Economics » Factors of Production » Determination of Wages, Interest, Profits


Wages are the reward for or price of labour. Classical economists argue that wages are determined (like all prices) by supply and demand. They call this the market theory of wage determination. When workers sell their labour, the price they can charge is influenced by several factors on the supply and demand sides. The most basic of these is the number of workers available (supply) and the number of workers needed (demand). In addition, wage levels are shaped by the skill sets workers bring and employers need, as well as the location of the jobs being offered. The factors that determine wages can be summarised as:

  1. Ability to Pay: The ability of an industry to pay will influence wage rates to be paid. If the industry is running into losses, then it may be able to pay higher wage rates. A profitable enterprise may pay more to attract good workers. During the period of prosperity, workers are paid higher wages because management wants to share the profits with labour.
  2. Demand and Supply: The labour market conditions or demand and supply forces also determine the wage rates. When the demand for a particular type of skilled labour is more and supply is less, the wages will be more. On the other hand, if supply is more than the demand, then more people will be available at lower wage rates.
  3. Prevailing Market Rates: No enterprise can ignore prevailing wage rates. The wage rates paid in other industries will form a base for fixing wage rates.
  4. Cost of Living: The wage rates are directly influenced by cost of living in a place. The workers will accept a wage which may ensure them an acceptable standard of living.
  5. Bargaining of Trade Unions: The wage rates are also influenced by the bargaining power of trade unions. The stronger the trade union, the higher the wage rate will be. The strength of a trade union is judged by its membership, financial position, and type of leadership.
  6. Productivity: Productivity is the contribution of the workers in order to increase output. It also measures the contribution of other factors of production like machines, materials, and management. Wage increase is sometimes associated with increase in productivity. Workers may also be offered additional bonus, raises, etc. if productivity increases beyond a certain level.
  7. Government Regulations: To improve the working conditions of workers, government may pass legislation for fixing minimum wages of workers.

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