The Theory of Wage Rates 1

Why Different Workers Are Paid Different Wages
and Receive Different Incomes

I have been asked, “Doesn’t the law of supply and demand, on the macro level, tell us that wages will fall to the point at which all seeking employment can be hired?“ The superficial answer is “yes,” but that is worthless unless you can explain how and why it happens.

The macro level is the level of the economy as a whole. The fundamental answer is that this question cannot be dealt with on that level. Rather, the answer has to be found on the level of “thousands of local worker markets where wages are set and individuals are hired.” Economic analysis has to begin with individuals: what they think, what they choose, why they do what they do. The macro level is just the statistical summation of what many individuals have done.

Another important set of questions also must be answered on the individual level: Why do different people receive different wages? What determines the wages people receive? Why are some people paid much more than others? This is not an idle inquiry. The practical value of a free economy in men’s minds depends on satisfactory answers to these questions.

Let us begin:

“Worker pools.” This is the key concept necessary to grasp the operation of local worker markets. Worker pools consist of the unemployed workers of every specific kind and type of occupation, a different pool for each occupation. The population of each pool is composed of people who have quit or who have been fired or who are entering the work force for the first time or who are reentering the work force after an absence and who are looking for work of a particular kind.

The members of a worker pool may be trained in a particular profession or skill like accounting or engineering or nursing and be looking for a job in their field. They may have a generalist kind of background in administration or management and be looking for a job where they can apply their knowledge. They may have little or no training or background and be looking for a job where they can learn a business, an occupation, a skill, or a trade. They may have no career ambition and be looking for any kind of work to support themselves and their families.

There are many, many pools of workers—as many pools as there are particular kinds, types, and classifications of jobs that can only be filled by workers with a particular skill or knowledge. In an advanced industrial economy, there are thousands of pools.

The number of men and women in each pool constitute the supply of workers relevant to the creation of the wage rate for that type of worker. If there are twenty-six bricklayers in the Chicago area looking for work, then the supply of bricklayers is twenty-six, and that is the supply (in conjunction with the demand) that causes the bricklayer wage rate to rise or fall or remain unchanged.

Now, what determines the demand?