Labour market: wage determination and minimum wages

Detail

1. The labour market reverses the usual roles

• In a goods market, firms sell and households buy. In the labour market it is the other way round:
• Households supply labour. They sell their time and effort.

• Firms demand labour. They buy work to produce goods.

• Labour is measured in hours of work, not in the number of workers. Ten workers doing 4 hours each supply the same labour (40 hours) as 5 workers doing 8 hours each.

• The "price" in this market is the wage rate (w), which is the payment for one unit (one hour) of labour.

2. Demand for labour: how a firm decides how many hours to hire

Assumptions of the model

• Labour is the only variable input. Capital and land are fixed in the short run.
• The firm is perfectly competitive and profit-maximising.
• The firm is a wage-taker. It is too small to change the market wage, so it takes the wage as given.
• Marginal product of labour (MPL) diminishes. MPL is the extra output from one more hour of labour. With fixed machines, each extra hour adds less output than the one before.

The hiring rule

• The firm keeps hiring until the cost of the last unit of labour equals the benefit from it.
• Cost of one more hour = w.
• Benefit of one more hour = MRPL (marginal revenue product of labour), which is the extra revenue the extra hour brings in.

• MRPL = MR × MPL, where MR (marginal revenue) is the extra revenue from selling one more unit of output.

• Under perfect competition, MR = p (the market price), so:

• MRPL = VMPL = p × MPL

• VMPL (value of marginal product of labour) is the market value of the extra output from one more hour.

• Equilibrium condition for the firm: w = VMPL = p × MPL.

• If the firm is not perfectly competitive, MR < p, so MRPL < VMPL. The firm hires where w = MRPL, which means fewer hours than a competitive firm would hire.

Why the firm stops where w = VMPL

• If VMPL > w, one more hour brings in more money than it costs, so hiring it adds to profit.
• If VMPL < w, the last hour costs more than it brings in, so cutting it adds to profit.
• Only at VMPL = w is there no further gain from changing the number of hours.

Worked example

• Price of output p = ₹10 per unit.

Hour of labour	MPL (units)	VMPL = p × MPL
1st	20	₹200
2nd	15	₹150
3rd	10	₹100
4th	6	₹60

• At w = ₹100: the firm hires 3 hours. The 4th hour would add only ₹60 but cost ₹100.
• At w = ₹150: the firm hires 2 hours. Only the 2nd hour's VMPL covers the wage.
• So a higher wage leads to fewer hours hired.

Why the labour demand curve slopes downward

• The logic runs in a chain:
• A higher wage means the firm needs a higher MPL to cover it.
• With diminishing returns, MPL is higher only when fewer hours are used.

• So the firm hires fewer hours. The firm's labour demand curve (its VMPL curve) slopes down.

• Market demand for labour is the horizontal sum of all firms' demand curves. At each wage, you add up the hours every firm wants. So market demand also slopes down.

3. Supply of labour: the income–leisure trade-off

• Every hour of the day goes either to work (earning income) or to leisure (rest, family, study).
• The wage is the price of leisure. An hour of leisure costs you the wage you could have earned in that hour. Economists call this the opportunity cost of leisure.

A wage rise has two opposite effects

• Substitution effect
• A higher wage makes leisure costlier.

• So the person swaps leisure for work and works more.

• Income effect

• A higher wage makes the person richer.
• A richer person wants more leisure (leisure is a normal good, meaning people want more of it as income rises).
• So the person works less.

Which effect wins, and the backward-bending curve

• At low wages the substitution effect wins. A wage rise → more hours offered. The supply curve slopes upward.
• At high wages the income effect wins. A wage rise → fewer hours offered. The curve bends back towards the vertical axis.
• The result is a backward-bending individual labour supply curve.
• Example: a worker offers 6 hours at ₹100/hour and 9 hours at ₹200/hour, but only 7 hours at ₹600/hour, because they can now earn enough in fewer hours.

Market supply still slopes upward

• At higher wages, some people already in work may cut their hours.
• But many new workers join: students, homemakers, retired people, and migrants from other regions or sectors.
• New entrants outweigh the cut in hours, so market labour supply slopes upward.

4. Equilibrium wage

• The equilibrium wage (w*) is the wage at which market labour demand = market labour supply.
• At w*, every hour workers want to sell at that wage is bought by firms. There is no excess supply and no excess demand.
• Above w* there is excess supply of labour (unemployment), so wages tend to fall.
• Below w* there is excess demand for labour (firms cannot find workers), so wages tend to rise.
• Shifts in the curves move w*. Higher output prices (p) or better technology (higher MPL) raise VMPL, shift demand right and raise the wage. More workers entering (for example through migration) shifts supply right and lowers the wage.

5. Minimum wage: a price floor in the labour market

Definition

• A minimum wage is a legal rule that stops the wage from falling below a set level.
• It is a price floor, which means a legal minimum price. It matters only when it is set above the equilibrium wage. A floor below w* has no effect.

Effect in the competitive model

• At the minimum wage (w_min > w*):
• Firms move down their demand curve and hire fewer hours.
• More people want to work at the higher wage, so more hours are offered.

• Hours offered > hours demanded, so there is excess supply of labour, which is unemployment.

• Worked example

• Equilibrium: w* = ₹300/day, with 100 lakh labour-days hired.
• Government sets w_min = ₹400/day.
• Demand falls to 80 lakh labour-days. Supply rises to 120 lakh labour-days.
• Excess supply = 120 − 80 = 40 lakh labour-days (unemployment).
• Workers who keep their jobs gain ₹100/day. Workers who lose jobs, or who cannot find one, lose.

Counter-arguments (beyond NCERT)

• Monopsony
• A monopsony is a market with a single dominant buyer. Here it means one big employer, such as a mill or plantation in a small town.
• Such an employer can pay below VMPL, because workers have nowhere else to go.

• A well-set minimum wage removes the employer's power to push wages down. It can raise both wages and employment together.

• Efficiency wages

• An efficiency wage is a wage paid above the market level on purpose.
• Better pay → workers are healthier, more motivated and less likely to quit → productivity rises and turnover (staff leaving) falls.

• So part of the higher wage pays for itself.

• Equity arguments

• A minimum wage reduces working poverty.
• It gives bargaining power to weak, unorganised workers who cannot negotiate on their own.

The NCERT framing in lower classes

• Class 9 and Class 7 present the minimum wage as protection against unfair practice, so that workers "earn enough for their hard work".
• The Class 12 model looks at efficiency (the unemployment cost). The lower-class texts look at fairness (protecting the worker).

6. International standard: ILO

• ILO Minimum Wage Fixing Convention, 1970 (No. 131) protects wage earners against unduly low wages, with special reference to developing countries [10].
• It requires states to set up a minimum wage system with machinery (formal procedures) for fixing and revising minimum wages [10].
• Governments must consult employers and trade unions when fixing minimum wages [10].
• Minimum wages should be "adjusted from time to time" [10].
• C131 does not require a single national minimum wage. The Minimum Wage Fixing Recommendation, 1970 (No. 135) says coverage can come "either by fixing a single minimum wage of general application or by fixing a series of minimum wages applying to particular groups of workers" [11].

7. India: from the Minimum Wages Act 1948 to the Code on Wages 2019

The old regime: Minimum Wages Act, 1948

• The Act applied only to "scheduled employments", which were jobs listed in a schedule. Workers outside the list had no legal minimum.
• The Centre announced a National Floor Level Minimum Wage (NFLMW), but it was only advisory:
• Raised from ₹100 to ₹115 per day, effective 1 April 2011 [7].

• Raised from ₹137 to ₹160 per day, effective 1 July 2015 [6].

• Expert Committee on the methodology for fixing the National Minimum Wage

• Set up on 17 January 2017, chaired by Dr Anoop Satpathy of the V.V. Giri National Labour Institute (VVGNLI) [8].
• Report submitted on 14 February 2019 [8].

The Code on Wages, 2019

• Passage: introduced 23 July 2019, passed by Lok Sabha 30 July 2019 and by Rajya Sabha 2 August 2019 [4].
• It merges four laws [4]:
• Payment of Wages Act, 1936
• Minimum Wages Act, 1948
• Payment of Bonus Act, 1965

• Equal Remuneration Act, 1976

• Universal coverage. The Code applies to all employees, in both the organised and unorganised sectors. The old list of "scheduled employments" is gone [3][4].

• Division of powers. The Centre fixes wages for railways, mines and oil fields. States fix them for other employments [4].
• Statutory floor wage
• The floor wage is now statutory, which means it is backed by law and no longer just advisory (NCERT: "the Centre notifies a national floor wage") [3].
• The Centre fixes it on the basis of workers' minimum living standards, such as food and clothing [3][4].
• It may differ by geographical area. The Centre first consults the Central Advisory Board and state governments [4].

• No state may fix a minimum wage below the floor wage [3][4].

• Factors for fixing minimum wages: the skill of workers and the difficulty (arduousness) of the work [4].

• Revision: minimum wages must be reviewed and revised at least once every five years [4][9].
• Overtime: paid at at least twice the normal wage rate [4].
• Gender equality: no discrimination in wages or recruitment "for the same work or work of similar nature" [4].
• Deductions from wages must not exceed 50% of total wages [4].
• Bonus: minimum is 8.33% of wages or ₹100, whichever is higher. Maximum is 20% of annual wages [4].
• Advisory Boards (Central and state): employers and employees in equal numbers, plus independent persons. One-third of members are women [4].
• Penalty: up to 3 months' imprisonment plus a fine of up to ₹1 lakh [4].

Implementation

• All four labour codes came into force on 21 November 2025 across the country (NCERT scaffold: "November 2025 — verify current"; confirmed) [2].
• The four codes are the Code on Wages 2019, the Industrial Relations Code 2020, the Code on Social Security 2020, and the Occupational Safety, Health and Working Conditions Code 2020.

• Together they merge and simplify 29 earlier Central labour Acts [2].

• Code on Wages (Central) Rules, 2026 were notified on 8 May 2026 [5]:

• The minimum wage is fixed on a day basis [5].
• The floor wage is based on minimum living standards (food, clothing, housing and other needs). It may be revised every five years and adjusted for changes in the cost of living [5].
• The variable dearness allowance is revised twice a year (before 1 April and 1 October), based on the Consumer Price Index for Industrial Workers (CPI-IW), a price index that tracks the cost of living of factory and industrial workers [5]. Dearness allowance is an extra payment that keeps wages in step with rising prices.
• Working hours: an 8-hour day for daily-wage workers, a maximum 48-hour week for others, at least one weekly rest day, and no more than 10 days in a row without a full day of rest [5].
• Gap: the 2025 draft set out detailed norms (consumption units, calorie needs, housing cost). The final 2026 Rules dropped them and left the criteria to later government orders [5].

Enforcement problem

• Enforcement is weak in the informal sector. Informal workers often have no written contract and no payslip, and they work far from any inspector.
• So a legal floor on paper often does not reach the workers who need it most. For depth, see the note employment-informal-sector.

Prelims Hooks

• Hiring rule for a competitive firm: w = VMPL = p × MPL. In general, MRPL = MR × MPL, and MRPL = VMPL only when MR = p (perfect competition).
• In the labour market, households are suppliers and firms are demanders. NCERT measures labour in hours of work, not in number of workers.
• Backward-bending individual labour supply: the income effect outweighs the substitution effect at high wages. Market labour supply still slopes upward.
• A minimum wage is a price floor. It works only if set above equilibrium, and in the competitive model it causes excess supply of labour (unemployment).
• Monopsony = a single dominant buyer of labour. Here a minimum wage can raise both wages and employment. Trap: this is not a feature of the competitive model.
• The Code on Wages, 2019 replaced 4 Acts: Payment of Wages 1936, Minimum Wages 1948, Payment of Bonus 1965 and Equal Remuneration 1976 [4].
• The floor wage is fixed by the Centre and is now statutory. States cannot set minimum wages below it [3][4].
• Minimum wages are revised at least every 5 years. Overtime is paid at ≥ 2× the normal rate. Deductions are capped at 50% of wages [4].
• All four labour codes came into force on 21 November 2025, merging 29 Central labour laws [2].
• ILO Convention No. 131 (1970) covers minimum wage fixing, with special reference to developing countries. It does not require a single national minimum wage [10][11].

Mains Points

• Efficiency vs equity (GS-III).
• The competitive model predicts unemployment from a minimum wage.
• But India's labour markets are often monopsonistic (plantations, brick kilns, small-town factories), and workers there have little bargaining power.

• A well-set floor wage can therefore raise wages without cutting jobs. Adding efficiency-wage gains and poverty reduction makes the case for a floor stronger.

• Cooperative federalism in wage-setting (GS-II).

• The statutory floor wage [3][4] stops states from competing to attract investment by keeping wages low (a "race to the bottom").
• Allowing geographical variation [4] still respects differences in living costs between regions.

• Tension: if the floor is set too high, jobs could move into the informal sector in poorer states.

• The implementation gap.

• Universal coverage on paper [3] means little without enforcement in the informal sector.
• The 2026 Rules dropped the detailed wage-fixing norms [5], which leaves room for decisions made case by case.

• The idea of an evidence-based national minimum wage methodology (Satpathy Committee, 2019) [8] is still to be put into practice.

• Labour market reform and growth. The codes merge 29 laws [2], cut compliance costs and bring wage protection to all employees. Together these help both formalisation (more jobs moving into the formal sector) and ease of doing business.