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Maximum price that management is willing to pay for an extra unit of a given limited resource. Management may wish to know whether it pays to add capacity in a particular department. It would be interested in the monetary value to the firm of adding, say, an hour per week of assembly time. This monetary value is usually the additional contribution margin (cm) that could be earned. This amount is the shadow price. A shadow price is, in a way, an opportunity cost -the CM that would be lost by not adding an additional hour of capacity. To justify a decision in favor of a short-term capacity decision, the decision maker must be sure that the shadow price exceeds the actual price of that expansion. For example, suppose that the shadow price of an hour of the assembly capacity is $8.75 while the actual market price is $9.50. That means it does not pay to obtain an additional hour of the assembly capacity. Read more: http://www.answers.com/topic/shadow-price#ixzz1bZutrKS1
Shadow pricing of labourWhen a project hires labour, it could have three possible impacts on the rest of the economy y It may take labour away from other employments. y It may induce the production of new workers. y And it may involve impact of workers. In the first case, the shadow price of labour is equal to what other users of labour are willing to pay for this labour. The social cost associated with inducing additional production of workers consist of the following y The marginal product of the worker in the previous employment. y The value assigned by the worker on the leisure that he may have to forego as a result of employment in the project.
y The additional consumption of food when a worker is fully employed. Etc. The social cost associated with the import of foreign workers is the wage they command. In their case, however, a premium should be added on account of the foreign exchange remitted abroad by these workers from their savings.
Shadow wage rateThe shadow wage rate is an important but difficult to determine element in SCBA. Its a function of several factors as1. The marginal productivity of labour. 2. The cost associated with urbanisation. 3. The cost of having an additional amount committed to consumption when it increases as a result of the higher income he enjoys in urban employment. L-M has suggest the following formula for calculating the shadow wage rateSWR = c`-1/s(c-m) Where, SWR - Shadow wage rate c` 1/s c m - additional resources devoted to consumption - value of a unit of committed resource - Consumption of the wage earner - Marginal product of the wage earner
The above formula may also be written as SWR = m+(c`-c) + (1-1/s) (c-m) where, (c`- c) - cost of urbanisation (1-1/s) (c m) - cost of having an additional amount (c-m) committed to consumption
(It may be noted that 1 is the value of a unit of uncommitted resource and 1/s is the value of a unit of committed resource.)
Illustrative Example- Calculating the Shadow Wage Rate for Unskilled Labor in a Government Rural Project
Consider the case of a government corporation that is undertaking a labor-intensive sugar project in a rural area. The project requires unskilled workers on a temporary basis and pays a gross-of-tax wage that varies by the month. This amount will be subject to a 5 percent income tax. The following schedule shows in column (3), the after tax monthly wage rate for landless labor working in several alternative formal sector activities in the area, and, in column (4), the projects monthly requirements for person-months. To estimate the economic cost of the unskilled labor to the project, we first need to calculate the monthly share of the annual person-months required by the project. This is obtained in column (5), above, by dividing the number of person-months for a particular month by the total yearly person-months.
Table- Shadow Wage Rate for Unskilled Labor Month Wage Employer Before Tax to Wage Employee After Tax to Person- Monthly Months Share of Annual Personmonths (4) 1,800 1,800 1,800 900 900 0 0 0 (5) 0.2 0.2 0.2 0.1 0.1 0.0 0.0 0.0
The weighted average monthly wage for casual labor is then calculated as 120 * 0.2 + 100 * 0.2 + . . . + 150 * 0.1 + 180 * 0.1 Average monthly wage after tax = 141 rupees per month, and Average monthly wage before tax = 148 rupees per month Shadow wage rate = (141 + 148) / 2 = 144.5