Thursday, August 27, 2009

Modern Theory of Wages and Employment

The modern economist by and large agree with Keynesian analysis. But there are some differences which lay foundation of modern theory of wages and employment. These differences are discussed below.

According to Keynes a decline in the real wage is condition for increase in employment. Since organisation, equipment and technique do not change in the short run, an increase in aggregate demand would lead to increased output and rise in marginal cost and prices. Rise in prices means a fall in real wages even when money wages remain constant.

But modern economists do not agree that an increase in employment resulting from increase in effective demand would necessarily lower real wage. They put forward the following arguments in support of this view.

(i) It is pointed out that in fixing prices of their products the producers usually follow “fuel cost” pricing policy rather than fixing them on the basis of marginal cost. When prices are fixed on full cost basis, costs will fall as output expands upto a point at which rising marginal cost rises above total unit cost. Till this point is reached, it is possible to expand output at prices lower than those obtaining before the expansion of output marted.

(ii) Keynes has assumed that in the short sum there is no change in organisation equipment and technique so that marginal costs must rise. But we know that improvement in these respects are continually being made which check the tendency of the marginal costs to rise.

(iii) The modern economists believe that the marginal cost curve remain flat over considerable range of output, where as Keynes believe that the marginal cost curve rises upward even with a small increase in out put. It follows therefore that in the view of modern economists it is not necessary for the cost and prices to rise as output expands and the real wage need not fall. Improvements in techniques may even result in the fall of the marginal cost. Hence real wages may even rise instead of falling. The modern economists do not, therefore subscribe to the view that there is an inverse relationship between wage rates and employment. They are more optimistic in thinking that there are possibilities of expanding employment through raising aggregate demand. This is because according to modern theory, prices need to rise less as employment and output expand then what Keynes had believed.

Barring the points mentioned above, the modern economists subscribe to Keynesian analysis of relationship between wages and employment.

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