The Modern Theory of Wages is an improvement over the Marginal Productivity Theory. It explains wage determination through the interaction of demand and supply of labour. According to modern economists, wages are determined not only by productivity but also by various economic and institutional factors.
Demand for labour is derived demand, meaning it depends on the demand for goods and services produced by labour. It is based on the marginal productivity of labour.
The demand curve for labour slopes downward because as more labour is employed, marginal productivity declines due to the law of diminishing returns. Therefore, employers are willing to pay less wage for additional workers.
Supply of labour refers to the number of workers willing to work at different wage rates. It depends on factors like population, skill level, working conditions, and preferences.
The supply curve of labour generally slopes upward, indicating that more workers are willing to work at higher wages.
According to the modern theory, wages are determined at the point where the demand for labour equals the supply of labour. This point represents equilibrium in the labour market.
If wages are above equilibrium, supply of labour exceeds demand, resulting in unemployment and downward pressure on wages. If wages are below equilibrium, demand exceeds supply, leading to a rise in wages.
Thus, wages adjust automatically to bring equilibrium in the labour market. This theory provides a more realistic explanation than earlier theories as it considers both demand and supply factors.
Equilibrium wage is determined where Demand = Supply of Labour
The Modern Theory of Wages provides a comprehensive explanation of wage determination by combining demand and supply factors. It is more realistic than earlier theories but still has certain limitations. It remains an important tool for understanding wage determination in modern economies.