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Theory vs Reality

Theory vs Reality

The Case of the Marginal Productivity Theory

Macroeconomists are often criticized for their imperfections and subjectivities, people point out the fact that macroeconomics does not have strong mathematical fundaments; they frequently make big reasoning jumps, usually based simply on “hints”. The inexistence of strong and uniform arguments lead to the creation of different schools, such the Austrian, Keynesian, Neokeynesian, Monetarist and many others.

One common way to give authority to macroeconomic theories is them link with microeconomic laws, which often are stronger, because they are mathematically based, and its axioms and propositions generally get a unique and clear result. However, the problem usually referred to micro it is that this branch from economics, although it is well constructed over its assumptions, it is based on wrong – or better, non real assumptions. Then in microeconomics, usually, people criticize precisely the assumptions that are taken.

One of the points from microeconomics which is sometimes criticized is the marginal productivity theory, which states that in order to maximize profits an employer will employ workers up to the point where the worker’s marginal cost equals the extra revenue added by that same worker.

What is the intuition behind this statement? Why would firms contract until marginal productivity equals marginal cost? It wouldn’t make sense for a firm to not contract a worker, if the revenue that he produces was higher than the cost of contracting him. And it wouldn’t make sense for a firm to contract one more worker, if this same worker would represent more costs than revenues for the firm. (Always assuming that firms want to maximize profits.) We also assume that, from some point, worker’s marginal revenues decrease faster than the marginal costs. If it wouldn’t be like this, independently from the number of workers that the firm has, new workers would always bring more profits, and then the optimal number of workers would be infinite.

If firms want to maximize profits this reasoning can be always applied, independently of other factors as competition, because either in perfect competition or in monopoly, each firm tries to make the best for itself, this means, a firms tries to maximize its own profit, and that implies, as it was shown in the previous paragraph, that firms contract until the marginal productivity equals the marginal cost.

However this is a reasonable result, in reality it could not be the case, a worker’s marginal productivity may not be possible (or easy) to calculate, for example: when workers are part of a team, it could be impossible to know the specific contribution for output from each single element from the same team. There are many professions, from which it could be almost impossible to quantify the individual productivity: what is the marginal productivity of a secretary, of a waitress, of a porter, of a security guard, or of a single member from a production line, or a musician that plays in one orchestra?

The theory may in part amend these problems, having into account that the employer may look not only into the number of workers, but also to the composition of teams and capital, and try to find (also with numbers) the structure which maximizes profit. Then, the actions that change the composition are also changing the marginal cost and the marginal revenue, and the employer must try to maximize profit, both achieving the optimal quantity of labour and capital, but also trying to find the optimal structure.

This still arises an important question that economists must try to answer. How can persons inside a team be evaluated in a way that maximizes profits? It is difficult to find a complete and general answer, but there are some strategies that may help to solve it. Usually a firm, which highly depends on teams, makes the wage of the worker depend in his personal results and in his team results, in order to give individual incentives, but also creating pression for efficiency in team work. Sometimes could be impossible to distinguish what is team work, from what is personal work.

This question has a very important role today, since many jobs depend a lot on team work. This is often the case for example of lawyers, consultants, managers and economists.

Finally, I could not avoid referring the moral critique, which says that if economists focus their attention exclusively on the fact that firms only want to maximize profits, then they are supporting this cause. They say that this theory is uniquely positivist and neglects a normative and moral part. Answering to this argument, I would say that it is a fact that the theory doesn’t refer moral rules, and that could be dangerous for an economist to think amorally, even in economics terms, however it doesn’t diminishes the value of the theory, it only forces economists to look into theory, but never forgetting that beyond the numbers and statistics there are human beings with family and values.

Concluding, in fact the microeconomics models are constructed in abstract terms, which are deviated from reality. However, it is very important to take into account, that the contribution of microeconomic is still very precious, and it tells us many things about reality. Yes, a model is a model, it is not the reality; yes, a modal explains partially the reality, and it is never able to explain it completely. Then, when we use one model it is very important to not look at it, as its results were absolute and necessarily valid, but it would be extremist and “irrational” to refuse (because of its incompleteness and abstraction) the knowledge and reasoning that a model gives us

As I tried to show with the Marginal Productivity Theory, the assumptions that are taken cannot give neither a general, nor a perfect answer; however they establish the main points which describe the economics behaviour, and although they are far from reality they help us understanding reality.

António Capela

Nº739

References:

– “Microeconomics” – Mansfield;

– “Economics” – John Sloman;

– Paul Krugman, 2009, “How did economists get it so wrong?”, New York Times, September 2;

– “Microeconomics Theory and Applications” Fred R. Glahe and Dwight R. Lee;

– F. A. von Hayek “Constitution of Liberty”;

– “Micro Economic Theory” – Walther Nicholson.

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Author: studentnovasbe

Master student in Nova Sbe

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