Theories of Wage Determination
- Subsistence theory of wages
This theory was presented by the physiography and was explained by a German economist Sallee. This theory may be known as The Iron Law of Wage
According to this theory, wages tend to settle at the level which is just sufficient to maintain the worker and his family at a minimum subsistence. If for some reason, wages are higher than this level, it is said that the workers would be encourage to marry, their number would increase by higher birth rate with the large supply of labour brings down the wage to the subsistence level.
If on the other hand, wages are below subsistence level marriages will be discouraged and ultimately labour supply will decrease, hence wages will rise and reach the subsistence level. This theory has been reflected because it is not realistic.
Criticisms of the theory.
- The law is applicable to less developed countries where wages are on low subsistence level unlike in more developed country.
- The theory only looks at increase in birth rates due to increase in wages neglecting other factors such as; early marriages.
- The term minimum subsistence is vague, because there is nothing like a fixed minimum subsistence as it keeps on changing.
- The theory is also unable to explain reasons for differences in wages.
- It is not always true that increase in wages is always accompanied by increase in the population size
Wages Fund Theory
This theory is associated with the name of J.S. Mill. According to him, a wage fund is created and the wages are paid by the employer out of this fund. According to this theory, wages depends on two quantities:-
- The wages fund set aside by the employer for the payment of wages and
- The number of labourers seeking employment. The actual rate of wages can be found by dividing the fund by the number of workers.
According to this theory, wages cannot rise unless either the wage fund is increased or the number of working class people decreases.
Criticism of the theory
- In real world there is nothing like a fixed wage fund as firms set wages according to the level of production.
- The theory does not explain the method used in determining the wage fund.
- The theory does not explain reasons for wage differentials among labourers.
Residual Claimant Theory.
This theory was advanced by the American economist John Walker.
According to him, wages are the residue left over after other agents of production have been paid. Rent, interest and profit, according to him are determined by definite laws. Out of the total production.When payments have been made to other factors, it is said that the whole of the remainder will go to workers.
This theory has also been rejected by most economists. It does not explain how trade unions are able to raise wages. Moreover, it is not the worker who is the residual claimant but the entrepreneur. The theory also ignores the influence of labour supply in wage determination.
Market theory of Wages.
According to this theory wages are determined by the interaction of demand & supply of the labour in the market and therefore the wage rate would be determined at the point of interaction of demand and supply curve for labour in the market.
Demand for labour is derived demand.Therefore when there is increase for demand of goods and services producers will demand more labour and the opposite is true.
Supply for labour refers to the number of labourers willing to work at the prevailing wage rate per period of time and it depends on factors such as population size, population composition etc.
From the above graph, Q_e W_e is the equilibrium wage rate.
Above that wage, demand for labour will be less than supply labour and hence surplus, labour but however that wage, demand for labour will exceed supply of labour and hence a shortage.
Marginal Productivity Theory
According to this theory a factor of production specifically labour should be paid according to its marginal productivity.
Marginal productivity is the additional output produced by an additional labour employed.Therefore a labour is paid according to his contribution (marginal product) to the firms total output. The higher the marginal productivity of the labourer, the higher the wage and the opposite is true.
If the employer pays a labourer more than the value of his marginal productivity it will instead result in to a loss.
Assumptions of the Theory.
The theory is based on the following assumptions:-
- All units of labour are homogeneous.
- The theory assumes that marginal productivity of any factor can be measured
- It assumes perfect mobility of factors of production eg.Labor
- The theory assumes operation of the law of diminishing returns.
- The theory also assumes that wages are only determined by marginal productivity of labour.
Criticism of the Theory
- In reality it is not true that all factors such as labour are homogeneous as it differs interms of strength, experience, skills etc.
- Perfect mobility of factors of production eg. labour as at time limited by factors such as old age, fear to lose family ties.
- The theory only looks at the demand side of labour neglecting the supply side of it
- Increased wages can as well be determined by other factor besides marginal productivity such as level of experience, education and training.
- In reality it is also difficult to measure marginal productivity of labour
- It is also not true that the productivity of labour depends on the labourer himself but however depends on the efficiency of other factors.
- Bargaining theory of Wages.
According to this theory wages are determined according to the bargaining strength of the labourers through their trade unions. Trade unions represent labourers to the management to discuss wage improvement and working conditions. Therefore the stronger the bargaining power, the higher the wages and the opposite is true.
Trade Union is an association of workers that aims at advocating for better payment and better working conditions.
It has been defined by Prof. Webb in the words “A Trade union is a continuous association of wage earners for the purpose of maintaining and improving the conditions of their employment.”
Method used by trade unions
- Collective bargaining: This is when the trade union leadership represents a group of workers in negotiation with the management about interests of the workers and the general improvement in the working conditions.
- Go slow tactics
- Sabotage (creates a bad image of the company)