Briefly outline the theory of marginal revenue productivity and then examine the criticisms of the theory?

Answer 1

Workers are needed for the output they are required to produce. We say that labour as a factor input is a derived demand. When firms see increasing demand for their products, they will need to employ extra workers and thus the demand for labour increases. Demand for labour and the market wage rate There is normally an inverse relationship between the demand for labour and the wage rate that the firm will have to pay for each additional worker. If wages are high, it is more costly to hire extra employees. When wages are lower, labour becomes cheaper than using capital equipment and it becomes more attractive and affordable for the business to take on more employees. Remember that firms are aiming to maximise profits. They will use the factor of production (labour or capital) that does the job as efficiently as possible for the lowest possible cost. Marginal Revenue Product Marginal revenue productivity (MRP) is a theory of wages where workers are paid the value of their marginal revenue product to the firm. MRP theory suggests that wage differentials result from differences in labour productivity and the value of the output that the labour input produces MRP theory is based on a competitive labour market and the theory rests on a number of key assumptions that are unlikely to exist in the real world. (In reality, most labour markets are imperfect, one of the reasons for earnings differentials between occupations) * Workers are homogeneous * Firms have no buying power when demanding workers * There are no trade unions * The productivity of each worker can be clearly measured * The supply of labour is perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate Marginal Revenue Product (MRP) measures the change in total revenue for a firm as a result of selling the output produced by an extra worker. MRP = Marginal Physical Product x Price of Output per unit ILLUSTRATING THE LABOUR DEMAND CURVE In the left hand diagram, when there is a fall in the wage rate from W1 to W2, the firm will expand employment from E1 to E2. This is because the labour input has become relatively cheaper for a given level of productivity, compared to other inputs. A rise in the wage rate from W1 to W3 causes a contraction of labour demand. Shifts in the marginal revenue product of labour Marginal revenue productivity of labour will increase when there is (a) an increase in labour productivity and/or (b) an increase in demand for the firm's output which causes higher prices and raises the value of output produced by the workforce. The right hand diagram shows how this causes an outward shift in the labour demand curve. For a given wage rate W1, a profit maximising firm will employ more workers. Total employment in the market will rise. Problems with marginal revenue productivity theory Marginal revenue productivity cannot be used as a valid basis for discussing labour demand for all types of workers. In many cases it is hard to objectively measure productivity because no physical output is produced by the workforce. Even if productivity can be measured, the output produced may not be sold at a market price. This makes it hard to place an exact valuation on the output of each extra worker. In other examples, wages may be set independently of the state of labour demand. Public sector workers may have their pay set directly by government. Marginal revenue product is useful in explaining the demand for labour in many occupations. But for a fuller explanation of wage determination and the existence and persistence of wage differentials, we must focus more on the supply side of individual labour markets.