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

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.