Marginal Productivity Theory of Income Distribution

1
Marginal Productivity Theory of Income
Distribution
2
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 labors share in the
  factor distribution of income?

3
Marginal Productivity Theory of Income
Distribution

• 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

4
All Producers Face the Same Wage Rate
(a) Farmer Jones
(b) Farmer Smith
Wage rate
Wage rate
Farmer Smiths
Farmer Jones's
VMPL
VMPL
corn
wheat
x
x
MPL
P
MPL
P
corn
corn
wheat
wheat
Market wage rate
200
200
VMPL
corn
VMPL
wheat
5
0
7
Quantity of labor (workers)
Quantity of labor (workers)
Profit-maximizing number of workers
Profit-maximizing number of workers
5
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.

6
Equilibrium in the Labor Market

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

7
Equilibrium in the Labor Market

• It doesnt 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.

8
Equilibrium in the Labor Market
Rental rate
Market Labor Supply Curve
Equilibrium value of the marginal product of labor
E
W
Market Labor Demand Curve
L
Quantity of labor (workers)
Equilibrium employment
9
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?

10
Is the Marginal Productivity Theory of Income
Distribution Really True?

• 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

11
Is the Marginal Productivity Theory of Income
Distribution Really True?

• Farmers have to consider rental rate a unit of
  land or capital is employed up to the point at
  which that units 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?

12
Equilibria in the Land and Capital Markets
(b) The Market for Capital
(a) The Market for Land
Rental rate
Rental rate
S
Land
R
S
Land
Capital
R
Capital
D
D
Capital
Land
Q
Q
Quantity
Quantity
Land
Capital
13
Marginal Productivity Theory of Income
Distribution

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

14
Marginal Productivity Theory of Income
Distribution

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

15
Marginal Productivity Theory of Income
Distribution

• 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?

16
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
10,000
5,000
0
Hispanic (male and female)
African American (male and female)
Female (all ethnicities)
White male
17
Earnings Differentials by Education, Gender, and
Ethnicity
Annual median earnings, 2006
No HS degree
HS degree
College degree
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
White male
White female
African-American male
African-American female
Hispanic female
Hispanic man
18
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

19
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20
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

21
Role of Productivity

• High productivity is due to
• Plentiful capital
• Access to abundant natural resources
• Advanced technology
• Labor quality
• Other factors

22
Size of the labor force, 2008
23
Average annual growth rates for the labor
force, 1998-2008
24
Average annual growth rates for full-time and
part-time employment, 1998-2008
25
Persons unemployed one year or longer as a
percent of total unemployment, 2008
26
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.

27
The Supply of Labor

• A rise in the wage rate causes both an income and
  a substitution effect on an individuals 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.

28
(No Transcript)
29
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
Individual labor supply curve
50
40
0
40
0
30
Quantity of leisure (hours)
Quantity of leisure (hours)
30
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

31
Marginal Productivity Theory of Income
Distribution Notes
32
Marginal Productivity Theory of Income
Distribution

• What does this say about the labors share in the
  factor distribution of income?

33
Marginal Productivity Theory of Income
Distribution

• 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

34
All Producers Face the Same Wage Rate
(a) Farmer Jones
(b) Farmer Smith
Wage rate
Wage rate
Farmer Smiths
Farmer Jones's
VMPL
VMPL
corn
wheat
x
x
MPL
P
MPL
P
corn
corn
wheat
wheat
Market wage rate
200
200
VMPL
corn
VMPL
wheat
5
0
7
Quantity of labor (workers)
Quantity of labor (workers)
Profit-maximizing number of workers
Profit-maximizing number of workers
35
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,

36
Equilibrium in the Labor Market

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

37
Equilibrium in the Labor Market

• It doesnt 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,

38
Equilibrium in the Labor Market
Rental rate
Market Labor Supply Curve
E
W
Market Labor Demand Curve
L
Quantity of labor (workers)
39
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?

40
Is the Marginal Productivity Theory of Income
Distribution Really True?

• 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

41
Is the Marginal Productivity Theory of Income
Distribution Really True?

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

42
Equilibria in the Land and Capital Markets
(b) The Market for Capital
(a) The Market for Land
Rental rate
Rental rate
S
Land
R
S
Land
Capital
R
Capital
D
D
Capital
Land
Q
Q
Quantity
Quantity
Land
Capital
43
Marginal Productivity Theory of Income
Distribution

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

44
Marginal Productivity Theory of Income
Distribution

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

45
Marginal Productivity Theory of Income
Distribution

• 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?

46
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

47
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

48
Role of Productivity

• High productivity is due to

49
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.

50
The Supply of Labor

• A rise in the wage rate causes both an income and
  a substitution effect on an individuals 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.

51
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 _____________________
• changes in _____________________
• changes in _____________________