1.

The Subsistence Theory of Wages:

The subsistence theory of wages was first formulated by Physiocratic School of French
economists of 18th century. Further, this theory was developed and improved upon by the
German economists. Lasalle styled it as the Iron Law of Wages or the Brazen Law of Wages.
Ricardo and Malthus also contributed to the theory of wages. Karl Marx made it the basis of his
theory of exploitation.
Assumptions:
According to Ricardo, this theory is based on the following two assumptions:
a. Population increases at a faster rate.
b. Food production is subject to the law of diminishing returns.
According to this theory, wages of a worker in the long run are determined at that level of wages
which is just sufficient to meet the necessaries of life. This level is called the subsistence level.
The classical economists called it the neutral level of wages. In this way, the pro-pounders of the
theory believed in the bargaining power of the workers. In such a situation, trade unions play an
important role in increasing wages.
Wages of labour are equal to subsistence level in the long ran. If wages fall below this level,
workers would starve. It will reduce their supply. Thus, the wage rate will rise to the subsistence
level. On the other hand, if wages tend to rise above the subsistence level, workers would be
encouraged to bear more children which will increase the supply of workers, which in turn will
bring wages down to the subsistence level.

It can be shown with the help of the following figure:

In Fig. 1 demand and supply of labour has been measured on OX-axis and wage rate on OY-axis.
OW is the subsistence level of wages. At OW wage rate supply of labour is perfectly elastic.
Since, supply of labour is perfectly elastic, wage rate neither can fall below OW nor can increase
above the level of OW. Although demand increases from DD to D1D1 yet the wage rate remains
the same at OW.
Criticism:
Following are the main defects of the subsistence theory of wages:
 One Sided Theory:
This theory examines the wage determination from the side of supply and ignores the demand
side.
 Pessimistic:
Subsistence theory of wages is highly pessimistic for the working class. It presents a dark picture
of the future of the society.
 Long Period:
This theory is based on the assumption of long run. It does not explain the determination of
wages at a particular period of time.
 No Historical Evidence:
This theory has been criticized on the grounds that it has not been correct in conclusions. The
case of western countries is different from the conclusions of this theory.
 No Difference in Wages:
This theory explains that all the workers get equal wages. As we know, the workers differ in
their productivity, and hence, the difference in their wages is natural.

2. Marginal Productivity Theory of Wages:

Marginal productivity theory of wages is an important theory of wages. This theory was first of
all propounded by Thunnen. Later on, economists like Wicksteed, Walras, J.B Clark etc.
modified the theory. The marginal productivity theory states that labour is paid according to his
contribution in production. A producer hires the services of labour because he possesses the
ability to contribute in production. If worker contributes more to production he is paid more
wages and if he contributes less, w ages also will be low.
“Marginal productivity of labour refers to change in total revenue by putting one
more labourer, keeping all the other factors constant.” Dooley
“As a result of competition between employees for labour and between workers for employment,
a wage-rate is determined that is equal to the marginal productivity of the labour-force, the
employers as a whole are willing to employ.” Prof. S.E. Thomas
“The marginal productivity theory contends that in equilibrium each labourer will be rewarded in
accordance with its marginal productivity”.
Assumptions:
The marginal productivity theory of wages is based on certain assumptions as stated below:
1. All labourers are equally efficient.
2. Constant technology
3. Perfect competition prevails both in factor and product markets.
4. There is full employment in the economy.
5. Law of diminishing marginal returns apply on the marginal productivity of labour.
6. Labour is perfectly mobile.
Explanation of the Theory:
Under the conditions of perfect competition, wages are determined by the value of marginal
product of labour. Marginal product of labour in any industry refers to the amount by which
output increases when one more labour is employed.
Value of marginal product of labour is the price which the marginal product can fetch in the
market. Under the conditions of perfect competition, an employer will go on employing more
labourers but, due to the operation of the law of diminishing returns, the marginal product of
labour will diminish until a point comes when the value of the increase in the product will be
equal to the wages paid to that labourer.
Why Marginal Productivity Theory is Most Satisfactory:
Here we may compare the Marginal Productivity Theory with the earlier classical theories.
The Marginal Productivity theory is an improvement over the earlier theories in the following
ways:
(i) This theory is not as rigid as the subsistence level theory and other classical theories.
(ii) It takes into consideration the demand for labour by the employers and the supply of labour,
although in an indirect form.
(iii) It shows why there are differences in wage rate. Wages according to this theory vary
because of marginal productivity differences of different workers.
(iv) It gives importance to the productivity of labour.
Criticism:
The marginal productivity theory of wages also suffers from certain defects as:
1. Unrealistic Assumptions:
The foremost defect of the theory is that it is based on unrealistic assumptions like perfect
competition, homogeneous character of labour etc. All these assumptions do not prevail in the
real world.
2. Incomplete:
Again, this theory fails to take into account that labour is also a function of wages. Less
productivity may be the effect of low wages which adversely affects the efficiency of labour and
in turn reduces the labour productivity. Thus, the theory is incomplete in all respects.
3. Static Theory:
Lord J.M Keynes criticized the theory as it is based on static conditions. It is only true when
there occurs no changes in the economy. But in real practice it cannot be so. Change is the law of
nature, though it may come gradually.
4. One Sided:
The marginal productivity theory is one sided. It takes into consideration only the demand side
and ignores the supply side.
5. Fails to determine Wages:
This theory only guides the employer to employ workers up to the level where their marginal
productivity equals price. But, it does not tell how the wages are determined.
6. Long Period:
The theory concerns itself with the long run. It explains that wages will be equal to MRP and
ARP in the long run but, the long run like tomorrow never comes. In other words, it does not
deal with the short-run.

3. Wage Fund Theory:

This theory was developed by J.S.Mill. According to him, the employers set apart a certain
amount of capital to pay wages for labourers. 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.
According to J.S.Mill, “wages depend upon the demand and supply of labour or as it is often
expressed as proportion between population and capital. By population is here meant the number
only of the laboring classes or rather of those who work for hire and by capital, only circulating
capital……….. “.
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.
Criticisms:
1. Wage fund theory states that the wage rate is found by dividing the wage fund by the number
of workers. But it does not tell us about the sources of wages fund and the method of estimating
it.
2. Wage fund theory is unscientific and illogical because it first decides the wages fund and then
determines wages. But in reality, wages should be found first and from that wage fund should be
calculated. This theory neglects the quality and efficiency of the workers in determining the
wage rate. This is considered to be a basic weakness of the theory.
3. This theory neglects the quality and efficiency of the workers in determining the wage rate.
This is considered to be a basic weakness of the theory.
4. This theory assumes that wages can increase only at the expense of profit. This is not correct.
The operation of the law of increasing returns will lead to a great increase in total output which
may be sufficient to raise both wages and profits.
5. The wages fund theory has been criticised by the trade unions for its assumption that wages
cannot be increased through bargaining.
6. Wages fund theory has failed to explain the differences in wage rate.
7. This theory believes that wages are paid out of circulating capital. But when the process of
production is short, wages are paid out of current production. When the process of production is
long, wages are paid out of capital.

4. Residual Claimant Theory:

This theory was propounded by Walker. According to this theory, rent and interest are
contractual payments. After deducting rent and interest from total product, the employer will
deduct his profits. What remains after deducting rent, interest and profits is wages. It is possible
to increase wages by increasing the total product by improving the efficiency of the workers.
This theory has several defects:
1. This theory assumes that the share of landlords, capitalists and entrepreneurs are fixed and it is
absolutely wrong.
2. It is not the worker who is the residual claimant but the entrepreneur.
3. It does not explain the influence of trade union in wage determination.
4. The supply side of labour has been totally ignored by the theory.

5. Supply and Demand Theory of Wages

Logically robust and the least refuted, this theory, postulates that if there are few jobs and the
supply of workers is high, wages will fall, conversely, if there are lots of jobs and a shortage of
workers, wages will rise. In the long run wages will be leveled at a point where demand and
supply is equated.
At the central core of labour economics is wage determination because, over time the changes in
the structure and level of wages determine the efficient allocation of labour and the maintenance
of demand and supply of labour in the marketplace. The starting point of the theoretical construct
in this context is the theory of perfect competition which makes some key assumptions:
a. Employers driven by profits seek to maximize utility or satisfaction.
b. Both employers and workers have perfect information about job opportunities and wages
in the market.
c. The skills and performance potentials of all workers are identical, and the jobs offered in
the market are identical in terms of working conditions and non-wage attributes.
d. In the labour market, there are infinite employers on the demand side and infinite number
of workers on the supply side. These large numbers of workers and employers result in
negligible influence of either in the marketplace.
e. There are no institutional barriers preventing the mobility of workers from one job to
another. The supply demand model, in labour economics considering these assumptions
take the form as illustrated below.
The forces of demand and supply determine the rate of pay for a particular type of labour in a
specific labour market. This model predicts that wages in the long run will be determined by the
equalisation of the demand and supply forces. The wages so determined will the equilibrium
wage. If the prevailing wage rate is higher than the equilibrium wage there will be excess supply
of labour and the resulting competition will push down the wage to the equilibrium wage. If the
prevailing wage is lower than the equilibrium wage the excess demand for labour and the
competiton for workers will raise the wage to the equilibrium wage.
In spite of the assumptions of perfect competition being restrictive and unrealistic this model is
important as it highlights the role of market forces in the process of wage determination. The
imperfections in the real world cause the wage rate to deviate from the theoretical ideal of perfect
competition. The market forces in the real world do not determine a unique wage rate for each
type of job but establish a range with an upper limit and a lower limit. The employer has some
discretion within this range. The employers or the firm cannot pay more than the upper limit as
the profits will be drastically reduced. Paying wage below the lower limit will not attract workers
at all. An area of indeterminacy is established between the lower limit and the upper limit within
which the firm can formulate its own wage policy. As firms have some discretion over the wage
rate they pay, it is possible to find a distribution of firms in the labour market. These firms in
terms of wage payment can be high wage firms, and low ways firms and the remainder
somewhere in middle. These placements are called contours. The determinants of a firm in being
a particular contour are the profitability of the firm and its ability to pay. These are additional
determinants, the primacy being the level established by supply and demand.