Thalasar Ventures

The classical and old theories of wages are either defective or inadequate while explaining the wage determination. Though marginal productivity theory is fairly satisfactory, it does not take into consideration the supply side of labor which is equally important as that of demand. Modern theory of wages provides a satisfactory explanation of wage determination. This theory takes into consideration not only the productive aspect; however, also other aspects viz., demand and supply of labor in the labor market in determining the wages. As such, this theory is called as “demand and supply of theory”.

According to this theory, the price of labor, like the price of any other commodity is determined by the market forces of demand and supply. Although the labor has certain peculiarities and it cannot be regarded as an ordinary commodity, yet the same principle of demand and supply also applies equally well.

Demand for labor: Demand for labor is not a direct demand but a derived demand. The elasticity of demand for labor also depends upon the elasticity of demand for goods which it produces. The demand for labor depends on the price of other complementary and competitive factors. For example, labor and machines are substitutes and they would be competing with each other for being engaged in a particular line of production. If the prices of machinery are higher than those of labor, the employer would prefer to employ more of labor. Thus the demand for labor would increase.

Apart from the above, a fundamental consideration governing the demand for labor is its productivity. Just like there is a demand price for goods, there is, also a demand price for labor. The demand for labor comes from the producers who want to engage them in the process of production. The demand price of labor depends upon productivity; to be more precise, the marginal productivity, i.e. marginal revenue product of labor. The higher the productivity of labor, the greater will be the demand for it from employers.

The law of diminishing marginal productivity comes to operate when more and more laborers are employed. The employer would keep on engaging more and more laborers so long as their contribution to production is more than the wages paid. However, the moment wages become equal to the marginal productivity of labor, further employment of labor would be stopped, as any more employment of labor would bring about a loss to the producers. Since all labor is assumed to be homogeneous what is paid to the laborer will be paid to all others. Hence wage would be equal to marginal productivity.