Session 6
The Theory of Distribution. Determination of the returns
to factors of production: rent, interest, profits, and
wages. The labour market and wage determination. Demand
for labour as "derived". Wage differentials.
What determines wage rates? Why do wage rates differ? How
do they differ in the U.K.?
CONCEPTS FOR REVIEW:
Marginal productivity. Law of diminishing returns.
Supply of and demand for factors of production.
Competitive ( deregulated ) labour markets.
Monopolies and monopsonistic labour markets. Trade
unions bargaining power: economic effects.
How the market distributes wages, rent, interest and profits?
Capitalist economic theory uses the marginal theory of distribution
as a justification of the way in which reward to capital and labour
differ.
The Marginal Theory of Distribution is based on the following concepts:
1.- workers are paid in accordance with what they produce;
2.- gross profits (rent, interest and profits) is the difference
between total revenue and total cost of labour;
3.- workers' labour adds to total output decreasing amounts because
of the law of diminishing returns.
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therefore, a model can be built with the following
assumptions:
a) the larger the number of workers,
the smaller the output added to the total
output by the last worker,
b) the larger the number of workers,
the larger total revenue, but
c) because of a) marginal revenue decreases
while number of workers increases
(marginal revenue here is labelled as
'marginal revenue product' in textbooks);
d) because of c) average revenue decreases
while number of workers increases
(average revenue here is labelled as
'average revenue product' in textbooks);
Example:
Number of Total Marginal Average
workers Revenue Revenue Revenue
1 11 11 11
2 21 10 10.5
3 30 9 10
4 38 8 9.5
5 45 7 9
6 51 6 8.5
7 56 5 8
8 60 4 7.5
9 63 3 7
10 65 2 6.5
11 66 1 6
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4.- Each new worker will have to be paid a higher wage than the
one before, because demand will increase. If we call the
wage paid to the last added labourer "marginal cost of labour"
we will have that marginal cost of labour will increase parallel
to number of workers increasing. Because of the above, average
cost of labour will increase also, and so Total Cost of Labour.
A model can be built with the above:
Number Total Cost Marginal Cost Average Cost
of Workers of labour of labour of labour
1 1 1 1
2 3 2 1.5
3 6 3 2
4 10 4 2.5
5 15 5 3
6 21 6 3.5
7 28 7 4
8 36 8 4.5
9 45 9 5
10 55 10 5.5
11 66 11 6
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Now, we can build a final model which will illustrate concepts
1.- and 2.- of the marginal theory of distributions. This model
will tell us where the firm will "maximize" profits and will pay
the last worker hired "a fair wage", that is the value of that
worker's marginal revenue product.
With the above data:
MRP = marginal revenue product
ARP = average revenue product
MCL = marginal cost of labour
ACL = average cost of labour
TR = total revenue (ARP x number of workers)
TC = total cost (ACL x number of workers)
GROSS PROFITS = TR - TC
Workers MRP ARP MCL ACL TR TC GROSS PROFITS
1 11 11 1 1 11 1 10
2 10 10.5 2 1.5 21 3 18
3 9 10 3 2 30 6 24
4 8 9.5 4 2.5 38 10 28
5 7 9 5 3 45 15 30
6 6 8.5 6 3.5 51 21 30--->the firm will stop
7 5 8 7 4 56 28 28 hiring workers here
8 4 7.5 8 4.5 60 36 24
9 3 7 9 5 63 45 18
10 2 6.5 10 5.5 65 55 10
11 1 6 11 6 66 66 0
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From the above, the following findings:
-the firm will not maximize employment;
-the average wage for the work force is BELOW the marginal
revenue product of the last worker hired;
-the more productive a worker is the larger the difference
between total revenue and total cost, which will lead to
further polarization in distribution of income.
Illustrating our findings, the following paragraph from Arthur Okun,
"Equality and Efficiency: the big tradeoff", Brookings Institution,
Washington, D.C., 1975:
"The conflict between equality and efficiency is our biggest
socioeconomic tradeoff, and it plagues us in dozens of dimensions
of social policy. We can't have our cake of market efficiency and
share it equally".
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Why wages are different?
Demand for labour is a "derived" demand, therefore it will fluctuate
with fluctuations in demand for different goods and services. Also,
supply of labour will fluctuate with levels of skills, experience, etc.
Even more, demand for labour can fluctuate because of non-economic
variables due to cultural habits, etc.
We can think of four groups of conditions which will make wage
differentials:
1) JOB ATTRACTIVENESS, such as
danger,
tedium,
significant physical labour;
significant intellectual labour;
makes supply of labour for the above relatively small, thus some
COMPENSATING DIFFERENTIALS could appear.
The reverse will happen if lesser levels of the above are required.
2)HUMAN CAPITAL, such as
experience,
education,
training,
will increase worker productivity on the one hand, and considering
that equal access to first quality education is inexistent, on the other
hand, supply of experienced, educated and trained workers will tend
to be relatively small, and compensating differentials will appear.
The reverse will be true for the overwhelming majority of the labour
force.
3) LABOUR MOBILITY, which is the ability/possibility of workers to
move from one area to another area;
the less mobility, the larger the differentials because the workers
will not be in a position to choose the best job
in a large area;
the more mobility, the less wage differentials.
4) DISCRIMINATION, which is treating people differently on a basis other
than individual merit;
four main types of discrimination:
ethnic;
gender;
religious;
age.
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A summary of the combined effects of the above on the economic status
in Great Britain, is given by the following table:
GREAT BRITAIN.- Spring 1995 (from Labour Force Survey,
Central Statistical Office)(Percentages)
Pakistani/
MALES White Black* Indian Bangladeshi Other** ALL***
Working full time 72 49 65 41 51 71
Working part time 5 8 7 8 8 5
Unemployed 8 21 10 18 12 9
Inactive 15 22 18 33 29 15
100 100 100 100 100 100
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Number in thousands 16,993 273 306 216 224 18,017
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FEMALES
Working full time 38 37 36 12 30 38
Working part time 29 15 19 6 16 28
Unemployed 5 14 7 7 8 5
Inactive 28 34 38 75 46 29
100 100 100 100 100 100
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Number in thousands 15,420 296 279 191 238 16,428
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*Includes Caribbean, African and other Black people of non-mixed origin
** Includes Chinese, other ethnic minority groups of non-mixed origin
and people of mixed origin.
*** Includes ethnic group not stated.
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UNITED KINGDOM.- AVERAGE HOURLY PAY, 1994
(Employment Gazette, June 1995) (£)
ALL MEN WOMEN
All origins 7.42 7.97 6.39
white 7.44 8.00 6.40
black 6.92 7.03 6.77
Indian 6.70 7.29 5.77
Pakistani/
Bangladeshi 5.39 5.47 5.15
Mixed/other
origins 7.70 8.45 6.75
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FOR THE UNITED STATES:
From U.S. Bureau of the Census
Workers Characteristics, for the 1990s
WHITE BLACK
Median wealth of families,
with white index as 1OO 100 10
Percent of families with
wealth over $500,000 3.16 0.13
Percent of labour force who
are scientist and engineers 2.01 0.44
Percent of labour force who
are doctors 0.47 0.15
Percent of 25-29 years old
with completed high school 86.6 80.9
Percent of 25-34 years old
college graduates 24.5 13.1
UNEMPLOYMENT RATES
Percent of adult men 3.9 10.8
Percent of adult women 4.1 10.0
Percent of teenagers 13.0 30.6
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