Marginal Productivity Theory of Income Distribution

Name: Marginal Productivity Theory of Income Distribution
Uploaded: 2017-07-15T20:41:42+00:00
Duration: PTM22S16
Channel: Janis Lambert
Description: Marginal Productivity Theory of Income Distribution

Marginal Productivity Theory of Income Distribution

Perfectly competitive factor markets maximize profit by hiring labor up to the point at which its value of the MP = P What does this say about the labor’s share in the factor distribution of income?

Labor market is in equilibrium Number of workers that producers want to employ is = to the number of workers willing to work All employers pay the same wage rate and each employer employs labor up to the point at which the MP of the last worker hired is equal to the market wage rate

All Producers Face the Same Wage Rate
(a) Farmer Jones (b) Farmer Smith Wage rate Wage rate Farmer Jones's VMPL Farmer Smith’s VMPL wheat corn = P x MPL = P x MPL corn wheat wheat corn Market wage rate $200 $200 VMPL corn Figure Caption: Figure 20-5: All Producers Face the Same Wage Rate Although Farmer Jones grows wheat and Farmer Smith grows corn, they both compete in the same market for labor and so must pay the same wage rate, $200. Each producer hires labor up to the point at which VMPL= $200: 5 workers for Jones, 7 workers for Smith. VMPL wheat 5 7 Quantity of labor (workers) Quantity of labor (workers) Profit-maximizing number of workers Profit-maximizing number of workers

Equilibrium in the Labor Market
Each firm will hire labor up to the point at which the value of the marginal product of labor is equal to the equilibrium wage rate. This means that, in equilibrium, the marginal product of labor will be the same for all employers.

So the equilibrium (or market) wage rate is equal to the equilibrium value of the marginal product of labor—the additional value produced by the last unit of labor employed in the labor market as a whole.

It doesn’t matter where that additional unit is employed, since the value of the marginal product of labor (MPL) is the same for all producers. According to the marginal productivity theory of income distribution, every factor of production is paid its equilibrium value of the marginal product.

Rental rate Market Labor Supply Curve Equilibrium value of the marginal product of labor E W* Figure Caption: Figure 20-6: Equilibrium in the Labor Market The market labor demand curve is the horizontal sum of the individual labor demand curves of all producers. Here the equilibrium wage rate is W*, the equilibrium employment level is L*, and every producer hires labor up to the point at which VMPL= W*. So labor is paid its equilibrium value of the marginal product, the value of the marginal product of the last worker hired in the labor market as a whole. Market Labor Demand Curve L* Quantity of labor (workers) Equilibrium employment

Is the Marginal Productivity Theory of Income Distribution Really True?
There are some issues open to debate about the marginal productivity theory of income distribution: Do the wage differences really reflect differences in marginal productivity, or is something else going on? What factors might account for these disparities and are any of these explanations consistent with the marginal productivity theory of income distribution?

If a farmer is considering whether to rent an additional acre of land for the next year, what does he consider? Compare the cost of renting the extra acre of land to the value of the additional output generated by employing an additional acre (MP of an acre of land) To maximize profit, the farmer must employ land up to the point at which the value of the MP of an acre of land is equal to the rental rate per acre

Farmers have to consider rental rate: a unit of land or capital is employed up to the point at which that unit’s value of the MP = to the rental rate over that time period How is this determined, by equilibria in the land market and the capital market?

Equilibria in the Land and Capital Markets
(a) The Market for Land (b) The Market for Capital Rental rate Rental rate S Land R* S Land Capital R* Capital D D Land Capital Figure Caption: Figure 20-7: Equilibria in the Land and Capital Markets Panel (a) illustrates equilibrium in the market for land; panel (b) illustrates equilibrium in the market for capital. The supply curve for land is relatively steep, reflecting the high cost of increasing the quantity of productive land. The supply curve for capital, in contrast, is relatively flat, due to the relatively high responsiveness of savings to changes in the rental rate for capital. The equilibrium rental rates for land and capital, as well as the equilibrium quantities transacted, are given by the intersections of the demand and supply curves. In a competitive land market, each unit of land will be paid the equilibrium value of the marginal product of land, R*Land. Likewise, in a competitive capital market, each unit of capital will be paid the equilibrium value of the marginal product of capital, R*. Q* Q* Land Quantity Capital Quantity

Every factor of production is paid its equilibrium value of the marginal product

Who or what decides that labor would get 70.4% of total U.S. income, why not 90% or 50%?

Wage rate earned by ALL workers in the economy is equal to the increase in the value of output generated by the last worker employed in the economy-wide labor market. Is this theory true?

Median Earnings by Gender and Ethnicity, 2006
Annual median earnings, 2006 $50,000 $45,722 45,000 40,000 35,000 $29,166 30,000 $27,337 $24,893 25,000 20,000 15,000 Figure Caption: Figure 20-8: Median Earnings by Gender and Ethnicity, 2006 The U.S. labor market continues to show large differences across workers according to gender and ethnicity. Women are paid substantially less than men; African-American and Hispanic workers are paid substantially less than White male workers. 10,000 5,000 Female (all ethnicities) African American (male and female) Hispanic (male and female) White male

Earnings Differentials by Education, Gender, and Ethnicity
Annual median earnings, 2006 $70,000 No HS degree HS degree College degree 60,000 50,000 40,000 30,000 20,000 Figure Caption: Figure 20-9: Earnings Differentials by Education, Gender, and Ethnicity, 2006 It is clear that, regardless of gender or ethnicity, education pays: those with a high school diploma earn more than those without one, and those with a college degree earn substantially more than those with only a high school diploma. Other patterns are evident as well: for any given education level, White males earn more than every other group, and males earn more than females for any given ethnic group. 10,000 White male White female African-American male African-American female Hispanic man Hispanic female

Labor, Wages, and Earnings
Labor means: Blue-and white-collar workers Professional people Owners of small businesses Wages is the price employers pay for labor Wage rate Nominal wage Real wage Real wage depends on your nominal wage and the prices of the goods and services your purchase

Role of Productivity The greater the productivity of labor, the greater is the demand for it If the total supply of labor is fixed, then the stronger demand for labor, the higher is the average level of real wages

Role of Productivity High productivity is due to: Plentiful capital
Access to abundant natural resources Advanced technology Labor quality Other factors

Size of the labor force, 2008

Average annual growth rates for the labor force,

Average annual growth rates for full-time and part-time employment, 1998-2008

as a percent of total unemployment, 2008
Persons unemployed one year or longer as a percent of total unemployment, 2008

The Supply of Labor Decisions about labor supply result from decisions about time allocation: how many hours to spend on different activities. Leisure is time available for purposes other than earning money to buy marketed goods.

The Supply of Labor A rise in the wage rate causes both an income and a substitution effect on an individual’s labor supply. The substitution effect of a higher wage rate induces longer work hours, other things equal. This is countered by the income effect: higher income leads to a higher demand for leisure, a normal good. If the income effect dominates, a rise in the wage rate can actually cause the individual labor supply curve to slope the “wrong” way: downward.

The Individual Labor Supply Curve
(b) The Income Effect Dominates (a) The Substitution Effect Dominates Wage rate Wage rate Individual labor supply curve $20 $20 10 10 Figure Caption: Figure 20-10: The Individual Labor Supply Curve When the substitution effect of a wage increase dominates the income effect, the individual labor supply curve slopes upward, as in panel (a). Here a rise in the wage rate from $10 to $20 per hour increases the number of hours worked from 40 to 50. But when the income effect of a wage increase dominates the substitution effect, the individual labor supply curve slopes downward, as in panel (b). Here the same rise in the wage rate reduces the number of hours worked from 40 to 30. Individual labor supply curve 40 50 30 40 Quantity of leisure (hours) Quantity of leisure (hours)

The Supply of Labor The market labor supply curve is the horizontal sum of the individual supply curves of all workers in that market. It shifts for four main reasons: changes in preferences and social norms changes in population changes in opportunities changes in wealth

Marginal Productivity Theory of Income Distribution Notes

What does this say about the labor’s share in the factor distribution of income?

Labor market is in ______________ Number of workers that producers want to employ is = to the number of workers willing to work All employers pay the same wage rate and each employer employs labor up to the point at which the MP of the last worker hired is equal to the market wage rate

All Producers Face the Same Wage Rate
(a) Farmer Jones (b) Farmer Smith Wage rate Wage rate Farmer Jones's VMPL Farmer Smith’s VMPL wheat corn = P x MPL = P x MPL corn wheat wheat corn Market wage rate $200 $200 VMPL corn Figure Caption: Figure 20-5: All Producers Face the Same Wage Rate Although Farmer Jones grows wheat and Farmer Smith grows corn, they both compete in the same market for labor and so must pay the same wage rate, $200. Each producer hires labor up to the point at which VMPL= $200: 5 workers for Jones, 7 workers for Smith. VMPL wheat 5 7 Quantity of labor (workers) Quantity of labor (workers) Profit-maximizing number of workers Profit-maximizing number of workers

Each firm will hire labor up to the point at which the value of the marginal product of labor is equal to the equilibrium wage rate. This means that, in equilibrium,

So the equilibrium (or market) wage rate is equal to the equilibrium value of the marginal product of labor—the additional value produced by the last unit of labor employed in the labor market as a whole.

It doesn’t matter where that additional unit is employed, since the value of the marginal product of labor (MPL) is the same for all producers. According to the marginal productivity theory of income distribution,

Rental rate Market Labor Supply Curve E W* Figure Caption: Figure 20-6: Equilibrium in the Labor Market The market labor demand curve is the horizontal sum of the individual labor demand curves of all producers. Here the equilibrium wage rate is W*, the equilibrium employment level is L*, and every producer hires labor up to the point at which VMPL= W*. So labor is paid its equilibrium value of the marginal product, the value of the marginal product of the last worker hired in the labor market as a whole. Market Labor Demand Curve L* Quantity of labor (workers)

There are some issues open to debate about the marginal productivity theory of income distribution: Do the wage differences really reflect differences in marginal productivity, or is something else going on? What factors might account for these disparities and are any of these explanations consistent with the marginal productivity theory of income distribution?

If a farmer is considering whether to rent an additional acre of land for the next year, what does he consider? Compare the cost of renting the extra acre of land to the value of the additional output generated by employing an additional acre (MP of an acre of land) To maximize profit, the farmer must employ land up to the point at which the value of the MP of an acre of land is equal to the rental rate per acre

Farmers have to consider rental rate: How is this determined, by equilibria in the land market and the capital market?

Equilibria in the Land and Capital Markets
(a) The Market for Land (b) The Market for Capital Rental rate Rental rate S Land R* S Land Capital R* Capital D D Land Capital Figure Caption: Figure 20-7: Equilibria in the Land and Capital Markets Panel (a) illustrates equilibrium in the market for land; panel (b) illustrates equilibrium in the market for capital. The supply curve for land is relatively steep, reflecting the high cost of increasing the quantity of productive land. The supply curve for capital, in contrast, is relatively flat, due to the relatively high responsiveness of savings to changes in the rental rate for capital. The equilibrium rental rates for land and capital, as well as the equilibrium quantities transacted, are given by the intersections of the demand and supply curves. In a competitive land market, each unit of land will be paid the equilibrium value of the marginal product of land, R*Land. Likewise, in a competitive capital market, each unit of capital will be paid the equilibrium value of the marginal product of capital, R*. Q* Q* Land Quantity Capital Quantity

Every factor of production is paid its equilibrium value of the marginal product

Who or what decides that labor would get 70.4% of total U.S. income, why not 90% or 50%?

Wage rate earned by ALL workers in the economy is equal to the increase in the value of output generated by the last worker employed in the economy-wide labor market. Is this theory true?

Labor, Wages, and Earnings
Labor means: Wages is the price employers pay for labor Real wage depends on your nominal wage and the prices of the goods and services your purchase

Role of Productivity If the total supply of labor is fixed, then the stronger demand for labor, the higher is the average level of real wages

Role of Productivity High productivity is due to:

The Supply of Labor Decisions about labor supply result from decisions about time allocation: how many hours to spend on different activities. Leisure is time available for purposes other than earning money to buy marketed goods.

The Supply of Labor A rise in the wage rate causes both an income and a substitution effect on an individual’s labor supply. _____________________of a higher wage rate induces longer work hours, other things equal. This is countered by the ______________ : higher income leads to a higher demand for leisure, a normal good. If the income effect dominates, a rise in the wage rate can actually cause the individual labor supply curve to slope the “wrong” way: downward.

The Supply of Labor The market labor supply curve is the horizontal sum of the individual supply curves of all workers in that market. It shifts for four main reasons: changes in __________________________ changes in _____________________

Marginal Productivity Theory of Income Distribution

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