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

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

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

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

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

2. 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.S. in this instance. /W. Microeconomic analysis typically assesses particular markets for labor.total income earned by households thus equals the total income earned by the labor. Labor generates considerably more income in the economy than all other factors of production combined. as in Panel (a). One way to analyze the labor market is to assume that it is a single market with identical workers. as suggested in Panel (a) of Figure 12. beauticians. Although the assumption of a single labor market flies wildly in the face of reality. We can view the labor market as a single market. We are. not individuals. or chiropractors. 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. Labor s Share of U. we could examine specific pieces of the market. Here we assume that all workers are identical. The remaining income was generated by capital and natural resources. assuming that perfect .2. as suggested in Panel (b). where labor is viewed as a single market.S. Workers have accounted for 70% of all the income earned in the United States since 1959. they take the market-determined wage as given and respond to it. that there is a single market for them. focusing on particular job categories or even on job categories in particular regions. 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. The model says that equilibrium wages are determined by the intersection of the demand and supply curves for labor in a particular market. Macroeconomic analysis typically makes use of the highly aggregated approach to labor-market analysis illustrated in Panel (a). For example. We calculate the total income earned by workers by multiplying their average wage times the number of workers employed. Workers and firms in the market are thus price takers. as the graphs in Panel (b) suggest. clerical workers in the Boston area. Figure 12. determine wages in the economy. We might even want to focus on the market for. and natural resources supplied to firms. say. and that they all earn the same wage. 1959 2007 shows the share of total income earned annually by workers in the United States since 1959. economists often use it to highlight broad trends in the market. When we use the model of demand and supply to analyze the determination of wages and employment. we would examine the demand for and the supply of a particular segment of workers. We might examine the market for plumbers. Alternative Views of the Labor Market . economy. Alternatively. capital. The rest is generated by owners of capital and of natural resources./ the level of employment is /L/. Labor accounts for roughly 73% of the income earned in the U. we are assuming that market forces. we can show labor as a single market in which the increase in demand raises wages and employment. as suggested by the graphs in Panel (b) of Figure 12.1. if we want to show the impact of an increase in the demand for labor throughout the economy. In such cases. Income.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

those in low-wage industries may face serious labor-supply problems. whereas others must continually use an aggressive recruitment program. the organization is able to vary its pay levels and hiring standards on the basis of its willingness to pay. Wage leadership may not only permit "skimming the cream" off the present labor force. Organizations in high-wage industries in low-wage areas experience few labor-supply problems. 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. 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. This approach partially explains the existence of wage leaders. or international) vary for different skills. . it is doubtful that any organization is free from labor-supply problems for at least some skills. The extent to which labor-supply considerations affect wage levels varies greatly among organizations. 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 %. Obviously. Jobs filled externally must meet or exceed the going rate. regional. Those with relatively closed internal labor markets fill almost all jobs from within. An expanding organization. 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. national. Jobs filled internally are constrained only by organization decisions. may want to upgrade the quality of its work force by paying above the market and raising standards of employability. Recent emphasis in compensation upon competency and skill based pay makes skill and education an important wage level determinant.7 to 4. such a course would deserve careful consideration. Wage leadership companies often have a waiting list of applicants.^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. most organizations operate in numerous labor markets. Not only does the extent of the market (local. *Skill and Education*. Between 1979 and 1995 the ratio between workers in the 90 percentile and those in the 10th percentile increased from 3.8. on the other hand. labor-supply considerations affecting wage levels vary with labor markets. If an employer can lower unit labor costs by raising the wage level and standards of employability. it may ensure a continuing supply of high-quality personnel from new entrants. S. Those with relatively open internal labor markets fill most jobs from outside. At the level of the economy this focus has been playing out for some time in the problem of wage inequality in the U. but the use of internal labor markets varies among organizations.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. Organizations that pay "on the high side" may do so in the hope of attracting a higher-quality labor force.this increase for workers in the 90th percentile continued through the 1990's. In both situations. Although most organizations fill most of their jobs from within.

employee expectations. For example. . Explain the functions of wage differen tials in a market economy. which occur due to market imperfections and discrimination on the part of the employer. become pertinent considerations. This process will incur costs including for gone wages. theory tells us that the acceptable wage will decrease the long er the employee takes to get the job. employee definitions of equity. when workers reject lower paid jobs in favour of looking for a more acceptable wage. 2. Ideally. acceptance. Explain the functions of wage differentials in a market economy. 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. If employees are unwilling to accept the wages offered. Labour market imperfections can occur on both the supply and demand side or in s ome case both sides. however there are also other wage differen tials. time will be spent looking fo r work offering acceptable wage rates. 3 and 4.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. 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. these considerations find their way into employers' decisions regarding their ability and willingness to pay. 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. benefits and a degree of security and a "peripheral" group of temporary and part time employees with low wages. 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 .^14 <#14> Movement up the scale is more and more on the basis of education. This statement suggests that all of the factors discussed in the introductory chapters. 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. and employee satisfaction or dissatisfaction with pay. are potential wage level determinants. the employment contract and the effort bargain are not completed. or potential-employee. This seems to be reflected in the move towards a "core" group of employees with good 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. As a result. There can be wage imperfect ions when information failure occurs. rather than experience. Wage differentials occur in all markets. one for the top and one the bottom. This situation would call for two clearly different wage levels. 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. So do the demands of unions and society (through laws and regulations).

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