National Minimum Wage (AQA A-Level Economics): Revision Notes
National Minimum Wage
What is the national minimum wage?
The national minimum wage (NMW) is a legally-enforced hourly pay rate that employers must pay to their workers. This means that by law, no employer can pay less than this set amount per hour, although in many labour markets, employers choose to pay wages above the minimum level.
The government determines the NMW rate, and it applies across different age groups, with varying rates for different age brackets. The primary purpose of this policy is to protect workers from exploitation and ensure they receive fair compensation for their labour.
The national minimum wage only directly affects labour markets where the current market wage would otherwise fall below the legal minimum. In sectors where competitive forces already push wages above the NMW, the legislation has no practical effect on wage determination.
Effects of a national minimum wage on labour markets
Impact in perfectly competitive markets
In a perfectly competitive labour market, wages are determined by the interaction of labour supply and demand. When these forces are left to operate freely, they establish an equilibrium wage where the quantity of labour supplied equals the quantity demanded.
However, when the government sets a minimum wage above this market-clearing level, it disrupts this natural equilibrium. Let's explore this with a worked example.
Worked Example: Plotting and Interpreting Labour Market Data
Consider the labour market for gardeners. The table below shows the relationship between hourly wage rates and the number of workers (in thousands) who want to work and whom employers want to hire:
| Wage rate (£ per hour) | Supply₁ | Demand₁ | Supply₂ |
|---|---|---|---|
| 5 | 40 | 160 | 100 |
| 7 | 60 | 150 | 110 |
| 9 | 80 | 140 | 120 |
| 11 | 100 | 130 | 130 |
| 13 | 120 | 120 | 140 |
| 15 | 140 | 110 | 150 |
| 17 | 160 | 100 | 160 |
Finding the initial equilibrium:
At £13 per hour, the demand for labour (120,000 workers) equals the supply of labour (120,000 workers). This is the equilibrium market wage, where all workers who want jobs at this wage can find employment, and all employers who want workers at this wage can hire them.
Effect of increased labour supply:
If the supply schedule shifts to Supply₂ (perhaps due to immigration or more people entering the workforce), the new equilibrium occurs at £11 per hour, where demand equals supply at 130,000 workers. The market naturally adjusts to this new clearing wage.
Introducing a minimum wage:
Now suppose the government sets a national minimum wage at £13 per hour. Looking at the Supply₂ column, at this wage rate, 140,000 workers want jobs. However, employers only want to hire 120,000 workers at this wage (from the Demand₁ column).
This creates unemployment of: 20,000 workers
These 20,000 individuals want to work at £13 per hour but cannot find jobs because the wage is above the level where supply equals demand.
Key Principle: When a minimum wage is set above the market equilibrium, it creates excess supply of labour. More people want to work than employers want to hire, resulting in unemployment.
Impact in monopsonistic markets
The analysis changes significantly when we consider labour markets with monopsony power. A monopsonist is a single buyer of labour (or a small group of buyers acting together) who can influence the wage rate by varying the quantity of labour they employ.
[IMAGE
]The diagram above compares wage determination in competitive and monopsonistic labour markets. In a monopsony:
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The Marginal Cost of Labour (MCL) curve shows how much it costs the employer to hire each additional worker. This rises steeply because to attract more workers, the monopsonist must raise wages for all workers, not just new hires.
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The Average Cost of Labour (ACL) is equivalent to the supply curve, showing the wage needed to attract different quantities of workers.
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The Marginal Revenue Product of Labour (MRPL) shows the additional revenue generated by each extra worker.
Without intervention, a monopsonist employs workers where (point B), hiring workers at wage . This is below the competitive wage rate , where the competitive market would employ workers (point C).
How a minimum wage can help in monopsony:
When a minimum wage is set at an appropriate level (such as in the diagram), something remarkable can happen. The monopsonist can no longer pay the low wage . The minimum wage effectively creates a horizontal section in the supply curve, eliminating the monopsonist's ability to drive wages down.
At wage , the employer may actually hire more workers (up to ) because the marginal cost of hiring additional workers is now constant at rather than rising along the MCL curve. This demonstrates how, in monopsonistic markets, a carefully-set minimum wage can potentially increase both wages and employment simultaneously.
This contrasts sharply with perfectly competitive markets, where minimum wages above equilibrium always reduce employment.
Advantages of a national minimum wage
Reducing exploitation and poverty
The primary argument supporting minimum wage legislation centres on worker protection. In many real-world labour markets, particularly those employing low-skilled workers, employers possess considerable market power. They can drive wages down to what supporters call "poverty rates."
By establishing a wage floor, the government prevents employers from exploiting vulnerable workers who have limited bargaining power or alternative employment options. This is particularly important for workers in sectors like hospitality, retail, and care work, where individual workers have little ability to negotiate higher wages.
Alleviating poverty and income inequality
Low wages contribute directly to poverty and income inequality. When workers cannot earn enough to meet basic living costs, they may require government support through benefits and tax credits. This means taxpayers effectively subsidise employers who pay very low wages.
A national minimum wage addresses this by:
- Redistributing income from employers to low-wage workers
- Reducing the need for government welfare payments
- Helping to narrow the gap between the highest and lowest earners
- Enabling workers to afford basic necessities like food, housing, and clothing
Evidence of minimal unemployment effects
Most research examining actual minimum wage implementations suggests that fears of mass unemployment are exaggerated. Studies generally conclude that while there may be some unemployment effects, these are extremely small compared to the benefits of raising incomes for low-paid workers.
According to research evidence:
"Most of the evidence collected since national minimum wages were first introduced suggests that 'wage floors' either slightly increase or slightly decrease employment. Either way, they do not result in mass unemployment. Recent studies generally conclude that, although there probably are unemployment effects, such effects are extremely slight."
The benefits of improved incomes for low-paid workers, according to this evidence, far exceed the costs of minor employment reductions. By raising wages with minimal impact on employment levels, minimum wage policies can effectively redistribute income without significant economic disruption.
Disadvantages of a national minimum wage
Unemployment and reduced working hours
Critics of minimum wage legislation argue that setting wages above market-clearing levels inevitably reduces employment. Free-market economists contend that if the wage is forced above the competitive equilibrium, employers will hire fewer workers, leading to unemployment.
Evidence from opponents suggests several negative effects:
International research indicates that minimum wage increases can lead to reduced working hours. Even if workers retain their jobs, employers may cut hours to control labour costs, potentially leaving workers no better off financially.
The timing of effects matters. Negative consequences may not appear immediately but emerge over longer periods as businesses adjust to higher labour costs by reducing new job creation rather than firing existing workers.
Impact on specific groups
Minimum wage increases tend to disproportionately affect certain vulnerable groups:
- Young workers (particularly 18-24 year olds) face higher unemployment risk. Employers may prefer hiring experienced workers over young people when forced to pay higher wages.
- The unskilled and those with limited qualifications find it harder to compete for jobs when wages rise.
- The long-term unemployed struggle to re-enter the workforce.
- Lower productivity regions where businesses operate on tighter margins.
Research has shown concerning trends. Youth unemployment rates among 18-24 year olds rose from 11.5% when the UK's NMW was introduced in April 1999 to 17.9%, with a significant proportion out of work for extended periods.
Free-market economics perspective
Economists who support free-market principles argue that minimum wages create more problems than they solve. A 2011 report commissioned by the Institute of Economic Affairs (IEA) concluded:
"Far from having positive effects for the working poor, the implementation of the minimum wage in the UK is likely to have had a negative effect on employment. The minimum wage has been routinely raised at a rate greater than inflation, resulting in a tremendous increase in the real value of the minimum wage."
The report argued that during economic recessions, the inflexibility of the minimum wage becomes particularly problematic. Rather than allowing wages to adjust downward temporarily (which could preserve jobs), the wage floor forces employers to cut employment instead.
Critics suggest that alternative policies, such as reforming tax credits or reducing inflation, would better help low-wage workers without distorting labour markets and creating unemployment.
Subsidy concerns
Some economists argue that in-work benefits like tax credits create perverse incentives. Nearly a third of tax credit recipient households have no adult in paid employment. The system may inadvertently subsidise employers who pay low wages while simultaneously subsidising workers who work fewer than 30 hours weekly.
The national living wage
What is the national living wage?
The national living wage (NLW) represents a higher minimum wage tier for older workers. While the national minimum wage still applies to younger age groups, the living wage provides enhanced protection for workers aged 23 and over.
The living wage concept originates from the idea of a minimum income necessary for workers to meet their basic needs, including food, clothing, and housing. It recognises that older workers often have greater financial responsibilities and living costs.
The UK introduced the NLW in April 2016 under a Conservative government, responding to public pressure for better wages. Initially, it applied only to workers aged 25 and over, but this threshold was lowered to 23 and over in subsequent years.
Current rates
The table below shows the structure of minimum wage rates as of April 2022:
| Age group | Hourly rate (£) |
|---|---|
| National living wage (23+) | 9.50 |
| National minimum wage (21-22) | 9.18 |
| National minimum wage (18-20) | 6.83 |
| National minimum wage (16-17) | 4.81 |
Notice how the rates are tiered by age, with older workers receiving higher minimum wages. This reflects both greater earning power expectations and higher living costs faced by older workers.
Historical development
Both the NMW and NLW have increased regularly since their introduction. The government typically raises these rates annually after consulting the Low Pay Commission, which provides independent advice on appropriate levels.
The table below shows how rates for workers aged 25 and over (23+ from 2021) have changed:
| Year | National minimum wage (£) | National living wage (£) |
|---|---|---|
| 2017 | 7.05 | 7.50 |
| 2018 | 7.38 | 7.83 |
| 2019 | 7.57 | 8.21 |
| 2020 | 7.76 | 8.72 |
| 2021 | 8.91 | 8.91 |
| 2022 | 9.50 | 9.50 |
Key observations:
- Both rates have increased substantially over this six-year period.
- The NLW has consistently been set higher than the NMW.
- In most years, the increases exceeded the inflation rate, meaning real wages (purchasing power) improved.
- From 2021 onwards, the single rate of £8.91 and then £9.50 applies to all workers aged 23 and over.
Nominal versus real values
When evaluating minimum wage changes, it's crucial to distinguish between nominal values (the actual money amounts) and real values (what that money can actually buy after accounting for inflation).
Nominal values are the actual monetary figures without adjustment for inflation. For example, the cash amount of £9.50 per hour is a nominal value.
Real values take inflation into account, measuring purchasing power. They tell us what wages can actually buy in terms of goods and services.
Formula for real wage change:
For example, if nominal wages increase by 3% but inflation is 2%, real wages have only increased by 1%. If nominal wages increase by 2% but inflation is 4%, real wages have actually fallen by 2% – workers are worse off despite earning more money.
Between 2017 and 2022, although nominal wage rates increased every year, whether workers experienced real wage growth depended on inflation rates during those periods. In some years, particularly during high inflation periods, the real value increases were much smaller than the nominal increases, or even negative.
Case study: should we have a national minimum wage?
The Card and Krueger research
One of the most influential studies supporting minimum wage policies comes from American economists David Card and Alan B. Krueger. Their 1994 research article "Minimum wages and employment: a case study of the fast-food industry in New Jersey and Pennsylvania" challenged conventional economic thinking.
Research Design:
On 1st April 1992, New Jersey increased its minimum wage from $4.25 to $5.05 per hour. Card and Krueger surveyed 410 fast-food restaurants in New Jersey and Pennsylvania (where the minimum wage remained at $4.25) before and after this increase.
They compared changes in wages, employment, and prices between stores in the two states, with Pennsylvania serving as a control group to isolate the effect of the minimum wage rise.
Key findings:
The research challenged predictions that minimum wage rises reduce employment. Their results showed:
"Our findings challenge the prediction that a rise in the minimum wage reduces employment. Relative to stores in Pennsylvania, fast food restaurants in New Jersey increased employment by 13 percent."
Furthermore, when comparing New Jersey stores that initially paid high wages with those that paid low wages, the results contradicted standard theory. Stores paying at the previous minimum wage level increased employment, while stores already paying higher wages showed no change in employment.
Conclusion:
Card and Krueger argued that their evidence did not support the claim that minimum wages necessarily cause job losses. Their work has been highly influential in shifting economic consensus toward accepting that minimum wages can be raised without catastrophic employment effects.
The British experience
When the UK introduced its national minimum wage in April 1999 under a Labour government, many economists and politicians predicted negative consequences. The Conservative Party initially opposed the policy. However, by 2010, Conservative Prime Minister David Cameron publicly stated that the minimum wage "turned out much better than many people expected."
This shift reflects accumulated evidence that the UK's minimum wage implementation did not produce the dire employment outcomes predicted by opponents.
Ongoing debate
Despite evidence supporting minimum wages, debate continues among economists and policymakers. In 2011, economist Karthik Reddy, writing for the IEA, maintained opposition to the policy:
"Far from having positive effects for the working poor, the implementation of the minimum wage in the UK is likely to have had a negative effect on employment. The minimum wage has been routinely raised at a rate greater than inflation, resulting in a tremendous increase in the real value of the minimum wage. This rise is particularly problematic for workers during times of recession."
The argument suggests that during economic downturns, wage flexibility is crucial. If wages cannot adjust downward, employers must cut jobs instead. Reddy proposed that gradually allowing inflation to reduce the real value of the minimum wage, rather than continuing to raise it, would stimulate employment while maintaining competitiveness.
Current situation:
Today, statutory minimum wage policies are standard throughout developed economies. Few countries in the developed world lack some form of wage floor. While debate continues about the appropriate level and implementation details, the basic principle of minimum wage protection has gained widespread acceptance among policymakers, even among those who initially opposed such interventions.
Key Points to Remember:
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The national minimum wage is a legally-enforced minimum hourly pay rate that employers must pay workers, protecting them from exploitation.
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In perfectly competitive labour markets, setting a minimum wage above the equilibrium wage creates unemployment, as more workers want jobs than employers want to hire at that wage.
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In monopsonistic labour markets, where employers have excessive power to drive down wages, a minimum wage can potentially increase both wages and employment levels by counteracting this market power.
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The advantages include reducing worker exploitation, alleviating poverty, redistributing income from employers to workers, and (according to most evidence) causing only minimal unemployment effects.
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The disadvantages include potential unemployment (especially for young and unskilled workers), reduced working hours, and market distortion according to free-market economists.
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The national living wage (NLW) is a higher minimum wage rate for workers aged 23 and over, replacing the standard NMW for this age group. As of April 2022, it stands at £9.50 per hour.
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Real-world evidence from studies like Card and Krueger's research suggests that minimum wage increases do not necessarily cause significant job losses, challenging traditional economic predictions and supporting the policy's continued use.