Economic And Behavioural Theories In Compensation Economics Essay


Wagess are determined by both the supply and demand of peculiar type of labor. The factors which influence rewards are supply, monetary value, accomplishment, experience, ability, repute. The rewards theories have of import policy deductions and applicable for some of the definite businesss or line of work, none of these is equal as a general theory holding cosmopolitan pertinence. The economic theories of rewards fail to supply a complete account of the job of pay finding. Surveies conducted by behavioural scientists to some extent make full the spreads in the earlier theories, which have highlighted the importance of psychological and sociological factors on rewards. The cardinal issues developed by economic and behavioural theoreticians are briefly reviewed in this chapter.


Compensation theories chiefly divided into two parts:

Economic theory

Behavioral theory

Economic theory consist the undermentioned and described as under:


David Ricardo, in his celebrated book ‘Principles of Political Economy and Taxation ‘ propounded the subsistence theory of rewards: Ricardo states that the monetary value of labour depends upon subsistence of labor. The theory was based on the premise that if the workers were paid more than subsistence pay, their Numberss of labor would increase as they would reproduce more ; and this would convey low the rate of compensation. If the rate of compensation decreased below the subsistence degree, the figure of workers would cut down – as many would decease because of deficiency of nutrient or hungriness, increased inability due to scarceness of nutrition, unnatural wellness conditions, cold, etc. and many of them could non get married because they fell that they could non able to accept the duty. This will ensue in reduced labor supply, which will in conclusion be same like as the demand for it. Ricardo viewed that the market monetary value of labor could non change from the subsistence degree for a long clip. For this ground, the subsistence pay theory was besides known as the ” Iron Law of Wages ” .

THE SURPLUS VALUE THEORY ( Given by KARL MARX in 1818-1883 )

This theory owes its development to Karl Marx. Harmonizing to this theory, the labor was an article of trade, which could be purchased on payment of ‘subsistence monetary value. ‘ Marx in many ways is closer to Ricardo in his attack to the inquiry of value for labour power. He accepted Ricardo ‘s position that the market monetary value of labour power could non for long depart from the value of the subsistence which is required for the care of that labour power. He, nevertheless, viewed that it was non the inclination of population, which brought rewards to the subsistence degree, but it was the inclination in the capitalist system to chronic unemployment and the being of industrial modesty ground forces, which drove rewards to the subsistence degree. Labour supply ever cared for the surplus of the demand for it of capitalist pay system. The capitalist was in a place to coerce the worker to pass more clip of his occupation than what was necessary to gain his subsistence pay. Product monetary value was set or fixed by the entire clip needed for bring forthing the end product by the labor. The monetary value of any merchandise was determined by the labour clip needed for bring forthing it. Harmonizing to Marx, the labor did non have complete wage for the clip he spent on their work topographic point or occupation. Marx, nevertheless, held the position that the debut of trade brotherhood bargaining and similar interventions could halt the inclination of rewards falling to their minimal degree and even change by reversal it.

THE WAGES FUND THEORY ( Given by ADAM SMITH in 1723-1790 )

This theory was propounded by Adam Smith. His basic premise was that rewards are paid out of money which lay excess with affluent individuals – as a consequence of nest eggs. It was the size of the fund, which determined the demand for labor and the rewards paid to them. Harmonizing to rewards fund theory, rewards are determined by:

( a ) the pay fund or portion of working capital which has been increased for acquiring the labour work ; and ( B ) the figure of workers seeking employment. The pay fund was assumed to be fixed and it does non alter. Any alteration in pay rate, because of addition or lessening in the size of labor acquiring occupation chance.

The rewards fund theory based on the productiveness of labor and profitableness of any organisation it shows that increased in the nest eggs increased in the rewards, it may alter after the fixed term of office. Increase in wage could assist to increase the efficiency of labor, it would presumptively augment the employers ‘ demand for that labor. Hence, a rise in pay degree non merely influences the supply conditions of labor but besides causes a displacement in the demand for labor. This is rather opposite to the premise made by the theory that the demand for labor is fixed.


This theory was propounded by Phillips Henry Wicksteed ( England ) and John Bates Clark ( USA ) . Harmonizing to this theory, compensation are based upon an enterpriser ‘s computation of the rate that will likely be get by the fringy worker. The fringy productiveness theory pretended that there was a certain measure of worker received the occupation and the wage value at which this worker could procure employment in a competitory labor market was equal to the add-on to entire production that resulted from using the fringy unit of that labour force. It was besides pretended that production is carried out under the conditions of decreasing returns to labor. The rule of decreasing fringy productiveness postulates that the part of each extra unit of labor would be less than that of the unit antecedently hired. Therefore, inspite of the fact that the productiveness of the single laborer may be higher than that of the fringy laborer, he will non be paid more than what the fringy laborer will acquire.

In the short tally pay rate can be both higher and lower than the fringy gross productiveness of laborers, but in the long tally it gets equalised with the fringy gross productiveness of laborers. If the prevailing pay rate is lower than fringy productiveness, it will be profitable for the employers and the resulting competition among employers to use more workers will be given to raise the rewards. On the contrary, if the prevailing pay rate is higher than the fringy productiveness, the employment of fringy workers will give him losingss and he would halt using them. This will ensue in competition among workers for occupations, which would take down the rewards. Therefore in the long tally the equilibrium pay rate will go equal to the fringy gross productiveness of labor.

The fringy productiveness theory is considered superior to the earlier theories on rewards.


John Davidson propounded this theory. He argued that the rewards and clip period of work were finally defineds by the comparative bargaining power between the employers and the employees.

Harmonizing to this theory, there is a top bound and a lower bound of compensation and the existent pay rates in between these bounds are set or calculated by the bargaining power of the employers and the employees. The upper bound could be the highest rewards that the employers would be willing to pay beyond which they will incur losingss ensuing from high labor costs. The lower bound could be either the minimal rewards prescribed under the legislative act or the strength of the workers at the necessary wage below which they will non be ready for work.


This theory is given by Marshall. He assumed the whole set of factors which govern demand for and supply of labor affected the finding of rewards. It is hence necessary to understand the assorted factors, which influence the demand for and supply of labor. The employers ‘ demand for labor is dependent on a figure of factors such as the demand for his/her merchandise, handiness of other factors of production ( the most of import being the supply of capital ) , the degree of technological advancement, etc. The demand monetary value of labor is determined by the fringy productiveness of single worker.

Supply of work force can be stated in a figure of senses. First, it refers to the figure of workers acquiring occupation and the workers with no option for endurance, fall in the labor market for acquiring the occupation for rewards. Second, it may be the figure of hours or given clip period for which each worker is ready for making occupation. Finally, the supply of labour varies with the strength of work. The supply of labour tends to increase if the workers work harder than earlier.

Therefore, Wage rates are influenced by a figure of factors regulating the demand for and supply of labor. The fringy productiveness of labor, determines its demand monetary value. It is the criterion of life of workers that plays an of import function in the finding of supply monetary value of labor. The existent pay rate is determined at that degree where the demand for and supply of labor are equal.

In existent universe, nevertheless, labour markets are by and large non-competitive. The pay degrees expected to ensue from the free interaction of demand and supply are frequently modified by the opposition from workers to accept rewards below the subsistence degree ; trade brotherhood action, authorities intercession in pay arrested development, and stationariness of workers.

Buying POWER THEORY ( Given by PIGOUN )

In the book “ General Theory of Employment, Interest and Money ” explained the construct of buying power. Harmonizing to him, pay is non merely the cost of production to the employer but besides an income for the labor. The same workers and their households consume a major portion of the merchandises of the industry.

Therefore, if the earning of the labor is high they will hold more overwhelming power, which would assist to higher the aggregative demand for goods and besides a high degree of end product. On the other manus, if the pay rates were low, their buying power would be less, which would convey about a lessening in the aggregative demand. This will hold an inauspicious consequence on the degrees of employment and end product. Harmonizing to Keynes, unemployment and depression will further add to the job. Therefore, a cut in pay national income falls ; it would hold an inauspicious consequence on employment rate.

Harmonizing to the Keynesian Theory, fill employment is a map of national income ; the higher the degree of national income the greater the volume of employment and both income and employment are determined by effectual demand. Hence, if the national income falls, it would hold an inauspicious consequence on employment.


Economists specialising in international trade argued about states, industries and companies viing on the footing of comparative advantage of inexpensive labor Employers are known to travel to countries where labor is inexpensive, be it within a state or across states. Capable to internal and external restraints, labor besides tends to demo a inclination to travel to countries, which pay higher value for their accomplishments and attempt. In recent old ages, nevertheless, there is force per unit area on states and companies viing on the footing of inexpensive labor to guarantee conformity with minimal nucleus labor criterions refering minimal age, freedom of association, right to collective bargaining forced labour and non-discrimination.


1. Harmonizing to Subsistence theory, the premise that the supply of labor is absolutely elastic at the subsistence pay degree is wrong. The theory does non see pay derived functions, which are bound to be across parts.

2. The subsistence theory ignores the importance of the function of the demand for labor and the function of trade brotherhoods in pay finding.

3. Economic theories either presume that rewards and monetary values are either to the full fixed or to the full flexible. The world lies someplace in between.

4. Most pay theories are based on the premise of full employment. In most developing states this is non truly the instance.

5. Labour is non every bit nomadic as capital and merchandises are. Therefore pay rates could be influenced by the alterations in the demand for and supply of factors other than labour excessively.

6. Wagess and benefits reflect industry features and personal features ( including accomplishment derived functions ) every bit good as social penchants and biass.

8. Intervention by authorities and trade brotherhoods could minimise the influence of the market forces of demand and supply of labor.

9. Technology and productiveness are major determiners. Low rewards may non intend low pay costs. Similarly high pay rates may non intend high unit labor costs.

10. With the turning force per unit area for associating labour criterions with international trade, progressively it will go hard ( for states, industries and companies ) to vie on the footing of comparative advantage of inexpensive labor.


Behavior means of course reaction or motion to the environment and yourself. Motivation is the procedure of trying to act upon others to make your work will through the possibility of addition or wages. Wage of every worker has a behavioural aim and seeks to carry through the endurance demand ( physiological or psychological ) to carry through the ends. Luthans argues that `motivation is a procedure that starts with a physiological or psychological lack or need that activates behavior or a thrust that is aimed at a end.

Compensation policy are targeted at honoring manpower for their accomplishment, endowment, public presentation, attempt, duty and working conditions and increase their morale for efficient public presentation.

Behavioral theories are divided into three classs: –

Contented theories

Procedure theories, and

Contemporary theories


The content theories explain what inspires manpower at their occupations. Maslow, Hergberg and Alderfer gives their important part to content theories. These are as follows: –


Abraham Maslow proposed the first theory called the hierarchy of demands theory. He proposed five demands of any people in needs hierarchy physiological or basic demand ( nutrient, shelter, vesture ) , safety demand ( emotional and physical safety – wellness insurance, pension ) , societal demand ( fondness and belongingness to society ) , Self-esteem demand ( power, accomplishment, position, etc. ) , and self- realization ( personal growing, realisation of possible ) . Maslow believed that within every person, there exists a hierarchy of five demands and each degree of demand must be satisfied before an single pursues the following higher degree of demand. As an single advancements trough the assorted degrees of demands, the proceeding demands loose their motivational value.

2.TWO FACTOR THEORY OF MOTIVATION: Herzberg extended work of Maslow and developed a specific content theory of work motive. Factors of this motivational theory divided into two classs:

Intrinsic cand Extrinsic. Interinsic factors are the incentives ( satisfiers ) for the work force and, Exterinsic factorsar the hygiene factors ( dissatisfiers ) . Intrinsic wage are incentives or satisfiers work for satisfy workers related to occupation content. It includes success, designation, duty, work enrichment, and works expansion. Extrinsic wage are hygiene factors and helps to cut down the dissatisfaction on the occupation. It includes company regulations ordinance and disposal, supervising, co-ordination, salary construction, interpersonal dealingss, working environment

3.ERG Theory: Clayton Alderfer identified 3 groups of nucleus demands ; they are- Existence, Relatedness and Growth.

( a ) The being demands are concerned with endurance.

( B ) The connected demands and the importance of interpersonal and societal relationship.

( degree Celsius ) The growing demands are concerned with person ‘s intrinsic desire for personal development. Based on a individual ‘s background and societal environment, one set of demands may predate over others.

The occupation of Maslow, Hergberg and Alderfer are related to content theories. They give utile theories but have limited deductions for policy and pattern.

Procedure THEORIES

Procedure theories were examined by public presentation of Vroom ( on valency and anticipation ) and Porter and Lawer ( performance-satisfaction linkage ) . They look at the related procedingss that go into motive or attempt, peculiarly the manner they relate to one another.

EXPECTANCY THEORY: Victor Vroom developed anticipation theory under procedure theory based on the abstract of valency, anticipation and instrumentality.

Valence provinces to an person ‘s orientation for a single consequence. For case, most old employees perceives value benefits against fewer, if any, younger employee in today ‘s cognition industry, individual ( single ) workers with fewer household duty have less or no demand for benefits like kids ‘s instruction, wellness benefits, leave travel allowance etc. than older, married employees with one or more kids.

Instrumentality refers that a people would be inspired to give better public presentation in expectancy of publicity.

Anticipation provinces that the grade of opportunities accor to a peculiar activity or procedure or attempt will take to peculiar first-level consequences on the other manus, Instrumentality states to the grade of opportunities that relates first-level consequences and desired second-level consequences. In simple words, Motivation is a -function of valency and anticipation.

Harmonizing to Vroom ‘s construct it can be interpreted that: work force gives to the organisation what it needs from people, higher public presentation and in exchange they expect publicity.

Contemporary Theory

The modern-day theories describe the modern construct of how people motivates at work. These include Equity and Attribution theories. These are explained as follows: –


J. Stacy Adams, developed by equity theory, and give their positions that primary input on occupation public presentation and satisfaction on the footing of equity that people hides in their on the job conditions. Inequity comes in being when a work force feels that the ratio of his or her consequences to inputs and the ratio of a relevant other ‘s consequences to inputs are imbalanced.

Equity can be stated in two elements. One is internal and other is external. Internal equity provinces that the instability in the wage between the several accomplishments or endowment and duty degree among the assorted work force. Internal equity is determined through occupation rating.

External equity provinces that when wage degrees for same accomplishments degrees in one organisation comparison with other workers in any different organisation in same industry and geographical part. External equity is determined normally through compensation studies or interview and compensation satisfaction studies. Companies, which pay wage at lower rate than the market rates, would be in job to pull, retain and animate manpower to execute with full efficiency.

Our work force does n’t comprehend felicity when they get lower wage than what they deserve. When an employee gets wage at higher rates than what he/she considers is just. Now the inquiry is that to look into out what they are having, what they deserve and what is just for our work force to keep balance or equity in compensation system.


This theory is contributed by Fritz Heider, Lewin and Festinger. They assume that people are rational and logical in their behaviour and that both inter and outer forces get composed additively to reason behavior. Peoples will act otherwise if they realize that their consequences are controlled or supervised more internally than externally. This theory has great efficiency for understanding organisational behavior and contributes deep penetrations on end scene, leading behavior and naming causal factors of employee public presentation.

Question: –

1. Explain the importance of the theory of rewards.

2. What are the different types of theory of rewards? Explain in item.

3. Are rewards determined merely on the footing of the demand and supply of labor?

4. Explain the significance of behavioral theories in Wages finding?

5. What are the restrictions that arise while rewards finding in economic theories?