According to economic theory, scarce factors of production are paid based on their marginal productivity. But, in practise, how does any businessman discern the marginal productivity of each factor? It seems to be something complicated.
And this is only the first question. I have a series of questions, but I want to ask them as a series with intervals right here in this thread. So please care to check in.
Whatever decision a businessman ultimately comes down to, it’s based on whether the additional cost matches the additional benefit. That’s actually up to him to decide what benefit is equivalent to what cost - the economist does not decide what the businessman should do, but simply sees why the businessman does what he does.
Perhaps he just happens to be of the mind that 50 workers should be paid $250, because of the way he possible perceives that the 50th worker does only $5 worth of work, and the 51st worker can’t possibly do anything more that would warrant paying the same $5. How does he discern it? Well, it’s not like he’s making some calculation here; it’s just that as far as he can see, there normally has not been much benefit derived from the 51st worker in his experience that warrants paying the same $5, perhaps from what he has seen in past business seasons.
The concern of the economist here is simply to see and rationalise what happened based on the incentives given, not what the businessman should have done or how he should discern marginal productivity.
It’s actually not too complicated. Assuming a free market, consumer goods prices are simply imputed backwards to create one portion of the prices for factors of production. The other portion comes from the competition among businesses for said factors of production.
A bolt and a screw out of a plane engine will render the entire machine useless. So by terms of marginal productivity, the screw must command the entire value of the machine? I know screws and bolts are available in large quantities, so the price of bolts and screws is quite cheap. But my point is, going by marginal productivity terms, the screw and bolt(or any other part of the engine) must command the entire value of the machine.
There are so many things that go into making a product. How does the entrepreneur calculate the value of each individual factor? Take the aircraft engine example for an instance.
But is each additional screw or bolt as necessary as the previous? There’s a point past which additional ones are useless, and I’m sure engines could be redesigned to use fewer fasteners (with perhaps a lower level of efficiency) if such a shortage existed.
Regardless, we’re not the entrepreneur, so we aren’t the one making the decision. Marginal productivity doesn’t only explain what entrepreneurs would do, but what they currently do as well. The fact of the matter is that entrepreneurs make decisions like this everyday, often without any kind of rigid or precise mathematical calculation outside of their own head.
Do you think it’s right to use the term ‘marginal productivity’ to denote the value a factor adds to production in the sector it is employed in?
I mean, nuts and bolts fix the aircraft in the final stage. That’s precisely the point when the aircraft attains any value at all. Won’t it be stupid now to say the marginal productivity of the nuts and bolts in the entire value of the aircraft? In fact taking of any component of the engine would render it useless.
Also consider the time factor. When building the engine in the factory, each nut and bolt is very cheap. If they were not another entrepreneur would provide them cheaper, because there is a low barrier to entry. If the engine is missing a bolt at the passengers are boarding, it may be much more expensive. The airplane cannot leave unless the bolt is in place. It will there fore pay much more for the same bolt. In both cases though, if 50 bolts are required, the 51st is useless and the manufacturer may be unwilling to pay anything for it (unless it buys an extra so as to not be gouged on the tarmac!)
Actually, according to economic theory, in the ERE, factors are paid their Discounted Marginal Value Product (DMVP). The Marginal Value Product is equal to the spread between the revenue a firm would earn by employing the factor of production and the revenue the firm would earn without employing the factor of production. The Marginal Value Product is discounted by interest to obtain the DMVP.
You should read Man, Economy, & State chapters 1-7.
Here is the problem. Lets say you make a cycle worth $200. You take the front wheel out of the cycle, and you find the cycle’s value now is zero. So the marginal value of the front wheel is $200. Next you take the back wheel out, and you find the cycle’s value is zero. So the marginal value of the back wheel is $200.
Don’t you find the problem now? The marginal values lost in separate cases, when added up, surpass even the total value of the entire product. Now it’s simply crazy to say factors are paid based on their marginal value.
As a cycle it’s value is zero. As a collection of parts, absent the one wheel, there still may be value. You’re basically arguing against the entire scrap industry, including auto junk yards, where partial cars are recovered one component at a time.
To someone with a wheel only, the remainder of the bike is a tremendous opportunity to make use of their wheel.
Your argument presumes that marginal value is objective, and not subjective.
No. I didn’t say that the wheel goes useless. I only said a cycle without a wheel becomes usless. That means, the marginal value that the wheel adds to the final product is the entire value of the cycle itself.
the marginal value to you of having your first bike is greater than the marginal value to
you of paying out the first 200$ of yours (.the price of purchase of the bike being 200$)
hence you buy one bike.
the marginal value to you of having your second bike is less than the marginal value to you
of foregoing your second set of 200$
hence you do not buy a second bike, you just have one bike.
if the marginal value to you of separating the front wheel of the bike is greater than the
marginal value to you of having a bike with the front wheel attached then that would explain
why you detached it. and had a wheel and a bike with no front wheel.
or else; it is less, and you keep it attached.
i think if you keep it attached you provide evidence that the marginal value to you of
having a detached wheel and bike without a front wheel is less than that of having a
fully functional bike.
(note: I have assumed away transactions costs)
No again. The issue is if factors are priced on the basis of their marginal value. It doesn’t seem so. If I have to be wrong, the front/back wheel of the cycle should be priced at the entire value of the cycle.
But it doesn’t as I illustrated with my scrap yard reference.
But this is untrue, because every component contributes to the marginal value. The order of assembly isn’t crucial, the cycle is not a cycle until fully assembled. It wouldn’t matter if you added a wheel or a handlebar or a pedal last. The value of the cycle qua cycle isn’t there until the last component is added. Prior to this, it is a different product. Heck, every cycle is a unique and differentiated product, even if made with the exact same parts, painted the same etc.
The appeal to objective value is misguided in my opinion.
Not untrue, according to the idea that factors are priced based on their marginal productivity.
You totally miss what I’m trying to point out. Lemme restate it.
It is said factors of production are priced based on their marginal productivity. For example, if adding a liter of milk to my ice-cream business increases my revenues by a dollar it means the marginal productivity of the liter of milk is a dollar.
Going by the same logic, take a bicycle. Suppose I want to determine the marginal productivity of the front wheel of the bicycle. So first I ask people to bid for the fully furnished cycle, and I find that the bid price is $200. Then I take off the front wheel and ask buyers to value it. Nobody wants a bicycle which has only a single wheel. So now the marginal productivity of the front wheel is $200. Now if I’m gonna do this sort of finding of marginal productivity of each factor that goes into making a bicycle, then the total sum of all these marginal productivities will surpass the actual value of the fully furnished bicycle.
no marginal value does not equal price. marginal value informs price formation, but is not the sole determinant.
in a market economy the marginal value of goods (to the people considering whether to buy them) that people choose to buy are more than their prices. and the marginal value of goods which go unbought (are maybe ‘economic bads’) have value (to their unbuyers) less than their prices.
not even people with spare wheels at home? i will buy the bike at a price greater than 0 but less than its marginal value to me, i will bid no more than 200$. the fact i have a wheel means of my own to attach means if you lower your price you will make me a buyer between 0 and 200.
i should note that the wheel-less bike you offer for sale does not have a marginal value of 200 for me, it has a marginal value of more than $200 but less than 201$
What you’re missing is that a thing takes the value of its marginal productivity in its marginal use–a screw, yes, can fail and cause the entire engine to fail, but it does not command the value of the machine because if the particular screw in the engine fails, screws will be moved from their other, less important uses up to this relatively more important use–making an airplane fly. Therefore the value of a screw is pennies because that is the marginal productivity of a screw in its least important use.
Exactly. Intermediate goods (goods that are used to create final consumption goods, such as a bike that is missing a wheel, wherein the bicycle itself would be the final consumption good) have monetary value because they may be combined with other intermediate goods to create consumption goods, which may then be sold or consumed. In other words, half-finished bicycles are still “valuable” because they may be used to create bicycles, goods that are presumably valued because they satisfy some consumer need. Of course, half finished bicycles may be used for other purposes as well (such as scrap metal, as liberty student noted), but that is not a problem since all goods may be used for a variety of different purposes.
Now, given that a half-finished bicycle would have some sort of monetary value, you could presumably find the marginal value product of adding the front wheel to the bicycle by noting the difference between the market value of a finished bicycle and the market value of a half finished bicycle (however, labour would presumably be needed to attach the wheel to the bicycle, so you’d need to take that factor’s contribution into account as well). Of course, I am assuming that there is a market price for half finished bicycles, which in the real world there may not be, but in some hypothetical equilibrium construction (say, an evenly rotating economy), there would be markets for all goods, including half-finished goods, and as such, there would be some market price for half finished bicycles that you could use to determine the marginal value product of a wheel.