DP5115 The Behavioural Effects of Minimum Wages

Author(s): Armin Falk, Ernst Fehr, Christian Zehnder
Publication Date: June 2005
Keyword(s): entitlement, fairness, labour market, minimum wages, monopsony, reservation wages
JEL(s): C91, D63, E64, J38, J42, J58, J68
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5115

The prevailing labour market models assume that minimum wages do not affect the labour 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 that 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 sub-minimum 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 behaviour by shaping the perception of what is a fair transaction and by creating entitlement effects.