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Wages

WAGES ARE COMPENSATION for a worker's time and effort on behalf of an employer. Wages are often specified as a rate of pay, which falls into two categories: time rates and piece rates. Under a time rate, workers are paid per unit of time, usually hourly. Under a piece rate, workers are paid according to the quantity they produce. Alternatively, many workers are paid an annual salary, regardless of the number of hours they work. Some pay schemes combine multiple methods.

For example, many sales representatives receive a base salary and a commission, which is equal to some prespecified percentage of the value of their sales. A worker's total compensation is composed of two main categories: money wages and benefits. Wages comprise the majority of a worker's total compensation, equal to over 70 percent of total compensation in the United States. Some benefits, such as health insurance, are generally not specified according to time worked or output produced, but provided to workers so long as they meet some minimum hours requirement. Other benefits, such as contributions to retirement plans, are tied to a workers' total monetary wages.

The wage rate is a price, and like any price, the wage rate provides a signal to both employers and employees. Holding all other factors constant, workers will supply more labor when the wage rate increases. Conversely, employers respond to increasing wages by decreasing their demand for labor.

In practice, workers take their total compensation into account when deciding what jobs to take and how many hours to work. Likewise, employers take the total hourly cost of employing labor, which includes total compensation and certain government taxes, when deciding how much labor to employ. Thus, money wages are only part of the story.

Time Rates and Piece Rates

Both time and piece rates are common in the United States, with great variation in their use across industries. Generally, employers are more likely to use piece rates when they can easily identify individual workers' output. This will be more difficult when the production process is characterized by significant amounts of teamwork or when the speed of production is out of an individual worker's control, as with an assembly line. Unlike time rates, piece rates give workers an incentive to expend more effort in order to increase output. Piece rates can also improve the quality of an employer's applicant pool since piece rates tend to attract the most productive workers. One potential drawback of piece rates is that they may also cause workers to sacrifice quality in order to increase the quantity they produce.

Additionally, some workers may fear the possibility that managers will interpret the high level of productivity achieved under a piece rate system as evidence that the job is not as difficult as first believed. In this case the managers may lower the piece rate to match their new expectations. This is known as the ratchet effect. In practice, many firms have experienced increases in productivity and profitability when moving from a time rate to a piece rate.

Wages and Human Capital

Wages are tied to a worker's productivity, which depends on the level of technology, the amount of capital used in the production process, and the worker's level of human capital. Human capital refers to the set of skills, knowledge, and ability a worker possesses. Workers can increase their stock of human capital either through education or on-the-job training. Gary Becker was the first economist to formalize the theory of human capital. In his well-known work, Human Capital, Becker showed that an individual will invest in human capital if the net return to that investment is positive. For example, a person will attend college if the returns to education, measured by the increase in future income, are greater than the direct costs of attending college (tuition, books, and other supplies) and the foregone income from hours the student would have worked if he did not attend school.

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