The Theory of Wage Rates 5

Why Different Workers Are Paid Different Wages

We still have to answer the question with which we began: Why are different workers paid different wages? The preceding four blogs have laid the groundwork for the answer.

Over time, the going wage roughly equates the number of workers entering a worker pool to the number of workers hired out of that pool. If instead the number of workers hired out consistently exceeds the number of workers entering the pool (demand exceeds supply), eventually the wage rises for that type of worker. The higher wage reduces the number of workers businessmen want to hire and increases the number of workers who want to enter that worker pool. When supply approximately equals demand, the wage stops rising.

If supply exceeds demand, the number of workers entering the pool exceeds the number hired out and the wages for that type of worker will fall. At the lower wage, businessmen will want to hire more workers of that type, and fewer workers will enter that worker pool. Eventually supply will approximately equal demand, and the wage rate will stop falling.

Here is the decisive point: Changes in supply relative to demand and in demand relative to supply are changes in relative scarcity. An increase in demand relative to supply is an increase in relative scarcity. An increase in supply relative to demand is a decrease in relative scarcity.

For example, suppose the pool of unemployed web masters is increasing by 1000 each month and businessmen want to hire 10,000 web masters each month. The increase in demand exceeds the increase in supply, the scarcity of web masters is increasing, and so will their wage rate.

Alternatively, suppose the number of unemployed new MBAs (Master of Business Administration) is increasing by 800 each month, while businessmen want to hire 500 new MBAs each month. The increase in supply exceeds the increase in demand, new MBAs are becoming less scarce, and their wage offers will decline or stop rising to reflect that fact.

The changes in supply and demand that change workers’ wages and salaries are simultaneously changes in relative scarcity. If the supply of crane operators increases relative to the demand, that is a decrease in the relative scarcity of crane operators and their wages fall. If the demand for brain operations increases relative to the supply of brain surgeons, that is an increase in the relative scarcity of brain surgeons, and they can charge more for their services.

The wage rate of every worker of whatever kind or type or skill or training reflects the scarcity of that kind of worker relative to all other kinds of workers. If we array the annual wages for all the workers in the economy, from lowest to highest, the result is a hierarchy reflecting the relative scarcity of every kind of employee. Workers with higher salaries are relatively more scarce than workers with lower salaries.

The same hierarchy ranks all the different types of employees according to their value to their employers. Employees with higher wages have higher value than employees with lower wages. This is because an employer chooses to pay the wage required by a worker’s relative scarcity only when he thinks the worker is worth it.

There is much more to say about this—next time.