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Friday, October 14, 2016

Does The Marginal Productivity Theory of Distribution Hold 'True'? (Class XII Economics Project Under WBCHSE Board)

“The distribution of income of society is controlled by a natural law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.” -J.B. Clark

It was assumed by him that the total stock of capital remains constant. Clark also supposed that the form of capital can be varied at will. In other words, physical instruments of production can be adapted to varying quantities and abilities of available labour. Further, he treats labour as a homogeneous factor by taking identical labour units and discusses how the wage rate of labour is determined.

Every rational employer or entrepreneur will try to utilise his fixed amount of capital so as to maximise his profits. For this he will hire as many labourers (labour units) as can be profitably put to work with a given amount of capital. For an individual firm or industry, marginal productivity of labour will decline as more and more workers are added to the fixed quantity of capital.

He will go on hiring more and more labour units as long as the addition made to the total product by an extra labour unit is greater than the wage rate he has to pay for it. The employer will reach equilibrium position when the wage rate is just equal to the marginal product of labour.

Amartya Sen writes (P.249-250,'Resources,Values and Development' by Amartya Sen),if marginal productivity theory of distribution of distribution applied,own share would have always been equal to 1 but that is not the case since the shortcomings of the theory are already well known.

Further,American economist Thomas Palley puts forward,"Dani is absolutely right about the empirical literature on pay, which is broad and multi-faceted. The question is what is the relation of that literature to marginal product theory and does it move mainstream economics beyond marginal product theory? I suggest not.
When it comes to unions, it is well documented that unions raise wages. Union supporters argue that (especially in highly unionized economies) unions do so with no adverse employment effects. Neo-classicals interpret unions through a marginal product labor demand lens, and generally argue they raise wages at the cost of lower employment. However, it is also the case that if employers have monopsony (buyer monopoly) power unions can also raise both wages and employment in a marginal product framework.
What about democracy? I suggest democracy raises wages by altering the division of the cake, but there is no adverse employment effect. Furthermore, by raising wages and improving income distribution, democracy strengthens consumer demand and may increase employment through a Keynesian channel. This is an argument based on a non-marginal product approach to income distribution.
What does neo-classical marginal productivity theory imply about democracy? Holding productivity constant, democracy would tend to lower employment because it raises wages. However, as with unions one could argue democracy lowers the monopsony power of employers, thereby raising both wages and employment. Under this neo-classical interpretation, democracy serves to move the economy closer to the idealized state of perfect competition in which the idealized version of marginal productivity theory of income distribution holds.
The bottom line is there are two stories about the wage effects of democracy (and unions) - one rooted in marginal product theory, the other not. My view is the institutionalist Keynesian story is more plausible. I am not sure what Dani's view is, as he seems to support both. However, that seems theoretically problematic.
When it comes to the neo-classical theory of income distribution you are either in or out with regard to the concept of marginal product. Under conditions of perfect competition, the marginal product of labor is the labor demand schedule, which tightly determines the relationship between wages and employment as a technological relationship. Under conditions other than perfect competition, the marginal product of labor remains ever-present and provides the reference point for determination of wages. However, if marginal product is an incoherent or unusable concept most of neo-classical economics (including its approach to income distribution) disintegrates: hence, the unwillingness to question marginal product analysis.
The bigger story is that the empirical data settle nothing and can be interpreted to be consistent with either theory. That suggests both should be taught with equal prominence in all economics departments, including top departments. Yet they are not. Instead, only the neo-classical marginal productivity theory is taught as part of the core curriculum, the concept of marginal product is never questioned, and heterodox theory is essentially suppressed."

MIT economists Peter Temin and Frank Levy have published a paper about the role of institutions in explaining inequality in 20th century America. Their paper is welcome and (to be self-promoting) expands analytical themes developed in my 1998 book, Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianism. The engagement of these economists may be a sign that the economics professionals thinking about income distribution is headed for change. If that is so, neo-classical economics will be in serious trouble because marginal productivity theory figures critically in its macroeconomics (both new classical and new Keynesian), its microeconomics, and it approach to trade and globalization.

In this sense, Clark’s middle-way policy approach is strategic: it coopts the reform impulse of the Progressives, while simultaneously and determinately delimiting the scope of policy intervention. When, around the time of Clark’s death in 1938, American neoclassical economics is importing the more mathematical Continental tradition, marginalism and theoretical abstraction cease to be professional liabilities, and Clark’s policy approach becomes more entrenched. This difference in policy approach,among the many others, may help explain the divergent paths of Progressive economics, which was a spentforce by the 1930s, and neoclassical economics, which has been ascendant for more than sixty years.
There is in Clark no algebra, and no reflexive assumption of maximization.What’s modern in Clark is his faith in the virtues of competitive markets, his marginalist approach to price and wage determination,his aspiration for generality in economic theory, his elevation of a benchmark competitive ideal to which markets and policy should aspire, and his innovative approach to regulation, which I have argued is best characterized as one of market-failure remedy, especially the remedy of promoting more and better competition. In these respects, Clark is not a Progressive, butan early precursor of the American neoclassical

Summing it up,quite a number of arguments have been stated against the marginal productivity theory of distribution to prove the presence of several loopholes,unconsidering which the theory had been asserted and valuated to be true.Some of them have been stated below (collected) - 

1. Unrealistic Assumptions:

The theory assumes that there exists perfect competition in all the markets. But in reality, perfect competition is only an imaginary concept. In modern days, perfect competition does not hold good.

2. All Factors are not Homogeneous:

This theory assumes that all units of a given factor are homogeneous. It is wrong. In reality different units of a given factor are heterogeneous.

3. Difficult to Measure MPP:

Prof. Hobson has criticized this theory on the ground that it is not possible to measure the marginal productivity. He maintained that if the number of labourers is increased to measure their marginal productivity then other factors like raw material, tools, implements etc. will also have to be increased.

4. Only One-Sided Theory:

Marshall, Friedman criticised this theory on the ground that it is only one sided theory. As it assumes supply to be constant to determine the marginal productivity, it is possible only in the short-run. But in the long run supply of every factor is variable.

5. Labour is not Perfectly Mobile:

This theory assumes that labour is perfectly mobile. In actual life factors of production are not perfectly mobile. It is very difficult to move from one occupation to another.

6. Short-Period Ignored:

The marginal productivity theory holds good in the long run only while it ignores the short period. But in actual practice, the problems of short period are more important than that of the long period. As Lord Keynes stated that in the long run we all are dead. Therefore, all problems are needed to be solved in the short run.

7. No Reward Determination:

This theory fails to determine the reward. It only explains how much quantity of factors can be employed at given prices.

8. Level of Employment and Wage Rate:

According to this theory, employment can be increased by wage cut. Moreover, according to Keynes, the volume of employment is not determined by wage rate but by effective demand.

9. Static:

Some economists criticized this theory saying that it is a static theory because it ignores the technical changes which cause a shift in production function. This theory assumes this curve to be given. Therefore, it is considered to be incomplete theory being static in nature.

10. Unrealistic Assumption of Full Employment:

The marginal productivity theory assumes that the situation of full, employment prevails in the economy. It is a rare phenomenon. But, in reality there exists hardly any country in the world whether advanced or less advanced which enjoys full employment. Therefore, these theory does not hold well in the real world.

11. Theory of Exploitation:

If units of factors are paid according to marginal productivity and the enterprise is subject to the law of diminishing returns, then it will result in the exploitation of the factor in question.

12. Effect of Factor Pricing on Productivity:

According to Prof. Clark, price of the factors also affect their productivity. Prof. Weblen was also of the opinion that factor price affects the marginal productivity.

13. Vague Concept of Marginal Productivity:

According to Taussig and Davenport, the concept of marginal productivity was vague. Production was the result of the co-operative efforts of all the four factors of production and it was not possible to separate out the contribution of one factor.

14. Fails to Determine Factor Pricing:

According to Prof. Fellner, marginal productivity theory does not determine factor pricing. Every firm has to pay the wages determined by the demand and supply of industry. At this prevailing wage rate, the firm only has to decide as to how many units of labour should be employed so that marginal productivity and marginal wages are equal. Thus this theory only determines the factor demand not the factor price.


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  1. Hi, Really great effort. Everyone must read this article. Thanks for sharing.


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