Marginal Revenue Productivity Theory of Wages According to WikiAnswers

[Capital_Pumper]

An analysis would appreciated, thanks.

http://wiki.answers.com/Q/Briefly_outline_the_theory_of_marginal_revenue_productivity_and_then_examine_the_criticisms_of_the_theory

Workers are needed for the output they are required to produce. We say that labour as a factor input is a derived demand. When firms see increasing demand for their products, they will need to employ extra workers and thus the demand for labour increases.

Demand for labour and the market wage rate

There is normally an inverse relationship between the demand for labour and the wage rate that the firm will have to pay for each additional worker. If wages are high, it is more costly to hire extra employees. When wages are lower, labour becomes cheaper than using capital equipment and it becomes more attractive and affordable for the business to take on more employees. Remember that firms are aiming to maximise profits. They will use the factor of production (labour or capital) that does the job as efficiently as possible for the lowest possible cost.

Marginal Revenue Product

Marginal revenue productivity (MRP) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.

MRP theory suggests that wage differentials result from differences in labour productivity and the value of the output that the labour input produces

MRP theory is based on a competitive labour market and the theory rests on a number of key assumptions that are unlikely to exist in the real world. (In reality, most labour markets are imperfect, one of the reasons for earnings differentials between occupations)

• Workers are homogeneous
• Firms have no buying power when demanding workers
• There are no trade unions
• The productivity of each worker can be clearly measured
• The supply of labour is perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate

Marginal Revenue Product (MRP) measures the change in total revenue for a firm as a result of selling the output produced by an extra worker.

MRP = Marginal Physical Product x Price of Output per unit

ILLUSTRATING THE LABOUR DEMAND CURVE

In the left hand diagram, when there is a fall in the wage rate from W1 to W2, the firm will expand employment from E1 to E2. This is because the labour input has become relatively cheaper for a given level of productivity, compared to other inputs. A rise in the wage rate from W1 to W3 causes a contraction of labour demand.

Shifts in the marginal revenue product of labour

Marginal revenue productivity of labour will increase when there is (a) an increase in labour productivity and/or (b) an increase in demand for the firm’s output which causes higher prices and raises the value of output produced by the workforce. The right hand diagram shows how this causes an outward shift in the labour demand curve. For a given wage rate W1, a profit maximising firm will employ more workers. Total employment in the market will rise.

Problems with marginal revenue productivity theory

Marginal revenue productivity cannot be used as a valid basis for discussing labour demand for all types of workers. In many cases it is hard to objectively measure productivity because no physical output is produced by the workforce. Even if productivity can be measured, the output produced may not be sold at a market price. This makes it hard to place an exact valuation on the output of each extra worker.

In other examples, wages may be set independently of the state of labour demand. Public sector workers may have their pay set directly by government.

Marginal revenue product is useful in explaining the demand for labour in many occupations. But for a fuller explanation of wage determination and the existence and persistence of wage differentials, we must focus more on the supply side of individual labour markets.

[Esuric]

@Capital Pumper

Marginal revenue productivity (MRP) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.

In current dollars.

@Capital Pumper

MRP theory is based on a competitive labour market and the theory rests on a number of key assumptions that are unlikely to exist in the real world. (In reality, most labour markets are imperfect, one of the reasons for earnings differentials between occupations)

• Workers are homogeneous
• Firms have no buying power when demanding workers
• There are no trade unions
• The productivity of each worker can be clearly measured
• The supply of labour is perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate

• Not required whatsoever. The firm will notice the more skilled laborer and will presumably try to keep him/her. If they don’t, the laborer can move on to more ‘profitable’ ventures.
• Firms do have buying power, but they compete amongst themselves, which ultimately causes real wages to rise.
• Helps, but is not necessary. Trade unions disrupt this process.
• Not needed at all, that’s the point of price mechanism and competition.
• That’s only needed for full employment. If this condition does not hold, then there will be frictional unemployment, but it has nothing to do with the remuneration to labor.

@Capital Pumper

Marginal revenue productivity cannot be used as a valid basis for discussing labour demand for all types of workers. In many cases it is hard to objectively measure productivity because no physical output is produced by the workforce. Even if productivity can be measured, the output produced may not be sold at a market price. This makes it hard to place an exact valuation on the output of each extra worker.

It doesn’t matter, workers get paid before the fact, that is, before the production process is complete. In the beginning of capitalist production (the early 18th century), it is likely, maybe even expected, that workers get paid less than their productivity, but competition and capital accumulation brings the wage level to equilibrium position. The fall in prices of the finished goods is really a problem for the capitalists, and then the workers if the capitalists productions are not warranted or demanded by society (but they can get another job, though this does put the laborer in a worse position, at least temporarily). Alterations in the price mechanism, especially the interest rate, will cause entrepreneurs to engage in unwarranted and ultimately unprofitable ventures–the ABCT.

@Capital Pumper

we must focus more on the supply side of individual labour markets.

An increase in the supply of laborers will translate into a lower marginal product of each additional laborer causing wages to fall. But as marginal product of labor falls, output still rises, causing the marginal product of capital to increase, which leads to an increased demand for capital. Once more capital is procured, labor demand will increase once again. Capital determines wealth, incomes, and everything else basically.

Everything else is okay.

I would also like to add that the mainstream neo-classical’s use production functions when determining wage rates, which will equal the equilibrium position, but this is not what you should expect in the real world. There may be times when capital accumulation is rapid and dramatic (increased savings), which would translate into wage levels above the equilibrium position (what mainstream economists call “quasi-rents” or Adam Smith’s “bargaining theory of wages”). The price level fluctuates around the equilibrium position, and is never really at it (which is true as a rule), especially with the disturbances our economy faces.

[Student]

To the Capital Pumper.

Based on the original question (outline the theory or marginal revenue productivity), I would have guessed that it was asking how marginal revenue productivity can be used to evaluate the demand of labor. In other words, that “labor supply considerations” were irrelevant (which seems to be the point at the end of the post). However, through out the post there are frequent references to factors that only influence labor supply. If there is a different intention of the post (maybe to explain the entire labor market or maybe to explain some example of in the history of economic thought), that probably needs to be cleared up.

Also, I might have added a mathematical derivation of marginal product. Or maybe just simply say that “the marginal product of labor is the first derivative of the production function with respect to labor”.

There are some other tweaks to recommend, some similar to what Esuric has already pointed out. However, I believe Esuric has gotten a few things slightly off, so let me help clear his comments as well as recommend changes for you Capital Pumper.

@Esuric

@Capital Pumper

MRP theory is based on a competitive labour market and the theory rests on a number of key assumptions that are unlikely to exist in the real world. (In reality, most labour markets are imperfect, one of the reasons for earnings differentials between occupations)

• Workers are homogeneous
• Firms have no buying power when demanding workers
• There are no trade unions
• The productivity of each worker can be clearly measured
• The supply of labour is perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate

• Not required whatsoever. The firm will notice the more skilled laborer and will presumably try to keep him/her. If they don’t, the laborer can move on to more ‘profitable’ ventures.
• Firms do have buying power, but they compete amongst themselves, which ultimately causes real wages to rise.
• Helps, but is not necessary. Trade unions disrupt this process.
• Not needed at all, that’s the point of price mechanism and competition.
• That’s only needed for full employment. If this condition does not hold, then there will be frictional unemployment, but it has nothing to do with the remuneration to labor.

First, Capital Pumper, I am not sure what you mean by saying that “the MRP theory is based on a competitive labor market”. One can easily use the same tools to study non-competitive labor markets. To help you see what I mean, here is an example marginal analysis being used to study an example of monopsony in the labor market. Maybe I am just misunderstanding what you’re saying.

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

Esuric, I will address each of your bullet points in the order you provided.

• Not exactly. You are correct that marginal productivity theory can easily handle differences between skilled and unskilled workers. Mathematically, you would simply write the production function to include two types of labor input–skilled and unskilled labor. For example, Q = f(Ls, Lu, K) where Ls is skilled labor and Lu is unskilled labor. Then you would take the first derivative of the function with respect the two types of labor to get the marginal productivity function of each. However, within each of these labor categories, workers must be assumed to be somewhat homogeneous for the function to be continuous.
  _

• Sort of. I think the point is only that an individual firms labor purchases will not impact the wage rate, which your right is a result of competition in the labor market. I think you’re both just saying the same thing in different ways.

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• 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).
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• 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.
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• I agree that this point is irrelevant to the point of the post at hand, but labor does not need to be fully elastic for there to be full employment. Unemployment is measured as the number of individuals that are not employees by currently seeking work. Unemployment would be zero if the labor market is in equilibrium, regardless of the elasticity of the supply of labor. This is because the individuals that are willing to work at the current wage rate are employed. Individuals not willing to work at current wages rates would not be seeking employment and would therefore not be counted as unemployed. However, you are right that in the real world static equilibrium is never achieved and there will always been some “frictional” unemployment as people move jobs and other things. However, I do not believe this has anything to do with the elasticity of labor.

Crap, gotta run but hopefully this helps. Have a good day everyone!

[Capital_Pumper]

@Esuric

• Not required whatsoever. The firm will notice the more skilled laborer and will presumably try to keep him/her. If they don’t, the laborer can move on to more ‘profitable’ ventures.

Is he using worker interchangeably with labour? What makes him think that MRP requires the assumption that workers be homogeneous?

@Esuric

• Firms do have buying power, but they compete amongst themselves, which ultimately causes real wages to rise.

Yeah, I thought as much.

@Esuric

• Not needed at all, that’s the point of price mechanism and competition.

Could you elaborate?