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Labor Theory Supply And Public Policy

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Discuss about the Labor Theory Supply and Public Policy.



The essay elucidates on the relationship between the pay and performance of the employees in the organization. The employee’s rewards are reliant on the project completion and their job performance. The study also highlights on the objectives, goals and the functions of the Australia’s Fair Work Commission (FWC). The FWC is an independent institution that carries out the functions in relation to employment (Schmitt, 2013). The efficiency wage theory and the concepts relating to general labor supply and backward bending supply curve is also explained in this essay. The implementation of efficiency wage theory in the firms and the issues encountered in it is also highlighted in this study. The recommendations on the efficiency wage theory are also given in this study.

The FWC mainly operates in social, industrial and economic environment, which is subject to recurrent changes. The main objectives of Australia’s FWC are to provide fairness in workplace and manage difficult circumstances in the business organizations. The goals of FWC are to recognize the diverse needs as well as expectations of the community and high compliance levels with legislative obligations. Their strategic goals include- efficiency, innovations, rising accountability and enhancing productivity. This independent body carry out certain functions that includes-

  • Promote cooperative and prolific relations in workplace
  • Resolve dismissal claims
  • Set national least wage
  • Approving the agreements of business enterprise
  • Deal with common protection claims
  • Assist with the resolution of organizational disputes
  • Assist the bargaining procedure for agreements in business enterprise

The free service that FWC provides includes-

  • Educating Australians about fair practices in work
  • Building strong relationships with the stakeholders and industry
  • Enforce laws in workplace and deter employees in doing wrong thing in community
  • Evaluating breaches of laws in workplace

Efficiency wage theory, General labor supply and pay performance structure

The concept of efficiency wage theory explains that a company might benefit from becoming highly productive if they pay their employees the wages that is higher than the equilibrium level. According to efficiency wage theories, the company benefits in four ways from less workers turnover, higher workers effort, skilled employees and rise in employee’s health.  These are explained as:

Increase in workers effort level- This theory reflects that the employees whose wage is above equilibrium wage will put more effort than those employees who are paid less than the equilibrium wage. Moreover, the workers slack off as higher wage leads to increase in opportunity cost of job loss (Lavoie and Stockhammer, 2013) Hence, it can be stated that there is a direct relationship between employees wages and their effort. The relationship between efforts per employees is given as-

Ei= e[Wi/ We], where Ei= workers effort, Wi= Wage given by the company  and We= Expected existing wage outside firm.

Decline in employee’s turnover- This theory explains that the wage above equilibrium wage decreases costly workers turnover. This explains that if the employees benefits outweigh cost , then they will choose to stay. Analogously, if business cost outweigh their benefits, then they will choose to quit. However, if the workers turnover decreases, then some resources might freed up and hence can be utilized in efficient processes.

Rise in workers quality- It suggests that efficiency wages will attract highly skilled employees in the business. The entity will offer efficiency wage to high quality workers in order to retain them in business (Shields et al., 2015). Thus, low quality workers will work for the equilibrium wage as high quality workers demand higher wages from the company.

Improve in employee’s health- This explains that the employees who are paid higher wages will improve their health and productivity. The reason behind this is that higher wage improves the standard of living of the workers. However, this raises the employee’s quality of living, which results in better health. This improve in worker’s health increases productive than those workers who are paid less wages.

There are various sub models of efficiency wage theories including -shirking model, fair wage-effort model, adverse selection model and turnover model. These models of efficiency wage assert that the workers productivity in the organization is directly related with the wages that the workers receive. This sub- models is illustrated below:

  • Shirking model- This model highlights that higher wage paid to the worker increases the risk of losing their job. However, the risk of shirking of employees reduces.
  • Fair wage-effort model- According to this model, if fair wage is not given to the employees, then the workers do not give higher effort in their work.
  • Adverse selection model- In this case, if the wage to be paid to the workers is above the equilibrium wage in the labor market, then it helps the entity in choosing better workers from large pool.
  • Turnover model- This model reflects that if the wages paid to the workers is higher than what they receive in other firms, then it will decrease the turnover in the entity. Thus, it also reduces the coat of firms in hiring as well as training their workers.

The SG Company is one of the main driving factors of the Singapore economy. The efficiency wage theory of this company has improved the firms performance. This means that as the SG Company increased the pay of their employees, the total productivity in the business improved. Although there has no changes in the responsibilities of their employees, implementation of new technologies required the skills of their employees. However, the company strategized to hire skilled employees by offering them higher pay. This strategy of utilization of skill-based pay as well as knowledge- based pay improved their job performance. This organization has also adopted flexible work pattern for improving productivity and save the cost of overtime. Even they introduced a plan of paying their employees one and half times higher than basic pay rate of employees who are working for overtime. The managers of this organization chose to pay efficiency wage in order to avoid decrease in turnover, shirking and attract skilled workers.This implementation of efficiency wage improved skills and productivity. This in turn improved the firms performance and  helped this company in expanding their business in global market.


General labor supply

Labor supply refers to the total work hours that the employees wishes to work at a particular wage rate.  Higher wages encourages the employees in supplying more labor as works becomes more attractive in comparison to leisure (Burdett & Mortensen, 2012). Thus, the labor supply curve becomes upward sloping.  The factors that influences the workers labor supply includes-

  • Substitution effect of increase in wages- Increase in wages will provide higher value to employees work than leisure. If the work becomes more profitable, then it raises the opportunity cost of leisure. Hence, the substitution effect leads to rise in work hours owing to rise in wages.
  • Income effect of high wages- In this case, the rise in wages causes the employees to work for less hours. The reason behind this is that the employees might get higher pay by working for few hours (Trevor, Reilly & Gerhart, 2012). Thus, this might lead to less work by the employees in business. However, after rise in wages, the employees might work less as they achieve their income by spending lesser hours in working.

Therefore, if substitution effect becomes greater than income effect of rise in wages, then the labor supply curve slopes upward. On the other hand, if the income effect becomes stronger than substitution effect beyond a particular wage rate, then the labor supply curve turns in backward direction. The labor supply curve shifts in response to variation in changes to range of factors that includes-

  • Change in workers preferences- Change in workers attitude towards leisure and work shifts the labor supply curve. If the employees decide to value more leisure, then they might work for lesser hours for the wage and this will shift the labor supply curve to left.
  • Variation in income- The rise in income will reduce the labor supply. The variation in income results from variation in wages that is shown by movement along supply curve
  • Change in product price- Several products are usually labor complements. This means that if the price of product changes, the workers might choose in consuming more time in leisure and hence supply less labor.
  • Changes in total population- Increase in total population increase the labor supply while decrease in population lowers it. The organizations of labor opposes to rise in immigration as increase in total number of employees shifts the labor supply curve in rightward direction.
  • Variation in expectations- Variation in expectations will impact on the labor supply is expectancy in life.

The backward bending supply curve of labor refers to the condition in which as the wages rises beyond the particular level, then the employees substitute leisure with respect to their total time in work. However, increase in wage leads to decline in supply of labor and hence less time for labor has being offered for sale (Canto, Joines & Laffer, 2014). This contrast indicates that higher wage tempt the employees to spend more hours in work for wage. Therefore, backward bending supply curve of labor occurs when higher pay basically entice employees in working less and consume high time for leisure.


Pay performance structure

Pay for performance framework implies pay that is directly related to the performance of an employee in meeting the objectives of the business. The managers of the specific business frames performance goal to which the workers are held accountable (Gerhart, B., & Fang, M, 2014). The performance of the workers are mainly analyzed with the help of metrics that can be either financial indicators or indirect indicators namely consumer satisfaction, development speed etc. In addition, schemes for pay performance combines fixed salary with different pay component, which varies with the performance of an individual. It has been stated by Fang, M., & Gerhart (2012), better performance of an employee will receive higher pay band while poor performance of an individual will get low pay band. This pay for performance structure is also termed as incentive pay.

In real world, this efficiency wage theory is sometimes not effective in maximizing profit of the business organizations. The models of efficiency wage attempts in predicting the behavior of the organizations and trade-off in the process of decision making. One thing that is common in all efficiency wage framework is that if the wages paid to the workers are above the market clearing level, then the production costs of the company’s increases that in turn generates involuntary unemployment.

In Singapore, the electronics-manufacturing sector is the main driving force of this economy as it contributes to higher percentage of this country’s GDP growth rate. It has been noted from the recent study that pay performance framework differs among the electronics firms (Fabris, 2013). The utilization of skilled-based pay as well as knowledge based pay has been widespread among this industry. This practice has been common among all the staffs that includes- skilled employees, mangers, supervisors etc. The difference in percentage of minimum and maximum pay for managerial staff ranged from 25% to 379%. In addition, few companies of this industry did not adjust the pay of their workers for acquiring management development or training program. However, they did provide efficiency wage to the employees of high quality. The pay range also varied in higher percentage among the senior managers and other executives. The various issues that this industry of this nation faces owing to implementation of this theory includes-

  • Inadequate criteria in measuring employees performance
  • Inappropriate systems for performance appraisal
  • Lack of regular performance feedback
  • In some companies, the pay system has not been designed in meeting the objectives of the business
  • Combination of intrinsic as well as extrinsic rewards has been absent in few firms.
  • Absence of scheme assessment in regular way
  • Lack of proper pay quantum


The recommendations for the implementation of the efficiency wage theory in the business organizations includes-

The companies must design their performance pay structure in such a way that it satisfies the needs of the workers while achieving their business targets (Weiss, 2014).  The performance pay framework must be designed in proper way for promoting the quality of performance that an organization requires. Before designing the framework, they must –

  • Analyze the business objectives and targets
  • The business policies as well as practices must be mentioned in their offer letter
  • The company should provide good business environment to the employees
  • Proper training and development program should be provided to each employees
  • Appropriate metric should be implemented by the company in order to assess the performance of workers in accurate way
  • The intrinsic system of reward must be strengthened through consultation, good communication, job satisfaction, participatory systems etc.
  • The employees must be consulted in order to ascertain that the desired business objectives can be met


The efficiency wage concept has become popular over the last few decades in the organizations of both the developed and developing countries. These concept also indicates dispersion in wage and involuntary unemployment that occurs within the firms. In these efficiency wage structure, the companies generally chooses to pay higher wages to skilled and knowledgeable employees in order to decrease employees turnover, eliminate shirking and increase productivity. Moreover, as the firm increases the wage of high quality employees, the low graded employees were given less pay. As a result, some employees quit the job and hence this leads to involuntary unemployment in the economy. This in other way adversely affects the GDP (Gross domestic product) growth of the respective economy.



Burdett, K., & Mortensen, D. T. (2012). Labor supply under uncertainty. In 35th Anniversary Retrospective (pp. 5-53). Emerald Group Publishing Limited.

Canto, V. A., Joines, D. H., & Laffer, A. B. (2014). Foundations of supply-side economics: Theory and evidence. Academic Press.

De Franco, G., Hope, O. K., & Larocque, S. (2013). The effect of disclosure on the pay-performance relation. Journal of Accounting and Public Policy, 32(5), 319-341.

Dunlop, J., & Segrave, M. (2016). The theory of wage determination. Springer.

Ehrenberg, R. G., & Smith, R. S. (2016). Modern labor economics: Theory and public policy. Routledge.

Keeley, M. C. (2013). Labor supply and public policy: A critical review. Elsevier.

Fang, M., & Gerhart, B. (2012). Does pay for performance diminish intrinsic interest?. The International Journal of Human Resource Management, 23(6), 1176-1196.

Fabris, N. (2013). Efficiency-wage model. Sociologija, 55(3), 461-474.

Frey, B. S., Homberg, F., & Osterloh, M. (2013). Organizational control systems and pay-for-performance in the public service. Organization Studies, 34(7), 949-972.

McDermott, A. M., Conway, E., Rousseau, D. M., & Flood, P. C. (2013). Promoting effective psychological contracts through leadership: The missing link between HR strategy and performance. Human Resource Management, 52(2), 289-310.

Gerhart, B., & Fang, M. (2014). Pay for (individual) performance: Issues, claims, evidence and the role of sorting effects. Human Resource Management Review, 24(1), 41-52.

Lavoie, M., & Stockhammer, E. (2013). Wage-led growth: Concept, theories and policies. In Wage-led Growth (pp. 13-39). Palgrave Macmillan UK.

Kruppe, T., Rogowski, R., & Schömann, K. (2013). Labour market efficiency in the European Union: Employment protection and fixed term contracts. Routledge

Schmitt, J. (2013). Why does the minimum wage have no discernible effect on employment?. Center for Economic and Policy Research, 22, 1-28.

Shields, J., Brown, M., Kaine, S., Dolle-Samuel, C., North-Samardzic, A., McLean, P., ... & Plimmer, G. (2015). Managing Employee Performance & Reward: Concepts, Practices, Strategies. Cambridge University Press.Weiss, A. (2014). Efficiency wages: Models of unemployment, layoffs, and wage dispersion. Princeton University Press.

Trevor, C. O., Reilly, G., & Gerhart, B. (2012). Reconsidering pay dispersion's effect on the performance of interdependent work: Reconciling sorting and pay inequality. Academy of Management Journal, 55(3), 585-610.


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