The Minimum Wage Decision
A state government is considering raising the minimum wage from $22 to $25 per hour, a 13.6% increase. The affected workforce is 180,000 people, mostly in hospitality, retail, and aged care. Economy-wide unemployment is 4.8%, but youth unemployment is 12.5%. Small businesses report thin margins; a survey suggests 30% would reduce hours or staff if costs rose by more than 10%. Aged care providers are largely government-funded and cannot easily raise prices. Aggregate demand is growing at 2.8% annually, and inflation is 3.2%, above the 2–3% target band. The government also wants to reduce income inequality.
1. Using supply and demand analysis for labour, predict the likely employment effects of the increase and explain why the outcome may differ across sectors.
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Standard analysis: A minimum wage above the market-clearing wage creates a surplus of labour: quantity supplied exceeds quantity demanded, producing unemployment. The 13.6% rise is large relative to the 10% threshold at which 30% of surveyed firms say they would cut hours or staff, so some employment loss is likely.
Why sectors differ:
- Hospitality and retail face elastic demand for their output and thin margins, so they are most likely to substitute capital (self-service checkouts) or reduce hours. Employment loss is most probable here.
- Aged care is government-funded and labour-intensive. Providers cannot pass on costs easily, so the government must raise funding or services will be cut. Employment may be maintained if funding rises, but taxpayers bear the cost.
Offsetting factors: Aggregate demand is growing at 2.8%, which raises demand for labour and may absorb some displaced workers. Higher wages also raise spending by low-income households, supporting demand in labour-intensive sectors. Youth unemployment at 12.5% means young, low-skilled workers are most at risk of being priced out.
Conclusion: Employment loss is likely to be modest economy-wide but concentrated among youth and small firms, while the effect on aged care depends on government funding decisions rather than market forces.
2. Assess whether the increase is likely to reduce income inequality, considering both the wage effect and the employment effect.
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Direct effect: Raising the wage for 180,000 workers by 13.6% raises their hourly earnings substantially. If those workers remain employed, the wage floor compresses the lower end of the distribution and reduces inequality. Low-income households have a high marginal propensity to consume, so the increase also supports aggregate demand.
Indirect effects:
- If some workers lose jobs or hours, their income falls to zero or near zero, which can increase inequality at the bottom of the distribution. Youth and low-skilled workers are most exposed.
- Firms may respond by reducing non-wage benefits, training, or shift loadings, eroding the real gain.
- Higher costs may be passed on as higher prices, which hurts all consumers and disproportionately affects the poor if affected goods (food, hospitality) are a large share of their budgets.
Net judgement: The inequality effect is likely positive but smaller than the headline wage increase suggests. The gain depends on employment retention. A phased increase, or a lower youth rate combined with targeted transfers, would reduce the risk of job losses while still compressing wages. The policy is a blunt instrument for inequality compared with the tax-and-transfer system, but it does raise the floor for those who keep their jobs.