How a Minimum Wage Can Improve Efficiency Even in Competitive Labor Markets: The Webbs and the Social Cost of Labor

Abstract

Neoclassical economists, using a competitive demand/supply model of labor markets, typically conclude a legislated minimum wage is harmful to economic efficiency and social welfare. The major theoretical counter-attack by proponents of a minimum wage is to argue that low-wage labor markets are better modeled as monopsonistic. This paper develops and formalizes a second theoretical defense for a legal minimum wage law. This defense rests on the concept of the social cost of labor, as originally popularized by Sidney and Beatrice Webb and then further developed by American institutional economists. This analysis is unique in that it continues to use the competitive demand/supply model but nonetheless demonstrates that a legislated minimum wage often simultaneously increases both economic efficiency and fairness, unlike the neoclassical prediction.