Central Planning and efficiency

Economics Economics Questions
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21

Looking at that post, it seems that you only disagreed with points three and four, but I don’t really understand your objections/positions.

You said,

  • I disagree. If you cannot measure the change in output from hiring an additional worker, you cannot measure marginal productivity. And it is my understanding we are attempting to discuss how the demand for labor is derived, which is only one side of the market for labor. So I am not sure how market mechanisms and prices would help you.

Are you saying that producers actually try to measure the marginal productivity of each laborer before they hire them/pay out salaries? My position, just to be clear, is that capital tries to absorb the entire labor supply, and engage in production. The most productive capital and the most productive employment of capital gets first dibs, and so on and so forth until the entire labor supply is absorbed. The market, through competition, pushes wage rates towards the marginal productivity of labor–but we should never expect it to actually reach or remain at this position. So an increase in the supply of real capital (brought about by savings) has to absorb a relatively fixed supply of labor, which pushes up real wage rates, and increases productivity (basically the same as saying that MPK falls, Q rises, MPL rises). As opposed to entrepreneurs using production functions trying to figure out how much labor to employ, and what to pay them.

Maybe I’m not understanding what you’re trying to say.

You also said,

  • Trade unions are irrelevant for deriving the demand of labor. Trade unions are typically about restricting the supply of labor, so this bullet point should probably be dropped (or maybe clarified if I am misinterpreting).

But trade unions elevate their wage rates above their marginal product, necessarily diminishing demand, and lowering the real wages rates of “out-sider’s.” Are you saying that wage rigidity doesn’t affect the demand for labor? If so, you’re going to have to explain why elevating the minimum wage rate generally leads to higher unemployment amongst teenagers and minorities. It may not mean anything for your linear homogeneous production functions (though it may), but we’re talking about the real world.

22

You have me a bit confused. The marginal revenue product of labor (or the related concept of marginal productivity of labor) is not something that wages are pushed toward, it is the additional revenue the firm generates by the employment of one additional unit of labor (see wikipedia for mathematical derivation: http://en.wikipedia.org/wiki/Marginal_revenue_productivity_theory_of_wages). Essentially, it is just the function that describes a firm’s demand for labor.

And you’re right, I do believe that employers attempt to measure the marginal revenue product of labor they hire. This doesn’t seem counter intuitive to me. For example, at my work, when we hire new people I am quite sure we try to take into some rough account the amount of output we can generate each with one extra employee and compare that to a competitive salary for that worker. It isn’t an exact measurement, but the though process is exactly the same as you learn in Econ 101.

Here is a graph to help make the concept of a small firm facing a large labor market clearer. If the MRP > wage, then the firm will hire an additional workers because the value of the output they generate will exceed the cost of employing that additional worker. The firm will hire until MRP = wage. If they hired additional workers after that, then MRP < wage and they would be paying more in wages than they were receiving in output from that additional worker.

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Well, trade unions are about restricting the supply of labor. It doesn’t directly impact the marginal productivity of labor (the firm’s demand for labor). Instead, you will see the supply curve for labor moving along the demand curve. In the graphic above, imagine the wage line increasing, the quantity of labor demanded will decrease. But the actual demand curve (the marginal revenue product of labor) stays the same. The same analysis is exactly so for a minmium wage increase.

For example, lets say in equilibrium the marginal revenue product of the 10th laborer hired by McDonalds is $5 per hour and the wage determined by a competitive labor market is also $5 per hour. However, the government decides to set a new minimum wage at $10 per hour. Well, then McDonalds will cut back employment until the marginal revenue product of the last worker is $10. If the demand for labor is unit elastic, I believe that the quantity of labor demanded will fall from 10 workers to 5 (typing quickly so feel free to double check).

Now, I know that may sound confusing “hey you just said the marginal productivity of labor didn’t change but in your example the marginal product of the last worker changed because the wage increased” but don’t be tricked by the awkward terminology. The marginal product of the last worker has changed, but the marginal productivity of labor (the demand curve) has not. Similar issues come into play when you’re dissecting phrases like “change in demand” and “change in quantity demanded”.

Hope this help clarifies my objections.

23

Of course the producer engages in some sort of economic calculation, but he must compete for that labor in the labor market, against all other entrepreneurs. The producers want to pay the lowest wage possible.

Traditional and basic economic theory tells us that the marginal product of labor equals real wages. The market, through competition, pushes real wages towards this position. It is a price like every price (and labor is a commodity), and markets (again, through competition) establish prices.And like all prices, we shouldn’t expect it to be at its equilibrium level in a dynamic market economy.

Of course. But when I said labor demand, I meant it in the non-technical way. Essentially, all I was saying is that as the government (or trade unions) arbitrarily elevates wage rates by decree, above the equilibrium rate (marginal product), we should expect to see higher unemployment. Or, in other words, businessmen hire less labor.

Right.

Don’t worry.

24

Yes, I do believe it is the norm from personal experience. But I do not have studies or anything that says this how everyone makes hiring decisions. I don’t think you could. But if this were not how employers made hiring decisions, I simply couldn’t imagine how else they would do it. Do you have something besides marginal analysis in mind?

Actually, the marginal product of labor would equal real wage regardless of competition. Consider my minimum wage example. In market equilibrium the wage was $5 per hour. The government came along and said “well now its going to be $10 per hour!” and the firm cut back employment until the marginal product of the last laborer was equal to $10 per hour.

It isn’t competition in the labor market that makes this happen, it is profit maximization on the part of the firm.

25

Producers want to pay the lowest wages possible. The same way that you want to pay the lowest possible price for any given good/service. Competition, and therefore the price mechanism, assures that scarce resources go to the most warranted employments. The producer would love to pay his worker $1 an hour, but at that depressed price he cannot secure the level of labor he requires for profitable production. His capital would remain barren, and he would take losses. The axiom (better more profit than less profit) moves wages rates towards their equilibrium position–that is, the entrepreneur will bid up the price of labor up until the point where labor is no longer profitable (this could be the equilibrium position determined by the market, or not–if not, then this producer must free up his capital for other more warranted employments). So I don’t dismiss marginalist logic, just mainstream marginalist methods/analysis.

I understand your position. You’re saying that if the government doubles the minimum wage (or whatever), the firm will lay off workers until the last workers marginal product equals the fiat wage rate (determined by the government). Now, it is true that even without competition, the wage rate should never exceed the marginal product of labor, and I agree with this (obviously). But without competition (one giant government protected cartel, for example) we should not expect real wages to equal the marginal product of labor. In essence, we should expect exploitation.

26

It is through the process of arbitrage that prices adjust. It is this same process that adjusts wages towards their DMVP (discounted marginal value productivit). Arbitrage implies competition. By competition, I mean as defined by free entry or no restriction on entry. That is all.

Of course it is profit seeking that induces employers to bid up wages as part of this competitive process.

27

I think this is addressing a totally different question. I agree that the wage that actually prevails in the market will depend on both the supply and demand of labor and the degree of competition in the marketplace. However, that isn’t what marginal productivity theory is only about one piece of the labor market–specifically the firm’s demand for labor.

A firm will hire labor until the marginal revenue product equals the real wage regardless of competition in the labor market place. If they did not do this, they would not be a profit maximizing firm.

28

Why would a profit maximizing agent pay a wage rate equal to the marginal product if he can secure the same level of labor at a lower price (wage)? If he can do this, then he certainly would. But the point is that he can’t (because of competition).

29

ohhh now I see what you’re saying. You’re talking about how wages are actually set in something like a case of monopsony.

http://en.wikipedia.org/wiki/Monopsony

You are right that if we had a market where an employer had some degree of market power then wages could fall below MRP.

However, this is exactly why we are talking past one another and why talking about competition is making this discussion more confusing than it has to be.

You are talking about the labor market as a whole. However, I am just talking about the demand side of this market (this was the subject of the original thread and of marginal productivity theory of wages). If a firm is simply given a wage for labor that they cannot influence, they will employee labor until the MRP equals that wage (this could be because the market a small firm is facing a wage set by a competitive labor market or it could be because as in my example the wage is set by government fiat). In other words, I am talking exclusively about how you can read the labor demand function.

If we are talking about how those wages are actually set as a result of the interaction between supply and demand, then the degree of competition will make a difference and firms could potentially pay less than the MRP. I acknowledged this in my original post in the other thread by saying the same marginal analysis could be used to consider competitive or non-competitive markets. But my point there (and here) has been to focus on the demand side of the labor market and not the labor market as a whole because that is where marginal productivity theory is most relevant.

30

Okay, so we’re in agreement. Basically I thought you were saying that wages must necessarily equal their marginal product under all conditions. This was an entertaining digression.

31

All’s well that ends well. :slight_smile:

32

At the very least it cannot be stated that the resources are wasted. Had they been wasted then they wouldn’t even be consumed by petty wants. Wasted resources are idle unused resources, or resources that were used to build things no one desired. If people are using the resources then they cannot be said to be wasted.

It’s really a side point but calling it being wastful is a mischaracterization of their argument, though they don’t realize it. They just have to word it differently to flower up what they are really saying. What they want is “from each according to his ability, to each according to his need”

When you expose their argument for what it really it is, it becomes a bit more trivial.

Also who decides what wants and needs are and how the taxonomy of those two items is done? An elite dictatorial body of men? Or are individuals allowed to make those decisions based on their situation and preference?

Ultimately who decides what is a good resources and a bad, is it the individual man working in concert on the market? Or a omniscient being up in a castle somewhere making these decisions for us?

33

The problem being discussed is, as far as I can tell, the issue of merit goods (merit bads). Goods that are, by some value judgement underprovided (overprovided) by the market, but do not necessarily fit into the category of public goods.

Brennan and Lomasky have an interesting argument in favour of government provision, although they admit that it is somewhat problematic and inconclusive, I forget the exact nuances so if you want to read it you’ll have to pick up a copy of their book. Essentially the argument is that there are different types of wants, some which might be described as more moral others which may be described as more base. Depending on the institutional framework we will choose to indulge different types of these wants. Invoking the concept of akrasia they point out that market actors aren’t very good at satisfying those wants that they recognise to be morally good due to the high initial cost of fulfilling them. I suppose one example might be smoking, another could be giving to charity. Many people feel that they should quit smoking for the good of themselves or those around them, but when the time comes to it they still end up lighting up the cigarette because the withdrawal symptoms are too painful.

Granted, because of the lack of immediate profit and loss signals and the winner takes all nature of the political market, politics is a poor means of providing most goods. However, the political arena is far more capable of providing merit wants since the cost of voting for a smoking ban is essentially zero (because of the low probability of ones vote being decisive) and as such akrasia is not as problematic. In fact, people gain positive utility from expressing certain kinds of preferences - usually those preferences they believe to be moral..

34

You don’t counter it. You change it. Someone who is interested in helping the people in the streets does not just up and fabricate this superfluous edifice of junk about petty wants and useless products. That junk comes from a contempt of the post simple life. If “basic needs” fell from the sky, the petty wants would still be petty and useless products would still be useless and professors would still write about the evils of consumerism. Minus the gobbeldeegook, the issue is stated as, “Some people are rich, some people are poor.” Now, it is apparently about equality.

35

Ask them the difference between a need and a want, and who is granted the authority to make that decision on behalf of others.

36

Wow. I never expected an exciting debate to happen. Thank you all for your intelligent answers. Now to be more specific about what socialists mean by needs. These are for example health care and education. South East Asian countries with fanatic leftist politicians and intellectuals want to socialize health care, they want everybody to have health care and education no matter how low quality and inefficient it is. But I’m still divided whether to move to ethics or stay with economics. I’m guessing the shorter route is to move to ethics but it’s more riskier since they might not be interested in libertarian ethics and think that libertarian economics is inefficient.

If I stay with economics I’ll have to show why there is a mismatch between the production of ‘petty wants’ and production of needs like health care and education. In which case I’ll have to point out to government regulations and taxes as the cause of expensive health care and education in the market.

I’m leaning towards economic arguments for now.

37

I’ve always wondered what people’s criteria were for calling things a need…

38

Then suggest that the government prints a healthcare card for everybody and that’s it. No medical services will actually be provided due to low quality and inefficiency.

I’m dead serious by the way.

Only when they choose to put efficiency and quality back on the table, can you continue to maybe have a rational conversation with them.