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.
Under the conditions of perfect competition, wages are determined by the value of marginal product of labour. Marginal product of labour in any industry refers to the amount by which output increases when one more labour is employed.
Assumptions
The marginal productivity theory of wages is based on certain assumptions as stated below:
- All labourers are equally efficient.
- Constant technology
- Perfect competition prevails both in factor and product markets.
- There is full employment in the economy.
- Law of diminishing marginal returns apply on the marginal productivity of labour.
- Labour is perfectly mobile.
Value of marginal product of labour is the price which the marginal product can fetch in the market. Under the conditions of perfect competition, an employer will go on employing more labourers but, due to the operation of the law of diminishing returns, the marginal product of labour will diminish until a point comes when the value of the increase in the product will be equal to the wages paid to that labourer.
The marginal productivity theory can be explained with the help of the following figure:
Diagram Explanation
In Figure, number of labourers is measured on OX-axis and wage rate on OY-axis. ARP and MRP are average revenue productivity and marginal revenue productivity curves respectively. The equilibrium wage rate will be determined at a point where both the ARP and MRP are equal to each other.
In the figure, the equilibrium wage rate (OW) is determined at point E because at this point both the ARP and MRP are equal. The firm at OW wage rate will employ OX number of labourers. If the firm employs more workers than OX, it will have to face more losses or fewer profits. Therefore, the ideal situation for a firm is to employ workers up to the point where ARP and MRP are equal.
Criticisms
i. In the real world, perfect competition does not exist
Both in the product market and in the labour market. Imperfect competition is found in all the markets. This theory, therefore, has limited applicability in the real world. If it is applied to the imperfectly competitive market, the workers will be subject to exploitation.
ii. Labour can never be homogeneous
Some may be skilled and some may be unskilled. Wage rate of a worker is greatly influenced by the quality of labour. A higher wage rate is enjoyed by the skilled labour compared to the unskilled labour. This simple logic has been totally ignored by the authors of this theory.
iii. Imperfect Mobility
Perfect mobility of labour is another unrealistic assumption. Mobility of labour may be restricted due to socio-political reasons.
iv. Ignores Supply
The marginal productivity theory of wage ignores the supply side of labour and concentrates only on the demand for labour. It is said that labour is demanded because labour is productive. But why labour is supplied cannot be answered in terms of this theory. This is because of the fact that, at a given wage rate, any amount of labour is supplied. But we know that higher the wage rate, higher is the supply of labour. This positive wage-labour supply relationship has been ignored by the makers of this theory.
Improvements Over Earlier Theories
The marginal productivity theory is an improvement over the earlier theories in the following ways:
- (i) This theory is not as rigid as the subsistence level theory and other classical theories.
- (ii) It takes into consideration the demand for labour by the employers and the supply of labour, although in an indirect form.
- (iii) It shows why there are differences in wage rate. Wages according to this theory vary because of marginal productivity differences of different workers.
- (iv) It gives importance to the productivity of labour.
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