LABOUR AND WAGES Wages are income derived from human labour.

Technically they cover all payments for the use of labour, mental or physical, but in ordinary usage the term excludes income of the self-employed and is restricted to compensation of employees . Occasionally fringe benefits are included, but generally they are not. The term is not fully synonymous with labour costs, which may include such items as cafeterias or meeting rooms maintained for the convenience of employees (such items are part of capital). Wages, in economic terms, however, do include remuneration in the form of extra benefits, such as paid vacations, holidays, and sick leave, as well as wage supplements in the form of pensions and health insurance paid for by the employer. A worker in covered industries also receives the protection of governmentally provided unemployment compensation, old-age pensions, and industrial accident compensation. Government services provided for workers are of even greater significance in European countries than in the United States and must be taken into account when comparisons of earnings are made. Residual-claimant theory. The residual -claimant theory holds that, after all other factors of production have received their share of the product, the amount left goes to the remaining factor. Adam Smith implied such a theory for wages, since he said that rent would be deducted first and profits next. Francis A. Walker in 1875 worked out a residual theory of wages in which the shares of the landlord, capitalist, and entrepreneur were determined independently and subtracted, thus leaving the remainder for labour in the form of wages. It should be noted, however, that any of the factors of production may be selected as the residual claimant, assuming that independent determinations may be made for the shares of the other factors. It is doubtful, therefore, that such a theory has much value as an explanation of wage phenomena. Bargaining theory. The bargaining theory of wages holds that wages, hours, and working conditions are determined by the relative bargaining strength of the parties to the agreement. Smith hinted at such a theory when he noted that employers had greater bargaining strength than employees, because it was easier for employers to combine in opposition to employees' demands and also because employers were financially able to withstand the loss of income for a longer period than the employees. This idea was developed to a considerable extent by John Davidson, who argued, in 1898, that the determination of wages is an extremely complicated process involving numerous influences that interact to establish the relative bargaining strength of the parties. There is no one factor or single combination of factors that determines wages, and there is no one rate that necessarily prevails. Because there are many possibilities, there is a range of rates within which any number of rates may exist simultaneously. The upper limit of the range is set by the rate beyond which the employer refuses to hire certain workers. This rate is influenced by such considerations as the productivity of the workers, the competitive situation, the size of the investment, and the employer's estimate of future business conditions. The lower limit of the range is set by the rate below which the workers will not offer their services to the employer. This rate is influenced by such considerations as minimum wage

legislation, the workers' standard of living, their appraisal of the employment situation, and their knowledge of rates paid to others. Neither the upper nor the lower limit is fixed, and either may move upward or downward. The rate or rates within the range are determined by relative bargaining power. The bargaining theory is very attractive to labour organizations, for, contrary to the subsistence and wages-fund theories, it provides a very cogent reason for the existence of unions. The bargaining strength of a union is much greater than that of the members acting as individuals. Also there are situations (bilateral monopoly, for instance) under which theoretical analysis arrives at a range of wage rates rather than a determinate rate. The actual rate must depend upon relative bargaining power. It should be observed, however, that historically labour was able to improve its situation before its bargaining power became more effective through organization. Factors other than the relative bargaining strength of the parties must have been at work. The bargaining theory often gives an excellent explanation of a short-run situation, such as the existence of certain wage differentials, but over the long run it fails to provide an adequate understanding of the changes that have taken place in the average level of wages. Marginal-productivity theory and its critics. Toward the end of the 19th century, marginal-productivity analysis was applied not only to labour but to other factors of production as well. It was not a new idea as an explanation of wage phenomena, for Smith had observed that a relationship existed between wage rates and the productivity of labour, and Johann Heinrich von Thnen, a German economist, had worked out a marginal-productivity type of analysis for wages in 1826. The Austrian economists made important contributions to the marginal idea after 1870; and, building on these grounds, a number of economists in the 1890s, including Philip Henry Wicksteed in England and John Bates Clark in the United States, elaborated the idea into the marginal-productivity theory of distribution. It is likely that the disturbing conclusions drawn by Marx from classical economic theory inspired this development. In the early 1930s refinements to the marginal-productivity analysis, particularly in the area of monopolistic competition, were made by Joan Robinson in England and Edward H. Chamberlin in the United States. As applied to wages, the marginal-productivity theory holds that employers will tend to hire workers of a particular type until the addition made by the last (marginal) worker to the total value of the product is equal to the addition to total cost caused by the hiring of one more worker. The wage rate is established in the market through the demand for, and supply of, the type of labour, and the operation of competition assures the workers that they will receive a wage equal to the marginal product. Under the law of diminishing marginal productivity, the contribution of each additional worker is less than that of his predecessor, but workers of a particular type are assumed to be alike, making them interchangeable, and any one could be considered the marginal worker. All receive the same wage, and, therefore, by hiring to the margin, the employer maximizes his profits. As long as each additional worker contributes more to total value than he costs in wages, it pays the employer to continue hiring. Beyond the margin, additional workers would cost more than their contribution and would subtract from attainable profits. The theory also provides an explanation of wage differentials. Wage

differentials are caused by differences in marginal product. The wages of skilled workers are higher than those of unskilled workers because there are fewer skilled workers, and their marginal product, therefore, is higher. The marginal-productivity theory of wages became the prevailing wage theory, and, although it has been attacked by many and discarded by some, no acceptable alternative has been devised. The chief basis for criticism of the theory is that it rests on unrealistic assumptions, such as the existence of homogenous groups of workers whose knowledge of the labour market is so complete that they will always move to the best job opportunities. Workers are, in fact, not homogenous; usually they have little knowledge of the labour market; and because of home ties, seniority, and other considerations, they do not often move quickly from one job to another. The assumption that employers are able to measure productivity accurately and compete freely in the labour market also is farfetched. Even the assumption that all employers attempt to maximize profits may be doubted. The profit motive does not affect charitable institutions or government agencies. For the theory to operate properly, labour and capital must be fully employed so that increased production can be secured only at increased cost; capital and labour must be easily substitutable for each other; and the situation must be completely competitive. Obviously these assumptions do not fit the real world, and some critics feel that the results of the theory are so misleading that the theory should be abandoned. The proponents argue, however, that productivity gives a rough approximation of wages, and that although productivity may not provide the immediate explanation in a particular case, it certainly indicates long-run trends. The theory, therefore, has important uses, and if the difficulties are kept in mind, it can be a valuable tool. In a modern economy, monopolistic or near monopolistic conditions exist in some important areas, particularly where there are only a few large producers (such as in the automobile industry) on one side of the bargaining table and powerful labour organizations on the other. Under such circumstances, the marginal productivity analysis cannot determine wages precisely; it can show only the positions that the union (as a monopolist of labour supply) and the employer (as a monopsonist, or single purchaser of labour services) will strive to reach, depending upon their current policies. Purchasing-power theory. The purchasing-power theory of wages involves the relation between wages and employment and the business cycle and is not, therefore, a theory of wage determination. It stresses the importance of spending through consumption and investment as an influence upon the activity of the economy. The theory gained prominence during the Great Depression of the 1930s, when it became apparent that lowering wages might not increase employment as previously had been assumed. John Maynard Keynes, the British economist, maintained in his Theory of Employment, Interest and Money/ (1936), that (1) depressional unemployment could not be explained merely by frictions in the labour market that interrupted the smooth movement of the economy toward full employment equilibrium and (2) the assumption that "all other things remained equal" presented a special case that had no real applicability to the existing situation. Keynes related changes in employment to changes in consumption and investment, a

nd he pointed out that stable equilibrium could exist with less than full employ ment. Because wages make up such a large percentage of the national income, changes in wages usually have an important effect upon consumption. It is possible that lowering wages will reduce consumption and that, with the decline in demand for goods and services, the demand for labour may also fall, thus decreasing employment rather than improving it. Whether this will be the result, however, depends upon several considerations, particularly the reaction upon prices. If wages fall more rapidly than prices, labour's real wages will be drastically reduced, and consumption will fall, accompanied by increased unemployment, unless total spending is maintained by increased investment. Entrepreneurs may look upon the lower wage costs in relation to prices as an encouraging sign toward greater profits, in which case they may increase their investments and employ more people at the lower rates, thus maintaining or even increasing total spending and employment. If employers look upon the falling wages and prices as an indication of further declines, however, they may contract their investments or do no more than maintain them. In this case, total spending and employment will decline. If wages fall less rapidly than prices, labour's real wages will increase, and consumption may rise. If investment is at least maintained, total spending in terms of constant dollars will increase, thus improving employment. If entrepreneurs look upon the shrinking profit margin as a danger signal, however, they may reduce their investments; and, if the result is a reduction in total spending, employment will fall. If wages and prices fall the same amount, there should be no change in consumption and investment; and, in that case, employment will remain unchanged. The purchasing-power theory involves psychological considerations as well as those that may be measured more objectively. Whether it can be used effectively to control the business cycle depends upon political as well as economic factors, because government expenditures are a part of total spending, taxes may affect private spending, etc. The applicability of the theory is to the whole economy rather than to the individual firm. Classical theories. Theories of wage determination and the share of labour in the gross national product have varied from time to time and have changed as the economic environment has changed. The body of thought referred to today as wage theories could not have emerged until the old feudal system had disappeared and the modern economy with its modern institutions had come into existence. Adam Smith, in The Wealth of Nations/ (1776), failed to propose a definitive theory of wages, but he anticipated several theories that were deve loped by others later. Smith thought that wages were determined in the marketplace through the law of supply and demand. Workers and employers would naturally follow their own self-interest; labour would be attracted to the jobs where labour was needed most, and the result would be the greatest overall benefit to the workers and to society. But Smith gave no precise analysis of the supply of and demand for labour; he discussed many elements that were involved but did not weave them into a consistent theoretical pattern.

Subsistence theory. Subsistence theories emphasize the supply aspects and neglect the demand aspects of the labour market. They hold that change in the supply of workers is the basic force that drives real wages to the minimum required for subsistence. Elements of a subsistence theory appear in /The Wealth of Nations,/ where Smith wrote that the wages paid to workers had to be enough to allow them to live and to reproduce themselves. Smith was more optimistic, however, than the British classical economists, such as David Ricardo and Thomas Malthus, who followed him, for he implied that--at least in an advancing nation--the wage level would have to be above subsistence to permit the population to grow enough to supply the additional workers needed. Ricardo maintained a more rigid view. He wrote that the "natural price" of labour was the price necessary to enable the labourers to subsist and to perpetuate the race without increase or diminution. Ricardo's statement was consistent with the Malthusian theory of population, which held that population adjusts to the means of supporting it. The market price of labour could not vary from the natural price for long: if wages rose above subsistence, the number of workers would increase and bring the wage rates down; if wages fell below subsistence, the number of workers would decrease and bring the wage rates up. At the time that these economists wrote, most workers were actually living near the subsistence level, and population appeared to be trying to outrun the means of subsistence. The subsistence theory seemed to fit the facts; and, although Ricardo said that the natural price of labour was not fixed and might be changed if custom and habit moderated population increases in relation to food supply and other items necessary to maintain labour, later writers tended to subscribe to the basic idea and not to admit exceptions. Their inflexible and inevitable conclusion earned the theory the name "iron law of wages." Wages-fund theory. Smith said that the demand for labour could not increase except in proportion to the increase of the funds destined for the payment of wages. Ricardo maintained that an increase in capital would result in an increase in demand for labour. Statements such as these foreshadowed the wages-fund theory, which held that a predetermined fund of wealth existed for the payment of wages. The size of the fund could be changed over periods of time, but at any given moment the amount was fixed, and the average wage could be determined simply by dividing the fund by the number of workers. Smith thought of the fund as surplus income of wealthy men--beyond the needs of their families and trade--which they would use to employ others. Ricardo thought of it in terms of capital--food, clothing, tools, raw materials, machinery, etc., necessary to give effect to labour. Regardless of the makeup of the fund, the obvious conclusion was that when the fund was large in relation to the number of workers, wages would be high. When it was relatively small, wages would be low. If population increased too rapidly in relation to food and other necessities (as outlined by Malthus), wages would be driven to the subsistence level. Therefore, it would be to the advantage of labour to help promote the accumulation of capital to enlarge the fund rather than to discourage it by forming labour organizations and making exorbitant demands. Also, it followed that legislation designed to raise wages would not be successful, for, with only a fixed fund to draw upon, increases gained by some workers

could be maintained only at the expense of others. This theory was generally accepted for 50 years by economists, including such well-known figures as Nassau William Senior and John Stuart Mill. W.T. Thornton, F.D. Longe, and Francis A. Walker were largely responsible for discrediting the theory during the decade following 1865. They pointed out that the demand for labour was not determined by a fund but was derived from the consumer demand for products. The proponents of the wages-fund doctrine had been unable to prove that there was a determinate wage fund, or any fund maintaining a predetermined relationship with capital or with the portion of the proceeds of labour's product paid out in wages. Actually the amount paid out depended upon a number of factors, including the bargaining power of labour. Yet, in spite of these telling criticisms, the wages-fund theory continued to exercise an important influence until the end of the 19th century. Marxian surplus-value theory. Karl accepted Ricardo's labour theory of value, but he subscribed to a subsiste nce theory of wages for a different reason than that given by the classical economists. In Marx's mind, it was not the pressure of population that drove wages to the subsistence level but rather the existence of a large army of unemployed, which he blamed on the capitalists. He stated that the exchange value of any product was determined by the amount of labour time socially necessary to create it. He held that under the capitalistic system, labour was merely a commodity and could get only its subsistence. The capitalist, however, could force the worker to spend more time on his job than was necessary to earn his subsistence, and the excess product, or surplus value, thus created, was taken by the capitalist. From the point of view of classical theory, Marx's argument appeared persuasive, although the term "labour time socially necessary" hid some serious objections. The fatal blow came when the labour theory of value and Marx's subsistence theory of wages were found to be invalid. Without them, the surplus-value theory collapsed. PERFECT MARKET The dramatic widening of the wage gap between workers with different levels of education reflects the operation of demand and supply in the market for labor. For reasons we will explore in this chapter, the demand for college graduates was increasing while the demand for high school graduates particularly male high school graduates was slumping. Why would the demand curves for different kinds of labor shift? What determines the demand for labor? What about the supply? How do changes in demand and supply affect wages and employment? In this chapter we will apply what we have learned so far about production, profit maximization, and utility maximization to answer those questions in the context of a perfectly competitive market for labor. This is the first of three chapters focusing on factor markets, that is, on markets in which households supply factors of production labor, capital, and natural resources demanded by firms. Look back at the circular flow model introduced in the initial chapter on demand and supply. The bottom half of the circular flow model shows that households earn income from firms by supplying factors of production to them. The

total income earned by households thus equals the total income earned by the labor, capital, and natural resources supplied to firms. Our focus in this chapter is on labor markets that operate in a competitive environment in which the individual buyers and sellers of labor are assumed to be price takers. Other chapters on factor markets will discuss competitive markets for capital and for natural resources and imperfectly competitive markets for labor and for other factors of production. Workers have accounted for 70% of all the income earned in the United States since 1959. The remaining income was generated by capital and natural resources. Labor generates considerably more income in the economy than all other factors of production combined. Figure 12.1, Labor s Share of U.S. Income, 1959 2007 shows the share of total income earned annually by workers in the United States since 1959. Labor accounts for roughly 73% of the income earned in the U.S. economy. The rest is generated by owners of capital and of natural resources. We calculate the total income earned by workers by multiplying their average wage times the number of workers employed. We can view the labor market as a single market, as suggested in Panel (a) of Figure 12.2, Alternative Views of the Labor Market . Here we assume that all workers are identical, that there is a single market for them, and that they all earn the same wage, /W;/ the level of employment is /L/. Although the assumption of a single labor market flies wildly in the face of reality, economists often use it to highlight broad trends in the market. For example, if we want to show the impact of an increase in the demand for labor throughout the economy, we can show labor as a single market in which the increase in demand raises wages and employment. One way to analyze the labor market is to assume that it is a single market with identical workers, as in Panel (a). Alternatively, we could examine specific pieces of the market, focusing on particular job categories or even on job categories in particular regions, as the graphs in Panel (b) suggest. But we can also use demand and supply analysis to focus on the market for a particular group of workers. We might examine the market for plumbers, beauticians, or chiropractors. We might even want to focus on the market for, say, clerical workers in the Boston area. In such cases, we would examine the demand for and the supply of a particular segment of workers, as suggested by the graphs in Panel (b) of Figure 12.2, Alternative Views of the Labor Market . Macroeconomic analysis typically makes use of the highly aggregated approach to labor-market analysis illustrated in Panel (a), where labor is viewed as a single market. Microeconomic analysis typically assesses particular markets for labor, as suggested in Panel (b). When we use the model of demand and supply to analyze the determination of wages and employment, we are assuming that market forces, not individuals, determine wages in the economy. The model says that equilibrium wages are determined by the intersection of the demand and supply curves for labor in a particular market. Workers and firms in the market are thus price takers; they take the market-determined wage as given and respond to it. We are, in this instance, assuming that perfect

competition prevails in the labor market. Just as there are some situations in the analysis of markets for goods and services for which such an assumption is inappropriate, so there are some cases in which the assumption is inappropriate for labor markets. We examine such cases in a later chapter. In this chapter, however, we will find that the assumption of perfect competition can give us important insights into the forces that determine wages and employment levels for workers. IMPERFECT MARKET Introduction. The current stage of development associated with a new look at *labor as one of the key resources of the economy. This new view - evidence of real growth of the human factor in technological phase of the STR, where there is a direct correlation of results from the production of quality, motivation and the nature of the workforce as a whole and the individual worker in particular. The increasing role of human factors in production is confirmed by the results of economic research of leading American scientists. Since 1929 the main source of growth in labor productivity and national income in the U.S. triad 'work - the land the capital' is the first factor, which covers the totality of education, qualifications, demographic and cultural characteristics of the workforce. The labor market has its own characteristics. This is due to the specific product that is bought and sold in this market. Unlike other resources (inputs), labor is a function of human life and inseparable from the person. Therefore, work itself may not be sold, and the "labor market " are bought and sold services work. An important feature of the labor market is the long duration of the relationship of the seller and buyer. If on the market contact the seller and the buyer in most cases limited to the transfer of ownership, that is extremely short duration of time, the *labor* market relations between seller and buyer's last all the time at which a contract. It should also be noted that an important role in the labor market are non-monetary factors - the prestige and complexity of work, working conditions and social guarantees, and so on. One of the most important features of the market is the predominance of its different forms of imperfect competition. This is due to the presence of market institutions, such as the state, labor unions, large corpora tions. In his work the author tries, summarizing the available information, to analyze the impact of the above institutions on the labor market, as well as assess the results of their activities on the market. The prevalence of imperfect competition in the labor market. 1. Competitive models of the *labor market*. I must say that the situation of perfect competition in the labor market practically does not occur. However, we try to simulate it in order to an alyze the demand and supply in the labor market. In conditions of perfect competition in the market a large number of companies competing with each other in the recruitment of a specific type of labor. At the same time many workers have the same qualifications, independently offer this type of service work. And, most importantly, neither the workers nor the company shall not exercise control over the price. In this case, the volume of demand for labor will be in inverse proportion to the value of wages. Since with an increase in wage rates entrepreneur, ceteris paribus, will reduce the use of forced labor.

The supply curve under perfect competition will gradually increase, due to the fact that in the absence of unemployment hire firms will be forced to pay higher wages to attract workers. The fact that wages must compensate for the possibility of alternative use of time or in other labor market, either in the household. The equilibrium wage rate and the equilibrium level of employment are at the intersection of supply and demand curves for labor (point E in Fig. 1). This point corresponds to a certain level of wages (WE), and given that the level of labor supply (LE). At point E the demand for labor equals supply of labor, and this means that the market is in equilibrium. That is, all employees according to this salary, jobs, and all the entrepreneurs who are willing to pay the wages WE, are in the market they need the number of labor. Therefore, point E shows the position of full employment. 2. Monopsony in the labor market. In the competitive job market every entrepreneur hires so few workers that can not affect the rate of wages. In the case of monopsony firm has the monopoly right to hire workers. In such a situation employed in this company make up the bulk of all those employed in the industry. As a result, the firm can "dictate wages", since the wage rate will be in direct proportion to the number of employed workers. Demand curve DL will coincide with the curve of the marginal product in monetary terms. But, as monopsonist pays equal pay for each unit of goods, the supply curve of labor for it is a curve of average costs (SL = AC). The involvement of each additional worker means raising wages for all workers, including those for the previously employed. Therefore MRCL marginal cost curve lies above the curve of average costs. When choosing the number of employees monopsonist will be guided by equality of the marginal product and marginal cost (point E1). After a vertical curve to the SL and designate a point M, we can determine the level of wages WM, as well as the amount of labor used by LM. While under perfect competition the equilibrium wage rate would be at the level of WE, and the equilibrium number of workers would be equal to "Le. Thus, ceteris paribus monopsonist maximizes profits by hiring fewer workers and thus pays a wage rate lower than in a competitive environment. In reality, the situation of monopsony can arise in the labor market in a small town, where there is, for example, only one plant, one hospital, a school, etc. 3. The presence of trade unions in the labor market. Trade unions are one of the main non-competitive factors in the labor market. Th e union - a union of workers having the right to negotiate with the employer on behalf and on behalf of all its members. The purpose of the union - to maximize the wages of their members, improve their conditions of work and receive additional pay and benefits. Consider the situation when the union occurs in a competitive market . He is negotiating with a relatively large number of employers. Its goal union may pursue different paths. The most desirable from the standpoint of the trade union, means a wage increase is the expansion of demand for labor. As a result, at the same time increase the rate of wages, as well as grow the number of jobs. The relative magnitude of the increase depends on the elasticity of labor supply. Increasing demand for labor union may by influencing the factors that determine demand. In particular, the union may try: 1) increase the

demand for final products. 2) improve productivity. 3) change the prices of substitute resources. Trade unions can contribute to the growth in demand for products and, consequently, increase the derived demand for their own labor services, through advertising or political lobbying. These methods are fairly common. Not surprisingly, that the unions builders use lobbyists to obtain contracts for the construction of new highways or the reconstruction of urban public space. Similarly, teachers' unions in favor of increased government spending on education and so on. Increased demand for labor also contributes to increased efficiency and quality of work. This is ensured, in particular the work of quality control circles, in which workers (often in conjunction with the administration) are looking for ways to increase productivity, a more profitable use of machinery equipment, raw materials savings and improve product quality. Trade unions can increase the demand for labor of its members, influencing the level of prices for raw materials substitutes. For example, trade unions, whose members are paid considerably more than the minimum wage, often act in support of raising the minimum wage rates. What would lead to an increase in the price of unskilled labor Another way to allow the union to achieve its goals - is limiting supply of labor. To limit the supply of labor unions actively promote the adoption of such laws, which limit immigration, reduce the use of child labor, contribute to reducing the working week, introduced the licensing of employees and so on. Achieved to reduce the supply of labor union may, by reducing the number of union members. Unions often force an employer to employ only its members, while receiving full control over the supply of labor in the industry. Then, through a policy of reducing its members (exorbitant entrance fee should be, long term training and even a ban on admission of new members) union is seeking an artificial reduction of labor supply. Another widely used means of limiting the supply is the licensing of workers. Union influence on the authorities, urging them to enact laws under which workers in certain occupations can be hired only if they meet certain qualification requirements. These requirements may include education, professional experience, special examinations, etc. Thus, the presentation is too high demands, an excessively strict examinations can significantly limit the supply of labor in the industry. Unions, which operate the above-described methods, often called "closed?. However, most unions do not seek to limit the number of its members. On the contrary, they try to unite all existing or potential employees. After all, in this case, the firm is under strong pressure from the union to conclude a treaty on the rate of wages. Such a strong influence of trade unions in the company due to the fact that with the strike the union could completely deprive the company of labor supply. Assume that the init ial equilibrium wage rate is equal to the WE, while the level of employment - LE. Assume that the union had imposed on the employer a higher wage, say WU. This leads to a modification of the supply curve for the employer (SLSL => WUaSL). Thus, if entrepreneurs believe that it is more expedient to pay a higher rate than to bring it out of the strike, they at the same time will have to reduce employment to LE to LU. The current way the unions are called open, or industry, as they often bring together employees of entire industries, such as automobiles, metallurgy, etc. 4. Bilateral monopoly on the labor market.

Special situation in the labor market is developing in the event that there are trade union monopoly and the employer-monopsonist. To analyze this situation graphically, it is necessary to combine the two graphs - one that reflects the activities of monopsony, the other the union. Under perfect competition the equilibrium wage rate would be established at the level of W, while it would be occupied by L man. However, the firm monopsonist will always strive to reduce wages to the level of Wm by reducing the number of employed with L up to Lm. The union, in turn, will seek to raise wages to WU, and reducing the supply of labor. Thus, with relatively small differences in the number of employed workers desired wage rate in the union and monopsony will vary significantly. What will be the level of wages, clearly impossible to say. Everything depends on the strength of opposing monopolies, it is also possible that the wage rate close to its equilibrium level. Thus, bilateral monopoly can lead to results that are much closer to a competitive market than to market conditions, where the monopoly of one party or another. THE WAGE LEVEL AND ITS DETERMINANTS* 04 Organization Wage Determinations. The wage level is the average wage paid to employees. This may mean all employees, some particular group of employees or a single employee of the organization. This has two implications. The first is external: how does the organization compare with other organizations? This question is a strategic one of how the organization wishes to position itself in the marketplace. The second implication is internal. The average wage is a reflection of the total wage bill of the organization. Labor is one of the claimants on organizational resources. The size of the wage bill is a reflection of monies paid to entry level workers on up to the top executive. The decision on compensation levels (how much will the organization pay?) may be the most important pay decision the organization makes: a potential employee's acceptance usually turns on this decision, and a large segment of the employer's costs are determined by it. Organizations have a wide range of discretion in setting wage levels. Although organizations seek out and use information on what other employers pay, this information is only one of the determinants of wage levels. This chapter attempts to set out some of these wage determinants and the manner in which they may be used. Although no claim is made that all wage-level determinants have been identified, it is hoped that enough are presented here to illustrate the process used and the factors considered when an organization decides how much to pay. THE VARIETY OF WAGE DETERMINANTS Numerous forces operate as wage determinants. These might be roughly classified as economic, institutional, behavioral, and equity considerations. Wage decisions appear to be made by comparison to labor markets, so many of the determinants appear to be economic. Both the meaning and force of economic variables are interpreted by organization decision makers, and these determinants are tempered by institutional, behavioral, and ethical variables. There is no doubt that wage determinants operate through labor markets and that they include economic forces.More profitable organizations tend to pay

higher wages for the same occupations than less profitable organizations. Capital-intensive organizations tend to be more profitable because additional capital usually increases productivity. Small organizations tend to pay lower wages often because those wages are all they can afford. Service industries that tend to be labor-intensive, low-profit, and low-wage are often composed of small organizations. Local labor markets vary in wage levels, depending on industrial composition. Communities in which a large proportion of organizations are in high-profit industries tend to be high-wage communities and often have a higher cost of living. Communities with a high proportion of organizations in low-profit industries tend to be low-wage. Sometimes communities experience short-run increases in wage levels because labor demand increases compared to labor supply; or there is a decrease in wage levels because of an increase in labor supply without a proportional increase in demand. Differentials among local labor markets are limited by a tendency for workers to leave low-wage communities and for organizations to locate new plants in low-wage areas. Unions sometimes attempt to eliminate differentials by making a concession in work rules affecting productivity. Wage levels tend to increase faster in good times: profits increase and this encourages workers to become more demanding and mobile. Unions reinforce this tendency by insisting on using gains made elsewhere to make their comparisons. Some less efficient organizations survive by paying less and lowering standards of employability even in good times. High profits, good times and increasing productivity tend to increase an organization's wage-paying ability, but organizations may or may not be willing to pay higher wages. Some of them do so to simplify recruiting problems and to forestall turnover. Others do so because above-average profits whet the appetites of workers and their unions. Most organizations tend to adopt a position in the wage structure of the community and attempt to maintain that position. Thus economic forces operate on wage decisions through the actions of decision makers. If decision makers believe that adjustments in wages are necessary or desirable on economic or other grounds, they make them. If they believe that the organization's present wage-paying position is prudent and acceptable, they do not. We classify wage level determinants on the basis of (1) employer ability to pay, (2) employer willingness to pay, and (3) employee (or potential employee) acceptance. Although some of these considerations have been used by arbitrators and wage boards, little is known about how they are used by wage-paying organizations or unions. We therefore emphasize how and when these determinants could be used by organizations. *EMPLOYER ABILITY TO PAY* When asked most organizations would say that the major determinant of their wage level is what the market is paying. However, there is usually a caveat to this and that is their statement "if we can afford it." So it would seem that the wage level of the organization is determined by external forces of the market but that the reality of the organizations financial position may modify or overrule carrying out this desire. This is expressed in surveys that ask about what determines the organization's wage level. When these organizations say "if they

can afford it" they are invoking the ability to pay. However, there is little that explains exactly what the ability to pay is. As reported, more profitable firms tend to pay higher wages, whether their profitability is based on the product market, technical efficiency, management ability, size, or some other factor. The situation with the automobile industry is an example of what can happen when an industry that is highly profitable falls on bad times and its wage level must fall in order to survive. This has been particularly hard since the industry is highly unionized.^3 <#3> In a very real sense, wage determination by the organization is an assessment of its ability to pay. The weight attached to other wage determinants may be determined by this estimate. Wages are labor costs to employers, and these costs are high or low depending on what the employer gets for the wage ? the results of effort. What the employer actually pays is labor cost per unit of output; this is the wage costs divided by these results termed productivity. A prospective wage increase may or may not increase labor cost per unit, depending on anticipated changes in productivity. A wage increase that would be offset by increases in productivity does not increase labor costs and meets the requirement of ability to pay. A wage increase that increases labor costs, however, requires determining whether the increase can be passed on to customers or offset by a reduction in other costs. Success in either effort again meets the requirements of ability to pay. Similarly, a union presumably attempts to estimate an organization's ability to pay before making its demands. High current profits or favorable future prospects signal ability to pay and strengthen the union's bargaining power. Unions have a very long history and some early union contracts tied wages to ability to pay. For example, a 1919 printing agreement tied wages to economic conditions in the industry. Contracts covering motion picture operators have based wages on the seating capacity of theaters. Coal industry agreements have tied wages to the productivity of coal fields. Sliding-scale agreements have geared wages to selling prices.Both the United Steelworkers and the United Auto Workers attempted (unsuccessfully) to secure agreements tying prospective wage increases in their industries to company profits. It is not likely today that this would be seen by the workers as a good bargain. Although employers profess to use ability to pay (or inability to pay) as a wage determinant, little is known about how they measure it. An early study found a number of organizations that estimated ability to pay by inserting a projected wage increase into the latest income statement. This definition accords closely with the definition contained in a glossary of compensation terms published by World at Work that states: "The ability of a firm to pay a given level of wages or to fund a wage increase while remaining profitable. Organizations probably react to the ability to pay when they perceive their ability is in danger. Executives are more likely to bring the ability to pay up in wage discussions than are compensation experts. Further, lowering wages and othe methods of reducing costs are more likely to be perceived as fair in bad economic times. Exactly how organizations measure their ability to pay is something of a mystery. However, the way in which organizations use wage surveys

suggests that they do so in a variety of ways. Organizations often say they use wage surveys to evaluate their ability to pay. If by evaluate they mean determine, this would be somewhat surprising, because surveys would logically reflect willingness to pay. This suggests that willingness to pay is a more important determinant for organizations. Actually, ability to pay is a composite of the economic forces facing a firm. As such, it involves decisions on how profits should be measured, against what standard (net worth or sales), and over what period. It also involves determining an appropriate rate of return and resolving the issues, such as product development, product mix, and pricing policy, that most affect profits. These considerations illustrate that although employing organizations and unions may cite ability to pay or inability to pay as a primary reason for wage decisions, no one suggests that it be used as the sole determinant. Such a strict application of ability to pay could lead to very undesirable results. It would, for example, completely disorganize wage relationships. Wage levels would bear no relationship to the going rate in the labor market. Organizations in the same industry could have vastly different wage levels. Wages would fluctuate widely along with profits. Any semblance of industry wage uniformity (usually strongly desired by unions) would disappear. Low-profit firms employing a high proportion of highly skilled people could have lower wage levels than high-profit firms employing only unskilled labor. In this way, unskilled labor could receive higher wages than highly skilled labor. Strong limits, moreover, would be placed on economic efficiency. Under a system wherein increases in profits are absorbed by wages, an efficient management would have nothing to gain from increased effort and inefficient management would be subsidized by low wages. In addition, employees could not leave inefficient organizations for more efficient ones, because expansion of output and employment in efficient firms would be forestalled by the paying out of increased profits in wages to present employees. Incentives for management to improve efficiency would be seriously impaired. Possibilities of expansion would be limited. For these reasons strict application of ability to pay is likely to hold little attraction for the parties. On the other hand, the general economic environment of the economy, the industry, and the firm is important in wage determination. When the demand for the product or service of an organization is strong, when potential employees are relatively scarce, and when prices can be increased without reduction in sales, unions are likely to point to ability to pay, placing management in a poor position to plead inability to pay. When economic conditions facing the industry, or especially the organization, are unfavorable, management estimates of inability to pay may set a low limit to wage increases. Union reactions to situations in which a company faces financial hardship are pragmatic: although they are strongly opposed to subsidizing inefficient organizations. While organizations report using ability to pay as a wage determinant in collective bargaining, such use is subject to strongly held opinions. Most union leaders consider ability to pay as irrelevant unless high profits are apparent. Most employers consider it no business of the union. The force of ability to pay is probably best seen at the extremes, in judging whether a wage adjustment, apparently justifiable on other grounds, can or cannot be met. Strong evidence of favorable prospects causes employers to have less resistance to prospective increases in wage levels. Similarly,

strong evidence of unfavorable prospects reduces pressure for a wage increase, especially if it is feared that such a wage adjustment might cause loss of jobs, and greatly increases employer resistance. Ability to pay is an expression of the economic forces that bear on wage determination. Although it is a determinant beset by measurement and forecasting problems, search theory suggests that organizations are able to estimate it when a decision calls for it. Productivity Productivity was used earlier in this section as a shorthand term for what the employer gets in return for the wage. Thus wage level determination is often referred to as the /effort bargain/. Actually, as will be seen, productivity is a result of the application of human and other resources. As such, it is a prime determinant of ability to pay. If production increases in the same proportion as wage costs, labor cost per unit remains unchanged. If, however, an increase in the wage level is not matched with a proportional increase in productivity, labor costs per unit rise. At some point this mismatch runs the risk of exceeding the employer's ability to pay. Although productivity is not widely used as an explicit wage level determinant, it is always present in the form of the effort bargain. If the employer gets more output for each unit of input, the organization's ability to pay is increased. For this reason, productivity deserves some discussion as part of the concept of ability to pay. What is productivity? How is it measured? Productivity refers to a comparison between the quantity of goods or services produced and the quantity of resources employed in turning out these goods or services. It is the ratio of output to input. But output can be compared with various kinds of inputs: hours worked, the total of labor and capital inputs, or something in between. The results of these different comparisons are different, as are their meanings; different comparisons are appropriate to different questions. Two main concepts and measurements of productivity are used, but for different purposes. The first, output per hours worked or /labor productivity/, answers questions concerning the effectiveness of human labor under the varying circumstances of labor quality, amount of equipment, sale of output, methods of production, and so on. The second, output per unit of capital and labor (/total factor productivity/), measures the efficiency of labor and capital combined. This second measure gauges whether efficiency in the conversion of labor and capital into output is rising or falling as a result of changes in technology, size, character of economic organization, management skills, and many other determinants. It is more complex and more limited in use.^8 <#8> The first measure, output per hours worked, is the appropriate measure to employ in wage questions. It reflects the combined effect of changes (1) in the efficiency with which labor and capital are used, (2) in the amount of tangible capital employed with each hour of labor, and (3) the average quality of labor. It is these three factors that have been found to best explain the long-term trend in the general level of real wages. It should be emphasized that labor productivity measures the contributions not just of labor alone, but of all the input factors. In fact, the potential for estimating the contribution of various factors makes measures of labor productivity at various levels appropriate, or inappropriate, for use as wage standards.

*Output per hours worked*. Output per hours worked can be measured at the job, plant, industry, or economy level. At the job level, it is possible to measure worker application and effort separately from other inputs as the basis for incentive plans. At the plant level, estimates of the source of productivity increases can be used as the basis of gainsharing plans. At the industry level, productivity improvements cannot be traced separately to the behavior of workers, managers, or investors in the industry. The contributions of one industry to another industry's productivity cannot be separated. Therefore the use of industry productivity as a wage determinant would have adverse economic consequences. For these reasons, industry productivity is seldom suggested as a wage determinant. Historically, at the level of the economy, changes in labor productivity have been used as appropriate for wage determination. In fact, the improvement factor in labor contracts employed in the automobile industry from 1948 until the early 1980s is an example of such a use. Then in the 1960?s wage-price guideposts were based on the argument that wage increases in organizations should be determined by economy-wide advances in productivity. However, this formula use of productivity for wage determination has advocates and opponents. Advocates point out that increasing wage levels in specific organizations, in accordance with annual increases in productivity in the economy, insures that productivity gains get distributed. They also argue that distributing these gains through price reductions may contribute to economic instability. Opponents point out that although there is a long-term relationship between productivity and wages, the short-term relationship is highly variable, which suggests that other wage-determining forces are more pertinent. They also argue that tying wages to productivity yields stable prices only when productivity increases are accepted as a limit to wage increases. Obviously, when the cost of living is increasing, limiting wage increases to productivity increases would be unpalatable to employees. Even more unacceptable would be wage cuts when economy-wide productivity declines, as has sometimes occurred. In auto contracts, the improvement factor was accompanied by a cost-of-living escalator clause and other wage increases. The guideposts broke down when price increases made the limiting of wage increases to economy-wide productivity increases impractical. The effect, of course, was to build higher prices into the cost structure that over time made for the demise of the U.S. automobile industry. The inflationary potential of productivity formulas that are not accepted as limits is enhanced by a tendency to seek a productivity measure that makes larger wage increases feasible. Increases in industry productivity, for example, may be higher, but industry indexes are less reliable and more variable. Such indexes may also conceal the contribution of one industry to another's productivity. Even indexes of national productivity may overstate non-inflationary wage-increase possibilities, by failing to measure the effects of transfers of workers from lower- to higher-productivity industries and other sources of increase in labor quality. Perhaps enough problems have been cited to argue against raising wages in strict accordance with productivity increases. The difficulty of

securing acceptance of wage increases, based on national productivity as a limit, argues against the use of such a formula. Different industries and organizations have such varying rates of change in productivity as to throw wages based solely on productivity completely out of line with other wage considerations. Higher-productivity industries would be penalized for their higher productivity, and this would harm the economy. Productivity, however, may be interpreted to mean that increases in labor productivity at constant wages lower labor cost per unit. This operates through ability to pay. Productivity may also be employed in the narrower sense ? that a productivity increase attributed to increased performance by employees calls for an equivalent increase in pay (as with merit increases or variable pay plans). Although productivity increases are often mentioned in wage level determination, especially in labor negotiations, their effect as a separate consideration is probably minimal. The 1970's and 80's showed a decline in productivity growth in the U.S. In fact, some of that time period shows a decline in productivity. The 1990's showed a resurgence in productivity growth with very high levels from 1995 onward. This has been attributed to technological change and is credited to the robust economy of those years. This productivity growth rate continued into the early 2000's despite a downturn in the economy.Interest in productivity as a wage determinant seems to ebb and flow with these changes. A major variable is the cost of living which tends to run counter to productivity gains. This will be covered later in this chapter. EMPLOYER WILLINGNESS TO PAY Employer willingness to pay may be a more powerful wage determinant than employer ability to pay. Organizations frequently obtain and use information on what other employers pay. Such information is undoubtedly the most used wage level consideration, sometimes considered along with the cost of living. Another determinant of employer willingness to pay consists of the state of supply of particular skills and the presence of tight or loose labor markets. This section devotes some attention to each of these wage determinants. Comparable Wages Comparable wages constitute, without a doubt, the most widely used wage determinant. They represent the way in which organizations achieve the compensation goal of being competitive. Not only are the wages and salaries of federal employees keyed directly to comparable wages in labor markets, but also those of most public employees in other jurisdictions. Also, unions emphasize "coercive comparisons," and private organizations consciously try to keep up with changes in going wages. Perhaps the major reason for this widespread use of the concept of comparable wages is its apparent fairness. In this view, comparable wages help in the attraction and retention goals of compensation. To most people, an acceptable definition of fair wages is the wages paid by other employers for the same type of work. Employers find this definition reasonable because it implies that their competitors are paying the same wages. In essence then, labor costs become even across the industry. Another reason for the popularity of the concept is its apparent simplicity. At first glance, it appears quite simple to "pay the market." However, this illusion of simplicity vanishes once we try to "determine

the market rate." Precise techniques, carefully employed, are required to find comparable jobs and comparable wage or salary rates. Numerous decisions must be made on which organizations and which jobs should be compared, and how best to compare them. Equally important are decisions concerning how to analyze the data and use them. Wage comparisons may involve other organizations in the area or in the industry, wherever located. These decisions will be examined in more detail in the next chapter on Wage Surveys. An important question to consider is whether differences in competitive conditions in the product market are significant enough to warrant a different wage level, regardless of labor-market influences. The going wage is an abstraction, the result of numerous decisions on what jobs and organizations to include, what wage information is appropriate, and what statistical methods to employ. Some employers decide to pay on the high side of the market, others on the low side as indicated in the previous chapter. The result is a range of rates to which various statistical measures may be applied. Various interpretations of the going rate may be made and justified. To rely on comparable wages as a wage determinant is to rely on wages as income rather than as costs. Comparable wage rates may represent entirely different levels of labor costs in two different organizations. Setting wage levels strictly on the basis of going wages could impose severe hardships on one organization but a much lower labor cost on another. These difficulties are not insurmountable: many employers lean heavily on wage and salary surveys. Employer choices on what surveys to acquire and use, what benchmark jobs to attend to, and how to analyze, interpret, and use the data suggest that reasonable accommodations to "the market" are usually possible. The next chapter on Wage Surveys will go into depth on this. In addition to offering a certain measurability, following comparable wages contains a good deal of economic wisdom. Wages are prices. One function of price in a competitive economy is the allocation of resources. Use of comparable-wage data operates roughly to allocate human resources among employers. Furthermore, comparisons simplify the task of decision makers and negotiators. Once appropriate comparisons are decided upon, difficulties are minimized. A wage level can be set where the wage becomes satisfactory as income and operates reasonably well in its allocation function. Wages as costs are also satisfied because unit labor costs can differ widely between two organizations having identical wage rates; also unit labor costs can be identical in two organizations having widely different wage rates. Comparable wages also operate as a force for generalizing changes in wage levels, regardless of the source of change. Unfortunately, however, although changes in going wages tell /what/ occurred, they don't tell /why/ it occurred. The changes may represent institutional, behavioral, or ethical considerations more than economic ones. On balance, however, comparable wages probably operate as a conservative force. Because wage decisions involve future costs, employers are understandably unwilling to outdistance competitors. In a tight labor market, changes in going wages may compel an organization to pay more to get and keep a labor force, especially of critical skills. But in more normal periods, where unemployment exceeds job vacancies, employers will more likely focus on equalizing their labor costs with those of

product-market competitors. In other words, comparable wages are followed as long as other considerations are not more compelling. Cost of Living Cost of living is emphasized by workers and their unions as a wage level consideration when it is rising rapidly. In such times, they pressure employers to adjust wages to offset the rise. In part, these demands represent a plea for increases to offset reductions in real wages (wages divided by the cost of living). Wage pressures resulting from changes in the cost of living fluctuate with the rapidity with which living costs rise; however, price rises in most years have produced employee expectations of at least annual pay increases. To employees a satisfactory pay plan must reflect the effect of inflation on financial needs. This can come into conflict with the current emphasis on variable pay. Employers understandably resist, or should, increasing pay levels on the basis of increases in the cost of living unless changes in competitive wages and/or productivity fully reflect these changes, which they seldom do. Increases in the cost of living are partially translated into wage increases by most employers through payment of comparable wages, and long-term contracts with unions have fostered other methods of incorporating cost-of- living changes. One such method is the /reopening clause/, which permits wages to be renegotiated during a long-term contract. Another is the /deferred wage increase/: an attempt to anticipate economic changes at the time the contract is signed. A third is the /escalator clause/ by which wages are adjusted during the contract period in accordance with changes in the cost of living. In this third method, living-cost changes are measured by changes in the Consumer Price Index. Escalator clauses vary in popularity from year to year in accordance with the rapidity of cost-of-living changes during the period immediately preceding the signing of the contract and with anticipation of subsequent rises. In the past, as much as 60 percent of workers under large union contracts have been covered by escalator clauses. Periods of reduced inflation tend to reduce their popularity. Nonunion employers are much less likely to adjust wage levels in accord with changes in the cost of living or at least to admit that they do. Most organizations would claim that they grant merit pay increases each year. However, when all or almost all employees get the same increase it looks more like a cost-of-living adjustment. In extreme conditions, such as the late 1970s double-digit inflation, organizations were prompted to make significant cost-of-living adjustments. Employing the cost of living as a wage-level determinant is somewhat controversial. Wage rates do tend to follow changes in the cost of living in the short run. Tying wages to changes in the cost of living provides a measure of fairness to employees by assuring them that their real wages are not devalued. But using the cost of living as a determinant also implies a constant standard of living. Historically, unions have opposed the principle for this reason. Methods that provide the same absolute cost-of-living adjustment for all employees may actually impair fairness to employees. Such flat adjustments imply that everyone's cost of living is the same and has changed by the same amount. Unfortunately, technical problems in measuring changes in the cost of living may make such effects inequitable.

Wage Rates and the Cost of Living. The argument can be made that there is no particular correlation between changes in labor market rates and the cost of living as the two are based upon very different measures. Market wages and their changes are based upon the supply and demand for labor which often changes without any consideration of the cost of living. The cost of living is a measure based upon the area?s cost of goods and services as surveyed by the federal government as will be discussed below.It is interesting to note, however, that the correlation between these two measures has been changing recently. ERI has been reporting on salaries and cost of living since 1986. They report these findings in two reports, the Geographic and Relocation Assessors. Thirty years ago the relationship between the salary and cost-of-living variances were explained by correlations of .30. Recently, that correlation has risen to. Cost of Living and Average Wage A cost-of-living index measures changes over time in the prices of a constant bundle of goods and services. The bundle of goods and services (called a /market basket/) is obtained by asking a group, whose cost of living is to be measured, to keep a record of the price of their purchases. These data are then used to create the index. The Bureau of Labor Statistics (BLS) has been publishing such an index since 1921, called the /Consumer Price Index/.The CPI was developed to measure the cost of living for families of urban wage earners. As such, it became the basis of escalator clauses in union contracts. Like any general index, the CPI is an abstraction that rarely corresponds with the actual living-cost changes for any given family. Family consumption patterns differ due to age, income, composition, tastes, and other characteristics. These differences mean that the CPI varies greatly in its ability to measure cost-of-living changes for various groups. Moreover, consumption patterns change over time, as does the quality of products. At present, two indexes are published: the CPI-U and the CPI-W. The CPI-U represents all urban households including urban workers in all occupations, the unemployed, and retired persons. The CPI-W represents urban wage and clerical workers employed in blue-collar occupations. Both CPI measures exclude rural households, military personnel, and persons in institutionalized housing such as prisons, old age homes, and long-term hospital care. The BLS has made changes to improve the index over time and to meet specific problems. The latest change to both indexes involved substituting a rent equivalent for home ownership. Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. Obviously, such technical problems mean that tying wage levels to the CPI varies in fairness to different groups. Moreover, at least in unions and perhaps in most organizations, fairness seems to suggest the same cost-of-living adjustment for everyone. A compressed wage structure

resulting from flat cost-of-living increases may produce difficulties in recruiting and keeping higher-level employees. It seems that changes in the cost of living do not closely parallel changes in the supply-demand situation of any specific employee group. Also, particular organizations and industries may face competitive situations in product markets that run counter to changes in living costs. It also seems that wage increases that fully reflect living-cost increases build inflation into the economy. Fortunately, although escalator clauses narrow the time gap between price and wage changes in an inflationary period, they have been found to yield only about 57 percent of a year's inflation, and they apply to only about ten percent of nonagricultural civilian employment. Although labor contracts containing wage re-openers, deferred increases, or escalators are prevalent in the United States, most wage level decisions are widely decentralized and give heavy weight to comparable wages. This may provide enough lag between price and wage changes to prevent more inflationary effects. In summary, the cost of living as a wage level determinant usually operates indirectly. Although attractive to employees, unions, and some employing organizations in periods of rapidly rising prices, it should never be used as the sole standard of wage adjustment. When influences in the labor market are stronger than those in the product market, cost-of-living considerations may increase an employer's willingness to pay. But when an employer is faced with strong competition in the product market, employees may have to choose between maintaining their real wages and maintaining their jobs. In inflationary periods, the cost of living reinforces going wages through employer willingness to pay. *Labor Supplies* One consideration always present in wage level determination is the compensation goal of obtaining and retaining an adequate work force. The wage level must be sufficient to perform this function or the organization cannot operate. Effectiveness of recruitment efforts, refusal of offer rates, and labor turnover levels may each be considered in wage level decisions. The wage level itself is only one determinant that effects recruitment effectiveness and labor turnover. But it is an important one in that it is usually agreed to be the major element in job choice. Changing economic conditions can have a rapid change in demand for certain skills. This creates a shortage of available workers with those skills, as supply does not change as rapidly. One such change occurred when interest rates fell and most home owners elected to re-finance their homes, on top of coinciding high sales of homes. This created an immediate high demand for Mortgage Loan Processors. Organizations were faced with raising wages for these workers far above equivalent jobs in their organizations. Further, organizations engaged in training people for these jobs. Then two things happened. First the supply began to catch up with the demand. Then the real estate market slumped and interest rates went up, meaning the demand for Mortgage Loan Processors fell, leaving organizations with a group of overpaid employees. If, however, an organization experiences no recruitment or turnover problems, it may presume that the present wage level is adequate to permit securing and holding a labor force. But quality issues may still arise. Is the quality of the labor force being maintained, or have employees of lower efficiency been the only ones available at the

present wages? Is the quality of the present labor force adequate? Is it more than adequate? Is a change in standards of employability a good idea? Can such a change be accomplished at present pay levels? Such questions emphasize the point that it may be more important to maintain the quality of a labor force than the quantity. A labor force of low quality at a given wage level may be more costly to the organization than a labor force of higher quality obtained at a higher wage level but resulting in lower unit labor costs. If an employer can lower unit labor costs by raising the wage level and standards of employability, such a course would deserve careful consideration. This approach partially explains the existence of wage leaders. Organizations that pay "on the high side" may do so in the hope of attracting a higher-quality labor force. Wage leadership may not only permit "skimming the cream" off the present labor force, it may ensure a continuing supply of high-quality personnel from new entrants. Wage leadership companies often have a waiting list of applicants, whereas others must continually use an aggressive recruitment program. Wage level decisions based on labor-supply considerations must be made in light of the prospects of the organization and the industry. Firms in declining industries may be forced to allow wage levels to drop with reduced productivity and to plan on less efficient and lower-paid work forces. An expanding organization, on the other hand, may want to upgrade the quality of its work force by paying above the market and raising standards of employability. The extent to which labor-supply considerations affect wage levels varies greatly among organizations. Organizations in high-wage industries in low-wage areas experience few labor-supply problems; those in low-wage industries may face serious labor-supply problems. Although most organizations fill most of their jobs from within, it is doubtful that any organization is free from labor-supply problems for at least some skills. As emphasized in Chapter 3, most organizations operate in numerous labor markets. Not only does the extent of the market (local, regional, national, or international) vary for different skills, but the use of internal labor markets varies among organizations. Those with relatively open internal labor markets fill most jobs from outside. Those with relatively closed internal labor markets fill almost all jobs from within. Obviously, labor-supply considerations affecting wage levels vary with labor markets. Jobs filled externally must meet or exceed the going rate. Jobs filled internally are constrained only by organization decisions. In both situations, the organization is able to vary its pay levels and hiring standards on the basis of its willingness to pay. *Skill and Education*. Recent emphasis in compensation upon competency and skill based pay makes skill and education an important wage level determinant. At the level of the economy this focus has been playing out for some time in the problem of wage inequality in the U. S. Between 1979 and 1995 the ratio between workers in the 90 percentile and those in the 10th percentile increased from 3.7 to 4.8. Maybe even more important is that real wages for workers in the 10th percentile fell from 1970 to 1990 while those in the 90th percentile rose by 10% to 15 %.this increase for workers in the 90th percentile continued through the 1990's.^13 <#13> One of the major forces behind this change has been the increasing need for educated workers and the response of many more people going on to college.

The result of this trend is creating an hour glass shaped work force in which the middle class is being squeezed out, leaving a large group of highly trained workers at the top of the labor market and another large group of unskilled workers at the bottom of the market.^14 <#14> Movement up the scale is more and more on the basis of education, rather than experience. To the extent that this trend is replicated in the organization it would indicate that developing a wage level based upon the organization?s average wage would be unsatisfactory for the majority of employees. This situation would call for two clearly different wage levels, one for the top and one the bottom. This seems to be reflected in the move towards a "core" group of employees with good wages, benefits and a degree of security and a "peripheral" group of temporary and part time employees with low wages, little in the way of benefits and no job security. *EMPLOYEE ACCEPTANCE* The considerations employers use in determining wage levels must meet their test of employee, or potential-employee, acceptance. If employees are unwilling to accept the wages offered, the employment contract and the effort bargain are not completed. This statement suggests that all of the factors discussed in the introductory chapters, 2, 3 and 4, are potential wage level determinants. For example, employee expectations, employee definitions of equity, and employee satisfaction or dissatisfaction with pay, become pertinent considerations. So do the demands of unions and society (through laws and regulations). Ideally, these considerations find their way into employers' decisions regarding their ability and willingness to pay. Explain the functions of wage differen tials in a market economy. Explain the functions of wage differentials in a market economy.

Wage differentials occur in all markets, in some cases these differentials act t o attract people to the market who would not ordinarily consider those jobs and to reflect the rarity of skills etc., however there are also other wage differen tials, which occur due to market imperfections and discrimination on the part of the employer.

Labour market imperfections can occur on both the supply and demand side or in s ome case both sides. Wages are lower when the employer is a monopsonist because they act as a monopolist and can erode union control of the labour in the market . On the supply side of the labour market Trade Unions cause imperfections, by u sing the threat of strikes and labour supply they can force up wages to the detr iment of employment levels. When the market has both demand imperfections in the form of monopsony and supply imperfections in the form of Unions the wage will depend on the negotiating position of the two sides. There can be wage imperfect ions when information failure occurs, employees may be misinformed about the ava ilability of jobs at different wages. As a result, time will be spent looking fo r work offering acceptable wage rates. This process will incur costs including for gone wages, when workers reject lower paid jobs in favour of looking for a more acceptable wage, theory tells us that the acceptable wage will decrease the long er the employee takes to get the job.

Employees who invest time in education are more valuable to employers due to hig her productivity and consequently they can demand a higher wage than unskilled l abour. The acquiring of skills is called human capital investment and is seen as a long-term assurance of high quality on the part of employers and long-term hi gh wages on the part of employees. Many professional occupations require several years of full-time education at university or college and others require interm ediate qualifications. One can see that through the increasing modernisation and industrialisation the demand for skilled labour continues to rise whilst employ ment opportunities for the unskilled continue to fall. The use of wage different ials in this situation is to reward the work involved in the attaining vocationa l qualifications; however, this is to the detriment of unskilled workers whose j obs become obsolete.

Another wage differential occurs as a compensating factor to employees who have to endure less attractive work conditions, this is known as a compensating wage differential. Where working conditions are undesirable then the supply will be r educed and therefore wages will have to be higher to attract the adequate amount of labour. Also, occupations, which demand unsociable hours, will command a hig her wages than comparable jobs. Pay may not be the only thing, which will be use d by employers to compensate for poor working conditions ie. A number of non-mon etary benefits such as long-holidays with pay, the opportunity to travel etc. wi ll all be used to increase market supply.

Regional variations can also explain certain wage differentials, as wages are hi gh in certain areas then labour will be drawn there, however, firms will try and do the opposite. Through the push and pull of certain factors, in the long run, the market should correct any regional differentials especially in key work are as.

Discrimination can also account for certain wage differentials, racial and gende r discrimination can account for a large amount of the differential in wages bet ween white males and the rest of the working population. Employers will pay wome n and ethnic minorities less due to ill-informed views about the intelligence, l oyalty and productiveness of female and non-white workers. The govt. has taken some action to counteract these unwanted and unproductive wage differentials wit h the introduction of the Equal Pay Act, the Sex Discrimination act and the Race Relation Act.

Wage differentials in a market economy are there to correct and compensate for d ifferences in labour markets, however they are not all perfect and can be divisi ve and unproductive.