The Marginal Productivity Theory of Wages in Explaining how Wages are Determined

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Assess the usefulness of the marginal productivity theory of wages in explaining how wages are determined.

Many theories have been advanced to explain the nature of wages. The first of them was the subsistence theory of wages, also called the
"iron law of wages," of which David Ricardo was one of the main exponents. The theory maintains that wages cluster around the bare subsistence level of workers. A wage rate much above the subsistence level causes an increase in the number of workers; competition will then lead to a depression of wages back toward the cost of subsistence. Wages that are below subsistence reduce the size of the working population; in that case competition will raise wages, but only up to the subsistence
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If reducing the amount of hours of labour cuts costs by more than it cuts revenues, a firm can increase its profits by using less labour This is the case of MRC exceeding MRP, It follows that if the firm has maximized profits, MRP must equal MRC. If the firm should increase resource use when MRP exceeds MRC, and if it should decrease resource use when MRP is less than MRC, then it is using just the right amount when MRP equals MRC.

To push the analysis further, assumptions that many firms buy labour expecting to change price within the market, but none can noticeably influence price in any market. This assumption that firms are price takers means that marginal revenue equals price of output, and that the marginal resource cost equals the price of the resource.

With these assumptions, a diagram similar that used to explain the technicalities of economic efficiency. On the left we have a representative worker who sells hours of unskilled labour. The supply curve is drawn so that it slopes upward. To find the market supply curve, you must add up all the hours of work which will be offered at each wage.

The labor market

On the right we have buyers of unskilled labour. Its demand curve will be the downward sloping part of its MRP curve. The MRP curve is the demand curve for labour because this curve tells how valuable another unit of the resource is to the firm. Hence, given a wage, one can tell how much labour a firm

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