Wage Determination Process

Wages can be expressed in two ways. When they are expressed in terms of money paid to the worker they are called nominal wages. But when they are expressed in terms of their purchasing power with reference to some base year they are called real wages. These wages are arrived at by making adjustment in the nominal wages for the rise or fall in the cost of living.

How do we measure changes in the cost of living, or changes in the prices that consumers pay? The measuring rod is the consumer price index number. This index number is intended to show over a period of time the average percentage change in the prices paid by the consumers belonging to the population group proposed to be covered by the index for a fixed list of goods and services consumed by them. The average percentage change, measured by the index, is calculated month after month with reference to a fixed period. This fixed period is known as the ‘base period’ of the index; and since the object of the index is to measure the effect of price changes only, the price changes have to be determined with reference to a fixed list of goods and services of consumption which is known as a fixed basket of goods and services.

Important steps in the construction of this index number are as follows:

  1. Selection of representative commodities consumed by the group.
  2. Making arrangements for obtaining their price quotations regularly.
  3. Selecting a base year and converting current prices into price relatives based on the prices of the base year.
  4. Obtaining a weighted average of the price relative taking the quantities consumed in the base year as weights.

How are wages determined?

Economists have developed a number of theories which try to explain how wages are determined on a macro level. The Subsistence Theory of Wages, for example, states that the real wages of unskilled workers always remain at or very little above subsistence level. If real wages rise more than enough to provide a bare subsistence, the population would expand at a greater rate than the increase of food and other necessaries. The growth of population would increase the number of workers seeking jobs and the pressure of the big supply of labor would force wages down again to subsistence level. Thus improvement in real wages can only be temporary. This theory has considerable validity in a heavily populated country with high birth rate like India. The wages of the great majority of workers in our country are still on the subsistence level and may continue to be so until our development programmes cause our rate of productivity growth to become considerably greater than the rate of population growth.

According to the Marginal Productivity Theory of Wages, in every enterprise there is a point beyond which it will not pay the management to engage more laborers. At this point the laborer produces just enough to cover his cost to the employer. All the laborers being assumed to be of the same quality, they will all receive the same wages, i.e., the wages representing the product of the marginal laborer. This is also not correct. In actual practice wages of laborers, even if they are of the same quality, differ.

What then determines the wages of a worker? In actual practice it seems to be determined by a number of factors such as the philosophy of management towards wages, region-cum-industry settlements, internal pricing through job evaluation, employer’s capacity to pay, court judgments, local area going rates, collective bargaining and government laws.

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]
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