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Workers and Wages

May 15, 2012

Any time money is spent, it creates income for the seller of the good. That income must go to some human being: holders of natural resources, holders of capital, or workers. The fraction going to workers is large and fairly stable, at a little over 70%.

Source: Measuring Labor’s Share of Income by Paul Gomme and Peter Rupert. .

The basic microeconomic intuition is that if more of one factor of production is added, it will face diminishing returns, and hence a lower price (wage). Natural resources are somewhat fixed in the short run, although I would point out that in the long run, people can create more natural resources, both by extraction and innovation. Capital is not fixed, but is created by humans. Additionally, if the ratio for capital to workers drops, that will create profit opportunities for investors to rebalance the capital stock. If there are a lot of workers and a small amount of capital, the returns to capital will be high. If the returns to capital are higher in one country, investors from other countries will invest there to capture the gains, and eventually the capital stock will return to the same proportion that it was. Likewise, high returns to capital will induce the new workers to invest their own wages, further raising the capital stock. So in the short run, basic supply and demand analysis suggests that more workers will lower the wage, but not by that much.

However, there are some other forces pushing against the basic supply and demand analysis. First, the extent of the market limits the specialization of labor. The more people you can get connected to one another in a web of trade, the more specialized they can become. One of the major reasons why the world is so much richer today than it was two hundred years ago is that there are four times as many people; people who can invent, invest, and create new products and firms. People often credit technology, but technology is a partial answer. How much people do you need to support a million people being scientists? How large do markets have to be before it is worthwhile to invest in new production techniques? The more people in an economy, the more technology will advance. Historically, the densest areas have often been the richest. Today, one can see plenty of examples of this: Tokyo, Singapore, the Chinese east cost, the United States’ northeast coast, Norther Europe, etc.

Average per capita income = (Total production)/(the number of workers)

Moving people from unemployed to working in the economy can only raise the average wage (so long as the 0’s were counted). Adding new people to the economy will increase the average wage if total production increases by more than the average productivity of the economy before. This can happen if the new worker is more productive than the average worker was, or if they increase other’s productivities.


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