Human Resource Economics

This essay discusses the economic principles related to the labour market and efficiency wage theory. It analyses the relationship between pay and performance, labour market equilibrium, and the backward bending labour supply curve. It also discusses the efficiency wage theory and its impact on the labour market.

Running head: HUMAN RESOURCE ECONOMICS
Human Resource Economics
Name of the student
Name of the University
Author Note

1HUMAN RESOURCE ECONOMICS
To increase productivity of a company, performance of labour plays a crucial role.
This is because better performance can help a company to increase its total production by
large extend while inefficient performance of labour can reduce this production level
(Preenen, Vergeer, Kraan & Dhondt, 2017). Thus, companies intend to increase this
efficiency level through applying various processes that wage theories can describe
appropriately. However, these theories have various arguments based on the concept that how
labour performance within an economy or an organisation can be increased. In this context,
some researchers have supported the efficient wage theories while some others have argued
for the minimum wage theory. While most of those researchers have intended to solve this
problem, they have experienced some limitations as well. For a developed country like
Australia, increasing labour efficiency is also an important issue. The country has adopted the
concept of minimum wage within their business sectors to increase its labour productivity
through providing more incentives to work more. On the other side, Fair Work Commission
has provided a range of functions to protect self-interest of labourers. Hence, this essay
intends to analyse the present situation of Singapore’s labour force, based on some economic
principles to understand that how these principles can help this country positively.
Approach 1:
Part 1:
The Australian labour market can be divided into two parts that are demand for and
supply of labour in firms or organisations. As capitalist economy is operated within this
country, it can be said that monetary values, which is, wage can influence demand and supply
of labour. Labour supply and wage have positive relation, which implies that labour supply
can be increased if wage increases and vice versa (Landais, Michaillat & Saez, 2018). This
upward slopping demand curve is shown below:

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Wages
Supply of labour
W1
W0
L0 L1
Ls
Figure 1: Labour supply curve
Source: (created by author)
Figure 1 represents an upward rising labour supply curve to show a positive
relationship between wages and supply of labour. At W0 wage, the country can obtain L0
amount of labour. As wages increase from W0 to W1 labour supply of Australia increase
from L0 to L1.
The concept of labour demand is also depends on wages though in this context this
relation shows an inverse one (Michaillat & Saez, 2015). Due to increase in wage, demand
for labour decreases while the opposite can also be occurred if wage decreases. This
negatively sloped demand curve is drawn below.

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Ld
Wage
O
Demand for labour
W1
W0
L1 L0
Figure 2: Labour demand curve
Source: (created by author)
The above figure represents a downward slopping demand curve for labour. As wage
increases from W0 to W1, labour demand decreases from L0 to L1.
With the help of these two curves, the labour market of Australia can determine its
equilibrium amount of wage at which equilibrium amount of labour can obtain their job
(Llull, 2017). At this level, total amount of labour equates with total amount of labour supply.

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Wages
Amount of labour
W*
L*
Ls
Ld
O
Figure 3: Equilibrium amount of labour
Source: (created by author)
In figure 3, labour market equilibrium is represented. These equilibrium amount of
wage and labour are represented by W* and L*, respectively. In this context, some important
indicators related to labour market can be described.
Employment: This economic phenomenon describes a situation, where a person can get a job.
According to the Australian Bureau of Statistics (ABS), a person can be called as employed if
he or she works for at least one hour or more than that as a paid employee or in a family
business without pay or as a self-employed person.
Labour force participation rate: The total labour force of a country represents total number of
population, aged between 16 and 64, who are employed or trying to get a job presently
(Temple, Rice & McDonald, 2017). By dividing total number of labour force with total
number of population, the labour force participation rate can be measured.
Labour force participation rate= Total labour force/ Total number of working age population

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Employment rate: Employment rate indicates the percentage of working age people, who are
employed (Martini & Fabbris, 2017). This rate can be described as the ratio of employed
person to working age population.
Employment rate = Total number of employed working age population/ total of working
population
Part-time employment: Part-time employment means the number of employed persons, who
work for less than 35 hours in a week. This concept is applicable for all types of jobs. This
type of employment has increased in Australia significantly.
With the help of economic concepts, backward bending labour supply curve can be
described. The most important determinant of labour supply is wage, as supply of labour and
wage has positive relation. However, like other factors of production, labour supply curve
does not increase continuously with increase in wage. After reaching the optimum wage
point, labour supply curve starts to decline as wage increases. This is because after certain
point, labour intends to choose between leisure and income (Açıkgöz, 2018). Two economic
situations, which are, substitution effect and income effect, influence this labour supply
curve. The substitution effect implies that higher wage attract workers more compare to
leisure. Hence, as wage increases, supply of labour increases correspondently. On the
contrary, income effect implies that a higher wage leads workers to work for fewer hours than
before. Therefore, after wage increase, workers prefer more leisure than work (Brecher &
Gross, 2018). The following diagram represents this backward bending labour supply curve.

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Figure 4: Backward bending labour supply curve
Source: (created by author)
In figure 4, backward bending labour supply curve represents both positive and
negative relation of labour supply with wage rate. When wage rate increases from W1 to W2,
labour supply increases from L1 to L2 due to substitution effect. However, after this W2
wage rate, the supply curve bends backward due to income effect. As wage increases from
W2 to W3, workers substitute their hours of works with leisure. Consequently, labour supply
decreases from L2 to L3.
In this context, two factors that can influence labour supply curve can be described.
These two factors are job contracts and the motivation for work. In practical world, it
becomes difficult for an individual to choose the accurate number of hours to work. However,
due to fixed contracts, working time for workers remains same though wage rate can be
increased. On the contrary, many factors can motivate workers to work more at a low hourly
wages.
Based on above discussion, a relationship between pay and performance can be
described, as workers start to respond strongly on incentives. Properly designed incentives
can generate value creation. Incentives are of two types, which are, monetary reward and
non-monetary reward that can motivate workers (Bratsberg, Raaum & Røed, 2018). Paying

7HUMAN RESOURCE ECONOMICS
incentives in the form of money can improve effort of workers, which in turn can increase
benefits of the organisation along with its objectives. Moreover, this monetary form of
incentives can develop self-selection in recruitment. In this situation, efficiency theory can be
described.
According to efficiency wage theory, increase in wage can lead the labour
productivity to increase further. In labour market, equilibrium wage rate determines the
amount of wage that each worker wants. Thus, workers can increase their performance until
they get this wage rate (Giménez‐Nadal, Molina & Velilla, 2018). However, after reaching
this level, workers can decrease their performance. In this theory, higher wages can increase
marginal productivity of labour due to some reasons, which are, fear to lose jobs, loyalty,
lower supervision cost, supply of skilled labour and gift exchange in labour market. If
workers get wage comparatively higher than alternative jobs or benefits then they can intend
to work more efficiently to sustain within the market. Loyalty also plays a vital to improve
performance of labour. If they get a higher amount of wage then they can show more loyalty
towards to organisation by working more efficiently. In addition to this, efficiency wage
theory states that higher wage can reduce supervision costs of the company as this can
motivate workers to perform accurately. Moreover, a company can receive more efficient and
skilled workers if it provides comparatively higher wages. This is because those workers can
feel that they receive a relatively better-paid job (Kondoh, 2017). Gift exchange in labour
market is other factor that can motivate workers positively. This gift exchange concept states
that good labour relation varies with goodwill. This means workers would take
responsibilities and initiatives if the company pays higher amount of wages.
These above-discussed economic concepts can be described efficiently with the help
of some literatures. According to Taylor & Taylor, it is difficult for the government to
determine the actual amount of remuneration for government employees to ensure optimum

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level of effort. However, employees in the public sector are less motivated with their high
wages compare to the private sector. Moreover, the researchers have also seen that many
government policy or schemes have become dysfunctional or meaningless in the public
sector. However, in the labour market, the common feature is that most of the people want a
minimum amount of remuneration for their effort. Thus, they have discussed about the
efficiency wage theory along with the public service motivation (PSM) (Van Loon et al.,
2018). According to this efficiency wage theory, companies need to offer a wage rate above
the market-clearing rate to their employees. On the other side, both public administration
practitioners and academicians have noticed that within public sector, people have strong
believes and emotions to perform over there. Thus, they have strong level of PSM. There
research framework has two parts based on these efficiency wage model and PSM model.
According to the first model, Ei represents effort per employee, which is a function of the
wage of employee in the company (Wn) relative to the existing wage outside the company
(We). This equation can be written as:
Ei = Wn/ We
Organisations do not force their workers to use full effort for working efficiently.
Rather, they can provide some incentives to make the work more attractive and consequently
workers would not fear to lose their job. This phenomenon indicates a competitive labour
market, where employees are indifferent regarding their job because these are identical. As a
result, employees intend to shirk and do not apply high effort (Card, Cardoso, Heining &
Kline, 2018). Thus, to perform efficiently, firms need to provide something new to their
workers.

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Figure 5: The effort and wage relation
Source: (Faberman & Menzio, 2018)
The above diagram has represented that when wage increases from W0 to Wn*, effort
of workers to work increases from A to B. However, further increment of wage rate can
reduce the effort of workers. Hence, through considering PSM, it can be said that a positive
relation between wage and the effort of workers can be seen up to the optimum level of wage
and after that, this relation becomes inverse.
Katz has also discussed the efficiency wage theories through analysing on the recent
developments within the concept of efficiency wage theories related to the unemployment.
Based on efficiency wage theory, a firm can provide higher wages to their employees
compare to the market clearing wage rate, as it can be profitable for the company (Landais,
Michaillat & Saez, 2018). High wages help the company to reduce the turnover, extract work
effort, attract employees with higher quality and prevent collective action of workers. This
efficiency wage models can describe different wages, involuntary unemployment and
different labour markets across industries and firms for those workers, who have similar skills
and productive characteristics. In this context, deferred payment schemes along with some

10HUMAN RESOURCE ECONOMICS
other labour market bonding mechanisms can solve problems related to the wage efficiency
without creating any industry unemployment and job rationing.
The American economist Yellen has also researched on efficiency wage models
related to unemployment. Keynesian economists have stated that due to business cycles,
involuntary unemployment can be seen. However, this model contradicts with efficiency
wage theory of labour market. In Keynesian model, an unemployed person wants to get a job
at a minimum wage rate though based on efficiency wage model decreasing wage cannot be
profitable for the firm (Campbell, 2017). This is because lower amount of wage can reduce
the productivity of labour.

11HUMAN RESOURCE ECONOMICS
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