Q.Explain the Marginal Productivity Theory of wages.
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Start your 14-day free trial to unlock the full solution →The Marginal Productivity Theory of wages explains how the wage rate is determined by looking at the employer's own hiring decision. As successive units of labour are added to a fixed amount of land and capital, the extra output contributed by each additional worker — measured in money terms as the Marginal Revenue Product (MRP) of labour — eventually starts to DECLINE (the law of diminishing returns).
A profit-maximising employer will keep hiring one more worker as long as that worker's MRP exceeds the wage that must be paid, since doing so adds more to revenue than to cost. The employer stops hiring at the exact point where the MRP of the last (marginal) worker hired has fallen to just equal the wage rate — hiring even one worker beyond this point would cost more in wages than the extra output is worth, and would reduce profit. This is why, under this theory, the equilibrium wage rate is determined by, and equals, the Marginal Revenue Product of the marginal unit of labour employed. …
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