Factor Markets: Theories of Income Distribution

1. Factor Markets:Theories of Income Distribution AP Economics Mr. Bordelon

2. Marginal Productivity Theory of Income Distribution • The division of income among the economy’s factors of production is determined by each factor’s marginal productivity at the market equilibrium.

3. Marginal Productivityand Wage Inequality • Any time two different people who are paid differently, there is wage inequality, and this is consistent with the marginal productivity theory of income distribution. • Why? 3 reasons

4. Marginal Productivityand Wage Inequality • Compensating differentials. A police officer in New York will make more than a police officer in Orange City. Workers during night shift often get higher wages than those during the day shift.

5. Marginal Productivityand Wage Inequality • Differences in Talent. More talented workers sometimes earn more than a less talented person. As they should.

6. Marginal Productivityand Wage Inequality • Differences in Human Capital. Some individuals receive higher wages because they have acquired more human capital than other co-workers. More human capital is usually associated with more productivity and thus a higher wage.

7. Market Power • Though these explanations for wage equality help, they don’t explain everything. • Firms with market power have the ability to raise the price of goods above competitive levels. • Labor unions help do the same thing—raise wages for membership above a competitive level through collective bargaining.

8. Efficiency Wages • Efficiency wage. When an employer pays a wage above competitive level as an incentive for workers to be more productive and to reduce employee turnover. • Paying a higher wage benefits the employer because workers have less incentive to quit and lose trained workers. Training workers costs money. • Efficiency wages work like price floors, because they create a surplus of workers who want an efficiency wage job. Thus, the wage disparity between those who have an efficiency wage job, and those who wish they had it.

9. Discrimination • Discrimination between race, sex, age, etc. can also help explain differences in wages. • But shouldn’t competitive markets eliminate wage discrimination?

10. Discrimination—Cat People • Cat people have traditionally faced some type of discrimination throughout history. But things have changed. • Rational “color blind” employer would prefer to hire Cat People who are equally productive but less expensive to employ. • VMPCat > Wcat. Employer can maximize profits by hiring more Cat People. • As hiring continues, the market-wide demand for Cat people increases, increasing Wcat. Wage differences are eliminated.

11. Discrimination • But you’re not naïve. You know we don’t live in that world. There’s an unfortunate truth that many of my students may very well possibly face in their lives, who don’t happen to be a white male. Whether it’s the intelligent unassuming Hispanic student looked over because he doesn’t fit whatever mold might be “appropriate,” or the young woman not taken seriously for her ideas because she happens to be attractive.

12. Discrimination • I tell you this, because I’ve seen it. It breaks my heart, to be honest. But the best revenge is to never let them see you coming. For any of you actually reading this, ask me about Rachel Siskind. • I will tell you that things are getting better, as the older generations pass, and old paternalistic white male attitudes fade with time. Your generation has a spirit of equality that started with your grandparents’. And I believe that’s a good thing for you and for this country. It gives me hope, and it should give you hope too.

13. Objections toMarginal Productivity Theory • Two groups of similar workers, X and Y. Average wages in X are greater than Y. Do we assume instantly that workers in X are more productive than workers in Y? • Regarding distribution of income, some consider it fair. Morally, some people are just more productive than others. If you don’t see this distribution of income as fair, then you must reject the theory itself outright. But is it fair?

14. Does Marginal ProductivityTheory Work? • Kinda. • Certainly, employers would not willingly pay a wage higher than your marginal revenue product. Any two people of equal productivity should receive the same wage. • But again, we’re not stupid. Many people believe that the current distribution of income is unfair and not entirely attributable to differences in productivity.