Chapter 10 · Macroeconomic objectives I: Low unemployment, low and stable rate of inflation
Structural unemployment: minimum wage
Use a competitive labour-market diagram to show a binding minimum wage. Compare labour demanded, labour supplied and the resulting unemployment.
The economic idea
Unemployment exists when people who are without work, available for work and actively seeking work cannot find employment. Structural unemployment is persistent unemployment caused by a mismatch between the skills, occupations or locations of workers and the jobs available.
A price control is a legal restriction on the price at which a product or factor may be exchanged. A price floor sets a legal minimum. A minimum wage is therefore a price floor for labour: employers may not legally pay covered workers less than that wage.
A minimum wage is binding only when it is set above the market-clearing wage. At that wage, more people are willing to supply labour than firms wish to employ. The model represents the difference as surplus labour, although measured unemployment also depends on active job search and labour-force participation.
The size of the employment effect depends on the wage elasticities of labour demand and supply, employers’ market power, compliance, productivity, prices, working hours and the time allowed for adjustment. A higher wage can also reduce labour turnover or raise productivity, which the simple model does not show.
Reading the wage floor, Qd and Qs
“Price of labour (wage)” is the price of labour and “Quantity of labour” is the quantity of labour.
“Demand for labour” slopes downward because firms generally demand fewer worker-hours at a higher real wage, while “Supply of labour” slopes upward because more labour is offered as the real wage rises.
“Qd” marks employment demanded and “Qs” marks labour supplied at “W”. The difference is a quantity of labour, not an unemployment rate.
First test: is the minimum wage binding?
“Minimum wage” is above the market-clearing wage, so it is binding. At “W”, quantity of labour supplied “Qs” exceeds quantity of labour demanded “Qd”. The horizontal gap “Qs − Qd” is surplus labour, represented here as unemployment.
Employment at Qd
Firms move along “Demand for labour” to “Qd” at the legal minimum wage. This is the quantity of labour demanded and therefore the level of employment in the simple model.
Labour supplied at Qs
Workers move along “Supply of labour” to “Qs”. Because “Qs” exceeds “Qd”, not everyone offering labour at the legal minimum wage is employed.
Read the employment effect and the access trade-off
A binding wage floor in the competitive labour-market model raises the wage for those who keep a job, while fewer workers are demanded at that wage. The labour-surplus gap compares workers willing to work with jobs firms offer; it is not the number of people employed.
This is a model-specific result. A full evaluation also asks about enforcement, productivity, the size of the wage increase and employers’ market power. Those conditions are not measured by this simple competitive diagram.
From a legal wage floor to the employment outcome
Compare “Minimum wage” with the wage where “Demand for labour” meets “Supply of labour”.
The floor is binding, so firms demand “Qd” while workers supply “Qs”.
Evaluate the size and duration of the effect rather than assuming every minimum-wage increase causes the same employment loss.
Common mistakes to avoid
- Do not claim unemployment until the minimum wage is shown above the market-clearing wage.
- The horizontal distance “Qs − Qd” is surplus labour; it is not automatically the official unemployment rate.
- A movement along labour demand is not a shift of labour demand.
- The model predicts direction under its assumptions, not a universal empirical magnitude.
How to draw this diagram
- Title the diagram “Structural unemployment: minimum wage”. Label the horizontal axis “Quantity of labour” and the vertical axis “Price of labour (wage)”.
- Draw Demand for labour first and label it clearly.
- Draw Supply of labour next and label it clearly.
- Draw Minimum wage next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Project important intersections to the axes with dashed guide lines and label the outcomes.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The diagram assumes a competitive, homogeneous labour market and omits employer market power.
- It treats employment as the main adjustment margin, although firms may change hours, benefits, training, prices or productivity.
- It does not show income gains for workers who remain employed or wider effects on poverty and inequality.
- Official unemployment depends on job-search behaviour and labour-force participation, not only surplus labour.