Q.Explain the wages-fund theory and the marginal productivity theory of wages.

The wages-fund theory and the marginal productivity theory offer two very different explanations of what determines the average wage rate.

Wages-fund theory, propounded by John Stuart Mill, holds that at any given time the economy has a fixed stock of circulating capital — the wage fund — accumulated out of past savings and set aside specifically to pay wages to labour. The average wage rate is simply this fund divided by the number of workers seeking employment:

On this view, the only way average wages can rise is if the wage fund grows faster than the number of workers, or if the workforce shrinks while the fund stays the same. The theory implies that attempts to raise wages generally (say, through worker demands) without first increasing the fund or reducing the workforce cannot succeed in the aggregate, since the fund available for distribution is fixed. Mill himself later distanced himself from a strictly fixed wage fund, and the theory has been criticised for treating the fund as a rigid, pre-determined amount rather than something that can expand with the economy's growing productive capacity.

Marginal productivity theory of wages applies the general marginal productivity principle specifically to labour. Under perfect competition, it holds that the wage rate tends to equal the marginal revenue product of labour (MRP_L) — the value of the output produced by the last unit of labour employed:

$\text{Wage Rate} = MRP_{L} = MPP_{L} \times MR$ …

A common error is treating the wages-fund theory and the marginal productivity theory as saying the same thing; they differ fundamentally — one treats the wage fund as a fixed pool to be divided, while the other links the wage rate to labour's productivity at the margin. Students should also avoid …