What Determines Pay?

Readers Question: What factors determine what someone deserves for pay?

Basic economic theory suggests that wages depend on a workers marginal revenue Product MRP. (this is basically the value that they add to the firm who employs them

MRP is determined by two factors

• MPP – Marginal phyiscal product – the productivity of a worker
• MR – Marginal Revenue of last good sold – Effectively the price and demand for the good that the worker produces.
• More on Marginal Revenue Product and determination of wages

Thus, if you imagine pay for strawberry pickers, the worker who picks much faster and fills his basket of strawberries should get paid higher than a lazy worker who falls asleep. For jobs such as strawberry picking, firms can pay piece – meal and link pay to productivity.

Another factor that determines pay, is the demand for the good. For example, the best football players get paid much more than the best hockey players because there is much more demand for watching football games, there is more money in the sport so clubs are willing and able to pay much higher salaries to get the service of the best players.

As well as demand, pay will be determined by supply. Workers who have specialist skills will generally be awarded with higher pay. You could say if someone spends 5 years to be trained as an accountant, they deserve higher pay to reimburse them for the investment of time in becoming skilled.

Problems with this Theory.

• It is difficult to measure productivity. As a teacher should my pay depend on the results of my students? – For a job like judge, teacher, nurse, there is no easy way to measure productivity. It becomes a normative judgement.
• It assumes competitive markets. But, in practice many labour markets are imperfect. Either firms have monopsony power or workers form trades unions. This means firms are often able to ignore MRP in setting wages.
• The question of who ‘deserves’ higher pay is different to who can command a higher wage. A footballer may be able to earn £50,000 a week, because he can earn his club alot of money. But, does that mean he necessarily deserves £50,000. Perhaps he doesn’t ‘deserve’ so much. But, it becomes a very normative judgement to decide who deserves what. Many may say a nurse ‘deserves’ as much as a popstar. But economic forces are unlikely to lead to equal pay.
• Pay will also vary depending on cultural differences. The best hockey players in Pakistan will be rewarded with high pay because it is one of the national sports. But, in England, hockey is a very minor sport so pay is relatively lower.