WEW-079

See below:

a) In a competitive (atomistic) industry, suppose that a maximum wage law lower than the equilibrium wage is imposed and enforced. Indicate graphically the implication for employment in the industry, the areas representing distributive transfer and those areas representing social gains or losses.

b) Do the same, but assume now that the industry is empowered to conscript laborers at the specified maximum wage.

Answers:

a) This is effectively a binding price ceiling. The artificially low maximum wage will result in a shortage in the supply of labor, with corresponding deadweight losses and losses to society since the allocation of labor resources is inefficient with too few jobs being held. This can be seen in Figure 1.

b) Now there will no longer be a shortage of supply, and the demand curve will become a straight line at the required supply of labor. The supply curve will be forced to shift until it supplies the proper amount at the low maximum wage. Though there is no deadweight loss visible, the opportunity cost--and therefore social cost-- is high since the labor resources are not allocated to their highest valued uses. This can be seen in Figure 2.

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