Let us assume wages in London are higher than in Newcastle.
The first thing to do is to consider what determines wage differentials in general.
The basic theory behind wage determination is:
- Marginal Revenue Product of Labour MRP = MPP *MR
- MPP = productivity of workers - Are workers in the London more productive than Newcastle? - Unlikely to be the case. Work environments are similar
- MR - The price of goods is higher in London than Newcastle. This is related to the cost of living. Because goods are more expensive, the workers add a greater MRP than in Newcastle. For example, to get a hair cut in london is more expensive. THerefore, you would expect hairdressers to be paid higher wages. This point is quite significant, especially for service sector type jobs. However, it wouldn't explain differences in Mcdonalds workers where the price of a Big Mac is the same
- Supply of Labour. Labour shortages in London are likely to push up wages. If there is a surplus of labour in Newcastle this puts downwards pressure on wages. Note: there is a shortgage of nurses in London, but free market forces don't operate for nurses.
- Government pay London Bonus. Because of London's costs of living, the government pay higher wages
- Monopsony power of workers in north?
- Trades Unions more powerful in London? - not the case
- High paying firms set up in London. E.g. More solicitors and bankers in London. Therefore, it is differences in types of jobs, that is quite important.
If you understand the basic principles behind wage determination you can use the theory for related questions: