An entry-level doctor in the United States gets paid an average of over $1001, whereas a worker working at McDonald's gets slightly over $122. To put that in perspective, the entry-level doctor gets almost ten times the wages that a worker at McDonald's gets. How are their wages determined?
It's all based on the law of demand and supply. High demand and low supply of doctors make up a perfect recipe for a $100 hourly wage. So what career should you focus on? Should you look at the labor market's supply or demand side?
You'll find the answers to these questions and much more by getting to the bottom of this article! At the end of it, you'll have a great understanding of how wages are determined.
Wages Definition
Wages definition refers to assigning of monetary value for labor services. Wages are also known as the price of labor. Wages can be based on an hourly, daily, or weekly basis. In its simplest form, wages are the hourly cost to employ a certain worker.
Wages are the payments that assign a monetary value to labor services, also known as the price of labor.
All wages in the economy are expressed in nominal terms.
Nominal wages are wages expressed in current dollars, and many employers have labor agreements to adjust nominal wages annually to keep pace with inflation.
The value of wages that have been adjusted for inflation is called real wages.
Real wages are of significant interest to economists, as the failure of employers to adjust nominal wages equally with inflation can lead to labor problems, such as shortages. That's because a fall in real wages lowers the workers' purchasing power. As a result, there is a disincentive for work. As the supply of labor declines, shortages of labor will emerge.
Today, wages are typically automatically adjusted to deduct taxes and employee contributions to employer-run retirement plans and health insurance packages. Therefore, the take-home pay, or net pay, of workers is usually somewhat lower than the gross pay (unadjusted total) that was listed for the job.
For hourly workers who receive wages, an increase in the wage is a standard reward for good job performance or tenure on the job.
Wages Determination
Determination of wages occurs based on the interaction of demand and supply for labor.
Doctors are highly paid due to the relatively high demand for medical care and a relatively low supply of workers qualified to be medical doctors.
Careers requiring lots of education and training have higher wages due to a reduced available labor supply. Therefore, lawyers, doctors, scientists, and other skilled workers earn higher wages than other generalized careers.
Simple manual labor tends to generate low wages because there is a large supply of acceptable workers.
Fig. 1 - Wage determination
Figure 1 shows the equilibrium wage, which occurs at the point where market demand and market supply intersect. At that point, the market wage is equally determined, and the quantity of labor is Qe.
Why does wage determination occur at the point where demand and supply intersect?
Imagine for a second that employers decided to pay a wage that is below We (W1). If the wage was at W1, there would be more demand for labor than supply. As employers don't have many workers to work for them, they will increase the wage to attract the workers to come back to the labor market.
On the other hand, if the wage was above the equilibrium wage, at W2, the supply of labor would be higher than the demand. That's because most people would supply their labor at higher wages. As the supply of labor is higher than the demand, employers can negotiate with the workers willing to work at a lower wage, bringing the wage down to the equilibrium level at We.
- An employee who brings in lots of revenue will be compensated accordingly, or they could easily find another employer who will offer them a wage closer to what they generate in revenue. If demand for the good or service created by a type of worker increases, the demand for that work will also increase and raise the wage rate. Conversely, if demand for the good or service decreases, demand for that work will fall, and the wage rate will decline.
The wage will deviate from the equilibrium only if there is a shift in either labor demand or supply, which results from other factors rather than the wage or quantity of labor.
Fig. 2 - Shift in demand for labor
Figure 2 shows a shift in the demand for labor to the right from D1 to D2 which causes the minimum wage to increase from W1 to W2.
Fig. 3 - Shift in supply of labor
Figure 3 shows a shift in the supply of labor from S1 to S2. As a result of the supply decrease, the wages increase from W1 to W2.
Types of Wages
Different types of wages affect the labor market and worker compensation overall.
The minimum wage is one of the main types of wages.
The minimum wage is the minimum amount of pay a worker is guaranteed by law.
The United States has a federal minimum wage of $7.25 per hour.3 A business must pay at least this amount if it wants to employ any worker. However, there are exceptions for those who work primarily for tips or voluntary rewards offered by customers.
The federal tipped wage is $2.13 per hour, meaning that even a restaurant server who receives zero tips from customers must be credited at least $2.13 per hour worked on their paycheck.4
Compensation differences that can occur due to the difference between the minimum wage and the tipped wage are often highly controversial, with many arguing that the tipped wage should be abolished and all employees should be subject to the minimum wage.
The minimum and tipped wages also differ by state, as some states set a higher minimum wage than the federal minimum wage. Currently, thirty states and Washington, D.C., have minimum wages higher than the federal minimum wage, meaning employers in twenty states use only the federal minimum wage.5
The prevailing wage is the average wage for a particular position and/or location.
It may be known as the market wage for a particular role in a specific area, such as a police officer in a large city. To be competitive, employers must be aware of the prevailing wage and set their offered compensation to a similar level.
Knowing the prevailing wage lets employers decide whether to match the wage and accompanying benefits (health insurance, retirement plan, and any employer perks like a company car, time off, tuition assistance, etc.), set a higher wage and comparable benefits, or set a lower wage but offer more desirable benefits.
A living wage is a wage that a worker in an area would have to earn to live a certain quality of life.
The living wage can differ widely from place to place depending on the local cost of living and also by family size.
For example, the living wage for a single parent with two children will be much higher than that for a recent college graduate with no dependents. Therefore, a living wage calculator is often helpful for people planning a job change or a move to a new city.
Frequently, the living wage is considerably higher than both the minimum and prevailing wage (market wage) in many states.
Subsistence Theory of Wages
The subsistence theory of wages says employers will pay the minimum necessary amount to attract enough workers. With an ample supply of workers, the subsistence wage can be virtually any wage chosen by the employer.
This was common in large cities during the industrial era when large influxes of immigrants and domestic migrants from rural areas meant workers had little bargaining power to force employers to raise wages.
The subsistence theory of wages argues that change in the supply of labor is the primary force driving real wages to the minimum required for subsistence (basic needs).
Due to the oversupply of workers, an increase in the demand for labor does not increase the subsistence wage. It is assumed that workers are of identical skill and ability, implying simple manual labor. In cities where the supply of labor was not virtually unlimited, employers had to offer higher wages to attract sufficient workers based on the supply of labor curve.
If the supply of labor increases, the wage rate falls because employers can offer less money to attract a sufficient quantity of labor. Conversely, if the labor supply falls, the wage rate rises to attract enough workers.
If business opportunities become available, making ready workers more desirable, the labor demand increases and drives the wage rate up. On the other hand, if business opportunities are few, such as during a recession, the demand for labor falls, and the wage rate declines.
Wages vs Salary
The main difference between wages vs salary is that wage workers are paid by the hour or for each completed unit of labor, while salary workers often get a set sum spread out over an entire year.
The words 'wage' and 'salary' are often used interchangeably in everyday conversation. Even though both refer to an employee's salary, there are differences in how companies compute and arrange that pay.
The primary difference between a wage and a salary is that wages are contingent on the amount of time or effort put in by the worker. In contrast, salaries are paid out in predetermined amounts over an entire year.
The annual salary is a predetermined sum, often including paid time off for vacation and illness. Wages benefit employers in some businesses, most often those that employ workers whose schedules are more unpredictable.
While salaried employees may receive hourly extra duty pay, they are typically not paid extra money for taking more hours per week to complete their routine tasks.
For example, a salaried accountant who spends some extra time during a week to complete a project is not paid for those extra hours. An hourly worker who is on the clock for more hours during a week is paid for those hours of labor.
Wages - Key takeaways
- Wages are the payments that assign a monetary value to labor services, also known as the price of labor.
- Nominal wages are wages expressed in current dollars, and many employers have labor agreements to adjust nominal wages annually to keep pace with inflation. The value of wages that have been adjusted for inflation is called real wages.
- The minimum wage is the minimum amount of pay a worker is guaranteed by law.The prevailing wage is the average wage for a particular position and/or location.A living wage is a wage that a worker in an area would have to earn to live a certain quality of life.
- The interaction between labor demand and labor supply determines the equilibrium wage.
- The subsistence theory of wages argues that change in the supply of labor is the primary force driving real wages to the minimum required for subsistence (basic needs).
References
- Salary.com, Wage for Entry Level Doctor Salary in the United States, https://www.salary.com/research/salary/posting/entry-level-doctor-hourly-wages
- Indeed.com ,How much does a Crew Member make at McDonald's in the United States?, https://www.indeed.com/cmp/McDonald's/salaries/Crew-Member#:~:text=Average%20McDonald's%20Crew%20Member%20hourly,which%20meets%20the%20national%20average.
- U.S. Department of Labor, Minimum Wage, 2022, https://www.dol.gov/general/topic/wages/minimumwage
- U.S. Department of Labor, Minimum Wages for Tipped Employees, 2022, https://www.dol.gov/agencies/whd/state/minimum-wage/tipped
- The Economic Policy Institute, Minimum Wage Tracker, 2022, https://www.epi.org/minimum-wage-tracker/
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