Introductory Economics

Introduction to Wages and theory of Labour

Wages:

• Price paid for the use of labour is called as wage in economics. The term labour refers to all those mental and physical activities which are under taken to earn income. According to Prof. Benham, A wage may be defined as a sum total of money paid under contract by an employer to a worker for services rendered.

Nominal and Real wages:

• Nominal wages refers to those wages which are paid to the labourer in term of money. Whereas real wages refers to the quantities of goods and services which a labourer gets in return of his money wages.
• Real wages are purchasing power of money wages. Purchasing power of nominal wages is called real wages.

Factors affecting real wages:

1. Money Wages: Others things remaining the same, if money wages are higher, real wages are also higher.

2. Price level: If prices are rising or purchasing power of money is falling, the real wages will also fall and vice versa.

3. Supplementary income: Real wages will be more if in addition to fixed money wage a labourer has additional income. Similarly, hours of work, working condition, trade expenses, period and cost of training, employment of dependents and social status also affect the real wages.

Marginal Productivity Theory of wage determination:
According to this theory under perfect competition and in long run a labourer gets wages equal to his marginal and average productivity. Marginal productivity refers to the addition made to the total revenue by employing one more unit of labourer

Assumption of the theory: Marginal productivity theory of wage determination is based on the following assumptions;

• Perfect competition in product and factor market
• Marginal productivity of labourer is subject to law of diminishing returns
• All labourers are homogeneous and so perfect substitute for one another
• Full employment situation is found in the economy
• It applies in the long run
• Techniques of production remain constant
• Each unit of labour is perfectly mobile. As a result of it wage rate will remain the same in different occupations

Analysis of the theory from the point of view of industry:

• Price of labourer is determined by industry at the level where its demand equals supply of labour.
• Marginal productivity theory is based on the assumption of full employment. On this assumption supply of labourer is fixed. As such wage rate will be determined by the demand for labour.
• Demand curve of industry can be estimated by lateral summation of the demand curve of the firms in the industry.
• Since under perfect competition number of firm in the long run is not constant, so it is not possible to have lateral summation of their marginal productivity curves. However the demand curve of the industry will correspond to the demand curve of the firms i.e.it will be downward sloping from left to right.
• Under perfect competition, marginal wage and average wage rate are equal (MW=AW). Hence in the long run, an industry will give marginal or average wage to the labourers equal to their marginal productivity.

• In this diagram units of labourers are shown on X-axis and wage and marginal productivity of labour (MRP) on Y-axis. DD curve represents industry’s demand curve for labour or marginal productivity curve. It slopes downward from left to right. SL SL is the supply curve of labour which is parallel to OY-axis. It means that supply of labour O SL remains fixed under condition of full employment. Demand and supply curves of labour intersect each other at point ‘E’. Hence, point ‘E’ is the equilibrium point. Demand for and supply of labour are equal at this point and equilibrium wage-rate is OW. This wage-rate is equal to the marginal productivity (OW =ESL =MRP) of labour.

Criticism of the theory: This theory has been criticised on the following grounds.

• It is based on unrealistic assumption of perfect competition
• It assumes that all units of a factors are homogeneous, but in reality it is not true
• The measurement of marginal productivity of any factor is not possible in practical life.
• It ignores the influence of other factors on the productivity.
• As per theory if wage rate is higher, a firm will employ less ,however in reality, while employing labourer, a firm does not only take into consideration the wage rate alone but also consider many other factors such as amount of profit, demand of the product etc.
• According to Keynes, it holds good only under static condition when there is no change