Lecture-29

Wages and Theory of Labour

Learning objective: concept of wages and marginal productivity 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:
Money Wages: Others things remaining the same, if money wages are higher, real wages are
also higher.
Price level: If prices are rising or purchasing power of money is falling, the real wages will
also fall and vice versa.
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 homogenous 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 industrys demand curve for labour or marginal
productivity curve. It slopes downward from left to right. S L SL is the supply curve of labour
which is parallel to OY-axis. It means that supply of labour O S L 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 homogenous, 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
Questions
1 The money paid to a worker as a reward for his work is known as
a) Real wages
b) Nominal wages
c) Quasi rent
d) None
2According to marginal theory of wages, every labour will receive a wage rate equal to the
_____________of labour
a) Marginal cost
b) Marginal factor
c) Marginal value product
d) Average value product
3 Modern theory of wage is otherwise called as

a) Iron law of wages

b) Wage fund theory
c) Demand-supply theory
4Marginal product of labour refers to
a) Additional cost incurred on labour to produce additional output in a firm
b) Average cost incurred on labour to produce additional output in a firm
c) Additional output produced in a firm due to use of additional unit of labour
d) Average output produced in a firm due to use of additional unit of labour
5Under competitive conditions, wage rate of labour in the long run will be equal to
a)
b)
c)
d)

Marginal revenue product

Average revenue product
Total revenue product
Both a and b

Answers
1 b)
2c)
3 d)
4 c)
5d)