- By Shubham Sir

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Shubham Tiwari
Theory of Wages
• Wage theory is that portion of economic theory that attempts to
explain the determination of the payment of labour.
• The term labour, is used for any kind of manual or mental activity
made in the process of production for the consideration. The
consideration, here, is the wages. In other words, it is the cost of
employing labour.
• Wage: It is the price paid to the labour for its contribution in the
process of production.
• Prof. Benham has defined wages as the sum of money paid under
contract by an employer to a worker for services rendered.
• Wages, in much broader sense, can be defined as the part of the
national income which is given to the labourers by way of price for
their work and services, whether mental or physical. It includes all
payments which are made to labourers in cash or kind
Shubham Tiwari
 Types of Wages
• Piece Wages
• Time Wages
• Cash wages
• Wages in kind
• Contract wages

Shubham Tiwari
Concept of Wage in Economics:
 Nominal Wage or Money Wage:
 Total amount of money received by labour in the process of
production is called money wage or nominal wage.

 Real Wage
 It refers to all those advantages, concessions and other facilities which
are provided to a worker in addition to his nominal wages.
 According to Prof. Thomas,” Real wages or real earnings refer to the
purchasing power of a worker’s remuneration, i.e., the amount of
necessaries, comforts and luxuries which the worker can command in
return for his services.”

Shubham Tiwari
 Factors determining Real Wages:
• Money wage
• Purchasing power of money
• Extra earnings
• Extra facilities and perks
• Nature of job
• Regularity of employment
• Future prospects
• Hours of Work
• Social Status, etc.

Shubham Tiwari
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Shubham Tiwari
Theory of Wages

Subsistence Theory of Wages

 The word Subsistence literally means supporting
oneself especially at a minimal level.
 So the theory is based on the idea that wages would be
equal to the amount just sufficient for subsistence. The
theory was first originated by the physiocrats.

Shubham Tiwari
Subsistence Theory of Wages

Assumptions of the theory:

There is a limit to expansion of food production.

Population increases at an increasing rate.

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Explanation of the theory:
 According to this theory, wages are determined by the cost of
production of labour or subsistence level. The wages so determined
will remain fixed. This payment is also called as ‘subsistence wages’. If
actual wages are higher than the subsistence level, then population
will increase leading to an increase in labour supply and lower wages.
 If on the other hand, the actual wages fall below the subsistence level,
population will decrease as a result of starvation death; malnutrition,
disease etc. and many would not marry resulting in a decline in labour
supply and rise in wages.
 Since there is a tendency for the wages to remain fixed at the
subsistence level, Lassaille called it as Iron Law of Wages.

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Subsistence Theory of Wages:

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Shubham Tiwari
 This theory was developed by Adam Smith (1723-
1790).
 His theory was based on the basic assumption
that workers are paid wages out of a pre-
determined fund of wealth. This fund, he called,
wages fund created as a result of savings.
 According to Adam Smith, the demand for labour
and rate of wages depend on the size of the
wages fund. Accordingly, if the wages fund is
large, wages would be high and vice versa.
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 At any given moment the wage fund was fixed, and the
average wage(wage rate) could be determined simply
by dividing the value of this fund by the number of
workers.

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Marginal Productivity
Theory of Wages

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Marginal Productivity Theory of Wages
 The marginal productivity theory of wage states that the price of labour,
i.e., wage rate, is determined according to the marginal product of
labour. This was stated by the neoclassical economists, especially J. B.
Clark, in the late 1890s.
 The term marginal product of labour is interpreted here in three ways:
marginal physical product of labour (MPPL), value of the marginal
product of labour (VMPL) and marginal revenue product of labour
(MRPL).
 The marginal product of labour (MPL) is the change in output that results from
employing an added unit of labour.
 When marginal product of labour is expressed in money terms we obtain VMPL.
 MRPL is the change in total revenue following a change in the employment of
labour.

Shubham Tiwari
Marginal Productivity Theory of Wages:
Assumptions:

� Perfect competition prevails in products market and in labour

market.
� Law of variable proportions operates.
� All labourers are homogeneous.
� Labour is mobile and is substitutable to capital and other inputs.
� Labours are fully employed.
� Techniques of production are constant
� Labours ae perfectly mobile
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Exlaination of the theory:
• Under Perfect Competition, wage rate will be determined by the
interaction of demand and supply curves of labour in the market.
• Labour demand curve is explained by the VMPL curve.
• Since perfect competition exists in the product market, VMPL curve
coincides with the MRPL curve.
• VMPL = MRPL curve is the firm’s demand curve for labour.
This curve slopes downward because of diminishing marginal
returns.
• In Fig., VMPL = MRPL = DL represents the firm’s demand curve for
labour.
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Exlaination of the theory:
• Further, as perfect competition exists in the labour market,
the labour supply, SL = ACL = MCL, curve has been drawn
perfectly elastic.
• In Fig., E is the equilibrium point since at this point labour
demand equals labour supply. The equilibrium wage rate thus
determined is OW. Corresponding to this wage rate,
equilibrium level of employment is OL.
• At this going wage rate (i.e., OW) the employer will be
maximizing profit by employing OL units of labour.

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Unrealistic Assumptions
 Units of labour are not homogeneous
Units of labour are not perfectly mobile
No full employment of labour
Production is not the result of labour alone
Neglect of technical progress

Shubham Tiwari
Modern theory of Wages
THANK YOU

Shubham Tiwari