In many European countries high minimum wages have led to high levels of unemployment and underemployment, and to a two-tier labour system. In the formal labour market, workers have good jobs that pay at least the minimum wage. In the informal, or black market for labour, workers have poor jobs and receive less than the minimum wage.

a. Draw a demand and supply diagram showing the effect of the imposition of a minimum wage on the overall market for labour, with wage on the vertical axis and hours of labour on the horizontal axis. Your supply curve should represent the hours of labour offered by workers according to the wage, and the demand curve should represent the hours of labour demanded by employers according to the wage. What type of shortage is created? Illustrate on your diagram the size of the shortage.

b. Assume that the imposition of the high minimum wage causes a contraction in the economy so that employers in the formal sector cut their production and their demand for workers. Illustrate the effect of this on the overall market for labour. What happens to the shortage? Illustrate with a diagram.

c. Assume that the workers who cannot get a job paying at least the minimum wage move into the informal labour market where there is no minimum wage. What happens to the size of the informal market for labour as a result of the economic contraction? What happens to the equilibrium wage in the informal labour market? Illustrate with a supply and demand diagram for the informal market.