Wage Floor in a Two-Sector Labour Market
A state government sets a minimum wage of $24 per hour for all workers. The labour market has two segments. In the formal segment, current equilibrium is $22 per hour with 400 000 workers employed; own-wage elasticity of demand is estimated at −0.4. In the informal segment, 150 000 workers earn an average of $16 per hour with no coverage. After the floor is announced, enforcement is funded at a level that reaches roughly 60 per cent of formal employers. Unions argue the floor lifts living standards; employer groups warn of job losses and a shift of activity into the informal segment. The government wants the policy judged on total worker earnings, not just the formal wage.
1. Estimate the formal-sector employment effect of the floor and explain what the elasticity figure implies about the size of the loss.
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The floor is $24 against an equilibrium of $22, a rise of about 9.1 per cent. Using the own-wage elasticity of −0.4: employment change ≈ −0.4 × 9.1% ≈ −3.6 per cent. Applied to 400 000 workers, that is roughly 14 500 jobs lost, leaving about 385 500 employed.
What the elasticity implies: demand is inelastic (|−0.4| < 1), so the proportional job loss is smaller than the proportional wage gain. Formal wage bill therefore rises: 385 500 × $24 ≈ $9.25 million per hour versus 400 000 × $22 = $8.8 million. So surviving formal workers and the total formal wage bill gain, while the displaced 14 500 lose their formal jobs entirely.
Caveat a strong answer adds: the elasticity is an estimate, not a certainty, and it is a partial-equilibrium figure that ignores demand-side spillovers and the informal segment. The estimate also assumes the floor binds only in the formal segment and that hours do not adjust, both of which are simplifications.
2. Given enforcement reaches only 60 per cent of formal employers, evaluate the claim that the policy should be judged on total worker earnings.
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The 60 per cent enforcement matters. If only 60 per cent of formal employers comply, the effective floor is applied to about 240 000 of the 400 000 formal workers. Non-compliant employers can undercut, so the formal wage distribution becomes bimodal: covered workers near $24, uncovered workers near the old $22 or lower as they compete with each other.
Informal segment: displaced and uncovered workers push into the informal segment, where supply rises and the average $16 falls further. Total earnings could therefore fall even though the formal wage bill rises, because the informal segment absorbs more workers at lower pay.
Judgement on the criterion: judging on total worker earnings is defensible in principle because it captures both the wage gain and the displacement cost, but it is only valid if informal earnings are measured. With 60 per cent enforcement, the policy creates a two-tier market, so a total-earnings test would likely show a smaller gain than the formal-only calculation suggests, and possibly a loss once informal dilution is counted. The criterion is right; the data needed to apply it are missing, which is the real weakness.