WAGE THEORY

PREPARED BY
Dr.Ruchi Sharma
GGDSD College,Chandigarh
Meaning of Wages

 In economics, the price paid to labour for its

contribution to the process of production is called
wages.
Definitions:
 “A wage may be defined as the sum of money paid
under contract by an employer to worker for services
rendered.” -Benham
 “Wage is the payment to labour for its assistance to
production.” -A.H. Hansen
Concepts of Wages

The following are the two main

concepts of wages:
 A. Nominal Wage
 B. Real Wage
Money Wages or Nominal Wages

 The total amount of money received by

the labourer in the process of production
is called the money wages or nominal
wages.
 Real Wages

Real wages mean translation of money wages

into real terms or in terms of commodities and
services that money can buy.

Price of Quantity bought Money Real wage

commodity wage

10 10 100 Money wage/P=

100/10=10
11 10 110 110/11=10
10 10 120 120/10= 12
 Factors determining Real Wages

 Money wages
 Price level
 Supplementary income
 Nature of employment
 Hours of work
 Working conditions
 Trade expenses
 Period and cost of training
Theories of Wage
determination
 The marginal productivity theory of wage
 Modern theory of wages
The marginal productivity theory of
wage
 The marginal productivity theory of wage
states that the price of labour, i.e., wage rate,
is determined according to the marginal
product of labour.
 This was stated by the neo­classical
economists, especially J. B. Clark, in the late
1890s.
Assumptions of Marginal Productivity Theory
of Wage

 Perfect competition prevails in products market and in labour market.

 Law of variable proportions operates.

 The firm aims at profit-maximization.

 All labourers are homogeneous and are divisible.

 Labour is mobile and is substitutable to capital and other inputs.
 Resources are fully employed
How are wages determined?
The marginal productivity theory of wage states
that wage rate, is determined according to the
marginal product (MRP) of labour.
 How the wages are determined?
 Wage rate will be determined by the interaction
of demand and supply curves of labour in the
market.
 Labour demand curve is explained by the
VMPL curve.
 Perfect competition exists in the product market
 VMPL = MRPL curve is the firm’s demand curve
VMP=MR for labour.
P
 Full employment is there.So SL is fixed.

VMP= MP x AR
MRP=MP x MR
Since AR=MR, both VMP and MRP are equal
Wage determination for firm in short
run
 Equilibrium conditions
 MRP=MW
 MRP should cut MW from above.
Short run equilibrium of firm

 In short run the firm may have

supernormal profits ,normal profits or
losses.
 Super normal profits when ARP> AW
 Normal profits when ARP=AW
 Losses when ARP<AW
 ARP=AP x AR
Supernormal profits
Losses
Normal profits
 Long run equilibrium of firm

 In long run only normal profits

due to existence of perfect
competition
 MRP=ARP=AW=MW
Limitations of Marginal
Productivity Theory of Wage
 In the real world, perfect competition does not exist—
both in the product market and in the labour market.
 Labour can never be homogeneous— some may be
skilled and some may be unskilled. Wage rate of a
worker is greatly influenced by the quality of labour. A
higher wage rate is enjoyed by the skilled labour
compared to the unskilled labour.
 Perfect mobility of labour is another unrealistic
assumption. Mobility of labour may be restricted due
to socio-­political reasons.
 Full employment of resources is another unrealistic
assumption.
 This theory ignores the usefulness of trade union in
wage determination. Trade union, through its
collective bargaining power, also influences wage rate
in favour of the members of the organization.
 The marginal productivity theory of wage ignores the supply side of
labour and concentrates only on the demand for labour.
 Difficult to measure marginal productivity
MODERN THEORY OF
WAGES
INTRODUCTION

 According to the modern theory of wages, wages are the price of

services rendered by a labour to the employer.
 As prices of products are determined with the help of demand and
supply curve.
 Similarly, the wages (prices of services rendered by labour) is also
obtained with the help of demand and supply of labor.
 Therefore, for the determination of wage level, it is necessary to study
the demand for labour, supply of labour, and the interaction between
them.
Demand for Labour

The demand for labor is dependent on various factors.

 Demand for a product
 Other factors of production: If other factors of production are
expensive then the demand for labor would be high.
 Marginal productivity :The producer would employ labour until the
increase in number of labour would increase the net output although at
the diminishing rate.
Supply of Labor

 Supply of labor refers to the number of hours spent by labor in the factor
market.
 In an economy, there are several factors that influence the supply of
labor.
 wage rate
 population size
 age structure
 availability of education and training employment opportunities for
women
 social security programs
 Supply curve of labour
 In an industry, the supply of labour is less
elastic in the short-run.
 In this case, the supply of labor is dependent
on the accessibility of workers in the nearby
areas and their willingness for overtime work.
 However, the supply of labor becomes more
elastic in the long-run.
 Industries attract labor by providing higher
wages, training facilities, and good working
conditions.
 Therefore, the supply curve of labor for an
industry is upward sloping.
Backward bending supply curve
Wage rate determination under
Perfect Competition
Short run equilibrium

 In short run the firm may have supernormal profits ,normal profits or
losses.
 Super normal profits when ARP> AW
 Normal profits when ARP=AW
 Losses when ARP<AW
 Long run equilibrium of firm

 In long run only normal profits

due to existence of perfect
competition
 MRP=ARP=AW=MW
Average wage and marginal wage in
perfect competition
Units of labour AW Total wage MW
1 10 10 10
2 10 20 10
3 10 30 10
4 10 40 10
Wage rate determination under
Imperfect Competition
Average wage and marginal wage in
imperfect competition
Wage rate determination under Imperfect
Competition

 Economists, such as Joan Robinson and Pigou, have contributed a lot in

determining wages in imperfect competition.
The wage rate determination can be explained under two heads:
 When there is imperfect competition in both labour market and product
market
 When there is imperfect competition in labour market and perfect
competition product market
When there is imperfect competition in
both labour market and product market
When there is imperfect competition in labour
market and perfect competition product market
Differences in Rates of Wages

Differences in Rates of Wages is due to three causes

 Non competing Groups
 Equalising Differences
 Market imperfections
Non competing Groups

 There are different groups of labour which are not competitive.

 Different occupations require labour of various qualities.
 The work of a doctor is different from that of an engineer.
 The teacher cannot do the work of a lawyer.
 So people belonging to a particular group can only compete for that
work.
 The existence of non-competing groups prevents mobility of labour and
thereby creates difference in wages.
Equalising Differences

 The nature of work influences the wage differences

 Dangerous, disagreeable, hazardous and risky work carry higher money
wages to attract larger supply of labour.
 For example, The labour working in the coal mines are getting more
wages than a peon in the office.
 Soldiers are getting more wages than ordinary police personnel. The
salary of the mining engineer is more than a civil engineer..
Market imperfections

 Geographical immobility Sometimes people are not prepared to

accept higher wages if it involves a change of place due to family,
housing facilities. language problem etc. So difference in wages in
different regions.
 Trade unions Wages in different occupations like factories, mines,
companies are determined by the bargaining strength of labour unions.
If the labour union is strong enough, the workers are getting higher
wages.
 Training and extra qualification:
Trained and skilled workers get more wages than ordinary workers. Extra
qualifications and special training demand higher wages for a job. If an
occupation requires expensive specialized training high wages will be
offered.
When there is imperfect competition
in Product market and perfect
competition in labour market