1
In 1933 the Federal Government enacted a $0.40 minimum wage law through the
National Industrial Recovery Act(Taylor & Klein 2008). Two years later in May of 1935 the
Supreme Court famously ruled that the National Industrial Recovery Act was unconstitutional in
Schechter Poultry Corp. v. United States. Justice Cardozo’s opinion was “We are of the opinion
that the attempt through the provisions of the code to fix the hours and wages of employees of
defendants in their intrastate business was not a valid exercise of federal power.”(A.L.A. 1935).
It was not long however, until the decision in Schechter Poultry Corp. v. United States was
reversed with respect to the minimum wage.
In 1937, the 1935 ruling was reversed in West Coast Hotel Co. v. Parrish when a
chambermaid sued her employer for paying her less than the minimum wage that the state of
Washington had established. The case ultimately went to the Supreme Court which ruled in
favor of the defendant, resulting in the overruling of the Court’s decision in 1935. The Court felt
that minimum wages can be established to protect the health and well-being of workers. Justice
Charles Hughes delivered the opinion of the Court which stated “The legislature was entitled to
adopt measures to reduce the evils of the "sweating system," the exploiting of workers at wages
so low as to be insufficient to meet the bare cost of living, thus making their very helplessness
the occasion of a most injurious competition.”(West 1936).
The overruling of Schechter Poultry Corp. v. United States opened way for the Fair
Labor Standards Act(FLSA) to be passed in June of 1938. The FLSA established a Federal
minimum wage of $.25 per hour, $3.86 in 2010 dollars(Grossman). FLSA allowed states to set
minimums above Federal levels. FLSA has been amended ten times2, since its inception, in
order to increase the Federal minimum wage.3 Between the enactment of FLSA in 1938 and

1
Violated the Due Process Clause on the grounds that people have the right to "to obtain from each other the best
terms they can as the result of private bargaining."
2
The bill has been ten times to increase the minimum wage; other amendments to FLSA have been passed that do
not deal with wages.
3
The Fair Labor Standards Act, 29 U.S.C. § 201

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2011 the Federal minimum wage has risen from $3.86 in 2010 dollars to $7.25 in 2010. The
real minimum wage peaked in 1968 at $10.03, 2010 dollars. The history of the nominal and real
increases in the Federal minimum wage is shown in Graph 1.
Graph 1 illustrates the effect of inflation on the value of the minimum wage. This effect
results in the famous saw-tooth chart. The real minimum wage level increases with minimum
wage increases and decreases as inflation erodes the value of the minimum wage.

GRAPH 1.

How Many Minimum Wage Workers are There?


In 2006 Ted Kennedy said this in reference to minimum wage workers, “...there are
millions of mothers and fathers for whom that’s the reality”(Ted, 2006). The fact of the matter is
minimum wage workers make up a very small portion of the total labor force. Moreover, since
the 1970’s the number of minimum wage workers as a part of the total labor force has been cut
by over 50%, see Graph 2.
The amount of minimum wage workers in 1979 was 6,912,000. This made up 6.6% of
the total labor force. By 2010 there were only 4,361,000 workers making at or below the
Federal minimum wage. These workers made up only 2.8% of the total work force. These
numbers are significantly smaller than the proponents and even the opponents of minimum
wage lead people to believe. These figures are important for both opponents and proponents of
minimum wage legislation to keep in mind because whether the policy produces positive or
negative effects the scale of the total impact will be small because of so few people being
affected.

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GRAPH 2.

Age
The Bureau of Labor Statistics publishes figures on the age of minimum wage workers
from the annual Current Population Survey. According to CPS, a large portion of minimum
wage workers, as of 2010, are under 25 years old, 49% of the minimum wage labor force. 16-
19 year olds made up 22.8% of the minimum wage labor force and 20-24 year olds made up
26.2% of the minimum wage labor force. Once one reaches the age of 25, ones likelyhood of
being a minimum wage worker drops precipitously. The 25-29 year olds made up only 19.4% of
the minimum wage labor force. Graph 3 shows how the older the demographic, the lower the
amount of minimum wage workers. So, if minimum wage has negative or positive effects it is
likely going to primarily effect 16 to 24 year olds. This is important to keep in mind when
considering who a minimum wage is aimed at helping, which will be discussed throughout this
paper.
It is constructive to keep in mind what these numbers mean in absolute terms. Graph 4
shows what part of the total labor force the different aged minimum wage workers makeup. The
16 to 24 year olds made up a mere 1.4% of the total labor force4. The 16-19 year olds made up
0.6% of the total labor force, the 20-24 year olds made up 0.7% of the total labor force, and the
25-29 year olds made up a low 0.3% of the total labor force. Once again, minimum wage
workers make up a very small proportion of the total labor force, i.e. there are few minimum
wage workers.

4
These are total minimum wage workers in the 16-24 year old demographic divided by total labor force.

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GRAPH 3.

GRAPH 4.

Education
Another useful statistic when studying the minimum wage is the educational attainment
of minimum wage workers. We see that in 2010 58% of minimum wage workers had a high
school diploma, but no college degree, 29% had an associate degree or higher and 13% had
less than a high school diploma. These statistics will be useful when we look at the training and
schooling effects of minimum wage. Additionally, these are important figures when considering
the demographics that minimum wage effects. They show that minimum wage primarily affects
people with high school diplomas and college degrees. Popular opinion appears lean towards
the idea that most minimum wage workers are high school dropouts.

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GRAPH 5.

Occupation
In addition to age, CPS also contains data on the industries that minimum wages effect.
These statistics will be important for when we look at labor demand and supply elasticities later
on. CPS statistics show us that a very large percent of minimum wage workers work in “Food
preparation and serving related occupations”. These workers make up 38.8% of the total
minimum wage labor force. The second largest industry with minimum wage workers is “Sales
and related occupations”. This industry has about 16.8% of minimum wage workers. “Personal
care and service occupations”, “Office and administrative support occupations”, “Transportation
and material moving occupations”, and “Building and grounds cleaning and maintenance
occupations” have between 6-7 percent of minimum wage workers respectively. These results
can be seen in Appendix 1, Graph 1A.
These statistics show us that most minimum wage workers are in service industries.
Despite most minimum wage workers being concentrated in service industries, there are also
non-service, production, industries which pay minimum wage and are effected by minimum
wage legislation. Again this will be discussed in more detail when we discuss labor demand
and supply elasticities.
Location
The last statistic that we will look at is location of minimum wage workers. Location is
another statistic that will come into our analysis when we discuss the conditions that minimum
wage legislation must meet in a monopsonistic market. CPS finds that there are large
differences in state level minimum wage participation. When comparing the state with the
highest portion of minimum wage worker's as a part of its labor force, Mississippi with 9.5%, with
the state with the smallest portion, Washington with 1.1%, there is an 8.4% difference between
minimum wage work forces. These differences are illustrated in Graph 2A in Appendix 1. The
idea here is that minimum wages affect different areas more or less. This statistic will be shown
to be important when crafting minimum wage legislation in a later section.

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II. COMPETITIVE MARKET THEORY AND THE MINIMUM WAGE
What is a labor market? A labor market is a market in which there are buyers and
sellers of labor. In this market we observe the buying and selling behaviors of firms and
laborers. Just like in a goods market where there are infinite types of goods that can be
demanded and supplied at different prices and quantities, in a labor market there are infinite
types of labor that can be demanded and supplied at different wages and employment levels.
The demand and supply of labor are represented by the labor demand and labor supply curves.
Aggregate Labor Demand
Aggregate labor demand is how much firms as a whole, the market, are willing to pay for
particular quantities of labor. In a competitive labor market, firms determine how much labor to
hire by finding the points of profit maximization when they face different costs. This is illustrated
in Charts 1A and 1B.
In Chart 1A we see three curves. We see a total cost curve with low wages, a total cost
curve with high wages, and a total product curve. The total product curve is based off of how
much output firms can produce with particular quantities of inputs. The total product curve
tends to be increasing at a decreasing rate. The reason for this is that the total product curve is
based how productive capital and labor are and capital and labor tend to have diminishing
returns.
The other curves in Chart 1A are the total cost curves. These curves consist of fixed
and variable costs, variable costs being rent and wages. What we see is that total cost curves
are increasing at an increasing rate. We can understand this by looking at a bakery. Let’s say
that a bakery wants to expand its operations. In order to do so they must buy more ovens, more
shop space, more insurance, etc. So what we see is that the more our bakery produces the
more costs it is going to have to pay in order to increase production. This results in an upward
sloping total cost curve as seen in Chart 1A.
The total cost curve changes when variable or fixed costs change, this includes changes
in wages. This can be seen when comparing the total cost curve with low wages versus the
total cost curve with high wages. As you can see when wages increase there is an upward shift
in the total cost curve.We can use the total cost and product curves to determine the marginal
cost and marginal product curves. The marginal cost and marginal product curves look at what
it costs to produce an additional unit or how much more products will be produced with
additional labor input.
The importance of the total cost and product curves and marginal cost and product
curves is that these curves give firms points of profit maximization in reference to specific cost
structures. The easiest way to find the point of profit maximization is by using the marginal
product and marginal cost curves. This is illustrated through Chart 2B. We see that when
wages increase QL-QH less labor is wanted.
We can use these curves to find the aggregate labor demand curve. We can do this by
showing how these curves respond to increases and decreases in wages. We saw earlier that
increases in wages resulted in an upward shift in total costs. When the total cost curve shifts
upwards, as seen in Chart 1A, the marginal cost curve also shifts upwards, as seen in Chart 1B.
This results in different points of profit maximization. Specifically, when total costs and marginal

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costs increase, firms hire less, as seen by the shift from QL to QH. Firms hire less labor when its
relative cost increases. What this means is that when wages increase, increasing total costs
and marginal costs, firms demand less labor, i.e. a downward sloping labor demand curve.

CHART 1.

Aggregate Labor Supply


Aggregate labor supply is how much labor, laborers are willing to provide at different
wages. The labor supply curve is really determined by an evaluation of opportunity cost.
Laborers deciding whether or not to work have two basic choices: consumption or leisure. If a
laborer decides to work, he will have more money, i.e. a greater ability to consume, but he will
also have less leisure time. This trade off can be seen in Chart 2A.
We can determine the aggregate labor supply curve by looking at how labors respond to
increases and decreases in wages. In Chart 2A laborer can either spend 24 hours a day in
leisure or work 24 hours a day at $10 an hour. He cannot spend more than 24 hours in leisure
or working because a day is only 24 hours long. Additionally, he cannot make more than $240
hours a day because of the time constraint and wage constraint. In this situation, our laborer
will choose x* hours of leisure and y* consumption. Now if we increase the wage to $20 an hour
our curve pivots. Our laborer can now either work 24 hours for $480 or spend 24 hours in
leisure. It is most likely that our laborer will work more, y’ compared to y*, and spend less time

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in leisure, x’ compared to x*, because the opportunity cost of not working is significantly higher.
His choice is seen by the differences in his indifference curves in these two situations.

CHART 2.

We can use the above discussion to formulate a labor supply curve. The more and
more the curve pivots upwards, a wage increase, the more work the laborer will provide. This
trend is seen in our aggregate labor supply curve by it being upward sloping.
Market Equilibrium
Once we have calculated the aggregate labor demand and aggregate labor supply
curves, we can find the market equilibrium. This is the point at which the two curves intersect,
where marginal cost equals marginal product. It tells us how much labor is demanded for an
entire labor market, i.e. total amount of labor that is demanded by an aggregate of firms. This is
illustrated in Chart 3A(Market). In a competitive labor market, market equilibrium is important
because it tells at what wage all individual firms will pay their workers.
Firm Equilibrium
According to competitive markets theory, market equilibrium establishes a flat marginal
cost curve for all firms. This means that an individual firm can hire as much labor as it wants at
the market equilibrium wage. This can be seen graphically in Chart 3A, where the aggregate
quantity of labor supplied is Q* and the market equilibrium wage is P*. The firm level chart tells
us what the individual firm’s labor demand curve is. An individual firm will purchase the amount
of labor at which their labor demand curve5 intersect the market equilibrium wage. This is point
Q’. According to competitive markets theory, an individual firm can hire as much labor as it
wants at the market equilibrium wage. This idea of a flat marginal cost curve is very important
in our discussion of minimum wage legislation. It is the main difference between a competitive
labor market model and a monopsonistic labor market model. We will discuss this difference in
more depth in the following section.
Assumptions for a Competitive Labor Market
In order for the above discussion to hold together labor markets must be competitive. In
order for a labor market to be competitive five assumptions must be upheld. The assumptions

5
The labor demand curve is different from firm to firm.

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say all agents have perfect information, all agents are identical, all units of output are identical,
there are a large number of firms, and all firms are price takers.

CHART 3.

Now, none of these assumption hold perfectly in labor markets, i.e. labor markets are not
perfectly competitive. Though these assumptions are not perfectly upheld, they can still be
used to judge how competitive labor markets are. For example, we do not see perfect
information in labor markets. Information may be costly and difficult to attain. If one is
interested in determining whether or not a labor market is competitive or not one must test how
close markets are to perfect information. All that is required for markets to be competitive is for
markets to be close to these assumptions. So, just because markets are not perfectly
competitive, the five assumptions are not perfectly upheld, does not mean markets are not
competitive.
Minimum Wage in a Competitive Labor Market
Minimum wage is by definition a price floor, meaning that the objective of minimum wage
legislation is to prevent wages from being under a particular level. A minimum wage set at $5
prevents the price of labor from going under $5. In order for a price floor to have an impact it
must be set above market equilibrium wage. A minimum wage set above market equilibrium
wage is called a “binding minimum wage”. If the minimum wage is not binding firms and
laborers will continue providing and purchasing the same amount of labor at the same wage.
This point is illustrated in Chart 4A. M” is the minimum wage; firms cannot pay laborers less
than M”. Since M” below the market equilibrium wage, therefore not a binding minimum wage,
the situation in Chart 4A will not result in any changes. The main reason for this is that firms are
profit maximizing and a minimum wage of M” does not change their cost structure; therefore it
does not change their points of profit maximization.
An “effective” minimum wage, a binding minimum wage, would be set above the market
equilibrium wage. In essence, the proponents of minimum wage legislation do not think that
market equilibrium wages are high enough, so they would set the minimum wage above the

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market equilibrium wage. Under a competitive market model, this would result in decreases in
employment and increase in unemployment6.
Chart 4B illustrates the effect of a binding minimum wage. In Chart 4B, firms want to
pay market equilibrium wages because this is the point at which profits are maximized, but the
minimum wage, M+, prevents this. Firms can no longer pay wages less than M+. Since the cost
structure facing the firm has now changed, firms now have a different point of profit
maximization. As discussed earlier when the cost structure becomes more expensive, total
costs increase, and firms hire less. As a result, total employment decreases by at least Q*-Q+78.

CHART 4.

6
Why say employment decreases and unemployment increases. A minimum wage will cause firms to hire less labor
in a competitive market decreasing employment and increasing unemployment, but a minimum wage also sends a
price signal to workers who were not considered part of the labor force to join the labor force(laborers who had
stopped looking for work). These new laborers enter the labor force and do not have jobs to take because the price
signal they responded to was artificial. This results in an increase in unemployment while not decreasing
employment.
7
The firm we are looking at would hire Q++-Q’ less labor.
8
This might not be entirely true, if firms are able to decrease on-the-job training, increase product prices, or change
another part of their cost or revenue structure. This idea will be discussed in later sections on prices and training.

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It is possible that unemployment increases by more than Q*-Q+. Prices send signals to
market participants. Higher prices tell producers to produce more. When the minimum wage is
increased it sends a signal to people to supply more labor. The labor force is calculated by
adding together the total number of employed persons and the total number of unemployed
persons, but there is an additional group that is in this calculation. This group is made up of
people who are unemployed and who have stopped looking for employment. It is possible that
a minimum wage will send a signal to these workers to start looking for employment again, but
since the minimum wage is not a natural market signal there will not be jobs for these
individuals. The individuals that start searching for employment again are called “added
workers”. The result of this is that we see increases from unemployment by both decrease in
employment and increases in added workers.

Are Labor Markets Competitive?


Labor markets are undoubtedly not perfectly competitive. The important idea here is not
necessarily whether or not markets are perfectly competitive, but rather how close they are to
perfectly competitive. Though the world is filled with labor market frictions, sometimes these
frictions are very small. The identical agents assumption for example, says that laborers are the
same, i.e. have homogeneous preferences. The reality is that workers are not identical and do
have heterogeneous preferences. To determine whether or not markets are competitive we
would have to evaluate how different workers preferences are.
One friction that has been greatly diminished is lack of perfect information. The perfect
information assumption is impossible. There is no way that laborers can know of every job
available and the details of those jobs. Information is costly and difficult to attain. But because
of technological developments this information friction has been greatly diminished. In the
Internet age, information about job opportunities is available instantly and at an affordable price,
if not for free. Additionally, technology has also made the friction of mobility less intense.
People can now travel all over the world at the lowest prices in history and at the fastest speeds.
So, despite labor markets not being perfectly competitive, this does not mean that labor markets
are not competitive. Moreover, if labor markets are close to enough to the competitive
assumptions, labor market models would look similar to the perfectly competitive model.

III. MINIMUM WAGE AND EMPLOYMENT UNDER MONOPSONY MODEL


What is monopsony theory? Competitive labor market theory tells us that if a market
looks similar to the assumptions of the model, individual firms will face perfectly elastic marginal
cost curves. Monopsony theory purports to show us what cost structures firms face when
markets are not competitive. The specific difference between a monopsonistic labor market and
a competitive labor market is that in a monopsonistic labor market firms face upward sloping
marginal cost curves as compared to a flat marginal cost curve in competitive labor markets.
Upward Sloping Versus Perfectly Elastic Marginal Cost Curves
In a competitive market we saw that individual firms faced a perfectly elastic marginal
cost curve that was established by the equilibrium of aggregate labor supply and aggregate
labor demand. What this meant was that an individual firm could hire as much labor as it
wanted at the market equilibrium wage. In a monopsonistic market, firms no longer face

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perfectly elastic marginal cost curves. Instead the marginal cost curve that firms face is upward
sloping.
The meaning of an upward sloping marginal cost curve is that if a firm wants to hire an
additional laborer, it must raise the equilibrium wage. In essence, firms must increase wages to
incentivize more laborers to work for them. Additionally, firms not only have to raise the wage
for the new laborer, but they must also pay all of their identical current workers this new wage,
i.e. a new market equilibrium wage is established.
We can illustrate this point further with an example. Suppose a firm is paying an
identical set of workers $5 an hour and then the firm decides that they want to hire an additional
laborer. In order to attract this new laborer, the firm must pay him $5.25. If the firm decides to
hire this new laborer, the firm must not only pay this new laborer $5.25, but the firm must
increase the wages of all of its other workers to $5.25. The validity of this idea will be discussed
in more depth in a later section when we discuss wage discrimination.
Why Do We See Differences in The Marginal Cost Curve?
Perhaps the most prominent economist who deals with monopsony theory is Alan
Manning. Manning discusses the topic in-depth in his book “Monopsony in Motion” and a joint
paper “Oligopsony and monopsonistic competition in labor markets”. Manning talks about the
appearance of monopsony as a result of labor market frictions.
Labor market frictions are basically the antithesis of the assumptions put forth by the
competitive markets theory. The presence of frictions means that the competitive markets
assumptions do not hold. Laborers may not be indifferent between where they work. For
example, let’s say that laborer A is deciding whether or not to take a nearly identical position at
either McDonalds or Burger King. The only difference between these two choices is that this
laborers father worked for Burger King when he was younger. We will assume this family
history makes working at Burger King more attractive than working at McDonald's. The
implication of this family history is that laborer A is more willing to work at Burger King than
McDonald's. So, in order for McDonald's to entice laborer A to work at McDonald's, they must
pay worker A more. This violates the assumption that firms can hire as much labor as they want
at the market equilibrium wage and creates a situation where firms must pay higher wages to
attract more laborers, an upward sloping marginal cost curve.
Obviously not all laborers are identical. Again this does not necessarily mean that a
labor market is not competitive. In order for this to mean that a labor market is not competitive,
there would have to be serious violations of the assumptions describing competitive markets.
Monopsony and Employment
The importance of monopsony is that it has serious implications on firms hiring
decisions. If firms are profit maximizing, they will always hire the amount of labor at where
marginal cost equals marginal product. The marginal costs that firms face in a monopsony
market have changed. The result of this change is that firms hire a different quantity of labor
because the point of profit maximization has changed. Specifically, when a monopsony is
present firms hire less labor because firms are facing higher marginal costs.
Chart 5A shows what a firm looks like in the presence of a monopsony. We see that
instead of facing a perfectly elastic marginal cost curve, as seen in the competitive market
model, the firm is facing an upward sloping marginal cost curve. This cost structure means that
firms must increase wages to attract more workers. Again, the assumption is that if a firm hires

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a new laborer at a higher wage, the firm must also increase the wages of all of its identical
workers to the new laborers wage. In essence, when firms face upward sloping marginal cost
curves it is more expensive to hire additional labor. This is unlike competitive labor markets
because firms in a competitive market can hire ‘as much’ labor as they want at one wage. This
difference is why will see less employment in a monopsonistic labor market, Chart 5A we see Q’
employment instead of Q* employment.
Minimum Wage in a Monosponistic Labor Market
If monopsony theory holds, then a minimum wage could theoretically be used to
increase employment. The idea here is that a minimum wage will institute a new cost structure.
So instead of firms facing an upward sloping marginal cost curve, a minimum wage will result in
a new flat, perfectly elastic marginal cost curve. Since firms are profit maximizing, firms will
respond by hiring the amount of labor were the new marginal cost curve, the minimum wage,
intersects the marginal product curve, i.e. the labor demand curve.
This concept is illustrated in both Charts 5B and Chart 5C. Minimum wages of M” and
M^ are set, both of which are binding. These new marginal cost curves intersect the marginal
product curve at (Q”, M”) and (Q^, M^) respectively. The result of this new cost structure is that
firms employ different quantities of labor than they otherwise would. In fact, the more profitable
decisions with these minimum wages would be to employ Q’-Q” and Q’-Q^ more labor, only
because they must pay at least the minimum wage. In effect the minimum wage increases
wages and employment in a monopsonistic labor market.
Now there are limits to positive effect. One limit is how high a minimum wage can be set
and still result in employment increases. Chart 5D illustrates this limit. We will discuss this limit
in more detail when we discuss the Joliet Corridor in the next section.
Are Labor Markets Monopsonistic?
One way to test whether or not labor markets are monopsonistic is to get an estimate of
the “wage elasticity of the labor supply curve facing the firm”(Manning 2003). While estimates
have been made of the wage elasticity of labor supply that firms face, these estimates are not
robust enough for us to form any definite conclusions(Manning 2003). Despite the lack of
empirical evidence it is very likely that labor market frictions do create situations and/or markets
where individual firms must raise wages in-order to attract more labor. These are the same
frictions that were in our discussion of perfectly competitive markets.

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CHART 5.

IV. Monopsony Model Problems and Considerations


In the previous section we saw that in the presence of a monopsonistic labor market a
minimum wage could have positive employment effects while increasing wages. While
monopsony theory does show that minimum wage legislation can have positive employment
effects, the legislation must meet certain criteria. In this section we will discuss what criteria
minimum wage legislation must meet in order to have optimal positive effects on employment.
We will pay particular attention to the effects of differing labor demand elasticity and what this
means for minimum wage legislation. State and local level variances in market characteristics
and the implications on optimal minimum wages will also be discussed. Lastly, we will discuss
whether or not FLSA actually fits the optimal minimum wage profile.
Labor Demand Elasticity, the Joliet Corridor, and the Employment Window
Monopsony theory does indeed tell us that a minimum wage can increase employment
and wages, but there is a specific range at which a minimum wage can have positive
employment effects. This range will vary depending on the elasticities of labor supply and
demand. Elasticity can be captured by the slope of the labor supply curve, percent change in

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hours worked divided by percent change in wages, and the labor demand curve, percent
change in employment divided by the percent change in wages.
Let’s first look at labor demand elasticity. Chart 6A is going to be our referencing
monopsonistic labor market. In Chart 6A, labor demand is unit elastic where Q” labor will be
supplied at P” wage. In Chart 6A there is a definite window in which a minimum wage can have
a positive employment effects. I call this window the “Joliet Corridor”. The Joliet Corridor is the
wages between the point at which the marginal cost curve intersects the labor demand curve,
P””, and the monopsony wage, P”. A minimum wage set anywhere between P”” and P”, the
Joliet Corridor, will have a positive employment effect. In sum, a minimum wage must be set in
the Joliet Corridor to have positive employment effects. The size of the Joliet Corridor varies
depending on the elasticity of labor supply and demand. Chart 6A, 6B, and 6C demonstrate the
effect of changes in labor demand elasticity, but before were look at these charts let’s look at
what influences labor demand elasticities.
Elasticity was first discussed by economist Alfred Marshall in his Principles of Economics
in 1890. John Hicks extended Marshall’s insights in 1932(Hicks 1966). Their work forms the
Hicks-Marshall Laws of Derived Demand and consists of four factors. The first law says that
when the elasticity of product demand is high then the elasticity of labor demand is high. In
other words if consumers are not willing to absorb higher product costs, then producers are less
able to absorb higher production costs, like wages, so they are more sensitive to wage changes.
Secondly, if labor substitutes are readily available, then labor demand elasticity will be greater.
Essentially, if firms are able to replace labor with capital equipment easily then changes in
wages will have larger impacts on employment. Third, if other factors of production are highly
elastic then labor demand will be highly elastic. In other words, if a firm can increase the usage
of other factors of production without it having a significant impact on costs of those inputs, the
usage of labor will be much more sensitive to changes in wages. Lastly, if labor represents a
large proportion of a firm’s total costs, labor demand elasticity will be higher. This means that if
a firm is highly reliant on labor, an increase in labor costs will greatly increase total costs. This
increase in total costs will either result in higher prices, which consumers may not be able to
absorb, or a decrease in profits which the firm may not be able to absorb(Borjas 2008). An
understanding of these four factors is needed to understand Chart@.
Now that we know what causes changes in labor demand elasticity, let’s see what this
means for the Joliet Corridor. Chart 6B demonstrates what happens to the Joliet Corridor when
the elasticity of labor demand increases. Essentially, the Joliet Corridor shrinks to between P+
and P++. So, when elasticity increases the Joliet Corridor decreases. Chart 6C on the other
hand demonstrates what happens when the demand for labor is relatively inelastic. In Chart 6C
you see that the Joliet Corridor increases to P^^ to P^. So, when the demand for labor is
inelastic, the Joliet Corridor is greater. Essentially what these three graphs show us is that as
labor demand elasticity increases the Joliet Corridor shrinks and as labor demand elasticity
decreases the Joliet Corridor expands. This means that the more inelastic labor demand is the
more room legislators have for making a mistake in setting the minimum wage. One is less
likely to set a minimum wage outside of the Joliet Corridor if the Corridor spans from $4 to $10
than if it spans from $4-$5.
The idea that the Joliet Corridor is larger when labor demand is more inelastic makes
sense if we remember back to the Hicks-Marshall Laws of Derived Demand. For example, labor

Page 17
demand is more inelastic when substitutes are not available, meaning labor is fairly valuable to
firms because as an input it cannot be easily replaced. If labor is relatively more valuable to a
firm, it is likely that they would be more ‘willing’ to put up with a minimum wage. Compare this
to a firm that has relatively elastic labor demand. This firm is very sensitive to wage changes,
possibly because it can replace labor with capital. Firms like this are likely not as flexible when
it comes to minimum wages because they can more easily change their business structure
away from labor. Charts 6A, 6B, and 6C show that optimal minimum wage legislation needs to
take into consideration differences in labor demand elasticities because while a minimum wage
set within the Joliet Corridor in Chart 6C would have positive employment effects, that same
minimum would likely have negative effects in Chart 6B.
Another interesting observation that we can see is that changes in labor demand
elasticity change the total possible employment impact of a minimum wage, meaning changes
in labor demand elasticity change how large the positive employment effect a minimum wage
can be. This implication is labeled as “EW” in Charts 6A, 6B, and 6C. I call this span the
Employment Window. The Employment Window is defined as the largest possible positive
employment effects a minimum wage can have. We see the largest Employment Window when
labor demand is unit elastic, Chart 6A. We also see that as labor demand becomes less elastic,
Chart 6C, and becomes more elastic, Chart 6B, in reference to Chart 6A, the Employment
Window shrinks. So, the further away from unit elasticity9 the demand curve goes the smaller
the Employment Window will become.
The Employment Window is an important factor to keep in mind when thinking about the
implications of minimum wage legislation. We saw that as labor demand becomes more
inelastic the Joliet Corridor increase, more opportunities to increase employment through
minimum wage legislation. Interestingly, while the Joliet Corridor is larger, the Employment
window is relatively smaller. So while the probability of setting a minimum wage that will
increase employment is relatively high, the total possible employment effects are relatively low.
Additionally, if labor demand is relatively elastic both Joliet Corridor and the Employment
Window will be relatively small, meaning when labor demand is relatively elastic the probability
of setting an optimal minimum wage is low and the total possible positive employment effects
are low. The idea that we can take away from this is that if labor demand is relatively elastic,
there is a high probability that minimum wage legislation will produce negative employment
effects because both the Joliet Corridor and Employment Window are relatively small.

9
Unit elasticity is a curve with a slope of 1 or -1.

Page 18
CHART 6.

Labor Supply Elasticity


As discussed earlier the main condition for minimum wage legislation to be effective in a
labor market is that firms face an upward sloping marginal cost curve. The slope of the
marginal cost curve depends on the degree of elasticity of the labor supply curve. Charts 7 and
8 illustrate the impact of differing elasticities on the Joliet Corridor and the Employment Window.
In Chart 7 we see a labor market with relatively elastic labor supply.10 This results in a Joliet
Corridor of about $20, “JC” and an Employment Window a little over one. So in this market a
minimum wage set between about $23 and $43 can employment up to a little over 1. In Chart 8
we see a labor market with a relatively inelastic labor supply curve resulting in a steeper
marginal cost curve. The span of the Joliet Corridor in this labor market is about $31 and an
Employment Window a little under one. In this labor market wages set between about $47 and
$78 can produce a little under one in positive employment effects.

10
The prices in this example are completely arbitrary and are meant for descriptive purposes only.

Page 19
So, what we see is that as the labor supply curve becomes more inelastic the Joliet
Corridor increases in size, but the Employment Window decreases in size. In other words, the
more inelastic labor supply is the greater the possibility for setting a minimum wage with positive
employment effects, but the total employment effects will be relatively small. Additionally, the
more elastic labor supply is the smaller the Joliet Corridor and the larger the Employment
Window. So while you may be able to produce relatively large positive employment effects
when labor supply is relatively elastic, the minimum wages that could produce that effect are
relatively small in size and in scope.
CHART 7.

CHART 8.

Since the elasticity of labor supply does have an impact on the Joliet Corridor and the
Employment Window, it must be taken into consideration when setting a minimum wage. If
legislation does not take this factor into consideration optimal outcomes will not be seen across
all labor markets. One factor that effect labor supply elasticity is marginal tax rate. People in
areas that can keep larger proportions of their earnings are more likely to respond to wage
changes. Specifically, localities with higher marginal tax rates are likely to see more inelastic

Page 20
labor supply curves versus localities with lower marginal tax rates.11 So, since tax rates vary
from state to state Federal legislation may want to take this into account when setting an
overarching Federal minimum wage.
Industry & Firm Considerations
We have seen that both labor demand and labor supply elasticities matter when
considering the structure of minimum wage legislation. In order to promote optimal employment
outcomes these factors need to be incorporated into the law. Labor demand can be
incorporated by setting minimum wages by industry and firm.
What the labor demand curve really tells us is what the cost structure of a firm is. It tells
us how sensitive firms are to varying cost changes. Since all firms and all industries have cost
structures that greatly vary, it would be reasonable to expect that we would see varying labor
demand elasticities across industries and firms. The sensitivity to labor wages is likely very
different when comparing car manufacturing to fast-food restaurants because of the differing
applicability of the Hicks-Marshall Laws.
There have been several studies that look specifically at the impact of minimum wages
on different industries. We would expect that if labor demand elasticity varies from industry to
industry, that a flat, over-arching minimum wage would have varying effects from industry to
industry. Two studies in particular have had wide focuses on this topic. One of the studies
looked at the varying employment effects of a minimum wage on four industries. They found a
10% increase in the minimum wage decreases employment in retail by 8-25%, eating and
drinking by 5-20%, other retail by 9-26%, and total non-farm by 10-21%(Partidge & Partridge
1999). A more recent study found a 10% increase in the minimum wage decreased eating and
drinking employment by 2% and increased hotel and lodging employment by 15-16%(Singell &
Terborg 2006). This evidence shows that a minimum wage affects different industries
differently12.
What does this evidence mean for minimum wage legislation? What we have seen is
that labor demand elasticity changes the both the Joliet Corridor and the Employment Window.
Additionally, we have discussed that labor demand elasticity likely differs by industry and firm.
So, a minimum wage that would produce positive results in one industry or firm might not do so
in another industry or firm. Chart 9 shows how a minimum wage, M*, set within the Joliet
Corridor for an industry with relatively inelastic labor demand produces positive results, Q#-Q+
more employment, while it produces negative employment results in an industry with unit elastic
labor demand, Q”-Q$ less employment. The policy implication of this is that minimum wages
should be set on the industry and firm levels. It would not make sense even in the presence of
a monopsonistic market to have one over-arching minimum wage for all industries and
businesses because of the differing labor demand elasticities. FLSA does this to an extent by
having a lower minimum for tipping jobs and having some agricultural jobs exempt, but this
likely does not go far enough.
Interestingly, FLSA once implemented a minimum wage strategy that took the above
concerns into consideration. An amendment to FLSA established 40 industry committees in
11
When comparing how much Americans age 15 to 64 versus French aged 15 to 64, Americans were found to work
50% more, “marginal tax rates explain virtually all of this difference”(Prescott).

12
These differences are necessary evidence, but they are not sufficient evidence in determining the impact of labor
demand elasticity. Other factors could be at work here.

Page 21
CHART 9.

Puerto Rico which set industry level minimum wages. This amendment was discontinued in
1974 when congress amended FLSA to have Puerto Rico conform to US standards.13
Some work has been done on this transition for industry boards to an overarching
standard. It was found that industries in Puerto Rico whose minimum was at or within $.10 of
the United States minimum saw between 1-2% reductions in employment after the
implementation of the 1974 amendment. Furthermore, it was found that industries that had
minimums set more than $.10 below what the United States minimum wage was faced
decreases in employment of 32% in the following years(Castillo-Freeman & Freeman 1992).
This is further evidence that industry labor demand elasticity should likely be taken into
consideration when structuring minimum wage legislation.
Locality Considerations
In addition to labor demand elasticity, another important factor affecting the viability of
minimum wage legislation is locality. The characteristics of economies are vastly different when
observing individual states in the US. Moreover, the characteristics of individual regions,
counties, and cities are very different across the US. The economy of Houston, Texas with a
population of 2.2 million and a median income of $42,945.00 (City Data, 2011a) differs greatly
from Cuevitas, Texas with a population of 45 and a median income of $10,720.00 (City Data,
2011b). These differences have serious implications when considering the viability of a
nationwide minimum wage.
These implications can be observed by looking at simple supply and demand in Chart 6.
These graphs look at the minimum wage window when the supply and demand for labor is
either high or low. In Charts 10A and 10B illustrate communities/states with high and low labor
13
Similar industry standards were established in the United Kingdom when they passed the Trade Boards Act in
1909. This established industry wage boards which set minimum wages by industry. In 1986 the Wages Act of 1986
was passed which put limits to these wage boards and eventually ended them in 1993. Trade unions saw these
industry councils as a threat against collective bargaining(Deakin 2009).

Page 22
demand. Charts 10C, 10D, and 10E on the other hand illustrate communities/states with
differing labor supply.
We see by comparing Charts 10A and 10B that as demand for labor increases so does
the Joliet Corridor and the Employment Window. This means that with a larger demand for
labor there is greater probability of setting an effective minimum wage and there is a greater
total possible positive employment effect.14 Larger wealthier communities usually have higher
demand for labor because; their economies can support such a demand. The ironic implication
here is that smaller less wealthy communities with lower labor demand, communities that FLSA
is intended to help, have a higher probability of being hurt because of the small span of the
Joliet Corridor in these economies and the lower wage levels within the span.
A community/state with a relatively large labor force would be described by Chart 10C
and a community/state with a relatively small labor force would be described by Chart 10E. We
see that in both of these situations the Joliet Corridor and Employment Window are about the
same span, but at different wage levels. While a minimum wage set within the Joliet Corridor in
Chart 10E would provide positive employment effects, it would be well above the Joliet Corridor
in Chart 10C, resulting in a decrease in employment. We see that the span of the Joliet
Corridor is relatively small when there are relatively small quantities of labor and relatively large
quantities of labor. So, when an economy can be described by this extreme situation, low and
high labor supplies, the probability of setting an optimal minimum wage is much lower.15
There is a definite policy implication to the differences seen in Charts 10A through 10E.
These charts show that a Federal minimum wage in a country with varying state, county, and
city economies may have positive impacts in some localities, but negative impacts in others.
For example if the minimum wage was set within the Joliet Corridor in Charts 10A and 10D
produces positive employment effects, this wage floor would be well above the Joliet Corridor
for localities whose economies look more like Chart 10B and 10C, producing negative
employment effects. What this tells us is that in order for Federal minimum wage legislation to
produce optimal positive employment effects, there must be different minimums set for different
localities even in the presence of a monopsony market.
To put some meat on this argument we will look at state variations in low-skill wages,
Chart 11. This chart looks at state median hourly wages in “Food Preparation and Serving
Related Occupations”(FPSRO) and compares these wages to the Federal minimum. As you
can see in the third column, states differ significantly in what wages they pay in the same
industry. The median wage for FPSRO in Alabama is 7.86% higher than the Federal minimum
wage, while the median wage for FPSRO in Nevada is 47.17% higher than the Federal
minimum wage. A 10% increase in the Federal minimum wage is likely to be more binding for
FPSRO jobs in Alabama than in than FPSRO jobs in Nevada because average wages are much
closer to the Federal minimum. If both of these states have monopsonistic labor markets in
FPSRO and we want to maximize employment, we need to set the minimum wage within the
Joliet Corridor, which is very likely, different in Alabama versus Nevada.
14
All firms have particular amounts of capital and labor. If a economic conditions allow a firm to expand it will change
the amounts of capital and labor it employs. This can result in an upward shift in labor demand. If labor demand
shifts the firm would have determined hiring more labor would increase profits. It is possible that with greater profits
firms are better able to absorb the imposed extra costs of minimum wage.
15
This ‘anomaly’ is interesting. It likely has serious implications for economies with large labor supplies like China
and economies with relatively small labor supplies like New York City.

Page 23
CHART 10.

Page 24
CHART 11.

Page 25
Wage Discrimination
One last consideration is whether or not firms actually have to increase the wages of all
workers when they hire a new worker. This is a very important factor that needs to hold in-order
for minimum wage to have positive employment effects. If for example a firm could carry out a
form of price discrimination where they pay different wages to identical laborers, firms would no
longer face an upward sloping marginal cost curve. For example, let’s say laborer A is willing to
accept a wage of $1 and worker laborer B is willing to accept a wage of $2, a firm could hire
both for a total cost of $3. If firms could discriminate on this level, they would be able to change
their marginal cost curve to perfectly reflect the labor supply curve. This would result in a
scenario where a minimum wage could not increase employment. This is a topic the needs to
be seriously investigated if we truly want to know the implications of minimum wages in
monopsonistic labor markets.

V. MINIMUM WAGE AND ITS EFFECT ON EMPLOYMENT SUMMARY

Page 26
The debate over minimum wage has traditionally focused on the employment effects of
minimum wage legislation. Two camps have appeared to emerge in this debate. These two
camps can be personified by two groups of researchers. In one camp sits David Card and Alan
Krueger. The empirical results of their research and the theoretical justifications for their results
point towards the conclusion that minimum wages have no effects to positive effects on
employment due to the presence of a monopsony(Card 1992a) (Card 1992b) (Card & Krueger
1994) (Card & Krueger 1995a) (Card & Krueger 1995b) (Card & Kreuger 2000).16 David
Neumark and William Wascher appear lead the other camp. The results of their research give
modern econometric backing to the argument that minimum wage legislation has significant
negative effects on employment (Neumark & Wascher 1992). Their results appear justify the
traditional competitive market model, though we will discuss later why we may see negative
results even in the presence of a monopsony.
The empirical research on minimum wage dates back to the 1950’s. The majority of the
empirical research from the 1950’s through the 1980’s regularly finds negative employment
effects. In general, the results of the research from the 1950’s through the 1980’s showed that
with a 10% increase in minimum wage there is a 1% to 3% decrease in teenage employment
with additional disemployment effects in other demographics(Neumark & Wascher 2007). It
was not until the early 1990’s that these results began to face serious empirical challenges.
This challenge came from David Card in 1992. David Card looked at the 1989 Federal
minimum wage hike and its effects on regional levels(Card 1992a). He was able use states with
state minimum wages already over the federal minimum wage as controls. He also controlled
for differences in regional economic characteristics. According to his model, if minimum wage
does have employment effects, then we should see more drastic changes in employment in
states that have minimum wages below the Federal level. This is because a new Federal
minimum wage would not be binding or as binding for states already above the Federal
minimum. His study was not able to find statistically significant employment effects caused by
the minimum wage, challenging the theoretical models and traditional research which almost
always found significant negative effects. Card and Krueger followed Card’s original paper with
several other research papers in which they found similar results. These empirical results
appear to give legitimacy to looking at minimum wages using a monopsony model or at least
reason to question competitive market theory. Since 1992, I was able to find empirical 32
papers have been published which have results similar to Card & Krueger. These papers have
posed a new challenge to the traditional competitive model approach.
Card and Krueger’s results were met almost instantly with criticism. These criticisms
ranged from not incorporating lagged effects17(Neumark & Waschler 1992) to simply the year
that the research was conducted18(Wessels 1997). Neumark and Waschler were the first to
16
As discussed earlier a binding minimum wage minimum wage sends a price signal. This could result in laborer
who had stopped looking for work to start looking again, added workers. This could result in an increase in the
number employed and an increase in number of unemployed, if these added workers cannot find employment. This
effect could result in seeing smaller employment effects in the research.
17
The idea here is that the employment effects of a minimum wage may take a particular amount of time. Neumark
and Waschler argue that Card did not appropriately control for this lagged effect.
18
Wessels actually replicated the model used by Card and Krueger in their 1995 study which looked at the 1990-
1991 Federal hike. Wessels found that when using the same model to look at 1996-1997 Federal minimum wage
hike, negative employment results are produced. Wessels says that, “the fraction affected changed in a significant

Page 27
empirically challenge Card in their 1992 paper looking at the effects of minimum wage using
state level panel data. Using differences in state level minimum wages and Federal minimum
wages as a means of control, Neumark and Waschler found results that backed the traditional
empirical work on minimum wage(Neumark & Waschler 1992). Since 1992, Neumark and
Waschler have produced 13 other empirical studies/reviews that have drawn similar conclusions
on the negative effects of minimum wages. A total of 52 papers since 1992 have drawn similar
conclusions. These results appear to give backing to competitive markets theory or reason to
believe that FLSA is very poorly structured.
Survey
I collected 138 empirical papers that deal with minimum wage and its impact on
employment. These studies date from 1957-2011. They test minimum wages effects in over 21
countries.19 This survey can be found in Appendix 1. Graph 6 gives a summary of the results of
the research from 1957-2011. My survey found that 64% of the research from this time period
resulted in negative employment effects, 19% found no effect, 12% found mixed effects, and 5%
found positive effects. This is seen in Graph 6. When the time period is narrowed to 1992-
201120, 52% of the research found negative employment effects, 25% found no effect, 16%
found mixed effects, and 7% found positive effects. These results are seen in Graph 7.
This survey gives us an estimation of whether or not competitive markets theory or
monopsony theory is correct. What we see is that the vast majority of research backs the
competitive markets theory or the idea that FLSA is poorly structured, even when looking just at
research from 1992-2011. Fortunately, as we saw in the beginning of this paper, minimum
wage workers make up a very small portion of the total labor force. Due to this fact, these
overall negative impacts are not that large.
Graph 6.

way between the two sets of minimum wage hikes.” which helps explain the different results.
19
United States, France, Indonesia, Canada, United Kingdom, Mexico, Columbia, Finland, New Zealand, Chile,
Czech Republic, Brazil, Honduras, Greece, Japan, Germany, China, Portugal, Sweden, Trinidad & Tobago, and the
Netherlands.
20
From David Card’s paper to present.

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Graph 7.

VI. MINIMUM WAGE AND ITS EFFECTS ON JOB TRAINING


“Even if an individual were to “buy” on-the-job training by taking a very low wage…the
minimum wage law would not permit him to do so…”(Feldstein 1973). Ones compensation for
work does not just include a monetary income. Compensation can take the form of health
benefits, work environment, vacation days, job training, etc. These are all considerations that
laborers and employers take into consideration when determining wages according to human
capital theory. For example, a pleasant work environment would likely result in lower monetary
compensation. Working in a pleasant work environment is a real benefit that costs money for
an employer to provide. Some workers are likely to give up some of their salary in order to have
that benefit.21
The topic of training and compensation is discussed in depth by economist Gary Becker.
Assuming a competitive labor market, ones marginal productivity equals ones wage. Becker
argues that “Persons receiving general training would be willing to pay these costs[lower wages]
since training raises their future wages.”(Becker 1994). So, at times a laborer may be receiving
less than their marginal productivity in monetary wages, but it is made up for through training
that an employer provides.
Assuming that a laborers marginal productivity is $7 in a competitive market a worker will
receive $7 in compensation. According to Beckers model, workers will receive $7 in
compensation, but compensation specification may differ. The laborer may by paid $5 in wages
and $2 dollars in training. Many laborers are willing to do this because acquiring general skills
increases their marginal productivity and their future wages.
This model is used in most of the research to justify why we would see negative effects
on job training(Hashimoto 82) (Mincer & Leighton 81) (Neumark &Wascher 98). The argument
21
There are two types of skills that laborers can get through training: general skills and specific skills. General skills
are skills that can be utilized at more than on job. Knowing how to use a cash register for example is skill that can be
used in many different businesses. Specific skills are skills that are firm specific. Knowing where the storage closet
is. This is something that can only be used at a specific firm. Laborers are more willing to give up monetary
compensation for general skills which increase their marginal productivity across firms.

Page 29
is made that by putting a wage floor in makes less room for variety in components of
compensation. For example, a laborer whose marginal productivity is $7 in a world with a $6
minimum wage, could only receive up to $1 in non-monetary compensation. Furthermore, if the
minimum wage is increased to $7 that worker would have to receive $7 in monetary
compensation. If a firm were to train this worker it would be compensating that worker above
his marginal productivity because during training, the worker is not as productive. Therefore,
when the minimum wage is raised theory suggests that we would see less and less job training
as room for varying compensation specification is diminished. Specifically, general training
would likely be reduced because this training decreases a laborers marginal productivity while
the training is taking place, compared to specific training where a laborers marginal productivity
is increased very quickly.
A seminal paper by Masanori Hashimoto measures the effect of minimum wage on
training by using “work-experience-induced growth rate” as a proxy for training(Hashimoto
1982). The intuition is that we would be able to see a decrease in experience induced earnings
if training was decreased. He uses the National Longitudinal Survey as his data source. He
specifically looks at the effects of the 1967 amendment to FLSA. He finds that the 1967
amendment reduced job training by $.23 to $1.27 or 2.7% to 15%, supporting traditional
theory(Hashimoto 1982).
The problem with Hashimotos research is a problem that has faced most of the
research, lack of good data. Specifically the research has not been able to generally use good
measures of job training(Fairris 2004).22 Lastly, Hashimoto does not use data to look at cross-
state variations, which most recent research uses to control for variables, but cross-state
variations are used in Neumark and Wascher’s research and they still find some negative
effects(Neumark & Wascher 1998).
More recent research has produced different results. Fairris and Pedace (2004) have
particularly interesting results. They were able to utilize a new/different data set23 which showed
the percentage of workforce receiving training and the average number of hours of training
received. In addition, they use cross-state variations as an instrument to look specifically at
minimum wages effect. They find that minimum wages decrease the total number of people
receiving training, but total hours of training remain constant. This means that the allocation of
training appears to change. According to a paper by Lechthaler and Snower (2007) the
allocation of training goes from low-skill workers to intermediate skill workers creating a skill
gap. So while a minimum wage increase may not have an effect on total training, it may have
an effect on who is getting trained and the type of training, they receive.
The research on minimum wages effect on job training is mixed. There do not appear to
be any definite conclusions that we can draw from the research so far. While more research is
clearly needed, if minimum wages prevent firms from offering training or alter the way firms train
workers we might expect to see decreases in income mobility. If laborers are not able to
receive the general training that they once were able to, it seems likely that they would not be
22
Job training is not always directly observable. Hours at work for example can be directly measured. One only
needs to calculate the difference between when one arrives and leaves work and then multiply by the days spent at
work. Training on the other had is not as concrete. Training could be learning to communicate over the phone. This
is not something that is directly measurable.
23
They used 1997 National Employer Survey. They supplemented this data with the Standard Establishment List
data collected by the U.S. Census Bureau.

Page 30
able to increases their marginal productivity’s resulting in a lag in income growth. Young people
would most likely be disproportionately hurt by this effect, seeing that a large proportion of
minimum wage workers are under the age of 25. This may result in a generation of young
people increasing their earnings less than the previous generation.
Lastly, these training effects are likely not specific to competitive markets. When a
minimum wage is set it changes the costs that firms face, both in competitive and monopsonistic
markets. A minimum wage in the Joliet Corridor means both wages and employment will go up,
meaning that the costs facing a firm have increased. When we looked at determining the labor
demand curve we saw that as wages increased demand for labor decreased because to this
added cost. If firms are not decreasing employment to compensate for wage rate increases it
seems reasonable for a firm to change its behavior in another way to adjust for these cost
changes, possibly by training less.
TABLE 1.

Survey
The empirical research on minimum wages effect on job training is very limited. I was
only able to find ten papers that had attempted to analyze the data on this topic. Of these ten

Page 31
papers four showed negative effects, three showed no effects, two showed no to some positive
effects, and one showed negative to no effects. Moreover, in almost every paper the
researchers say that there is not enough evidence to draw a conclusion on this subject and that
further research must be conducted. These results can be seen in Table 1.

VII. MINIMUM WAGE AND ITS EFFECTS ON SCHOOLING


A minimum wage creates a price floor. This price floor in a competitive labor market
prevents employers from hiring anyone whose marginal productivity is lower than the minimum
wage. Laborers have limited choices in their response to the wage floor. They can: move to an
uncovered part of the economy(there are a limited number of employment options that are
exempted from FLSA), they can go unemployed, or they can go to school to increase their
marginal productivity. In response to the limitations in employment, theory suggests that
laborers stay in school longer or return to school in order to overcome the employment barrier
that the minimum wage creates(Mattila 1981).
Similar to training, schooling is another topic related to minimum wage that there is little
empirical research on. In my research I was able to find a total of 14 papers analyzing this
subject. These 14 papers varied in results from significant negative effects on schooling to
significant positive effects on schooling, as seen in Table 2. In the following paragraphs we will
take a look at the theories that support these differing results. Additionally, we will take a look at
the empirical evidence that is available.
We will first look at the evidence and theory of positive effects of minimum wage on
schooling. One of the first papers that looks at minimum wages relation to schooling is “The
Impact of Minimum Wages on Teenage Schooling and on the Part-Time/Full-Time Employment
of Youths” (Mattila 1981). Using a regression analysis and data from the Current Population
survey, Mattilla found that a minimum wage increased schooling.24 These results were
theoretically justified by looking at what every good economist looks at, how consumers and
producers respond to prices.
The counter argument to the evidence that Mattila provides says that minimum wages
decrease the schooling that individuals receive. This theory takes a more in-depth look at the
supply side. It looks at how laborers, the suppliers of labor, respond to increases in wages.
Arguably the most important aspect of prices is their ability to send information across a diverse
and wide group of market actors. Prices tell us how much labor needs to be supplied and how
much is demanded. In Chart 4B25 we see a competitive labor market with a binding minimum
wage. The question we should now ask is what does this tell employers and laborers? The
answer to this question is fairly intuitive. Someone demanding labor, an employer, is going to
want less because of an increase in prices, but someone providing labor, a laborer, will want to
supply more because of the opportunity for higher profits.

TABLE 2.

24
He found that a 10% increase in the minimum wage increase the proportion of 18-19 year olds in school by 1.33%
(males) and 1.26%(Females). Both of these estimates are statistically significant.
25
This is on page 13.

Page 32
Neumark and Wascher use this theory as the justification for the results in their papers
on this topic. They argue that market actors with higher marginal productivities are going to
leave school and join the labor force when they see higher prices imposed by a minimum wage.
The intuition is that minimum wages make working more attractive than going to school because
of the now higher pay.
One of the first empirical papers on this topic was produced by James Cunningham in
1981. Cunningham used the US Census to do a cross-sectional examination of minimum wage
effects on schooling. The result of his research was that minimum wage increases have a
negative effect on schooling. He added to the traditional theoretical justification by looking at
changes in part-time and full-time employment. He found that part-time workers are normally
paid less than full-time workers. Furthermore, when a minimum wage is imposed, part-time
positions are diminished. Students who formally worked part-time to pay for their education are

Page 33
now no longer able to do so. As a result, more people drop-out and take full-time
positions(Cunningham 1981).
This effect of minimum wage is particularly concerning. Minimum wage is a method that
is purported to help the lowest-skilled in the labor force. If minimum wage decreases schooling
it may have the impact of increasing the amount of low-skilled workers. This may result in lower
income mobility and increase the gap between rich and poor.
In summary, we can draw no definite conclusions from the research on minimum wages
effect on schooling. While most of the research does seem to be leaning in the direction of
negative effects on schooling, there is not enough evidence to make a definite conclusion. Like
training, more research needs to be done in order to draw a substantive conclusion on minimum
wages effect on schooling.
Despite the lack of definitive evidence on this effect, if we assume that the effect does
happen we would likely see it in monopsonistic markets as well as competitive markets. A price
signal is still being sent in monopsonistic markets. Depending on where the minimum wage is
set in a monopsonistic market, it may result in added workers entering the labor force who were
formally in school. This is seen for a minimum wage set above where the labor supply and
labor demand curves intersect. Minimums set above that point will result in firms wanting less
labor than laborers want to provide. Bottom line, prices are not arbitrary and have serious
implications in both competitive and monopsonistic markets.

VIII. MINIMUM WAGE AND ITS EFFECT ON PRICES


Unlike the previous two sections, the research on minimum wages effects on prices
appears to be much clearer because of the more uniform results and the greater amount of
research done. In this section we will go over the economic theory that would explain minimum
wages effect on prices. Additionally, I will present a survey of the research that has been
conducted on this subject
What happens to a firms cost structure when a minimum wage is instituted? Chart 9
shows a firms total cost and total revenue schedule with and without a binding minimum wage.26
What we see is that a binding minimum wage shifts the total cost curve that a firm faces up.
This diminishes the amount of profits that a firm can make. Firms, especially corporations, need
to make certain amounts profits to stay in business. Firms can respond to this change in costs
by changing the amount of people they employ, buying more capital equipment, and looking for
other cost saving techniques.
According to monopsony theory, a firm will increase employment when its total costs go
up from minimum wage legislation. If this new cost cannot be absorbed through lower
employment and firms need to maintain a particular level of profits, firms can increase prices to
do this. If a firm increases its prices its total revenue curve will shift upwards increasing profits,
though there are definite limitations to this strategy.

CHART 9.

26
This is similar, but different than when we looked at total cost and total product at the beginning of this paper.

Page 34
Survey
If our assumptions on the effects of minimum wage in the previous example hold, then
the empirical research should show similar results. In my research I was able to find 28 unique
papers on minimum wages impact on prices. Of these 28 papers, 20 found that minimum wage
increased prices, 7 found it had no effect, and 1 found mixed effects. None of these papers
found decreases in prices. These results can be seen in more depth in Table 3.
Thinking back on what industries are effected by minimum wage, Appendix 1 Graph 1,
makes for interesting implications of minimum wage legislation. What we saw was that the vast
majority of minimum wage workers are concentrated in “Food preparation and serving related
occupations”. So if the results from the papers in my survey are correct, “Food preparation and
serving related occupations” are going to likely increase the prices of their products. So,
minimum wages may increase employment, but these newly employed persons along with other
market participants are going to be facing higher food/restaurant prices. Interestingly,
poor/minority communities that minimum wage legislation is supposed to help have high
concentrations of fast-food restaurants and convenience stores(Block et al 2004). So, the very
people minimum wage is supposed to be helping through employment, it is likely hurting
through higher food prices.

IX. Does Minimum Wage Legislation Help the Poor?: A Survey


We have seen that minimum wage legislation can have a variety of impacts that vary in
scope depending on whether labor markets are competitive or monopsonistic and whether or
not legislation is structured properly. There are those who say that minimum wage may have
these negative impacts, but it is still a good policy on grounds that it reduces poverty. Though
minimum wages may reduce employment, the idea is that those workers who continue working
are now making higher monetary wages than they were. The position says those who are
receiving this now higher wage are primarily poor people. If this is true a minimum wage could
have negative effects with respect to employment and aid the working poor at the same time.
Proponents of this theory say that minimum wage hikes will specifically help single
mothers and fathers and other hard working families. Proponents argue that it is too difficult to
live off of a minimum wage in today's economy. Interestingly, these populations usually either
make more than the minimum wage individually or they have multiple wage earners in their
family, according to some research(Sabia & Burkhauser 2010).

Page 35
Sabia and Burkhauser (2010) did a study that looked at who was impacted by a
minimum wage increase. They estimated the effects of raising the minimum wage to $9.50 an
hour and the effects of the most recent minimum wage increase to $7.25. What they found was
that those affected by a minimum wage increase were likely to not be the only earner in a family
and were not likely to be the highest earner in that family. They estimated that in the most
recent minimum wage increase, 57.3% of the minimum wage hourly paid workers affected were
not the highest wage earners in their families. So, most workers who were affected by the
increase had other wage earners in their family, earning more. They estimated that if the
minimum wage were to be raised to $9.50 an hour, 42.3% of those affected would live in
households with incomes of $50,233.00. This is three times the poverty line for these
households.
Additionally, they looked at the minimum wage hike’s effect specifically on single
mothers and fathers. They found that only 12.5% of women and 5.5% men who are minimum
wage earners, who are unmarried, and who have children were affected positively by the most
recent increase in minimum wage. These are relatively small numbers when one considers that
minimum wage workers make up less than 3% of the total labor force. One of the main reasons
for these results is that single mothers tend to earn more than state and federal minimum
wages. Many single mothers, over 50%, from 1991-2004 had earnings above the 2004 Federal
minimum wage of $5.15(Sabia 2008). Additionally, there tend to be lower labor participation
rates among the poorest American households, which explains why minimum wage likely does
not have a significant effect on poverty(Leigh 2007).
Survey
The findings of most of the research indicate that minimum wage legislation is likely a
poor way of helping the poor. I was able to collect 28 empirical studies that tested whether or
not minimum wage legislation had a beneficial impact on poverty. These papers date from 1989
to 2011 and are conducted eight countries. The survey can be found in Table 1A in the
appendix. The results are summarized below in Graph 8. Out of the 28 studies 16, 59.3%,
concluded that minimum wage was ineffective at reducing poverty, 6, 22.2%, found that it was
effective, 4, 14.8%, found small effectiveness, and 1, 3.7%, found mixed results.
We have now looked at who is affected by minimum wage legislation. We have
seen that minimum wage workers tend to be young. Most, 49%, are under 25 years old. We
also saw that most, 57.3%, workers affected by minimum wage legislation are not the only or
highest earners in their families. Moreover, very few single mothers,12.5%, and fathers, 5.5%,
are effected by minimum wage increases. These results raise serious questions to the
argument that minimum wages help raise people out of poverty.

GRAPH 8.

Page 36
X. Conclusion
The public should be very weary of politicians and economists promising employment
increases and poverty decreases from minimum wage legislation. These claims are based off
of economic models that might not accurately describe labor markets and evidence that appears
to be pointing in the other direction. Moreover, the legislation that has been and is being
proposed does not fit with monopsony theory. Even if we could restructure FLSA so that it
would take locality, industry, and individual firms into consideration and even if it had no
negative unintended consequences, the positive impacts of the minimum wage legislation would
likely be minuscule because of the small size of the minimum wage labor force. The lack of our
understanding of labor markets, our inability to pass rational legislation, and the small size of the
minimum wage labor force are why it is a myth that we can manipulate this labor market to
produce meaningful outcomes.

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APPENDIX 1.
GRAPH 1A.

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GRAPH 2A.

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27

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27
TABLE 1A

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2829

28
TABLE 2A. Many of the results were taken from abstracts. Additionally, several of the papers and results were found in
Neumark and Wschlers paper “Minimum Wages and Employment” (2007)
29
TABLE 2A

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