No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seven: Production: Man at Work 170 Let’s also assume that each sandwich nets $1.50 revenue (after the cost of the sandwhich, raw materials would have to be scrapped if not used) to SUBWAY’s, so the Marginal Revenue is: MR = $1.50 How much should SUBWAY be willing to pay the worker? If each worker can produce six sandwiches per hour, and the change in revenue is $1.50 per sandwich, then an additional worker is worth up to $9/hr. to SUBWAY. The marginal revenue product is simply the product of the MP L and MR, or: MRP L = MP L × MR The marginal revenue product is what each individual worker can “bring to the table.” Firms don’t hire workers out of charity (usually), and individuals have worth; the marginal revenue product helps a firm estimate how valuable an employee could be to their bottom line. The MRP L is what the worker is worth. In competitive markets, firms will bid up labor prices until the prevailing equilibrium wage equals the marginal revenue product of labor—the worker is worth his wages ! This concept, pioneered by John Bates Clarke, helps decisively answer the question of how markets pay a just wage. Competitive markets are forced to pay up to what the marginal worker produces. They don’t pay according to charity or by what they can extort out of workers. In competitive markets, if they don’t pay up to what a worker is worth, the worker can take his labor elsewhere, and other competitors will maximize their profit by expanding production, per Figure 7-11 , and will pay a wage rate equal to the MRP L ! IT’S A WRAP! Much of this chapter’s discussion assumed a competitive market—that an entrepreneur has no say on both input and output prices. Our entrepreneur had to take a given price for her product, and had to pay the prevailing wage for labor and the market price for capital equipment. That is not always the case, and in the next chapter we’ll explore such concepts as monopoly power and oligopoly. In competitive markets, firms will bid up labor prices until the prevailing equilibrium wage equals the marginal revenue product of labor—the worker is worth his wages ! Marginal revenue product: the contribution each productive input makes at the margin, equal to the inputs marginal product multiplied by the marginal revenue of output.