Employment Differentiation, Minimum Wages, and Firm Exit

The economic literature acknowledges that labor markets can often be described by monopsonistic competition. In such a structure, employers have market power and in the long run, zero profits due to the free entry and exit of firms. This article builds a partial equilibrium model to analyze the role of minimum wages when employment is differentiated. It shows that first-best and second-best minimum wages can increase employment and improve efficiency by reducing market power, at the expense of firm exit, higher concentration among employers, and less employment variety. As such, this article can provide insights into the ambiguous effect of minimum wages on employment levels systematically found in the literature, and on the higher firm exit rates observed among new, small, and lower productivity firms.