Question

A state imposes a minimum wage of $10 per hour when the equilibrium price is $7. The resulting labor surplus is greater in the long run than in the short run: long-run unemployment (LR) is greater than short-run unemployment (SR). Why does this occur

Answer 1

With a minimum wage that is higher than the equilibrium price, firms, in the short-run, would still have to hire many workers in order to meet their production obligations and customer demand.

However, because hiring has now become more expensive than it should be, firms will start to invest more in capital, and to look for ways to replace workers with capital investments, for example, machinery.

This will in turn reduce the demand for labor even more in the long-run, leading to a higher labor supply surplus in the long-run than in the short-run.