Theories of Income Distribution
1. The Marginal Productivity Theory of
Income Distribution
a. Marginal Productivity and Wage Inequality
i.
A large part of the observed inequality in wages
can be explained by considerations that are
consistent with the marginal productivity theory
of income distribution.
ii. Three sources of wage differences
1. Compensating differentials
a.
Across different types of jobs, wages are often
higher or lower depending on how attractive or
unattractive the job is.
b. Example
▫ Workers in unpleasant or dangerous jobs receive a higher wage
than workers in jobs that require the same skill, training and
effort but lack the unpleasant or dangerous qualities.
c.
For any particular job the marginal productivity
theory holds true.
1.
For any worker in a given field they will be paid a
wage equal to the equilibrium value of the marginal
product of the last person in employed in the
market.
2.
Differences in Talent
a. People differ in their abilities: a
high-ability person, by producing a
better product commands a higher
price compared to a lower-ability
person, generates a higher value for
the marginal product.
i. Those differences in the MP
translate into differences in
earning potential.
3. Differences in the quantity of human capital
a.
Different people “embody” quiet different
quantities of human capital, and a person with
more human capital typically generates a higher
value of the marginal product by producing more
or better products.
b. The most direct way to see the effect of human
capital on wages is to look at the relationship
between education levels and earnings.
c. Also formal education is not the only source of
human capital; on the job training and experience
are also very important.
b. Market Power
i.
Marginal productivity theory is based on the
assumption that factor markets are perfectly
competitive.
ii. Not all markets are perfectly competitive though.
ii. One source of differences in wages between
otherwise similar workers is unions.
a. These are organizations that try to raise wages
and improve working conditions for their
members.
b. When successful unions replace one on one wage
deals between workers and employers with
collective bargaining.
c. This leads to higher wages for those workers who
are represented by unions.
iv. Employers can sometimes organize to pay lower
wages than would result from competition
1. For example: Health care workers argue that
HMOs engage in a collective effort to hold down
their wages.
v. Collective action, by either workers or by employers,
is less common in the United States than it used to
be.
c. Efficiency Wages
i.
This a type of incentive scheme used by
employers to motivate workers to hard work and
to reduce worker turnover.
ii. Efficiency-wage model
1. Some employers pay an above-equilibrium wage
as an incentive for better performance and loyalty
d. Discrimination
i.
Discrimination is not a natural part of market
competition. The market actually works against
it.
ii. Two reasons why it can happen.
1. When labor markets don’t work well, employers
may have the ability to discriminate without
hurting profits.
2. Discrimination has sometimes been
institutionalized in government policy.
e. Wage Disparities in Practice
2. Is the Marginal Productivity Theory
of Income Distribution Really True?
a. Although the marginal productivity theory of
income distribution is a well-established part of
economic theory, it is the source of some
controversy.
i.
Two objects to the theory
1.
In the real world we see large disparities in income
between workers who, in the eyes of some observers,
should receive the same payment.
a.
Example: the average wages between men and
women and among various racial and ethnic groups.
2. Many people wrongly believe that the marginal
productivity theory gives a moral justification for the
distribution of income, implying that the existing
distribution is fair and appropriate.
b. So Does Marginal Productivity Theory Work?
i.
First it is not a perfect description of how factor
incomes are determined but that it works pretty
well.
ii. By and large, in a modern economy with wellfunctioning labor markets, factors of production
are paid the equilibrium value of the marginal
product.