Wages: Marginal Productivity Theory of Wages

Wages refer to monetary compensation that companies give workers in exchange for the services they do. Wages are a component of the national dividend that goes to labor because it is a factor of production. Wages are simply the compensation received for labor rendered. In general, wages refer to the sum of money that is paid for a person's services on an hourly, daily, weekly, or monthly basis.

Types of wages

• Money wages: Money wages are the earnings that an employer pays to a worker for his or her services each hour, day, week, or month and are expressed in terms of money. It also goes by the name "nominal wages."
• Real wages: Real wages comprise not only the monetary compensation for the worker's services but also other benefits including the cost of necessities, comforts, and luxuries.

Determinants of real wages

• Purchasing power of money: It alludes to its ability to purchase goods and services. Therefore, real earnings are determined by purchasing power. Real wages will be lower and vice versa if the purchase power of money decreases.
• Additional facilities: The amenities that a worker could obtain in exchange for his labor have an impact on the pricing as well. Even if a worker's money pay are low, his real wages will be higher the more in line he is with them.
• Regularity of employment: In several professions, employees only receive employment for a few months rather than the entire year. While the nominal earnings are higher in many occupations, the real pay are lower. Therefore, it is preferable to have a permanent position to one that pays well.
• Nature of works: Some jobs are exceedingly dangerous. Work must be done in hazardous conditions with potential health risks. All of these vocations require high nominal compensation despite extremely low real wages.

Marginal productivity theory of wages

J.B. Clark, A.C. Pigou, A. Marshall, etc. created this hypothesis. This idea holds that a laborer's or worker's wage is determined by his marginal productivity. The idea is predicated on the following claims:

• Their marginal productivity serves as the primary criterion for paying workers' wages.
• The equilibrium point where the marginal cost of work matches the marginal productivity of labor is where wages are set.

This idea is predicated on a number of presumptions. The following are the theory's main presumptions:

• The company wants to maximize profits.
• Technology for manufacturing is continual.
• The economy is in full employment.
• Long-term economic operations are common.
• On the marginal productivity of labor, the law of diminishing marginal returns is in effect.
• Labor is the only changeable factor, and its market is fiercely competitive.
• In the markets for both products and factors, perfect competition is present.
• With their movement, the work is uniform and ideal.
• The market wage rate is perfectly known to both employers and employees.

MRP is equivalent to M.W. The increase in overall production caused by using an additional unit of labor is known as marginal productivity. The marginal productivity of the workers is calculated in terms of money because they are paid with money.

Marginal Revenue Productivity is what we call this (MRP). MRP is the increase in revenue that results from hiring one more labor unit. When the wage of a laborer is equal to the marginal revenue product, a producer will maximize his profit. The producer will experience a loss if MW is higher than MRP (MW > MRP) and wage is higher than marginal revenue product. Employees receive less pay and pay more if the marginal wage for labor is higher than the marginal revenue output. He thus loses.

On the other hand, the producer will profit if he pays the worker less than MRP (ME MRP). However, his gain won't be maximized. He will benefit from keeping workers on for so long if MW = MRP. As a result, MRP - M.W.0 will be used to calculate a worker's wage.

Assume that a producer is working three additional laborers as part of the production process. His total gain or earnings from the selling of his output is Rs. 200. He would earn an additional Rs. 300 in earnings if he hired a second worker. Thus, by hiring one additional laborer, he increases the total income or revenue by Rs. 100 (300–200); this increase in Rs. 100 is known as MRP (Marginal revenue productivity). In a market with perfect competition, a laborer would be paid to his marginal revenue productivity.

The new price exceeds their marginal productivity if the workers desire more than Rs. 100 (like 120, 125). As a result, the producer will hire fewer employees than before. The unemployed workers will drive down the salary to the equilibrium level when fewer workers receive better pay. In the long run, wages will typically tend to be equal to worker marginal productivity. The producer considers hiring extra workers in this scenario in order to increase his profit. Until salaries match workers' marginal productivity, this trend will continue.

The various flaws in marginal productivity have led to criticism of the concept. Here are a few of them:

• It is predicated on the premise of perfect competition, the mobility of production components, and the homogeneity of the various units of production factors. However, this presumption is fanciful and unreasonable. The theory thus appears to be unworkable.
• It completely disregards the labor supply side. This idea relies far too heavily on the supply side.
• With the help of the four production variables of land, labor, capital, and entrepreneur, production is still happening. It is unrealistic to claim that the addition of one worker or labor has enhanced production. In the real world, adding a worker to the workforce has no real impact on a large-scale industry.
• The theory doesn't change. It only applies when there is no economic change.
• According to this idea, wages will be equal to MRP and ARP.
• MRP is challenging to quantify since every product is a composite of both fixed and variable elements.
• This theory is severe and brutal. The marginal value of the elderly, the elderly and the blind, etc., is never considered in this theory.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan