Historically, the idea of a minimum wage was to allow a full-time worker to earn enough to buy the basic necessities of life. Following the Great Depression of the 1930s and World War II, watershed legislation established minimum wages around the world, most notably the Fair Labor Standards Act (FALSA) of 1938 in the United States and the Wage Council Act of 1945 in the United Kingdom. FALSA, for instance, established a minimum wage of 25 cents per hour when it was formed; that became $5.85 in 2007, and will increase to $7.25 by 2009. The value of this minimum, however, declines over time due to inflation or productivity growth. The problem with the minimum wage is its interference with the labor-market mechanism, creating ambiguous influences on employers, workers, and teenagers (and even more so on nonwhite teenagers) for whom the market-clearing wage is lower than the minimum wage. In the case of extreme poverty, the argument that policy authorities should pass a legal minimum wage through legislation is not in dispute, but disagreement over a minimum wage abounds in the areas of efficient allocation of resources, full employment, effect on income, and alternative ways to combat poverty (Stigler 1946).
Economists study the effect of minimum wages relative to the market equilibrium wages. If the demand for labor, Nd, is not equal to the supply of labor, N , then wages change. At equilibrium, the change in the wage rates, w, over time, t, is dw / dt = f (Nd – N ) = 0. One implication of the equilibrium is that a laborer is paid a wage, w, equal to the marginal product of labor (MPL). If a minimum wage is binding, such as for the unskilled, young, less educated, and part-time workers, then the minimum wage would exceed the equilibrium wage, creating unemployment. The unemployed may transfer to industries that are not covered by the minimum wage, thus decreasing wage and productivity there. One possibility is that employers may then substitute more automation, or skilled labor for low-skilled labor as wages increase. Another factor is that competition between the covered and the uncovered sectors of the labor market tends to equilibrate the wages between the two sectors. Thus, the MPL of workers still employed in the covered industry will tend to rise to where w = MPL (Hicks 1948, p. 179). As Martin Bronfenbrenner asserts: "If they were better fed and clothed and housed, and better cheered as well, by higher wages, their physical efficiency might rise in the same proportion as the wage rate" (Bronfenbrenner 1943, p. 82).
Economists emphasize empirical work to assess the net possible effect of minimum wages. Several studies by David Card and Alan Krueger held that minimum wages increase the employment in fast-food firms such as Burger King, KFC, Roy Rogers, and Wendy’s. At the firm level, Card and Krueger (1994) studied the increase in minimum wages in New Jersey, the highest minimum wage in the nation as of April 1, 1992, against no change in the minimum wage in Pennsylvania. They found that employment increased in New Jersey by 0.6 workers, and declined in Pennsylvania by 2.1 workers, a difference-indifferences of 2.7 workers. Similar findings were made for firm-level data in Texas, and for state data in California (Card and Krueger 1995). An attempt by David Neumark and William Wascher (2000) to replicate the Card and Krueger finding used employment data reported by establishments rather than survey data. They found that the job gain in New Jersey could be zero or slightly negative. The technology of the fast-food firms suggests that employers may need a fixed number of employees per grill or cash register, and therefore will not reduce employment when minimum wages increase, but that they may be discouraged from opening new franchises, thus lowering potential employment.
The analysis of the amount of the unemployment can be stated in elasticity of demand terms. If the elasticity is less than one, increase in wages will increase payroll, enhancing benefits to workers. The elasticity of — 1 is the standard labor market assumption, which leads to the expectation that unemployment will fall in equal proportion to wage increases. Earlier empirical studies by Charles Brown, Curtis Gilroy, and Andrew Kohen (1982; 1983) indicated that the effect of minimum wages on employment was slightly negative or insignificant, indicating an elasticity of demand close to zero.
In the Keynesian world, "the customary treatment of involuntary unemployment and unemployment equilibrium frequently is based upon rigidity of money wage rate" (Horn 1983, p. 725). The post-Keynesians are well known for defending the wage-rigidity assumption. John Maynard Keynes’s (1973, p. 54) correspondence with the classical economist Arthur Cecil Pigou revealed a rigid labor supply curve, indicating rigid wages for some level of employment. Keynes, however, eased up on the wage-rigidity assumption in chapter 19 of his General Theory of Employment, Interest, and Money (1936). According to Axel Leijonhufvud (1968, p. 37) the assumption of a minimum wage is maintained by Keynesians, who assume competitive conditions make wage rigidity into a special case for this model. Don Patinkin (1948, p. 545) argued that rigidity in the Keynesian system is possible under static modeling of Keynesian economics, but rigidity is not an essential Keynesian element in a more dynamic setting.
Modern macroeconomic discussion involves models dealing with wage-setting, where wages are set as a markup on expected price, and with price-setting, where prices are set as a markup on expected wages. Unemployment then depends on the solution of the joint
wage, u is unemployment, p is price, e is expected, and the Greek letters are parameters to be estimated (Layard, Neckell, and Jackman 1994, pp. 19-20). When price and wage expectations materialize, real wages can be analyzed against employment. Any factors that contribute to wage push, 70, such as the minimum wage, raise the unemployment rate.
