Theories of Wages Determination
Professor Mustapha Muktar
Introduction
A
factor of production is an economic
term that describes the inputs used
in the production of goods or
services in order to make an economic profit. Factors of
production are the resources people use to produce goods and services; they are
the building blocks of any economy. Economists they are basically four: land,
labor, capital, and entrepreneurship.
The term “land” in economics is
used in technical
sense. It includes the surface of the soil and all those natural resources
which are the free gift of nature like farm land, forest, fishing areas and
mineral wealth (such as coal, gold, iron, ore, tin, petroleum, etc). Land resources
are the raw materials in the production process. These resources can be
renewable, such as forests, or nonrenewable such as oil or natural gas. The
income that resource owners earn in return for land resources is called. The return
to land is rent.
Labour is human mental and physical effort
that is used in production. In other words, it is human energy and brain that
is used in any production process. The number of people willing to work is
called the labour force; the total number of hours they are willing to work is
called the supply of labour. Supply of labour
may also mean the supply of labour services available for production. Labor resources include the work done by soldiers,
teachers and engineers. The return to labour are salaries, wages,
bonuses and other payments
The capital stock consists of all
those produced goods that are used in the production of other goods and
services. Factories, machines, tools, computers, roads, bridges, houses and
railways are a few examples. According to Marshall “capital consists of all
kind of wealth, other than free gift of nature, which yields income”.
The income
earned by owners of capital resources is interest. The pure return on capital is the
amount that capital could earn in a favorable investment at
equilibrium. When expressed as a
return per N1 worth of capital invested, the result is called the interest
Entrepreneurship is the
process of designing, launching and running a new business, which is often
initially a small business. The people who create these businesses are called entrepreneurs. An entrepreneur is a person who
combines the other factors of production - land, labor, and capital - to earn a
profit. The most successful entrepreneurs are innovators who find new ways
produce goods and services or who develop new goods and services to bring to
market. Without the entrepreneur combining land, labor, and capital in new
ways, many of the innovations we see around us would not exist. The reward to
entrepreneur is profits.
Theories
of Wages Determination
Subsistence theory of Wages determination
Subsistence theory of Wages determination
was put forward by economists prominent among them is David Ricardo and Karl Marx
Assumptions:
According to Ricardo, this theory is based on the
following two assumptions:
1. Population increases at a faster rate.
2. Food production is subject to
the law of diminishing returns.
According to this theory,
wages of a worker in the long run are determined at that level of wages which
is just sufficient to meet the necessaries of life. This level is called the
subsistence level. The classical economists called it the neutral level of
wages. In this way, the pro-pounders of the theory believed in the bargaining
power of the workers. In such a situation, trade unions play an important role
in increasing wages.
Wages
of labour are equal to subsistence level in the long run. If wages fall below
this level, workers would starve. It will reduce their supply. Thus, the wage
rate will rise to the subsistence level. On the other hand, if wages tend to
rise above the subsistence level, workers would be encouraged to bear more
children which will increase the supply of workers, which in turn will bring
wages down to the subsistence level. It
can be shown with the help of the following figure:
In
Fig. 1 demand and supply of labour has been measured on OX-axis and wage rate
on OY-axis. OW is the subsistence level of wages. At OW wage rate supply of
labour is perfectly elastic. Since, supply of labour is perfectly elastic, wage
rate neither can fall below OW nor can increase above the level of OW. Although
demand increases from DD to D1D1 yet the wage rate remains the same at OW.
Limitations of the theory
One Sided Theory: This theory examines the wage determination from the side
of supply and ignores the demand side.
Pessimistic:
Subsistence theory of wages is highly pessimistic for the working class. It
presents a dark picture of the future of the society.
This theory is based on the assumption of
long run. It does not explain the determination of wages at in the shortrun
The theory assumes that all the workers
get equal wages. As we know, the workers differ in their productivity, and
hence, wages have to be different
Marginal Productivity Theory of
Wages Determination
This theory was first of all
propounded by Thunnen. Later on, economists like Wicksteed, Walras, J.B Clark
etc. modified the theory. The marginal productivity theory states that labour
is paid according to his contribution in production. A producer hires the
services of labour because he possesses the ability to contribute in
production. If worker contributes more to production he is paid more wages and
if he contributes less, wages also will be low. Marginal productivity of labour
refers to change in total revenue by putting one more labourer, keeping all the
other factors constant.
As a result of competition between
employees for labour and between workers for employment, a wage-rate is
determined that is equal to the marginal productivity of the labour-force.
Assumptions:
1. All labourers are equally
efficient.
2. Constant technology
3. Perfect competition
prevails both in factor and product markets.
4. There is full employment of
resources
5. Law of diminishing marginal
returns apply on the marginal productivity of labour.
6. Labour is perfectly mobile.
Under the conditions of perfect
competition, wages are determined by the value of marginal product of labour.
Marginal product of labour in any industry refers to the amount by which output
increases when one more labour is employed.
Value of marginal product of
labour is the price which the marginal product can fetch in the market. Under
the conditions of perfect competition, an employer will go on employing more
labourers but, due to the operation of the law of diminishing returns, the
marginal product of labour will diminish until a point comes when the value of
the increase in the product will be equal to the wages paid to that labourer.
The
marginal productivity theory can be explained with the help of the following
figure:
In Fig. 2 number of labourers
is measured on OX-axis and wage rate on OY-axis. ARP and MRP are average
revenue productivity and marginal revenue productivity curves respectively. The
equilibrium wage rate will be determined at a point where both the ARP and MRP
are equal to each other.
In the figure, the equilibrium
wage rate (OW) is determined at point E because at this point both the ARP and
MRP are equal. The firm at OW wage rate will employ OX number of labourers. If
the firm employs more workers than OX, it will have to face more losses or
fewer profits. Therefore, the ideal situation for a firm is to employ workers
up to the point where ARP and MRP are equal.
Limitations
of the Theory
Unrealistic Assumptions:
The foremost defect of the
theory is that it is based on unrealistic assumptions like perfect competition,
homogeneous character of labour and others
The theory fails to take into account
that labour is also a function of wages. Less productivity may be the effect of
low wages which adversely affects the efficiency of labour and in turn reduces
the labour productivity.
The marginal productivity
theory is one sided. It takes into consideration only the demand side and
ignores the supply side. It also failed to
determine Wages since it only guides the employer to employ workers up
to the level where their marginal productivity equals price. But, it does not
tell how the wages are determined.
Modern Theory of Wages Determination
Modern theory of wages regards
wages as a price of labour and all other prices determined by the usual supply
and demand analysis. According to this approach, wages are determined by the
interaction of market forces of demand and supply.
Demand for Labour:
The demand for labour comes
from the entrepreneurs as it is used for the production of goods and services.
Thus, the demand for labour depends upon the productivity of labour i.e., the
higher the productivity of labour, the greater will be the demand for it from
employers. Thus, demand for labour depends upon the marginal productivity of
labour; since the marginal productivity of labour will slope downwards after a
stage, the demand curve of labour will also slope downward.
Supply of Labour:
Supply of labour in an economy
depends upon both economic as well as non-economic factors. Economic factors
influencing the supply of labour comprises of existing employment, desire to
increase monetary income, bargaining power of the labourers, size of population,
income distribution etc. while the non-economic factors consist of family
affection, social conditions, domestic environment etc.
Psychological factors also
affect the supply of labour. It is only due to the psychological factors that a
worker decides how much time he should devote to work and how much to leisure.
Moreover, the supply of labour also depends on the elasticity.
The supply of labour for a
firm is perfectly elastic, so, the firm at current wages can employ as many
workers as it wishes. On the contrary the nature of supply of labour for an
industry is not infinitely elastic. Thus, it cannot employ more and more
labourers at the current wage rate. The industry can do so by attracting
labourers from other industries by offering them higher wages.
According to the modern theory, wages are
determined at the point of intersection of demand and supply for labour.
Factors
that Determines wages in reality
1.
Demand
and supply conditions of labour
2.
Length
of training and working experience
3.
Trade
or Workers Union
4.
Social
Importance of Job
5.
Government
and or employers Policy
6.
Other
factors
