Here is a compilation of essays on the ‘Theories of Wages’ for class 11 and 12. Find paragraphs, long and short essays on the ‘Theories of Wages’ especially written for school and college students.
Essay on the Theories of Wages
- Essay on the Ricardo’s Iron Law of Wages
- Essay on the Standard of Living Theory
- Essay on Wages Fund Theory
- Essay on Marx’s Surplus Value Theory
- Essay on Residual Claimant Theory
- Essay on the Bargaining Theory of Wages
- Essay on the Welfare Theory of Wages
- Essay on the Behavioural Theory of Wages
- Essay on the Theory of Shadow Wage
- Essay on the Keynesian Theory of Wages
- Essay on the Marginal Productivity Theory of Wage
- Essay on the Keynesian Theory of Wages
1. Essay on the Ricardo’s Iron Law of Wages:
David Ricardo and Physiocrats (French Economists) propounded this theory according to which normal level of wages that is “natural price of labour” always tends to remain at the minimum level of subsistence.
If actual wages that is “market price” as determined by the interaction of demand and supply of labour, exceed this subsistence level, this excess will soon disappear on account of the tendency of population to multiply itself on the basis of Malthusian theory of population.
Thus, there seems to be a natural law which keeps wages fixed at the subsistence level. This theory of wages is also known as Iron Law of Wages or Brazen Law of Wages as propounded by the German economist Lassale.
2. Essay on the Standard of Living Theory:
Some economists propounded the standard of living theory as modified version of subsistence theory in later part of the 19th century. According to this theory, wages are influenced by the Standard of living to which workers in a particular class are accustomed. Higher the standard of living higher the demand for wages.
This theory is based on the following assumptions which are, however, acceptable and plausible:
First, the theory emphasized the standard of living and not subsistence level as the determinant of wages.
Second, the theory takes into account labour productivity and demand function of labour which are related to labour efficiency.
Third, the theory is optimistic and attempts to discredit Malthusian theory of population by putting a limit on population explosion as standard of living tends to check over-populations.
However, the difficulty of the theory is that it is not possible to say definitely whether standard of living influences wages or wages influence standard of living. Though mutually related, the standard of living also is difficult to prescribe in a definite manner for heterogeneous groups of workers.
The theory is a supply theory of labour considering labour as a commodity, which is wrong. The theory is basically pessimistic in approach. It visualizes a grim future of workers as it holds out the perpetuation of wages at subsistence level. Actually, the theory was the reflection of England’s socio-economic conditions of workers during Ricardo’s time.
Subsequent history falsified the pessimistic notion of the theory. Yet, at the same time, it may be said that, in over-populated underdeveloped countries, the empirical evidence of poor workers’ conditions confirm the fact that workers live at subsistence level.
The theory is, however, defective as it does not explain differences in wages assuming labour as homogeneous. The theory is also based on discredited doctrine of Malthusian theory of population, in general. The theory is silent on labour productivity, demand for labour and standard of living.
3. Essay on Wages Fund Theory:
Adam Smith and John S. Mill were associated with this theory according to which, “Wages depend upon the proportion between population and capital” or rather between “The number of labouring class and the aggregate funds consisting of circulating capital spent on labour this stock of capital being wages-fund.”
The theory assumes that the stock of circulating capital is fixed in a country, and therefore total fixed wages fund available to be paid to labourers. If the number of labourers increases, wages rates will decline. And if the number declines, there shall be a rise in wage rate.
The theory has been examined by different economists from two view points. A group of economists like Jevons, Thornton and, in a sense, Mill himself have criticised the theory and have tried to modify. The other group headed by Keynes, Taussig and Cairnes has given qualified support to the theory. The following is the gist of criticism.
It has been contended that rise in wages occurs by increasing wages fund or by a fall in the number of labourers. But the theory does not tell us about the sources of wages fund and the method by which it is estimated.
Further, wages fund is assumed to be stock which is fixed. But, contemporary idea about the capital fund is not stock but flow. This fund is elastic and changes according to the prospects of profits which depend on the productivity of labour and its efficiency.
The theory is based on the wrong supposition, as it considers wage determination according to the size of wages fund, not according to due remuneration of workers. The theory is also defective as it does not explain difference of wages in different occupations.
Keynes, the noted British economist, has, however, sought to modify the theory by contending that, since wages are advances made by capitalists to labourers, the total amount of circulating capital fixes the total amount of real wages payable to labourers.
Keynes also sought to include in the wages fund the total volume of working capital in addition to the existing volume of circulating capital. The wage-fund comprising these two items constitutes the total, out of which all wages must be paid.
Cannon has criticised this Keynesian modification by arguing that fixity of capital fund not only affects labourer, but all other classes of society. So, like wage-fund, there ought to be rent-fund, profit-fund and interest-fund as well.
4. Essay on Marx’s Surplus Value Theory:
Karl Marx, in his famous “Das Capital”, has, propounded this theory, according to which labour creates surplus value in the process of production which is not wholly paid to them as wages. The capitalists exploit labourers by paying less than what they produce. Marx believes that, the price or exchange value of any product is determined by the amount of labour time “socially” necessary to create it.
The excess product or “surplus value” created by labour is appropriated by capitalists which goes to rent, interest and profit. Marx’s value theory is related to Ricardo’s value theory of wages.
But while Ricardo analyses wages in terms of subsistence level, Marx believes that this subsistence level of wages is the creation of capitalists by creating unemployed reserve army as Marx calls it. Thus, workers are paid at subsistence level as a process of exploitation.
Marx’s theory, as is well known, had tremendous impact on labouring class particularly on labour movement throughout the world as a political crusade against capitalism. But, Marx’s theory of communist revolution as absolute international phenomenon has been falsified as reality.
Yet, Marxian approach to the origin of surplus value and labour’s share focuses attention to the basic fact that workers are not compensated according to their productivity.
Marginal productivity theory of labour as explanation of wage determination has much to owe to Marx’s approach though Marxian viewpoint is controversial. Marxian approach is also definitely an improvement on Ricardo and Smith’s position of labour theory of value. Marx has reduced all sorts of labour, skilled and unskilled, into abstract labour power as measuring unit of wage which is a novel feature of Marxian theory.
5. Essay on Residual Claimant Theory:
Walker has propounded this theory on the basis of labour’s claim to national dividend only as a residual claimant. Specifically, this theory advocates that out of four factors of production land, labour, capital and organisation the total product should be distributed as price first to land as rent, to capital as interest, to organisation as profit and wages are to be paid to labour only as the last claimant.
According to Walker, payments are made to land, capital and entrepreneur according to certain formal laws or rules independently. But, since there are no definite rules or laws governing payment of general wage rates, this should be paid to workers only after other payments are made to other three factors of production.
Though this theory has been discarded long ago as outmoded method of wage determination, it has important contribution to the principles of wage differentials on the basis of labour efficiency or labour’s definite claim to output. The main controversy, however, is about labour’s share as residue.
The theory has been subjected to the following main points of criticism:
Walker’s contention that shares of land, capital and entrepreneurship as rent, interest and profit are fixed by economic laws independent of output is not correct. Because, this implies that these payments are of the nature of the fixed or constant prices and that when the output is enlarged, the share going to these factors of production other than labour remains constant is not logically and actually valid.
Further, wage is not paid to labour as residue, but actually it is paid to sale of output along other factors of production on the basis of contract. The theory also ignores supply of labour as the determinant of wages. As a matter of fact, today wages are paid to labour throughout the world as matter of contract, or on the basis of bargaining, or law of the country, not as a residue, but as a first claim to the job.
6. Essay on the Bargaining Theory of Wages:
According to bargaining theory of wages, rates of wages are determined by the respective bargaining powers of unions and employers.
There are two important theories in this respect:
(i) One is Hicks’ approach.
(ii) The other is Edge worth bilateral monopoly approach.
The two theories visualize collective bargaining as the basic method of industrial relations system.
Hicks’ Bargaining Theory of Wages:
Let us first examine Hicks approach to bargaining theory of wages. According to Hicks, rate of wage is determined by the interaction of employers’ concessions and unions’ resistance put forth by unions in the context of collective bargaining and time period of possible strike.
The following diagram explains the basic approach. In the diagram, vertical axis measures wage rate and horizontal axis measures time path of strike period that employers have to face and unions have to demonstrate in the context of collective bargaining.
AA line indicates standard wage rate (OA wage rate) that employers would like to pay to workers assuming absence of union’s bargaining power—that is, this is the competitive wage rate in the labour market without reference to union.
However, E curve indicates employers’ concession curve according to which employer would be agreeable to pay wage rate at higher levels than competitive level A, in the face of lengthening possibility of strike period. This concession after maximum point will decline, that is, employer will not pay higher wages after this point whatever might be the strike period.
U curve indicates union’s resistance curves which shows the minimum that the union would accept starting from preferred maximum point B. That is, union bargains from the preferred wage rate B without a strike. But, union is ready to accept minimum as the strike period (strike cost) buyers to increase along horizontal line.
This minimum declines as the prospective strike becomes longer, and eventually U curve intersects AA, that is, there is some maximum length of strike beyond which the union would prefer simply to accept employer’s terms.
It is evident from the diagram, as Hicks concludes; intersection of two curves at C wage rate is the determinate wage rate which is based on both the parties’ equilibrium bargaining power. This is both union and management would agree to wage C rather than face a strike as S period.
However, Hicks bargaining theory of wage’ determination raises an important question. It is not clear whether Hicks’ approach to wage determination is before or after strike.
If the assumption is that the entire exercise is before a strike, and both management and union know each other’s strategy and intentions of collective bargaining fully well, assuming strike period would last at least S period, then the theory is quite clear.
But this assumption of the process before strike is not plausible enough, as the essence of collective bargaining is uncertainty and deadlock about each other’s strategy and approach during collective bargaining.
If, however, the process is after a strike when negotiations have broken down, Hicks’ approach may be a useful analysis of interpreting wage determination on the basis of bargaining power. Hicks, in fact, recognized this drawback.
He said, “If there is a considerable divergence of opinion between the employer and the union representatives about the length of time, the men will hold out rather than accept a given set of terms, then the union may refuse to go below a certain level. Leaders believe that they can induce the employer to consent to it by refusing to make anything less. The employer may refuse to conclude it, because he does not believe the union can hold out long enough for concession to be worth his while. Under such circumstance, a deadlock is inevitable, and a strike will ensure, but it arises from the divergence of estimates and from no other cause”.
Edgeworth Bilateral Monopoly Approach to Bargaining Theory:
Assuming a situation of bilateral monopoly in labour market, when a single buyer (employer) (monopsony) of a certain kind of labour faces a single union seller (monopoly), Edgeworth provides a model which may be considered as wage-setting process on the basis of bargaining of the union and employers.
In the diagram, D curve is employer’s labour demand curve, S curve is labour supply and MC curve is marginal cost. On the basis of bargaining, we find MC intersects D curve at B, where at E, employment, a possible settlement of wage is possible.
The following diagram may be illustrated:
At E, employment, according to S curve, wage rate is W. Assuming this as low level of wage rate, unacceptable to union, the possible highest wage rate demanded by union may be assumed at W2. But, equilibrium wage rate is W0 at the intersection point of B.
New, Edgeworth contends that, under this situation a determinate wage rate is difficult to fix up, as between the contract zone W1, W2 somewhere wage rate may be fixed up. It is, however, quite likely that W0 wage rate may be a possible solution to stalemate.
7. Essay on the Welfare Theory of Wages:
Legislative or Administered Theory of Wages:
Almost in all countries of the world, both -ill advanced and developing countries (both in capitalistic and socialistic economy), the role of state in administering basic minimum wages, fair wages and welfare benefits is recognised as the promoter of economic welfare. Pigou has analysed the basic tenets of the role of state with regard to wages in his famous treatise, “Economics of Welfare.”
According to Pigou, economic welfare of a country is maximised when private net product (private economic interests) and public net product (public economic interests) are equalized. And economic welfare is dependent on maximization of national dividend (income), which is economic yardstick of economic welfare.
This maximization of economic welfare is ensured when the state plays its positive role in ensuring the administration of minimum and fair wages and industrial peace for optimum industrial efficiency.
Specifically, according to welfare theory of wages, Pigou prescribes the following courses of state interference to maximize economic welfare and wages:
(i) State interference to raise wages where they are unfair,
(ii) State interference to ensure national minimum time-wage, fixed and fluctuating wage rates,
(iii) State interference to effect redistribution of purchasing power from non-labour to labour.
It is, however, difficult to examine in details the implications of Pigou’s approach to wages in the context of above theory. Because, the scope and the context of Pigou’s approach , to national dividend and labour in his famous book is vast and magnificent.
Nevertheless, it is presumed that Pigou’s approach to wage is not necessarily a formal theory of wages, as such. It explains how wage questions are functionally related to economic welfare and the state interference. Probably, Pigou advocated welfare state as witnessed in the U.K. under Labour Government, and welfare capitalism as functioned in the U.S.
In India, one can say, however, that Pigou’s approach is quite relevant to our mixed economic system, where the role of state has assumed positive dimensions since the inauguration of Five Year Plans. This, however, became controversial in India later on.
Relevance of the Theory in India as Welfare State:
Industrial policy of Union Government, 1948 and 1956, firmly established India as a welfare state where co-existence of private sector and public sector has ushered in a planned as well as mixed economy. Russian social economic system, American “Welfare Capitalism” and British Beverage Plan have all recognized the positive role of state as maximize of economic welfare in different forms and under varying conditions.
Pigou’s vision and prescription of welfare maximization have been sought to be experimented under different wage laws and welfare laws in India. But to what extent all these measures have maximised national dividend (income) since the First Plan is a matter of deep regret and controversy.
8. Essay on the Behavioural Theory of Wages:
In recent times, it is being increasingly felt that wage fixation and salary administration cannot be determined always by theories of wages, both classical and modern. There are psycho-social aspects of wages which may be reasonably explained by psychology and sociology.
Recent researches and theories of motivation and organisational behaviour by behavioural scientists’ have given rise to the following main types of behavioural theories of wages which are largely based on psychology and sociology.
According to this theory, wage level is determined by the equilibrium process, or a balance of employee’s productivity to firm and utilities or inducements provided by firm (employer). In other words, wage level is determined by labour productivity as well as the capacity of utilities provided by firm.
Another approach seeks to determine internal wage structure of an organisation not with reference to job evaluation or merit rating process but by certain social norms and prestige that an organisation carries as motivator to their employees. According to this theory, labour markets exert psychological pressures on labour force for certain types of jobs, especially for executives, professionals and craftsmen.
Because of psychological limitations of wage theories, that is, money as motivator, theories of motivation and non-wage incentives are capable of explaining the non-wage factors as the main motivators. This approach is particularly helpful under certain cases where labour supply curve begins to react unfavourably even if wagers are raised sufficiently.
Elliott Jacques in his famous Glacier Project has propounded an integrated wage theory which, while, accepting money as motivate, enunciates a new approach to wage determination with reference to “time span of discretion”.
According to this theory, every job can be measured in terms of “time span of discretion” which means that wage or salary of an employee would be determined by the period of time during which the employee should be able to perform his job according to his discretion without supervision or control.
As a logical corollary, this denotes that lower level jobs— where employees are not required to exercise or have no scope of discretion will be paid lower wages.
Admittedly, this theory and also many others, recently developed by behavioural scientists can explain various complex aspects of job behaviour and enable organisations to determine wage levels, and wage structure more successfully. These approaches, however, are more relevant in advanced countries.
But in a country like India, where workers are poor and educationally backward and national income at low level, money still is a principal motivator. Hence, psycho-social theories probably can more explain job behaviour rather than wage determination and wage fixation at a company level.
Nevertheless, a personnel manager may find these behavioural theories positively helpful as specific guidelines in dealing with union pressures, governmental legislative intervention while confronting with collective bargaining in matter of wage determination.
9. Essay on the Theory of Shadow Wage:
Emerging Pattern in Developing Economy of India:
In recent times, a modern theory known as the theory of shadow wage has emerged.
The shadow wage in the urban sector is not necessarily smaller than the market wage, if the rate of population growth rises with rise in per capita consumption.
The literature on the shadow wage rate (SWR) puts emphasis on its components:
(i) The value of foregone output, and
(ii) The value of foregone investment. Different dynamic models assume a constant rate of population growth and hence their analysis on the second component concentrates on the point that the additional employment in the urban sector reduces investment fund available to the government, and raises consumption and hence social welfare. This keeps the SWR in the urban sector below the market wage rate.
Population growth rate as a positive function of per capita income (consumption) has been considered in the models of low level equilibrium trap. One may not like to defend or criticize the trap models, but it may be pointed out that if the rate of population growth is a positive function of per capita consumption, then the value of SWR should be higher than that considered in the standard analysis.
With increase in employment in the urban sector, rural employment falls due to induced migration. This raises the rural wage rate. But if urban wage rate exceeds the marginal productivity of labour in the rural sector, then per capita consumption rises; and hence the rate of population growth rises.
So the SWR takes a higher value than that obtained in the standard analysis; and may be equal to or even greater than the market wage.
There are two sectors rural and urban; and each of them produces the same commodity with a constant production function using capital and labour as inputs. Capital is measured in terms of the same commodity. The urban sector employs labour at an institutionally fixed wage rate. Each rural worker receives his average productivity of labour. The entire rural output and the urban wage income are consumed.
Surplus of the urban sector is allocated as investment between the urban and the rural sector. Non-shift-ability of capital stock is assumed and the depreciation is ruled out in both the sectors. Rate of population growth is assumed to be a positive function of per capita consumption, and this is the key to the analysis.
This analysis attempts to examine the significance of Keynesian theory of wages and money wages and real wages and then specifically analyses the trends in Indian manufacturing sector in the perspective of a national wage policy.
10. Essay on the Keynesian Theory of Wages:
At the outset, Keynesian theory of money wages which has already been noted should be examined in the context of wage out and employment under Indian conditions. Under the leadership of Pigou, classical theory continued to assume that wage rate flexibility led to self-adjusting mechanism in the economic system and full employment. Keynes denied this proposition as a general theory.
Keynes conceded that, while fall in wages and prices in single industry on a firm might lead to rise in employment under certain conditions, a general wage cut is most likely to reduce employment by adversely affecting aggregate demand. But this situation is to be examined in the context of the proportionality of fall in wage rate and fall in aggregate demand which depends on the situation of non-wage groups.
The greater the possibility of substituting lower price labour for other factors of production, the more will wage falls tend to push non-wage money incomes down in line with money wages. This possibility is likely to drive aggregate demand down in proportion to the fail in money wages. Harrods’ article in Economic Journal, March 1934.
As a matter of fact, wage rates, aggregate outlays and employment are all interdependent complex; one cannot establish a general and unique proposition with regard to wage-cut in employment. Keynes also found no simple answer to the problem of wage reduction and employment.
Traditional analysis considers the aggregate quantity of labour supply to be a function of the real wage rates. Keynes, on the contrary, substitute’s money wages for real wages and assumes that up to a certain point, defined by him as the point of full employment, on particular level of money wages at which the supply of labour is perfectly elastic, and below which no labour can be hired at all.
The deliberate exclusion of the cost of living as a determinant of labour supply makes the latter independent of the level of real wages.
The monetary supply curve of labour is a fundamental postulate of Keynes, in a sense, in which the classical supply curve is not. The money wage rate may be assumed to be entering directly into the worker utility function.
Confronted with a choice between two or more situations in both of which his real income and real effort are the same, but if one of the money wage rates and prices of consumers’ goods are higher than in the capital goods, he would show a definite preference for the former.
The monetary basis of Keynes’ supply curve of labour may also be stressed to the influence of some outside factors, e.g. a minimum wage law. Whatever the shapes of intrinsic or potential supply curve, no worker can be hired in this case at a wage rate which is lower than the legal minimum.
11. Essay on the Marginal Productivity Theory of Wage:
This theory as originally propounded by Wick-steed and Clark and later on developed by J. Robinson, Chamberlain and Hicks, among others, is the most important economic reasoning of wage determination, on the basis of certain assumptions.
This theory is, in fact, an extension on application of general theory of distribution according to which each factor of production (i.e., land, labour, capital and organisation) is paid according to its marginal productivity. However, marginal productivity theory of labour postulates that, in a competitive market, wages tends to be equal to the net product of labour at the margin of employment.
Net product is defined as the net addition to the total value of total product by an extra unit of labour after deduction of extra expenses indirectly related to employment of extra unit of labour.
As long as the net product of labour is greater than the rate of wages, the employer will continue to employ more and more units of labour. Profit will be maximised when wages are equal to the value of the marginal net product of labour.
Managerial Implications of the Theory:
The theory is based on certain assumptions which are discussed subsequently. But some managerial implications are inherent in the theory. The employer endeavors to employ each agent up to that margin at which the net product would no longer exceed the price he would have to pay for it.
The operation of diminishing returns is implicit and the entrepreneur is also supposed to apply the principle of substitution for the determination of the marginal net product of labour.
Prof. Hicks is of opinion that there is a distinction between marginal productivity and net productivity. Net productivity assumes methods of production as fixed; while marginal productivity assumes variability of production process which is a reality. To the employer marginal productivity of labour is equal to marginal physical productivity multiplied by the price per unit of output.
Employer pays wages to all workers at the same rate while a marginal worker is entitled under competitive labour market. If a worker produces more than a marginal worker, employer however, does not pay more, thus he increases his profit. Employer finds it profitable to employ workers till wage costs are at least equal to marginal productivity of worker.
When labour proves costly employer takes recourse to capital intensive production function employing less labourers. Thus, the theory postulates inverse relationship between wage rate and employment on the basis of diminishing marginal productivity. Economists like Keynes thus believe that higher employment is possible only through wage-cut, other things remaining the same.
The theory and its major implications as outlined above are based on the following assumptions:
(1) The labour, as a factor of production, is homogeneous, substitutable, interchangeable and divisible with other factors of production and within units.
(2) Perfect competitions, perfect mobility of labour and capital and full employment are assumed to exist.
(3) Share of wages in the national dividend is assumed to be constant on the basis of Cobb-Douglas production function which again assumes linear homogeneous production function. This means that it yields constant returns to a proportionate increase in the use of all inputs.
(4) If every productive unit is paid according to its marginal product, then logically it is assumed that entire production should be exhausted when the distribution is made fully among factors of production leading to neither surplus nor deficit.
In recent times, the theory has been subjected to a good deal of criticism. At the-same time, it must be noted that the theory has contributed to valuable reasoning of wage determination. Hence evaluation may be made, first, from the standpoint of its main drawbacks.
The basis of foregoing assumptions of the theory is not valid under all circumstances. The labour as a factor of production is not homogeneous, and though substitutable, with capital not divisible, and therefore cannot be apportioned to determine marginal productivity.
The theory specifically deals with demand side neglecting supply side of labour. In fact, modern theory of wages takes into account both demand supply function. The theory cannot explain wage differentials and assumptions of perfect competition, perfect mobility of labour and full employment are not correct.
As regards the assumptions of Cobb-Douglas productions function and constancy of labors’ share in national income, Samuelson has contended that the question of surplus or deficit arising out of the assumption very much depends on market conditions.
In the long run, under perfect competition, little will remain as surplus. On the other hand, under monopolistic market conditions, surplus in the shape of excess projects will emerge in the short run.
A fundamental postulate of the theory is that as the number of labourers employed by a firm increases, their marginal productivity is diminished. This sets limits, if not very narrow, marginal productivity theory cannot be used as the exact determinant of the equilibrium level of wages.
The concept of profit maximization by employers through paying same wage rates to all workers at the rate of marginal labour is not found practicable, especially in many Indian public sector undertakings where social welfare and government subsidy entail running enterprises only on cost basis and statutory limits have been set on declaration of dividends.
Further recent wage legislation and other forms of wage determination including collective bargaining do not always bother about determination of marginal productivity of labour.
Notwithstanding criticisms, the theory, however, has the great merit of focusing our attention on the paramount need, of giving importance to productivity as the determinant of wage, especially in a developing economy of India, where the problems of economic stagnation and inflation persist.
Further, in India, in the context of 21st century technological breakthrough, the significance of computerisation, data processing and automation in some selected industries necessitate labour substitution despite labour surplus economy. This admits of scientific reasoning of the theory which is necessary for the sophistication of wage and salary administration.
Discounted Marginal Productivity Theory of Wages:
Prof. Taussig has propounded a modified version of marginal productivity theory of wages known as discounted marginal productivity/theory. According to this theory, wages cannot be equal to the marginal net product of labour, since there is an interval of time between the payment of wages and the eventual sale of the marginal product of labour.
Wages, therefore, must be equal to the present discounted value of the future marginal net product of labour, discounting taking place at the current rate of interest.
The theory suffers from all the defects to which marginal productivity theory are subjected as discussed previously. Apart from this, Taussing’s theory is vitiated by circular reasoning.
Logically the theory is defective on account of the following flaws:
The rate of interest at which discount is to be made is, according to classical theory, determined by the marginal productivity of capital. But the marginal productivity of capital cannot be known unless the rate of wages is already known.
Thus the theory of wages is assorted to be as, accord- ding to classical theory, determined by the marginal productivity of capital. But the marginal productivity of capital cannot be known unless the rate of wages is already known. Thus the theory of wages is assumed to be known before the rate of interest can be determined.
But in the statement of the discounted marginal productivity theory, it is assumed that the rate of interest is already known before the rate of wages can be determined. Thus, there is the fallacy of circular reasoning.
But Taussig has sought to correct this fallacy of reasoning by introducing Keynesian liquidity preference theory of interest according to which rate of interest can be determined by supply of capital without reference to demand for capital.
Some economists have described this theory as a sort of modern version of residual claimant theory of wages, since it postulates that the rate of interest must be known before the rate of wages can be determined. Hicks have described the theory a kind of modern version of “wage fund” theory.
Because it is assumed that the total volume of circulating capital is fixed. If the period of production is not variable, an increased supply of labour will necessitate some amount of discounting of the marginal product of labour, if all labourers are to be paid out of the existing volume of circulating capital.”
The discounted marginal productivity theory however, fills up an important gap in the reasoning of marginal productivity theory and, thus, contributes to its logical culmination. In the production function, an individual firm is faced with problems of time involved in input- output relationship.
Whenever there is a difference between the time of input and the time of output, the marginal productivity theory must be reinterpreted as discounted marginal productivity. It is only when it is assumed that input and output can take place simultaneously that the doctrine of discounted marginal productivity theory loses its force of reasoning and validity.
Some Recent Trends in Wage and Productivity Theory:
On the basis of perfectly competitive market conditions, marginal productivity theory of wage envisages equality of marginal cost of labour and marginal revenue product of labour.
Thus, under perfect competition, all workers of a particular category will receive uniform wages on the basis of a marginal labour’s (cost) wage and this will also represent average cost of labour; which will again be equal with marginal revenue product of labour.
There might be three possible situations between wage (average cost of labour) and average revenue product of labour.
Firstly, when at a particular level of employment the marginal wage is equal to marginal revenue product of labour, but the average wage, at this level of employment, exceeds average revenue product of labour, resulting in net loss to the firm.
Secondly, at a particular level of employment, when average wage is less than average revenue product of labour resulting in net surplus or excess profit to firm.
Thirdly, at a particular level of employment, a firm will neither earn excess profit, nor incur loss, but will be in perfect equilibrium when average wage is equal to the average revenue product of labour.
Theoretically, however, it is quite possible that in the short period, a firm may face any of the above mentioned situations. But, in the long run, only the third situation will prevail, i.e., the firm will neither earn excess profit, nor incur loss, but will earn only normal profit. This long run equilibrium will prevail because of the following implications.
If the firm faces the first situation, that is, incurs loss by employing a certain amount of labour, when average wage is higher than average revenue product of labour, the firm will stop production as a loss. The demand for labour falling, average wage rate will also decline being equal to average revenue product of labour.
Thus, in the long run, the firm will ‘not face loss. If, however, the firm is earning excess profit by employing a certain amount of labour, when average revenue is higher than average wage cost, other new firms will be attracted to industry leading to rise in demand for labour.
This will raise average wage cost and ultimately, average revenue will be equal to average wage cost. Thus, in the long run, the firm will enjoy only normal profit.
12. Essay on the Keynesian Theory of Wages:
The supply of labour is a function of the real wage. And real wage is function of the number of men who are employed in the wage good industry. Keynes substitute’s money wages for real wages in the supply curve of labour as a general theory.
There are wide variations in the volume of employment without any apparent change either in minimum real demand for labour or in its productivity. Falling money wages and rising real wages are likely to accompany decreasing employment.
Traditional analysis considers the aggregate quantity of labour supplied to be a function of the real wage rates. Keynes, on the contrary, substitute’s money wages for real wages and assumes that, up to a certain point, defined by him as the point of full employment, one particular level of money wages at which the supply of labour is perfectly elastic and below which no labour can be hired at all.
The deliberate exclusion of the cost of living as a determinant of labour supply makes the latter independent of the level of real wages.
The monetary supply curve of labour is a fundamental postulate of Keynes, in a sense, in which the classical supply curve is not. The money wage rate may be assumed to be entering directly into the worker’s utility function.
Confronted with a choice between two or more situation in both of which his real income and real effort are the same, but if one of the money wage rates and prices of consumers’ goods are higher than in the capital goods he would show a definite preference for the former.
From such a monetary utility function, a monetary supply curve for labour can be easily derived. The monetary basis of Keynes’ supply curve of labour may also be stressed to the influence of some outside factors, e.g. a minimum wage law. Whatever, the shape of intrinsic or potential supply curves no workers can be hired in this case at a wage rate which is lower than the legal minimum.
To Keynes, the rate of real wages does not affect the supply of labour which is only influenced by the rate of money wages. At a certain money rate, there will be sane who will offer themselves as workers but will not get jobs.
To classical, there is only voluntary unemployment. Keynes says that at a particular money level, supply of labour is perfectly elastic up to the full employment level. Therefore, everything depends upon the demand curve. Full employment depends on how much the demand curve may be shifted. Keynesian theory is a monetary concept and it introduces certain rigidity (rigid rate-of money wages).
These are fundamental assumptions because their preferences depend on empirical knowledge. Keynes derives his monetary principles from the concept of time lag. Wages always rise later after the prices have risen.
According to classical school, unemployment is incompatible with all equilibrium. The existence of any unemployment will have the effect of lowering wages until all unemployment is removed. So unemployment can persist only if the state or trade union prevents the unemployed from offering their services at lower wages.
Keynes has two objections, viz:
(a) Practical uselessness of this advice and
(b) If money wages are reduced, (this is all that labourers can do) it does not follow that there will be any increase in employment. A general reduction of wages will reduce the marginal cost and therefore the prices of wage goods. Therefore, real wages will remain the same.
There are two contradictory conclusions from mere cost considerations which follow from classical and Keynesian economics. According to Pigou, a cost in money wages means larger employment and the marginal product of labour working with fixed equipment, therefore, becomes less.
Marginal costs are higher relatively to wages; prices are therefore also higher relatively to wages, also that the workers by cutting this money wages have been successful in reducing their real wages.
According to Keynes, however, the marginal cost will fall as much as wages and prices will have to fall in the same proportion at cost, so that there is no change in real wages and therefore there is no increase in employment.