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 Thünen, 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

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

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

They hold that change in the supply of workers is the basic force that drives real wages to the minimum required for subsistence. later writers tended to subscribe to the basic idea and not to admit exceptions. Therefore. and. most workers were actually living near the subsistence level." Wages-fund theory. if wages fell below subsistence. with only a fixed fund to draw upon. The size of the fund could be changed over periods of time. necessary to give effect to labour. tools.Subsistence 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. At the time that these economists wrote./ where Smith wrote that the wages paid to workers had to be enough to allow them to live and to reproduce themselves. 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. however. which held that a predetermined fund of wealth existed for the payment of wages. who followed him.. 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. Subsistence theories emphasize the supply aspects and neglect the demand aspects of the labour market. Ricardo's statement was consistent with the Malthusian theory of population. Statements such as these foreshadowed the wages-fund theory. If population increased too rapidly in relation to food and other necessities (as outlined by Malthus). Ricardo thought of it in terms of capital--food. which held that population adjusts to the means of supporting it. Regardless of the makeup of the fund. The subsistence theory seemed to fit the facts. wages would be high. 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. Smith was more optimistic. Ricardo maintained a more rigid view. The market price of labour could not vary from the natural price for long: if wages rose above subsistence. Also. and the average wage could be determined simply by dividing the fund by the number of workers. wages would be driven to the subsistence level. such as David Ricardo and Thomas Malthus. When it was relatively small. Ricardo maintained that an increase in capital would result in an increase in demand for labour. 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. increases gained by some workers . but at any given moment the amount was fixed. than the British classical economists. the obvious conclusion was that when the fund was large in relation to the number of workers. etc. and population appeared to be trying to outrun the means of subsistence. raw materials. Elements of a subsistence theory appear in /The Wealth of Nations. 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. wages would be low. clothing. machinery. for. Their inflexible and inevitable conclusion earned the theory the name "iron law of wages. it followed that legislation designed to raise wages would not be successful. the number of workers would increase and bring the wage rates down. the number of workers would decrease and bring the wage rates up.

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

as suggested by the graphs in Panel (b) of Figure 12. Labor accounts for roughly 73% of the income earned in the U.S. In such cases. we would examine the demand for and the supply of a particular segment of workers. as suggested in Panel (b). as the graphs in Panel (b) suggest. Income. When we use the model of demand and supply to analyze the determination of wages and employment. and natural resources supplied to firms.S. assuming that perfect . Macroeconomic analysis typically makes use of the highly aggregated approach to labor-market analysis illustrated in Panel (a). We might even want to focus on the market for. Labor s Share of U. One way to analyze the labor market is to assume that it is a single market with identical workers. /W. The model says that equilibrium wages are determined by the intersection of the demand and supply curves for labor in a particular market. For example.2. We might examine the market for plumbers.1. as in Panel (a). Microeconomic analysis typically assesses particular markets for labor. 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. Workers have accounted for 70% of all the income earned in the United States since 1959. we could examine specific pieces of the market. 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. and that they all earn the same wage. determine wages in the economy. Labor generates considerably more income in the economy than all other factors of production combined. focusing on particular job categories or even on job categories in particular regions. Here we assume that all workers are identical. in this instance. Alternatively. clerical workers in the Boston area. they take the market-determined wage as given and respond to it. say.2. Alternative Views of the Labor Market . 1959 2007 shows the share of total income earned annually by workers in the United States since 1959. income earned by households thus equals the total income earned by the labor. Figure 12. Workers and firms in the market are thus price takers. The remaining income was generated by capital and natural resources. not individuals. We can view the labor market as a single market. economy. Alternative Views of the Labor Market . But we can also use demand and supply analysis to focus on the market for a particular group of workers. as suggested in Panel (a) of Figure 12. or chiropractors./ the level of employment is /L/. The rest is generated by owners of capital and of natural resources. that there is a single market for them. beauticians. we can show labor as a single market in which the increase in demand raises wages and employment. if we want to show the impact of an increase in the demand for labor throughout the economy. We are. we are assuming that market forces. Although the assumption of a single labor market flies wildly in the face of reality. where labor is viewed as a single market. economists often use it to highlight broad trends in the market. We calculate the total income earned by workers by multiplying their average wage times the number of workers employed.

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

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

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

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

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

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

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

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

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

Also. some of that time period shows a decline in productivity. To most people. In fact. an acceptable definition of fair wages is the wages paid by other employers for the same type of work. 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.securing acceptance of wage increases." and private organizations consciously try to keep up with changes in going wages. their effect as a separate consideration is probably minimal. labor costs become even across the industry. EMPLOYER WILLINGNESS TO PAY Employer willingness to pay may be a more powerful wage determinant than employer ability to pay. and this would harm the economy. In this view. Comparable Wages Comparable wages constitute. This productivity growth rate continued into the early 2000's despite a downturn in the economy. This section devotes some attention to each of these wage determinants. The 1970's and 80's showed a decline in productivity growth in the U.Interest in productivity as a wage determinant seems to ebb and flow with these changes. however. 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. argues against the use of such a formula. Such information is undoubtedly the most used wage level consideration. Perhaps the major reason for this widespread use of the concept of comparable wages is its apparent fairness. but also those of most public employees in other jurisdictions. Organizations frequently obtain and use information on what other employers pay. Employers find this definition reasonable because it implies that their competitors are paying the same wages. based on national productivity as a limit. This has been attributed to technological change and is credited to the robust economy of those years. A major variable is the cost of living which tends to run counter to productivity gains.S. At first glance. In essence then. sometimes considered along with the cost of living. This operates through ability to pay. comparable wages help in the attraction and retention goals of compensation. may be interpreted to mean that increases in labor productivity at constant wages lower labor cost per unit. Higher-productivity industries would be penalized for their higher productivity. 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). unions emphasize "coercive comparisons. without a doubt. Another reason for the popularity of the concept is its apparent simplicity." However. Although productivity increases are often mentioned in wage level determination. this illusion of simplicity vanishes once we try to "determine . Productivity. especially in labor negotiations. 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. the most widely used wage determinant. This will be covered later in this chapter. The 1990's showed a resurgence in productivity growth with very high levels from 1995 onward. it appears quite simple to "pay the market.

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

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

called the /Consumer Price Index/. two indexes are published: the CPI-U and the CPI-W.Wage Rates and the Cost of Living. Thirty years ago the relationship between the salary and cost-of-living variances were explained by correlations of . it became the basis of escalator clauses in union contracts. and persons in institutionalized housing such as prisons. These data are then used to create the index. the CPI is an abstraction that rarely corresponds with the actual living-cost changes for any given family. 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.30. 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. income. As such. such technical problems mean that tying wage levels to the CPI varies in fairness to different groups. The CPI-W represents urban wage and clerical workers employed in blue-collar occupations. at least in unions and perhaps in most organizations. A compressed wage structure .The CPI was developed to measure the cost of living for families of urban wage earners. consumption patterns change over time. Moreover. The bundle of goods and services (called a /market basket/) is obtained by asking a group. and retired persons. The BLS has made changes to improve the index over time and to meet specific problems. At present. the unemployed. such as a house. The latest change to both indexes involved substituting a rent equivalent for home ownership. that correlation has risen to. ERI has been reporting on salaries and cost of living since 1986. as does the quality of products. Like any general index. The asset price method treats the purchase of an asset. 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. Both CPI measures exclude rural households. The Bureau of Labor Statistics (BLS) has been publishing such an index since 1921. whose cost of living is to be measured. Obviously.It is interesting to note. military personnel. They report these findings in two reports. and other characteristics. to keep a record of the price of their purchases. the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. Moreover. tastes. Recently. Until the early 1980s. 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. fairness seems to suggest the same cost-of-living adjustment for everyone. that the correlation between these two measures has been changing recently. composition. however. the Geographic and Relocation Assessors. and long-term hospital care. These differences mean that the CPI varies greatly in its ability to measure cost-of-living changes for various groups. old age homes. Family consumption patterns differ due to age. The CPI-U represents all urban households including urban workers in all occupations. 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. as it does the purchase of any consumer good.

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

This approach partially explains the existence of wage leaders. or international) vary for different skills.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. it may ensure a continuing supply of high-quality personnel from new entrants. Jobs filled internally are constrained only by organization decisions. If an employer can lower unit labor costs by raising the wage level and standards of employability. the organization is able to vary its pay levels and hiring standards on the basis of its willingness to pay. Between 1979 and 1995 the ratio between workers in the 90 percentile and those in the 10th percentile increased from 3. Those with relatively closed internal labor markets fill almost all jobs from within. Those with relatively open internal labor markets fill most jobs from outside. Wage leadership may not only permit "skimming the cream" off the present labor force. The extent to which labor-supply considerations affect wage levels varies greatly among organizations. . Recent emphasis in compensation upon competency and skill based pay makes skill and education an important wage level determinant. it is doubtful that any organization is free from labor-supply problems for at least some skills. 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.this increase for workers in the 90th percentile continued through the 1990's. Not only does the extent of the market (local. Wage leadership companies often have a waiting list of applicants. most organizations operate in numerous labor markets. 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. Although most organizations fill most of their jobs from within.7 to 4.8. Jobs filled externally must meet or exceed the going rate. national. labor-supply considerations affecting wage levels vary with labor markets. such a course would deserve careful consideration. *Skill and Education*. Wage level decisions based on labor-supply considerations must be made in light of the prospects of the organization and the industry. As emphasized in Chapter 3. 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 %. on the other hand. In both situations. An expanding organization. whereas others must continually use an aggressive recruitment program.^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. but the use of internal labor markets varies among organizations. regional. those in low-wage industries may face serious labor-supply problems. may want to upgrade the quality of its work force by paying above the market and raising standards of employability. 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. Organizations in high-wage industries in low-wage areas experience few labor-supply problems. Organizations that pay "on the high side" may do so in the hope of attracting a higher-quality labor force. Obviously.

theory tells us that the acceptable wage will decrease the long er the employee takes to get the job. 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. are potential wage level determinants. the employment contract and the effort bargain are not completed. by u sing the threat of strikes and labour supply they can force up wages to the detr iment of employment levels. As a result. employee expectations. 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. or potential-employee. Labour market imperfections can occur on both the supply and demand side or in s ome case both sides. So do the demands of unions and society (through laws and regulations). This statement suggests that all of the factors discussed in the introductory chapters. 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 .The result of this trend is creating an hour glass shaped work force in which the middle class is being squeezed out. employees may be misinformed about the ava ilability of jobs at different wages. Explain the functions of wage differen tials in a market economy. This seems to be reflected in the move towards a "core" group of employees with good wages. This situation would call for two clearly different wage levels. 3 and 4. For example. and employee satisfaction or dissatisfaction with pay. . employee definitions of equity. when workers reject lower paid jobs in favour of looking for a more acceptable wage.^14 <#14> Movement up the scale is more and more on the basis of education. On the supply side of the labour market Trade Unions cause imperfections.. benefits and a degree of security and a "peripheral" group of temporary and part time employees with low wages. acceptance. rather than experience. become pertinent considerations. If employees are unwilling to accept the wages offered. however there are also other wage differen tials. 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. 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. Explain the functions of wage differentials in a market economy. Ideally. This process will incur costs including for gone wages. time will be spent looking fo r work offering acceptable wage rates. There can be wage imperfect ions when information failure occurs. which occur due to market imperfections and discrimination on the part of the employer. *EMPLOYEE ACCEPTANCE* The considerations employers use in determining wage levels must meet their test of employee. 2. one for the top and one the bottom. Wage differentials occur in all markets. little in the way of benefits and no job security. these considerations find their way into employers' decisions regarding their ability and willingness to pay.

Employers will pay wome n and ethnic minorities less due to ill-informed views about the intelligence. in the long run. occupations. The use of wage different ials in this situation is to reward the work involved in the attaining vocationa l qualifications. this is to the detriment of unskilled workers whose j obs become obsolete. A number of non-mon etary benefits such as long-holidays with pay. 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. however. The govt. as wages are hi gh in certain areas then labour will be drawn there. 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. this is known as a compensating wage differential. will command a hig her wages than comparable jobs. Through the push and pull of certain factors. which will be use d by employers to compensate for poor working conditions ie. Many professional occupations require several years of full-time education at university or college and others require interm ediate qualifications. 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. however. Wage differentials in a market economy are there to correct and compensate for d ifferences in labour markets. the opportunity to travel etc. .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. Another wage differential occurs as a compensating factor to employees who have to endure less attractive work conditions. Discrimination can also account for certain wage differentials. wi ll all be used to increase market supply. firms will try and do the opposite. Also. the Sex Discrimination act and the Race Relation Act. has taken some action to counteract these unwanted and unproductive wage differentials wit h the introduction of the Equal Pay Act. which demand unsociable hours. 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. Regional variations can also explain certain wage differentials. however they are not all perfect and can be divisi ve and unproductive. the market should correct any regional differentials especially in key work are as. Pay may not be the only thing. l oyalty and productiveness of female and non-white workers.

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