Minimum Wage Effects on Reservation Wages

Abstract

Reservation wages are part of the transmission mechanism between minimum wages and unemployment via the labour force participation decision. The limited available empirical evidence on the relationship between reservation wages and legal minimum wages suggest that individuals use minimum wages as benchmarks against which their reservation wages are set. This has a profound behavioural effect that may encourage individuals to either enter the labour force or price themselves out of potential employment. We employ a fuzzy regression discontinuity design to explore the influence of minimum wages on reservation wages. Our findings suggest that the behavioural response is too small to be extracted from the variability of the reservation wage data. For policy makers this finding is important. While minimum wages raise earnings and living standards, they can push some workers out of the labour force by increasing their reservation wage beyond the minimum. We do not find any evidence of such a response of the reservation wage of jobseekers to the minimum wage in the UK.