Modern theory of wage determination explained


Modern economist opines that the price or remuneration of labour i.e. wage is determined by interaction of forces of demand and supply. Wage is determined at the point where demand for and supply of labour are equal to each other. This is why the modern theory is known as supply and demand theory of wages,

Demand for labour:

Demand for the laborer is derived demand. Factors of production are demanded because they have productivity or efficiency. Productivity of a factor refers to the addition made by it total productivity. Demand for laborers depends on the demand for the goods they produce.


The demand for a factor is affected the prices of other factors. Laborers can be substituted for other factors of production. Technical factors also affect the demand for labour. When old techniques are applied there will be more demand for labour. With the introduction of new technique of production the demand for labour declines. Besides the technique production and the prices of other goods, there is a main factor earning the demand for workers is their marginal productivity, original productivity is stated in money forms.

Stated in money s it is called marginal revenue productivity. Workers are demanded up to the point where their marginal revenue productivity also labor’s wage. Therefore an entrepreneur employs labor up to the part where their wages are equal to their marginal activity. With the increasing number of laborers the marginal activity will go on diminishing. Thus the demand curve for labour is downward sloping,

Supply of labour:

Supply of labour means the number of workers ready to at the existing wage rate. Unlike the supply of other goods, the supply of labour can not be increased with the rise in their demand. Under perfect competition, the supply curve of a firm is perfectly elastic. A firm can not influence price. It accepts market price as the given datum. Thus the demand of an individual firm for laborer cannot affect price (wage).


On the other hand the supply curve of an industry slopes upward from left to right. This means that an industry can get more laborers at higher wages. An upward rising supply curve of an industry shows the more of workers are employed at higher wages. Determination of the Equilibrium wage level:

Wage rate is determined by the supply of and demand for labour. Equilibrium wage state is said be determined at the point where supply and demand are equal.  At point F demand curve DD and supply curve SS cut each other. OP is the equilibrium wage rate. When demand rises from DD to D1D1 the new equilibrium is restored at point E and wage rate fixed is OQ1 Increase in demand leads to rise in wage. When demand curve shifts to the position D2D2 wage falls from OP to OP2. OP is the ruling market wage. On the basis of the price OP a firm can earn super normal profit, normal profit, or suffers losses from employment labour.

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