Employment gains from minimum‐wage hikes under perfect competition: A simple general‐equilibrium analysis

Abstract

Contrary to conventional wisdom, higher minimum wages may lead to greater levels of employment under perfect competition. We demonstrate this possibility in a simple general-equilibrium model of involuntary unemployment, with two goods produced by two factors and consumed by two representative households. Within our model, hiking a minimum wage redistributes income between heterogeneous consumers. This redistribution may create an excess demand for the labor-intensive good, and hence increase total employment to restore equilibrium, despite the fact that every firm becomes less labor intensive. | IN TRO DUCT IO NAs we show within a simple general-equilibrium model of perfect competition, higher minimum wages may paradoxically lead to greater levels of total employment. Such a paradox has typically been associated with departures from perfectly competitive behavior. For example, the pioneering article by Stigler (1946) includes a monopsonist in the labor market, Manning (1995) has firms setting wages to affect effort, and Flinn (2006) considers wage bargaining with search-and-matching frictions. In contrast to these studies, the present paper assumes that firms take wages as given, in the way usually associated with perfect competition.Intuitively, a hike in the minimum wage has three effects. First, producers engage in factor substitution, leading to a reduction in labor intensity within each industry. Second, because the wage hike raises the relative price of the labor-intensive good, consumers substitute away from this good, toward the capital-intensive one. Third, income is redistributed between heterogeneous households with different marginal propensities to consume, possibly increasing the relative demand for the labor-intensive good. If this income-redistribution effect outweighs the combined substitution effects in production and consumption, the resulting excess demand for the labor-intensive good requires an increase in employment to restore equilibrium. While the standard partial-equilibrium treatment of minimum-wage Rev Int Econ. 2018;26:165-170.wileyonlinelibrary.com/journal/roie

Appropriation, migration, and unemployment

“…Card and Krueger (1993, 1995) empirically study the employment of the fast‐food industry in New Jersey and Pennsylvania and they find that employment increases with the minimum wage rate. Similar results are derived in Ahn, Arcidiacono, and Wessels (2003), Aaronson and French (2007), Brecher and Gross (2018), and Marjit, Ganguly, and Acharyya (2021). For example, Marjit et al (2021) derives this positive relationship between the minimum wage and employment using the same framework proposed by Gruen and Corden (1970).…”

“…However, the changes of prices are wrongly anticipated within the search models. In order to explain this result, many supplementary attributes are gradually introduced into traditional models, such as monopsony, heterogeneous consumers and the complementary relation (see Aaronson & French, 2007; Brecher & Gross, 2018). Distinguished from the existing theoretical literature, the discussion of this part provides a new mechanism that can be a potential explanation of the relationship between the minimum wage and unemployment.…”

Minimum wage, firm dynamics, and wage inequality: Theory and evidence​

“…Burdett and Mortensen (1998) find higher levels of employment along with increasing minimum wages when the labor market is characterized by monopsonistic competition with search activities. Under heterogeneous consumers, Brecher and Gross (2018) obtain a positive effect of minimum wages on employment via income redistribution, which can yield higher demand for labor-intensive goods. Neumark et al (2013) find that, by controlling spatial heterogeneity, there are in general no reductions in employment from minimum wage regulations but employment is lowered for teenagers.…”

The Impact of the Minimum Wage on Employment: An EU Panel Data Analysis

“…recent work suggests that a relative consensus on the effects of the minimum wage on employment came undone". Some authors, such as Brecher and Gross [5], have identified (theoretical) conditions under which "within a simple general-equilibrium model of perfect competition, higher minimum wages may paradoxically lead to greater levels of total employment". They introduced heterogeneous households with specific propensities to consume, using a two goods model.…”