MODULE 37 (73) Theories of Income Distribution

2. MODULE 37 (73)Theories of Income Distribution

3. Labor market applications of the marginal productivity theory of income distribution • Sources of wage disparities and the role of discrimination

4. The Marginal Productivity Theory of Income Distribution • When the markets for goods and services and the factor markets are perfectly competitive, factors of production will be employed up to the point at which the value of the marginal product is equal to the price. • Does the marginal productivity theory of income distribution help to explain why some workers earn more than others?

5. Marginal Productivity and Wage Inequality • There are a three well-understood sources of wage differences across occupations and individuals: • compensating differentials • wage inequality • differences in the quantity of human capital

6. Marginal Productivity and Wage Inequality • Compensating differentials are wage differences across jobs that reflect the fact that some jobs are less pleasant than others. • Workers in unpleasant or dangerous jobs receive a higher wage than workers in jobs the require the same skill, training, and effort but lacks the unpleasant or dangerous qualities. • hazardous-load truckers are paid a wage equal to the equilibrium value of the marginal product of the last person employed in the market for hazardous-load truckers.

7. Marginal Productivity and Wage Inequality • Wage inequality is related to differences in talent. • A high-ability person generates a higher value of the marginal product by producing a better product that commands a higher price compared to a lower-ability person. • These differences in the value of the marginal product translate into differences in earning potential

8. Marginal Productivity and Wage Inequality • Differences in the quantity of human capital are a reason for wage differences. • Education increases human capital. • A person with more human capital typically generates a higher value of the marginal product by producing more or better products. 

9. Earnings Differentials by Education, Gender, and Ethnicity Annual median earnings, 2009 No HS degree HS degree College degree $70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 African-American male White male White female African-American female Hispanic man Hispanic female

10. Marginal Productivity and Wage Inequality: Market Power • The marginal productivity theory of income distribution is based on the assumption that factor markets are perfectly competitive. Is it Valid? • Unions are organizations of workers that try to raise wages and improve working conditions for their members by bargaining collectively. • There is Market power through unionization of workers or collective efforts from employers. • Ex: Health Maintenance Organizations (HMO).

11. Marginal Productivity and Wage Inequality • Second source of wage inequality is efficiency-wage. • According to the efficiency-wage model,some employers pay an above equilibrium wage as an incentive for better performance. • E.g., a job where employees’ performance cannot be perfectly observed - childcare provider. • Discrimination has historically been a major factor in wage disparities. • Market competition tends to work against discrimination. • Still the discrimination arises from (a) market inefficiency due to imperfect competition and (b) institutionalized government policies.

12. Wage Disparities in Practice Median Earnings by Gender and Ethnicity, 2009 Annual median earnings, 2009 $50,000 $46,696 45,000 40,000 $35,724 35,000 $32,292 $29,952 30,000 25,000 20,000 15,000 10,000 5,000 0 Female (all ethnicities) African American (male and female) Hispanic (male and female) White male

13. Is the Marginal Productivity Theory of Income Distribution Really True? • There are two main objections to the marginal productivity theory of income distribution: • First, in the real world we see large disparities in income between workers who, in the eyes of some observers, should receive the same payment. • Second, many people wrongly believe that the marginal productivity theory of income distribution gives a moral justification for the distribution of income.

14. So Does Marginal Productivity Theory Work? • The main conclusion you should draw from this discussion is that the marginal productivity theory of income distribution is not a perfect description of how factor incomes are determined, but that it works pretty well. • It’s important to emphasize that this does not mean that the factor distribution of income is morally justified.

15. Large disparities in wages raise questions about thevalidity of the marginal productivity theory of incomedistribution. • Many disparities can be explained bycompensating differentials and by differences intalent, job experience, and human capital across workers. • Market interference in the form of unions and collectiveaction by employers also creates wage disparities. • Theefficiency-wage model, which arises from a type ofmarket failure, shows how wage disparities can resultfrom employers’ attempts to increase worker performance.