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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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OK I understand that labour can have different uses but I don't see how this changes that it must be combined with capital in order to produce something?

It doesn't. Where did I say it does?

 

Sure, but I'm saying that this is not possible.

So you are arguing the point regarding factors being entirely specific and therefore MVP indeterminate? If so, what is your argument for every factor of production being specific when they manifestly can be switched to other uses (especially labour and to a lesser degree capital and land)? Even if you're referring to teamwork, this again can be measured in ways outside of traditional wage packages like Student mentioned, e.g. via commission based models. There are many ways for a firm's owner to measure productivity of a team and of members within that team.

This is true. If the MW goes up then it will possibly alter the structure of production. However, labour will still have to be employed too

No, not necessarily. Certainly not the same labour that was employed before.

- perhaps more, perhaps less, perhaps roughly the same - the overall effect is ambiguous. That's when I'd defer to the evidence (probably not worth dicussing here).

if you can isolate it down to that single factor in order to produce "evidence" based on causation (and not mere observed correlations), go ahead.

Why would they not have hired these workers already if they are more productive

Higher cost. They're now forced to pay them that price so they might as well get the best value of services for their money.

? There's a possibility that the MW will create unemployment, if a worker is unable to produce more than he can when combined with capital. But otherwise it will just eat into profits.

It isn't a "possibility". It will cause some factors to go into "unemployment" one way or the other. It will not eat into "profits" but rather into wages, and possibly interest on capital and rents to the degree that they are specific. Since it is labour being price-controlled, it is the most obvious contender. This is assuming also that capital in the form of increased automation is not relied upon instead to control costs. Note that for interest on capital or rent to be eaten into, all factors would have to be specific, because if labour is not then it is easy to calculate its MVP.  If I were to grant your case and assume capital did suffer a reduction in income attributable to it, all that would happen is its owners would disinvest from it (or cease funneling further money into it), resulting in productivity losses.

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UnlearningEcon:
Your post was interesting but I have a feeling I will end up responding to too many people and don't want to get into the minimum wage specifically. However it is entirely possible, within your example, that existing entrepreneurs would offer more jobs by expanding with less competition.

To some extent that might be true, but could this offset this fully? Since too high employment costs caused already others to not hire people and become empoyees themselves I hardly doubt it would seduce the remaining employers to do that in a large enough quantity. Anyway I don't want to sabotage this thread, so fair enough.

"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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@UnlearningEcon, 

Yes, you are right - it is possible that capital will be able to substitute capital for labour, absolutely. But it is also possible to subtitute labour for labour. The relative ability of each to do this will determine bargaining power, no matter the nature of the potential replacement.

So the relative ability to substitute one worker for another will influence bargaining power? I agree. But I would argue that this should be captured in supply function for labor. So it shouldn't contradict the MVP theory of wages.

I'm not sure what better we can do than asking businessmen what costs they face - surely they will know what is going on inside the firm?

Well, I don't think the average businessman thinks in terms of average cost curves. So I think if you just showed him a set of average cost curves and said "which best represents your business" you wouldn't get a very reliable answer. I could be wrong of course, but the way you would show that they do understand would be to do cognitive interviews and maybe pilot testing several different versions of the survey (each version asking the same questions in different ways) and seeing if you get the same results. This type of pre-testing is common practice today, but E&G don't mention doing anything like that.

You may well have read Piero Sraffa's paper on why this will be the case, if you'd like a more logical approach.

Thanks for the recommendation. I have not read this, but I will take a look when I get time. Yesterday was the first day of classes, so my reading list is pilling up fast. 

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skylein: 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?

Yes.

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?

No.

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?

More or less, but...

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.

...I don't think I agree with this.

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?

Sorta. I think more people producing it is more of a decisive factor.

What is your goal by the way?

To understand how prices are formed.

Do want to be able to judge if a factor of production was paid its fair price?

No, not really.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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Fool on the Hill:

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?

No.

Ok. So let’s go through it.

Imagine entrepreneur Joe wanting to produce a new consumption good G and he thinks he can get 100USD/pc. He needs only one factor of production P that nowhere else is needed. He finds supplier Bob who could deliver this. Considered the alternative things Bob could produce he will at least want 20 USD/pc initially to produce it to be profitable enough. As fate wants it both agree on the 20USD/pc for P. This means now that Joe reaps a huge profit (just assume for the sake of the argument that he has no costs for selling it for 100 USD/pc) of 400%! You really don’t assume it will stay this way do you? If I am right either the selling price of G has to go down or the price of P will have to go up. In fact standard price theory will tell us that every profit rate tends to approximate the average profit rate in the economy. So if you disagree with what I said you disagree with the tendency of profit rate equalization.

Scenario A: The demand for the consumption good G is way higher than the supply of P: This would lead to many new firms starting to sell G as well when they see the profit rate of Joe. Since the supply of P is low compared to the demand for G (which selling price will stay at around 100 USD/pc this way) the competition to get P increases heavily therefore driving its price up until it is near the general profit rate that prevails in the rest of the economy. If this was 10%, then P will cost approx.. 90 USD/pc at the end.

Scenario B: The demand for consumption good G is way lower than the supply of P: In this case also lots of other businesses will be jealous about the huge profit Joe is reaping, also starting to buy P to sell G. But now there is plenty of P compared to the demand for G. In this case firms will bid each other down in term of the price of G. Again until the profit rate is similar like in the rest of the economy. Again if this was 10% the price of G will be around 22 USD/pc.

Do you agree now?

Fool on the Hill:

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?

More or less, but...

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.

...I don't think I agree with this.

I just mean with this one that yes in a thought experiment like the ERE (Evenly Rotating Economy) in which nothing changes and everything is always the same there would only be one ideal price pattern/structure, which means there were no price ranges observable. However in the real world, which is far from stable, you always have room to negotiate. The data and conditions are changing all the time opening new possibilities to profit, while closing others which were profitable in the past.. If people are going to buy a car they very often try to think of strategies of how to get the dealer to give them the lowest price. Already a different tone can change what the dealer might offer. So it’s just like as if Joe and Bob don’t settle with 20USD/pc for P initially but they settle for 25. And even if Joe approaches the assumed general 10% profit rate. They can still have room in scenario A to decide for 91 or 88 instead of 90… Overall I only wanted to emphasize that there is in the real world always a price range that due to the way the market works has the tendency to get smaller, but never can vanish completely because there is always change, limited knowledge etc...

"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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It doesn't. Where did I say it does?

Apologies, you didn't. I got the impression you thought labour being a specific factior of production was somehow essential my analysis, which you restate below. But I'm not sure I see it. If you're saying my hypothesis is inaccurate because firms can switch between labour and capital, I don't see how that undermines it. If I am bargaining over a 'collective MVP' with someone, it doesn't matter what they can replace me with - all that matters is how easily they can replace me.

Even if you're referring to teamwork, this again can be measured in ways outside of traditional wage packages like Student mentioned, e.g. via commission based models. There are many ways for a firm's owner to measure productivity of a team and of members within that team.

Under some circumstance, such as a salesperson, it's much easier to determine what they make (although they still need to thing they are selling). But even if you can confirm how hard somebody within a team works, it sort of falls apart if they have to work with someone else to achieve something. To take the two men carrying a box example, even if one is doing substantially more lifting, he wouldn't be able to lift at all without the other guy adding that bit extra.

It isn't a "possibility". It will cause some factors to go into "unemployment" one way or the other.

This is the part where we talk past each other! Imagine a taxi and its driver. Together they produce £100 a day; wages and profit are split 50:50. The minimum wage rises to £60 - what happens? Surely the only short term possibility is that profits are reduced?

If I were to grant your case and assume capital did suffer a reduction in income attributable to it, all that would happen is its owners would disinvest from it (or cease funneling further money into it), resulting in productivity losses.

Lack of investment is a possibility but that depends on circumstance, and could also go in the other direction - if wages and therefore consumption is too low firms won't invest. With the current ratio of wages to profits I'd say it's not a problem.

So the relative ability to substitute one worker for another will influence bargaining power? I agree. But I would argue that this should be captured in supply function for labor. So it shouldn't contradict the MVP theory of wages.

I do regard demand-supply and bargaining power as different ways of saying something similar, but perhaps that's not for here.

It still contradicts the MVP theory, because it doesn't suggest the wage is exactly what the labourer themselves is producing; rather, it reflects other circumstances.

Evidence also suggests that many firms use cost-plus pricing, which involves calculating average costs and tacking on a bit. So they might not be too unfaimiliar with the idea of average costs.

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No, I am saying it fails even if it is specific. The fact that labour is not specific undermines it even further. Teams only tend to be difficult to gauge when the nature of the work itself is difficult to gauge, e.g. HR. The firm in that case is taking a risk in that it may not get its full money's worth out of the labour services consumed, and in that case it will need to seek alternative measures of managing productivity.  All of life requires cooperation to yield results. To leap from this to the fact that individual contributions are not measurable is a pure non sequitur.

And again you keep using the term "profits". Profits are simply the reward for adapting favourably to changes in consumer demand. You must be referring to returns on capital.

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To leap from this to the fact that individual contributions are not measurable is a pure non sequitur.

How? If nothing is produced by one person, but something is by two people, no matter how you switch them, why is not reasonable to say the MVP belongs to a team rather than a person?

And again you keep using the term "profits". Profits are simply the reward for adapting favourably to changes in consumer demand. You must be referring to returns on capital.

Profit is the returns to capital. I only use the former because it is more commonly used and shorter. You seem to have an ideological objection.

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skylien: Imagine entrepreneur Joe wanting to produce a new consumption good G and he thinks he can get 100USD/pc. He needs only one factor of production P that nowhere else is needed. He finds supplier Bob who could deliver this. Considered the alternative things Bob could produce he will at least want 20 USD/pc initially to produce it to be profitable enough. As fate wants it both agree on the 20USD/pc for P. This means now that Joe reaps a huge profit (just assume for the sake of the argument that he has no costs for selling it for 100 USD/pc) of 400%! You really don’t assume it will stay this way do you? If I am right either the selling price of G has to go down or the price of P will have to go up. In fact standard price theory will tell us that every profit rate tends to approximate the average profit rate in the economy. So if you disagree with what I said you disagree with the tendency of profit rate equalization.

Scenario A: The demand for the consumption good G is way higher than the supply of P: This would lead to many new firms starting to sell G as well when they see the profit rate of Joe. Since the supply of P is low compared to the demand for G (which selling price will stay at around 100 USD/pc this way) the competition to get P increases heavily therefore driving its price up until it is near the general profit rate that prevails in the rest of the economy. If this was 10%, then P will cost approx.. 90 USD/pc at the end.

Scenario B: The demand for consumption good G is way lower than the supply of P: In this case also lots of other businesses will be jealous about the huge profit Joe is reaping, also starting to buy P to sell G. But now there is plenty of P compared to the demand for G. In this case firms will bid each other down in term of the price of G. Again until the profit rate is similar like in the rest of the economy. Again if this was 10% the price of G will be around 22 USD/pc.

Do you agree now?

I'm confused. You start out with the assumption that the supply of P is 0. Joe then contracts with Bob to produce P, setting the price in advance. Since the supply is 0, the supply has nothing to do with the price. Then all of the sudden your two scenarios assume a preexisting supply. Where does this supply come from? Does Bob simply on his own produce this supply of a completely useless good until Joe and the others come along with an idea as to how it can be used? Or does Bob, while working for Joe, produce some extra P on the side with no goal in mind?

And for Scenario A to work, Bob has to be the only one that can produce P. In the scenario, capitalists outnumber laborers, but how realistic is that? Indeed, if laborers outnumber capitalists then Scenario B always holds. Rather than the price of P going up to reach G, the price of G goes down to near the price of P. The price of P remains as it began, and thus is not determined by the price of G.

"The limits of my language mean the limits of my world." ~ Ludwig Wittgenstein
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Student replied on Fri, Aug 17 2012 10:11 PM

@UnlearningEconomics

 It still contradicts the MVP theory, because it doesn't suggest the wage is exactly what the labourer themselves is producing; rather, it reflects other circumstances.

If you are suggesting that the supply of factors is not part of the MVP theory, then I don't think that is the most fair way of defining the theory. The New School's History of Economic Thought website has a good discussion on this. Here is the bottom line, but they go into more historical details.

The marginal productivity theory caused something of a little tornado around the turn-of-the-century, which deserve some attention...

The first and most straightforward error (which is sometimes repeated today) is to assume that the marginal productivity theory says that factor prices are determined by marginal products... It has never said that, regardless of whatever [J.B. Clark] let himself say in unguarded moments. Factor prices and factor quantities are determined by the demand and supply of factors, period. 
http://cruel.org/econthought/essays/margrev/distrib.html#marginal

I especially think this quote by Alfred Marshall speaks most directly to what you say above. 

The doctrine that the earnings of a worker tend to be equal to the net product of his work, has by itself no real meaning... 
http://www.econlib.org/library/Marshall/marP43.html

-----------

Evidence also suggests that many firms use cost-plus pricing, which involves calculating average costs and tacking on a bit. So they might not be too unfaimiliar with the idea of average costs.

Well, I am sure that the avg businessman understands what average costs means. But the average cost curve reflects how average costs change over all ranges of production and that is what E&G's questions were based on. And I think many or most businessmen (especially in 1952) would have a very hard time guessing the shape of their average cost curve over some range of production, at least not without doing some sort of internal review. Like I said, I could be wrong. Maybe E&G's survey respondents knew exactly what they were talking about. But E&G simply don't report the type of pre-testing that would save their paper from these types of concerns.  

You have probably already seen this, but if you like E&G 1952, you might want to check out Blinder's book Asking About Prices. Keen apparently loves it. And based on his review of the book it sounds like a more rigorous version of the same type of survey work E&G did. That being said I have not read it myself so I don't know anything about their survey methodology. Johnathan Catalin has read Blinder's book and he seems to like it. So he might have more to say about Blinder's survey methods. 

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Fool on the Hill:
I'm confused. You start out with the assumption that the supply of P is 0. Joe then contracts with Bob to produce P, setting the price in advance. Since the supply is 0, the supply has nothing to do with the price. Then all of the sudden your two scenarios assume a preexisting supply. Where does this supply come from? Does Bob simply on his own produce this supply of a completely useless good until Joe and the others come along with an idea as to how it can be used? Or does Bob, while working for Joe, produce some extra P on the side with no goal in mind?

And for Scenario A to work, Bob has to be the only one that can produce P. In the scenario, capitalists outnumber laborers, but how realistic is that? Indeed, if laborers outnumber capitalists then Scenario B always holds. Rather than the price of P going up to reach G, the price of G goes down to near the price of P. The price of P remains as it began, and thus is not determined by the price of G.

 

Actually this is really quite simple. Joe plans to introduce his good G into the market with an amount of X and is of course looking for a supplier who can deliver  P in the needed amount and sets his expected price at 100USD/pc. Bob says yes I can deliver you P (although he has none yet) and I would do that for 20USD/pc for the requested amount. After this Joe saw that the market introduction of G worked as expected he gets back to Bob and asks for many more P! And at this stage it just depends on the relative possibility to supply P versus the demand of G. If P is hard to produce for whatever reason, meaning it is relatively scarce in supply compared for the demand for G, then clearly the price of P must go up. If P is fairly easy to supply compared to the demand for G then the price of G will fall. It really doesn't matter if Bob remains the only supplier for P or others jump in.

Of course there are costs to produce P else Bob would have a profit rate that is infinitely high. I said that Bob (a supplier) will ask at least for 20USD/pc else he will use his time for other things. If we assume other things would make him the given 10% profit rate in the economy he has costs to produce P of maybe 18 USD/pc. If another supplier finds out how to produce P cheaper and only asks for 10USD/pc then this will push the profitability for Joe even more, producing an even higher incentive to crank out loads of G to make insane profits. But one price will have to give way and the profit rate will align with the general profit rate in the economy. If the tendency will be the price of P goes up or G goes down or both approximate each other is just a question of the final data of supply and demand pushed by the incentive to make money.

Also I nowhere made a capitalist vs laborer scenario. It is only entrepreneurs here. Joe and Bob have their own firms! You usually don't call a laborer a supplier…

Do you really not believe that profit rates have the tendency to equalize?

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How? If nothing is produced by one person, but something is by two people, no matter how you switch them, why is not reasonable to say the MVP belongs to a team rather than a person?

Different people contribute to teams to differing extents. There is no "team" to speak of but individuals cooperating to yield a result. Now it may be true that you need both to attain the result, and it may be true that some individuals synergise better with other individuals. You are leaping from this to the assertion that they don't contribute to differing extents to the final outcome. Sure, an employer could simply toss them a pile of cash as a "team" and let them split it up, but in the event where their respective contributions to the "team" (i.e. productivities) do differ, they are then simply subsidising the weaker member and punishing the more productive one, so there is every incentive to make an accurate split (even if approximate) rather than just divide "equally" between team members, even when their contributions are not equivalent. Now it might occur sometimes that the differences in productivity are too minute/difficult to measure to bother with, in which case trying to price wages based on productivity might be too costly to introduce.

Teams exist in order to capitalise upon the advantages accrued by the division of labour, which by definition means differing tasks will be performed by the various members of the team, each with a different contribution to the final product sought and each performed with differing levels of efficiency.

Profit is the returns to capital. I only use the former because it is more commonly used and shorter. You seem to have an ideological objection.

Nah. More of an economics objection. Interest will persist even in the absence of any adjustments to be made to supply and demand (the uncertainty which allows for profits to arise), and capital goods will continue to attract it as production takes time, and will continue to do so even when supply and demand don't fluctuate and are perfectly predictable. Profit and returns on capital are often conflated but that is due to sloppy analysis.

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@student

Those are some interesting quotes. However I still, generally speaking, disagree with the idea of an MVP demand schedule, which generally assumes that capital is fixed and additional labour 'squeezes' more, at a decreasing rate, out of it. I just don't think this is possible - an additional office worker must have a computer, which is generally speaking provided by the firm at the point of employment. The worker's wages partially be determined by how much they produce when combined with the computer, partially by something you could call either the supply schedule or bargaining power. In any case, the MVP of the labourer alone is not possible to discern. The cruel.org article itself says this much, so I don't even think there's disagreement.

Yes, I should read Blinder's book.

@jon

There is no "team" to speak of but individuals cooperating to yield a result.

? To me this just seems like the definition of a team.

I still don't really see how we can identify what each factor of production contributes alone. This is especially true for labour and capital, but when you consider teams you seem to be taking an 'adding up' approach, whereas what really occurs is 'multiplication,' so that a reductionist method loses important elements.

For example, if one person is good at making burgers and another is good at taking orders, working together they will produce a more efficient outcome than if they, say, both cooked and took orders separately (this is basic DoL, obviously you already know it and I doubt you'll object). So how do we determine how much each one is producing? Have the one of them alone, also taking orders, and see how that differs from the productivity of the two combined? This only seems to work if factors of production are 'added up,' rather than if they combine to form unique new arrangements.

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I am trying to emphasise the point that there is no homogeneous entity called "the team". The employees which offer their services know what other wages they could get in positions requiring a similar skill level. The owner knows how much else they could get in employing their capital in other functions. The sale value of the good is known. This is all enough information for pricing labour services in teams, even if by proxies. I never spoke of "adding up", but where are the "multiplications" exactly?

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Those are some interesting quotes. However I still, generally speaking, disagree with the idea of an MVP demand schedule, which generally assumes that capital is fixed and additional labour 'squeezes' more, at a decreasing rate, out of it. I just don't think this is possible - an additional office worker must have a computer, which is generally speaking provided by the firm at the point of employment. 

I think the conversation is comming full circle. :) If this is how you want to characterize the production process (to produce 1 unit of output you need 1 worker and 1 computer), then I agree you can't compute a MVP demand schedule.

But there are other ways of deriving factor demands. For example, you can solve the cost-minimization problem to derive a "conditional factor demand". Here, demand for a particular factor depends only on the level of output. Unlike the MVP demand function, which depends on the price of output and given levels of other factors. Chapter 4 of Varian has more details:
http://mileslight.com/armenia/Varian-MicroeconomicAnalysis.pdf

So I think you might be focusing on the wrong thing. The fact that some production functions are not differentiable is a mathematical concern that we can get around. The important part of the neoclassical theory of factor prices is that those prices are set by the forces of supply and demand. 

But, putting that aside, I personally don't think most production processes can be described as these sorts of "recipies" you mention. Where you can only produce a unit of output if you have 1 person and 1 computer. Not even cake recipies are that strict. :P

Think about it this way. If you make one input cheaper, firms are going to substitute toward that over the long run. Example: 30 years ago most office workers did NOT have computers. They used type writers and filed things in physical locations. Your "1 worker" plus "1 computer" recipe wouldn't make sense back then. But as computers became cheaper, they became more widely used. 

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