A minimum‐wage model of unemployment and growth: The case of a backward‐bending demand curve for labor

Abstract

We add a minimum wage and hence involuntary unemployment to a conventional two‐sector model of a perfectly competitive economy with optimal saving and endogenous growth. Our resulting model highlights the possible case of a backward‐bending demand curve for labor, along which a hike in the minimum wage might increase total employment. This theoretical possibility complements some controversial empirical studies, in challenging the standard textbook prediction of an inverse relationship between employment and the minimum wage. Our model also implies that a minimum‐wage hike has negative implications for both the growth rate and lifetime utility.