Market Wages Below Productivity and the Employment Effects of Minimum Wages

In contrast to common theoretical expectations, the negative employment effects of minimum wages have mostly been found to be small or insignificant by empirical studies. In order to explain these findings, we use a labor market model that is based on the insight that market wages may be systematically below workers’ average productivity even in a competitive market. Small negative employment effects of minimum wages are derived under plausible conditions. These small effects might be offset by accompanying factors such as increasing product demand.