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It follows therefore that if producers are going to increase output they are going to incur some additional
costs - raw materials and so on and so may want to receive a higher price in order to persuade them to offer
more. In general we would expect a supplier to be willing to offer more items for sale at higher prices than
lower prices. We say there is a positive relationship between price and supply and the supply curve slopes
upwards from left to right.
The government may also increase taxes to cover higher fuel and energy costs, forcing
companies to allocate more resources to paying taxes.
Marginal Productivity Theory
Neo-Classical Version
In economics, the theory that firms will pay a productive agent only what he
or she adds to the financial earnings of the firm. Developed by writers such
as John Bates Clark and Philip Henry Wicksteed at the end of the 19th
century, marginal productivity theory holds that it is unprofitable to buy, for
example, a man-hour of labour if it costs more than it contributes to its
buyer's income. The amount in excess of costs that a productive input yields
is the value of its marginal product; the theory posits that every type of input
should be paid the value of its marginal product.
What is marginal productivity theory?
In economics, the marginal product or marginal physical product is the extra
output produced by one more unit of an input (for instance, the difference in
output when a firm's labor is increased from five to six units). Assuming that
no other inputs to production change, the marginal product of a given input
(X) can be expressed as:
MP = ΔY/ΔX = (the change of Y)/(the change of X).
"Political Economy, you think, is an enquiry into the nature and causes of
wealth -- I think it should rather be called an enquiry into the laws which
determine the division of produce of industry amongst the classes that
concur in its formation. No law can be laid down respecting quantity, but a
tolerably correct one can be laid down respecting proportions. Every day I
am more satisfied that the former enquiry is vain and delusive, and the latter
the only true object of the science."
(David Ricardo, "Letter to T.R. Malthus, October 9, 1820", in
Collected Works, Vol. VIII: p.278-9).
"It is the purpose of this work to show that the distribution of income to
society is controlled by a natural law, and that this law, if it worked without
friction, would give to every agent of production the amount of wealth which
that agent creates."
(John Bates Clark, Distribution of Wealth, 1899: p.v)
"Please forget or disregard what John Bates Clark wrote about marginal
productivity and do not blame modern theorists for what our predecessors
may have "intended". The intention of marginal productivity theories in
modern theory is not the explanation of factor prices."
(Fritz Machlup, "Reply to Professor Takata", Osaka Economic
Papers, 1955)
Although some Neoclassicals have agreed to this Classical definition, most
have taken on the Austrian definition of economic earnings in terms of
opportunity costs. If a producer wishes to secure the employment of a
particular factor, it has to pay that factor at least what it might receive in
alternative employments. This is the opportunity cost of the factor. So, if a
factor is paid $7 an hour by a particular producer and could find alternative
employment only for $5 an hour, then the factor's opportunity cost (and thus
its economic earnings) are $5 and its surplus earnings are $2.
Explanation of the Theory,
To see the issues involved, it is best to be clear with an example. Suppose
that we have an enterprise which uses one unit of land which can produce
ten units of output. Adding a unit of labor, we applying successive laborers
to a field, we have the following.
Demand for factor resources:-
Qty. of Total Average Marginal
Labor Product Product Product
One 10 10 10
Laborer
Two 18 9 8
Laborers
Three 24 8 6
Laborers
Let us assume (for the sake of argument, for this is not implied), that the
average product represents the actual contribution of the laborer to total
output. So, one laborer alone contributes 10 units of output, two laborers
contribute 9 each, three laborers contribute 8 each. But, except for the first
case, the factors are not paid what they contribute: they are paid the
marginal product. Thus, when there are two laborers, each contributing 9,
each of them only receives 8 units in wage payments. When there are three,
each contributing 8, they each only receive 6 units in wage payments. If
laborers are paid their marginal product, we hardly have "moral justice" in
this case!
Of course, the perceptive should have noticed immediately that the product
exhaustion theorem does not hold in this example as the sum of factor
payments is less than the total product. That is because we have not
assumed constant returns to scale in this example. Under constant returns
to scale, the marginal product will be equal to average product and so, in
that case, the payment to a factor in our example will indeed be equal to its
contribution and thus Clarkian "moral justice" is achieved.
But the lesson should be clear: "moral justice" does not arise merely from
paying factors their marginal product; that could be unjust if we do not have
constant returns. But if constant returns to scale applies, then paying
workers their marginal products may be considered just. Economists assume
that firms attempt to maximize their profits. One question that might be
asked is whether the employment of an additional unit of labor raises or
lowers a firm's profits. To analyze this, recall that:
The diagram below combines the MRP and MFC curves for a firm in a
perfectly competitive labor market. Notice that the MRP curve will be
downward sloping ad have this same basic shape regardless of whether the
output market is perfectly or imperfectly competitive. The only difference is
that MRP will be lower when the output market is imperfectly competitive
(since MR < P in this case).
The diagram above can be used to determine the profit-maximizing level of
labor use.
Suppose that the firm chooses to employ Lo workers. At this level of labor
use, MRP > MFC. The firm can increase its profits in this case by increasing
the level of employment (since the additional revenue generated by an
additional unit of labor exceeds the cost of this additional labor). If it hires L'
workers, however, the additional cost of the last unit of labor exceeds the
additional revenue generated by this labor. In this case, the firm could
increase its profits by hiring fewer workers. Profits are maximized at a level
of labor use equal to L*. Profits would be lower at any alternative level of
labor use.
1-MOVING OF FACTORS:
It is assumed that the various factors of
production can be moved from one use to another.
3-PERFECT COMPETITION:
6-CONCEPT OF MP IS WRONG:
The biggest objection on this theory is
this, MP cannot be assessed. It is so because that the
production of any good is the result of join efforts of all
the factors of production. As in the production of cloth,
the labor, land, capital and entrepreneurs all contribute. It
is difficult to find the contribution of an additional labor in
the total production of cloth.
1-HOMOGENITY:
3-PERFECT KNOWLEDGE:
SHORT RUN
EQUILIBRIUM OF THE FIRM
UNDER PERFECT
COMPETITION
FIRM'S EQUILIBRIUM
2-NORMAL PROFITS
3-LOSSES