Answer to Question #249135 in Microeconomics for Aayu

Question

When the supply of labour exceed its demand, due to free play of forces of supply and demand, how can a legislation of minimum wage help the workers? Explain it diagrammatically and relate it to the problem of unemployment

Answer 1

When the supply of labour is greater than the demand for labour, the wage rate in a competitive market will decline. The fall in the wage rate implies a decline in the income of workers and hence living standards. To address such a problem, the government can enact minimum wage legislation. The minimum wage is an example of a price floor that is enacted above the equilibrium wage rate. As a result, the minimum wage will raise the income of workers. However, at a minimum wage, the quantity of labour supplied will exceed the quantity of labour demanded. This implies that there will be an increase in unemployment. 

In the figure below, the labour market is in equilibrium at point K where the equilibrium wage rate is P* whereas the equilibrium quantity of labour is Q*. When a minimum wage is imposed at P1, the quantity demanded of labour becomes Qd while the quantity of labour supplied rises to Qs. The difference between Qd and Qs shows unemployment resulting from the enactment of minimum wage legislation.