Wages in Economics
For a long time, wages have been a crucial subject in economics. The cost of living and the demand for work both play a role in determining wages, which are a component of a nation's economy. Some people think that wages should be low so that companies can afford to pay their employees well and offer decent benefits. Conversely, wealthy business owners may afford to pay greater wages. The wages of employees are influenced by a variety of economic variables, including unemployment rates and economic expansion. As workers spend their excess income on products and services, high wages can cause inflation.
Wages are regarded as the price paid for the laborer's services provided during production in economics. It encompasses every compensation given to work. Depending on the circumstances, the worker may be self-employed or employed by an employer. The ability of a human being to do a specific task that is related to economic activities comprises both their mental and physical well-being. Labor is a commodity that can be purchased and sold. The utility determines the demand for a good or service, but productivity determines the demand for labor.
Real wages as opposed to money wages
Wages are the monetary sums that are paid in exchange for the utilization of labor. Real wage, on the other hand, is the sum of monetary value paid for the use of labor in the form of products and services. Real wages are estimated by dividing money wages by the market price of goods and services, whereas money wages, or nominal wages, are derived by multiplying the number of goods and services by the market price.
Real wages = price x money wages
Real wages are determined by dividing the price by the money wage.
Thus, lower real wages are associated with higher price levels, and vice versa. Real wages rise as a result of additional earnings like tips, bonuses, and overtime. additional services, such as medical allowances, education allowances, insurance premiums, and a calm work atmosphere kept up real wages. On the other hand, a rise in commodity prices reduces real earnings. Extra work without payment decreases real wages. Regular and secure employment may give lower money wages than irregular and insecure employment.
Real wages were regarded by classical economics as a consequence of labor supply. Keynes believed that because wages are sticky in nature, a rise in price does not enrage labor as much as a reduction in pay. Therefore, the employee is unwilling to labor for reduced pay. Due to robust economies and growing populations in the 18th century, both Europe and North America had low salaries. Employers had no problem offering lower wages because they could expect strong profits because of their reduced costs. Since it encouraged more people to apply for jobs, this was advantageous for businesses. Low salaries also made it simple for governments to combat poverty by giving their most vulnerable residents access to free or cheap housing, clothing, and food. This meant, however, that some people were unable to better themselves beyond the requirements. Governments found it challenging to provide social programs like education and healthcare for workers due to low earnings. These organizations were able to offer high-earning businesses free or inexpensive services because of the low cost of living.
Today's high wages make it much easier for employees to seek higher pay. Low inflation makes it easy for workers to compare their current wages with previous ones. In addition, low unemployment rates make it much harder for companies not to pay higher wages. Low unemployment also makes it easier for governments to provide social programs since taxpayers aren't forced to pay extra money each month for programs that benefit lower-wage workers. Employers are much more likely to give raises when the economy is doing well; in bad times they may reduce pay increases or completely stop giving them altogether. Low wages have disadvantages though- increases can be hard to afford when pay raises aren't going far enough to cover rising living expenses.
Economists often set wages without considering the impact on low-wage workers' pay schedules. Most economists believe that low wage rates help lower-class citizens in several ways. For example, low wages help poor families financially by providing them with jobs, leading them towards improving their living standards by gaining additional income. In addition, low wage rates help racial inequality by encouraging racial separation in the workforce where possible. This encourages companies to hire white people over black ones since white people generally have higher pay rates than black ones do. In addition, having low starting wage rates encourages unskilled young adults into entering the workforce where possible by making it easier for employers not to pay higher rates for experienced workers with greater responsibilities or skill sets.
Theories of Wages
The relationship between supply and demand does not entirely apply to determining salaries. Labor and laborer cannot be distinguished. Some unique characteristics of labor, like inadequate negotiating power versus powerful employers, the perishable nature of labor, the preference for leisure over work, etc. economics need a separate theory of wage.
On the list, they are:
- Subsistence Theory
- Wage Fund Theory
- Residual Claimant Theory
- Marginal Productivity Theory of Wages
- Taussig's Theory of Wages
- Modern Theory of Wages
Subsistence Theory:
French economist F. Quesnay was the first to present the subsistence theory of pay. Classical economists like Adam Smith, David Ricardo, and others expanded on it.
According to the subsistence theory, wages tend to stabilize at a level that is only adequate to cover the cost of living or to exist. The wage may change over the short term, but it will remain at the subsistence level over the long term. The workers are urged to have more children if their pay increases. The labor supply grows due to population growth, raising wages to an adequate level. Marriage and childbirth will be discouraged if the wage is below the subsistence level, and malnutrition will raise the death rate. In the end, the labor supply declines, and wages increase to a natural level.
Criticism: While this idea was somewhat applicable to developing nations, it did not apply to richer nations. The German economist condemned the rule as the "iron law of wages" and asserted that wages should be set at a level sufficient to maintain a standard of living and boost worker productivity in addition to sustenance. The subsistence hypothesis disregards the labor demand side of the economy and the labor union's function in setting wages. Because sensible people may spend on their own welfare activities, such as education, health, training, and physical infrastructure, rather than creating and nourishing more children. Population growth does not solely depend on pay rates.
Wage Fund Theory:
Wage fund theory was developed by the classical economist JS Mill. According to the wage fund theory, labor supply and demand dynamics determine the wage rate in a perfectly competitive market. The wage fund(Capital) controls the demand side. The portion of the capital set aside for the payment of wages is known as a wage fund. Population, which relates to the number of workers, controls the supply side. By dividing the wage fund by the number of employees, the wage fund theory aids in determining the average wage rate.
Average wage rate = Wage fund / Number of workers
The wage rate and wage fund have a direct link, and the wage rate and the number of employees have an inverse relationship. Therefore, whether capital expands faster than the population or the population increases faster than the capital determines whether wages will increase or decrease.
Criticism: The wage fund assumption concerning the source of wage is incorrect because wages are paid from current production rather than accumulated capital. In addition, to pay money, wages also depend on the stage of development, the government's policies, and the unemployment rate.
Although this idea is grounded in static theory, wage funds may rise or fall depending on the business cycle stages. Wage funds may increase during an expansion and may decrease during a recession.
Trade unions, like the ILO, are essential in setting the minimum wage, but this theory ignores their function.
In addition to dividing wage money by the number of workers, wages are also paid according to the productivity of the workforce.
Residual Claimant Theory:
Walker, an economist from the United States, has advanced the residual theory. This idea states that the workers receive a payment from the remaining portion of the total output after paying rent, interest, and profit. This hypothesis acknowledges the possibility of a pay increase due to increased labor productivity.
Criticism: This view disregards the role that trade unions, including the ILO, play in determining the minimum wage. It disregards how salaries are impacted by the labor supply side.
Marginal Productivity Theory of Wages:
The ability of a person to generate products or services is measured by productivity in economics. Usually, more production results in higher revenues and higher living conditions for the general populace. However, because the wages paid per unit produced fall with higher productivity, some workers may see their pay decline. When wages are less than the worker's marginal productivity, this decline in pay is referred to as wage inefficiency. According to the marginal productivity theory, wages fluctuate over time, and some workers' earnings drop as a result of declining productivity.
The main idea behind the marginal product theory is that each worker only gets paid a portion of what he actually creates. In actuality, this occurs even before workers receive pay increases. This occurs as a result of their current pay not covering their overall productivity. They begin to make more money than they did before as their new wages climb faster than their new marginal productivity. The fact that their new compensation is less than the additional items they can generate once that new level of production is reached, however, means that even after raising their pay above their new marginal productivity level, they continue to produce below their potential. In essence, once workers increase their wages above their present level of production, wage efficiency does not happen instantaneously; it takes time.
Modern economics use the marginal productivity hypothesis to explain how wages are determined in both perfect and imperfect competition. A company keeps hiring more and more labor units until the marginal revenue product from labor equals the marginal wage. Marginal revenue productivity car represents the firm's demand for labor. Marginal revenue productivity of labor would become sticker and the wave rates would have to be reduced considerably to enable the forms to employ an additional unit of labor.
Assumption:
- Perfect competition in the labor market also implies that both employees and businesses act as wage-takers and that no one has any influence over the wage rate.
- It follows the law of varying proportions.
- The business seeks to maximize profits.
- Every worker is equal and dividable.
- Labor is flexible and can be used in place of capital and other inputs.
Wage and Marginal Productivity Relationship Under Perfect Competition
The industry sets the wage as a result of the relationship between labor supply and demand. The individual company that accepts the wage rate set by the industry is handed it as a given. The individual firm accepts the supplied pay in the same way that the individual firm accepts the price of the good as set by the industry in an environment of perfect competition. The labor supply curve for each company is therefore a horizontal straight line. In the figure, PQ is the wage determined by the industry. MN line represents the average cost and marginal cost of labor.
Let's investigate the connection between the average cost of labor and the average labor-generated revenue. Between the average cost of labor and the average labor revenue product, there are three possible outcomes.
When the average wage is more than the average sales of the product in instance 1, the company will incur a loss in hiring personnel. Area WPQT is the loss.
When the average wage is less than the average revenue of the product in scenario 2, the company will gain money by hiring employees. Area WPQ1T1 is equal to the profit.
When the average wage is equal to the average revenue of the product in scenario 3, neither profit nor loss will be experienced by the company from hiring personnel.
Criticism: The marginal product hypothesis is mostly criticized for how it explains how wages fluctuate over time. It does not explain why the labor portion of the national income has fallen over time, in particular. Some people think that this decline is the result of workers' productivity gradually declining over time being countered by greater labor output efficiency. There have been many historical occurrences that have led to these changes in the income distribution between workers and capitalists over time, even though this offset may have happened unintentionally and without anybody intending it. These comprise, but are not limited to, international conflicts, domestic economic downturns, and cross-border mergers and acquisitions of businesses inside or across nations.
It's possible that workers with the same efficiency and expertise won't make the same money in two separate locations.
The bargaining power of the labor union affects the wage rate.
The quality of capital and effective management are factors outside of the control of the workforce that affect labor productivity.
Low salaries could be a contributing factor to low productivity.
Taussig's Wage Theory
The marginal discount product of labor is the name given by American economist Taussig to a modified form of the marginal productivity of wage. Because manufacturing takes time and the end result of effort cannot be reached right away, in his view, labor is unable to obtain the entire marginal output. The employer in a capitalist system does not pay the entire expected marginal output of labor. To make up for the risk she/he took by paying in advance, s/he deducts a specific percentage from the final product. The current interest rate is used to calculate the deduction. Therefore, wages are equal to the sum of all labor products less the discount.
Drawback
The idea is not concrete.
The combined product is discounted at the current interest rate.
Modern Theory of Wage
The relationship between labor supply and demand is a key component of the current theory of wages. The market value of the product at various levels of production and worker productivity are both factors that are reflected in the demand for labor. The demand is what drives the demand for labor. Demand for the goods that labor contributes to producing is what drives the labor market.
Technology has an impact on the work market. New technology requires less labor, whereas old technologies require more. Marginal activity declines as the number of workers rises, which causes the demand curve to slant downward. Workforce availability refers to the number of people willing to accept existing pay. The point at which the supply and demand curves cross is where the pay rate is determined. Population and leisure preferences have an impact on the labor supply. The wage rate changes in the short term but maintains equilibrium over the long term. The number of workers at Point "N" is "L1," and the hourly rate is "W1." Unemployment results when labor demand is lower than labor supply.
Conclusion:
Wages are payments made to employees in exchange for their labor. It is a motivation to work harder rather than a reward. The employee is rewarded because they accomplished a good job and created something worthwhile.
Wages can take on a variety of shapes, including hourly pay, piece rates, commission rates, bonuses, and more. They all share the same trait in that they are all compensations given by employers to workers for services done. It can be challenging to identify the factor that will have the biggest impact on you when deciding how much to pay your staff in the end.
According to contemporary thinking, supply and demand determine the wage rate. Wages will increase if there are more employees than jobs available. This indicates that if there is a rise in the demand for labor, firms will need to offer greater wages to recruit workers.
Wages have changed a great deal over time thanks to changes in economics, government programs, and worker requests. Today's high wages make it much easier for workers to compete with other companies' employees and encourage higher pay rates in the workplace. Despite these changes, some believe that low wage rates are necessary to encourage lower-class citizens into seeking employment; however, this ignores how difficult it is for lower-class citizens to even find regular jobs in the first place due to government inaction or racism against certain groups in culture and economics alike!
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