According to economic theory, scarce factors of production are paid based on their marginal productivity. But, in practise, how does any businessman discern the marginal productivity of each factor? It seems to be something complicated.
And this is only the first question. I have a series of questions, but I want to ask them as a series with intervals right here in this thread. So please care to check in.
You can only discover factor prices if they are non-specific or the only specific factor. You're implicitly assuming that both the cycle - 1 wheel and the wheel are specific factors.
See Rothbard here:
When a factor is isolable, i.e., if its service can be separated out in appraised value from other factors, then its price will always tend to be set equal to its DMVP. The factor is clearly not isolable, if, as mentioned in note 3 above, it must always be combined with some other particular factor in fixed proportions. If this happens, then a price can be given only to the cumulative product of the factors, and the individual price can be determined only through bargaining. Also, as we have stated, if the factors are all purely specific to the product, then, regardless of any variability in the proportions of their combination, the factors will not be isolable. It is, then, the nonspecific factors that are directly isolable; a specific factor is isolable if it is the only specific factor in the combination, in which case its price is the difference between the price of the product and the sum of the prices of the nonspecific factors. But by what process does the market isolate and determine the share (the MVP of a certain unit of a factor) of income yielded from production?
When a factor is isolable, i.e., if its service can be separated out in appraised value from other factors, then its price will always tend to be set equal to its DMVP. The factor is clearly not isolable, if, as mentioned in note 3 above, it must always be combined with some other particular factor in fixed proportions. If this happens, then a price can be given only to the cumulative product of the factors, and the individual price can be determined only through bargaining. Also, as we have stated, if the factors are all purely specific to the product, then, regardless of any variability in the proportions of their combination, the factors will not be isolable.
It is, then, the nonspecific factors that are directly isolable; a specific factor is isolable if it is the only specific factor in the combination, in which case its price is the difference between the price of the product and the sum of the prices of the nonspecific factors. But by what process does the market isolate and determine the share (the MVP of a certain unit of a factor) of income yielded from production?
Liberals don't mean to destroy people. They just do.
Whatever decision a businessman ultimately comes down to, it's based on whether the additional cost matches the additional benefit. That's actually up to him to decide what benefit is equivalent to what cost - the economist does not decide what the businessman should do, but simply sees why the businessman does what he does.
Perhaps he just happens to be of the mind that 50 workers should be paid $250, because of the way he possible perceives that the 50th worker does only $5 worth of work, and the 51st worker can't possibly do anything more that would warrant paying the same $5. How does he discern it? Well, it's not like he's making some calculation here; it's just that as far as he can see, there normally has not been much benefit derived from the 51st worker in his experience that warrants paying the same $5, perhaps from what he has seen in past business seasons.
The concern of the economist here is simply to see and rationalise what happened based on the incentives given, not what the businessman should have done or how he should discern marginal productivity.
It's actually not too complicated. Assuming a free market, consumer goods prices are simply imputed backwards to create one portion of the prices for factors of production. The other portion comes from the competition among businesses for said factors of production.
Prateek Sanjay:Perhaps he just happens to be of the mind that 50 workers should be paid $250, because of the way he possible perceives that the 50th worker does only $5 worth of work, and the 51st worker can't possibly do anything more that would warrant paying the same $5. How does he discern it? Well, it's not like he's making some calculation here; it's just that as far as he can see, there normally has not been much benefit derived from the 51st worker in his experience that warrants paying the same $5, perhaps from what he has seen in past business seasons.
A bolt and a screw out of a plane engine will render the entire machine useless. So by terms of marginal productivity, the screw must command the entire value of the machine? I know screws and bolts are available in large quantities, so the price of bolts and screws is quite cheap. But my point is, going by marginal productivity terms, the screw and bolt(or any other part of the engine) must command the entire value of the machine.
poppies:Assuming a free market, consumer goods prices are simply imputed backwards to create one portion of the prices for factors of production.
There are so many things that go into making a product. How does the entrepreneur calculate the value of each individual factor? Take the aircraft engine example for an instance.
Prashanth Perumal:A bolt and a screw out of a plane engine will render the entire machine useless. So by terms of marginal productivity, the screw must command the entire value of the machine? I know screws and bolts are available in large quantities, so the price of bolts and screws is quite cheap. But my point is, going by marginal productivity terms, the screw and bolt(or any other part of the engine) must command the entire value of the machine.
But is each additional screw or bolt as necessary as the previous? There's a point past which additional ones are useless, and I'm sure engines could be redesigned to use fewer fasteners (with perhaps a lower level of efficiency) if such a shortage existed.
Regardless, we're not the entrepreneur, so we aren't the one making the decision. Marginal productivity doesn't only explain what entrepreneurs would do, but what they currently do as well. The fact of the matter is that entrepreneurs make decisions like this everyday, often without any kind of rigid or precise mathematical calculation outside of their own head.
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Justin Spahr-Summers: But is each additional screw or bolt as necessary as the previous? There's a point past which additional ones are useless, and I'm sure engines could be redesigned to use fewer fasteners (with perhaps a lower level of efficiency) if such a shortage existed. Regardless, we're not the entrepreneur, so we aren't the one making the decision. Marginal productivity doesn't only explain what entrepreneurs would do, but what they currently do as well. The fact of the matter is that entrepreneurs make decisions like this everyday, often without any kind of rigid or precise mathematical calculation outside of their own head.
Also consider the time factor. When building the engine in the factory, each nut and bolt is very cheap. If they were not another entrepreneur would provide them cheaper, because there is a low barrier to entry. If the engine is missing a bolt at the passengers are boarding, it may be much more expensive. The airplane cannot leave unless the bolt is in place. It will there fore pay much more for the same bolt. In both cases though, if 50 bolts are required, the 51st is useless and the manufacturer may be unwilling to pay anything for it (unless it buys an extra so as to not be gouged on the tarmac!)
Actually, according to economic theory, in the ERE, factors are paid their Discounted Marginal Value Product (DMVP). The Marginal Value Product is equal to the spread between the revenue a firm would earn by employing the factor of production and the revenue the firm would earn without employing the factor of production. The Marginal Value Product is discounted by interest to obtain the DMVP.
You should read Man, Economy, & State chapters 1-7.
Stephen:The Marginal Value Product is equal to the spread between the revenue a firm would earn by employing the factor of production and the revenue the firm would earn without employing the factor of production.
Here is the problem. Lets say you make a cycle worth $200. You take the front wheel out of the cycle, and you find the cycle's value now is zero. So the marginal value of the front wheel is $200. Next you take the back wheel out, and you find the cycle's value is zero. So the marginal value of the back wheel is $200.
Don't you find the problem now? The marginal values lost in separate cases, when added up, surpass even the total value of the entire product. Now it's simply crazy to say factors are paid based on their marginal value.
Prashanth Perumal:Here is the problem. Lets say you make a cycle worth $200. You take the front wheel out of the cycle, and you find the cycle's value now is zero. So the marginal value of the front wheel is $200. Next you take the back wheel out, and you find the cycle's value is zero. So the marginal value of the back wheel is $200.
As a cycle it's value is zero. As a collection of parts, absent the one wheel, there still may be value. You're basically arguing against the entire scrap industry, including auto junk yards, where partial cars are recovered one component at a time.
Prashanth Perumal:Don't you find the problem now? The marginal values lost in separate cases, when added up, surpass even the total value of the entire product. Now it's simply crazy to say factors are paid based on their marginal value.
To someone with a wheel only, the remainder of the bike is a tremendous opportunity to make use of their wheel.
Your argument presumes that marginal value is objective, and not subjective.
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liberty student:You're basically arguing against the entire scrap industry, including auto junk yards, where partial cars are recovered one component at a time.
No. I didn't say that the wheel goes useless. I only said a cycle without a wheel becomes usless. That means, the marginal value that the wheel adds to the final product is the entire value of the cycle itself.
the marginal value to you of having your first bike is greater than the marginal value to you of paying out the first 200$ of yours (.the price of purchase of the bike being 200$)
hence you buy one bike. the marginal value to you of having your second bike is less than the marginal value to you of foregoing your second set of 200$ hence you do not buy a second bike, you just have one bike. if the marginal value to you of separating the front wheel of the bike is greater than the marginal value to you of having a bike with the front wheel attached then that would explainwhy you detached it. and had a wheel and a bike with no front wheel.
or else; it is less, and you keep it attached.
i think if you keep it attached you provide evidence that the marginal value to you of having a detached wheel and bike without a front wheel is less than that of having a fully functional bike.
(note: I have assumed away transactions costs)
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liberty student: To someone with a wheel only, the remainder of the bike is a tremendous opportunity to make use of their wheel. Your argument presumes that marginal value is objective, and not subjective.
No again. The issue is if factors are priced on the basis of their marginal value. It doesn't seem so. If I have to be wrong, the front/back wheel of the cycle should be priced at the entire value of the cycle.
Prashanth Perumal:No. I didn't say that the wheel goes useless. I only said a cycle without a wheel becomes usless.
But it doesn't as I illustrated with my scrap yard reference.
Prashanth Perumal:That means, the marginal value that the wheel adds to the final product is the entire value of the cycle itself.
But this is untrue, because every component contributes to the marginal value. The order of assembly isn't crucial, the cycle is not a cycle until fully assembled. It wouldn't matter if you added a wheel or a handlebar or a pedal last. The value of the cycle qua cycle isn't there until the last component is added. Prior to this, it is a different product. Heck, every cycle is a unique and differentiated product, even if made with the exact same parts, painted the same etc.
The appeal to objective value is misguided in my opinion.
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