How does minimum wage affect the labor market and prices?

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The immediate effect on the labor market of imposing a minimum wage above the market wage is to increase unemployment, either by decreasing the number of workers or by decreasing the average number of hours worked by each worker, or both. Even there were no unemployment as a direct result...

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The immediate effect on the labor market of imposing a minimum wage above the market wage is to increase unemployment, either by decreasing the number of workers or by decreasing the average number of hours worked by each worker, or both. Even there were no unemployment as a direct result of the imposition of a minimum wage, it would increase the labor pool available, because the higher the wage, the more people want to do the job.

Say, for instance, that the market wage in a particular industry is $8 an hour. There are 10,000 people employed in this industry, and the government decides to impose a minimum wage of $10 an hour. The industry used to get 400,000 hours of work a week for a total of $3.2 million. The same amount of work now costs the industry $4 million. The industry may attempt to make savings by cutting average hours from 40 to 32 and week, or by cutting 20% of the workforce, in which case there are now 2,000 unemployed people in this industry. However, there are more than this, because there may well be another 3,000 people who did not want to work in the industry at $8 an hour but who do want the same job if it pays $10 an hour. The pool of labor is therefore greatly increased at a single stroke.

The effect on prices varies widely, according to whether the business is willing and able to pass increased employment costs on to the consumer. Sometimes a business will choose to absorb 100% of cost increases, including those caused by the minimum wage, to maintain the product at a stable price. Perhaps the most famous example of this is Coca-Cola. The price of a 6.5 ounce bottle of Coke was 5 cents from 1886 to 1959. There were specific reasons for this (including the huge expense of adapting vending machines to take other coins), but in a highly competitive market such as soft drinks, companies will generally be very reluctant to pass costs on to consumers, meaning a minimum wage would not necessarily affect prices in the short term.

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