Detail Note on Modern Theory of Wages


We have studied various theories which explain the determination of wages but they all stand discredited as they do not offer satisfactory explanation of wages. The modern economists are of the opinion that just as the price of a commodity is determined by the interaction of the forces of demand and supply, the rate of wages cal also be determined in the same way with the help of usual demand and supply analysis. Let us now discuss in brief as to what we mean by demand and supply of labour.

1) Demand for Labour:

There are various factors which influence the demand for labour. These factors in brief are as under.

(a) Demand for labour is derived demand: Demand for labour is not a direct demand. It is derived from the demand for the commodities and services, it helps to produce. If the demand for a product is high in the market, the demand for labour producing that particular commodity will also be high. In case the demand for commodity is small the demand for that labour will also be low.

(b) Elasticity of demand for the product: If the demand for a particular product is inelastic, the demand for the type of labour that produces this product will also be inelastic. The demand for labour will be elastic if cheaper substitute of the product are available in the market or the demand for the commodity it produces is elastic.

(c) Proportion of labour cost to total cost: If the wages of workers account for only a small proportion to total cost of product then the demand for labour will tend to be inelastic. In capital intensive industry. For instance, a slight increase in the workers wages will have little effect on unit cost of product; so the rise in wages will not reduce the demand for labour.

(d) Availability of substitutes for labour: If the substitutes of labour producing a particular product are easily available in the market, the demand for labour will then be elastic.
After considering the various factors which influence the demand for labour, we now take up the demand price of labour.

Demand Price of Labour: An employer hires a labour in order to make profit. He while employing a worker, compares the cost of hiring a worker to the contribution he is expected to make the total revenue of the firm. So long as the addition made by the labour to the revenue is greater then the cost of employing him, the entrepreneur will engage that labour. In other words we can say that so long as the marginal revenue product of labour is higher than the cost of employing him, the employer employs that worker. The entrepreneur will continue hiring the worker up to the point at which the cost of employing a worker is just equal to the marginal revenue product of the labour.

2) Supply of Labour:

The supply of labour for the entire economy is influenced by various factors such as wage rate, size of population, age composition, availability of education and training, the length of training period, provision of opportunities for women to work, the social security program etc.

The supply of labour for the industry as a whole is less elastic in short run. The supply of labour here depends on the availability of workers in the locality and from the nearby areas ad the willingness of the labour to work overtime. In the long run supply of labour for the industry is more elastic. The labour can be affected by offering hire wages, providing training facilities, making working conditions pleasant etc. So the supply of the labour for the industry is of the normal shape rising upward from left to right.

In the above figure supply curve of labour to an industry shows an upward slope. At OW wage rate, ON workers are ready to work. At OW' wage, the supply of labour increases to ON'.

Wage Determination: So far we have discussed the forces operating behind the demand for and supply of labour in competitive market. At regards the price or the wage of particular grade of labour, it is determined by the interaction of the forces of demand for and supply of in the competitive market. The determination of wage rate is explained with the help of following diagrams.

In figure (a) DD' is the demand curve of labour say carpenters to the industry. It is found by summations of the demands of carpenters of all the firms. Similarly SS' represents the supply curve of carpenters to industry. The market demand curve DD' intersects the market supply curve SS' at point ON. The equilibrium wage rate NL or Rs. 20 and the number of workers hired at the equilibrium wage rate (Rs. 20) is 200 thousand. Figure (b) shows that a firm in competitive market takes the market wage rate of carpenters as given. So the supply curve which it faces is a horizontal one. A firm will continue hiring labour so long the MRP is higher then the wage rate. When the MRP and the wage rate are equal, it will stop employing further labour. The firm at the wage rate of Rs. 20 per hour employs 40 workers. We thus conclude that in a competitive market the wages are set in the market much like other prices.

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