The National Living Wage (NLW) is a legally enforced minimum hourly wage for workers aged 21 and over. In low-paid sectors it is set above the free-market equilibrium wage, so it acts as a price floor in the labour market. In April 2026 it rose by 4.1% to £12.71 an hour. A "significant" increase means one that raises the NLW's bite, its level relative to median earnings, which is what determines how far it distorts individual labour and product markets.
In a competitive labour market, a significant rise in the NLW from W1 to W2 causes an extension in the supply of labour from L1 to Ls. Higher wages make work more attractive than leisure or benefits, so more workers enter the market. It also causes a contraction in the demand for labour from L1 to Ld, so an excess supply of labour (Ls − Ld) emerges.
Diagram 1: wage on the vertical axis, quantity of labour on the horizontal axis; downward-sloping D = MRP and upward-sloping S labour; wage floor W2 above equilibrium W1; excess supply between Ld and Ls.
The demand for labour is a derived demand, coming from demand for the final product. So the number of jobs lost depends on the wage elasticity of demand for labour. That elasticity is higher when:
- wages are a large share of total costs;
- capital can easily be substituted for labour;
- demand for the final product is price elastic.
Hospitality fits all three conditions. Labour is roughly a third of a restaurant's costs, and consumers can easily switch to cooking at home, so demand for labour is relatively elastic and employment could fall noticeably. The adjustment may not show up as redundancies at all. Firms may instead:
- cut hours or rely on zero-hours contracts;
- replace staff with self-service tills and app ordering, as supermarkets and fast-food chains have done;
- cut spending on training.
This last response reduces workers' human capital and future earnings. Young and low-skilled workers are most affected because their marginal revenue product is lowest relative to the new wage.
However, the size of these losses varies greatly. In social care, demand for labour is wage inelastic: care cannot easily be automated and much of it is funded by local authorities with statutory duties. Most of the increase therefore goes into higher pay rather than lost jobs. Labour may also leave care for supermarkets that now pay similar rates, which worsens shortages. The bite also differs by region. £12.71 is close to the median wage in parts of the North East but well below typical pay in London, where the floor is barely binding. Unemployment effects are therefore likely to be concentrated in low-wage regions rather than spread evenly. Time matters too. In the short run firms cannot easily replace workers, but in the long run capital becomes variable and automation makes demand for labour more elastic. Small effects observed so far may understate future job losses.
Most importantly, the competitive model may not apply. The Low Pay Commission has found little evidence of significant job losses from previous rises, even as the NLW reached two-thirds of median earnings in 2024. Monopsony helps explain this. Where a dominant employer faces an upward-sloping supply of labour, such as a large care-home chain or distribution centre in a small town, the marginal cost of labour (MCL) lies above the average cost of labour (ARL). The firm therefore employs Lm, where MCL = MRP, and pays only Wm. A wage floor set between Wm and the competitive wage makes MCL horizontal at that wage, up to the supply curve. As a result, the firm employs more workers at a higher wage. In this case a significant rise improves both equity and efficiency, up to the point where the floor exceeds the competitive wage.
Diagram 2: monopsony; MRP, ARL = S and MCL curves; original Wm and Lm; wage floor Wmin creates a horizontal section of MCL, giving higher wage and employment Lmin > Lm.
The second microeconomic effect falls on firms and product markets. A higher NLW raises variable costs, shifting AC and MC upwards.
Diagram 3: firm cost and revenue curves; AC and MC shift up; profit area shrinks; for a price-taking firm P falls below the new AVC, so it shuts down.
For a firm with market power, the supernormal profit area shrinks. For firms in highly competitive markets, such as independent cafés, hairdressers and small care providers operating on thin margins, price may fall below average variable cost. These firms shut down, reducing competition and consumer choice. Firms that survive will try to pass costs on through higher prices. How much they can pass on depends on price elasticity of demand. With inelastic demand, such as care paid for by councils, most of the burden falls on consumers or taxpayers through higher prices. With elastic demand, such as eating out, most falls on profits. Either way consumer surplus falls and allocative efficiency may be reduced as output contracts.
These cost effects are partly self-correcting. Efficiency wage theory suggests higher pay raises motivation and productivity, lowering unit labour costs. Higher pay also reduces labour turnover, which matters in hospitality and care, where turnover is high and recruitment and training are expensive. The impact also depends on firm size. Large firms such as Tesco can absorb costs through economies of scale and invest in automation. Small firms with limited reserves bear the burden and are the ones most likely to close. This could increase market concentration over time.
Weighing the stakeholders:
- Low-paid workers in employment: clear winners, gaining higher incomes and lower relative poverty.
- Workers who lose hours or jobs: losers.
- Owners of small firms: losers.
- Consumers: their losses are usually small, because labour is only part of the final price.
Overall, the microeconomic effects of a significant increase in the NLW are likely to be net positive in the short to medium term. Two reasons support this. First, many low-pay labour markets, particularly social care and retail in smaller towns, show monopsony features or inelastic demand for labour. Second, the evidence so far suggests that higher pay has largely not come at the cost of jobs. This judgement depends on four conditions:
- Size of the rise relative to median earnings: a sudden jump well beyond two-thirds of the median in low-wage regions would push the floor above the competitive wage.
- Sector: the effect is worst in elastic sectors such as hospitality.
- Monopsony power: the less monopsony power employers have, the closer outcomes are to the competitive model and the greater the job losses.
- Time period: as capital substitution becomes possible, automation and the closure of small firms make the long-run effects more negative than the short-run evidence suggests.
The most significant factor is therefore the bite of the rise. Gradual increases that track median pay deliver gains to low-paid workers with limited costs, but an unusually large rise risks reversing that balance.