The Fair Labor Standards Act was the government’s attempt to raise the underpaid and overworked American workers out of poverty in the 1930s. The act regulated working hours and set the wage floor at $0.25 per hour.
Over the years, Congress made revisions to the Fair Labor Standards Act seeking to offset the erosion of the minimum wage rate due to inflation. Typically, when the minimum wage rate is set, it has a nominal value at about 55 percent of the current average wage rate.
Proponents applaud Congress for approving increases even while arguing that such actions were long overdue. Opponents, however, argue against the implementation of minimum wage started from its inception. They argue that the minimum wage not only does not provide help as promised but actually worsens the employment prospects for low-wage workers. Hence, these opponents of universal wage floors view the erosion of the real values of the minimum wage as beneficial.
Labor economics textbooks clearly identify inevitable employment losses caused by the minimum wage for unskilled, low-wage workers predicted by comparative static analysis in a competitive environment. In a perfectly competitive world, the demand and supply of all types of workers determine the equilibrium quantity of labor and wage rate in each market. When the government imposes a wage floor higher than the equilibrium wage rate, the labor market will be in disequilibrium. More people will be willing to work at the new higher rate. However, employers will want to reduce the quantity of labor used because the demand for labor is inversely related to the wage rate.
Quantity demanded unskilled labor decreases. Thus, many workers face the possibility of unemployment due to the wage hike. When the labor supply and demand curve are more elastic, the increases in unemployment probabilities will be greater. The employment effect of a change in the minimum wage can also be explained by scale and substitution effects on labor demand. For workers directly impacted by the minimum wage, the combined scale and substitution effects have a negative impact on the worker’s employment prospects. Holding output constant, the substitution effect measures the change in employment resulting from a change in the relative price of labor.
The scale effect measures the change in employment resulting from the effect of the minimum wage change on the employer’s costs of production and production level before the wage increases, the firm is operating at a profit-maximizing level of output on an expansion path. Immediately following a minimum wage increase, employers reduce the number of minimum wage workers. One way to accomplish this is to hire more skilled workers or other inputs. Thus, the quantity demanded minimum wage workers decreases. The quantity demanded may be reduced even further because of the scale effect.