What is 'Minimum Wage'

A minimum wage is a legally mandated price floor on hourly wages, below which non-exempt workers may not be offered or accept a job. As of June 2016, the minimum hourly wage rate in the United States is $7.25. This means it is illegal for an American worker to sell their labor for less than $7.25 per hour unless the worker falls into a category specifically exempted from the Fair Labor Standards Act (FLSA).

BREAKING DOWN 'Minimum Wage'

Minimum wage laws were first used in Australia and New Zealand in an attempt to raise the incomes of unskilled workers. Most modern developed economies and many underdeveloped economies enforce a national minimum wage. Examples of countries with no established minimum wage include Sweden, Denmark, Iceland, Norway, Switzerland and Singapore.

Even though the United States enforces a federal minimum wage, individual states and localities may also pass different minimum wage laws. As of 2016, minimum wage rates exceeded the federal rate in 29 of the 50 states, led by California and Massachusetts at $10 per hour.

Economics of the Minimum Wage

Like all price floors, a minimum wage law only has a measurable effect when set above the market clearing price for a transaction. For example, a minimum wage of $10 per hour will have no effect for workers whose marginal productivity in a given line of work is greater than $10 per hour. The legal supply and demand remains unchanged for such labor.

For those with a marginal productivity less than $10 per hour, however, a $10 per hour minimum wage creates an artificial shortage for profitable labor. An unskilled worker with a marginal productivity of $8 per hour in California or Massachusetts can only offer to work at a loss to his or her potential employer — that is, the employer can only hire the worker if they are willing to pay more in salary than marginal revenue produced by the worker, or unless the employer incorrectly estimates the worker’s marginal productivity to be above $10 per hour.

Effects on Unemployment

There is a high elasticity of demand for low-skilled labor. This means a small change in the price for low-skilled labor tends to have a large effect on its demand. For these reasons, too high a minimum wage can lead to increasing unemployment among the low-skilled.

Low-skilled laborers in the United States can be exempted from the minimum wage if a sizable portion of their income is derived from tips. If exempted, a lower minimum wage of $2.13 per hour is applied. Eight states enforce a “tipped minimum wage,” which forbids tipped workers from selling their labor for less than the normal minimum wage rate.

In modern times, the proliferation of improved technology also increases the marginal rate of technical substitution for low-skilled labor. When the cost of labor increases, companies find it increasingly profitable to switch to labor-replacing technology, such as the decision by Wendy’s Co. in 2016 to introduce self-serve kiosks in response to higher minimum wage laws.

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