Payment of wages differs from industry to industry and also it differs from country to country. The payment of wages is payment by time, payment by result, and also payment by piece rate, etc.
Wages are fixed as a result of individual bargaining, collective bargaining or by public or State regulation. How wages are determined has been the subject of many theories of wages.
The history of wage theory may roughly be divided into three periods according to Dunlop. The first, up to 1870, was dominated by the wage fund theory; the second, up to 1914, was the period when the theory of marginal productivity held sway; and the third, extending from the First World War till the present day was characterised by the process of collective bargaining and the Keynesian enquiry into the general wage level and employment.
Different theories of wages are:-
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1. Subsistence Theory 2. Wage Fund Theory 3. Marginal Productivity Theory 4. Residual Claimant Theory 5. Bargaining Theory 6. Employment Theory
7. Exploitation Theory 8. Labour Theory of Value 9. Competitive Theory 10. Low-Wage Labour Market Theory 11. Purchasing Power Theory 12. Surplus Value Theory of Wages 13. The Investment Theory
14. The Contingency Theory 15. Equity Theory 16. Agency Theory and 17. Behavioural Theories.
Theories of Wages: Subsistence Theory, Wage Fund Theory, Marginal Productivity and Residual Claimant Theory
Theories of Wages – Top 11 Theories: Subsistence Theory, Wage Fund Theory, Marginal Productivity Theory, Residual Claimant Theory and a Few Others
The history of wage theory may roughly be divided into three periods according to Dunlop. The first, up to 1870, was dominated by the wage fund theory; the second, up to 1914, was the period when the theory of marginal productivity held sway; and the third, extending from the First World War till the present day was characterised by the process of collective bargaining and the Keynesian enquiry into the general wage level and employment.
1. Subsistence Theory:
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Adam Smith (1723-90) is regarded as the founder of the classical economics. He was an exponent of natural social harmony and was strongly opposed to all forms of state interference with the ordinary business of industry and commerce. He also propounded the theory of productivity of labour or theory of value and regarded labour as the source of the fund which originally supplied every nation with all the necessaries and conveniences of life which it annually consumed.
Division of labour became for Adam Smith the principal cause of increasing productivity. His book on Wealth of Nations contains elements of various wage theories including the subsistence, the wage-fund, the exploitation, the bargain, and the productivity theories.
The subsistence theory of wages states that in the long run, wages would tend towards that sum which is necessary to maintain a worker and his family. Wages beyond the subsistence level would induce workers to have larger families resulting in spurt in supply of labour which brings down wages to subsistence level.
No matter what the demand conditions were, supply would adjust itself until wages equaled the subsistence level. He, however, believed that there is a limit below which “the ordinary wages of even the lower species of labour” cannot be reduced and this limit is set by the cost of maintenance of labour. “A man must always live by his work and his wages must atleast be sufficient to maintain him,” he asserted.
2. Wage Fund Theory:
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In the beginning of the nineteenth century, a new wage theory, the wage fund theory emerged, supplementing the subsistence theory rather than replacing it. This theory stated that at any given moment, wages are determined by the relative magnitude of work force and the whole or a certain part of the capital of the country.
The wages are paid from a fixed ‘wage fund’. The wage fund theory was a rigid demand and supply explanation of wages, which assumed that the supply of labour at any time was fixed or absolutely inelastic, and that the demand for labour consisted of a fixed sum determined by the intentions of capitalistic employers.
According to John Stuart Mill (1878), wage was a variable dependent on the relation between the labouring population and the aggregate funds set aside by the capitalists to pay them. He viewed wage as a kind of advance fund earmarked out of existing capital for payment to workers.
The attack on the wage fund theory came from Francis A. Walker, who observed that wages are the residual claimant upon the output of industry. He argued that wages were paid out of the product of labour and not from some previously accumulated capital. There is no reason to assume that the available fund would be constant. It is production that furnishes the true measure of wages. After deduction of rent, interest and profit, the remaining portion of wealth reverts to the labouring class.
3. Marginal Productivity Theory:
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Whereas the classical theories laid more emphasis on the supply aspects of labour, later theories such as the marginal productivity theory focused on demand for labour. Alfred Marshall and J.R. Hicks are the main exponents of this theory. According to this theory, in a competitive labour market situation, labour like any other factor of production is determined by the marginal productivity of labour.
The wages received by the marginal labourer determines the wages paid to all the other labourers on the same grade. This theory uses the firm as the unit determining the wage rate.
4. Residual Claimant Theory:
Francis A. Walker (1840-97) is probably best known as one of the chief opponents of the wage fund doctrine. In its place he propounded a residual claimant theory of wages as that part of residual surplus which is left after other factor charges have been met. Rent, interest and profits are, according to him, determined by the definite laws, but there is no specific law which determines wages. Workers get the residual.
Therefore, according to him, the increase of national dividends are on account of greater efficiency and that results in increase in wages. These views were expounded in a number of his writings, of which the earliest was The Wages Question (1876). This theory was designed to emphasise the interest of the working class in continual process and accumulation.
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This theory ignores that wages are the first charge on an industry. It does not explain how trade unions are able to increase the wages. It ignores other factors which influence wage determination. Further, this theory did not consider the aspect of labour market and the role of labour in productivity.
5. Bargaining Theory:
Bargaining theory of wages was propounded by John Davidson in 1989. According to him, wages are determined by the relative bargaining power between workers or trade unions and employers; and basic wages, fringe benefits, job differentials and individual differences tend to be determined by the relative strength of the organisation and the trade union.
Exponents of the bargaining theory are of the view that there should be upper and lower limits for the rate for the given type of labour. The wage paid within this range depends on the relative bargaining power of labour and employees. The greatest weakness of bargaining theory of wages is its failure to define the limits precisely or to estimate the range between them.
The upper limit is that rate above which the employer will refrain to hire a certain group of workers, and the lower limit is the rate below which workers refuse to work. Supply and demand analysis plays an important role in the formulation of the limits.
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Bargaining has received considerable attention in view of the fact that wages are now being determined by collective groups of workers organised into trade unions and employers organised into employers’ associations. Bargaining theories form important elements of the general wage theories.
In construction of the bargaining theories, the vital part played by organised labour in determining wages has been openly recognised and given a place of equal importance with that played by the managements. The motives that influence trade union leaders in demanding and accepting certain specific wage levels or wage rates are sort to be discovered and expressed through various models of the bargaining process.
The actual wage rate which is ultimately embodied in a collective bargaining agreement will depend upon the relative bargaining strength of the employer and employees.
Collective bargaining may be seen as the process through which labour supply and demand are equated in the labour market. Various aspects of bargaining could usefully be summarised into three groups – (a) contract for sale of labour, (b) form of industrial government, and (c) method of management.
It is a system in which the union and the management participate together to regulate the terms and conditions of employment and in decision-making. In a modern democratic society, wages are determined by collective bargaining of trade unions in contrast to individual bargaining by workers in the past.
6. Employment Theory:
There are essentially two schools of thought which propounded the inter-relationship between wages and employment. One was by classical economists like J.B. Say, and Pigou. According to this school, unemployment would disappear if the workers were to accept a voluntary cut in wages.
They strongly pleaded for wage flexibility as a means of promoting employment at a time of depression. These wage-cuts, according to them, would bring down the costs and a consequent fall in prices. This fall in prices would cause additional demand necessitating increased production and hence employment of more workers.
John Maynard Keynes in General Theory of Employment, Interest and Money (1936) has developed a new approach. In his theory of employment, he advocated wage rigidity in place of wage flexibility. The classical economists firmly believed that any cut in money wages had little or no effect on the effective demand of the economy.
But the serious flaw in this argument is that even though a general cut in money wages means reduced costs, it also means a serious reduction in aggregate effective demand on account of a cut in the purchasing power of the working class. Reduction in aggregate effective demand leads to reduced employment because the latter depends on the former.
7. Exploitation Theory:
The Wages of Labour, Adam Smith suggests the basis for an exploitation theory. He referred to the original state of things in which the whole produce of labour belonged to the labourers and when there were no landlords nor masters to share with them.
However, Karl Marx, a contemporary of Mill, drew more extensively from the writings of Ricardo and his followers. From Ricardo he adopted such ideas as the labour theory of value, the Ricardian theory of rent, and the notion that wages and profits increase only at the expense of one another.
Starting with Ricardo’s notion that labour creates all value, Marx contended that profit, interest, and rent are unwarranted deductions from the product that labour alone creates. According to Marx, the capitalist compels his employees to work for more hours a day than is necessary in order to produce their subsistence.
The difference between the exchange value of the workers’ product and the subsistence wages they receive is the “surplus value” that is “expropriated” by the capitalists and distributed as profit, interest, and rent. In short, Marx assumes that labourers produce an “expropriated” amount in addition to their subsistence and that the capitalists, through superior bargaining power, can force the workers to perform that additional work.
8. Labour Theory of Value:
According to Marx (1893), the simplest concept which related to man’s activity of producing his means of livelihood was human labour. He considered labour as an article of commerce which could be purchased on payment of subsistence price. The price of any product was determined by the labour time needed for producing it.
But the labourer was not paid in proportion to the time spent on work but much less and the surplus went to the owner. His theory is also known as surplus value theory of wages. Labour might be viewed in its natural (universal) form and in its social (historical) quality. As such, ‘labour is a natural condition of human existence; a condition of the metabolism of man and nature which is independent of all social forms’.
9. Competitive Theory:
The force on which economists have traditionally laid the greatest stress in wage determination is demand and supply. Adam Smith, an early English economist (1723-90), argued that if wages were fixed in accordance with demand and supply, workers would be attracted by high wages to industries, occupations and localities where they were most needed and would tend to leave industries and places where the supply of labour was greater than demand.
More precisely, the basic assumption of competitive theories of pay is that employers compete among themselves by offering a higher wage to attract employees; while the employees compete with others for jobs by offering their services for a lower wage. Competition, then, is essentially a disequilibrium process by which excess demand and excess supply cause changes in wages.
10. Low-Wage Labour Market Theory:
There are several conceptual approaches which can be adopted for analysing the behaviour of low-income labour market. One such theory is known as the Queue theory. Stated in its simplest form, the Queue theory asserts that workers are ranked according to the relationship between their potential productivity and their wage rates.
The most preferred workers are selected from the queue first, leaving the less preferred to find work in the least desirable jobs on the fringes of the economy or to remain unemployed. The disadvantaged have limited access to the most preferred employment opportunities.
11. Purchasing Power Theory:
According to this theory, wage increases are desirable because they raise labour income and thereby stimulate consumption. Since wage earners spend a very large proportion of their incomes, it is held that higher wages will result in a rise in consumer spending and thus act to sustain or to stimulate the economy.
This argument has been used by the unions in all periods, boom, recession, and recovery which is not sustainable. The under-consumption theory used by the unions is not the only cause or even primary cause of business cycles.
They are due to variety of causes. Purchasing power and consumption are usually increasing just prior to recession; workers account for only part of total consumers spending; the assumption that general overproduction can be overcome by higher wages; are some of the basic limitations of this theory.
Theories of Wages
Payment of wages differs from industry to industry and also it differs from country to country. The payment of wages is payment by time, payment by result, and also payment by piece rate, etc.
Wages are fixed as a result of individual bargaining, collective bargaining or by public or State regulation. How wages are determined has been the subject of many theories of wages.
They are given below:
1. Theory of Subsistence:
This theory is also known as “Iron Law of Wages”. This theory was introduced by David Ricardo. This came into force in 1817. The theory postulated that labourers are paid to enable them subsist for a long period. The theory is based on assumption that the workers’ wage and their number would increase as they would bring down the rate of wages. If the wages fall below the subsistence level, the number of workers would decrease, as many would die of hunger and malnutrition, etc.
2. Wage Fund Theory:
As per J.S. Mill, the wages are determined on the basis of the amount of funds allotted for the purpose of payment of wages and number of workers. As per Adam Smith, wages are paid out of predetermined funds which can be surplus with wealthy persons as a result of saving. This fund could be utililsed for employing labourers for work. If the funds are large, wages will be high; if the funds are small, wages are reduced to the subsistence level.
3. Surplus Value Theory of Wages:
This theory was developed by Karl Mark. According to his theory, the labour was an article of commerce and this can be purchased by payment of subsistence price. The price of any product can be determined by the ‘Labour time’ needed for making it. In this labourer was not paid in proportion with time spent on work, whereas payment was much less, and the surplus was utilised on other expenses.
4. Residual Claimant Theory:
Francis A. Walker discovered this theory. According to him there were four factors of production (Business) activity, such as—land, labour, capital and entrepreneurship. Wages represent an amount of value created in production which left back after payment has been adjusted for all these factors of production, labour is the residual claimant.
5. Marginal Productivity Theory:
The theory was produced by Phillips Henry Wicksteel (England) and John Bates Clark (USA). According to them Wages are based on an entrepreneur’s estimate of the value may be produced by the last or marginal worker. It assumes that wages depend upon demand for and supply of labour.
Accordingly workers are paid, what they are economically worth-in all respects. At the same time, employer has a large share of profit which was not paid to the marginal workers. If additional workers contribute more to the total value than the cost in wages, it pays the employer to continue hiring where this does not become economically possible. At this stage the employer may resort to superior ways.
Apart from aforesaid theories there are a few more theories which are important ones:
i. Bargaining Theory of Wages
ii. Behavioural Theories
i. Bargaining Theory of Wages:
This theory was propounded by John Davidson. In this theory wages are determined by the relative bargaining strength of two parties, viz., the employer and the employee. Webbs stated that “higgledy-piggledy (confusion) of the market which under a system of free competition and individual bargaining determined the candidate’s wage structure.
ii. Behavioural Theory:
This theory was supported by a number of behavioural scientists, industrial psychologists and sociologists like Marsh and Simon Robert Dubin and Elot Jacques have given their views on wage and salaries on the basis of research studies conducted by them.
They are:
a. Employee’s acceptance of a wage level
b. The internal wage structure
c. Wages, salaries and motivation.
Since basic cost of standard of living increased along with other wages unrelated to an individual’s own productivity, typically stated falling into maintenance category in due course of time.
Theories of Wages – 11 Important Wage Theories
Wage theories ascertain the levels and sources of wages. How much and on which basis wages should be paid to the worker for services rendered by them has been a subject matter of great concern among economic thinkers. Attempts have been made by them to interpret prices and price systems from the standpoint of demand and supply and macro and micro approach.
Some important wage theories are:
Theory # 1. Wage Fund:
Adam Smith (1723-1790), developed this theory. His basic assumption was that wages are paid out of a predetermined fund of wealth to the workers. This fund is created as a result of savings and could be utilized for employing labourers for work. The demand for labour and rate of wages depend on the size of the wage fund. If the fund was large, wages would be high; if it was small, wages would be reduced to the subsistence level. It was held that the lump sum had been distributed equally among the workers obtained in the labour market.
Theory # 2. Subsistence:
David Ricardo (1772 – 1823), developed this theory. Also known as “Iron Law of Wages” was of the opinion that “labourers are paid to enable them to subsist and perpetuate the race without increase or diminution”. If the workers are paid wages more than subsistence level, workers’ number will increase and, as a result, wages will come down to the subsistence level. If the wages fall below the subsistence level, the number of workers would decrease – as many would die of hunger, malnutrition, disease, cold etc., the wage rate would go up to the subsistence level. The subsistence wages refers to minimum wages.
Theory # 3. The Surplus Value Theory / Labour Value:
This theory was developed by Karl Marx (1849-1883). It is based on the assumption that the value of a particular commodity is equivalent to the magnitude of labour involved in it. The labour was an article of commerce, which could be purchased on payment of ‘subsistence price’ i.e., wages. The price of any product was determined by the labour time needed for producing it. The labourer was not paid in proportion to the time spent on work, but much less. The surplus, thus created, was utilized for paying other expenses.
Theory # 4. Residual Claimant:
This theory was developed by Francis A. Walker (1840-1897). According to him, there were four factors of production/business activity viz. land, labour, capital and entrepreneurship. He views that once all other three factors are rewarded what remains left is paid as wages to workers. Thus, labour is the residual claimant.
Theory # 5. Marginal Productivity:
Phillips Henry Wicksteed developed this theory. According to this theory, wages depend upon the demand for and supply of labour and price economy. Wages are based upon an entrepreneurs’ estimate of the value that will probably be produced by the last or marginal worker. Wage that is paid to an employee should be equal to the extra value of productivity that the employees add to total production.
The revenue the employer can realize from the workers’ productivity determines the value of the workers’ production. As the employer hires additional workers, a point eventually is reached at which the last worker hired just produces enough products to pay his or her own wages. The latest worker hired is called the “marginal employee”, and the increased production attributed to the worker is called “marginal productivity”. The result is that the employer has a larger share in profit as he has not pay the non-marginal workers.
Theory # 6. Bargaining:
John Davidson propounded this theory. This theory assumes that wages are determined by interaction of management and labour in a collective bargaining process. When a trade union is involved, monetary benefits, incentives, fringe benefits and individual differences tend to be determined by the relative strength of bargaining agents. If workers are strong in bargaining process, then wages trends to be high and if employers’ bargaining power is high, then wages tends to be low.
Theory # 7. Investment:
H.M. Gitelman developed this theory. He recognized that labour markets vary in the scope of “worker investment” required for their particular industry. The individuals are paid in terms of their investment in the form of training, education and experience. Thus, according to this theory, individual workers’ compensation is determined by the rate of return on that workers’ investment i.e., what the individuals “bring to” a job.
Theory # 8. Contingency:
It has been found that there is no single ‘best way’ to evolve payment system. The effectiveness of a particular scheme is a function of a match between it and the specific organizational factors depending on the motivation. According to Lupton and Bowey, “Essentially, a contingency approach is one in which it is argued that in some industries and in some environments one kind of managerial practice will contribute to some desired objectives. But in other industries and circumstances entirely different result may occur.
Accordingly, as they further suggest, while designing payment system, managers are required to take into consideration the following issues:
(a) Objectives towards which the payment system is geared.
(b) Available payment system.
(c) Payment system most likely to contribute towards the desired objectives in the context of situational factors prevailing in the Company.
Theory # 9. Expectancy:
Vrooms’ expectancy theory focuses on the link between rewards and behaviour. According to this theory, motivation is the product of valence, instrumentality and expectancy. Remunerating system is based on the impact on these motivational components.
Theory # 10. Equity:
Adams’ equity theory assumes that an employee who perceives inequity in his or her rewards seeks to restore equity. There should be equity in pay structure of employees’ remuneration. There should be a feeling of ‘a fair day’s work for fair day’s pay’ among the employees which denotes a sense of equity. Any feeling of inequity leads to job dissatisfaction, high employee turnover, absenteeism and lower productivity.
Theory # 11. Agency:
The agency theory focuses on the divergent interests and goal of the organization stakeholders and the way employee remuneration can be used to align these interests and goals. It provides the most relevant implication for the design of a compensation system for the organization. The fundamental compensation problem is how to develop either an explicit or an implicit incentive-reward contract that aligns the interests of management with those of the stockholders.
Employers and employees are the two stakeholders of a business unit, the former assuming the role of principals and the later the role of agents. The wages paid to the employees are the agency costs. The agency theory says that the principal must choose a contracting scheme that helps align the interest of the agents with the principal’s own interests. These contracts can be classified as either behaviour oriented (merit pay) or outcome oriented (stock option scheme, profit sharing and commissions). As profits go up, rewards also increase and remuneration falls when profits go down.
Theories of Wages – 7 Main Wage Theories:
Different methods of wage payment are prevalent in different industries and in various countries. There may be payment by time or payment by results, including payment at the piece rate. Wages are fixed mainly as a result of individual bargaining, collective bargaining or by public or State regulation.
How wages are determined has been the subject of several theories of wages:
1. Subsistence Theory:
This theory, also known as Iron Law of Wages, was propounded by David Ricardo (1772-1823). This theory states that the labourers are paid to enable them to subsist and perpetuate the race without increase or diminution. The theory was based on the assumption that if the workers were paid more than the subsistence wage, their numbers would increase as they would procreate more, and this would bring down the rate of wages.
If the wages fall below the subsistence level, the number of workers would decrease — as many would die of hunger, malnutrition, disease, cold, etc. and many would not marry, when that happened the wage rate would go up. Criticism
This theory is criticised on the following grounds:
(i) This theory is a one-sided theory as it totally ignores the demand of labour and only takes in account the supply of labour.
(ii) Causes of differences in wages are not explained through this theory.
(iii) Relationship between efficiency and productivity is also ignored in this theory.
(iv) It is a pessimistic theory as according to it, wage rate cannot be more than the subsistence level.
(v) According to this theory, the rise in wage rate encourages the workers to live luxurious life which leads to increase in population but this is not so as it is seen that where workers enjoy luxuries they keep the birth rate low.
2. Wage Fund Theory:
This theory was developed by Adam Smith (1723-1790). His basic assumption was that wages are paid out of a predetermined fund of wealth, which lies surplus with wealthy persons- as a result of savings. This fund can be utilised for employing labourers for work. If the fund were large, wages would be high; if it were small, wages would be reduced to subsistence level.
The demand for labour and the wages that can be paid to them are determined by the size of the fund. Francis A Walker had attacked this theory. He argued that wages are paid out of the product of labour and not from some previously accumulated capital. It is production that furnishes true measure of wages.
(i) The source of wage fund as well as how it is formed is not explained in this theory.
(ii) The relation between the efficiency and productivity is not explained in this theory.
(iii) The reason of differences in wages in different countries as well as among different classes of workers is also not explained in this theory.
(iv) This theory is a one-sided theory as it totally ignores the demand of labour and only takes into account the supply of labour.
(v) This theory is unscientific because it determines wage rate after determining wage fund. In fact, it is after determining wage rate that wage fund is established.
3. The Surplus Value Theory of Wages:
This theory owes its development to Karl Marx (1849-1883). According to this theory, the labour was an article of commerce, which could be purchased on payment of subsistence price. The price of any product is determined by the labour time needed for producing it. The labourer was not paid in proportion to the time spent on work, but much less, and the surplus went to the owner, to be utilised for paying other expenses.
4. Residual Claimant Theory:
Francis A. Walker (1840-897) propounded this theory. According to him, there were four factors of production viz., land, labour, capital and entrepreneurship. Wages represent the amount of value created in the production, which remains after payment has been made for all these factors of production. In other words, the labour is the residual claimant.
Wages – Total Production – Rent – Interest – Profit
5. Marginal Productivity Theory:
This theory was developed by Philips Henry and Jon Bates. According to this theory, wages are based upon the entrepreneur’s estimate of the value of that will probably be produced by the last or the marginal worker. In other words, it assumes that wages will depend upon the demand for and supply of the labour. Consequently, the workers are paid what they are economically worth. The result is that the employer has a larger share in profit as he does not have to pay the non-marginal worker.
As long as each additional worker contributes more to the total value than the cost in wages, it helps the employer to continue hiring, where this becomes uneconomical, the employer may resort to superior technology.
Marginal productivity theory of wage explains that under perfect competition a worker’s wage is equal to marginal as well as average revenue productivity. In other words, marginal revenue productivity (MRP) and average revenue productivity (ARP) of a worker determine his wages. According to this theory, wage of a labourer is determined by his marginal productivity. In other words, MRP= MW Marginal productivity is the addition made to total productivity by employing one more unit of a labourer.
As the labourers are given money wage, their marginal productivity is calculated in terms of money. This is called MRP. MRP is the addition made to the total revenue by employing one more unit of a worker. A producer will maximise his profit when the wage of a labourer is equal to the marginal revenue product.
If MW is greater than MRP (MW > MRP), wage is greater than marginal revenue product. Then, the producer will sustain loss. If MW for labour is higher than its marginal revenue product then the employers get less and pay more. Thus he loses.
On the other hand, if the producer pays wage less than MRP (MW < MRP), he will gain. But his gain will not be maximised. Thus he will gain by employing workers so long when MW = MRP. Thus the wage of a labourer will be determined where MRP – MW. Suppose producer employs three labourers with other factors of production. He gets Rs.200 as total revenue i.e. income from the sale of output.
If he employs an additional labourer his total revenue increases by Rs.300. Thus by employing one additional labourer, he adds Rs. (200-100) = Rs.100 to the total revenue, this increase in Rs.100 is called MRP. Under perfect competition, a worker gets wages equal to his marginal revenue productivity. If the labourers demand more than Rs.100, the producer will employ lower number of workers since their new price exceeds their marginal productivity.
When less number of workers get higher wage, the unemployed labourers will bring down the wage, to the equilibrium level. Ultimately, wages will tend to equal marginal productivity of workers. In such a situation the producer thinks of employing more labourers to maximise his profit. This process will continue until wages become equal to the workers’ marginal activity.
(i) Perfect competition prevails in both product and factor market.
(ii) Law of diminishing marginal returns operates on the marginal productivity of labour.
(iii) Labour is homogeneous.
(iv) Full employment prevails.
(v) The theory is based on long run.
(vi) Modes of production are constant.
(i) The theory is based on the assumption of perfect competition. But perfect competition is unreal and imaginary. Thus theory seems impracticable.
(ii) The theory puts too much emphasis on demand side. It ignores supply side.
(iii) Production is started with the combination of four factors of production. It is ridiculous to say that production has increased by the additional employment of one worker. Employment of an additional labourer amounts nothing in a big-scale industry.
(iv) The theory is static. It applies only when no change occurs in the economy. Under depression wage cut will not increase employment.
(v) This theory explains that wages will be equal to MRP and ARP.
(vi) It is difficult to measure MRP because any product is a joint product of both fixed and variable factors.
(vii) According to Watson the theory is cruel and harsh. This theory never takes into consideration the marginal product of the old, aged, blind etc.
6. The Bargaining Theory of Wages:
John Davidson propounded this theory. Under this theory, wages are determined by the relative bargaining power of workers or trade union is involved, basic wages, fringe benefits, job differentials and individual differences tend to be determined by the relative strength of the organisation and the trade union.
7. Behavioural Theories:
Many behavioural scientists have presented their views on the wages and salaries on the basis of research studies and action programmes conducted by them.
Briefly, such theories are:
(i) The Employee’s Acceptance of the Wage Level:
This type of thinking takes into consideration the factors which may induce an employee to stay with a company. The size and prestige of the company, the power of the union, the wages and benefits the employee receives in proportion to the contribution made by him— all have their impact.
(ii) The Internal Wage Structure:
Social norms, traditions, customs, prevalent in the organisation and psychological pressures on the management, the prestige attached to certain jobs in terms of social status, the need to maintain internal consistency in wages at the higher levels, the ratio of the maximum and minimum wage differentials and the norms of span of control, and demand for specialised labour—all affect the internal wage structure of an organisation.
(iii) Wage and Salaries Motivators:
Money often is looked upon as means of fulfilling the most basic needs of man. Food, clothing, shelter, transportation, insurance, pension plans, education, and other physical maintenance and security factors are made available through the purchasing power provided by monetary income i.e. wages and salaries.
Merit increases, bonuses based on performance, and other forms of monetary recognition for achievement are genuine motivators. However, basic pay, cost of living increases, and other wage increases unrelated to an individual’s own productivity typically may fall into maintenance category.