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Federal Reserve Bank of Chicago
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Firm Dynamics and the Minimum Wage: A Putty-Clay Approach
Daniel Aaronson
Eric French
Isaac Sorkin

We document two new facts about the market-level response to minimum wage hikes: firm exit and entry both rise. These results pose a puzzle: canonical models of firm dynamics predict that exit rises but that entry falls. We develop a model of firm dynamics based on putty-clay technology and show that it is consistent with the increase in both exit and entry. The putty-clay model is also consistent with the small short-run employment effects of minimum wage hikes commonly found in empirical work. However, unlike monopsony-based explanations for small short-run employment effects, the model implies that the efficiency consequences of minimum wages are potentially large.

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Daniel Aaronson & Eric French & Isaac Sorkin, Firm Dynamics and the Minimum Wage: A Putty-Clay Approach, Federal Reserve Bank of Chicago, Working Paper Series WP-2013-26, 14 Dec 2013.
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Keywords: Employment; minimum wage; putty-clay model
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