Modern Theory of Wages: Demand & Supply of Labour

According to the modern theory of wages, wages are the price of services rendered by a labor to the employer.

As products the prices are determined with the help of demand and supply curve. Similarly, the wages (prices of services rendered by labor) is also obtained with the help of demand and supply of labor.

Therefore, for the determination of wage level, it is necessary to study the demand for labor, supply of labor, and the interaction between them.

Demand for Labor:

The demand for labor is dependent on various factors.

Some of these factors are as follows:

i. Demand for a product:

Refers to one of the important determinant of demand for labor. The demand for labor is derived from the demand of the product it produces. In case, the demand for the product increases, the demand for labor would also increase However, this is the expected demand of the product and not the current demand. Therefore, the expected demand of the product determines the demand for labor. Moreover, along with the magnitude of demand, the elasticity of demand for labor is also need to be determined. The elasticity of output helps in determining the elasticity of labor.

The following are the conditions for determining the elasticity of demand of labor:

a. Condition 1:

Labor would be inelastic if their wages contribute only a small amount to the total wages of industry

b. Condition 2:

Labor would be elastic if the product produced by him is elastic

c. Condition 3:

Labor would be elastic if cheaper substitutes of products are available

Elasticity of demand of labor depends on two factors, which are technical aspects of production and elasticity of demand for the product. The long-term demand for labor is more elastic than the short-term demand of labor.

ii. Other factors of production:

Helps in determining the demand of labor. The price and amount of other factors of production employed affects the demand for labor. For example, if other factors of production are expensive then the demand for labor would be high. However, if other factors are available at cheaper quantity, then the demand for labor would reduce. Similarly, an increase in the demand of technology would reduce the demand for labor.

iii. Marginal productivity:

Refers to one of the most important factor that helps in the determination of demand for labor. An employer hires labor to increase his/her profit. For this, the employer needs to provide wages to avail the services of labor’ He/she would employ labor until the increase in number of labor would increase the net output but at the diminishing rate.

The employer would not hire any more labor when the output produced by an additional labor is equal to the additional cost incurred to hire that labor. Therefore, the wages paid to the labor is equal to the additional output/marginal output produced by that labor.

However, labor is considered as the homogeneous commodity; therefore, the amount of wage paid to one additional labor is similar to the amount of wage paid to the rest of the labor. The demand schedule of labor shows that the decrease in wage would increase the demand for labor. It is similar to the demand schedule of a product.

Increase in number of labor would increase the output of product that would result in lowering down the product’s price. This results in the decrease of marginal productivity of the industry. The change produced in the demand of labor can be determined with the help of change produced in wage rate of labor.

However, the degree of this change is obtained with the help of elasticity of demand of labor. If smaller change in the wage rate of a labor produces a larger change in the demand of labor, then the demand of labor is elastic and vice-versa.

Supply of Labor:

Supply of labor refers to the number of hours spent by labor in the factor market. In an economy, there are several factors that influence the supply of labor. Some of the factors are wage rate, population size, age structure, availability of education and training employment opportunities for women, and social security programs.

On the other hand, in an industry, the supply of labour is less elastic in the short-run. In this case, the supply of labor is dependent on the accessibility of workers in the nearby areas and their willingness for overtime work. However, the supply of labor becomes more elastic in the long-run. Industries attract labor by providing higher wages, training facilities, and good working conditions. Therefore, the supply curve of labor for an industry is upward sloping.