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2b Show that a minimum wage set above the market clearing wage rate causes excess supply of labour. Why would a government impose minimum wage despite knowing its effect on unemployment? Answer The demand for labour will be negatively sloped in all types of production for two reasons. First, a rise in the wage rate increases the costs of firms producing the commodity, forcing them to raise their selling prices. As the price of the product rises consumers will buy less of it and less output will be produced and sold. This means that less labour will be used. Second, since a rise in wages makes labour more expensive relative to capital, firms will substitute capital for labour. This means that less labour will be used to produce whatever output the firms in the industry sell. If the wage is free to adjust in response to market forces it will move to We, where the demand for labour equals the supply. When the wage is above We, more labour will be presented fo