Compensation and Benefits

Wage Theories

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 Wage Theories

Wage theory attempts to explain the determination of the payment of labour. The workers are paid wages or

salaries for the work done by them. Thus, the return to the workers should be according to their efforts and

the pay standards prevailing in the industry.

There are three types of questions which a wage theory attempts to answer:

o Wage Level Related Questions

o Wage Structure Questions

o Variations in Wage Rates and Structures

Wage Theories

Wage Theories

Residual
Subsistence Wage Fund Behavioral
Claimant
Theory Theory Theory
Theory

Standard of Marginal Bargaining

Living Theory Productivity Theory
Theory
 SUBSISTENCE THEORY

The theory was formulated by Physiocrats later elaborated by David Ricardo Lassale called this theory as
IRON LAW OF WAGES. It is based on two assumptions:

1. Law of diminishing returns applies to the industry

2. Population always tends to increase

• This theory states that the wages of labour must remain at the subsistence level.
• If the labour is paid below the subsistence level, they will die out of malnutrition, disease or hunger and
therefore, the number of workers gets reduced.
• If on the other hand, the actual wages fall below the subsistence level, population will decrease resulting in a
decline in labour supply and rise in wages.
• Thus, there is a subsistence level, which is maintained and is not either increased or decreased.
 STANDARD OF LIVING
THEORY
This theory is an improved and refined version of subsistence theory.

• According to this theory, wage is determined by the standard of living of the workers.
• Standard of living refers to the bare necessaries of life and also education, and recreation to which the worker
is habituated.
• It gives importance to the efficiency and productivity of the worker.

CRITICISM
➢ Individuals do not have any fixed standard of living.
➢ It ignores wage differences.
 WAGE FUND THEORY

This theory was developed by Adam Smith and later expounded by J.S.Mill.

• It states that workers are paid wages out of a pre-determined fund of wealth. This is fixed and constant. This is
called as wages fund. Wage is determined by the amount of wages fund and the total number of labourers.

Wage rate = Wage fund / Number of labourers

• An increase in wage rate is possible only by an increase in wage fund or by a reduction in the number of
labourers.
• Thus, there exists a direct relation between wage rate and wages fund and inverse relation between wage rate
and number of labourers.
• This theory also states that trade unions are powerless in rising the general wage rate.
 MARGINAL PRODUCTIVITY THEORY

• Marginal productivity theory of wages is an extension of marginal productivity theory of distribution.

• It is given by Phillips Henry Wicksteed and John Bates Clark, and it is based on the assumption that wage is determined

on the basis of last worker’s contribution in the production i.e. the marginal production.

• So, wage for labour should be equal to the value of the marginal product under conditions of perfect competition. As far as,

the marginal productivity is equal to the wages paid, a firm will continue employing more labour.

CRITICISM

➢ The theory deals with the demand side only. The supply side is totally ignored.

➢ In practice, the employers offer wages less than the marginal productivity of labour.

➢ In many cases, the labour unions are able to bargain for wages higher than the
 RESIDUAL CLAIMANT THEORY

Francis. A Walker propounded this theory, and according to him there four factors of production viz. Land,

labour, capital and entrepreneurship.

• It says that, once all other three factors are rewarded what remains left is paid as wages to workers. Thus,

according to this theory, worker is the residual claimant.

Wage= Whole production- (Rent+ Interest+ Profit)

CRITICISM

➢ It is not the worker who is the residual claimant but the entrepreneur.

➢ It does not explain the influence of trade union in wage determination.

➢ The supply side of labour has been totally ignored by the theory.
 BARGAINING THEORY
• John Davidson has given this theory.
• It states that, the fixation of wages depends on the bargaining power of workers/trade unions and of employers.
• If workers are stronger in bargaining process, then wages tend to be high. In case, employer plays a stronger role,
then wages tend to be low.

BEHAVIORAL THEORY
• It states that there are various factors such as employer’s concern for the workers, the strength of unions, size
and prestige of company, etc. that determines the amount of wage to be disbursed among the workers.
• Thus, the firm can adopt either of the wage methods depending on the nature of a job and the worker’s
contribution towards the accomplishment of a work.