The Marginal Productivity Theory of Wages in Explaining how Wages are Determined

The Marginal Productivity Theory of Wages in Explaining how Wages are Determined

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Assess the usefulness of the marginal productivity theory of wages in
explaining how wages are determined.

Many theories have been advanced to explain the nature of wages. The
first of them was the subsistence theory of wages, also called the
"iron law of wages," of which David Ricardo was one of the main
exponents. The theory maintains that wages cluster around the bare
subsistence level of workers. A wage rate much above the subsistence
level causes an increase in the number of workers; competition will
then lead to a depression of wages back toward the cost of
subsistence. Wages that are below subsistence reduce the size of the
working population; in that case competition will raise wages, but
only up to the subsistence level again.

In the surplus-value theory as propounded by Karl Marx, the value
produced by the worker in excess of what is paid in wages is called
surplus value. The surplus value, exacted from the worker, constitutes
the capitalist's profit. The wage-fund theory is that wages are
advanced out of a fixed fund of capital, from which an excess
withdrawal, either through legislation or through union pressure, will
ultimately reduce the amount available for other workers. Any increase
in wages would also have to be taken out of profits, and their
reduction would cause a decline in savings, which provide the capital
from which the wage fund is derived.

The marginal-productivity theory maintains that employers will only
pay a wage that is, at most, equal to the amount of extra value added
to the total product by one additional worker. The bargaining theory
modifies the marginal-productivity theory by taking into consideration
other factors (e.g., laws and social and political changes) that might
affect the determination of wage levels and by acknowledging that
certain basic assumptions (equal bargaining power of employer and
employee, free competition between the two, and mobility of labour)
that characterize the marginal-productivity theory do not hold in our
present economic system.

Common sense says that a firm will tend to buy labour if the added
benefit to the firm (the Marginal Revenue Product) exceeds the added
cost (Marginal Resource Cost). The added benefit is the value to the
firm of the extra output which the hours of labour produces. If
increasing the amount of the hours of labour raises re...

... middle of paper ...

...performance is often called
tournament theory. One place where this explanation should work is in
contests with winners and losers. For example, consider two almost
equally able gladiators fighting in the arena of ancient Rome.

Another place where relative ability may matter a great deal is in the
managerial ranks of corporations. There are limited numbers of
promotions available, and they are usually determined by relative
performance. Only one person can be CEO of a company at a time, and
small differences in ability among those contending for the top spot
can result in large differences in rewards. Further, it may be in the
interests of the company to structure pay so that the winner makes
very large sums as a way of spurring on those lower in the hierarchy.
The primary reason for the high pay given to the CEO may be to give
those lower in the hierarchy an incentive to work hard, not to give
the CEO himself the incentive to perform well.

The argument that winner-take-all contests tend to over-attract
entrants closely parallels the argument that the problem of the
commons yields inefficiency: people respond to average benefit rather
than to marginal benefit.

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