The most acceptable theory of wages is the modern theory of wages. It is also known as Demand and Supply theory of wages. According to this theory wages are determined by demand and supply of labour.
Demand for labour : Producers demand labour because labour is productive. When a labourer is employed he produces goods. The capacity of labourer can be measured in terms of goods. According to marginal productivity theory of wages the rate will be equal to the marginal productivity of labour. No producer will pay a wage higher than the marginal productivity of labour. As more labourers are employed, the marginal productivity of labour falls keeping the other factors constant. This happens because of the operation of the law of diminishing returns. At higher level of wages the demand for labour will be low, and at lower level of wages the demand for labourers will be high. So, the demand curve for labour slopes downward from left to right.
Supply of labour : By the supply of labour, we mean the number of workers of a given type of labour which would offer themselves for employment at various wage rates. The supply of labour depends on the following factors:
1) Population, 2) Age composition of population, 3) Working age, 4) Expenses of education, 5) Preference between leisure and work, 6) Attitude of women towards work, 7) Birth control 8) Wages.
If other things are constant, generally as wages increases the supply of labour will increase, and vice versa. So the supply curve for labour slopes upward from left to right.
Determination of wages : According to this theory wage rate is determined by the interaction of demand for supply of labour. This can be shown with the help of the following diagram:
In the diagram, SS is the supply curve of labour, And DD is the demand curve for labour. These two curves intersect each other at point E. So, OW is the equilibrium wage rate as at this wage rate both the demand for the supply of labour are equal. At a wage higher than OW the demand for labour is less than the supply of labour.
So, some labourers will not be able to find employment. So, the wage rate will come down till all the labourers can be employed. On the contrary if the wage rate is below OW, the demand for labour will be more than the supply of labour. Consequently the wage rate will rise through competition among employers till the demand for labour becomes equal to the supply of labour.
