Why Raising the Minimum wage could be a good idea

15 October 2016
15 Oct 2016
3 min read

Raising the minimum wage has recently been a hot button issue for many people. On one hand, we have those against such an increase. Their thinking goes that if the cost of labor increases, firms will shift away from that input (labor) and move towards other inputs (capital, etc). More people will then be unemployed, resulting in a loss of jobs for those who most need it. This theory can be found in any labor economics class and has guided decision making for years.

On the other side of the debate, we have those that are for such an increase. Oftentimes the only justification given is a moral one: it is impossible to support a family with a low minimum wage. However, there are ideas supporting such an increase: the income effect along with efficiency wage theory are two of them. A discussion on which side is correct is beyond the scope of this blog post; however, I will attempt to better illustrate what these benefits are and how they benefit both the worker and the firm.

The Income Effect

The income effect says that increasing the minimum wage will give the workers more income (shockingly). The workers will then spend that money, increasing the demand for the goods that the workers buy. As a simple example, imagine workers at a widget factory. The wage increases for those workers. The workers then turn around and buy more widgets, because they can now afford to. This new demand for widgets forces the factory to increase output: potentially forcing the factory to hire even more workers! With the increase in output, the factory receives more profit and the workers have a higher wage. Everyone is happier with more money in their pockets, all due to the initial increase in the minimum wage.

Efficiency Wage Theory

The second benefit that can result from an increase in the minimum wage is efficiency wage theory. Efficiency wage theory is the idea that workers become more productive the more they get paid. While seeming counterintuitive at first, the idea makes sense logically; if I’m getting paid a lot of money, I want to keep that job. This implies that I’ll work harder at that same job, becoming more productive (and consequently more valuable) as a worker. The value that the company receives from me working harder may outweigh my additional pay. A recent New York Times article shows a example of this idea being put into practice. Walmart increased the pay of their workers which resulted in more valuable employees. The stores were cleaner and customer satisfaction increased; well worth the slight increase in pay for those employees.


This article was not meant to offer a firm conclusion on raising the minimum wage; it was intended to spark a discussion on some of the undiscussed benefits that could result from such an increase. Raising the minimum wage is often defined as a no win situation; however, that is not the case. The income effect and efficiency wage theory demonstrates some of the value companies can possibly receive out of a increase in the cost of labor.

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