The minimum wage and wage floors

The big picture

Labour market intervention sits closer to politics than almost any other topic on the course, and the examiner wants none of the politics: the marks come from the mechanism and the welfare consequence, supported by an accurate diagram. Anchor every wage floor to a specific labour market failure. The National Living Wage (NLW) is the UK's flagship response to below-subsistence pay, an equity failure in the first instance, though where one employer dominates a labour market the same floor can correct an allocative failure at the same time.

A question asking you to assess the disadvantages of the NLW wants a judgement about how large those disadvantages actually are, and under which conditions the standard unemployment prediction holds or breaks down. That conditional move separates a Level 2 answer from a Level 3 one. One caution before the theory: the standard diagram assumes the pre-policy wage sat at a competitive equilibrium with the wage equal to MRP, and in UK low-pay sectors it often did not, so the policy's "disadvantage" is sometimes measured against a distorted baseline.

The theory

Begin with the competitive baseline. A floor W_min set above the equilibrium wage W_e changes both sides of the market. Firms hire labour only while the wage is no higher than the marginal revenue product (MRP), so the quantity of labour demanded contracts to L_d; the higher wage draws additional workers in, so the quantity supplied extends to L_s. The gap between them is an excess supply of labour, classical unemployment equal to L_s minus L_d. A Level 3 diagram shows both movements, clearly labelled.

Why the predicted unemployment often fails to appear

In a monopsony the supply curve is the employer's average cost of labour, and the marginal cost of labour lies above it, because hiring one more worker means raising the wage for everyone already employed. The employer hires where the marginal cost of labour equals MRP and pays a wage read off the supply curve, below both MRP and the competitive wage. A wage floor set between the monopsony wage and MRP makes labour supply horizontal at the floor and removes the incentive to restrict hiring, so the wage and employment rise together: the floor corrects a distortion that was already there. Card and Krueger's 1994 study of New Jersey and Pennsylvania fast food found no employment loss, and some gains, where these conditions held. The Neumark and Shirley meta-analysis pushes back, with a majority of studies finding negative employment effects, strongest for young and less-educated workers, though chiefly in markets that really are competitive rather than institutionally depressed.

Elasticities decide the size of any employment effect. Where labour demand is inelastic, because workers are hard to replace and the service is essential (NHS nursing, social care), the employment fall from a given floor is small; where tasks are routine and codifiable (checkout work, picking), demand is elastic and the fall is larger. Labour supply matters too, and it is the point most students omit: elastic supply into urban hospitality widens the unemployment gap, while the four-to-five-year training pipeline in skilled construction keeps supply inelastic and the gap narrow. The worst case pairs elastic demand with elastic supply.

Then cross-examine the standard diagram with the vacancy data. It predicts an excess supply of labour, yet UK low-wage sectors show excess demand: over 150,000 adult social care vacancies (Skills for Care, 2023), over 40,000 NHS nursing vacancies, and a shortfall of 225,000 construction workers, with hospitality vacancies elevated too. Persistent vacancies at the going wage are evidence of pay below the market-clearing rate, so these markets sat to the left of competitive equilibrium before the NLW, and a rising floor closes a gap rather than opening one.

What the floor does to firms

For firms the floor arrives as a cost shock: it raises the marginal cost of each worker and shifts average cost upward, and it bites hardest in labour-intensive sectors with thin margins. The responses come in a predictable order. Hours are cut before heads (ONS found the average hours of NLW hospitality workers fell 5 per cent in the year after the largest NLW increase); capital replaces labour in routine tasks (McDonald's has run self-order kiosks in all its UK restaurants since 2019); and costs push into prices, with casual dining menu prices up 8 to 12 per cent over 2022 to 2023 (ONS). Against all of this sits an efficiency-wage offset: higher pay cuts turnover and absenteeism, clawing back part of the gross cost.

The maximum wage

A maximum wage is the mirror image at the top of the distribution, aimed at the principal-agent problem: shareholders cannot perfectly monitor executives, who exploit that information gap to negotiate pay above their MRP. Egypt introduced a maximum wage of $5,800 a month in 2015, set at 35 times the public sector minimum wage. The case for a ceiling is wage compression: the top-to-bottom ratio falls, the relative position of the majority improves without any change in their nominal pay, and freed resources can be redirected downward. The case against is brain drain: a ceiling only lowers pay if the capped workers cannot leave, and 200 Egyptian banking executives resigned, taking institutional knowledge and client relationships with them. The exit incentive is strongest for the most productive, so the policy is weakest exactly where the principal-agent problem is most severe.

Application

Learn the rates as a dated sequence: the NLW stood at £8.72 in 2020, rose to £10.42 in April 2023 for workers aged 23 and over (a rise the Low Pay Commission estimated directly benefited over 2 million workers), and reached £11.44 in April 2024. The Low Pay Commission has found no significant employment loss in social care, retail or hospitality from NLW rises, and the Resolution Foundation reports minimal job losses across UK low-pay sectors, while warning in early 2023 that further large rises could cost jobs in labour-intensive, low-margin sectors.

Notice what a fact does inside an answer. "The NLW rose to £11.44 in April 2024" is application on its own; it earns analysis marks when welded to a mechanism: the April 2024 rise raised the wage bill of labour-intensive care providers whose revenue is fixed by local authority commissioning rates, which is why the pressure surfaces as provider exit rather than unemployment. A dated figure tied to a mechanism scores; a floating one merely decorates.

Building the paragraph

A top-band paragraph opens with a topic sentence carrying the mechanism, the direction of the effect and one piece of headline evidence, then walks a chain in which each step causes the next. Here is the social care version.

Because local authorities fix most care providers' revenue through commissioning rates, a rising NLW raises costs without raising income, so its main risk in social care is provider exit rather than unemployment: even as the floor rose, Skills for Care counted over 150,000 vacancies in 2023.

1. Identify the failure precisely: care pay sits at or near the floor with 28 per cent annual turnover, and persistent vacancies signal wages below the market-clearing rate, in a market where local authorities commission over 70 per cent of residential and domiciliary care in England.
2. The NLW rise to £11.44 in April 2024 raises the marginal cost of every worker and shifts each provider's average cost curve upward.
3. Diagram step: draw the monopsony labour market with the floor between the monopsony wage and MRP, showing the pre-intervention failure first and then the wage and employment both rising.
4. Providers cannot pass the cost on, because their price is the commissioning rate, set by the local authority rather than by a market.
5. Where rates stay frozen, average cost rises above average revenue and providers slip below normal profit: Unison and Care England estimated 30 to 50 per cent of providers at risk of financial distress in 2022 to 2023.
6. The welfare consequence lands on third parties: provider exit creates "care deserts", and demand for care is inelastic and rising with an ageing population, so the loss falls on people who cannot substitute away.

Key terms

Term	Precise definition	Where it earns marks
National Living Wage	The UK's statutory hourly wage floor for older workers: £10.42 from April 2023 (aged 23 and over), £11.44 from April 2024.	Dated application (AO2) that anchors any wage floor answer.
Monopsony	A market with a dominant buyer of labour, who sets the wage below MRP and restricts employment below the competitive level.	The Level 3 counter to the standard unemployment prediction.
Excess supply of labour	At a floor above equilibrium, the quantity of labour supplied exceeds the quantity demanded; the gap is classical unemployment.	The precise reading of the wage floor diagram (AO3).
Efficiency wage	Higher pay reduces turnover and absenteeism and can raise productivity, offsetting part of the gross wage cost.	An offset inside any cost chain, and a ready evaluation point (AO4).
Maximum wage	A legal ceiling on pay, aimed at the principal-agent problem of executives negotiating pay above their MRP.	Pairs with Egypt's 2015 ceiling as the mirror-image wage control.