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Optimal Minimum Wage in a Competitive Economy: an Alternative Modelling Approach

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  • Gorostiaga Alonso, Miren Arantzazu
  • Rubio-Ramírez, Juan F.

Abstract

This paper analyzes whether a minimum wage can be an optimal redistribution policy when distorting taxes and lump-sum transfers are also available in a competitive economy. We build a static general equilibrium model with a Ramsey planner making decisions on taxes, transfers, and minimum wage levels. Workers are assumed to differ only in their productivity. We find that optimal redistribution may imply the use of a minimum wage. The key factor driving our results is the reaction of the demand for low skilled labor to the minimum wage law. Hence, an optimal minimum wage appears to be most likely when low skilled households are scarce, the complementarity between the two types of workers is large or the difference in productivity is small. The main contribution of the paper is a modelling approach that allows us to adopt analysis and solution techniques widely used in recent public finance research. Moreover, this modelling strategy is flexible enough to allow for potential extensions to include dynamics into the model.

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Bibliographic Info

Paper provided by University of the Basque Country - Department of Foundations of Economic Analysis II in its series DFAEII Working Papers with number 2004-07.

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Date of creation: Oct 2006
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Handle: RePEc:ehu:dfaeii:200407

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Postal: Dpto. de Fundamentos del Análisis Económico II, = Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain
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Keywords: redistribution policy; minimum wage; Ramsey Problem;

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  1. Juan J. Dolado & Florentino Felgueroso & Juan F. Jimeno, . "The Role of the Minimum Wage in the Welfare State: An Appraisal," Working Papers 2000-12, FEDEA.
  2. Gorostiaga, Arantza, 2003. "Should fiscal policy be different in a non-competitive framework?," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1311-1331, September.
  3. Allen, Stephen P, 1987. "Taxes, Redistribution, and the Minimum Wage: A Theoretical Analysis," The Quarterly Journal of Economics, MIT Press, vol. 102(3), pages 477-89, August.
  4. Richard Dickens & Stephen Machin & Alan Manning, 1994. "The Effects of Minimum Wages on Employment: Theory and Evidence from Britain," CEP Discussion Papers dp0183, Centre for Economic Performance, LSE.
  5. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers 200105, Rutgers University, Department of Economics.
  6. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 569-587.
  7. Askenazy, Philippe, 2001. "Minimum wage, exports and growth," CEPREMAP Working Papers (Couverture Orange) 0109, CEPREMAP.
  8. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  9. Stephen Machin & Alan Manning, 1992. "Minimum Wages," CEP Discussion Papers dp0080, Centre for Economic Performance, LSE.
  10. Boadway, Robin & Cuff, Katherine, 2001. "A minimum wage can be welfare-improving and employment-enhancing," European Economic Review, Elsevier, vol. 45(3), pages 553-576, March.
  11. Lang, Kevin & Kahn, Shulamit, 1998. "The effect of minimum-wage laws on the distribution of employment: theory and evidence," Journal of Public Economics, Elsevier, vol. 69(1), pages 67-82, July.
  12. Gorostiaga Arantza, 2005. "Optimal Fiscal Policy with Rationing in the Labor Market," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-22, July.
  13. Bhaskar, V & To, Ted, 1999. "Minimum Wages for Ronald McDonald Monopsonies: A Theory of Monopsonistic Competition," Economic Journal, Royal Economic Society, vol. 109(455), pages 190-203, April.
  14. Swinnerton, Kenneth A, 1996. "Minimum Wages in an Equilibrium Search Model with Diminishing Returns to Labor in Production," Journal of Labor Economics, University of Chicago Press, vol. 14(2), pages 340-55, April.
  15. Anthony A. Sampson, 2002. "The minimum wage in an adverse selection economy," Oxford Economic Papers, Oxford University Press, vol. 54(1), pages 150-159, January.
  16. Marceau, Nicolas & Boadway, Robin, 1994. " Minimum Wage Legislation and Unemployment Insurance as Instruments for Redistribution," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(1), pages 67-81.
  17. Dreze, Jacques H. & Gollier, Christian, 1993. "Risk sharing on the labour market and second-best wage rigidities," European Economic Review, Elsevier, vol. 37(8), pages 1457-1482, December.
  18. James B. Rebitzer & Lowell J. Taylor, 1991. "The Consequences of Minimum Wage Laws: Some New Theoretical Ideas," NBER Working Papers 3877, National Bureau of Economic Research, Inc.
  19. Guesnerie, Roger & Roberts, Kevin, 1987. "Minimum wage legislation as a second best policy," European Economic Review, Elsevier, vol. 31(1-2), pages 490-498.
  20. Cahuc, Pierre & Michel, Philippe, 1996. "Minimum wage unemployment and growth," European Economic Review, Elsevier, vol. 40(7), pages 1463-1482, August.
  21. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report 251, Federal Reserve Bank of Minneapolis.
  22. Gorostiaga Alonso, Miren Arantzazu, 1999. "Should Fiscal Policy be different in a Non-Competitive Framework?," DFAEII Working Papers 2002-28, University of the Basque Country - Department of Foundations of Economic Analysis II.
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