Economics
Marginal Productivity Theory
The Marginal Productivity Theory states that the value of a factor of production is determined by its marginal productivity, or the additional output produced by adding one more unit of that factor. In other words, the theory suggests that the price of a factor of production, such as labor, should be equal to the value of the additional output it produces.
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10 Key excerpts on "Marginal Productivity Theory"
eBook - ePub- Milton Friedman(Author)
- 2017(Publication Date)
- Routledge(Publisher)
marginal productivity ) determine price. But note that even in this case a change in supply—in the fixed amount of a factor—will change the price of the factor, unless demand is perfectly elastic. So it will be better in all cases to regard the theory of marginal productivity as a theory solely of the demand for factors of production. A complete theory requires a theory of both the demand for and the supply of factors of production.In the main, the Marginal Productivity Theory is a way of organizing the considerations that are relevant to the demand for a factor of production. It has some, but not very much, substantive content. This is reflected in our ability to speak of an abstract factor of production—factors A or B, etc.—without having to specify it any further. To say that wages are equal to the value of the marginal product, for example, says relatively little in and of itself. Its function is rather to suggest what to look for in further analysis. The value of the marginal product is not a single number determined by forces outside the control of individuals or society; it is rather a schedule or function of many variables. It will depend on the quality and quantity of workers, the quantity of capital they have to work with, the quality of the management organizing their activities, the institutional structure of the markets in which they are hired and the product sold, etc. In concrete applications, the basic substantive issue is likely to be what determines the marginal productivity and how the changes under consideration will affect it.The analysis of the demand for factors of production is closely related to the analysis of the supply of products, and, indeed, is really only another way of looking at or organizing the same material. In analyzing the supply curve of a product, we are interested in tracing the effect of changes in the demand for it under given conditions on the factor markets. In consequence, we direct attention to the output of the firm or industry and take for granted the changes in the quantity of the various factors of production employed and in their prices as demand for the product and with it output of the product change. In distribution theory, our interest centers in the factor markets, and so we concentrate attention on a different facet of the same adjustment by the firm. To put it differently, the statement that a firm seeks to equate marginal factor cost to marginal value product is another way of saying that it seeks to equate marginal revenue to marginal cost rather than an additional condition on the equilibrium of the firm.
eBook - PDFMicroeconomics
A Global Text
- Judy Whitehead(Author)
- 2020(Publication Date)
- Routledge(Publisher)
This is the counterpart to the modern theory of value which was the focus of the earlier chapters. The modern theory is mainly marginalist in nature. Consequently, the modern distribution theory has been given the title of the Marginal Productivity Theory . John Bates Clark, writing at the turn of the twentieth century, is considered to be responsible for the marginal productive theory. The Marginal Productivity Theory is therefore based on supply and demand analysis in similar manner to that of the pricing of products except that the demand for factors is a derived demand, derived, as is evident later, from the marginal productivity of the factor and the value of the product it produces at the margin. This chapter deals with the Marginal Productivity Theory. 14.2 SHORT-RUN FACTOR DEMAND UNDER Marginal Productivity Theory C H A P T E R 14 The demand for a factor of production in the short-run is done under certain assumptions. These include: • There is a single variable factor input. This is usually considered to be labour. All other factors are assumed to be fixed and can therefore be subsumed under capital ( K ). • There is Perfect Competition in the factor market. In the short-run analysis of the demand for a factor of production, it is assumed that the price of the factor is fixed. That is, the firm can hire all the supply of the factor it wants at the going price. This is generally referred to as having Perfect Competition in the factor market. • The supply of the variable factor is unlimited at the fixed price. Therefore, the firm can have the quantity of the factor it wants at the going factor price (e.g. wage rate of labour). 395 THE FACTOR MARKET C H A P T E R 14 • Technology is given and known. • The prices of other factors are given. • The demand depends on whether the product market is characterized by perfect competition or imperfect competition.
eBook - ePubIntermediate Microeconomics
Neoclassical and Factually-oriented Models
- Lester O. Bumas(Author)
- 2015(Publication Date)
- Routledge(Publisher)
CHAPTER FIVEThe Production Function, Productivity, and Productivity GrowthThe production function relates the rate of production to the state of technology and the employment of the factors of production. It is arguably the most important function in the neoclassical paradigm because: (1) It is the basis of the cost functions. (2) Its slope, the marginal productivity function, is the foundation of the factor demand functions. (3) And with factor supplies given, marginal productivity functions yield the distribution of income to the factors of production.In a general sense, the production function represents very practical and well-known relationships implicit in all employment change decisions made by managers to vary the rate of production.The analysis used in the area of production closely parallels that used in the basic neoclassical models of consumer behavior. Marginal productivity analysis, to be used here, is very much like marginal utility analysis previously covered. The same is true of the close relationship between the isoquant analysis of this chapter and the previously presented indifference curve analysis.Finally, an increasing standard of living, a common aspiration in acquisitive societies, essentially requires advances in technology and productivity, which shifts the production function.The Production Function
The production function is defined as follows:The production function relates the maximum rate of production possible, Q , to the employment of the factors of production—labor, L , and capital, K —at a given level of technology, T : Q = f(T; L,K) .Why the omission of the third factor of production, land or natural resources? The answer rests on David Ricardo’s definition of land as “the original and indestructible powers of the soil.” Once a unit of land is worked on by labor or capital, it is no longer in its original or natural state. This transforms land into capital, the produced means of production. There is, however, no law against breaking capital down into categories, one or more of which could be land or closely related to land. Thus, a not uncommon form of the production function has the rate of production as a function of the employment of labor, L ; capital in the form of facilities and equipments, K ; and materials purchased from other producers, M : Q =f(T; L,K,M) . The omission of the level of technology, T
eBook - PDF- Sharma, Arti(Authors)
- 2021(Publication Date)
- Scholars World(Publisher)
Chapter 2 Theory of Production Function and Economic Efficiency A production function relates to physical output of a production process to physical inputs or factors of production. The production function is one of the key concepts of neoclassical theories, used to define marginal product and to distinguish allocative efficiency, the defining focus of economics. The primary purpose of the production function is to address technical efficiency, resource use efficiency and allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors, while abstracting away from the technological problems of achieving technical efficiency, aggregate production functions are estimated to create a framework in which to distinguish how much of economic growth to attribute to changes in factor allocation and how much to attribute to advancing technology. 2.1 Concept of Production Functions The theory of production is mainly concerned with maximizing profit or in some instances minimizing cost. Both are indicative of economic efficiency. The profit-maximizing firm in perfect competition (taking output and input prices as given) will choose to add input right up to the point where the marginal cost of additional input matches the marginal product in additional output. This implies an ideal division of the income generated from output into an income due to each input factor of production, equal to the marginal product of each input. To satisfy the mathematical definition of a function, a production function is customarily assumed to specify the maximum output This ebook is exclusively for this university only. Cannot be resold/distributed. obtainable from a given set of inputs. The production function, therefore, describes a boundary or frontier representing the limit of output obtainable from each feasible combination of input.
eBook - ePubThe Microeconomics Anti-Textbook
A Critical Thinker's Guide - second edition
- Rod Hill, Tony Myatt(Authors)
- 2021(Publication Date)
- Zed Books(Publisher)
In this case, Thurow points out that ‘subsidiary distribution theories are necessary in every variant except the strict interpretation in which every individual factor is paid his marginal product at every instant of time’. He warns that the theory is in danger of becoming a tautology – something that is true by definition: ‘factors in general must be paid in accordance with the productivity of factors in general’. 9 Questions for your professor: Does the Marginal Productivity Theory predict that workers receive the value of their actual marginal product every hour (for example), or their average marginal product over a longer period? Given such things as seniority pay, how long might that period be? If individuals’ marginal products can’t be observed, are they paid the average marginal product of the group to which they belong? If so, how can the group be identified? The adding up problem A theory of factor prices may try to explain the prices of all factors. If so, then the incomes of factor owners must add up to the value of total production. Otherwise there would be something left over or there would be not enough to go around. This is the so-called ‘adding-up problem’ that preoccupied some economists in the 1890s as the Marginal Productivity Theory was being developed. (Note that the problem can be avoided if the theory includes a factor, such as entrepreneurial talent, that gets whatever is left over. But this leaves the theory unable to explain the returns to that factor.) 10 While the technical details need not concern us here, it turns out that the incomes of factors do indeed add up to the value of the goods produced if the economy has perfectly competitive factor and product markets. Production must be carried out with constant returns to scale, because perfectly competitive firms are incompatible with increasing returns to scale
eBook - ePubThe Economics Anti-Textbook
A Critical Thinker's Guide to Microeconomics
- Rod Hill, Tony Myatt(Authors)
- 2010(Publication Date)
- Zed Books(Publisher)
Thurow’s basic point is that ‘subsidiary distribution theories are necessary in every variant except the strict interpretation in which every individual factor is paid his marginal product at every instant of time’. He warns that the theory is in danger of becoming a tautology – something that is true by definition: ‘factors in general must be paid in accordance with the productivity of factors in general’ (ibid.: 215).Questions for your professor: Does the Marginal Productivity Theory say that workers will receive their actual marginal product at every point in time, or their average marginal product over a longer period? Or will individuals receive the average marginal product of the group to which they belong?2.4 Empirical testing of the competitive modelDespite Thurow’s misgivings, researchers have attempted to test the marginal product theory of distribution. As you read this section, ask yourself whether this research refutes the marginal product theory of distribution, or merely delineates the subsidiary theories that Thurow suggests are necessary to give the theory more substance.Even when marginal products cannot be directly measured there are indirect ways of testing the competitive labour market model. First, the competitive model predicts a single market wage for workers of a given quality, doing the same work, no matter where they do it. A second prediction follows: workers of different quality should receive different wages even if they work in the same firm. The evidence refutes both predictions.Regarding the first prediction, Akerlof and Yellen (1988) cite an impressive amount of evidence showing that workers of identical characteristics receive different wages in different industries and occupations.9 Indeed, industries that have high wages for one occupation also have high wages for other occupations; wages are strongly positively correlated with industry profits.Regarding the second prediction, there is strong evidence that workers’ wages differ by less than their marginal productivities. This phenomenon is known as wage compression . Robert Frank (1984)
- Bhat, Anil(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
Chapter 2 Economic Theories of Production Production refers to the economic process of converting of inputs into outputs. Production uses resources to create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a market economy. This can include manufacturing, storing, shipping, and packaging. Also level of output of a particular commodity depends upon the quantity of input used for its production. In other words production means transforming inputs land, labour, capital) into an output. 2.1. Theoretical Orientation 2.1.1. Laws of Production Theory of production is based on the following laws of production such as: “Law of Diminishing Returns/Law of Increasing Cost, Law of Increasing Returns/Law of Diminishing Cost and Law of Constant Returns/Law of Constant Cost“ 2.1.1.1. Law of Diminishing Returns/Law of Increasing Cost The law of diminishing returns (also called the Law of Increasing Costs) is an important law of micro economics. The law of diminishing returns states that: “If increasing amounts of a variable factor are applied to fixed quantity of other factors per unit of time, the increments in total output will first increase but beyond some point, it begins to decline ”. This ebook is exclusively for this university only. Cannot be resold/distributed. Richard A. Bilas describes the law of diminishing returns in the following words: “If the input of one resource to other resources are held constant, total product (output) will increase but beyond some point, the resulting output increases will become smaller and smaller ”. · (a) Operation of Law of Diminishing Returns The classical economists were of the opinion that the law of diminishing returns applies only to agriculture and to some extractive industries, such as mining, fisheries urban land, etc. The law was first stated by a Scottish farmer as such.
eBook - PDFA Concise History of Economic Thought
From Mercantilism to Monetarism
- G. Vaggi, P. Groenewegen(Authors)
- 2016(Publication Date)
- Palgrave Macmillan(Publisher)
Just as the marginal utility of a commodity determines its price, the marginal utility of a productive service determines the price of this service. If P is the product, and A the flow of productive services, then dP/dA is the marginal utility of that productive service in terms of its product or its marginal product. Wicksteed saw this as a truism. After all, entrepreneurs will only hire an additional factor so long as the return in terms of product of its service is greater than (or at the margin equal to) its cost. This was a simple application of the marginalist rules for efficient resource use. The crucial problem for the theory was to show that the sum of the payments to each factor according to its marginal product exactly exhausts the product. For the general case of N factors contributing to the production of P, that is, for a production function: P = F(A, B, C, . . . N) it must be shown that: P = A. δP/δA + B. δP/δB + C. δP/δC + . . . + N· δP/δN Wicksteed’s own proof of this proposition was lengthy and rather clumsy. However, a review of his contribution in the Economic Journal by A.W. Flux, a former student of Marshall, argued that the proof could be greatly simplified by invoking Euler’s theorem. This required that the production function; P = F (A, B, C, . . . N) is homogenous and linear, that is, that mP = F (mA, mB, mC, . . . mN) Clark, Wicksteed and Marginal Productivity 241 In that case, it followed automatically from Euler’s theorem that P = A. δP/δA + B. δP/δB + C. δP/δC + . . . + N· δP/δN A linear and homogenous production function, implicitly assumed in Wicksteed’s Essay (1894) ensured exhaustion of the product automatically via the application of Euler’s theorem. The appropriateness of this assumption about the nature of the produc- tion function was hotly debated.
- Berkeley Hill(Author)
- 2013(Publication Date)
- Pergamon(Publisher)
Other examples of Diminishing Returns can be seen in the over-feeding of animals or in stretching the use of machines beyond their designed capacity such as might occur when an increased number of cows is put through a small one-man milking parlour. This law is very similar to the Law of Diminishing Marginal Utility experienced in the Theory of Consumer Choice (Chapter 2). As with that Law, diminishing returns (falling Marginal Products) do not neces-sarily start at once. Fig. 5.1 shows that increasing returns accompany the first few units of fertiliser, but this is soon reversed. It is obvious that, in the real world, Diminishing Returns do occur. If they did not, it would be possible to grow the whole world's food requirements on one hectare of land. Also in Fig. 5.1 is the Average Product of the fertiliser — this is the Total Product (yield) at each level of fertiliser use divided by the total quantity of fertiliser needed to produce it. Notice that Average Product rises, then falls. When 6 units of fertiliser are used, average yield at 22 units of barley per unit of fertiliser is highest. From a technical viewpoint, this is the most efficient level of production to aim for, but it may well not be the level at which most profit is made. Economic efficiency is concerned with this most profitable level, so economic and technical efficiency mean different things. Total Product, Marginal Product and Average Product at different levels of variable input (fertiliser) are shown in graphical form in Fig. 5.2. Notice that: (a) The point where Marginal Product (MP) starts declining (called the point of maximum Marginal Product, or Point of Diminish-ing Returns) corresponds to the point of inflection of the S-
eBook - PDF- Sharma, Pawan Kumar(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
This can be displayed in a chart that lists the output level corresponding to various levels of input. The diagram shows a typical total product curve. In this example, output increases as more inputs are employed up until point A (Fig. 2a). The maximum output possible with this production process is 30. If there are other inputs used in the process, they are assumed to be fixed. Total Average Product Curve The average physical product is the total production divided by the number of units of variable input employed. It is the output of each unit of input. The average product varies as more of the input is employed. Average physical product curve is plotted in Fig. 2b based on the data obtained from the schedule. Marginal Physical Product Curve The marginal physical product of a variable input is the change in total output due to a one unit change in the variable input. The marginal physical product curve is plotted in Fig. 2c based on the data obtained from the production schedule. This ebook is exclusively for this university only. Cannot be resold/distributed. Fig. 2a: Plot of Total Product Curve Fig. 2b: Plot of Average Product Curve This ebook is exclusively for this university only. Cannot be resold/distributed. Fig. 2c: Plot of Marginal Product Curve Experiment – 3 3 Objective: To study the “Law of Diminishing Returns” and demarcation of 3 stages of production. (Using Production data from Exp. 2). The Principle The principle of Diminishing returns is used under the conditions where resources are available in abundance. The principle states that ”as more investment in an area is made, overall return on that investment increases at a declining rate, as- suming that all variables remain fixed”. If one factor of production is increased while the others remain constant, the overall returns will relatively decrease after a cer- tain point e.g.
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