Marginal Productivity Theory of Wages: Statement and Limitations of the Theory

Statement of the Theory:

The marginal productivity theory states that, under conditions of perfect competition, every worker of same skill and efficiency in a given category will receive a wage equal to the value of the marginal product of that type of labour.

The marginal product of labour in any industry is the amount by which the output would be increased if one more man was employed while the quantities of other factors of production employed in the industry remained constant.

In short, it is the output of a single worker unaccompanied by any change in other factors of production.

The value of the marginal product of labour is the price at which the marginal product can be sold in the market. Under conditions of perfect competition, an employer will go on employing more and more workers until the value of the product of the last man he employs is equal to the marginal or additional cost of employing the last man.

Further, the condition of perfect competition implies that the marginal cost of labour is always equal to the wage rate, irrespective of the number of men the employer may engage. Every industry being ultimately subject to law of diminishing returns, this marginal product must start declining sooner or later. Wages remaining the same, the employer stops employing more workers at that point where the value of the product of a worker is equal to the wage rate.

So far we have assumed that the quantities of other factors remain constant while that of labour alone increases. This, however, is not realistic, because quantities of other factors too can be increased, though this may not be true in the short run.

To allow for this fact, the economists make use of the term “marginal net product of labour” instead of “marginal product of labour”. The value of marginal net product of labour may be defined as being the value of the amount by which output would be increased by employing one more man with the appropriate addition of other factors of production, less the addition to the cost of the other factors caused by increasing the quantities of other factors.

The theory may thus finally be re-stated as follows:

Under conditions of perfect competition in the labour market and in the market for the products of the industry, and irrespective of the number employed, every worker will receive a wage equal to the value of marginal net product of his labour.

Limitations of the Theory:

We have already studied in detail the various limitations and criticisms of the Marginal Productivity Theory as a general principle of distribution. With reference to its application to wages, we may repeat that the theory is true only under certain assumptions such as perfect competition, perfect mobility of labour from employment to employment, homogeneous character of all labour, constant rates of interest and rent and given prices of the product. It is a static theory.

The actual world is dynamic. All the factors assumed to be constant are in fact constantly changing, competition is never perfect; mobility of labour is restricted for various reasons; all labour is not of the same grade, remuneration to other factors of production does not remain constant; and the prices of the products of labour vary. All these changes modify the theory when applied to actual conditions. The theory, however, as an assertion of a tendency is true and is valuable in understanding the basic forces that determine wage rates.

In the actual world, owing to the absence of the above assumptions, there is no single rate of wages that may be applicable to all labour of a particular type. Wages differ from place to place, from person to person and from employment to employment.

The following limitations or points of criticism of the marginal productivity theory may now be noted:

Firstly, this theory has little applicability to reality:

The labour is not perfectly mobile. Workers of the same skill and efficiency may not receive the same wages at two different places.

Secondly:

Though the condition of a large number of independent sellers is fulfilled for a few industries of all countries and for most industries of some countries, the employers usually combine to the disadvantage of the workers. It is a case of monophony, i.e., one buyer (i.e., the employer) and many sellers (i.e., workers). The employers succeed in pulling down the wages below the value of the marginal net product of labour.

If employees are also collectively organized, the wage rates may or may not be equal to the values of marginal net product of labour in the occupations or industries concerned. The wages are determined by the relative bargaining strength of the two parties, but will not for a long time exceed the value of the marginal net product of labour.

Thirdly:

The market for goods is in general characterised by imperfect competition. This also upsets the theory.

Fourthly:

The productivity of workers is also dependent on factors such as the quality of capital and efficiency of management. These factors are beyond the control of workers.

Fifthly:

Productivity is also dependent on wages. Low productivity may be the cause of low wages, which may tell on the efficiency of the worker, lower his standard of living, and ultimately check the supply of labour. The theory takes the supply of labour for granted.

In short, the marginal productivity theory ignores the effect of wage changes on the supply of labour, bargaining strength and monopoly conditions, etc.

Conclusion:

In spite of these limitations, it may be said that the marginal productivity theory is more satisfactory than the earlier theories. It furnishes a more satisfactory explanation of difference in wages in different countries or at different times in the same country.