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    Wages are income derived from human labour. Technically they cover allpayments for the use of labour, mental or physical, but in ordinaryusage the term excludes income of the self-employed and is restricted tocompensation of employees .Occasionally fringe benefits are included, but generally they are not.

    The term is not fully synonymous with labour costs, which may includesuch items as cafeterias or meeting rooms maintained for the convenienceof employees (such items are part of capital). Wages, in economic terms,however, do include remuneration in the form of extra benefits, such aspaid vacations, holidays, and sick leave, as well as wage supplements inthe form of pensions and health insurance paid for by the employer. Aworker in covered industries also receives the protection ofgovernmentally provided unemployment compensation, old-age pensions, andindustrial accident compensation. Government services provided forworkers are of even greater significance in European countries than inthe United States and must be taken into account when comparisons ofearnings are made.

    Residual-claimant theory.

    The residual -claimant theoryholds that, after all other factors of production have received theirshare of the product, the amount left goes to the remaining factor. AdamSmith implied such a theory for wages, since he said that rent would bededucted first and profits next. Francis A. Walker in 1875 worked out a residualtheory of wages in which the shares of the landlord, capitalist, andentrepreneur were determined independently and subtracted, thus leavingthe 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 madefor the shares of the other factors. It is doubtful, therefore, thatsuch a theory has much value as an explanation of wage phenomena.

    Bargaining theory.

    The bargaining theory of wagesholds that wages, hours, and working conditions are determined by therelative bargaining strength of the parties to the agreement. Smithhinted at such a theory when he noted that employers had greaterbargaining strength than employees, because it was easier for employersto combine in opposition to employees' demands and also because

    employers were financially able to withstand the loss of income for alonger period than the employees. This idea was developed to aconsiderable extent by John Davidson, who argued, in 1898, that thedetermination of wages is an extremely complicated process involvingnumerous influences that interact to establish the relative bargainingstrength of the parties. There is no one factor or single combination offactors that determines wages, and there is no one rate that necessarilyprevails. Because there are many possibilities, there is a range ofrates within which any number of rates may exist simultaneously. Theupper limit of the range is set by the rate beyond which the employerrefuses to hire certain workers. This rate is influenced by suchconsiderations as the productivity of the workers, the competitivesituation, the size of the investment, and the employer's estimate of

    future business conditions. The lower limit of the range is set by therate below which the workers will not offer their services to theemployer. This rate is influenced by such considerations as minimum wage

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    legislation, the workers' standard of living, their appraisal of theemployment situation, and their knowledge of rates paid to others.Neither the upper nor the lower limit is fixed, and either may moveupward or downward. The rate or rates within the range are determined byrelative bargaining power.

    The bargaining theory is very attractive to labour organizations, for,

    contrary to the subsistence and wages-fund theories, it provides a verycogent reason for the existence of unions. The bargaining strength of aunion is much greater than that of the members acting as individuals.Also there are situations (bilateral monopoly, for instance) under whichtheoretical analysis arrives at a range of wage rates rather than adeterminate rate. The actual rate must depend upon relative bargainingpower. It should be observed, however, that historically labour was ableto improve its situation before its bargaining power became moreeffective through organization. Factors other than the relativebargaining strength of the parties must have been at work. Thebargaining theory often gives an excellent explanation of a short-runsituation, such as the existence of certain wage differentials, but over

    the long run it fails to provide an adequate understanding of thechanges that have taken place in the average level of wages.Marginal-productivity theory and its critics.

    Toward the end of the 19thcentury, marginal-productivity analysis was applied not only to labourbut to other factors of production as well. It was not a new idea as anexplanation of wage phenomena, for Smith had observed that arelationship existed between wage rates and the productivity of labour,and Johann Heinrich von Thnen, a German economist, had worked out amarginal-productivity type of analysis for wages in 1826. The Austrianeconomists 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 theUnited States, elaborated the idea into the marginal-productivity theoryof distribution. It is likely that the disturbing conclusions drawn byMarx from classical economic theory inspired this development. In theearly 1930s refinements to the marginal-productivity analysis,particularly in the area of monopolistic competition, were made by JoanRobinson in England and Edward H. Chamberlin in the United States.

    As applied to wages, the marginal-productivity theory holds thatemployers will tend to hire workers of a particular type until theaddition made by the last (marginal) worker to the total value of theproduct is equal to the addition to total cost caused by the hiring ofone more worker. The wage rate is established in the market through thedemand for, and supply of, the type of labour, and the operation ofcompetition assures the workers that they will receive a wage equal tothe marginal product. Under the law of diminishing marginalproductivity, the contribution of each additional worker is less thanthat of his predecessor, but workers of a particular type are assumed tobe alike, making them interchangeable, and any one could be consideredthe marginal worker. All receive the same wage, and, therefore, byhiring to the margin, the employer maximizes his profits. As long aseach additional worker contributes more to total value than he costs inwages, 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

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    differentials are caused by differences in marginal product. The wagesof skilled workers are higher than those of unskilled workers becausethere are fewer skilled workers, and their marginal product, therefore,is higher.

    The marginal-productivity theory of wages became the prevailing wagetheory, and, although it has been attacked by many and discarded by

    some, no acceptable alternative has been devised. The chief basis forcriticism of the theory is that it rests on unrealistic assumptions,such as the existence of homogenous groups of workers whose knowledge ofthe labour market is so complete that they will always move to the bestjob opportunities. Workers are, in fact, not homogenous; usually theyhave little knowledge of the labour market; and because of home ties,seniority, and other considerations, they do not often move quickly fromone job to another. The assumption that employers are able to measureproductivity accurately and compete freely in the labour market also isfarfetched. Even the assumption that all employers attempt to maximizeprofits may be doubted. The profit motive does not affect charitableinstitutions or government agencies. For the theory to operate properly,

    labour and capital must be fully employed so that increased productioncan be secured only at increased cost; capital and labour must be easilysubstitutable for each other; and the situation must be completelycompetitive.

    Obviously these assumptions do not fit the real world, and some criticsfeel that the results of the theory are so misleading that the theoryshould be abandoned. The proponents argue, however, that productivitygives a rough approximation of wages, and that although productivity maynot provide the immediate explanation in a particular case, it certainlyindicates long-run trends. The theory, therefore, has important uses,and if the difficulties are kept in mind, it can be a valuable tool.

    In a modern economy, monopolistic or near monopolistic conditions existin some important areas, particularly where there are only a few largeproducers (such as in the automobile industry) on one side of thebargaining table and powerful labour organizations on the other. Undersuch circumstances, the marginal productivity analysis cannot determinewages precisely; it can show only the positions that the union (as amonopolist of labour supply) and the employer (as a monopsonist, orsingle purchaser of labour services) will strive to reach, dependingupon their current policies.

    Purchasing-power theory.

    The purchasing-power theory ofwages involves the relation between wages and employment and thebusiness cycle and is not, therefore, a theory of wage determination. Itstresses the importance of spending through consumption and investmentas an influence upon the activity of the economy. The theory gainedprominence during the Great Depression of the 1930s, when it becameapparent that lowering wages might not increase employment as previouslyhad been assumed. John Maynard Keynes, the British economist,maintained in his Theory of Employment,Interest and Money/ (1936), that (1) depressional unemployment could notbe explained merely by frictions in the labour market that interruptedthe smooth movement of the economy toward full employment equilibrium

    and (2) the assumption that "all other things remained equal" presenteda special case that had no real applicability to the existing situation.Keynes related changes in employment to changes in consumption and investment, a

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    nd he pointed out that stable equilibrium could exist with less than full employment.

    Because wages make up such a large percentage of the national income,changes in wages usually have an important effect upon consumption. Itis possible that lowering wages will reduce consumption and that, withthe decline in demand for goods and services, the demand for labour may

    also fall, thus decreasing employment rather than improving it. Whetherthis will be the result, however, depends upon several considerations,particularly the reaction upon prices. If wages fall more rapidly thanprices, labour's real wages will be drastically reduced, and consumptionwill fall, accompanied by increased unemployment, unless total spendingis maintained by increased investment. Entrepreneurs may look upon thelower wage costs in relation to prices as an encouraging sign towardgreater profits, in which case they may increase their investments andemploy more people at the lower rates, thus maintaining or evenincreasing total spending and employment. If employers look upon thefalling wages and prices as an indication of further declines, however,they may contract their investments or do no more than maintain them. In

    this case, total spending and employment will decline.

    If wages fall less rapidly than prices, labour's real wages willincrease, and consumption may rise. If investment is at leastmaintained, total spending in terms of constant dollars will increase,thus improving employment. If entrepreneurs look upon the shrinkingprofit margin as a danger signal, however, they may reduce theirinvestments; and, if the result is a reduction in total spending,employment will fall. If wages and prices fall the same amount, thereshould be no change in consumption and investment; and, in that case,employment will remain unchanged.

    The purchasing-power theory involves psychological considerations as

    well as those that may be measured more objectively. Whether it can beused effectively to control the business cycle depends upon political aswell as economic factors, because government expenditures are a part oftotal spending, taxes may affect private spending, etc. Theapplicability of the theory is to the whole economy rather than to theindividual firm.

    Classical theories.

    Theories of wage determination and the share of labour in the grossnational product have varied from time to time and have changed as theeconomic environment has changed. The body of thought referred to todayas wage theories could not have emerged until the old feudal system haddisappeared and the modern economy with its modern institutions had comeinto existence. Adam Smith, in The Wealth of Nations/ (1776), failed to proposea definitive theory of wages, but he anticipated several theories that were developed by otherslater. Smith thought that wages were determined in the marketplacethrough the law of supply anddemand. Workers and employers would naturally follow their ownself-interest; labour would be attracted to the jobs where labour wasneeded most, and the result would be the greatest overall benefit to theworkers and to society. But Smith gave no precise analysis of the supplyof and demand for labour; he discussed many elements that were involved

    but did not weave them into a consistent theoretical pattern.

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    Subsistence theory.

    Subsistence theories emphasizethe supply aspects and neglect the demand aspects of the labour market.They hold that change in the supply of workers is the basic force thatdrives real wages to the minimum required for subsistence. Elements of asubsistence theory appear in /The Wealth of Nations,/ where Smith wrote that the

    wages paid toworkers had to be enough to allow them to live and to reproducethemselves. Smith was more optimistic, however, than the Britishclassical economists, such as David Ricardo and Thomas Malthus, whofollowed him, for he implied that--at least in an advancing nation--thewage level would have to be above subsistence to permit the populationto grow enough to supply the additional workers needed. Ricardomaintained a more rigid view. He wrote that the "natural price" oflabour was the price necessary to enable the labourers to subsist and toperpetuate the race without increase or diminution. Ricardo's statementwas consistent with the Malthusian theory of population, which held thatpopulation adjusts to the means of supporting it. The market price of

    labour could not vary from the natural price for long: if wages roseabove subsistence, the number of workers would increase and bring thewage rates down; if wages fell below subsistence, the number of workerswould decrease and bring the wage rates up. At the time that theseeconomists wrote, most workers were actually living near the subsistencelevel, and population appeared to be trying to outrun the means ofsubsistence. The subsistence theory seemed to fit the facts; and,although Ricardo said that the natural price of labour was not fixed andmight be changed if custom and habit moderated population increases inrelation to food supply and other items necessary to maintain labour,later writers tended to subscribe to the basic idea and not to admitexceptions. Their inflexible and inevitable conclusion earned the theorythe name "iron law of wages."

    Wages-fund theory.

    Smith said that the demand forlabour could not increase except in proportion to the increase of thefunds destined for the payment of wages. Ricardo maintained that anincrease in capital wouldresult in an increase in demand for labour. Statements such as theseforeshadowed the wages-fund theory, which held that a predetermined fundof wealth existed for the payment of wages. The size of the fund couldbe changed over periods of time, but at any given moment the amount wasfixed, and the average wage could be determined simply by dividing thefund by the number of workers. Smith thought of the fund as surplusincome of wealthy men--beyond the needs of their families andtrade--which they would use to employ others. Ricardo thought of it interms of capital--food, clothing, tools, raw materials, machinery, etc.,necessary to give effect to labour. Regardless of the makeup of thefund, the obvious conclusion was that when the fund was large inrelation to the number of workers, wages would be high. When it wasrelatively small, wages would be low. If population increased toorapidly in relation to food and other necessities (as outlined byMalthus), wages would be driven to the subsistence level. Therefore, itwould be to the advantage of labour to help promote the accumulation ofcapital to enlarge the fund rather than to discourage it by forming

    labour organizations and making exorbitant demands. Also, it followedthat legislation designed to raise wages would not be successful, for,with only a fixed fund to draw upon, increases gained by some workers

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    could be maintained only at the expense of others.

    This theory was generally accepted for 50 years by economists, includingsuch well-known figures as Nassau William Senior and John Stuart Mill.W.T. Thornton, F.D. Longe, and Francis A. Walker were largelyresponsible for discrediting the theory during the decade following1865. They pointed out that the demand for labour was not determined by

    a fund but was derived from the consumer demand for products. Theproponents of the wages-fund doctrine had been unable to prove thatthere was a determinate wage fund, or any fund maintaining apredetermined relationship with capital or with the portion of theproceeds of labour's product paid out in wages. Actually the amount paidout depended upon a number of factors, including the bargaining power oflabour. Yet, in spite of these telling criticisms, the wages-fund theorycontinued to exercise an important influence until the end of the 19thcentury.

    Marxian surplus-value theory.

    Karl accepted Ricardo's labour theory of value, but he subscribed to a subsistence theory of wages fora different reason than that given by the classical economists. InMarx's mind, it was not the pressure of population that drove wages tothe subsistence level but rather the existence of a large army ofunemployed, which he blamed on the capitalists. He stated that theexchange value of any product was determined by the amount of labourtime socially necessary to create it. He held that under thecapitalistic system, labour was merely a commodity and could get onlyits subsistence. The capitalist, however, could force the worker tospend more time on his job than was necessary to earn his subsistence,and the excess product, or surplus value, thus created, was taken by thecapitalist.

    From the point of view of classical theory, Marx's argument appearedpersuasive, although the term "labour time socially necessary" hid someserious objections. The fatal blow came when the labour theory of valueand Marx's subsistence theory of wages were found to be invalid. Withoutthem, the surplus-value theory collapsed.


    The dramatic widening of the wage gap between workers with differentlevels of education reflects the operation of demand and supply in themarket for labor. For reasons we will explore in this chapter, thedemand for college graduates was increasing while the demand for highschool graduatesparticularly male high school graduateswas slumping.

    Why would the demand curves for different kinds of labor shift? Whatdetermines the demand for labor? What about the supply? How do changesin demand and supply affect wages and employment? In this chapter wewill apply what we have learned so far about production, profitmaximization, and utility maximization to answer those questions in thecontext of a perfectly competitive market for labor.

    This is the first of three chapters focusing on factor markets, that is,on markets in which households supply factors of productionlabor,capital, and natural resourcesdemanded by firms. Look back at the

    circular flow model introduced in the initial chapter on demand andsupply. The bottom half of the circular flow model shows that householdsearn income from firms by supplying factors of production to them. The

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    total income earned by households thus equals the total income earned bythe labor, capital, and natural resources supplied to firms. Our focusin this chapter is on labor markets that operate in a competitiveenvironment in which the individual buyers and sellers of labor areassumed to be price takers. Other chapters on factor markets willdiscuss competitive markets for capital and for natural resources andimperfectly competitive markets for labor and for other factors of


    Workers have accounted for 70% of all the income earned in the UnitedStates since 1959. The remaining income was generated by capital andnatural resources.

    Labor generates considerably more income in the economy than all otherfactors of production combined. Figure 12.1, Labors Share of U.S.Income, 19592007 shows the share of total income earned annually byworkers in the United States since 1959. Labor accounts for roughly 73%of the income earned in the U.S. economy. The rest is generated by

    owners of capital and of natural resources.

    We calculate the total income earned by workers by multiplying theiraverage wage times the number of workers employed. We can view the labormarket as a single market, as suggested in Panel (a) of Figure 12.2,Alternative Views of the Labor Market. Here we assume that all workersare identical, that there is a single market for them, and that they allearn the same wage, /W;/ the level of employment is /L/. Although theassumption of a single labor market flies wildly in the face of reality,economists often use it to highlight broad trends in the market. Forexample, if we want to show the impact of an increase in the demand forlabor throughout the economy, we can show labor as a single market inwhich the increase in demand raises wages and employment.

    One way to analyze the labor market is to assume that it is a singlemarket with identical workers, as in Panel (a). Alternatively, we couldexamine specific pieces of the market, focusing on particular jobcategories or even on job categories in particular regions, as thegraphs in Panel (b) suggest.

    But we can also use demand and supply analysis to focus on the marketfor a particular group of workers. We might examine the market forplumbers, beauticians, or chiropractors. We might even want to focus onthe market for, say, clerical workers in the Boston area. In such cases,we would examine the demand for and the supply of a particular segmentof workers, as suggested by the graphs in Panel (b) of Figure 12.2,Alternative Views of the Labor Market.

    Macroeconomic analysis typically makes use of the highly aggregatedapproach to labor-market analysis illustrated in Panel (a), where laboris viewed as a single market. Microeconomic analysis typically assessesparticular markets for labor, as suggested in Panel (b).

    When we use the model of demand and supply to analyze the determinationof wages and employment, we are assuming that market forces, notindividuals, determine wages in the economy. The model says thatequilibrium wages are determined by the intersection of the demand and

    supply curves for labor in a particular market. Workers and firms in themarket are thus price takers; they take the market-determined wage asgiven and respond to it. We are, in this instance, assuming that perfect

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    competition prevails in the labor market. Just as there are somesituations in the analysis of markets for goods and services for whichsuch an assumption is inappropriate, so there are some cases in whichthe assumption is inappropriate for labor markets. We examine such casesin a later chapter. In this chapter, however, we will find that theassumption of perfect competition can give us important insights intothe forces that determine wages and employment levels for workers.


    Introduction.The current stage of development associated with a new look at *labor as one ofthe key resources of the economy. This new view - evidenceof real growth of the human factor in technological phase of the STR,where there is a direct correlation of results from the production ofquality, motivation and the nature of the workforce as a whole and theindividual worker in particular. The increasing role of human factors inproduction is confirmed by the results of economic research of leadingAmerican scientists. Since 1929 the main source of growth in labor

    productivity and national income in the U.S. triad 'work - the land -the capital' is the first factor, which covers the totality ofeducation, qualifications, demographic and cultural characteristics ofthe workforce.The labor market has its own characteristics. This is due tothe specific product that is bought and sold in this market.Unlike other resources (inputs), labor is a function of human lifeand inseparable from the person. Therefore, work itself may not be sold,and the "labor market " are bought and sold services work. Animportant feature of the labor market is the long durationof the relationship of the seller and buyer. If on the marketcontact the seller and the buyer in most cases limited to the transferof ownership, that is extremely short duration of time, the *labor*

    market relations between seller and buyer's last all the time atwhich a contract. It should also be noted that an important role in thelabor market are non-monetary factors - the prestige andcomplexity of work, working conditions and social guarantees, and so on.One of the most important features of the market is thepredominance of its different forms of imperfect competition. This is due to thepresence of market institutions, such as the state, labor unions, large corporations. In his work theauthor tries, summarizing the available information, to analyze theimpact of the above institutions on the labor market, aswell as assess the results of their activities on the market.The prevalence of imperfect competition in the labormarket.

    1. Competitive models of the *labor market*.I must say that the situation of perfect competition in the labormarket practically does not occur. However, we try to simulate it in order to analyze the demand and supply in the labor market.In conditions of perfect competition in the market a large numberof companies competing with each other in the recruitment of a specifictype of labor. At the same time many workers have the samequalifications, independently offer this type of service work. And, mostimportantly, neither the workers nor the company shall not exercisecontrol over the price.

    In this case, the volume of demand for labor will be in inverseproportion to the value of wages. Since with an increase in wage ratesentrepreneur, ceteris paribus, will reduce the use of forced labor.

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    The supply curve under perfect competition will gradually increase, dueto the fact that in the absence of unemployment hire firms will beforced to pay higher wages to attract workers. The fact that wages mustcompensate for the possibility of alternative use of time or in otherlabor market, either in the household.The equilibrium wage rate and the equilibrium level of employment are atthe intersection of supply and demand curves for labor (point E in

    Fig. 1). This point corresponds to a certain level of wages (WE), andgiven that the level of labor supply (LE). At point E the demandfor labor equals supply of labor, and this means that themarket is in equilibrium. That is, all employees according to thissalary, jobs, and all the entrepreneurs who are willing to pay the wagesWE, are in the market they need the number of labor.Therefore, point E shows the position of full employment.

    2. Monopsony in the labor market.

    In the competitive job market every entrepreneur hires so fewworkers that can not affect the rate of wages. In the case of monopsony

    firm has the monopoly right to hire workers. In such a situationemployed in this company make up the bulk of all those employed in theindustry. As a result, the firm can "dictate wages", since the wage ratewill be in direct proportion to the number of employed workers. Demandcurve DL will coincide with the curve of the marginal product inmonetary terms. But, as monopsonist pays equal pay for each unitof goods, the supply curve of labor for it is a curve of averagecosts (SL = AC). The involvement of each additional worker means raisingwages for all workers, including those for the previously employed.Therefore MRCL marginal cost curve lies above the curve of averagecosts. When choosing the number of employees monopsonist will be guidedby equality of the marginal product and marginal cost (point E1). Aftera vertical curve to the SL and designate a point M, we can determine the

    level of wages WM, as well as the amount of labor used by LM.While under perfect competition the equilibrium wage rate would be atthe level of WE, and the equilibrium number of workers would be equal to"Le.Thus, ceteris paribus monopsonist maximizes profits by hiring fewerworkers and thus pays a wage rate lower than in a competitiveenvironment. In reality, the situation of monopsony can arise in thelabor market in a small town, where there is, for example,only one plant, one hospital, a school, etc.

    3. The presence of trade unions in the labor market.

    Trade unions are one of the main non-competitive factors in the labor market. The union - a union of workers having the right tonegotiate with the employer on behalf and on behalf of all its members.The purpose of the union - to maximize the wages of their members,improve their conditions of work and receive additional pay and benefits.Consider the situation when the union occurs in a competitive market. He is negotiating with a relatively large number of employers. Itsgoal union may pursue different paths.The most desirable from the standpoint of the trade union, means a wageincrease is the expansion of demand for labor. As a result, at thesame time increase the rate of wages, as well as grow the number ofjobs. The relative magnitude of the increase depends on the elasticityof labor supply.

    Increasing demand for labor union may by influencing the factorsthat determine demand. In particular, the union may try:1) increase the

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    demand for final products.2) improve productivity.3) change the prices of substitute resources.Trade unions can contribute to the growth in demand for products and,consequently, increase the derived demand for their own laborservices, through advertising or political lobbying. These methods arefairly common. Not surprisingly, that the unions builders use lobbyists

    to obtain contracts for the construction of new highways or thereconstruction of urban public space. Similarly, teachers' unions infavor of increased government spending on education and so on.Increased demand for labor also contributes to increasedefficiency and quality of work. This is ensured, in particular the workof quality control circles, in which workers (often in conjunction withthe administration) are looking for ways to increase productivity, amore profitable use of machinery equipment, raw materials savings andimprove product quality.Trade unions can increase the demand for labor of its members,influencing the level of prices for raw materials substitutes. Forexample, trade unions, whose members are paid considerably more than the

    minimum wage, often act in support of raising the minimum wage rates.What would lead to an increase in the price of unskilled laborAnother way to allow the union to achieve its goals - is limiting supplyof labor. To limit the supply of labor unions activelypromote the adoption of such laws, which limit immigration, reduce theuse of child labor, contribute to reducing the working week,introduced the licensing of employees and so on.Achieved to reduce the supply of labor union may, by reducing thenumber of union members. Unions often force an employer to employ onlyits members, while receiving full control over the supply of laborin the industry. Then, through a policy of reducing its members(exorbitant entrance fee should be, long term training and even a ban onadmission of new members) union is seeking an artificial reduction of

    labor supply.Another widely used means of limiting the supply is the licensing ofworkers. Union influence on the authorities, urging them to enact lawsunder which workers in certain occupations can be hired only if theymeet certain qualification requirements. These requirements may includeeducation, professional experience, special examinations, etc. Thus, thepresentation is too high demands, an excessively strict examinations cansignificantly limit the supply of labor in the industry. Unions,which operate the above-described methods, often called "closed?.However, most unions do not seek to limit the number of its members. Onthe contrary, they try to unite all existing or potential employees.After all, in this case, the firm is under strong pressure from theunion to conclude a treaty on the rate of wages. Such a strong influenceof trade unions in the company due to the fact that with the strike theunion could completely deprive the company of labor supply. Assume that the initialequilibrium wage rate is equal to the WE, while the level of employment- LE. Assume that the union had imposed on the employer a higher wage,say WU. This leads to a modification of the supply curve for theemployer (SLSL => WUaSL). Thus, if entrepreneurs believe that it is moreexpedient to pay a higher rate than to bring it out of the strike, theyat the same time will have to reduce employment to LE to LU.The current way the unions are called open, or industry, as they oftenbring together employees of entire industries, such as automobiles,metallurgy, etc.

    4. Bilateral monopoly on the labor market.

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    Special situation in the labor market is developing in theevent that there are trade union monopoly and the employer-monopsonist.To analyze this situation graphically, it is necessary to combine thetwo graphs - one that reflects the activities of monopsony, the other -the union. Under perfect competition the equilibrium wage rate would beestablished at the level of W, while it would be occupied by L man.However, the firm monopsonist will always strive to reduce wages to the

    level of Wm by reducing the number of employed with L up to Lm. Theunion, in turn, will seek to raise wages to WU, and reducing the supplyof labor. Thus, with relatively small differences in the number ofemployed workers desired wage rate in the union and monopsony will varysignificantly. What will be the level of wages, clearly impossible tosay. Everything depends on the strength of opposing monopolies, it isalso possible that the wage rate close to its equilibrium level. Thus,bilateral monopoly can lead to results that are much closer to acompetitive market than to market conditions, where themonopoly of one party or another.


    04 Organization Wage Determinations.

    The wage level is the average wage paid to employees. This may mean allemployees, some particular group of employees or a single employee ofthe organization. This has two implications. The first is external: howdoes the organization compare with other organizations? This question isa strategic one of how the organization wishes to position itself in themarketplace. The second implication is internal. The average wage is areflection of the total wage bill of the organization. Labor is one ofthe claimants on organizational resources. The size of the wage bill isa reflection of monies paid to entry level workers on up to the top


    The decision on compensation levels (how much will the organizationpay?) may be the most important pay decision the organization makes: apotential employee's acceptance usually turns on this decision, and alarge segment of the employer's costs are determined by it.

    Organizations have a wide range of discretion in setting wage levels.Although organizations seek out and use information on what otheremployers pay, this information is only one of the determinants of wagelevels. This chapter attempts to set out some of these wage determinantsand the manner in which they may be used. Although no claim is made thatall wage-level determinants have been identified, it is hoped thatenough are presented here to illustrate the process used and the factorsconsidered when an organization decides how much to pay.


    Numerous forces operate as wage determinants. These might be roughlyclassified as economic, institutional, behavioral, and equityconsiderations. Wage decisions appear to be made by comparison to labormarkets, so many of the determinants appear to be economic. Both themeaning and force of economic variables are interpreted by organizationdecision makers, and these determinants are tempered by institutional,behavioral, and ethical variables.

    There is no doubt that wage determinants operate through labor marketsand that they include economic forces.More profitable organizations tend to pay

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    higher wages for the same occupations thanless profitable organizations. Capital-intensive organizations tend tobe more profitable because additional capital usually increasesproductivity. Small organizations tend to pay lower wages often becausethose wages are all they can afford. Service industries that tend to belabor-intensive, low-profit, and low-wage are often composed of smallorganizations.

    Local labor markets vary in wage levels, depending on industrialcomposition. Communities in which a large proportion of organizationsare in high-profit industries tend to be high-wage communities and oftenhave a higher cost of living. Communities with a high proportion oforganizations in low-profit industries tend to be low-wage. Sometimescommunities experience short-run increases in wage levels because labordemand increases compared to labor supply; or there is a decrease inwage levels because of an increase in labor supply without aproportional increase in demand.

    Differentials among local labor markets are limited by a tendency for

    workers to leave low-wage communities and for organizations to locatenew plants in low-wage areas. Unions sometimes attempt to eliminatedifferentials by making a concession in work rules affecting productivity.

    Wage levels tend to increase faster in good times: profits increase andthis encourages workers to become more demanding and mobile. Unionsreinforce this tendency by insisting on using gains made elsewhere tomake their comparisons. Some less efficient organizations survive bypaying less and lowering standards of employability even in good times.High profits, good times and increasing productivity tend to increase anorganization's wage-paying ability, but organizations may or may not bewilling to pay higher wages. Some of them do so to simplify recruitingproblems and to forestall turnover. Others do so because above-average

    profits whet the appetites of workers and their unions. Mostorganizations tend to adopt a position in the wage structure of thecommunity and attempt to maintain that position.

    Thus economic forces operate on wage decisions through the actions ofdecision makers. If decision makers believe that adjustments in wagesare necessary or desirable on economic or other grounds, they make them.If they believe that the organization's present wage-paying position isprudent and acceptable, they do not.

    We classify wage level determinants onthe basis of (1) employer ability to pay, (2) employer willingness topay, and (3) employee (or potential employee) acceptance. Although someof these considerations have been used by arbitrators and wage boards,little is known about how they are used by wage-paying organizations orunions. We therefore emphasize how and when these determinants could beused by organizations.


    When asked most organizations would say that the major determinant oftheir wage level is what the market is paying. However, there is usuallya caveat to this and that is their statement "if we can afford it." Soit would seem that the wage level of the organization is determined byexternal forces of the market but that the reality of the organizations

    financial position may modify or overrule carrying out this desire. Thisis expressed in surveys that ask about what determines theorganization's wage level. When these organizations say "if they

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    can afford it" they are invoking the ability to pay. However, there islittle that explains exactly what the ability to pay is.

    As reported, more profitable firms tend to pay higher wages, whethertheir profitability is based on the product market, technicalefficiency, management ability, size, or some other factor. Thesituation with the automobile industry is an example of what can happen

    when an industry that is highly profitable falls on bad times and itswage level must fall in order to survive. This has been particularlyhard since the industry is highly unionized.^3

    In a very real sense, wage determination by the organization is anassessment of its ability to pay. The weight attached to other wagedeterminants may be determined by this estimate. Wages are labor coststo employers, and these costs are high or low depending on what theemployer gets for the wage ? the results of effort.

    What the employer actually pays is labor cost per unit of output; thisis the wage costs divided by these results termed productivity. A

    prospective wage increase may or may not increase labor cost per unit,depending on anticipated changes in productivity. A wage increase thatwould be offset by increases in productivity does not increase laborcosts and meets the requirement of ability to pay. A wage increase thatincreases labor costs, however, requires determining whether theincrease can be passed on to customers or offset by a reduction in othercosts. Success in either effort again meets the requirements of abilityto pay.

    Similarly, a union presumably attempts to estimate an organization'sability to pay before making its demands. High current profits orfavorable future prospects signal ability to pay and strengthen theunion's bargaining power. Unions have a very long history and some early

    union contracts tied wages to ability to pay. For example, a 1919printing agreement tied wages to economic conditions in the industry.Contracts covering motion picture operators have based wages on theseating capacity of theaters. Coal industry agreements have tied wagesto the productivity of coal fields. Sliding-scale agreements have gearedwages to selling prices.Both the United Steelworkers and theUnited Auto Workers attempted (unsuccessfully) to secure agreementstying prospective wage increases in their industries to companyprofits. It is not likely today that this would be seen by theworkers as a good bargain.

    Although employers profess to use ability to pay (or inability to pay)as a wage determinant, little is known about how they measure it. Anearly study found a number of organizations that estimated ability topay by inserting a projected wage increase into the latest incomestatement. This definition accords closely with the definitioncontained in a glossary of compensation terms published by World at Workthat states: "The ability of a firm to pay a given level of wages or tofund a wage increase while remaining profitable.

    Organizations probably react to the ability to pay when they perceivetheir ability is in danger. Executives are more likely to bring theability to pay up in wage discussions than are compensation experts.Further, lowering wages and othe methods of reducing costs are morelikely to be perceived as fair in bad economic times.

    Exactly how organizations measure their ability to pay is something of amystery. However, the way in which organizations use wage surveys

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    strong evidence of unfavorable prospects reduces pressure for a wageincrease, especially if it is feared that such a wage adjustment mightcause loss of jobs, and greatly increases employer resistance.

    Ability to pay is an expression of the economic forces that bear on wagedetermination. Although it is a determinant beset by measurement andforecasting problems, search theory suggests that organizations are able

    to estimate it when a decision calls for it.


    Productivity was used earlier in this section as a shorthand term forwhat the employer gets in return for the wage. Thus wage leveldetermination is often referred to as the /effort bargain/.

    Actually, as will be seen, productivity is a result of the applicationof human and other resources. As such, it is a prime determinant ofability to pay. If production increases in the same proportion as wagecosts, labor cost per unit remains unchanged. If, however, an increase

    in the wage level is not matched with a proportional increase inproductivity, labor costs per unit rise. At some point this mismatchruns the risk of exceeding the employer's ability to pay. Althoughproductivity is not widely used as an explicit wage level determinant,it is always present in the form of the effort bargain. If the employergets more output for each unit of input, the organization's ability topay is increased. For this reason, productivity deserves some discussionas part of the concept of ability to pay.

    What is productivity? How is it measured? Productivity refers to acomparison between the quantity of goods or services produced and thequantity of resources employed in turning out these goods or services.It is the ratio of output to input. But output can be compared with

    various kinds of inputs: hours worked, the total of labor and capitalinputs, or something in between. The results of these differentcomparisons are different, as are their meanings; different comparisonsare appropriate to different questions. Two main concepts andmeasurements of productivity are used, but for different purposes. Thefirst, output per hours worked or /labor productivity/, answersquestions concerning the effectiveness of human labor under the varyingcircumstances of labor quality, amount of equipment, sale of output,methods of production, and so on. The second, output per unit of capitaland labor (/total factor productivity/), measures the efficiency oflabor and capital combined. This second measure gauges whetherefficiency in the conversion of labor and capital into output is risingor falling as a result of changes in technology, size, character ofeconomic organization, management skills, and many other determinants.It is more complex and more limited in use.^8

    The first measure, output per hours worked, is the appropriate measureto employ in wage questions. It reflects the combined effect of changes(1) in the efficiency with which labor and capital are used, (2) in theamount of tangible capital employed with each hour of labor, and (3) theaverage quality of labor. It is these three factors that have been foundto best explain the long-term trend in the general level of real wages.

    It should be emphasized that labor productivity measures thecontributions not just of labor alone, but of all the input factors. In

    fact, the potential for estimating the contribution of various factorsmakes measures of labor productivity at various levels appropriate, orinappropriate, for use as wage standards.

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    *Output per hours worked*. Output per hours worked can be measured atthe job, plant, industry, or economy level.

    At the job level, it is possible to measure worker application andeffort separately from other inputs as the basis for incentive plans.

    At the plant level, estimates of the source of productivity increasescan be used as the basis of gainsharing plans. At the industry level,productivity improvements cannot be traced separately to the behavior ofworkers, managers, or investors in the industry. The contributions ofone industry to another industry's productivity cannot be separated.Therefore the use of industry productivity as a wage determinant wouldhave adverse economic consequences. For these reasons, industryproductivity is seldom suggested as a wage determinant.

    Historically, at the level of the economy, changes in labor productivityhave been used as appropriate for wage determination. In fact, theimprovement factor in labor contracts employed in the automobile

    industry from 1948 until the early 1980s is an example of such a use.Then in the 1960?s wage-price guideposts were based on the argument thatwage increases in organizations should be determined by economy-wideadvances in productivity. However, this formula use of productivity forwage determination has advocates and opponents. Advocates point out thatincreasing wage levels in specific organizations, in accordance withannual increases in productivity in the economy, insures thatproductivity gains get distributed. They also argue that distributingthese gains through price reductions may contribute to economicinstability.

    Opponents point out that although there is a long-term relationshipbetween productivity and wages, the short-term relationship is highly

    variable, which suggests that other wage-determining forces are morepertinent. They also argue that tying wages to productivity yieldsstable prices only when productivity increases are accepted as a limitto wage increases. Obviously, when the cost of living is increasing,limiting wage increases to productivity increases would be unpalatableto employees. Even more unacceptable would be wage cuts wheneconomy-wide productivity declines, as has sometimes occurred.

    In auto contracts, the improvement factor was accompanied by acost-of-living escalator clause and other wage increases. The guidepostsbroke down when price increases made the limiting of wage increases toeconomy-wide productivity increases impractical. The effect, of course,was to build higher prices into the cost structure that over time madefor the demise of the U.S. automobile industry.

    The inflationary potential of productivity formulas that are notaccepted as limits is enhanced by a tendency to seek a productivitymeasure that makes larger wage increases feasible. Increases in industryproductivity, for example, may be higher, but industry indexes are lessreliable and more variable. Such indexes may also conceal thecontribution of one industry to another's productivity. Even indexes ofnational productivity may overstate non-inflationary wage-increasepossibilities, by failing to measure the effects of transfers of workersfrom lower- to higher-productivity industries and other sources ofincrease in labor quality.

    Perhaps enough problems have been cited to argue against raising wagesin strict accordance with productivity increases. The difficulty of

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    securing acceptance of wage increases, based on national productivity asa limit, argues against the use of such a formula. Different industriesand organizations have such varying rates of change in productivity asto throw wages based solely on productivity completely out of line withother wage considerations. Higher-productivity industries would bepenalized for their higher productivity, and this would harm the economy.

    Productivity, however, may be interpreted to mean that increases inlabor productivity at constant wages lower labor cost per unit. Thisoperates through ability to pay. Productivity may also be employed inthe narrower sense ? that a productivity increase attributed toincreased performance by employees calls for an equivalent increase inpay (as with merit increases or variable pay plans). Althoughproductivity increases are often mentioned in wage level determination,especially in labor negotiations, their effect as a separateconsideration is probably minimal.

    The 1970's and 80's showed a decline in productivity growth in the U.S.In fact, some of that time period shows a decline in productivity. The

    1990's showed a resurgence in productivity growth with very high levelsfrom 1995 onward. This has been attributed to technological change andis credited to the robust economy of those years. This productivitygrowth rate continued into the early 2000's despite a downturn in theeconomy.Interest in productivity as a wage determinant seemsto ebb and flow with these changes. A major variable is the cost ofliving which tends to run counter to productivity gains. This will becovered later in this chapter.


    Employer willingness to pay may be a more powerful wage determinant thanemployer ability to pay. Organizations frequently obtain and use

    information on what other employers pay. Such information is undoubtedlythe most used wage level consideration, sometimes considered along withthe cost of living. Another determinant of employer willingness to payconsists of the state of supply of particular skills and the presence oftight or loose labor markets. This section devotes some attention toeach of these wage determinants.

    Comparable Wages

    Comparable wages constitute, without a doubt, the most widely used wagedeterminant. They represent the way in which organizations achieve thecompensation goal of being competitive. Not only are the wages andsalaries of federal employees keyed directly to comparable wages inlabor markets, but also those of most public employees in otherjurisdictions. Also, unions emphasize "coercive comparisons," andprivate organizations consciously try to keep up with changes in goingwages. Perhaps the major reason for this widespread use of the conceptof comparable wages is its apparent fairness. In this view, comparablewages help in the attraction and retention goals of compensation. Tomost people, an acceptable definition of fair wages is the wages paid byother employers for the same type of work. Employers find thisdefinition reasonable because it implies that their competitors arepaying the same wages. In essence then, labor costs become even acrossthe industry. Another reason for the popularity of the concept is itsapparent simplicity. At first glance, it appears quite simple to "pay

    the market."

    However, this illusion of simplicity vanishes once we try to "determine

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    the market rate." Precise techniques, carefully employed, are requiredto find comparable jobs and comparable wage or salary rates. Numerousdecisions must be made on which organizations and which jobs should becompared, and how best to compare them. Equally important are decisionsconcerning how to analyze the data and use them. Wage comparisons mayinvolve other organizations in the area or in the industry, whereverlocated. These decisions will be examined in more detail in the next

    chapter on Wage Surveys. An important question to consider is whetherdifferences in competitive conditions in the product market aresignificant enough to warrant a different wage level, regardless oflabor-market influences.

    The going wage is an abstraction, the result of numerous decisions onwhat jobs and organizations to include, what wage information isappropriate, and what statistical methods to employ. Some employersdecide to pay on the high side of the market, others on the low side asindicated in the previous chapter. The result is a range of rates towhich various statistical measures may be applied. Variousinterpretations of the going rate may be made and justified.

    To rely on comparable wages as a wage determinant is to rely on wages asincome rather than as costs. Comparable wage rates may represententirely different levels of labor costs in two different organizations.Setting wage levels strictly on the basis of going wages could imposesevere hardships on one organization but a much lower labor cost onanother. These difficulties are not insurmountable: many employers leanheavily on wage and salary surveys. Employer choices on what surveys toacquire and use, what benchmark jobs to attend to, and how to analyze,interpret, and use the data suggest that reasonable accommodations to"the market" are usually possible. The next chapter on Wage Surveys willgo into depth on this.

    In addition to offering a certain measurability, following comparablewages contains a good deal of economic wisdom. Wages are prices. Onefunction of price in a competitive economy is the allocation ofresources. Use of comparable-wage data operates roughly to allocatehuman resources among employers.

    Furthermore, comparisons simplify the task of decision makers andnegotiators. Once appropriate comparisons are decided upon, difficultiesare minimized. A wage level can be set where the wage becomessatisfactory as income and operates reasonably well in its allocationfunction. Wages as costs are also satisfied because unit labor costs candiffer widely between two organizations having identical wage rates;also unit labor costs can be identical in two organizations havingwidely different wage rates.

    Comparable wages also operate as a force for generalizing changes inwage levels, regardless of the source of change. Unfortunately, however,although changes in going wages tell /what/ occurred, they don't tell/why/ it occurred. The changes may represent institutional, behavioral,or ethical considerations more than economic ones.

    On balance, however, comparable wages probably operate as a conservativeforce. Because wage decisions involve future costs, employers areunderstandably unwilling to outdistance competitors. In a tight labormarket, changes in going wages may compel an organization to pay more to

    get and keep a labor force, especially of critical skills. But in morenormal periods, where unemployment exceeds job vacancies, employers willmore likely focus on equalizing their labor costs with those of

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    product-market competitors. In other words, comparable wages arefollowed as long as other considerations are not more compelling.

    Cost of Living

    Cost of living is emphasized by workers and their unions as a wage levelconsideration when it is rising rapidly. In such times, they pressure

    employers to adjust wages to offset the rise. In part, these demandsrepresent a plea for increases to offset reductions in real wages (wagesdivided by the cost of living). Wage pressures resulting from changes inthe cost of living fluctuate with the rapidity with which living costsrise; however, price rises in most years have produced employeeexpectations of at least annual pay increases. To employees asatisfactory pay plan must reflect the effect of inflation on financialneeds. This can come into conflict with the current emphasis on variablepay.

    Employers understandably resist, or should, increasing pay levels on thebasis of increases in the cost of living unless changes in competitive

    wages and/or productivity fully reflect these changes, which they seldomdo. Increases in the cost of living are partially translated into wageincreases by most employers through payment of comparable wages, andlong-term contracts with unions have fostered other methods ofincorporating cost-of- living changes. One such method is the /reopeningclause/, which permits wages to be renegotiated during a long-termcontract. Another is the /deferred wage increase/: an attempt toanticipate economic changes at the time the contract is signed. A thirdis the /escalator clause/ by which wages are adjusted during thecontract period in accordance with changes in the cost of living. Inthis third method, living-cost changes are measured by changes in theConsumer Price Index.

    Escalator clauses vary in popularity from year to year in accordancewith the rapidity of cost-of-living changes during the periodimmediately preceding the signing of the contract and with anticipationof subsequent rises. In the past, as much as 60 percent of workers underlarge union contracts have been covered by escalator clauses. Periods ofreduced inflation tend to reduce their popularity.

    Nonunion employers are much less likely to adjust wage levels in accordwith changes in the cost of living or at least to admit that they do.Most organizations would claim that they grant merit pay increases eachyear. However, when all or almost all employees get the same increase itlooks more like a cost-of-living adjustment. In extreme conditions, suchas the late 1970s double-digit inflation, organizations were prompted tomake significant cost-of-living adjustments.

    Employing the cost of living as a wage-level determinant is somewhatcontroversial. Wage rates do tend to follow changes in the cost ofliving in the short run. Tying wages to changes in the cost of livingprovides a measure of fairness to employees by assuring them that theirreal wages are not devalued. But using the cost of living as adeterminant also implies a constant standard of living. Historically,unions have opposed the principle for this reason. Methods that providethe same absolute cost-of-living adjustment for all employees mayactually impair fairness to employees. Such flat adjustments imply thateveryone's cost of living is the same and has changed by the same

    amount. Unfortunately, technical problems in measuring changes in thecost of living may make such effects inequitable.

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    Wage Rates and the Cost of Living. The argument can be made that thereis no particular correlation between changes in labor market rates andthe cost of living as the two are based upon very different measures.Market wages and their changes are based upon the supply and demand forlabor which often changes without any consideration of the cost ofliving. The cost of living is a measure based upon the area?s cost ofgoods and services as surveyed by the federal government as will be

    discussed below.It is interesting to note, however, that thecorrelation between these two measures has been changing recently. ERIhas been reporting on salaries and cost of living since 1986. Theyreport these findings in two reports, the Geographic and RelocationAssessors. Thirty years ago the relationship between the salary andcost-of-living variances were explained by correlations of .30.Recently, that correlation has risen to.

    Cost of Living and Average WageA cost-of-living index measures changes overtime in the prices of a constant bundle of goods and services. Thebundle of goods and services (called a /market basket/) is obtained by

    asking a group, whose cost of living is to be measured, to keep a recordof the price of their purchases. These data are then used to create theindex.

    The Bureau of Labor Statistics (BLS) has been publishing such an indexsince 1921, called the /Consumer Price Index/.The CPI wasdeveloped to measure the cost of living for families of urban wageearners. As such, it became the basis of escalator clauses in unioncontracts.

    Like any general index, the CPI is an abstraction that rarelycorresponds with the actual living-cost changes for any given family.Family consumption patterns differ due to age, income, composition,

    tastes, and other characteristics. These differences mean that the CPIvaries greatly in its ability to measure cost-of-living changes forvarious groups. Moreover, consumption patterns change over time, as doesthe quality of products.

    At present, two indexes are published: the CPI-U and the CPI-W. TheCPI-U represents all urban households including urban workers in alloccupations, the unemployed, and retired persons. The CPI-W representsurban wage and clerical workers employed in blue-collar occupations.Both CPI measures exclude rural households, military personnel, andpersons in institutionalized housing such as prisons, old age homes, andlong-term hospital care.

    The BLS has made changes to improve the index over time and to meetspecific problems. The latest change to both indexes involvedsubstituting a rent equivalent for home ownership. Until the early1980s, the CPI used what is called the asset price method to measure thechange in the costs of owner-occupied housing. The asset price methodtreats the purchase of an asset, such as a house, as it does thepurchase of any consumer good. Because the asset price method can leadto inappropriate results for goods that are purchased largely forinvestment reasons, the CPI implemented the rental equivalence approachto measuring price change for owner-occupied housing.

    Obviously, such technical problems mean that tying wage levels to the

    CPI varies in fairness to different groups. Moreover, at least in unionsand perhaps in most organizations, fairness seems to suggest the samecost-of-living adjustment for everyone. A compressed wage structure

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    resulting from flat cost-of-living increases may produce difficulties inrecruiting and keeping higher-level employees. It seems that changes inthe cost of living do not closely parallel changes in the supply-demandsituation of any specific employee group. Also, particular organizationsand industries may face competitive situations in product markets thatrun counter to changes in living costs.

    It also seems that wage increases that fully reflect living-costincreases build inflation into the economy. Fortunately, althoughescalator clauses narrow the time gap between price and wage changes inan inflationary period, they have been found to yield only about 57percent of a year's inflation, and they apply to only about ten percentof nonagricultural civilian employment. Although labor contractscontaining wage re-openers, deferred increases, or escalators areprevalent in the United States, most wage level decisions are widelydecentralized and give heavy weight to comparable wages. This mayprovide enough lag between price and wage changes to prevent moreinflationary effects.

    In summary, the cost of living as a wage level determinant usuallyoperates indirectly. Although attractive to employees, unions, and someemploying organizations in periods of rapidly rising prices, it shouldnever be used as the sole standard of wage adjustment. When influencesin the labor market are stronger than those in the product market,cost-of-living considerations may increase an employer's willingness topay. But when an employer is faced with strong competition in theproduct market, employees may have to choose between maintaining theirreal wages and maintaining their jobs. In inflationary periods, the costof living reinforces going wages through employer willingness to pay.

    *Labor Supplies*

    One consideration always present in wage level determination is thecompensation goal of obtaining and retaining an adequate work force. Thewage level must be sufficient to perform this function or theorganization cannot operate. Effectiveness of recruitment efforts,refusal of offer rates, and labor turnover levels may each be consideredin wage level decisions. The wage level itself is only one determinantthat effects recruitment effectiveness and labor turnover. But it is animportant one in that it is usually agreed to be the major element injob choice.

    Changing economic conditions can have a rapid change in demand forcertain skills. This creates a shortage of available workers with thoseskills, as supply does not change as rapidly. One such change occurredwhen interest rates fell and most home owners elected to re-financetheir homes, on top of coinciding high sales of homes. This created animmediate high demand for Mortgage Loan Processors. Organizations werefaced with raising wages for these workers far above equivalent jobs intheir organizations. Further, organizations engaged in training peoplefor these jobs. Then two things happened. First the supply began tocatch up with the demand. Then the real estate market slumped andinterest rates went up, meaning the demand for Mortgage Loan Processorsfell, leaving organizations with a group of overpaid employees.

    If, however, an organization experiences no recruitment or turnoverproblems, it may presume that the present wage level is adequate to

    permit securing and holding a labor force. But quality issues may stillarise. Is the quality of the labor force being maintained, or haveemployees of lower efficiency been the only ones available at the

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    present wages? Is the quality of the present labor force adequate? Is itmore than adequate? Is a change in standards of employability a goodidea? Can such a change be accomplished at present pay levels?

    Such questions emphasize the point that it may be more important tomaintain the quality of a labor force than the quantity. A labor forceof low quality at a given wage level may be more costly to the

    organization than a labor force of higher quality obtained at a higherwage level but resulting in lower unit labor costs. If an employer canlower unit labor costs by raising the wage level and standards ofemployability, such a course would deserve careful consideration. Thisapproach partially explains the existence of wage leaders. Organizationsthat pay "on the high side" may do so in the hope of attracting ahigher-quality labor force. Wage leadership may not only permit"skimming the cream" off the present labor force, it may ensure acontinuing supply of high-quality personnel from new entrants. Wageleadership companies often have a waiting list of applicants, whereasothers must continually use an aggressive recruitment program.

    Wage level decisions based on labor-supply considerations must be madein light of the prospects of the organization and the industry. Firms indeclining industries may be forced to allow wage levels to drop withreduced productivity and to plan on less efficient and lower-paid workforces. An expanding organization, on the other hand, may want toupgrade the quality of its work force by paying above the market andraising standards of employability.

    The extent to which labor-supply considerations affect wage levelsvaries greatly among organizations. Organizations in high-wageindustries in low-wage areas experience few labor-supply problems; thosein low-wage industries may face serious labor-supply problems. Althoughmost organizations fill most of their jobs from within, it is doubtful

    that any organization is free from labor-supply problems for at leastsome skills. As emphasized in Chapter 3, most organizations operate innumerous labor markets. Not only does the extent of the market (local,regional, national, or international) vary for different skills, but theuse of internal labor markets varies among organizations. Those withrelatively open internal labor markets fill most jobs from outside.Those with relatively closed internal labor markets fill almost all jobsfrom within.

    Obviously, labor-supply considerations affecting wage levels vary withlabor markets. Jobs filled externally must meet or exceed the goingrate. Jobs filled internally are constrained only by organizationdecisions. In both situations, the organization is able to vary its paylevels and hiring standards on the basis of its willingness to pay.

    *Skill and Education*. Recent emphasis in compensation upon competencyand skill based pay makes skill and education an important wage leveldeterminant. At the level of the economy this focus has been playing outfor some time in the problem of wage inequality in the U. S. Between1979 and 1995 the ratio between workers in the 90 percentile and thosein the 10th percentile increased from 3.7 to 4.8. Maybe even moreimportant is that real wages for workers in the 10th percentile fellfrom 1970 to 1990 while those in the 90th percentile rose by 10% to 15%.this increase for workers in the 90th percentile continued through the1990's.^13 One of the major forces behind this change has been the

    increasing need for educated workers and the response of many morepeople going on to college.

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    The result of this trend is creating an hour glass shaped work force inwhich the middle class is being squeezed out, leaving a large group ofhighly trained workers at the top of the labor market and another largegroup of unskilled workers at the bottom of the market.^14 Movement up the scale is more and more on the basis of education, ratherthan experience. To the extent that this trend is replicated in theorganization it would indicate that developing a wage level based upon

    the organization?s average wage would be unsatisfactory for the majorityof employees. This situation would call for two clearly different wagelevels, one for the top and one the bottom. This seems to be reflectedin the move towards a "core" group of employees with good wages,benefits and a degree of security and a "peripheral" group of temporaryand part time employees with low wages, little in the way of benefitsand no job security.


    The considerations employers use in determining wage levels must meettheir test of employee, or potential-employee, acceptance. If employees

    are unwilling to accept the wages offered, the employment contract andthe effort bargain are not completed. This statement suggests that allof the factors discussed in the introductory chapters, 2, 3 and 4, arepotential wage level determinants. For example, employee expectations,employee definitions of equity, and employee satisfaction ordissatisfaction with pay, become pertinent considerations. So do thedemands of unions and society (through laws and regulations). Ideally,these considerations find their way into employers' decisions regardingtheir ability and willingness to pay.

    Explain the functions of wage differentials in a market economy.

    Explain the functions of wage differentials in a market economy.

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

    Labour market imperfections can occur on both the supply and demand side or in some case both sides. Wages are lower when the employer is a monopsonist becausethey act as a monopolist and can erode union control of the labour in the market. On the supply side of the labour market Trade Unions cause imperfections, by using the threat of strikes and labour supply they can force up wages to the detriment of employment levels. When the market has both demand imperfections in theform of monopsony and supply imperfections in the form of Unions the wage willdepend on the negotiating position of the two sides. There can be wage imperfections when information failure occurs, employees may be misinformed about the availability of jobs at different wages. As a result, time will be spent looking for work offering acceptable wage rates. This process will incur costs including forgone wages, when workers reject lower paid jobs in favour of looking for a moreacceptable wage, theory tells us that the acceptable wage will decrease the long

    er the employee takes to get the job.

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    Employees who invest time in education are more valuable to employers due to higher productivity and consequently they can demand a higher wage than unskilled labour. The acquiring of skills is called human capital investment and is seen asa long-term assurance of high quality on the part of employers and long-term high wages on the part of employees. Many professional occupations require severalyears of full-time education at university or college and others require interm

    ediate qualifications. One can see that through the increasing modernisation andindustrialisation the demand for skilled labour continues to rise whilst employment opportunities for the unskilled continue to fall. The use of wage differentials in this situation is to reward the work involved in the attaining vocational qualifications; however, this is to the detriment of unskilled workers whose jobs become obsolete.

    Another wage differential occurs as a compensating factor to employees who haveto endure less attractive work conditions, this is known as a compensating wagedifferential. Where working conditions are undesirable then the supply will be r

    educed and therefore wages will have to be higher to attract the adequate amountof labour. Also, occupations, which demand unsociable hours, will command a higher wages than comparable jobs. Pay may not be the only thing, which will be used by employers to compensate for poor working conditions ie. A number of non-monetary benefits such as long-holidays with pay, the opportunity to travel etc. will all be used to increase market supply.

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


    Discrimination can also account for certain wage differentials, racial and gender discrimination can account for a large amount of the differential in wages between white males and the rest of the working population. Employers will pay women and ethnic minorities less due to ill-informed views about the intelligence, loyalty and productiveness of female and non-white workers. The govt. has takensome action to counteract these unwanted and unproductive wage differentials with the introduction of the Equal Pay Act, the Sex Discrimination act and the RaceRelation Act.

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