Optimal Minimum Wage Policy in Competitive Labor Markets

David Lee, Emmanuel Saez

NBER Working Paper No. 14320
Issued in September 2008
NBER Program(s):Labor Studies, Public Economics

This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market. We show that a binding minimum wage -- while leading to unemployment -- is nevertheless desirable if the government values redistribution toward low wage workers and if unemployment induced by the minimum wage hits the lowest surplus workers first. This result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a minimum wage effectively rations the low skilled labor that is subsidized by the optimal tax/transfer system, and improves upon the second-best tax/transfer optimum. When labor supply responses are along the extensive margin, a minimum wage and low skill work subsidies are complementary policies; therefore, the co-existence of a minimum wage with a positive tax rate for low skill work is always (second-best) Pareto inefficient. We derive formulas for the optimal minimum wage (with and without optimal taxes) as a function of labor supply and demand elasticities and the redistributive tastes of the government. We also present some illustrative numerical simulations.

download in pdf format
   (514 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w14320

Published: David Lee & Emmanuel Saez, 2012. "Optimal minimum wage policy in competitive labor markets," Journal of Public Economics, vol 96(9-10), pages 739-749. citation courtesy of

Users who downloaded this paper also downloaded* these:
Luttmer w13012 Does the Minimum Wage Cause Inefficient Rationing?
Brown, Gilroy, and Kohen w0846 The Effect of the Minimum Wage on Employment and Unemployment: A Survey
Aghion, Algan, and Cahuc w14327 Can Policy Interact with Culture? Minimum Wage and the Quality of Labor Relations
Dickens, Machin, and Manning w4742 The Effects of Minimum Wages on Employment: Theory and Evidence from the US
Neumark and Wascher w6127 Do Minimum Wages Fight Poverty?
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us