Equilibrium Effects of the Minimum Wage: The Role of Labor and Product Market Power

Abstract

We study the role of firms’ market power in the equilibrium effects of the minimum wage. A higher minimum wage compresses labor market power by increasing workers’ reservation wage. On the other hand, it boosts product market power by reallocating market shares towards large firms, which raise price markups. We call this novel mechanism “concentration channel” of the minimum wage. To quantify the net market power response, we construct a novel structural model with frictional labor markets and oligopolistically-competitive product markets, which generate endogenous markdowns and markups. We estimate the model on Italian social security data replicating key labor market statistics for different worker types and the detailed structure of sectoral product markets. We find that both the aggregate labor share and output are hump-shaped in the minimum wage size. We compute the optimal minimum wage when firms have market power, which trades off productivity gains from workers’ reallocation against employment losses from higher labor costs. The optimal minimum wage induces welfare gains from 0.7 to 2.3% consumption equivalent units, depending on the completeness of asset markets.

Lorenzo Pesaresi

PhD Candidate in Economics

I’m a PhD candidate in Economics at the University of Zurich. My research interests are Macroeconomics, Labor Economics, Search Theory, and Monetary Economics.