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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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I agree with student that this is coming full circle, but thanks for an interesting discussion. Student's and other's ideas about the evolution of factors of production and substitution of one for the other just make me think we should be look at more dynamic models of the economy that emphasise rates of change rather than static demand-supply levels.

A final point to jon: what I was getting at with the 'multiplying' versus 'adding up' is that when inputs interact they produce something more or different than the sum of their parts, and so cannot be disaggregated. In your example the substitutes will potentially tell us what the labour is worth elsewhere but not what it is producing. All I'm saying overall is that individual productivities are not only difficult to measure - they are often impossible.

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The Austrians already view the economy in a dynamic way. I am not certain what the relevance of that is, though. The "problem" you're specifying is productivities being impossible to measure due to the production process apparently yielding a "new" product entirely. I still don't see why this hinders the consumer of labour services from measuring the extent to which each factor contributes to the process and rewarding them accordingly. You say it cannot, but I don't see why. Perhaps Student is right and it depends on how one looks at the problem.

Here, demand for a particular factor depends only on the level of output.

I'm a bit confused by this. What's the assumptions that go into it? Demand based on output under the constraint of cost-minimisation?

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

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Sorry, skylien, I didn't get to your post earlier.

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.

I wouldn't say that something which is hard to produce is the same thing as being scarce in supply. If the supply refers to the difficulties of production and not the quantity of items produced, then does that mean production doesn't increase the supply? I think supply and difficulty of production are distinct concepts.

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…

I see, Bob is also a capitalist. I had assumed he was a freelance laborer or something. In that case, instead of contracting with Bob, Joe could also produce P by hiring laborers himself. The price Joe would have to pay the laborers might be higher than paying Bob to produce the product, but this price sets an upward bound for the price of P. If Joe could hire laborers to produce P for 40USD/pc, then the price that Joe would pay Bob could not exceed 40USD/pc no matter how much Joe can sell G for. So the price of P is not determined by the price of G but by the price of the labor Joe would have to pay to produce the item in-house. Whether the price G sells for is 100USD/pc, 1000USD/pc, or 1,000,000USD/pc, the price of P remains unaffected. 

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

No, I do believe there is a tendency for it to equalize. But it is not because the prices of higher order goods are determined by the price of consumer goods. Rather competitors jump in to produce G, lowering the price to the point where they are making the average rate of profit. Products generally don't become more expensive after they are invented but cheaper. If no competitors were able to figure out how to make G, Joe would indeed make super profits.

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Fool on the Hill:
Sorry, skylien, I didn't get to your post earlier.

No problem.

Fool on the Hill:
No, I do believe there is a tendency for it to equalize.

I will make it short. If you agree to this then you agree logically to this, although you said no at first:

skylien:
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?

And not all prices go down. Also the prices of factors of production may be bid up until the general profit rate is reached. This solely depends on the market data.

Anyway I want to take back one recommendation I made. I said you should read Menger. Don't, I say now read MES from Rothbard. At least the first 60-100 sites (starting after the introduction and foreword etc.). I started reading it now, and it explains value, price and the pricing process in such a clear way that I only can recommend reading that! (I avoided MES from Rothbard for a while because at the beginning I read so much about the same issues that I didn't want to go over it again in MES. So I read a few other things for a while and it is a real pleasure to go through MES now. And honestly I didn't expect that much clarity and painstaking detail achieved by Rothbard in MES. So far (page 212) there is really nothing that I could object to). You safe yourself a lot of time arguing if you read that.

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Fool on the Hill:
No, I do believe there is a tendency for it to equalize.

I will make it short. If you agree to this then you agree logically to this, although you said no at first:

skylien:
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, that actually doesn't logically follow. Correlation doesn't equal causation. Water is a solid at or below 0 C and a gas at or above 100 C. But this doesn't mean that the temperature of the air depends on the state of the water. Similarly, the gap (profit) between the cost price and final price of a good tends to be equal across all goods. Therefore, either the cost price or the final price must depend on the other. I maintain that the final price is at least generally the dependent variable, while Mises seems to believe the opposite.
And not all prices go down. Also the prices of factors of production may be bid up until the general profit rate is reached. This solely depends on the market data.
But my impression is that when demand increases for a consumer good, the producers try to produce more of it to meet the demand. Now in trying to produce more of it, they may have to bid up the prices of the factors of production. But it is only as a result of the increase in the price of the factors of production that the price of the consumer good goes up. So again, the price of the higher order good determines that of the lower, and not the other way around.
Anyway I want to take back one recommendation I made. I said you should read Menger. Don't, I say now read MES from Rothbard.
I've read some of it and have critiqued a few points here. I think Rothbard makes some pretty big errors. I do appreciate his clarity though.
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You seem to be stuck with a cost of production theory. I hope you at least see the contradiction you have to solve if you on the one hand argue that the costs of higher order goods determine the price of the lower order goods, and on the other hand agree that higher order goods only can have value and therefore a price if the final consumption goods made with them are valued by people.

I hope you just don’t fall for this fallacy: An increase in the demand for say consumer good A which in turn will cause a higher demand for the higher order goods to produce A and therefore increases their price also has an impact on other consumer goods that also need the same factors of production. If consumer good B needs the same factors of production while its demand schedule stays the same, then this will mean that to keep the profit rate the same, B’s price will have to go up because of a higher price for the factors of production. And since the demand schedule stayed the same for B, now a lower amount of B will be sold. The fallacy here is to assume now that it was ultimately the higher price of the factors of production that resulted to an increase for B, when it ultimately was an increase in the demand for A that started this.

Since you said you have read parts of it I assume you did not read MES from the beginning to approx. page 180? If not, I urge you to do it. It is a step by step build up process. If you disagree with Rothbard fundamentally on this section of the book, I’d like to hear what specifically.

If not, then for my point of view this problem should be solved for you.

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Guys, it turns out Dennis Robertson solved the problem a long time ago. Here's an anecdote of Reisman's about a class he took with George Stigler in the following blog post on the law of costs: 

http://archive.mises.org/5505/more-from-bohm-bawerk-on-cost-of-production-as-a-determinant-of-prices/

"Specifically, I had taken a class from Prof. George Stigler at Columbia University and learned of Dennis Robertson’s attempt to deal with the problem of calculating the marginal product of a tenth hole digger in the face of the availability of only nine shovels. Robertson’s answer, as reported by Stigler, was that the tenth worker could be sent to fetch beer."

 

cheeky

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You seem to be stuck with a cost of production theory. I hope you at least see the contradiction you have to solve if you on the one hand argue that the costs of higher order goods determine the price of the lower order goods, and on the other hand agree that higher order goods only can have value and therefore a price if the final consumption goods made with them are valued by people.

No, I don't think there is really a contradiction. Suppose I want to go on a hiking trip and take the maximum amount of water with me that I can. There are two possible determinants of how much water I can take with me: (1) how much water I have access to, and (2) how much water I can carry. I have access to nearly an unlimited amount of water through my faucet. On the other hand, the amount of weight I can carry is very much less than that. So it seems to me right to say that the amount of weight I can carry determines how much water I take with me. Nevertheless, despite the weight I can carry being the decisive quantitative factor, it is definitely true that I need to have access to water in order to carry it. The same goes for the price of water. People have to want to buy water in order for someone to get something for selling it. But how much they want it isn't the decisive factor of its price. I would be willing to spend all of my money for water, but thankfully the cost of obtaining the water is far below that. The cost of production then is the determining factor.

I hope you just don’t fall for this fallacy: An increase in the demand for say consumer good A which in turn will cause a higher demand for the higher order goods to produce A and therefore increases their price also has an impact on other consumer goods that also need the same factors of production. If consumer good B needs the same factors of production while its demand schedule stays the same, then this will mean that to keep the profit rate the same, B’s price will have to go up because of a higher price for the factors of production.

If we assume this higher order good is a factor in all consumer goods, then it is hard to see how your example can work. What we have been talking about is labor, which indeed is a factor in all goods. Now there is the issue of whether every laborer is capable of producing all goods. If we leave that aside for a moment and assume that each laborer can produce any good, then we have found the highest order good, which cannot only produce every consumer good but also every producer good. Thus, if we have, as you say, an increase in demand for good A, while the demand for all other goods remain constant, then the price of all goods and all wages must increase. But this is simply inflation. You've added additional money to the system. If on the other hand, no new money is added, then the only way the demand for one good can increase is if the demand for another decreases. In this case it is not at all clear why the price of wages must rise. Wouldn't people laid off from producing the good that experienced a decrease in demand go to work at the one that experienced an increase in demand? Why would this entail an increase in wages across the board? If they did go up, wouldn't this then entail perpetual price-inflation regardless of the money supply? My labor is capable of being a higher order good in the production of iPhones in a factory assembly line, why didn't my wage go up due to the increased demand for the iPhone 5?

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@skylien: BTW, I hope you are oversimplifying profit calculations on purpose.

I mean, to get 10% annual profit one does not need to sell with price-cost margin of 10%. It all depends on the speed of transactions - if you buy/produce/sell 10 times a year, you only need roughly 1% margin, that over the course of 10 periods will accumulate to 10% profit.

To make it specific:

1. Buy 1 unit of Input for $20, produce 1 unit of Output, sell for $20.2 => $0.20 PCM (1%)

...

10. Buy 1 unit of Input for $20, produce 1 unit of Output, sell for $20.2

-----

You made $2 gross profit on $20 investment = 10% (even without using compound growth).

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@ Birkmanis,

You are right with your assumption and your example or course. For the sake of the argument this true technicality is not important though...

abskebabs:
Guys, it turns out Dennis Robertson solved the problem a long time ago. Here's an anecdote of Reisman's about a class he took with George Stigler in the following blog post on the law of costs:

http://archive.mises.org/5505/more-from-bohm-bawerk-on-cost-of-production-as-a-determinant-of-prices/

"Specifically, I had taken a class from Prof. George Stigler at Columbia University and learned of Dennis Robertson’s attempt to deal with the problem of calculating the marginal product of a tenth hole digger in the face of the availability of only nine shovels. Robertson’s answer, as reported by Stigler, was that the tenth worker could be sent to fetch beer."

Nice anecdote!

 

@ FotH

I will answer later in the weekend.

"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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the tenth worker could be sent to fetch beer

I appreciate the joke, but seriously - there may be better solutions. E.g., rotating diggers to reduce fatigue thus increasing productivity. Also, in an uncertain world an idle resource has value as a backup - imagine diggers working in dangerous conditions, where probability of a digger being at least temporarily incapacitated is higher than probability of losing a shovel.

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For the sake of the argument this true technicality is not important though...

It may not change the spirit of the argument, but it changes its letter - the equilibrium prices for products can be arbitrarily close to the sum of prices of their factors, as opposed to being padded by at least the average profit rate - provided the speed of production can be increased sufficiently.

This works two ways - if production is inherently slow (the full cycle takes more then a year), then the price-cost margin must be higher than the average profit rate.

Also, this observation explains why producers would hire additional labor even if the amount of output is not affected - as long as increase in speed of production, and as a result in profit rate cover the cost of additional worker, he will be hired.

Sorry if this distracts from your main point.

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I understand how the rate of turnover affects the rate of profit. I don't think its necessary for considering this point.

Also, this observation explains why producers would hire additional labor even if the amount of output is not affected - as long as increase in speed of production, and as a result in profit rate cover the cost of additional worker, he will be hired.

But an increase in speed would mean an increase in output, wouldn't it?

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But an increase in speed would mean an increase in output, wouldn't it?

I meant the same amount of output per unit of input, not per unit of time.

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