ChainWhat it assumes · how to break it
Start
The National Living Wage rises, raising costs for labour-intensive firms such as restaurants, hotels and care homes.
1
As a result, employers must raise the hourly pay of every worker earning below the new legal floor.
national minimum wage · wage floor
national minimum wage · wage floor
Assumes: Firms comply with the law.
But: Enforcement relies on HMRC inspections and complaints, so some employers underpay through unpaid hours, deductions for uniforms or false self-employment.
2
This means firms' wage bills and average costs rise, most of all in labour-intensive sectors where wages are a large share of total costs.
labour costs · average costs
labour costs · average costs
Assumes: Wages are a large share of the firm's costs.
But: In capital-intensive firms, such as much of manufacturing, few staff are paid the minimum, so costs barely change.
3
Consequently, the supply curve of the product shifts left and firms raise prices, for example for restaurant meals and care home places.
cost-push · price elasticity of demand
cost-push · price elasticity of demand
Best link to attack
Assumes: Firms can pass the cost on to consumers.
Assumes: Firms can pass the cost on to consumers.
But: If demand for the product is price elastic, because of strong competition or cheaper imports, firms cannot raise prices without losing many sales.
4
Therefore, any cost not passed on to consumers reduces profit margins, squeezing small firms with thin margins most.
profit margins
profit margins
Assumes: Productivity does not rise to offset the higher wage.
But: If higher pay cuts staff turnover and raises output per worker, unit labour costs rise by less than the wage.
End
Prices rise in labour-intensive sectors and profit margins are squeezed, especially where demand is price elastic.
Evaluation chain
- E1However, how far prices rise depends on the price elasticity of demand for the firm's product.
- E2When a firm faces many close competitors, demand for its product is price elastic, so a price rise loses many customers.
- E3As a result, the firm must absorb most of the cost through lower profits, or cut jobs and hours to protect its margins.
- E4So prices rise most where demand is inelastic, while in highly competitive markets the cost falls mainly on profits and employment.
Another way to attack it: Low-paid workers spend most of any rise in income, so demand for local services such as shops and takeaways rises, offsetting part of the higher cost for those firms.
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Questions this answers
- Assess the impact of a rise in the National Living Wage on firms in the hospitality industry.
- Explain how an increase in the minimum wage may affect the prices consumers pay.
- Discuss who bears the cost of a higher minimum wage.
Diagram
Product market supply and demand: higher labour costs shift supply left from S1 to S2, so price rises and quantity falls. With inelastic (steep) demand, more of the cost is passed on in price and less falls on profits.
Reverse and related
Minimum wage cut in real terms → labour costs fall, giving firms room to cut prices or widen margins.