IMPACT OF LINKING MINIMUM WAGE TO INFLATION 2

Impact of Linking Minimum Wage to Inflation

Some politicians have argued that minimum wage should be pegged on consumer price
index (CPI), a general level of prices of goods and services of a fixed basket that a typical
household buys each month (Taylor & Greenlaw, 2015). Only through such pegging would
workers who earn minimum wages be able to match inflation and, therefore, allow them to
effectively adjust to changes in cost of living. Whether this policy is desirable or not can be
determined through aggregate demand/aggregate supply (AD/AS) analysis.

Aggregate demand is the total consumer spending on domestic goods and services in a
given economy (Taylor & Greenlaw, 2015). Aggregate supply, on the other hand, is the total
quantity of goods and services that are produced in a given economy (Taylor & Greenlaw, 2015).
Aggregate demand and aggregate supply are usually analyzed using AD/AS model. This model
has two curves, an aggregate demand curve and an aggregate supply curve. While linking wages
with inflation may also have an effect on aggregate demand, its most significant impact is on
aggregate supply.

There are two main factors that influence a shift in aggregate supply curve. These are cost
of inputs and productivity growth (Greenlaw & Shapiro, 2017). Labor is part of inputs. When the
cost of inputs rises, the aggregate supply curve will shift to the left (Greenlaw &Shapiro, 2017).
This means that at a given price, there will be less goods and services being produced.

Adjusting minimum wage to reflect inflation or CPI inevitably means increasing wages.
Thus, this proposal involves increasing the cost of inputs. It will shift the AS curve to the left.
The result of this shift is a lower output, and rise in unemployment. It will also shift AD curve to

IMPACT OF LINKING MINIMUM WAGE TO INFLATION 3
the right will lead to rise in inflation. Thus, based on AD/AS analysis, tying minimum wage to
consumer price index (CPI) is not an economically sound idea.

IMPACT OF LINKING MINIMUM WAGE TO INFLATION 4

References

Greenlaw, S. A., & Shapiro, D. (2017). Principles of Macroeconomics 2e. Rice University.

Taylor, T., & Greenlaw, S. A. (2015). Principles of macroeconomics for AP® courses. OpenStax
College, Rice University.