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Unlearning Econ - On the Incoherence of ‘Marginalist’ Labour Economics

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Student posted on Tue, Aug 7 2012 12:32 PM

Here is an old blog post from the blog "Unlearning Economics" that I thought might get some non-macro discussion going (doesn't anyone else get bored of chatting up the gold standard and ABCT?). 

http://unlearningeconomics.wordpress.com/2012/03/27/on-the-incoherence-of-marginalist-labour-economics/

Basically, UE argues that wages argues against the "MVP theory of wages". He doesn't spell out exactly what he means by this (and it actually meant different things to different people in the past), but I take him to mean that wages are not set by the interaction of supply and "demand" (defined as the marginal revenue value product of labor) for labor. 

He gives two reasons:

  1. the notion of a "marginal unit of labor" is incoherent -  you simply can't produce an extra unit of your product by hiring one extra person and holding all other factors constant. So you can never calculate a "marginal value product". One taxi ride requires 1 driver and 1 cab. If you hire 1 extra driver his marginal product is zero unless you also employ another cab. 
     
  2. team production - even if you ignore the first problem, workers typically produce goods in "teams". imagine a construction team building a house. you need a plumber, a dry waller, and all different types of workers to finish 1 house. if you didn't have a plumber, you couldn't build the house. but surely that doesn't mean the marginal product of a plumber is 1 house! so you have to evaluate the performance of the team as a whole. 

These 2 reasons sound almost identitical to me, but I think they are slightly different. I have my own reasons for doubting their validity, but I was wondering....

Is there a uniquely Austrian take on UE's arguments? Do you agree, do you disagree?? Am I getting his argument wrong? I am curious to know what my micro-minded forum-mates think.

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@ Student,

Ok. I am not sure what UE really is aiming at, so I didn't want to go into UE's assertion. I only wanted to correct the wrong assumptions that things are generally practically worthless as soon as one part is missing like the plumbing in the house or the steering wheel of car. That is not to say that certain things cannot be worthless at all if one thing is missing. It depends just on the costs to refit it with the missing thing compared to the market value as soon as it is complete. Hence is it economical to refit it or should it be scrapped.

Fool on the Hill:
So the finished house must determine the price of both the unfinished house and the plumbing. But how can it do that? It can only tell us the sum of the two factors and not what each is worth individually.

I don't think you fully grasp the subjective theory of value. Please read Carl Mengers Principles of Economics. It is very helpful.

Imagine one consumption good that only needs factors of production that nowhere else are needed. In this instance it is clear if this consumption good is valued at a certain price in the market that also those factors of production are valued at a certain price. If this consumption good at some point in the future is not valued at all in the market anymore it means that also all this factors of production are completely worthless suddenly.

Now imagine there is another company making another different kind of consumption good that needs exactly the same factors of production. Depending on what customers prefer more as a consumption good (= willingness to pay more) gives the two firms different bargaining power for the same factors of production. So yes it is about bargaining power of course. Every price in the market is finally determined by two bargaining parties constraint by certain conditions and competition. And where does the bargaining power come from? Ultimately from the subjective valuation of the consumer to pay lower or higher prices for the final consumption good. It is exactly in this way consumption goods determine the prices of higher order goods. No one said you can exactly calculate every price of each factor of production for building a house just because you know the final market price of the house. Those factors of production you need for building a house are also needed for other consumption goods, which create quite a complicated supply and demand situation. Especially for labor this is complicated since labor is used in everything, and labor is quite heterogeneous and people have preferences for different kinds of work!

EDIT a few things for clarity.

"Quis custodiet ipsos custodes, qui custodes custodient? Was that right for 'Who watches the watcher who watches the watchmen?' ? Probably not. Still...your move, my lord." Mr Vimes in THUD!
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@FoolontheHill

 

UE: Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power.

Bingo. I started developing such a perspective in this thread.

I am not sure UE's approach makes sense to me as written (which was one reason I was more focusing on his critique of the neoclassical approach as opposed to his own).

I mean, here he says that the share of one factor of production is determined by its relative ability to replace the other factors of production. However, earlier in the post, it sounded like he was using examples where there is no ability to replace one factor for another. Look at his taxi cab example. There is simply no opportunity to replace taxi cabs with people (I can keep buying cars, but unless they drive themselves, I wont be able to expand the quantity of taxi services i produce). 

If he ACTUALLY believes that elasticity of substitution between factors is not zero, then his first criticism falls apart. In that situation, you have a production process where marginal productivities are calcuable. 

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Yes, that article makes some good points (it's a similar point to the Cambridge Capital Controversy, right?). It fits in with what I was saying about the Austrian/neoclassical view of exchange here. It's as if workers have preexisting things that they just throw into a pot and the capitalist then sells the pot as merely the sum of everything inside. It ignores how labor changes things qualitatively. I think people are having trouble grasping why its wrong because they are unconsciously substituting the correct view of things when looking at the examples.

I'm not sure how it "ignores" anything of the sort. Care to elaborate? The whole intention of production is to transform resources into more valuable goods with a combination of factors.

 (although Mises's definition might actually exclude all goods from being consumer goods)

Because...?

. So the finished house must determine the price of both the unfinished house and the plumbing. But how can it do that? It can only tell us the sum of the two factors and not what each is worth individually.

Depends entirely on the specificity of those f.o.p. if they are entirely specific, you are correct. If not, then it is competition for use on the market which will determine how much the factor sells for.  When capital goods are highly specific (UNLIKE labour, which is non-specific) then yes, bargaining power does enter the fray.

UE: Given that the only coherent way to think of produce is as a result of all of the factors of production combined, what determines each factor of production’s share of the produce? Each wants as much as possible, but each requires the others in order to gain any produce at all. So the share for one factor of production is determined by its relative ability to replace the other factors of production. Or, to put it another way, the produce is distributed by bargaining power.

Which bargaining power is in turn determined by marketability and profitability.

 

With the movers example, it really depends on how much effort the purchaser of their services wants to go to. If they do not believe the expenditure of determining that productivity is warranted, anyway. So I'd agree with Alchian, in some instances it might just not be worth it to monitor productivity too closely and opt for a traditional compensation scheme.

Freedom of markets is positively correlated with the degree of evolution in any society...

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skylein: Now imagine there is another company making another different kind of consumption good that needs exactly the same factors of production. Depending on what customers prefer more as a consumption good (= willingness to pay more) gives the two firms different bargaining power for the same factors of production. So yes it is about bargaining power of course. Every price in the market is finally determined by two bargaining parties constraint by certain conditions and competition. And where does the bargaining power come from? Ultimately from the subjective valuation of the consumer to pay lower or higher prices for the final consumption good. It is exactly in this way consumption goods determine the prices of higher order goods. No one said you can exactly calculate every price of each factor of production for building a house just because you know the final market price of the house. Those factors of production you need for building a house are also needed for other consumption goods, which create quite a complicated supply and demand situation. Especially for labor this is complicated since labor is used in everything, and labor is quite heterogeneous and people have preferences for different kinds of work!

I just don't see how the prices can be determined in this way. Suppose you have a house that requires bricks and plumbing. A small office building also requires bricks and plumbing. Both finished buildings are valued at $200,000. How does one determine the portion of the value that each component makes up? Is the the plumbing $50,000, $100,000, or $150,000? Even if we consider the house made of wood instead of brick, how does this help? Every product that uses wood also includes something else (labor at least)?

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Student: I mean, here he says that the share of one factor of production is determined by its relative ability to replace the other factors of production. However, earlier in the post, it sounded like he was using examples where there is no ability to replace one factor for another. Look at his taxi cab example. There is simply no opportunity to replace taxi cabs with people (I can keep buying cars, but unless they drive themselves, I wont be able to expand the quantity of taxi services i produce). 

If he ACTUALLY believes that elasticity of substitution between factors is not zero, then his first criticism falls apart. In that situation, you have a production process where marginal productivities are calcuable.

Yes, I think the factor has to be labor, whose elasticity is obviously not zero. My conception is rather complicated, but I am working on a detailed explanation to be published somewhere eventually.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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UE is reviewing Steve Keen's Debunking Economics chapter by chapter. I suggest reading the book; Keen's arguments are very strong, and actually borrow a lot from established criticisms within the orthodoxy.

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That capital goods have their value imputed from consumer goods doesn't mean that each individual capital good is actually priced at its marginal value. One major detail that sets the Austrian theory of prices apart from its Neoclassical brother is that the former operates heavily in the area of disequilibrium. Ironically, Austrian price theory also has some things in common with post Keynesian price theory. For instance, recently the theory of expectations has begun to play a larger role in price determination; also, Böhm-Bawerk provides a much better cost plus mark-up price theory.

Böhm-Bawerk explains that the price of a factor of production is based on its least valuable output. Why? Because the loss of that factor of production (or group of means of production, which is what Böhm-Bawerk talks about in the second volume of Capital and Interest) manifests itself as one less unit produced of the least valuable output. So, the prices of the means of production will depend heavily on expectations of profits in various alternative investments (it also follows that these prices are also heavily influenced by expectations, or expected future profits).

Neoclassical price theory is an extreme form of marginalism, where in fact (according to Keen) the models aren't even internally (mathematically) consistent. This is why real world price data doesn't fit Neoclassical models.

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Fool on the Hill:
I just don't see how the prices can be determined in this way. Suppose you have a house that requires bricks and plumbing. A small office building also requires bricks and plumbing. Both finished buildings are valued at $200,000. How does one determine the portion of the value that each component makes up? Is the the plumbing $50,000, $100,000, or $150,000? Even if we consider the house made of wood instead of brick, how does this help? Every product that uses wood also includes something else (labor at least)?

That is why I suggested to read Mengers book because he painstakingly explains the process with examples.

I want to know with which element of my explanation above you do not agree:

Do you agree that a factor of production only can have value if you can use it at least for the production of one consumption good  that is valued by people?

Do you agree that the value/price assigned to this factor of production is higher or lower depending on how high the final consumption good is valued by the people?

Do you agree that the final and exact price is only determined by two people negotiating it, and that they have of course a certain price range in which the final price can be and at every price within this range still both are better off than not doing the trade? It is this price range that is partly determined by the final (expected) price of the consumption goods. This also means that if more factors of production are needed that it lies in the sole discretion of all bargaining parties of how the whole (expected) earnings from selling the consumption good are divided onto each factor and that different price patterns are possible.

Do you agree that the more people are involved in trading this factor of production or/and the consumption good the narrower these price ranges become?

What is your goal by the way? Do want to be able to judge if a factor of production was paid its fair price?

If you agree to all those points above then it should be clear that you cannot look at the price of one consumption good and calculate backwards what each factor of production necessary for producing it is “worth” exactly. You would need to at least take into account ALL (actual and expected) prices of ALL consumption goods. And then you are left with price ranges not with an exact price like 19.85687978 USD. And this ignores that you have goods which are both higher order goods and consumption goods. It ignores preferences of what people like to work or not like to work, where to live, with whom to work.... It ignores skills people have, it ignores cultural differences etc…

Maybe you should also Read Hayek’s essay about the knowledge Problem

Edit: Additional word in green.

"Quis custodiet ipsos custodes, qui custodes custodient? Was that right for 'Who watches the watcher who watches the watchmen?' ? Probably not. Still...your move, my lord." Mr Vimes in THUD!
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Böhm-Bawerk explains that the price of a factor of production is based on its least valuable output. Why? Because the loss of that factor of production...manifests itself as one less unit produced of the least valuable output.

I'm not exactly sure what you mean. Depending on how you define the production process removing one unit of a particular factor of production could reduce output by more or less or exactly one unit. And so long as the elasticity of subtitution is not zero, you can replace having less of one factor of production by adding more of another so that production doesn't fall at all.  

Maybe you can make what you are saying more concrete by applying it to the UE example that inspired this thread. Say you are looking at the taxi driving industry. The production process is pretty simple: 1 driver + 1 cab = 1 day of taxi driving services. How would you (or Böhm-Bawerk) say that taxi driver compensation is determined in the market? How would your answer differ from a "neoclassical" answer? 

Neoclassical price theory is an extreme form of marginalism, where in fact (according to Keen) the models aren't even internally (mathematically) consistent.

I would have to see this to believe it. I have been reading UE's review of Keen's book but so far have not been able to read the book itself (it's not my uni's library). I think UE has nailed some good points (usually those already noted by "neoclassical" authors), but he has not convinced me to abandon neoclassical theory as an effective tool for analysis. 

This is why real world price data doesn't fit Neoclassical models.

Says who? That is a pretty broad assertion. And I don't know if the empirical work citied in Keen's book is better than what UE references on his blog, but so far the empirical papers UE has posted have not exactly blown me over.  

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Student,

You write,

I'm not exactly sure what you mean. Depending on how you define the production process removing one unit of a particular factor of production could reduce output by more or less or exactly one unit. And so long as the elasticity of subtitution is not zero, you can replace having less of one factor of production by adding more of another so that production doesn't fall at all. 

That's not the point. The point is deriving the value of the means of production — i.e. of producers' goods.

Says who?

For starters, Alan Blinder, Asking About Prices.

I would have to see this to believe it.

Then, honestly, you should get off these forums and replace UE's blog with the academic work. Keen's book is an introduction, but it has a lot of references. Here is a paper by Keen (and Lee) on the heterodox critique of Neoclassical economics. Other papers,

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Thanks for the links to Keen's work Jonathan I think I've been guilty of ignoring this literature for too long.

 

@ Student, for a concrete example, consider the following (I've been watching the American version of The Office a lot recently). Let's say at our paper company Dunder Mifflin, we have 2 types of paper printing machines (our "fixed" capital) from which we produce respectively two types of standard business forms used by our clients, and since now I've run out of imagination lets call these A and B.

 

Now say that Dunder Mifflin receives special paper it uses to make stacks A and B (therefore making it the variable, convertible capital). With a stack of the special paper and one of the machines it takes a day to make either of these stacks. Now say tomorrow 2 clients will arrive, one willing to pay $100 for a stack of A and the other willing to pay $300 for a stack of B. If either customer sees the product they want is not there, they will simply leave without purchasing.

 

In your warehouse today you initially have lets say one stack of this special paper (not buyable on the open market and produced by 1 supplier who don't give their next shipment lets say until a week from now for argument's sake), a stack of B already ready and of course each of the paper printing machines. But unfortunately let's say one of your incompetent employees (probably Dwight...) accidentally sets fire to your stack of B, ruining it so it can't be sold any more. 

 

However immediately after this happens, a salesman appears and offers to sell you a stack of B. If you put yourself in Michael or Andy's shoes (the boss depending on the season of The Office you might be acquainted with). What's the maximum you'd be willing to buy this stack from the salesman for, assuming you'd only buy if you could improve the situation of your bottomline from what it currently is? (and knowing you have a day before your customers arrive)

 

Ignore all other considerations like the value of maintaining long term customer loyalty, the depreciation of the machines, cost of ink, etc. Puzzling through this type of problem I think is a good way to understand what Jonathan's getting at with his remarks, and how BB's work helps us realise the extensions of marginal utillity and productivity theory and its wider ramifications to factor and product pricing.

 

"When the King is far the people are happy."  Chinese proverb

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Who is BB?

Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid

Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring

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Sorry, it's a shorthand I use for Bohm Bawerk. Likewise with Rothbard RB.

"When the King is far the people are happy."  Chinese proverb

For Alexander Zinoviev and the free market there is a shared delight:

"Where there are problems there is life."

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Johnathan,

Well, first, you have not attempted to answer the question this thread was created to discuss. You seem to be trying to divert discussion to Keen's book. I'm not sure why. He was not referenced in the UE post that spawned this thread. And if his book answers the specific question posed in my OP, you have not said so (specific chapter or page reference would be helpful). 

Anyways, I don't want this discussion to devolve into yet another free-ranging attack on neoclassical economics. I had a very specific question and for the most part that is what I am going to stick to. So here are the ONLY comments I am going to post in response to your remarks on Keen's book and the books/papers you pulled from Keen's references (though if you could answer my questions below that would be very helpful).

JC: This is why real world price data doesn't fit Neoclassical models.
ST: Says who?

JC: For starters, Alan Blinder, Asking About Prices.

Throwing up entire books with no specific citations as to what portions you have in mind? This seems more like an attempt to shut down conversation than to answer a legit query. "Here, go read this 380 page monster, THEN get back to me!". Could you please offer some specific passages where Blinder discusses how "real world price data doesn't fit Neoclassical models"? 

I looked around to see if I could find something on my own but had no luck. I did see the only Amazon review of this book was written by (suprise suprise) Steve Keen. But Keen's review doesn't actually mention Blinder trying to use price data to show neoclassical models don't fit. According to Keen, Blinder surveyed a large number of firms and found that they believe they rarely face upward sloping marginal cost curves and that they experience relatively high fixed costs.

But that really isn't the same thing as what you said you found in Blinder. First off, that isn't price data. Second, even if we believe these results, that still doesn't really imply that neoclassical models don't fit the data. Sure, if marginal costs are not rising in some industries that might spell bad news for applying the perfect competition model to those industries. But perfect competition is not the only model of market structure in the neoclassical tool kit. Maybe those industries where marginal costs are not rising could better be described by another neoclassical model like a monopoly?

Keen certainly never quotes Blinder as saying that his results bring the whole of "neoclassical models" into question. Instead, he only quotes Blinder vaguely talking about how his results raise questions for traditional economic theory. In the most specific quote Keen provides, Blinder only talks about how his results might conflict with certain theoretical conclusions like price equaling marginal cost. But again P=MC is a specific conclusion of the perfect competition model, so that quote can't really be read as questioning neoclassical models on the whole. 

Now obviously I have not read the book, so I might be missing something. It is also possible Keen might not be discussing the specific parts of Blinder's book you had in mind. So could you please point me to the specific sections you had in mind when you wrote your previous post? I would be curious to look into this later when my reading load clears up. 

 

Then, honestly, you should get off these forums and replace UE's blog with the academic work. Keen's book is an introduction, but it has a lot of references. 

If my goal was to do rigorous research on heterodox critiques of mainstream economics, then I would probably do just that. But I never set out to do that. Instead, I am just trying to have a mostly-casual discussion about an interesting question I saw raised on a blog a month or two ago.

But then, out of no where, someone jumps into that casual conversation and just asserts that neoclassical models don't fit the data and are internally inconsistant. And then seems shocked when I say "I would have to see it to believe it"! 

Now, I'm glad you gave me a link to Keen's paper and I will read it if i have time. Bu I am a little suprised you are so huffy over my initial reaction. I'm not sure how else I should have responded. Well, actually, looking back I probably should have just ignored it. At least then I could have avoided having a blogger chastise me for spending too much time reading blogs and not enough time reading his new favorite author. frown

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Student,

Since the topic of the thread has to do with a criticism of Neoclassical price theory, borrowed from Keen's Debunking Economics, it's only natural that I direct you to actually read the book. It's not my favorite book and I'm not chastizing you, but you said "I have to see it to believe it — since your eyes are your own, I suggest to you to actually go see it. Yet, you accuse me of trying to peddle a book on the forums. This being said, the entirety of Blinder's book should be taken as evidence. Indeed, it's purpose is to provide evidence of real world prices, and not to attack Neoclassical price theory. Upon reviewing the evidence, Blinder suggests that real world prices don't fit the Neoclassical models. Finally, I'm not telling you to "get back to me." My purpose here isn't to hold a debate; I was trying to direct you to the literature on the topic — literature bound to be much more elucidating than any thing this forum (as wonderful as it may be) can offer.

Some more specific comments.  You write,

But Keen's review doesn't actually mention Blinder trying to use price data to show neoclassical models don't fit. According to Keen, Blinder surveyed a large number of firms and found that they believe they rarely face upward sloping marginal cost curves and that they experience relatively high fixed costs.

It wouldn't be possible that some of the surveyed data revolves around real world prices? Oh, I guess not.

But perfect competition is not the only model of market structure in the neoclassical tool kit. Maybe those industries where marginal costs are not rising could better be described by another neoclassical model like a monopoly?

Possible, but it could also mean that real world prices are somewhere in the middle, and that Neoclassical models don't give us a good theory of price setting (which is probably why post Keynesians prefer to opt for the less rigorous theory of cost plus mark-up).

In any case, if you're not interested in reading the literature out there — reading that would go to great lengths to answer this question all other questions — well, that's too bad for you.

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