The Theory of Wage Rates 3

Why Different Workers Are Paid Different Wages

In the creation of wage rates, the pools of unemployed workers of each occupation are the market supply of workers of that kind. The market demand for workers of each occupation is the total quantity of workers of that kind that businessmen want to hire (in the relevant geographical area over some time period.)

In a normal economy (the economy is neither booming nor crashing), newly unemployed workers looking for work join their specific pools at some rate per month. Over the same time, businessmen looking for workers of that kind hire the men they need at approximately the same rate. The pool remains roughly the same size as the number of jobs offered and filled rises and falls while the market wage is unchanged.


The key to understanding changes in wages is the thinking of the businessman who changes his wage offer first. Once we understand his thinking, usually it will be obvious why others follow—but first we have to understand the one who goes first.

Wages change when the worker pools shrink or expand to the point that businessmen find it significantly harder or easier to hire the workers they need. Let us first consider a shrinking pool:

A pool of unemployed workers of a particular type shrinks because either the demand for those workers increases or the supply decreases. An increase in demand is an increase in the number of workers businessmen want to hire at the current wage. This increase causes a decrease in supply as businessmen hire workers out of a specific pool at an increased rate.

Suppose the pool of accountants looking for work is shrinking due to a general increase in demand for accountants. At some point, the businessmen looking for accountants start to have difficulty finding employees they want to hire. More and more time is required to identify an acceptable candidate, and then he accepts another offer.

Eventually, some one businessman decides that he must offer a higher wage to get the man he wants. This is how wages rise. The first businessman to offer a higher wage does so because he must in order to hire the worker he needs. Even if he does not advertise the new wage, it will quickly become known to the interested parties. Other businesses who also are looking for accountants to hire will have to match the higher wage in order to hire anyone.

This is how businessmen compete for employees. They offer to pay the going wage, they offer a higher wage when necessary to hire the workers they want, and they raise the wages of their current employees when the going wage rises. They do this because they must in order to get and keep the workers they need.

Next time we will see how wages fall.