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The National Minimum Wage

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Economics

Should the UK’s national minimum wage increase or decrease? What is the minimum wage? This is a yearly debate in the UK and most countries. There aren’t any easy answers. This article will give you some tools to evaluate the benefits and drawbacks of a minimum wage and it will help you analyse if an effective minimum wage is possible.

What is a national minimum wage?

The national minimum wage is the legal minimum wage an employer can pay. Its main objective is to protect low-income workers.

The national minimum wage is different from the living wage. It is calculated on the proportion of the median income earnings. The living wage is calculated based on the amount of money people need to get by.

The current minimum wage depends on the person’s age:

23 and over
21-22
18-20
Under 18
Apprentice
Current Rate

(2021)

£8.91
£8.36
£6.56
£4.62
£4.30

Effects of a minimum wage on labour markets

The effects of a minimum wage depends on the type of labour market.

There is a large pool of workers in an unskilled labour market, so it is very competitive. There are relatively few barriers to entry and employers can easily replace workers. Because of that, workers are sensitive to wage changes. A minimum wage in an unskilled labour market can ensure that employers pay workers fairly and not exploit them.

The National Minimum Wage Minimum wage i unskilled labour market StudySmarterFigure 1. Minimum wage in an unskilled labour market - StudySmarter Originals.

A minimum wage can benefit existing workers in an unskilled labour market. However, as illustrated in Figure 1, it results in fewer job vacancies in the market because Qs is greater than Qd. Thus, it can create unemployment, affecting unskilled workers actively seeking employment.

However, in a skilled labour market, a minimum wage won’t affect this particular labour market. This is because firms are happy to operate above the national minimum wage. You can see this in Figure 2 below. As the equilibrium wage is higher than the minimum wage, there is no change in the workers’ wages in this market.

The National Minimum Wage Minimum wage in skilled labour market StudySmarterFigure 2. Minimum wage in a skilled labour market - StudySmarter Originals.

If firms refuse to pay above the minimum wage in a skilled labour market, workers will look for alternative job opportunities to be fully compensated for their labour.

Advantages of a national minimum wage

Many people argue that the minimum wage is a good idea for the following reasons:

  • Reduces relative poverty: a minimum wage provides an appropriate income level for the lowest paid. These workers will have more income to improve their standard of living and thus reduce relative poverty.
  • Increases productivity: according to the ‘efficiency wage theory,’ a high minimum wage can help create an incentive for people to work harder increasing their labour productivity.
  • Increases incentive to look for employment: a minimum wage creates an incentive for the unemployed to get a job to earn an income. This will reduce a country’s unemployment rate. Firms gain more workers, which will increase their output and their profit.
  • Boost economic growth: a high wage will create more disposable income for consumers and they will spend more in the economy. This consumer spending will boost the aggregate demand in the economy.

Efficiency wage theory

This theory states that increasing wages can lead to higher productivity levels because workers are motivated by higher pay. Workers benefit from higher wages and firms benefit because they experience higher retention rates and higher labour productivity. This, in turn, brings more profit to the firms.

The National Minimum Wage Efficiency wage theory StudySmarterFigure 3. Efficiency wage theory - StudySmarter Originals.

As you can see in Figure 3, high wages increase MRP (marginal revenue product ). Thus, the higher labour costs will recover through the increase in productivity.

Some reasons that explain why high pay motivates high labour productivity are:

  • Fear of losing their jobs. Workers have more to lose from being made redundant. Compared to alternative jobs, their current job offers higher wages and benefits, which motivates them to work hard.
  • Loyalty. If workers are paid a higher wage, they feel more loyalty to the company which motivates them to work hard. If they were being exploited by a monopolist employer, workers are more likely to do the minimum and not work as hard.

Henry Ford is a good example of implementing this theory. The average wage in 1914 was around £2.00 - £3.00 per day. At the Ford Motor Company, he paid his workers £5.00 per day. This increased labour productivity as many workers knew that they weren’t going to find similar pay anywhere else. In addition, the company received many job applications.

Disadvantages of a national minimum wage

Many people argue that the minimum wage is a bad idea for the following reasons:

  • Increased labour costs: a minimum wage can increase the labour costs for some firms. They can pass these higher costs onto consumers through higher prices to cover the increase in labour costs.
  • Increase inflation: a minimum wage stimulates an increase in inflation due to the increased spending powers of workers.
  • Increased unemployment: labour costs are one of the major costs for firms, so a minimum wage could cause firms to cut jobs to keep profits. This would increase unemployment in a country and place a burden on the welfare state.
  • Regional differences: the minimum wage could be too low in some regions. For example, London has higher living costs than other areas in the UK. A national minimum wage could be too low for a worker in London.

Effective national minimum wage

The impact of a minimum wage depends on where it is set. If the government is to set an effective minimum wage, they must consider a number of factors. Some of these factors include:

  • Economic climate: if the economy is experiencing strong economic growth and low and stable unemployment rates, firms will be more inclined to pay higher wages. In this case, a higher minimum wage would be effective.
  • Regional disparities: the cost of living differs across the UK. A minimum wage may be effective in the North of the UK but might not work in London. An effective minimum wage would account for regional differences.
  • Elasticity of demand: in an unskilled labour market, demand for wages is inelastic. Any change in wages will affect employment as firms are very sensitive to wage changes.

The national minimum wage in the UK

The national minimum wage was introduced in April 1999. Before the introduction of the national minimum wage, there were a variety of systems to control wages. However, these were only focused on specific industries.

The national minimum wage was introduced due to the weakening of employees’ bargaining power and the growth of low pay employments, specifically in the service sector.

Since its introduction, the minimum wage’s impacts on the UK’s unemployment have been negligible. The UK’s unemployment levels have been naturally low, but they increased slightly due to the 2008 Financial crisis and the 2020 Covid pandemic.

Minimum wage trends in the UK

In 1999, the minimum wage for those aged 21 and over was £3.60. For those under 18, it was £3.00. Generally, the minimum wage increases annually. The table below shows the increase in the minimum wage over the last five years.

Year23 and over21-2218-20Under 18
2021£8.91£8.36£6.56£4.62
2020£8.72£8.20£6.45£4.55
2019£8.21£7.70£5.90£4.35
2018£7.83£7.38£5.60£4.20
2017£7.50£7.05£5.55£4.05

Annually, the UK’s national minimum wage increases to keep up with inflation and rising living costs.

Macroeconomic impacts of the national minimum wage

To conclude, let’ look at how a minimum wage can have an impact on a macroeconomic scale.

The minimum wage largely impacts the poorest in society. They earn more once there is a minimum wage. As they have a high MPC (marginal propensity to consume), consumption will increase, causing aggregate demand (AD) to shift outward. This leads to economic growth and higher employment as illustrated in Figure 4 below.

The National Minimum Wage Macroeconomic impacts of a minimum wage StudySmarterFigure 4. Macroeconomic impacts of a minimum wage - StudySmarter Originals.

However, labour costs for firms increase as well, causing the aggregate supply (AS) curve to shift inwards. Higher labour costs will lead to UK domestic firms seeing a decrease in competitiveness. This would negatively affect the trade balance as other countries will demand fewer UK exports. As seen in the figure above, this puts inflationary pressure on the UK’s economy.

The National Minimum Wage - Key takeaways

  • The national minimum wage is the legal minimum wage an employer can pay. It aims to protect low-income workers.
  • In an unskilled, competitive labour market the minimum wage can help protect workers from being exploited by monopolist employers.
  • The minimum wage has no effect in a skilled labour market because employers are happy to pay above that wage.
  • For a minimum wage to be effective, it must consider many different factors, such as the economic climate, regional differences, and the elasticity of demand.
  • In the UK, the national minimum wage increases annually to keep up with inflation and increasing living costs.

The National Minimum Wage

The national minimum wage is the legal minimum wage an employer can pay their employees.

No. The national minimum wage is different from the living wage. The national minimum wage is calculated on the proportion of the median income earnings, while the living wage is calculated based on the amount of money people need to get by.

As of January 2022, the UK’s minimum wage is £8.91 for those aged 23 and over.

Final The National Minimum Wage Quiz

Question

What is the national minimum wage and why was it introduced?

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Answer

The national minimum wage is the legal minimum wage an employer can pay. Its aim was to protect low-income workers.

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Question

What is the impact of a minimum wage in an unskilled labour market?

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Answer

It can ensure that workers are paid fairly and not exploited by their employers, but results in job vacancies in the market as a whole.

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Question

What is the impact of a minimum wage in a skilled labour market?

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Answer

It won't have an effect,  because firms are happy to operate above the national minimum wage.

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Question

What does the Efficiency wage theory state?

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Answer

It states that increasing wages can lead to higher productivity levels because workers are motivated by higher pay.

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Question

Give an example of the Efficiency wage theory.

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Answer

Henry Ford implemented higher wages in his company, the Ford Motor Company, which led to an increase in labour productivity and job applications.

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Question

What must an effective minimum wage consider?

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Answer

Economic climate.

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Question

The UK’s national minimum wage has impacted unemployment.

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Answer

True

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The national minimum wage is the same as the living wage.

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Answer

False

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What are some advantages of a minimum wage?

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Answer

Increases labour productivity.

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What are some disadvantages of a minimum wage?

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Answer

Increases labour costs.

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Question

Explain the macroeconomic impacts of a national minimum wage on the UK economy.

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Answer

A minimum wage allows the poorest in society to earn more. As they have a high marginal propensity to consume (MPC), consumption will increase, causing the aggregate demand (AD) curve to shift outward. This leads to economic growth and higher levels of employment. However, labour costs for firms increase, and this will lead to UK domestic firms see a decrease in competitiveness. This negatively affects the trade balance. In the short run, the aggregate supply (AS) curve will increase causing higher inflation rates.


Show question

Question

What is the UK’s current minimum wage for those aged 23 and over?

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Answer

As of January 2022, the UK’s minimum wage is £8.91 for those aged 23 and over.


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Question

What is the trend of the UK’s national minimum wage?

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Answer

The UK’s national minimum wage increases annually to keep up with rising inflation rates and higher costs of living. It also rises faster than average wages.

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Question

Explain how a national minimum wage can help reduce relative poverty.

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Answer

A minimum wage provides an appropriate income level especially for the lowest paid. These workers will have more income to improve their standard of living and thus reduce relative poverty.

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Question

Explain how a national minimum wage can increase unemployment in an economy.

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Answer

Labour costs are one of the major costs for firms, so a minimum wage would result in higher labour costs. In order to keep profits, firms could cut jobs. This would increase unemployment in a country and place a burden on the welfare state.

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Question

As the consumption increase, the aggregate demand (AD) while shift ___________ .  

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Answer

outward 

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Question

The poorest in society can earn more once there is a minimum wage. This is one of the macroeconomic impacts of a minimum wage. 

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Answer

True

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Question

The national minimum wage increases annually to keep up with ___________ .

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Answer

inflation and increasing living costs. 

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Question

What is not a disadvantage of a national mininum wage?

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Answer

Increased labour costs

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What are the benefits of a national miniumm wage?

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Answer

Increases productivity 

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Question

A minimum wage has no impact on wages in the ___________  labour market.

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Answer

skilled

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Question

In a ___________  labour market, if firms refuse to pay above the minimum wage, workers will look for alternative job opportunities to be fully compensated for their labour.

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Answer

skilled

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Question

___________   is calculated based on the amount of money people need to get by. 

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Answer

The living wage 

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Question

The unskilled labour market is very competitive. 

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Answer

True

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