Here is an old blog post from the blog “Unlearning Economics” that I thought might get some non-macro discussion going (doesn’t anyone else get bored of chatting up the gold standard and ABCT?).
Basically, UE argues that wages argues against the “MVP theory of wages”. He doesn’t spell out exactly what he means by this (and it actually meant different things to different people in the past), but I take him to mean that wages are not set by the interaction of supply and “demand” (defined as the marginal revenue value product of labor) for labor.
He gives two reasons:
the notion of a “marginal unit of labor” is incoherent - you simply can’t produce an extra unit of your product by hiring one extra person and holding all other factors constant. So you can never calculate a “marginal value product”. One taxi ride requires 1 driver and 1 cab. If you hire 1 extra driver his marginal product is zero unless you also employ another cab.
team production - even if you ignore the first problem, workers typically produce goods in “teams”. imagine a construction team building a house. you need a plumber, a dry waller, and all different types of workers to finish 1 house. if you didn’t have a plumber, you couldn’t build the house. but surely that doesn’t mean the marginal product of a plumber is 1 house! so you have to evaluate the performance of the team as a whole.
These 2 reasons sound almost identitical to me, but I think they are slightly different. I have my own reasons for doubting their validity, but I was wondering…
Is there a uniquely Austrian take on UE’s arguments? Do you agree, do you disagree?? Am I getting his argument wrong? I am curious to know what my micro-minded forum-mates think.
huh? what is wrong with accepting that in the taxi example an extra driver would normally be expected to have a marginal product of zero? how does that stand against DMVP?
If you dont have a plumber ,you have a house sans plumping… I mean those other workers did all the stuff apart from putting the plumbing in right?
I’m sorry I haven’t given you a ‘uniquely austrian’ response, but I dont see the warrant.
He could argue that there is no such thing as a marginal unit of half a laborer, because half a laborer will drop dead on the spot, since he is sawn in half. And he’s right, of course.
But that only shows that we have chosen our basic unit uncorrectly. Instead of half a laborer, the basic unit is a whole laborer, not sawn into two.
Similarly, in the cases he discusses, the unit has to be modiffied. In point two, the marginal unit is a team. In point one, it’s a cab and a driver.
Ok, I suppose his question is really about factor pricing. And presumably in the taxi example he ‘meant to ask’, how is it that if both a driver and a cab are needed to deliver a transport service then how can those two factors possibly command different prices if they are both in some respect ‘equally necessary’ . We can start by noticing that one can hire cars without drivers and drive them oneself… And then we start to think about opportunity costs, and it all becomes a lot simpler when we have money to use in appraisal of such choices.
Do I need to go on, or shall we make this homework ?
huh? what is wrong with accepting that in the taxi example an extra driver would normally be expected to have a marginal product of zero? how does that stand against DMVP?
There is nothing wrong with accepting the MVP is zero. But his point is that most production processes can be described this way. So if the MVP is almost always zero, how do you determine wages? Thoughts?
If you dont have a plumber ,you have a house sans plumping… I mean those other workers did all the stuff apart from putting the plumbing in right?
Think of it this way. A house in the US without plumbing would probably not go for much on the open market because you are basically talking about a really nice shed. Say a really nice shed sells for $10,000 and a house with plumbing of similar size sells for $400,0000. I think he is balking at the notion that the MVP for the plumber is $390,0000.
I think a better example for what unlearning econ is talking about from a paper by Armen Alchian where you have two movers. The movers have to move furniture together. Here you can only observe how many pieces of furniture they move. You cannot easily observe if one mover is doing more of the lifting than the other. So how do you determine marginal productivities?
I’m sorry I haven’t given you a ‘uniquely austrian’ response, but I dont see the warrant.
huh. That is interesting. I’ve read several places about austrian disastification with the profit-maximizing neo-classical theory of the firm that yields the MVP demand for labor (http://mises.org/journals/qjae/pdf/qjae8_4_3.pdf). But you are saying you think applied micro is really no different between the two schools of thought?
ok. At this point I’m realising that whats being posed is the classic ‘paradox’ , of what value to impute to a a steering wheel that will complete a luxury car, a screw that will complete a jet liner.
The mistake is that one has gone from asking about what determines the marginal utility of the finished product (house,car,jet), to asking about what determines the marginal utility of the item that would complete the finished produce.
You are realy asking ’ what is the marginal utility of K hours Plumbing labour time’ in a world where a house lacking plumbing exists (and lots of other things exist also). Now its clear from your example that the MAXIMUM utility of such plumbing hours is the completion of the house, (unless maybe there are other, even yet more wonderfull houses, lacking rudimentatary plumbing). But the Austrains recognise that the non-specifity of the factor is the thing. It becomes a question of opportunity costs. the Marginal Value Product will be less than the maximum utility, and it will be more than it would have been an an identical world minus the unfinished house, which might bid away the K hours plumbing labour time from its next most valuable use..
Remember the parable of Mengers horses and cows.
The marginal analysis that is relevant in the paradox is answered by asking, if I lost the particular plumber that said he would fix up the plumbing in my otherwise saleable house that I could sell for $400k (plumber A, on my job A) , what would be lost? The plumber can be replaced by another (plumber B) , leaving whatever job plumber B would have been doing, undone (job B). In a world where our marginal plumber (plumber A) is introduced, plumber B is freed to fill the next most valued job. The marginal utility of plumber A, is the accomplishment of Job B !!!
This is a divisibility/definitional issue that just means you have to compute marginal products for each member of the team at a given point in time. Or the marginal product of a team as a whole.
Sorry this is just not true. If I sell my used car, that normally would go for a market price of approx. 10000 USD and the clutch is gone and needs to be replaced, then the price of my car is neither nought nor only 10% or something like this. My car is worth approximately 10000 minus the costs of replacing the clutch. If this is 1000 USD, the car’s value as a basis for negotiations will be at around 9000 USD.
It is the same with the house. If the necessary plumbing works will cost around 40,000 USD to do afterwards then the basis price for negotiations will be around 360,000 USD.
I think a better example for what unlearning econ is talking about from a paper by Armen Alchian where you have two movers. The movers have to move furniture together. Here you can only observe how many pieces of furniture they move. You cannot easily observe if one mover is doing more of the lifting than the other. So how do you determine marginal productivities?
@RobinHood - I don’t think switching units to “teams” addresses unlearning econ’s concern. His question would still be how we determine the distribution of compensation to each member of the team.
@nigra - I don’t think that quite gets at UE’s main points. Primarily, one of his major arguments is that you can’t calculate MVP and your response assumes you can. Beyond that, I may not be getting the full flavor of everything you are saying since I am not quite familiar with your use of terminology (maximum utility etc). But it sounds like you are describing how competition will lower the wage that plumbers actually recieve? If that is correct, I don’t disagree, but I don’t think it directly responds to UE’s complaint.
@sky - I don’t diagree with what you are saying. But it sounds like your comment applies more to the price of the house than the wage of the plumber. That is a different question from the one UE is asking.
Like I said before, I really don’t like UE’s house building example. Building a house is not an easy production process to describe. That’s whjy I suggested Alchian’s movers example instead. It illustrates the same point that UE was trying to make–that you can only observe the the total output of the movers (how many pieces of furniture they move) and not their individual contribution.
Maybe it would be easier if we get UE’s second bullet point of the way first. That way we can move on from his housing example. IMO, Alchian and Demsetz already addressed this (very real) problem back in 1972. http://web.cenet.org.cn/upfile/100413.pdf
Their solution was to say “You are right, there are lots of production processes where the cost of observing an individual’s productivity are very high. But, there are typically things you can observe that are signals to a person’s productivity (such as how often they come in late or how often they take a smoke break). Those factors could give you clues for how to set wages. However, if monitoring costs are too high, a set hourly wage (or yearly salary) may be the wrong compensation arrangement. In those cases, having workers work for comission might be a better solution.”
So that is how I would respond to UE’s second bullet point. But what about the first. I think he is totally correct that the MP of a taxi driver is zero. So does anyone have any ideas for how to set the wages for taxi drivers?
Yes, that article makes some good points (it’s a similar point to the Cambridge Capital Controversy, right?). It fits in with what I was saying about the Austrian/neoclassical view of exchange here. It’s as if workers have preexisting things that they just throw into a pot and the capitalist then sells the pot as merely the sum of everything inside. It ignores how labor changes things qualitatively. I think people are having trouble grasping why its wrong because they are unconsciously substituting the correct view of things when looking at the examples.
Mises says: “Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers’ goods or goods of the first order.” He goes on to say that the price of higher order goods is determined by the consumer goods. Neither the house without plumbing nor the plumbing itself is a consumer good because their “serviceableness depends on the cooperation of other economic goods.” Only the finished house is a consumer good (although Mises’s definition might actually exclude all goods from being consumer goods). So the finished house must determine the price of both the unfinished house and the plumbing. But how can it do that? It can only tell us the sum of the two factors and not what each is worth individually.
UE: Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power.
Bingo. I started developing such a perspective in this thread.
So does anyone have any ideas for how to set the wages for taxi drivers?
The owner of a fleet estimates how much money that driver will make him, if any, deducts a percent for his profits and expenses, and that’s the wage he sets. If he has to buy a new taxi and he can, he will cut a bit from that wage to pay off the cost of the new cab slowly. In other words, it will be included in his expenses. If he can’t afford a new taxi, he won’t hire him.
Which leads me to ask, why are all fleet owners lumped together when they obviously shouldn’t be? Procustrean bed.
Ok. I am not sure what UE really is aiming at, so I didn’t want to go into UE’s assertion. I only wanted to correct the wrong assumptions that things are generally practically worthless as soon as one part is missing like the plumbing in the house or the steering wheel of car. That is not to say that certain things cannot be worthless at all if one thing is missing. It depends just on the costs to refit it with the missing thing compared to the market value as soon as it is complete. Hence is it economical to refit it or should it be scrapped.
Imagine one consumption good that only needs factors of production that nowhere else are needed. In this instance it is clear if this consumption good is valued at a certain price in the market that also those factors of production are valued at a certain price. If this consumption good at some point in the future is not valued at all in the market anymore it means that also all this factors of production are completely worthless suddenly.
Now imagine there is another company making another different kind of consumption good that needs exactly the same factors of production. Depending on what customers prefer more as a consumption good (= willingness to pay more) gives the two firms different bargaining power for the same factors of production. So yes it is about bargaining power of course. Every price in the market is finally determined by two bargaining parties constraint by certain conditions and competition. And where does the bargaining power come from? Ultimately from the subjective valuation of the consumer to pay lower or higher prices for the final consumption good. It is exactly in this way consumption goods determine the prices of higher order goods. No one said you can exactly calculate every price of each factor of production for building a house just because you know the final market price of the house. Those factors of production you need for building a house are also needed for other consumption goods, which create quite a complicated supply and demand situation. Especially for labor this is complicated since labor is used in everything, and labor is quite heterogeneous and people have preferences for different kinds of work!
UE: Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power.
Bingo. I started developing such a perspective in this thread.
I am not sure UE’s approach makes sense to me as written (which was one reason I was more focusing on his critique of the neoclassical approach as opposed to his own).
I mean, here he says that the share of one factor of production is determined by its relative ability to replace the other factors of production. However, earlier in the post, it sounded like he was using examples where there is no ability to replace one factor for another. Look at his taxi cab example. There is simply no opportunity to replace taxi cabs with people (I can keep buying cars, but unless they drive themselves, I wont be able to expand the quantity of taxi services i produce).
If he ACTUALLY believes that elasticity of substitution between factors is not zero, then his first criticism falls apart. In that situation, you have a production process where marginal productivities are calcuable.
Yes, that article makes some good points (it’s a similar point to the Cambridge Capital Controversy, right?). It fits in with what I was saying about the Austrian/neoclassical view of exchange here. It’s as if workers have preexisting things that they just throw into a pot and the capitalist then sells the pot as merely the sum of everything inside. It ignores how labor changes things qualitatively. I think people are having trouble grasping why its wrong because they are unconsciously substituting the correct view of things when looking at the examples.
I’m not sure how it “ignores” anything of the sort. Care to elaborate? The whole intention of production is to transform resources into more valuable goods with a combination of factors.
(although Mises’s definition might actually exclude all goods from being consumer goods)
Because…?
. So the finished house must determine the price of both the unfinished house and the plumbing. But how can it do that? It can only tell us the sum of the two factors and not what each is worth individually.
Depends entirely on the specificity of those f.o.p. if they are entirely specific, you are correct. If not, then it is competition for use on the market which will determine how much the factor sells for. When capital goods are highly specific (UNLIKE labour, which is non-specific) then yes, bargaining power does enter the fray.
UE: Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power.
Which bargaining power is in turn determined by marketability and profitability.
With the movers example, it really depends on how much effort the purchaser of their services wants to go to. If they do not believe the expenditure of determining that productivity is warranted, anyway. So I’d agree with Alchian, in some instances it might just not be worth it to monitor productivity too closely and opt for a traditional compensation scheme.
skylein: Now imagine there is another company making another different kind of consumption good that needs exactly the same factors of production. Depending on what customers prefer more as a consumption good (= willingness to pay more) gives the two firms different bargaining power for the same factors of production. So yes it is about bargaining power of course. Every price in the market is finally determined by two bargaining parties constraint by certain conditions and competition. And where does the bargaining power come from? Ultimately from the subjective valuation of the consumer to pay lower or higher prices for the final consumption good. It is exactly in this way consumption goods determine the prices of higher order goods. No one said you can exactly calculate every price of each factor of production for building a house just because you know the final market price of the house. Those factors of production you need for building a house are also needed for other consumption goods, which create quite a complicated supply and demand situation. Especially for labor this is complicated since labor is used in everything, and labor is quite heterogeneous and people have preferences for different kinds of work!
I just don’t see how the prices can be determined in this way. Suppose you have a house that requires bricks and plumbing. A small office building also requires bricks and plumbing. Both finished buildings are valued at $200,000. How does one determine the portion of the value that each component makes up? Is the the plumbing $50,000, $100,000, or $150,000? Even if we consider the house made of wood instead of brick, how does this help? Every product that uses wood also includes something else (labor at least)?
Student: I mean, here he says that the share of one factor of production is determined by its relative ability to replace the other factors of production. However, earlier in the post, it sounded like he was using examples where there is no ability to replace one factor for another. Look at his taxi cab example. There is simply no opportunity to replace taxi cabs with people (I can keep buying cars, but unless they drive themselves, I wont be able to expand the quantity of taxi services i produce).
If he ACTUALLY believes that elasticity of substitution between factors is not zero, then his first criticism falls apart. In that situation, you have a production process where marginal productivities are calcuable.
Yes, I think the factor has to be labor, whose elasticity is obviously not zero. My conception is rather complicated, but I am working on a detailed explanation to be published somewhere eventually.
