The Behavioral Effects of Minimum Wages
Institute for the Study of Labor (IZA); University of Bonn - Economic Science Area; CESifo (Center for Economic Studies and Ifo Institute)
University of Zurich - Department of Economics
University of Lausanne
IZA Discussion Paper No. 1625
The prevailing labor market models assume that minimum wages do not affect the labor supply schedule. We challenge this view in this paper by showing experimentally that minimum wages have significant and lasting effects on subjects' reservation wages. The temporary introduction of a minimum wage leads to a rise in subjects' reservation wages which persists even after the minimum wage has been removed. Firms are therefore forced to pay higher wages after the removal of the minimum wage than before its introduction. As a consequence, the employment effects of removing the minimum wage are significantly smaller than are the effects of its introduction. The impact of minimum wages on reservation wages may also explain the anomalously low utilization of subminimum wages if employers are given the opportunity of paying less than a minimum wage previously introduced. It may further explain why employers often increase workers' wages after an increase in the minimum wage by an amount exceeding that necessary for compliance with the higher minimum. At a more general level, our results suggest that economic policy may affect people's behavior by shaping the perception of what is a fair transaction and by creating entitlement effects.
Number of Pages in PDF File: 35
Keywords: minimum wages, labor market, monopsony, fairness, reservation wages, entitlement
JEL Classification: C91, D63, E64, J38, J42, J58, J68
Date posted: June 8, 2005
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