Marginal revenue productivity theory of wages

Marginal revenue productivity theory of wages is an economic theory which states that the wage rate of a worker is determined by the amount of revenue that the worker brings in for the business. The theory suggests that the wages are set at a level that is equal to the marginal revenue generated by the addition of the new worker to the business. In other words, the wages of a worker is equal to the revenue that the worker generates for the business.

This theory is based on the concept of marginal revenue, which is the additional revenue generated by the addition of an extra unit of output. The theory assumes that employers will pay a wage rate that is equal to the marginal revenue generated by the worker, as this is the most efficient way to maximize profits. As such, the wage rate of a worker is based on the amount of revenue they generate for the business.

The theory has several implications for the labour market and wage setting process. Firstly, it suggests that wages are determined by the productivity of the worker, rather than simply their cost of living. Secondly, it implies that employers will pay higher wages to workers who are more productive, as it is in their best interests to do so. Finally, it implies that the wage rate of a worker is determined by their ability to generate revenue for the business, rather than by their experience or qualifications.

Example of Marginal revenue productivity theory of wages

To illustrate the marginal revenue productivity theory of wages, consider an example of a business which produces widgets. The business has a fixed cost of $100, and the variable cost of making one widget is $10. The selling price of each widget is $20. In this case, the marginal revenue of adding an additional worker is $20, as the additional worker will be able to produce one additional widget, which can be sold for $20. Therefore, the wages of the worker would be set at $20, as this is the amount of revenue that the worker generates for the business.

Overall, the marginal revenue productivity theory of wages suggests that the wage rate of a worker is determined by the revenue that they generate for the business. This theory has several implications for the labour market and wage setting process, and can be illustrated using the example of a widget-producing business.

Formula of Marginal revenue productivity theory of wages

The formula for Marginal revenue productivity theory of wages is as follows:

Wage rate = Marginal Revenue Product (MRP)

Where MRP = Marginal Revenue Productivity = MP x MR

MP = Marginal Productivity of labour

MR = Marginal Revenue

Therefore, the wage rate of a worker is determined by the level of productivity they bring to the business and the amount of revenue they generate for the business. This means that employers will pay higher wages to workers who are more productive, as they generate more revenue for the business.

When to use Marginal revenue productivity theory of wages

The marginal revenue productivity theory of wages is most useful when the focus is on the wages of individual workers, rather than the whole labour market. The theory can be used to determine an appropriate wage rate for a particular worker, based on their productivity and the amount of revenue they generate for the business. It can also be used to compare the wages of different workers, and to identify which workers are most productive and therefore should be paid higher wages.

Types of Marginal revenue productivity theory of wages

There are three main types of marginal revenue productivity theory of wages:

• The firm-based model: This model assumes that wages are determined by the marginal revenue generated by the addition of a specific worker to the business. This model is based on the assumption that employers will pay a wage rate equal to the marginal revenue generated by the worker, as this is the most efficient way to maximize profits.
• The sector-based model: This model assumes that wages are determined by the marginal revenue generated by the addition of a specific sector of workers to the business. This model is based on the assumption that employers will pay a wage rate equal to the marginal revenue generated by the sector, as this is the most efficient way to maximize profits.
• The aggregate model: This model assumes that wages are determined by the marginal revenue generated by the addition of all workers to the business. This model is based on the assumption that employers will pay a wage rate equal to the marginal revenue generated by the addition of all workers to the business, as this is the most efficient way to maximize profits.

Steps of Marginal revenue productivity theory of wages

1. Employers calculate the marginal revenue that the worker will bring in.

• This involves estimating the additional revenue that the worker will generate for the business, taking into account the cost of the worker's labour.
• The marginal revenue generated by the worker should be greater than the cost of hiring them, in order for the employer to make a profit.

1. Employers set a wage rate that is equal to the marginal revenue generated by the worker.

• This means that the wages are set at a level that is equal to the additional revenue generated by the addition of the new worker.
• This is done in order to maximize profits for the business.

1. The wages are adjusted based on the productivity of the worker.

• If the worker is more productive and generates more revenue for the business, their wages may be increased accordingly.
• Conversely, if the worker is less productive, the wages may be reduced.

Advantages of Marginal revenue productivity theory of wages

• Increased efficiency: This theory suggests that wages are set at a level that is equal to the marginal revenue generated by the addition of the new worker to the business. This ensures that employers are paying a wage rate that is in line with the productivity of the worker and is likely to result in increased efficiency in production.
• Profits maximization: By setting wages at a level that is equal to the marginal revenue generated by the worker, employers are able to maximize their profits. This is because they are paying a wage rate that is in line with the productivity of the worker and is likely to result in increased profits.
• Wage fairness: This theory also suggests that wages are determined by the productivity of the worker, rather than simply their cost of living. As such, this theory implies that employers will pay higher wages to workers who are more productive, which can be seen as a form of wage fairness.

Limitations of Marginal revenue productivity theory of wages

The marginal revenue productivity theory of wages has several limitations. Firstly, it assumes that employers are able to accurately measure the marginal revenue generated by each worker. This is often difficult in practice, as it can be difficult to accurately quantify the value of a worker's contributions to the business. Secondly, it assumes that employers are willing to pay a wage rate that is equal to the marginal revenue generated by the worker. This is not always the case, as employers may not be willing to pay a wage rate that fully reflects the value of the worker's contribution. Finally, it does not take into account the effect of external factors such as unions or minimum wage laws, which can have an effect on the wage rate of a worker.

Other approaches related to Marginal revenue productivity theory of wages

• The human capital theory: This theory suggests that an individual's wages are determined by their skills, abilities, education and experience. It assumes that employers will pay a higher wage to employees with higher levels of human capital.
• The efficiency wage theory: This theory suggests that firms will pay higher wages in order to motivate and retain employees, as this will lead to increased productivity. It assumes that higher wages will lead to higher levels of motivation and hence higher productivity.
• The bargaining theory: This theory suggests that wages are determined by the bargaining power of the worker and the employer. It assumes that workers will bargain for higher wages if they have more bargaining power than the employer.

In conclusion, the marginal revenue productivity theory of wages suggests that the wage rate of a worker is determined by the amount of revenue that the worker brings in for the business. This theory has several implications for the labour market and wage setting process, such as the fact that wages are determined by productivity rather than cost of living, higher wages will be paid to more productive workers and the wage rate of a worker is determined by their ability to generate revenue for the business.

Marginal revenue productivity theory of wages — recommended articles

Rybczynski theorem — Cross elasticity of demand — Horizontal equity — Diminishing marginal utility — Baumol model — Learning curve — Real cost — Price setting — Willingness to pay

References

• Cahuc, P., Marque, F., & Wasmer, E. (2008). A theory of wages and labor demand with intra‐firm bargaining and matching frictions. International Economic Review, 49(3), 943-972.