Labour theory of wages

LABOUR - THEORY OF WAGES

PROF. PRABHA PANTH,DEPT OF ECONOMICS, OSMANIA UNIVERSITY, HYDERABAD

1. SUBSISTENCE THEORY OF WAGES:

• First given by the French Physiocrats:• Called the “iron law of wages.”• Cost of labour is the bare cost of subsistence.• The cost of subsistence determines the price of labour or the wage rate.• Based on the Supply of labour alone, not on Demand for labour.• Assume that a rise in wage rate leads to increase in population, until the wage

rate again falls to subsistence.• Converse happens if wage rate < subsistence. Death rate rises, supply of labour

falls, and wage rate rises to subsistence levels.01/05/2023 Prabha

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2. THEORY OF THE WAGE FUND

• Employers kept aside a ‘fund’ to pay labour.• This fund is fixed, so increase in employment leads to fall in wage rate.• For example if 100₤ kept aside by an employer to be paid as wages, and

he employs 10 workers, then wage rate would be 10 ₤ each.• But if he employs 15 workers, then the wage rate would fall to 6.6₤ each.• If he employed only 8 men, then wage rate would rise to 12.5₤ each.• Any legislation to increase wage rates, would lead to unemployment.• This theory persisted for a long time.

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3. LABOUR THEORY OF VALUE

• Adam Smith’s concept of ‘value in use’ vs. ‘value in exchange’.• In a primitive society, with only labour and no capital

inputs, the exchange value of commodities would depends on the amount of time taken to produce them, other things remaining constant.• For e.g. if it takes 2 hours to hunt a beaver, and 1 hour to

hunt a deer, then the exchange rate would be 1 beaver = 2 deer.


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3A. RICARDO: LABOUR THEORY

• Ricardo subscribed to the Labour theory of value.• Labour embodied in production gives relative value to commodities.• Even if capital is used, capital is nothing but embodied labour. Instead of direct labour

values, indirect labour values have to be computed to take note of capital inputs. • Tools and equipment are produced by labour over time, so labour is embodied in them.• But the nature of capital is complicated – capital goods are heterogenous, durable,

and there is interdependence over processes, and time is involved in production. • This complicates the direct relationship of labour input and relative prices.


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3B. MARXIAN LABOUR THEORY OF VALUE

• Continuing from Ricardo, Marx expanded the Labour theory of value.• Labour creates value, but the labour value of the wages paid to it are

less than the value it creates.• For e.g. if it takes 10 hours to produce a commodity, but the real wages

(e.g. corn) paid to labour need only 6 hours to produce, then the difference (10 – 6) is the surplus value, created but not paid to labour.

• This surplus value is retained by the capitalist, and is the basis of “exploitation of labour” by the capitalists.


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4. MARGINAL PRODUCTIVITY THEORY OF WAGES:

• Neo classical theory of wages and employment.• Labour (L) is a commodity bought and sold in the labour market.• Wage rate is determined by the demand and supply of labour.• Work is regarded as a disutility, and has to be paid for.• Demand for labour is a derived demand – i.e. L is demanded for

the product it produces, or service it provides.


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DEMAND FOR LABOUR – FIRM’S LEVEL:

• Demand for L is derived demand, for the product it produces.

• D for L depends on the Value of MP of L.

• In Neo-classical theory as L input increases, ceteris paribus, the MP of L falls.

• MP x P of the product = VMP of L.• Assuming PC in product market, VMPL

is downward sloping.


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Q

0L

VMP of L

SUPPLY OF LABOUR:

• Supply of labour: a) Short run depends on wage rate, b) long run depends on population growth.

• Individual’s supply of labour: A worker has to allocate his time between work and leisure – one extra hour of work means one hour less for leisure.

• The opportunity cost of an hour of leisure time equals the wage rage for that period of time.

• As wage rate increases, supply of labour (hours of work) increases. Every hour of work has higher opportunity cost, so workers will substitute work for leisure. This is the substitution effect.

• But increase in wage rate leads to increase in income, and demand for leisure increases. This is the income effect of rise in total wages.


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BACKWARD BENDING SUPPLY CURVE OF LABOURThe individual’s supply curve of

labour, first rises and then falls due to the substitution and income effects of rising wages.In Fig.1a, hours available for work/ leisure is say 18 hours of 24 in a day.To be distributed between leisure and work, which are inversely related. Work ↑ leisure ↓As wage rate ↑, initially the hours of work ↑.As income increases, demand for leisure increases, and hours of work falls.This gives a backward bending supply curve of labour (Fig.1b).


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Wag

e rat

e

HoursLeisureWork

w3w2

0

w1

Wage offer curve

a

bc

h1 h2 h3 18 hours

Wag

e rat

e

Hours of work

ab

c

Backward bending Supply curve of L

Fig. 1a Fig. 1b

18 hours

BACKWARD BENDING SUPPLY CURVE OF LABOUR – INDIVIDUAL WORKER’S LEVEL

• Initially, workers will work more hours, when wage rate increases. From w0 to w1, labour increases from L0 to L1.

• This goes on as long as the substitution effect > income effect. Point b. Supply curve of L increases, has positive slope.

• At higher wage rates (income levels) the demand for leisure increases.

• Now the Income effect > substitution effect.• The supply of L thus falls with higher wage

rates. W2, supply of L is L2 < L1.• The S-curve of L will bend backwards.


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Supply curve of L

L1L20

w

b

Labour hours

w0

w2

L0

w1

a

c

Sub eff > Y eff

Y eff > Sub eff

MARKET EQUILIBRIUM

Market Supply curve of Labour: • Horizontal summation of individual labour supply curves.• Upward sloping throughout, as labour supply increases with more workers

entering the market at higher wages,• Demand curve of Labour:• Market Demand curve of Labour = Summation of all the VMPs of individual

firms.• Demand and Supply of Labour determines the Market wage rate.• All firms offer this same wage to their workers.


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EQUILIBRIUM WAGE RATE• Market D and Market S of labour

intersect to give the Market or Equilibirium wage rate.• If Supply of L is S1, intersects the VMP

at A. Market w = 0w1, and employment is 0L1.• If Supply of L increases to S2, new

equilibrium at B, wage rate has falls to 0w2. Employment increases to 0L2.• If D for L increases, i.e. VMP shifts

upwards, then w and emp will increase.


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0 L

VMP = D for L

Q S1

w1A

w2B

S2

L1

w1

w2

L2

ROLE OF TRADE UNIONS

• In PC, if unions demand higher wage rates:

- will lead to decrease in employment.• Market wage rate = 0w1,

employment = 0L1• Union wants 0w2, and employment

= 0L2• At 0w3, firms will employ only 0L3 at

point A.• So AB = level of unemployment.


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0 LD for L

S of LQ

L3 L1 L2

w1

A B

Ew2

QUESTIONS

I. Short answers:1. Write a short note on the Subsistence theory of wages.2. Critically examine the Wage Funds theory.3. Briefly explain the Marxian Labour theory of value.4. What is a “backward bending Supply curve of labour” ?5. Can trade unions achieve higher wages for their members? What is the disadvantage according to the MP theory of wages?


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ESSAY ANSWERS

• Examine critically the various Classical theories of wages.• Explain the MP theory of wages. What are its major

limitations?


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Education

Labour theory of wages